§6. Technical Superiority of Present Goods

Böhm-Bawerk is among those who sensed the inadequacy of time preference or impatience as the sole determinant of the rate of interest. Yet he calls his theory the agio theory of interest, since he finds the essence of the rate of interest in the agio, or premium, on present goods when exchanged for future goods.

Böhm-Bawerk presented the agio theory, or what is here called the impatience or time preference theory, clearly and forcibly, and disentangled it from the crude Edition: current; Page: [474] and incorrect notions with which it had previously been associated. It was only when he attempted to explain the emergence of this agio by means of his special feature of "technical superiority of present over future goods" that, in my opinion, he erred greatly.

Böhm-Bawerk distinguishes two questions: (1) Why does interest exist? and (2) What determines any particular rate of interest?

In answer to the first question, he states virtually that this world is so constituted that most of us prefer present goods to future goods of like kind and number. This preference is due, according to Böhm-Bawerk, to three circumstances: (1) the "perspective underestimate" of the future, by which is meant the fact that future goods are less clearly perceived, and therefore less resolutely striven for, than those more immediately at hand; (2) the relative inadequacy (as a rule) of the provision for present wants as compared with the provision for future wants, or, in other words, the relative scarcity of present goods compared with future goods; (3) the "technical superiority" of present over future goods, or the fact, as Böhm-Bawerk conceives it, that the roundabout or capitalistic processes of production are more remunerative than those which yield immediate returns.

The first two of these three circumstances are undoubtedly pertinent, and are incorporated, under a somewhat different form, in this book. It is the third circumstance—the so-called technical superiority of present over future goods—which, as I shall try to show, contains fundamental errors.

My criticism of this third thesis, however, does not, as some have implied, consist in denying the existence or importance of the "technical" element in interest but in Edition: current; Page: [475] denying the soundness of the way in which Böhm-Bawerk applies it. It was for the purpose of presenting what in my view constitutes the true character of this element that I have placed so much emphasis on the opportunity principles given in Chapters VII, VIII, XI and XIII of this book.

According to Böhm-Bawerk, labor invested in long processes of production will yield larger returns than labor invested in short processes. In other words, labor invested in roundabout processes confers a technical advantage upon those who have command of that labor. In the reasoning by which Böhm-Bawerk attempts to prove this technical superiority, there are three principal steps. The first consists of postulating an "average production period," representing the length of the productive processes of the community; the second consists of the proposition that the longer this average production period, the greater will be the product; and the third consists in the conclusion that, in consequence of this greater productiveness of lengthy processes, present goods possess a technical superiority over future goods.

Although the first two of these three steps are of secondary importance, the following remarks concerning them are in point. The concept of an average production period is, I believe, far too arbitrary and indefinite to form a basis for the reasoning that Böhm-Bawerk attempts to base upon it. At best, it is a special, and very hypothetical, case not general enough to include the whole technical situation.

Böhm-Bawerk himself, in his reply to my original criticism, asserts his agreement with my contention concerning the second step that, while long processes are in general more productive than short processes, this is not Edition: current; Page: [476] a universal truth. Of the infinite number of possible longer processes only those which are more productive than shorter ones are chosen.101 This is what was noted in Chapter XI when it was shown that the O curve is concave simply because the reëntrant parts are skipped!

It is the third step which is crucial to the theory of the technical superiority of present goods, namely, that the productiveness of long processes gives a special technical advantage to the possessor of present goods or present labor. This advantage produces, so Böhm-Bawerk asserted, a preference for present over future goods which is entirely apart from, and in addition to, the preference due to the underendowment of the present. Granting, for the moment, the validity of the concept of a production period, and that the longer the period, the greater its product, it may still be shown that no such technical superiority follows. Böhm-Bawerk regards this part of his theory as the most essential of all, and repeatedly states that the theory must stand or fall by the truth or falsity of that part.

Böhm-Bawerk supports his assertion of the existence of a technical superiority102 by elaborate illustrative tables.103 Each table is intended to show the investment Edition: current; Page: [477] possibilities of a month's labor available in any particular year. That longer processes are more productive than shorter ones, Böhm-Bawerk indicated by an increasing number of units of product for each successive year. The marginal utility of each year's yield when obtained is illustrated by a decreasing series, since the marginal utility of a stock of goods decreases as the number of units in the stock increases. Since the year 1888 was considered as the time of reference, or the first year in which the investment of labor was to be made, the numerical series representing the marginal utilities of the optional products as of the respective years of their production was reduced, by discounting, to a series of numbers representing the marginal utility of each year's yield as of the year 1888. The subjective value of each year's yield as of the year 1888, Böhm-Bawerk obtained by multiplying the number of units of each year's yield by its reduced marginal utility.

Of course, that investment of the month's labor available as of any particular year would be made which showed the maximum present value. When, however, the table of any one year is compared with that of any succeeding year, the maximum present subjective value selected is the greater the earlier the month's labor is available.

For example, a month's labor available in 1888 was shown to be most advantageously invested in the process which yielded the maximum present subjective value of 840 in 1890. But a month's labor available in 1889 yielded Edition: current; Page: [478] its maximum present value when invested so as to mature in 1893. In this latter case, however, the maximum was only 720 as compared with the maximum of 840 for a month's labor available in 1888.

Böhm-Bawerk therefore concludes that a month's labor available in 1888 is more productive than one available in 1889, 1890 or any succeeding year. In other words, entirely independent, according to him, of the perspective underestimate, and the under-endowment of the present, there inheres a technical superiority in present over future goods.

"This result", he writes,104 "is not an accidental one, such as might have made its appearance in consequence of the particular figures used in our hypothesis. On the single assumption that longer methods of production lead generally to a greater output, it is a necessary result; a result which must have occurred, in an exactly similar way, whatever might have been the figures of quantity of product and value of unit in the different years."

But Böhm-Bawerk is mistaken in ascribing any part of this result to the fact that the longer processes are the more productive. In his tables he assumes the existence of one or both of the other two factors—the relative under-provision for the present as compared with the future, and the perspective undervaluation of the future, due to lack of intellectual imagination or emotional self-control. It is these elements, and these alone, which produce the advantage of present over future goods which the tables display.

That the result does not at all follow from "the single assumption that longer methods of production lead generally to a greater output" and has nothing whatever to Edition: current; Page: [479] do with that assumption, we can see clearly if we make the opposite assumption from that of Böhm-Bawerk, namely, that the longer the productive process the smaller will be the return. The very same result would still follow. The labor would still be invested at the earliest possible moment. In other words, let the figures representing units of product decrease instead of increase. The only difference would be that the month's labor available in 1888 would now be so invested as to bring returns in that year instead of being invested in a two years' process as before. If calculations are performed for each year and the results are compared, it will appear that the investment in 1888 yields the highest return, just as it did on the previous hypothesis.

Again, the same result would follow if the productivity increased and then decreased in all the tables, or if the productivity should first decrease and then increase. As long as the figure representing reduced marginal utility decreases, the "units of product" may be of any description whatever, without in the least affecting the essential result that the earlier the month's labor is available, the higher is its value.

On the other hand, if the conditions are reversed and the reduced marginal utility does not decrease, the earlier available labor will not have a higher value, whatever may be the character of the "units of product."

Böhm-Bawerk, however, specifically denies this:105

"The superiority in value of present means of production, which is based on their technical superiority, is not one borrowed from these circumstances [i.e., the perspective underestimate of the future and the relative underendowment of the present]; it would emerge of its own strength even if these were not active at all. I have introduced Edition: current; Page: [480] the two circumstances into the hypothesis only to make it a little more true to life, or, rather, to keep it from being quite absurd. Take, for instance, the influence of the reduction due to perspective entirely out of the illustration."

In his table it is true that the month's labor available in the present is more highly valued than the same month's labor available at a later date. But Böhm-Bawerk carefully retained in his illustration one of the "two circumstances" which he told us could be discarded, namely, the relative overprovision for the future. To leave one of these two circumstances effective instead of both is merely to change slightly the series of "reduced marginal utility". The change in the particular numbers is quite immaterial so long as the series is still descending, and it does not matter whether the descent is due to perspective or to the relative underprovision for the present, or to both.

The only fair test of the independence of Böhm-Bawerk's third factor—the alleged technical superiority of present over future goods—would be to strike out both the other elements (underestimate and overprovision of the future) so that there should be no progressive decrease in marginal utilities; in other words, to make the numbers representing "reduced marginal utilities" all equal. Böhm-Bawerk, for some reason, hesitates to do this. He says:106

"But if we were also to abstract the difference in the circumstances of provision in different periods of time, the situation would receive the stamp of extreme improbability, even of self-contradiction."

Even if this be true, and in my view it is not, it is no reason for refusing to push the inquiry to its limit. When Edition: current; Page: [481] this is done, however, the figures of present value of the various yearly products become absolutely alike; hence the maximum of the former, if there be a maximum, must be identical with the maximum of the latter.

Though Böhm-Bawerk did not consider this case in his tables, he speaks of it briefly in his text, but seems to be somewhat puzzled by it. He says:107

"If the value of the unit of product were to be the same in all periods of time, however remote, the most abundant product would, naturally, at the same time be the most valuable. But since the most abundant product is obtained by the most lengthy and roundabout methods of production—perhaps extending over decades of years—the economic center of gravity, for all present means of production, would, on this assumption, be found at extremely remote periods of time—which is entirely contrary to all experience."

Böhm-Bawerk's confusion here is probably to be ascribed to his insistence on the indefinite increase of product with a lengthening of the production period. Practically we ought to assume that somewhere in the series the product decreases. We would then have a more practical illustration of the fact that the labor available this year and that available next year stand on a perfect equality.

The conclusion is that, if we eliminate the "other two circumstances" (relative underestimate of, and overprovision for, the future), we eliminate entirely the superiority of present over future goods. The supposed third circumstance of technical superiority, in the sense that Böhm-Bawerk gives it, turns out to be non-existent.

The fact is that the only reason any one does prefer the product of a month's labor invested today to the product of a month's labor invested next year is that today's Edition: current; Page: [482] investment will mature earlier than next year's investment.108 If a fruit tree is planted today which will bear fruit in four years, the labor available today for planting it is preferred to the same amount of labor available next year for the reason that if the planting is deferred a year, the fruit will likewise be deferred a year, maturing in five instead of four years from the present. It does not alter this essential fact to speak of the possibility of a number of different investments. A month's labor today may, it is true, be spent in planting slow-growing or fast-growing trees, but so may a month's labor invested next year. It is from the preference for the early over the late fruition of any productive process that the so-called technical superiority of present over future goods, as conceived by Böhm-Bawerk, derives all its force.

Böhm-Bawerk, however, attempts to prove that his third circumstance—the alleged technical superiority of present goods—is really independent of the first two, by the following reasoning:109

"...if every employment of goods for future periods is, not only technically, but economically, more remunerative than the employment of them for the present or near future, of course men would withdraw their stocks of goods, to a great extent, from the service of the present, and direct them to the more remunerative service of the future. But this would immediately cause an ebb-tide in the provision for the present, and a flood in the provision for the future, for the future would then have the double advantage of having a greater amount of productive instruments directed to its service, and those instruments employed in more fruitful method of production. Thus the difference in the circumstances of provision, Edition: current; Page: [483] which might have disappeared for the moment, would recur of its own accord.

"But it is just at this point that we get the best proof that the superiority in question is independent of differences in the circumstances of provision: so far from being obliged to borrow its strength and activity from any such difference, it is, on the contrary, able, if need be, to call forth this very difference.... We have to deal with a third cause of the surplus value, and one which is independent of any of the two already mentioned."

The argument here is that if "the other two circumstances" which produce interest, namely, underestimate of the future and underendowment of the present, are temporarily absent, they will be forced back into existence by the choice of roundabout processes. In other words, the technical superiority of present goods produces interest by restoring the other two circumstances. But this is tantamount to the admission that technical superiority actually depends for its force on the presence of these other two circumstances and is not independent. The essential fact is that the presence of technical superiority does not produce interest when the other two are absent.110

Although Böhm-Bawerk devoted many pages in the third edition of his book and the Supplements (Exkurse) to answering my criticisms,111 I can find nothing in his answers which affects the main argument as set forth Edition: current; Page: [484] above.112 I have omitted certain of the less important of my original criticisms to which Böhm-Bawerk has replied.

Perhaps the most interesting point about Böhm-Bawerk's failure correctly to formulate the "technical" feature which he thus vainly sought is that it is really much simpler than he imagined. It does not require his elaborate tables and comparisons among their many columns. Merely the first column of his tables contains implicitly the true "technical" feature in one of its many forms of choosing from among optional income streams. This shows the successive amounts of product obtainable for a series of production periods of different lengths. This series is exactly analogous to the successive ordinates in Chart 16 showing the lumber to be obtained from a forest at different dates. There comes a point in such a series or such a curve, where a further lengthening of the time by one year will add to the product over the preceding year (i.e., will yield a rate of return over cost Edition: current; Page: [485] both reckoned in kind) at a rate harmonizing with the rate of interest. Oddly enough Böhm-Bawerk does not mention this derivative from his table. Another form, more nearly what Böhm-Bawerk apparently was groping for, could have been presented had his table been extended to include not merely one dose of 100 days labor but many such doses and if "labor" and "product" were reduced to a common denominator. Then the product of the marginal labor would be the return while the labor itself would be the cost from which return over cost could be derived. But the comparisons which Böhm-Bawerk actually employed are beside the point.