Suppose that, making use of our entire store of technological skill and our present-day knowledge of geography, we were to undertake to resettle the earth’s surface in such a way that we should afterwards be in a position to take maximum advantage of the natural distribution of raw materials. And suppose further that for this purpose the entire capital wealth of the present were at our disposal in a form that would allow us to invest it in whatever way was regarded as the most suitable for the end in view.

In such a case the world would certainly take on an appearance that would be very considerably different from the one it now presents. Many areas would be less densely populated; others, in turn, more densely populated, than they are today. Land that is now cultivated would be allowed to lie fallow, while other land that today lies fallow would be farmed. Many mineral deposits that are presently exploited would be left unused. Factories would exist in fewer number than they do today and often in different locations. The great trade routes would follow other courses. In the factories themselves only the most modern machinery would be employed. Economic and commercial geography would have to be completely rewritten, and many machines and types of equipment still used today would remain only in museums.

It has been a repeated subject of criticism that the present actual state of affairs does not correspond to this ideal picture that we construct with the help of our technological and geographical knowledge, The fact that production has not been “made completely rational” is regarded as a sign of backwardness and wastefulness inimical to the general welfare. The prevailing ideology, which makes capitalism responsible for all evils, sees in this situation a new argument in favor of interventionism and socialism. Everywhere commissions and councils are set up “for the efficient use of resources.” An abundant literature occupies itself with questions of “the most efficient utilization of the factors of production,” and “making the economy rational” has become one of the most popular clichés of the day. The treatment given this subject, however, scarcely touches upon the problems involved.

First of all, catallactics must take as the basis of its reasoning the proposition that only “true capital,” in Clark’s sense, has mobility, but that individual capital goods do not.1  Capital goods as produced, material factors of production are intermediary steps on the way toward a definite goal?a consumer’s good. If in the course of the period of production subsequent changes in the entrepreneur’s goals are caused by a change in the data of the market, the intermediary products already available cannot always be used for the attainment of the new goals. This holds true both of goods of fixed and goods of circulating capital, although in greater measure of the former. Capital has mobility in so far as it is technologically possible to transfer individual capital goods from one branch of production to another or to transport them from one location to another. Where this is not possible, “true capital” can be shifted from branch to branch or from place to place only by not being replaced as it is used up and by the production of other capital goods elsewhere in its stead.

In accordance with the purpose of our investigation, we do not wish to take up the question of the mobility of goods of circulating capital any further. And for the time being, in considering the mobility of fixed capital, we shall disregard the case of a decrease in demand for the final product. The two questions that concern us are: What consequences are brought about by limitations in the convertibility of fixed capital in the event of a change in the conditions determining the location of industries or in the case of technological progress?

First, let us consider the second, simpler case. A new machine, more efficient than those used previously, comes on the market. Whether or not the plants equipped with the old, less efficient machines will discard them in spite of the fact that they are still utilizable and replace them by the new model depends on the degree of the new machine’s superiority. Only if this superiority is great enough to compensate for the additional expenditure required is the scrapping of the old equipment economically sound. Let p be the price of the new machine, q the price that can be realized by selling the old machine as scrap iron, a the cost of producing one unit of product by the old machine, and b the cost of producing one unit of product by the new machine without taking into account the costs required for its purchase. Let us further assume that the advantage of the new machine consists merely in a better utilization of circulating capital?for example, by saving labor?and not in manufacturing a greater quantity of products, and that thus the annual output z remains unchanged. Then the replacement of the old machine by the new one is advantageous if the yield z(a - b) is large enough to compensate for the expenditure of p - q. We may disregard the writing off of depreciation in assuming that the annual quotas are not greater for the new machine than for the old one. Consequently, the case can very well occur that plants equipped with the older model are able to compete with those equipped with the better, more recent model. Every businessman will confirm this.

The situation is exactly the same in the first case. When more propitious natural conditions of production are made accessible, plants change their location only if the difference in net proceeds exceeds the costs of moving. What makes this a special case is the fact that obstacles standing in the way of the mobility of labor are also involved. If the workers do not also migrate and if there are no workers available in the regions favored by nature, then neither can production migrate. However, we need not go into this further, since we are interested here only in the question of the mobility of capital. We need merely establish the fact that production would change its location, even if labor were perfectly mobile, only if the conditions described above were met. This too is confirmed again and again by experience.

With regard to choice of location and technological performance, new plants appear most efficient in the light of the existing situation. But in both cases that have been discussed, consideration for capital goods produced in the past under certain circumstances makes the technologically best method of production appear uneconomical. History and the past have their say. An economic calculation that did not take them into account would be deficient. We are not only of today; we are heirs of the past as well. Our capital wealth is handed down from the past, and this fact has its consequences. What is involved here is not the play of irrational factors in the rationality of economic activity, as we might perhaps be inclined to say were we to follow a fashion in science that is hardly to be recommended. Nor are we confronted here with an instance of alleged “noneconomic” motives. On the contrary, it is precisely strict rationality that induces the entrepreneur to continue production in a disadvantageous location or with obsolete equipment. Therefore it would also be a mistake to speak in this connection of “symptoms of friction.” This phenomenon can be most appropriately described as the effect of the influence of the past upon production.2

If technologically obsolete machines are retained, or if production is continued at an unfavorable location, it may still be profitable to invest new capital in these plants in order to increase their efficiency as much as the situation permits. Then a production aggregate that, from the purely technological point of view, appears outclassed can continue to compete profitably for a long time to come.

The merely technological view, which neglects the consideration of the influence of the past, finds it inexplicable, from the rational standpoint, how backward production methods can continue to exist alongside the more advanced. It resorted to all kinds of inadequate attempts at an explanation. One would think that the procedure of drawing upon the factors of the past to explain present conditions would have appeared especially obvious to the Historical School. Yet here too it failed completely. It could see in this problem nothing but ammunition for its attack upon capitalism.

This came very opportunely for the socialists of all varieties. On the one hand, the knowledge was growing that socialism could keep its promise of improving the lot of everybody only if it were a more productive system than capitalism. On the other hand, it was becoming increasingly evident that a sharp decline in productivity would very definitely have to be expected in the socialist planned economy. To the extent that people were becoming aware of these facts it became important for the socialists to collect seeming arguments with which one could justify the prophecy of abundance in the socialist community of the future. It seemed useful for this purpose to point repeatedly to the fact that under capitalism there is still technological backwardness everywhere. That the equipment of some enterprises does not conform to the ideal picture presented by the most advanced establishments was attributed, not to the influence of the past upon production or to the scarcity of available capital, but to the inherent shortcomings of capitalism. To it one contrasted the utopian vision of a socialist planned economy. It was assumed unhesitatingly and as a matter of course that under socialism all plants will be equipped with the most modern machinery and will be situated in the most favorable locations. We are not told, of course, where the resources for their construction and equipment are to come from.

Very characteristic of this method of providing a deceptive proof of the higher productivity of socialism is the book of Atlanticus-Ballod.3  This work attained great renown in the recent past precisely because it harmoniously combines the bureaucratic socialism of the public functionary and Marxism. Here the attempt is made simply “to point out in an approximate way what could be accomplished with present-day science and technology under the natural conditions given today in a socialist-operated community.”4  To appreciate his method of treating the subject that lie embarks on with this declaration, it is enough to mention his statement that in German agriculture there will be “nothing left” for the socialist state to do “but to rebuild completely almost all farms.” In place of the existing farms 36,000 new ones are to be set up, each with approximately 400 hectares of arable land.5  Similar measures are to be taken in industry. How simply the question of obtaining capital is answered by Ballod is shown by his observation: “It is therefore quite out of the question for the individualist state to pay for the electrification of the railways. The socialist state can do so without great difficulties.”6  The entire book demonstrates no appreciation whatsoever of the fact that investment of capital is possible only within given limits and that in view of the scarcity of capital it would be the greatest waste to abandon still utilizable plants that have come down from the past solely because they would have been equipped differently if they were to be designed for the first time today.

Even a socialist community could not proceed differently from the capitalists of the economic order based on private property. The manager of a socialist economy would also have to take account of the fact that the means of production available are limited. He too would have to consider carefully, before abandoning a still utilizable plant to erect a more modern one in its place, whether there is not a more urgent need for the resources that the new plant must require. That a socialist community could by no means make this comparison of input and output, of costs and proceeds, because economic calculation is not possible under socialism, does not further come into question here. The impossibility of economic calculation makes a socialist economy based on the division of labor altogether unfeasible. A completely socialist economy can exist only in thought, not in reality. However, if one seeks, in spite of this, to describe the communist paradise in an imaginary construction, one must, in order not to become involved in self-contradictory nonsense, assign to the scarcity of capital the same role it plays in the economic life of capitalism.

In business practice the problem before us usually appears as the opposition between the viewpoint of the businessman, who coolly and calculatingly examines the profitability of investments, and that of the visionary engineer, who declares himself for the “technologically most perfect plant,” even if it is unprofitable under the given circumstances. Wherever the pure technologist has his way, capital is malinvested, i.e., squandered.

• 1Cf. Clark, The Distribution of Wealth (New York, 1908), p. 118.
• 2The influence of the past is also operative in the two cases that we have not considered: obstruction of the mobility of circulating capital and a decrease in demand for the final product. But this need not be gone into any further because the relationship is obvious from what has been said. Equally simple is the application to “durable goods” in Böhm-Bawerk’s sense.
• 3Cf. Atlanticus-Ballod, Der Zukunftsstaat, Produktion und Konsum im Sozialstaat (2nd ed.; Stuttgart, 1919).
• 4Ibid., p. 1.
• 5Ibid., p. 69.
• 6Ibid., p. 213.

The infant industries argument advanced in favor of protective tariffs represents a hopeless attempt to justify such measures on a purely economic basis, without regard to political considerations. It is a grievous error to fail to recognize the political motivation behind the demand for tariffs on behalf of infant industries. The same arguments as are advanced in favor of protecting a domestic product against foreign competition could also be adduced in favor of protecting one part of a general customs area against the competition of other parts. The fact that, nevertheless, protection is asked only against foreign, but not also against domestic, competition clearly points to the real nature of the motives behind the demand.

Of course, it may happen in some cases that the industry already in existence is not operating in the most favorable of the locations that are presently accessible. However, the question is whether moving to the more favorable location offers advantages great enough to compensate for the cost of abandoning the already existing plants. If the advantages are great enough, then moving is profitable and is carried out without the intervention of a tariff policy. If it is not profitable in itself and becomes so only by virtue of the tariff, then the latter has led to the expenditure of capital goods for the construction of plants that would otherwise not have been constructed. These capital goods are now no longer available where they would have been had the state not intervened.

Every tariff under whose protection new plants come into existence that otherwise would not have been built so long as the older plants established elsewhere were still utilizable leads to the squandering of capital. Of course, the fanatics on both sides of the ocean who want to “make the economy rational” do not care to see this.

Under the protection of tariffs—and other interventionist measures that bring about the same result—industries come into existence in places where they would not have been established in a world of free trade. If all tariff walls were now to fall at one blow, these plants would prove to be malinvestments. It would then become evident that it would have been more practical to have erected them in more favorable places. Nevertheless, they are there now, and the question whether they should be abandoned in order to set up new ones in more advantageous places is again to be decided by examining whether or not this would be the most profitable application for the employment of capital available for new investments. Consequently, the transfer of production from the places to which it has been brought by the interference of the tariff policy to the locations it would have chosen in a free economy, and which are now still regarded as the most favored by nature, will take place only gradually. The effects of the protectionist policy still continue even after its abandonment and disappear only in the course of time.

If one country alone removes its tariffs while all other countries continue to adhere to protectionism and retain their immigration barriers, its economy would have to adjust itself by concentrating on those branches of production for which conditions in that country are relatively most advantageous. Such an adjustment requires the investment of capital, and the profitability of this capital is again dependent on whether the difference in the costs of production between the enterprises to be abandoned and the ones to be newly established is great enough to justify the necessary expenditure of capital at that time. In this case too the effects of the protectionist policy continue for a certain period after its abandonment.

Everything that has been said concerning protection in foreign trade is, of course, equally true of the protection of one group of domestic enterprises against another. If, for example, tax rates favor savings banks over commercial banks, consumer cooperatives over businessmen, agricultural producers of alcohol over industrial producers, small business over big business, all those consequences appear that are brought about by the protection of the less efficient domestic industry against its more efficient foreign competitor.

The malinvestment of capital goods can have come about in several ways.

1. The construction of the plant was economically justified at the time it was established. It is not so any longer because since then new methods of production have become known or because today other locations are more favorable.
2. Though originally a sound investment, the plant has become uneconomic because of changes that have occurred in the data of the market, such as, for example, a decrease in demand.
3. The plant was uneconomic from the very first. It was able to be constructed only by virtue of interventionist measures that have now been abandoned.
4. The plant was uneconomic from the very first. Its construction was an incorrect speculation.
5. The incorrect speculation (case 4) that led to the malinvestment has been brought about by the falsification of monetary calculation consequent upon changes in the value of money. The conditions of this case are described by the monetary theory of the trade cycle (the circulation-credit theory of cyclical fluctuations).

If the malinvestment is recognized and it nevertheless proves profitable to continue in business because the gross revenue exceeds the current costs of operation, the book value of the plant is generally lowered to the point where it corresponds to the now realizable return. If the necessary writing off is considerable in relation to the total capital invested, it will not take place in the case of a corporation without a reduction in the original capital. When this happens the loss of capital occasioned by the malinvestment becomes visible and can be reported by statistics. Its detection is still easier if the firm collapses completely. The statistics of failures, bankruptcies, and balance sheets can also provide much information on this point. However, a not inconsiderable number of investments that have failed elude statistical treatment. Corporations that have sufficient hidden reserves available can sometimes leave even the stockholders, who are, after all, the most interested parties, completely in the dark about the fact that an investment has failed. Governments and local administrative bodies decide to inform the public of their mistakes only when losses have become disproportionately great. Enterprises that are not under the necessity of giving a public accounting of their activities seek to conceal losses for the sake of their credit. This may explain why there is a tendency to underestimate the extent of losses that have been brought about by the malinvestment of fixed capital.

One must call special attention to this fact in view of the prevailing disposition to overrate the importance of “forced saving” in the formation of capital. It has led many to see in inflation in general, and in particular in credit expansion brought about by the policy of the banks of granting loans below the rate that would otherwise have been established on the market, the power responsible for the increasing capital accumulation that is the cause of economic progress. In this connection we may disregard the fact that inflation, though it can, of course, induce “forced saving,” need not necessarily do so, since it depends on the particular data of the individual case whether dislocations of wealth and income that lead to increased savings and capital accumulation really do occur.7  In any case, however, credit expansion must initiate the process that passes through the upswing and the boom and finally ends in the crisis and the depression. The essence of this process consists in rendering the appraisement of capital misleading. Therefore, even if more capital is accumulated to begin with than would have been the case in the absence of the banks’ policy of credit expansion, capital is lost on the other hand by incorrect appraisement, which leads it to be used in the Wrong place and in the wrong way.

Whether or not the increase in capital is equalled or even exceeded by these losses is a quaestio facti. The advocates of credit expansion declare that there is always an increase in capital in such cases, but this certainly cannot be so unhesitatingly asserted. It may be true that many of these plants were erected only prematurely and are not by nature malinvestments, and that if there had been no trade cycle they would certainly have been constructed later, but not otherwise. It may even be true that in the last sixty to eighty years, especially during the upswing of the trade cycle, plants were built that surely would have been constructed later—railroads and power plants in particular—and that therefore the errors that bad been committed were made good by the passage of time. However, owing to the rapid progress of technology in the capitalist system, we cannot reject the supposition that the later construction of a plant would have influenced its technical character, since the technological innovations that appeared in the meanwhile would have had to be taken into account. The loss that results from the premature construction of a plant is then certainly greater than the above optimistic opinion assumes. Very many of the plants whose establishment was due to the falsification of the bases of economic calculation, which constitutes the essence of the boom artificially inaugurated by the banks’ policy of credit expansion, would never have been built at all.

The sum total of available capital consists of three parts: circulating capital, newly formed capital, and that part of fixed capital which is set aside for reinvestment. A shift in the ratio of circulating capital to fixed capital would, if not warranted by market conditions, itself represent a misdirection of capital. Consequently, the circulating capital in general must not only be maintained, but also increased by the allocation of a part of the newly formed capital. Thus only an amount that is quite modest in comparison with total capital is left over for new fixed investment. One must take this into consideration if one wishes to estimate the quantitative importance of the malinvestment of capital. It is not to be measured by comparison with the total amount of capital, but by comparison with the amount of capital available for new fixed investments.

Without doubt, in the years that have elapsed since the outbreak of the World War, very considerable amounts of fixed capital have been malinvested. The stoppage of international trade during the war and the high-tariff policy that has since prevailed have promoted the construction of factories in places that certainly do not offer the most favorable conditions for production. Inflation has operated to produce the same result. Now these new factories are in competition with those constructed earlier and mostly in more favorable locations—a competition that they can sustain only under the protection of tariffs and other interventionist measures. These extensive malinvestments took place precisely in a period in which war, revolution, inflation, and various interferences of the political authorities in economic life were consuming capital in very great volume.

One may not neglect all these factors if one wishes to investigate the causes of the disturbances in the economic life of the present day.

The fact that capital has been malinvested is visibly evident in the great number of factories that either have been shut down completely or operate at less than their total capacity.

• 7Cf. my Geldwertstabilisierung und Konjuncturpolitik, p. 45 et seq.

Economic progress in the narrower sense is the work of the savers, who accumulate capital, and of the entrepreneurs, who turn capital to new uses. The other members of society, of course, enjoy the advantages of progress, but they not only do not contribute anything to it; they even place obstacles in its way. As consumers they meet every innovation with distrust, so that new products at first are unable to command the price that they could reach if the buyers were less conservative in their tastes. This is the reason for the not inconsiderable costs of introducing new articles. As workers, the masses fight against every change in the accustomed methods of production, even though this opposition only seldom leads today to open sabotage, to say nothing of the destruction of the new machines.

Every industrial innovation must take into account the fact that it will encounter opposition from those who cannot easily accustom themselves to it. The worker lacks precisely the nimbleness of mind that the entrepreneur must have if he is not to succumb to his competitors. The worker is unable and often is even unwilling to adapt himself to the new and to meet the demands that it makes upon him. Precisely because he does not possess this ability he is an employee and not an entrepreneur. This slowness on the part of the masses works as an obstacle to every economic improvement. It too represents the effect of the influence of the past upon labor as a factor of production, and as such it must be taken into account in every calculation of new undertakings. If it is not taken into consideration, then there is just as much malinvestment in this case as in all other cases in which an enterprise proves to be unprofitable. Every enterprise has to adapt itself to the given situation, and not reckon on the situation it would like to be given.

This applies in particular to enterprises established in regions in which suitably qualified workers are not to be found. However, it is no less valid for those that have been established with the purpose of utilizing workers of inferior ability, as soon as this inferiority disappears—that is to say, from the moment in which “cheap labor” is no longer available. A great part of European agriculture was able to withstand competition from farmers working on better land abroad only so long as culturally backward masses could be employed as workers. As industry was able to attract these workers and the “flight from the land” began, the wages of agricultural laborers had to be increased in order to make remaining on the farms more attractive. Consequently, the profitability of running these farms dwindled, and the great amounts of capital that were invested in them in the course of time now proved to be malinvested.

The foregoing discussion makes quite clear the conduct of the individual entrepreneur and of the individual capitalist in the face of losses that come about through the commitment of inconvertible capital in enterprises in which a person having complete knowledge of all the relevant circumstances would no longer invest it today. Nevertheless, the way in which businessmen and the press generally discuss these matters differs markedly in many respects from our description. Yet it is only the businessman’s view of the situation that is different; his conduct, however, is in complete conformity with our description of it.

Let us suppose that it becomes obvious that the earning capacity of an enterprise will be permanently diminished in the future or that a diminution of revenue that had hitherto been regarded as temporary proves to be lasting. This fact is appraised in different ways—particularly in the case of corporations and other similar associations for raising capital—according to whether it is necessary to make clear in the books the loss of fixed capital that has taken place, or whether this can be avoided because the fixed investments do not at present appear in the books with higher appraisements than correspond to their now diminished values. It is hardly necessary to point out that this has nothing to do with the question whether the enterprise should be abandoned altogether in view of the new state of affairs. It is obvious that what gives this secondary decision such great importance is merely consideration for what the stockholders may think of the achievements of the responsible management, for the credit of the firm, and for the price of its stock.

One often hears the view expressed that when a concern writes off a great part of its investment this very fact offers it the possibility of entering into competition with other firms that operate under more favorable conditions. Here too the situation is no different from the case just mentioned. The book value of a concern’s fixed investment has no bearing whatever on the question of its ability to withstand competition. What is alone decisive is whether, after covering all current operating costs and after paying interest on the circulating capital, there is still so much left over from the gross revenue that something more can be reaped than an adequate return on the value which, after discontinuation of the enterprise, the fixed capital would have in view of the possibility of using it for other production (occasionally this will be only the scrap value of the machines and bricks). In that case the continuation of the enterprise is more profitable than its discontinuation. If the fixed capital has a higher book value than corresponds to its present and probable future earning capacity, then the book value must be lowered to that extent.

What the businessman wants to say in using his mode of expression is nothing else than that an enterprise whose investment has already been written off either wholly or to a great extent out of previous earnings appears, when considered in regard to the entire duration of its life, as still profitable even in the later periods of its existence if only it is still able to pay interest on the circulating capital.

The case is similar where, as is generally said, competition with enterprises operating for the rest under more favorable conditions is possible because a source of special advantage not within their reach is available—like the value of a popular brand name. If the remaining conditions of production were perfectly equal, then this advantage would constitute the source of a differential rent. As the situation stands, the resources needed to make up an existing disadvantage are obtained from it.