Comments on Capitalism: A Treatise on Economics by George Reisman. Part 1

Capitalism: A Treatise on Economics is free at this link.
The theory of marginal utility resolved the paradox of value which had been propounded by Adam Smith and which had prevented the classical economists from grounding exchange value in utility. “The things which have the greatest value in use,” Smith observed, “have frequently little or no value in exchange; and on the contrary, those which have the greatest value in exchange have frequently little or no value in use. Nothing is more useful than water: but it will purchase scarce any thing; scarce any thing can be had in exchange for it. A diamond, on the contrary, has scarce any value in use; but a very great quantity of other goods may frequently be had in exchange for it.”

The only explanation, the classical economists concluded, is that while things must have utility in order to possess exchange value, the actual determinant of exchange value is cost of production. In contrast, the theory of marginal utility made it possible to ground exchange value in utility after all—by showing that the exchange value of goods such as water and diamonds is determined by their respective marginal utilities. The marginal utility of a good is the utility of the particular quantity of it under consideration, taking into account the quantity of the good one already possesses or has access to. Thus, if all the water one has available in a day is a single quart, so that one’s very life depends on that water, the value of water will be greater than that of diamonds. A traveler carrying a bag of diamonds, who is lost in the middle of the desert, will be willing to exchange his diamonds for a quart of water to save his life. But if, as is usually the case, a person already has access to a thousand or ten thousand gallons of water a day, and it is a question of an additional quart more or less—that is, of a marginal quart—then both the utility and the exchange value of a quart of water will be virtually nothing. Diamonds can be more valuable than water, consistent with utility, whenever, in effect, it is a question of the utility of the first diamond versus that of the ten-thousandth quart of water.
I'm not satisfied with the way this passage explains the issue (I don't think I have a disagreement with Reisman about economics here, though). It doesn't mention supply, demand and competition, which I think are crucial. It leaves a reader to wonder: why not charge the value of people's first quart of water? Sure you wouldn't sell the marginal 10,000th quart at that price (they'd find the price higher than the utility), but you could potentially make more profit, with less water inventory, at a higher price. The reason is because other water sellers would compete with you and that keeps prices down, not because of marginal utility. This answer's Smith's question about how something so valuable can be cheap.

Water isn't just cheap because of mariginal utility (the utility of the 10,000th quart is much lower than of the first quart, lowering demand after prior quarts of water are supplied), it's also because a large supply is cheaply available from nature. If the question is about starting a new business to acquire and sell additional water, than the marginal utility of water is the relevant issue. But if the question is about the cheap pricing of current water, I think prices would be raised (despite that meaning fewer quarts sell) if not for competition. (BTW I'm ignoring issues like government regulations and the real-life water situation, and just treating it as a free market commodity.)

If I'm mistaken about any of this, then I'd still say the passage's explanation is unsatisfactory, because in that case it apparently didn't adequately clarify matters for me.
Very soon thereafter, the whole Circle Bastiat, myself included, met again with Ayn Rand. We were all tremendously enthusiastic over Atlas. Rothbard wrote Ayn Rand a letter, in which, I believe, he compared her to the sun, which one cannot approach too closely. I truly thought that Atlas Shrugged would convert the country—in about six weeks; I could not understand how anyone could read it without being either convinced by what it had to say or else hospitalized by a mental breakdown.

The following winter, Rothbard, Raico, and I, and, I think, Bob Hessen, all enrolled in the very first lecture course ever delivered on Objectivism. This was before Objectivism even had the name “Objectivism” and was still described simply as “the philosophy of Ayn Rand.” Nevertheless, by the summer of that same year, 1958, tensions had begun to develop between Rothbard and Ayn Rand, which led to a shattering of relationships, including my friendship with him.
That Rothbard letter can be found here. I think it may be Rothbard's most interesting writing.

I agree with Reisman that Atlas Shrugged should have persuaded the whole country in about six weeks. That it didn't is one of the largest and most important unsolved philosophical problems. (Note I'm thinking of this problem broadly. Why didn't Popper's work persuade more people? Mises? Szasz? Deutsch? I consider those the same issue. Atlas Shrugged is the best, but there's a lot of good work which should have persuaded a lot of people but has only had limited success.)
13. Cf. Murray N. Rothbard, For a New Liberty (New York: Macmillan, 1973). In that book, Rothbard wrote: “Empirically, the most warlike, most interventionist, most imperial government throughout the twentieth century has been the United States” (p. 287; italics in original). In sharpest contrast to the United States, which has supposedly been more warlike even than Nazi Germany, Rothbard described the Soviets in the following terms: “Before World War II, so devoted was Stalin to peace that he failed to make adequate provision against the Nazi attack. . . . Not only was there no Russian expansion whatever apart from the exigencies of defeating Germany, but the Soviet Union time and again leaned over backward to avoid any cold or hot war with the West” (p. 294).
I already had a very low opinion of Rothbard. He has a lot of really awful views, such as anti-semitism and children-as-property. I didn't know this specific thing. (Some of his writing about economics is actually pretty decent.)
It is the division of labor which introduces a degree of complexity into economic life that makes necessary the existence of a special science of economics. For the division of labor entails economic phenomena existing on a scale in space and time that makes it impossible to comprehend them by means of personal observation and experience alone. Economic life under a system of division of labor can be comprehended only by means of an organized body of knowledge that proceeds by deductive reasoning from elementary principles. This, of course, is the work of the science of economics. [emphasis mine]
I disagree with this epistemology, which thinks you have some foundations and deduce the rest. For info on my epistemology, see my David Deutsch and Karl Popper reading recommendations, and my own writing on my websites.

Elliot Temple | Permalink | Messages (0)

Refutation of Tabarrok’s Criticism of Reisman

This is a critical response to Alexander Tabarrok regarding his debate with George Reisman regarding the merits of Reisman’s book Capitalism: A Treatise on Economics. As context: it’s an internal debate between Austrian economists from 1997-8, and Reisman is an Objectivist as well.

The debate began with Review of Capitalism: A Complete and Integrated Understanding of the Nature and Value of Human Economic Life. It’s a critical, negative review by Tabarrok (who denies it’s negative because he praised some ideas, but he also claimed e.g. that one of Reisman’s main themes throughout the book is “fundamentally misguided”).

Reisman replied in Reisman on Capitalism. I regard this article as refuting Tabarrok's review. Reisman's concluding paragraph summarizes:

In this response, I have dealt with five instances of misrepresentation in the review: its claim that I ignore the essential theme of support for businessmen and capitalists, its misrepresentation of my use of classical economics' concept of demand and supply, its distortion of my definition of economics, its misrepresentation of my views on time preference as a determinant of the rate of profit and interest, and finally, its denial of my contributions to aggregate economic accounting and "macroeconomics." These five instances are merely a good sample. [...]

Tabarrok replied briefly in Response to Reisman on Capitalism. That concludes the original debate.

I’ll now respond by pointing out major errors in Tabarrok’s response, thereby vindicating Reisman’s response and his Capitalism. Here’s Tabarrok’s first paragraph:

Reisman's Capitalism is longer than either Mises's Human Action or Rothbard's Man, Economy, and State. It thus seems unreasonable to object to my review because it ignores major portions of his work. Reisman's other objections are similarly weak.

Reisman didn’t make that objection. Rather than criticizing Tabarrok for ignoring (omitting) some topics in the original review, Reisman criticized Tabarrok for misrepresentation. Tabarrok didn’t just fail to discuss some parts of the book; he made incorrect claims about the contents of the book.

Tabarrok repeats one of his misrepresentations in his next sentence:

Capitalism has surprisingly little to say on entrepreneurship or other typically Austrian and Objectivist themes.

Tabarrok made that claim in his first review, too. The problems are that it’s incorrect and that Reisman already refuted it in his response. Nevertheless, Tabarrok repeats the point without engaging with Reisman’s arguments.

Tabarrok’s original argument was that “there is no index entry for entrepreneurship”, plus he didn’t find those themes when reading Capitalism. It’s true that Reisman didn’t say much about the word “entrepreneurship”, but that’s because he used synonyms. He used the words “businessmen” and “businessman” a combined 678 times, and he talked extensively about capitalists. Reisman had already informed Tabarrok of this, but somehow Tabarrok didn’t reconsider.

To show Reisman really did cover this theme, I’ll list some of the section titles found in the table of contents of Capitalism. I think they're adequate to make the point, but if you have doubts about which side of this debate is correct, read some of these sections and see for yourself.

  • The Benefit from Geniuses

  • The General Benefit from Reducing Taxes on the “Rich”

  • The Pyramid-of-Ability Principle

  • Productive Activity and Moneymaking

  • The Productive Role Of Businessmen And Capitalists

    • 1. The Productive Functions of Businessmen and Capitalists
      • Creation of Division of Labor
      • Coordination of the Division of Labor
      • Improvements in the Efficiency of the Division of Labor
    • 2. The Productive Role of Financial Markets and Financial Institutions
      • The Specific Productive Role of the Stock Market
    • 3. The Productive Role of Retailing and Wholesaling
    • 4. The Productive Role of Advertising
  • Smith’s Failure to See the Productive Role of Businessmen and Capitalists and of the Private Ownership of Land

  • A Rebuttal to Smith and Marx Based on Classical Economics: Profits, Not Wages, as the Original and Primary Form of Income

  • Further Rebuttal: Profits Attributable to the Labor of Businessmen and Capitalists Despite Their Variation With the Size of the Capital Invested

  • The “Macroeconomic” Dependence of the Consumers on Business

My conclusions are that Tabarrok is mistaken, that Reisman’s Capitalism is a great book, and that no major criticisms of Capitalism exist.

Reisman may be mistaken, as every author may be, but no one has discovered Reisman’s errors and written down explanations of them. Along with the writings of his teacher, Ludwig von Mises, Reisman’s Capitalism constitutes some of the best existing economics knowledge.

See also my Review of Kirzner Reviewing Reisman and Criticism of Bagus Criticizing Reisman on Deflation.

Elliot Temple | Permalink | Messages (3)

Criticism of Bagus Criticizing Reisman on Deflation

Deflation: When Austrians Become Interventionists by Philipp Bagus criticizes George Reisman and five other Austrian economists regarding their views on deflation. This post will respond to the criticism of Reisman. My goal here is just to point out a few errors, not to discuss Bagus' overall view of deflation. All italics in quotes are my emphasis.

Yet, Reisman’s plan of monetary reform is not the direct abolition of government interventions into the monetary system, which would bring about deflation, but it is a new intervention, guaranteeing the results of past interventions. He proposes a new government intervention into the economic system, i.e., according to his own standards, a violation of freedom, in order to bail out the unsound banking system.

In Capitalism: A Treatise on Economics, Reisman explained why the results of past interventions and injustices should be guaranteed and left alone, in general, after a time limit passes. Property rights must be made secure, as quickly as possible, so that people are in a position to work to improve their property and to plan for the future.

If claims about past injustices can result in new redistributions of property, then my property isn’t secure. Whatever I think I own, I can’t count on it.

Reisman explains this regarding land reform and it applies to all types of property:

The Demand for Land Reform

The doctrine that present titles are invalid because of past acts of violence in the appropriation of property, is often associated with demands for “land reform.” Land reform is a demand that property be forcibly transferred from its present owners to a new group of owners. The connection to the violent-appropriation doctrine exists whenever this new group is alleged to be descended from earlier possessors whose rights the ancestors of the present owners allegedly violated.

It should be realized that no amount of past violence in the appropriation of land can justify land reform. Land reform is simply a new, fresh act of violent transfer of land. It is one thing for the actual victim of a dispossession, or his children or grandchildren, to demand to be put back in the possession of the property that was forcibly taken from him. But if for any reason these individuals are denied justice, it becomes a fresh injustice to later on dispossess an owner on the grounds that his ancestors, or the ancestors of some previous seller, lacked just title. In order for justice to be done, there must be a time limit on the recognition of claims for the redress of past injustices.

If this were not the case, no one could be secure in his property. At any time, parties could step forward claiming dispossession of their ancestors by the current owner’s ancestors or by the ancestors of some previous seller of the property. And claims of any one group of alleged victims could in turn be superseded by the claims of still another group of alleged victims able to trace the dispossession of its ancestors further back. In a country like England, for example, the same piece of ground might be contended for by those able to trace the dispossession of their ancestors to the War of the Roses, or, alternatively, to the Norman Conquest, or to the still earlier invasions of the Danes, Saxons, Romans, and even Picts and Celts.

It would certainly be a gross injustice to ask anyone to work and save to improve his property, and then take it from him on the basis of such claims. For justice to be done, conditions must be such that people can work and save to improve their property. And for such conditions to exist, property rights must be put beyond challenge as quickly and as completely as possible. This means, as a minimum, a strict time limit on the recognition of claims based on past injustices.

Once private property rights are made secure, not only are the effects of past injustices washed away, but, as should already be clear, the land of a country is quickly put to its most efficient uses.

The issue also comes up in the section From Socialism to Capitalism: How to Privatize Communist Countries:

Provided that the essential requirements of security of property, the separation of employment and ownership, and the unrestricted freedoms to buy and sell, hire and fire, and compete, are observed, what remains is to accomplish the transition to private ownership as quickly as possible. Reasonable but strict time limits must be set for the location of former owners or their heirs, and it must be firmly established that thereafter no new claims will be heard on their account. This is an essential part of establishing the security of property. All of the assets in the hands of the state must likewise be disposed of within a strict time limit, so that no one in the market need labor under any uncertainty about what properties will be available and when and thus what plans he can and cannot make. This is essential to making the economic system as efficient as possible as soon as possible.

Let’s move on to a second point by Bagus:

At one point, [Reisman] stresses the practical difficulties of mass bankruptcies during a deflation:

[M]ass bankruptcies, which, given the inability of today's judicial system to keep pace even with its current case load, would probably take a decade or more to get sorted out. That would mean that in the interval the economy would be largely paralyzed, because no one would know just who owned what. (1996, p. 961)

The ability of the present-day judicial system to handle cases of mass bankruptcy is not, of course, a theoretical argument against deflation. For Reisman's argument deals with the practical difficulties a severe deflation might have to face in today's judicial system. Yet there is no theoretical reason why there could not be a judicial system that could settle the lawsuits quickly. But let us deal with this practical argument.

The quote starts mid paragraph, leaving out a sentence by Reisman which reads:

Solving the problem of “an excessive debt burden” by means of inflation in any form is a reprehensible practice.

Bagus agrees with Reisman that that's reprehensible. Omitting that part of Reisman's view was misleading. Bagus presents Reisman as defending inflation using a weak argument (a mere practical point rather than a theoretical argument). But Reisman wasn't trying to defend inflation, he was just bringing up an important practical consideration about not destroying civilization.

Bagus continues:

It must be stressed that an increased demand for judicial services on the free market brings about an increased supply of those services. Yet, Reisman could contend that we face a government monopoly of judicial services. However, politicians would likely come up with emergency measures if deflation caused bankruptcies which overstrained the judicial system.[35] For politicians are eager to search and find problems they can fix. Also the judicial system itself could come up with solutions for this problem.

The basic theme of Bagus’ article is that six Austrian economics aren’t, in his opinion, radical enough, not even Rothbard. Bagus wants full 100% capitalism and freedom no matter what. I read him as such an anti-government libertarian that I think he’s an anarchist. With that context in mind:

Why is Bagus expressing his confidence in the government to come up with some emergency measures to fix a problem? Why does he think this is something politicians can fix effectively? I don’t get it. Here Bagus is objecting from a perspective of trusting government competence much more than Reisman does, contrary to the general themes of Bagus’ other comments.

Bagus provides no arguments about why government would be able to succeed at improving the judicial system. We've seen historically that the importance or urgency of an issue, such as war, education or healthcare, does not automatically make governments wise or competent.

Of course some entrepreneurs can have difficulties in the sense, that other entrepreneurs who anticipated the price drop and held their money back, can bid resources away from them. Entrepreneurs who anticipate price changes can always profit relative to the entrepreneurs who did not anticipate them.

Is the job of the entrepreneur to anticipate market conditions, anticipate government policies that affect market conditions, or both? Bagus seems to find it acceptable that businessmen lose money, including going bankrupt, for not anticipating new government policies that cause deflation.

I think a businessman's job should be focused on his industry, not on understanding politicians, lobbying for policies (being a cause of government policy makes it easier to anticipate), getting friends in high places to give him tips about the balance of power, etc. I want businessmen to be separate from government. See Atlas Shrugged for further discussion of political pull – it was men like James Taggart, not Hank Rearden, who were better able to anticipate new government policies.

Elliot Temple | Permalink | Messages (3)