In Ludwig von Mises’s intellectual testament, Memoirs, he discusses his life and work in Europe prior to 1940. In that book he reveals that he first read Carl Menger’s Principles of Economics around Christmastime in 1903. “It was through this book,” Mises relates, “that I became an economist.” Before that, in his first years at the University of Vienna, he was schooled in historicist interventionism. As Guido Hülsmann tells us in The Last Knight of Liberalism, Mises began his studies “a champion of interventionist statism.” Although his turn toward free-market classical liberalism was not instantaneous, after reading Menger’s Principles he would never be the same. I have much the same relationship with the book we are celebrating at this event.
When I encountered Mises’s Human Action for the first time as a sophomore in college, I was not an historicist, interventionist statist. My family was a blue-collar family. My dad worked in a meatpacking plant while my mother frugally managed the household budget. Without even knowing any formal economic principles, growing up I was practically schooled in comparisons of marginal cost and marginal benefit and in maximizing utility per dollar spent almost every day. Not knowing what the discipline of economics was, I took my first microeconomics course as a freshman in college and was immediately impressed and interested in the sort of questions raised and the sort of analysis undertaken in answering them. I was quickly drawn to economics as a major.
I had lingering doubts, however, about whether economics was rooted in reality or built merely on constructs so artificial that their conclusions were irrelevant to the real world. While pondering this, I purchased my first copy of Mises’s Human Action from the old Conservative Book Club, began to read it, and was delighted to find that there is an economic framework rooted in reality and, hence, worth devoting my life to studying and teaching. What Menger’s Principles was for Mises Human Action was to me. It is the book that made me an economist.
From the first time I began reading the first pages of Human Action, I found Mises’s entire approach very refreshing. He does not begin by looking at reams of descriptive statistics and GDP, à la Samuelson. He does not even begin by examining individual markets or the nature of wealth. Instead, he painstakingly lays out the very foundations of economics, by examining in some detail the nature of human action.
His effort pays significant dividends by keeping his reader from potentially shipwrecking his economics on the rocky shoals of scientism. He refrains from constructing economic theories via abstract modeling built on unrealistic assumptions. He never models people as mere representative agents who are narrowly selfish and who act with perfect information. He does not assume benevolent and omnipotent economic planners. Consequently, the economist building on Mises is not deluded into thinking that economics is about developing elegant mathematical models that are irrelevant for the real world of uncertainty in which prices, quantities, efficient firm sizes, and market concentrations are arrived at through the real market process.
Mises also steers clear of positivist nihilism. Mises’s foundation allows him to develop economic theorems that are true economic laws, rather than hypothetical propositions always subject to rejection by the next empirical test. The economic actors causing all economic phenomena are more than inanimate objects reacting to stimuli. They are more than biological creatures driven by instincts. In fact, better than anyone before him, Mises sets the action of real human beings as the foundation for economic science.
Human Action and the Foundations of Economics
One of the hallmarks of Mises’s Human Action is its logically consistent, systematic unfolding of economic law from the firm foundation of realistic human action. The methodological agnosticism of much of modern economics notwithstanding, this is no small matter.
I have long thought that the foundations of economics are of key importance. Twenty-five years ago, in a lecture at the Mises Institute celebrating the publication of the scholar’s edition of Human Action, I noted that “when a rocket is launched, if its trajectory is off target just a degree or two, it can miss its destination by miles. The same holds true with scholarship. When one sets out on the path of the academic, it is important that he is starting from a firm foundation and that the course is true.” This methodological point is far from being merely academic. The millions who died of starvation and disease under socialist governments are testimony to that.
The tragic demise of Robert Franklin Hoxie brings the importance of economic foundations to a very personal level. Hoxie was a labor economist at the University of Chicago from 1906 to 1916 and was on the US Commission on Industrial Relations from 1914 to 1915.
He was also a devotee of institutionalist Thorstein Veblen. Hoxie’s friend and colleague Alvin Johnson documents how damaging faulty foundations can be for an economist. Johnson explained Hoxie’s economic framework as follows: “Hoxie boasted that his whole system of thought came from Veblen. It was Veblen who had taught him that all ideas of reconciling the interests of labor and the employer were a fantastic delusion. For the minds of labor and of the employer were built out of completely different philosophic elements.” Hoxie came to understand, however, that Veblen’s economics was built on a rotten foundation and that the bad leaven leaveneth the whole lump. Alas, Hoxie was emotionally shattered.
Johnson relates that on one sad day, Hoxie visited New York, where Johnson had relocated, and asked Johnson to come to his hotel for the evening. Hoxie was “frightening in his appearance.” He told Johnson that he was finished. “I can see now, all my work has been bunk. All my writing, every lecture I have ever given, has been bunk.” When asked for the reason, Hoxie continued, “I’ve come to see through Veblen.”
Hoxie told Johnson he could not understand: “How could a man be so great a scientist and such a damn fool? And the more I thought, the more the idea rode my mind: how great a scientist is he?” Upon more cogitation, Hoxie concluded that Veblen “knew his equations didn’t solve, but he used them just the same.” This realization was devastating to Hoxie. He told Johnson, “I wouldn’t care if it was just the matter of my finding out a phony I had taken for okay. But Veblen has been the premise of all my work. My work is all rotten with Veblenism.” Hoxie understood that foundations do, indeed, matter.
Johnson conversed with Hoxie for eight hours, finally calming him down enough for sleep. Johnson plaintively closed his narrative, writing, “I left him, promising to visit him in Chicago and renew the discussion. But before I could get around to a Chicago trip Hoxie killed himself.”
Now, my point is not that economists who do not begin with Human Action as their foundation will eventually become suicidal. (On the other hand, why risk it?) No, my point is that foundations matter. Hoxie came to this important realization. He unfortunately could not find a way past his epiphany.
The analytical framework Mises perfects and sets forth in Human Action is useful for all of economics. It was the economic basis for my first book, Foundations of Economics. One of the most important questions students of economics need to answer satisfactorily for themselves is whether their professor of economics is pulling the wool over their eyes. I needed to do so as a student, and I sense my students need to do that as well. They need to apprehend that the laws of economics are actual laws and not merely necessary conclusions implied by artificial constructs dreamed up by academics.
As I note in Foundations of Economics, “The first six chapters of Mises’ Magnum Opus provide the seminal explanation of the nature of human action and its implication for how we discover economic truth.” Tying action to our nature as human beings, Mises defines human action as purposeful behavior. People must apply means according to their ideas to achieve ends, because our means are scarce. Because means are scarce, we must choose to achieve some ends and leave others unfulfilled. When acting, people choose to do one thing while simultaneously choosing not to do something else. This choice requires that we rank our ends, which necessitates preference. Action, therefore, requires valuation, which in turn implies concepts of benefit and cost, and ultimately profit and loss, the law of marginal utility, and the laws of supply and demand.
About eight years after the publication of my first book, I turned my attention toward writing a book about the nature and causes of economic prosperity. I had been prompted to consider this topic years before that by a conversation I had with a graduate student who attended Grove City College’s Austrian Student Scholars Conference. He suggested to me that while Austrians have a recognized business cycle theory, they don’t have a recognized theory of economic development. His claim was not that we do not have a theory of economic progress, but that it is not recognized as such. After teaching Economic Expansion and Development for about twenty years, my ideas on the subject had been percolating, and I decided to try to articulate a general theory of economic prosperity. I naturally turned to Mises as a starting point in my research. The economic framework and insights of Mises point to a theory of economic progress more robust and relevant than those of his conventional macroeconomic counterparts. Mises’s causal-realist praxeological approach allows for the development of a theory of economic expansion and development that is more holistic and that therefore is more likely to provide helpful policy guidance for purposes of economic progress.
Mises is quite helpful at the beginning of this conversation with his very definition of economic progress. A progressing economy is one in which there is an increase in per capita wealth. He goes further, however, by helpfully noting its subjective nature. He reminds us that “goods, commodities, and wealth and all the other notions of conduct are not elements of nature; they are elements of human meaning and conduct. He who wants to deal with them must not look at the external world; he must search for them in the meaning of acting men.” Wealth, therefore, is not merely stuff. It is economic goods that are valued subjectively as useful to attain ends by the people using them. As such, wealth cannot be scientifically measured. That is not to say that we are unable to make any judgment about whether a society has or is enjoying economic progress. It is merely to say that we do this with what Mises calls “historical understanding” and not with scientific measurement. We can observe people enjoying the use of more and better goods for lower prices.
The question then becomes, How do we enjoy economic progress thus described? The answer is increases in productivity and the ability to use the fruits of our production according to our subjective purposes.
Mises points us to the theory of economic progress in a discussion about whether monetary inflation increased general social welfare in history: “The question is whether the fall in purchasing power was or was not an indispensable factor in the evolution which led from the poverty of ages gone by to the more satisfactory conditions of modern Western capitalism. . . . What is needed is a clarification of the effects of changes in purchasing power on the division of labor, the accumulation of capital, and technological improvement.” Those are the three processes that result in economic progress: expansion of the division of labor, capital accumulation, and improvements in technology.
Mises has much to say about all three. The division of labor opens the door to increased productivity by allowing people to specialize in production according to efficiency. This increased productivity results in higher real incomes and societal wealth.
While Mises was not, of course, the first to recognize the contribution of the division of labor to prosperity, he emphasizes several points about exchange and the division of labor that are innovative. One is his expanding of David Ricardo’s law of comparative advantage into the full-fledged law of association. It is not only that different countries with different opportunity costs in the production of various goods could benefit from specialization and exchange. What is true of people in different countries is true of everyone, everywhere trade occurs.
Mises also understood that the division of labor and human cooperation are the fundamental social phenomenon. He sees the division of labor as “the social tie” that, along with reason and language, is uniquely human.
In so doing, he also explicitly rejects social Darwinism as a theory for the development of society. Society is not a competitive struggle for survival. It is the product of cooperation, not conflict. Social Darwinism, on the other hand, is a theory of antisocial devolution.
A progressing economy, Mises explains, is actuated by an increase in available productive capital goods in addition to an expanding market division of labor. The use of capital goods contributes to economic progress by increasing the productivity of the user. However, before capital goods can be used, they must be produced. In order to accumulate capital, people must be willing to put off present consumption so that they will have resources available to invest in the production of capital goods. As Mises explains, “Saving is the first step on the way toward improvement of material well-being and toward every further progress on this way.”
Another important yet underappreciated contribution in Mises’s Human Action is the conception of capital. Mises conceives of capital as a tool of economic calculation and defines it as the sum of the whole complex of goods destined for acquisition evaluated in money terms. Capital, therefore, is neither merely a fund of investable money nor a mere stock of physical capital goods. As Mises explains, “There is no such thing as an abstract or ideal capital that exists apart from concrete capital goods . . . Capital is always embodied in definite capital goods and is affected by everything that happens with regard to them. The value of an amount of capital is a derivative of the value of the capital goods in which it is embodied.” As the value of an entrepreneur’s capital goods goes, therefore, so goes his capital.
This helps explain why capital spending per se does not necessarily contribute to economic prosperity. Investment must be spent on specific capital goods allocated toward the production of those specific goods that can be sold for a profit, because only then can the capital goods maintain or increase their capital value.
Another insight from Mises is that technology does not determine the entrepreneur’s production technique. Rather it is his “supply of capital goods available at each moment that determines which of the many known technological methods of production will be employed.” What holds back underdeveloped countries, such as Rumania in the 1800s, is not a lack of technical knowledge but the quantity of capital goods needed to put the technology into practice. Indeed, because capital is scarce, there is always technology that could be applied toward the attainment of some end but must remain unused because of a lack of necessary capital goods embodying that technology. When considering the speed with which a society enjoys the benefits from technical advance, he similarly notes that “what slows down technological improvement is not the imperfect convertibility of capital goods, but their scarcity. We are not rich enough to renounce the services which still utilizable capital goods could provide.”
Finally, throughout Human Action is the recognition that the market division of labor, capital accumulation, and the use of technology all require wise entrepreneurial judgment for economic progress to result. Entrepreneurship, therefore, is a fourth contributor to economic progress.
Entrepreneurship is important because to sustain economic progress over time, it is important not to waste capital that has already been accumulated. Production decisions in the present are based on a forecast of uncertain future market conditions. If the producer forecasts incorrectly, he will use his capital to produce goods that will not return a profit.
Mises famously showed us that entrepreneurs need to use economic calculation if they are to direct factors of production toward their most valued uses. Market prices allow entrepreneurs to make meaningful comparisons of social value between different consumers’ and producers’ goods because money prices are all expressed in terms of the same good. These same objective prices are determined by the subjective preferences of buyers and sellers. If the expected price of a final product is greater than the sum of the prices of the factors of production, the entrepreneur will produce that good. When entrepreneurs reap a profit, they do it precisely by providing those goods that people value the most in the least costly manner.
One cannot neatly sever the components responsible for economic expansion from one another and find a single key that explains economic progress. A highly developed division of labor would be impossible without the accumulation and use of capital goods. Likewise, the entrepreneur must invest real capital in the production process, and if he errs in his market forecast, he can indeed reap large losses. At the same time, capital per se never guarantees economic progress either, because it must be wisely utilized. Economic progress is the happy consequence of a highly developed division of labor taking advantage of an increasing capital stock that embodies economically appropriate technology wisely invested by entrepreneurs.
Consequently, if we want society to benefit from economic expansion, we need social institutions that foster the development of the division of labor, capital accumulation, technological improvement, and successful entrepreneurship. Searching for a common condition that is necessary for all of the above to function, one finds that all require private property and sound money.
People can only benefit from the division of labor if they are free to exchange the goods that they produce. We can therefore benefit from the division of labor only in a society whose institutions support voluntary trade. We can exchange goods only in an environment of private property.
Likewise, for capitalists to have the incentive to accumulate capital, they must be secure in their property. If, for example, the state enforces confiscatory taxation, regulates business, and imposes price controls, capital accumulation is hindered. Taxes reduce both the ability and the incentive to save and invest. Regulations and price controls direct capital away from their most highly valued ends.
The entrepreneur’s need for monetary market prices to calculate profit and loss also points to the necessity of private property and sound money for entrepreneurship. Only voluntary prices are manifestations of the subjective values of the buyers and sellers in society. Without voluntary exchange, there can be neither money nor market prices. Falsification of prices due to monetary inflation at best leads entrepreneurs astray, at worst leaves them paralyzed. Without rational economic calculation, those directing the allocation of factors of production have no way to know how to allocate them wisely. Capital is consumed and standards of living fall.
In short, one of the great lessons of Mises’s Human Action is that the institutions of the free society—private property and sound money—make up the environment enabling economic progress, and hence, human flourishing.
