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From Human Action, Yale University Press, pp. 582-586.  I post this because it refutes a common charge made by philosophical critics of unhampered markets to whom I otherwise owe much.  (See, for example, my prefatory comments to Bernard Lonergan’s “Bias, Liberation, and Cosmopolis” elsewhere on this site.)  The whole text of Human Action is available online at Mises.org.

The Errors of Anti-market “Disproportionality” Doctrines

Ludwig von Mises

Guided by the Marxian slogan “anarchy of production,” the present-day nonmonetary cycle doctrines explain the cyclical fluctuations of trade in terms of a tendency, allegedly inherent in the capitalist economy, to develop disproportionality in the size of investments made in various branches of industry.  Yet even these disproportionality doctrines do not contest the fact that every businessman is eager to avoid such mistakes, which must bring him serious financial losses.  The essence of the activities of entrepreneurs and capitalists is precisely not to embark upon projects which they consider unprofitable.  If one assumes that there prevails a tendency for businessmen to fail in these endeavors, one implies that all businessmen are short-sighted. They are too dull to avoid certain pitfalls, and thus blunder again and again in their conduct of affairs. The whole of society has to foot the bill for the shortcomings of the thick-headed speculators, promoters, and entrepreneurs.

Now it is obvious that men are fallible, and businessmen are certainly not free from this human weakness.  But one should not forget that on the market a process of selection is in continual operation.  There prevails an unceasing tendency to weed out the less efficient entrepreneurs, that is, those who fail in their endeavors to anticipate correctly the future demands of the consumers.  If one group of entrepreneurs produces commodities in excess of the demand of the consumers and consequently cannot sell these goods at remunerative prices and suffers losses, other groups who produce those things for which the public scrambles make all the greater profits.  Some sectors of business are distressed while others thrive.  No general depression of trade can emerge.

But the proponents of the doctrines we have to deal with argue differently.  They assume that not only the whole entrepreneurial class but all of the people are struck with blindness.  As the entrepreneurial class is not a closed social order to which access is denied to outsiders, as every enterprising man is virtually in a position to challenge those who already belong to the class of entrepreneurs, as the history or capitalism provides innumerable examples of penniless newcomers who brilliantly succeeded in embarking upon the production of those goods which according to their own judgment were fitted to satisfy the most urgent needs of consumers, the assumption that all entrepreneurs regularly fall prey to certain errors tacitly implies that all practical men lack intelligence. It implies that nobody who is engaged in business and nobody who considers engaging in business if some opportunity is offered to him by the shortcomings of those already engaged in it, is shrewd enough to understand the real state of the market.  But on the other hand the theorists, who are not themselves active in the conduct of affairs and merely philosophize about other people’s actions, consider themselves smart enough to discover the fallacies leading astray those doing business.  These omniscient professors are never deluded by the errors which cloud the judgment of everyone else. They know precisely what is wrong with private enterprise.  Their claims to be invested with dictatorial powers to control business are therefore fully justified.

The most amazing thing about these doctrines is that they furthermore imply that businessmen, in their littleness of mind, obstinately cling to their erroneous procedures in spite of the fact that the scholars have long since unmasked their faults. Although every textbook explodes them, the businessmen cannot help repeating them.  There is manifestly no means to prevent the recurrence of economic depression other than to entrust—in accordance with Plato’s utopian ideas—supreme power to the philosophers.

Let us examine briefly the two most popular varieties of these disproportionality doctrines.

There is first the durable goods doctrine.  These goods retain their serviceableness for some time.  As long as their life period lasts, the buyer who has acquired a piece abstains from replacing it by the purchase of a new one.  Thus, once all people have made their purchases, the demand for new products dwindles.  Business becomes bad.  A revival is possible only when, after the lapse of some time, the old houses, cars, refrigerators, and the like are worn out, and their owners must buy new ones.

However, businessmen are as a rule more provident than this doctrine assumes.  They are intent upon adjusting the size of their production to the anticipated size of consumers’ demand.  The bakers take account of the fact that every day a housewife needs a new loaf of bread, and the manufacturers of coffins take into account the fact that the total annual sale of coffins cannot exceed the number of people deceased during this period. The machine industry reckons with the average “life” of its products no less than do the tailors, the shoemakers, the manufacturers of motorcars, radio sets, and refrigerators, and the construction firms. There are, to be sure, always promoters who in a mood of deceptive optimism are prone to overexpand their enterprises.  In the pursuit of such projects they snatch away factors of production from other plants of the same industry and from other branches of industry.  Thus their overexpansion results in a relative restriction of output in other fields.  One branch goes on expanding while others shrink until the unprofitability of the former and the profitability of the latter rearranges conditions.  Both the preceding boom and the following slump concern only a part of business.

The second variety of these disproportionality doctrines is known as the acceleration principle.  A temporary rise in the demand for a certain commodity results in increased production of the commodity concerned.  If demand later drops again, the investments made for this expansion of production appear as malinvestments.  This becomes especially pernicious in the field of durable producers’ goods.  If the demand for the consumers’ good a increases by 10 per cent, business increases the equipment p required for its production by 10 per cent.  The resulting rise in the demand for p is the more momentous in proportion to the previous demand for p, the longer the duration of serviceableness of a piece of p is and the smaller consequently the previous demand for the replacement of worn-out pieces of p was.  If the life of a piece of p is 10 years, the annual demand for p for replacement was 10 per cent of the stock of p previously employed by the industry.  The rise of 10 per cent in the demand for a doubles therefore the demand for p and results in a 100 per cent expansion in the equipment r needed for the production of p.  If then the demand for a stops increasing, 50 per cent of the production capacity of r remains idle.  If the annual increase in the demand for a drops from 10 per cent to 5 per cent, 25 per cent of the production capacity of r cannot be used.

The fundamental error of this doctrine is that it considers entrepreneurial activities as a blindly automatic response to the momentary state of demand.  Whenever demand increases and renders a branch of business more profitable, production facilities are supposed instantly to expand in proportion.  This view is untenable.  Entrepreneurs often err.  They pay heavily for their errors.  But whoever acted in the way the acceleration principle describes would not be an entrepreneur, but a soulless automaton.  Yet the real entrepreneur is a speculator, a man eager to utilize his opinion about the future structure of the market for business operations promising profits.  This specific anticipative understanding of the conditions of the uncertain future defies any rules and systematization.  It can be neither taught nor learned.  If it were different, everybody could embark upon entrepreneurship with the same prospect of success.  What distinguishes the successful entrepreneur and promoter from other people is precisely the fact that he does not let himself be guided by what was and is, but arranges his affairs on the ground of his opinion about the future.  He sees the past and the present as other people do; but he judges the future in a different way.  In his actions he is directed by an opinion about the future which deviates from those held by the crowd.  The impulse of his actions is that he appraises the factors of production and the future prices of the commodities which can be produced out of them in a different way from other people.  If the present structure of prices renders very profitable the business of those who are today selling the articles concerned, their production will expand only to the extent that entrepreneurs believe that the favorable market constellation will last long enough to make new investments pay.  If entrepreneurs do not expect this, even very high profits of the enterprises already operation will not bring about an expansion.  It is exactly this reluctance of the capitalists and entrepreneurs to invest in lines which they consider unprofitable that is violently criticized by people who do not comprehend the operation of the market economy. Technocratically minded engineers complain that the supremacy of the profit motive prevents consumers from being amply supplied with all those goods with which technological knowledge could provide them.  Demagogues cry out against the greed of capitalists intent upon preserving scarcity.

A satisfactory explanation of business fluctuations must not be built upon the fact that individual firms or groups of firms misjudge the future state of the market and therefore make bad investments.  The objective of the trade cycle is the general upswing of business activities, the propensity to expand production in all branches of industry, and the following general depression.  These phenomena cannot be brought about by the fact that increased profits in some branches of business result in their expansion and a corresponding overproportional investment in the industries manufacturing the equipment needed for such an expansion.

It is a very well known fact that the more the boom progresses, the harder it becomes to buy machines and other equipment.  The plants producing these things are overloaded with orders.  Their customers must wait a long time until the machines ordered are delivered.  This clearly shows that the producers’ goods industries are not so quick in the expansion of their own production facilities as the acceleration principle assumes.

But even if, for the sake of argument, we were ready to admit that capitalists and entrepreneurs behave in the way the disproportionality doctrines describe, it remains inexplicable how they could go on in the absence of credit expansion.  The striving after such additional investments raises the prices of the complementary factors of production and the rate of interest on the loan market.  These effects would curb the expansionist tendencies very soon if there were no credit expansion.

The supporters of the disproportionality doctrines refer to certain occurrences in the field of farming as a confirmation of their assertion concerning the inherent lack of provision on the part of private business.  However, it is impermissible to demonstrate characteristic features of free competitive enterprise as operation in the market economy by pointing to conditions in the sphere of medium-size and small farming.  In many countries this sphere is institutionally removed from the supremacy of the market and the consumers.  Government interference is eager to protect the farmer against the vicissitudes of the market.  These farmers do not operate in a free market; they are privileged and pampered by various devices.  The orbit of their production activities is a reservation, as it were, in which technological backwardness, narrow-minded obstinacy, and entrepreneurial inefficiency are artificially preserved at the expense of the nonagricultural strata of the people.  If they blunder in their conduct of affairs, the government forces the consumers, the taxpayers, and the mortgagees to foot the bill.

It is true that there is such a thing as the corn-hog cycle and analogous happenings in the production of other farm products.  But the recurrence of such cycles is due to the fact that the penalties which the market applies against inefficient and clumsy entrepreneurs do not affect a great part of the farmers.  These farmers are not answerable for their actions because they are the pet children of governments and politicians.  If it were not so, they would long since have gone bankrupt and their former farms would be operated by more intelligent people.