Foreword

to the English translation
by G. L. S. SHACKLE

The great economic theoreticians whose work was completed in the first century and a half from the publication of The Wealth of Nations are hardly more than a score. In the compiling of such a list the name of Wicksell would be an early and unquestioned entry, and some might say that he more than any other was the precursor and prophet of modern macroeconomic theory, and provided some of its chief elements a full generation before their power and significance were properly recognized. Wicksell’s life coincides to the very year at its beginning and its end with the second half of this first 150 years in the main history of economics: seventy-five years carries us from The Wealth of Nations in 1776 to the birth of Wicksell in 1851, and seventy-five years again to his death in 1926.

The early economists beheld a society whose members seemed to fall easily into broad classes according to the parts they played in the economic process. There were those who worked with their hands, those who owned the resources of nature, and those who had accumulated a reserve of more adaptable, mobile or directly enjoyable wealth which made it possible for society to use methods of production affording, as it were, a certain leverage to men’s efforts in their endeavour to wrest a living from their surroundings. A prime question which interested these early economists was what principle or mechanism determines the proportions in which the whole product is shared out amongst these classes, the workers, landowners, and capitalists. The idea that men’s and nature’s work are rewarded with a share of what they jointly produce is easily accepted: but what is the essential nature of the service rendered by an accumulated stock of wealth? How does the availability of such a stock increase the effectiveness with which men’s work is applied to nature? And what determines the size which such a stock will at any date attain? The first economist to propose an exact answer to these questions, and thus to construct a theory accounting for the claim of capital owners to a share of the whole produce, and for the precise size of this share, was Böhm-Bawerk ; and the essence of his answer was a theory of the role of time in the economic process. Böhm-Bawerk was born in the same year as Wicksell, and it is interesting to compare their early careers. Wicksell devoted himself first to mathematics. After taking his first degree in 1872 he seems to have allowed himself a long exploratory period in which postgraduate studies were interrupted by work as a school teacher. He took his final degree in mathematics in 1885, and thus it was not until his thirty-fifth year that he was ready to attack seriously the study of economics. He spent the next five years in England, Germany, Austria and France, and thus was in Austria in those very years when Böhm-Bawerk, whose study of law had led him directly to economics at an earlier age, was completing his theory of capital. Böhm-Bawerk’s greatest contribution to economic theory was thus made while Wicksell was still, in economics, in some sense a student. But Wicksell had spent his time in equipping himself with mathematics, and it was this equipment which enabled him to give a more precise and elegant shape to the theory of capital and interest whose main structure had been created by Böhm-Bawerk, and to incorporate it into a general theory of the interdependent mutual determination of income shares on the principle of marginal productivity. The result was Wicksell’s first book, which appeared in 1893 under the title Über Wert, Kapital und Rente, and which has in the following pages been for the first time translated into English.

The use of the marginal analysis to explain the prices of the factors of production was achieved by several economists independently of each other, notably by Marshall, J. B. Clark and Wicksteed as well as Wicksell. The thinking on marginal lines which Marshall embodied in his Principles was begun before 1870, but The Principles of Economics was not published till 1890. J. B. Clark’s The Distribution of Wealth was not published till 1899, but Clark had been working on its substance for a decade before publication. Wicksell is said to have conceded the claim that it was Wicksteed who, in his Essay on the Co-ordination of the Laws of Distribution, published in 1894, first showed that, under some restrictive but still interesting definitions and assumptions, if each engaged unit of each factor of production is paid the marginal product of that factor, the whole produce will be exactly exhausted without surplus or deficit. But this proposition is at least implicit in Über Wert, Kapital und Rente. Thus Wicksell’s first great contribution to economic theory used the method nowadays called comparative statics, whereby we study the ultimate and supposedly stable consequences themselves of some change of the governing conditions, rather than the mechanism or process by which those consequences are brought about. But Wicksell had in a supreme degree the urge and the power to synthesize, to see economic theory as a comprehensive unity where every important economic phenomenon must find an explanation at least compatible with that of every other such phenomenon. His mathematical training, or perhaps the natural aptitude and proclivity of mind that had led him to seek such a training, must have been a powerful factor in this drive towards synthesis. Über Wert, Kapital und Rente was a first step, for it brought time, in some aspects at least, into the previously timeless theory of value and income distribution. When Wicksell began to work on the explanation of what determines the general level of money prices and of how the changes of this level come about, he did not turn his back on the theory of the ‘real’ economic forces and start afresh, but on the contrary the theory of the ‘real’ interest rate, which he had developed in Über Wert, Kapital und Rente on Böhm-Bawerkian foundations, became a central and essential element. And this theory of the general price level turned out to be one of the chief sources of inspiration for later theorists of the business cycle and thus an integral part of a still more inclusive conception.

Wicksell’s work was like a mountain from whose flanks divergent streams run down and bring fertility to widely separated fields, only to merge again later into a single broad river. For the fiercest and most exciting battle of economic theory in the first half of the twentieth century was that fought in the middle thirties between the adherents of Professor Hayek’s over-investment theory of the business cycle, on the one hand, and Lord Keynes and his lieutenants on the other. No two theories, it seemed at that time, could be more directly opposed to each other in method and conclusions. Yet in both of the books from which the controversy started, Keynes’s Treatise on Money which appeared in 1930 and Professor Hayek’s Prices and Production which was published in 1931, Wicksell’s name was prominent and the power and insight of his analysis acknowledged.¹ And the solution of this paradox, as we can now discern it, is no less surprising: Lord Keynes was setting out the theory of under-employment and Professor Hayek that of over-employment; these were in a fundamental sense two sides of the same theory, one of them describing what happens when effective demand for productive resources is less than the available resources and the other explaining the mechanism of boom, crisis, and collapse which result from an attempt to use more resources than there are. The flat contradiction in which the two theories seemed to confront each other was illusory; they were no more contradictory than the two statements, that if a stone is denser than water it will sink, and if a cork is less dense than water it will float. The basis of Professor Hayek’s theory was the Austrian theory of capital, which Böhm-Bawerk had founded and Wicksell had interpreted and refined. Professor Hayek showed how the power of the banking system to create money and thus, through an ‘artificially’ low market rate of interest, delude the economy into thinking that it had a larger potential flow of real investible resources than in fact it had, could lead to a crisis where people might find themselves rich in half-constructed railways but starving for lack of today’s dinner; and it is precisely the mechanism and nature of the ultimate dependence of our choice of methods of production upon our available reserves of sustenance that Wicksell, following Böhm-Bawerk and in essence the wage-fund theorists, is concerned with in Über Wert, Kapital und Rente. The banks’ power to create money? But this is also what Keynes was concerned with in his Treatise, and again what Wicksell had been concerned with in his famous book Geldzins und Güterpreise, published in 1898, in which the essential and many-fold importance of time in the economic process is made the king-pin of a fundamental synthesis.

In the early 1870’s Jevons, Menger and Walras had independently and almost simultaneously created the marginal utility theory of value, which explains how the ratios in which different goods exchange for one another are determined by the balancing of marginal subjective desires. But there was one startling omission from the list of things whose value in terms of each other could be thus accounted for. The subjective theory of relative prices depends on the principle of diminishing marginal utility; utility, that is to say, for purposes of consumption. But money is not consumed, it is merely exchanged or stored, its utility must therefore be of quite a different kind from that of consumable goods, and its value in terms of these goods must require some different principle for its explanation. In Wicksell’s own words ‘It is of no consequence whatever to a purchaser that he has to pay more for one commodity provided he can be certain of himself obtaining a correspondingly higher price for some other commodity.’¹ The general level of absolute or money prices was, in fact, left unexplained by the marginal utility theory of value, and some other account had to be given of it. Until the appearance of Geldzins und Güterpreise the prevailing explanation was the Quantity Theory, whose crude arithmetical argument presents a striking contrast, às Professor Hicks has pointed out,² with the subtlety of the theory of value. The Quantity Theory assumes that the frequency with which money units change hands, when averaged over all the money units in existence, is fairly constant through time, and from this deduces that the total money value of transactions per unit of time is proportional to the number of money units in existence. Thus so long as the size of the stream of goods being bought and sold remains in some sense unchanging, the general level of prices will depend on the Quantity of Money, that is, on the number of money units in existence.

Wicksell by no means rejected the Quantity Theory in toto, but he was disturbed by its dependence, in its classical form, on the assumption of a constant velocity of circulation of money: ‘The Quantity Theory,’ he says,¹ ‘is theoretically valid so long as the assumption of ceteris paribus is firmly adhered to. But among the “things” that have to be supposed to remain “equal” are some of the flimsiest and most intangible factors in the whole of economics—in particular the velocity of circulation of money, to which, in fact, all the others can be more or less directly referred back.’ How strongly these words suggest Lord Keynes’s later pre-occupation with the elusive essence of money and its recalcitrance to a purely mechanical, non-psychological analysis. Ricardo had, of course, believed that there was an intimate and indeed an obvious connection between changes in the quantity of money, changes in the general level of prices (or its inverse, the value of money) and the level of the interest-rate. A willingness of the banking system to increase continually the outstanding amount of its loans or of its note issue could express itself, and become effective, only by a low rate of interest. As soon as the outflow of extra money into public circulation ceased, prices of goods would soon adjust themselves to this new larger quantity of the circulating medium; at these new higher prices, the quantity of money would no longer be in effect any greater than before, and the interest-rate would accordingly return to its former level. But Wicksell, though agreeing with Ricardo’s conclusion, did not think that Ricardo had penetrated deeply enough into the mechanism by which interest, the quantity of money, and the price-level are connected with each other. For what, he asked, is a low rate of interest? By what criterion do we judge when the rate of interest is low? By comparison with what is it low?

Wicksell found the answer by looking back at that branch of economic theory which had been his earliest concern, and which he had expounded in Über Wert, Kapital und Rente, the theory of capital. The more highly articulated, specialized and elaborate the system of equipment becomes through which men apply their effort to their natural environment, the larger the ultimate reward to a given effort, but to carry the elaboration from a given degree to a still higher one implies the foregoing of, say, N units of consumable output which would have been available in year T in exchange for the prospect of an extra m units per year in perpetuity, beginning in year T + 1. The ratio then represents, nearly enough, what Wicksell called the natural rate of interest. It is a measure of the ‘worthwhileness,’ at any stage of the development of the economy’s total assemblage of productive equipment, of adding one more ‘unit’ to that equipment. How are such units to be defined? In making such an addition to their total equipment the people composing the economy are, in effect, postponing the consumption of some of the output which their current input of productive services entitles them to consume. The average time elapsing between the moment when a dose of work or of the services of nature is put into the productive process, and the moment when the dose of consumable product attributable to that dose of work comes out, is thus lengthened, and this average time, Böhm-Bawerk’s ‘average period of production,’ can serve as a measure of the size of the total capital equipment. A balanced assemblage of such capital equipment,¹ comprising tools, machines, buildings, flocks and herds, growing crops, forests, mines, libraries, transportation systems, and indeed the whole material frame of civilized life, is like a great reservoir into which human effort has been poured and from which the means of living can be drawn off. The metaphor of a reservoir will serve to illustrate the meaning and use of the average period of production. If a heavy shower of rain falls on an actual reservoir on a particular day, some of this rainwater will flow out for use on that same day, but a large proportion will remain for many days or weeks mixed with the rest of the reservoir’s contents, and it would indeed be possible to describe the size of the reservoir by saying how long, on the average, with a given outflow, each drop of water that enters it remains in it. The natural rate of interest, then, is a measure of the strength of the inducement to increase the average period of production; and in a given set of other circumstances, the numerical value of the natural rate, the percentage , will be a decreasing function of the length of the average period of production. But these ‘Other circumstances’ are, of course, just as important, in determining the natural rate of interest, as the average period of production itself is. In Wicksell’s own words:² ‘The natural rate is not fixed or unalterable in magnitude. ... In general, we may say, it depends on the efficiency of production, on the available amount of fixed and liquid capital, on the supply of labour and land, in short on all the thousand and one things which determine the current economic position of a community; and with them it constantly fluctuates.’ Now it was this natural rate of interest by comparison with which, at any time, the rate of interest charged by the banks for money loans could be said to be high or low. ‘Now let us suppose,’ says Wicksell,¹ ‘that the banks and other lenders of money lend at a different rate of interest, either lower or higher, from that which corresponds to the current value of the natural rate of interest on capital. The economic equilibrium of the system is ipso facto disturbed. If prices remain unchanged, entrepreneurs will in the first instance obtain a surplus profit... over and above their real entrepreneur profit or wage. This will continue to accrue so long as the rate of interest [on loans of money] remains in the same relative position. They will inevitably be induced to extend their business in order to exploit to the maximum extent the favourable turn of events,... As a consequence, the demand for services, raw materials, and goods in general will be increased, and the price of commodities must rise.’

In this brief and simple-seeming passage we have the epitome of Wicksell’s great theoretical achievement : to have shown that the link between the quantity of the circulating medium and the general price-level can be explained by reference to those same principles of individual maximization of advantage which underlie the theory of relative prices and income shares. The classical Quantity Theory was a mere piece of arithmetic masquerading as an explanation, for it did not show by what mechanism and through what human motives, decisions and conduct the change in the price-level would come about ; and without a reference to human motives and conduct there can be no understanding of price.

The value of the contribution which an economic theoretician has made to his subject is not to be assessed by means of the questions: Are the analytical tools that he invented still in use? Do we still think along precisely the lines that he laid down? The fact that ships now sail through the Suez and the Panama Canals does not lessen the importance of the voyages of Vasco da Gama and Magellan. The steam locomotive, perhaps, is nearly obsolete, but it has played its part in building up the material resources and the technical knowledge of modern society. Amongst the concepts for which a tool of rather different meaning and character has nowadays been substituted is Wicksell’s natural rate of interest, but its disappearance from our vocabulary can never alter the truth that a large part of the route to our present understanding was cleared by Wicksell’s efforts. Wicksell’s concern was with the mechanism of a continuous rise in the general price-level going on while real resources were all the time fully employed, and not in any sense with that of the growth of real output beginning in conditions of heavy under-employment. In the 1930’s, however, it was, of course, upon this latter problem that attention was concentrated, and in the Keynesian theory of employment, instead of a natural rate of interest determined by technical conditions as these work or would work in a state of full employment, a natural rate determined, that is to say, independently of the prevailing level of employment and of the supply-prices of capital goods which vary with the level of employment, a natural rate which thus stands immovable while the money rate conforms or fails to conform with it, attention was directed instead to the marginal efficiency of capital, defined as that rate of discount which, when applied to the series of expected net earnings of pieces of capital equipment, yields for these pieces a ‘present value’ equal to their current supply-price. The marginal efficiency of capital, thus defined, is, of course, a function of the supply-prices of capital goods, and will fall in numerical value as these prices are pushed upwards, along a rising supply-curve, by an increase in the level of net investment. So long as business men’s valuations of equipment stand above the supply-price of this equipment, they will have an incentive to increase the quantity of it that they order per unit of time; through this increase in the pressure upon the equipment-producing industries, the price of equipment will be raised to the point where the marginal efficiency of capital is brought to equality with the market rate of interest on loans of money. The differences between this theory of the determination of the size of the net investment flow, that is, the determination of the pace of net enlargement or improvement of the economy’s equipment, on the one hand, and Wicksell’s theory of the consequences of inducing enterprisers, through an unnaturally low interest rate, to seek to expand their operations when all real resources are already fully employed, are clear and striking and may be thought to set the two theories far apart from each other. Yet both theories clearly belong to the same family, and Wicksell’s conception, of a mechanism in which the peculiar properties of bank-created money can work through the interest rate and the inducement to expand enterprise to generate a self-propelling cumulative process, entitles him to be considered the founder of that unified theory of money, employment, and the business cycle, to which Sir Dennis Robertson, Professor Hayek, Lord Keynes and many others later gave such a complex and dramatic evolution.

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The translation here offered of Wicksell’s Über Wert, Kapital und Rente has been made by Mr. Stephen Horst Frowein. The endless care which he has lavished upon the work, his natural gift for the subtleties of language, his qualifications as an economist who graduated at the University of Bonn and studied later at the University of Leeds, and the felicity of his English prose style, have produced a translation whose excellence must, I think, be apparent to every reader, and must surely astonish those who have any practical acquaintance with the difficulties of such a task. One may fairly claim that this book, which was written by a Swede in German, here reads as though it was the original work of an Englishman. An admirable tribute has thus been paid by the translator and his publishers to the memory of a very great economist.

The value to economists and historians of economic thought of this first English version of Wicksell’s earliest book has, I think, been greatly enhanced through the generosity of Mr. Arne Amundsen of the Universitetets Socialøkonomiske Institutt of Oslo, who, with a kindness that we most warmly appreciate, has allowed his complete bibliography of Wicksell’s published works to be printed for the first time as an Appendix to this volume.

G. L. S. SHACKLE

University of Liverpool
August 28, 1953

¹ ‘There remains, however, one outstanding attempt at a systematic treatment, namely Knut Wicksell’s Geldzins und Güterpreise, published in German in 1898, a book which deserves more fame and much more attention than it has received from English-speaking economists. In substance and intention Wicksell’s theory is closely akin ... to the theory of this Treatise.’

J. M. Keynes, A Treatise on Money, Vol. I, p. 186.

¹Interest and Prices, by Knut Wicksell, translated by R. F. Kahn (Macmillan and Co. Ltd., London 1936) p. 39.

² See ‘A suggestion for simplifying the theory of money,’ by J. R. Hicks, Economica, New Series, No. 5

¹Interest and Prices, p. 42.

¹ In Über Wert, Kapital und Rente Wicksell treated highly durable goods as ‘Rentengüter,’ that is, goods whose durability renders them economically akin to the self-maintaining forces of nature.

²Interest and Prices, p. 106.

¹ Interest and Prices, p. 105.