Appendix B: Professor Rolph and the Discounted Marginal Productivity Theory

Of current schools of economic thought, the most fashionable have been the Econometric, the Keynesian, the Institutionalist, and the Neo-Classic. “Neo-Classic” refers to the pattern set by the major economists of the late nineteenth century. The dominant neoclassical strain at present is to be found in the system of Professor Frank Knight, of which the most characteristic feature is an attack on the whole concept of time preference. Denying time preference, and basing interest return solely on an alleged “productivity” of capital, the Knightians attack the doctrine of the discounted MVP and instead advocate a pure MVP theory. The clearest exposition of this approach is to be found in an article by a follower of Knight's, Professor Earl Rolph.³⁵

Rolph defines “product” as any immediate results of “present valuable activities.” These include work on goods that will be consumed only in the future. Thus,

workmen and equipment beginning the construction of a building may have only a few stakes in the ground to show for their work the first day, but this and not the completed structure is their immediate product. Thus, the doctrine that a factor receives the value of its marginal product refers to this immediate product. The simultaneity of production and product does not require any simplifying assumptions. It is a direct appeal to the obvious. Every activity has its immediate results.

Obviously, no one denies that people work on goods and move capital a little further along. But is the immediate result of this a product in any meaningful sense? It should be clear that the product is the end product—the good sold to the consumer. The whole purpose of the production system is to lead to final consumption. All the intermediate purchases are based on the expectation of final purchase by the consumer and would not take place otherwise. Every activity may have its immediate “results,” but they are not results that would command any monetary income from anyone if the owners of the factors themselves were joint owners of all they produced until the final consumption stage. In that case, it would be obvious that they do not get paid immediately; hence, their product is not immediate. The only reason that they are paid immediately (and even here there is not strict immediacy) on the market is that capitalists advance present goods in exchange for those future goods for which they expect a premium, or interest return. Thus, the owners of the factors are paid the discounted value of their marginal product.

The Knight-Rolph approach, in addition, is a retreat to a real-cost theory of value. It assumes that present efforts will somehow always bring present results. But when? In “present valuable activities.” But how do these activities become valuable? Only if their future product is sold, as expected, to consumers. Suppose, however, that people work for years on a certain good and are paid by capitalists, and then the final product is not bought by consumers. The capitalists absorb monetary losses. Where was the immediate payment according to marginal product? The payment was only an investment in future goods by capitalists.

Rolph then turns to another allegedly heinous error of the discount approach, namely, the “doctrine of nonco-ordination of factors.” This means that some factors, in their payment, receive the discounted value of their product and some do not. Rolph, however, is laboring under a misapprehension; there is no assumption of nonco-ordination in any sound discounting theory. As we have stated above, all factors—labor, land, and capital goods—receive their discounted marginal value product. The difference in regard to the owners of capital goods is that, in the ultimate analysis, they do not receive any independent payment, since capital goods are resolved into the factors that produced them, ultimately land and labor factors, and to interest for the time involved in the advance of payment by the capital-ists.³⁶ Rolph believes that nonco-ordination is involved because owners of land and labor factors “receive a discounted share,” and capital “receives an undiscounted share.” But this is a faulty way of stating the conclusion. Owners of land and labor factors receive a discounted share, but owners of capital (money capital) receive the discount.

The remainder of Rolph's article is largely devoted to an attempt to prove that no time lag is involved in payments to owners of factors. Rolph assumes the existence of “production centers” within every firm, which, broken down into virtually instantaneous steps, produce and then implicitly receive payment instantaneously. This tortured and unreal construction misses the entire point. Even if there were atomized “production centers,” the point is that some person or persons will have to make advances of present money along the route, in whatever order, until the final product is sold to the consumers. Let Rolph picture a production system, atomized or integrated as the case may be, with no one making the advances of present goods (money capital) that he denies exist. And as the laborers and landowners work on the intermediate products for years without pay, until the finished product is ready for the consumer, let Rolph exhort them not to worry, since they have been implicitly paid simultaneously as they worked. For this is the logical implication of the Knight-Rolph position.³⁷

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¹The mathematical bent toward replacing the concepts of cause and effect by mutual determination has contributed to the willingness to engage in circular reasoning. See Rothbard, “Toward a Reconstruction of Utility and Welfare Economics,” p. 236; and Kauder, “Intellectual and Political Roots of the Older Austrian School.”

²Clearly, the longer the period of time, the more variable will factor proportions tend to be. Technologically, varying amounts of time are needed to rearrange the various factors.

³This justifies the conclusion of Mises, Human Action, p. 336, as compared, for example, with the analysis in George J. Stigler's Production and Distribution Theories. Mises adds the important proviso that if the factors have the same fixed proportions in all the processes for which they are nonspecific, then here too only bargaining can determine their prices.

⁴Strictly, we should be dealing with discounted MVPs here, but treating just MVPs at this stage merely simplifies matters.

⁵We are here postulating that equal quantities of factors produce equal quantities of results. The famous question whether this condition actually holds (sometimes phrased in pretentious mathematical language as whether the “production function is linear and homogeneous”) is easily resolved if we realize that the proposition: equal causes produce equal results, is the major technological axiom in nature. Any cases that appear to confute this rule only do so in appearance; in reality, supposed exceptions always involve some “indivisibility” where one factor, in effect, cannot change proportionately with other factors.

⁶This is not strictly true, but the technical error in the statement does not affect the causal analysis in the text. In fact, this argument is strengthened, for MVP actually equals MPP × “marginal revenue,” and marginal revenue is always less than, or equal to, price. See Appendix A below, “Marginal Physical and Marginal Value Product.”

⁷It might be asked why we now employ mathematics after our strictures against the mathematical method in economics. The reason is that, in this particular problem, we are dealing with a purely technological question. We are not dealing with human decisions here, but with the necessary technological conditions of the world as given to human factors. In this external world, given quantities of cause yield given quantities of effect, and it is this sphere, very limited in the overall praxeological picture, that, like the natural sciences in general, is peculiarly susceptible to mathematical methods. The relationship between average and marginal is an obviously algebraic, rather than an ends-means, relation. Cf. the algebraic proof in Stigler, Theory of Price, pp. 44 ff.

⁸This law applies to all factors, specific and nonspecific.

⁹See the excellent discussion in Böhm-Bawerk, Positive Theory of Capital, pp. 304–12. For a further discussion of DMVP as against MVP, see Appendix B below, “Professor Rolph and the Discounted Marginal Productivity Theory.”

¹⁰See Wicksell, Lectures on Political Economy, I, 108.

¹¹See the excellent analysis in ibid., pp. 189–91, 193–95.

¹²This was realized by Carl Menger. See F.A. Hayek, “Carl Menger” in Henry W. Spiegel, ed., The Development of Economic Thought (New York: John Wiley, 1952), pp. 530 ff.

¹³Böhm-Bawerk, Positive Theory of Capital, p. 88.

¹⁴Mises, Human Action, pp. 477, 485f. Also see Menger, Principles of Economics, pp. 166–67.

¹⁵“Nonreplaceable” as a criterion for land, in contrast to capital goods, is not equivalent to “permanent.” “Permanent” is a subdivision of “non-replaceable.” It is clear that permanent improvements do not have to be replaced. However, depletable natural resources, such as coal, ores, etc., are not permanent, but are also nonreplaceable. The key question is whether a resource has to be produced, in which case it earns only gross rents. If it does not or cannot, it earns net rents as well. Resources that are being depleted obviously cannot be replaced and are therefore land, not capital goods. See the section on depletable resources below.

¹⁶We may use “permanent” and “nonpermanent” in this section, because resources that are being depleted obviously cannot be included in any evenly rotating equilibrium. For more on depletable resources, see below. With depletable resources left aside, “permanent” becomes identical with “nonreproducible.”

¹⁷Cf. Wicksell, Lectures on Political Economy I, 186 and passim; and Hayek, Pure Theory of Capital, pp. 54–58.

¹⁸Neither is there any relation between the present issue of permanence or nonpermanence and the cosmological question of the permanence of matter and energy. See Mises, Human Action, p. 634.

¹⁹Stigler charges that the various distinctions between land and capital goods based on permanence or origin, such as are discussed herein, are physical rather than economic. These strictures miss the point. No one denies that these homogeneous factors can change greatly in value over time. But whether or not a given factor is original or improved, or permanent or needing to be maintained, is a physical question, and one that is very relevant to economic analysis. Certainly, the Knightian argument that all land is capital goods, because no land is original, is also an argument in the physical realm. Stigler, Production and Distribution Theories, p. 274.

²⁰John V. Van Sickle and Benjamin A. Rogge, Introduction to Economics (New York: D. Van Nostrand, 1954), p. 141.

²¹But while the position is permanent, even the land itself was necessarily altered by man to prepare it for urban use. See chapter 2 above.

²²This concept of rent is based on the original contribution of Frank A. Fetter. Cf. Fetter, Economic Principles, pp. 143–70. Fetter's conception has, unfortunately, had little influence on economic thought. It is not only in accord with common usage; it provides a unifying principle, enabling a coherent explanation of the price determination of unit services and of the whole goods that embody them. Without the rental-price concept, it is difficult to distinguish between the pricing of unit services and of whole goods.

Fetter used the rental concept to apply only to the services of durable goods, but it is clear that it can be extended to cover cases of nondurable goods where the unit service is the whole good.

²³See chapter 4 above. On capitalization, see Fetter, Economic Principles, pp. 262–84, 308–13; and Böhm-Bawerk, Positive Theory of Capital, pp. 339–57.

²⁴It is often more convenient to define rent as equal to the MVP, rather than the DMVP. In that case, the capital value of the whole factor is equal to the discounted sum of its future rents.

²⁵Fetter's main error in capital theory was his belief that capitalization meant the scrapping of any distinction between capital goods and land.

²⁶Cf. Boulding, Economic Analysis, pp. 711–12.

²⁷In the long run, increases in the capital value of capital goods are unimportant, since they resolve into increases in wages and increases in the capital value of ground land.

²⁸The problem of gains from changes in capital values will be treated further below.

²⁹Cf. Fred R. Fairchild, Edgar S. Furniss, and Norman S. Buck, Elementary Economics (New York: Macmillan & Co., 1926), II, 147.

³⁰Hayek, Pure Theory of Capital, p. 58 n.

³¹Ibid., p. 92.

³²Unusual terms because robbery has been distinctively defined as seizure of someone else's property without his consent, not the use of one's own property.

³³As Stigler says in discussing the charge of “wasted” resources on the market, “It is an interesting problem to define ‘wasteful’ sensibly without making the word synonymous with ‘unprofitable.’” Stigler, Theory of Price, p. 332 n. For a discussion of natural resources and a critique of the doctrines of “conservation,” see Anthony Scott, Natural Resources: The Economics of Conservation (Toronto: University of Toronto Press, 1955).

³⁴A curious notion has arisen that considering MR, instead of price, as the multiplier somehow vitiates the optimum satisfaction of consumer desires on the market. There is no genuine warrant for such an assumption.

³⁵Earl Rolph, “The Discounted Marginal Productivity Doctrine” in W. Fellner and B.F. Haley, eds., Readings in Theory of Income Distribution (Philadelphia: Blakiston, 1946), pp. 278–93.

³⁶Rolph ascribes this error to Knut Wicksell, but such a confusion is not attributable to Wicksell, who engages in a brilliant discussion of capital and the production structure and the role of time in production. Wicksell demonstrates correctly that labor and land are the only ultimate factors, and that therefore the marginal productivity of capital goods is reducible to the marginal productivity of labor and land factors, so that money capital earns the interest (or discount) differential.

Wicksell's discussion of these and related issues is of basic importance. He recognized, for example, that capital goods are fully and basically coordinate with land and labor factors only from the point of view of the individual firm, but not when we consider the total market in all of its interrelations. Current economic theorizing is, to its detriment, even more preoccupied than writers of his day with the study of an isolated firm instead of the interrelated market. Wicksell, Lectures on Political Economy, I, 148–54, 185–95.

³⁷Rolph ends his article, consistently, with a dismissal of any time-preference influences on interest, which he explains in Knightian vein by the “cost” of producing new capital goods.