More from Böhm-Bawerk on Cost of Production as a Determinant of Prices

The following adds to my previous post about what Böhm-Bawerk says concerning the explanatory role of cost of production in Austrian economics. The quotation is from his essay “Value, Cost, and Marginal Utility,” (trans. George Reisman, Quarterly Journal of Austrian Economics, vol. 5, no. 3, pp. 43-44).

[I]n order to rule out every doubt and every misunderstanding, I want to make a few explicit declarations:

(1) We too [i.e., we “marginal-value theorists,” as he describes his school, i.e., we Austrian economists—GR] fully recognize the sway of a “law of costs” for goods that are reproducible at will. “There is a law of costs”—I once wrote—“costs exercise an important influence on the value of goods.”[18] “That costs of production of goods exercise an important influence on their value is a fact so well verified by experience that it absolutely cannot be doubted.”[19] “One is in fact correct, when one says that costs govern value.”[20]

(2) We too recognize the necessity of “supplementing” the universal law of marginal utility by means of special provisions that relate to the value of goods reproducible at will and that the substance of these is precisely the law of costs. And we have accomplished this "supplementing” in full detail, both for the field of subjective value and for that of objective value and prices.[21]

(3) We too understand the law of costs in such a way that we ascribe to the height of the costs of production, that is to say, to the value of the means of production, the status of a cause—though, to be sure only an intermediate cause—in relation to the value of those products to which the law of costs generally applies. “In our present case (that of goods reproducible at will and of higher direct marginal utility), the value of the product must accommodate itself” (to the value of the means of production). “The value of products of higher direct marginal utility. . . comes to them from the side of the means of production.”[22]

(4) In connection with this, we too acknowledge that changes in the conditions of producing goods reproducible at will never fail to bring about a change in the value of those goods and, to be sure, even without a change in the supply of finished products necessarily having to take place.[23]

[18] “Grundzüge der Theorie des wirtschaftlichen Güterwerts,” new series, vol. 13, p. 73.

[19] Ibid. p. 61.

[20] Ibid. p. 71.

[21] “Grundzüge,” pp. 61ff., 534ff. Positive Theorie des Kapitals
(Innsbruck, 1889), pp. 189ff. and esp. pp. 234ff. [The material referred to appears in English translation in Eugen von Böhm-Bawerk, Capital and Interest, 3 vols., trans. George D. Huncke and Hans F. Sennholz (South Holland, Ill.: Libertarian Press, 1959), vol. 2, pp. 168–76 and 248–56. Vol. 2, pp. 173–76 are on line at http://www.capitalism.net/excerpts/boehm_q.htm.]

[22] “Grundzüge,” p. 70.

[23] Thus, for example, on one occasion, Wieser says: “Cases of the kind last discussed are conspicuous in that the effect of cost on the value of the products takes place without the quantity of products being affected” (Der naturliche Wert [Vienna, 1889], p. 171; [Natural Value (1893; New York: Kelley and Millman, 1956), p. 178. (In the QJAE, Natural Value is mistakenly rendered Natural Law.)])

The above footnote references to Grundzüge can now be found in an English-language translation of that volume. The translation is titled Basic Principles of Economic Value, trans. Hans Sennholz (Grove City, Pennsylvania: Libertarian Press, 2005). The footnote references are to pp. 79, 67, 77, 67-80, 161-167, and 76-77, respectively. There are some generally minor differences between my translation of the sentences quoted by Böhm-Bawerk and their translation by Prof. Sennholz.

I consider it extremely unfortunate that neither Rothbard nor Mises explicitly deals with this very important aspect of Böhm-Bawerk’s writings, which I consider to be one of his major contributions to economic thought. Its inclusion, in my judgment, would have considerably enriched their discussions of prices. Mises did, however, implicitly endorse Böhm-Bawerk’s views on the subject when, immediately after singling out the latter’s Capital and Interest, he wrote: “These masterful expositions are unsatisfactory in some minor points and disfigured by unsuitable expressions. But they are essentially irrefutable. As far as they need to be amended, it must be done by a consistent elaboration of the fundamental thoughts of their authors rather than by a refutation of their reasoning.” [Human Action, 3d ed. rev. (Chicago: Henry Regnery Company, 1966), p. 201.]

Böhm-Bawerk’s treatment of cost and its relationship to marginal utility and price is a very prominent feature of Capital and Interest: it occupies the whole of two chapters in Book III of Volume II, which is titled “Value and Price,” namely, Chapter VII of Part A and Chapter IV of Part B; it also occupies the whole of Excursus VIII in Volume III. Mises must certainly have meant to include this material in his endorsement; it certainly could not be described as “minor points” or “unsuitable expressions.”

Beyond this, I was in the fortunate position of learning more of Mises’s views on the subject of the role cost and of his endorsement of Böhm-Bawerk’s views on the subject, as the result of being a member of his seminar at NYU. This made it possible for me to ask him direct questions on the subject. Specifically, I had taken a class from Prof. George Stigler at Columbia University and learned of Dennis Robertson’s attempt to deal with the problem of calculating the marginal product of a tenth hole digger in the face of the availability of only nine shovels. Robertson’s answer, as reported by Stigler, was that the tenth worker could be sent to fetch beer.

I was very dissatisfied with such an answer and began to see serious problems with efforts to derive marginal products and marginal value products from consumers’ goods in many cases. First, I raised the matter with Rothbard, who referred me to various textbooks for the solution. They did not satisfy me any more than had Robertson’s answer. I then raised the matter with Mises. Almost immediately, Mises asked if I had in mind deriving the value of original factors of production or produced factors of production. I replied that I was concerned with both. The value of produced factors of production, he said, was determined by their cost of production.

This was an answer that greatly surprised me. Because until then, I had thought that Mises and all of sound economics totally denied any possibility of value or price being determined by cost. Mises referred me to Capital and Interest for elaboration. The specific reference he gave was to Excursus VII, which is a brilliant essay on the value of complimentary goods and is closely related to Böhm-Bawerk’s views on the subject of costs. Reading it soon led me into the other portions of Böhm-Bawerk’s work that I’ve cited. Mises’s directing me to Böhm-Bawerk on the subjects of imputation and costs, of course, only deepens what for me is the mystery of why he didn’t explicitly incorporate this aspect of Böhm-Bawerk’s writings into Human Action. And as I think back now, a mystery almost as large is why I never thought of asking him.


The quotations from Böhm-Bawerk are copyright © 2002 by Transactions Publishers. The rest of this article is copyright © 2006, by George Reisman. Permission is hereby granted to reproduce and distribute the article electronically, other than as part of a book and provided that mention of the author’s web site www.capitalism.net is included. (Email notification is requested.) All other rights reserved. George Reisman is the author of Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson Books, 1996) and is Pepperdine University Professor Emeritus of Economics.

The Austrian Economics that Most of Today’s “Austrians” Don’t Know

To the great majority of those who today consider themselves to be supporters of Austrian economics, any suggestion that there are cases in which the direct, immediate determinant of price is cost of production is likely to be greeted as though it were indicative of such profound ignorance as to be cause for scandal. These “Austrians” believe that the prices of factors of production—labor, land, and capital goods of all descriptions—are determined by the prices of their respective products and can never determine the prices of their products.

This, however, was not the view of two of the most important Austrian economists of the 19th and early 20th centuries, namely, Eugen von Böhm-Bawerk and Friedrich von Wieser, who were the two leading disciples of Carl Menger, the founder of the Austrian school. Böhm-Bawerk was also the teacher of Ludwig von Mises, and was probably considered by Mises to be the most important of all Austrian economists, himself included. (Mises, I think, could sometimes be unduly modest about his own enormous accomplishments, which, in fact, surpassed those of Böhm-Bawerk, great as the latter’s were.)

Without further ado, I am simply going to quote Böhm-Bawerk from his masterwork Capital and Interest, using the same quotation I’ve been permitted to use in my own book.

Böhm-Bawerk on How and When Costs Determine Prices

Up to this point in our discussion the law of the value of production goods was developed subject to the simplifying hypothesis that every group of means of production admits of utilization only to one very definite purpose. That hypothesis is in real life only very rarely in agreement with the facts. It is preeminently production goods, far more than consumption goods, which are characterized by egregious heterogeneity. The overwhelming majority of them will be capable of service in several productive fields, some are adaptable to thousands of such productive services. Examples are iron, coal, and above all, human labor. Of course, we have to take these factual circumstances into account in conducting our theoretical investigation. We must observe what modifications, if any, affect the law that the value of a group of goods occupying remote orders is governed by the value of their product.

Let us alter the order of the presuppositions of our typical example accordingly. Someone possesses a rather large supply of means of production of second order (G2). From each of these groups he can produce at will a consumption good of the category A, or one of category B or finally, of category C. He desires, of course, to take advance measures toward balanced provision for his various wants, and will therefore draw simultaneously on various parts of his supply of means of production to produce consumption goods of all three categories. And he will produce amounts in each in accordance with his needs. If there is genuinely balanced provision, the quantities produced will be so regulated that needs of approximately equal importance depend upon the last specimen in each category, and that thus the marginal utilities are approximately equal. In spite of that it is not impossible that there will be differences—possibly even quite considerable differences—in the marginal utilities because, as we already know, the gradation of concrete wants occurring in any one category is not always either uniform or continuous. The first stove in my room will afford me a very considerable utility, say one we might designate with an index of 200. A second stove will afford no utility at all. I shall most emphatically call a halt in providing stoves when I have a single specimen with its marginal utility of 200, even though in other areas provision for needs may see a dropping off of the average of marginal utility to as little as 120 or even 100. And so it is permissible and necessary, if our example is to be true to nature, to assume that the marginal utility of a specimen will be different in each of the categories A, B and C. Let us call it 100 for A, 120 for B and 200 for C.

Now the question arises, “What is the value, under these circumstances, of a group of means of production, G2?”

We have had so much practice with selective decisions of a similar nature that we can give the answer without hesitation. The value will be equal to 100. For if one of the available groups of means of production should be lost, the owner would naturally shift the loss to the least sensitive area. He would not curtail production in category B where he would be sacrificing a marginal utility of 120, and certainly not in category C where the sacrifice would go as high as 200. He would quite simply produce one specimen fewer of category A where the reduction in well-being is only 100. Let us express it in general terms. The value of a unit of means of production is governed by the marginal utility and the value of that product which has the least marginal utility among all those products for the making of which the unit means of production could have justifiably been used.

All the relations which we had declared to be plainly in force with regard to the value of means of production and their products under the simplifying assumption of only a single possible disposition, are therefore generally valid as between the value of means of production and value of its least valuable product.

And what is the situation with respect to the other categories of products, B and C? That question brings us to the origin of the “law of costs.”

If under all circumstances the marginal utility attainable by a good within its own category were determinative, then the categories B and C would have to receive a value divergent not only from that of category A, but also from the value of its costs G2. B would then have a value of 120, C a value of 200. But here we are confronted with one of the cases where, through substitution, a possible loss in one category is transferred to another, and as a result, the marginal utility of the latter becomes determinative for the other as well. Thus, if a specimen of category C is lost, it is not necessary to forgo the marginal utility of 200 which the specimen would have delivered directly. Instead, it is possible to convert one unit of the means of production G2 into a new specimen C, and in its place rather produce one specimen fewer in that category in which the marginal utility, and hence the loss in utility is least. And indeed that possibility becomes a reality. The category in question in our example is the category A. Because of the opportunity which production offers for substitution, a specimen C is therefore not valued in accordance with its own marginal utility of 200, but in accordance with the marginal utility of the least valuable related product, the product A; its value is therefore 100. The same applies, naturally, to the value of category B, and would apply generally to every category of good which is “productionally related” to A, and of which the direct marginal utility is also greater than that of category A.

This leads to some important consequences. The first is that in this way the value of goods having a higher individual marginal utility occupies the same rank as the value of the “marginal product”; and hence also the same rank as the means of production from which both emanate. The identity which exists in principle between “value” and “costs” therefore obtains in this instance as well. But it is to be carefully noted that here the coinciding is brought about in quite a different way from that which was followed in the case of costs and marginal product. In the latter instance the two coincide because the value of the means of production accommodates itself to the value of the product. The value of the product is the determinant factor, the means of production is the factor that is determined. In our present case it is the other way around, and it is the value of the product that must do the accommodating. Ultimately it accommodates only to the value of another product. But initially it accommodates also to the value of the means of production from which it emanates and which brings about its substitutional connection with the marginal product. The transmission of value proceeds, so to speak, along a broken line. First it goes from the marginal product to the means of production, fixes the value of the latter, and then ascends in the opposite direction from the means of production to the other products which it is possible to produce from them. In the end product, then, the products of higher immediate marginal utility derive their value from their means of production. Let us translate the abstract formula into terms of concrete practice. Good B or good C is, in general, a product of higher immediate marginal utility. If now we consider what good B or C is worth to us our first response is, “Just exactly as much as the means of production are worth to us from which we can at any moment replace the product.” If we then inquire further and ask how much the means of production themselves are worth, we arrive at the marginal utility of the marginal product A. But on innumerable occasions we can spare ourselves this further inquiry. Time and again we already know the value of the goods that comprise the cost, without any necessity for working it out from its foundation and proceeding onward from case to case. And on all these occasions we simply determine the value of products by their costs, and in doing so we are taking advantage of an abbreviation which is as accurate as it is convenient.

And now the whole truth about the celebrated law of costs is revealed. It is indeed quite correct to say that costs govern value. Only it is imperative to remain aware of the limits within which this “law” is valid and of the source from which it derives its virtues. In the first place it is only a particular law. It is valid only so long as the possibility is present of furnishing, through production, substitute specimens in any quantity and at any time they are desired. If there is no possibility of substitution, then in the case of each product, value must be determined by its immediate marginal utility in its own category. In that case its value no longer coincides with that of the marginal product and of the intermediate means of production. Therein lies the explanation of the empirically established principle that the law of costs is valid only for the goods that are “reproducible at will,” and that it is a law of only approximate validity. For it does not bind the goods over which it holds sway to slavishly meticulous adherence to costs. On the contrary, it permits fluctuations above and below such costs, depending on whether production at the moment lags behind demand or outstrips it.

A second and still more important consideration is that even where the law of costs is valid, those costs are not the final, but only an intermediate cause of the value of goods. In the last analysis, they do not give value to their products, but receive it from them. That is clear as crystal in the case of production goods for which there is only one productive use. Surely no one will wish to deny that it would be erroneous to assert that Tokay wine is valuable because Tokay vineyards possess value; everyone will concede that the truth is the other way around, and those vineyards have a high value because their product is highly valued. It is just as hopeless to deny that the value of a quicksilver mine depends on that of the quicksilver, the value of a wheatfield on that of wheat, the value of a brickkiln on that of brick, and not vice versa. Only because of the manysidedness of most cost goods is it possible for the situation to present the opposite appearance. As the moon reflects the light of the sun upon the earth, so do the manysided cost goods reflect the value which they receive from their marginal product on their other products. (Eugen von Böhm-Bawerk, Capital and Interest. 3 vols., Sennholz and Huncke translation (South Holland, Illinois [Grove City, Pennsylvania]: Libertarian Press, 1959), vol. 2, pp. 173-176. Quoted with permission of Libertarian Press. See also ibid., vol. 3, Excursus 8, and Böhm-Bawerk’s article “Value, Cost, and Marginal Utility,” George Reisman, trans., Quarterly Journal of Austrian Economics, vol. 5, no. 3, pp. 43-45.

As I wrote in Capitalism, what Böhm-Bawerk has shown in these passages is that when the price of goods whose own, direct marginal utility is extremely high is determined on the basis of cost of production, precisely then is its value determined on the basis of marginal utility—the marginal utility of the means of production used to produce it, as determined in other, less important employments. The buyer of an automobile fan belt or any other essential automotive part, for example, does not pay a price corresponding to the value he attaches to his car, but a much lower price corresponding to the marginal utility of the materials and labor required to produce fan belts or whatever—a marginal utility that in turn is determined by the marginal utility of products other than fan belts or whatever. As Böhm-Bawerk develops the law of diminishing marginal utility, it is no more surprising that the price of vital components and parts, or any necessity, is in conformity with its cost of production rather than its own direct marginal utility than it is that the marginal utility of the water on which our physical survival depends is no greater than the utility of the marginal quantity of water we use. Determination of price by cost is merely a mechanism by means of which the value of supramarginal products is reduced to the value of marginal products. The only complication is that the marginal products in this case are physically different and lie in other lines of production.

Here I must add that Böhm-Bawerk’s demonstration has the potential to accomplish two very major results: One, is to overthrow the core of contemporary “microeconomics” and its fixation on “marginal revenue” and the concomitant alleged ability of all significant sized firms to exploit marginal revenue at the expense of consumers. Böhm-Bawerk’s doctrine implies that wherever there is legal freedom of entry into an industry, the concept of marginal revenue becomes largely irrelevant. Price will be determined on the basis of cost, irrespective of the degree of inelasticity of demand and potential willingness of buyers to pay higher prices.

The second major result is a very substantial narrowing of the gap that is perceived as separating Austrian economics from British classical economics. As I’ve shown throughout Capitalism, there is enormous value in classical economics that has been overlooked for no genuinely good reason. If what is of value in classical economics could be added to the already great strengths of Austrian economics, the result would be a far more powerful defense of economic freedom and assault on statist intervention than is now possible.

But the most important, the overriding and sufficient reason for accepting Böhm-Bawerk’s analysis here is simply that it is profoundly enlightening—it’s the enlightenment yielded by the principle of marginal utility all over again, on a higher plane.


The quotation from Böhm-Bawerk in this article is copyright © 1959 by Libertarian Press and may not be reproduced without the permission of Libertarian Press. If that can be obtained, permission is hereby given to reproduce and distribute the rest of the article, which is copyright © 2006, by George Reisman, electronically and in print, other than as part of a book and provided that mention of the author’s web site www.capitalism.net is included. (Email notification is requested.) All other rights reserved. George Reisman is the author of Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson Books, 1996) and is Pepperdine University Professor Emeritus of Economics.

Mining for the Next Million Years

For many years, I’ve been pointing out that the entire mass of the earth, from the upper limits of its atmosphere 4,000 miles straight down to its core, consists of nothing but solidly packed chemical elements. There is not one cubic centimeter anywhere in the earth’s mass that is not some chemical element or other, or some combination of chemical elements. This, I’ve said, is nature’s contribution to the supply of natural resources, along with all of the enormous quantities of energy that go with it, from the energy contained in fossil fuels, uranium, wind, water, and the earth’s core to the energy contained in thunderstorms and static electricity.

How much of this immense quantity of matter and energy can be transformed into the narrower category of natural resources that are economically useable by and accessible to man depends on the state of science, technology, and supply of capital equipment. In other words, it depends on the extent of man’s knowledge of nature and the degree of his physical power over it. As man enlarges this knowledge and power, he increases the fraction of nature that constitutes economically useable, accessible natural resources. In the process, he transforms what had up to then been mere nature-given things into economic goods and wealth.

I’ve also always pointed out that up to now our power over nature—our ability to actually get at its contents and direct them to the satisfaction of our needs—has been measured in depths of feet rather than miles and has essentially been confined just to the thirty percent or so of the earth’s surface that is land. The clear implication is that we are still at the very beginning of our ability to extract economically useable natural resources from nature.

I’ve now gathered some empirical data that indicates just how modest man’s mining activities actually are compared to the size of the earth. For example, total global production of petroleum is approximately 30 billion barrels per year. Each barrel of petroleum measures approximately .16 of a cubic meter. This means that in terms of cubic meters, the physical volume of all the petroleum extracted in the world in a year is .16 times 30 billion, which is 4.8 billion cubic meters. Since a thousand meters equals 1 kilometer, a billion cubic meters translates into a mere 1 cubic kilometer. So the physical volume of total annual global petroleum production is presently 4.8 cubic kilometers. And because 1 cubic mile equals approximately 4.17 cubic kilometers, this means that all of the world’s petroleum production in a year represents about 1.15 cubic miles.

All by itself, this is enough to suggest that total global mining operations are extremely small relative to the size of the earth, which is 1.1 trillion cubic kilometers, or approximately 260 billion cubic miles. This conclusion is confirmed when one considers the global annual production of other important minerals, such as iron ore, coal, aluminum, and natural gas.

Global iron ore production was approximately 1.16 billion metric tons in 2003, the most recent year for which data are readily available. The density of iron ore varies between approximately 4 metric tons per cubic meter and 5 metric tons per cubic meter, depending on the type of ore. The smaller the number of metric tons per cubic meter, the larger the number of cubic meters required for any given tonnage. Using the lower figure of 4 metric tons per cubic meter, the total cubic volume of iron ore production in 2003 would be 291 million cubic meters, which is .291 cubic kilometers or .07 cubic miles. Because much of the iron ore extracted had a higher density, the actual physical volume of iron ore extracted was considerably less.

Global coal production in 2005 was 5.84 billion metric tons. Since the density of coal is roughly 1.3 metric tons per cubic meter, the physical volume of the coal extracted was about 4.5 cubic kilometers, or about 1.08 cubic miles.

Global aluminum production in 2001 was 32 million metric tons. The production of 1 ton of aluminum requires the mining of 4 to 6 tons of bauxite. Thus 32 million tons of aluminum production implies the mining of as much as 192 million tons of bauxite. Inasmuch as the density of bauxite is 1.28 metric tons per cubic meter, the cubic volume of the total amount of bauxite mined in 2001 was 150 million cubic meters. This in turn equals .15 cubic kilometers, or less than .04 of a cubic mile.

Global dry natural gas production in 2004 was approximately 98.62 trillion cubic feet, which equals 2,774 cubic kilometers. To put this figure in perspective, it should be realized that when liquefied, the volume of natural gas is reduced by a factor of 600. Thus the equivalent of this much gas in liquid form is 4.62 cubic kilometers, or a little over 1.1 cubic miles. This, of course, is somewhat less than the cubic volume of petroleum production.

If we add up these numbers, they total 14.28 cubic kilometers or 3.42 cubic miles. To allow both for the mining of everything else and for any extractions we may have overlooked in connection with the items we’ve considered, let’s just assume the nice round number of 100 cubic kilometers or roughly 24 cubic miles as representing all current mining operations combined on an annual basis for the world as a whole.

In a tolerably free, rational society, motivated human intelligence is easily capable not only of continuing man’s ability to extract this volume of useful materials from the earth but also substantially to increase it. If the present annual volume of such extractions were merely to continue, it could do so at least for the next 100 million years. By that time, a total of 10 billion cubic kilometers or roughly 2.4 billion cubic miles of earth would have been extracted, which would represent a little less than 1 percent of the earth’s total physical volume. If economic progress in coming centuries serves to increase the annual rate of extractions by a factor of 100, then mining operations could continue on that vastly larger scale for a million years, before 1 percent of the earth’s volume had been extracted. The exhaustion of useable, accessible mineral deposits is simply not a problem for an economy as free as that of the United States was until a few generations ago.

Our growing problems in connection with the supply of natural resources are not caused by nature but by us. We have allowed ourselves to abandon our reason and give up our freedom. We have allowed ourselves to be led by people who would have us freeze and be immobilized rather than spill some oil on snow hardly any of us will ever see or disturb the habitat of wild animals that mean nothing to us. If we allow this to continue, then where we are headed is to a world describable by these terrible words of despair:

You must know that the world has grown old, and does not remain in its former vigour. It bears witness to its own decline. The rainfall and the sun’s warmth are both diminishing; the metals are nearly exhausted; the husbandman is failing in the fields, the sailor on the seas, the soldier in the camp, honesty in the market, justice in the courts, concord in friendships, skill in the arts, discipline in morals. This is the sentence passed upon the world, that everything which has a beginning should perish, that things which have reached maturity should grow old, the strong weak, the great small, and that after weakness and shrinkage should come dissolution.[1]

As I wrote in Capitalism, that passage is not a quotation from some contemporary environmentalist or ecologist. It was written in the third century—long before the first chunk of coal, drop of oil, ounce of aluminum, or any significant quantity of any mineral whatever had been taken from the earth. Then as now, the problem was not physical, but philosophical and political. Then as now, men were turning away from reason and toward mysticism. Then as now, they were growing less free and falling ever more under the rule of physical force. That is why they believed, and that is why people in our culture are beginning to believe, that man is helpless before physical nature. There is no helplessness in fact. To men who use reason and are free to act, nature gives more and more. To those who turn away from reason or are not free, it gives less and less. Nothing else is involved.

[1] The passage quoted above appears In W. T. Jones, The Medieval Mind, vol. 2 of A History of Western Philosophy, 2d ed. (New York: Harcourt, Brace, and World, 1969), p. 6

This article is copyright © 2006, by George Reisman. Permission is hereby granted to reproduce and distribute it electronically and in print, other than as part of a book and provided that mention of the author’s web site www.capitalism.net is included. (Email notification is requested.) All other rights reserved. George Reisman is the author of Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson Books, 1996) and is Pepperdine University Professor Emeritus of Economics.

Free-Market Science vs. Government Science

In a free market, science originates in the minds of individual scientists, who have studied and thought about problems that interest them and who from time to time arrive at new insights, which they develop further and verify. In the course of their work and in the dissemination of its results, they often need more funds than they can personally provide. In such cases, inspired by the value they see in their work, they attempt to obtain the necessary funds from those other individuals whom they can persuade to share their understanding of their work and its value.

In a free market, the main source of funds would be wealthy businessmen and wealthy heirs. In a free market, there would be no income or inheritance taxes, both of which are a violation of the freedom of the individual to spend his own wealth as he chooses. And because there would be no income or inheritance taxes, there would be no need for the establishment of foundations and trusts as means of avoiding these taxes, nor for the appointment of trustees or anyone else with power to determine the use of one’s funds. There would thus simply be wealthy businessmen and heirs in full control of their own funds. And a businessman would not have to worry about running afoul of any regulatory agency agency that might use its power to harm his business in retaliation for his supporting research that was unpopular.

The possession of substantial wealth by single individuals, with full power to determine its use, is of vital importance. This is because not only do new ideas originate in the minds just of single individuals, who necessarily must set out completely alone in any quest to change the understanding of the rest of mankind, but the change in other people’s understanding, which must subsequently be brought about, also proceeds just one mind at a time.

For an individual to understand something that is new and significant is not an easy or automatic task even in the best of circumstances. For the original discoverer it must be somewhat daunting to think that there is a significant truth that as yet, in the entire world and in the entire history of the world, he alone understands. Such an individual needs to have considerable confidence in the power and reliability of his mind. Galileo, Newton, Pasteur, Edison—all the great innovators in science and invention have necessarily been in this position.

The first people to be persuaded of the truth and significance of a new discovery, after the discoverer himself, must also have considerable confidence in the power and reliability of their minds as well. Their situation is that as yet only they and the discoverer understand this truth and its value. They must be prepared to proceed on the basis of no foundation but that of their own, independent judgment that the discovery is in fact true and valuable.

In this connection, it should be realized that even the utmost obviousness of a truth is never a guarantee of its acceptance by an individual. There are many people so doubtful of their own capacity to judge the truth, so fearful of the possible need to defend it in a conflict with others, who they expect will disagree, that their response even to an extremely obvious but not yet generally recognized truth is, in effect, that it need not be true because if it were, it would already be generally recognized and accepted. For such people, the ability to recognize the truth melts away without the assurance that practically everyone else is prepared to confirm the truth as true. Only then can acceptance of a truth be sufficiently separated from the possibility of conflict with others that it can take place without being blocked by fear.

Consider, for example, how the great mass of people could once go on believing, century after century, that the world was flat. Certainly that was how the world appeared to them any time they looked out at a broad expanse of land in front of them. But some people in this period knew that the world was round and that its appearance of flatness could easily be reconciled with the fact of its roundness.

The conclusion that the world was round was an obvious inference to be drawn from such facts as the tops of the masts of sailing vessels appearing on the horizon first, followed by more and more of the masts, and then by the body of the vessels, as they came closer. It was an obvious inference to be drawn from the knowledge that while one could see only so far when one looked out at the land in front of one, the limit of one’s field of vision was not the limit of the extent of the earth, which went further. Curvature of the earth was the obvious explanation in both cases.

While some people undoubtedly did understood this much at the time, most people could not be persuaded of it for many centuries. They were essentially immune to this knowledge. Whether is was simply out of fear of conflict with others to whom they might have to explain it in the face of resistance and possible derision, or simply a matter of intellectual laziness on their part, or both, the essential fact is that here was a very simple truth that the great majority of mankind could not be gotten to accept for a very long time. And even today, when virtually everyone finally does acknowledge that the earth is round, it is probably the case that a large proportion of the people who now do so, have no better reason for doing so than that this is what they know the great majority of people believe and is thus what they are expected to believe.

Intellectually inert and fearful people continue to be extremely numerous. They are to be found at all levels of educational attainment. Those with higher levels of education simply know more about what most people supposedly believe and that they are thus expected to believe. They hold their knowledge virtually as a collection of public opinion polls. Very little if any of their ostensible knowledge is solidly grounded. They have little or no basis for forming an independent judgment of the truth or falsity of new knowledge.

Such people are so numerous that even in relatively small groups one or more of them can be expected to be found. This is what makes it so important that the power to make decisions rests in the hands of single individuals, not groups, committees, or boards of any kind. To the extent that it is groups, committees, or boards that decide, the likely presence of such people and their mutual reinforcement of each other constitutes a major obstacle in the way of a valuable new idea going forward.

The advancement of science depends on a free market, because the free market and its vesting of decision-making power in the hands of single individuals rather than groups is able to shunt aside those who lack the power of independent judgment. They are relegated to the sidelines, where they can enjoy all the benefits of scientific and economic progress but not get in its way.

Now let us turn to science under the tutelage of the state.

State control of science is the attempt to combine opposites. In essence, science is mind; the state is physical force. Science makes its way by means of the voluntary assent of the individual human mind to its recognition of truth. In contrast, the state and what the state sponsors makes its way by means of the use of physical force and the threat of physical force. There is no law, regulation, ruling, edict, or decree made by the state that is not backed by the threat of physical force to compel obedience to it. The state does not say to the individual do or do not do this because of its reasonableness or lack of reasonableness, and take as long as you like before coming around to our position. No. It says, do this or do not do this if you want to stay out of jail and avoid being injured or killed in resisting.

Any financial support the state may provide to science is by means of taxes collected at the point of a gun, from people who know that they will be imprisoned if they do not pay the taxes and injured or killed if they resist being imprisoned. This is a remarkable foundation for the progress of science, much like a purported construction of a laboratory by gorillas.

Thus, the starting point of state-sponsored science is the exact opposite of the starting point of actual science: it is physical force not the voluntary assent of the individual mind.

There is another important difference in starting point. Science begins in the mind of the individual scientist seeking important truth not previously identified. State-sponsored science in contrast typically begins with an already established consensus concerning the subject to be pursued. This is because the existence of a consensus increases the likelihood of being able to obtain political support for the project.

Of course, not all state-sponsored science requires an existing consensus. Stalin did not need a consensus when he decided to promote the career of the biologist Lysenko, because of the latter’s support for the theory of acquired characteristics.

The example of Stalin and Lysenko sheds light on the kind of scientific quest that any politician or government official will initiate if he can. Because the primary concern of such a person is always the maintenance and enhancement of his power, the projects he initiates will be projects designed to increase his power and prestige. Any connection with scientific truth is likely to be merely coincidental. Thus in the case of Stalin and Lysenko, the objective was not the promotion of the science of biology, but support, wrung at the expense of the science of biology, for the Marxist doctrine that life under Communist rule could change human nature by virtue of a succession of generations acquiring characteristics that would then be genetically transmitted to later generations.

Whether state-sponsored science rests on an existing consensus or on the initiative of an individual politician, it differs radically from genuine science in yet another respect. This concerns the relationship between science and money. In a free market, it is the truth and importance of the science that drives the raising of money. Money is raised in order to facilitate the development and dissemination of the science. Money is the means; science is the end. With state-sponsored science, this relationship is largely reversed.

The state, in effect, offers pots of money in the form of “grants” for the study of matters selected by politicians and their appointees, and then scientists must choose areas of investigation that are most likely to secure them some of that money. The “scientists” gather around the pots of money, like bees around pots of honey, eagerly seeking as best they can to slurp up some of the money by means of writing whatever kind of grant proposals they think will promote the agenda of whichever officials have the power to determine the award of the grants.

The meaning of this state of affairs is that the initiative for science passes from scientists to the state, i.e., to politicians and their appointees. And instead of money serving science, science now serves money, and, it must be stressed, not ordinary money, but money collected at the point of a gun, and made available on conditions determined by politicians and the appointees of politicians.

In a free market, of course, applied science serves money. There are companies that want to develop specific products and they employ scientists to help develop them. But the funds are raised voluntarily and the applied science must be true, or the products will not work. There are also companies and wealthy individuals in a free market who may be interested in the exploration of various fields of basic science and who offer monetary incentives to scientists to pursue such research. Again, at the very least, the relationship is strictly voluntary.

What is crucial is that in a free market, there is room for independent scientists, scientists who themselves take the initiative in their work and who, thanks largely to the existence of a substantial number of wealthy businessmen and heirs, have a real chance of obtaining the funds they need in order to pursue their work and disseminate its results. Indeed, in a free market, without income taxes, there might well be significant financial support for independent science extending deep into the ranks of the middle class.

State-sponsored science comes into existence on a large scale in an environment in which the foundations of genuine basic science are already largely undercut by the existence of progressive income and inheritance taxes and an accompanying collectivization even of private decision making: i.e. the replacement of individual decision making with decision making by groups of various kinds, notably boards and committees.

Once state support of science comes into existence, there is little prospect of major advances in science gaining any support from it. A major advance in science represents the radically new and different. However true it may be, its truth as yet lacks adherents. And precisely for this reason, it is almost certain to be rejected by those whose standard of truth is acceptance by others. It does not yet and cannot yet have this acceptance because of its very newness. If it is to be accepted, it must be accepted on the basis of independent judgment and nothing else. But the exercise of independent judgment virtually cries out for the foundation of the ownership of independent wealth. Independent, i.e., privately owned, wealth, can be used in support of the radically new and different. In that case if the judgment is wrong, the loss is that of the person who made it. But when the wealth being used is publicly owned, then whoever makes the judgment concerning its use, must above all be sure that he can prove that he did absolutely nothing out of the ordinary with it. Only in that way, can he avoid blame for any loss.

State-funded science is necessarily a swamp of mediocrity. It is the domain of peer-reviewed journal articles and of statistical studies. In peer-reviewed journals, nothing is considered worthy of publication unless deemed to be so by “peers.” What this means is that in order for a radical new idea to be accepted for publication, it must immediately gain the support of those who hold the opposing, now outmoded ideas that it shows to be in error, or else it cannot be published. Such an arrangement is tantamount to requiring that before Galileo can publish, his ideas must have the endorsement of astronomers who up to the moment of reading him have adhered to the Ptolemaic system of astronomy. It is tantamount to requiring that before Louis Pasteur can publish on the subject of the germ theory of disease, he must have the assent of those who deny the very existence of germs.

State-funded science is very much at home with statistical studies. This is because they can all be made to fit easily specified criteria with respect to such matters as sample size, confidence intervals, and confidence levels. They are thus a very good way for large numbers of “scientists” to be kept employed attempting to establish or deny the likelihood of a relationship existing between practically any two things in the universe. Provided the “scientist” can verify that he has followed the rules of such a study, he can rely on keeping his government grant check and go on to the next “study” and the next government grant.

Perhaps some may find the most telling criticism of state­-funded science the simple visualization of the faces of various politicians and government officials, coupled with the realization that it is they who are now in charge of science. Even though our President, his Cabinet officers, and our legislators do not personally award government grant money, they might as well do so. This is because it is still their judgment, such as it is, that determines the appointment of those who do award the grants, or the appointment of those who whose further job it is to make such appointments. And in the same way, with whatever intervening layers of appointees that there may be, it is their judgment that ultimately underlies the choice of all members of the government’s panels of science advisors.

There is first of all the very great problem of the ability of our politicians and officials to make any kind of sound appointments. Who are they, after all? What is it that they actually know about science, or about anything for that matter? What qualifies them to determine the qualifications of an appointee? And then there is the further problem of who is it that seeks out such jobs as determining the award of government grant money? Who is it who seeks appointment to the government’s advisory panels of scientists?

Serious scientists are concerned with the pursuit of science, not the politics of science. It is not likely that they will be interested in obtaining such positions. Such positions are sought precisely by the opposite kind of “scientists,” namely, those for whom it is the politics of science that counts, and not the actual substance of science. These are the kind of people who actually enjoy being members of committees. And it is these people, several rungs down in the bureaucratic hierarchy, who are now the masters of science on a day-to-day basis.

State-sponsored science is the destroyer of science. If science is to live, government funding of science must end.

This article is copyright © 2006, by George Reisman. Permission is hereby granted to reproduce and distribute it electronically and in print, other than as part of a book and provided that mention of the author’s web site www.capitalism.net is included. (Email notification is requested.) All other rights reserved. George Reisman is the author of Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson Books, 1996) and is Pepperdine University Professor Emeritus of Economics.

Wage Rates and Purchasing Power

An individual who earns more money per week is obviously in a position to spend more in buying consumers’ goods than is an individual who earns less money per week. For example, a man who makes $1,000 per week has the ability to spend $1,000 per week, while a man who makes only $900 per week has the ability to spend only $900 per week. (For the sake of simplicity, we’re ignoring such possibilities as going into debt or using up savings, and assuming that the individuals both want to live within their incomes.)

When there is unemployment and free-market economists urge the freedom of wage rates to fall as the means of eliminating the unemployment, many people think of examples like the above and conclude that the free-market solution would only serve to make matters worse. They reason, in effect, that now workers who had been earning $1,000 per week would only earn $900 per week and thus be reduced to spending only $900 per week instead of $1,000 per week. Generalizing from this example to wage reductions of any size, and to their effect across the whole economic system, people conclude that wage-rate reductions cause reductions in overall consumer spending and therefore must serve to make the problem of unemployment worse, rather than better. In fact, often going under the name of Keynesianism, this is far and away the prevailing doctrine on the subject and is why reductions in wage rates are rarely if ever advocated as the means of reducing unemployment in the present-day world.

However, let us approach matters now not from the perspective of an individual wage earner, but from that of the economic system as a whole, essentially just like Henry Hazlitt did in his brilliant Economics In One Lesson.

In the economic system as a whole, in any given year, there’s a certain overall total amount of payroll expenditures by business firms, i.e., a certain overall total amount of wage payments. There’s also a certain overall total amount of consumer spending that takes place in the year. Since it‘s always essential to think in terms of numbers when dealing with such matters, let’s assume that in the economic system as a whole in a given year total payroll expenditures amount to 400 units of money. (This is certainly a very small number of units, but each unit can be understood as representing as many billions or tens of billions of dollars as may be necessary for the 400 units to represent the actual total payrolls of the present-day United States. Thinking in terms of a small number of units allows us to avoid wasting valuable brain space in holding strings of unnecessary zeros in our minds)

Let’s also assume that total annual spending to buy consumers goods in this economic system is 500 units of money, with each unit of money representing as many billions or tens of billions of dollars as does each of the 400 units of money paid as wages.

So here we are: 400 units of money is total wage payments and 500 units of money is total consumer spending in our hypothetical economic system.

We can assume that 400 of the 500 of consumer spending represents consumption expenditure by wage earners, out of their 400 of wage incomes. The remaining 100 of consumer spending can be taken as representing consumption by businessmen and capitalists, out of profits, interest, and dividends, and/or out of previously accumulated capital.

Now imagine that in this hypothetical economic system, there is 10 percent unemployment. That means that there is also 90 percent, positive employment. Going from 10 percent unemployment to full employment means increasing positive employment in the ratio of 10 to 9.

Isn’t it clear that if total payroll spending were maintained, a 10 percent reduction in wage rates would secure full employment? That it would mean 10/9 the workers employed at 9/10 the average wage. Wouldn’t consumer spending also hold up in these circumstances, with 10/9 the workers spending 9/10 the average wage per worker?

And if the output per worker remained the same, wouldn’t the same total consumer spending of 500 units of money be sufficient to buy 10/9 the output at 9/10 the prices? And wouldn’t total profit in the economic system, and, by implication, the average rate of profit, be the same, despite the fall in prices? (Wouldn’t total profit essentially continue to be 500 units of money in the form of consumption expenditure minus 400 units of money in the form of wage payments?)

What of real wages? If prices and wage rates both fall to the same extent, wouldn’t real wage rates be the same? In fact, wouldn’t real take-home wage rates actually increase because of the elimination of the burden of supporting the unemployed, who would now be employed and supporting themselves?

And notice the implication for how real wage rates can continually be further increased, namely, simply by virtue of labor becoming more and more productive and thus progressively increasing the supply of consumers’ goods relative to the supply of labor, thereby more and more reducing prices relative to wage rates.

This example, of 400 of wage payments and 500 of consumer spending, is a depiction of the economic world in terms of essentials. Mises would call it an imaginary construction. It is very highly simplified. Yet it is also extremely pregnant with implications: for employment/unemployment, for real wages, for profit/interest, and for much else besides.

Whoever starts to think about this example will have many questions, the answers to which obviously cannot be fitted into a brief article such as this. The questions can concern such things as the effects of adding the buying and selling of capital goods into the example, the effects of allowing for changes in the amount of spending in the economic system and for changes in the relationship between different kinds of spending, and more. For answers to all such questions, I invite those interested to read my book Capitalism: A Treatise on Economics. There I think they will find not only just about all of the answers they are looking for, but also many questions they have not thought of asking, along with the answers to those questions as well.


This article is copyright © 2006, by George Reisman. Permission is hereby granted to reproduce and distribute it electronically and in print, other than as part of a book and provided that mention of the author’s web site www.capitalism.net is included. (Email notification is requested.) All other rights reserved. George Reisman is the author of Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson Books, 1996) and is Pepperdine University Professor Emeritus of Economics.

How Environmentalism Raises Profits at the Expense of Wages

In my last article, “How Government Budget Deficits Reduce Wages and Raise Profits”, I explained why those who complain about profits rising at the expense of wages should not blame the free market but, in part at least, the growth in government budget deficits. I’d now like to show that in addition they should blame the environmental movement and the government intervention that it has inspired.

Environmentalism operates systematically to withhold land and natural resources from the market. Wherever it can, it prohibits economic development, in the form of housing construction, power-plant construction, and road construction. It attempts to stop the opening of new mines and especially new oil fields. While it claims to favor what it calls renewable natural resources, it also attempts to stop logging operations, even though new trees can be grown to replace those removed. It has also succeeded in imposing limits on the emission of such chemicals as sulfur dioxide, nitrogen, and chlorofluorocarbons (cfcs) into the atmosphere, and in these cases systems of “tradable emissions rights” have been established. It currently seeks similarly to limit the emission of carbon dioxide into the atmosphere and to establish a system of tradable emission rights in its case too; indeed, a limitation on carbon dioxide emissions and a system of tradable emission rights for carbon dioxide already exist in the European Union.

Under a system of tradable emission rights, the government acknowledges long-standing emissions and confers a legal right for them to continue. For example, if for many years, a firm has been emitting a ton of sulfur dioxide into the atmosphere each year, the government may grant it a legal right to continue doing so indefinitely and, in addition, to sell that right in the market from year to year or to sell it permanently, just as the firm might rent or sell any other durable property that it owns. Newcomers who wish to emit sulfur dioxide, or established firms that wish to increase their emissions, cannot do so unless they buy emission rights from the firms that possess them. Emission rights quickly become scarce and progressively more valuable as the need for additional production of the kind that must result in more emissions intensifies and comes up against the barrier of the prohibition on a larger volume of emissions.

I do not know of any reliable estimates of the aggregate dollar value of the tradable emissions that are now purchased in a given year in the United States or around the world. But whatever it may be, it represents a clear addition to the aggregate amount of profits in the economic system. This is because the firms that sell their emission rights thereby have sales revenues for something that costs them virtually nothing whatever to provide. And so long as they sell these rights merely on an annual basis or for a limited term of years these sales revenues and profits will be recurring.

Furthermore, looking at things now from the perspective of the purchasers of the emission rights, the need to purchase emission rights equivalently reduces the funds available to business firms for the purchase of other things, notably capital goods and labor services. Thus, the effect of the existence of tradable emission rights is both an increase in the aggregate amount of profit in the economic system and a decrease in the aggregate amount of wages paid in the economic system.

The effect of payments for emission rights on wages can be further inferred from the following considerations. Assume for the moment that the price of emission rights were to count simply as an additional cost of production, added to all of the other costs of production, and to correspondingly drive up the prices of goods to the point required to cover this additional cost. If this happened, the quantity of goods demanded in the economic system would fall. It would fall simply as the result of the combination of higher prices and limited funds with which to pay prices.

The result of the fall in the quantity of goods demanded would be unemployment. If unemployment is to be avoided, the prices of goods must not rise. But in order for them not to rise, their costs of production must also not rise. In order for costs not to rise in the face of the addition of the new component of cost that is constituted by the price of emission rights, another primary component of cost, notably wages, must fall. In other words, the value of tradable emission rights ends up being at the expense of wages. Thus, environmentalism and the system of tradable emission rights serve to raise profits and reduce wages.

It must be stressed that if wage rates do not fall in order to offset the additional costs constituted by the value of tradable emission rights, then the result is both higher prices and unemployment. In this case, while wage rates in terms of money do not fall, wage rates in terms of buying power still fall because the same wage rates in money must be used to pay higher prices for goods.

The fact that such are the consequences of the system of tradable emission rights should not be taken as a criticism simply of that system. The imposition of the same environmentalist restrictions on production without an accompanying system of tradable emission rights would result in even worse consequences. This is because the costs of complying with the environmental regulations would then be far greater, with the result either that prices would have to rise or wage rates fall by that much more.

For example, a firm that could avoid a million dollars of additional costs if it could emit an additional ton of sulfur dioxide would simply have to incur those additional costs even though elsewhere in the economic system there was a firm that would incur additional costs of only a few thousand dollars if it reduced its emission of sulfur dioxide by a ton. The absence of tradable emission rights in this case would cause the needless imposition of almost a million dollars of unnecessary costs, requiring a corresponding rise in prices or fall in wages in the economic system. It is clearly the substantially lesser evil in this case even if the right to emit a ton of sulfur dioxide were to be sold for several hundred thousand dollars.

The problem is not the system of tradable emission rights. The problem is the prohibition of the increase in emissions that is the necessary accompaniment of the increase in production. The prohibition of additional emissions thus serves to prohibit the increase in production. Of course, in the absence of prohibitions on additional emissions, there would be no basis for the existence of systems of tradable emission rights, and thus they would simply not exist.

As indicated at the beginning of this article, environmentalism’s prohibitions on production go far beyond those that have been accompanied by systems of tradable emission rights. With or without tradable emission rights, the effect of imposing laws and regulations based on environmentalism is to make land and natural resources artificially scarce relative to human labor and thus to enhance the economic value of land and natural resources while reducing the economic value of human labor, above all, wage rates. In the terminology of the old British classical economists, what environmentalism is doing is increasing the portion of national income that takes the form of “land rent,” and doing it at the expense of the portion of national income that is wages.

The rise in the economic value of land and natural resources—the rise in land rent—shows up in the form of a rise in profits. All net monetary earnings derived from the ownership of land or natural resources are profits from the point of view of business accounting. Profits rise to the extent that the prices of minerals and of agricultural products rise relative to the costs of producing them. And precisely this is what happens when the demand for these products rises and environmentalism has meanwhile succeeded in preventing commensurate increases in their supply.

The leading example of this phenomenon at present is the recent rise in the price of oil and natural gas. A growing population and a growing need for oil here in the US, coupled with major economic progress in China and other parts of Asia, has substantially increased the demand for oil and natural gas. However, the environmental movement has done everything in its power to prevent increases in the supply of these commodities.

It has prevented the development not only of the oil deposits in the North Slope of Alaska but also oil and gas deposits on the continental shelf off California and the Gulf Coast, as well as oil and gas deposits present in the vast land areas set aside as wilderness preserves and wildlife areas. In addition, it has prevented the construction of new atomic power plants, whose existence would serve to diminish the demand for oil by the electric power industry and thus make oil more available for other purposes, and at a lower price. The same is true in connection with coal mining. Its expansion too is blocked, and thus the availability of this major substitute for oil is also held back. The result is that the need for oil is made that much more intense and its price correspondingly higher.

Different parts of the supply of minerals and of agricultural commodities have different costs of production. For example, there are some petroleum deposits which are so easily accessible and so productive that they can be exploited at a cost of production of perhaps just $3 or $4 per barrel. But such petroleum deposits can meet only a small portion of the demand. The rest of the demand must be met by exploiting higher-cost deposits, deposits with a cost of production of $10, $20, $30 per barrel, and more. Every time the price of oil rises because its supply is prevented from increasing, profits are increased on all the petroleum deposits in production.

The same principles apply to wheat production and housing construction. The result of all increases in demand not matched by an increase in supply, because environmentalism prevents the increase in supply, is a rise in price and an increase in the portion of the good’s price that reflects the resulting greater scarcity and higher value of land and natural resources. And, as we have seen, this higher value of the economic contribution of land and natural resources that environmentalism causes takes the form of higher profits.

In sharpest contrast to today’s markets that are distorted by environmentalism and the government intervention that it has brought about, a free market would produce results of an opposite kind. In a free market, with its powerful incentives to increase production and to find new and more efficient ways of doing so, supply would increase not only commensurately with the increase in demand but more than commensurately. Lower-cost methods of production would be found that would make it possible for prices to be driven down rather than up. A free market operates to increase the supply of useable, accessible land and mineral deposits relative to the supply of human labor and thus to make them progressively cheaper in real terms.

Accordingly, profits based on the ownership of lower-cost natural resources and farm land would be sharply contained, and even diminish, as scientific and technological progress and capital accumulation served to make available more such deposits and farm land or equally good or better substitutes for them and thus to drive the prices of products produced by means of such deposits and land closer to their low costs, meanwhile further reducing those low costs.

In a free market, wages rise relative to the value of land and natural resources and are thus correspondingly higher relative to profits. This was the record of the United States and the rest of the Western World for approximately 200 years following the start of the Industrial Revolution.

Environmentalism is a movement dedicated to the undoing of the Industrial Revolution. If not checked, one of its results will be the progressive reduction of wages and the further elevation of profit incomes based on the ownership of land and natural resources.


This article is copyright © 2006, by George Reisman. Permission is hereby granted to reproduce and distribute it electronically and in print, other than as part of a book and provided that mention of the author’s web site www.capitalism.net is included. (Email notification is requested.) All other rights reserved. George Reisman is the author of Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson Books, 1996) and is Pepperdine University Professor Emeritus of Economics. For elaboration of the subject of this article, the reader is urged to see Capitalism, pp. 316-317, 667-668, and 313-316.

How Government Budget Deficits Reduce Wages and Raise Profits

In recent years there have been growing complaints over slow growth in wages compared to profits. Those who make the complaints usually offer little in the way of explanation. Here is a part of the explanation: growing government budget deficits.

Government budget deficits are financed partly by the creation of new and additional money. But for the rest, they are financed by selling government securities to the citizens, who pay for the securities with money that already exists and which is part of their savings. If the government had not been running at a deficit and had not needed to sell these securities, the citizens would have used most of the savings with which they buy the government securities to buy corporate securities and in other ways to make their funds available to business firms.

Those savings, in the hands of business firms would have been used to purchase capital goods and to pay wages. These wages, however, never come into existence if the savings out of which they would have been paid are diverted to the government to finance its deficit. Thus, wage payments in the economic system are smaller because of government deficits.

Yes, it is true that the government itself pays wages to some extent. But it is unlikely to do so to the same extent as do business firms. And to whatever extent the additional wage payments it makes out of the proceeds of its securities sales are less than the wage payments that business firms cannot make because of the diversion of part of what would have been their capital funds to the government, total wage payments in the economic system are reduced.

In addition to this likely reduction in overall wage payments in the economic system, the effect of government budget deficits is an increase in the aggregate, i.e., total, economy-wide, amount of business profits. Here’s why.

Whether business gets money to finance its purchase of capital goods and payment of wages, or the government gets money to buy goods and services, including meeting its own payroll, and, of course, simply to give money away in carrying out various welfare-state functions, the amount of business sales revenues in the economic system will be pretty much the same. This is because a dollar from the sale of a good to a business firm and a dollar from the sale of a good to the government is still a dollar of sales revenues. A dollar from the sale of a good to an employee of business or dollar from the sale of a good to a government employee is again still a dollar of sales revenues. And finally, a dollar from the sale of a good to someone who has received his money under one or another of the government’s welfare-state programs is no less a dollar of sales revenues than a dollar spent by someone who had earned that dollar.

But here’s a crucial difference: The dollars spent by business firms in buying capital goods and in paying wages sooner or later show up as costs of production. Those costs of production, of course, must be deducted from sales revenues in calculating profits. Aggregate profit in the economic system reflects their subtraction.

To the extent that government budget deficits divert funds from the purchase of capital goods and the payment of wages by business firms, their effect is sooner or later to reduce the magnitude of costs of production in the economic system and equivalently to increase the aggregate amount of profit in the economic system. Costs reflect prior outlays of money. To the extent that those outlays are less, the costs will be less. The reduction in costs of production raises profits equivalently, because, as we have just seen, the amount of sales revenues in the economic system is the same either way; it’s the same with or without the budget deficits. In the face of the same aggregate sales revenues, reduced aggregate costs mean equivalently higher profits.

So growing budget deficits are part of the explanation of profits rising relative to wages.

Before concluding, it’s necessary to point out that a rise in profits achieved in this way is not a cause for joy. What is present is an illustration of the dichotomy identified by Ricardo that often exists between monetary value and physical wealth. (See his Principles of Political Economy and Taxation, chap. XX.) Aggregate money profit is up, but in large part that is the result simply of the expenditure for capital goods being down. What that signifies is less previously produced wealth being available to serve in the production of future wealth. A part of the output of the economic system that would have gone into the production of future output is instead diverted to the government’s consumption and to the consumption of those to whom the government gives money.

The effect of this cannot fail to be that the productivity of labor in the economic system will be less than it otherwise would have been and that real wages in the future will consequently suffer from production being less than it otherwise would have been and thus from prices being higher than they otherwise would have been. And, ironically, as an integral part of these developments, while total costs of production in the economic system, are lower, unit costs of production will be higher than they otherwise would have been, because of the reduced output that results from the smaller total outlays of business and the consequent reduction in the supply of capital goods available for use in further production.

In sum, the effect of government budget deficits is lower money wages, higher money profits, and lower real wages to the extent that the deficits serve to increase prices and unit costs on top of reducing money wages.


This article is copyright © 2006, by George Reisman. Permission is hereby granted to reproduce and distribute it electronically and in print, other than as part of a book and provided that mention of the author’s web site www.capitalism.net is included. (Email notification is requested.) All other rights reserved. George Reisman is the author of Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson Books, 1996) and is Pepperdine University Professor Emeritus of Economics. This article is an application of his theory of profit/interest presented in Capitalism. It is based specifically on the discussion on pp. 829-830 of his book.

Politics Masquerading as Science, by Mark Humphrey

The following comment by Mr. Mark Humphrey was originally posted on the blog of the Mises Institute on June 29. It is reprinted here with his permission.

The global warming crusade is politics masquerading as "science". One indication of this bait and switch tactic is the argument, continually promoted by left-wing Greens, that a "consensus" of climate scientists supports this officially sanctioned thesis. Aside from the questionable truth of this claim (more on this below), consensus has nothing to do with the process of identifying evidence, facts, and the logical integrations that lead to new scientific breakthroughs. So scientists properly ought not to be concerned with consensus. Consensus is the obsession of politicians maneuvering to impose their will by force on other people.

Reasonable people should be highly skeptical of much of the "science" produced by contemporary state-sanctioned institutions, because those institutions owe their existence to coercion. They are financed with tax dollars, and more and more they tend to be staffed and run by ambitious political types, who know how to massage the system for grants, prestigious awards, budget boosts, and official approval. Authentic scientists devoted to the adventure of discovery and understanding do not fare well in these institutions of Correctness, because the greater their devotion to science, the higher their resistance to compromising truth for political gain. There are many examples from history of the basic contempt for knowledge fostered by and characteristic of command science. As Ayn Rand explained years ago, force and intelligence are logically and fundamentally antagonistic.

In sharp contrast to the deceit that emerges when science is distorted by a regime of coercion, privately funded science, whether by Exxon or some other organization, has a major stake in establishing the truth. For private funding is voluntary, so both sponsors and scientists have a huge stake in getting results, which in this case means establishing facts. The privately-funded scientists want to establish facts because their reputations and prospects for advancement in science depend on it. Their sponsors want to establish facts, because such is their only effective defense against those who attack them. "Scientists" who embark on a career in tax-funded politically-driven institutions think of themselves as engaged in science, but to the extent that their job security and advancement depend on acceding to political considerations, they are engaged in pretend-science. And these political considerations, whether or not they are acknowledged in public, comprise the whole purpose behind the institution that employs them!

The seeming unanimity of opinion among scientists about global warming is the result of powerful political tides, all pulling in one direction. Dissenters get the silent treatment, are denied grants and fellowships, and will be demoted, sidelined and ostracized by their more politically-sensitive brethren. But despite this great pressure to conform with the official line, 17,000 scientists signed a petition a few years ago dissenting from the global warming thesis. These were scientists who had some professional connection to this issue, climatologists, oceanographers, astronomers, etc. The left-wing dominated press, whose reporters all emerged from public universities with nearly identical ideological outlooks, saw fit to bury this news—a program that continues to this day.

No Fourth of July Celebration at The New York Times/Pravda

The New York Times does not mention Independence Day on its editorial page. And there is no word of celebration of it on its Op-Ed page. What is present on the Op-Ed page is a further demonstration of that newspaper’s hostility to the fundamental values on which the United States was built.

One article, titled “Spinning the Revolution,” seeks to undercut the value of the American Revolution by presenting it not as the kind of great world-shaking event that it was, signifying for the first time in human history the establishment of a government dedicated to the protection of individual rights, but as a matter of mere “spin,” manufactured by a collection of writers and pamphleteers. In the same vein, it belittles the value Americans have rightly attached to the Declaration of Independence and the United States Constitution by sarcastically describing those documents as being viewed as “sacred scripture."

Another article, “Billionaires to the Rescue,” which compares Warren Buffet’s gift of $31 billion to charity to the charitable giving of Andrew Carnegie early in the last century, proceeds as though it never heard of such a thing as the right to the pursuit of happiness. Clearly revealing the perspective of a collectivist, it dares to ask,

Is society served by permitting so much capital to be accumulated by so few? Should we have to rely on the usually unfulfilled hope that fortunes of this magnitude will be put to a good cause? What becomes of a society that must rely on "gifts" from a handful of socially conscious billionaires to save its schools, cure disease and alleviate poverty?

The author believes that “society,” i.e., politicians and government officials have the right to thwart the individual’s accumulation of wealth, thereby denying his right to the pursuit of happiness. In claiming that it is an accidental matter whether large fortunes are put to a good cause, he reveals his ignorance of the fact that the fortunes are invested in business firms as capital, and thereby serve as the source of supply of goods and services to consumers and of demand for the services of wage earners. He demonstrates further ignorance in failing to realize that the high profits out of which fortunes are accumulated are the result of introducing a series of important innovations in the form of new and better products or more efficient methods of production.

He also does not realize that all that prevents the charitable giving of fortunes from resulting in a reduction in the well-being of consumers and wage earners is their continuing to remain invested rather than being consumed by the recipients of charity. The consumption of the recipients of charity needs to be held within the limits of the income on the capital in order for this destructive outcome to be avoided.

Finally, seizing the fortunes by the government to “save . . . schools, cure disease and alleviate poverty” will accomplish little but the reduction of capital. Schools, books, and all the means of learning are properly the province of private business firms meeting the demand of consumers, just as is the supply of food and clothing. Likewise, curing disease is properly the province of privately owned pharmaceutical firms, hospitals, clinics, and of physicians in private practice. The alleviation of poverty is the daily work of businessmen who introduce the newer and better products and more efficient methods of production: in addition to being the source of fortunes, these last are the source of the rise in the standard of living of everyone. They are what enable almost everyone in the modern world to be well fed, clothed, and housed and to have such goods as indoor plumbing, central heating, refrigerators, stoves, telephones, and television sets.

To the extent that schools, medical care, and poverty represent problems in need of solution, the first step in the solution is removing the government from the picture and allowing the profit motive and the pursuit of happiness to succeed in solving these problems. That is a principle to be remembered on America’s Independence Day.

These pathetic articles are what The Times has to offer on the day dedicated to the celebration of America’s existence. It is an alien publication, dedicated to collectivism and the worship of the State, to principles the opposite of those on which the United States was founded. Over the years, it has been the champion of Stalin, of Mao, and of Castro, and more recently, of the reincarnation of socialism known as environmentalism. One cannot expect it to be the champion of Washington and Jefferson and of the United States. And it certainly is not.

This article is copyright © 2006, by George Reisman. Permission is hereby granted to reproduce and distribute it electronically and in print, other than as part of a book and provided that mention of the author’s web site www.capitalism.net is included. (Email notification is requested.) All other rights reserved. George Reisman is the author of Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson Books, 1996) and is Pepperdine University Professor Emeritus of Economics.

The Spring is Silent on DDT by Llewellyn H. Rockwell, Jr.

It's as if the socialists discovered that their plan creates poverty, so they decided to change their name to environmentalists and make poverty their goal.

Let there be no doubt that the war on malaria has failed. It is estimated that 800,000 children in Africa die from the disease every year, and as many as three million people altogether every year.

We know how people contract it: from mosquitoes. We know how to control it: kill the carrier mosquitoes. And we know what kills them: DDT.

So why has the war on malaria failed? Because governments banned the cure. Now they claim to wonder why people are sick and dying.

DDT was discovered during World War II to be a great means of stopping infection from typhus and malaria. Its inventor, Paul Hermann Mueller, won the Nobel Prize in 1948.

It was used throughout the 1950s and '60s and was on the verge of wiping out mosquito-borne diseases from the planet. Then something very peculiar came along. A book called Silent Spring by Rachel Carson was published in 1962, and it eventually created a fantastic backlash against progress. The spring was silent supposedly because of the lack of birds, all killed off by DDT.

The only problem is that Carson's claims were never scientifically validated. Indeed, it was a hoax. Studies pumped primates full of DDT with no effect. Human volunteers ingested the stuff with no effect. Workers with 600 times the typical exposure to DDT showed no increased side effects. (Some details here.) What's more, she never once mentioned in her book that DDT had saved hundreds of thousands of lives.

Even so, governments acted. First in Norway and Sweden in 1970. The United States banned it in 1972. The United Kingdom acted in 1984. The Stockholm Convention of 2001 called for the complete elimination of DDT. Of course, the United States government enforced its opposition through its foreign aid programs.

Here it is 2006 and what happens? People are stunned that malaria is back with a vengeance. Every 30 seconds, someone dies of malaria, and three-quarters of the victims are under the age of 5. Survivors can be left with insufferable mental and physical ailments. So far as I know, neither governments nor greens were ever held liable.

Today, the big bucks are looking to fix the problem. Nearly $1 billion was spent last year alone. Warren Buffett ($31 billion) and the Gates Foundation have gotten in on the act. Where is the money going? Only a tiny portion will be spent on DDT spraying, the restrictions on which are only now being slightly loosened, provided it is sprayed in homes and not on crops.

Mostly the money is going to nets. Nets! As if this were the 19th century! It's obvious that the agencies involved in this struggle are reluctant to reach for the spray can, or even discuss it.

The hidden hand behind this horror is none other than the environmentalists. The frenzy against DDT launched their movement. It is what emboldened them, and gave their political agenda momentum. In some ways, their campaign against DDT perfectly sums up their political bent: using state power to ban products and services that help humans, and thereby cause history to roll backward.

The extent to which the green movement is wrapped up in this history is obvious from the fact that we are living through a genuine silent spring, with the press ignoring the causes of malaria. The New York Times presents the epidemic as "mystifying," and most people know nothing about the role of the environmentalists who are responsible for millions of deaths by malaria, and in Africa, of all places, the continent that the Left claims to love to help.

Does no one at the New York Times read back issues? The full case is presented in the zillion-word magazine masterpiece from Tina Rosenberg "What the World Needs Now Is DDT" (April 11, 2004).

The politics of the environmentalists are increasingly predictable and obvious. They oppose all forms of capitalistic innovation. Indeed, they represent a special kind of danger to the human race that socialism never did. At least the socialists favored human progress, or at least said they did. These greens are against all that. They claim that we should be happy to live amidst disease, filth, and death, if only the bugs and birds can be left alone to thrive and kill us.

It's as if the socialists discovered that their plan creates poverty, so they decided to change their name to environmentalists and make poverty their goal.

And note how their agenda fits so well with the state agenda. The state hobbles and hinders productivity in millions of ways through its taxing, regulating, and warmongering. But that makes little difference to the state, which prefers the exercise of power to the good of society. So too do the environmentalists pursue their agenda without regard to the effects on human society.

Currently, there are many environmental issues alive in the policy world, from the debate over sprawl to the frenzy over global warming. The environmentalists have the upper hand in all of them, which is a crying shame, given that they're responsible for millions of lost lives – in just one of their conquests. More victories for them are sure to make life worse for all of us.


Lew Rockwell is president of the Mises Institute and editor of LewRockwell.com. Send email to Rockwell@mises.org. See Lew's columns on Mises.org. Comment on the blog