Empirical Studies showing that Prices are Correlated with Labour Costs do not Prove the Classical Marxist Labour Theory of Value!

I can’t count the number of times some absurd apologists for Marxism cite some paper in my comments section showing prices are correlated with labour costs – as if this proves the classical Marxist labour theory of value.

It does no such thing. The Marxist labour theory of value says much more than this.

In volume 1 of Capital, the “law of value” expounded there was later described by Marx in these terms:

“The assumption that the commodities of the various spheres of production are sold at their value implies, of course, only that their value is the center of gravity around which prices fluctuate, and around which their rise and fall tends to an equilibrium.” (Marx 1909: 208–210).

This is something very much more than the simple claim that prices are correlated with labour costs.

In fact, Eugen von Böhm-Bawerk gave the right response to the latter view made by Marxists over a century ago:

“In various parts of the third volume Marx claims for the law of value that it ‘governs the movement of prices,’ and he considers that this is proved by the fact that where the working time necessary for the production of the commodities decreases, there also prices fall; and that where it increases prices also rise, other circumstances remaining equal.

This conclusion also rests on an error of logic so obvious that one wonders Marx did not perceive it himself. That in the case of ‘other circumstances remaining equal’ prices rise and fall according to the amount of labor expended proves clearly neither more nor less than that labor is one factor in determining prices. It proves, therefore, a fact upon which all the world is agreed, an opinion not peculiar to Marx, but one acknowledged and taught by the classical and ‘vulgar economists.’ But by his law of value Marx had asserted much more.” (Böhm-Bawerk 1949: 39).

The mere citation of empirical studies that show a correlation between hours worked/wage-bill data of workers and prices of commodities does not vindicate Marx.

Prices are correlated with labour costs because labour costs are often a very important component of prices. No sensible person denies this.

But so are energy costs for many industries. And so are non-labour factor input costs. You’d find a correlation there too, especially in capital/energy-intensive industries. Furthermore, if workers demand wage rises without their hours changing we would also find a correlation with prices.

BIBLIOGRAPHY
Böhm-Bawerk, Eugen von. 1949. “Karl Marx and the Close of His System,” in Paul. M. Sweezy (ed.), Karl Marx and the Close of His System and Böhm-Bawerk’s Criticism of Marx. August M. Kelley, New York. 3–120.

Marx, Karl. 1909. Capital. A Critique of Political Economy (vol. 3; trans. Ernst Untermann from 1st German edn.). Charles H. Kerr & Co., Chicago.

Engels’ View of the Theory of Value in Volume 1 of Capital in the 1890s

This can be seen in an article Engels wrote in May 1895 for the Neue Zeit (Marx 1991: 1027, n.), which is available as the “Supplement and Addendum” to Volume 3 of Capital in Marx (1991: 1027–1047).

Right at the beginning of this supplement, Engels notes that people such as Achille Loria had pointed to the devastating contradiction between volume 1 and volume 3 of Capital in the theory of value (Marx 1991: 1027–1028).

Next, Engels mentions that Werner Sombart, in a review of Marx’s work (Sombart 1894), declared that the labour theory of value as presented in volume 1 of Capital could not be empirically supported and was a mere “logical” concept (Marx 1991: 1032) (that is, in modern terms, a non-empirical and “analytic” concept true by definition and proposed as an identity or definition).

So, too, Conrad Schmidt in an 1895 review of volume 3 (Schmidt 1895) had also declared that the labour theory of value was a “necessary fiction” (Marx 1991: 1032). Engels describes Schmidt’s criticisms:

“Schmidt, too, has his formal reservations about the law of value. He calls it a scientific hypothesis put forward to explain the actual exchange process, which proves the necessary theoretical point of departure, illuminating and indispensable even for the phenomena of prices under competition, which appear completely to contradict it. Without the law of value, in his opinion too, any theoretical insight into the economic mechanism of capitalist reality is impossible. In a personal letter which he has allowed me to mention, Schmidt declares that the law of value in the capitalist form of production is a fiction, though a theoretically necessary one.” (Marx 1991: 1032).

Now it is clear that Engels’ “law of value” here is referring to the idea that commodities tend to exchange at their pure labour values.

Engels was well aware that hostile critics of Marx had declared that volume 3 of Capital utterly contradicted and overthrew the theory of value in volume 1. In fact, it seems that Conrad Schmidt was actually one of the first to point out the contradiction between commodities tending to exchange at their labour values and an average rate of profit in his 1889 work Die Durchschnittsprofitrate auf Grundlage des Marxschen Wertgesetzes [The Average Rate of Profit on the basis of Marx’s Law of Value] (Stuttgart, 1889) (see Böhm-Bawerk 1949: 28, with n. 2).

Engels desperately sought a solution and found a passage in volume 3 of Capital where Marx himself was trying to salvage the theory of value in volume 1, which had been overthrown by that in volume 3.

That passage of Marx comes in Chapter 10 of volume 3 and is as follows:

“The exchange of commodities at their values, or approximately at their values, requires, therefore, a much lower stage than their exchange at their prices of production, which requires a relatively high development of capitalist production.

Whatever may be the way in which the prices of the various commodities are first fixed or mutually regulated, the law of value always dominates their movements. If the labor time required for the production of these commodities is reduced, prices fall; if it is increased, prices rise, other circumstances remaining the same.

Aside from the fact that prices and their movements are dominated by the law of value, it is quite appropriate, under these circumstances, to regard the value of commodities not only theoretically, but also historically, as existing prior to the prices of production. This applies to conditions, in which the laborer owns his means of production, and this is the condition of the land-owning farmer and of the craftsman in the old world as well as the new. This agrees also with the view formerly expressed by me that the development of product into commodities arises through the exchange between different communes, not through that between the members of the same commune. It applies not only to this primitive condition, but also to subsequent conditions based on slavery or serfdom, and to the guild organisation of handicrafts, so long as the means of production installed in one line of production cannot be transferred to another line except under difficulties, so that the various lines of production maintain, to a certain degree, the same mutual relations as foreign countries or communistic groups.

In order that the prices at which commodities are exchanged with one another may correspond approximately to their values, no other conditions are required but the following: 1) The exchange of the various commodities must no longer be accidental or occasional, 2) So far as the direct exchange of commodities is concerned, these commodities must be produced on both sides in sufficient quantities to meet mutual requirements, a thing easily learned by experience in trading, and therefore a natural outgrowth of continued trading, 3) So far as selling is concerned, there must be no accidental or artificial monopoly which may enable either of the contracting sides to sell commodities above their value or compel others to sell below value. An accidental monopoly is one which a buyer or seller acquires by an accidental proportion of supply to demand.

The assumption that the commodities of the various spheres of production are sold at their value implies, of course, only that their value is the center of gravity around which prices fluctuate, and around which their rise and fall tends to an equilibrium.” (Marx 1909: 208–210).

So here Marx was saying that the theory of value in volume 1 – that commodities tend to exchange at their pure labour values which are anchors for the price system – was a historically contingent phenomenon existing in the “lower stage … of capitalist production” and before the emergence of a higher stage of capitalism where Ricardo’s prices of production are the anchors for the price system.

It is particularly interesting to note how Marx specifically described the theory of value in volume 1 as follows:

“The assumption that the commodities of the various spheres of production are sold at their value implies, of course, only that their value is the center of gravity around which prices fluctuate, and around which their rise and fall tends to an equilibrium.” (Marx 1909: 208–210).

This and Marx’s whole discussion around the passage clearly damn and refute all those pathetic Marxist hacks who want to tell us that the law of value in volume 1 – namely, that commodities tend to exchange at their pure labour values which are anchors for the price system – is only a “simplifying assumption” or some highly abstract system never intended to apply to the real world.

Clearly Marx did even in volume 3 of Capital apply it to the capitalist system in an empirical sense, but to those historical periods at a “lower stage … of capitalist production” confined to the older medieval and pre-modern eras. Crucially, this is exactly how Engels interpreted the passage, as we can see below in a quotation from Engels’ supplement to volume 3.

Engels cites the passage I have quoted above from volume 3 of Capital and says this:

“If Marx had been able to go through the third volume again, he would undoubtedly have elaborated this passage significantly. As it stands, it gives only an outline sketch of what needs to be said on the point in question. Let us therefore go into the matter somewhat more closely.

We all know that at the beginnings of society products are used by the producers themselves, these producers living in indigenous communities that are organized more or less on a communist basis; that the exchange of their surplus products with foreigners, which introduces the transformation of products into commodities, is of later date. It takes place first of all simply between individual communities of different tribes and only later does it come to prevail within the community, where it makes a decisive contribution to the dissolution of this community into larger or smaller family groups. Even after this dissolution, however, the family heads who exchange with one another remain working peasant farmers, who produce almost all their requirements on their own holdings, with the aid of their families, and obtain only a small portion of the items they need from outside, in exchange for their own surplus product. Not only does the family pursue agriculture and stock-raising, it also works up the products of these activities into finished articles of use, still doing its own milling in places with their hand mill, baking bread, spinning, dyeing, weaving flax and wool, curing leather, erecting and repairing wooden buildings, producing tools and equipment, and often doing its own carpentry and metalwork too; so that the family or family group is basically self-sufficient.

Now the little that such a family has to obtain from others by exchange, or buy, consisted right up to the early nineteenth century, in Germany, predominantly of objects of handicraft production, i.e. things whose mode of production was in no way strange to the peasant and which he himself failed to produce only because either the raw material was unavailable or the purchased article was much better or very much cheaper. For the peasant of the Middle Ages, therefore, the labour-time needed to reproduce the objects he obtained in exchange was quite accurately known. The village smith and cartwright were at work under his very eyes; similarly the tailor and shoemaker, who in my own youth still travelled round to our Rhineland peasants in turn, working up materials provided into clothes and shoes. Both the peasant and the people from whom he bought were workers themselves, and the articles exchanged were their own products. What had they applied in the production of these articles? Labour, and labour alone: to replace tools, to produce raw material and work it up, all they spent was their own labour-power; how else then could they exchange these products of theirs with those of other working producers than in proportion to the labour applied to them? The labour-time applied to these products, then, was more than just the most suitable measure for the quantitative determination of the magnitudes to be exchanged; no other measure was possible. Or are we to believe that peasant and village artisan were so stupid that one of them would part with the product of ten hours’ labour for that of a single hour? For the entire period of natural peasant economy, no other exchange is possible except that in which the amounts of commodities exchanged tend more and more to be measured according to the amounts of labour embodied in them. From the moment money penetrates into this economic mode, the tendency of adaptation to the law of value (Marx’s formulation, nota bene!) becomes more explicit, though it is already infringed by the interventions of usurer’s capital and fiscal extortion, so that the periods over which prices approximate on average to values, down to a negligible difference in magnitude, already become more drawn out.

The same applies to exchange between the products of peasants and those of urban artisans. At the beginning, this takes place directly, without the mediation of the merchant, on the town market-days when the peasant sells and makes his purchases. Here, too, the artisan’s conditions of labour are known to the peasant, and the peasant’s to the artisan. He is himself still one part peasant, and not only has his kitchen-garden and orchard but also very often a bit of a field, one or two cows, pigs, fowl, etc. People in the Middle Ages were thus in a position to reckon up each other’s production costs in raw and ancillary materials, and in labour-time, with a fair degree of accuracy – at least as far as articles of general daily use were concerned.

But how could the amount of labour be reckoned, even indirectly and relatively, when this served as the measure of exchange for products that required more prolonged labour, interrupted and at irregular intervals, and uncertain in its results, products like corn or cattle, for instance? And, moreover, with people who were unable to count? Evidently, only by a lengthy process of zig-zag approximation, often groping back and forth in the dark, in which, as in other things, wisdom was attained only by painful accident. But the need for each person to have a rough idea of his own costs helped time and again in the correct direction, and the small number of types of article coming into exchange, as well as the stable mode of their production, often over centuries, made the goal more easily attainable. That it in no way took so long until the relative values of these products were established with a fair degree of accuracy is shown by the simple fact that the commodity in which this seems most difficult on account of the long production time of the individual item, i.e. cattle, was the first fairly generally recognized money commodity. In order to arrive at the value of cattle, its exchange ratio with a whole series of other commodities must already have won established recognition to a relatively unusual degree, it must be unchallenged over an area of several tribes. And the people of that time were certainly clever enough – the cattle-breeders as well as their customers – not to part with the labour-time they had spent without an equivalent in exchange. On the contrary, the closer people stand to the original state of commodity production – e.g. Russians and Orientals – the more time they still spend today in extracting full compensation for the labour-time spent on a product by long and stubborn haggling.

Proceeding from this determination of value by labour-time, commodity production as a whole, and with it the manifold relationships in which the different aspects of the law of value make themselves felt, now develops as presented in Part One of Capital Volume 1; therefore, in particular, the conditions become established under which labour is value-forming. These conditions, moreover, prevail although those involved do not become aware of them, so that they can be abstracted from everyday practice only by tedious theoretical analysis; they operate in the form of a natural law, which as Marx showed followed necessarily from the nature of commodity production. The most important and incisive progress was the transition to metal money, but this had the consequence that the determination of value by labour-time was no longer visibly apparent on the surface of commodity exchange. Money became the decisive measure of value for practical purposes, and all the more so, the more diverse were the commodities coming into trade, the more they originated from distant countries, and the less therefore the labour-time needed for their production could be checked. Even the money itself came mostly from abroad at first; and when it was obtained in a particular country as precious metal, the peasant and artisan were in no position to assess even approximately the labour applied to it, while their own awareness of the value-measuring property of labour was also pretty well obscured by the custom of reckoning in money; money came to represent absolute value in the popular conception.

To sum up, Marx’s law of value applies universally, as much as any economic laws do apply, for the entire period of simple commodity production, i.e. up to the time at which this undergoes a modification by the onset of the capitalist form of production. Up till then, prices gravitate to the values determined by Marx’s law and oscillate around these values, so that the more completely simple commodity production develops, the more do average prices coincide with values for longer periods when not interrupted by external violent disturbances, and with the insignificant variations we mentioned earlier. Thus the Marxian law of value has a universal economic validity for an era lasting from the beginning of the exchange that transforms products into commodities down to the fifteenth century of our epoch. But commodity exchange dates from a time before any written history, going back to at least 3500 B.C. in Egypt, and 4000 B.C. or maybe even 6000 B.C. in Babylon; thus the law of value prevailed for a period of some five to seven millennia. We may now admire the profundity of Mr Loria in calling the value that was generally and directly prevalent throughout this time a value at which commodities never were sold nor could be sold, and which no economist will ever bother himself with if he has a glimmer of healthy common sense!” (Marx 1991: 1034–1038).

The passage in yellow highlighting is crucial: this is how Engels understood the theory of value in volume 1 of Capital at the end of his life.

This view is that commodities did historically tend to exchange at pure labour values in less developed forms of capitalism up until about the 15th century. That is, it actually happened in the pre-modern “period of simple commodity production” (Marx 1991: 1037).

Then what happened was that the “transition to metal money” obscured exchange at pure labour values:

“The most important and incisive progress was the transition to metal money, but this had the consequence that the determination of value by labour-time was no longer visibly apparent on the surface of commodity exchange. Money became the decisive measure of value for practical purposes, and all the more so, the more diverse were the commodities coming into trade, the more they originated from distant countries, and the less therefore the labour-time needed for their production could be checked. Even the money itself came mostly from abroad at first; and when it was obtained in a particular country as precious metal, the peasant and artisan were in no position to assess even approximately the labour applied to it, while their own awareness of the value-measuring property of labour was also pretty well obscured by the custom of reckoning in money; money came to represent absolute value in the popular conception.” (Marx 1991: 1037).

After this point, the advanced form of modern capitalist production developed and prices of production replaced labour values as the anchors for the price system.

This view of Engels is splendidly confirmed in a letter he wrote to Werner Sombart (1863–1941) on March 11, 1895 about the labour theory of value (on which, see here), which was a response to a hostile review of volume 3 of Capital by Sombart (1894).

The crucial passage from this letter of Engels is below:

“When commodity exchange began, when products gradually turned into commodities, they were exchanged approximately according to their value. It was the amount of labour expended on two objects which provided the only standard for their quantitative comparison. Thus value had a direct and real existence at that time. We know that this direct realisation of value in exchange ceased and that now it no longer happens. And I believe that it won’t be particularly difficult for you to trace the intermediate links, at least in general outline, that lead from directly real value to the value of the capitalist mode of production, which is so thoroughly hidden that our economists can calmly deny its existence. A genuinely historical exposition of these processes, which does indeed require thorough research but in return promises amply rewarding results, would be a very valuable supplement to Capital.”
Letter, Engels to W. Sombart, from London, March 11, 1895
https://www.marxists.org/archive/marx/works/1895/letters/95_03_11.htm

Unfortunately, Engels’ attempt to save the law of value in volume 1 – which was undoubtedly a development of Marx’s own desperate attempt to save it as we have seen above – is still a feeble and unconvincing theory.

Why? The reason is that Marx, in volume 1, never makes any such qualifications or limitations to the law of value. In fact, in volume 1, Marx states that money prices depend on the labour value embodied in units of gold or silver, so that long-run prices are determined by abstract socially-necessary labour time needed to produce relevant units of the money commodity (Marx 1906: 108, 111). But Marx says nothing about the rise of commodity money overthrowing his law of value in modern capitalist production.

At the same time, Marx thinks that the second mechanism driving prices is the fluctuation of labour values of commodities as against money (Marx 1906: 111). This is succinctly summed up in what Marx calls the “laws of the exchange of commodities” in Chapter 5 of volume 1:

“It is true, commodities may be sold at prices deviating from their values, but these deviations are to be considered as infractions of the laws of the exchange of commodities, which, in its normal state is an exchange of equivalents, consequently, no method for increasing value.” (Marx 1906: 176–177).

So either (1) Marx meant to apply this to modern capitalism in its contemporary form or (2) he was so incompetent and useless he never told his readers how the theory had to be strictly limited to pre-modern times. Either way Marx is damned.

Moreover – and as the death blow to the Marxist cult – there is no convincing empirical evidence for Marx’s and Engels’ attempt to salvage the law of value in volume 1 by restricting it to the past.

As a matter of fact, and as I have noted before, Piero Sraffa examined this question in the late 1920s by studying the anthropological and historical literature of his day, such as F. R. Eldridge’s Oriental Trade Methods (1923), Karl Bücher’s Industrial Evolution, Raymond Firth’s Primitive Economics of the New Zealand Maori (1929), and E. E. Hoyt’s Primitive Trade. Its Psychology and Economics (1926) and other works (Kurz and Salvadori 2010: 200–202). Sraffa found no evidence that time and labour played the fundamental role in determining exchange value in non-Western and less economically-developed societies (Kurz and Salvadori 2010: 200–201).

Bücher (1907: 19), for example, noted that in the absence of modern time-keeping methods, tribal societies seem to face severe difficulties even properly measuring time. How, then, can they have relied on labour time as the fundamental determinant of exchange value in the distant past?

Admittedly, I have not done a detailed survey of the most recent anthropological and historical literature on this question, but a quick look suggests that modern anthropology seems to confirm what Sraffa found, and that subjective utility, reciprocal satisfaction, ceremonial exchange, and fairness play the fundamental role in ancient, medieval and non-Western exchange of commodities, not labour time (e.g., Sahlins 1972; Firth 1965: 342; Gregory 2002). Indeed, the practice of “silent trade” where the parties do not even meet directly (Dale 2010: 91) appears to make a nonsense of the idea that pre-modern people engaged in commodity production determined exchange values in real commodity exchange by labour time.

If the modern literature upholds what Sraffa found, then not even Marx and Engels’ weak attempt to salvage the labour theory of value in volume 1 can be taken seriously.

Finally, we can see how the Temporal Single System Interpretation (TSSI) Marxists are engaged in an intellectually dishonest and contemptible perversion of Marx’s thought. One wonders whether these people have the slightest concern with what Marx actually wrote and thought rather than their own fantasy world readings of Marx.

BIBLIOGRAPHY
Bücher, Karl. 1907. Industrial Evolution (trans. S Morley Wickett from 3rd German edn.). Henry Holt and Company, New York.

Dale, Gareth. 2010. Karl Polanyi: The Limits of the Market. Polity, Cambridge.

Engels, F. 1895. Letter, Engels to Conrad Schmidt, March 12, 1895
https://www.marxists.org/archive/marx/works/1895/letters/95_03_12.htm

Engels, F. 1895. Supplement to Capital, Volume III
https://www.marxists.org/archive/marx/works/1894-c3/supp.htm

Firth, Raymond. 1929. Primitive Economics of the New Zealand Maori. G. Routledge & Sons, London.

Firth, Raymond. 1965. Primitive Polynesian Economy (2nd edn.). Routledge & K. Paul, London.

Gregory, C. A. 2002. “Exchange and Reciprocity,” in Tim Ingold (ed.), Companion Encyclopedia of Anthropology. Routledge, London and New York. 911–930.

Kurz, Heinz D. and Neri Salvadori. 2010. “Sraffa and the Labour Theory of Value: A Few Observations,” in John Vint et al. (eds.), Economic Theory and Economic Thought: Essays in Honour of Ian Steedman. Routledge, London and New York. 189–215.

Marx, Karl. 1909. Capital. A Critique of Political Economy (vol. 3; trans. Ernst Untermann from 1st German edn.). Charles H. Kerr & Co., Chicago.

Marx, Karl. 1991. Capital. A Critique of Political Economy. Volume Three (trans. David Fernbach). Penguin Books, London.

Sahlins, Marshall David. 1972. Stone Age Economics. Aldine-Atherton, Chicago.

Schmidt, Conrad. 1889. Die Durchschnittsprofitrate auf Grundlage des Marxschen Wertgesetzes [The Average Rate of Profit on the basis of Marx’s Law of Value]. Stuttgart.

Schmidt, Conrad. 1895. “Der dritte Band des Kapital,” Sozialpolitisches Zentralblatt 22 (25th February): 254–258.

Sombart, Werner. 1894. “Zur Kritik des ökonomischen Systems von Karl Marx” [Toward a Critique of the Economic System of Karl Marx], Archiv für soziale Gesetzgebung und Statistik 7: 555–594.

Marx on the Labour Theory of Value in Volume 1 of Capital

I refer to Chapter 1, Section 1 of volume one of Capital (Marx 1982).

Here Marx gives his definition of a commodity:

“The commodity is first of all, an external object, a thing which through its qualities satisfies human needs of whatever kind. The nature of these needs, whether they arise, for example, from the stomach, or the imagination, makes no difference. Nor does it matter here how the thing satisfies man’s need, whether directly as a means of subsistence, i.e. an object of consumption, or indirectly as a means of production” (Marx 1982: 125).

This is already somewhat problematic: does it include and encompass what neoclassicals call subjective value too? If so, Marx’s economics badly neglects the reality of subjective value, and how it is just as much a source of price determination as labour expended in the production of the good.

When Marx speaks of the “use value” of commodities, he seems to have in mind the physical usefulness of goods, and does not include subjective pleasure or, for example, delusional “use value” in his definition:

“The usefulness of a thing makes it a use-value. But this usefulness does not dangle in mid-air. It is conditioned by the physical properties of the commodity, and has no existence apart from the latter. It is therefore the physical body of the commodity itself, for instance iron, corn, a diamond, which is the use-value or useful thing. This property of a commodity is independent of the amount of labour required to appropriate its useful qualities. When examining use-values, we always assume we are dealing with definite quantities, such as dozens of watches, yards of linen, or tons of iron. The use-values of commodities provide the material for a special branch of knowledge, namely the commercial knowledge of commodities. Use-values are only realized [verwirklicht] in use or in consumption.” (Marx 1982: 126).

But the usefulness of a commodity need not be limited to the “physical properties of the commodity.” People can buy things like magic charms or magic potions (and certainly people in the past did this in large numbers) or psychic readings. Some small numbers of people today probably think these things can give some kind of magic effect, but clearly there is no rational reason to think any such thing. The value or usefulness of such goods doesn’t lie in the “physical properties of the commodity.” People just mistakenly think the goods do certain things. But let us put all these points aside.

Marx further defines “exchange-value” as something that “appears first of all as the quantitative relation, the proportion, in which use-values of one kind exchange for use-values of another kind” (Marx 1982: 126). Marx admits readily that exchange values constantly change and are not fixed (Marx 1982: 126). But the exchange value is a “form of appearance” (Marx 1982: 127) concealing something deeper.

Marx sees exchange values in barter trades as being equivalent values (Marx 1982: 127). But this does not necessarily follow at all. In fact, when one person exchanges one good for another, it seems likely that in many cases he values the good he receives more highly than the good he gives up in the trade, and vice versa. Marx never considers this.

Marx assumes that, since goods must be equivalent in value during barter exchanges, therefore they must be reducible to some common value:

“… the exchange values of commodities must be reduced to a common element, of which they represent a greater or a lesser quantity.” (Marx 1982: 127).

We can quote his argument at length:

“This common element cannot be a geometrical, physical, chemical or other natural property of commodities. Such properties come into consideration only to the extent that they make the commodities useful, i.e. turn them into use-values. But clearly, the exchange relation of commodities is characterized precisely by its abstraction from their use-values. Within the exchange relation one use-value is worth just as much as another, provided only that it is present in the appropriate quantity. Or, as old Barbon say: ‘One sort of wares are as good as another, if the value be equal. There is no difference or distinction in things of equal value … One hundred pounds worth of lead or iron, is of as great a value as one hundred pounds worth of silver and gold.’

As use-values, commodities differ above all in quality, while as exchange-values they can only differ in quantity, and therefore do not contain an atom of use-value.

If then we disregard the use-value of commodities, only one property remains, that of being products of labour. But even the product of labour has already been transformed in our hands. If we make abstraction from its use-value, we abstract also from the material constituents and forms which make it a use-value. It is no longer a table, a house, a piece of yarn or any other useful thing. All its sensuous characteristics are extinguished. Nor is it any longer the product of the labour of the joiner, the mason or the spinner, or of any other particular kind of productive labour. With the disappearance of the useful character of the products of labour, the useful character of the kinds of labour embodied in them also disappears; this in turn entails the disappearance of the different concrete forms of labour. They can no longer be distinguished, but are all together reduced to the same kind of labour, human labour in the abstract.”

Let us now look at the residue of the products of labour. There is nothing left of them in each case but the same phantom-like objectivity; they are merely congealed quantities of homogeneous human labour, i.e. of human labour-power expended without regard to the form of its expenditure. All these things now tell us is that human labour-power has been expended to produce them, human labour is accumulated in them. As crystals of this social substance, which is common to them all, they are values – commodity values [Warenwerte].” (Marx 1982: 127–128).

As a defence of the labour theory of value, this argument is a non sequitur. It simply does not necessarily follow. There is no necessary reason to think there must be an underlying universal, single objective value to all commodities. In fact, we need not even assume that in all trades the people value the goods exchanged equally at all, as we have seen.

Even worse, it is also very clear how Marx must ignore the reality of different types of labour, whether of different professions but more generally of differences in skilled, professional, or unskilled labour, even though Marx himself understands that there are “heterogeneous forms of useful labour, which differ in order; genus, species and variety” (Marx 1982: 132).

Nevertheless, Marx is forced to reduce all labour to a homogeneous abstract unit.

Marx is adamant that labour time is the quantitative measure of labour value:

“A use-value, or useful article, therefore, has value only because abstract human labour is objectified [vergegenständlicht] or materialized in it. How, then, is the magnitude of this value to be measured? By means of the quantity of the ‘value-forming substance’, the labour, contained in the article. This quantity is measured by its duration, and the labour-time is itself measured on the particular scale of hours, days etc.” (Marx 1982: 129).

But immediately Marx hits up against the problem of why heterogeneous human labour can be meaningfully reduced to mere labour time as an objective measure of economic value. Why is this homogenous unit a truly accurate measure of labour value when everyone knows that workers work at different professions, speeds, levels of competence, and have different skills and expertise?

Quite frankly, Marx’s answer does not solve this devastating problem, but mostly just evades it:

“It might seem that if the value of a commodity is determined by the quantity of labour expended to produce it, it would be the more valuable the more unskilful and lazy the worker who produced it, because he would need more time to complete the article. However, the labour that forms the substance of value is equal human labour, the expenditure of identical human labour-power. The total labour power of society, which is manifested in the values of the world of commodities, counts here as one homogeneous mass of human labour-power, although composed of innumerable individual units of labour-power. Each of these units is the same as any other, to the extent that it has the character of a socially average unit of labour-power and acts as such; i.e. only needs, in order to produce a commodity, the labour time which is necessary on an average, or in other words is socially necessary. Socially necessary labour-time is the labour-time required to produce any use-value under the conditions of production normal for a given society and with the average degree of skill and intensity of labour prevalent in that society. ….

What exclusively determines the magnitude of the value of any article is therefore the amount of labour socially necessary, or the labour-time socially necessary for its production. The individual commodity counts here only as an average sample of its kind. Commodities which contain equal quantities of labour, or which can be produced in the same time, have therefore the same value. The value of a commodity is related to the value of any other commodity as the labour-time necessary for the production of the one is related to the labour-time necessary for the production of the other. ‘As exchange-values, all commodities are merely definite quantities of congealed labour-time.’” (Marx 1982: 129–130).

Marx evades the severe problem of heterogeneous human labour by simply reducing all labour time to an abstract, homogenous unit: socially-necessary labour time. But this doesn’t solve the problem. It attempts to ignore the issue by means of wishful thinking.

Marx assumes that total labour power of a nation can be aggregated by reducing all labour to a “socially average unit of labour-power.” This won’t do. Labour is too heterogeneous and too radically different in terms of profession, skill, competence, experience, and skills to be aggregated in such a crude manner. Highly skilled labour (e.g., a professional surgeon) produces more subjective value and to most people more objective value than unskilled manual labour (e.g., a person who mops floors). That is why a surgeon is paid more than a janitor. What Marx calls “labour-power” can be very different in different cases, and Marx’s attempts to reduce labour to an abstract unit is as unconvincing as any neoclassical who reduces real capital to a homogeneous putty.

And matters are no better when Marx later argues that the value of a commodity made by “complicated labour” can be reduced to quantities of “simple labour,” which seems to be defined as “simple labour-power, i.e. of the labour-power possessed in … [sc. the] bodily organism by every ordinary man, on the average, without being developed in any special way” (Marx 1982: 135). Here once again heterogeneous labour has to be reduced to a common measure, but what is it? It sounds rather like energy expended by human beings in their labour, but I see no reason why this should be an eternal source of economic value and the price determination of goods.

Neither the abstract “socially-necessary labour time” solution nor the “simple labour” unit reductionism can really solve the problem of heterogeneous human labour. On these grounds alone, the labour theory of value is unsound and unconvincing.

Finally, we have another utterly devastating problem with the labour theory of value:

“A thing can be a use-value without being a value. This is the case whenever its utility to man is not mediated through labour. Air, virgin soil, natural meadows, unplanted forests, etc. fall into this category. A thing can be useful, and a product of human labour, without being a commodity. He who satisfies his own need with the product of his own labour admittedly creates use value, but not commodities. In order to produce the latter, he must not only produce use-values, but use-values for others, social use-values. (And not merely for others. The medieval peasant produced a corn-rent for the feudal lord and a corn-tithe for the priest; but neither the corn-rent nor the corn-tithe became commodities simply by being produced for others. In order to become a commodity, the product must be transferred to the other person, for whom it serves as a use-value, through the medium of exchange.) Finally, nothing can be a value without being an object of utility. If the thing is useless, so is the labour contained in it; the labour does not count as labour, and therefore creates no value.” (Marx 1982: 131).

If labour value is totally worthless and cannot confer exchange value when the object has no utility (“use value”), then the whole labour theory of value is undermined.

For labour is not even a sufficient condition for economic value or exchange value. Clearly utility is also a necessary condition for economic value or exchange value, along with (1) labour time and (2) use value. And once we add subjective value into the mix, the Marxist labour theory of value becomes even more unsound. For now it is not even necessary for a commodity to have use value for it to command exchange value. Plenty of goods have no use value, e.g., pet rocks, but fetch an exchange value.

If Marxists want to argue that the Marx’s definition of “use value” includes “subjective value” as well, matters are no better. We are still left with the same devastating problem: labour time is not the only necessary condition for economic value or exchange value.

So Marx’s “labour theory of value” is obviously a blatantly one-sided and incomplete theory of both value and price.

And, finally, notice how all these issues are so devastating even before we get to yet another damning point, which I have made time and again, but which Marxists can never answer.

Most prices in modern economies are mark-up prices. It is not labour time per se but average unit cost of labour along with the average unit cost of all other non-labour factors at a given quantity of output that is used to calculate most prices. Given differing economies of scale, if you change the given quantity of output, then total average unit costs radically change, regardless of the total number of labour hours. After they calculate total average unit costs, businesses add a profit mark-up to this, nearly always. The profit mark-up can vary and is not related to labour.

Once again, on straightforward empirical grounds, we have no rational reason to accept the Marxist mystical dogma that “socially-necessary labour time” determines exchange value or prices in modern capitalism.

Further Reading
“Marx’s ‘Socially Necessary Labour Time’: A Quick Overview and Critique,” March 26, 2015.

“Progress in Marxism on the Labour Theory of Value?,” March 18, 2015.

“Mysticism and the Labour Theory of Value,” May 7, 2014.

“Lavoie on ‘Should Sraffian Economics be dropped out of the Post-Keynesian School?,’” June 19, 2014.

“Sraffians versus Kaleckians versus Fundamentalist Post Keynesians,” June 17, 2014.

“Did Kalecki Accept the Labour Theory of Value?,” April 18, 2014.

“Automation and Robots in the News,” February 23, 2015.

“Adam Smith on the Labour Theory of Value,” April 20, 2014.

BIBLIOGRAPHY
Marx, Karl. 1982. Capital. Volume One. A Critique of Political Economy (trans. Ben Fowkes). Penguin Books, Harmondsworth, England.

Reality versus Rothbard: Prices, Demand and Production in the Real World

If one reads Rothbard’s Man, Economy, and State with Power and Market: The Scholar’s Edition (2nd edn.; 2009), one finds a long discussion of prices, but so often the discussion is stated in terms of exchange ratios of goods in barter economies. The absurdity of such “barter” analysis is that it is simply irrelevant to a modern monetary economy, certainly one where extensive mark-up pricing exists.

But, more than this, at times when Rothbard was dimly aware of the reality of prices and production, he was still living in a fantasy world:

“The specific feature of the ‘clearing of the market’ performed by the equilibrium price is that, at this price alone, all those buyers and sellers who are willing to make exchanges can do so. At this price five sellers with horses find five buyers for the horses; all who wish to buy and sell at this price can do so. At any other price, there are either frustrated buyers or frustrated sellers. Thus, at a price of 84, eight people would like to buy at this price, but only two horses are available. At this price, there is a great amount of ‘unsatisfied demand’ or excess demand. Conversely, at a price of, say, 95, there are seven sellers eager to supply horses, but only three people willing to demand horses. Thus, at this price, there is ‘unsatisfied supply,’ or excess supply. Other terms for excess demand and excess supply are ‘shortage’ and ‘surplus’ of the good. Aside from the universal fact of the scarcity of all goods, a price that is below the equilibrium price creates an additional shortage of supply for demanders, while a price above equilibrium creates a surplus of goods for sale as compared to demands for purchase. We see that the market process always tends to eliminate such shortages and surpluses and establish a price where demanders can find a supply, and suppliers a demand.

It is important to realize that this process of overbidding of buyers and underbidding of sellers always takes place in the market, even if the surface aspects of the specific case make it appear that only the sellers (or buyers) are setting the price. Thus, a good might be sold in retail shops, with prices simply ‘quoted’ by the individual seller. But the same process of bidding goes on in such a market as in any other. If the sellers set their prices below the equilibrium price, buyers will rush to make their purchases, and the sellers will find that shortages develop, accompanied by queues of buyers eager to purchase goods that are unavailable. Realizing that they could obtain higher prices for their goods, the sellers raise their quoted prices accordingly. On the other hand, if they set their prices above the equilibrium price, surpluses of unsold stocks will appear, and they will have to lower their prices in order to ‘move’ their accumulation of unwanted stocks and to clear the market.

The case where buyers quote prices and therefore appear to set them is similar. If the buyers quote prices below the equilibrium price, they will find that they cannot satisfy all their demands at that price. As a result, they will have to raise their quoted prices. On the other hand, if the buyers set the prices too high, they will find a stampede of sellers with unsalable stocks and will take advantage of the opportunity to lower the price and clear the market. Thus, regardless of the form of the market, the result of the market process is always to tend toward the establishment of the equilibrium price via the mutual bidding of buyers and sellers.” (Rothbard 2009: 117–119).

Rothbard must think that this really is a fundamental and universal (or near universal) state of real world markets, in order for his reasoning to work:

“It is important to realize that this process of overbidding of buyers and underbidding of sellers always takes place in the market, even if the surface aspects of the specific case make it appear that only the sellers (or buyers) are setting the price. Thus, a good might be sold in retail shops, with prices simply ‘quoted’ by the individual seller. But the same process of bidding goes on in such a market as in any other. If the sellers set their prices below the equilibrium price, buyers will rush to make their purchases, and the sellers will find that shortages develop, accompanied by queues of buyers eager to purchase goods that are unavailable. Realizing that they could obtain higher prices for their goods, the sellers raise their quoted prices accordingly. On the other hand, if they set their prices above the equilibrium price, surpluses of unsold stocks will appear, and they will have to lower their prices in order to ‘move’ their accumulation of unwanted stocks and to clear the market.”

This is simply untrue as either a (1) universal or (2) even general description of what happens in the real world.

Now you can certainly find some markets where what Rothbard is saying does actually happen. But the extent of these markets is grossly exaggerated.

Try walking into any number of supermarkets or department stores that sell newly-produced goods, and attempting to haggle with the staff to bring the price of goods down. You might be able to do it in some limited cases (especially in second hand goods stores or where retail businesses try and match their competitors’ prices), but everyone knows it is a grossly unrealistic strategy and likely to be a waste of time in most cases. Most prices are not set in auction-like markets or by a mutual haggling process between buyers and sellers. The price displayed is the price you pay, or you cannot have the good.

Moreover, in the real world, most firms are mark-up pricing firms and as producers they have excess capacity and inventories to deal with demand changes so that they can, generally speaking, leave prices unchanged: if demand rises, many firms can simply ramp up production by increasing capacity utilisation, and draw down inventories, and leave the price unchanged.

The empirical evidence overwhelmingly confirms this. In a recent survey of 654 UK businesses, the firms were asked: what do you do when there is a boom in demand which cannot be met from stocks or inventories? Most UK firms said they simply increase overtime of workers (as reported by 62% of firms), hire more workers (12%), or increase capacity (8%), in order to produce more output, rather than increase the price of their product. Only 12% said they would increase the price of their product (Hall, Walsh and Yates 2000: 442).

Most service industries, too, experience fluctuations in demand on a daily basis that may not be trivial, but they leave prices unchanged. Excess demand in hair salons, dentists, doctors, locksmiths etc. does not normally induce businesses to change prices: instead, people simply wait their turn in line, and pay the same price for any given service. Temporary “shortages” in the economic sense are common in services, but hardly anyone thinks this is some disastrous crisis of production or some terrible economic “problem” that should be solved by flexible prices to clear markets. In fact, if you arrived at your local hair salon and found 10 people waiting in line and the barber announced he was going to auction off the next 5 haircuts for the next hour to the highest bidders, it would be bizarre and utterly atypical behaviour.

Furthermore, in many retail stores, if things get sold out, the store will maintain the price and will simply order more of the good and put up a sign: “Out of stock,” “Sold out,” or “This product is temporarily unavailable” – or words to that effect.

If the typical firm faces a period of slack demand during a recession, the normal action is to cut production, fire workers, and cut costs, while leaving the price unchanged.

During a recession, mark-up prices can stay the same or even increase. The proof of this can be seen in how, in virtually every recession since WWII, in most nations inflation continues during recessions: deflation is rare, and recessions tend to have disinflation (which is still a form of inflation).

BIBLIOGRAPHY
Hall, S., Walsh, M. and A. Yates. 2000. “Are UK Companies’ Prices Sticky?,” Oxford Economic Papers 52.3: 425–446.

Rothbard, M. N. 2009. Man, Economy, and State with Power and Market: The Scholar’s Edition (2nd edn.). Ludwig von Mises Institute, Auburn, Ala.

Where Gardiner Means went Wrong

It was in his interpretation of Keynes’ General Theory, and this is clear in Means’ brief article “Which was the True Keynesian Theory of Employment?” (Challenge 19.3 [1976]: 61–63).

When the General Theory of Employment, Interest and Money (1936) was published, Gardiner C. Means – the originator of the administered price thesis – was unclear about what Keynes’ fundamental arguments against the neoclassical system actually were, and whether the theory depended on inflexible wages and prices.

This is illustrated by a fascinating piece of forgotten history told by Means himself: his visit to John Maynard Keynes in July 1939:

“In the summer of 1939, on my way to a holiday in Norway, I made it a point to visit Keynes with the specific purpose of asking him to what extent his explanation of persistent unemployment rested on an assumption of wage-rate or price inflexibility. His answer was a categorical: ‘Not at all.’ I asked the question in several different ways in order to make sure there was no failure of minds to meet and the answer was always the same. I said, ‘Suppose that prices and wage-rates met the classical assumption of perfect flexibility so that, if there were excessive unemployment, the price-wage level would fall frictionlessly. Then with the nominal money stock remaining constant, wouldn’t the rise in the real value of the money stock create added demand which would tend to absorb unemployed workers?’ But still the answer was no. Once interest rates had fallen to their limit there would be no further corrective. We were in complete agreement that, in practice, neither prices nor wage-rates were as flexible as classical theory assumed, but he insisted that his theory of unemployment did not depend at all on this fact.” (Means 1976: 61–62).

Despite these emphatic statements by Keynes, Lee (2000: 403) notes that Means was dissatisfied with Keynes’ replies (see also Ware 1992 for another account of the meeting).

Later, Means (1976) defended the neoclassical synthesis interpretation of the General Theory contrary to the explicit answers Keynes had given to him in 1939, because Means continued to believe in the efficacy of the real balances effect (Means 1976: 63).

Had Means properly read and understood Chapter 19 of the General Theory, he would not have made this error.

What also emerges from this article is that Means himself sent a draft of his famous Senate document “Industrial Prices and their Relative Flexibility” (1935) to Keynes, and Keynes even asked him to publish a version of this in the Economic Journal (of which Keynes was the editor), though Means was unable to do this (Means 1976: 61).

Keynes, then, must have been aware of the empirical evidence on administered prices by the mid-1930s, and he was explicitly aware of them in his work on buffer stocks in 1938 (Keynes 1938: 452–453).

BIBLIOGRAPHY
Keynes, J. M. 1938. “The Policy of Government Storage of Foodstuffs and Raw Materials,” Economic Journal 48.191: 449–460.

Lee, F. 2000. “Gardiner C. Means (1896–1988),” in Philip Arestis and Malcolm Sawyer (eds.), A Biographical Dictionary of Dissenting Economists (2nd edn.), Edward Elgar, Cheltenham, UK and Northampton, MA. 399–405.

Means, Gardiner C. 1935. “Industrial Prices and their Relative Flexibility,” Senate Document no 13. 74th Congress, 1st Session, 17 January.

Means, Gardiner C. 1976. “Which was the True Keynesian Theory of Employment?,” Challenge 19.3 (July/August): 61–63.

Ware, C. 1992. “Academic Resistance to Administered Prices,” in Frederic S. Lee and Warren J. Samuels (eds.), The Heterodox Economics of Gardiner C. Means: A Collection. M.E. Sharpe, Armonk, N.Y. 337–348.

Imagine if the Price of Haircuts was Determined by Supply and Demand

A simple thought experiment shows how far the real world diverges from marginal pricing theory.

Imagine if barbers or hairdressers really determined the price of their service by supply and demand dynamics and in an auction-like market.

Imagine you went to get a haircut in such a world. You enter the store. If you were the only customer in the store, then you and the barber would engage in a mutual haggling process by which you negotiate a price for the haircut: you would give a lower price and the barber his higher price, and the haggling would continue until a price would emerge on which you could both agree.

Now imagine you went to get a haircut and there was a crowd of people in the store. At this point, the barber would auction off the next haircut or sequence of haircuts, and you would competitively bid against other clients. In the latter case, when the bidding was complete, all who wanted a haircut would have bid successfully for one, and all those who did not like the price offered would have left. The market – at least in a minor sense in the particular store – would have cleared, and supply offered at the relevant time period would equal demand.

It is likely that the price of haircuts would really fluctuate considerably in relation to demand and supply in such a world.

Simple reflection on how you really pay for haircuts reveals that this scenario is irrelevant for how the price of haircuts is normally set in the real world.

In reality, you enter a store and the prices for services are usually given in a list. The price is fixed and most probably based on the store’s total average costs plus a profit mark-up, and probably with reference to competitors’ prices too (and the internet is filled with sites advising small business-people like hairdressers how to calculate such prices just like this one). The price, then, is an inflexible cost-based, mark-up or administered price.

It is unlikely you can just haggle over the price. Instead of attempting to clear markets by price adjustments, barbers leave their prices unchanged and simply serve clients in the order in which they arrive: costumers simply wait their turn, as they read magazines or whatever (e.g., the last time I went for a haircut I read a National Geographic and the wait didn’t really bother me!).

In this sense, excess demand happens all the time in the hairdressing business, but although some people may grumble at having to wait their turn, nobody sees it as some disastrous economic “problem” where fixed prices lead to economic inefficiency and shortages. And who would want to live in a world in which you could never be sure what the price of a haircut would be every time you wanted to get one? By contrast, the real world tends to fix prices and to reduce uncertainty – and people prefer this world.

If a barber sees that he has long lines of costumers over a period of time and expects that this demand is going to last, he will hire more help: in essence, he will ramp up production and either (1) adjust his mark-up price to cover the new labour costs, or (2) might actually leave prices unchanged, if he already has a sufficient profit margin.

We live in a world where, in market after market, conventional supply and demand dynamics and auction-like markets are generally irrelevant to price setting.

What explains how we set prices in many markets is tradition, economic and social convention, and institutional development, not tidy supply and demand curves.

The Marginalist Pricing Controversy Revisited

While neoclassical theory holds that firms generally set their prices by equating marginal revenue with marginal cost, the reality is quite different.

The accounting research literature has provided strong evidence that firms generally use total average unit costs (or full costs or normal costs) as the basis for mark-up price setting (Gordon, Cooper, Falk and Miller 1980; Scapens et al. 1983; Govindarajan and Anthony 1983; Cooper 1990; Emore and Ness 1991; Bright et al. 1992; Shim and Sudit 1994; Drury and Tayles 2000).

These results were already known in the 1930s and 1940s (Hall and Hitch 1939) and the “full cost” reality gave rise to the “marginalist controversy” in which neoclassical economists tried desperately to explain away the gap between their theory and reality (Lucas 2003: 203).

Defenders of neoclassical theory included Edwards (1952), Alchian (1950), Pearce (1956), and Simon (1959).

One solution was the doctrine of “implicit marginalism”: the idea that, while firms do not deliberately and consciously equate marginal revenue with marginal cost, in practice they nevertheless act as if they were doing so (Lucas 2003: 203). This was usually related to the methodological instrumentalism of Milton Friedman in his famous essay “The Methodology of Positive Economics” (Friedman 1953), in which Friedman argued that the best test of a theory is whether it predicts outcomes (Lucas 2003: 204), not tests of its assumptions.

Both “implicit marginalism” and Friedman’s instrumentalism have provided neoclassical economics with an absurd escape hatch to evade empirical reality.

Friedman, for example, claimed to use an empiricist (or positivist) method, but his belief that it is not necessary to test the fundamental assumptions of a theory and that only predictive powers of theories matter is utterly unconvincing.

In responding to charges that neoclassical theory was grossly unrealistic, Friedman dismissed such charges as follows:

… criticism of this type is largely beside the point unless supplemented by evidence that a hypothesis differing in one or another of these respects from the theory being criticized yields better predictions for as wide a range of phenomena. Yet most such criticism is not so supplemented; it is based almost entirely on supposedly directly perceived discrepancies between the ‘assumptions’ and the ‘real world.’ A particularly clear example is furnished by the recent criticisms of the maximization-of-returns hypothesis on the grounds that businessmen do not and indeed cannot behave as the theory ‘assumes’ they do. The evidence cited to support this assertion is generally taken either from the answers given by businessmen to questions about the factors affecting their decisions – a procedure for testing economic theories that is about on a par with testing theories of longevity by asking octogenarians how they account for their long life – or from descriptive studies of the decision-making activities of individual firms. Little if any evidence is ever cited on the conformity of businessmen’s actual market behavior – what they do rather than what they say they do – with the implications of the hypothesis being criticized, on the one hand, and of an alternative hypothesis, on the other.” (Friedman 1953: 31).

There you have it: a theory that claims to explain how a firm acts cannot be tested by asking business people how they act!

Now, while it is true that the evidence of econometrics cannot necessarily be used to settle debates in economics, the empirical evidence of direct surveys and case studies has a much greater value than econometric evidence in questions about the behaviour and decision making of firms.

The concocted analogy that Friedman gives to try and dismiss the value of empirical surveys here is a ridiculous one. While it may well be that asking old people how they personally account for their long life cannot test scientific theories of longevity, it does not follow that their evidence has no value in testing such theories: on the contrary, one can ask them how they lived and what lifestyles they had in terms of diet, exercise, smoking, drinking etc., which would be highly relevant to such theories.

And marginalist theories of price setting can be tested by asking business people whether their decision making and actions conform to the assumptions of the theory and the prior model of what constitutes rational or profit-maximising behaviour.

To return to Friedman’s statement above, he, not wishing to seem like a bizarre anti-empiricist extremist, quickly qualified his position in a footnote:

“I do not mean to imply that questionnaire studies of businessmen’s or others’ motives or beliefs about the forces affecting their behavior are useless for all purposes in economics. They may be extremely valuable in suggesting leads to follow in accounting for divergencies between predicted and observed results; that is, in constructing new hypotheses or revising old ones. Whatever their suggestive value in this respect, they seem to me almost entirely useless as a means of testing the validity of economic hypotheses.” (Friedman 1953: 31, n. 22).

But this qualification does very little to soften the extremism of Friedman’s position, which, if anything, reads more like the apriorist fantasies of Ludwig von Mises than any empiricist method, in its unwillingness to accept that empirical evidence can refute an economic theory.

Assumptions of economic theories (and indeed any theory) matter very much. One could, for example, concoct all sorts of theories with unrealistic and even absurd assumptions that manage to predict outcomes consistent with the observed data, but one must have a criterion for deciding which one is most likely the true and the best theory: here testing the fundamental assumptions of theories is necessary.

The empirical evidence of direct surveys and case studies on price setting shows that the marginalist theory of pricing in either (1) an explicit form or (2) the implicit form is mistaken and untenable (Lucas 2003: 207).


BIBLIOGRAPHY
Alchian, A. A. 1950. “Uncertainty, Evolution and Economic Theory,” Journal of Political Economy 58: 211–221.

Bright, J., Davies, R. E., Downes, C. A., and R. C. Sweeting. 1992. “The Deployment of Costing Techniques and Practices: A UK Study,” Management Accounting Research 3: 201–211.

Cooper, R. 1990. “Explicating the logic of ABC,” Management Accounting: 58–60.

Drury, C. and M. Tayles. 2000. “Cost Systems and Profitability Analysis in UK Companies: Discussing Survey Findings,” Munich. Paper presented to Annual Congress of the European Accounting Association.

Edwards, R. S. 1952. “The Pricing of Manufactured Products,” Economica 19: 298–307.

Emore, J. R. and J. A. Ness. 1991. “The Slow Pace of Meaningful Change in Cost Systems,” Journal of Cost Management 4.4: 36–45.

Friedman, M. 1953. “The Methodology of Positive Economics,” in M. Friedman, Essays in Positive Economics. University of Chicago Press, Chicago.

Gordon, L., Cooper, R., Falk, H. and D. Miller. 1980. The Pricing Decision. National Association of Accountants Society of Management Accountants of Canada, Hamilton, New York.

Govindarajan, V. and R. Anthony. 1986. “How Firms use Cost Data in Price Decisions,” Management Accounting 65: 30–34.

Hall, R. L. and C. J. Hitch. 1939. “Price Theory and Business Behaviour,” Oxford Economic Papers 2: 12–45.

Lucas, M. R. 2003. “Pricing Decisions and the Neoclassical Theory of the Firm,” Management Accounting Research 14.3: 201–217.

Machlup, F. 1946. “Marginal Analysis and Empirical Research,” American Economic Review 36: 519–554.

Pearce, I. F. 1956. “A Study in Price Policy,” Economica n.s. 23.90: 114–127.

Scapens, R. W., Gameil, M. Y. and Cooper, D. J. 1983. “Accounting Information for Pricing Decisions,” in J. Arnold, R. W. Scapens, M. Y. Gameil, and D. J. Cooper (eds.), Management Accounting Research and Practice. CIMA, London. 283–306.

Shim, Eunsup, and Ephraim Sudit. 1995. “How Manufacturers Price Products,” Management Accounting 76.8: 37–39.

Simon, H. A. 1959. “Theories of Decision Making in Economies,” American Economic Review 49: 253–283.

Mark-up Pricing in Germany

Stahl (2005) reports the results of a survey on price setting behaviour by German manufacturing firms (see also Stahl 2007).

The survey was conducted in 2004 by the Ifo Institute for the Deutsche Bundesbank (Germany’s central bank) and involved 1200 manufacturing firms (Stahl 2005: 9–10).

The firms were asked how prices are determined. The results were as follows:

Constant mark-up on calculated unit costs | 4%
Taking calculated unit costs as a reference and varying the mark-up | 69%
Taking the price of the main competitor as a reference | 17%
Tying the price to another price | 2%
Other | 7%
(Stahl 2005: 10).

Mark-up pricing accounts for 73% of price setting – a very high percentage. Stahl (2005) argues that those firms that set a constant mark-up on unit costs are the mark-up price leaders: the most powerful firms that determined the price in a given market (Stahl 2005: 11). By contrast, time-varying mark-up pricing is used by firms which follow price leaders and must pay more attention to market conditions and competition (Stahl 2005: 11).

Even in the case of the third category (“taking the price of the main competitor as a reference”), it may be the case that these are “price followers” and although less powerful than other mark-up price setters, some of them may also be using mark-up pricing.

When asked what theories best explain price stickiness, the following results were obtained from the most important to least important:

(1) Nominal fixed-term contract
(2) Coordination failure
(3) Price elasticity of demand
(4) Regular date
(5) Regular time interval
(6) Transitory shock
(7) Sluggish costs
(8) Menu costs
(9) Other
(Stahl 2005: 13).

The failure to include cost-based pricing as a theory in this list is a serious oversight, but the results are in line with other surveys: both (1) explicit (and implicit) contracts and (2) coordination failure (the fear that if prices were raised, competitors will not follow suit, and if prices were reduced, then this would set off a destabilising price war) are fundamental factors that restrain prices.

In questions asking about what causes price changes, the following result strongly confirms the important of cost-based pricing:

“It turned out that the most important motivation for price changes is changes in the costs of materials … . Their impact is larger for price rises than for price reductions.” (Stahl 2005: 14).

This also means that prices are more flexible upwards than downwards, and confirms that there is a bias towards upwards movements (rather than downwards movements) in mark-up pricing changes.

BIBLIOGRAPHY
Stahl, Harald. 2005. “Price Setting in German Manufacturing: New Evidence from New Survey Data,” ECB Working Paper Series No. 561
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=868433

Stahl, Harald. 2007. “Price Setting in German Manufacturing: Evidence from New Survey Data,” in S. Fabiani, C. Suzanne Loupias, F. M. Monteiro Martins and Roberto Sabbatini (eds.), Pricing Decisions in the Euro Area: How Firms set Prices and Why. Oxford University Press, New York. 97–109.

Murphy on Sticky Wages

Robert P. Murphy in his recent response to Krugman on Mises and the Great Depression refers us to the following post to refute the idea that “sticky wages” really are a problem for free market economics:

Murphy, Robert P. 2010. “Do Sticky Wages Weaken the Case for Markets?,” Mises Daily, June 7
http://mises.org/daily/4353/Do-Sticky-Wages-Weaken-the-Case-for-Markets

This post deserves to be read by everyone who wants to see how far Austrian economists (and, incidentally, even mainstream New Keynesians like Mankiw) are from understanding real-world capitalism.

Keynes was clear that even if wages and prices were perfectly flexible this would still be no reliable and automatic cure for involuntary unemployment, and that there could still be failures of aggregate demand (Davidson 1992). Keynes, then, would not have been a New Keynesian like Mankiw.

But the issue here is wage stickiness.

First, Murphy does not even dispute that wage stickiness is a real phenomenon in modern market economies (what is now called a “stylised fact”), but instead wishes to put the blame for it mostly on modern governments.

I will return below to why this is wrong, but Murphy makes an astonishing claim that is utterly untrue:

“Now we have to ask, why do workers hold out for so long without jobs, insisting on wages that no one is willing to pay? After all, the other goods and services in the economy see their prices fall in a speedy fashion even though the sellers of these items depend on them for their livelihood. So if a street vendor knows enough to slash his hot dog prices when demand collapses, why don’t hairdressers accept pay cuts when the same happens to their industry?

What was that? Murphy is saying that real world “prices fall in a speedy fashion”?

Has Murphy ever noticed that in virtually all recessions since the late 1930s throughout the developed world, even recessions tend to be inflationary? Deflation has virtually disappeared.

Relative price rigidity is a fact of life. Even in the terrible disaster that was the Great Depression it was a clear phenomenon.

The reason has been known since the work of Gardiner Means: most prices in modern capitalist economies are relatively inflexible mark-up/administered prices (for the empirical evidence, see Appendix 2 below).

Flexible price setting as required in standard economics textbooks – where prices are set by supply and demand dynamics – is largely shunned by the private sector itself.

A great part of the economy of each modern capitalist nation consists of mark-up pricing sectors, but even though (of course) flexprice markets do exist they are a considerably smaller part of the economy than most people think (perhaps less than 30% in many nations).

And, even though many nations saw price deflation in the Great Depression, even in the 1930s mark-up prices were significant and relatively inflexible as compared with other markets: Gardiner Means, for example, discovered that the administered pricing sector of the US economy had seen price declines of only about 10% during the depression, whereas the more competitive or flexprice sectors had seen price falls of about 40 to 60% (Means 1975).

So even Robert Murphy’s initial assumption that we live in a world of highly flexible prices cannot be taken seriously, and utterly collapses.

But to return to the issue of sticky wages. The main cause of sticky wages is not government intervention.

The empirical evidence that has accumulated over the years shows that people in general object to having their nominal wages cut. But even managers and capitalists often dislike pay cuts. Recent studies suggest that employers avoid pay cuts because they diminish workers’ morale, and then falling morale reduces productivity, amongst many other reasons (Bewley 1999). The evidence of Bewley shows that even employers are often averse to wage cuts during recessions. A nice summary of Bewley’s work on wages is available here.

But moving on, even Murphy’s explanation of wage rigidity during the depression in the US is flawed:

“…why don’t hairdressers accept pay cuts when the same happens to their industry? In the case of the Great Depression, the answer is simple enough: the federal government didn’t allow wages to fall. After the 1929 crash, Herbert Hoover gathered the nation's leading businessmen for a conference in Washington and urged them to allow profits and dividends to take the hit, but to spare workers’ paychecks. Rather than cut wages, businesses were supposed to implement spread-the-work schemes where workers would cut back their hours.”

First, Hoover’s “high wage” policy was not an alien, evil government intervention imposed on unwilling and hostile business people: it was a policy that many largely agreed with, as I note here. Already in the 1920s and 1930s many employers had grown averse to wage cuts.

Secondly, Rose (2010) presents some (admittedly ambiguous) evidence that Hoover’s “high wage” policy actually did not have much effect on the timing of US wage cuts during the depression.

Of course, that rigid wages in the face of falling prices squeezed profits and induced business pessimism and bankruptcy is undoubtedly true, but the solution was not wage cuts.

Why? Keynes showed why in Chapter 19 of the General Theory (Keynes 1964 [1936]: 257–271), and one important reason is that, even when nominal wages fall, this induces debt deflationary effects (especially when levels of private debt are very high), just as Irving Fisher had argued (Fisher 1933; see also Dimand 1997 and Dimand 2011).

Above all, if price deflation is quite uneven across sectors and product markets (as in many countries during the depression), the burden of fixed nominal debt will soar, inducing difficulty in servicing debt to many debtors and actual bankruptcy to others.

A further means by which demand for final goods and services is contracted is that a greater transfer of wealth from debtors to creditors occurs and creditors often have a lower marginal propensity to consume.

And eventually severe debt deflation will cause distress and bankruptcy to creditors and the financial system. So the smooth and rapid market clearing as postulated by Austrians and other mainstream neoclassicals as the cure for high involuntary unemployment simply could not and did not happen.

Murphy cites the recession of 1920–1921 as an example of how (alleged) wage and price flexibility cleared markets and led to a (supposedly) quick recovery. But the recession of 1920–1921 is highly anomalous, as I have shown elsewhere (see Appendix 1 below), and a demand-side explanation is more convincing as an explanation of recovery in 1921. There was no financial crisis, no banking failures, the deflation was probably expected, some actual positive supply shocks, and private debt levels were considerably lower than in 1929.

Murphy is also wrong that the Federal Reserve “jacked rates up to record high levels,” if he is talking about the recovery in 1921:

Discount Rate of the Federal Reserve Bank of New York
Date | Rate
1920
May | 6%
June | 7%
Dec. | 7%
1921
Jan. | 7%
Apr. | 7%
May. | 6.5%
Jun. | 6%
Jul. | 5.5%
Sep. | 5%
Nov. | 4.5%

1922
Jan. | 4.5%
Jun. | 4%.
http://fraser.stlouisfed.org/download-page/page.pdf?pid=38&id=1477

As we can see, the Fed lowered interest rates from May 1921, and a recovery began in August 1921, after looser monetary policy had been adopted.

Then from November 1921 to June 1922, the Fed engaged in unprecedented open market operations to aid the recovery process.

The Austrian obsession with the recession of 1920–1921 is strange, given its anomalous nature. Why don’t they look at the US recessions of the 1870s and 1890s, for example?

The US had no central bank in these years, small government, a gold standard, either no or very limited unemployment relief at best, and (presumably) a greater degree of price and wage flexibility (although even in this period wage stickiness existed: see Sundstrom 1990; Sundstrom 1992; Hanes 1992; Hanes 1993). Yet serious economic problems occurred in both the 1870s and 1890s.

Take the 1890s. The graph below shows US unemployment in the 1890s according to three estimates. For various reasons, Lebergott’s estimates may be the better ones for unemployment rates in this period.

High unemployment continued for years after the shock of 1892–1893.

So what is the Austrian explanation for this? If wages and prices were not sticky, then there was still no rapid recovery and quickly self-adjusting labour market.

If wages were sticky, then not even late Gold Standard capitalism escaped the “stylised fact” of relatively rigid wages.

Either way the Austrian view is damned.

Appendix 1: The Recession of 1920–1921
“The US Recession of 1920–1921: Some Austrian Myths,” October 23, 2010.

“There was no US Recovery in 1921 under Austrian Trade Cycle Theory!,” June 25, 2011.

“The Depression of 1920–1921: An Austrian Myth,” December 9, 2011.

“A Video on the US Recession of 1920-1921: Debunking the Libertarian Narrative,” February 5, 2012.

“The Recovery from the US Recession of 1920–1921 and Open Market Operations,” October 4, 2012.

“Rothbard on the Recession of 1920–1921,” October 6, 2012.

Appendix 2: Empirical Evidence on Administered Prices
“Downward’s Pricing Theory in Post-Keynesian Economics: Chapter 8,” January 23, 2014.

“Mark-up Pricing in South Africa,” January 20, 2014.

“Mark-up Pricing in Sweden,” January 9, 2014.

“Mark-up Pricing in Canada,” January 7, 2014.

“Some More Empirical Evidence on Full Cost Pricing,” December 10, 2013.

“Mark-up Pricing in New Zealand,” November 30, 2013.

“Mark-up Pricing in Australia,” November 30, 2013.

“Mark-up Pricing in Japan,” November 29, 2013.

“Mark-up Prices in Iceland,” November 25, 2013.

“Mark-up Pricing in Norway,” November 23, 2013.

“Mark-up Pricing in Ireland,” November 22, 2013.

“Two Marketing Studies on US Administered Prices,” November 16, 2013.

“Hall and Hitch on Marginal Cost and Price,” November 4, 2013.

“Administered Pricing in the United Kingdom,” October 19, 2013.

“Administered Prices in the Eurozone: Some Empirical Data,” October 16, 2013.

“Gardiner Means on Administered Prices,” June 20, 2013.

“Early Literature on Administered Pricing,” May 8, 2013.

BIBLIOGRAPHY
Bewley, T. F. 1999. Why Wages Don’t Fall During a Recession. Harvard University Press, Cambridge, MA.

Davidson, P. 1992. “Would Keynes be a New Keynesian?,” Eastern Economic Journal 18.4: 449–463.

Dimand, Robert W. 1997. “Debt-Deflation Theory,” in D. Glasner and T. F. Cooley (eds), Business Cycles and Depressions: An Encyclopedia, Garland Pub., New York. 140–141.

Dimand, Robert W. 2011. “Lessons from the 1929 Crash and the 1930s Debt Deflation: What Bernanke and King Learned, and what they could have learned,” in Claude Gnos and Louis-Philippe Rochon (eds.), Credit, Money and Macroeconomic Policy: A Post-Keynesian Approach. Edward Elgar, Cheltenham. 33–44.

Fisher, Irving. 1933. “The Debt-Deflation Theory of Great Depressions,” Econometrica 1.4: 337–357.

Keynes, J. M. 1964 [1936]. The General Theory of Employment, Interest, and Money. Harvest/HBJ Book, New York and London.

Means, Gardiner C. 1975. “Simultaneous Inflation and Unemployment: A Challenge to Theory and Policy,” in Gardiner C. Means et al., The Roots of Inflation: The International Crisis. Wilton House Publications, London.

Sundstrom, William A. 1990. “Was There a Golden Age of Flexible Wages? Evidence from Ohio Manufacturing, 1892–1910,” The Journal of Economic History 50.2: 309–320.

Sundstrom, William A. 1992. “Rigid Wages or Small Equilibrium Adjustments? Evidence from the Contraction of 1893,” Explorations in Economic History 29.4: 430–455.

Mises’s Explanation of the Great Depression: A Critique

Ludwig von Mises lived through the Great Depression as Keynes did, and produced his own explanation of it. I present a critique of Mises’s explanation of the Great Depression below.

First, some background. Around 1930 Mises joined an Austrian government economic commission to study the causes of the depression in Austria, along with (interestingly enough) the future Austro-fascist leader Engelbert Dollfuss (Hülsmann 2007: 614), to whom Mises was later to give economic advice (see below on this). The report of the committee blamed (1) inflationary expectations in Austria and (2) rises in taxation and government spending and increased wage rates (which had all squeezed business profits) for the inability of Austria to attract foreign capital needed to facilitate quicker adjustment and recovery from the depression (Hülsmann 2007: 614–615).

But Mises was not satisfied with the report (Hülsmann 2007: 615), and formed his own explanations for the depression, which were published as various articles and papers (see Mises 2006 [1931]; Mises 2002a [1931]; Mises 2002b [1932]).

On February 28, 1931, Mises gave a lecture called “The Causes of the World Economic Crisis” in Czechoslovakia (Mises 2006 [1931]).

In the published version of that lecture, Mises expounded his Austrian business cycle theory (ABCT) (Mises 2006 [1931]): 160–162), with its belief in monetary expansion driving the market rate of interest below its Wicksellian natural level, causing malinvestment which is physically unsustainable. This theory is, of course, false and untenable, for reasons explained here (in the links in section 32). Amongst the many reasons why the theory is wrong is that there is no such thing as a Wicksellian natural rate of interest, and neither the Great Depression nor booms and busts in general are explained by the ABCT because banks cannot push interest rates below a non-existent natural rate.

However, it is interesting that Mises thought that his Austrian monetary theory of the cycle could not adequately explain the severity and length of the Great Depression (as also noted by Hülsmann 2007: 617–618):

“The crisis from which we are now suffering is also the outcome of a credit expansion. The present crisis is the unavoidable sequel to a boom. Such a crisis necessarily follows every boom generated by the attempt to reduce the ‘natural rate of interest’ through increasing the fiduciary media. However, the present crisis differs in some essential points from earlier crises, just as the preceding boom differed from earlier economic upswings. The most recent boom period did not run its course completely, at least not in Europe. Some countries and some branches of production were not generally or very seriously affected by the upswing which, in many lands, was quite turbulent. A bit of the previous depression continued, even into the upswing. On that account—in line with our theory and on the basis of past experience—one would assume that this time the crisis will be milder. However, it is certainly much more severe than earlier crises and it does not appear likely that business conditions will soon improve.

The unprofitability of many branches of production and the unemployment of a sizable portion of the workers can obviously not be due to the slowdown in business alone. Both the unprofitability and the unemployment are being intensified right now by the general depression. However, in this postwar period, they have become lasting phenomena which do not disappear entirely even in the upswing. We are confronted here with a new problem, one that cannot be answered by the theory of cyclical changes alone.” (Mises 2006 [1931]: 163–164).

Mises saw the answer in his belief that (1) the high unemployment of the depression was caused by trade unions forcing wages up above market clearing levels (confirmed in Hülsmann 2007: 620), (2) governments had allegedly “capitulated to the labor unions,” and (3) the state provision of unemployment relief had allowed wage rates to remain high:

“The unions now have the power to raise wage rates above what they would be on the unhampered market. However, interventions of this type evoke a reaction. At market wage rates, everyone looking for work can find work. Precisely this is the essence of market wages—they are established at the point at which demand and supply tend to coincide. If the wage rates are higher than this, the number of employed workers goes down. Unemployment then develops as a lasting phenomenon. At the wage rates established by the unions, a substantial portion of the workers cannot find any work at all. Wage increases for a portion of the workers are at the expense of an ever more sharply rising number of unemployed.

Those without work would probably tolerate this situation for a limited time only. Eventually they would say: ‘Better a lower wage, than no wage at all.’ Even the labor unions could not withstand an assault by hundreds of thousands, or millions of would-be workers. The labor union policy of holding off those willing to work would collapse. Market wage rates would prevail once again. It is here that unemployment relief is brought into play and its role [in keeping workers from competing on the labor market] needs no further explanation.

Thus, we see that unemployment, as a long-term mass phenomenon, is the consequence of the labor union policy of driving wage rates up. Without unemployment relief, this policy would have collapsed long ago. Thus, unemployment relief is not a means for alleviating the want caused by unemployment, as is link in the chain of causes which actually makes unemployment a long-term mass phenomenon.” (Mises 2006 [1931]: 167–168).

The solution, then, for Mises was eliminating unemployment relief (presumably forcing the unemployed to starve and accept lower wages), cutting government spending and taxes (Mises 2006 [1931]: 175), and not only to cut wages but also to make wage determination free from labour unions (Mises 2006 [1931]: 169).

How suppression of trade unions was to be achieved and their freedom of association restricted was left understated, and Mises’s feeble hope that the “formation of wage rates should be hampered neither by the clubs of striking pickets nor by government’s apparatus of force” (Mises 2006 [1931]: 169) rings hollow.

How else could such suppression of trade unions be realistically achieved except by government coercion?

Mises hints at the solution in a passage where unions are themselves blamed as perpetrators of all sorts of evil:

“If the government were to proceed against those who molest persons willing to work and those who destroy machines and industrial equipment in enterprises that want to hire strikebreakers, as it normally does against the other perpetrators of violence, the situation would be very different. However, the characteristic feature of modern governments is that they have capitulated to the labor unions.” (Mises 2006 [1931]: 167).

This is the point in the essay where Mises may as well have been winking at his audience to indicate what his words imply: that governments should break up and repress unions and restore labour market freedom.

It comes as no surprise that Mises had praised Mussolini’s fascism in 1927 because it had (according to Mises) “saved European civilization.” Mises also contended that the “merit that Fascism … [had] thereby won for itself will live on eternally in history.” Part of the reason for this sickening praise was no doubt that Italian fascism had smashed independent trade unions. And, if that wasn’t enough, Mises was himself in the 1930s to become an economic adviser to the Austro-fascist Engelbert Dollfuss (Chancellor of Austria from 1932), who did indeed smash independent trade unions in Austria.

But to return to the point at hand. Why was Mises’s wage rate explanation wrong?

The reason is that capitalist investment and demand for labour is not a simple function of the wage rate or interest rate, as naïve, ignorant and incompetent Austrian ideologues like Mises thought, and many still think.

The propensity to invest is a complex phenomenon involving many factors, not just interest rates and the wage rate, but fundamentally the level of demand for output, the degree of uncertainty of capitalists about the future, the expectations of business people, the general state of expectations, and the state of the financial system and credit markets, and so on. Above all, the first three factors – demand for output, uncertainty and expectations – must be considered fundamental causes of the inducement to invest for many businesses, especially those that are mark-up price enterprises with excess capacity and inventories.

In the Great Depression, business expectations were shattered in an unprecedented way, as was demand for output. Simply reducing wages was no reliable or effective cure for unemployment in the 1930s (or indeed during recessions in general) when business expectations were deeply pessimistic, demand was stagnant and uncertainty about the future deep. If we also add to this the fact that many nations had banking crises and lending practices would have become deeply conservative, Mises’s focus on wages as the main cause of 1930s unemployment can be seen as the folly it was.

Whatever lowering of demand for labour that might have been caused by higher wage rates during the depression could have been overcome and rendered irrelevant by effective expansion of aggregate demand.

Furthermore, Mises’s economic analysis was just as flawed when he came to analyse prices:

“The demand that a reduction in prices be tied in with the reduction in wage rates ignores the fact that wage rates appear too high precisely because wage reductions have not accompanied the practically universal reduction in prices. Granted, the prices of many articles could not join the drop in prices as they would on an unhampered market, either because they were protected by special governmental interventions (tariffs, for instance) or because they contained substantial costs in the form of taxes and higher than unhampered market wage rates. The decline in the price of coal was held up in Germany because of the rigidity of wage rates which, in the mining of hard coal, come to 56 percent of the value of production. The domestic price of iron in Germany can remain above the world market price only because tariff policy permits the creation of a national iron cartel and international agreements among national cartels. Here too, one need ask only that those interferences which thwart the free market formation of prices be abolished. There is no need to call for a price reduction to be dictated by government, labor unions, public opinion or anyone else.” (Mises 2006 [1931]: 169–170).

Mises was blissfully unaware of what many economists were to discover in the 1930s and what Gardiner Means had already discovered: that real world price rigidities are mainly caused by the private sector itself, because most businesses adopt relatively inflexible mark-up/administered prices.

The type of price setting required by Mises’s economic theory is largely shunned by the private sector itself, so that the price flexibility Mises thought would clear markets cannot be attained.

Even though many nations saw price deflation in the Great Depression, even in the 1930s mark-up prices were significant and relatively inflexible as compared with other markets: Gardiner Means, for example, discovered that the administered pricing sector of the US economy had seen price declines of only about 10% during the depression, whereas the more competitive or flexprice sectors had seen price falls of about 40 to 60% (Means 1975) – a very clear disparity.

Finally, there is not a shred of evidence that Mises ever understood that even if wages and price were highly flexible, the existence of fixed nominal debt impedes and thwarts his imagined type of market clearing dynamics. For if debts remain fixed and wages and prices fall (or even more disastrously if wages fall but prices are less flexible), then it is likely that debtors will face severe problems as their burden of debt soars, and most probably deflation will induce bankruptcy of debtors and then bankruptcy of creditors and banks.

All in all, Mises’s analysis of the Great Depression was wrong, and he was ignorant of economics and economic reality. Austrians who still adhere to Mises’s ideas are just as ignorant and mistaken.

BIBLIOGRAPHY
Hülsmann, J. G. 2007. Mises: The Last Knight of Liberalism. Ludwig von Mises Institute, Auburn, Ala.

Means, Gardiner C. 1975. “Simultaneous Inflation and Unemployment: A Challenge to Theory and Policy,” in Gardiner C. Means et al., The Roots of Inflation: The International Crisis. Wilton House Publications, London.

Mises, Ludwig von. 2006 [1931]. “The Causes of the Economic Crisis,” in Percy L. Greaves (ed.). The Causes of the Economic Crisis, and Other Essays Before and After the Great Depression. Ludwig von Mises Institute, Auburn, Ala. 155–181.

Mises, L. von. 2002a [1931]. “The Economic Crisis and Capitalism,” in Richard M. Ebeling (ed.). 2002. Selected Writings of Ludwig von Mises: Between the Two World Wars: Monetary Disorder, Interventionism, Socialism, and the Great Depression (vol. 2). Liberty Fund, Indianapolis, Ind.

Mises, L. von. 2002b [1932]. “The Myth of the Failure of Capitalism,” in Richard M. Ebeling (ed.), Selected Writings of Ludwig von Mises: Between the Two World Wars: Monetary Disorder, Interventionism, Socialism, and the Great Depression (vol. 2). Liberty Fund, Indianapolis, Ind. 182–191.