Chapter III: The Relativity of Economic "Quantities"

CHAPTER III THE RELATIVITY OF ECONOMIC " QUANTITIES " 1. THAT aspect of behaviour which is the subjectmatter of Economics is, as we have seen, conditioned by the scarcity of given means for the attainment of given ends. It is clear, therefore, that the quality of scarcity in goods is not an "absolute" quality. Scarcity does not mean mere infrequency of occurrence. It means limitation in relation to demand. Good eggs are scarce because, having regard to the demand for them, there are not enough to go round. But bad eggs, of which, let us hope, there are far fewer in existence, are not scarce at all in our sense. They are redundant. This conception of scarcity has implications both for theory and for practice which it is the object of this chapter to elucidate. 2. It follows from what has just been said that the conception of an economic good is necessarily purely formal.1 There is no quality in things taken out of their relation to men which can make them economic goods. There is no quality in services taken 1 Of course, the conceptions of any pure science are necessarily purely formal. If we were attempting to describe Economics by inference from general methodological principles, instead of describing it as it appears from a consideration of what is essential in its subjectmatter, this would be a guiding consideration. But it is interesting to observe how, starting from the inspection of an apparatus which actually exists for solving concrete problems, we eventually arrive, by the necessities of accurate description, at conceptions which are in full conformity with the expectations of pure methodology.

46 m RELATIVITY OF ECONOMIC " QUANTITIES " 47 out of relation to the end served which makes them economic. Whether a particular thing or a particular service is an economic good depends entirely on its relation to valuations. Thus wealth1 is not wealth because of its substantial qualities. It is wealth because it is scarce. We cannot define wealth in physical terms as we can define food in terms of vitamin content or calorific value. It is an essentially relative concept. For the community of ascetics discussed in the last chapter there may be so many goods of certain kinds in relation to the demand for them that they are free goods— not wealth at all in the strict sense. In similar circumstances, the community of sybarites might be "poor". That is to say, for them, the self-same goods might be economic goods. So, too, when we think of productive power in the economic sense, we do not mean something absolute —something capable of physical computation. We mean power to satisfy given demands. If the given demands change, then productive power in this sense changes also.

A very vivid example of what this means is to be found in Mr. Winston Churchill's account of the situation confronting the Ministry of Munitions at 11 a.m. on November 11th, 1918—the moment of the signing of the Armistice. After years of effort, the nation had acquired a machine for turning out the 1 The term wealth is used here as equivalent to a flow of economic goods. But I think it is clear that there are profound disadvantages in using it in this sense. It would be very paradoxical to have to maintain that, if "economic" goods by reason of multiplication became "free" goods, wealth would diminish. Yet that might be urged to the implication of this usage. Hence, in any rigid delimitation of Economics, the term wealth should be avoided. It is used here simply in elucidation of the implications for everyday discussion of the somewhat remote propositions of the preceding para48 SIGNIFICANCE OF ECONOMIC SCIENCE OH.

materials of war in unprecedented quantities. Enormous programmes of production were in every stage of completion. Suddenly the whole position is changed. The "demand" collapses. The needs of war are at an end. What was to be done? Mr. Churchill relates how, in the interests of a smooth change-over, instructions were issued that material more than 60 per cent, advanced was to be finished. "Thus for many weeks after the war was over we continued to disgorge upon the gaping world masses of artillery and military materials of every kind."1 "It was waste", he adds, "but perhaps it was a prudent waste." Whether this last contention is correct or not is irrelevant to the point under discussion. What is relevant is that what at 10.55 a.m. that morning was wealth and productive power, at 11.5 had become "not-wealth," an embarrassment, a source of social waste. The substance had not changed. The guns were the same. The potentialities of the machines were the same. From the point of view of the technician, everything was exactly the same. But from the point of view of the economist, everything was different. Guns, explosives, lathes, retorts, all had suffered a sea change.

The ends had changed. The scarcity of means was different.2 1 The World Crisis, vol. v., pp. 33-35. * It is, perhaps, worth while observing how our practice here differs from the practice which would seem to follow from Professor Cannan's procedure. Having defined wealth as material welfare, Professor Carman would be logically compelled to argue that we were not producing during the War. In fact, he gets out of the difficulty by arguing that we may say that we were producing produce but not material welfare (Review of Economic Theory, p. 51). From the point of view of the definitions here adopted, it follows, not that we were not producing, but simply that we were not producing for the same demands as during peace time. Prom either point of view, the rum-comparability of material statistics of war and peace follows clearly. But from our point of view the persistence of formal economic laws is much more clearly emphasised.

¤i RELATIVITY OF ECONOMIC " QUANTITIES " 49 3. The proposition which we have just been discussing, concerning what may be described as the relativity of "economic quantities", has an important bearing on many problems of Applied Economics— so important, indeed, that it is worth while, here and now, interrupting the course of our main argument in order to examine them rather more fully. There can be no better illustration of the way in which the propositions of pure theory facilitate comprehension of the meaning of concrete issues. A conspicuous instance of a type of problem which can only be satisfactorily solved with the aid of the distinctions we have been developing, is to be found in contemporary discussions of the alleged economies of mass production. At the present day the lay mind is dominated by the spectacular achievements of mass production. Mass production has become a sort of cure-all, an open sesame. The goggled eyes of the world turn westward to Ford the deliverer.

He who has gaped longest at the conveyors at Detroit is hailed as the most competent economist. Now, naturally, no economist in his senses would wish to deny the importance for modern civilisation of the potentialities of modern manufacturing technique. The technical changes which bring to the door, even of the comparatively poor man, the motor-car, the gramophone, the wireless apparatus, are truly momentous changes. But, in judging their significance in regard to a given set of ends, it is very important to bear in mind this distinction between the mere multiplication of material objects and the satisfaction of demand, which the definitions of this chapter elucidate. To use a convenient jargon, it is important to bear in mind the distinction between technical and 4 50 SIGNIFICANCE OF ECONOMIC SCIENCE OH. value productivity. The mass production of particular things irrespective of demand for them, however technically efficient, is not necessarily "economical".

As we have seen already, there is a fundamental difference between technical and economic problems.1 We may take it as obvious that, within certain limits (which, of course, change with changing conditions of technique), specialisation of men and machinery is conducive to technical efficiency. But the extent to which such specialisation is "economical" depends essentially upon the extent of the market—that is to say, upon demand.2 For a blacksmith producing for a small and isolated community to specialise solely on the production of a certain type of horse-shoe, in order to secure the economies of mass production, would be folly. After he has made a limited number of shoes of one size, it is clearly better for him to turn his attention to producing shoes of other sizes, additional units of which will be more urgently demanded than additional units of the size of which he has already manufactured a large quantity.

So, too, in the world at large at any particular moment, there are definite limits to the extent to which the mass production of any one type of commodity to the exclusion of other types is in conformity with the demands of consumers. If it is carried beyond these limits, not only is there waste, in the sense that productive power is used to produce goods of less value than could be produced otherwise, but there is also definite financial loss for the productive enterprise concerned. It is one of the paradoxes of the history of 1 See above, pp. 32·38. 2 See Allyn Young, Increasing Returns and Economic Progress (Economic Journal, vol. xxxviii., pp. 528-542). On the sense in which it is legitimate to use the term "economical" in this connection, see Chapter VI. below.

m RELATIVITY OF ECONOMIC " QUANTITIES " 51 modern thought that, at a time when the disproportionate development of particular lines of production has wrought more chaos in the economic system than at any earlier period in history, there should arise the naïve belief that a general resort to mass production, whenever and wherever it is technically possible, regardless of the conditions of demand, will see us out of our difficulties. It is the nemesis of the worship of the machine, the paralysis of the intellect of a world of technicians. This confusion between technical potentiality and economic value, which, borrowing a phrase of Professor Whitehead's, we may call the "fallacy of misplaced concreteness",1 also underlies certain notions at present unduly prevalent with regard to the value of fixed capital. It is sometimes thought that the fact that large sums of money have been sunk in certain forms of fixed capital renders it undesirable, if consumer's demand changes, or if technical invention renders it possible to satisfy a given consumer's demand in other more profitable ways, that the capital should fall into disuse. If the satisfaction of demand is assumed as the criterion of economic organisation, this belief is completely fallacious. If I purchase a railway ticket from London to Glasgow, and halfway on my journey I receive a telegram informing me that my appointment must take place in Manchester, it is not rational conduct for me to continue my journey northwards, just because I have "sunk capital" in the ticket which I am unable to recover. It is true that the ticket is still as "technically efficient" in procuring me the right to go to Glasgow. But my objective has now changed. The power to continue my journey 1 Science and the Modern World, p. 64.

52 SIGNIFICANCE OF ECONOMIC SCIENCE OH. northward is no longer valuable to me. To continue nevertheless would be irrational. In Economics, as Jevons remarked, bygones are forever bygones. Exactly similar considerations apply when we are considering the present status of machinery for whose products demand has ceased, or which has ceased to be as profitable, taking everything into account, as other kinds of machinery. Although the machinery may be technically as efficient as it was before these changes, yet its economic status is different.1 No doubt, if the change in demand or in cost conditions which led to its supersession had been foreseen, the disposition of resources would have been different. In that sense it is not meaningless to speak of a waste due to ignorance—although there are difficulties here. But once the change has taken place, what has happened before is totally irrelevant—it is waste to take it into further consideration. The problem is one of adjustment to the situation that is given.

When every legitimate criticism of the subjective theory of value has been taken into account, it still remains the unshakable achievement of this theory that it focuses attention on this fact, as important in applied Economics as in the purest of pure theory. As a last example of the importance for applied Economics of the propositions we have been considering, we may examine certain misconceptions 1 Compare Pigou, Economics of Welfare, 3rd edition, pp. 190-192. It is, perhaps, worth noting that most contemporary discussion of the socalled Transport Problem completely ignores these elementary considerations. If there is a concealed subsidy to motor transport through public expenditure on roads, this is a matter for the Chancellor of the Exchequer. It is no argument for attempting to make people go by train who prefer to travel by road. If we want to preserve railways which are unprofitable in the present conditions of demand, we should subsidise them as ancient monuments.

in RELATIVITY OF ECONOMIC " QUANTITIES " 53 with regard to the economic effects of inflation. It is a wellknown fact that during periods of inflation there is often for a time extreme activity in the constructional industries. Under the stimulus of the artificially low interest rates, overhauling of capital equipment on the most extensive scale is often undertaken. New factories are built. Old factories are reequipped. To the lay mind, there is something extraordinarily fascinating about this spectacular activity; and when the effects of inflation are being discussed, it is not infrequently regarded as a virtue that it should be instrumental in bringing this about. How often does one hear it said of the German inflation that, while it was painful enough while it lasted, it did at least provide German industry with a new capital equipment. Indeed, no less an authority than Professor F. B. Graham has given the weight of his authority to this view.1 But, plausible as all this may seem, it is founded on the same crude materialist conception as the other fallacies we have been discussing. For the efficiency of any industrial system does not consist in the presence of large quantities of up-to-date capital equipment, irrespective of the demand for its products or the price of the factors of production which are needed for the profitable exploitation of such equipment. It consists in the degree of adaptation to meet demand of the organisation of all resources. Now it 1 Exchange, Prints and Production in Hyperinflation : Germany, 19201923, p. 320. "So far as output is concerned, there is little support in actual statistics for the contention that the evils of inflation were other than evils of distribution." In his conclusion, Professor Graham does indeed make the grudging admission that "in the later stages of inflation, investment in durable goods took on a bizarre aspect". But he seems to believe that the "quality" of capital equipment may deteriorate without any detriment to its "quantity".

54 SIGNIFICANCE OF ECONOMIC SCIENCE OH. can be shown1 that, during times of inflation, the artificially low rates of interest tend to encourage expansion of certain kinds of capitalistic production in such measure that, when the stimulus is exhausted, it is no longer possible to work them as profitable undertakings. At the same time, liquid resources are dissipated and exhausted. When the slump comes, the system is left high and dry with an incubus of fixed capital too costly to be worked at a profit, and a relative shortage of "liquid capital" which causes interest rates to be stringent and oppressive. The beautiful machinery which so impressed the newspaper correspondents is still there, but the wheels are empty of profit. The material is there. But it has lost its economic significance. Considerations of this sort might have been thought to be very remote from reality at the time of the German inflation or at the time of stabilisation. After years of chronic " capital shortage" in that unhappy country, they begin to appear less paradoxical.2 4. It is time to return to more abstract considerations. We have next to consider the bearing of our definitions upon the meaning of Economic Statistics.

Economic Statistics employ two kinds of units of reckoning—physical units and value units. Reckoning is by "weight and tale" or by valuation—so many tons of coal, so many pounds sterling worth of coal. From the point of view of economic analysis, what meaning is to be attached to these computations? 1 See Mises, The Theory of Money and Credit, pp. 339-366; Hayek, Monetary Theory and the Trade Cycle, and Prices and Production; Strigl, Die Produklion unier dem Einflusse einer Kreditexpansion (8chriften des Vereins fur Sozialpolitilc, Bd. 173, pp. 187-211). 2 See Bonn, Das Schicksal des äetitscAen Kapitalismus, pp. 14-31. Breaciani-Turroni, II Vicendi del Marco Tedesco.

in RELATIVITY OF ECONOMIC " QUANTITIES " 55 So far as physical reckonings are concerned, what has been said already is sufficient. There is no need further to labour the proposition that, although, as records of fact, physical computations may be unimpeachable and, in certain connections, useful, yet from the point of view of the economist they have no significance apart from relative valuations. No doubt, assuming a certain empirical permanence of relative valuations, many physical series have direct significance for applied Economics. But from the logical point of view this is an accident. The significance of the series always depends upon the background of relative valuation. So far as reckonings in terms of value are concerned, there are other subtler difficulties which we must now proceed to unravel. According to modern price theory, the prices of different commodities and factors of production are expressions of relative scarcity, or, in other words, marginal valuations.1 Given an initial distribution of resources, each individual entering the market may be conceived to have a scale of relative valuations; and the interplay of the market serves to bring these individual scales and the market scale as expressed in relative prices into harmony with one another.2 Prices, therefore, express in money a grading of the various goods and services coming on the market.

Any given price, therefore, has significance only in relation to the other prices prevailing at that time. Taken by itself it means nothing. It is only as the expression in money terms of a certain order of preference that it means anything at all. As Samuel 1 See below, Chapter IV., Section 2. a For an exhaustive description of the process, see especially Wicksteed, Commonsense of Political Economy, pp. 212-400.

56 SIGNIFICANCE OF ECONOMIC SCIENCE OH. Bailey pointed out over a hundred years ago, "As we cannot speak of the distance of any object without implying some other object between which and the former this relation exists, so we cannot speak of the value of a commodity, but in reference to another commodity compared with it. A thing cannot be valuable in itself without reference to another thing, any more than a thing can be distant in itself without reference to another thing."1 It follows from this that the term which, for the sake of continuity and to raise certain definite associations, we have used hitherto in this chapter, the term "economic quantity" is really very misleading. A price, it is true, expresses the quantity of money which it is necessary to give in exchange for a given commodity. But its significance is the relationship between this quantity of money and other similar quantities. And the valuations which the price system expresses are not quantities at all. They are arrangements in a certain order. To assume that the scale of relative prices measures any quantity at all save quantities of money is quite unnecessary. Value is a relation, not a measurement.2 But, if this is so, it follows that the addition of prices or individual incomes to form social aggregates 1 A Critical Dissertation on Value, p. 5.

2 Recognition of the ordinal nature of the valuations implied in price is fundamental. It is difficult to overatress its importance. With one slash of Occam's razor, it extrudes for ever from economic analysis the last vestiges of psychological hedonism. The conception is implicit in Monger's use of the term Bedeutung in his statement of the Theory of Value, but the main credit for its explicit statement and subsequent elaboration is due to subsequent writers. See especially Cuhel, Zur Lehre von den Bedürjnissen, pp. 186216; Pareto, Manuel d'Economie Politique, pp. 5iO-2; and Hicks and Allen, A Reconsideration of the Theory of Value (Economica, 1934, pp. 51-76). In this important article it is shown how the most refined conceptions of the theory of value, complementarity, substitutability, etc., may be developed without recourse to the notion of a determinate utility function.

ra ßELATIVITY OF ECONOMIC " QUANTITIES " 57 is an operation with a very limited meaning. As quantities of money expended, particular prices and particular incomes are capable of addition, and the total arrived at has a definite monetary significance. But as expressions of an order of preference, a relative scale, they are incapable of addition. Their aggregate has no meaning. They are only significant in relation to each other. Estimates of the social income may have a quite definite meaning for monetary theory. But beyond this they have only conventional significance. It is important to realise exactly both the weight and the limitations of this conclusion. It does mean that a comprehensive aggregate of prices means nothing but a stream of money payments. Both the concept of world money income and the national money income have strict significance only for monetary theory—the one in relation to the general theory of indirect exchange, the other to the Ricardian theory of the distribution of the precious metals. But, of course, this does not exclude a conventional significance. If we like to assume that preferences and distribution do not change rapidly within short periods, and that certain price changes may be regarded as particularly significant for the majority of economic subjects, then no doubt we may assign to the movements of these aggregates a certain arbitrary meaning which is not without its uses. And this is all that is claimed for such estimates by the best statisticians. All that is intended here is to emphasise the essentially arbitrary nature of the assumptions necessary. They do not have an exact counterpart in fact, and they do not follow from the main categories of pure theory.

We can see the bearing of all this if we consider for a moment the use which may be made of such 58 SIGNIFICANCE OF ECONOMIC SCIENCE OH. aggregates in examining the probable effects of drastic changes in distribution. From time to time computations are made of the total money income accruing within a given area, and, from these totals, attempts are made to estimate the effects of large changes in an equalitarian direction. The best known of such attempts are the estimates of Professor Bowley and Sir Josiah Stamp.1 Now, in so far as such estimates are confined to ascertaining the initial amount of spending power available for redistribution, they are valuable and important. And, of course, this is all that has ever been contended by the distinguished statisticians who put them forward. But beyond this it is futile to attach any precise significance to them. For, by the very fact of redistribution, relative valuations would necessarily alter. The whole "set" of the productive machine would be different. The stream of goods and services would have a different composition. Indeed, if we think a little further into the problem, we can see that an estimate of this sort must very grossly overestimate the amount of productive power that would be released by such changes. For a substantial proportion of the high incomes of the rich are due to the existence of other rich persons. Lawyers, doctors, the proprietors of rare sites, etc., enjoy high incomes because there exist people with high incomes who value their services highly. Redistribute money incomes, and, although the technical efficiency of the factors concerned would be the same, their place on the relative scale would be entirely different. With a constant volume of money and a constant velocity 1 See Bowley, The Division of the Product of Industry, and Stamp, Wealth and Taxable Capacity.

HI KBLATIVITY OF ECONOMIC " QUANTITIES " 59 of circulation, it is almost certain that the main initial result would be a rise in the prices of articles of working-class consumption. This conclusion, which is obvious enough from the census of occupations, tends actually to be concealed by computations in money—pessimistic as these computations are often supposed to be. If we compute the proportion of the population now producing real income for the rich who could be turned to producing real income for the poor, it is easy to see that the increase available would be negligible. If we attempt greater precision by means of money computations, we are likely to exaggerate. And the greater the degree of initial inequality, the greater the degree of exaggeration.1 5. It is a further consequence of the conception of value as an expression of an order of preference that comparisons of prices have no precise significance, unless exchange is possible between the commodities whose prices are being compared.

It follows, therefore, that to compare the prices of a particular commodity at different periods of time in the past, is an operation which, by itself, does not necessarily afîord results which have further meaning. The fact that bread last year was 8d. and bread this year is 6d. does not necessarily imply that the relative scarcity of bread this year is less than the relative scarcity of bread last year. The significant comparison 1 Of course, this is not necessarily so. If, instead of spending their incomes on the expensive services of doctors, lawyers, and so on, the rich were in the habit of spending them on vast retinues of retainers who wert supported by the efforts of others, the change in money incomes might release factors which, from the point of view of the new conditions of demand, represented much productive power. But in fact this is not the case. Even when the rich do support vast retinues of retainers, the retainers spend most of their time looking after each other. Anyone who has lived in a household in which there was more than one servant will realise the force of this consideration.

60 SIGNIFICANCE OF ECONOMIC SCIENCE OH. is not the comparison between 8d. last year and 6d. this year, but the comparison between 8d. and other prices last year and the comparison between 6d. and other prices this year. For it is these relationships which are significant for conduct. It is these relationships alone which imply a unitary system of valuations.1 At one time it used to be thought that these difficulties could be overcome by correcting individual prices for variations in the "value of money". And it may be admitted that, if the relations between each commodity and all the others save the one under consideration remained the same, and only the supply of money and the demand or supply of this particular commodity altered, such corrections would be sufficient. If, that is to say, the original price relationships were P.=P,=P«=P,=P. (1) and in the next period they were P.-èP»=iP.=*P,=iP. (2) then matters would be simple, and the comparison would have some meaning. But such a relationship is 1 On all this, the classical discussion is still to be found in Samuel Bailey's chapter (op. cit., pp. 71-93) "On comparing commodities at different periods". Bailey overstates his case to this extent, that he does not mention prospective value relations through time (see below, p. 61). But in every other respect his position is unassailable, and his demonstrations are among the most elegant to be found in the whole range of theoretical analysis. Even the most blase could scarcely resist a thrill at the exquisite delicacy of his exhibition of the ambiguities of the first proposition of Ricardo's Principles.

£t was one of the few real injuries done to the progress of Economic Science by the solidarity of the English Classios that, presumably because of its attacks on Ricardo and Malthus, Bailey's work was allowed to drop into neglect. It is hardly an exaggeration to say that the theory of index number is only today emancipating itself from errors into which a regard to Bailey's main proposition would effectively have prevented it from falling.

m RELATIVITY OF ECONOMIC " QUANTITIES " 61 not possible save as a result of a series of compensatory accidents. This is not merely because demand or the conditions of production of other commodities may change. It is because almost any conceivable change, either real or monetary, must bring about different changes in the relation of a particular good to each other commodity. That is to say, save in the case of a compensatory accident, any change will lead not to a new set of relationships of the order of equation (2), but rather to a set of relationships of the order P„=ÌP„=iP„=fP.=P (3) It has long been recognised that this must be the case with real changes. If the demand for a changes, it is most improbable that the demand for b, c, d, e . . . will change in such a way that the change in relation between a and b will be equivalent to the change in relation to b and c . . . and so on. With changes in technique, factors of production which are released from the production of a will not be likely to be distributed between b, c, d in such proportions as to preserve P6 : Pc : : P„ : Pá . . . But, as may be demonstrated by very elementary reasoning,1 the same is true of "monetary" changes. It is almost impossible to conceive a "monetary" change which does not affect relative prices differently. But, if this is so, the idea of precise "correction" of price changes over time is illusory.2 Samuel Bailey's conclusion remains: "When we say that an article in a former 1 See especially Hayek, Prices and Production, oh. iii.

2 It is not always realised that the difficulty of attaching precise meaning to the idea of changes in value, if there are more than two commodities and the ratios of exchange between one and the rest do not move in the same proportion, is not limited to the idea of changes in the "value of money". The problem of conceiving changes in the "purchasing power" of pig iron is just as insoluble as the problem of conceiving changes in the purchasing power of money. The difference is a practical one. The fact that 62 SIGNIFICANCE OF ECONOMIC SCIENCE OH. age was of a certain value, we mean that it exchanged for a certain quantity of some other commodity. But this is an inapplicable expression in speaking of only one commodity at two different periods."1 It is important to realise the exact significance of this proposition. It does not deny the possibility of intertemporal price relationships. Quite clearly, at any moment, anticipations of what prices will be at a future period inevitably influence present valuations and price relationships.2 It is possible to exchange goods now for goods in the future, and we can conceive an equilibrium direction of price change through time. This is true and important. But while there is and must be a connection between present prices and anticipations of future prices, there is no necessary connection or significant value relationship between present prices and past prices. The conception of an equilibrium relationship through time is a hypothetical relationship. It is realised only in so far as anticipations are proved to have been justified.

Through history, the data change, and though at every moment there may be tendencies towards an equilibrium, yet from moment to moment it is not the same equilibrium towards which there is movement. There is a fundamental asymmetry in price relationships through time. The future—the apparent future, that is to say—affects the present, but the past is irrelevant. The effects of the past are now simply part of the data. production is determined by relative valuations makes it unnecessary for practical purposes to worry about changes in the purchasing power of pig iron, while for all sorts of reasons, some good, some bad, we are obliged to worry a good deal about the effects of "monetary" changes. 1 Op. cü., p. 72. 2 See Fetter, Economic Principles, p. 101 ff„ and pp. 235-277. See also Hayek, Das interiemporàU Glek,hgewichtsysUm der Preise und die Bewegungen its "Qeldwerles`` (Wellwirtschaftliches Archiv, Bd. 28, pp. 33-76).

m RELATIVITY OF ECONOMIC " QUANTITIES " 63 So far as the act of valuation is concerned, bygones are forever bygones. Here, again, as in the case of our considerations regarding aggregates, there is no intention of denying the practical utility and significance of comparisons of certain prices over time, or of the value of "corrections" of these prices by suitably devised index numbers. It is not open to serious question that for certain questions of applied Economics on the one hand, and interpretation of history on the other, the index number technique is of great practical utility. Given, a willingness to make arbitrary assumptions with regard to the significance of certain price sums, it is not denied that conclusions which are important for practice may be reached. All that it is desired to emphasise is that such conclusions do not follow from the categories of pure theory, and that they must necessarily involve a conventional element depending either upon the assumption of a certain empirical constancy of data1 or upon arbitrary judgments of value with regard to the relative importance of particular prices and particular economic subjects.

6. The interpretation of economic statistics is not 1 As in discussions of changes in real income and the cost of living. On all this see Haberler, Der Sinn der Indexzahlen, passim. Dr. Haberler's con elusion is definitive. "Die Wissenschaft macht sich einer Grenzüberschreitung schuldig, sie fällt ein Werturteil wenn sie die Wirtschaftsubjekte belehren will welches von zwei Naturaleinkommen daa 'grössere' Realeinkommen enthält. Darüber zu entscheiden, welches vorzuziehen ist, sind einzig und allein die Wirtschafter selbst berufen." p. 83 ("Soience is guilty of trespassing beyond its necessary limits—that is to say. it is delivering a judgment of value—if it attempts to lay down for others which of two real incomes is the 'larger'. To decide on this, to decide which real income is to be preferred, is a task which can only be done by him who is to enjoy it— that is, by the individual as 'economic subject'". The translation is very free, for there is no English equivalent to the very useful German contrast between Naturaleinkommen and Sealeinkommen unless we use "Real income"

as equivalent to Naturaleinkommen and Fetter's "Psychic income" for the German Sealeinkommen).

64 SIGNIFICANCE OF ECONOMIC SCIENCE OH. the only department of economic studies to be affected by this conception of our subjectmatter. The arrangement and elaboration of the central body of theoretical analysis is also considerably modified. This is an interesting example of the utility of this kind of investigation. Starting from the intention to state more precisely the subject of our generalisations, we reach a point of view which enables us, not only to pick out what is essential and what is accidental in those generalisations, but also to restate them in such a way as to give their essential bearing much greater force. Let us see how this happens. The traditional approach to Economics, at any rate among English-speaking economists, has been by way of an enquiry into the causes determining the production and distribution of wealth.1 Economics has been divided into two main divisions, the theory of production and the theory of distribution, and the task of these theories has been to explain the causes determining the size of the "total product" and the causes determining the proportions in which it is distributed between different factors of production and different persons. There have been minor differences of content under these two headings. There has always been a great deal of trouble about the position of the theory of value. But, speaking broadly, up to quite a recent date, this has been the main "cut"

into the body of the subject. Now, no doubt, there is a strong prima facie case for this procedure. As Professor Cannan urges,2 the 1 See Cannan, Theories of Production and Distribution, ch. ii. 2 "The fundamental questions of economics are why all of us taken together are aa well off as we are and why some of us are much better off and others much worse off than the average ..." (Cannan, Wealth, 3rd edition, p. v).

m RELATIVITY OF ECONOMIC " QUANTITIES " 65 questions in which we are interested from the point of view of social policy are—or at any rate appear to be —questions relating to production and distribution. If we are contemplating the imposition of a tax or the granting of a subsid3r, the questions we tend to ask (whether we understand what we mean or not) are: What will be the effects of this measure on production? What will be its effects on distribution? It is not unnatural, therefore, that, in the past, economists have tended to arrange their generalisations in the form of answers to these two questions.1 Yet, if we bear in mind what has been said already with regard to the nature of our subjectmatter and the relativity of the "quantities" it contemplates, it should be fairly clear that from this point of view the traditional division has serious deficiencies. It should not be necessary at this stage to dwell upon the inappropriateness of the various technical elements which almost inevitably intrude into a system arranged on this principle. We have all felt, with Professor Schumpeter, a sense almost of shame at the incredible banalities of much of the socalled theory of production—the tedious discussions of the various forms of peasant proprietorship, factory organisation, industrial psychology, technical education, etc., which are apt to occur in even the best treatises on general theory arranged on this plan.2 1 Whether their generalisations did answer the questions, especially that relating to personal distribution, is another matter (see Cannan, Economic Outlook, pp. 215-253, and Review of Economic Theory, pp. 284-332; see also Dalton, Inequality of Incomes, pp. 33-158). The point is that they thought they ought to answer them. The fact that they did not is not necessarily to the discredit either of economists or their generalisations.

There is strong reason for supposing that personal distribution is determined in part by extra-economic causes. 2 See Schumpeter, Das Wesen unã der Hauplin!uiÜ der theoretischen Nalionalö`konomie, p. 156. 5 66 SIGNIFICANCE OF ECONOMIC SCIENCE OH. But there is a more fundamental objection to this procedure; it necessarily precludes precision. Scientific generalisations, if they are to pretend to the status of laws, must be capable of being stated exactly. That does not mean, as we shall see in a later chapter, that they must be capable of quantitative exactitude. We do not need to give numerical values to the law of demand to be in a position to use it for deducing important consequences. But we do need to state it in such a way as to make it relate to formal relations which are capable of being conceived exactly.1 Now, as we have seen already, the idea of changes in the total volume of production has no precise content. We may, if we please, attach certain conventional values to certain indices and say that we define a change in production as a change in this index; for certain purposes this may be advisable. But there is no analytical justification for this procedure. It does not follow from our conception of an economic good. The kind of empirical generalisation which may be made concerning what causes will affect production in this sense, can never achieve the status of a law.

For a law must relate to definite conceptions and relationships; and a change in the aggregate of production is not a definite conception. As a matter of fact, nothing which can really be called a "law" of production in this sense has ever been elaborated.2 Whenever the generalisations of 1 See üdgiworth, Mathematical Psychics, pp. 1-6; Kaufmann, Was !cann die mathematische Methode in der Nationalökonomie leisten? (Zeitschrift für Nationalökonomie, Bd. 2, pp. 754-779). 2 The nearest approach to a law of production is embodied in the celebrated Optimum Theory of Population. This starts from the perfectly precise law of Non-proportional Returns which relates to variations of productivity in the proportionate combinations of individual factors, and appears to achieve a similar precision in regard to variations of all human ra RELATIVITY OF ECONOMIC " QUANTITIES " 67 economists have assumed the form of laws, they have related not to vague notions such as the total product, but to perfectly definite concepts such as price, supply, demand, and so on. The Kicardian System which, in this respect, provides the archetype of all subsequent systems, is essentially a discussion of the tendencies to equilibrium of clear-cut quantities and relationships. It is no accident that wherever its discussions have related to separate types of economic goods and ratios of exchange between economic goods, there the generalisations of Economics have assumed the form of scientific laws.1 For this reason, in recent years economists have tended more and more to abandon the traditional arrangement. We no longer enquire concerning the causes determining variations of production and distribution. We enquire rather concerning the conditions of equilibrium of various economic "quantities",2 given certain initial data, and we enquire concerning the effects of variations of these data. Instead of factors in a fixed material environment. In fact, however, it introduces conceptions of averages and aggregates to which it is impossible to give meaning without conventional assumptions. On the Optimum Theory see my Optimum Theory of Population in London Essays in Economics, edited by Dalton and Gregory. In that essay I discussed the difficulties of averaging, but I had not then perceived the full weight of the general methodological difference between statements relating to averages and statements relating to precise quantities. Hence my emphasis on this point is insufficient.

1 It is important not to overstress the excellence of past procedure. The theory of money e.g., although in many respects the moat highly developed branch of Economic Theory, has continually employed pseudoconcepts of the sort we have just declared suspect—the price level, move, ments of purchasing power parities, etc. But it is just here that the difficulties of monetary theory have persisted. And recent improvements in monetary theory have been directed to eliminating all dependence on these fictions. 2 On the various types of equilibrium contemplated, see Knight, Bisk, Uncertainty and Profit, p. 143, note; Wicksell, Lectures ore Political Economy, vol. i; and Robbins, On a Certain Ambiguity in the Conception of Stationary Equilibrium (Economic Journal, vol. xl., pp. 194-214).

68 SIGNIFICANCE OF ECONOMIC SCIENCE OH. dividing our central body of analysis into a theory of production and a theory of distribution, we have a theory of equilibrium, a theory of comparative statics and a theory of dynamic change. Instead of regarding the economic system as a gigantic machine for turning out an aggregate product and proceeding to enquire what causes make this product greater or less, and in what proportions this product is divided, we regard it as a series of interdependent but conceptually discrete relationships between men and economic goods; and we ask under what conditions these relationships are constant and what are the effects of changes in either the ends or the means between which they mediate and how such changes may be expected to take place through time.1 As we have seen already, this tendency, although in its completest form very modern indeed, has its origin very early in the literature of scientific Economics. Quesnay's Tableau Economique was essentially an attempt to apply what is now called equilibrium analysis. And, although Adam Smith's great work professed to deal with the causes of the wealth of nations, and did in fact make many remarks on the general question of the conditions of opulence which are of great importance in any history of applied Economics, yet, from the point of view of the history of theoretical Economics, the central achievement of his book was his demonstration of the mode in which the division of labour tended to be kept in equilibrium by the mechanism of relative prices—a demonstration 1 See Pareto, Manuel d`E¢onomie Politique, p. 147 ; also my article on Production in the Encyclopaedia of the Social Sciences. In the first edition of this essay I subsumed the theory of comparative statics and the theory of dynamic change under the single heading, "Theory of Variations." I now think it it better to make explicit the two types of variation theory. For further elucidations see below, Chapter IV., Section 7.

ni RELATIVITY OF ECONOMIC " QUANTITIES " 69 which, as Allyn Young has shown,1 is in harmony with the most refined apparatus of the modern School of Lausanne. The theory of value and distribution was really the central core of the analysis of the Classics, try as they might to conceal their objects under other names. And the traditional theory relating to the effects of taxes and bounties was always couched in terms thoroughly consistent with the procedure of modern comparative statics. Thus, though the appearance of modern theory may be new, its substance is continuous with what was most essential in the old. The modern arrangement simply makes explicit the methodological foundations of the earlier theories and generalises the procedure.2 At first sight it might be thought that these innovations ran the risk of over-austerity; that they involved dispensing with a mass of theory which is genuinely illuminating. Such a belief would be founded on an absence of knowledge of the potentialities of the new procedure. It may safely be asserted that there is nothing which fits into the old framework, which cannot be more satisfactorily exhibited in the new.

The only difference is that, at every step in the new arrangement, we know exactly the limitations and implications of our knowledge. If we step outside the 1 Op cü„ pp. 540-542. 2 The beginning of the change dates from the coming of the subjective theory of value. So long as the theory of value was expounded in terms of costs, it was possible to regard the subjectmatter of Economics as something social and collective, and to discuss price relationships simply as market phenomena. With the realisation that these market phenomena were, in fact, dependent on the interplay of individual choice, and that the very social phenomena in terms of which they were explained—costs—were in the last analysis the reflex of individual choice—the valuation of alternative opportunities (Wieser, Davenport)—this approach becomes less and less convenient. The work of the mathematical economists in this respect only sets out particularly boldly a procedure which is really common to all modern theory.

70 SIGNIFICANCE OF ECONOMIC SCIENCE OH. sphere of pure analysis and adopt any of the conventional assumptions of applied Economics, we know just where we are. We are never in danger of asserting as an implication of our fundamental premises something which is smuggled in on the way by means of a conventional assumption. We may take as an example of the advantages of this procedure the modern treatment of organisation of production. The old treatment of this subject was very unsatisfactory: A few trite generalisations about the advantages of the division of labour copied from Adam Smith, and illustrated perhaps by a few examples from Babbage; then extensive discursions on industrial "forms" and the "entrepreneur" with a series of thoroughly unscientific and question-begging remarks on national characteristics—the whole wound up, perhaps, with a chapter on localisation. There is no need to dwell on the dreariness and mediocrity of all this. But it is perhaps just as well to state definitely its considerable positive deficiencies. It suggests that from the point of view of the economist "organisation" is a matter of internal industrial (or agricultural) arrangement—if not internal to the firm, at any rate internal to "the" industry—although, as might be expected, "the" industry is seldom satisfactorily defined. At the same time it tends to leave out completely the governing factor of all productive organisation — the relationship of prices and costs. That comes in a different division which deals with "value". As a result, as almost any teacher who has taken over students reared on the old textbooks will realise, it was quite possible for a man to have an extensive knowledge of value theory and its copious refinements and to be able to prattle m RELATIVITY OF ECONOMIC " QUANTITIES " 71 away at great length about the rate of interest and its possible "causes", without ever having realised the fundamental part played by prices, costs, and interest rates in the organisation of production.

In the modern treatment this is impossible. In the modern treatment, discussion of "production" is an integral part of the theory of equilibrium. It is shown how factors of production are distributed between the production of different goods by the mechanism of prices and costs, how given certain fundamental data, interest rates and price margins determine the distribution of factors between production for the present and production for the future.1 The doctrine of division of labour, heretofore so disagreeably technological, becomes an integral feature of a theory of moving equilibrium through time. Even the question of "internal" organisation and administration now becomes related to an outside network of relative prices and costs; and since this is how things work in practice, what is at first sight the greater remoteness of pure theory in fact brings us much nearer to reality. 1 The best discussions are to be found in Wioksell, Lectures on Political Economy, vo].i., pp. 100-206 ; Hans Mayer, Produktion in the Handwörterbuch der Staatswissenschaften.