[Originally published October 2006.] While it was the reading of Menger's path-breaking book, Principles of Economics, by Mises's own account that turned him into an economist,1 it was his attendance at Böhm-Bawerk's legendary seminar at the University of Vienna that awakened Mises's creative genius and gave direction to his life-long research interests. Following the example ...
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[Originally published October 2006.]
While it was the reading of Menger's path-breaking book, Principles of Economics, by Mises's own account that turned him into an economist,1 it was his attendance at Böhm-Bawerk's legendary seminar at the University of Vienna that awakened Mises's creative genius and gave direction to his life-long research interests.
Following the example and suggestions of his revered teacher Böhm-Bawerk, Mises also read widely and absorbed a myriad of influences from a diverse group of economists. Although unfailingly generous in his attribution of specific ideas and concepts to other thinkers, Mises was quite sparing in his praise for individual economists. Indeed he once wrote, "There never lived at the same time more than a score of men whose work contributed anything essential to economics."2
But even among these men, Mises definitely had his favorites. And it was in connection with these select few, whose work had helped him advance Menger and Böhm-Bawerk's paradigm, that Mises uncharacteristically used superlatives such as "great," "best," and "outstanding."
Two economists whose native tongue was English elicited such effusive praise from Mises. Both of them — one American, one British — have been virtually forgotten by today's mainstream economists. Yet both contributed major building blocks to and left indelible imprints on the Misesian system of economic theory and political economy.
Both economists are still worth reading today and several of their works constitute part of the canon that is the required reading of every serious student of Austrian economics. The two economists were the American John Bates Clark (1847–1938) and the Briton Edwin Cannan (1861–1935). This article will focus on the former and a follow-up article will be devoted to the latter.
Mises referred to Clark as an "outstanding economist" and as "the founder of the great American school [who] utilized and elaborated the ideas of the Austrian school."3 The latter characterization was made in the context of those economists outside of Austria who embraced Menger's doctrines.
Although Mises included in this list economists from the Netherlands, the Scandinavian countries and Italy in addition to the United States, it is significant that Clark was the only economist mentioned by name. Mises also referred to the methodological controversy between the "the school of John Bates Clark" and American Institutionalism and noted its parallel with "the Methodenstreit between the Austrian economists and the Prussian Historical School."4
Elsewhere, Mises wrote, "The ideas of the Austrian school were developed in the United States especially by John Bates Clark, founder of the renowned American school. Clark … is a worthy associate of the Economics Society of Vienna."5 F.A. Hayek echoed Mises, writing that "at least some of the members of the second or third generation [i.e., Mises's generation] of the Austrian school owed nearly as much to the teachings of J.B. Clark as to their immediate teachers."6 For his part Clark fully and humbly acknowledged his debt to the early Austrians writing: "Nothing gives me greater pleasure than to render full honor to the eminent thinkers, mainly Austrians, who were earlier in this field than myself, and who carried their analysis to greater lengths."7
Today, it is true, the John Bates Clark Medal is awarded to "that American economist under the age of forty who is adjudged to have made a significant contribution to economic thought and knowledge."8 Ironically, since World War II, Clark's name has been rarely invoked in theoretical discourse, his former status as the first great modern Anglo-American economic theorist having long ago been stripped away and awarded to his contemporary, the anti-Austrian Alfred Marshall. The only time Clark is mentioned in the contemporary literature is by historians of thought and then only to criticize the incompleteness of his formulation of the marginal productivity theory and his naiveté in attempting to derive from the theory a moral justification for market-determined income shares (wages, rent, and interest).
So what exactly did Mises learn from Clark? Menger had demonstrated that all real market prices were equilibrium prices in the sense that their emergence always coincided with a momentary lull in the market process in which the mutual gains of exchange among all buyers and sellers were completely exhausted. No further exchanges would take place, Menger showed, because, at this "point of rest," no pair of individuals could be found in the market both of whom valued a quantity of a good possessed by the other more highly than a quantity of another good he himself possessed.
Böhm-Bawerk further elaborated Menger's analysis, referring to the situation in which all mutually beneficial exchanges had been consummated as a "momentary equilibrium" and pointing out that it described a real state of affairs. A Mengerian exchange equilibrium actually prevails, for example, when we observe an individual exiting a supermarket with given quantities of various items that he has purchased. The fact that he bought definite quantities of each good and no more indicates that the buyer was unwilling to purchase additional units of any good because the value of the sum of money he retained in his possession exceeded the value of the extra gallons of milk, pounds of steak, bottles of wine, etc. that he refrained from purchasing at their respective market prices. Conversely, the supermarket's owners preferred the goods they retained on their shelves to accepting less than the prevailing market prices for them.
In analyzing the problems of how the pure interest rate was determined and how resource prices were imputed from the prices of consumer goods, Böhm-Bawerk further recognized that it was necessary to formulate the image of a long-run, changeless economy in which prices and production were fully adjusted to the underlying data of the economic system, i.e., consumer preferences, technology, and the available stocks of labor and natural resources. Unfortunately, Böhm-Bawerk, still under the influence of the classical economist John Stuart Mill, erroneously imagined that such a fully adjusted economy would actually come into being were it not for "frictional obstacles" preventing instantaneous adjustment of the economy to change. This led Böhm-Bawerk to the disastrous concession that economic laws only held with "ideally complete validity" in a world of long-run equilibrium.9
Clark's enduring contribution to Mises's intellectual development and to Austrian economics was in being the first to perceive and explicitly argue that the starting point of theorizing about causal economic laws was the imagining of what he called a "static state," that is, a changeless economy in which prices and the allocation of resources have been completely adjusted to the underlying economic data, uncertainty is absent, and entrepreneurial profits and losses are therefore nonexistent. For Clark, using the static state in economic reasoning was "a heroic but necessary application of the isolating method" that allows us to analyze "forces" which "we always see … working in connection with other forces, but we have to imagine working alone." However, he insisted that such an economy was "completely imaginary" and that "a static society was an impossible one."10
Yet, in contrast to Böhm-Bawerk, Clark affirmed that "static laws" deduced with the aid of this mental construct were "nevertheless real laws … that still operate in the changing world of reality." Furthermore, according to Clark, "static laws dominate the activities of a real and dynamic society" and their influence on dynamic adjustment processes "are not imaginary; they are as real as anything on earth."11
Clark's direct influence can be seen in Mises's dictum about economic method: "The specific method of economics is the method of imaginary constructions…. The method of imaginary constructions is indispensable for praxeology; it is the only method of praxeological and economic inquiry." Although Mises eventually rejected Clark's misleading terminology of the "static state" and "static laws," Mises's concepts of "the "evenly rotating economy" (ERE) and the "final state of rest" (FSR) are both Clarkian constructions. Mises employed the former to deduce true economic laws concerning the source and nature of entrepreneurship and profit (and loss) in a dynamic world. The ERE is based on the image of a hypothetical and unrealizable economy in which production has been completely adjusted to tastes, technology and resources which are fixed forever, and therefore supply and demand conditions on all markets eternally recur in a regular pattern so that uncertainty is completely absent. In this construction, all prices are constant and equal to per-unit money costs plus a uniform interest return reflecting peoples' preferences for present over future goods: there are no profits or losses; the entrepreneur is superfluous; the past and future are irrelevant; and the plans of all consumers and producers are robotic responses to constant prices.
Although wildly unrealistic, the ERE enables the economist to identify entrepreneurship as a purposive response to anticipated changes in future conditions of supply and demand. Those entrepreneurs with relatively superior foresight and technical expertise in first recognizing and adjusting production to changing market conditions earn profits, while losses are the lot of comparatively short-sighted and technically inept entrepreneurs. Mises's theory of entrepreneurship is thus deeply rooted in the work of Clark, who was the first to explicitly recognize that profit and loss would be absent in the static state.
Mises adopted a second methodological innovation developed by Clark which was closely related to the ERE. This Mises called "the imaginary construction of functional distribution." In this construct income earners were precisely defined and classed according to a specific function in the production process, namely, landowners, capitalists, and entrepreneurs. Using this analytical device the classical theory of aggregate income distribution among actual historical classes of workers, employers and landlords was transformed by Clark into an integrated theory of factor pricing determined by the "static" law of marginal utility. Once functional income shares such as wages, rent, interest, and profit were analytically isolated and explained by recourse to Clark's imaginary construct, then and only then did it become possible to explain the forces operating to determine the personal "distribution" of income or, more accurately, the imputation of income shares to historical persons. Mises improved upon Clark's construct by incorporating into it the concept of time preference to account for the interest return to capitalists and sharpening the conception of the entrepreneurial function and its related income, profit. Yet the elaboration and justification of the construct in its modern form originated in Clark's work and this was recognized by Mises who recommended Clark's "epistemological treatment of functional distribution."12
FSR analysis also begins from a fully adjusted economy in which profits are currently zero. However in this construction the past and future are relevant to economic planning. Alterations in the economic data are permitted to occur but only one at a time and with a lapse of time between changes sufficiently long to permit a complete adjustment of prices and production in the economy to each change, thus resulting in the emergence of a new zero-profit FSR before another change in the economic data can occur. During the transition to the new FSR, profits and losses appear across the economy spurring entrepreneurs to shuffle and reshuffle resources and capital combinations to take advantage of profit opportunities and avoid losses.
This construct, which Clark developed in his second book on "economic dynamics,"13 is today called "comparative statics" in mainstream economics and is mainly restricted to analyzing only the long-run consequences of changes in real variables such as technology, consumer value scales, and resources in partial equilibrium or single markets. Mises, however, used Clark's construct in formulating a "step-by step" or "process" analysis logically demonstrating the sequence of changes which occur throughout the entire interdependent system of markets in the transition to the new FSR. It was the utilization of this method that permitted Mises to deduce his path-breaking theorem that increases in the money supply bring about permanent changes in the structure of consumer demands and prices and in the pattern of resource allocation and income distribution. Thus he was able to irrefutably demonstrate that expansion of the money supply does not raise all prices and wage rates proportionally and instantly and that in the long run money is not "neutral" to the real economy, as quantity theorists past and present have claimed.
In an important sense, then, Clark was a key figure in the development of the praxeological method and the structure of economic theorems developed through its application. Mises clearly recognized this in an early publication (1929) on praxeology, which he referred to at the time as "sociology":
We call the method of scientific work that examines the effect, ceteris paribus, of change in one factor, the static method. Nearly everything that sociology and its hitherto best developed branch, economics have thus far accomplished is due to the use of the static method. The assumption it makes, viz., that all other conditions remain perfectly unchanged, is an indispensable fiction for reasoning and science. In life everything is continually in flux, but for thought we must construct an imaginary state of rest. In this manner we conceptually isolate the individual factors in order to be able to study the effect of changes in them. The word 'static' should not prevent us from seeing that the method in question is one whose goal is precisely the investigation of change. [emphasis added]14
Note that in this passage Mises uses Clark's terminology of "static method" and "imaginary," also citing Clark in a footnote to this passage. In Human Action, Mises finally jettisoned the term "static method" and replaced it with the term "method of imaginary constructions," because of the persistence of the former term's misleading implication that the method was only appropriate to the analysis of a changeless economy, and that the analysis of "economic dynamics" had yet to be developed. However, despite his eventual abandonment of Clark's infelicitous terminology, the actual method developed by Mises to analyze real-world economic phenomena owed more to Clark than to any other economist.
- 1. Ludwig von Mises, Notes and Recollections, trans. Hans F. Sennholz (South Holland, IL: Libertarian Press, 1978), p. 33.
- 2. Ludwig von Mises, Human Action: A Treatise on Economics, Scholar's Edition, ed. Jeffrey M. Herbener, Hans-Hermann Hoppe, and Joseph T. Salerno (Auburn, AL: Ludwig von Mises Institute, 1998), p. 869.
- 3. Ludwig von Mises, Socialism: An Economic and Sociological Analysis, 3rd ed. (Indianapolis, IN: Liberty Classics, 1981), p. 326; idem, Selected Writings of Ludwig von Mises between the Two World Wars: Monetary Disorder, Interventionism, Socialism and the Great Depression, ed. Richard M. Ebeling (Indianapolis, IN: Liberty Fund, Inc., 2002), p. 327.
- 4. Mises, Human Action, p. 4.
- 5. idem, "Carl Menger and the Austrian School of Economics," in Bettina Bien Greaves, ed., Austrian Economics: An Anthology Irvington-on-Hudson, NY: The Foundation for Economic Education, 1996), p. 50.
- 6. Quoted in The Collected Works of F. A. Hayek, Volume 4, The Fortunes of Liberalism: Essays on Austrian Economics and the Ideal of Freedom, Peter G. Klein, ed. (Chicago: University of Chicago Press, 1992), p. 39.
- 7. Quoted in ibid.
- 8. See http://en.wikipedia.org/wiki/John_Bates_Clark_Medal.
- 9. Eugen von Böhm-Bawerk, Capital and Interest, Vol. 2, Positive theory of Capital, trans. and ed. by George D. Huncke and Hans F. Sennholz (South Holland, IL: Libertarian Press, 1959), pp. 255–56.
- 10. John Bates Clark, The Distribution of Wealth: A Theory of Wages Interest and Profits (New York: Augustus M. Kelley, 1965), p. 400.
- 11. Ibid., pp. 37, 401.
- 12. Mises, Human Action, p. 255, n.15.
- 13. John Bates Clark, Essentials of Economic Theory: As Applied to Modern Problems of Industry and Public Policy (New York: The MacMillan Company, 1907).
- 14. Ludwig von Mises, Epistemological Problems of Economics, 3rd ed., ed. Jörg Guido Hülsmann, trans. George Reisman (Auburn, AL: Ludwig von Mises Institute, 2003), p. 117.