Fifteen Great Austrian Economists
Auburn, AL.: Ludwig von Mises Institute, 1999,
pp. 113-122
Eugen von Böhm-Bawerk: Capital,
Interest, and
Time
by Roger W. Garrison
Eugen
von Böhm-Bawerk
was in the right place at the right time to contribute importantly to
the
development of Austrian economics. Studying at the University of
Vienna,
he was twenty years old when Carl Menger's Principles of Economics
appeared in print in 1871. His formal university training was in law
(and
thus he was not actually a student of Menger's), but after completing
his
doctorate in law in 1875, he began preparing himself both at home and
abroad
to teach economics in his native Austria. A parallel progression from
law
to economics characterized the career of his classmate (and, later,
brother-in-law)
Friedrich von Wieser, best known for his Natural Value
published
in 1893. The strong influence of Menger's writings on
Böhm-Bawerk's
thinking, together with a life-time relationship with Wieser, made him
a natural for expositing and developing the Austrian theory.(1)
Böhm-Bawerk's career
as a scholar, however, was an intermittent one. The most significant
span
of scholarly activity was his years at the University of Innsbruck
(1881-1889).
It was during the 1880s that he first published two of the three
volumes
of his magnum opus, Capital and Interest. His later
years
were dominated by his duties as the Austrian Minister of Finance, a
position
he held, though not continuously, throughout the 1890s and beyond-and
for
which he is fittingly honored by having his likeness on Austria's
one-hundred
schilling note. After serving in this capacity and assuming other
governmental
duties, he returned to teaching in 1904. With a chair at the University
of Vienna, he became a colleague of Wieser, successor to the retired
Menger.
Students who passed through the university during the last decade of
Böhm-Bawerk's
career (and life: he died in 1914) included Joseph Schumpeter and
Ludwig
von Mises. In 1959 the twelve-hundred pages of Capital and Interest
were translated into English by Hans Sennholz and George Huncke and
published
as a single volume. Reviewing this new translation, Mises described
this
"monumental work" as "the most eminent contribution to modern economic
theory."(2) He indicated that no one
could
claim to be an economist unless he was perfectly familiar with the
ideas
advanced in this book, and he even went so far as to suggest—as only
Mises
could—that no citizen who takes his civic duties seriously should
exercise
his right to vote until he has read Böhm-Bawerk!
The first volume of Capital
and Interest, titled History and Critique of Interest Theories (1884),
is an exhaustive survey of the alternative treatments of the phenomenon
of interest: use theories, productivity theories, abstinence theories,
and many more. Most significant in this early work is his devastating
critique
of the exploitation theory, as embraced by Karl Marx and his
forerunners:
Capitalists do not exploit workers; they accommodate workers-by
providing
them with income well in advance of the revenue from the output they
helped
to produce. More than a decade later, Böhm-Bawerk was to revisit
the
issues raised by the socialists. Karl Marx and the Close of His
System(3)
established that the question of how income is distributed among the
factors
of production is fundamentally an economic-rather than a
political-question.
And the Austrian answer effectively rebutted the labor theory of value
as well as the so-called "iron law of wages." Böhm-Bawerk's Positive
Theory of Capital (1889), offered as the second volume of Capital
and Interest, contains his most substantial and profound
contribution
to our understanding of the economy's time-consuming production
processes
and of the interest payments they entail. But this volume offers much
more.
Its treatment of "Value and Price" (Book III) builds on Menger's Principles
to present a distinctly Austrian version of marginalism. It is here
that
we find Böhm-Bawerk's celebrated discussion (p. 143) of the
pioneer
farmer faced with decisions about the allocation of his sacks of grain
among the various uses-as basic feed for himself, his chickens and his
parrots, and as an ingredient for making brandy. The essence of
Austrian
marginalism is conveyed with his telling the story of what would happen
(Parrots beware) if the farmer were to suffer the loss of one sack of
grain.
This story and many variations on it, told countless times by textbook
writers over the decades since, stand in contrast to the
twice-differentiable
total-utility functions that evolved from William Stanley Jevons'
marginalism
and the general-equilibrium equations that dominate in Leon
Walras'.
Appendicies to the third
edition of the second volume (1909-1912) appeared as a separate third
volume
in 1921 with the title Further Essays on Capital and Interest.
Here,
Böhm-Bawerk offers clarifications, qualifications, and extensions
to his theory and responds to his critics. These essays, which contain
much of substance, also reveal much about its author's scholarly and
rhetorical
methods. Böhm-Bawerk reasons like and economist and argues like a
lawyer; his most critical remarks are directed towards those whose
theories
most closely resemble his own. For instance, Gustav Cassel's theory, in
which the interest rate brings the supply and demand for "waiting" into
balance, is flatly rejected. And despite the fact that the Austrian
school
is noted for its attention to methodological matters, Böhm-Bawerk
took a no-holds-barred approach. Schumpeter articulates the implicit
maxim:
"Write little or nothing on method, and instead work the more
energetically
with all available methods."(4)
Modern economics is
notorious
for its inattention to capital in the sense of an intertemporal
structure
of intermediate goods. Production takes time, and the time that
separates
the formulation of multiperiod production plans and the satisfaction of
consumer demands is bridged by capital. If mentioned at all in modern
textbooks,
these aspects of economic reality are introduced as "the thorny issues
of capital," a tell-tale phrase that portends a dismissive treatment of
this critical subject area. Though a lacuna in mainstream economics,
Austrian
economics has almost from its beginnings given a special prominence to
capital theory. With a full awareness of all the thorns,
Böhm-Bawerk
built his academic career around the goals of understanding the
relationship
between capital and interest and extending value theory to the context
of intertemporal allocation.
Early in his career,
Böhm-Bawerk
took up a central question that was much discussed by his
contemporaries
and predecessors. "Is there any justification for the payment of
interest
to the owners of capital?"(5) The
justification,
in his view, rests on a simple fact of reality: people value present
goods
more highly than future goods of the same quantity and quality. Future
goods trade at a discount, or alternatively, present goods trade at a
premium.
The payment of interest is a direct reflection of this intertemporal
value
differential. This interest, or agio, paid to capitalists allows
workers
to receive income on a more timely basis than would otherwise be
possible.
Böhm-Bawerk's "agio theory" and its implications for the
alternative
"exploitation theory" were undoubtedly enough to win him recognition by
historians of economic thought. But with it he broke new ground and was
able to parlay his refutation of socialist doctrine into a new
understanding
of the capitalist system. His Positive Theory culminates in a
macroeconomic
model of general equilibrium that serves to illuminate the classical
issues
of capital accumulation and technical progress, to resolve the
neoclassical
problem of the existence and the determination of the rate of interest,
and to do still more. He combined his agio theory of interest with
Menger's
theory of marginal value to show that given the wage rate that the
market
establishes, profit-maximizing capitalist-entrepreneurs will engage in
production activities that not only employ the labor force to the
fullest
but also fully absorb the economy's subsistence fund.(6)
Making use of the earliest and most foundational Austrian insights and
taking an economywide perspective, Böhm-Bawerk linked the
intertemporal
structure of production to the intertemporal preferences of workers and
other income earners. Nearly a half-century before John Maynard Keynes
made assertions to the contrary and offered them up as a General
Theory,
the Positive Theory showed that the market for labor and the
market
for loanable funds-or, more broadly, the market for subsistence-could
simultaneously
find their respective equilibria.
We have it, then, that
Böhm-Bawerk
was a macroeconomist—and a self-reflective one at that. The classical
economists,
especially Ricardo, could in retrospect be considered macroeconomists
in
an era that predates any hint of the modern distinction. The
actual word "macroeconomics," of course, is a relatively modern one.
Paul Samuelson, who reorganized the subject matter of economics on the
basis of a first-order distinction between microeconomics and
macroeconomics,
traces the distinction itself to Ragnar Frisch and Jan Tinbergen and
dates
the word's debut in print to Erik Lindahl in 1939.(7)
But in his 1891 essay on "The Austrian Economists" cited
earlier,
Böhm-Bawerk wrote that "One cannot eschew studying the microcosm
if
one wants to understand properly the macrocosm of a developed economy."(8)
Packed into this understated methodological maxim is both his desire to
understand the macroeconomy and his recognition that microeconomic
foundations
are essential for a viable macroeconomics—a view that, in the
mainstream,
dates only to the mid 1960s.
To aid in his exposition
of the macroeconomics of capital and interest, Böhm-Bawerk
introduced
his bull's-eye figure-a pattern of concentric rings intended to depict
the time-structure of production. Production begins in the center with
the use of the original means (land and labor); the process emanates
outward
over time; and the final product emerges at the outermost ring to
satisfy
the consumers' ultimate ends. Two bull's eye figures appearing on
consecutive
pages are used to contrast a well-developed economy with a
less-well-developed
one.(9) This idiosyncratic depiction can
be seen as a forerunner of the more straightforward representation of
the
means-ends framework introduced by F. A. Hayek during the interwar
period.
The Hayekian triangle captures the essential linearity-not to deny that
there are significant non-linearities-in the structure of production.
The
triangle, which is divided along the time axis into "stages of
production,"
corresponds closely with the bull's eye figure, which is divided along
the radius into "maturity classes."
Though static by its very
construction, the bull's-eye figure, as well as the better known
Hayekian
triangle, is intended to facilitate the analysis of change. What is the
nature of the market forces that govern the allocation of resources
among
the various rings? Böhm-Bawerk's formal analysis-and the simple
graphics
plus some arithmetic illustrations is the extent of the
formalities-helps
the reader in "getting the picture." For Böhm-Bawerk, however,
"getting
the picture" is but a prelude to "telling the story." His story
telling,
his informal analysis of the nature of the process of change, breaks
free
of the static representation. In the case of the stationary state, the
concentric rings have two interpretations: (1) the production process
can
be seen as proceeding over time from earliest input to final output and
(2) the areas of the rings can represent the amounts of the different
kinds
of capital (goods in process) that exist at a given point in time. But
to depict the stationary state is only to establish a starting point
for
a discussion of change. Böhm-Bawerk briefly considered the
question:
"What is the procedure if we wish just to preserve the amount of
capital
in its previous magnitude?" His answer, given in short order, is
followed
by the more important question: "What must be done if there is to be an
increase in capital?" The answer to this key question, which
distinguishes
Austrian macroeconomics from what would later become mainstream
macroeconomics,
involves a change in the configuration of the concentric rings. Several
types of changes are suggested, each entailing the idea that real
saving
is achieved at the expense of consumption and of capital in the outer
rings
and that the saving makes possible the expansion of capital in the
inner
rings. Böhm-Bawerk indicates that in a market economy it is the
entrepreneurs
who bring such structural changes about and that their efforts are
guided
by changes in the relative prices of capital goods in the various
rings.
Formal or informal, the
message is clear: An expansion of the capital structure is not to be
viewed
as a simultaneous and equiproportional increase in capital in each of
the
maturity classes; it is to be viewed as a reallocation of capital among
the maturity classes. Overlooked by his predecessors and
largely
ignored by the modern mainstream, this is the market mechanism that
keeps
the economy's intertemporal production plans in line with the
intertemporal
preferences of consumers. The significance of this market mechanism was
at issue in his debate with John B. Clark, who held that once capital
is
in place, the maintenance of capital is automatic and that production
and
consumption are, in effect, simultaneous. Although a modern reader may
conclude that Böhm-Bawerk won the debate and that in later years
Hayek
was similarly victorious in his debate with Frank Knight, the
development
of mainstream macroeconomics reflects the implicit belief that it was
Clark
and Knight who won.(10)
It is easy for modern
Austrian
economists to see that Böhm-Bawerk was just a step away from
articulating
the Austrian theory of the business cycle. This step, which was
actually
taken by Mises and Hayek, would have involved a comparison of changes
in
the configuration of the rings on the basis of whether those changes
were
preference-induced or policy-induced. A change in intertemporal
preferences
in the direction of increased saving reallocates capital among the
rings
such that the economy experiences capital accumulation and sustainable
growth; a policy-induced change in credit conditions, that is, a
lowering
of the interest rate achieved by the lending of newly created money,
misallocates
capital among the rings such that the economy experiences unsustainable
growth and economic crisis.
Development of the theory
in this direction was beyond Böhm-Bawerk for the simple reason
that
he would not allow himself to venture into monetary theory. His
attitude
toward this subject matter is revealed in the letters to Swedish
economist,
Knut Wicksell,(11) whose ideas about
the
divergence of the market rate of interest and the natural rate would
become
an important part of the Austrian theory. In 1907, he wrote: "I have
not
myself given thought to or worked on the problem of money as a scholar,
and therefore I am insecure vis-à-vis this subject." In
1912:
"You know that I do not really feel competent as regards the extremely
difficult theory of money." Also in 1912, referring to The Theory
of
Money and Credit, in which Mises first articulates the Austrian
theory
of the business cycle, Böhm-Bawerk mentions to Wicksell "a book on
the theory of money by a young Viennese scholar, Dr von Mises. Mises is
a student of myself and Prof. Wieser, which, however, does not mean
that
I would want to take responsibility for all his views. I have just
begun
to read his book myself, and am not yet familiar with its content." And
finally in 1913, a year before his death, "I have not yet included the
theory of money in the subject-matter of my thinking, and I therefore
hesitate
to pass a judgement on the difficult questions it raises."
Schumpeter lists five
general
subject areas that Böhm-Bawerk excluded from his research agenda,
one of which was money: Böhm-Bawerk endorsed the "indestructible
core
of truth" in the quantity theory, but accepted the idea that money is a
veil. A second excluded area-in retrospect a clear corollary to the
first-was
business cycle theory: Böhm-Bawerk took economic crises to be
"neither
an endogenous nor a uniform economic phenomenon but rather the
consequences
of what are in principle accidental disturbances of the economic
process."
(The other three excluded subject areas are population, international
trade,
and applied price and distribution theory.)(12)
We can easily forgive
Böhm-Bawerk
for these sins of omission. When a profound thinker makes a great leap
forward, we are not entitled to complain that the leap was not greater
still. We should recognize instead that the successive leaps by Mises,
Hayek and others have made Böhm-Bawerk's look all the
greater.
Early and modern literature
on Böhm-Bawerk's economics has identified many supposed sins of
commission
as well. Much of the criticism comes from with the Austrian school: His
theory was insufficiently subjectivist. His defense of the agio theory
of interest relied needlessly on psychological considerations. His
reckoning
of production time was backward-looking rather than forward-looking.(13)
Criticism from outside the Austrian school stem largely from undue
attention
to Böhm-Bawerk's arithmetic illustrations and from attempts to
restate
his theory in the language of formal neoclassical theory. His
conclusions
about the relationship between the interest rate and the degree of
roundaboutness
in the production process apply less generally that he would have us
believe.
The economy's intertemporal structure of capital cannot be reduced to a
single number. The definitional dependence of the average period of
production
on the rate of interest invalidates much of his theory. Fortunately,
these
and many other criticisms leave intact the essential ideas that were
important
to Böhm-Bawerk and to the future development of Austrian
theory.
As substantial an economist
as Schumpeter could claim that interest is a disequilibrium phenomenon
and fantasize about a long-run equilibrium where market forces have
pushed
the interest rate to zero. John Maynard Keynes imagined interest to be
a purely monetary phenomenon. Creating what Hayek called a "mythology
of
capital," Frank Knight, following Clark, held that production and
consumption
occur simultaneously, that the period of production is irrelevant, and
that the interest rate is wholly determined by technological
considerations.
These and other twists and turns in twentieth century views of capital
and interest give increased significance to the enduring wisdom of
Eugen
von Böhm-Bawerk.
Roger W. Garrison
Auburn University
Selected Bibliography
Böhm-Bawerk, Eugen von, "The Positive
Theory of Capital
and Its Critics," Quarterly Journal of Economics, vol. 9,
(January),
1895, pp. 113-131.
________. Karl Marx and the Close of His
System.
Translated by Alice McDonald. London: T. Fisher Unwin, 1898. Reprinted
in Karl Marx and the Close of His System... New York: Augustus
M.
Kelley, 1949.
________. Capital and Interest (3
vols. in one).
South Holland, IL: Libertarian Press. Trans. By George D. Huncke and
Hans
F. Sennholz. 1959.
________. Shorter Classics of Eugen von
Böhm-Bawerk. South Holland, Ill.,
Libertarian Press,
1962
Garrison, Roger W.
"Austrian Capital
Theory: the Early Controversies," History of Political Economy,
supplement to vol. 22, 1990, pp. 133-154. Published as Bruce J.
Caldwell,
ed., Carl Menger and his Legacy in Economics Durham, NC: Duke
University
Press, 1990.
Hennings, Klaus H. "Böhm-Bawerk, Eugen
von," in John
Eatwell, Murray Milgate, and Peter Newman, eds., The New Palgrave:
A
Dictionary of Economics, 1987, pp. 254-259.
________. The Austrian Theory of Value and
Capital:
Studies in the Life and work of Eugen von Böhm-Bawerk.
Brookfield, VT: Edward Elgar, 1997.
Kirzner, Israel. Essays on Capital and
Interest: An
Austrian Perspective. Brookfield, Vt., Edward Elgar, 1996
Kuenne, Robert E. Eugen von Böhm-Bawerk
(Columbia Essays on Great Economists, No. 2). New York: Columbia
University
Press, 1971.
Mises, Ludwig von, "Capital and Interest:
Eugen
von Böhm-Bawerk and the Discriminating Reader," Freeman,
vol.
9, no. 8 (August) 1959, pp. 52-54.
Schumpeter, Joseph A. Ten
Great Economists.
New York: Oxford University Press, 1951.
________. History of
Economic Analysis.
New York: Oxford University Press, 1954.
1. Böhm-Bawerk did
receive formal
training from Karl Knies of the older Historical School and Albert
Schaffle,
who early on had written against socialist doctrine. These Viennese
economists
had a significant influence on Böhm-Bawerk's thinking according to
Klaus Hennings (The Austrian Theory of Value and Capital: Studies in
the Life and work of Eugen von Böhm-Bawerk. Brookfield,
Vt: Edward Elgar, 1997, p. 54 and passim). In the judgment of
Schumpeter
(History of Economic Analysis, New York: Oxford University
Press,
1954, p. 846), Böhm-Bawerk "was so completely the enthusiastic
disciple
of Menger that it is hardly necessary to look for other influences."
2. Ludwig von Mises, "Capital
and
Interest: Eugen von Böhm-Bawerk and the Discriminating
Reader,"
Freeman, vol. 9, no. 8 (August) 1959, p. 52.
3. Originally
a 1896
contribution to a volume in honor of Karl Knies, this counteroffensive
was translated into English and published as a book in 1898.
4.
Schumpeter, Ten
Great Economists (New York: Oxford University Press, 1951) p. 158.
5. In his
chapter on
"The Genesis of a Theory," Hennings establishes that this and similar
questions
were "in the air" at the time that Böhm-Bawerk began to write (Austrian
Theory of Value and Capital, pp. 53-73).
6. Hennings, Austrian
Theory of Value and Capital, p. 2 and 65; Schumpter, Ten Great
Economists,
p. 187. Böhm-Bawerk's own assessment in 1891 of the Austrian
contribution
is very much to the point. Citing primarily himself and Menger, he
remarks
that the Austrian economists "have set forth a new and comprehensive
theory
of capital into which they have woven a new theory of wages, besides
repeatedly
working out the problems of the entrepreneur's profits and of rent."
("The
Austrian Economists," The Annals of the American Academy of
Political
and Social Science, Philadelphia, Pa., January 1891, pp. 361-384,
Reprinted
in Shorter Classics of Böhm-Bawerk, South Holland,
Ill.:Libertarian
Press, 1962)
7. Samuelson,
Paul A.
"Credo of a Lucky Textbook Author," Journal of Economic Perspectives,
vol. 11, no. 2 (Spring), 1997, p. 157.
8. Hennings, Austrian
Theory of Value and Capital, p. 74. The fact that Böhm-Bawerk
issued so few methodological pronouncements makes this one all the more
striking.
9. Though
rarely reproduced
or discussed in modern assessments of Böhm-Bawerk, these figures
are
central to his vision of a capital-using economy. They appear in
Chapter
5, "The Theory of the Formation of Capital," of Book II "Capital as a
Tool
of Production" of Volume II, Positive Theory of Capital. Bull's
eye figures appear on pp. 106 and 107. One of the figures is reproduced
in Hennings, Austrian Theory Value and Capital, p. 131.
10. Clark's
reviewed
Capital and Interest in "The Genesis of Capital," Yale Review,
vol.
11 (November), pp. 302-315. Böhm-Bawerk responded in "The Positive
Theory of Capital and Its Critics," Quarterly Journal of Economics,
vol. 9 (January), 1895, pp. 113-131. For a modern discussion of the
Clark-Knight
view of capital, see Israel M. Kirzner, Essays on Capital and
Interest:
An Austrian Perspective (Brookfield, Vt.: Edward Elgar, 1996), pp.
60-64 and 75-77.
11. Forty
letters from
Böhm-Bawerk to Wicksell (1893-1914) are included as an Appendix to
Hennings, The Austrian Theory of Value and Capital.
12.
Schumpeter, Ten
Great Economists, pp. 161-62.
13. These
first-three-listed
criticisms are the basis for Mises' dissatisfaction with
Böhm-Barwark's
theory, according to Kirzner (Essay's on Capital and Interest,
pp.
125-128.
|