[This article is excerpted from chapter 15 of Human Action. This article follows “The Market, Part 1.”]
8. Entrepreneurial Profit and Loss
Profit, in a broader sense, is the gain derived from action; it is the increase in satisfaction (decrease in uneasiness) brought about; it is the difference between the higher value attached to the result attained and the lower value attached to the sacrifices made for its attainment; it is, in other words, yield minus costs. To make profit is invariably the aim sought by any action. If an action fails to attain the ends sought, yield either does not exceed costs or lags behind costs. In the latter case the outcome means a loss, a decrease in satisfaction.
Profit and loss in this original sense are psychic phenomena and as such not open to measurement and a mode of expression which could convey to other people precise information concerning their intensity. A man can tell a fellow man that a suits him better than b; but he cannot communicate to another man, except in vague and indistinct terms, how much the satisfaction derived from a exceeds that derived from b.
In the market economy all those things that are bought and sold against money are marked with money prices. In the monetary calculus, profit appears as a surplus of money received over money expended, and loss as a surplus of money expended over money received. Profit and loss can be expressed in definite amounts of money. It is possible to ascertain in terms of money how much an individual has profited or lost. However, this is not a statement about this individual’s psychic profit or loss. It is a statement about a social phenomenon, about the individual’s contribution to the societal effort as it is appraised by the other members of society. It does not tell us anything about the individual’s increase or decrease in satisfaction or happiness. It merely reflects his fellow men’s evaluation of his contribution to social cooperation. This evaluation is ultimately determined by the efforts of every member of society to attain the highest possible psychic profit. It is the resultant of the composite effect of all these people’s subjective and personal value judgments as manifested in their conduct on the market. But it must not be confused with these value judgments as such.
We cannot even think of a state of affairs in which people act without the intention of attaining psychic profit and in which their actions result neither in psychic profit nor in psychic loss.16 In the imaginary construction of an evenly rotating economy, there are neither money profits nor money losses. But every individual derives a psychic profit from his actions, or else he would not act at all. The farmer feeds and milks his cows and sells the milk because he values the things he can buy against the money thus earned more highly than the costs expended. The absence of money profits or losses in such an evenly rotating system is due to the fact that, if we disregard the differences brought about by the higher valuation of present goods as compared with future goods, the sum of the prices of all complementary factors needed for production precisely equals the price of the product.
In the changing world of reality, differences between the sum of the prices of the complementary factors of production and the prices of the products emerge again and again. It is these differences that bring about money profits and money losses. As far as such changes affect the sellers of labor and those of the original nature-given factors of production and of the capitalists as moneylenders, we will deal with them later. At this point we are dealing with entrepreneurial profit and loss. It is this problem that people have in mind when employing the terms profit and loss in mundane speech.
Like every acting man, the entrepreneur is always a speculator. He deals with the uncertain conditions of the future. His success or failure depends on the correctness of his anticipation of uncertain events. If he fails in his understanding of things to come, he is doomed. The only source from which an entrepreneur’s profits stem is his ability to anticipate better than other people the future demand of the consumers. If everybody is correct in anticipating the future state of the market of a certain commodity, its price and the prices of the complementary factors of production concerned would already today be adjusted to this future state. Neither profit nor loss can emerge for those embarking upon this line of business.
The specific entrepreneurial function consists in determining the employment of the factors of production. The entrepreneur is the man who dedicates them to special purposes. In doing so he is driven solely by the selfish interest in making profits and in acquiring wealth. But he cannot evade the law of the market. He can succeed only by hest serving the consumers. His profit depends on the approval of his conduct by the consumers.
One must not confuse entrepreneurial profit and loss with other factors affecting the entrepreneur’s proceeds.
The entrepreneur’s technological ability does not affect the specific entrepreneurial profit or loss. As far as his own technological activities contribute to the returns earned and increase his net income, we are confronted with a compensation for work rendered. It is wages paid to the entrepreneur for his labor. Neither does the fact that not every process of production succeeds technologically in bringing about the product expected, influence the specific entrepreneurial profit or loss. Such failures are either avoidable or unavoidable. In the first case they are due to the technologically inefficient conduct of affairs. Then the losses resulting are to be debited to the entrepreneur’s personal insufficiency, i.e., either to his lack of technological ability or to his lack of the ability to hire adequate helpers. In the second case the failures are due to the fact that the present state of technological knowledge prevents us from fully controlling the condition on which success depends. This deficiency may be caused either by incomplete knowledge concerning the conditions of success or by ignorance of methods for controlling fully some of the known conditions. The price of the factors of production takes into account this unsatisfactory state of our knowledge and technological power. The price of arable land, for instance, takes into full account the fact that there are bad harvests, as it is determined by the anticipated average yield. The fact that the bursting of bottles reduces the output of champagne docs not affect entrepreneurial profit and loss. It is merely one of the factors determining the cost of production and the price of champagne.17
Accidents affecting the process of production, the means of production, or the products while they are still in the hands of the entrepreneur are an item in the bill of production costs. Experience, which conveys to the businessman all other technological knowledge, provides him also with information about the average reduction in the quantity of physical output which such accidents are likely to bring about. By opening contingent reserves, he converts their effects into regular costs of production. With regard to contingencies the expected incidence of which is too rare and too irregular to be dealt with in this u ay by individual firms of normal size, concerted action on the part of sufficiently large groups of firms takes care of the matter. The individual &ms cooperate under the principle of insurance against damage caused by fire, flood, or other similar contingencies. Then an insurance premium is substituted for an appropriation to a contingency reserve. At any rate, the risks incurred by accidents do not introduce uncertainty into the conduct of the technological processes.18 If an entrepreneur neglects to deal with them duly, he gives proof of his technical insufficiency. The losses thus incurred are to be debited to bad techniques applied, not to his entrepreneurial function.
The elimination of those entrepreneurs who fail to give to their enterprises the adequate degree of technological efficiency or whose technological ignorance vitiates their cost calculation is effected on the market in the same way in which those deficient in the performance of the specific entrepreneurial functions are eliminated. It may happen that an entrepreneur is so successful in his specific entrepreneurial function that he can compensate losses caused by his technological failure. It may also happen that an entrepreneur can counterbalance losses due to failure in his entrepreneurial function by the advantages derived from his technological superiority or from the differential rent yielded by the higher productivity of the factors of production he employs. But one must not confuse the various functions which are combined in the conduct of a business unit. The technologically more efficient entrepreneur earns higher wage rates or quasi-wage rates than the less efficient in the same way in which the more efficient worker earns more than the less efficient. The more efficient machine and the more fertile soil produce higher physical returns per unit of costs expended; they yield a differential rent when compared with the less efficient machine and the less fertile soil. The higher wage rates and the higher rent are, ceteris paribus, the corollary of higher physical output. But the specific entrepreneurial profits and losses are not produced by the quantity of physical output. They depend on the adjustment of output to the most urgent wants of the consumers. What produces them is the extent to which the entrepreneur has succeeded or failed in anticipating the future — necessarily uncertain — state of the market.
The entrepreneur is also jeopardized by political dangers. Government policies, revolutions, and wars can damage or annihilate his enterprise. Such events do not affect him alone; they affect the market economy as such and all individuals, although not all of them to the same extent. For the individual entrepreneur they are data which he cannot alter. If he is efficient, he will anticipate them in time. But it is not always possible for him to adjust his operations in such a way as to avoid damage. If the dangers expected concern only a part of the territory which is accessible to his entrepreneurial activities, he can avoid operating in the menaced areas and can prefer countries in which the danger is less imminent. But if he cannot emigrate, he must stay where he is. If all entrepreneurs were fully convinced that the total victory of Bolshevism was impending, they would nevertheless not abandon their entrepreneurial activities. The expectation of imminent expropriation will impel the capitalists to consume their funds. The entrepreneurs will be forced to adjust their plans to the market situation created by such capital consumption and the threatened nationalization of their shops and plants. But they will not stop operating. If some entrepreneurs go out of business, others will take their place — newcomers or old entrepreneurs expanding the size of their enterprises. In the market economy there will always be entrepreneurs. Policies hostile to capitalism may deprive the consumers of the greater part of the benefits they would have reaped from unhampered entrepreneurial activities. But they cannot eliminate the entrepreneurs as such if they do not entirely destroy the market economy.
The ultimate source from which entrepreneurial profit and loss are derived is the uncertainty of the future constellation of demand and supply.
If all entrepreneurs were to anticipate correctly the future state of the market, there would be neither profits nor losses. The prices of all the factors of production would already today be fully adjusted to tomorrow’s prices of the products. In buying the factors of production the entrepreneur would have to expend (with due allowance for the difference between the prices of present goods and future goods) no less an amount than the buyers will pap him later for the product. An entrepreneur can make a profit only if he anticipates future conditions more correctly than other entrepreneurs. Then he buys the complementary factors of production at prices the sum of which is smaller than the price at which he sells the product.
If we want to construct the image of changing economic conditions in which there are neither profits nor losses, we must resort to an unrealizable assumption: perfect foresight of all future events on the part of all individuals. If those primitive hunters and fishermen to whom it is customary to ascribe the first accumulation of produced factors of production had known in advance all the future vicissitudes of human affairs, and if they and all their descendants until the last day of judgment, equipped with the same omniscience, had appraised all factors of production accordingly, entrepreneurial profits and losses would never have emerged. Entrepreneurial profits and losses are created through the discrepancy between the expected prices and the prices later really fixed on the markets. It is possible to confiscate profits and to transfer them from the individuals to whom they have accrued to other people. But neither profits nor losses can ever disappear from a changing world not populated solely with omniscient people.
9. Entrepreneurial Profits and Losses in a Progressing Economy
In the imaginary construction of a stationary economy the total sum of all entrepreneurs’ profits equals the total sum of all entrepreneurs’ losses. What one entrepreneur profits is in the total economic system counterbalanced by another entrepreneur’s loss. The surplus which all the consumers together expend for the acquisition of a certain commodity is counterbalanced by the reduction in their expenditure for the acquisition of other commodities.19
It is different in a progressing economy.
We call a progressing economy an economy in which the per capita quota of capital invested is increasing. In using this term we do not imply value judgments. We adopt neither the “materialistic” view that such a progression is good nor the “idealistic” view that it is bad or at least irrelevant from a “higher point of view.” Of course, it is a well-known fact that the immense majority of people consider the consequences of progress in this sense as the most desirable state of affairs and yearn for conditions which can be realized only in a progressing economy.
In the stationary economy the entrepreneurs, in the pursuit of their specific functions, cannot achieve anything other than to withdraw factors of production, provided that they are still convertible,20 from one line of business in order to employ them in another line, or to direct the restoration of the equivalent of capital goods used up in the course of production processes toward the expansion of certain branches of industry at the expense of other branches. In the progressing economy the range of entrepreneurial activities includes, moreover, the determination of the employment of the additional capital goods accumulated by new savings. The injection of these additional capital goods is bound to increase the total sum of the income produced, i.e., of that supply of consumers’ goods which can be consumed without diminishing the capital equipment used in its production and thereby without impairing the output of future production. The increase of income is effected either by an expansion of production without altering the technological methods of production or by an improvement in technoIogical methods which would not have been feasible under the previous conditions of a less ample supply of capital goods.
It is out of this additional wealth that the surplus of the total sum of entrepreneurial profits over the total sum of entrepreneurial losses flows. But it can be easily demonstrated that this surplus can never exhaust the total increase in wealth brought about by economic progress. The laws of the market divide this additional wealth between the entrepreneurs and the suppliers of labor and those of certain material factors of production in such a way that the lion’s share goes to the nonentrepreneurial groups.
First of all we must realize that entrepreneurial profits are not a lasting phenomenon but only temporary. There prevails an inherent tendency for profits and losses to disappear. The market is always moving toward the emergence of the final prices and the final state of rest. If new changes in the data were not to interrupt this movement and not to create the need for a new adjustment of production to the altered conditions, the prices of all complementary factors of production would — due allowance being made for time preference — finally equal the price of the product, and nothing would be left for profits or losses. In the long run every increase in productivity benefits exclusively the workers and some groups of the owners of land and of capital goods.
In the groups of the owners of capital goods there are benefited:
Those whose saving has increased the quantity of capital goods available. They own this additional wealth, the outcome of their restraint in consuming.
The owners of those capital goods already previously existing which, thanks to the improvement in technological methods of production, are now better utilized than before. Such gains are, of course, temporary only. They are bound to disappear as they cause a tendency toward an intensified production of the capital goods concerned.
On the other hand, the increase in the quantity of capital goods available lowers the marginal productivity of capital; it thus brings about a fall in the prices of the capital goods and thereby hurts the interests of all those capitalists who did not share at all or not sufficiently in the process of saving and the accumulation of the additional supply of capital goods.
In the group of the landowners all those are benefited for whom the new state of affairs results in a higher productivity of their farms, forests, fisheries, mines, and so on. On the other hand, all those are hurt whose property may become submarginal on account of the higher return yielded by the land owned by those benefited.
In the group of labor all derive a lasting gain from the increase in the marginal productivity of labor. But, on the other hand, in the short run some may suffer disadvantages. These are people who were specialized in the performance of work which becomes obsolete as a result of technological improvement and are fitted only for jobs in which — in spite of the general rise in wage rates — they earn less than before.
All these changes in the prices of the factors of production begin immediately with the initiation of the entrepreneurial actions designed to adjust the processes of production to the new state of affairs. In dealing with this problem as with the other problems of changes in the market data, we must guard ourselves against the popular fallacy of drawing a sharp line between short-run and long-run effects. What happens in the short run is precisely the first stages of the chain of successive transformations which tend to bring about the long-run effects. The long-run effect is in our case the disappearance of entrepreneurial profits and losses. The short-run effects are the preliminary stages of this process of elimination which finally, if not interrupted by a further change in the data, would result in the emergence of the evenly rotating economy.
It is necessary to comprehend that the very appearance of an excess in the total amount of entrepreneurial profits over the total amount of entrepreneurial losses depends upon the fact that this process of the elimination of entrepreneurial profit and loss begins at the same time as the entrepreneurs begin to adjust the complex of production activities to the changed data. There is never in the whole sequence of events an instant in which the advantages derived from the increase in the amount of capital available and from technical improvements benefit the entrepreneurs only. If the wealth and the income of the other strata were to remain unaffected, these people could buy the additional products only by restricting their purchases of other products accordingly. Then the profits of one group of entrepreneurs would exactly equal the losses incurred by other groups.
What happens is this: The entrepreneurs embarking upon the utilization of the newly accumulated capital goods and the improved technological methods of production are in need of complementary factors of production. Their demand for these factors is a new additional demand which must raise their prices. Only as far as this rise in prices and wage rates occurs are the consumers in a position to buy the new products without curtailing the purchase of other goods.
Only so far can a surplus of the total sum of all entrepreneurial profits over all entrepreneurial losses come into existence.
The vehicle of economic progress is the accumulation of additional capital goods by means of saving and improvement in technological methods of production the execution of which is almost always conditioned by the availability of such new capital. The agents of progress are the promoting entrepreneurs intent upon profiting by means of adjusting the conduct of affairs to the best possible satisfaction of the consumers. In the performance of their projects for the realization of progress they are bound to share the benefits derived from progress with the workers and also with a part of the capitalists and landowners and to increase the portion allotted to these people step by step until their own share melts away entirely.
From this it becomes evident that it is absurd to speak of a “rate of profit” or a “normal rate of profit” or an “average rate of profit.” Profit is not related to or dependent on the amount of capital employed by the entrepreneur. Capital does not “beget” profit. Profit and loss are entirely determined by the success or failure of the entrepreneur to adjust production to the demand of the consumers. There is nothing “normal” in profits and there can never be an “equilibrium” with regard to them. Profit and loss are, on the contrary, always a phenomenon of a deviation from “normalcy,” of changes unforeseen by the majority, and of a “disequilibrium.” They have no place in an imaginary world of normalcy and equilibrium. In a changing economy there prevails always an inherent tendency for profits and losses to disappear. It is only the emergence of new changes which revives them again. Under stationary conditions the “average rate” of profits and losses is zero. An excess of the total amount of profits over that of losses is a proof of the fact that there is economic progress and an improvement in the standard of living of all strata of the population. The greater this excess is, the greater is the increment in general prosperity.
Many people are utterly unfit to deal with the phenomenon of entrepreneurial profit without indulging in envious resentment. In their eyes the source of profit is exploitation of the wage earners and the consumers, i.e., an unfair reduction in wage rates and a no-less-unfair increase in the prices of the products. By rights there should not be any profits at all.
Economics is indifferent with regard to such arbitrary value judgments. It is not interested in the problem of whether profits are to be approved or condemned from the point of view of an alleged natural law and of an alleged eternal and immutable code of morality about which personal intuition or divine revelation are supposed to convey precise information. Economics merely establishes the fact that entrepreneurial profits and losses are essential phenomena of the market economy. There cannot be a market economy without them. It is certainly possible for the police to confiscate all profits. But such a policy would by necessity convert the market economy into a senseless chaos. Man has, there is no doubt, the power to destroy many things, and he has made in the course of history ample use of this faculty. He could destroy the market economy too.
If those self-styled moralists were not blinded by their envy, they would not deal with profit without dealing simultaneously with its corollary, loss. They would not pass over in silence the fact that the preliminary conditions of economic improvement are an achievement of those whose saving accumulates the additional capital goods and of the inventors, and that the utilization of these conditions for the realization of economic improvement is effected by the entrepreneurs. The rest of the people do not contribute to progress, but they are benefited by the horn of plenty which other people’s activities pour upon them.
What has been said about the progressing economy is mutatis mutandis to be applied to the conditions of a retrogressing economy, i.e., an economy in which the per capita quota of capital invested is decreasing. In such an economy there is an excess in the total sum of entrepreneurial losses over that of profits. People who cannot free themselves from the fallacy of thinking in concepts of collectives and whole groups might raise the question of how in such a retrogressing economy there could be any entrepreneurial activity at all. Why should anybody embark upon an enterprise if he knows in advance that mathematically his chance of earning profits are smaller than those of suffering losses? However, this mode of posing the problem is fallacious.
Like other people, entrepreneurs do not act as members of a class, but as individuals.
No entrepreneur bothers a whit about the fate of the totality of the entrepreneurs. It is irrelevant to the individual entrepreneur what happens to other people whom theories, according to a certain characteristic, assign to the same class they assign him. In the living, perpetually changing market society there are always profits to be earned by efficient entrepreneurs. The fact that in a retrogressing economy the total amount of losses exceeds the total amount of profits does not deter a man who has confidence in his own superior efficiency. A prospective entrepreneur does not consult the calculus of probability which is of no avail in the field of understanding. He trusts his own ability to understand future market conditions better than his less gifted fellow men.
The entrepreneurial function, the striving of entrepreneurs after profits, is the driving power in the market economy. Profit and loss are the devices by means of which the consumers exercise their supremacy on the market. The behavior of the consumers makes profits and losses appear and thereby shifts ownership of the means of production from the hands of the less efficient into those of the more efficient. It makes a man the more influential in the direction of business activities the better he succeeds in serving the consumers. In the absence of profit and loss the entrepreneurs would not know what the most urgent needs of the consumers are. If some entrepreneurs were to guess it, they would lack the means to adjust production accordingly.
Profit-seeking business is subject to the sovereignty of the consumers, while nonprofit institutions are sovereign unto themselves and not responsible to the public. Production for profit is necessarily production for use, as profits can only be earned by providing the consumers with those things they most urgently want to use.
The moralists’ and sermonizers’ critique of profits misses the point. It is not the fault of the entrepreneurs that the consumers — the people, the common man — prefer liquor to Bibles and detective stories to serious books, and that governments prefer guns to butter. The entrepreneur does not make greater profits in selling “bad” things than in selling “good” things. His profits are the greater the better he succeeds in providing the consumers with those things they ask for most intensely. People do not drink intoxicating beverages in order to make the “alcohol capital” happy, and they do not go to war in order to increase the profits of the “merchants of death.” The existence of the armaments industries is a consequence of the warlike spirit, not its cause.
It is not the business of the entrepreneurs to make people substitute sound ideologies for unsound. It rests with the philosophers to change people’s ideas and ideals. The entrepreneur serves the consumers as they are today, however wicked and ignorant.
We may admire those who abstain from making gains they could reap in producing deadly weapons or hard liquor. However, their laudable conduct is a mere gesture without any practical effects. Even if all entrepreneurs and capitalists were to follow their example, wars and dipsomania would not disappear. As was the case in the precapitalistic ages, governments would produce the weapons in their own arsenals and drinkers would distill their own liquor.
Some Observations on the Underconsumption Bogey and on the Purchasing-Power Argument
In speaking of underconsumption, people mean to describe a state of affairs in which a part of the goods produced cannot be consumed because the people who could consume them are by their poverty prevented from buying them. These goods remain unsold or can be swapped only at prices not covering the cost of production. Hence various disarrangements and disturbances arise, the total complex of which is called economic depression.
Now it happens again and again that entrepreneurs err in anticipating the future state of the market. Instead of producing those goods for which the demand of the consumers is most intense, they produce less-urgently-needed goods or things which cannot be sold at all. These inefficient entrepreneurs suffer losses while their more efficient competitors who anticipated the wishes of the consumers earn profits. The losses of the former group of entrepreneurs are not caused by a general abstention from buying in the part of the public; they are due to the fact that the public prefers to buy other goods.
If it were true, as the underconsumption myth implies, that the workers are too poor to buy the products because the entrepreneurs and the capitalists unfairly appropriate to themselves what by rights should go to the wage earners, the state of affairs would not be altered. The “exploiters” are not supposed to exploit from sheer wantonness. They want, it is insinuated, to increase at the expense of the “exploited” either their own consumption or their own investments. They do not withdraw their booty from the universe. They spend it either in buying luxuries for their own household or in buying producers’ goods for the expansion of their enterprises. Of course, their demand is directed toward goods other than those the wage earners would have bought if the profits had been confiscated and distributed among them. Entrepreneurial errors with regard to the state of the market of various classes of commodities as created by such “exploitation” are in no way different from any other entrepreneurial shortcomings. Entrepreneurial errors result in losses for the inefficient entrepreneurs which are counterbalanced by the profits of the efficient entrepreneurs. They make business bad for some groups of industries and good for other groups. They do not bring about a general depression of trade.
The underconsumption myth is baseless self-contradictory balderdash. Its reasoning crumbles away as soon as one begins to examine it. It is untenable even if one, for the sake of argument, accepts the “exploitation” doctrine as correct.
The purchasing-power argument runs in a slightly different manner. It contends that a rise in wage rates is a prerequisite of the expansion of production. If wage rates do not rise, there is no use for business to increase the quantity and to improve the quality of the goods produced. For the additional products would find no buyers or only such buyers as restrict their purchases of other goods. What is needed first for the realization of economic progress is to make wage rates rise continually. Government or labor-union pressure and compulsion aiming at the enforcement of higher wage rates are the main vehicles of progress.
As has been demonstrated above the emergence of an excess in the total sum of entrepreneurial profits over the total sum of entrepreneurial losses is inseparably bound up with the fact that a portion of the benefits derived from the increase in the quantity of capital goods available and from the improvement of technological procedures goes to the nonentrepreneurial groups. The rise in the prices of complementary factors of production, first among them wage rates, is neither a concession which the entrepreneurs willy-nilly must make to the rest of the people nor a clever device of the entrepreneurs in order to make profits. It is an unavoidable and necessary phenomenon in the chain of successive events which the endeavors of the entrepreneurs to make profits by adjusting the supply of the consumers’ goods to the new state of affairs are bound to bring about.
The same process which results in an excess of entrepreneurial profits over losses causes first — i.e., before such an excess appears — the emergence of a tendency toward a rise in wage rates and in the prices of many material factors of production. And it is again the same process that would in the further course of events make this excess of profits over losses disappear, provided that no further changes, increasing the amount of capital goods available, were to occur. The excess of profits over losses is not a consequence of the rise in the prices of the factors of production. The two phenomena — the rise in the prices of the factors of production and the excess of profits over losses — are both steps in the process of adjustment of production to the increase in the quantity of capital goods and to the technological changes which the entrepreneurial actions actuate. Only to the extent that the other strata of the population are enriched by this adjustment can an excess of profits over losses temporarily come into being.
The basic error of the purchasing-power argument consists in misconstruing this causal relation. It turns things upside down when considering the rise in wage rates as the force bringing about economic improvement.
We will discuss at a later stage of this book the consequences of the attempts of the governments and of organized-labor violence to enforce wage rates higher than those determined by a nonhampered market.21 Here we must only add one more explanatory remark.
When speaking of profits and losses, prices and wage rates, what we have in mind is always real profits and losses, real prices and real wage rates. It is the arbitrary interchange of money terms and real terms that has led many people astray. This problem too will be dealt with exhaustively in later chapters. Let us incidentally only mention the fact that a rise in real wage rates is compatible with a drop in nominal wage rates.
10. Promoters, Managers, Technicians, and Bureaucrats
The entrepreneur hires the technicians, i.e., people who have the ability and the skill to perform definite kinds and quantities of work. The class of technicians includes the great inventors, the champions in the field of applied science, the constructors and designers as well as the performers of the most simple tasks. The entrepreneur joins their ranks as far as he himself takes part in the technical execution of his entrepreneurial plans. The technician contributes his own toil and trouble; but it is the entrepreneur qua entrepreneur who directs his labor toward definite goals. And the entrepreneur himself acts as a mandatary, as it were, of the consumers.
The entrepreneurs are not omnipresent. They cannot themselves attend to the manifold tasks which are incumbent upon them. Adjustment of production to the best possible supplying of the consumers with the goods they are asking for most urgently does not merely consist in determining the general plan for the utilization of resources. There is, of course, no doubt that this is the main function of the promoter and speculator. But besides the great adjustments, many small adjustments are necessary too. Each of them may seem trifling and of little bearing upon the total result. But the cumulative effect of shortcomings in many of these minor matters can be such as to frustrate entirely the success of a correct solution of the great problems. At any rate, it is certain that every failure to handle the smaller problems results in a squandering of scarce factors of production and consequently in impairing the best possible satisfaction of the consumers.
It is important to conceive in what respects the problem we have in mind differs from the technological tasks of the technicians. The execution of every project upon which the entrepreneur has embarked in making his decision with regard to the general plan of action requires a multiplicity of minute decisions. Each of these decisions must be effected in such a way as to prefer that solution of the problem which — without interfering with the designs of the general plan for the whole project — is the most economical one. It must avoid superfluous costs in the same way as does the general plan. The technician from his purely technological point of view either may not see any difference in the alternatives offered by various methods for the solution of such a detail or may give preference to one of these methods on account of its greater output in physical quantities. But the entrepreneur is actuated by the profit motive: this enjoins upon him the urge to prefer the most economical solution, i.e., that solution which avoids employing factors of production whose employment would impair the satisfaction of the more intensely felt wants of the consumers.
He will prefer among the various methods with regard to which the technicians are neutral, the one the application of which requires the smallest cost. He may reject the technicians’ suggestion to choose a more costly method securing a greater physical output if his calculation shows that the increase in output would not outweigh the increase in cost required. Not only in the great decisions and plans but no less in the daily decisions of small problems as they turn up in the current conduct of affairs, the entrepreneur must perform his task of adjusting production to the demand of the consumers as reflected in the prices of the market.
Economic calculation as practiced in the market economy, and especially the system of double-entry bookkeeping, make it possible to relieve the entrepreneur of involvement in too much detail. He can devote himself to his great tasks without being entangled in a multitude of trifles beyond any mortal man’s range of sight. He can appoint assistants to whose solicitude he entrusts the care of subordinate entrepreneurial duties. And these assistants in their turn can be aided according to the same principle by assistants appointed for a smaller sphere of duties. In this way a whole managerial hierarchy can be built up.
A manager is a junior partner of the entrepreneur, as it were, no matter what the contractual and financial terms of his employment are. The only relevant thing is that his own financial interests force him to attend to the best of his abilities to the entrepreneurial functions which are assigned to him within a limited and precisely determined sphere of action.
It is the system of double-entry bookkeeping that makes the functioning of the managerial system possible. Thanks to it the entrepreneur is in a position to separate the calculation of each part of his total enterprise in such a way that he can determine the role it plays within his whole enterprise. Thus he can look at each section as if it were a separate entity and can appraise it according to the share it contributes to the success of the total enterprise.
Within this system of business calculation each section of a firm represents an integral entity, a hypothetical independent business, as it were. It is assumed that this section “owns” a definite part of the whole capital employed in the enterprise, that it buys from other sections and sells to them, that it has its own expenses and its own revenues, that its dealings result either in a profit or in a loss which is imputed to its own conduct of affairs as distinguished from the result of the other sections. Thus the entrepreneur can assign to each section’s management a great deal of independence. The only directive he gives to a man whom he entrusts with the management of a circumscribed job is to make as much profit as possible.
An examination of the accounts shows how successful or unsuccessful the managers were in executing this directive. Every manager and submanager is responsible for the working of his section or subsection. It is to his credit if the accounts show a profit, and it is to his disadvantage if they show a loss. His own interests impel him toward the utmost care and exertion in the conduct of his section’s affairs. If he incurs losses, he will be replaced by a man whom the entrepreneur expects to be more successful, or the whole section will be discontinued. At any rate, the manager will lose his job. If he succeeds in making profits, his income will be increased, or at least he will not be in danger of losing it. Whether or not a manager is entitled to a share in the profit imputed to his section is not important with regard to the personal interest he takes in the results of his section’s dealings. His welfare is at any rate closely connected with that of his section. His task is not like that of the technician, to perform a definite piece of work according to a definite precept. It is to adjust — within the limited scope left to his discretion — the operation of his section to the state of the market.
Of course, just as an entrepreneur may combine in his person entrepreneurial functions and those of a technician, such a union of various functions can also occur with a manager. The managerial function is always subservient to the entrepreneurial function. It can relieve the entrepreneur of a part of his minor duties; it can never evolve into a substitute for entrepreneurship. The fallacy to the contrary is due to the error confusing the category of entrepreneurship as it is defined in the imaginary construction of functional distribution with conditions in a living and operating market economy. The function of the entrepreneur cannot be separated from the direction of the employment of factors of production for the accomplishment of definite tasks. The entrepreneur controls the factors of production; it is this control that brings him either entrepreneurial profit or loss. It is possible to reward the manager by paying for his services in proportion to the contribution of his section to the profit earned by the entrepreneur. But this is of no avail. As has been pointed out, the manager is under any circumstances interested in the success of that part of the business which is entrusted to his care. But the manager cannot be made answerable for the losses incurred. These losses are suffered by the owners of the capital employed. They cannot be shifted to the manager.
Society can freely leave the care for the best possible employment of capital goods to their owners. In embarking upon definite projects these owners expose their own property, wealth, and social position. They are even more interested in the success of their entrepreneurial activities than is society as a whole. For society as a whole the squandering of capital invested in a definite project means only the loss of a small part of its total funds; for the owner it means much more, for the most part the loss of his total fortune. But if a manager is given a completely free hand, things are different. He speculates in risking other people’s money. He sees the prospects of an uncertain enterprise from another angle than that of the man who is answerable for the losses. It is precisely when he is rewarded by a share of the profits that he becomes foolhardy because he does not share in the losses too.
The illusion that management is the totality of entrepreneurial activities and that management is a perfect substitute for entrepreneurship is the outgrowth of a misinterpretation of the conditions of the corporations, the typical form of present-day business. It is asserted that the corporation is operated by the salaried managers, while the shareholders are merely passive spectators. All the powers are concentrated in the hands of hired employees. The shareholders are idle and useless; they harvest what the managers have sown.
This doctrine disregards entirely the role that the capital and money market, the stock and bond exchange, which a pertinent idiom simply calls the “market,” plays in the direction of corporate business. The dealings of this market are branded by popular anticapitalistic bias as a hazardous game, as mere gambling. In fact, the changes in the prices of common and preferred stock and of corporate bonds are the means applied by the capitalists for the supreme control of the flow of capital. The price structure as determined by the speculations on the capital and money markets and on the big commodity exchanges not only decides how much capital is available for the conduct of each corporation’s business; it creates a state of affairs to which the managers must adjust their operations in detail.
The general direction of a corporation’s conduct of business is exercised by the stockholders and their elected mandataries, the directors. The directors appoint and discharge the managers. In smaller companies and sometimes even in bigger ones the offices of the directors and the managers are often combined in the same persons. A successful corporation is ultimately never controlled by hired managers. The emergence of an omnipotent managerial class is not a phenomenon of the unhampered market economy. It was, on the contrary, an outgrowth of the interventionist policies consciously aiming at an elimination of the influence of the shareholders and at their virtual expropriation.
In Germany, Italy, and Austria it was a preliminary step on the way toward the substitution of government control of business for free enterprise, as has been the case in Great Britain with regard to the Bank of England and the railroads. Similar tendencies are prevalent in the American public utilities. The marvelous achievements of corporate business were not a result of the activities of a salaried managerial oligarchy; they were accomplished by people who were connected with the corporation by means of the ownership of a considerable part or of the greater part of its stock and whom part of the public scorned as promoters and profiteers.
The entrepreneur determines alone, without any managerial interference, in what lines of business to employ capital and how much capital to employ. He determines the expansion and contraction of the size of the total business and its main sections. He determines the enterprise’s financial structure. These are the essential decisions which are instrumental in the conduct of business. They always fall upon the entrepreneur, in corporations as well as in other types of a firm’s legal structure. Any assistance given to the entrepreneur in this regard is of ancillary character only; he takes information about the past state of affairs from experts in the fields of law, statistics, and technology; but the final decision implying a judgment about the future state of the market rests with him alone. The execution of the details of his projects may then be entrusted to managers.
The social functions of the managerial elite are no less indispensable for the operation of the market economy than are the functions of the elite of inventors, technologists, engineers, designers, scientists, and experimenters. In the ranks of the managers many of the most eminent men serve the cause of economic progress. Successful managers are remunerated by high salaries and often by a share in the enterprise’s gross profits. Many of them in the course of their careers become themselves capitalists and entrepreneurs. Nonetheless, the managerial function is different from the entrepreneurial function.
It is a serious mistake to identify entrepreneurship with management as in the popular antithesis of “management” and “labor.” This confusion is, of course, intentional. It is designed to obscure the fact that the functions of entrepreneurship are entirely different from those of the managers attending to the minor details of the conduct of business. The structure of business, the allocation of capital to the various branches of production and firms, the size and the line of operation of each plant and shop are considered as given facts and it is implied that no further changes will be effected with regard to them. The only task is to go on in the old routine. In such a stationary world, of course, there is no need for innovators and promoters; the total amount of profits is counterbalanced by the total amount of losses. To explode the fallacies of this doctrine it is enough to compare the structure of American business in 1945 with that of 1915.
But even in a stationary world it would be nonsensical to give “labor,” as a popular slogan demands, a share in management. The realization of such a postulate would result in syndicalism.22
There is furthermore a readiness to confuse the manager with a bureaucrat.
Bureaucratic management, as distinguished from profit management, is the method applied in the conduct of administrative affairs, the result of which has no cash value on the market. The successful performance of the duties entrusted to the care of a police department is of the greatest importance for the preservation of social cooperation and benefits each member of society. But it has no price on the market, it cannot be bought or sold; it can therefore not be confronted with the expenses incurred in the endeavors to secure it. It results in gains, but these gains are not reflected in profits liable to expression in terms of money. The methods of economic calculation, and especially those of double-entry bookkeeping, are not applicable to them. Success or failure of a police department’s activities cannot be ascertained according to the arithmetical procedures of profit-seeking business. No accountant can establish whether or not a police department or one of its subdivisions has succeeded.
The amount of money to be expended in every branch of profit-seeking business is determined by the behavior of the consumers. If the automobile industry were to treble the capital employed, it would certainly improve the services it renders to the public. There would be more cars available. But this expansion of the industry would withhold capital from other branches of production in which it could fill more urgent wants of the consumers. This fact would render the expansion of the automobile industry unprofitable and increase profits in other branches of business. In their endeavors to strive after the highest profit obtainable, entrepreneurs are forced to allocate to each branch of business only as much capital as can be employed in it without impairing the satisfaction of more urgent wants of the consumers. Thus the entrepreneurial activities are automatically, as it were, directed by the consumers’ wishes as they are reflected in the price structure of consumers’ goods.
No such limitation is enjoined upon the allocation of funds for the performance of the tasks incumbent upon government activities. There is no doubt that the services rendered by the police department of the City of New York could be considerably improved by trebling the budgetary allocation. But the question is whether or not this improvement would be considerable enough to justify either the restriction of the services rendered by other departments — e.g., those of the department of sanitation — or the restriction of the private consumption of the taxpayers. This question cannot be answered by the accounts of the police department. These accounts provide information only about the expenses incurred. They cannot provide any information about the results obtained, as these results cannot be expressed in money equivalents. The citizens must directly determine the amount of services they want to get and are ready to pay for. They discharge this task by electing councilmen and officeholders who are prepared to comply with their intentions.
Thus the mayor and the chiefs of the city’s various departments are restricted by the budget. They are not free to act upon what they themselves consider the most beneficial solution of the various problems the citizenry has to face. They are bound to spend the funds allocated for the purposes the budget has assigned them. They must not use them for other tasks. Auditing in the field of public administration is entirely different from that in the field of profit-seeking business. Its goal is to establish whether or not the funds allocated have been expended in strict compliance with the provisions of the budget.
In profit-seeking business the discretion of the managers and submanagers is restricted by considerations of profit and loss. The profit motive is the only directive needed to make them subservient to the wishes of the consumers. There is no need to restrict their discretion by minute instructions and rules. If they are efficient, such meddling with details would at best be superfluous, if not pernicious in tying their hands. If they are inefficient, it would not render their activities more successful. It would only provide them with a lame excuse that the failure was caused by inappropriate rules. The only instruction required is self-understood and does not need to be especially mentioned: seek profit.
Things are different in public administration, in the conduct of government affairs. In this field the discretion of the officeholders and their subaltern aids is not restricted by considerations of profit and loss. If their supreme boss — no matter whether he is the sovereign people or a sovereign despot — were to leave them a free hand, he would renounce his own supremacy in their favor. These officers would become irresponsible agents, and their power would supersede that of the people or the despot. They would do what pleased them, not what their bosses wanted them to do. To prevent this outcome and to make them subservient to the will of their bosses it is necessary to give them detailed instructions regulating their conduct of affairs in every respect. Then it becomes their duty to handle all affairs in strict compliance with these rules and regulations. Their freedom to adjust their acts to what seems to them the most appropriate solution of a concrete problem is limited by these norms. They are bureaucrats, i.e., men who in every instance must observe a set of inflexible regulations.
Bureaucratic conduct of affairs is conduct bound to comply with detailed rules and regulations fixed by the authority of a superior body. It is the only alternative to profit management. Profit management is inapplicable in the pursuit of affairs which have no cash value on the market and in the nonprofit conduct of affairs which could also be operated on a profit basis. The former is the case of the administration of the social apparatus of coercion and compulsion; the latter is the case in the conduct of an institution on a nonprofit basis, e.g., a school, a hospital, or a postal system. Whenever the operation of a system is not directed by the profit motive, it must be directed by bureaucratic rules.
Bureaucratic conduct of affairs is, as such, not an evil. It is the only appropriate method of handling governmental affairs, i.e., the social apparatus of compulsion and coercion. As government is necessary, bureaucratism is — in this field — no less necessary. Where economic calculation is unfeasible, bureaucratic methods are indispensable. A socialist government must apply them to all affairs.
No business, whatever its size or specific task, can ever become bureaucratic so long as it is entirely and solely operated on a profit basis. But as soon as it abandons profit — seeking and substitutes for it what is called the service principle — i.e., the rendering of services without regard as to whether or not the prices to be obtained for them cover the expenses — it must adopt bureaucratic methods for those of entrepreneurial management.23
11. The Selective Process
The selective process of the market is actuated by the composite effort of all members of the market economy. Driven by the urge to remove his own uneasiness as much as possible, each individual is intent, on the one hand, upon attaining that position in which he can contribute most to the best satisfaction of everyone else and, on the other hand, upon taking best advantage of the services offered by everyone else. This means that he tries to sell on the dearest market and to buy on the cheapest market. The resultant of these endeavors is not only the price structure but no less the social structure, the assignment of definite tasks to the various individuals.
The market makes people rich or poor, determines who shall run the big plants and who shall scrub the floors, fixes how many people shall work in the copper mines and how many in the symphony orchestras. None of these decisions is made once and for all; they are revocable every day. The selective process never stops. It goes on adjusting the social apparatus of production to the changes in demand and supply. It reviews again and again its previous decisions and forces everybody to submit to a new examination of his case. There is no security and no such thing as a right to preserve any position acquired in the past. Nobody is exempt from the law of the market, the consumers’ sovereignty.
Ownership of the means of production is not a privilege, but a social liability. Capitalists and landowners are compelled to employ their property for the best possible satisfaction of the consumers. If they are slow and inept in the performance of their duties, they are penalized by losses. If they do not learn the lesson and do not reform their conduct of affairs, they lose their wealth. No investment is safe forever. He who does not use his property in serving the consumers in the most efficient way is doomed to failure. There is no room left for people who would like to enjoy their fortunes in idleness and thoughtlessness. The proprietor must aim to invest his funds in such a way that principal and yield are at least not impaired.
In the ages of caste privileges and trade barriers there were revenues not dependent on the market. Princes and lords lived at the expense of the humble slaves and serfs who owed them tithes, statute labor, and tributes. Ownership of land could only be acquired either by conquest or by largesse on the part of a conqueror. It could be forfeited only by recantation on the part of the donor or by conquest on the part of another conqueror.
Even later, when the lords and their liegemen began to sell their surpluses on the market, they could not be ousted by the competition of more efficient people. Competition was free only within very narrow limits. The acquisition of manorial estates was reserved to the nobility, that of urban real property to the citizens of the township, that of farm land to the peasants. Competition in the arts and crafts was restricted by the guilds. The consumers were not in a position to satisfy their wants in the cheapest way, as price control made underbidding impossible to the sellers. The buyers were at the mercy of their purveyors. If the privileged producers refused to resort to the employment of the most adequate raw materials and of the most efficient methods of processing, the consumers were forced to endure the consequences of such stubbornness and conservatism.
The landowner who lives in perfect self-sufficiency from the fruits of his own farming is independent of the market. But the modern farmer who buys equipment, fertilizers, seed, labor, and other factors of production and sells agricultural products is subject to the law of the market. His income depends on the consumers and he must adjust his operations to their wishes.
The selective function of the market works also with regard to labor. The worker is attracted by that kind of work in which he can expect to earn most. As is the case with material factors of production, the factor labor too is allocated to those employments in which it best serves the consumers. There prevails the tendency not to waste any quantity of labor for the satisfaction of less urgent demand if more urgent demand is still unsatisfied. Like all other strata of society, the worker is subject to the supremacy of the consumers. If he disobeys, he is penalized by a cut in income.
The selection of the market does not establish social orders, castes, or classes in the Marxian sense. Nor do the entrepreneurs and promoters form an integrated social class. Each individual is free to become a promoter if he relies upon his own ability to anticipate future market conditions better than his fellow citizens, and if his attempts to act at his own peril and on his own responsibility are approved by the consumers. One enters the ranks of the promoters by aggressively pushing forward and thus submitting to the trial to which the market subjects, without respect for persons, everybody who wants to become a promoter or to remain in this eminent position. Everybody has the opportunity to take his chance. A newcomer does not need to wait for an invitation or encouragement from anyone. He must leap forward on his own account and must himself know how to provide the means needed.
It has been contended again and again that under the conditions of “late” or “mature” capitalism it is no longer possible for penniless people to climb the ladder to wealth and entrepreneurial position. No attempt has ever been made to prove this thesis. Since it was first advanced, the composition of the entrepreneurial and capitalist groups has changed considerably. A great part of the former entrepreneurs and their heirs have been eliminated and other people, newcomers, have taken their places.
It is, of course, true that in the last years institutions have been purposely developed which, if not abolished very soon, will make the functioning of the market in every regard impossible. The point of view from which the consumers choose the captains of industry and business is exclusively their qualification to adjust production to the needs of the consumers. They do not bother about other features and merits. They want a shoe manufacturer to fabricate good and cheap shoes. They are not intent upon entrusting the conduct of the shoe trade to handsome amiable boys, to people of good drawing-room manners, of artistic gifts, of scholarly habits, or of any other virtues or talents. A proficient businessman may often be deficient in many accomplishments which contribute to the success of a man in other spheres of life.
It is quite common nowadays to deprecate the capitalists and entrepreneurs. A man is prone to sneer at those who are more prosperous than himself. These people, he contends, are richer only because they are less scrupulous than he. If he were not restrained by due consideration for the laws of morality and decency, he would be no less successful than they are. Thus men glory in the aureole of self-complacency and Pharisaic self-righteousness.
Now it is true that, under the conditions brought about by interventionism, many people can acquire wealth by graft and bribery. In many countries interventionism has so undermined the supremacy of the market that it is more advantageous for a businessman to rely upon the aid of those in political office than upon the best satisfaction of the needs of the consumers. But it is not this that the popular critics of other people’s wealth have in mind. They contend that the methods by which wealth is acquired in a pure market society are objectionable from the ethical point of view. Against such statements it is necessary to emphasize that, so far as the operation of the market is not sabotaged by the interference of governments and other factors of coercion, success in business is the proof of services rendered to the consumers.
The poor man need not be inferior to the prosperous businessman in other regards; he may sometimes be outstanding in scientific, literary, and artistic achievements or in civic leadership. But in the social system of production, he is inferior. The creative genius may be right in his disdain for commercial success; it may be true that he would have been prosperous in business if he had not preferred other things. But the clerks and workers who boast of their moral superiority deceive themselves and find consolation in this self-deception. They do not admit that they have been tried and found wanting by their fellow citizens, the consumers.
It is often asserted that the poor man’s failure in the competition of the market is caused by his lack of education. Equality of opportunity, it is said, could be provided only by making education at every level accessible to all. There prevails today the tendency to reduce all differences among various peoples to their education and to deny the existence of inborn inequalities in intellect, will power, and character. It is not generally realized that education can never be more than indoctrination with theories and ideas already developed. Education, whatever benefits it may confer, is transmission of traditional doctrines and valuations; it is by necessity conservative. It produces imitation and routine, not improvement and progress. Innovators and creative geniuses cannot be reared in schools. They are precisely the men who defy what the school has taught them.
In order to succeed in business, a man does not need a degree from a school of business administration. These schools train the subalterns for routine jobs. They certainly do not train entrepreneurs. An entrepreneur cannot be trained. A man becomes an entrepreneur in seizing an opportunity and filling the gap. No special education is required for such a display of keen judgment, foresight, and energy. The most successful businessmen were often uneducated when measured by the scholastic standards of the teaching profession. But they were equal to their social function of adjusting production to the most urgent demand. Because of these merits, the consumers chose them for business leadership.
12. The Individual and the Market
It is customary to speak metaphorically of the automatic and anonymous forces actuating the “mechanism” of the market. In employing such metaphors people are ready to disregard the fact that the only factors directing the market and the determination of prices are purposive acts of men. There is no automatism; there are only men consciously and deliberately aiming at ends chosen. There are no mysterious mechanical forces; there is only the human will to remove uneasiness. There is no anonymity; there is I and you and Bill and Joe and all the rest. And each of us is both a producer and a consumer.
The market is a social body; it is the foremost social body. The market phenomena are social phenomena. They are the resultant of each individual’s active contribution. But they are different from each such contribution. They appear to the individual as something given which he himself cannot alter. He does not always see that he himself is a part, although a small part, of the complex of elements determining each momentary state of the market. Because he fails to realize this fact, he feels himself free, in criticizing the market phenomena, to condemn with regard to his fellow men a mode of conduct which he considers as quite right with regard to himself. He blames the market for its callousness and disregard of persons and asks for social control of the market in order to “humanize” it. He asks on the one hand for measures to protect the consumer against the producers. But on the other hand he insists even more passionately upon the necessity of protecting himself as a producer against the consumers. The outcome of these contradictory demands is the modern methods of government interference whose most outstanding examples were the Sozialpolitik of imperial Germany and the American New Deal.
It is an old fallacy that it is a legitimate task of civil government to protect the less efficient producer against the competition of the more efficient. One asks for a “producers’ policy” as distinct from a “consumers’ policy.” While flamboyantly repeating the truism that the only aim of production is to provide ample supplies for consumption, people emphasize with no less eloquence that the “industrious” producer should be protected against the “idle” consumer.
However, producers and consumers are identical. Production and consumption are different stages in acting. Catallactics embodies these differences in speaking of producers and consumers. But in reality they are the same people. It is, of course, possible to protect a less efficient producer against the competition of more efficient fellows. Such a privilege conveys to the privileged the benefits which the unhampered market provides only to those who succeed in best filling the wants of the consumers. But it necessarily impairs the satisfaction of the consumers. If only one producer or a small group is privileged, the beneficiaries enjoy an advantage at the expense of the rest of the people. But if all producers are privileged to the same extent, everybody loses in his capacity as consumer as much as he gains in his capacity as a producer. Moreover, all are injured because the supply of products drops if the most efficient men are prevented from employing their skill in that field in which they could render the best services to the consumers.
If a consumer believes that it is expedient or right to pay a higher price for domestic cereals than for cereals imported from abroad, or for manufactures processed in plants operated by small business or employing unionized workers than for those of another provenance, he is free to do so. He would only have to satisfy himself that the commodity offered for sale meets the conditions upon which he makes the allowance of a higher price depend. Laws which forbid counterfeiting of labels of origin and trademarks would succeed in attaining the ends aimed at by tariffs, labor legislation, and privileges granted to small business, But it is beyond doubt that the consumers are not prepared to act in this way. The fact that a commodity is marked as imported does not impair its salability if it is better or cheaper, or both. As a rule the buyers want to buy as cheaply as possible without regard for the origin of the article or some particular characteristics of the producers.
The psychological root of the producers’ policy as practiced today in all parts of the world is to be seen in spurious economic doctrines. These doctrines flatly deny that the privileges granted to less efficient producers burden the consumer. Their advocates contend that such measures are prejudicial only to those against whom they discriminate. When, pressed further, they are forced to admit that the consumers are damaged too, they maintain that the losses of the consumers are more than compensated by an increase in their money income which the measures in question are bound to bring about.
Thus in the predominantly industrial countries of Europe the protectionists were first eager to declare that the tariff on agricultural products hurts exclusively the interests of the farmers of the predominantly agricultural countries and of the grain dealers. It is certain that these exporting interests are damaged too. But it is no less certain that the consumers of the country that adopts the tariff policy are losing with them. They must pay higher prices for their food. Of course, the protectionist retorts, that this is not a burden. For, he argues, the additional amount that the domestic consumer pays increases the farmers’ income and their purchasing power; they will spend the whole surplus in buying more of the products manufactured by the nonagricultural strata of the population. This paralogism can easily be exploded by referring to the well-known anecdote of the man who asks an innkeeper for a gift of ten dollars; it will not cost him anything because the beggar promises to spend the whole amount in his inn. But for all that, the protectionist fallacy got hold of public opinion, and this alone explains the popularity of the measures inspired by it. Many people simply do not realize that the only effect of protection is to divert production from those places in which it could produce more per unit of capital and labor expended to places in which it produces less. It makes people poorer, not more prosperous.
The ultimate foundation of modern protectionism and of the striving for economic autarky of each country is to be found in this mistaken belief that they are the best means to make every citizen, or at least the immense majority of them, richer. The term “riches” means in this connection an increase in the individual’s real income and an improvement in his standard of living. It is true that the policy of national economic insulation is a necessary corollary of the endeavors to interfere with domestic business, and that it is an outcome of warlike tendencies as well as one of the factors producing these tendencies. But the fact remains that it would never have been possible to sell the idea of protection to the voters if one had not been able to convince them that protection not only does not impair their standard of living but raises it considerably.
It is important to emphasize this fact because it utterly explodes a myth propagated by many popular books. According to these myths, contemporary man is no longer motivated by the desire to improve his material well-being and to raise his standard of living. The assertions of the economists to the contrary are mistaken. Modern man gives priority to “noneconomic” or “irrational” things and is ready to forego material betterment whenever its attainment stands in the way of those “ideal” concerns. It is a serious blunder, common mostly with economists and businessmen, to interpret the events of our time from an “economic” point of view and to criticize current ideologies with regard to the alleged economic fallacies implied. People long for other things more than for a good life.
It is hardly possible to misconstrue the history of our age more crassly. Our contemporaries are driven by a fanatical zeal to get more amenities and by an unrestrained appetite to enjoy life. A characteristic social phenomenon of our day is the pressure group, an alliance of people eager to promote their own material well-being by the employment of all means, legal or illegal, peaceful or violent. For the pressure group nothing matters but the increase of its members’ real income. It is not concerned with any other aspects of life. It does not bother whether or not the realization of its program hurts the vital interests of other men, of their own nation or country, and of the whole of mankind. But, of course, every pressure group is anxious to justify its demands as beneficial to the general public welfare and to stigmatize its critics as abject scoundrels, idiots, and traitors. In the pursuit of its plans it displays a quasi-religious ardor.
Without exception, all political parties promise their supporters a higher real income. There is no difference in this respect between nationalists and internationalists and between the supporters of a market economy and the advocates of either socialism or interventionism. If a party asks its supporters to make sacrifices for its cause, it always explains these sacrifices as the necessary temporary means for the attainment of the ultimate goal, the improvement of the material well-being of its members. Each party considers it as an insidious plot against its prestige and its survival if somebody ventures to question the capacity of its projects to make the group members more prosperous. Each party regards with a deadly hatred the economists embarking upon such a critique.
All varieties of the producers’ policy are advocated on the ground of their alleged ability to raise the party members’ standard of living. Protectionism and economic self-sufficiency, labor-union pressure and compulsion, labor legislation, minimum wage rates, public spending, credit expansion, subsidies, and other makeshifts are always recommended by their advocates as the most suitable or the only means to increase the real income of the people for whose votes they canvass. Every contemporary statesman or politician invariably tells his voters: My program will make you as affluent as conditions may permit, while my adversaries’ program will bring you want and misery.
It is true that some secluded intellectuals in their esoteric circles talk differently. They proclaim the priority of what they call eternal absolute values and feign in their declamations — not in their personal conduct — a disdain of things secular and transitory. But the public ignores such utterances. The main goal of present-day political action is to secure for the respective pressure group memberships the highest material well-being. The only way for a leader to succeed is to instill in people the conviction that his program best serves the attainment of this goal.
What is wrong with the producers’ policies is their faulty economics.
If one is prepared to indulge in the fashionable tendency to explain human things by resorting to the terminology of psychopathology, one might be tempted to say that modern man in contrasting a producers’ policy with a consumers’ policy has fallen victim to a kind of schizophrenia. He fails to realize that he is an undivided and indivisible person, i.e., an individual, and as such no less a consumer than a producer. The unity of his consciousness is split into two parts; his mind is inwardly divided against himself. But it matters little whether or not we adopt this mode of describing the fact that the economic doctrine resulting in these policies is faulty. We are not concerned with the pathological source from which an error may stem, but with the error as such and with its logical roots. The unmasking of the error by means of ratiocination is the primary fact. If a statement were not exposed as logically erroneous, psychopathology would not be in a position to qualify the state of mind from which it stems as pathological. If a man imagines himself to be the king of Siam, the first thing which the psychiatrist has to establish is whether or not he really is what he believes himself to be. Only if this question is answered in the negative can the man be considered insane.
It is true that most of our contemporaries are committed to a fallacious interpretation of the producer-consumer nexus. In buying they behave as if they were connected with the market only as buyers, and vice versa in selling. As buyers they advocate stern measures to protect them against the sellers, and as sellers they advocate no less harsh measures against the buyers. But this antisocial conduct which shakes the very foundations of social cooperation is not an outgrowth of a pathological state of mind. It is the outcome of a narrow-mindedness which fails to conceive the operation of the market economy and to anticipate the ultimate effects of one’s own actions.
It is permissible to contend that the immense majority of our contemporaries are mentally and intellectually not adjusted to life in the market society although they themselves and their fathers have unwittingly created this society by their actions. But this maladjustment consists in nothing else than in the failure to recognize erroneous doctrines as such.
13. Business Propaganda
The consumer is not omniscient. He does not know where he can obtain at the cheapest price what he is looking for. Very often he does not even know what kind of commodity or service is suitable to remove most efficaciously the particular uneasiness he wants to remove. At best he is familiar with the market conditions of the immediate past and arranges his plans on the basis of this information. To convey to him information about the actual state of the marker is the task of business propaganda.
Business propaganda must be obtrusive and blatant. It is its aim to attract the attention of slow people, to rouse latent wishes, to entice men to substitute innovation for inert clinging to traditional routine. In order to succeed, advertising must be adjusted to the mentality of the people courted. It must suit their tastes and speak their idiom. Advertising is shrill, noisy, coarse, puffing, because the public does not react to dignified allusions. It is the bad taste of the public that forces the advertisers to display bad taste in their publicity campaigns. The art of advertising has evolved into a branch of applied psychology, a sister discipline of pedagogy.
Like all things designed to suit the taste of the masses, advertising is repellent to people of delicate feeling. This abhorrence influences the appraisal of business propaganda. Advertising and all other methods of business propaganda are condemned as one of the most outrageous outgrowths of unlimited competition. It should be forbidden. The consumers should be instructed by impartial experts; the public schools, the “nonpartisan” press, and cooperatives should perform this task.
The restriction of the right of businessmen to advertise their products would restrict the freedom of the consumers to spend their income according to their own wants and desires. It would make it impossible for them to learn as much as they can and want about the state of the market and the conditions which they may consider as relevant in choosing what to buy and what not to buy. They would no longer be in a position to decide on the basis of the opinion which they themselves have formed about the seller’s appraisal of his products; they would be forced to act on the recommendation of other people. It is not unlikely that these mentors would save them some mistakes. But the individual consumers would be under the tutelage of guardians. If advertising is not restricted, the consumers are by and large in the position of a jury which learns about the case by hearing the witnesses and examining directly all other means of evidence. If advertising is restricted, they are in the position of a jury to whom an officer reports about the result of his own examination of evidence.
It is a widespread fallacy that skillful advertising can talk the consumers into buying everything that the advertiser wants them to buy. The consumer is, according to this legend, simply defenseless against “high-pressure” advertising. If this were true, success or failure in business would depend on the mode of advertising only. However, nobody believes that any kind of advertising would have succeeded in making the candle makers hold the field against the electric bulb, the horse drivers against the motorcars, the goose quill against the steel pen and later against the fountain pen. But whoever admits this implies that the quality of the commodity advertised is instrumental in bringing about the success of an advertising campaign. Then there is no reason to maintain that advertising is a method of cheating the gullible public.
It is certainly possible for an advertiser to induce a man to try an article which he would not have bought if he had known its qualities beforehand. But as long as advertising is free to all competing firms, the article which is better from the point of view of the consumers’ appetites will finally outstrip the less appropriate article, whatever methods of advertising may be applied. The tricks and artifices of advertising are available to the seller of the better product no less than to the seller of the poorer product. But only the former enjoys the advantage derived from the better quality of his product. The effects of advertising of commodities are determined by the fact that as a rule the buyer is in a position to form a correct opinion about the usefulness of an article bought.
The housewife who has tried a particular brand of soap or canned food learns from experience whether it is good for her to buy and consume that product in the future too. Therefore advertising pays the advertiser only if the examination of the first sample bought does not result in the consumer’s refusal to buy more of it. It is agreed among businessmen that it does not pay to advertise products other than good ones. Entirely different are conditions in those fields in which experience cannot teach us anything. The statements of religious, metaphysical, and political propaganda can be neither verified nor falsified by experience. With regard to the life beyond and the absolute, any experience is denied to men living in this world.
In political matters, experience is always the experience of complex phenomena which is open to different interpretations; the only yardstick which can be applied to political doctrines is aprioristic reasoning. Thus political propaganda and business propaganda are essentially different things, although they often resort to the same technical methods.
There are many evils for which contemporary technology and therapeutics have no remedy. There are incurable diseases and there are irreparable personal defects. It is a sad fact that some people try to exploit their fellow men’s plight by offering them patent medicines. Such quackeries do not make old people young and ugly girls pretty. They only raise hopes. It would not impair the operation of the market if the authorities were to prevent such advertising, the truth of which cannot be evidenced by the methods of the experimental natural sciences. But whoever is ready to grant to the government this power would be inconsistent if he objected to the demand to submit the statements of churches and sects to the same examination. Freedom is indivisible. As soon as one starts to restrict it, one enters upon a decline on which it is difficult to stop. If one assigns to the government the task of making truth prevail in the advertising of perfumes and toothpaste, one cannot contest it the right to look after truth in the more important matters of religion, philosophy, and social ideology.
The idea that business propaganda can force the consumers to submit to the will of the advertisers is spurious. Advertising can never succeed in supplanting better or cheaper goods available and offered for sale.
The costs incurred by advertising are, from the point of view of the advertiser, a part of the total bill of production costs. A businessman expends money for advertising if and as far as he expects that the increase in sales resulting will increase the total net proceeds. In this regard there is no difference between the costs of advertising and all other costs of production. An attempt has been made to distinguish between production costs and sales costs. An increase in production costs, it has been said, increases supply, while an increase in sales costs (advertising costs included) increases demand.24 This is a mistake. All costs of production are expended with the intention of increasing demand. If the manufacturer of candy employs a better raw material, he aims at an increase in demand in the same way as he does in making the wrappings more attractive and his stores more inviting and in spending more for advertisements. In increasing production costs per unit of the product the idea is always to increase demand. If a businessman wants to increase supply, he must increase the total cost of production, which often results in lowering production costs per unit.
14. The “Volkswirtschaft”
The market economy as such does not respect political frontiers. Its field is the world.
The term Volkswirtschaft was long applied by the German champions of government omnipotence. Only much later did the British and the French begin to speak of the “British economy” and “l’économie française” as distinct from the economies of other nations. But neither the English nor the French language produced an equivalent of the term Volkswirtschaft. With the modern trend toward national planning and national autarky, the doctrine involved in this German word became popular everywhere. Nonetheless, only the German language is able to express in one word all the ideas implied. The Volkswirtschaft is a sovereign nation’s total complex of economic activities directed and controlled by the government. It is socialism realized within the political frontiers of each nation.
In employing this term people are fully aware of the fact that real conditions differ from the state of affairs which they deem the only adequate and desirable state. But they judge everything that happens in the market economy from the point of view of their ideal. They assume that there is an irreconcilable conflict between the interests of the Volkswirtschaft and those of the selfish individuals eager to seek profit. They do not hesitate to assign priority to the interests of the Volkswirtschaft over those of the individuals. The righteous citizen should always place the volkswirtschaftliche interests above his own selfish interests. He should act of his own accord as if he were an officer of the government executing its orders.
Gemeinnutz geht vor Eigennutz (the welfare of the nation takes precedence over the selfishness of the individuals) was the fundamental principle of Nazi economic management. But as people are too dull and too vicious to comply with this rule, it is the task of government to enforce it. The German princes of the 17th and 18th century, foremost among them the Hohenzollern electors of Brandenburg and kings of Prussia, were fully equal to this task. In the 19th century, even in Germany the liberal ideologies imported from the West superseded the well-tried and natural policies of nationalism and socialism. However, Bismarck’s and his successors’ Sozialpolitik and finally Nazism restored them. The interests of a Volkswirtschaft are seen as implacably opposed not only to those of the individuals, but no less to those of the Volkswirtschaft of any foreign nation. The most desirable state of a Volkswirtschaft is complete economic self-sufficiency. A nation which depends on any imports from abroad lacks economic independence; its sovereignty is only a sham. Therefore a nation which cannot produce at home all that it needs is bound to conquer all the territories required. To be really sovereign and independent a nation must have Lebensraum, i.e., a territory so large and rich in natural resources that it can live in autarky at a standard no lower than that of any other nation. Thus the idea of the Volkswirtschaft is the most radical denial of all the principles of the market economy. It was this idea that guided, more or less, the economic policies of all nations in the last decades.
It was the pursuit of this idea that brought about the terrific wars of our century and will probably kindle still more pernicious wars in the future.
From the early beginnings of human history the two opposite principles of the market economy and of the Volkswirtschaft fought each other. Government, i.e., a social apparatus of coercion and compulsion, is a necessary requisite of peaceful cooperation. The market economy cannot do without a police power safeguarding its smooth functioning by the threat or the application of violence against peace breakers. But the indispensable administrators and their armed satellites are always tempted to use their arms for the establishment of their own totalitarian rule. For ambitious kings and generalissimos the very existence of a sphere of individuals’ lives not subject to regimentation is a challenge. Princes, governors, and generals are never spontaneously liberal. They become liberal only when forced to by the citizens.
The problems raised by the plans of the socialists and the interventionists will be dealt with in later parts of this book. Here we have only to answer the question of whether or not any of the essential features of the Volkswirtschaft are compatible with the market economy. For the champions of the idea of the Volkswirtschaft do not consider their scheme merely as a pattern for the establishment of a future social order. They declare emphatically that even under the system of the market economy, which, or course, in their eyes is a debased and vicious product of policies contrary to human nature, the Volkswirtschaft of the various nations are integrated units whose interests are irreconcilably opposed to those of all other nations’ Volkswirtschaft. What separates one Volkswirtschaft from all the others is not, as the economists would have us believe, merely political institutions. It is not the trade and migration barriers established by government interference with business and the differences in legislation and in the protection granted to the individuals by the courts and tribunals that bring about the distinction between domestic trade and foreign trade. This diversity is, on the contrary, the necessary outcome of the very nature of things, of an inextricable factor; it cannot be removed by any ideology and produces its effects whether the laws and the administrators and judges are prepared to take notice of it or not. The Volkswirtschaft is a nature-given reality, while the world-embracing ecumenic society of men, the world economy (Weltwirtschaft), is only an imaginary phantom of a spurious doctrine, a plan devised for the destruction of civilization.
The truth is that individuals in their acting, in their capacity as producers and consumers, as sellers and buyers, do not make any distinction as between the domestic market and the foreign market. They make a distinction as between local trade and trading with more distant places as far as the costs of transportation play a role. If government interference, such as tariffs, render international transactions more expensive, they take this fact into account in the same way in which they pay regard to shipping costs. A tariff on caviar has no effect other than would a rise in the cost of transportation. A rigid prohibition of the importation of caviar produces a state of affairs no different from that which would prevail if caviar could not stand shipping without an essential deterioration in its quality.
There has never been in the history of the West such a thing as regional or national autarky. There was, as we may admit, a period in which the division of labor did not go beyond the members of a family household. There was autarky of families and tribes which did not practice interpersonal exchange. But as soon as interpersonal exchange emerged, it crossed the boundaries of the political communities. Barter between the inhabitants of regions more remote from one another, between the members of various tribes, villages, and political communities preceded the practice of barter between neighbors. What people wanted first to acquire by barter and trade were things they could not produce themselves out of their own resources. Salt, other minerals and metals the deposits of which are unequally distributed over the earth’s surface, cereals which one could not grow on the domestic soil, and artifacts which only the inhabitants of some regions were able to manufacture, were the first objects of trade. Trade started as foreign trade. Only later did domestic exchange develop between neighbors. The first holes that opened the closed household economy to interpersonal exchange were made by the products of distant regions. No consumer cared on his own account whether the salt and the metals he bought were of “domestic” or of “foreign” provenance. If it had been otherwise, the governments would not have had any reason to interfere by means of tariffs and other barriers to foreign trade.
But even if a government succeeds in making the barriers separating its domestic market from foreign markets insurmountable and thus establishes perfect national autarky, it does not create a Volkswirtschaft. A market economy which is perfectly autarkic remains for all that a market economy; it forms a closed and isolated catallactic system. The fact that its citizens miss the advantages which they could derive from the international division of labor is simply a datum of their economic conditions. Only if such an isolated country goes outright socialist does it convert its market economy into a Volkswirtschaft.
Fascinated by the propaganda of neomercantilism, people apply idioms which are in contrast to the principles they take as guides in their acting and to all the characteristics of the social order in which they are living. Long ago the British began to call plants and farms located in Great Britain, and even those located in the dominions, in the East Indies, and in the colonies, “ours.” But if a man did not just want to make a show of his patriotic zeal and to impress other people, he was not prepared to pay a higher price for the products of his “own” plants than for those of the “foreign” plants. Even if he had behaved in this way, the designation of the plants located within the political boundaries of his nation as “ours” would not be adequate. In what sense could a Londoner, before the nationalization, call coalmines located in England which he did not own “our” mines and those of the Ruhr “foreign” mines? Whether he bought “British” coal or “German” coal, he always had to pay the full market price. It is not “America” that buys champagne from “France.” It is always an individual American who buys it from an individual Frenchman.
As far as there is still some room left for the actions of individuals, as far as there is private ownership and exchange of goods and services between individuals, there is no Volkswirtschaft. Only if full government control is substituted for the choices of individuals does the Volkswirtschaft emerge as a real entity.
16. If an action neither improves nor impairs the state of satisfaction, it still involves a psychic loss because of the uselessness of the expended psychic effort. The individual concerned would have been better off if he had inertly enjoyed life.
17. Cf. Mangoldt, Die Lehre vom Unternehmergewinn (Leipzig, 1855), p. 82. The fact that out of 100 liters of plain wine one cannot produce 100 liters of champagne, but a smaller quantity, has the same significance as the fact that 100 kilograms of sugar beet do not yield 100 kilograms of sugar but a smaller quantity.
18. Cf. Knight, Risk, Uncertainty and Profit (Boston, 1921), pp. 211–213.
19. If we were to apply the faulty concept of a “national income” as used in popular speech, we would have to say that no part of national income goes into profits.
20. The problem of the convertibility of capital goods is dealt with below, pp. 499–505.
21. Cf. below, pp. 763–773.
22. Cf. below, pp. 808–816.
24. Cf. Chamberlin, The Theory of Monopolistic Competition (Cambridge, Mass., r935), pp. 123 ff.