Chapter VII: Rich and Poor

“La majestueuse égalite des lois, qui interdit au riche comme au pauvre de coucher sous les ponts, de mendier dans les rues et de voler du pain.”

ANATOLE FRANCE, Le Lys Rouge, VII

1. The Distribution of Income

As he analyzes the mechanism of our economic system, the economist finds himself lapsing easily into the language of GHQ communiqués—those cold, impersonal descriptions of military operations which leave it to the reader to picture the sum of human resolves, deeds, and sufferings that lie behind the bare words. We speak facilely, for example, of the purchasing power of money, although we know quite well that money does not enter the market by itself but that it gets there because individual human beings, at once deliberate, weak, and passionate, have spent it. Similarly, we have spoken of the demand for a good almost as if it were a physical quantum, in the certain expectation that the reader would remain at every instance aware of the abbreviated form of expression which we here employed. As a matter of fact, the demand for a good is made up of the demands of all individuals who, with reference to a specific price, decide to employ a specific part of their income for the said good. These individual portions of demand, moreover, vary greatly in amount, not only because of differences in taste but also because of the inequality of incomes.

Herewith our discussion turns upon that phase of economic inquiry which, in every age, has most deeply interested the majority of mankind. The contrast between rich and poor, between the hovel and the palace, between the haves and the have-nots—this is the great question which for thousands of years has agitated the minds and hearts of men. And, inevitably, the ages in which the contrast was most acute brought forth the champions of justice and equality: the prophets of the Old Testament, the Gracchi of Rome, the founders of the great religions, the peasant leaders and the religious dissenters of the Middle Ages and of the Reformation, the socialists, Communists, and anarchists, the agrarian and social reformers from Solon to the present. In the civilized countries of our own day this problem has lost nothing of its actuality, although it is precisely in the most advanced countries that we find a tendency for it to become less rather than more acute. The distribution of income is everywhere unequal in the sense that as contrasted with the large number of small incomes, we find only a small number of large incomes. While to this law there appears to have been never and nowhere an exception—least of all in Soviet Russia—inequality in some countries has lessened due to the existence of an extensive middle class. Contrariwise, in other countries—and those certainly not the highly developed “capitalistic” countries—we find the bitterest poverty standing directly alongside the most ostentatious wealth. But what arouses doubt about the justice of the existing social order are not only the differences in the size of incomes, but also the differences in the origin and nature of these incomes. While one income accrues from the visible application of effort and hence is intimately connected with the health and well-being of the income receiver, another is made up of interest, dividends, rents, profits and indemnities which reflect no visible work (and frequently no invisible work either) and are independent of the health of the receiver. And lastly, the larger income confers not only a greater power over the use of things but also a greater power over men; it confers on its recipients prestige, influence, and both educational and cultural advantages.¹

Before entering upon a scientific study of the distribution of income, it remains for us to note the following possible types of income formation: 1. The extra-economic formation of income, so designated because income accrues to the recipient irrespective of whether he performs a corresponding service in exchange, i.e., it has no connection with the process of production, be it obtained through violence or fraud, or through governmental charities (welfare and relief payments, gifts, and that “distribution according to need” which doctrinaire Communists would establish for the whole of society). 2. The economic distribution of income, which arises from the participation of each individual in the economic process, i.e., from the sale of goods and services of all kinds. In this fashion is formed that type of income referred to previously (p. 120) as original income. Although the extra-economic formation of income is frequently encountered in our economic system, it is the economic formation of income which predominates and upon which the attention of economists is concentrated.

2. Income Distribution—A Problem of Price Formation

There are two points of view from which we may investigate the distribution of income. On the one hand, we may ask why one person has an income of this size and another person an income of that size. In so doing we make use of the popular interpretation of income distribution as a personal distribution of income. But we may also proceed by relating income to the several factors of production and then examining the amount of income accruing to each of these factors (e.g., a capital of $100), without necessarily concerning ourselves with the number of units of such factor (or factors) possessed by the income receiver. Our aim in using this method is to discover what principle determines the amount of wages paid for an hour of work, the amount of rent paid for a unit of land, the amount of interest paid for a capital of $100 (functional distribution of income). As contrasted with this method of inquiry, there is the analysis of the personal distribution of income in which the fact that interests us is that from the several factorial sources of income, individual A receives a total income of $2,000, B an income of $20,000, and C an income of $1,000,000. The principal categories which we establish for a theory of functional income distribution are wages, rent, interest and profits, corresponding to the factors of production labor, land, capital, and entrepreneurship. In this way, we arrive finally at a theory of price formation for the factors of production. Hence, the explanation of the functional distribution of income involves the application of the general principles of price theory. This indeed is the road which the contemporary theory of income distribution has followed.² Let us leave aside, for a moment, the important questions connected with the personal distribution of income and try to put in relief the essentials of the modern concept of the functional distribution of income.

Once it has been recognized that the problem of distribution is identical with the problem of price, it can no longer be doubted that the distribution of income is an integral part of the entire economic process and that it is subject to the same laws as the other parts of this process. Equally little doubt can be entertained about the essential role played by the price-forming process among the factors of production (into which the distribution of income can be resolved). Where it is desired to ensure the orderly progress of economic life, this process can be ignored neither by our economic system nor by a socialist one. That wages in one country stand at such and such a level, that rents, interest, and profits are of such and such an amount—this is hardly to be ascribed to chance. Rather, these situations are the result of specific economic data. Every attempt to alter such data by force will produce disorder in the economic system which, in turn, will engender still greater counter-forces. That the prices of the factors of production stand at any given moment at a certain level is an essential condition of economic equilibrium, in our system as in any other. He who wishes to change these prices—and what economist would not wish to see rewards to the human factor of production at as high a level as possible-is certainly free to attempt to do so. But instead of trying to acquire the facile reputation of a “social-minded” man by vague demands for a “just wage,” by railing against “interest slavery” and “profiteering,” by emotional outpourings over “gluttonous landlords,” and real estate “speculators,” and instead of shoving aside as “liberalistic” the objections of those who understand something of these matters, one would serve his country better by applying himself to an unprejudiced study of the complex interrelationships of the economy. The insights thus acquired would enable him to discover what the basic factors are upon which it is necessary to act in order to be able to alter the existing distribution successfully, i.e., without provoking a costly disturbance of equilibrium. This is a difficult, thankless, and self-denying task, but one which a genuine social sense and a genuine patriotism oblige us to undertake.

Is it impossible, then, to forcibly raise wages by lowering the return to capital? It is certainly not impossible, but every attempt of this sort leads to a situation which shortly becomes untenable and results in serious disadvantages to the wage receivers themselves. It must be emphasized at the outset that those who promise great things from a transfer of income to the working class are the victims of an optical illusion. Large incomes attract much attention, but most people forget that given the small number of such incomes no particular benefits to the huge number of small income receivers could be expected to result from an equal distribution of the wealth. There would be all the less likelihood of such benefits—and this is the decisive consideration—inasmuch as a forcible transfer of this kind would lead to serious disturbances whose effects would be ultimately borne by the working class. Among the principal disturbances of such a wage policy would be a critical reduction of the economy’s supply of capital and a slowing down of investment activity with its consequent effects on employment opportunities. Capital earnings (interest and dividends) go normally to individuals who spend only a small part of them and return the major share to production as fresh capital. It is very doubtful whether this income, once in the hands of workers, would be saved and invested in the same proportion as previously. To this must be added the fact that a collapse of the securities market, which is to be expected from such a policy, would seriously damage one of the most sensitive and at the same time one of the least understood elements in the complicated apparatus which sees to it that the economy is supplied with sufficient capital and that this capital is rationally allocated. Indeed, a policy of this kind would have a depressing effect on the entire economy and from the interaction of these various causes and effects, depression and unemployment could be expected all along the line. That regard for the economy’s capital requirements and for its investment activity obliges us to set limits to the extent to which wages can be increased, is not a devilish peculiarity of our economic system but—and this is true even of a socialist state—a necessity based on fact. In any case, we have not yet had any information to the effect that the Russian government has fixed wages so high that no surplus funds remain in its hands, nor that this government counts on voluntary savings of the workers for its supply of capital.

Let us take another instance of what happens when wages are increased to a degree which is not justified by the market situation. An arbitrary raising of prices on the labor market will (just as similar arbitrary price rises on other markets) render a part of the “merchandise” unsaleable, i.e., will cause unemployment. If the unemployed are not supported by the state, they will bring their total weight to bear on the wage level (via competition) until an equilibrium situation is again achieved. If, on the other hand, the unemployed are taken care of by the state, their pressure on the wage level will be deflected for the most part. But at the same time there will result such an extreme gap as between the abnormally high wages of those who are employed and the bitter poverty of those condemned to unemployment (not to mention the worsened situation of the tax-paying groups) that we cannot speak of an improvement in the situation of the working class as a whole, but only of an improvement in the situation of one stratum of workers at the expense of the others.

The above picture, of course, has been sketched in broad outline only. In reality, things are, as always, much more complex. Thus, the smaller the forcible increase in wages is, the more prudent and conditional should be our judgment of it. Indeed, there are circumstances under which wage increases may be absorbed without damage to the national economy. We ought also never forget that there is always a degree of “play” between the moving parts of our economic mechanism, making it possible to apply corrective measures without provoking countermovements.³ On the other side, it is also true that the more macroscopic the relationships are, i.e., the greater the amount of force used to alter the wage level, the more inexorably the disturbance to the economy’s equilibrium will claim its revenge. There is a point beyond which a policy of forcible increase of wages may not go without finally provoking inflation and civil war. To deny this is demagogy, which no state, least of all a socialist one, would tolerate.

Or let us take another case in which the interest rate is forcibly lowered. Thorny questions of monetary theory are involved here, and the fabric of interrelationships is even more complicated than that which we observed in connection with our previous example of a forcible alteration of wages. Nevertheless, in this case as in the preceding, there can exist no doubt as to the essential outcome. Here, too, there are likely to be after-effects by which the economic system avenges itself when violence is done to it. In the first place, a reduction in, or even a complete abolition of interest by state decree would probably cause those engaged in capital transactions to find ways of circumventing the control of the state or of the community. In devious ways, an illegal interest rate will establish itself, a rate which will not only correspond to the actual ratio of supply to demand on the capital market but one which will be increased by an amount necessary to meet the costs of more complicated transactions, including an indemnity to cover the extra risks run in transgressing the law. But if we posit the rather unlikely situation where the maximum rate of interest decreed by the state is really enforced, we will find that sooner or later an untenable situation will develop on the capital market. As in every instance where a policy of ceiling prices is enforced, a disproportion between supply and demand will develop. In consequence, the state will be forced to take a further step, viz., to ration the available supplies of credit. This means that the state itself will now take over the functions which hitherto had been exercised by the free formation of interest. Can we assume that it will do the job in a satisfactory manner?

To answer this question, we must keep clearly in mind the fact that the rate of interest of the free capital market is, in the first instance, an appeal to all those who are seeking credit to weigh the urgency of their need by comparing the amount of interest they will have to pay with the profit they may expect from their use of the capital. In this way, interest functions as a mechanism which assures a rational allocation of the normally limited quantity of capital. Let us assume now that this function devolves upon the state. Nothing more efficient or better could happen, many will say. At long last, so they think, capital will be allocated in accordance with the needs of the “national economy.” But when these persons are asked to state their meaning more exactly, they are thrown into the greatest embarrassment. The only certain notion which can be extracted from them is that each would like to see the largest possible amount of this newly cheapened capital allocated to that branch of production which, for material or idealistic reasons, lies closest to his heart. But how will the state and its agencies, confronted by such a multiplicity of wishes, reach a decision? Let us suppose that the state will really seek after an objective norm, and that it will stop its ears against the siren songs of the special interests or of self-styled benefactors of the people, and let us suppose further that the state takes up the concrete question of whether the shoe industry has greater need of capital than the automobile industry. The authorities must obviously begin with the question of how useful the employment of capital in the one and the other industry will be. Now this usefulness, this utility is measurable and comparable only in monetary terms. But this monetary measure is precisely the one which, via the unhindered formation of interest, would distribute the available supplies of capital. In spite of its imperfections and its weaknesses, such a mode of distribution is far more to be relied upon than one based upon arbitrary estimates of the utility of this or that enterprise by state agencies which, moreover, are not liable for the economic losses resulting from a wrong decision, as are the shoe and automobile manufacturers. The case is, of course, relatively simple when it is a question of comparing industries whose employment of capital, in relation to other factors, is in per cent terms the same (capital intensity).⁴ But it remains a mystery as to how the state will make a rational decision in comparisons involving industries with different degrees of capital intensity. Whether, in a given country, more or less capital-intensive types of production should be favored obviously depends on the amount of capital available in that country as compared with the other factors of production, i.e., land and labor. Here again it is only the free formation of interest, in conjunction with the free formation of the prices of the other factors of production, which can furnish us with a fair degree of reliable information.

Next to wages, rent, and interest, there is still another large and important category of income which can be fitted only with difficulty into the framework of our previous considerations. Let us take the case of an entrepreneur who has entered on his books the costs of the various factors of production, employed under the following headings: wages to the workers, rent to the owner of the land (or to himself as the case may be), interest on capital (also to himself should he have contributed the capital), and a normal rate of compensation for his own services (entrepreneur’s wage). Assume now that our entrepreneur has been able to dispose of his output in such a way that a surplus income remains to him after he has paid for all of the above “costs” of doing business. This surplus we call entrepreneur’s profit, i.e., profit in the narrow and proper meaning of the word. To be sure, this income also arises from the process of price formation since the prices of the saleable output and of the factors of production are the resultants of this process. But it is distinguished from the previously considered types of income in that it represents merely a differential gain and not the market-determined price accruing from the sale of a “service” as it is usually understood. The difficult task of a theory of entrepreneur’s profit is to explain on general grounds the origin of such pure profit, whereby the hardly less frequent case of entrepreneur’s loss (negative pure profit) must also be taken into consideration. Such a theory will also have to answer the question as to whether entrepreneur’s profit fulfills a specific positive function within our economic system or whether it is a simple case of enrichment unrelated to any particular function.

Because of the very nature of the phenomenon to be explained, a satisfactory theory of entrepreneur’s profit must be broad enough to include the manifold sources of such profit (monopoly profits, speculative or cyclical profits, profits resulting from technical or organizational innovations, pressure on wages, payment of risk premiums, profits arising from disturbances in the economic process, etc.). According to the origin of the pure profit in question, it may be judged either positively as a reward for the performance of a useful function or negatively as an enrichment unrelated to any function. There are, however, two considerations of a general nature which need to be emphasized. First, we must not forget that the possibility of the entrepreneur making profits as a reward for efficient service is no less necessary to the functioning of our economic system than the possibility of his suffering losses as punishment for being inefficient. To understand the motive power behind our economic system is also to recognize, in principle, the necessity of entrepreneur’s profit. This point takes on especial significance when it is realized that a healthy rate of investment (which, as will be shown further on, is intimately connected with the economy’s equilibrium) can be expected only if there is the hope of a reasonable profit for the entrepreneur. Denied the possibility of making profits, the entrepreneur would be loath to assume the heavy risks which are invariably associated with the building of a factory, the modernizing of a plant, the expansion of production, the introduction of a technical innovation, even the replacement of machinery. It takes quite a bit of courage to assume such risks in the first place. If we leave to the entrepreneur only his losses and continue to reduce his profits through taxation, wage increases, or other means, private investment activity will be reduced to a game in which one can only lose. The consequence is then stagnation, unemployment, and impoverishment. Secondly, it is to be noted that competition furnishes us with a very efficacious means of eliminating entrepreneur’s profits in cases where they are only a nonfunctional source of enrichment and of reserving such profits for those who perform useful services.⁵

The masses see only the successful man of business and have but a meager understanding of how such a success is achieved. Equally vague is their knowledge of the silent and pitiless process of elimination which—provided always that competition exists—is carried on among entrepreneurs, a process to which those are sacrificed who are weighed in the scales of the market and found wanting. Thus, the entrepreneur appears in a genuinely competitive market economy as a sort of trustee whom the community has placed in charge of its means of production. Comparing the costs of his services with those of a bureaucratic state-controlled economy, our entrepreneur may be regarded as a very inexpensive public servant, one who really assumes risks, while the politician is apt to be answerable only to God and history. Such a risk-assuming entrepreneur, who disdains the comfortable crutches both of state subventions and of monopoly, should be protected against attacks of a vulgar anticapitalism. From all that we know at present, it is certain that in Communist Russia the differences in income between the economically favored and the workers are far greater than in the capitalist countries, although the population is consoled, from one five-year plan to another, with the promise of a final redemption in which there will be a notable change for the better in its condition. Again, the cliché of the “two hundred families” who are supposed to be secretly exerting an irresponsible control over the free economy’s destiny is, when applied to the entrepreneurs we have described above, thoroughly out of place. The difference between the market economy and the collectivist economy rests precisely in the fact that in the first case economic decisions are distributed among very many “families” which, in turn, are bound by the supreme authority of the market, i.e., in the last analysis by the votes of the consumers. In the collectivist state, on the other hand, these decisions devolve upon a single family—assuming that the dictator has one—against which there is no appeal. These statements are valid, of course, only on the supposition that the entrepreneur does not himself become confused and fall into the defeatism of seeking his salvation under the sheltering roof of monopoly or of the state, forgetting that in so doing he destroys himself.

3. Should Interest and Rent be Abolished?

We have seen that the principal categories of income—wages, interest, rent, and profits—are to be regarded as the prices of the factors of production to which each corresponds, that these prices are determined by the economic process as a whole, and that they cannot be arbitrarily changed without causing a more or less radical dislocation of all economic relationships. Although it has already been made clear that this in no way precludes a successful change in price relationships in favor of wages (viz., by acting on the original factors), there are many to whom our findings will be a cause of extreme irritation. They reject the idea that interest and rent, for example, should be placed on the same footing with wages, and argue instead that these highly unjust forms of nonfunctional income should be summarily abolished. Are they not right? And if such abolition is not possible within the framework of our economic system, is this not reason enough to make an end once for all of this system and its execrable “laws” about which economists make such a great to-do?

To add some light to all this heat, it will be useful to distinguish once again between the personal and the functional distribution of income. In truth, we must sharply distinguish between the one fact that rent and interest are paid at all, and the other that they are paid to individuals in such unequal amounts. If the distribution of property were more equal than it is today and if, in consequence, the masses were to receive a larger share of the income accruing from the ownership of land and capital, the attitude of the average person towards rent and interest would probably be much less hostile. We have here, then, two different questions to answer. Let us for the moment confine our attention to the first: whether interest and rent are justified at all, regardless of to whom and in what amounts they are paid. In answering this question we can under no circumstances ignore the fact that rent and interest are not meaningless sources of enrichment but institutions which have a specific significance and function. Although we have already discussed the functions of interest in the preceding paragraph, the point seems to be important enough to justify a fuller and more general explanation. Such an explanation should, above all, secure recognition of the fact that behind rent and interest is concealed a complex of relationships, knowledge of which is just as important in a socialist as in a “capitalist” state.

We know that interest and rent are nothing else than the prices which are paid for the services of the corresponding factors of production. These factors of production are available, however, only in limited quantities, while the demand for them may be measured on a scale which extends to infinity. The formation of prices, which leads in this instance to the phenomena of rent and interest, is thus only a special case (although a very important one) of the general principle of equilibrium which, as we saw previously (pp. 26ff., 33ff.), rules our economic system.

All economic systems, of whatever kind, are confronted with the task of effecting a rational allocation of land and capital as among the various possible uses open to them. This task can be accomplished in different ways. Our economic system is distinguished from others in that it seeks to solve this eternal human task by placing prices on land and capital; in this way, he who wishes to employ one or the other factor is compelled to give way to the person who believes he can put the factor in question to a better use. This is certainly not an ideal solution but it is all the same a solution. It was not thought up by anybody in particular, but came into being in a thoroughly natural way over a span of time which extends back thousands of years. In this long probationary period, it has demonstrated its practicality. A socialist state would have to find some substitute for it. As a matter of fact, such a state, if it wanted to have a rational economy, would have to invent rent and interest even if this were only with the purpose of providing itself with calculating devices to guide it in its use of these scarce factors of production. Otherwise, it would run the danger of having them appear on its books as free goods, thereby opening the doors wide to waste. If the economic calculations of the socialist state were to fail to take account of the scarcity of land and capital by means of some sort of index, these calculations would be hopelessly wrong. But it is to be feared that having destroyed the free market economy, such a state will have deprived itself of the mechanism which alone can solve the mathematical problem involved in calculating an index of this kind.⁶

In order to appreciate fully the difficulty which would face a socialist state in solving this problem, we must visualize the decisions which the government would have to make every hour of every day. These decisions are far more complicated than those described above in our example of the shoe and automobile industries. To bring us somewhat closer to the realities of the situation, assume that a large number of other industries are simultaneously pressing their claims for capital (e.g., the phonograph industry), that farmers are complaining about shortages of reaping-machines, and that besides all this there is talk of adopting a new-type locomotive. The method which the socialist planned economy usually falls back on in such case is to have the government itself decide, quite arbitrarily, where the capital can be most usefully employed. (It may happen, for instance, that a majority of the decision-making commissars detest phonograph music, in which case they will go over the heads of the only really competent judges, viz., the consumers, and decide that the capital requirements of the phonograph industry will not be met). The other alternative is for the government to leave it up to the population to decide where its capital can be most usefully employed. In such case, as we have seen, the population makes use of a scale which, in our economic system, results in a more or less efficient distribution of capital. Nevertheless, there are grounds for believing that such decisions by the people would be impossible in a socialist state.⁷ This all goes to prove that interest is not a stupid and provocative device for the impoverishment of some and the enrichment of others, not an organ like the appendix which can be removed with impunity, but a vital organ which in every economic system has an essential function to fulfill.⁸

The same is true of rent, whose existence is predicated on the necessity of making demand for land conform to the degree of need in each case, and of equating this need with the limited supplies available. Rent fulfills in our economic system a function which must be fulfilled in every economic system, viz., the introduction of reasonable order into the allocation of the limited supply of land. A very vivid appreciation of this function of rent may be had by observing the countryside from the vantage point of an airplane. The division of the land into residential and farm areas, forests and meadows, railroads and highways, the silhouettes of the cities with the skyscrapers in the center and the villas in the outskirts—all this is, fundamentally, the work of rent which through a series of gradations in its amount causes one piece of land to be used for this purpose and another for that purpose. Just as interest—to express this idea in more drastic form—ensures that subways will not be built in every country town, so rent acts to prevent the planting of potatoes in Regent Street or on Fifth Avenue. Rent is a warning, as it were, that land of a given quality or in a given location is scarce, and that therefore it should be entrusted only to those who are able and willing to make the best and most profitable use of it. The general regulatory principle which rules the whole of our economic system comes here, as elsewhere, into full play. That land is reckoned among the production costs of every economic good (since a price in the form of rent must be paid for its use) is an expression of the truth that the use of a piece of land for one purpose precludes its use for another purpose. In consequence, we see that rent differs in no wise from other cost elements.

This, of course, does not prevent rent from exhibiting certain peculiarities which, though the theoreticians of another day gave them undue importance, cannot be ignored. Although it would be an error to speak of an absolutely fixed or even of a monopolized supply of land, it is nonetheless true that land of a given fertility or location is more or less fixed in amount. Hence, where there is increasing demand for land there is a tendency for its price to rise, with no possibility of reestablishing equilibrium between supply and demand through increased production. Consequently, rising standards of living and an increasing population undoubtedly have a tendency to force up rents. On the other hand, we should be careful of over-estimating the strength of this tendency. It would be wrong, for instance, to believe that rent, like a ripening fruit, will wax bigger while the landowner contentedly sleeps. It is too easily forgotten that the rent of a specific piece of land can, in spite of increasing population and economic development, just as easily fall as rise, since there may occur shifts in demand for the several classes of land. With respect to land, one can lose as easily as one can gain, just as in every other form of capital investment. As one share of stock differs from another share, so does one piece of land differ from another due to its location or its quality. It often happens that even within a rapidly expanding urban area considerable losses may be sustained as the result of rent declines in what were once fashionable quarters, whereas they may be sharp increases in rents in areas that had been hitherto neglected. The same principle holds true for agricultural rents which, in spite of population growth, are equally subject to fluctuation. Naturally, we must guard against exaggeration in considering any of these possible alternatives. Still, it often happens that thanks to the sudden development of a city, to improvements in communications systems, or to construction of railroads and canals, those who happen through coincidence to be the owners of the land in question, may be legitimately regarded as the beneficiaries of an “unearned increase in value.” In cases of this kind, special taxation may be justified. But here we are anticipating our discussion of the personal distribution of income.⁹

4. Changing the Distribution of Income

After a considerable detour we have finally arrived at that decisive stage in our investigations where we may take a position on the burning question of a just distribution of income, without being sucked into a torrent of blind passions. Several times in the course of this book we have been at pains to explain the purpose and the character of our economic system. On each such occasion we saw ourselves obliged to admit that the equilibrium mechanism we had described functioned only under a certain condition—and one which can be criticized from many angles—viz., the existing and unequal distribution of income. While the “capitalistic” economic process can be compared to a continuing plebiscite in which each piece of currency represents a ballot and in which the consumers, via their demands, are constantly voting to decide what types and amounts of goods shall be produced, this right of the consumers to vote par-takes of that “majestic equality” to which Anatole France alludes so ironically in the motto to this chapter. The ballots are in truth very unequally distributed. It is right that the mechanism of our economic system should be so constructed that it synchronizes production with the wants of the consumers, and it is an objection which holds no water to say that producers seek to influence these wants by advertising their goods in the same way that political parties make propaganda for their programs and their candidates.¹⁰ But since what counts are only those wants which are backed up by money, we have not the right to regard the outcome of the consumers’ plebiscite as a complete and satisfying one. While our voting mechanism ensures, in the long run, that the production of houses will correspond to that demand for houses which arises from the existing distribution of income, it does not of itself prevent the production of houses from lagging behind the need for decent and healthful living accommodations. Outright condemnation of our economic system would seem to be the next logical step, and there are many who take it. The considerations upon which we have dwelt throughout this book make it possible for us to recognize the confusion which lies at the bottom of this popular condemnation, and to find a way to avoid the ruinous consequences of unreasoning anger.

Even the adversaries of our economic system do not, as a rule, deny that the services which it renders in the sphere of production are deserving of considerable respect. A number of them were not even dissuaded by the economic crisis of the thirties from holding that in this regard our economic system is very much superior to a communist one. Only because it is so unjust, they say, should it be done away with. To criticisms of this sort one must resolutely affirm that it is thoroughly possible, and even necessary, to bring about changes in distribution so long as such action does not result in the destruction of the high achievements of our economic system in the realm of production. To accomplish this purpose, three courses of action are available: 1) an “organic” change in the functional distribution of income; 2) a change in the personal distribution of income; 3) the use of extra-economic means to offset a change in the distribution of income.

We have already established that for a change in the functional distribution of income, it is not required to employ force, but rather to effect an “organic” change by acting on the original factors. To describe these factors in detail would require a whole book, the reading of which would not be easy since it would be necessary to treat of the very thorny questions connected with the theories of wages, interest, and rent. What must here be stressed is only the most essential consideration, viz., that both theory and experience point to productivity as being the final determining cause of the average level of wages in a country. All the differences in national living standards—between the United States and Europe, between Sweden and the countries in the Danube basin—can be traced back to this single factor. Everything which increases the productivity of labor, increases wages. Of decisive importance is the fact that the productivity of labor is greater, the larger are the quantities of capital and of land with which the labor factor of production can be combined. This depends, in turn, on the quantitative ratios of the three factors of production to one another, a circumstance whose importance has already been made clear to us (pp. 133 ff.). We can doubly understand now why the level of wages is high in a country where the labor factor of production is scarce in relation to capital and land. Because labor is scarce, a higher price must be paid for it, and because it is combined with a greater quantity of capital and land, its productivity is increased. This much established, it can be easily demonstrated that both points are reducible to the same common denominator. Of especial importance in this connection is the quantitative relationship between the productive factors of labor and capital, a fact corroborated by the classical theory of wages (wages fund theory), if not in its premises, nevertheless in its conclusions. At the same time, the truth is once again borne in upon us that an unrestricted increase of population will almost certainly cause a change in the distribution of income to the detriment of the wage income of the masses. A waste of capital caused by unproductive government expenditures has, in the long run, an identical effect.

Last but not least, we must make mention of the role played by foreign trade. The more completely a country participates in the international division of labor, thereby making the most rational use of its factors of production, the more favorable are the terms of trade which it can obtain on international markets. The less restricted a country is in buying foreign goods where they are cheapest and in selling its own where they are dearest, the higher will be the wage level of that country. This is a factor which plays an especially big role today in the surprising prosperity of certain small countries such as Switzerland and the Scandinavian countries.

We have thus arrived at a strange but suggestive result. It turns out that the functional distribution of income is the more prejudicial to wage income the poorer—i.e., the more unproductive, the more “proletarian,” and capital-poor—a country is. On the other hand, the greater a country’s average wealth, the more equitable will be its distribution of wage and property incomes. There is some truth to Uncle Bräsig’s famous thesis in Fritz Reuters Ut mine Stromtid “that poverty comes from being poor.”^* We can see from the foregoing that it is possible to formulate a policy of raising the national level of wages which will have a real chance of success. Such a policy will consist of the following: increasing capital wealth (by means, if need be, of capital imports and a rational organization of credit), allocation of the factors of production to their most productive uses, intelligent participation in the international division of labor, exploitation of technological and organizational progress, restrained increases in population, a reasonable economic policy in all fields, peace, security, confidence and order—such are the bases of national prosperity.

A change in the functional distribution of income in favor of wages will result at the same time in a more equal distribution of personal income since it will give to the masses of wage receivers the increasing possibility of obtaining—via wealth formation—income from the ownership of property of all kinds. The consequence will be a “de-proletarianization” which ought to be close to the hearts of those who need no propertyless masses for the fulfillment of their political ambitions. This process can be assisted by a number of direct measures, above all by an economic policy which sees to it that the equalizing effects of the competitive principle are not frustrated by manipulations which lead to an undeserved enrichment of the few at the expense of the many. An antimonopoly policy is thus always a good income policy, as is also the suppression of abuses born of the competitive struggle. Other measures that would help to reduce excessive concentration of wealth are housing programs, encouragement of independent farming, easing the difficulties encountered in progressing from one social class to another, attention to the credit needs of small industries, and numerous other measures.

As a last resort, there is available the extra-economic correction of the distribution of income. This consists in the state awaiting the results of the economic distribution of income as they are crystallized in the market processes, and then correcting these results by taxing the rich and spending for the poor. As a matter of fact, a considerable portion of the public finances is devoted to such rectification, supplemented by the efforts of private welfare groups. Obviously, there are certain limits here which may not be overstepped if paralyzing effects on the process of production are to be avoided. It is, of course, clear that the state can go much further in employing such corrective measures the smaller are its expenditures for other purposes.

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^* “Armut kommt von der ‘Poverteh.’ ”

NOTES

1. (p. 184) The Unequal Distribution of Income

The unequal distribution of income in all the civilized countries raises a host of economic, statistical, sociological and political questions for which we must refer the reader to a special—although not too extensive—literature. For the conceptual and statistical clarification of the phenomenon we are indebted to V. Pareto (especially in his Cours d’Economie politique (Vol. 2 [Lausanne, 1897]). He found that the inequality of income distribution in all advanced countries exhibited such regularity that it could even be expressed in a mathematical formula (Pareto’s first law). He believed further that it could be shown that inequality of income distribution lessens as average income per capita increases (Pareto’s second law). This second law of Pareto is in agreement with what we established on pp. 192 ff. For excellent work in this field see also Edwin Cannan, especially Wealth (London, 1914), and the work of his pupils: Hugh Dalton, Some Aspects of the Inequality of Incomes in Modern Communities (London, 1920); F.C. Benham, The Prosperity of Australia (London, 1928); W.H. Hutt, Economists and the Public (London, 1936), pp. 313 ff. See also the standard work of A.C. Pigou, The Economics of Welfare (4th ed.; London, 1932); Bertrand de Jouvenel, The Ethics of Redistribution (Cambridge, 1951); Einkommensbildung und Einkommensverteilung, papers at conference of Verein für Sozialpolitik ar Cologne, 1956. A collation and interpretation of statistical data from several countries may be found in: Colin Clark, The Conditions of Economic Progress (2nd ed.; London, 1950).

2. (p. 185) Evolution of Distribution Theory

Although we find little awareness in classical theory of the distinction between the personal and the functional distribution of income (classical theory was concerned almost exclusively with the latter), the classicists succeeded, nevertheless, in laying the foundations for a scientific study of the problem of distribution by breaking down individual income into definite income-types (wages, rent, and “capital profits”). In this regard, we may point to the still accepted classical view that production and distribution (formation of value and formation of income) are closely connected with one another, and that income formation is subject to the laws governing the whole of the economic process. This idea was developed with especial vigor and clarity by Ricardo. The classical doctrine, of course, did not progress so far as to conceive of the individual categories of income as being in themselves price phenomena. Consequently, it was constrained to construct a number of special theories, but without being able to join these together into a coherent whole. The weakness of these special theories was subsequently one of the main reasons why the classical concept of an economically determined distribution (by categories) had to give way almost completely to that agnostic-activist view which was defended throughout the nineteenth century by the adversaries of the classical school, the socialists and the historical school. The belief that the established power relationships in society are the determining factors, and that consequently a change in distribution could only be effected by state decree or the pressure of labor unions, found increasingly wide acceptance. The result was that progress in the theoretical analysis of the problem of distribution, which the classicists had carried rather far forward, was halted for a considerable period of time. Ultimately, modern theory, applying the marginal principle in this field as it had in others, arrived at solutions which, though largely confirming the results of classical theory, established the problem on a new and broader foundation. For the first time it was possible to have a total view of income distribution deduced not from arbitrary special theories but from the general principles of value and price theory. The concept which has proved itself of the greatest usefulness in this connection is that of the “marginal productivity” of the factors of production. The classicists, it must be admitted (especially Ricardo and J.H. von Thünen), did have an inkling of this concept, but the first complete exposition of the principle and its establishment as the basis of distribution theory, we owe to the American J.B. Clark in his The Distribution of Wealth (New York, 1899). The “imputation of costs” theory developed by the Austrian School leads, fundamentally, to a similar set of conclusions. As a result of the recognition that functional distribution (or factorial distribution) is really the outcome of the formation of the prices of the factors of production, the classical doctrine of an economically determined distribution was proven in a most convincing way. How sound this modern theory of distribution is can be ascertained by its readiness to concede the more or less considerable degree of “play” which must be allowed to the undetermined factors in distribution, and its willingness to admit such corrections and adjustments as may therefore be necessary. One of the accomplishments for which are indebted to modern distribution theory is its clear distinction between the personal and the functional distribution of income. This is shown most notably in E. Cannan, History of the Theories of Production and Distribution in English Political Economy from 1776 to 1848 (London, 1893).

3. (p. 188) The Theory of Wages

On the many and complex aspects of the theory of wages the following literature is recommended: R. von Strigl, Angewandte Lohntheorie (Vienna, 1926); J. Marschak, Die Lohndiskussion (1931); J.R. Hicks, The Theory of Wages (London, 1932); W.H. Hutt, The Theory of Collective Bargaining (London, 1930); P.H. Douglas, The Theory of Wages (London, 1934); Ch. Cornélissen, Théorie du salaire et du travail salarlé (Paris, 1908); A. Amonn, Das Lohnproblem (2nd ed.; Berne, 1945); D. Robertson, Wages (London, 1955). On the relationships between wage theory and cyclical theory see Wilhelm Röpke, Crises and Cycles, op. cit. On the interrelationships of wage and interest theory see the classical study of F.W. Taussig, Wages and Capital (first published in 1896, new ed., London, 1935).

Of the many complexities of the theory of wages we shall select only one for mention here. Repeated efforts have been made to get around the fact that wages are economically determined. Thus it has been argued that an arbitrary increase in wages will of itself so change the known economic determinants (the “original” factors in our text) that the new wage increase ceases to be arbitrary. What the proponents of this view try to prove, in other words, is that a rise in wages can increase the productivity of labor. This “theory of high wages” is met under two forms. According to the one, high wages cause an increase in the productivity of labor since it increases both the capacity and the will to produce of the workers. Insofar as this idea is not simply a product of the confusion of cause and effect, it involves a thesis which has no general validity in the first place and is unprovable in the second. The other variant of the “theory of high wages” reposes on the notion that high wages will indirectly cause an increase in mass purchasing power, thus stimulating mass production with a resultant increase in productivity (purchasing power theory of wages). In spite of the numerous errors with which this theory (most popular in the United States) bristles, it contains a modicum of truth, especially in connection with certain findings of cyclical theory. But this bit of truth in purchasing power theory cannot be considered as anything more than as a kind of broadening of the “zone of indeterminism” in wage determination.

With the extension and solidification of modern labor union power the problem of the wage as a “monopoly price” has assumed increasing importance. See Henry C. Simons, “Some Reflections on Syndicalism” in Economic Policy for a Free Society (Chicago, 1948); Fritz Machlup, Monopolistic Wage Determination as a Part of the General Problem of Monopoly (Washington, D.C.: Chamber of Commerce of the United States, 1947); J.A. Schumpeter, “The March into Socialism,” American Economic Review, May 1950; Charles E. Lindblom, Unions and Capitalism (New Haven, 1949); The Impact of the Union, ed. D.M. Wright (New York, 1951).

4. (p. 190) Interest and Differences in Capital Intensity

The existence of manual labor alongside machine production shows us how different, even within the same industry, is the “intensity” of capital (to which Marx applied the somewhat confusing appellation “the organic composition of capital”). Whether the one or the other kind of production is more suitable is something which, in our economic system, is decided by the ratio of interest to wages. In East Asia, for example, this ratio is so unfavorable to the use of machinery that human labor power (ricksha coolies) plays a role even in the transport of persons, a thing which would be impossible if wage levels were higher. The varying intensity of capital is a fact which Ricardo himself found embarrassing in constructing his theory of profit.

5. (p. 191) Entrepreneur’s Profit

Entrepreneur’s profit is differentiated from other kinds of income in that it does not constitute an integral part of the costs of production (and hence is not a determining cause of price). Rather, it is itself a product of the process of price formation, a sort of ex post facto income as it were. It is just because of this that we experience difficulty in assigning to entrepreneur’s profit its proper functional importance. In all such cases in which a surplus profit remains after the costs of doing business have been paid, we speak of rents. Since rent in the usual sense (ground rent) also contains such an element, the term came gradually to be applied to this phenomenon exclusively. Strictly speaking, however, this usage is incorrect and distracts attention from the essential character of ground rent as a type of cost income. Literature: H. von Mangoldt, Die Lehre vom Unternehmergewinn (1855), a pathmaking book by a German economist who only now is receiving his proper due; J. Niehans, article “Unternehmereinkommen”, Handwörterbuch der Sozialwissenschaften, 1959; J. Schumpeter, The Theory of Economic Development (Cambridge [Mass.], 1934); A. Amonn, “Der Unternehmergewinn” in Die Wirtschaftstheorie der Gegenwart, Vol. 3 (1928); D.H. MacGregor, Enterprise, Purpose, and Profit (Oxford, 1934). There is, finally, a copious and especially high level American literature on the subject, in particular, F.H. Knight, Risk, Uncertainty, and Profit (New York, 1921), a standard work, especially on the element of risk in entrepreneur’s profit; A.E. Monroe, Value and Income (Cambridge [Mass.], 1931); F.B. Hawley, Enterprise and the Productive Process (New York, 1907); Clare E. Griffin, Enterprise in a Free Society (Chicago, 1949).

6.(p. 194) Economic Calculation in a Collectivist State

It is to a group of non-Marxist economists that we owe thanks for drawing attention in recent years to the problem of economic calculation, that is, to the method by which the economic system makes a rational allocation of its productive resources. This is, in fact, the central problem of a collectivist state: how to arrive at a halfway rational method of economic calculation in the absence of the free formation of the prices of the factors of production, especially of land and capital. See L. von Mises, Socialism (London, 1936); T.J.B. Hoff, Eco-nomic Calculation in the Socialist Society (London, 1949); Pohle-Halm, Kapitalismus und Sozialismus (4th ed.; 1931); B. Brutzkus, Die Lehren des Marxismus im Lichte der russischen Revolution (1928), a book which combines penetrating analysis with an interesting evaluation of the Russian experiment (an English translation is contained in the first part of Economic Planning in Soviet Russia [London, 1935]); F.A. von Hayek (ed.), Collectivist Economic Planning (London, 1935); F.A. von Hayek, Individualism and Economic Order (Chicago, 1948); W. Röpke, article “Sozialisierung,” Handwörterbuch der Staatswissenschaften, 4th ed.; R.L. Hall, The Economic System in a Socialist State (London, 1936); W. Röpke, Civitas Humana (London, 1948). The immensity of the problem of rational economic calculation in the collectivist state, with which the above literature is concerned, finds additional confirmation in the failure of all efforts in Russia to establish a genuine collectivist system. On the realities of collectivism see: W.H. Chamberlin, A False Utopia: Collectivism in Theory and Practice (London, 1937); W. Lippmann, The Good Society (Boston, 1937); L.E. Hubbard, Soviet Labour and Industry (London, 1942); A. Baykov, The Development of the Soviet Economic System (London, 1946); J. Jewkes, Ordeal by Planning (London, 1948); W. Eucken, “On the Theory of the Centrally Administered Economy: An Analysis of the German Experiment,” Economica, May and August, 1948; A. Müller-Armack, Wirtschaftslenkung und Marktwirtschaft (Hamburg, 1947); W. Röpke, Mass und Mitte (Erlenbach-Zurich, 1950), pp. 86-134; W. Röpke, The Problem of Economic Order (Cairo, 1951).

7. (p. 195) Socialism and Democracy

A continuing plebiscite or popular referendum in a socialist state must be considered as impossible, from which it follows that socialism is incompatible with genuine democracy and individual freedom, and hence necessarily presupposes a totalitarian state. Extensive and still unrefuted argumentation for the truth of this highly significant thesis, one confirmed also by all previous experience, may be found in the following works: W. Lippmann, op. cit.; F.A. von Hayek, The Road to Serfdom (Chicago, 1944); W. Röpke, Civitas Humana, op. cit. The effort made by J.A. Schumpeter in Capitalism, Socialism, and Democracy (2nd ed.; New York, 1947) to refute these arguments must be regarded as unsuccessful (see F.A. von Hayek, “The Use of Knowledge,” American Economic Review, September 1945; W. Röpke, “Kapitalismus, Sozialismus und Demokratie” in Gegen die Brandung [2nd ed.; Erlenbach-Zurich, 1959], pp. 354-362).

8. (p. 195) The Theory of Interest

The essence of interest may be understood from a study of the essence of capital (see Chapter V, pp. 130 ff. and Note 9). The difficulties of capital theory reappear in the theory of interest; current scientific discussion of the one and the other is equally intense. The point of departure for the study of these matters is still the pathmaking work of Böhm-Bawerk on capital and interest theory, (Eng. tr. by George D. Huncke and Hans F. Sennholz, Capital and Interest, 3 volumes [South Holland, 111.; 1959]); see also the article “Zins”, Handwörterbuch der Staatswissenschaften, 4th ed., revised and expanded by F.X. Weiss. Until Böhm-Bawerk, theories of capital and interest were thoroughly unsatisfactory. He set the theories on their proper foundation by stressing as the central fact of his explanation the time dimension of capital and interest (the sacrifice of the present in favor of the future, “waiting”). The underlying idea to which Böhm-Bawerk gave expression dominates all of modern interest theory. The form in which he expressed himself, however, has left his findings open to many legitimate criticisms, especially since they do not comprise a complete or unified theory. In point of fact, the “agio” theory of Böhm-Bawerk, the “scarcity” theory of Cassel (The Theory of Social Economy [1932]), the “impatience” theory of Irving Fisher, the marginal productivity theory of interest (a model explanation of which is to be found in E. Cannan, An Economist’s Protest [London, 1927], pp. 285 ff.), and related theories are, at bottom, only variations on the same fundamental theme. It is to be noted that the modern time-difference theory, which is the leitmotif of all these variations, should not be confused with the abstinence theory of Senior to which we drew attention in another section (Chapter II, Note 4, p. 38). Interest ought not to be paid as a reward for a sacrifice, but because “waiting” is necessarily scarce by reason of the greater attractiveness of current consumption and the unlimited demand for capital which would develop if there were no interest. Nor should it be thought that interest is something which is required to induce men to create capital. The supply of capital is more often than not inelastic, i.e., largely independent of the rate of interest. A certain amount of saving would take place without interest. It is even possible that not a few individuals, in their desire to draw a given amount of interest-income, would save more where the interest rate is low than where it is high (see W. Röpke, Die Theorie der Kapitalbildung [1929]). From the foregoing we may conclude that the function of interest is more to regulate and to sift the demand for capital than to regulate its supply. We may summarize by saying that the existence, rate, and function of interest are explainable in terms of the time factor. In our economic system, interest is the “time gland,” so to speak, which balances the present and the future in the national economy, and which ensures that scarce capital in each case will be rationally distributed among the several competing uses for it. Its counterpart is rent which, as a sort of “space gland,” has the function of ensuring spatial order in the economy. Most recent literature: F.A. von Hayek, The Pure Theory of Capital (London, 1941); J.R. Hicks, Value and Capital (Oxford, 1939); J.M. Keynes, “Alternative Theories of the Rate of Interest,” Economic Journal, June 1937, pp. 246-248; J.M. Fleming, “The Determination of the Rate of Interest,” Economica, August, 1938, pp. 333-341; W. Eucken, Kapitaltheoretische Untersuchungen (1934); R. v. Strigl, Kapital und Produktion (Vienna, 1934); F.A. Lutz, Zinstheorie (Zürich-Tübingen, 1956).

Quite outside the contemporary explanation of interest in terms of the time dimension are two other theories of interest: the dynamic theory and the theory of exploitation. According to the dynamic theory, represented chiefly by J. Schumpeter (The Theory of Economic Development, op. cit.), interest is possible only in a progressing and developing economy and not in a static one. According to the exploitation theory, held for the most part by socialists (Marx, Franz Oppenheimer, and most recently Hans Peter in Grundprobleme der theoretischen Nationalökonomie, Vol. 1 [1953], pp. 85 ff.), interest is interpreted as an enrichment arising from changing power relationships. For a critique of both theories see F.X. Weiss, supplement to the article “Zins,” Handwörterbuch dei Staatswissenschaften, 4th ed.

From the beginning it was recognized that the problem of interest is not only a real (natural) problem, but also a monetary one. It is precisely this fact which adds to the complexity of interest rate theory and which has been too long ignored in the literature. The monetary theory of interest has become nevertheless increasingly important. A pioneer in this field is the Swede Knut Wicksell (originally in his book Interest and Prices [1898], more recently in his Lectures on Political Economy, ed. Robbins, Vol. 2, [London, 1935]). Additional readings: L.A. Hahn, Volkswirtschaftliche Theorie des Bankkredits (3rd ed., 1930); L. von Mises, Theory of Money and Credit (New York, 1934); F.A. von Hayek, The Pure Theory of Capital, op. cit.;, Frank A. Fetter, “Interest Theory and Price Movements,” American Economic Review, Supplement, March 1927; D.H. Robertson, Banking Policy and the Price Level (3rd ed., London, 1932); J.M. Keynes, A Treatise on Money (London, 1930); J.M. Keynes, The General Theory of Employment, Interest and Money (London, 1936); F. Machlup, Börsenkredit, Industriekredit und Kapitalbildung (Vienna, 1931); W. Röpke, “Kredit und Konjunktur,” Jahrbücher für Nationalökonomie, March-April 1926; W. Röpke, Crises and Cycles (London, 1936), pp. 111 ff.; Hans Gestrich, Kredit und Sparen (2nd ed., Godesberg, 1948); W. Lautenbach, Zins, Kredit und Produktion (Tübingen, 1952); F.A. Lutz, op. cit.

9. (p. 197) The Theory of Rent

Here again we are confronted with difficulties which were passed over in the text in order not to distract the reader’s attention from fundamentals. We may best begin with the Ricardian theory of rent, the extraordinary durability of which is proven by the fact that it still holds an important place in contemporary theory. Ricardo laid the greatest possible stress on the differential character of ground rent. Rent for Ricardo is not an element of costs; hence it is not a cause but a consequence of the prices of agricultural products. Since for all producers the price of grain in the market will be the same, whether it is produced on rich or poor land, on land far removed from the market or near to it, or with much or little labor and capital, a differential gain will accrue to the land having the lower costs of production. If there should be, perchance, a rise in the price of grain, this will not be because rent has increased; rather, rent in-creases because the price of grain (perhaps on account of increasing population) has gone up. In this way, Ricardo believed he had completely eliminated the land factor of production as an element in the formation of prices of agricultural products.

Ricardo’s theory of rent remained for a long time the most durable part of his work and is still regarded as correct by many economists. It cannot, however, be accepted any longer within the framework of modern theory; at least not in the form which Ricardo gave it. The fact is that rent appears in quite another light if viewed in the theoretical scheme of modern economics. Rent is now seen to be the price paid for the use of the factor of a production “land”; like every other price, it is determined by the scarcity of the factor. This price which is paid for the use of land is also a real cost element and corresponds to the modern view of costs as a reflection of the utility which could have been obtained from another use of the factor. In other words: rent expresses the fact that land which is used for one purpose cannot be used for another; it indicates that land of a certain type is scarce and by its amount shows the degree of that scarcity. The function of rent, then, is to make these facts known and to see to it that the best possible use is made of land of a given quality or location. Consequently, rent will always appear where land of a given quality or location becomes scarce. It follows that differential rent is basically nothing else than the price of a factor of production which, just as the prices of other factors of production, is an integral part of value (price) calculation, since it represents an element of cost in the subjective sense of a sacrifice of alternative uses (opportunity cost). Even a socialist economy must take the scarcity of land into account since if it did not, land would be treated as a free good and the state itself would be in the position of having abetted the ensuing waste. The difficulty, however (which was spared the reader in the text), lies in the fact that the real cost character of rent is revealed only insofar as a piece of land actually has an alternative use. If, however, the land in question has a specific use, e.g., the land of a famous vineyard, we cannot explain the rent which is paid for it in terms of the other uses to which it could be put, since these other uses practically do not exist. In this case, the pure rent character (differential gain) of rent cannot be denied. See Franz X. Weiss, “Die Grundrente im System der Nutzwertlehre,” Die Wirtschaftstheorie der Gegenwart, Vol. 3 (Vienna, 1928); A. v. Navratil, “Rentenprinzip und Grundrente,” Zeitschrift für die gesamte Staatswissenschaft, Vol. 94, 1933; O. v. Zwiedineck-Südenhorst, Allgemeine Volkswirtschaftslehre (1932), pp. 234 ff.; Hubert D. Henderson, Supply and Demand, op. cit.

On urban rents: Adolf Weber, “Die städtische Grundrente,” Die Wirtschaftstheorie der Gegenwart, Vol. 3, (Vienna, 1928); F. von Wieser, “Die Theorie der städtischen Grundrente,” Gesammelte Abhandlungen (1929), pp. 126 ff.

10. (p. 197) Advertising

Advertising limits the freedom of economic choice of the consumer no more and no less than election propaganda limits the freedom of voters. Nor is this freedom of the consumer constrained by the fact that his decisions are guided by a whole set of motivations and influences of which advertising is only one. The choice of the consumers remains always free in the sense that in the economic democracy of the market we cast our votes in accordance with our preferences. But this freedom, it should be noted, exists only in the market economy, not in the collectivist “command economy.” Of course, it is true that advertising frequently causes a want to appear where none existed before, and induces us to purchase something which we otherwise would have done without. Surely, however, it does not conflict with our concept of a rational human economy if the producer steps out of his role of a waiter standing by for his orders and recommends something new on the menu or wine list. Even orange juice originally achieved its popularity as the result of advertising. But who has bitter thoughts about advertising when he drinks a glass of orange juice? Be this as it may, advertising has aroused many severe criticisms which may be found elsewhere. In this connection, see: W. Röpke, Mass und Mitte (Erlenbach-Zurich, 1950), pp. 200-218; W. Röpke, A Humane Economy, op. cit., pp. 137-138; E.A. Lever, Advertising and Economic Theory (London, 1947); Herbert Wilhelm, Werbung als wirtschaftstheoretisches Problem (1961).