The dominant British tradition received its first serious challenge in many years when Carl Menger’s Principles of Economics was published in 1871. Menger, the founder of the Austrian School proper, resurrected the Scholastic-French approach to economics, and put it on firmer ground.
Menger spelled out the subjective basis of economic value, and fully explained, for the first time, the theory of marginal utility (the greater the number of units of a good that an individual possesses, the less he will value any given unit). In addition, Menger showed how money originates in a free market when the most marketable commodity is desired, not for consumption, but for use in trading for other goods. Menger restored economics as the science of human action based on deductive logic, and prepared the way for later theorists to counter the influence of socialist thought. Indeed, his student Friederich von Wieser strongly influenced Friedrich von Hayek’s later writings.
Menger’s admirer and follower at the University of Innsbruck, Eugen Böhm-Bawerk, took Menger’s exposition, reformulated it, and applied it to a host of new problems involving value, price, capital, and interest. His History and Critique of Interest Theories, appearing in 1884, is a sweeping account of fallacies in the history of thought and a firm defense of the idea that the interest rate is not an artificial construct but an inherent part of the market. It reflects the universal fact of “time preference,” the tendency of people to prefer satisfaction of wants sooner rather than later.
Böhm-Bawerk’s Positive Theory of Capital demonstrated that the normal rate of business profit is the interest rate. Capitalists save money, pay laborers, and wait until the final product is sold to receive profit. In addition, he demonstrated that capital is not homogeneous but an intricate and diverse structure that has a time dimension. A growing economy is not just a consequence of increased capital investment, but also of longer and longer processes of production.
Böhm-Bawerk favored policies that deferred to the ever-present reality of economic law. He regarded interventionism as an attack on market economic forces that cannot succeed in the long run. But one area where Böhm-Bawerk had not elaborated on the analysis of Menger was money, the institutional intersection of the “micro” and “macro” approach. A young Ludwig von Mises, economic advisor to the Austrian Chamber of Commerce, took on the challenge.
The result of Mises’s research was The Theory of Money and Credit, published in 1912. He spelled out how the theory of marginal utility applies to money, and laid out his “regression theorem,” showing that money not only originates in the market, but must always do so. Drawing on the British Currency School, Knut Wicksell’s theory of interest rates, and Böhm-Bawerk’s theory of the structure of production, Mises presented the broad outline of the Austrian theory of the business cycle. To note once again, his was not a theory of the physical capital, but a theory of interest. So, even if some of the economists of the school had covered through their writings the complexities of the structure of production, that wasn’t really their research object, but rather what their concentration really opted for was interest phenomenon, trade cycle or entrepreneurship.
Ludwig Lachmann in his Capital and its Structure is most serious about the complexities of the structure of production, especially on the heterogeneity of physical capital not only in relation to successive stages of production, but denying any possibility of systematically categorizing, measuring or aggregating capital goods. But, does that mean he is from a different camp? Evidently not, since much of his discussion contains an important contribution to the historically specificity of capital, in that the heterogenous is not itself the research object, but only a problem statement for the theory of the entrepreneur. Says he,
For most purposes capital goods have to be used jointly. complementarity is of the essence of capital use. but the heterogenous capital resources do not lend themselves to combination in any arbitrary fashion. For any given number of them only certain modes of complementarity are technically possible, and only a few of these are economically significant. It is among the latter that the entrepreneur has to find the ‘optimum combination’.
for him, the true function of the entrepreneur must remain hidden as long as we disregard the heterogeneity of capital. But, Peter Lewin’s Capital in Disequilibrium reads Lachmann revealingly. What makes it possible for entrepreneurs to make production plans comprising numerous heterogenous capital goods is a combination of the market process and the institution of money and financial accounting. There, you can see Lachmann slipping into the historical territory. Says Lewin,
Planning within firms proceeds against the necessary backdrop of the market. Planning within firms can occur precisely because “the market” furnishes it with the necessary prices for the factor inputs that would be absent in a fullblown state ownership situation.
Based on these prices, the institution of monetary calculation allows entrepreneurs to calculate retrospective and prospective profits. The calculation of profits, Lewin states, is “indispensable in that it provides the basis for discrimination between viable and non-viable production projects.” The approach is not concerned with the heterogeneity of capital goods as such but, to the contrary, with the way these goods are made homogeneous so that entrepreneurs can make the calculations their production plans are based on. Without this homogeneity of capital goods in relation to the goal of the entrepreneur – making monetary profit – it would be difficult, if not impossible, to combine them in a meaningful way.