Capitalism

ELEMENTS OF PRICE THEORY: DEMAND, SUPPLY, AND COST OF PRODUCTION The Circularity of Contemporary Economics’ Concept of Demand 169 CHAPTER 6.. THE DEPENDENCE OF THE DIVISION OF LABOR ON C

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CAPITALISM

A Treatise on Economics

George Reisman

Prepublication, Interim Edition

Jameson Books, Ottawa, Illinois

All rights reserved No part of this book may be reproduced in any mannerwithout written permission, except in the case of brief quotations embodied inreviews.

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Manufactured in the United States of America

04 03 02 01 00 99 / 7 6 5 4 3

To Ludwig von Mises, my teacher, and Edith Packer, my wife.

CONTENTS IN BRIEF

PART ONE

THE FOUNDATIONS OF ECONOMICS

PART TWO

THE DIVISION OF LABOR AND CAPITALISM

CHAPTER 5 THE DEPENDENCE OF THE DIVISION OF LABOR ON CAPITALISM I 135

CHAPTER 6 THE DEPENDENCE OF THE DIVISION OF LABOR ON CAPITALISM II:

CHAPTER 7 THE DEPENDENCE OF THE DIVISION OF LABOR ON CAPITALISM III:

CHAPTER 8 THE DEPENDENCE OF THE DIVISION OF LABOR ON CAPITALISM IV:

CHAPTER 9 THE INFLUENCE OF THE DIVISION OF LABOR ON THE INSTITUTIONS

CHAPTER 11 THE DIVISION OF LABOR AND THE CONCEPT OF PRODUCTIVE ACTIVITY 441

PART THREE

THE PROCESS OF ECONOMIC PROGRESS

CHAPTER 15 AGGREGATE PRODUCTION, AGGREGATE SPENDING, AND THE

CHAPTER 16 THE NET-CONSUMPTION/NET-INVESTMENT THEORY OF PROFIT AND INTEREST 719CHAPTER 17 APPLICATIONS OF THE INVARIABLE-MONEY/NET-CONSUMPTION ANALYSIS 809

EPILOGUE

CHAPTER 20 TOWARD THE ESTABLISHMENT OF LAISSEZ-FAIRE CAPITALISM 969

THE FOUNDATIONS OF ECONOMICS

CHAPTER 1 ECONOMICS AND CAPITALISM

PART A THE NATURE AND IMPORTANCE OF ECONOMICS

1 Economics, the Division of Labor, and the Survival of Material Civilization 15

PART B CAPITALISM

1 The Philosophical Foundations of Capitalism and Economic Activity 19

The Indivisibility of Economic and Political Freedom 23

The Growth of Corruption as the Result of the Decline of Freedom 26

4 Capitalism and the Economic History of the United States 28

The Prevailing Prescientific Worldview in the Realm of Economics 32

CHAPTER 2 WEALTH AND ITS ROLE IN HUMAN LIFE

Human Reason and the Scope and Perfectibility of Need Satisfactions 43

The Objectivity of Economic Progress: A Critique of the Doctrines of Cultural Relativism

The Objective Value of a Division-of-Labor, Capitalist Society 48

4 The Law of Diminishing Marginal Utility and the Limitless Need for Wealth 49

6 “Scarcity” and the Transformation of Its Nature Under Capitalism 54

CHAPTER 3 NATURAL RESOURCES AND THE ENVIRONMENT

PART A NATURAL RESOURCES

The Law of Diminishing Returns and the Limitless Potential of Natural Resources 69

PART B THE ECOLOGICAL ASSAULT ON ECONOMIC PROGRESS

2 The Claims of the Environmental Movement and Its Pathology of Fear and Hatred 76

The Environmental Movement’s Dread of Industrial Civilization 78The Toxicity of Environmentalism and the Alleged Intrinsic Value of Nature 80The Alleged Pollution of Water and Air and Destruction of Species 83The Alleged Threat from Toxic Chemicals, Including Acid Rain and Ozone Depletion 85

Why Economic Activity Necessarily Tends to Improve the Environment 90

Environmentalism and the Externalities Doctrine 96

4 The Economic and Philosophic Significance of Environmentalism 98

PART TWO

THE DIVISION OF LABOR AND CAPITALISM

CHAPTER 4 THE DIVISION OF LABOR AND PRODUCTION

CHAPTER 5 THE DEPENDENCE OF THE DIVISION OF LABOR ON CAPITALISM I

PART A THE NATURE OF THE DEPENDENCIES

1 Dependence of the Division of Labor on Private Ownership of the Means of Production 135

2 The Dependence of the Division of Labor on Saving and Capital Accumulation 139

3 The Dependence of the Division of Labor on Exchange and Money 141

4 The Dependence of the Division of Labor on Economic Competition 144

5 The Dependence of the Division of Labor on the Freedom of Economic Inequality 145Egalitarianism and the Abolition of Cost: The Example of Socialized Medicine 148Government Intervention, Democracy, and the Destruction of the Individual’s Causal Role 150

PART B ELEMENTS OF PRICE THEORY: DEMAND, SUPPLY, AND COST OF PRODUCTION

The Circularity of Contemporary Economics’ Concept of Demand 169

CHAPTER 6 THE DEPENDENCE OF THE DIVISION OF LABOR ON CAPITALISM II:

THE PRICE SYSTEM AND ECONOMIC COORDINATION

PART A UNIFORMITY PRINCIPLES

1 The Uniformity-of-Profit Principle and Its Applications 172Keeping the Various Branches of Industry in Proper Balance 173The Power of the Consumers to Determine the Relative Size of the Various Industries 174

The Effect of Business Tax Exemptions and Their Elimination 183

2 The Tendency Toward a Uniform Price for the Same Good Throughout the World 187Why the Arab Oil Embargo Would Not Have Been a Threat to a Free Economy 188Tariffs, Transportation Costs, and the Case for Unilateral Free Trade 190

3 The Tendency Toward Uniform Prices Over Time: The Function of Commodity Speculation 191Rebuttal of the Charge That the Oil Shortages of the 1970s Were “Manufactured” by

4 The Tendency Toward Uniform Wage Rates for Workers of the Same Degree of Ability 194

PART B ALLOCATION PRINCIPLES

1 The General Pricing of Goods and Services in Limited Supply 201

2 The Pricing and Distribution of Consumers’ Goods in Limited Supply 202

3 The Pricing and Distribution of Factors of Production in Limited Supply 206

4 The Free Market’s Efficiency in Responding to Economic Change 209

5 The Economic Harmonies of Cost Calculations in a Free Market 212

CHAPTER 7 THE DEPENDENCE OF THE DIVISION OF LABOR ON CAPITALISM III:

PRICE CONTROLS AND ECONOMIC CHAOS

PART A PRICE CONTROLS AND SHORTAGES

Rebuttal of the Accusation That Producers Withhold Supplies to “Get Their Price” 224Price Controls and the “Storage” of Natural Resources in the Ground 225

d The Supply of Particular Types of Labor and Particular Products of a Factor of Production 226

The Destruction of the Utilities and the Other Regulated Industries 227

4 Ignorance and Evasions Concerning Shortages and Price Controls 228

How the U.S Government, Not the Oil Companies, Caused the Oil Shortage 234

Rebuttal of the Charge That Private Firms “Control” Prices 238PART B FURTHER EFFECTS OF PRICE CONTROLS AND SHORTAGES

1 Consumer Impotence and Hatred Between Buyers and Sellers 239How Repeal of Rent Controls Would Restore Harmony Between Landlords and Tenants 240

4 Chaos in the Geographical Distribution of Goods Among Local Markets 244

5 Chaos in the Distribution of Factors of Production Among Their Various Uses 245

The Absurdity of the Claim That Price Controls “Save Money” 248

How Repeal of Our Price Controls on Oil Reduced the Price Received by the Arabs 254PART C UNIVERSAL PRICE CONTROLS AND THEIR CONSEQUENCES

2 Universal Price Controls and Universal Shortages 257

The Prosperity Delusion of Price Controls: The World War II “Boom” 262

CHAPTER 8 THE DEPENDENCE OF THE DIVISION OF LABOR ON CAPITALISM IV:

SOCIALISM, ECONOMIC CHAOS, AND TOTALITARIAN DICTATORSHIP

PART A THE CHAOS OF SOCIALISM

2 The Essential Economic Identity Between Socialism and Universal Price Controls 267

3 The Myth of Socialist Planning—The Anarchy of Socialist Production 269

4 Further Economic Flaws of Socialism: Monopoly, Stagnation, Exploitation,

5 Socialism’s Last Gasp: The Attempt to Establish a Socialist Price System and

PART B THE TYRANNY OF SOCIALISM

5 Socialism as a System of Aristocratic Privilege and a Court Society 288

7 From Socialism to Capitalism: How to Privatize Communist Countries 290

CHAPTER 9 THE INFLUENCE OF THE DIVISION OF LABOR ON THE INSTITUTIONS

OF CAPITALISM

PART A PRIVATE OWNERSHIP OF THE MEANS OF PRODUCTION

1 The General Benefit from Private Ownership of the Means of Production 296

The Direct Relationship Between the General Benefit from Capital and Respect for the

2 The Capitalists’ Special Benefit from Private Ownership of the Means of Production 300

The “Successful” Nationalizations of Oil Deposits: A Rebuttal 305

3 The General Benefit from the Institution of Inheritance 306

PART B ECONOMIC INEQUALITY

2 Critique of the Marxian Doctrine on Economic Inequality 330Economic Inequality and the Law of Diminishing Marginal Utility 332

Education and the Freedom of Opportunity 342

PART C ECONOMIC COMPETITION

The Enemies of Competition as the True Advocates of the Law of the Jungle 348

Comparative Advantage Versus the Infant-Industries Argument 354How the Less Able Can Outcompete the More Able in a Free Labor Market 355

Freedom of Competition and the General Gain from the Existence of Others 357

Free Trade and the Economic Superiority of the United States Over Western Europe 361

8 The Harmony of Interests in the Face of Competition for Limited Money Revenues 367

CHAPTER 10 MONOPOLY VERSUS FREEDOM OF COMPETITION

High Capital Requirements as an Indicator of Low Prices and the Intensity of Competition 376

Licensing Law Monopoly 378

The Monopolistic Protection of the Inefficient Many Against the Competition of the

Monopoly Based on Minimum-Wage and Prounion Legislation: The Exclusion of the

Government-Owned and Government-Subsidized Enterprises as Monopoly 385

3 Further Implications of the Political Concept of Monopoly: High Costs Rather Than High Profits 387Patents and Copyrights, Trademarks and Brandnames, Not Monopolies 388All Monopoly Based on Government Intervention; Significance of Monopoly 389

5 The Alleged Tendency Toward the Formation of a Single Giant Firm Controlling the

Incompatibility With the Division of Labor—Socialism as the Only Instance of Unlimited

Inherent Limits to the Concentration of Capital Under Capitalism 393Government Intervention as Limiting the Formation of New Firms 394The Incentives for Uneconomic Mergers Provided by the Tax System 395

“Predatory Pricing” in Reverse: The Myth of Japanese “Dumping” 403The Chain-Store Variant of the Predatory-Pricing Doctrine 403

The Predatory-Pricing Doctrine and the Inversion of Economic History 406

The Myth of Standard Oil and the South Improvement Company 407

8 Marginal Revenue and the Alleged “Monopolistic Restriction” of Supply 408Competitors’ and Potential Competitors’ Costs—Ultimately, Legal Freedom of Entry—as

Ricardo and Böhm-Bawerk on Cost of Production Versus the Elasticity of Demand 414

10 “Monopoly” and the Platonic Competition of Contemporary Economics 425

CHAPTER 11 THE DIVISION OF LABOR AND THE CONCEPT OF PRODUCTIVE ACTIVITY

PART A THE ROLE OF MONEYMAKING IN PRODUCTIVE ACTIVITY

Classification of Capital Goods and Consumers’ Goods Not Based on Physical Characteristics 445

Capital Goods and Consumers’ Goods Internally Produced; Other Revenues 447

Capital and Wealth 448

PART B THE PRODUCTIVE ROLE OF BUSINESSMEN AND CAPITALISTS

1 The Productive Functions of Businessmen and Capitalists 462

2 The Productive Role of Financial Markets and Financial Institutions 464

PART C BUSINESSMEN AND CAPITALISTS: CLASSICAL ECONOMICS VERSUS

THE MARXIAN EXPLOITATION THEORY

1 The Association Between Classical Economics and the Marxian Exploitation Theory 473

2 Correcting the Errors of Adam Smith: A Classical-Based Critique of the Conceptual

Smith’s Failure to See the Productive Role of Businessmen and Capitalists and of the

A Rebuttal to Smith and Marx Based on Classical Economics: Profits, Not Wages, as

Further Rebuttal: Profits Attributable to the Labor of Businessmen and Capitalists Despite

A Radical Reinterpretation of “Labor’s Right to the Whole Produce” 482

Implications for the Incomes of “Passive” Capitalists 483Acceptance of the Conceptual Framework of the Exploitation Theory by Its Critics 484

Harmonization of the Labor Theory of Value With Supply and Demand and the Productive

Classical Economics’ Limitations on the Labor Theory of Value 487The Actual Significance of Quantity of Labor in Classical Economics 491

Adam Smith’s Mistaken Belief in the Arbitrary Power of Employers Over Wage Rates 493

Classical Economics’ Mistaken Denial of the Ability to Tax Wage Earners 497

6 Marxian Distortions of Classical Economics; The Final Demolition of the Exploitation Theory 497

PART THREE

THE PROCESS OF ECONOMIC PROGRESS

CHAPTER 12 MONEY AND SPENDING

The Quantity Theory of Money as the Explanation of Rising Prices 505

2 The Origin and Evolution of Money and the Contemporary Monetary System 506The Potential Spontaneous Remonetization of the Precious Metals 510

Changes in the Quantity of Money as the Cause of Changes in the Demand for Money 519

4 The Demand for Money: A Critique of the “Balance of Payments” Doctrine 526

The Balance of Payments Doctrine Under an International Precious Metal Standard 531

The Contribution of the Concept of Invariable Money to Economic Theory 538

CHAPTER 13 PRODUCTIONISM, SAY’S LAW, AND UNEMPLOYMENT

PART A PRODUCTIONISM 542Productionism Versus the Anti-Economics of Consumptionism 543

9 Advertising as Allegedly Fraudulent but Economically Beneficial 555

PART B SAY’S (JAMES MILL’S) LAW

2 The Referents of Say’s Law and Its Confirmation by Cases Apparently Contradicting It 561

5 Falling Prices Caused by Increased Production Are Not Deflation 573

The Anticipation of Falling Prices 574Economic Progress and the Prospective Advantage of Future Investments Over

PART C UNEMPLOYMENT

World War II as the Cause of Impoverishment in the United States 592

“Excess” Inventories, Malinvestment, and the Deficiency of Inventories 597Inflation and Credit Expansion as the Cause of Malinvestment in Inventories 598Why “Excess” Inventories and Monetary Contraction Are Associated 598

CHAPTER 14 THE PRODUCTIVITY THEORY OF WAGES

PART A THE MARXIAN EXPLOITATION THEORY

PART B THE PRODUCTIVITY THEORY OF WAGES

1 The Irrelevance of Worker Need and Employer Greed in the Determination of Wages 613

2 Determination of Real Wages by the Productivity of Labor 618

3 The Foundations of the Productivity of Labor and Real Wages: Capital Accumulation

Technological Progress as a Source of Capital Accumulation 629The Reciprocal Relationship Between Capital Accumulation and Technological Progress 631The Economic Degree of Capitalism, the Wage “Share,” and Real Wages 632Other Factors, Above All Economic Freedom and Respect for Property Rights, as Sources

The Undermining of Capital Accumulation and Real Wages by Government Intervention 636The Nonsacrificial Character of Capital Accumulation Under Capitalism 639Appendix to Section 3: An Analytical Refinement Concerning the Rate of Economic Progress 641

4 The Productivity Theory of Wages and the Interpretation of Modern Economic History 642The Cause of Low Wages and Poor Working Conditions in the Past 642

5 A Rise in the Productivity of Labor as the Only Possible Cause of a Sustained, Significant

The Futility of Raising Money Wage Rates by Means of an Increase in the Quantity of Money

The Futility of a Rise in the Demand for Labor Coming at the Expense of the Demand

The Futility of Raising the Demand for Labor by Means of Taxation 648The Limited Scope for Raising Real Wages Through a Rise in the Demand for Labor 650

7 The Employment of Women and Minorities 663

8 The Productivity Theory of Wages and the Wages-Fund Doctrine 664

9 The Productivity Theory of Wages Versus the Marginal-Productivity Theory of Wages 666The Productivity Theory of Wages and the Effect of Diminishing Returns 667

CHAPTER 15 AGGREGATE PRODUCTION, AGGREGATE SPENDING, AND THE ROLE

OF SAVING IN SPENDING

1 Gross National Product and the Issue of “Double Counting”: A Is A Versus A Is A+ 674

2 The Role of Saving and Productive Expenditure in Aggregate Demand 682

The Demand for Consumers’ Goods and the Demand for Factors of Production as

Application to the Critique of the Keynesian Multiplier Doctrine 690

The “Macroeconomic” Dependence of the Consumers on Business 696Saving as the Source of Increasing Aggregate Demand, Both Real and Monetary 698

The Consumption Illusion of Contemporary National-Income Accounting 700

4 Importance of Recognizing the Separate Demand for Capital Goods for the Theory of

The Inverse Relationship Between National Income and Economic Progress in an Economy

Overthrow of the Keynesian Doctrines of the Balanced-Budget Multiplier and the

CHAPTER 16 THE NET-CONSUMPTION/NET-INVESTMENT THEORY OF PROFIT AND INTEREST

PART A THE POSITIVE THEORY

The Rate of Profit Not Based on Demand and Supply of Capital, but on the Difference

Between the Demand for Products and the Demand for Factors of Production 721Determinants of the Average Rate of Profit in the Economic System Different from Deter-

minants of the Rate of Profit of the Individual Company or Industry 721Critique of the Doctrine That the Interest Rate on Government Bonds Expresses the Pure

The Path of Explanation: Net Consumption and Net Investment 723The Problem of Aggregate Profit: Productive Expenditure and the Generation of Equivalent

2 Net Consumption and the Generation of an Excess of Sales Revenues Over Productive Expenditure 725Net Consumption: Its Other Sources, Wider Meaning, and Relationship to the Saving of

Why Businessmen and Capitalists Cannot Arbitrarily Increase the Rate of Net

The Net-Consumption Rate and the Gravitation of Relative Wealth and Income 737

4 Net Investment as a Determinant of Aggregate Profit and the Average Rate of Profit 744

The Prolongation of Net Investment Under an Invariable Money 754Net Investment as the Result of the Marginal Productivity of Capital Exceeding the Rate of Profit 756

Capital Intensification and the Tendency Toward the Disappearance of Net Investment

5 The Addition to the Rate of Profit Caused by Increases in the Quantity of Money 762

The Impact of Increases in the Quantity of Money on the Net-Investment and

Increases in the Quantity of Money and the Perpetuation of Net Investment 768The Increase in the Quantity of Commodity Money as an Addition to Aggregate Profit 771Summary Statement of the Determinants of the Rate of Profit 773

6 Increases in the Real Rate of Profit Dependent on Increases in the Production and Supply of Goods 774

Capital Intensiveness and the Monetary Component in the Rate of Profit 784

PART B THE NET-CONSUMPTION/NET-INVESTMENT THEORY AND ALTERNATIVE THEORIES

1 Exposition and Critique of the Productivity Theory in Its Traditional Form 787

2 Exposition and Critique of the Time-Preference Theory in Its Traditional Form 792The Contradiction Between Böhm-Bawerk’s “First Cause” and the Doctrine of the

The Disappearance of the Higher Value of Present Goods at the Margin: Böhm-Bawerk’s

Appendix to Section 3: Critique of Ricardo’s Doctrine of the Falling Rate of Profit 799

4 Other Proponents of the Net-Consumption/Net-Investment Theory 801

CHAPTER 17 APPLICATIONS OF THE INVARIABLE-MONEY/NET-CONSUMPTION ANALYSIS

2 Why Capital Accumulation and the Falling Prices Caused by Increased Production Do Not

Confirmation of Fact That Falling Prices Caused by Increased Production Do Not Constitute

More on the Relationship Between Technological Progress and the Rate of Profit 818

The Rate of Profit and the Demand for Money 820

3 Why Capital Accumulation Does Not Depend on a Continuous Lengthening of

The Average Period of Production and the Limits to Technological Progress as a Source

4 Implications for the Doctrine of Price Premiums in the Rate of Interest 825

7 How Government Budget Deficits Raise the Rate of Profit 829

The Government’s Responsibility for the Emphasis of Today’s Businessmen on

8 Profits, the Balance of Trade, and the Need for Laissez Faire in the United States 831

Why the Actual Significance of Saving Lies at the Gross Level 835

10 More on Saving and “Hoarding”: “Hoarding” as a Long-Run Cause of a Rise in the

11 Critique of the Investment-Opportunity and Underconsumption/Oversaving Doctrines 838

How the Demand for Capital Goods and Labor Can Radically and Permanently Exceed

Consumption as the Purpose of Production and the Progressive Production of Consumers’

A Rise in the Demand for Capital Goods and Fall in the Demand for Consumers’ Goods:

12 More on Why Savings Cannot Outrun the Uses for Savings 856

The Housing Outlet and Consumer Interest 857The Automatic Adjustment of the Rate of Saving to the Need for Capital 858

CHAPTER 18 KEYNESIANISM: A CRITIQUE 863

2 The Unemployment Equilibrium Doctrine and Its Basis: The IS Curve and Its Elements 867

The Declining-Marginal-Efficiency-of-Capital Doctrine and the Fallacy of Context Dropping 879The Marginal-Efficiency-of-Capital Doctrine and the Claim That the Rate of Profit Is Lower

in the Recovery from a Depression Than in the Depression 881The Unemployment Equilibrium Doctrine and the Claim That Saving and Net Investment Are

at Their Maximum Possible Limits at the Very Time They Are Actually Negative 881The Marginal-Efficiency-of-Capital Doctrine’s Reversal of the Actual Relationship Between

The Contradiction Between the Marginal-Efficiency-of-Capital Doctrine and the

A Fall in Wage Rates as the Requirement for the Restoration of Net Investment and

Keynesianism Versus the Rate of Profit: “The Euthanasia of the Rentier” and

Notes 892CHAPTER 19 GOLD VERSUS INFLATION

PART A INFLATION OF THE MONEY SUPPLY VERSUS ALTERNATIVE THEORIES OF

RISING PRICES

1 The Analytical Framework of the Quantity Theory of Money 895The Vital Demand/Supply Test for All Theories of Rising Prices 897The Elimination of Less Supply as the Cause of an Inflationary Rise in Prices 897

PART B THE DEEPER ROOTS AND FURTHER EFFECTS OF INFLATION

1 The Connection Between Inflation and Government Budget Deficits 922

3 Inflation and Deficits Versus Representative Government and Economic Freedom 927

4 Inflation as the Cause of a Redistribution of Wealth and Income 928

Reversal of Safety 930

Gold Clauses and Prospective Inflation of Paper as the Cause of Deflation in Gold 940

Inflation and the Potential Destruction of the Division of Labor 949PART C GOLD

1 Freedom for Gold as the Guarantee Against the Destruction of Money 951

Falling Prices Under the 100-Percent-Reserve Gold Standard Would Not Be Deflationary 954The 100-Percent-Reserve Gold Standard as the Guarantee Against Deflation 955

The Moral Virtue of the 100-Percent-Reserve Gold Standard 957

3 The 100-Percent-Reserve Gold Standard as the Means of Ending Inflation Without a Depression 959

The 100-Percent-Reserve Gold Standard, Liquidity, and the Dismantling of the Welfare State 962

EPILOGUE

CHAPTER 20 TOWARD THE ESTABLISHMENT OF LAISSEZ-FAIRE CAPITALISM

The Capitalist Society and a Political Program for Achieving It 971

2 Privatization of Property: Importance of Fighting on Basis of Principles 972

The Case for the Immediate Sweeping Abolition of All Violations of the Freedom of

Firing Government Employees and Ending Subsidies to Business 978

8 Separation of State from Education, Science, and Religion 986

A BIBLIOGRAPHY OF WRITINGS IN DEFENSE OF CAPITALISM 993