NEW PERSPECTIVES ON POLITICAL ECONOMY
A Bilingual Interdisciplinary Journal
In this issue:
Youliy Ninov: An Alternative View on Saving and Investment From an
Austrian Economics Perspective
Bradley K. Hobbs and Nikolai G. Wenzel: Income Inequality and
Poverty: Are We Asking the Right Questions?
Jakub Bożydar Wiśniewski: Austrian Economics as a Paradigm of
Golden Mean Thinking
Frank Daumann and Florian Follert: COVID-19 and Rent-Seeking
Competition: Some Insights from Germany
Vol. 16. No. 1-2, 2020
NEW PERSPECTIVES ON POLITICAL ECONOMY
A Bilingual Interdisciplinary Journal
New Perspectives on Political Economy is a peer-reviewed semi-annual bilingual interdisciplinary
journal, published since 2005 in Prague. The journal aims at contributing to scholarship at the intersection
of political science, political philosophy, political economy and law. The main objective of the journal is
to enhance our understanding of private property-, market- and individual liberty-based perspectives
in the respected sciences. We also believe that only via exchange among social scientists from different
fields and cross-disciplinary research can we critically analyze and fully understand forces that drive
policy-making and be able to spell out policy implications and consequences. The journal welcomes
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Editor-in-chief
Dominik Stroukal, CEVRO Institute, Prague
Founding Editor
Josef Šíma, President, CEVRO Institute, Prague
Editorial Board
Terry Anderson, Hoover Institution, Stanford University
Peter Boettke, George Mason University
Hardy Bouillon, Trier University
Enrico Colombatto, University of Turin
Frank van Dun, Ghent University, Faculty of Law
Richard Ebeling, Northwood University
Richard Epstein, New York University School of Law
Robert Higgs, The Independet Review
Jesus Huerta de Soto, Universidad Rey Juan Carlos
Jorg Guido, Hulsmann Université Anger
Stefan kolev, University of Applied Sciences Zwickau
Peter G. Klein, Baylor University
Michael Munger, Duke University
Svetozar Pejovich, Texas A&M University
Gerald Steele, Lancaster University
Language Editor
Caleb Groen and Samantha A. Lansing
New Perspectives on Political Economy, Vol. 16, No. 1-2, 2020
New Perspectives on Political Economy [ 4 ]
An Alternative View on Saving and
Investment From an Austrian Economics
Perspective
Youliy Ninov
T
he contemporary Austrian economics views about saving and investment are derived
from a basic Robinson Crusoe type of economy. The latter leads to oversimplification,
and the alternative ways to save and invest observable in any contemporary
economy can not be accounted for. In a monetary, capitalistic economy, the process
of saving does not require that consumption goods or their intermediate products
be accumulated in advance for investment to take place. We also show that any economy
possesses an amount of free capital, which is self-sustaining and can be used exclusively for
capital substitution and investment, thus avoiding the necessity for constant saving on the part
of the economic agents. Secular economic growth becomes possible without net saving.
Introduction
The standard Austrian economics view about what constitutes saving can be found in many
scholarly texts. It begins with the statement that saving is the postponement/curtailing of
consumption. The latter statement is beyond reproach, but its continuation, i.e., the explanation
of how saving is transferred into investment is questionable. In particular, we will argue that the
standard Austrian view on the matter is very narrow, i.e., that it applies only to the particular
case of a barter economy that does not possess capital, i.e., to a basic, Robinson Crusoe type of
economy. In a contemporary economy, the processes of saving and investment do not require
the prior accumulation of consumer goods or their intermediate products.
Once we have shown how saving and investment function from this perspective, we will deal
with the problem of how savings are accumulated and used in a contemporary economy, i.e.,
an economy that possesses money and physical capital. We will show that every economy has
an “investment fund” of capital, which is used for capital substitution and investment. Based
New Perspectives on Political Economy [ 5 ]
on this view, we will also show how this fund can compensate for the capital depreciation, thus
avoiding the necessity for net saving on the part of the economic agents. In other words, we
intend to show that net saving is not a prerequisite for economic growth.
Saving in a monetary, capitalistic economy
In order to reveal the real problem, we will make use of the standard example used to introduce
saving, namely, the case of Robinson picking berries to feed himself. Robinson lives on a
deserted island, and the only way for him to survive is to pick berries from the trees. His problem
is that he cannot get many of them and must work most of his time just to survive. If Robinson
had a suitable stick, he could pick berries with less effort and, therefore, either get more berries
in a single day or work less time for the same number of berries he used to eat before. The
problem is that in order to create a suitable stick, Robinson needs time just for this purpose, but
this will prevent him from picking berries, and he will starve. The way out of this unfortunate
situation is for Robinson to save some berries, i.e., to curtail his current consumption and create
a stash of berries over some days, which he could use to sustain himself during the period of
stick production. After the necessary amount of berries has been accumulated, he creates his
stick and becomes much more productive.
We must note several apparent facts. First, the Robinson economy does not possess any capital,
and second, it does not use money (i.e., a barter economy). In economic terms, what Robinson
does can be explained in the following way: He produces the usual amount of consumer goods
(berries) for some days but sets some of them aside. In a later period, he consumes his saved
consumer goods (berries, now considered capital goods) while producing fixed capital (a stick)
in the meantime. He invests his effort and capital (stashed berries) into the production of a
durable capital good.
The above describes the simplified view that determines the contemporary ideas about what
saving and investment are. The problem with it is that it is derived for the most simple, basic
case of an economy, and due to this fact, alternative ways to implement saving/investment
cannot be observed. In other words: the model used is oversimplified. In particular, we note
that in order to save, Robinson must first produce the berries, and just then, when the stashed
berries are available, can he use them. In a contemporary economy, the process of saving
includes money, however. Thus Robinson would save not berries but money. However, whereas
berries constitute a consumption (or a capital) good, money does not. Money is not used up in
consumption or production; it is the ultimate exchange good. Thus when Robinson saves money,
New Perspectives on Political Economy [ 6 ]
he does not implicitly save consumption goods. Besides, since he has curtailed his consumption
(does not spend the money on consumer goods), fewer consumer goods are produced on
the market. However, what immediately follows is that if he lends his saved money to a capital
good producer, he does NOT implicitly transfer consumption goods. The reason for the latter
is straightforward: by not consuming, he has decreased the demand for consumer goods,
and in a short transitional time, the consumer goods produced by the market will decrease in
order to comply with (match) this fact. The act of saving is indeed preceded by the production
of consumption goods or their intermediate products. Still, this does not mean that these
consumption goods will be accumulated in order for the investment to take place. In practice,
the unused consumption goods will be sold either at a loss or at prices corresponding to a rate
of profit below the prevalent one in the economy at that time. The latter will immediately force
the producers to cut down production soon.
What we explained above stays in stark contrast to the contemporary economic views
that Robinson hands out consumption goods to the capital producers for investment. The
contemporary Austrian economics views assert that Robinson gives the capital producers
consumption goods that they use for paying their workers and for sustaining themselves. Let
us quote Ludwig von Mises (1990, ch.4): “Capital goods come into existence by saving. A part
of the goods produced is withheld from immediate consumption and employed for processes
the fruits of which will only mature at a later date”. Alternatively, we can quote Huerta de Soto
(2012, pp.275) (more explicit): “Saving always results in capital goods, even when initially these
merely consist of the consumer goods (in our example the “berries”) which remain unsold (or
are not consumed). Then gradually some capital goods (the berries) are replaced by others (the
wooden stick) as the workers (Robinson Crusoe) combine their labor with natural resources
through a process which takes time and which humans are able to go through due to their
reliance on the unsold consumer goods (the saved berries). Hence saving produces capital
goods first (the unsold consumer goods that remain in stock) which are gradually used up and
replaced by another capital good (the wooden stick)”.
As we explained, however, this is simply not the case in a contemporary economy for the
following reason: Robinson has decreased his consumption of consumer goods, but instead
of these goods being produced first and handed out to the capital producers later (as in the
basic Robinson economy) they are simply NOT produced. However, something which is not
produced (does not exist) cannot be given to anybody. Let us give an example to clarify the
situation. In a particular economy, the consumers are used to going to a restaurant on average
New Perspectives on Political Economy [ 7 ]
once per week. Suddenly they decide to eat out once every two weeks. The result will be that
if the restaurants have produced X amount of services before, they will have to produce half of
that amount (X/2) after consumer preferences change. The non-produced restaurant services,
however, simply do not come into existence. However, since they are not created, there is no
way for them to be transferred to somebody else (i.e., to the capital producers). Note that we
have purposefully used services in our example, but the same situation can be described with
material goods.
The quotation from Huerta De Soto above shows in particular how the Austrian economic
theory has generalized from an oversimplified model situation of an isolated individual to a
general economic model valid for the whole economy. Further examples for the latter can be
found in Rothbard (2009, ch.1/8,9).
How saving turns into investment in a monetary, capitalistic
economy under invariable money
After we explained what the real problem with the contemporary views is, we can try to clear
up the confusion. Let us figure out what happens in a contemporary economy when Robinson
saves money out of his monetary income. The first direct consequence will be that the demand
for consumer goods will go down. After some (transitional) time, the consumer goods producers
will realize that the demand has slackened. They will adjust to the new market situation by
producing less, and therefore they will curtail the production of consumption goods. Lowering
their prices permanently is not an option for them since this will either entail direct losses or
simply diminish their profits below the going rate of profit typical for the particular economy.
What that means is that resources will have to be freed. In the case of the previous restaurant
example, this means the following: People will be laid off, buildings will be left free (the
restaurants themselves), the capital equipment used for the restaurant business will not be used
(bought). In addition, intermediate capital goods, such as meat, flour, and oil, will not be used
(bought). Note that the above represents all basic types of capital: original means of production
(land and labor), fixed (houses, cooking stoves, tables,etc.) and circular (unprocessed meat,
etc.). However, let us now imagine what will happen to the suppliers of these restaurants. The
suppliers of restaurant equipment (of stoves, for instance) will also realize that their products are
not needed. Thus they will also curtail production, again releasing people, production facilities,
etc. Later their suppliers (of metal parts for stoves) will also have to do the same. And the
suppliers of the suppliers (which create the metal for the metal parts) will also have to release
resources. What we observe is the following: the initial act of saving causes the release of capital
New Perspectives on Political Economy [ 8 ]
(original, i.e., land and labor, fixed and circular one) up the production chain. A simple change
of consumption habits affected all branches that produced intermediate capital goods geared
towards the production of consumer goods and services (restaurant services in particular).
To summarize what has happened: The act of saving led to a release of capital of all sorts in the
industries, which were dependent on the production of the particular good, whose consumption
has decreased. This is precisely the capital that can be used for investment afterward. Up to this
moment, it was geared towards the final production of consumer goods, but once released, it can
be geared into another direction, namely towards the production of fixed capital goods such as
trucks, oil-tankers, etc. The latter will happen because the saved money will fill the bank coffers
(to keep the situation simple). Banks will lower the interest rates and extend credit to producers
of durable capital goods. For example, the building of a new shipyard will be started. Thus a
part of the resources will flow towards shipbuilding (i.e., labor, building materials, machines,
etc.). The needs of the ship-builders will have to be matched by their suppliers, however. Thus
another part of the freed capital will flow towards the suppliers and later to the suppliers of the
suppliers. As we see, the released capital will find new uses, all of them with the final goal to
produce durable capital goods. Note that no additional consumer goods for support during the
transition period and during the time necessary for the shipyard production are required. The
same people who worked in the restaurants before will now work in the shipyard (for example),
and since they are employed and paid, they can provide for their existence. No previously
accumulated quantity of consumer goods is needed. The overall production of consumer goods
has decreased, and that is why the consumption of the workers from this moment on will be
lower for some time (until the additionally accumulated capital gets operational and raises their
incomes). They had voluntarily agreed to consume less than before the transitional process
took place in order to be able to consume more in the future. Thus the so-called “subsistence
fund” (Mises 1912), which supposedly consists of saved consumption goods or alternatively of
saved intermediate products used for producing consumer goods, does not play any significant
part in a contemporary monetary, capitalistic economy. Providing for the needs of the economy
out of current production is the most efficient use of capital possible since no capital is idle at
any time, i.e., no consumer goods need to be stored.
The building of an industrial plant can serve as an example. Building a plant takes at least
several years. During this time, the people working on it must be fed, and this happens from
current production, not from some previously saved amount of food for consumption or from
saved (delayed) intermediate products for food production (such as saved wheat) that are
New Perspectives on Political Economy [ 9 ]
brought to completion. The same applies to the materials used for building the plant. Steel is
being created on-demand, i.e., iron ore is typically mined and processed to steel in the same
year (time period) in which it is needed. No previously accumulated amounts of steel or iron ore
(an intermediate product) are necessary.
Note that the above-given description is simply a description of a transition of an economy
that moves from producing less to producing more durable capital goods. How secular growth
happens and what the differences are will be handled in the subsequent part of the paper. Still,
we must note some significant differences when comparing the discussed process to the one
present in the simple Robinson Crusoe economy. In the Robinson case (no capital, no money),
we need to produce consumption goods first, and only then can we start producing new capital
goods. In a contemporary economy, however, this is simply not necessary. The intermediate
step (producing consumption goods for sustaining Robinson) is simply passed over. What this
shows is that the contemporary economy is much more efficient in using the available capital. In
particular, less capital will be used (just the one necessary for the production of the final durable
capital goods), and much less time will be needed (no time for the production of consumer
goods is required). A contemporary economy has more degrees of freedom than the basic
Robinson Crusoe economy. It has a capital structure and money, i.e., additional ways for capital
redistribution exist. In other words, a contemporary economy is much more flexible and efficient
with respect to the capital transfer and capital usage.
Accumulation of savings, capital depreciation and growth in a
monetary, capitalistic economy under invariable money
Once we have dealt with how net saving is converted into investment in a contemporary
economy, we could deal with how these savings are accumulated and used. The necessary
simplification for the following discussion is to consider an economy with invariable money
only, i.e., the case of 100% fractional reserve with no new money creation. The case of increasing
money supply will be omitted for the sake of simplicity of explanation. Furthermore, we will
limit most of our discussion to the case of extensive growth, i.e., we intend to show how the
overall capital in an economy can grow without considering the technological progress. The
accumulation of information and technological knowledge are essential drivers of growth, but
we intend to show how simple capital accumulation can happen even in their absence.
In every economy, the amount of capital available and the fixed capital in particular (machines,
tools, buildings, etc.) continually depreciates. In other words, this capital wears out and needs
New Perspectives on Political Economy [ 10 ]
substitution if the particular economy is expected to grow. Presently there are two significant
Austrian economics views on how an economy can compensate and overcompensate this loss of
capital so that economic growth becomes possible. In the first one, represented in Hayek (1967)
and Rothbard (2009), the rate of interest must always go down for sustained economic growth
to take place. Thus the economic agents are supposed to not only save but save progressively
more with the growth of the economy. In the second, more popular one (Garrison 2002), the
rate of interest can stay the same, but the economic agents must nevertheless save some
part of their monetary income. What is common between these two views is that net saving
is always necessary for an economy to grow ( increasing in the former case and constant in
the latter). Both theories claim that net saving is necessary to offset the real depreciation and
allow the economy to grow. From here, it follows that both ordinary workers in companies and
the businessmen who run these companies must put a part of their monetary income/profits
either in a bank account or in another saving option (for instance, by buying company bonds
or shares). The latter must happen on the average (i.e., not everybody needs to save) and must
be continuous (i.e., saving never stops).
We intend to discuss the consequences of the above-given view for a banking system in an
economy with invariable money. We will further accept that under invariable money, the banking
branch of the economy functions in the same way as any other economic branch (i.e., retail,
ore-mining, etc.). In other words, we will presume that the conclusions we derive from the
banking system will apply to the other branches of the economy as well. We have singled-out
banking because the processes we will describe are simpler to observe and more evident in this
particular case from an economic standpoint.
Banks always have some amount of own capital, but most of the capital comes from outside, i.e.,
from savers who entrust the bank with the task not only to protect the amount of money they
have put in it but also to increase it (i.e., they expect to be paid interest on their bank account
balances). Banks on their side lend the money they have obtained against interest (note again
that the discussion takes place under invariable money). They are motivated to protect the
monetary capital they have, and therefore lend it at such a rate of interest and choose their
clients in such a way that they generate profit. Thus on average, the capital in the banks does
not decrease. What this implies is that whatever capital is being lost ( e.g., bad loans and bank
capital depreciation) will have to be compensated. And it is being compensated by a part of
the banking revenues. Let us, however, assume the contrary and see what follows from it. We
will first presume that bank capital depreciation must be compensated by additional savings
New Perspectives on Political Economy [ 11 ]
on the part of the banking clients. Savers, however, will expect that the additional money they
put into their savings accounts is also protected, i.e., they will expect that their money does
not decrease, i.e., that it is not lost. If this were not the case, they would simply withdraw their
money from the bank. However, the latter would imply that the banks cannot use the additional
savings to compensate for the depreciated/lost capital. What is more, for steady growth in
time, we must presume that savers never stop saving. Still, reality shows that savers save up for
something (“SUFS,” as discussed in Garrison (2002), pp.40), i.e., when a particular amount of
savings is reached, then people stop saving on the average. Still, they should never stop saving
if the depreciated capital is to be continuously compensated. All of the above leads us to a
contradiction, which implies that our initial supposition is not correct, i.e., that the depreciated/
lost capital in banking is not compensated by net saving on the part of their clients.
Up to this moment, we showed that external savings (from clients) could never be used to
compensate for the depreciated/lost capital, which by itself is a significant conclusion. But
what about the banks themselves? Maybe they save and compensate for the mentioned
depreciation? The answer to this question is negative since banks (and businessmen in general)
view the money used for compensating the depreciation as explicit costs. In the same way, as
for ordinary workers, net saving comes out of net income, in the case of businessmen net saving
can come only from profits, which are the difference between revenues and costs. However,
since the money for capital maintenance represents explicit costs, it can never come out of net
saving on the part of the businessmen. Therefore depreciation cannot be a cost and net saving
at the same time. In other words, depreciated capital cannot be restored out of profits. Note
that the usage of net saving for capital depreciation contradicts the view that savings represent
accumulated purchasing power to be exercised later. If net saving was used to compensate
the capital depreciation, it would be lost forever, i.e., the purchasing power could neither be
accumulated nor exercised later.
This general point is important and needs further discussion. Suppose that we have a company,
which up to this moment has had costs X and revenues Y. Suddenly something adverse happens,
and it loses some capital. Of course, the company will have to cover this unexpected loss from
the revenue Y, and consequently, it will have to make do with a lower profit. This one-time
loss, however, will not lead to a permanent drop in the profits. The company will raise its sales
prices in the future so that it can compensate for such (regular) losses. Since the depreciation is
predictable, it can be taken into account, and the sales prices which the company asks for can
be set high enough to compensate for this particular loss. We wish to stress that the average
New Perspectives on Political Economy [ 12 ]
rate of profit for the company is determined by the going rate of profit in the economy and
cannot be permanently lowered because of the depreciation losses.
What all of the above shows is that this branch of the economy can protect its capital without
the need for net saving in general. Still, depreciation must be compensated somehow, and
companies do it by passing their depreciation costs to their clients, i.e., by raising their sales
prices, as a part of their revenues, but not at the expense of their profits.
A corollary from the above discussion is that capital depreciation losses are identical to the
general capital losses (due to bad management decisions, economic disasters, bad luck, etc.).
All of these losses are being covered by the revenues of the (successful) companies. Thus
singling out depreciation as the only loss in an economy, which is to be compensated, is a
wrong approach. One should ask himself how all the losses inherent to an economy are to be
compensated. As a side note, it must be pointed out that even the production of intermediate/
circular capital goods entails production losses. These losses are covered in the same way
as depreciation, namely, through raising the production sales prices. An example: A mining
company produces iron ore. A part of the produced ore gets lost during the transportation
process from the mine to the flotation facilities and during the flotation process itself. This
loss is added to the production costs, i.e., taken into account when forming the end product
price. Thus if the iron ore production losses increase for whatever reason, the end price will
increase, but if a new technology, which has lower losses, is introduced, the end prices can
decrease (typically due to competition). As we see, compensating losses of all kinds is done
by increasing the sales prices at the expense of the company’s clients. These losses become a
part of the cost of production (the cost of doing business). Despite all of the discussed, we will
continue considering depreciation as the only form of capital loss in order to adhere to how
this is traditionally done in the economic literature. And the reason will be that the extension
to the case when we include all losses is straightforward and will change nothing in the line of
reasoning or final conclusions.
Up to this point, we were discussing only banking. The rest of the branches of the economy
however, are not supposed to work differently under invariable money. Thus in them, capital
depreciation will also be compensated by their revenues. From here, we can generalize that
since an economy is all economic branches taken together and since no net saving is required
in any branch, then net saving is not necessary for the existence of the economy in general. In
other words, net saving is not necessary for compensating the economy-wide capital losses.
New Perspectives on Political Economy [ 13 ]
Once we have dealt with the net-saving issue, we can discuss the source of capital used for
compensating the capital depreciation. As we discussed above, depreciation losses are being
compensated by the revenues. Thus we have to explain how on a macro level, there is an excess
of capital available for compensating losses (and depreciation in particular). In other words, how
companies can pass their losses to their clients without decreasing the amount of gross savings
in the economy as a whole. Here comes the contribution of George Reisman [Reisman 1990],
who noticed that gross saving is able to reproduce itself. In particular, Reisman noticed that
an economy produces not only consumer goods but also fixed/final capital goods. The latter
is not clearly visible in the contemporary views about the structure of an economy, i.e., in the
Hayekian triangle [Hayek 1967]. In such a structure, the fixed/final capital goods are supposedly
just an intermediate station towards the production of consumer goods. They are not explicitly
shown (and can not be shown in general), which makes them practically invisible, but still exist.
Note that it is the fixed capital goods that depreciate in an economy, not the circular capital
goods or the original means of production (land and labor). However, if we admit that an
economy produces final/fixed capital goods, then we must realize that these newly produced
fixed capital goods can be used to compensate for the depreciated/lost ones. Then it becomes
a matter of quantitative difference between the produced and depreciated fixed capital goods
to determine if an economy retrogresses, is in a stationary state, or grows. If we manage to
reach the state where the produced fixed capital goods compensate for the depreciated/lost
ones, we will find ourselves in a situation where the economy self-supports itself. Once we have
reached it, we need not put any additional effort in order to create capital goods, i.e., no net
saving will be necessary. The process will become self-sustaining, i.e., it will feed on itself. In the
exact sciences, such systems are called positive feedback systems. These systems do not require
to be driven; they drive themselves.
Now the question we have to ask ourselves is how to reach such a state, in which an economy
produces more fixed capital goods than it loses. Let us remind ourselves that the production
of capital goods and consumption goods are complementary ones. In other words, we can
only produce more of the one type at the expense of the other type. At any moment, however,
the overall productive ability of the economy is limited. The latter is best exemplified with the
famous Guns and Butter graph [discussed in Garrison 2002]. We can use the available resources
for producing different goods in an economy at a particular stage of development, but we have
a technologically determined limit, which we cannot surpass. Still, it is a matter of our choice
where we decide to be on this particular graph. Thus every economy has a choice to produce
more capital goods (fixed capital in particular) at the expense of consumer goods or vice-versa.
New Perspectives on Political Economy [ 14 ]
Note however, that the particular amount of capital that the economy possesses will depreciate
in the same way, independently of what we produce. Thus the depreciation rate is fixed, but how
much new fixed capital we produce depends on us. Therefore, if we decide to place ourselves in
a situation (on the graph) where we produce enough capital goods to counter the depreciation,
we will find ourselves in a stationary economy. In the same way, if we decide to produce more
capital goods than the ones being lost due to the depreciation, we will find ourselves in a
growing, self-sustaining economy of the positive feedback type discussed above.
What we established so far is that an economy can grow by self-supporting itself, which in
practice means that no net saving will be required on the part of the economic agents. Thus an
economy can have zero net saving and still have a positive net investment. Still, the question
stays how we move the economy from producing fewer capital goods to producing more so
that we compensate for the lost/depreciated capital. The answer to this question is simple: by
saving, as described in section 3. Thus if we do not produce enough fixed capital goods to offset
the existing depreciation, we start saving, i.e., let net saving get positive. What will happen is
that fewer consumption goods will be produced, and the released economic resources will
be re-targeted towards the production of fixed capital goods. But once we find ourselves in a
situation where we produce enough fixed capital goods to over-compensate the depreciation/
losses, we can stop net saving, and the economy will still grow.
From now on, we will call the amount of capital used for capital substitution and investment
“the investment fund.” In contrast to the “subsistence fund,” the investment fund consists of
all types of economic resources, not only of consumer goods. The investment fund includes
all three basic types of capital, namely, original means of production (land and labor), fixed
and circular capital used in all the stages of production. The latter can be observed when
one realizes that banks give loans for hiring labor ( original means of production), for buying
machines and buildings (fixed capital) and for buying supplies for production (circular capital).
The “investment fund” is self-sustaining, and it is constantly invested and reinvested. It is the
extension of the concept of “subsistence fund” into an economy that, in contrast to the one
of Robinson, possesses capital and money. As such, the subsistence fund is meaningless for a
contemporary economy and cannot be a part of a modern theory of capital.
It is instructive to describe how new investment is possible in a simple economy that grows
with zero net saving. A simplified example is an economy under invariable money in which
the only way to save and invest is through the banking system. In other words, we presume
that the profits in the economy for the regular companies are entirely consumed, and the
New Perspectives on Political Economy [ 15 ]
only money available for investment can be obtained through the banking system. Thus banks
have a constant amount of money, which they use for investment into the economy. However,
there is no net saving, since on the average economic agents will not save. The saving of
some (e.g., young people, saving for retirement) will be offset by the dissaving of others (i.e.,
retirees drawing down their savings). The latter will guarantee that the amount of bank money
used for investment purposes will stay constant. As already discussed, banks can cover their
capital depreciation losses from their revenues. We observe that funds will be invested, i.e.,
some companies will get loans to support their future operations, thus being able to invest
in new technological processes. Still, the latter happens without the presence of net saving.
Once the loans extended for investment are paid back, the same money will be lent out again,
thus ensuring the continuity of the investment process in time. All of the above stays in full
compliance with George Reisman’s views (Reisman 1990, ch. 15) but described from a different
perspective.
Given all of the above, we can generalize that an economy can grow with positive net saving
(well known), with zero net saving (just discussed) and even for a while with negative net
saving. The latter may happen if the investment fund has initially been big enough to guarantee
economic growth and its decrease due to the negative net saving has not brought it to equality
with the depreciation yet.
We could contrast the process of secular growth we just described with the transitional process
we described in section 3. During the transitional process, net saving was present, and it led
to re-directing resources from lines of production, leading towards final consumer goods to
lines of production leading towards durable (fixed) capital goods. A shift of capital towards
the investment fund happened. During the process of secular growth described above, no
net saving is present, but net investment still exists. No capital gets shifted in or out of the
investment fund, but still, the economy grows because investment in all production lines is
present.
Conclusions
In a contemporary economy, the processes of saving and investment are based on money.
Thus the availability of a previously accumulated amount of consumer goods or of intermediate
products of the consumer goods to make investment possible is simply not necessary. In this way,
in contrast to a Robinson Crusoe economy (no capital, no money), saving-induced investment
takes place without producing consumer goods first.
New Perspectives on Political Economy [ 16 ]
We showed that every contemporary economy has an “investment fund,” i.e., an amount of free
capital that is self-sustaining and is used for capital substitution and investment. When the size
of this investment fund is big enough, it can compensate for the existing capital depreciation
and let the economy grow without net saving being present. In this way, we show that an
economy supplies by itself the necessary funds for compensating capital depreciation and all
economic losses in general.
References
Huerta de Soto, Jesus (2012), Money, Bank Credit, and Economic Cycles. Auburn, Alabama:
Ludwig von Mises Institute.
Garrison, Roger (2002), Time and Money., New York, NY: Routledge
Hayek, Friedrich (1967), Prices and Production. Auburn, Alabama: Ludwig von Mises Institute.
Mises, Ludwig (1912), Theory of Money and Credit. Liberty Fund
Mises, Ludwig (1990), Economic Freedom and Interventionism: An Anthology of Articles and
Essays. Auburn, Alabama: Ludwig von Mises Institute.
Reisman, George (1990), Capitalism. A Treatise on Economics. Laguna Hills, California: TJS Books.
Rothbard, Murray (2009), Man, Economy, and State with Power and Market. Auburn, Alabama:
Ludwig von Mises Institute.
Bio
Youliy Ninov
Independent scholar
New Perspectives on Political Economy, Vol. 16, No. 1-2, 2020
New Perspectives on Political Economy [ 17 ]
Income Inequality and Poverty: Are We
Asking the Right Questions?
Bradley K. Hobbs, Clemson University
Nikolai G. Wenzel, Fayetteville State University
I
t is frequently taken for granted that income inequality is a problem in the US. This
paper examines the data and confirms that income inequality does indeed exist in the
US – and has been rising in the past 40 years. There are, however, two problems. First,
the rise in income inequality masks a significant improvement in the lot of the poorest
Americans. Second, government efforts to reduce inequality – much like government
efforts to reduce poverty – are likely to have unintended consequences that hurt the poorest.
The paper concludes with international data and general analysis. Too much poverty persists and
income inequality can have some negative consequences; however, government efforts should
not target inequality, but should instead focus on reducing barriers to earning.
Acknowledgments
For comments and feedback, thanks to Nathan Schlueter, Steve Horwitz, Shane Courtland,
John Tomasi, and participants at colloquia at the University of Minnesota-Duluth, Western
Carolina University, Florida Gulf Coast University, and the Asia Institute for Political Economy at
Hong Kong University. We also thank two anonymous reviewers. The usual disclaimer applies.
Introduction
Income inequality has galvanized many Americans, including economists and public
intellectuals. The issue is inevitably more complex than a news soundbite. First, we need to
ascertain the breadth and depth of income equality. Second, in the classical liberal tradition,
we must recognize that any policy addressing inequality will inevitably trigger a cascade of the
ubiquitous unintended consequences accompanying any government action. In short, it is
prudent to tread cautiously in adopting policies, lest the unintended consequences overwhelm
the intended ones.
New Perspectives on Political Economy [ 18 ]
We will argue in this paper that income inequality has indeed been rising in the US over the
past 40 years, but (a) it is not the problem that many say it is; and (b) efforts to reduce income
inequality will likely end up hurting the poorest Americans. There is too much poverty in the
US (if only in the sense that it is largely avoidable, if only the economy were allowed fully to lift
up the poorest) – but income inequality is the wrong problem, and most policies to reduce it
will ultimately be detrimental, especially to the poorest.
We address the problem of income disparity in four sections. Section one discusses income
disparity trends in the US over the past 40 years. Section two examines the economic importance
of these trends. Section three examines the costs of addressing income inequality. The final
section concludes.
Income Inequality in the US
Prior to any policy discussion on income inequality, we need to assess its current status.1
We
begin by examining income statistics in the U.S. from 1970 to 2007. This 37-year period is
sufficiently long to be representative. But we intentionally end the table’s data in 2007, because
of the distortionary effects of the housing bubble, recession, recovery, and bailout.2
SHARE EARNED
Year Lowest Fifth Second Third Fourth Highest Fifth
1970 4.1 10.8 17.4 24.5 43.3
1980 4.2 10.2 16.8 24.7 44.4
1990 3.8 9.6 15.9 24 46.6
2000 3.6 8.9 14.8 23.4 49.7
2007 3.4 8.7 14.8 23.4 49.7
% Change -0.7 -2.1 -2.6 -1.1 6.4
Table 1. U.S. income by quintile, 1970-20073
1 We note that inequality is ultimately about consumption opportunities; but production (income) must precede consumption,
so we discuss that first, and turn to consumption in the next section.
2 We speculate that the recovery process favored political activity over economic activity, thus increasing income
inequality – as did the growth of government. But the issue is sufficiently complex to make for a separate paper.
3 http://www.census.gov/data/tables/time-series/demo/income-poverty/historical-income-households.html Table H-2
New Perspectives on Political Economy [ 19 ]
Table 1 shows U.S. income divided amongst five quintiles of income earners. Note that we
are intentionally using earner, indicating that income is “earned” rather than “taken.” Indeed,
Hazlitt (1973, 186) reminds us that “the real problem of poverty is not a problem of ‘distribution’
but of production. The poor are poor not because something is being withheld from them,
but because, for whatever reason, they are not producing enough. The only permanent way to
cure poverty is to increase their earning power.” We should note that in a world of high barriers
to labor entry, including licensing requirements, something is indeed being withheld from the
poor: the opportunity to make an honest living (we discuss this below). But in a society honoring
private property and the rights of individuals, income must be earned through production, not
expropriated or taken.4
Under an economic system honoring these – capitalism – one earns
by producing goods and services and trading their production (or the income earned from
production) under mutually-agreed upon, voluntary terms of trade. As does Hazlitt (1973,
56), we prefer to use the more accurate expression “income variation” rather than the popular
moniker “income distribution” (which implies that economic output is a given, and that some
entity is taking, and then distributing, income).
From Table 1, we see that there has been an obvious increase in income variation in the U.S. The
share of income earned by the lowest quintile of earners has fallen from 4.1% to 3.4%, a drop of
0.7% of the total, from 1970 to 2007. Likewise, the share of income of the bottom four quintiles
has also fallen. The share of income earned by the highest quintile increased from 43.3% in
1970 to 49.7 percent in 2007, an increase of 6.4%. It is beyond dispute that income variation
has increased in the past 40 years. It is also beyond dispute that the highest quintile of earners
is earning almost half of national income.
However, some observations are worth noting about this quick snapshot. Income mobility
is a bigger, separate question; but we note here that a majority of people in the bottom 20%
have also been in the top 20% sometime in the past 30 years. Less than 1% of the American
population remains permanently in the bottom 20% of income earners. Of those in the middle
quintile in 1996, 42% moved to a higher quintile by 2005, 25% went down, and only one third
remained in the middle quintile (Sowell 2015, 182).
Horwitz (2015) notes the importance of looking at the dynamic aspects of income distribution,
and in particular, upward mobility in the US: “the story is the same for most US households:
4 Assuming the US is indeed a capitalist system, although one third to one half of the economy controlled (directly or
indirectly) by the state, and political activity increasingly rewarded over economic activity. We discuss the effects of cronyism
below.
New Perspectives on Political Economy [ 20 ]
they enter the income ladder near the bottom and, over time, work their way up through
several of the quintiles. As existing households move up the ladder, the bottom is filled in by
new households just entering the process. That’s why more households can move up than
down – the set of households changes year to year.”5
The numbers are the same for the poorest
as for the middle class. Iceland (2013, 48) reports that 45-59% of those in poverty are in poverty
for only one year, 70-84% for four years or less, and only 12% of those in poverty remain there
for 10 or more years.6
This indicates high fluidity within the distribution, a fact that is linked to
life cycle patterns on both earnings and expenditures.
As we look at statistics, we also must be careful about the typical data used, which measure
households rather than individuals. For instance, there are 39 million people in the bottom 20%
of households, while there are 64 million people in the top 20% of households.7
While there
may be good reasons to choose household income over individual income, we simply want
to acknowledge that assumptions will significantly affect these statistics. Given the passions
surrounding income variation, this is particularly important to address forthrightly.
Poverty and Inequality: Are We Asking the Right Questions?
The major question that is sidestepped by the statistics on income variation is the distinction
between absolute income, and relative income variation – that is, the lot of the poorest and
their ability to purchase basic necessities, rather than their status compared to others. Perhaps
the biggest puzzle – and marvel – lies in explaining how large swaths of humanity slipped the
chains of poverty at all. To be blunt, until the mid-18th
century there was too little income for
anyone to worry about questions of “proper” variation. For almost all of humanity, the norm
was deep, omnipresent, and dire poverty. Income disparities have been common for thousands
of years, and were far more egregious prior to the growth of modern capitalism (see Sowell
2015, 1). What, then do income disparities over the past 40 years tell us – and what do they hide
about the deeper, more important problem of poverty?
5 For an alternate explanation to income disparity – beyond upward mobility or cronyism, see Goodhart et al. (2015),
who simply point to demographic trends affecting returns to labor versus capital.
6 Iceland (op. cit.) also indicates that there is a high risk of return to poverty. I leave details to further work.
7 On household composition generally, see Russ Roberts, „Inequality and Stagnation,“ http://cafehayek.com/2012/02/
inequality-and-stagnation.html
New Perspectives on Political Economy [ 21 ]
SHARE
Year
Lowest
Fifth Second Third Fourth
Highest
Fifth
GDP8
% Change GDP/CAPITA9
% Change
1970 4.1 10.8 17.4 24.5 43.3 4269 n/a 24,000 n/a
1980 4.2 10.2 16.8 24.7 44.4
5839 37% 30,000 25%
1990 3.8 9.6 15.9 24 46.6
8033 88% 37,000 54%
2000 3.6 8.9 14.8 23.4 49.7
11226 162% 46,000 92%
2007 3.4 8.7 14.8 23.4 49.7
13206 209% 52,000 117%
%
Change -0.7 -2.1 -2.6 -1.1 6.4
x3 x2
Table 2. US income by quintile, with real GDP growth, 1970-2007
We can start this discussion by looking at table 2, which replicates table 1, but with the addition
of inflation-adjusted (real) US GDP and US GDP/capita for the years in question. We have
already noted changes in income disparity over that time. But it is also important to note
that real GDP in the US increased by a factor of three between 1970 and 2007. Contributing
factors included a dynamic economy that achieved productivity gains, globalization of trade,
significant advances in technology, increased workforce education, and accumulations of capital
(including complementary capital that further increased labor productivity). This means that
from 1970 to 2007, while the lowest fifth of earners in the U.S. did earn a slightly smaller slice of
the economic pie, they were enjoying a slice from a much larger pie. Specifically, the lowest fifth
of income earners in the US, from 1970 to 2007, went to earning 0.7% less of national income,
but that income had increased by a factor of three. The gains are slightly lower if we account
for population growth by examining GDP/capita, instead of GDP, but the general lesson is
8 Billions, 2005 dollars
9 Billions, 2005 dollar (rounded average over four quarters); https://fred.stlouisfed.org/tags/series?t=gdp%3Bper+-
capita%3Busa
New Perspectives on Political Economy [ 22 ]
the same. This pattern holds true for all four of the bottom quintiles of income; each earned
a slightly lesser relative share of a real national income that had tripled – we will return to these
absolute gains below. This is particularly important because, those at the bottom of the income
variation benefit the most from general growth; as Hazlitt (1973, 53) explains, if “everybody’s
real income doubles… the marginal satisfactions of those at the bottom of the income scale
are increased by more than the marginal satisfactions of those at the top. The latter merely
buy more luxuries, or save more; the former can afford more necessities. Hence even a merely
proportional increase in unequal incomes tends to reduce inequalities in real welfare. Or to put
it another way, the proportional inequalities tend to mean less.”
Mean Income in 2010 Dollars
Year Lowest Quintile Second Third Fourth Top Fifth
1970 10,854 29,403 47,348 66,740 118,155
1980 11,808 29,388 48,494 71,444 127,381
1990 12,608 31,723 52,399 79,003 153,315
2000 13,979 34,903 58,125 90,357 195,803
2007 13,205 33,656 57,120 90,435 192,014
Change 22% 15% 21% 36% 63%
Table 3. US mean income by quintile, 1970-200710
A similar result comes from table 3, which shows inflation-adjusted mean income in the US from
1970 to 2007. Not surprisingly, given the tripling of the size of the economy, mean income has
increased significantly for all quintiles. For example, the inflation-adjusted mean income of the
lowest quintile of earners went from $9,982 to $12,147, a real increase of 22%. While income
gains have indeed been largest for the top quintile, we should also note that mean income
has increased by 15 to 20% for the lowest three quintiles, and has increased for all quintiles. In
short, the oft-stated and well-trotted idiom that “the rich are getting richer, while the poor are
getting poorer” implies that only the rich have gained. This static view of economics as a zerosum
game is as inaccurate as it is misleading.
10 http://www.census.gov/data/tables/time-series/demo/income-poverty/historical-income-households.html Table H-3
New Perspectives on Political Economy [ 23 ]
Year Inflation-Adjusted Median Income Growth
1970 47,281 n/a
1980 48,518 2%
1990 52,684 11%
2000 57,790 22%
2007 57,423 21%
Table 4. Inflation-adjusted US median income growth, 1970-200711
We now turn to table 4, which gives data on real median income. In 1970, inflation-adjusted
median income was $47,281; in 2007 that figure had increased by 21% to $57,423.
One last point rounds out our analysis of income variations: the drop in the consumption gap.
“Poor Americans today live better, by…measures [of consumption] than did their middle class
counterparts in the 1970s” – “as a result, inequality of consumption is far less than inequality
of income or wealth” (Horwitz 2015). This increased consumption comes from several sources:
first, worker productivity gains (leading to increased purchasing power per hour of work);
second, lower inflation-adjusted prices for many of the goods consumers purchase, due to
greater manufacturing productivity;12
and third, diminished barriers to trade, which have allowed
producers to produce at lower opportunity cost, and thus lower prices (Horwitz 2015). It is
important to note that the first two factors originate in physical and human capital accumulation,
a point to which we return below.
Horwitz (2015) gives examples of the impressive changes in consumption opportunities.13
A basic bundle of household appliances cost the average worker 885.6 hours of work in 1959,
versus 170.4 hours of work in 2013.14
During that time, the “hours-of-work” cost at the average
11 http://www.census.gov/data/tables/time-series/demo/income-poverty/historical-income-households.html Table H-6
12 Between 1987 and the first quarter of 2017 real output in manufacturing rose by approximately 85% while employment
in that sector fell from 17.5million to 12.4million . < http://www.pewresearch.org/fact-tank/2017/07/25/most-ameri-
cans-unaware-that-as-u-s-manufacturing-jobs-have-disappeared-output-has-grown/>
13 A counter-argument to this line of reasoning holds that consumption is a skewed measure, because the poorest are
financing this consumption with debt. We acknowledge that low savings rates, loose monetary policy, lax lending standards,
and shifting norms on debt are worthy of further research. For present purposes, we note that income has increased, and
prices have diminished, so the rising income gap hides a falling consumption gap.
14 Beyond consumer goods, Horwitz (2015) also discusses the rising real prices of healthcare, housing, and education.
He notes that all three of these sectors are heavily subsidized and regulated, which accounts for the rise in price. And, at
least for healthcare and housing, the quality of goods available has increased dramatically, along with the price; the same is
not true of education, where professional administrators and government bureaucrats are increasingly impeding teaching in
New Perspectives on Political Economy [ 24 ]
worker’s wage fell from 100.5 to 23.3 for a washing machine; 90.9 to 20.7 for a dishwasher; and
127.8 to 20.7 for a color TV – and all these examples do not even consider quality change within
the goods themselves. This is compounded by considering one extraordinary fact: the “whole
range of items commonly found in US households, including poor ones, that did not even exist
a generation ago” (Horwitz 2015). The readily available necessities of today’s millenials was the
stuff of science fiction for their grandparents.
Another way of looking at the increased consumption available to the lowest-income groups
involves looking at the percentage of households that had certain consumer goods just 30 years
ago versus now. In 1984, 58.2% of poor households had a washing machine; in 2005, 68.7%
did (and 84% of all households; Horwitz 2015). During that same period, household ownership
of air conditioners in the lowest income groups went from 42.5% to 78.8%; for computers (not
including smart phones), from 2.9% to 42.4%, and the list goes on. Similarly, Iceland (2013, 27)
notes that food expenditures have fallen from 1/3 to 1/8 of income for the average American
household in the past century; the USDA reports that, from 1970 to 2007, food expenditures
as a percentage of income fell from 14% to 9%.15
In sum, the consumption baskets available
to all income quintiles in the US have expanded rapidly in real ways, with diminished costs and
increased quality. Again, we are not trying to dismiss poverty in the US (poverty, after all, is our
primary motivation), but to contextualize it.
The Cost of Fighting Inequality
Is Income Inequality a Problem in the First Place?
Given our claim in the previous section – that there has been a clear increase in the absolute
well-being of all income quintiles, just as relative income inequality has increased – it bears
pausing a moment to examine some of the rationale behind the prevalent deep concern for
income inequality. We identify three potential problems with income inequality.
First, there seems to be a tribal, visceral reaction against inequality, generally. To many, it just
doesn’t seem right that some should have more than others (see Schoeck 1987 on envy). But
some level of inequality is inevitable. Indeed, people are diverse in many ways, including their
interests, abilities, skills, luck, and choices in consumption versus saving. Relativist perspectives
favor of process. We leave details to a separate paper.
15 USDA, Economic Research Service, Food Expenditure Series, Table 7. http://www.npr.org/sections/the-
salt/2015/03/02/389578089/your-grandparents-spent-more-of-their-money-on-food-than-you-do
New Perspectives on Political Economy [ 25 ]
can easily lead towards a spiraling trap of envy without perspective on the real, tangible, and
absolute improvements in the lives of the poor (improvements that we consider to be insufficient,
and that we want to expand, rather than worrying about relative standing). We argue instead
that relative standing is a distraction from a much more important question: the level of absolute
well-being in our society, and specifically of the poorest among us. Beyond obscuring the real
problem of absolute well-being, envy leads to greater demands for redistribution at the ballot
box. This is problematic because redistribution slows the very economic growth required to
lift the poorest out of poverty, and creates a cycle of unintended consequences. But it is also
problematic because redistribution leads to an idea trap: bad ideas lead to bad policies; in
turn, bad policies lead to bad outcomes; the wrong ideas are blamed, and more bad policies
are adopted. Bad ideas, bad policies and bad outcomes thus become mutually reinforcing
(Caplan 2003). In this case, the redistributive state blocks growth and favors political activity
over economic activity, thus concentrating income at the top. Voters blame markets and
demand more redistribution (and thus more government control of the productive process);
redistribution thwarts growth and increases inequality, but voters blame markets and demand
even more intervention. The cycle continues – and the only way to break it is to scale back
government impediments to wealth creation and access to jobs.
Second, there are concerns about the health of the polity, and social cohesion within a democracy
that exhibits high levels of inequality.16
It is certainly true that high income disparities have
historically been associated with concentrations of power at the top and suffering at the bottom.
Most of the great revolutions of the 18th
, 19th
and 20th
centuries either originated in, or were
fed by, income inequality. The problem is that these revolutions typically replaced one form of
interventionism (feudalism or mercantilism) with another (socialism or communism); the lot of
the poor was not enhanced by these revolutions (which typically expanded the power of the
state, but changed the groups in power) – but by capitalism and rule of law (when they were
finally adopted). Indeed, commercial power can temper absolutism in political power. The great
communist countries of the 20th
century engaged in widespread and persistent democide. As
Friedman (1967) explains that political power has a natural tendency to centralize, whereas
commercial power has a natural tendency to decentralize:
Economic power can be widely dispersed. There is no law of conservation which
forces the growth of new centers of economic strength to be at the expense of
16 Parenthetically, this makes the roots of modern democracy in ancient Athens quite odd. Indeed, discussions of income
equality among the writers of the era are scarce and the consensus of historians is that social and economic inequality
was wide (de Ste. Croix, 1981; Arabaster, 2002; Cavanaugh, 2009; Liddel, 2009).
New Perspectives on Political Economy [ 26 ]
existing centers. Political power, on the other hand, is more difficult to decentralize.
There can be numerous and small independent governments. But it is far more
difficult to maintain numerous equipotent small centers of political power in
a single large government than it is to have numerous centers of economic
strength in a single large economy. There can be many millionaires in one large
economy. But can there be more than one really outstanding leader, one person
on whom the energies and enthusiasms of his countrymen are centered?
Where commercial power joins hands with political power – today’s cronyism17
– political power
enables and exacerbates these problems. We also argue that political capture is a primary
consequence of government expansion, not of income inequality – and income inequality is
primarily a consequence of government inequality, as political activity comes to be favored
over economic activity. As we explain below, state efforts to redistribute wealth contribute to
absolute poverty. A powerful state is more likely to engage in cronyism of all types, relative to
a weak one, thus increasing income inequality – even if the stated purpose was the reduction
of income inequality.
Third, we acknowledge a vast literature that finds a relationship between inequality and lower
growth, lower mobility, lower financial stability, and a host of social ills.18
We argue, however,
(a) that the real problem is poverty and reduced opportunity to produce; and (b) that efforts to
reduce inequality will inevitably backfire.
A Thought Exercise: The Cost of Redistribution
To illustrate the unintended consequences of redistribution, let us assume that lower income
variation is a national priority – to be pursued with eyes wide open and a sober recognition
of tradeoffs. Assuming the redistribution is successful (a benefit, according to our assumed
national priority), there will also be costs. First, there will be a bureaucracy assigned to collecting
and redistributing the income, and there will necessarily be some expense in establishing and
maintaining such an agency. Second, a redistribution of income from top earners will create
disincentives to activities that build earnings. This is likely to occur through both investment
and labor channels (how much will depend on the details of the redistribution scheme). Top
earners will earn less because of the redistributive taxation itself; but they will also reduce their
labor and entrepreneurial efforts in response to the lower marginal returns from those efforts.
17 We prefer „cronyism,“ „democratically-enabled cronyism,“ or „government-granted privilege“ as more accurate wording
than „crony capitalism“ (which isn‘t really capitalism). The protection of economic privilege is enabled by political power.
18 For a summary, see https://www.brookings.edu/wp-content/uploads/2016/06/overstating-inequality-costs-winship.
pdf
New Perspectives on Political Economy [ 27 ]
Likewise, top earners will tend to invest marginal income at a higher rate than lower earners,
who will tend to spend more (or all) of their marginal dollars.19
Government redistribution of
income from higher earners to lower earners may temporarily help the lower earners, but this
will decrease investment, and thus capital growth, productivity, and overall growth. As we
explained above, overall growth is required for poverty alleviation, and benefits the poorest the
most.
The cumulative effect will be less growth in countries that forcibly redistribute wealth. Results
and details vary and are subject, of course, to empirical study, but the principle remains that
every action, no matter how desirable, involves both benefits and costs.20
We now turn to table 5 (adapted from Tomasi 2012, 235). In this hypothetical example, assume
a society with a 4% annual growth rate (“Growth Society”). In a parallel “Redistribution Society,”
government redistribution of income will cause growth to fall to 2% per year – for the reasons
cited above, income redistribution will reduce the overall levels of economic activity and growth.
In some base year (1910), the richest third in Growth Society earn $4,000, the middle third
$2,000, and the poorest $1,000. After a century of growth at 4%, the poorest will earn about
$50,000 per year, about one quarter of the $200,000 earned by the most productive third.
19 In more technical language, the MPC (marginal propensity to consume) varies with income levels – and with distribution
of income (see Carroll, Slacalek and Tukuoka 2014).
20 Mitchell (2005) goes into greater detail, listing the following costs of government intervention: the extraction cost,
the displacement cost (as private-sector activity is crowded out), the negative multiplier cost (as regulations impose higher
costs than just the enforcement of the regulations), the behavioral subsidy cost (as government creates perverse incentives),
the behavioral penalty cost (as government discourages good behavior), the market distortion cost, the inefficiency cost, and
the stagnation cost (as government thwarts innovation and growth). We have intentionally not gone into this level of detail.
New Perspectives on Political Economy [ 28 ]
GROWTH REDISTRIBUTION
4% growth 2% growth
Year Years Elapsed Poor Middle Rich Poor Middle Rich
1910 1,000 2,000 4,000 1,500 2,000 3,500
1920 10 1,480 2,960 5,921 1,828 2,438 4,266
1930 20 2,191 4,382 8,764 2,229 2,972 5,201
1940 30 3,243 6,487 12,974 2,717 3,623 6,340
1950 40 4,801 9,602 19,204 3,312 4,416 7,728
1960 50 7,107 14,213 28,427 4,037 5,383 9,421
1970 60 10,520 21,039 42,079 4,922 6,562 11,484
1980 70 15,572 31,143 62,286 5,999 7,999 13,998
1990 80 23,050 46,100 92,199 7,313 9,751 17,064
2000 90 34,119 68,239 136,477 8,915 11,886 20,801
2010 100 50,505 101,010 202,020 10,867 14,489 25,356
Table 5. A Tale of Two Countries: Redistribution and Growth
Redistribution Society successfully diminishes income inequality, by redistributing $500 from
the richest third to the poorest third. Thus, we see incomes of $3,500 for the most productive
third, $2,000 for the middle, and $1,500 for the least productive. Redistribution Society grows
at 2% per year. At the end of the century, the lowest third is earning about $11,000, just slightly
less than half of the $25,000 earned by the richest third.
Which society is more desirable? Clearly, Redistribution Society has less income inequality.
However, the poorest in Growth Society have an income that is five times higher than the
poorest in redistribution society. To put this in contemporary context, 2015 GDP per capita for
the US was roughly $50,000, while $11,000 approximates the GDP per capita of Egypt. Ceteris
paribus, who is better off? Somebody earning the GDP per capita of contemporary Americans
in a less equal society? Or somebody earning the GDP per capita of Egyptians, in a more
egalitarian society. In fact, the US has a higher income inequality than Egypt, so the example
does mirror reality.21
21 https://www.cia.gov/library/publications/the-world-factbook/rankorder/2172rank.html
New Perspectives on Political Economy [ 29 ]
Of course, this example is simplified, and is primarily meant as a thought exercise. We have
simply assumed a cost of redistribution (which will vary in reality, depending on circumstances
and policy details).. We intentionally sidestep questions of inflation and purchasing power (there
will presumably be upward pressure on prices in Growth Society) – but these are compensated
by questions of productivity gains and higher capital accumulation (leading to downward
pressure on prices in Growth Society). Some citizens may derive psychic utility from a more
equal distribution of income – but that more equal distribution will come at a cost for the poor
(are the happy citizens aware of this? Are they willing to accept this cost?). The point, for now,
is simply to ask whether the reduction of income inequality is a desirable policy, once we have
accepted the reality of the costs of that redistribution – and the absolute lot of the poorest.
3.3 The Knowledge Problem: Planned Chaos in a World of Good Intentions22
Hayek (1945) explained that policymakers largely lack the information to understand – let alone
fix – the workings of a complex market economy. In a market, entrepreneurs require information
about which goods and services consumers wish them to produce. This information is generated
and transmitted through the price mechanism (Read 1958). Thus, even if policymakers have
good intentions – which may, or may not actually be the case23
– we must be wary of the
dynamics of intervention: intervention in one market distorts the epistemic function of prices
(Horwitz 2015) and blocks the knowledge-generating functions of the market (Mises 2007[1955]).
This leads to a distortion in related markets… followed by calls for intervention to fix the newlyaffected
market… and the cycle continues. As we will see, interventionism – even with the noble
aspiration of reducing inequality – has a direct and visible cost, especially on the poorest.
3.4 The Welfare State and Poverty: Lessons for Income Inequality
We have already seen that redistribution and the rise of the regulatory state impede growth
and thus hurt the poorest (who need growth the most). The next problem is government
attempts to reduce poverty.
22 See Mises 2007[1947]
23 See Buchanan and Tullock 1962 or Bastiat 2012[1850].
New Perspectives on Political Economy [ 30 ]
Figure 1. US Poverty Rates, 1947-201224
Figure 2. Welfare Spending (1950-2008)25
24 http://www.heritage.org/multimedia/infographic/2014/09/poverty-rate-1947-2012
25 http://www.heritage.org/research/reports/2010/06/confronting-the-unsustainable-growth-of-welfare-entitlements-
principles-of-reform-and-the-next-steps
New Perspectives on Political Economy [ 31 ]
Figure 1 shows US poverty rates since 1959. Note that the rate of poverty, was falling –
significantly – before the US government took aim at poverty in 1964. By the mid-1960s,
when President Johnson’s Great Society was launched, the poverty rate in the U.S. had already
fallen below 15%, thanks to the post-war recovery and prosperity. Despite 50 years of federal
government involvement, the rate of poverty remains right about at 15% today, the point to
which it had already fallen before the Great Society efforts. The ineffectiveness of the federal
war on poverty is also highlighted by figure 2, which shows total welfare spending since 1950.
Over the half century in which the federal government has been actively fighting poverty, to the
tune of more than $1 trillion in 2015,26
national poverty rates have not changed.27
While federal
welfare programs may not be solely responsible, there is certainly a compelling parallel pattern
of government growth, lingering poverty, and increasing income disparity.
Why would government efforts at fighting poverty be unsuccessful (or even detrimental)?
Take the example of wage controls. Minimum wage laws cause unemployment, but the problem
is especially prevalent among uneducated and unskilled workers who are priced out of the
market. The primary role of an entry-level job is to acculturate neophyte workers to the norms
and expectations of the workplace; entry-level workers almost never provide as much value to
employers as they are paid. Wage controls affect both the processes and likelihood of entrylevel
positions in the work force. These are crucial to further human capital developments
– a lack of opportunity in these jobs can have long-lasting, pernicious effects on work force
participation over a lifetime. Indeed, most households in the bottom quintile have nobody
working (Sowell 2015, 168). From an employer’s perspective, as Hazlitt (1973, 147) explains, “we
cannot make a man worth a given amount by making it illegal for anyone to offer him less. We
merely deprive him of the right to earn the amount that his abilities and opportunities would
permit him to earn, while we deprive the community of the moderate services he is capable of
rendering.”
More generally, the welfare state provides disincentives to work, and increases income inequality:
“to the extent that the expanding welfare state allows more people to live without working –
and therefore without earning income or developing their own human capital – supporters of
the welfare state are contributing to the very income disparities they so much decry” (Sowell
26 This includes federal, state and local spending. This does not include indirect welfare spending like education, Social
Security and Medicaid. http://www.usgovernmentspending.com/entitlement_spending
27 Of course, one might argue the counter-factual, that poverty rates would have been higher than 15% today, there
but for government involvement. But why assume a sudden reversal of the pre-1965 trends, especially considering that the
economy has grown by a factor of almost four?
New Perspectives on Political Economy [ 32 ]
2015, 168; see Hazlitt 1973, 230-231). Tanner and Hughes (2013) share an apocryphal quip
about “cliff points” (when workers lose net income by earning more, because they lose welfare
benefits): the “highest marginal tax rate for anyone in the US [is] for a person leaving welfare
for work.” Consider the following facts from Tanner and Hughes (2013):
• Welfare pays more than minimum wage in 35 states
• In 13 states, welfare pays more than $15/hour
• In 8 states, welfare pays more than the median income; and in 40 states, welfare pays 80%
or more of the median income
• Only 2.6% of full-time workers in the US are poor; but 15% of part-time workers and 24% of
non-working adults are poor
• Less than 42% of adult welfare recipients are actually working (despite the 1996 welfare
reforms)
• There are currently 126 federal anti-poverty programs in place in the US
These figures simply reflect the moral hazard problems associated with significant wealth
redistribution by the government. The creation of dependency among able-bodied adults (and
the political spoils associated with the process) has been a problem long recognized by several
thinkers (Tocqueville 2015[1835], 23-25 and 35; Hazlitt 1973, 71 and 185-186; Sowell 2015). Yet
it persists.
Moving from the micro- to the macro-level, government spending crowds out private enterprise
and investment, and thus capital accumulation and growth. In the years “1995-2012, OECD
member countries that increased government expenditures as a percentage of GDP grew 30%
slower than member countries that trimmed government expenditures as a percentage of the
economy over that span – average annual growth of 1.9% compared with 2.5%.”28
As we have
seen above, it is precisely the poorest who benefit the most from economic growth.
28 „The Mythical Link between Income Inequality and Slow Growth,“ Matthew Schoenfeld, The Wall Street Journal, October
12, 2015, http://www.wsj.com/articles/the-mythical-link-between-income-inequality-and-slow-growth-1434319942
New Perspectives on Political Economy [ 33 ]
While welfare policies in the U.S. may arguably have some short-term palliative effect, they also
do not encourage investment in human capital, and have done little for income mobility (see
Hazlitt 1973, 56 and chapter 10).
In closing, we add a brief commentary on regulation that is officially for the public good. The
cost for Americans to comply with federal regulations has reached about 10% of GDP. This
represents resources that are diverted away from productive investments, job creation, and
productivity gains, with a regressive impact (Thomas 2019). In the specific case of employment
regulation, approximately 1/3 of Americans today require occupational licenses, up from 5%
in the 1950s. The Institute for Justice reports that “on average, these licenses force aspiring
workers to spend nine months in education or training, pass one exam and pay more than $200
in fees. One third of the licenses take more than a year to earn.” This kind of job licensing
will typically be regressive, as those with higher incomes are more able to pay for the required
courses, exams, and other licensing fees than will be those at the bottom end of income, and
especially those who were attempting to enter the job market.
Having examined what does not work, we discuss alternative solutions to poverty in the
conclusion.
Crushing Innovation: From Luxury to Banality
At best, the government is ineffective in its anti-poverty efforts. At worst, these efforts have
caused the poorest of Americans to be partially excluded from national productivity gains. If
government efforts at fighting poverty have been counter-productive, we would expect the
same from government efforts to fight inequality. Indeed, Hazlitt (1973, 49) notes that income
inequality was already falling in the two decades before grand government action in the 1960s,
and has been rising since. This is the crux of the problem.
Hazlitt(1973,123)explainsthattheprogressivetaxationusedtofightinequalitydisproportionately
seizes funds that were destined for investment, rather than consumption – thus ultimately hurting
the poor more than the rich. Lower investment means diminishing growth in productivity,
capital accumulation, job creation, and innovation – all of which also dampen decreases in real
consumer prices. In sum, investment is the greatest form of charity (Hazlitt 1973, 2).
Redistribution has consequences for investment – and thus (as we have seen) consumption
by the poorest. Because top earners have more disposable income, they purchase the luxury
goods of today that become the standard features for the rest of us tomorrow. Luxury purchases
New Perspectives on Political Economy [ 34 ]
by the rich help to drive innovation, allowing entrepreneurs to invest in production and bring
those goods to the market at lower prices, thus making them accessible to the middle class,
and eventually to all. Hayek (1960, 43-44) summarizes the point nicely: “A large part of the
expenditure of the rich, though not intended for that end, thus serves to defray the cost of the
experimentation with the new things that, as a result, can later be made available to the poor…
Even the poorest today owe their relative material well-being to the results of past inequality”
(see also Mises 1985[1929], I.5; more generally, see Bastiat 1995[1848]).
Take the example of automobiles in the early 20th
century, or mobile phones in the 1990s, or
smart phones and car rearview cameras in the early 2010s – all of these started as luxuries, and
eventually become commonplace. Imagine the consequences of attempting to level income
disparity by imposing a progressive consumption tax – as has been suggested by economist
Robert Frank.29
Taxing cell phones as a luxury in the early 1990s would have discouraged many
of the few consumers from purchasing them and would have thwarted the investments that
lowered their prices. For those who remember the “bricks” of the 1990s and the “flip phones” of
the early 2000s, the transformation has been nothing short of miraculous. Today’s smart phone
penetration rate approaches 80%30
– that’s not just 80% of Americans who can now peruse
pictures of family, friends, and pets on Facebook, instantly chat with their Instagram friends, or
enjoy other entertaining frivolities. More significantly, it also represents cheap and easy access
to the internet for school research, job searches, or online non-traditional banking. The last is
an especially pertinent point. High banking costs – largely driven by federal regulations in the
wake of the 2008 financial crisis – keep an estimated 10 million Americans unbanked, and 20% of
American households underbanked.31
Fortunately, non-traditional banking (on smartphones)
presents an alternative.
Horwitz (2015) explained (above) that the consumption gap has been falling steadily over the
past 40 years; but that gap would be increased by redistributive efforts. Schumpeter (1942,
67-68) elegantly summarizes the issue:
The capitalist engine is first and last an engine of mass production which
unavoidably also means production for the masses. . . . It is the cheap cloth, the
29 „The Progressive Consumption Tax: A Win-Win Solution for Reducing American Income Inequality.“ December 7,
2011. http://www.slate.com/articles/business/moneybox/2011/12/the_progressive_consumption_tax_a_win_win_solution_for_
reducing_american_economic_inequality_.html
30 http://www.marketingcharts.com/online/smartphone-penetration-nears-80-of-the-us-mobile-market-65214/
31 https://www.forbes.com/sites/realspin/2014/08/04/how-to-help-the-unbanked-repeal-the-durbin-amend-
ment/#5afbea5b71ad
New Perspectives on Political Economy [ 35 ]
cheap cotton and rayon fabric, boots, motorcars and so on that are the typical
achievements of capitalist production, and not as a rule improvements that
would mean much to the rich man. Queen Elizabeth owned silk stockings. The
capitalist achievement does not typically consist in providing more silk stockings
for queens but in bringing them within reach of factory girls.
Conclusion
Income inequality exists in the US, and it has clearly been increasing in the past 40 years.
However, it would be incomplete to look only at income inequality. The poorest of Americans
are better off in the US than they were 40 years ago – but they would also be much higher, had
government expansion not crowded out economic growth (Mitchell 2005).
Too much poverty still remains, with no good reason (but plenty of bad reasons, from cronyism to
failed government redistribution). Indeed, Hazlitt (1973, 232) bluntly reminds us that “capitalism
has already eliminated mass poverty” (see also Mises 2007[1955] and 1985[1929]). Lingering
poverty is thus doubly frustrating, because it is avoidable (if only we would let markets work
and stop preventing the poor from earning). As Posner (1986) opines, “in a world of scarce
resources waste should be regarded as immoral” (see also DeBow 1992).
The purpose of this paper has not been to dismiss income inequality entirely – but to question
whether inequality is the real problem and outline the costs of changing it, including the
distraction from the real issues: absolute poverty and barriers to productivity for the poor.
Income redistribution, which stifles growth, is not a solution, as we have seen from the abysmal
U.S. war on poverty. Any real solution to poverty must address the ability to earn. Hazlitt (1973,
209) reminds us, once again, that the real solution is not government relief, but an increase in
productivity; “one is ashamed to keep repeating anything so obvious, but the only real cure for
poverty is the production of wealth.”
For the sake of the poorest of Americans, it is of vital importance that policymakers not make
the same mistakes in addressing income inequality as they have made in attempting to address
poverty over the past half century. As Hazlitt (1973, 125) foresaw, “any attempt to equalize
wealth or income by forced redistribution must only tend to destroy wealth and income.” In
sum, “the promotion of economic equality and the alleviation of poverty are distinct and often
conflicting” (Bauer 1981, 23).
New Perspectives on Political Economy [ 36 ]
The point here is not to abandon the poor – quite the contrary. But, rather than engaging in
redistributive programs with unintended consequences, governments can do two things: first,
get out of the way, and stop thwarting the market’s wonderful process of growth; and second,
let civil society handle those who fall through the cracks of the market.32
In sum, markets create
more wealth, and they do so more effectively and more evenly than government intervention.
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32 See Beito 2000 on a century of voluntary, fraternal mutual aid efforts – efforts that were effectively killed by the rise
of the welfare state
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Friedman, M. (1962) Capitalism and Freedom. University of Chicago Press.
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Hayek, F.A. (1945), “The Use of Knowledge in Society,” American Economic Review, XXXV, No. 4.
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University of California Press
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to Greek and Roman Political Thought, London: Basil Blackwell.
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No. 1831, March 31, 2005, Washington, DC: The Heritage Foundation
Mises, L. (1985[1929]), Liberalism: The Classical Tradition. Irvington-on-Hudson: Foundation for
Economic Education.
Mises, L. (2007[1955]), Economic Policy: Thoughts for Today and for Tomorrow, Auburn: Ludwig
von Mises Institute.
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Posner, R. (1986), Economic Analysis of Law, 3rd
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Schoeck, H. (1987), Envy: A Theory of Social Behaviour, Indianapolis: Liberty Fund
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Sowell, T. (2015), Wealth, Poverty and Politics: An International Perspective, New York: Basic
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Welfare Benefits by State,” Cato Institute
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Bio
Bradley K. Hobbs
Clinical Professor of Economics
Clemson University
Nikolai G. Wenzel
L.V. Hackley Chair for the Study of Capitalism and Free Enterprise
Distinguished Professor of Economics
Fayetteville State University
Corresponding author: nikolaiwenzel@gmail.com; +1.703.609.4000
New Perspectives on Political Economy, Vol. 16, No. 1-2, 2020
New Perspectives on Political Economy [ 39 ]
Austrian Economics as a Paradigm of
Golden Mean Thinking
Jakub Bożydar Wiśniewski, University of Wroclaw
T
he main contention of the present paper is that the tradition of the Austrian School
is a paradigmatic example of the application of the Aristotelian golden mean to the
realm of economic theorizing. Consequently, it argues that the Austrian tradition
allows for uniquely clear and perceptive interpretation of the workings of the
catallactic order and it is uniquely placed to develop economics as a methodologically
and substantively distinct scholarly discipline, which does not have to borrow the tools or subject
matter of any other field of inquiry.
Introduction
The Aristotelian concept of the golden mean indicates that achieving virtues requires the
avoidance of normative polar excesses. This precept applies to moral and intellectual virtues
alike, thus providing solid guidance for both socio-relational and scholarly endeavors. In the
context of the latter, it points in particular to the necessity of using the right sources of knowledge
in the right areas of inquiry and in the right proportions, so that our understanding of reality
may grow along a realistic path, free of epistemic distortions and lopsided exaggerations.
My main contention in the present paper is that the tradition of the Austrian School is
a paradigmatic example of the application of the Aristotelian golden mean to the realm of
economic theorizing. In the next section, I shall comment on the methodological subtlety of
Austrian economics as involving a balanced use of complementary analytical tools, thereby
allowing its practitioners to arrive at a carefully realistic vision of the logical structure of human
action. Then, in the succeeding sections, I shall point to several substantive contributions of
the Austrian school that are characteristically nuanced in their conceptual elaborations and
their practical relevance. More specifically, I shall comment on the Austrian value theory and
the corresponding theory of the entrepreneurial market process understood as scholarly
New Perspectives on Political Economy [ 40 ]
achievements that assiduously avoid various one-sided overstatements present in their
counterparts developed by other traditions.
In sum, I shall suggest that, on account of its deep philosophical self-awareness and the
resulting golden mean orientation, the Austrian school allows for uniquely clear and perceptive
interpretation of the workings of the catallactic order. I shall also imply that for the same reason
it is uniquely placed to develop economics as a methodologically and substantively distinct
scholarly discipline, which does not have to borrow the tools or subject matter of any other field
of inquiry.
Let me finish this section with a few additional methodological remarks aimed at countering
potential criticism of the approach adopted in this paper. One might suggest that, if invoking the
golden mean in this context is to serve as something more than merely drawing an interesting
parallel to a specific philosophical tradition, then it should be demonstrated that the same line
of thinking ought to be applied in most, if not all, fields of scholarly inquiry.
I consider such a suggestion to be misplaced on at least two accounts. First, I believe that
economics can be rightly regarded as unique among the social sciences insofar as it emerges
from introspectively self-evident propositions and culminates in exceptionless qualitative laws.
As such, it bridges the realm of logical deduction and that of empirical interpretation, just as
human action – the cornerstone of economic analysis – bridges the realm of human mind and
that of the surrounding reality. Thus, conducting cogent economic investigations requires a
substantial degree of methodological awareness, knowing when to deploy which source of
knowledge and how to ensure the harmonious cooperation of all such sources. In this, I would
argue, economics differs both from other social sciences – which are purely empirical in virtue
of focusing on the contents of specific human actions and contingent regularities that subsume
them – and from abstract philosophical speculation on the nature of one’s internal mental life,
which can be purely deductive.
In other words, it might be argued that among social scientists the practitioners of economics
are particularly exposed to the danger of falling into various methodological excesses, which
makes adopting the golden mean orientation a particularly advisable move on their part.
Second, one should notice that even the original Aristotelian formulation of the notion under
consideration suggests that it is more of a highly reliable heuristic than a truly exceptionless
principle. For instance, with respect to theoretical wisdom, which Aristotle deems the highest of
all human virtues, there does not seem to be any cutoff point beyond which excess begins. And
New Perspectives on Political Economy [ 41 ]
with respect to certain other virtues, such as courage, some excesses are regarded as worse
than others – rashness, for example, for all its defects, is considered by Aristotle to be closer to
courage than cowardice.
We may employ the same observation in the realm of scholarly endeavors. Thus, instead of
conceding that the application of the golden mean in this general area would require using all
sources of knowledge in well-balanced proportions in every separate intellectual discipline, it
might be argued that, to follow the Aristotelian precept in question, it suffices to realize that
each available source of knowledge has its distinct epistemic value, which turns into a disvalue
when utilized outside of its proper domain. That is to say, it is perfectly justifiable to use only
deduction when doing pure mathematics and to use only experimentation when doing biology
or chemistry, but neither experimental mathematics nor aprioristic biology or chemistry would
take us very far.
In other words, what the golden mean orientation teaches us in this context is that the general
quest for epistemic success – especially among professional truth-seekers – requires building a
capital structure of production composed of heterogeneous and precisely interlocking forms of
intellectual capital. Furthermore, economics, on account of its aforementioned methodological
complexity, is by itself a microcosmic representation of this general approach, since, even as
an individual discipline, it requires combining insights derived from distinct yet complementary
sources of knowledge.1
My contention in this paper is that the Austrian tradition is most fully
cognizant of the above points and follows their implications most closely, thereby offering a
particularly nuanced and perceptive analysis of economic phenomena and the broader realm
of cooperative processes.
Having hopefully made my overall position clear enough, let me now demonstrate how it plays
itself out in a number of specific areas of economic research.
Method, action, and rationality
Austrian economics is alternatively known as the causal-realist tradition (Salerno 2010), which
unambiguously indicates that it is grounded in the causal analysis of the structure of realworld
economic phenomena. More specifically, since Austrian theorists identify human action
1 Other possible examples of such methodologically complex disciplines might be psychology, which combines introspective
and experimental insights, and philosophy, which can utilize practically every source of knowledge, including introspection,
intuition, perception, deduction, and induction.
New Perspectives on Political Economy [ 42 ]
as the keystone of all economic activity, their mode of investigation consists in rendering the
phenomena in question intelligible in terms of the categories of human action and their logically
necessary causal interrelations (Lachmann 1977).
This methodological approach clearly testifies to careful philosophical self-reflection undertaken
by the Austrian school, which resulted in its representatives’ clear understanding of the material
and formal distinctness of economics as compared with other social sciences (Gordon 1996).
Consequently, Austrian economics steers a middle course between apriorism and empiricism,
refusing to imitate the methods of any discipline that relies exclusively on one or the other of
these epistemological orientations.
Thus, on the one hand, it rejects the highly formalized abstractions and stylized mathematical
models of Walrasianism, since it regards them as paradigmatic instances of sterile apriorism that
fails to capture the essence of the dynamic market process (Kirzner 2017). However, it should
be borne in mind that this is by no means a rejection of a priori reasoning as such, but only a
rejection of the kind of a priori reasoning that is in manifest conflict with the broadly empirical,
immediately graspable laws of reality (Rothbard 1957). In other words, it is not an admission
that logic can be invalidated by experience, but a recognition that logic – in order to advance
from validity to soundness – needs to be grounded in the fundamental facts of experience.
Such a recognition is particularly important given the fact that the analytical error of describing
the workings of the economy in terms of unrealistic, highly mathematized models is oftentimes
compounded by the normative error of trying to make the real-world economy conform to
the models in question in order to supposedly bring it closer to the state of optimal efficiency
(Demsetz 1969).
On the other hand, the Austrian tradition also rejects the approach of those who claim that
even the most unrealistic hypotheses can be vindicated by means of experiential confirmation
understood in terms not of immediate apprehension, but of quasi-experimental testing. This
rejection stems from the realization that in the process of discovering economic laws one cannot
rely on empirical facts to speak for themselves – any sufficiently complex set of such facts can
illustrate a potentially infinite number of hypotheses, including some that contradict each other.
Thus, a priori logical deduction is needed to arrive at a sound interpretation of the empirical
data at hand (Long 2006) – one that makes sense in view of the logical structure of human
action, together with its feasible potentialities and inevitable limitations.
New Perspectives on Political Economy [ 43 ]
In sum, Austrian economics is logical-deductive on the level of theory formation and causalrealistic
on the level of theory application. Consequently, it embodies the golden mean thinking
of the methodological variety, consistently avoiding the twin pitfalls of unrealistic apriorism (as
exhibited by Walrasianism) and blind empiricism (as exhibited by neoclassical positivism).
Such an approach is not only uniquely fruitful when it comes to developing substantive economic
insights, but it may also be indispensable in the context of filtering such insights through the
philosophical lens of soundly understood human action. In other words, it allows for grounding
economic phenomena in the pure logic of choice, unadulterated with ad hoc psychological
assumptions or idealizations. This, in turn, allows the economic theorist to arrive at a lucid
understanding of such crucial praxeological concepts as rationality, and, more importantly, at
a clear assessment of how they bear on such crucial catallactic issues as the self-regulatory
potential of large-scale social cooperation.
Here, again, the golden mean orientation of the Austrian school is eminently visible. On the one
hand, Austrian theorists do not rely on overly demanding, highly-laden concepts of rationality,
which require of economic agents that they be fully informed, constant in their preferences,
and always capable of keeping their unreflective impulses at bay. Nor do they assume that the
informational features of any institutional environment can make economic agents act as if
they were rational in the above sense (Gertchev 2007). Thus, they reject the conclusion that a
sufficiently “efficient” market needs to be impervious to systemic breakdowns (Fama 1970).
On the other hand, however, Austrian economists are equally resistant to the suggestion that
market participants are naturally irrational and prone to acting on uninformed whims, thereby
periodically thrusting the market into general disarray (Akerlof and Shiller 2009). This is because
such a suggestion is at best based on contingent psychological observations, which cannot be
elevated to the rank of universally applicable insights into the nature of the catallactic order.
Furthermore, such a claim cannot account for the emergence of complex market environments
in the first place, as well as for their continuing existence in the face of various temporary
upheavals and downturns.
The Austrian vision of rationality carefully avoids both of the abovementioned extremes. Rational
action, as viewed through the lens of causal-realist analysis, is tantamount to purposive action
– that is, behavior grounded in an underlying consciously conceived means-ends relationship
(Wiśniewski 2009). The fact that such mental representations may not conform to the structure
of external reality in no way impugns the rationality of the corresponding actions – what matters
New Perspectives on Political Economy [ 44 ]
in this context is that they are purpose-driven and goal-oriented. Nor does this fact in any way
undermine the self-regulatory potential of large-scale social cooperation. After all, no matter
how impulsive and uninformed some of the participants of a given market may be, the profit
and loss system inherent in every genuine market is bound to promote the relatively more
thoughtful and knowledgeable of its participants and penalize those who are relatively less
so (Mises 1996, chap. 15). At the same time, it should be noticed that the selection system in
question does not need to endow its users with perfect or “full” knowledge in order to allow for
market self-regulation – it is enough if it continually generates a discovery procedure whereby
various economic agents can intersubjectively compare the relative efficiency of their respective
plans (Hayek 2002).
In sum, the Austrian concept of rationality strays neither in the direction of New Classical
overestimation nor in the direction of behavioral economic underestimation, once again
charting a middle course between analytically dubious extremes.
Value, scarcity, and subjectivism
Carl Menger, the founding father of the Austrian school, is widely known as one of the pioneers
of the marginalist revolution, which has fundamentally transformed the discipline of economics
by grounding it in a new value theory, capable of decisively solving the age-old paradox of
water and diamonds. This theory, when reflected upon from a philosophical point of view,
can be seen as yet another instance of golden mean thinking, which, in virtue of identifying
scarcity and utility as the twin pillars of economic value, navigates between the twin pitfalls of
objectivism and hypersubjectivism.
On the one hand, the marginalist revolution delivered a deadly blow to classical economics
and its labor theory of value, thereby undermining in particular the economic foundations
of Marxism (Böhm-Bawerk 1898). Furthermore, the Mengerian branch of marginalist thinkers
mounted serious criticism of the fledgling neoclassical tradition, seeing its adherence to value
subjectivism as half-hearted and unjustifiably concessive to the idea of objective costs (BöhmBawerk
1894/5).
On the other hand, however, Austrian economists have always been particularly insistent in
emphasizing the physically scarce nature of genuine economic goods. This allowed them to
identify those instances in which the representatives of the dominant neoclassical synthesis
tried to perform the conceptual trick of turning stones into bread by seemingly conjuring away
New Perspectives on Political Economy [ 45 ]
the scarcity of capital. For example, such a trick appears to be embedded in the Keynesian
suggestion that, under recessionary conditions, stimulating “idle resources” through deficit
spending is capable of generating positive “multiplier effects”. The crucial issue overlooked in
this suggestion, which the Austrians never tire of pointing out, is that “idleness” of resources
in no way eliminates their scarcity and the corresponding opportunity costs (Boyes 2014). In
other words, if at a given moment no entrepreneur is willing to employ a particular resource,
then this resource either possesses no utility in the eyes of current market participants, or they
consider all of its conceivable present uses to be suboptimal as compared with anticipated future
opportunities. Thus, stimulating it through the use of funds coercively siphoned away from the
private sector is not only incapable of conjuring additional economic value into existence, but
is bound to exacerbate resource misallocation, making the ineradicable condition of scarcity all
the more painful.2
A similar conceptual ploy seems to be involved in the neoclassical theory of public goods.
Among other things, the theory in question postulates that one of the essential characteristics
of public goods is their non-rivalness – that is, the feature of being consumable by a given
agent without losing use value for other agents. In view of this, it is then claimed that producing
non-rival goods on a for-profit basis is economically suboptimal. The phenomenon of nonrivalness,
however, is bound to be at best temporary – more specifically, it can persist only
until the full carrying capacity of a particular capital structure of production is reached and the
crowding effect kicks in. In other words, the supposed non-rivalness of certain consumer goods
turns out to be economically insignificant in view of the inescapable scarcity of the underlying
capital goods and the necessity of subjecting the latter to the entrepreneurial calculation of
opportunity costs (Wiśniewski 2013). Hence, once again, trying to divorce utility from scarcity
even in apparently exceptional circumstances results in a defective understanding of catallactic
phenomena.
Finally, the Austrian school is clear and consistent in emphasizing that goods that are useful, but
genuinely non-scarce, are not economic goods but free goods, and as such are not subject to
2 One might argue that the Keynesian error in question stems from a rudimentary misunderstanding of the nature of
employment rather than from any specifically methodological confusion. This, however, seems to be a false alternative. More
specifically, while it is true that the said error is not methodological in a direct sense, it may be ultimately traced to a rejection
of the strictly nomothetic character of economics. In this particular case, the rejection involved consists in suggesting that
economic goods may display different characteristics in different circumstances, sometimes ceasing to be scarce. The causal-realist
tradition, on the other hand, sees economics as a fully integrated science, capable of interpreting both micro- and
macro-level phenomena through the lens of universal laws derived from the action axiom. Consequently, it admits of no
exceptions to the law of scarcity and regards temporary idleness of resources as an important element of intertemporal plan
coordination on the part of entrepreneurs.
New Perspectives on Political Economy [ 46 ]
the principles of economizing. Thus, any attempt to make them artificially scarce by restricting
their replication inevitably leads to utility losses. A paradigmatic example of such a procedure
is that of obtaining copyrights and patents, whereby one forcibly constrains the dissemination
and utilization of productive ideas and innovations, which become naturally superabundant as
soon as they are initially brought into existence (Kinsella 2008).
In sum, contrary to common opinion, it is not only classical economics that is at odds with the
insights of marginalism. As indicated above, it is also neoclassical economics that occasionally
allows itself to apply those insights in an inconsistent manner, sometimes regarding scarce
goods as free goods (as in the context of the theory of public goods), and sometimes regarding
free goods as scarce goods (as in the context of utilitarian analyses of intellectual property laws
(Posner 2005)). In contrast, the Austrian school – that is, the Mengerian branch of marginalism
– is steady in its adherence to causal-realist value theory, thereby avoiding the mistakes of both
classicism and neoclassicism.
That is to say, it succumbs neither to wholesale methodological materialism nor to excessive
methodological subjectivism. Thus, on the one hand, it dispels the notion that economic values
inhere objectively in physical goods or in the physical processes leading to their creation, while
on the other hand it rejects the claim that economic goods can be created outside the ambit of
physical scarcity. As shown above, taking such a middle course allows it to develop a nuanced
theory of value and utility capable of generating logically consistent and universally applicable
recommendations for those eager to preserve the essential conditions of extended social
cooperation, even under supposedly atypical circumstances.
Uncertainty, entrepreneurship, and the market process
The final area in which I would like to illustrate the golden mean orientation of the Austrian
school is its theory of entrepreneurship and the market process.
Those economists who are clearly cognizant of the processual nature of market activity have long
debated the issue of whether the influence of entrepreneurship on the direction of the economy
is predominantly equilibrating or disequilibrating. According to the Schumpeterian perspective
(Schumpeter 1975, p. 42-5), it is primarily disequilibrating. According to some interpretations of
the Kirznerian perspective (Kirzner 1973) – particularly those that tend to analyze the work of
Kirzner through the neoclassical rather than the characteristically Austrian lens – it is primarily
equilibrating. By comparison, what might be regarded as the purely Austrian approach to the
subject suggests that the whole question is misplaced, since the goal of entrepreneurship is
New Perspectives on Political Economy [ 47 ]
not to push the economy towards or away from some hypothetical long-run equilibrium, but
to carry out the function of capital ownership in the face of an uncertain future (Salerno 2008).
Thus, performing the entrepreneurial role may include both introducing disruptive innovations
and exploiting arbitrage opportunities, the latter being a natural market response to the former
or vice versa, the two being complementary rather than mutually exclusive (Holcombe 1998).
In other words, according to the Austrian view the defining feature of the entrepreneur is neither
creativity, nor alertness, nor any other psychological characteristic, but the ability to exercise
businessjudgmentunderconditionsofuncertainty,whichisthefunctionalessenceofharmonizing
supply and demand in the necessarily dynamic world of human action (Foss and Klein 2012).
This perspective allows the economic theorist to realize that what is particularly important in the
context of understanding the economically essential role of entrepreneurship is not whether its
influence is ultimately equilibrating or disequilibrating, but what is the institutional environment
in which the exercise of entrepreneurial judgment can operate unimpeded (Henrekson and
Sanandaji 2011). It also allows for deducing some of the indispensable features that any such
environment needs to exhibit, including robust protection of property rights, legal transparency,
monetary stability, and respect for peaceful competition. In sum, by following the golden mean
approach, the Austrian tradition refuses to narrow down the definition of the entrepreneur to
any particular ideal type, instead investigating the praxeological preconditions of performing
the core function of entrepreneurial activity in all of its varieties.
Furthermore, the Austrian emphasis on the uncertain character of business decisions and the
necessity of harmonizing them with the anticipated will of sovereign consumers sheds light
on the nature of entrepreneurial opportunities. In contrast to the objectivizing view that treats
such opportunities as discovered and the hypersubjectivizing view that treats them as created,
the causal-realist perspective treats them as imagined (Klein 2008). In other words, it neither
underplays the importance of unforeseen contingencies in the execution of business plans nor
overplays the ability of the entrepreneur to shape the tastes and preferences of his clients. In
this context, the middle ground charted by the Austrians allows for an economically robust
understanding of the goal of entrepreneurial efforts, which is not colored by psychologically
appealing yet logically unsound metaphors.
Finally, the Austrian reflection on the nature of the firm articulates a subtle compromise
between the respective roles played by spontaneous and planned orders in the area of
business organization. On the one hand, the Misesian theorem of the impossibility of economic
calculation under socialism clearly demonstrates that no single firm could conceivably take over
New Perspectives on Political Economy [ 48 ]
the whole market, since, as the sole user of various non-specific factors of production, such a
firm would face insurmountable economic challenges similar to those confronting a socialist
central planner (Klein 1996). On the other hand, however, consistent application of the Ricardian
law of association and the attention paid to the entrepreneurial aspects of the managerial
role make causal-realist scholars realize that even in a decentralized, knowledge-intensive
economy creating and maintaining a well-functioning system of corporate governance requires
a substantial amount of top-down planning (Foss and Klein 2014). Thus, while obviously alert to
the inherent inefficiency of socialism, the Austrian tradition is perfectly willing to acknowledge
certain important advantages of planned orders as long as they are grounded in voluntary
contracts and embedded in a broader competitive environment.
In sum, on account of its focus on the logical essence of the market process, the causal-realist
approach is singularly capable of providing a cogent and balanced account of entrepreneurship
and the firm, which neither romanticizes the entrepreneur nor reduces him to a quasi-automatic
coordinating device. More specifically, the approach in question avoids the excesses of both the
mechanical neoclassical outlook, where entrepreneurs are at best conceptualized as Walrasian
auctioneers capable of robotically keeping the economy in the state of near-equilibrium, and
the grandiose quasi-historicist outlook, where the entrepreneur is seen as a revolutionary
figure capable of single-handedly shaping market reality according to his will. That is to say,
the Austrians see the domain of business and entrepreneurship as it is, with both its great
potential and its unavoidable limitations, which nonetheless cannot be improved upon by any
constructivist extra-market schemes.
Conclusion
As demonstrated in the numerous examples above, the Austrian school, as compared with
other economic traditions, is uniquely justified in regarding itself as an embodiment of golden
mean thinking. As such, it offers a distinct, internally integrated and analytically self-sufficient
vision of the extended social order, which is properly economic, meaning that it does not have
to borrow the methodological precepts or substantive concerns of any other science, be it
social or natural. By the same token, it avoids the categorical mistakes and interpretive excesses
typically associated with extending the application of any given discipline into areas where
it does not belong. Furthermore, in the context of specific, substantive economic issues, it
consistently traces them all the way back to the self-evident action axiom, thus insisting both
on their strictly deductive interpretability and on their rootedness in the domain of empirical
New Perspectives on Political Economy [ 49 ]
events, without allowing either of these methodological characteristics to dominate the other.
Hence, it promises to be a particularly fruitful approach in providing a logically clear and realistic
perspective on various economic phenomena that are to appear in the future, especially
insofar as they embody increasing technological ingenuity, organizational complexity, and
entrepreneurial emancipation.
References
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Firm (Cambridge, UK: Cambridge University Press).
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(1), 73-80.
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Economics, 1 (2), 45-62.
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Kirzner, I. M. (1973), Competition and Entrepreneurship (Chicago: University of Chicago Press).
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Economics, 9 (2), 3-28.
Klein, P. G. (2008), ‘Opportunity Discovery, Entrepreneurial Action, and Economic Organization’,
Strategic Entrepreneurship Journal, 2, 175–90.
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Expectations, and the Market Process (Kansas City: Sheed Andrews and McMeel).
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Quarterly Journal of Austrian Economics, 9 (3), 3-23.
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Perspectives, 19 (2), 57-73.
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Economics, 11 (3), 188-207.
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Economics, 23 (1), 1-16.
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Wiśniewski, J. B. (2009), ‘Well-informedness and rationality: a philosophical overview’, Quarterly
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Bio
Jakub Bożydar Wiśniewski (jakub@cantab.net) is an assistant professor in the
Faculty of Law, Administration, and Economics at the University of Wroclaw and
an affiliated scholar and a member of the Board of Trustees of the Ludwig von
Mises Institute Poland.
New Perspectives on Political Economy, Vol. 16, No. 1-2, 2020
New Perspectives on Political Economy [ 52 ]
COVID-19 and Rent-Seeking Competition
Frank Daumann, Friedrich Schiller University Jena
Florian Follert, Seeburg Castle University
T
The COVID-19 pandemic affects the everyday and working life of several parts of the
population. Politicians, scientists and entrepreneurs face new challenges, decisions
are made under enormous uncertainty. Under the primacy of infection control,
restrictive political measures have been implemented worldwide with economic,
social and mental-health consequences which can hardly be assessed at present.
Not at least, the pandemic has eroded bastions of freedom whose existence would have been
considered unshakeable in many countries just a year ago. The present paper does not aim at
a (final) evaluation of these measures. Rather, the theory of rent-seeking will be used to sketch
a mechanism that will be stimulated by the current crisis and that will promote rent-seeking
competition that could finally result in non-efficient resource allocations. Given a high degree of
uncertainty and incomplete information on both sides of the political market, interest groups try
to take advantage from this situation by putting the political actors under pressure. At the end
of this chain of effects occurs the problem of restaurant bills and the question: “Who is going to
pay for this?”
Acknowledgment:
The authors would like to thank two anonymous reviewers for helpful comments on a previous
version of the paper.
Introduction
The COVID-19 pandemic is a global crisis phenomenon that challenges business, politics
and science. While in the first months of the crisis the main focus was on virological and
epidemiological considerations (e.g., Christian Drosten, Hendrik Streeck, or Alexander Kekulé
in Germany), other disciplines, esp. from the social sciences, are now also participating in the
scientific discussion (e.g., Armbruster and Klotzbücher, 2020; Bickley et al., 2020; Chan et al.,
2020; Drewes et al., 2020; Eichenberger et al., 2020). The present paper aims to contribute to
this discussion by transferring the phenomenon of rent-seeking well-known from Public Choice
literature (e.g., Tullock, 1967; Krueger, 1974; Buchanan, 1980; Tollison, 1982; Nitzan, 1994; Ekelund
New Perspectives on Political Economy [ 53 ]
and Thornton, 2020) to the current situation. We therefore discuss a chain of potential effects at
the end of which there is an unleashing of rent-seeking competition. In our analysis we follow
Olson (2002) and assume that individuals form interest groups to better achieve their goals,
which will be the case if the benefits in terms of the target function of the individual member
exceed its costs. We further assume with respect to the Public Choice literature that interest
groups try to influence legislation in the interests of their members through targeted lobbying
and thus seek rents. The fact that this rent-seeking competition can lead to misallocations and
welfare losses from a perspective of a society as a whole has already been discussed in detail
in the literature (Olson, 1982; Acemoglu and Robinson, 2012; another opinion is provided by
Becker, 1983). We take up these findings and discuss, on the basis of the current situation
in Germany, that the economic policy measures lead to considerable deadweight effects and
government becomes a “[p]layball of group interests” (Hayek, 1982 [1973], p. 99). With regard
to this metaphore we follow Tollison (1982, p. 578) in his interpretation that “[r]ent seeking is the
expenditure of scarce resources to capture an artificially created transfer”.
It cannot be denied that this is a stylized consideration under the typical assumptions of economic
theory (e.g., Schumpeter, 1950; Downs, 1957; Niskanen, 1975). However, valuable insights can
be derived from this analysis with regard to the assessment of political actions. Although we
refer to the political and legal situation in Germany, the implications are transferable to most
democratic countries.
The paper is organized as follows: First, in section 2 we present our theoretical framework and
highlight the relevant assumptions of Public Choice. After that, we present central mechanisms
within the political process in section 3. Then, we focus on COVID-19 in section 4, where we
show how COVID-19 stimulates rent-seeking competition between different interest groups
that try to take advantage from the uncertainty of the crisis (on the uncertainty of the COVID-19
pandemic see Altig et al., 2020) and the given incomplete information. Section 5 summarize
finally the results of our analysis.
Theoretical Framework
In indirect democracies, competencies for decisions affecting all or parts of the population are
delegated to representatives elected by the population in secret elections (in the following
Daumann, 2017). If one looks at this manifestation of the democratic constitutional state from
an economic perspective, it can be interpreted as a relational contract between the members of
the state (the citizens) as principals and their representatives as agents (Richter and Furubotn,
New Perspectives on Political Economy [ 54 ]
2010, pp. 524–525; on the interpretation as contractual democracy see fundamentally Gersbach,
2012), so that a client-contractor relationship exists in essence (on this, also in the following
Follert, 2018, pp. 237–241; Follert, 2020). As it is well-known from new institutional economics,
such an agency relationship is accompanied by an asymmetrical distribution of the already
incomplete information (Stigler, 1961; Akerlof, 1970; Spence, 1973; as an overview, e.g., Spremann,
1990), from which the typical problems of decision-making and control arise both a priori and
after the conclusion of the contract (e.g., Holmström, 1979).
Parliament, as the Assembly of Representatives, acts as a legislative body. Changes to the existing
legal system require the approval of a majority of the members of Parliament and must be in
accordance with the Constitution. The members of Parliament in turn elect the government.
The economic view of the political system in general and of democracy (Downs, 1957) and
bureaucracy (Niskanen, 1975) assumes that a self-interested actor is involved. It also postulates
that the preferences of citizens are subjective and heterogeneously distributed. According to
Arrow (1951), a mere aggregation of individual preferences is therefore problematic; maximizing
a social objective function is precisely not compatible with the assumption of democracy (on
this point, also Frey, 1977, p. 31). The following can therefore be assumed for government
politicians (Downs, 1957; further Daumann, 1999):
Their primary objective is to secure their position as members of the government, with all the
comforts, and to keep the current ruling party in government. In this respect, it is a maximization
of benefits under the secondary condition of re-election. The less competition there is between
the parties, the more likely it is that the political actors will be able to behave differently (e.g.,
Frey, 1977, pp. 129–130). Furthermore, they have only limited knowledge of the needs of voters or
individual groups of voters. Due to the highly differentiated preferences of voters, high costs are
incurred in order to gain knowledge of voters’ preferences. Finally, politicians have only limited
instrumental knowledge to be able to satisfy the voters’ preferences in a targeted manner. This
instrumental knowledge includes not only knowledge of the appropriate form of the applicable
measures but also their effect on the target figure. The politician must therefore know which
measures come into question and how they are to be designed in order to be conducive to
his objective. With respect to Kirzner (1973) we understand the market process as a dynamic
competition, where the chance to take economic rents stimulates entrepreneurial decisions
(see also Tollison, 1982). Given the incomplete information which is asymmetrical distributed,
we follow the interpretation of Public Choice theory that interest groups engages in lobbying
to take advantages from the situation on behalf of their members. In this way, scarce resources
New Perspectives on Political Economy [ 55 ]
are allocated to specific interest groups by means of a transfer artificially generated by lobbying
(Tollison, 1982). While “rents” in a market process have usually productive implications, rents
in the context of this paper could lead to economic wastefulness of scare resources (Krueger,
1974; Buchanan, 1980; Tollison, 1982). The link between the Downsian assumptions on political
behavior and the theory of rent-seeking by different interest groups can be pointed out by
Hayek (1982 [1973], p. 99):
“The reason is that democratic government, if nominally omnipotent, becomes
as a result of unlimited powers exceedingly weak, the playball of all the separate
interests it has to satisfy to secure majority support.”
In the following, we will show by the current example of the COVID-19 pandemic, how the
uncertain situation stimulates a rent-seeking process at the expense of the economy as a whole.
Design of the Political Process
The following description of the political process is presented with regard to Germany’s
parliamentary democracy, which is characterized by a federalism with 16 federal states
(Bundesländer). Therefore, the Bundestag and the Bundesrat (representing the federal states)
act as legislative bodies. To reduce the complexity of our analysis we would like to concentrate
only on two actors on the political market: The voter on the demand side and the politician/or
government on the supply side.
In general, we can note that the large number and high complexity of the areas of potential
state intervention require a considerable amount of professional expertise. It now becomes
apparent that a sanction of government politicians is only possible to a limited extent for the
following reasons (Knappe, 1980; Daumann, 1999):
1. Thus, the representatives are elected for the entire legislative period (four years in the
German Parliament Bundestag), so that citizens do not have the possibility to dismiss their
representative during the term as a sanction instrument (on this topic see e.g., Gersbach,
2017; Follert, 2018, pp. 242–243; Follert, 2020).
2. Thevotercanonlychoosebetweenbundlesofplannedpoliticaldecisions(electionprograms).
A differentiation is not possible due to the complexity and existing information asymmetries.
Moreover, the possibility of choice is further restricted by the formation of parties that channel
opinions in the form of a uniform election program and sanction positions that deviate from
it to varying degrees. In addition, the party is not legally bound by “election promises” (Franz
New Perspectives on Political Economy [ 56 ]
Müntefering at the time of the statement German Vice-Chancellor of Cabinet “Merkel I”:
“I maintain that the fact that we are often measured by election campaign statements is
not fair”; Schmiese, 2006, translated). Obviously, breaches of trust reduce the reputation
of political actors and c.p. the chance of re-election. From a game theoretical perspective,
however, this argumentation only applies if further rounds of the game are foreseeable.
Since party decisions are also taken by a majority, this argumentation may not necessarily
apply at the collective level, but it does confirm at the individual level. If, for example, the
opportunity costs of an elected member of Parliament are only high enough and he or she
has made an (internal) decision not to stand for re-election, there is discretionary potential
and a strong incentive to deviate.
3. Potential competition is made considerably more difficult by institutional barriers to market
entry. For example, the “5 percent”-clause effectively prevents certain groups of voters
from finding representation in parliament. In addition, there are de facto further hurdles,
for example, because new political organizations—regardless of their political color—are
viewed with general skepticism very often in media. A further narrowing of voters’ choices is
achieved through cartel agreements between the parties. Thus, certain options for action are
excluded from the political agenda from the outset by agreements between the parties (e.g.
non-introduction of the death penalty in the 1950s, introduction of the euro in the 1990s). It
is well known from competition economics that such agreements prevent competition. In a
democracy, this also limits competition between parties and may be more significant than in
the market sector (see Becker, 1958, p. 108).
4. The principle of the unity of action and liability that constitutes a market economy (Eucken,
2004, pp. 279–280) is largely suspended. This means that political decision-makers can only
be held accountable for their actions to a very limited extent, if one disregards (ordinary)
voting out (in the following Follert, 2018, pp. 245–246, on the liability claim also Gebauer,
2016; 2019; Follert, 2020). The fact that political actors are not liable for their actions to the
same extent as members of the management board of a stock corporation if they violate
the so-called “business judgment rule” (well-known from US law (e.g., Arsht, 1993) and since
more than twenty years in section 93 (1) sentence 2 of the German Stock Corporation Act) is
incomprehensible in as much as in the case of stock corporations there is also a separation
of ownership and power of disposal and in as much as a client-contractor relationship exists
(e.g., Berle and Means, 1968). With respect to this, from an economic perspective, it would
only be consistent to implement a liability of the political actors and correspondingly a
New Perspectives on Political Economy [ 57 ]
liability-free area for responsible decisions made under uncertainty, like a “political judgment
rule” (Follert, 2018, pp. 245–246; Foller, 2020).
This situation on the supply side meets further deficits on the demand side:
1. Content-related limitations: The state takes action in so many areas of life and so obsessed
with detail that the voter can no longer gain a complete overview of it. Therefore, many
voters will limit the procurement of information relevant for the election to those areas
that they consider to be their most important areas of life. This information will also be
incomplete and therefore very selective (rational ignorance).
2. Time-limited horizon of memory: The horizon of perception of most voters is also timelimited
and shorter than a legislative period.
As a result, voters will only use the sanction potential available to them to a very limited extent
and some government decisions that are negative for them will not be sanctioned at all. For
the government, this results in a considerable discretionary potential. This is limited by the
constitution, the available budget and the opposition: The German constitution provides a
framework for state action; originally—and this is often misunderstood—the constitution
regulates the relationship between citizen and the state: The Grundgesetz (German constitution)
is supposed to guarantee the citizen certain civil rights as well as equality and basic procedural
rights. Laws and thus state action must not, in principle, violate individual fundamental rights.
Restrictions are subject to the proportionality principle of public law. Nevertheless, the Basic
Law and the Federal Constitutional Court allow the legislature to formulate state objectives and
to implement them.
Goods and services provided by the state (e.g. in the form of monetary transfers or subsidies)
are financed from the state budget. The government’s scope for action is therefore limited by
the size of the available state budget. This amount depends on tax revenues and the possibilities
for borrowing. The latter is limited by the debt brake. In principle, however, there can be no
doubt that democratic governments, which can be interpreted as administrators for a legislative
period tend to incur debt due to their time preference (e.g., Hoppe, 2007) and to uses political
business cycles to maximize their utility (e.g., Frey and Lau, 1968; Nordhaus, 1975, Rogoff, 1990).
The opposition’s options for action consist of showing alternatives to the government’s actions
and making the negative consequences of the government’s actions transparent to the voters.
New Perspectives on Political Economy [ 58 ]
The limited knowledge of government politicians about the preferences of voters or individual
groups of voters and about the corresponding instrumental knowledge can be remedied by
the interest groups as lobbyists: The interest groups possess extensive information about
their members, which they collect primarily in the context of fulfilling domestic private sector
functions such as market observation and the ongoing information of members about sectorrelevant
facts (Daumann, 1999, pp. 121–122). This information relates to the framework conditions
relevant to the actions of the members (relevant legal regulations, characteristics of the upstream
and downstream markets, relevant technological knowledge), the economic potential of the
members (information on income and expenditure structure, structure of the workforce etc.)
and the market behavior of the members (knowledge of different business strategies and of the
use of the different action parameters) (Daumann, 1999, pp. 121–122).
This makes it clear how government politicians will use the discretionary potential: They will
use the necessarily selective information offered by interest groups to obtain information
about the preferences of important voter groups and the necessary instrumental knowledge
at low cost. The influence of interest groups, e.g. the banking industry, is evident from a large
number of published position papers and intensive advice to the government on legislative
amendments. Government politicians will favor measures that ensure re-election by increasing
the benefits for large constituencies in areas that are important to these voters. Such measures
must be compatible with the law and should place only a minimal burden on the state budget.
Admittedly, disadvantaged minorities must not be allowed to aggregate into a majority. This
can be achieved by keeping the extent of disadvantage to individual groups of voters and the
transparency of the effects of disadvantage as small as possible.
Even before the COVID-19 pandemic, rent-seeking by numerous interest groups was already
apparent in Germany, which were able to take advantage in particular of phases of greater
uncertainty. Examples include the long-standing protests against nuclear energy in Germany
and the more recent demonstrations concerning human-made climate change (Fridays for
Future). In this context, enormous pressure was exerted on the government. In particular, the
younger past shows that political decisions can often be driven by public pressure and the
anticipation of future votes. A prominent example of this is the sudden exit from nuclear energy
by the German government after the terrible accident in Fukushima, Japan, in March 2011.
Follert and Daumann (2020) assume that this decision could be the result of a change in the
population’s subjective perception of danger, which was anticipated by the Merkel-government.
The geographical conditions and thus the uncertainty regarding the dangers have not changed
New Perspectives on Political Economy [ 59 ]
as a result of the accident in Japan, so that the explanation of the political action may have to be
sought using public choice theory. With respect to the massive funding of renewable energies
by wind or solar power (e.g., Federal Office for Economic Affairs and Export Control 2020),1 it is
reasonable to assume that especially those interest groups that positioned themselves against
conventional power generation at an early stage have been able to generate rents.
COVID-19 as a Stimulator of the Rent-Seeking Competition
Covid-19 is a viral infection that is apparently highly contagious and probably poses a
considerable risk to life and limb (on the COVID-19 mortality see e.g., Promislow, 2020; Ruan
et al., 2020). The fact of the matter is that the knowledge about this disease is rather limited,
as there are hardly any comparable data concerning the spread of the novel coronavirus, that
is a member of a group that we already know as zoonotic pathogens (e.g., Millán-Oñate et
al., 2020). Consequently, on both sides of the political market there is incomplete information
on the medical risks of the spread of the virus. Moreover, it is difficult to predict the social,
economic and psychological consequences of the pandemic. In particular, phases of lockdown
as we have seen in Germany in March and April 2020, which for many people go hand in hand
with isolation, appear to pose different dangers (e.g., Armbruster and Klotzbücher, 2020).
However, since the government has the opportunity to obtain the necessary information
through scientific expertise (in Germany especially by the advice of Christian Drosten and
Hendrick Streeck), the supply side tends to have an information advantage over the voters.
Nevertheless, there is also an information gap on the government side as well, since forecasts
are also associated with uncertainty for scientists and every scientist interprets the implications
derived from the data differently (on the role of science in this context see Follert et al., 2020).
Furthermore, there is a considerable degree of uncertainty for the electorate concerning
the future developments of the pandemic and the effects on individual life. In particular, the
uncertainty cannot be sufficiently mitigated by approximate estimates of future environmental
conditions based on past indicators. The negative scenario is reinforced by media reports
and, in particular, social media, which of course focus primarily on the threats posed by the
disease to the individual, the health care system and the economy (on risk perception and its
influence on political decisions, recently Follert and Daumann, 2020). There is at least anecdotal
evidence that the dreadful images from northern Italy showing the removal of corpses by
military trucks increased the perception of danger in Germany and influenced politicians
to take more stringent governmental measures. For most of the voters, the pandemic has
1 On the expansion of renewable energies in Germany after the accident in Fukushima see Rave (2016).
New Perspectives on Political Economy [ 60 ]
created a completely new and unknown threat to both their own health and their economic
resources. In this respect, the threat potential of the pandemic goes beyond the financial
and economic crisis of 2008. A prevention of a bank run in the situation at that time was also
achieved by the fact that Chancellor, Angela Merkel, and Federal Minister of Finance, Peer
Steinbrück, had a strategy for reducing the subjective perception of danger by announcing
the apparent safety of all savings deposits (on the importance of trust in this context e.g.,
Butzbach, 2016; Waschbusch, Schuster, and Berg, 2018, pp. 62–64). More than a decade later,
such a measure probably no longer would have the desired effect on the financial sector
either. One reason could be seen in the fact that, although the information on the effects of
the pandemic is incomplete, this vacuum has led to the circulation of numerous untruths and
absurdities in addition to serious and scientific criticism. The average man faces a problem
of selection. Confidence-building measures can hardly be implemented by the political side.
In this uncertainty, parts of the population are understandably looking for reliability and a
“strong” state of some kind. Since the threats in the current period are perceived as more
dangerous than any threats in future periods, the pandemic raises the threshold of tangibility
and improves the acceptance of government measures among voters. In other words, the
majority of voters would have refused to favor individual groups of voters, for example in the
form of direct transfers, before the pandemic, but the pandemic has brought about a greater
degree of acceptance.
Like every government, the German government is fighting on two fronts against COVID-19. On
the one hand, it is trying to keep the number of infections as low as possible and, on the other,
it tries to contain the economic consequences. In the context of COVID-19 crisis-decisions, the
government is basically confronted with three information problems:
(1) The effectiveness of infection control measures.
(2) The reaction of the population to the measures.
(3) The effectiveness of the measures for economic stabilization.
While the measures to combat a pandemic (1) are largely known through epidemiological
research with regard to their effectiveness in achieving the goal of “protection against infection”,
especially (2) and (3) are characterized by a high degree of uncertainty. Particularly the reaction
of the population is relevant for politicians to reach their overall political goal. The fact that
this situation can lead in a political competition is demonstrated by the Minister Presidents,
New Perspectives on Political Economy [ 61 ]
Armin Laschet (North Rhine-Westphalia) and Markus Söder (Bavaria). While Söder pursues a
particularly strict policy, Laschet tried to implement less restrictive measures in his state.
This information problem mentioned in (3) turn also favors the interest groups, which point to
a particularly difficult situation of their clientele and demand state support services. In Germany
governmental aid began with “Immediate Federal Economic Assistance [Corona Soforthilfen]”.
Federal Ministers Peter Altmaier and Olaf Scholz emphasizes on 03/29/20:
“The Federation and the Länder have jointly put in place the necessary
requirements for quick applications for the coronavirus Immediate Assistance
Programme and for quick payments, and have done so in record time. We are
acting in response to the hardship faced by many small businesses, own-account
workers, members of the free professions, and farmers who are in urgent need of
this assistance. The application and payment process is to be swift and free from
red tape. Up to €50 billion of federal budgetary funding can be accessed by the
Länder for this purpose as of this Monday” (Altmaier, 2020).
“The Federation and the Länder have acted very swiftly so as to be able to deploy
the coronavirus Immediate Assistance Programme immediately. Own-account
workers and businesses employing up to ten people can claim grants for their
operational costs – a total of €50 billion has been set aside for this. The Länder
can begin to access these funds as of tomorrow (Monday), so that the grants can
be paid out quickly and without red tape. It is good that the Federation and the
Länder are working so closely together to ensure that the assistance will quickly
be available to those who need it” (Scholz, 2020).
To point out his determination to fight against the economic consequences of the COVID-19
pandemic, Federal Minister of Finance, Olaf Scholz, uses the image of “bazooka” (e.g., Chazan
and Fleming, 2020), which shows clearly that the governmental expanses are no longer limited.
If, despite the almost unlimited possibilities of today’s (paper) monetary system (fundamental
insights on the monetary system by Huerta de Soto, 2012), one assumes that financial resources
are a scarce resource, competition between the various interest groups will develop. The German
economic newspaper Handelsblatt (2020, translated by the authors) emphasizes the problem
of rent-seeking competition:
“Whether in the automotive industry, tourism, transport, pharmaceuticals or retail:
everyone wants to secure as much of the package as possible. […] Olaf Scholz
must feel like Santa Claus. The Federal Minister of Finance is literally showered
with wish lists. Since it became known that the federal government wants to
New Perspectives on Political Economy [ 62 ]
put together an economic stimulus package worth billions, [Scholz] has received
approximately 350 letters of request from all over the country.”
The demands of individual interest groups thus trigger the phenomenon of the “rat race”, which
is well known from sports economics (Akerlof, 1976; further Daumann, 2019, pp. 177–178): Several
rats try to reach a piece of cheese. Since only the first rat can eat the piece of cheese, all rats
make an increased effort to reach the cheese first. Due to these basic conditions, overinvestment
occurs. This is the situation in which the interest groups believe they find themselves: Other
associations try to counter the advance of individual associations; they do not want to stand
back and also want to achieve advantages for their members. If they are too reluctant to do so,
they run the risk, in their opinion, of coming too late in gaining state support for their members.
Failure to do so could lead to the association being delegitimized by its members, since its
original purpose is to represent particular interests, which would then not be provided (Olson,
2002). Large interest groups tend to start lobbying, while in the following further stakeholder
groups appear on the scene. Especially those organizations which prima facie do not act as
lobbyists but as so-called “activists” should not be underestimated in their influence on the
political actors of modernity, which can be seen in the effects of Fridays for Future on political
behavior. Benson (1984, p. 388) describes this mechanism as a
“spiraling process of government growth since successful rent seeking by one
interest group generally requires expansion of bureaucratic powers, while at the
same time creating incentives for the formation of additional rent-seeking interest
groups. Legislative responses to these new groups requires further expansion of
the bureaucracy and creates incentives for more rent seeking, so the growth
process continue.”
In the final step, the government also becomes aware of the scarcity of its resources, which is due
not least to the debt brake. Due to the limited term of office, the assumption of new liabilities at
the expense of later generations does not tend to be a particular obstacle, so that finally it is to
be feared that the pandemic will override the budget constraint: The debt brake is simply tilted
and the “restaurant bill problem” arises (Koslowski, 1994, p. 306): if a larger group decides to go
out for dinner in the evening and simply divide the total expenditure according to the number of
heads, then much more is eaten than if everyone has to pay for himself. In other words, all groups
of voters now try to get state benefits because the cornucopia has been opened.
The result could be considerable deadweight effects and a misallocation of scare resources.
Since transfer payments in acute crisis situations must necessarily be carried out quickly and
New Perspectives on Political Economy [ 63 ]
unbureaucratically without a careful examination of the economic conditions, the state cannot
distinguish between “good” and “bad” companies. Subsidies are distributed by watering can, so
that business models are kept alive which would actually have already gone bankrupt without
the crisis. In addition, support is also given to companies that do not need it. Incidentally,
the same would also be expected with a flat-rate “child premium” if it were not possible to
differentiate between the economic and social conditions of households. In extreme cases,
there is also discretionary potential for fraud. Only a short time after the start of aid payments,
several fraud cases in Germany become known, especially in Berlin, cases of suspected subsidy
fraud are increasing (e.g., Stehle, 2020).
Concluding Remarks
The aim of this paper is to transfer the mechanism of rent-seeking competition that is known
from Public Choice theory to the COVID 19 pandemic. We emphasize that the current crisis
is characterized by a high degree of uncertainty, because the phenomenon is mostly new
and difficult to compare with other health crises in the past. Especially the incomplete and
asymmetrically distributed information leads to a political vacuum that offers rent-seeking
potential. The uncertain and complex situation could be used by various interest groups to
seek for rents for their members. It is typical for such a situation that politicians are receptive to
this lobbying, which is already derived from the goal of the maximization of votes to stay in the
office. This leads to increased spending in the COVID-19 crisis, which burdens future generations
of tax payers. In the end there is the typical “restaurant bill problem”, where the expenses are
divided among all parties involved, which tends to lead to increased expenses.
With this analysis we would like to sensitize the reader to the political-economic dimension of
the COVID-19 pandemic and show that—apart from the known health-related risks—, there
may also be considerable economic consequences that have to be discussed. Future research,
particularly from an ex post perspective, should attempt to examine, on the basis of empirical
evidence, the extent to which state measures were favored by lobbying activities, although a
causal connection can hardly be established.
At the end of our analysis, it should be pointed out that we are building on some assumptions,
especially those of Public Choice theory. It is obvious, that these do not necessarily apply to
every individual. However, we broaden the perspective of neoclassical Public Choice theory
to the extent that a central point of our essay is the incomplete and asymmetrical distributed
information that favors certain mechanisms within the COVID-19 pandemic.
New Perspectives on Political Economy [ 64 ]
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Bio
Prof. Dr. Frank Daumann
Faculty of Social and Behavioral Sciences, Friedrich Schiller University Jena,
Germany.
Ass.-Prof. Dr. Florian Follert
Faculty of Management, Seeburg Castle University, Seekirchen am Wallersee,
Austria.
Corresponding Author: florian.follert@uni-seeburg.at