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The Making of Modern Civilization: Savings, Investment, and Economic Calculation

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Institutionalism1 is used to ridicule the classical economists because they started with “Crusoe economics.” In the beginning a fisherman got the idea that he could catch more fish one day than he needed and then he could have some leisure time to manufacture fishing nets. These nets and saved fish are “capital goods”; I don’t call them “capital.”

Capital goods are the intermediate factors between the given natural factors of production and consumer goods. Nature—given resources and human labor are the given natural factors. But if they are to produce, they must be guided. The produced, intermediary factors of production—capital goods—are not only tools; they are also all other intermediary goods, half-finished products, and supplies of consumer goods which are used for the support of those who are producing with the aid of capital goods. The production process which we are organizing and operating today started in the early ages of history, in the remotest ages of history. If the children used up the nets and fish produced by their parents, capital accumulation would have had to start all over again. There is a continuous progress from simpler conditions to more refined conditions. It is important to realize this because we must know that, from the early beginnings on, the first step toward this system of producing with the aid of capital goods was saving, and has always been saving.

The concept of “capital” must be distinguished from the concept of “capital goods.” It is impossible to think and to deal with the problems of capital goods without using and referring to the concepts which we have developed in the complicated modern system of capital calculation. Capital goods are something material—something that could be described in terms of physics and chemistry. The concept of “capital” refers to the valuation of a supply of these capital goods in terms of money. This valuation of capital goods in terms of money is what marks the beginning of what may be called a new and higher period in human endeavors to improve the external conditions of mankind. The problem is how to maintain or to preserve the amount of capital available and how to avoid consuming the available capital goods without replacing them. The problem is how not to consume more, or if possible, how to consume less, than the amount of newly produced products. It is the problem of capital preservation, maintenance, and of course of increasing the capital available.

Under some circumstances, it is possible to deal with this problem without any special calculation or computation. If a farmer continues to produce in the same way and if the methods of construction and method of living haven’t changed, he can estimate his condition because he can establish comparisons in physical and biological terms—two barns are more than one barn, a dozen head of cattle is more than two cows, and so on. But such simple methods of computation are insufficient in an economic system in which there is change and progress. Replacement may not be in the same form as the factors which are used up. Diesel engines may be substituted for steam engines, and so on. Replacement and maintenance of capital under such conditions require a method of computation and calculation which can only be figured in terms of money. The various physical and external factors of production cannot be compared in any other way than from the point of view of the services they render to men, calculated in terms of money.

It was one of the fundamental errors of Aristotle that he believed that in exchanges the things which were exchanged must have the same value. Since the days of Aristotle, for two or three thousand years, the same error has prevailed again and again, leading great thinkers, as well as simple men, astray. The same error appears in the first pages of Marx’s Das Kapital, making everything Marx said about these problems useless. This error was repeated even much later in the writings of Henri Bergson2, the eminent French philosopher. 

There is no equivalence in exchange. On the contrary, it is differences that bring about exchange. You cannot reduce the terms of exchange and of trade to equivalence; you can only reduce them to differences in evaluation. The buyer values what he gets more highly than what he gives away; the seller values what he gives less highly than what he gets. Therefore, the equivalence that we use in determining the importance the various capital goods have in our lives can only be expressed in terms of prices. In calculating in terms of prices you can establish a system of prices, and determine whether or not a price has increased or decreased— that is, in terms of money. Without a price system there cannot be any calculation. In the socialist system, which cannot have a price system as we have it in the market system, there cannot be established calculation and computation.

In the system of economic calculation, we have the terms “capital” and “income”—terms and notions that cannot be thought of outside this system. “Capital” is the sum of the prices that can be obtained on the market for a definite given supply of capital goods. The businessman employs economic calculation in a specific way; he could not operate without this system of economic calculation. At the beginning of his enterprise he establishes a total value of all the capital goods at his disposal and calls it his “capital,” or the “capital” of his firm or corporation.

Periodically, he compares the value of the prices of all the capital goods available in the firm with the prices of these capital goods at the beginning. If there is an increase he calls it “profit.” If there is a decrease, he calls it “loss.” No other system would make it possible to establish whether what has been done has increased the capital available, improved it, or decreased it. From another point of view, the total surplus that he calls “profit” can also be called “income,” insofar as it makes it possible for the owner—corporation or individual—to consume this amount without reducing the amount of capital available and without, therefore, living at the expense of the future. Thus the concepts of “capital” and “income” developed only within this system of economic calculation.

If the total amount of “income” is consumed, then there is no change in the amount of capital available for the enterprise. If a part is saved, i.e., not consumed but reinvested—that is, if it is used to expand the stock of capital goods working in the enterprise—then we can say additional capital has been accumulated; the enterprise has earned some “income.” If the contrary is the case, if the amount consumed by the owner exceeds the income, then we have capital consumption, or capital decumulation, and there will be less available in the future for the production of consumer goods.

I don’t want to enter into how much knowledge the ancient Greeks and Romans had of these ideas. They had some knowledge at least, but by the Middle Ages it had entirely disappeared. Under the conditions of the Middle Ages, there was no need for such calculation. It developed slowly, step by step in the latter part of the Middle Ages in the countries in which at that time economic progress was much better than other countries, in Italy, for instance. As a result, some of the fundamental terms of accountancy preserve their Italian origin, for instance the word “capital” itself.

In the beginning, the terms of accountancy were not very clear. People were not very good at arithmetic, and we discover very bad errors simply in arithmetical problems even in the books of big fifteenth-century firms. Gradually these ideas developed more and more until the system of double-entry bookkeeping was developed. Our whole thinking is now influenced by these ideas, even the ideas of those who know nothing of the problems of accountancy and who are not in a position to read and interpret the balance sheet of a corporation. Accountants and bookkeepers are only the handymen in this fundamental way of dealing with all material and external problems. However, these problems concern others than accountants and bookkeepers. Goethe, who was a great poet, scientist, and a precursor of the science of evolution, described a merchant’s doubleentry accounting system as “one of the most marvelous inventions of the human spirit.” Goethe realized these ideas were fundamental to the modern system of producing and acting and that these concepts were a kind of practical mathematics and logic in the way people deal with all these problems.

In our age, public opinion and legislation have completely lost all understanding of these problems. This is due to modern income-tax legislation. First of all, in the legislation concerning income taxes, the law-giver calls salaries and wages “income” or “earned income.” However, the main characteristic of “income” in the economic sense is that it is that surplus over a businessman’s costs that may be consumed without reducing capital, i.e., without living at the expense of the future. You cannot consume “income” without deteriorating your opportunities for future production. The concepts of “capital” and “income” developed only within the system of economic calculation. 

These income-tax laws also deal with “profits” as if they were salaries. The income-tax authors are very astonished if a firm doesn’t have a profit every year. They don’t realize that there are good years and bad years for an enterprise. One consequence was that during the depression in the early 1930s people used to say,“How unjust that a man who owns a big factory doesn’t have to pay any income tax this year, while a man who makes only $300 a month has to pay.” It was not unjust from the point of view of the law; that year the big factory owner had no “income.”

The authors in promulgating these income-tax laws had not the slightest idea of what “capital” and “income” in the economic system really meant. What they didn’t see was that the greater part of the great profits and great incomes wasn’t spent by the businessmen, but reinvested in capital goods and plowed back into the enterprise to increase production. This was precisely the way in which economic progress, improvement in material conditions, took place. Fortunately I do not have to deal with the income-tax laws, nor with the mentality that led to these laws. It is enough to say that, from the point of view of the individual worker, it would be much more reasonable to tax only income spent, not income saved and reinvested.

In many cases, it is difficult for a man in the late years of his life to make a living, or at least to earn as much as he had earned in his prime. To make it simple, take the situation of singers whose years of big earning are definitely limited.

What I want to deal with is the idea that saving in general, or that saving under special circumstances, is supposedly bad from the point of view of the welfare of the commonwealth and, therefore, that something should be done to restrict saving or to direct it into special channels. In fact, we may say, and nobody can deny it, that all material progress, everything that distinguishes our conditions from those of earlier ages, is that more has been saved and accumulated as capital goods. This also distinguishes the United States from, let us say, India or China. The most important difference is only a difference in time. It is not too late for them. We just started earlier to save some of the excess of production over consumption.

The most important institutional factor in the development of nations was the establishment of a system of government and of legislation that made large-scale saving possible. Large-scale saving was impossible and still is impossible today in all those countries in which the governments believe that when one man has more it must necessarily be the cause of other people’s distress. This was once the idea of all people. And it is today the idea of the people in many countries outside the countries of Western civilization. It is the idea that is now jeopardizing Western civilization by introducing different methods of government into the constitutions which made possible the development of Western civilization. It was also the idea prevailing in most European countries until the rise of modern capitalism, that is, until the age very inappropriately called the “Industrial Revolution.”

To show how strong this idea was, I quote from Immanuel Kant3, one of the most important philosophers—but he lived in the east, in Kaliningrad, then called Königsberg: “If one man has more than necessary, another man has less.” This is mathematically perfectly true, of course, but mathematics and economics are two different things. The fact is that in all those countries in which people believed in this dictum and in which governments believed that the best way to improve conditions was to confiscate the wealth of successful businessmen—it was not necessary to confiscate the wealth of those who were unsuccessful—in all those countries, it was not possible to save and invest.

If someone asked me why the ancient Greeks did not have railroads, I would answer, “Because there was a tendency in those days to confiscate wealth. Why should people then invest?”The Greek philosopher Isocrates4 made some speeches which are still available to us. He said if a wealthy citizen stood trial in Athens he had no chance to win because the judges wanted to confiscate his wealth, expecting this would improve their situation. Under such conditions there couldn’t be any question of large-scale savings.

Large-scale savings developed only from the eighteenth century on. And from that time on there developed also those institutions which made saving and investment possible, not only by the well-to-do, but also of small sums by the poor man. In the early days the poor man could save only by hoarding coins. But coins don’t bear any interest, and the advantage he got from his savings was not very great. Moreover, it was dangerous to have such small hoards in his regular home; they could be stolen easily and they didn’t earn anything. From the beginning of the nineteenth century on, we had a large-scale development that made saving possible for the broad masses.

One of the characteristic differences between a capitalistic and a pre-capitalistic system is that in the capitalistic system even those who are not very well off are owners of savings and have small investments. Many people do not recognize this difference. Still today, in dealing with the problem of interest, statesmen, or politicians, as well as public opinion, believe that creditors are the rich and the debtors are the poor. Therefore, they think that a policy of easy money, a policy of lowering interest rates artificially by government interference, is in favor of the poor and against the rich. In fact, the poor and the less well-to-do own deposits with savings banks, have bonds, insurance policies, and are entitled to pensions. According to a newspaper account today, there are 61 /2 million owners of bonds (promises to pay) in this country. I don’t know whether or not this figure is accurate. But nevertheless these bonds are widely distributed, and so this means that the majority are not debtors but creditors. All these people are creditors. On the other hand, the owners of the common stock of a corporation that has issued bonds, or is indebted to banks, are not creditors, but debtors. Similarly the big real estate operator who has a big mortgage is also a debtor. Therefore, it is no longer true to say that the rich are creditors and the poor are debtors. Conditions in this regard have changed considerably.

One of Hitler’s great rallying cries was: “Do away with interest slavery. Long live the debtor; perish the creditor.” But one German newspaper recognized the error in this and wrote an article with the headline, “DO YOU KNOW THAT YOU YOURSELF ARE A CREDITOR?” I cannot say that this article was appreciated by Hitler.

There developed some years ago a hostility to saving and capital accumulation. This opposition to saving can’t be attributed to Marx, because Marx didn’t understand how capital was accumulated. Karl Marx didn’t foresee the development of large corporations and ownership by many small savers. A Russian economist who was influenced by Marx declared years ago that the whole economic system of capitalism was self-contradictory. Instead of consuming everything that was produced, a great part of the things produced is saved and accumulated as additional capital. There will be more and more for coming generations. What is the sense of this? For whom do they accumulate all this? Like a miser they accumulate, but who will enjoy what the saver earns? It is ridiculous; it is bad; something should be done about it.

John Maynard Keynes5 succeeded with his anti-saving program. According to him, there is danger in over-saving. He believed, and many people accepted his view, that opportunities for investment were limited. There may not be sufficient investment opportunities to absorb all the income that is set aside as savings. Business will become bad because there is too much savings. Therefore, it was possible to save too much. The same doctrine from another point of view had been prevalent for a very long time. People believed that a new invention—a labor-saving device—would produce what was called “technological unemployment.” This was the idea that led the early unions to destroy machines. Present-day unions still have the same idea, but they are not so unsophisticated as to destroy the machines—they have more refined methods.

As far as we can see, human wants are practically unlimited. What we need to fulfill satisfactions is more accumulation of capital goods. The only reason we don’t have a higher standard of living in this country is that we don’t have enough capital goods to produce all the things that people would like to have. I don’t want to say that people always make the best use of economic improvements. But whatever it is that you want, it requires more investment and more manpower to satisfy it. We could improve conditions, we could think of more ways to employ capital, even in the wealthiest parts of the United States, even in California. There will always be plenty of room for investment as long as there is scarcity of the material factors of production. We cannot imagine a state of affairs without this scarcity. We cannot imagine life in a “Land of Cockaigne,” where people have only to open their mouths and let food enter and where everything else people wanted was available.

Scarcity of the factors of production means a scarcity of capital goods. Therefore, the whole idea that we must stop saving and start spending is fantastic. In 1931 or 1932, Lord Keynes and a number of his friends published a declaration in which they stated there was only one means to avoid catastrophe and to improve economic conditions immediately— that was to spend, spend more, and still more. Economically we must realize that spending in this sense does not create jobs that investment wouldn’t have created just as much. It doesn’t matter whether you use your money for the purchase of a new machine or you spend it in a night club. According to Keynes’s theory the man who spends the money on a better life creates jobs, while the man who buys a machine and improves production is withholding something from the public. It is not true that when Keynes wrote his book conditions in Great Britain justified his theory of government spending to create full employment. What created the unfavorable situation in Great Britain was that British industries after World War I did not have the means required to improve the material equipment in their factories. Therefore, the British machines were inefficient when compared with the machines in some other countries, especially in the United States. As a result, the marginal productivity of labor was lower in Britain. But as the unions would not tolerate any significant reduction of wage rates to make British industry more competitive, the result was unemployment. What Great Britain needed was more investment to improve the productivity of the factors of production, just as they need to do the same today.

Lord Keynes was very peculiar about this idea. An American friend published an article dealing with his personal friendship with Lord Keynes. He tells a story about visiting Keynes in a Washington hotel. In washing his hands, the friend was very careful not to soil more than a single towel. Keynes then crumpled all of the towels and said in that way he was making more jobs for American chambermaids. From this point of view, the best way to increase employment would be to destroy as much as possible. I would have thought that idea had been demolished once and for all by Frédéric Bastiat6 in his broken window story. But evidently Keynes didn’t understand this tale of Bastiat’s. The fallacy that labor-saving machines create technological unemployment has not only been disproved by theoretical examination but also by the fact that the whole history of mankind consists precisely of the introduction of more and more labor-saving machines. Today we produce a greater amount of various amenities with a smaller amount of human labor. Yet there are more people and more employment. Therefore, it is not true that people are deprived of their jobs because some new machines are invented.

It is no less a fable, and it is also a very bad fable, that the accumulation of capital hurts the workers. The more capital goods available, the higher the marginal productivity of labor—other things being equal. If an employer considers the hiring of an additional worker or the firing of an additional worker, he asks himself what the employment of this man adds to the value of his products. If the employment of one worker more adds something to the quantities produced, the employer’s problem is, does his employment cost more than it brings from the sale of his production? The same problem arises when the employment of an additional amount of capital goods is considered.

The greater amount of capital available per head of the worker, the greater the marginal productivity of the worker and consequently the higher the wages the employer can pay. The more capital accumulated—other things being equal—the more workers can be employed at the same rates, or at higher rates.

Two businessmen—J. Howard Pew7 of Sunoco, and Irving Olds8 of U. S. Steel—have tried, without too much success, to explain to other businessmen the effect of inflation on their capital accumulation, inventories, depreciation, and so forth. Inflation raises the businessmen’s selling prices, creating the illusion that they are making profits. The government then taxes and uses for current expenses these apparent “profits” which would otherwise have been used for investment or set aside for depreciation and replacement.

If an individual takes out a policy with a private insurance company, the insurance company invests this money. Later, of course, when the insurance has to be paid out, it has to disinvest. Individuals come to the point where they must disinvest, but insurance companies expand from year to year, and as there is capital accumulation taking place in the whole country, the insurance companies as a whole do not have to disinvest. It is different with the Social Security system. The government talks about actuarial statistics but this does not mean what it means to an insurance company. What the individual pays, the government spends for current expenses. The government then gives to the “Social Security Fund” an IOU which it calls a “bond.”Thus the government “invests” in government bonds. When the government collects “Social Security” taxes, it says, “give me your money to spend and in return I promise that in 30 or 40 years the taxpayers will be willing to pay back the debt which we have incurred today.” Therefore the Social Security system is something very different from private insurance. It doesn’t mean something has been saved. On the contrary, the savings of individuals are collected by government for “social security” but they are used for current expenses. I am fully convinced the government will pay, but the question is, in what kind of dollars? The whole thing depends on the readiness of future Congresses and the future public to pay in good money. If people don’t like the paper money, they won’t use it. For instance, California stayed on hard currency during the Civil War era of the greenbacks.

Bismarck’s idea of social security was that he wanted everybody to receive something from the government. He compared the situation with that of the French, many of whom owned government bonds and received interest. He thought that was why the French were so patriotic; they were receiving something from the government. Bismarck wanted the individual German, too, to depend on the government. So he started an additional government bonus of 50 Marks to every old-age pensioner. This was called the Reichszuschuss [governmental supplementary allowance]. The problems of capital are problems of economic calculation. You cannot increase “capital goods” by inflation, although you can seemingly increase “capital.” The result is a discrepancy between capital goods and capital, as is pointed out by economic calculation.

Excerpted from Marxism Unmasked
  • 1. A school of thought that stresses the importance of social, historical, and institutional factors within the economic realm rather than individual human action.
  • 2. 1859-1941
  • 3.
    1724–1804
  • 4. 436–438 BC
  • 5. 1883–1946
  • 6.
    1801–1850
  • 7. 1882–1971
  • 8. 1887–1963

Ludwig von Mises was the acknowledged leader of the Austrian School of economic thought, a prodigious originator in economic theory, and a prolific author. Mises's writings and lectures encompassed economic theory, history, epistemology, government, and political philosophy. His contributions to economic theory include important clarifications on the quantity theory of money, the theory of the trade cycle, the integration of monetary theory with economic theory in general, and a demonstration that socialism must fail because it cannot solve the problem of economic calculation. Mises was the first scholar to recognize that economics is part of a larger science in human action, a science that he called "praxeology."

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