Neoclassical Economic Theory, 1870 To 1930 (Warren J. Samuels, Klaus Hennings & Warren J. Samuels)

NEOCLASSICAL ECONOMIC THEORY,
1870 to 1930
Recent Economic Thought Series
Editor:
Warren J. Samuels
Michigan State University
East Lansing, Michigan, U.S.A.
Previously published books in

the series:
1. Feiwel, G.: Samuelson and Neoclassical
Economics
2. Wade, L.: Political Economy: Modern Views
3. Zimbalist, A.: Comparative Economic
Systems: Recent Views
4. Darity, W.: Labor Economics: Modern
Views
5. Jarsulic, M.: Money and Macro Policy
6. Samuelson, L.: Microeconomic Theory
7. Bromley, D.: Natural Resource Economics:
Policy Problems and Contemporary
Analysis
8. Mirowski, P.: The Reconstruction of
Economic Theory
9. Field, A.: The Future of Economic History
10. Lowry, S.: Pre-Classical Economic Thought
11. Officer, L.: International Economics
12. Asimakopulos, A.: Theories of Income
Distribution
13. Earl, P.: Psychological Economics:
Development, Tensions, Prospects
14. Thweatt, W.: Classical Political Economy
15. Peterson, W.: Market Power and The
Economy
16. DeGregori, T.: Development Economics
17. Nowotny, K.: Public Utility Regulation
18. Horowitz, I.: Decision Theory
19. Mercuro, N.: Law and Economics
20. Hennings, K. and Samuels, W.:
Neoclassical Economic Theory, 1870
to 1930
Neoclassical Economic Theory,
1870 to 1930
edited by
Klaus Hennings and Warren J. Samuels
.....
"
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NaocIassIcIII eoonomic meory, 1870_ 1930/K ....... Hennings and Warren
J, SMnuela, edftonI,
p. cm._(Reoonl economiclhooghl)
1 _ bll>logrnpl1ll111_lndex.
ISBN·ll: 976·94"{)10·7~ 77·l e-ISBN-ll : 976-94-009-2161-11
DOl: 10.1007/976-9<1-009-2161-8
1. Neoclassical SCI>OOI olooco""""ca. I. Hennings, KlaUS.
II. Samuels, WarrenJ., 1933- III. Sarles.
HB98.2.N43 1990
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Copyright 01990 by lOuwer Academic; Publishers

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Soltcover r eprint of the hardcover 1st edition 1990
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In Memoriam: Klaus Hennings
Contents
Contributing Authors ix
1
Introduction
Warren J. Samuels
2
Neoclassical Value and Distribution Theory: The English-Speaking
Pioneers 13
Peter Groenewegen
Commentary by John Creedy 52
3
Hawtrey and Robertson: Real and Monetary Roots of English
Macroeconomics in the Twentieth Century 59
Patrick Deutscher
Commentary by Donald A. Walker 88
4
The Lausanne Tradition: Walras and Pareto 95
Claude Menard
Commentary by Donald A. Walker 137
5
Menger, Bohm-Bawerk, and Wieser: The Origins of the Austrian School 151
E. Streissler
Commentary by Robert F. Hebert 190
6
The Austrian Tradition: Schumpeter and Mises, 201
Stephan Boehm
Commentary by Israel M. Kirzner 242
7
The Swedish Tradition: Wicksell and Cassel 251
Bjorn A. Hansson
Commentary by Carl J. Uhr 280
Vll
Contributing Authors
Professor Stephan Boehm

Department of Economics
University of Graz
A-8010 Graz, Austria
Professor John Creedy

University of Melbourne
Parkville, Victoria 3052 Australia
Patrick Deutscher
111 James Street
Ottawa, Ontario, KI R 5M2 Canada
Professor Peter Groenewegen

University of Sydney
Sydney, NSW 2006 Australia
Professor Bjorn Hansson

University of Lund
Box 5137
3-22005 Lund, Sweden
Professor Robert F. Hebert

Auburn University
Auburn University, Alabama 36849-3501
IX
x CONTRIBUTING AUTHORS
Professor Israel Kirzner

269 Mercer Street, 7th Floor
New York University
New York, NY 10003
Professor Claude Menard

Sciences Economiques
University de Paris I-Pantheon-Sorbonne
90, Rue de Tolbiac
75634 Paris Cedex d13, France
Professor E. Streissler
Institut fur Wirtschaftswissenschaften
Universitat Wien
A-1 01 0 Wien, Austria
Professor Carl Uhr

University of California
Riverside, CA 92521
Professor Donald A. Walker

Indiana University of Penna.
Indiana, PA 15705-1087
Professor Thomas Wilson

Lade Cottage
Kilmahog, Callander, FK17 8HD Scotland
1 INTRODUCTION
Warren J. Samuels
Each book in this series explores the present status of its field in terms of
where it is, how it got there, the existing tensions within the field, and
something of how the field might develop in the future. Each book
presumes that work in each field is neither settled nor unequivocal. Each
book attempts to comprehend its field as an evolving, developmental
process or set or efforts.
This particular book, covering neoclassical economics, is the third of
three in the field of the History of Economic Thought. The others are
Pre-Classical Economic Thought, edited by S. Todd Lowry, and Classical
Political Economy, edited by William O. Thweatt. Each one conducts the
same kind of analysis as the others in the series, with the understanding
that here we are dealing with the history of interpretation, rather than a
substantive body of analysis of a certain aspect of the economy: for
example, labor or international trade. (That understanding must be com-
plex and subtle, inasmuch as revision of interpretation of earlier ideas is
part of the process-both cause and consequence-of re-analyzing the
economy.) In this group we are interested in how recent and contemporary
writers have interpreted the history of economic thought differently, both
among themselves and from earlier writers.
1
2 NEOCLASSICAL ECONOMIC lHEORY
Several topics must be discussed to place such work in perspective, in

part as it is here applied to the history of the interpretation of neoclassical
economics.
1. The ideas of any particular writer-for example, Adam Smith,
David Ricardo, Karl Marx, John Maynard Keynes-or school of econo-
mic thought are so multifaceted that they can be interpreted in different
ways. Moreover, different interpreters approach these ideas from different
perspectives. Hence, it is not surprising that different and indeed con-
flicting interpretations of those ideas are forthcoming.
The interpretation of a school of economic thought will depend, in part,
upon the interpretive position of the analyst. Interpretation tends to give
effect to and be tautological with the premises of the interpreter's stand-
point. Two key points apply. First, the doctrines of a particular person or
school will appear and be stated differently by members inside of a school
and by members of other schools. The doctrines of school A as viewed by
members of school A (A's view of A) will differ from A as viewed by
members of other schools (B's view of A), and vice versa. Second, the
doctrines of a particular person or school will be perceived differently
depending on which future school, and which wing within it, becomes the
basis from which the earlier doctrines are interpreted.
2. The history of modern economics, of the economics of the post-
. classical period, is preeminently the history of the rise to prominence of
neoclassical economics. One cannot do interpretive justice to the history of
twentieth century economic thought without focusing on neoclassicism. To
be an historian of modern economic thought is perforce to be, to no minor
extent, an historian of neoclassical economics.
The justifications for this book, therefore, are that neoclassicism has
been the predominant school of economic thought in the twentieth century
and that the interpretation and critical appraisal of the doctrines of the
earliest neoclassical writers have in fact changed over the years. Accord-
ingly, we need to examine the state of interpretive scholarship dealing
with the early history of neoclassical economics. In short, it makes sense to
divide the history of economic thought into pre-classical, classical, and
neoclassical epochs, and to analyze the state of interpretation of each.
3. Two further and related points about twentieth century economics:
First, neoclassicism itself has been heterogeneous (to be expouded upon
shortly). Second, twentieth century economics encompasses more than
neoclassicism and is indeed extremely heterogeneous. There are also, for
example, radical (or Marxian) economics; institutional economics; social
economics; Keynesian economics of several varieties, including post-
Keynesian economics; and so on. Several other books in this series deal
INTRODUCTION 3
with other schools of twentieth century economics; and Samuelson and

Neoclassical Economics, edited by George R. Feiwel, examines the archi-
tectonic influence of Paul A. Samuelson on the post-World War Two
development of neoclassicism and perforce of economics.
4. The definition of neoclassical economics is not perfectly self-
evident. It has meant different things to different writers, some practicing
neoclassical economics as they understood it, and others studying the
history of neoclassical economics. These different meanings include: (1)
the subjective marginal utility theory of the 1870s and beyond; (2) the
economics of Alfred Marshall; (3) the work of twentieth century writers
working in the tradition, or mold, established by Marshall and some
others, most notably Leon Walras; (4) some combination ofthe foregoing;
and, inter alia, (5) work under the aegis of the (Samuelsonian) neoclassical
synthesis of microeconomic price and resource allocation theory with
Keynesian macroeconomics. The present book covers the period of 1870
through 1930 and, as the Table of Contents reveals, encompasses the
British contribution (Jevons, Marshall, and Pigou; and Hawtrcy and
Robertson); the Lausanne school (Walras and Pareto); the Austrian
tradition (Menger, Wieser, and Bohm-Bawerk; and Schumpeter and
Mises); and the Swedish contribution (Wicksell and Cassel).
Neoclassicism has also had a variety of technical meanings as to its
central problem: the mechanics of utility, price determination or opera-
tion of the price mechanism, the working of the free enterprise system,
the operation of pure markets, the mechanics of the pure theory or logic
of choice, constrained maximization decision making, the allocation of
resources, and so on. Not all these meanings are mutually exclusive;
indeed, many of them are mutually reinforcing. My own general view
is that neoclassical economics comprises work in the tradition of Marshall,
Walras, and others on how the price mechanism of the market allocates
resources in a context of the mechanics of choice from within opportunity
sets. For this book, the Samuelsonian emphasis on economics as the logic of
constrained maximization decision making is a transformation coming well
after its closing date of 1930, to wit, after World War II.
5. There is much less equivocation as to who in fact is a neoclassical
economist, at least among the writers in economics during the period
encompassed in this book. There are several dozen major persons, not all
of whose interpretive literature could be treated here-testimony to the
power of the concept of scarcity, on which neoclassicism has no monopoly.
One figure is conspicuous by his absence: John Maynard Keynes. We
have three of the great early English microeconomists: Jevons, Marshall,
and Pigou; only Edgeworth is notably missing. We have two of the great
4 NEOCLASSICAL ECONOMIC THEORY
early macroeconomists: Hawtrey and Robertson; the great Keynes, among

some others, is missing. We have Walras and Pareto of the Lausanne
tradition (with no serious contender missing), and Menger, Wieser, and
Bohm-Bawerk of the early Austrian school (again, with no serious conten-
der missing). We therefore have the four great developers of marginalism:
Jevons, Marshall, Walras, and Menger. We also have two of the great
contributors to the later development of the Austrian tradition: Schumpe-
ter and Mises (though Schumpeter is far more than an Austrian econom-
ist); and only Hayek is missing. And we have two writers who are less
easily pigeonholed, though they obviously are neoclassicist and represent
the Scandinavian tradition within neoclassicism: Wicksell and Cassel (with
several serious contenders missing). But no Keynes.
The justification for excluding Keynes as a central figure is complex but
straightforward: partly the mundane reason of limited space, which led to
constraining the period covered to 1870-1930; partly the enormity of the
literature on the interpretation of Keynes (though there is much-albeit
not as much-on several economists included herein); partly that the
General Theory came after 1930; and partIy that Keynes is so much more
than a neoclassical economist. In other words, given that neoclassicism is
preeminently microeconomics, Keynes' was predominantly macroecono-
mics (the microfoundations of macroeconomics being present but not
center stage); and so on.
Similarly, not every aspect of the work of those economists chosen for
inclusion could be covered. This is particularly grievous in the case of
Pareto, who, like Adam Smith, Karl Marx, and Max Weber, practiced a
much broader conception of the economy and economics than is contem-
plated by neoclassicism qua neoclassicism, but who was (unlike the three
others, of course) still a neoclassical economist insofar as an important part
of his work is concerned.
There remains, however, at least one other conspicuous domain of
omission: the American contribution to neoclassicism during the period
covered by this book. It may well be true that there was no premier
American theoretical innovator during that period of the significance and
status of, say, Marshall and Menger. But there were major American
writers who contributed to the evolution of the theory of value into the
theory of price (etc.): John Bates Clark, Herbert J. Davenport, Frank
Albert Fetter, Irving Fisher, Frank Knight, Frank W. Taussig, and Jacob
Viner, to name a few. Only a couple of these names arise in the follow-
ing chapters. To a large extent they are omitted and eclipsed, deservedly
or not.
INTRODUCTION 5
6. If neoclassicism encompasses all of the economists discussed here,

and many others as well, it should be obvious that however neoclassicism is
defined, it has in fact been extremely diverse-as has the history of
interpretation of these early neoclassical writers.
Two points, should be made about the evolution of the interpretation of
early neoclassical writings and economists: interpretation has largely (but
by no means completely) taken place within neoclassical economics, and
interpretation reflects in part the development of neoclassical economics
itself. Indeed, it is of the utmost importance for the reader to recognize
that reconsideration and reinterpretation of the work of earlier economists
reflects the varying subsequent interests and preconceptions of the inter-
preters. The retrospective understanding of the work of an earlier writer
is a function of both the writings themselves and the interpretive position
of the interpreter. It is because earlier works can be interpreted from
different perspectives and because interpreters do in fact approach
earlier works from different perspectives that the problem of multiple
interpretation arises.
7. The foregoing discussion has necessarily alluded to the concept of
marginalism. This concept, too, has had diverse meanings and is also part
of the history of the practice as well as of the interpretation of neoclassic-
ism. Marginalism has meant: (1) the subjective marginal utility theory of
value; (2) the economy as a process of adjustment at the margin; (3) the
practice of constrained maximization by economic actors (for example,
equating marginal cost and marginal revenue); and, inter alia, (4) price and
resource allocation.
Related questions concern the dating of the so-called marginal revolu-
tion and whether such a revolution actually took place. The latter raises the
larger question of whether there was a major paradigmatic shift between
classical and neoclassical economics. But of greater present interest are
these further questions: (1) of what did the putative revolution consist and
(2) whether the so-called revolution took place in the 1870s, as is so often
understood, or a short time later, say, with the preeminence of Marshallian
economics, or still later, with the more firm establishment of an Austrian
school, or (as George Stigler argues) much later, perhaps the 1960s, with
the adoption of now the more-or-Iess conventional practice of using utility
functions to formulate research problems? It will be obvious, perhaps, that
each of these possibilities may presume something different regarding the
content of marginalism.
These considerations about marginalism are noted principally to empha-
size the enormous diversity both within neoclassical economics and of
possible historical interpretation and reinterpretation of neoclassical eco-

nomics, as well as the evolution of neoclassical economics (for example,
defined as the theory of price mechanism, market, and resource allocation
from Marshall to the present). The retrospective interpretation of earlier
writers and earlier works will differ on the basis, in part, of different
conceptions of what neoclassical marginalism involves.
8. Twentieth century economics is marked by (a) the rise to hegemo-
nic, orthodox status of neoclassical economics; (b) diversity within neo-
classical economics; (c) the contemporaneous development of heterodox
economics as part of economics, alongside neoclassical economics (not-
withstanding the propensity of neoclassical economists to define economics
as neoclassical microeconomics); and (d) considerable diversity or heter-
ogeneity within heterodox economics. The late nineteenth and early
twentieth century origins of these developments consisted of a variety of
factors and forces, including: (1) the heterogeneous and kaleidoscopic
character of the economy, coupled with the opportunity to, and the fact of,
viewing the economy from different perspectives; (2) the desire of econom-
ists to enjoy the status and prestige of scientists, with the meaning of
science being quite variegated; (3) the desire of economists to perform one
or another role as experts, that is, of the man/woman of knowledge; and
(4) the desire of economists, and of noneconomists, for economists to have
something to say about the economic role of government. Several tensions
are immediately obvious: between economics as objective science and as
policy advocacy, including advocacy of the existing economic system as
such and/or of specific policies; between the economy as an independently
given phenomenon and as a matter of human social construction; and,
inter alia, between the general tenor of noninterventionist laissez faire and
the practice of policy activism.
The development of twentieth century economics, including the ascend-
ence of neoclassical economics, constituted, as it were, something of a
"solution" to the identity crisis in which economists during the period from
roughly 1880 to 1914 found themselves. Among the elements of this
identity crisis were: (1) the very name of the discipline, "political eco-
nomy" or "economics"; (2) the status of the "founding fathers," most of
whom were English, namely, Adam Smith, David Richardo, Thomas
Robert Malthus, James Mill, Jeremy Bentham, and perhaps John Stuart
Mill, among others; (3) the nature of the central problem of the discipline
from which it derived much of its identity: value, exchange, wealth,
resource allocation, growth, distribution, organization, and control, and so
on; (4) the status of classical value theory, namely, the labor theory of
value, especially but not solely in view of Karl Marx's use of it; (5) the
INTRODUCTION 7
status of the Western economic system, particularly in view of the chal-

lenges rendered to it by Marx and other critics of the system, both socialist
and nonsocialist, but also in light of the fairly common view (held, for
example, by Smith and Ricardo as well as Marx) that the economy
undergoes fundamental or systemic changes from one stage to another;
(6) the question of the identification of economics with a particular status
quo or stage; (7) the scope and the methodology of economics-for
example, its relation to other "sciences," its practice as science and as
art, and, inter alia, its practice as an inductive, empirical, and/or historical
discipline; and so on. The development of economics, including neoclas-
sical economics, in the twentieth century not only constituted an ongoing
working-out of these matters but also manifested continuing conflicts
over those very issues, resulting in diversity both within and without
neoclassical economics.
9. The reader should be aware that this book is intended to be neither
a history of economic thought per se nor strictly a study of the ideas of the
economists whose names grace the chapter titles. The intention is to
examine the state of the interpretive literature that deals with the work of
those economists. It is an interpretation and critique of interpretation.
10. A number of further considerations are raised by this book (and its
companion books) that are important to: (1) the conduct of analysis within
neoclassical economics, (2) both the interpretation and evaluation of
neoclassical economics, and (3) the conduct of work in the field of the
history of economic thought in general. These considerations are by no
means treated either directly or exhaustively here; but the reader should be
alert to them, as they represent major fault lines in the discipline. These
considerations, which to some extent overlap, include:
a. The nature of economic thought, including neoclassical economics,
as a definition of an independent and preeminent reality, a set of tools, a
mode of discourse, a story, a system of belief, and/or a paradigm, and so
on.
b. The functioning of economics as knowledge, social control, and
psychic balm.
c. The role of economics in the social (re)construction of the actual
economy.
d. The combination of the theory- and/or paradigm-laden nature of
"facts," and the system- and experience-specific nature of "theory"; the
conjunction of "is" and "ought" elements in both facts and theory; and the
inevitable combination of deductive and inductive elements in all analysis.
Apropos of the latter point, the subtle problems and nuances encountered
in interpreting work as empirical or theoretical suggests the difficulties of
sorting out the threads of deductive and inductive work that are inexorably
combined in doing each and every sort of economics.
e. The significance for both ordinary and analytical discourse and
for both the normative nature and apologetic role of economics of the
continued use of the same words or terms in the face of a changing eco-
nomy: the language and imagery of methodological (as well as normative)
individualism arguably serving to obscure the realities of a corporate,
managerial economy.
f. The importance of paradigm both for the identification and compre-
hension of "facts" and for the establishment of professional status: state-
ments of fact and of professional accomplishment are paradigm-specific.
Paradigms also are the great filtering device in both interpreting and
assessing the history of economic thought, and in theory choice through the
test of paradigm consonance.
g. As several contributors point out, interpretation of an earlier body
of work is found in two kinds of subsequent work: in both the intentionally
interpretive-critical literature and the substantive work of dedicated
followers-extenders-revisers of that work. In both respects, the meaning of
an early text or body of work will vary from interpretation to interpretation
and from later development to later development.
h. The development of conventional practice along the lines of seeking
determinate, equilibrium, and/or optimal solutions, supplemented by con-
ventionalist treatments of fundamental concepts and analytical techniques,
has resulted in a neoclassicism capable of variegated interpretation: as a
more or less close description of reality, as a pattern model of reality, as a
story more or less loosely related to and expressive of reality, and, inter
alia, a set of tools with which to analyze reality.
i. The interpretive problem (noted, for example, by Claude Menard)
whether the doctrines or analyses of a "school" is to be identified in terms
of its original formulation or its subsequent realization. This problem is
further complicated by the situation (also noted by Menard) that develop-
ments strongly tend to comprise more syntheses of theoretical problems or
positions than achieved theoretical solutions. It is not inapposite to this
and other points to call attention to the view of Arjo Klamer that "the
foundations on which the first modern neoclassicals thought their theories
rested have all but disappeared.,,1
j. The "astonishing paradox" (again Menard) that neo-Walrasian and
comparable developments in neoclassical theory have attempted to illu-
minate a decentralized market economy by referring to or invoking ele-
ments of what otherwise are understood to constitute a centrally planned
economy-for example, the autioneer. A comparable paradox arises in
the frequent (but by no means universal) response to existential uncertain-
INTRODUCTION 9
ty (radical indeterminacy), under the aegis of seeking determinate (and

also optimal) solutions, of presuming perfect knowledge of the future
and/or of prereconciled prices. In these matters, it should be pointed out,
there are substantial differences between Marshallian and Walrasian neo-
classical economists and between mainstrean neoclassical economists and
the Austrian and neo-Austrian tributary. Diversity of belief and practice is
once again the rule, but the fact of diversity by no means negates the
principal tendency to seek determinate solutions.
k. The heterogeneous and kaleidoscopic nature of the economy and of
the practice of economics inevitably leads, even within neoclassical econo-
mics alone but also and especially between orthodox neoclassical and
varieties of heterodox economics, to contradictory portrayals and explana-
tions of the economy and of the economics of leading economists-both of
which, but especially the latter, are amply evident in this book.
1. The combination of the heterogeneous character of economic
thought (even within neoclassicism) and the fact of the evolution of
(neoclassical) economic thought, means that any particular vision of past
thought is but one such possible vision. To the extent that the vision is
dependent upon development(s) subsequent to the past thought under
consideration, different developments would have encompassed different
interpretive standpoints and thus different visions and comprehensions of
past thought.
m. There are inevitable tensions between what is "given" and what is
"neglected" in both the practice of economic analysis and the history of
economic thought. Two examples: Is resource allocation, as a central
problem, taken for granted but subsumed in classical economics (perhaps
in the form of a paradigm centering on various aspects of the allocation of
capital), or is it negiected, perhaps not even understood, therein? Is the
fact that there is no unique Pareto optimal solution, only solutions specific
to the existing or presumed structure of power (distribution of rights), so
understood that it does not always have to be acknowledged, or is it
neglected in the quest for singular determinate and optimal solutions?
Among other things, such considerations affect one's answer to the ques-
tion of whether there has been only one dominant par<;ldigm in economics
(say, since Smith) or a paradigm shift (say, with the rise and predominance
of neoclassical economics).
n. Is the core of neoclassical economics the theory of value in the
nineteenth century sense: namely, the quest for the absolute and ultimate
basis of price; or is it a theory of price, and of nothing more metaphysical
than price? And, as a theory of price, is it anything more than a theory of
prices as simple coefficients of choice (as Joseph Schumpeter put it) or as
temporary, episodic resting points in the eternal dance of supply and
demand? Furthermore, is it a theory of price (or of value) at all, or is it a

theory of the allocation of resources, a theory in which prices, ostensibly
generated by the "price mechanism," register whatever demand-and-
supply forces are generated within the existing structure of power, regulate
resource allocation? This is not solely a question of the relative importance
of price mechanism (market) and power (institutions) structure. It is here
principally a question of the very nature of microeconomics, of neoclassic-
ism, and of the work of the neoclassical economist.
o. There are also sociological aspects of the development of econo-
mics, especially of neoclassical economics in the context of the larger
economics of the twentieth century and in its own heterogeneity. These
include: the in-group versus out-group and hierarchical structure of the
discipline by both schools of thought and universities of employment; the
relative openness of economic associations and journals to divergent ideas;
the training and recruitment of economists; the social origins of econom-
ists; the internal reward-and-incentive and self-selective processes within
the discipline; and so on. It is not surprising that these sociological
considerations amply arise in Professor Streissler's essay on the early
Austrian school: Writers in the mainstream of orthodoxy (and of heter-
odoxy) are much less alert to these considerations of inclusion and exclu-
sion than are those not in the mainstream-and especially those not in
orthodoxy at all. Yet all that is not entirely or conclusively clear and is
perhaps quite relative-the latter, for example, from the point of view of
those who see Austrian economics as but one branch of neoclassicism and
who perceive their own heterodox ideas as much more excluded from the
mainstream professional literature and status system.
p. There is more to neoclassical economics than microeconomics
(price and resource allocation theory), though everything else is pro-
foundly influenced and channeled by its microeconomics. Both points
are evident in the contributions by Hansson on Wicksell and Cassel;
by Deutscher on Hawtrey and Robertson; by Streissler on Menger,
Bohm-Bawerk, and Wieser; by Boehm on Mises and Schumpeter; by
Groenewegen on Marshall and Pigou; and by Menard on Walras and
Pareto; and in their respective commentaries. Leading examples include
theories of distribution, growth, the economic order, what eventually came
to be called macroeconomics, and the fundamentals of the economic role
of government-all in addition to work in specialized fields, such as
international trade, public finance, and so on.
q. There is a tendency, given the propensity ( and necessity) for ceteris
paribus reasoning, to seek singular explanations for complex problems or
phenomena. This includes, but by no means is limited to, the using of
INTRODUCTION 11
partial equilibrium solutions as proxies for solutions to general equilibrium

problems.
r. In the contributions to this book there is evidence supporting both
sides in the contlict between absolutist and relativist, or intemalist and
extemalist, interpretations of the origin and development of economic
theory, the interests of economists in certain types of work (theoretical or
otherwise), and the choice between specific theoretical formulations. For
example, the theoretical treatment of the rate of interest may (or may
not) have reflected, in part, contemporary experience (Wilson).
s. There are other numerous interpretive considerations and questions
the positions on and answers to which profoundly affect one's understand-
ing of the development, status, and interpretation of neoclassical econo-
mics, including: whether neoclassicism is to be taken to exhaust economic
theory; the relation of Austrian to neoclassical economics; the nature and
st3;tus of a pre-Keynesian macroeconomics, especially in the 1920s; the
impact of the professionalization and institutionalization of economics and
of narrow specialization of practice (though not so much always of under-
standing); the relevance of personal biography in understanding authorial
intentions and meaning; the evolution of the meaning and nuances of
utilitarianism; differential assessments of the lasting impact of Marshall
and of what has been neglected, perhaps unduly, in Marshall-and the
same in the case of other subjects; differential views as to what is a strength
and what is a weakness in the work of an economist; the problem of
distinguishing between economic and noneconomic behavior; the relation
of neoclassical economic theory to nineteenth century laissez-faire liberal-
ism, and the meaning of "noninterventionism"; marginal productivity
theory as an example of an idea or theory that can be given either narrow,
technical or broad, paradigmatic, if not also ideological, specification; the
substantial heterogeneity among the early (as well as later) marginalists;
the range of possibilities that comprised neoclassicism vis-a-vis what neo-
classicism became; different views of the relationship of the early marginal
utility theorists-]evons, Menger, Bohm-Bawerk, and Marshall-to mod-
em theory; the relative paucity and perhaps superficiality of early metho-
dological discussion, though most of the historically important issues did
arise; the continuing power of the idea of the "natural" in economics, the
efforts of Marshall notwithstanding; the putatively significant interpretive
power of earlier writings and theories when reconsidered in the light of
later theoretical developments-and vice versa-though depending as
much if not more on the interests of the interpreters than the interests of
the original writers; the slow but cumulative growth of understanding of
the importance of bank credit as a form of money and of uncertainty, and
of the relation of money to uncertainty; the limits upon originality; the

relevance of a particular preconception of the nature and substance of
"economicorder"; and inter alia, the view of Stephan Boehm, that "There
is really something scandalous in the way some economists' stock on
the bourse of intellectual reputations is at the whim of academic
speculators,"-though it would seemingly be impossible to escape the
inevitable reinterpretation and reevaluation of later writers. All these and
other considerations and questions arise in the following pages-in addi~
tion to the enormous varieties of interpretation of specific writings and
particular theories; it is a feast of interpretive diversity. One finds here the
richness of both neoclassicism and interpretation, the two being perhaps
inseparable-but, richness being a relative matter, judgments of richness
are by no means conclusive when comparison is made with other twentieth
century schools of thought. But that is another story, well beyond the
design of this book.
Finally, a word about the books origins. In 1984, Klaus Hennings kindly
agreed to meet with me in Frankfurt. Because of his mastery of the
relevant literature and the respect and esteem with which he was held by
our colleagues, I asked Klaus to edit the volume on the interpretation of
neoclassical economics. Because of reasons of health and the pressure of
other commitments he could not undertake the task immediately. I was
prepared to wait. With some cooperation from me, he eventually defined
the scope and organized both the division of material and the contributors
to this book. Klaus died, alas, before the initial arrangements could be
completely settled. It seemed sensible for me, as series editor and an
historian of economic thought, to assume the work of continuing to edit the
book. It is therefore structured, in terms of subjects and authors, substan-
tially along the lines Klaus had intended and actually arranged. Only a few
authors remained for me to recruit. In understaking to edit the book
further, I have followed two principal rules: to abet the fruition of Klaus'
original intent, and to allow the contributors complete discretion in writing
their chapters. Klaus would join me, I am certain, in thanking the
contributors for so nicely following the intentions of the editors. And, I am
no less certain, the contributors join me in dedicating this volume to Klaus.
Notes
1. Arjo Klamer, "Review of Donald M. McCloskey, The Rhetoric of Economics," in

Review of Radical Political Economics, 19 (Fall 1987), 80.
2
NEOCLASSICAL VALUE AND
DISTRIBUTION THEORY:
THE ENGLISH-SPEAKING PIONEERS
Peter Groenewegen
A new economics of market prices and resource allocation was developed

in several countries from the early 1870s. It is well known that, in England,
that development was initiated by Jevons, consolidated by Marshall from
the 1890s, and reinforced through the work of their colleagues, followers,
or students: Wicksteed, Edgeworth, and Pigou in England, J. B. Clark and
Irving Fisher in that other vast English-speaking world across the Atlantic.
As Schumpeter (1954) pointed out, the key English figures in these
developments are Jevons and Marshall, but this does not mean that the
theoretical contributions to the new economics by the other leading figures
in these developments on both sides of the Atlantic can be ignored. This is
clearly demonstrated by the pioneering literature of this epoch in the
history of economic thought. Stigler (1941), in his account of the formative
period of the new production and distribution theory, only omits Pigou
from his study, while Fisher, though not given a chapter of his own in the
book, is mentioned as a prominent exponent of the new economics in the
United States on a par with J. B. Clark. The other important specialist in
early history of this period (Hutchison, 1953) likewise acknowledges these
economists as the great English-speaking contributors to this new, more
rigorous form of economics that based itself on the application of a
13
marginaUst method to problems of choice and generalized price determina-

tion theory. The views expressed in these authoritative sources combined
with Stigler's (1950) equally authoritative account of the development of
utility theory form the point of departure from which to review more
recent work on these "English-speaking" marginalist pioneers.
By way of further introduction, an adaptation of the table with which
Stigler (1941, p. 11) introduced this subject matter is useful as a pre-
liminary "review of the troops" (see table 2-1). This puts the dramatis
personae of this chapter immediately into chronological perspective and,
in addition, allows some initial generalizations and comment on their
respective backgrounds.
With the exception of Wicksteed, the writers included here were
academic economists for the greater part of their working life. For Jevons
this only eventuated after practice of a number of other quite distinct
professions and even then was combined with the teaching of other moral
sciences and logic. All, however, had received a good university education,
but only two had formally studied political economy at university. Jevons
had done so for his B.A. degree; Pigou, while taking the second part of the
Moral Sciences Tripos after completing Part I of the History Tripos. Two
(Marshall and Fisher) had concentrated on mathematics in their university
studies; two (Wicksteed and Edgeworth) on languages and classics, and
one followed up his first general degree with postgraduate studies in
Germany in historical economics (Clark). These pioneers conform there-
fore to the pattern of professionalization in economics which Schumpeter
(1954) and other scholars have associated with this period, and which is
mentioned later in this chapter.
It may be noted at the outset that none of these seven authors special-
ized narrowly on topics in value and distribution, and that few (Marshall
being the major exception)l concentrated exclusively on economics.
Jevons, it is well known, published widely both within theoretical and
applied economics, in logic and scientific method. Particularly during his
early years, Jevons wrote on subjects as diverse as meteorology, statistics
of Shakespearean literature, astronomy, and wider social issues (the social
cesspools of Sydney, New South Wales; new facts concerning the interior
of Australia, amusements ofthe people; cruelty to animals), some of which
reveal his lasting interest in matters Australian. 2 Edgeworth wrote on
ethics and utilitarianism in addition to his very substantial contributions
to mathematical and economic statistics and economic theory (Creedy,
1986a, esp. pp. 9-11, 153-154). Wicksteed, as Steedman (1987a, p. 915)
indicates, was an accomplished linguist, philosopher, and classical scholar.
He produced work on Dante, Aquinas, Ibsen, and many theological pieces
NEOCLASSICAL VALUE AND DISTRIBUTION TIIEORY 15
Table 2-1.
Appearance of
Major Major Relevant
Name Born Died Education Occupation Work a
Jevons, W. S. 1835 1882 University Teaching 1871

College Manchester
London London
Marshall, A. 1842 1924 Cambridge Teaching 1890
Cambridge
Bristol
Wicksteed, P. H. 1844 1927 University Ministry 1894
College Lecturing
London
Edgeworth, F. Y. 1845 1926 Trinity Teaching 1881
College Oxford
Dublin,
Oxford
Clark, J. B. 1847 1938 Brown Teaching 1886
Amherst Carleton
Amherst
Fisher, I. 1867 1947 Yale Teaching 1892
Columbia
Yale
Pigou, A. C. 1877 1959 Cambridge Teaching 1912
Cambridge
a These works are:

Theory of Political Economy (1871)
Principles of Economics (1890)
An Essay on the Co-ordination of the Laws of Distribution (1894)
Mathematical Psychics-An Essay on the Application of Mathematics to the Moral Sciences
(1881)
The Philosphy of Wealth. Economic Principles Newly Formulated (1886)
Mathematical Investigation in the Theory of Value and Price (1892)
Wealth and Welfare (1912)
in addition to his work on economics which concentrated on value and

distribution theory. The two Americans also contributed to areas outside
economics. J. B. Clark followed his work on value and distribution with
applied studies on the control of trusts and monopolies before devoting his
energies to the international peace movement and studies of war and
militarism in an international setting (J. M. Clark, 1952, pp. 396-397).
Irving Fisher's massive bibliography of nearly 2,500 entries (Fisher, 1961)
covers many economic topics combined with writings on health, peace and
prohibition, mathematics, mechanics, astronomy, and mathematical statis-
tics. Last but not least, Pigou not only contributed to the "whole field of
economics" but his books include studies on theism and Robert Browning
(Datta, 1959, p. 4 and n. 1), while like Clark and Fisher he had also been
an active pacifist during the First World War (Collard, 1981, p. 108).
The degree of commentary that has been published on these authors
varies enormously. Marshall, in this respect followed by Jevons, has
undoubtedly received the most extensive treatment in the literature.
Papers devoted to their work have been collected in the series devoted to
important economists edited by John Wood (1982, 1988). On the other
hand, what post-1950 material there is on Pigou, Fisher, and J. B. Clark is
largely directed to issues not immediately concerned with their contribu-
tions to value and distribution theory, though it may also be noted here
that some work of these two Americans was criticized during the Cam-
bridge controversies in capital theory of the 1950s and 1960s. Finally,
Edgeworth and Wicksteed have been Virtually ignored in the literature,
and only recently has their economics been re-examined, in both cases
largely through the work of one person: John Creedy and Ian Steedman,
respectively. Finally, Stigler's quantitative study of citations (Stigler, 1979,
esp. pp. 181-184) for 1886-1925 and 1925-1969 may also be usefully
mentioned in this context. Fisher, Clark, Marshall, and Edgeworth were
frequently cited during the first period; Fisher, Marshall, and Pigou during
the second. Hence only Marshall as an economist whose major work was
done before 1900 survived the second citation test. Fisher, on the other
hand, was the only economist of the seven who published major work in
both centuries.
The framework for surveying this substantial quantity of material on
early English-American neoclassical economics is as follows. First, biog-
raphical and bibliographical material is discussed in order to highlight the
new work done in these areas, especially with respect to Jevons and
Marshall. This is followed by more specific, and selective, evaluations of
the more important commentary on their economics essentially to empha-
size changes in and the dynamics of interpretation of these neoclassical
NEOCLASSICAL VALUE AND DISTRIBUTION THEORY 17
pioneers. A final section provides conclusions largely devoted to more

general perspectives on this period in the history of economics in the
English-speaking world.
Biographical Foundations
Despite controversy over the role of biography in the history of economic

thought (see, for example, Jaffe 1965; Stigler, 1976), considerable bio-
graphical work continues to be done on economists, in varying ways
illuminating the development of theory. Hence biographical material
needs to be considered an important part of the literature on the econom-
ists of the early neoclassical period, particularly since it has been used for
interpreting various aspects of their work and its development. Some
examples of this are given subsequently. First, however, it may be noted
that three of the economists featured in this chapter had their lives essayed
by J. M. Keynes (1972): Marshall in 1924, Edgeworth in 1926 (both
initially as obituaries), and Jevons in 1936 as a centenary allocution.
Furthermore, Schumpeter (1952) sketched Marshall and Fisher with equal
acumen as samples of his ten great economists. Second, while biographies
have appeared of Wicksteed (Herford, 1931), Fisher (Fisher, 1956), and
Jevons (K6nekamp, 1972), Marshall, Edgeworth, Clark, and Pigou still
await their biographers. 3 In addition, only Jevons' correspondence has
been systematically collected' and published (Black, 1972-1981, II-V)
though it may be noted with pleasure that Marshall's collected correspond-
ence, edited by John Whitaker, is well on the way to publication and, like
the Jevons project, supported by the Royal Economic Society.
In the context of this chapter, detailed biographical material is particu-
. larly relevant to settling disputes about the origins of the marginal revolu-
tion, hence enhancing understanding of the precise nature of changes in
economic thinking at the end of the nineteenth century which transformed
economic theory in the opening of the next. Jaffe (1965, pp. 229-231), for
example, has illuminated aspects of Walras' economics by his biographical
discoveries. The wealth of biographical data unearthed for Jevons and,
increasingly, Marshall has done the same for those English pioneers.
Examples include the usefulness of such data for assessing the validity of a
recent hypothesis (Mirowski, 1984) on the association between a branch of
energy physics and some key propositions of the new marginalist econo-
mics. Similarly, publication of Jevons' private journal, diaries and corres-
pondence has sparked renewed, and continuing, controversy about the
early influences on Jevons' economics (see, for example, White 1982, 1984;
Hutchison, 1982) and the manner in which he came to develop his

reconstruction of political economy on marginalist and mathematical lines.
Similar work can still be fruitfully done on Marshall. Apart from Keynes'
account (1972, pp. 165-174) and its critical development by Whitaker
(1975, pp. 5-10), very little is available on the details of, and reasons for,
Marshall's shift to the study of economics in the late 1860s. An intriguing
aspect of this shift is the role therein of Cournot's work, more widely
available and known than histories of the marginal revolution often
assume. Biographical data on Marshall disclose his familiarity with Cour-
not almost a decade before Jevons claimed to have become familiar with it,
while Todhunter's query to which Jevons referred in this context raises
intriguing questions about the degree of conversational intercourse on such
matters at Cambridge. 4 Marshall's early acquaintance with Cournot helps
to explain how easy it was for a mathematician to convert Mill's view on
the subject into a geometrical supply and demand analysis, without neces-
sarily using "utility" underpinnings.
With two exceptions, the role of biography in illuminating aspects of the
marginal revolution cannot be further pursued here. Where relevant, it is
raised in the individual treatments of the various authors. The first excep-
tion to this is that biography reminds of the close personal ties that existed
between the seven authors considered here, despite the geographical
distances involved. Marshall, for example, was acquainted either per-
sonally or through correspondence with all of the other six; the same can
be said of Edgeworth, and only Jevons' early death prevented him from
forming contacts with the younger generation of Pigou, Fisher, and Clark.
The enormous correspondence of Walras supports the view of the tightknit
nature of the intercourse among the economic academic community at the
time. Second, it may be noted that all longer studies of the economists
studied here present some biographical material of their subjects, an
indication that for their authors this remains either a useful aspect of their
subject matter or, sometimes more strongly, an indispensible aid to
understanding their subject's views.
William Stanley Jevons (1835-1882)
Jevons' research has greatly benefited from the symposia organized for a
number of important anniversaries associated with his life and work and
frequently published in the Manchester School. The more important were
the centenary of the publication of his Theory of Political Economy and the
earlier anniversary of A Brief Account of a General Mathematical Theory
of Political Economy. In addition, the centenary of his death, as had earlier

been the case with that of his birth, induced significant contributions.
These have tended to concentrate on assessments of Jevons' work in
general and have less frequently focused on more detailed aspects of
his theoretical work. The theory of capital is one such instance, aspects
of his theory of demand another, and it is on these that this section
largely concentrates. 5
Unlike the treatment of Jevons' capital theory by Keynes (1972, p. 132),
Robbins (1936, pp. 317-320) and Stigler (1941, pp. 26-29), Steedman
(1972) concentrated on analyzing the internal coherence of Jevons' theory
on the basis of its final presentation in the second edition of the Theory.
Four issues are raised, all concerning criticisms associated with the Cam-
bridge controversies in the theory of capital. The first concerns definitions
of the "amount of capital" and the "amount of investment" where remin-
ders are given that "neither the physical composition of free capital nor the
amount of investment can be known independently of relative prices and
hence of the interest rate" (Steedman, 1972, pp. 33,35). The second part
shows, as earlier demonstrated in Garegnani (1960, pp. 38-39, 61-65),
that the average period of production depends for its meaning on the
amount of capital and the amount of investment and has little operational
use apart from situations of simple interest (cf. Lutz, 1967, esp. pp. 18-21)
and when no fixed capital considerations are involved. Fixedness is defined
for this purpose in terms of the continuous output case and not in tenns of
construction periods and durability. The third section then demonstrates
that Jevons' theory is a very special case, not only because it deals with the
point input-point output case but, more important, because it unwittingly
assumes a non-commodity world. In short, "Jevons's theory provides no
explanation of the level of the rate of interest; it follows that it fails to
determine wages, prices or quantities" and from the fact this theory has
been called the point of departure for Bohm-Bawerk and Wicksell, that it
is "Jevons rather than Ricardo who shunted the car of Economic Science
onto a wrong line" (Steedman, 1972, pp. 48, cf. 51). Hence the capital
theory hailed as innovative by Robbins is now shown to be wrong, and the
"most interesting of the later chapters" (Hutchison, 1953, p. 45) has turned
out to be the one most logically unsound. Such are the paradoxes of
intellectual history. 6
Just as devastating, but in some ways more intensive, has been the
debate about Jevons' contributions to demand theory. It is well known that
this was never fully developed in his Theory of Political Economy (see
Stigler, 1950, pp. 88-89,90) and it seems not unfair to argue that it was not
really developed very far at all (Blaug, 1964, p. 283). Claims, dating back
to Keynes' (1912) review of the fourth edition of levons' Theory, that

levons had used demand functions in his lecture notes, have been shown to
be misleading (Black, VI, pp. x, 15-17,84-89; cf. Keynes, 1972, p. 138, n.
2). A recent paper by Bostaph and Shieh (1987) criticizes this proposition,
while Creedy (1986b) has shown that levons did attempt to specify a
functional demand form based on the famous King-Davenant "law of
demand." Associated with this debate has been controversy about the
precise origins of levons' demand and utility theory. These have often
been attributed to debates on railway economy in which levons had
become interested during his Australian sojourn (1854-1859).
The matter of levons' use of demand curves in his lectures can be
examined first. It is clear that the lecture note discussion (Black, VI, pp.
14-17), to which Bostaph and Shieh (1987, pp. 109-11) refer, derives
largely from discussion in the Theory of Political Economy (levons, 1910,
pp. 146-159) on numerical determination of the laws of utility and the
usefulness for that purpose of the King-Davernant law of demand. The
curves presented in the lectures do not have their axes marked, but one is
described explicitly as expressing utility while the other is designed to show
. the influence on price of variations in supply when price is the dependent
variable. However, the second curve, although explicitly drawn to express
utility, can be implicitly linked to demand from levons's statement con-
trasting sugar with corn where people "will take a greater quantity of it if
they can get it at a moderate price" (Black, VI, p. 16). The context of the
lecture, starting as it does with an examination of Banfield's hierarchy of
wants, suggests that levons' concern in it was to illustrate the different
nature of wants by contrasting luxuries (sugar) with necessities (corn).
From their association with levons' discussion of numerical estimates of
utility and the King-Davenant law of demand, can these functions be
interpreted as empirical determinations of demand functions as Creedy
(1986b, p. 198) and Bostaph and Shieh (1987, pp. 117-119) suggest? The
ingeniousness of levons' attempts in this direction were already noted by
Stigler (1950, pp. 88-89), and there can be no doubt that levons made
such attempts at empirical estimation of price laws. In the posthumous
Principles, levons (1905, chapter XXXV) himself drew attention to the
importance of this type of work, though he also recognized its many
difficulties, in particular the inevitable changes of tastes over the long
periods for which in the early 1860s he had gathered his price data. In
addition, levons (1905, pp. 147-148) commented on the complexities of
the interactions of prices on demand that made empirical investigation of
price laws even more difficult. 7
Not unrelated to this r~newed interest in levons' demand and utility
theory is a current debate on its origins. Hutchison (1953, pp. 35-36),
perhaps following La Nauze (1949, 1953), saw 1857 as the crucial year in
Jevons' economic development. It was then that he first started devoting a
substantial part of his time to the study of the subject, that he read
Lardner's Railway Economy and wrote his first articles and letters critical
of New South Wales land development and railway policy. His interest in
utility economics and supply and demand theory, Hutchison infers, derived
from a direct interest in real world problems, in common with other
pioneers of marginalism like Dupuit, Lardner, Ellet, and Launhardt
(Hutchison, 1982, pp. 367-368). In a reassessment of Jevons in Australia,
White (1982, pp. 32-33) casts the net wider. White suggests that Jevons'
basic premises for the study of political economy were also influenced by
Pell and Woolley, two foundation professors of the University of Sydney
and, on particular matters, by reading Whateley's lectures on political
economy which was also part of his 1857 study of the subject. This has
induced debate on the significance for Jevons' economics of his Antipo-
dean interlude in which some have defended the role of Lardner (Bostaph
and Shieh, 1986) while Hutchison (1982, pp. 376-377) has criticized the
wider inferences White derived from additional influences on Jevons he
identified during Jevons' Australian sojourn. Needless to say, investiga-
tions of this type have been greatly facilitated by the splendid collection
of previously unpublished Jevons material in the edition of Black (and
Konekamp, 1972-1981).
White's contribution shows that much of the foundations of Jevons'
theory of price determination, competition, and its application to social
welfare and government intervention, basically originated in the context of
the railway debates, but that Pell's contributions may here have been more
important than previously thought. 8 The Woolley and Whateley influence,
on the other hand, White relates to Jevons' development of some utili-
tarian propositions. These concern competition's role in promoting the
"greatest happiness" by "maximising wealth" and the perception of man as
a pleasure maximizing, pain-minimizing, calculating machine. White's line
of investigation contrasts with Black's (1972, p. 123) remark that while
Jevons was beginning to read political economy in Australia, "he does 'not
seem to have paid much attention to philosophy, and none at all to
Bentham." This was undoubtedly a useful inference for combatting the
"half-truth" of making "simple hedonism" of Bentham the foundation of
Jevons' work. However, it ignores the implications of Jevons' father's
strong advice that Jevons seek the company of all three professors of
the newly founded University of Sydney (1 April 1855, in Black, 1973,
II, p. 136 and n. 2), while in addition it confounds the wider meaning
the nineteenth century gave to· philosophy. 9
The Pell material has already been exhaustively discussed in the litera-
ture (White, 1982; Goodwin, 1966, pp. 286-291) and needs no further
comment here. The case is different for Woolley's lectures. These dealt
with moral philosophy intertwined with observations on political economy
and its uses, a subject incidentally in which Woolley was very interested
and "touched on .. .in his university work on several occasions" (Good-
win, 1966, p. 546). Two of these lectures, given in 1855 and 1856, are
particularly important. The first dealt with "social difficulties," was orig-
inally published in the Sydney University Magazine for April 1855, and
combined observations of Dickens's Hard Times with a discussion of the
"drink question" and the master and servant's act. The second, entitled
"The Selfish Theory of Morals," was attended by Jevons and commented
on in detail in his journal (Black and Konekamp, 1972, I, pp. 27-28,
132-134). This provides the basis for White's conjecture of a Woolley
influence on the formation of Jevons' "hedonism," as earlier had been
suggested by Konekamp (1972, pp. 27-28). Both the lecture and Jevons'
comments on it show that philosophical speculations on hedonism were
readily available in the colonial Sydney of the 1850s and that these had
attracted the attention of the young Jevons.
The 1855 lecture has not been commented on before in connection with
Jevons. In some respects it is more interesting because part of its contents
emphasize the social utility of developing and diffusing sound principles of
political economy, a subject in which Woolley had practical interests. Two
reasons are advanced in support of this social role for political economy.
First, economic principles and their diffusion were essential to social health
because "unrighteous and obtrusive Government ... sooner or later violate
the principles of Political Economy" and hence preservation of freedom
requires their wide knowledge. Second, political economy can remove the
"jealousy" between rich and poor, by ascertaining and fixing "the relations
of capital and labour upon a scientific basis" and in this way not
only prevent the creation of "two antagonistic nations" but, at a more
immediately useful level, prevent strikes and other "conflicts between
employers and employed which still shake to its centre our manufactur-
ing prosperity" by ensuring these "principles are properly understood and
made known" (Woolley, 1862, pp. 128~131). There is no record that
Jevons heard the delivery of this lecture, but the fact that he later offered
copies (for 1857 to 1859 only) of the Sydney University Magazine to the
chief librarian of the British Museum (Black, 1973, II, p. 449) shows that
more than likely he had had access to it at the time. In fact, in his review of
Hearn's Pluto[ogy Jevons praised Woolley's essays (Woolley, 1862) as "a
collection of scholarly essays" (La Nauze, 1941, p. 256). Other actions also
show that the sentiments in these lectures-including its praises of free
trade, harmony, and the moral impossibility for the social existence of a
"true separation of interests" (Woolley, 1862, pp. 102, 104, 114, 129)-
would not have been uncongenial to him at the time,though his final
publication, The State in Relation to Labour, is highly critical of laissez
faire. They may also explain the subsequent interest in Whateley's intro-
ductory lectures with their similar sentiments (to which he may even have
been referred by Woolley) and his advice on economics to his sister in
letters from the first half of 1857 (Black, 1973, II, pp. 276-277,292). My
reading of the evidence on Jevons' Australian interlude suggests that he
benefited from his acquaintance with the University of Sydney's three
foundation professors in different ways and that his father's advice to seek
their company paid diverse dividends.
The matters associated with J evons surveyed here show the enormous
value of the Jevons material recently published (Black and Konekamp,
1972-1981) not only for raising and sometimes settling questions of origins
but also for shedding new light on technical matters. Few final conclusions
are as yet possible on issues raised here on the origins and practice of
Jevons on demand and utility. It can, however, be safely asserted that
some of the earlier suppositions on this can no longer be sustained.
Likewise interpretations of Jevons' theory of capital have to be modified
from the findings of the 1960s' capital controversies. None of this detracts,
of course, from the accolade of genius so often bestowed on Jevons or from
the conclusion offered by the Jevons scholar of the century that Jevons
"made innovations which have proved of lasting significance" (Black,
1981, p. 29).
Alfred Marshall (1842-1924)
As befits the undoubtedly key figure in the development of the marginal

revolution in the English-speaking world, the economics of Alfred Mar-
shall continues to attract extensive attention, despite the enormous litera-
ture available on this subject before the early 1950s. A number of strands
in this voluminous Marshall literature of the period can be distinguished.
The first relates to continuing controversy about key concepts in Marshall's
economics, including its method. The second is associated with investiga-
tions of the wider significance of Marshall's work for the professioalization
and institutionalization of economics from the end of the nineteenth
century onward. Third, and in some respects the more important because
it is the more novel, there have been re-evaluations of Marshall's work
in the light of what has become known about activities of the "young
Marshall,,,lO a task greatly facilitated by the publication of many of

Marshall's early writings (Whitaker, 1975; also Harrison, 1963; and Stigler,
1969). This has induced some detailed investigation and subsequently new
light on the origins, sources, and especially the contents of pre-Principles
Marshall.
A recent survey of Marshall's economics (O'Brien, 1981, p. 63) con-
cludes that "most of the literature on Marshall's economic writings concen-
trates upon minutiae," adding that this is inappropriate for the present
generation of economists. These all can learn much from an overall
perspective of the work of an economist who invariably attempted to
"produce a balanced overall picture of the economic system with due
weight given to historical and institutional factors. " Reisman's (1986) study
of the economics of Marshall provides an overall picture of the core of
Marshallian economics-the system of determining normal prices in the
long run by means of an apparatus of supply and demand-and which
thereby attempts that merging of the theory of value and growth which
some (e.g., Whitaker, 1974; Dardi, 1984) have seen as characteristic of the
work of the young Marshall. The implicit shift toward examination of
Marshall's method that this implies, and its identification as the more
important Marshall legacy for current generation economists, contrasts
strongly with the examination of Marshall by Stigler (1941), with its
emphasis on Marshall's theoretical contributions and Samuelson's (1967a)
complaint that "the ambiguities of Alfred Marshall paralysed the best
brains in the Anglo-Saxon branch of our profession for three decades"
because of nonrigorous distinctions between perfect and less than perfect
competition and an intentional fuzziness that is both confusing and con-
fused. Hutchison's (1953, ch. 4) evaluation by contrast is more cautious
and considerably more balanced than his more recent evaluation of the
Cambridge school that Marshall helped to found (Hutchison, 1981, ch. 3,
esp. pp. 51-56). Perhaps this is because Hutchison's stress on method is
more in harmony with the times than Stigler's rigorous (and still very
instructive) attempt to examine the marginalist credentials of one of his
heroes by an intentional concentration on Marshall's theoretical lapses
from this task (Stigler, 1941, pp. 61-62).
O'Brien's "minutiae," not to be taken pejoratively in this context, are
reflected in a still very considerable literature devoted to specific aspects of
Marshall's economics. Examples are the many articles on issues raised in
Friedman's (1949) controversial interpretation of the Marshallian demand
curve, particularly aspects associated with the meaning to be given to the
constancy of marginal utility of money assumption and the role of income
effects in Marshall's demand theory. More recently this has sparked
NEOCLASSICAL VALUE AND DISTRIBUTION lHEORY 25
renewed investigation of the origins of Giffen's "hint" in Marshall and its

purposes (Dooley, 1985; White 1987a, 1987b). In addition, articles have
been directed at elucidating other features of Marshall's system such as the
labor supply curve, notions of competition, consumer surplus, the repre-
sentative firm, and the theory of the firm in genera1. 11 More wide-ranging
are a series of classical reviews of Marshall's theory of value. These include
Frisch's (1950) survey, and studies by Newman (1960) and Loasby (1978)
questioning the proposition that modern microeconomics has appropriated
all that is worthwhile from Marshall's economics, leaving only the analy-
tical errors. They also bemoan the fact that problems of time in the
theory of value have been the major victim of this practice together with
a neglect in analysing competitive processes. Loasby further illustrates this
by showing the disappearance of a general link between value and growth
and the neglect of the importance of expectations and information in
modern theories of the competitive firm (within oligopolistic competition
rather than perfect or imperfect competition). This implicit challenge has
elicited various responses. Examples are Williams' (1978, 1986) analysis of
Marshall's contribution to the emergence of a theory of the firm, and his
reconstruction of Marshall's temporary equilibrium pricing process.
Aspects of the laws of returns have been revisited by Levine (1980),
Negishi's (1985) rehabilitation of Marshall's life cycle of firms theory, and
Sylos Labini's (1985) review of the Sraffian critique of Marshallian price
theory. More generally, Boland (1982) has surveyed the difficulties Mar-
shall raised through the element of time, so often ignored in modern
economic discussion.
The reviews of Marshall's theory of value, and the criticism of conven-
tional views of Marshallian economics to which they have led, introduce
the concern with methodological issues in the recent Marshall literature.
Two aspects stand out. One is the transformation of Marshall's stylistic
predelictions for imprecision and qualification into a virtue because it
highlights the fact that economics is essentially an imprecise subject
(Shackle, introduction to Reisman, 1986). Another is a renewed interest in
assessing the value of Marshall's pleas for economic biology in preference
to the economic mechanics he so often practiced in the Principles (Moss,
1982; Levine, 1983; Reisman, 1987, ch. 7). These include some interesting
observations on the mathematics of evolution in terms of Taylor's theorem
as practiced by Marshall (1961, mathematical note XI). Such methodolo-
gical discussions are also presented in re-examinations of Marshall's clas-
sical antecedents (e.g., Levine, 1982), particularly noticeable in Marshall's
early work with its emphasis on value and growth and not completely
suppressed in the "mature" Marshall (d. O'Brien, 1981, pp. 51-52).
A second type of Marshall studies that can be identified concern his

contributions to the professionalization and institutionalization of econo-
mics, which go a long way to explain the consolidation of the marginal
revolution in its Marshallian variant in the English-speaking world. Part of
Marshall's contribution came from his role in establishing the Royal
Economic Society and the Economic Journal, both vehicles for the dis-
semination of sound economic ideas (Coats, 1968), and perhaps some of
the most significant events in the history of economics at the end of the
nineteenth century. Another is Marshall's role in establishing the Cam-
bridge Tripos and his direction and control of the Cambridge School in its
formative period (Coats, 1967; Hutchison, 1981, ch. 3; Groenewegen,
1988), a theme that has been treated by Maloney (1985) and, from a
different perspective, by Winch and Collini (1983). Maloney (1985, p. 3) in
particular shows how Marshall's objectives for economics in the
universities-that is, training in a specialized body of theory, a defined
monopoly over a specialized function or functions, and the development of
a professional ethics-match his sociological notion of professionalization,
visible in the actual developments taking place in English economics at the
turn of the century. Like Stigler (1986, p. 372) I would give greater
emphasis than Maloney to the move of economics into the universities
during this period, as reflected in the career paths of the seven economists
surveyed here. This aspect of the marginal revolution was rightly stressed
by Schumpeter (1954, e.g., pp. 829-840) and partly studied by Hutchison
(1953) with respect to Marshall.
The most interesting Marshall work since the 1950s has been associated
with the rediscovery of the young Marshall, whose original visage was
invariably based on the rather selective picture 12 presented in Pigou's
Memorials (1925) supplemented by the more daunting official papers
edited by Keynes (1926). This rediscovery owes much to the publication
by Whitaker (1975) of many of the early papers preserved in the Mar-
shall Library and his detailed analytical work on their contents. Both
have opened up a wide variety of new issues on the sources, origins,
and interpretation of Marshall's economics. Historical evaluation of the
development of Marshall's economics was also assisted by publication
of the variorum edition of Marshall's Principles (Guillebaud, 1961) with
its painstaking, though sadly incomplete and sometimes defective (see
Stigler, 1962, pp. 233-234) analysis of textual changes from 1890 to 1920.
The enormity of this task can only be appreciated by contemplating, for
example, the massive changes in layout Marshall prepared for the fifth
edition. Regrettably there is as yet no reprint of Marshall and Marshall
(1879), the book A. Marshall suppressed and that now seems only readily
available in an Italian translation (Robertson, 1976, pp. 448-451).
The most important of Whitaker's interpretative studies published so far

are his presentation of Marshall's 1881 system as a system of distribution
and growth (Whitaker, 1974), his general analysis of the distribution
theory in Marshall's Principles (Whitaker, 1987), and that of the emerg-
ence of Marshall's period analysis from the early 1870s (Whitaker, 1982).
The first presents what Chakravarty (1982, pp. 8-12) has called the Millian
foundations of Marshallian growth and distribution theory, based on the
transformation into differential equations of Marshall's favorite book from
Mill's Principles (Book IV on the influence of the progress of society on
production and distribution) as he wrote later to J.B. Clark (217/1900 in
Pigou, 1925, pp. 412-413). Marshall's growth and distribution theory,
despite its seemingly classical antecedents, implied the abandonment of
three classical perspectives, as Chakravarty has also shown (1982, p. 8).
First, he abandoned the classical notion of surplus as the source of
accumulation (only lip service is paid to it in the Principles: for example,
Marshall, 1961, pp. 504-505). Second, he neglected the discontinuities and
irreversibilities so crucial to understanding real growth processes (though
aspects are preserved in Appendix H of the Principles). Finally, he
replaced the classical theory of value by a fully fledged relative price theory
in terms of supply and demand analysis (cf. Bharadwaj, 1978a, pp. 32-35).
This is unambiguously indicated in Whitaker's presentation (1974, pp.
3-6) which also illustrates the view that in 1881 Marshall advanced a
marginal productivity theory of distribution for the first time since
Longfield and Butt (Stigler, 1941, p. 344). The growth and distribution
theory illustrates one aspect of Marshall's use of the Millian inheritance.
A second aspect of this Millian legacy is very clearly present in Mar-
shall's early manuscript on value dated around 1870, which makes Mar-
shall's "radical and systematic departure from Ricardo" perfectly clear
(Bharadwaj, 1978b, p. 601). The four value situations analyzed by Mar-
shall are all supply and demand oriented, thereby substantively altering the
explanatory basis for natural prices presented in the classical literature
(Bharadwaj, 1978b, p. 615). Bharadwaj's paper (1978b, pp. 619-620), and
the perspectives given on Marshall's early work by Whitaker (1975,
pp. 44-47) also allow a more or less definite conclusion that Marshall's
basic ideas on value and distribution owed little to Jevons (d. Walker,
1985, p. 171), while they emphasize the importance of Couroot and Mill
in that development. 13
An alternative reading points to the other type of inference that can be
made from studying the young Marshall. This emphasizes his antipathy to
the marginalists critique of the classics and his divergence from many purist
marginalist perspectives. Such a reading is given in Dardi's (1984) impor-
tant study, which places the origins of Marshall's economics firmly in the
debates about the wages fund doctrine at their height during the late 1860s
when Marshall resolved to become an economist. This wages fund con-
troversy background meant that Marshall came to grips with problems
of accumulation and distribution at the outset and that he had to find
solutions to the difficulties in supply and demand analysis which that
controversy disclosed. Hence, as Dardi (1984, p. 119) points out, Marshall
considered his task as involving an integration of matters of pure theory
(the analytical supply/demand apparatus he was developing with the aid of
Cournot, Jenkin, and his mathematics) and the classical theory, if he was
to successfully remove conundra associated with Mill's eclectic treatment.
As Whitaker (1982) has also demonstrated, time analysis in this context
of value and distribution theory came therefore naturally to the young
Marshall as a problem to be solved. The tools for this were developed
at an early stage, and traces of these dynamic considerations never dis-
appeared from the pages of the Principles, particularly those devoted to
the treatment of distribution. Whether this is a strength in Marshall's
economics (Reisman, 1986) or a weakness (Stigler, 1941, e.g., pp. 63, 83)
remains debatable, if only because if relies on positions regarding the
purpose of economic theory. It does, however, illustrate the need to
set Marshall apart in some way from marginalist economics, as Dobb
(1931, pp. 368-371) had already done in his characterization of the
Cambridge school.
In this respect, as in some others, Marshall remains an enigma. A part
of the "marginalist revolution" by virtue of his support of many of its
fundamental principles, he also diverged from its aims in significant ways.
Examples are the emphasis on dynamics even when inconsistent with the
demands of rigorous static theory (for examples see Stigler, 1941, pp.
68-76), his distrust of simple equilibrium statements, and, above all, his
growing awareness of the difficulties in applying the new doctrines, particu-
larly his favorite, consumer surplus. Some of this is explicable in terms of
the formative influences on Marshall's thought when he turned to eco-
nomics during the second half of the 1860s. Whitaker (1977, p. 478) has
summarized some of these as "a heady but turgid mixture of German
Idealism, Spencerean evolutionism, and utilitarianism, the latter derived
from a close reading of Bentham and Mill and from the personal influence
of Sidgwick, a mixture to which he was introduced as a young graduate
through his participation in the stimulating discussion at the Grote Club."
When this is combined with the specific early influences on his econo-
mics-J. S. Mill, Cournot, and the background to the wages fund contro-
versy-then at least some of Marshall's peculiarities can be explained.
Others derive from his insatiable urge to be realistic and understood
by businessmen. Furthermore, the breadth of Marshall's concerns in eco-

nomics as a moral science stand out starkly against more narrow perspec-
tives of some of the English contemporaries and in some respects those
of his immediate successor to the Cambridge chair.
Philip Henry Wicksteed (1844-1927)
Wicksteed's work is in sharp contrast with Marshall's ambiguous attitude

to the new economics. Wicksteed's unwavering support of the validity of
the marginalist principles as he had critically derived them from Jevons
earned him the distinction of being described as the "purist" of marginalist
theory (Sraffa, 1960, p. v). Basically independent of Marshall's econo-
mics, Wicksteed rejected much of what Marshall viewed as crucial com-
ponents of the theory of economics (for example, the supply curve) and
greatly disliked the many "classical" trappings remaining in the Marshal-
lian system (Wicksteed, 1913). There is another contrast between Marshall
and Wicksteed relevant to this survey. Wicksteed has been substantially
ignored in the literature. Schumpeter (1954, pp. 831-832), for example,
pointed to the fact that only Stigler (1941, pp. 323-335) had realized the
true worth of Wicksteed's (1894) seminal contribution to distribution
theory, that few economists appreciated the originality of his Common
Sense (Wicksteed, 1910, 1933) and even fewer the brilliance of his obser-
vations on Jevons (Wicksteed, 1889). Schumpeter would therefore have
been delighted that Creedy (1986b) has repaired the third of these omis-
sions, that Davidson and Meiners (1976) have rediscovered certain novel
aspects of Wicksteed's Common Sense, and finally, that Steedman (1987b)
has not only fully reviewed the contents and context of Wicksteed's Co-
ordination (1894) but that he has recovered the complete Wicksteed. He
has even compensated for Schumpeter's regret at inability to do full
justice to Wicksteed's personality as "it radiated upon" him in 1906 with
its complex blend of qualified "reponse," "benevolence," "simplicity,"
and "modesty" (Schumpeter, 1954, p. 831).14
Davidson and Meiners (1976) and Creedy (1986b) both deal with
aspects of Wicksteed's price theory. The first suggest that Wicksteed's
analysis is "far closer to the position of many modern writers" because
of his views on the unsatisfactory nature of a "dual-decision mechanism."
Simultaneous determination by supply and demand made the price deter-
mination problem unduly complex in Wicksteed's view. Wicksteed's
analysis based on fixed and inaugmentable supply, according to Davidson
and Meiners, allows easier consideration of dynamic decision-making
processes, presents price makers as the market norm, while it resembles

inventory-adjustment type models and anticipates current search and
auction-market-type analysis.
Creedy's (1986b) analysis of Wicksteed's critique of Jevons' use of the
King-Davenant demand data reveals some general features of Wicksteed's
economic approach amid the technical details of this issue. It highlights
Wicksteed's theoretical purity by emphasizing his rejection of Jevons' (and
Marshall's) device of allowing alternative uses of corn to be operative over
the range of price variations to which the observations extend. Second,
Wicksteed's ingrained common sense is illustrated from his critique of
Jevons' depiction of the demand curve at very high and low prices. In
addition, Creedy (1986b) reveals much about the seriousness with which
Wicksteed held mathematics as a tool for economic investigation and the
limitations under which he worked in this respect.
Steedman's rich contributions to the meager Wicksteed literature need
to be savored in themselves. Attention can be drawn to some highlights,
largely from his introduction to Duckworth's proposed reissue of Wick-
steed (1894). There he draws repeated attention to the fact that Wicksteed
avoided arguments in terms of "artificial aggregate factors" or that he used
an aggregate form of the production function as sometimes misleadingly
claimed. In Wicksteed's attempts to include the rate of interest in the
analysis, aggregate value capital is not necessary because the analysis is
totally in terms of the individual maximizing agent faced with given factor
prices and a given rate of interest. However, this procedure induces some
other slips. Wicksteed's presentation includes allocative peculiarities inhe-
rent in a thought experiment that uniformly applies doses of a variable
factor to a fixed factor and thereby implies uneconomic use of the fixed
factor over certain ranges of the analysis. Finally, Steedman stresses that
Wicksteed shows no signs of "apologetic intent" in the development of his
marginal productivity theory, a characteristic of his scientific probity also
visible in his Jevonian critique of Marx (see Steedman, 1988).
A further matter of interest in Wicksteed's economics is emphasized in
Steedman (1986). This illustrates Wicksteed's concern with the principle of
choice as the unifying principle of economics, permitting his association
with certain modern perspectives on the scope of economics of the Virginia
school and undoubtedly explaining his great appeal to, and influence on,
Robbins. Here is an important aspect of his Jevonian legacy, marking him
as a true marginalist in his general economic philosophy. Steedman notes
that taken to its logical conclusion, Wicksteed's position implies no possi-
bility of distinguishing between economic and noneconomic behavior, and
that altruism therefore need not be reconciled with rational economic
behavior. In addition, his concessions to some lexical ordering makes the

principle of equating diminishing marginal significance less general than
Wicksteed's overall stance suggests. Recent work on Wicksteed, together
with Schumpeter's and Stigler's earlier opinions, suggest that Wicksteed is
an economist whose writings can still be studied with profit, if only because
they reveal the foundations of the new economics in all their simplicity
and generality.
Francis Ysidro Edgeworth (1945-1926)
Edgeworth, like Wicksteed, has been totally eclipsed by Marshall's work.

Only part of this can be attributed to the fact that Edgeworth wrote few
books, and these all early in his career, while of his many scientific papers
and reviews, including no less than 131 entries in the Palgrave Dictionary
of Economics, only a relatively small proportion were gathered in his
collected papers (Edgeworth, 1925). Though containing interesting con-
tributions to a wide variety of fields, this material is now virtually for-
gotten. His name is currently remembered from the Edgeworth box, his
"invention" of indifference curves, and his application of the "indeter-
minacy" properties of isolated exchange to wage bargaining. As the linguist
in English economics of this period (no mean feat when contending with
Wicksteed, or even Marshall), he was also a major bridge, and sometimes
an obstruction,15 between European developments in economic theory,
particularly in France and Italy, and those in England.
Edgeworth's contributions as a whole have been interpreted with clar-
ity and wit in Creedy (1986a; a shorter version is Creedy, 1981), which
corrects past errors in interpretation and greatly expands knowledge about
this fascinating economist. Stigler (1941) had already exhaustively dis-
cussed Edgeworth's contributions to production and distribution theory
and justly praised his contributions to utility and competition theory in
his well-known critical evaluations of the development of these concepts.
The "modernity" of Edgeworth's Mathematical Psychics has since then
been acknowledged by Samuelson (1974, p. 1279) in terms of his discussion
of "indifference contours, recontracting, supply and demand, contract
curves and (deepest of all) the core." As Edgeworth (1881, p. 1) explicitly
indicates, much of this was inspired by Jevons' development of a calculus
of pleasure and pain, and consequent explorative application of mathe-
matics to the social sciences. In this introduction, Edgeworth reveals
the psychological, ethical, and philosophical foundations of his work com-
bined with an ambition to develop a social mechanics designed to rival
celestial mechanics where maximum pleasure in the first, like maximum

energy in the second, constitutes the general idea around which to build a
mathematical psychics (Edgeworth, 1881, pp. 9-12). Edgeworth's work
provides a particularly clear illustration of the early association in Eng-
land between marginalism and applied utilitarian ethics, an aspect of
Edgeworth's work that Hutchison (1953, pp. 108-114) singled out for
evaluation and criticism.
Creedy (1986a) illuminates aspects of Edgeworth's work particularly
relevant to the purpose of this survey. First, he (1986a, p. 23) stresses
Edgeworth's early work on utilitarianism and argues its importance
for "a proper understanding of the later contributions." Relevant for dis-
tinguishing him from Marshall,16 Edgeworth strongly disliked Hegelian
idealism (e.g., 1881, p. 97); but, like Marshall, he embraced "evolution-
ism" and expressed a wish for its constructive merger with utilitarianism.
Two further aspects of Creedy's discussion of this part of Edgeworth's
thought need to be mentioned. His utilitarianism did not yield "natural
harmony" conclusions but stressed conflict; second, it was based on a
considerable knowledge of experimental psychology, and his generalized
utility function derived directly from his knowledge of Fechner's work
(Creedy, 1986a, pp. 27-29). Another feature of Creedy's evaluation
(1986a, pp. 82-84) is an emphasis on the contractarian aspects in Edge-
worth's utilitarianism. Distributive justice, Creedy argues, needs to be
interpreted in this context. Such features of Mathematical Psychics were
subsequently largely ignored, all the more surprising when they also·
featured in Edgeworth's taxation economics. There the quid pro quo view
of taxation was rejected because public expenditure and taxation decisions
do not result from competitive exchange processes. A social contract
between taxpayer and government is required to provide the necessary
principle of tax justice.
Creedy's (1986a, pp. 123-126) emphasis on the continuity in Edge-
worth's work from the foundations provided by Mathematical Physics 17 -
with its contributions to the theory of contract, justice, and distribution as
a new justification for utilitarianism-allow him to remove a number of
important misconceptions about the development and origins of marginal-
ism in England. Most important is his argument on the fundamental role
of utility and utilitarianism in early marginalism, contrary to the views
of Schumpeter (1954, pp. 830-831) and Hutchison (1953) and, more here-
tical, on its continuing role in applications of economic theory to subjects
like taxation policy (Creedy, 1986a, pp. 128-130; cf. Roy, 1984). Second
he points to criticism of dogmatic laissez-faire positions as a characteristic
of Edgeworth and other early English marginalists. Edgeworth's belief that
in practice a widespread tendency to indeterminacy existed formed the

basis for his sceptical views on this (pp. 127 -128). Finally, Creedy argues
(pp. 130-132) that despite Edgeworth's linguistic proclivities, or perhaps
because of them, the effective international flow of ideas was not nearly as
great as may be presumed from the immense personal contact between
leaders in the early development of marginalism. Perhaps because of the
overwhelming dominance of Marshall, English economics sank into a
period of "unsplendid isolation" from the early twentieth century and
even ignored relevant contributions from American economists. In brief,
Creedy's general differentiation of late Victorian marginaiism from its
modern counterpart is an important service of his study of Edgeworth,
though like him, I fear that too many economists will leave the study of
major writers of this period to specialist historians of economic thought.
John Bates Clark (1847-1938)
As Stigler (1941, pp. 196-197) points out, "Clark independently dis-

covered both the marginal utility and the marginal productivity theories,"
and this is the basis for his claim to an important place in the history of
economics. It is also the justification for his inclusion in this chapter. In
addition, Stigler noted that at least till the end of the 1930s, "continental
economists" considered Clark's version "to be the marginal productivity
theory" and that Clark's "naive productivity ethics" with its prescriptions
combined with analysis was a major disservice to economics. Schumpeter
(1954, pp. 868-870) is in substantial agreement with this view, while
Hutchison (1953, p. 253), in addition, emphasizes the conversion in
method that Clark is said to have experienced between publishing his first
book (Clark, 1886) and his more important theoretical contribution on
distribution (Clark 1899). In his American Economic Association centen-
ary paper on neoclassical theory in America, Tobin (1985, pp. 29, 31-32)
also makes these points. Not surprisingly, the conversion in method and
the marginal productivity ethics are the issues in Clark's economics to
which most discussion has been devoted, with the debate on marginal
productivity largely confined to Clark's theory of capital and interest.
Samuelson (1962, pp. 213-225,233-234) brought J. B. Clark's capital
and interest theory into the Cambridge controversies on capital theory with
devastating results for the "parables" derived from it. Their examination
(Garegnani, 1970) led directly to the reswitching results and identifica-
tion as an unobstrusive postulate of the widely held inverse relationship
between interest rates and capital intensity (Pasinetti, 1969; Harcourt,
1969, esp. pp. 390-394). The simplified models derived from Clark's
work, in terms of the aggregate production functions he perhaps unwittingly
sponsored, were shown to be logically flawed, with similar consequences
for their application to empirical work in analyzing macrogrowth. Tobin's
(1985, pp. 31-32) appraisal of Clark mentions use of Clark's production
model in macro growth theory but omits any reference to weaknesses
disclosed by the capital controversies. With quite specific reference to J. B.
Clark, these have been evaluated by Moss (1980, esp. pp. 64-73) as
marking the end of orthodox capital theory and similar to the destruction
of much Austrian capital theory by these arguments. Tobin (1985), how-
ever, raises the important question of how much of this analysis is actually
attributable to Clark but this does not obviate the fact that Clarkian
parables and the productivity ethics based on them must now be relegated
to errors from the past.
Clark's so-called methodological conversion, including its relationship
with his marginal productivity views, has also been reviewed. Jalladeau
(1975) investigated this precisely because of its association with the mar-
ginal revolution in America. By way of conclusion, Clark's aims are
depicted as establishing "economic ideas on a moral basis" from analy-
tical foundations so strong that they would be unchallengeable. This is
also seen as a sign of the "gentle optimism" that fills the work "of this
tormented humanitarian and liberal theoretician" in developing a deduc-
tive, scientific approach to economics from his earlier descriptive, his-
torical, and morally speculative work (pp. 225-226). Henry (1982, 1983)
has challenged notions of methodological conversion in Clark's work and
the associated view that he moved away from Ruskinesque socialism and
criticism of capitalism. A methodological change, he contends, allows
separation of what is called the purely scientific part of Clark's work, the
marginal productivity theory, from its ethical features. Such a view under-
lies Schumpeter's argument that the technical features of Clark's argument
can be easily separated from the normative part, leaving a value-free core
of marginal productivity theory. Henry (1982, pp. 167-168) posits contrary
propositions: first, Clark was always "pro-capitalist," the seemingly early
criticism of capitalism being really a manifestation of "populism," and
attacks on monopoly and ethics of the market in this vein are combined
by the young Oark with criticisms of socialism. Second, Henry (1983)
develops this theme by emphasizing a connection between ethical and
moral aspects of Clark's distribution theory with similar pro-capitalism
motivation for Clark's early critique of classical economics and defense
of marginalist principles. The foundation of Henry's argument-political
preconception and a priori ethical positions are an indication of dubious
theoretical pronouncements-cannot be sustained in my view; only logical

argument and empirical data can indicate theoretical deficiency. As men-
tioned previously, some logical foundations of Clark's marginal productiv-
ity analysis as a theory of distribution were removed in the Cambridge
capital controversies. However, for those interested in the origins of
marginalism, it is clear that the foundations of Clark's economics require
further discussion and evaluation than they have received so far. (For
example, Goodwin's (1972) useful study of marginalism's spread to the
New World hardly deals with Clark's work.) Such evaluations need also
recall Clark's popularization of the conception of a stationary economy, an
important simplifying procedure for the new economics.
Irving Fisher (1867-1947)
By birth, Irving Fisher is the first of the two "second generation" marginal-
ist economists included in this chapter though, as shown in table 2-1, his
first book was produced within a decade from the publication of the major
works of Marhshall, Wicksteed, Edgeworth, and Clark. He also was the
only one of the seven who published major theoretical work in both the
nineteenth and twentieth centuries. Schumpeter (1954, pp. 871-872, and
cf. 1952, pp. 224-227) rightly praised Fisher's first work (Fisher, 1892), as
a great classic in the new marginalist tradition: "a masterly presentation
of the Walrasian groundwork" with at least two important innovations.
The first was Fisher's proposed method for measuring marginal utility;
the second, similar to Edgeworth's work of a decade before, Fisher's
independent development of a general utility function and his use of
indifference curves. This affinity between the work of Fisher and Edge-
worth undoubtedly explains why they got on so well together (Fisher, 1956,
pp. 49-50,92-94; cf. Creedy, 1986a, p. 100). In addition, he enriched the
literature of the new economics with a theory of interest that in many
respects remains influential. It is therefore still discussed in general works
on the subject like Lutz (1967) and Conard (1963). Fisher's monetary
theory, which has received the greatest amount of attention in the post-
1950s' literature, is not discussed here. Space only allows brief treatment of
some literature devoted to his capital and interest theory and his views on
"operational utility." These topics were two of ten included among econo-
mic studies in the tradition of Irving Fisher published for the centenary of
his birth, while emphasis on price theory and the analysis of capital and
interest is likewise a feature of Tobin (1985).
Some of the recent interest in Fisher's capital theory can be explained
by his apparent ability to sidestep the problem of defining a real capital

magnitude through concentrating on "the terms of trade between today's
and tomorrow's consumption as the objective counterpart of the rate of
interest" (Samuelson, 1967b, p. 18). Fisher's development of the Austrian
theory as it had been left by B6hm-Bawerk is then identified as an analysis
of the interaction of an impatience to spend with opportunities to invest
to produce, as Samuelson put it (1967b, pp. 29-30), a brilliant general
equilibrium theory of interest in terms of supply and demand. In his
concluding praise of the modernity of Fisher's theory, he makes a pass-
ing reference to reswitching, with the implication that Fisher's theory
is immune from its otherwise devastating consequences (p. 35, n. 13).
Samuelson's comment was effectively challenged by Pasinetti (1969) which
showed that switches of technique did affect the Fisherine notion of the
rate of return, not as a tool for allocation decisions when all prices were
known but as a proxy underlying marginal productivity explanations on the
"opportunities for investment" side (Pasinetti, 1969, pp. 525, 529). This
view has never been challenged but it may be noted, passe Professor
Samuelson, that Fisher (1907, pp. 252-253) had himself recognized the
phenomenon of reswitching and, like Joan Robinson 50 years later, had
described it as "perverse" (see Velupillai, 1975).
Another part of Fisher's economics that continues to draw attention is
his theoretical work on utility measurement. Stigler (1950, pp. 117-121)
shows that Fisher (1892) demonstrated that the general utility functions he
developed there, and which he preferred on theoretical grounds, made
cardinal utility measurement virtually impossible. Fisher (1927) returned
to the subject. By using independent utility functions, at least for impor-
tant commodities like food and housing, he produced something concrete
on utility measurement largely from a desire to apply such findings to
arguments on the justice of the progressive income tax. Fellner (1967, esp.
pp. 59-69) has since then demonstrated that the Fisher-Frisch method
(Frisch applied Fisher's theoretical work to actual measurement) can
produce some interesting results in utility measurement, even though these
results remain highly speculative. In addition, many of the obstacles to
developing an operational utility identified by Fisher (1927) remain to be
solved by future investigators (Fellner, 1967, pp. 74).
Arthur Cecil Pigou (1877-1959)
Pigou, the other second generation marginalist economist to be considered

in this chapter, was also Marshall's student in the full sense of the word,
succeeding him to the chair in Cambridge ind 1908 and holding it for the
next 40 years. Pigou was first in the first class honors list of Part II of the
Moral Sciences Tripos in 1900, after a first in the History Tripos of 1899. 18
He commenced lecturing in 1901, became Girdler lecturer in the new
economics tripos at Cambridge in 1904 and Professor at 31 in 1908. Schum-
peter (1954, pp. 833, 948) says relatively little about Pigou. He described
him simply as the first major member of the Marshall school, as essentially
an economic theorist but one who produced a detailed treatise on labor
economics (Pigou, 1905), much of which he subsequently developed in
Wealth and Welfare (Pigou, 1912), the foundation for all of Pigou's later
economics. Johnson (1978, p. 177), in fact, suggests that much of Pigou's
working life can be seen as elaborating the superstructure of that book and
strengthening its foundations, a position that Collard (1981) supports.
Apart from obituaries, little has been produced on Pigou's economics of
relevance to this chapter. Post-1950s' literature, when it has discussed
Pigou, has dealt with his monetary theory, the Pigou effect, and other
features of his "macroeconomics." Exceptions are Collard's (1981) survey,
which now must be the starting point for all serious Pigou students, and
some discussion related to his Wealth and Welfare. This includes Bharad-
wafs (1972) reproduction and evaluation of Mrshall's comments on that
work, and the praise for Pigou's (1910) method of measuring price elastici-
ties of demand (Deaton, 1975) in which Pigou's linear relationship between
price and income elasticities under additivity is described as "Pigou's law."
Like Edgeworth, Pigou's name is therefore unlikely to be forgotten.
However, his books are now largely unread, and the absence of serious
Pigou criticism can be generally ascribed to the bad reputation he gained in
accounts of the Keynesian revolution, particularly Keynes's own contemp-
tuous dismissal of his work (cf. Collard, 1981, esp. pp. 107, 132-133 from
which much of the argument in this and the next paragraph is taken).
Pigou (1905) on industrial peace is described by Collard (1981, p. 107)
as a "rather discursive work based on Sidgwick and Edgeworth with a
collaborataive appendix, on bargaining diagrams, with J. M. Keynes-an
astonishing early collaboration. ,,19 The book combines a basically utilita-
rian perspective in its analysis with an enormous amount of detail of the
"nuts and bolts of industrial peace." This early work of Pigou is rarely
discussed and sometimes not even included among his works (for example,
Brahmanand, 1959, p. 469). However, it seems important to understand-
ing Pigou's work for at least two reasons. It is reminiscent of the strong
applied utilitarian foundations of the Cambridge school (via Sidgwick but
also Edgeworth) and reveals the strong practical interest at Cambridge in
labor relations, particularly conciliation and arbitration as a means for
settling industrial conflict. This is presumably why Hutchison (1953), after

mentioning it, ignores it. As Johnson (1978, p. 177) also explains, this book
forms the bridge via a growing interest in unemployment to Pigou's strong
interest in developing welfare economics.
Pigou's Wealth and Welfare was respectfully dedicated to his master,
Alfred Marshall. Collard (1981, p. 110) suggests a direct link with Mar-
shall's Principles from Pigou's (1907) review of it which, among other
things, emphasized the notion of the national dividend as the focus and
kernel of economic theory. The national and social dividend definitely takes
the center stage in Wealth and Welfare. Pigou discusses its com-
position, growth, measurement I and distribution as well as artificial
impediments to its growth and its fluctuations. Collard also points to
its Sidgwickian ancestry: both the distinction between social and private
costs, and the associated externality concept, as well as its norms for
distributive justice and identifying wealth with welfare came from Sidg-
wick's Principles (1883, Book III). Bharadwaj (1972) has shown that
Marshall was not very impressed with Pigou's work in this area. Marshall's
dissatisfaction came from its over-reliance on "statical method" and, more
particularly, from deficiencies in Pigou's use of the marginal supply price.
In his critical notes, Marshall also emphasized the problem of time. He
admitted he had himself largely ignored this with respect to demand
analysis, but Pigou was now attempting to ignore it on the supply side as
well, a far more unpardonable form of "violence," as Marshall put it.
Pigou's approach in the book, Bharadwaj (1972, p. 218) suggests, appears
to have transformed Marshall's "abberrations in the working of a competi-
tive system" into Pigou's diagnosis of "a general failure of the competitive
system to achieve maximum welfare." hence turning qualifications of
laissez faire into a general critique. It can be said that with these develop-
ments marginalism and its implications for social welfare started to turn full
circle because the hopes of early marginalists like Jevons of linking the new
science with the benefits of competition for social welfare were beginning
to be questioned more seriously by the subsequent generation of econom-
ists.
Conclusions
This survey of the literature on the early English marginalists suggests a

number of conclusions. An obvious one is that on some of them much work
remains to be done. As Creedy (1986b, pp. 132-133) argued, such work
needs to deepen the limited understanding of the pioneers of neoclassical
economics and highlight the width of their inquiry as comapred with the
more narrow focus of mainstream economics. Such differentiation of
the pioneers from more modern views need also pay attention to Klaus
Hennings' (1986, pp. 237-238) summary of the major differences between
the conceptions of early marginalism and what he calls "neo-neoclassical
economics." These relate to equilibrium versus processes of economic
growth, statics versus dynamics, perfect competition versus competition in
general, and, at a formal level, the different attitudes to maximization and
minimization between the first generations of marginalist and current
practice. This survey suggests, as Hennings also did (1986, p. 226 n. 7),
that on many issues, knowledge about specific aspects of work by these
pioneers has advanced little beyond the investigations of Hutchison (1953),
Stigler (1941, 1950), and Schumpeter (1954).
Three general exceptions can be noted to this last conclusion, and these
can be used to draw together various otherwise disjointed themes from the
component parts of this survey devoted to specific economists. They alter
at least part of the picture of English marginalism in the formative period
as presented by these three foundation commentators. Recent work
has allowed greater illumination of the diverse origins of marginalism in
England, provides a number of significant reasons for differentiating
between the views of the English-speaking pioneers, and, with respect to
critiques of their doctrines, focuses on matters quite different from those
raised previously.
Study of the origins of marginalism has been greatly assisted by the
wider availability of important material on the young Jevons and young
Marshall emphasized in this survey and by reinterpretations of key work of
some of the later generation. The utilitarian connection, downgraded in
the early .1950s by Schumpeter and Hutchison, can now be shown to be
very important. For Jevons, this is visible even in the Australian inter-
lude; for Edgeworth, from the early work and the aims of Mathematical
Psychics; for Marshall, from the influence on his early economics of the
Grote Club, Sidgwick, and his own reading of Mill and Bentham, while it is
also crucial to Pigou's early work. Sidgwick's influence on the Cambridge
school in particular needs more work. One aspect of this applied social
ethics seems dominant: its apparent usefulness to solving the growing labor
question. This provided motivation and stimulus to the new marginalism
from Jevons to Pigou. However, such an association does not mean
reverting to crude Marxist explanations of the new economics. If there was
an unambiguous "apologetic intent" in the new economics, it is only
discernable in the work of J. B. Clark. In fact, the applied utilitarian
features of the new doctrines were distinctly radical-their application, for
example, to tax policy and particularly the progressive income tax, as seen
in the work of Edgeworth, Fisher, and, though not surveyed here, Pigou
(1912, pp. 369-378). In addition, such concerns are revealed in the many,
and largely unsuccessful, attempts to make utility a more operational
concept. For reasons perhaps related to tax questions (Roy, 1984), the
cardinal aspects of utility began to disappear from the English research
agenda during the 1930s.
Changing critical perspectives on marginalism have altered interpreta-
tions of its doctrines in a number of respects. The Cambridge controversy
results in capital theory necessitate revaluations of the worth of the
contributions in this area by Jevons, Clark, and Fisher. They also open
different perspectives on contributions like Wicksteed's generalized pro-
duction function. More generally, in the wake of Straffa's (1960) contribu-
tion there have been reassessments of the broader significance of the
marginal revolution in England, particularly work by Dobb (1973) and
Bharadwaj (1978a). As Steedman's work on Wicksteed shows, this does
not mean a return to conspiracy theories; however, as his work on Jevons
illustrates, it may lead to paradoxical results. Some of these wider issues
were canvassed in Henning's (1986) evaluation of marginalism as an
exchange theory.
The new work on the early English marginalists also permits their
considerable dehomogenization. Marshall's classical roots and their con-
sequences for the more dynamic aspects of his theory and for his analysis of
supply differentiated his work from that of Jevons, and, even more, from
that of Wicksteed. Edgeworth and Pigou likewise exhibited their differ-
ences from Marshall, not only with respect to technical matters like the
nature of the utility function and marginal supply price but also on the
precise implications of the findings from the new economics for the welfare
consequences of laissez faire. Although it is easy to concentrate on the
shared features in the new doctrines, such a focus should not detract from
the substantial differences between the early English marginalists.
Finally, new work discussed in this survey draws attention to the lessons
that can still be learned from the writings of this past generation of
economic writers. Examples of this were given in the context of work on
Marshall's· theory of value, Edgeworth's contractarian economics, Wick-
steed's price determination analysis, and Fisher's theory of saving and
operational utility, and much can still be learned from Jevons, Clark, and
Pigou. This remains the most important reason for returning to the writings
of past generations of economists. Unlike old soldiers who fade away, old
economists, provided that they exhibit the talent and originality that
characterizes the work of all seven discussed here, continue to have
something of value to offer to successive generations of economists.

Revisiting English marginalism from 1870 to 1920 may produce dividends
far beyond the interests of intellectual history, and nowhere is this better
illustrated than in some of the new work on Jevons, Marshall, Wicksteed,
Edgeworth, Clark, Fisher, and Pigou. 2o
Notes
1. This is demonstrated in Keynes's bibliography, in whose compilation Mary Paley

Marshall assisted, given in Pigou (1925, pp. 500-508). Apart from the 1874 articles in the
Beehive (Harrison, 1963) and a substantial number of letters to the Times (see O'Brien, 1981,
p. 37), this bibliography is virtually complete with respect to published work.
2. See the bibliography in Jevons (1910, Appendix IV) and Black (1972-1981, VII
123-127). In addition to value and distribution, Jevons' economics covered money, economic
fluctuations, labor economics, taxation, energy economics, ahd the economics of public
utilities. See Black (1981) for a full range survey of Jevons' economics contribution.
3. Full-blown Marshall biographies are in preparation by Becattini and Groenewegen;
detailed aspects of Marshall's life have been chronicled by Whitaker (1972, 1975), Coase
(1986), and Groenewegen (1985). There are good biographical sketches of Edgeworth, Clark,
and Pigou in Creedy (1986a, esp. chs. 1, and 2), and Hicks (1984) for Edgeworth; Homan
(1928) and J. M. Clark (1952) for J. B. Clark and Johnson (1978): Saltmarsh and Wilkinson
(1960) and Brahmanand (1959) for Pigou. Walker (1985) presents an interesting evaluation of
these Keynes biographies. Reference should also be made to the biographies of the seven in
the New Palgrave Dictionary.
4. Jevons (1910, 1879, pp. xxix-xxi), Black (V., p. 24); Pigou (1925, p. 413). The case of
Todhunter remains mysterious. He was a Johnian mathematician and knew second wrangler,
Marshall, for whom he wrote a testimonial in support of his application for Bristol. In
addition, Todhunter was Whewell's biographer and, although not mentioned in Todhunter's
account, Whewell at least knew of Cournot's work by 1849 (Rashid, 1977, p. 388) via Graves,
the Professor of Law at University College, London, who also claims to have recommended
Cournot's work to Babbage. But in 1875 on Jevons' account, Todhunter had written that he
was unfamiliar with Cournot's Recherches. Interestingly, John's College Library Cambridge,
does not have a copy of the first edition. Marshall's copy of the first edition is in the Marshall
Library, with his own extensive annotations. Marshall may in fact have become acquainted
with it from his early reading of Roscher (1854, §22) which referred to Coumot's work as
novel in a manner designed to attract the attention of someone like Marshall. See also
Hutchison and associates (1955, esp. pp. 7-8).
5. This "means ignoring contributions on Jevons' theory of labor (Kerton, 1971), on
Jevons' law of indifference and competitive equilibrium (Negishi, 1982), and more generally
some important work on Jevons' method and his conception of science (Mays, 1962;
McLellan, 1972). The birth anniversary was celebrated in the pages of Econometrica, the
1962, 1971, and 1982 centenaries in the pages of the Manchester School.
6. Both Hutchison and Stigler in their written comments reminded me that Knight's
criticism of the Austrian theory (of which J evons was such a clear forerunner) anticipates, and
in some respects, parallels Steedman's critique referred to in the text. Given the time period
covered by this survey, a summary of Knight's perspective on the matter is inappropriate.
7. Such considerations seem to rule out Bostaph and Shieh's construction of figure 3
(1987, p. 118). It is surprising that Stiglcr (1954) who deals with empirical studies of consumer
behavior, does not mention these early attempts by Jevons as outlined in this posthumous
publication. It may also be noted that Wicksteed (1889) had severely criticized Jevons'
analysis of the King-Davenant law, largely on theoretical grounds (see Crccdy, 1986b, pp.
201-206). For a full discussion see White (1989).
8. Pell's morc important work on railways was given as a lecture in 1856 at a meeting of a
Philosophical Society to which Jevons belonged (Black, 1973, II, p. 249, n. 17). This was not
published till 1858 (Pell, 1858). Jevons did not read Lardner till April/May 1857, not long
after purchasing it, presumably because of this growing involvement in the railway debates of
New South Wales. On internal evidence from Theory of Political Economy, there is good
reason to believe that Lardner's precise influence on Jevons' theoretical formulations has
been overstated, contrary to the position advanced by Bostaph and Shieh (1986), and earlier
Hutchison (1953). Nothing of this, of course, negates Hutchison's hypothesis of an association
between railway economics and Jevons' marginalism. Hutchison (1982) is partly inspired by
his opposition to Dobb's (1973) interpretation of the Ievonian revolution and similar
perspectives such as those presented by Bharadwaj (1978a, esp. pp. 26-32).
9. Personal diaries for the Australian period and later indicate that during this period
Jevons was reading Whewell's Philosophy of Inductive Sciences (Black, 1982, VII, p. 117, n.
14) and that in May 1857 he contemplated, and in fact started, an introduction for a book Qn
social anthropology combining political and social economy with moral philosophy. What-
cley's lectures which he had been reading in the previous months are highly "philosophical"
(Black, 1982, VII, p. 118) as were Woolley's lectures (Woolley, 1862), at least one of which
he attended in 1856. Jevons was also reading Chalmers and Quetelet at the time. Black's 1972
conclusion cannot be sustained by the facts he himself later made available.
10. A description borrowed from the title of Dardi (1984) which is a product of the
extensive Marshall scholarship practiced in Italy under the encouragement and leadership of
Giacomo Becattini who himself has invited a re-reading of Marshall in the light of an Italian
translation of Marshall and Marshall (1879) published under his auspices.
11. Most of the articles referred to in the first part of this paragraph have been included
in Wood (1982), Volume III, together with a large numbcr of others. On consumer surplus,
reference should also be made to more recent articles such as Dooley (1983), Ekelund and
Hebert (1985, pp. 433-439) and Roy (1984).
12. For some of the probalems associated with this selectiveness in Pigou's editing, see
Whitaker (1968, p. 144) who in this context also mentions its consequences for the selective-
ness of the Marshall holdings in the Marshall Library at Cambridge. An outline of the
contents of these holdings is given in McWilliams (1969).
13. This is not to say that Marshall owed nothding to Jevons. The utility theory owed
much to Jevons, as did, in some of its details, the welfare theory based on it. Examples, of
which I am reminded by Michael White, include in particular the specific formulation of the
consumer surplus theory such as the practice of treating utility and price as the dependent
variable in diagrammatic presentations and the simplifying assumption about normal distribu-
tions on the basis of which comparisons of utility in terms of groups may become permissible.
14. Unfortunately, not all of Steedman's writings on Wicksteed are as yet in print, and
I take this opportunity to thank him for his willingness to make them available to me in
manuscript form. Klaus Hennings drew my attention to this work in correspondence when I
suggested that Wicksteed and Edgeworth, together with Fisher and Clark, should be included
in the chapter. It may also be noted that Lionel Robbins greatly admired Wicksteed's work
and made it readily available in reprint during the 19305. Alas, these reprints and Wicksteed's
Alphabet of Economic Science (1888) have now become rare, hence Duckworth's reprinting
of Wicksteed (1894) which unfortunately has still not been published.
15. See, for example, the symposium on the transmission of ideas in the American
Economic Review (Hutchison et aI., 1955, esp. pp. 10-11,37-39) where reference is made
to Edgeworth's suppression of Walras' work possibly at the instigation of Marshall. Similar
sentiments were expressed by Schumpeter (1954, p. 831, n. 3), and see also Creedy (1986a,
pp. 130-132 and cf. 19, 21-31, 109). Creedy also provides examples of instances where
Edgeworth was critical of Marshall (1986a, pp. 96-98).
16. Creedy draws attention to many aspects of comparison with Marshall in Edgeworth's
work, relating to issue like the theory of demand, the problem of indeterminacy, the nature of
the utility function, and even the use of Plato's expression, "the one in the many and the many
in the one." In his interesting discussion of Edgeworth's mathematical training, Creedy seems
to have underplayed the Marshall-Clifford connection (Creedy, 1986a, pp. 39-41) which
Keynes described as a close and intimate friendship (Keynes, 1972, pp. 174, n. 3, 181, n. 2).
John Whitaker suggests that Keynes probably overstated the Marshall-Clifford connection
which he thinks would not have survived much beyond Marshall's philosopical period.
However, an undated fragment, probably from late in Marshall's lifetime that survives in the
Marshall Library, states, "[Alfred Marshall] had a profound admiration for Clifford [who]
cared most for his ideas" (Large Brown Box, Item 26, in Mary Paley's handwriting).
17. To reinforce his justified emphasis on the importance of Mathematical Psychics to the
understanding of Edgeworth, Creedy (1986a, pp. 135-50) provides a most useful reader's aid
to this difficult work including errata, translations from the Greek, and references to sources.
These illustrate the wide foundations on which Edgeworth constructed his new approach to
utilitarianism and economics.
18. Johnson (1978, p. 175) also recounts that in 1899 he won the Chancellor's Gold
Medal for English verse with an ode to "Alfred the Great," the last few lines of which reflect
the idealism that led Pigou to economics as a follower in Marshall's footsteps. Hutchison
(1981, p. 63) cites Pigou's view from his inaugural lecture that economists should be fired by
social enthusiasm as a sign of the beginning of the end of positive economics at Cambridge.
Cf. Hutchison (1953, p. 284) which gives a more generous quotation from Pigou's lecture.
Like Marshall, Pigou devoted much of his early life to government inquiries and royal
commissions; unlike Marshall he published widely and much (see Brahmanand, 1959).
19. Pigou (1905, see p. v) developed from his Adam Smith Prize essay (1903) and Jevons
Memorial Lectures given in 1903-1904, Sidgwick's influence appears rather indirect. His
Practical Ethics (1898) of which Essay 4, "The Morality of Strife," tackled issues of
arbitration in labor disputes (Sidgwick, 1898, pp. 108-12) is not quoted. In fact, Pigou (1905,
p. 181, n.) only directly cites Sidgwick's Elements of Politics. Marshall was a much greater
influence, through his Principles (for example, Pigou (1905, pp. 89-90) uses the derived
demand distribution analysis of Book V, chapter VI, to some effect), but also the Report of
the Royal Commission on Labour (1894) in which Marshall had been very heavily involved,
Marshall's introduction to Price's Industrial Peace (1887), and Marshall's Elements of the
Economics of Industry (1902), particularly Book VI, chapter XIV. There is no reference to
Marshall and Marshall (1879) of which Book III, especially chapter VIII, would have been
highly relevant to Pigou's topic. In June 1905 Keynes completed his Mathematical Tripos
(12th wrangler) and by October 1905 he was contemplating entering Part II of the Economics
Tripos. As Skidelesky (1983, pp. 124-125) indicates, in 1904 Pigou had given an assessment
of the young Keynes in Cranta but both that, and Skidelsky, fail to mention Keynes'
collaboration with Pigou on the mathematics of bargaining.
20. Revisions of this chapter have benefited from perceptive comments by Terence
Hutchison, Warren Samuels, Ian Steedman, George Stigler, John Whitaker, Michael White
and my official commentator, John Creedy. Needless to say, their valued assistance does not
absolve me from any remaining errors.
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Commentary by John Creedy
Peter Groenewegen has provided a very interesting account of the secon-

dary literature relating to seven English-speaking pioneers in value and
distribution theory, involving familiarity with an impressive range of
sources. His survey suggests a number of general themes, and the purpose
of this commentary is to draw out some of these themes rather than
concentrating on fine detail.
The first point arises simply from the number of authors considered; the
fact that it is feasible for someone to include seven major economists in one
chapter shows not just a succinctness on Groenewegen's part but that the
task is in fact manageable. As noted by Groenewegen, only Jevons and
Marshall have received extensive treatment, while the other five have been
largely neglected. While the period under consideration has witnessed
the professionalization of the subject, helped significantly by Marshall's
efforts, economists have shown little interest, via their professional organi-
zatios, in their past. The splendid and invaluable work of Black and
Whitaker, respectively, on Jevons' and Marshall's papers and correspond-
ence are exceptions that prove the rule. This work has been published
under the aegis of the Royal Economic Society but could not have been
completed without funds from other sources and extraordinary persistence
by the two editors. In view of the length of time before editions of Smith
and Ricardo appeared, one should perhaps not show too much impatience.
(The Smith edition was in fact supported by the Scottish Economic Society,
which also supported scholarly editions of James Mill, MuCulloch, and
Steuart). Yet an extraordinary amount of support has been given to the
Royal Economic Society's largest project, the edition of the complete
writings of J. M. Keynes. (Meanwhile many copies of a valuable and highly
regarded multi-volume work that had earlier received partial support from
52
the Royal Economic Society was only saved from destruction-or "wast-
ing" in the publishing argot-at the last minute.) The superb edition of J.
S. Mill's work has been produced in Canada. Similarly, many people would
probably agree that America's greatest economist is Irving Fisher; yet
he has not been well treated by the American Economic Association.
Indeed, publishers have shown a much greater enthusiasm for publishing
the "collected papers" of living economists than they have for publishing
work in the history of economic analysis.
The fact that there has . been so little work on these major economists
is, of course, also a reflection of the nature of a modern economics
education and the general lack of recognition of such work in terms of
career development. Very few students now study the history of economic
analysis as part of their general training in economics. It appears that one
economist has recently been asked, quite seriously on several occasions, if
his work on the history of economic thought is a hobby, as if it were a
leisurely and relaxing activity! Groenewegen has argued correctly that the
historical work reviewed provides much more than pathology or intellec-
tual interest only. It provides a deeper understanding of the nature of the
subject and its possibilities.
It is also symptomatic that the selection is of "English-speaking"
pioneers; indeed most of the other chapters in the present volume are
arranged according to geographical or linguistic origins. It is most unfor-
tunate that language has been a significant barrier to the appreciation of
non-English works by continental writers, although, of course, the late
nineteenth century neoclassical economists themselves were fluent in a
range of languages and were in regular contact; this period has been
described by Hutchison as a high point of cosmopolitanism in economics. 1
Although the newly founded Royal Economic Society initially planned to
support the translation of "foreign" language works, this type of activity
has been patchy.2 The only translation Edgeworth encouraged seemed to
be that of Pierson. 3 The English translation of Walras required the huge
individual effort of Jaffe; Fisher arranged for his brother-in-law to translate
Cournot; Wieser and Bohm-Bawerk were translated because of the enthu-
siasm of Smart. 4 Much of the important public finance literature of
Wicksell and the long Italian tradition-part of which involved the attempt
to apply the new theory of demand to public finance-is still only known
through the work of Musgrave and Buchanan. De Viti de Marco is the
exception rather than the rule. 5 Any institutional encouragement for
translations has been short-lived. The series of translations in International
Economic Papers lasted little more than a decade, and Robbins' invaluable
efforts at the London School of Economics did not last long. 6 The list of
54 NEOCLASSICAL ECONOMIC TIIEORY
major works which still have not been translated is too long to mention
here. There is a nice irony in the fact, noted by Groenewegen, that the only
available printing of the Marshalls' Economics of Industry is an Italian
translation (and interestingly this book had a significant influence on
Pantaleoni whose major work, at least, has been translated into English).7
An interesting example of the distortion that can arise because of a
language barrier is provided by Cassel who, unlike his compatriot Wick-
sell, was very energetic in getting his work (especially his Theory of Social
Economy) translated into English. Weintraub (1985) has argued that the
early general equilibrium theory of the 1930s, by Wald and others, was
actually stimulated by Cassel's summary of Walras' system of equations, in
ignorance of its true origins simply because Cassel gave no acknowledge-
ments and Walras had not been translated. s Even the scholarly Phelps
Brown, who produced his interesting exposition of general equilibrium
theory in 1936, based it in part on Cassel without being aware that it was
taken from Walras. Indeed, it may be suggested at this point that the work
on general equilibrium theory leading up to the Arrow-Debreu contri-
bution is a major aspect of value and distribution theory that has yet
to be extensively reviewed; existing studies have provided only a very
partial account.
Turning to the main themes of the chapter, the more recent work on
the neoclassical writers has revealed, as discussed by Groenewegen, their
considerable breadth of influences and preoccupations. These aspects were
somewhat neglected in the earlier studies which concentrated on the more
analytical and technical aspects of their contributions. The late nineteenth
century saw a great deal of philosophical debate, particularly in moral
philosophy, and it must now be recognized that these issues had a signi-
ficant influence on the approach to economics in that period. Indeed,
appreciation of the neoclassical economists has been helped by work in the
history of philosophical thought; a good example is Schneewind's (1977)
valuable study of Sidgwick. The importance of evolutionary ideas must
also be recognized, particularly in the work of Marshall and Edgeworth.
The contemporary work of psychologists has often been underestimated,
although their importance to Jevons and Edgeworth is now much clearer.
Similarly, the influence of scientific work cannot be ignored. In coming to
economics from other disciplines, whose boundaries were not so clearly
defined as they later became, the early neoclassicals brought to their work
a considerably wider vision. As Whitaker has suggested in discussing
Marshall's influences, their range contrasts sharply with the narrow con-
cerns of modern economic analysis. Furthermore, most economists now
have only a very superficial and simplistic introduction to methodological
issues as part of their training, despite the vigor of the debates in the area.
It is also pertinent, for example, that Skidelsky's recent biography of J. M.

Keynes devoted much attention to the philosophical debates of the period,
in attempting to clarify the importance of G. E. Moore's influence.
As economic theory was attempting to discard any vestige of a car-
dinal concept of utility and of utilitarianism in general, the latter's impor-
tance to the early neoclassical economists tended to be correspondingly
neglected. Schumpeter, of course, had a very strong dislike of anything
that suggested utilitarianism. Similarly, it became fashionable to quote
Hutchison's remark that what was important for marginal utility analysis
was the adjective rather than the noun. However, it now has to be
recognized that not only has economics failed to dispense entirely with
cardinal utility but that its importance to the pioneers was much more
subtle than has often been recognized. (As Groenewegen mentions, even
Fisher, at an early stage strongly critical of cardinality, attempted to
measure marginal utility in order to assess the "justice" of the income tax).
The contractarian nature of Edgeworth's utilitarianism was totally ignored
until it was pointed out by Rawls, who nevertheless (not surprisingly) did
not recognize its general importance for Edgeworth's economics, or the
electic nature of his early views. Edgeworth's discussion of utilitarianism
and the contract curve was described by Hutchison as "intolerably ambi-
guous" and "trivial," and contained in "steaming metaphysical fluids."
Such extreme views would now, it is argued, need to be revised. Further-
more, a recent thorough study of Robbins has shown that on questions of
practical policy, the author of The Nature and Significance of Economic
Science was a pragmatic utilitarian; see O'Brien (1988a). This whole
subject clearly requires further investigation. However, it seems that
Marshall's support for utilitarianism was more qualified, and Herford has
made it clear that Wicksteed was much more sympathetic toward the
positivism of Comte than he was toward utilitarianism, although he was not
sympathetic toward Comte's religious views. On the other hand, and as
Groenewegen mentions in his chapter, the influence on Jevons of Benth-
amite views has been shown to be rather greater than initially suggested.
The "de homogenization" of these writers, mentioned by Groenewegen,
clearly has some way to go. Incidentially, with regard to the importance to
Jevons of debates in railway economics, it may be noted here that
Foxwell's obsession for book collecting began with the suggestion by
Jevons that he should purchase a copy of Lardner's book that they saw in
Great Portland Street. The important contribution to economics of the
French railway engineers has only recently begun to receive the attention it
deserves; see the useful discussion and references in Ekelund and Hebert
(1983, pp. 271-275).
Groenewegen suggests that a further area where some re-evaluation is
required is the capital theory of Jevons, often praised as pioneering work.

It should not, of course, be any surprise that an analysis of Jevons,
following the "Cambridge controversies," should find him wanting in a
number of respects. Judgment about the relative importance of the critic-
isms is bound to vary, and no doubt this issue will be a subject for future
investigations.
On the earlier major studies by Stigler, Schumpeter, and Hutchison,
Groenewegen judges that they have generally stood up well to the test of
time, although the emphasis on technical detail of the first two writers led
to excessive criticism of Marshall. It is suggested here that the value of
Hutchison's Review of Economic Doctrines has perhaps even increased
over the 35 years since its publication. Further work seems to have
strengthened its claim to be the single most valuable source on the period.
Conversely, the usefulness of Keynes's essays on three of the pioneers
discussed in this chapter has declined significantly, as subsequent research
has revealed a greater attention by Keynes to turn of phrase than to
accuracy of judgment.
A further question that is raised by consideration of the secondary
literature on value and distribution concerns the nature of the "marginal
revolution" itself. Although it has been argaued that the changes in
questions, methods, and emphasis of economists were not so abrupt as
initially implied, it nevertheless remains clear that there was indeed a
gestalt shift during the last quarter of the nineteenth century. The precise
nature of this change is particularly difficult to identify in the case of
Marshall, who made quite remarkable claims about the continuity of
economics and his indebtedness to the classical economists. The evaluation
of those claims (and judgment of indebtedness were explicit acknowledg-
ment was not made) requires an extensive and deep knowledge of classical
economics as well as of Marshall's own writings. This task has recently
been undertaken by O'Brien (without, it may be said, the embellishments
of broken quotations and added emphasis) who argues that "Marshall's
own acknowledgements, in their generosity of spirit, significantly distort
the true distribution of the weight of his classical inheritance" (1988b, p.
1). O'Brien shows that in the macroeconomic fields of money and trade,
Marshall's claims, though less insistent, are consistent. But in the analysis
of value of distribution Marshall is shown to have made very significant
contributions that have helped to change the way in which economics is
studied.
As Groenewegen suggests, there has been a considerable amount of
work on detailed aspects of Marshall's work, but it is only very recently
that a balanced and more complete picture has begun to emerge. This
picture helps to show those aspects of Marshall's analysis that have been
neglected by or even explicitly thrown out of the more modern neoclassical
research program, which can ill afford to lose them. There is without doubt
much interesting and importance work to be done on the other neoclassical
economists; it can only be hoped that resources are available to make that
work possible.
Notes
1. See the useful discussion in Hutchison (1955). The issue is also discussed briefly in
Creedy (1986, pp. 130-133).
2. One example is Knapp's The State Theory of Money, translated by H. M. Lucas and J.
Bonar (advised by C. P. Sanger), but the author was clearly disappointed by the extent to
which it was abridged. The RES also supported Henry Higgs' translation of Cantillon's Essai
sur la Nature du Commerce en General; Higgs had been joint editor of the Economic lournal
with Edgeworth during 1892-1905. The translation by M. Kuczynski and R. L. Meek of
Quesney's Tableau Economque was published with the joint support of the RES and the
AEA.
3. This was N. G. Pierson's Principles of Economics, translated by A. A. Wotzel (and
helped by Sanger), although Edgeworth's practica1 support was minor. Edgeworth (1920) also
suggested that Cassel's Theory of Social Economy should be translated.
4. W. Smart's role in translating works is impressive. He translated Bohm-Bawerk's
Capital and Interest (1890), read the manuscript and proofs of Cassel's English edition of The
Nature and Necessity of Interest, edited F. von Wieser's Natural Value (1893) (translated by C.
A. Malloch), and directed the translations of C. Gide's Political Economy (translated by C. J.
M. Archibald) and Gide and Rist's History of Economic Doctrines (trimslated by R.
Richards). Wieser's Social Economics (1927) was later translated by A. F. Hinrichs in the
United States (helped by Hayek), and given a foreword by W. C. Mitchell. Other individual
translating achievements include O. Spann's Types of Economic Theory (1930), translated by
E. and C. Paul; A. Menger's The Right to the Whole Produce of Labour (1899), translated by
M. E. Tanner and introduced by Foxwell; A. S. Schwier's translation of Pareto's Manual
(1971). Zeuthen's important works on Problems on Monopoly and Economic Warfare and
Economic Theory and Method were translated by his wife (assisted by K. I. Wiggs and helped
by H. M. Somers, respectively).
5. De Viti's First Principles of Public Finance (1936) was translated by E. P. Marget.
Buchanan's (1960) chapter on "the Italian tradition in fiscal theory" is a valuable source,
along with Musgrave and Peacock (1958); the latter was supported by the International
Economic Association.
6. Robbins encouraged his colleagues to read foreign language works, with significant
and well-known results. Bresciani-Turroni's The Economics of Inflation (1937) was translated
by M. E. Sayers and given a foreword by Robbins (financial support came from the Sir Halley
Stewart foundation). He was, of course, involved with the translation (by E. Classen) of
Wicksell's Lectures, published under the aegis of the London School of Economics (although
his first book Value, Capital and Rent had to wait until 1954 to be translated by S. H. Frowein,
and introduced by G. L. S. Shackle; Interest and Prices was translated by R. Kahn). Robbins
also provided an introduction to H. E. Batson's translation of L. von Mises' The Theory of
Money and Credit (1934); Mises' Socialism was translated by Robbins' friend Kahane. Also
relevant is Batson's (1930) Bibliography, introduced by Robbins, which provides a useful

guide to French, German, and Italian works.
7. This is the Pure Economics (1898), translated by T. Boston Bruce.
8. However, Weintraub does not seem to be aware that Cassel's Theory of Social
Economy was first translated by J. McCabe in 1923. It was criticized by Dalton (1923) for
being "half German still." The fifth edition was translated by S. L. Barron in 1932. Cassel was
assisted by L. B. Eyre in preparing an English edition of his Money and Foreign Exchange
after 1914. (See also footnote 4.)
References
Batson, H. E. 1930. A Select Bibliography of Modern Economic Theory 1870-
1929. London: George Routledge.
Buchanan, J. M. 1960. Fiscal Theory and Political Economy. Chapel Hill: Univer-
sity of North Carolina Press.
Creedy, J. 1986. Edgeworth and the Development of Neoclassical Economics
Oxford: Basil.Blackwell.
Dalton, H. 1923. "Review of Theory of Social Economy," Economics, 223-226.
Edgeworth, F. Y. 1920. Review of Theory of Social Economy." Economic Journal,
30, 530-536.
Ekelund, R. B., and Hebert, R. F. 1983. A History of Economic Theory and
Method. New York: McGraw-Hill.
Hutchison, T. W. 1955. "Insularity and Cosmopolitanism in Economic Ideas 1870-
1914." American Economic Association. Papers and Proceedings, 45, 1-16.
Musgrave, R. A., and Peacock, A. T. 1958. Classics in the Theory of Public
Finance. London: Macmillan.
O'Brien, D. P. 1988a. Lionel Charles Robbins. London: Macmillan.
O'Brien, D. P. 1988b. "Marshall's Work in Relation to Classical Economics."
Durham University.
Phelps Brown, E. H. 1936. The Framework of the Pricing System. London:
Chapman and Hall.
Schneewind, J. B. 1977. Sidgwick's Ethics and Victorian Moral Philosophy.
Oxford: Oxford University Press.
Weintraub, E. R. 1985. General Equilibrium Analysis. Cambridge: Cambridge
University Press.
3 HAWTREY AND ROBERTSON:
REAL AND MONETARY ROOTS OF
ENGLISH MACROECONOMICS IN
THE TWENTIETH CENTURY
Patrick Deutscher
1. Introduction
A number of significant similarities exist between the careers of Dennis

Robertson and Ralph Hawtrey. Both made their main contributions in the
fields of monetary theory and economic cycles. Both first published works
on economics shortly before the First World War, and their output con-
tinued into the 1960s. Their early academic paths were similar: Eton,
Cambridge, and the Apostles (though Robertson joined the Apostles in
1918 while Hawtrey had resigned in 1906). To varying degrees and at
varying times, both were friends of and either collaborators with or critics
of J. M. Keynes. With this much in common, it is not surprising that their
paths crossed frequently.
Robertson's reputation among economists has been more durable than
I am indebted to Don Moggridge, Susan Howson, and Warren Samuels for their very
helpful comments. Unpublished material from Hawtrey's papers, identified by the prefix
HTRY and the file number, were made available by the Archivist of Churchill College, Cam-
bridge. Other letters between Hawtrey and Robertson that are cited were very kindly pro-
vided by Professor S. R. Dennison.
59
Hawtrey's. Consideration of Hawtrey's theories fell off sharply after the

Second World War. Moreover, Robertson's place as a forerunner of the
Keynesian revolution has received greater attention. Each, however,
played an important part in the development of macroeconomics during
the interwar period, and the historical literature evaluating their contribu-
tions is growing.
Their contemporaries recognized both Hawtrey and Robertson as
important contributors to macroeconomics in the interwar period. Using
citations as indicators of professional valuation, it can be shown that they
were among the most discussed authorities in the literature of macroecono-
mics. I have reported the results of counting citations in articles classified
by the Index of Economic Journals under the headings "Aggregative and
Monetary Theory and Cycles" (2.3-2.33) and the nonhistorical categories
of "Money, Credit, and Banking" (section 9) in detail elsewhere (Deuts-
cher, 1984).
Over the period of 1920 through 1930, Hawtrey and Robertson shared
sixth place in the ranking of most cited macroeconomists. Ahead of them
in the list were Irving Fisher, Wesley C. Mitchell, A. C. Pigou, Alfred
Marshall, and W. S. Jevons. J. M. Keynes was in tenth position. In the
1930s, there was a marked rearrangement of the pattern of citations.
Following the publication ofthe Treatise on Money, Keynes rose to the top
spot and remained there throughout the 1930s. However, economists
continued to pay close attention to Robertson and Hawtrey, and they both
moved up the rank. Over the period of 1931 through 1935, the cutoff date
selected to separate approximately the pre- and post-General Theory
periods, Robertson rose to second place while Hawtrey climbed into fourth
spot, following Hayek. All four of these economists took part in the
debates over the Treatise, and many of the citations were cross-references
in articles by the participants or comments by other writers who were
further from the center of the debate. In the post-General Theory period,
1936-1939, Keynes not only remained in the top position but maintained a
near hegemony in the literature, being cited two-and-a-half times as
frequently as his nearest rival, Dennis Robertson. Hawtrey dropped back
into sixth spot, behind Hicks (3), Pigou (4), and Harrod (5).
Counting citations is a rough way of demonstrating contemporary
importance, but the exercise has apparent limitations. The statistic shows
only the number of articles in which an individual was cited over a given
period. But references have unequal significance. For example, in an
article dealing exclusively with issues arising out of the General Theory in
which an observation of Robertson's is cited only in passing, Keynes and
Robertson are both given one count. In addition, positive and negative
REAL AND MONETARY ROOTS OF ENGLISH MACROECONOMICS 61
commentary are given equal weight. However, over a period of several

years, the anomalies wash out, and the number of citations provides a
useful indication of whose work most warranted examination by contem-
porary economists.
The next section assesses the interpretive literature on Robertson's
positive contributions, focusing on his work in macroeconomics and
monetary theory. The third section takes up his relationship with Keynes, a
topic that could not be entirely excluded from the preceding discussion.
The fourth and fifth sections deal in a parallel manner with the interpretive
literature on Hawtrey. It may seem unfortunate to use Keynes continually
as a reference point in the interpretation of Hawtrey and Robertson, but
given the centrality of Keynes's work in the economics of this century and
his importance in their professional and personal lives, it is understandable
that this has been a main focus of the interpretive literature. The sixth
section looks at studies that have investigated their connection with
monetarist economics. Finally, the closing section discusses the debates
that occurred between Hawtrey and Robertson.
2. Robertson's Contributions
Studies of Robertson's work has been so dominated by his relationship

with Keynes that examination of his contributions in their own right has
been relataively neglected. Even Presley's Robertsonian Economics, which
is the most thorough guide to Robertson's ideas, is largely concerned with
the Keynes connection. This has probably been a sensible allocation of
historical resources, but it is likely that our understanding of Robertson has
suffered because his work has persistently been studied in Keynes' shadow.
Robertson's contributions were not restricted to macroeconomics and
monetary theory. He contributed significantly to economic knowledge in
the fields of utility theory, competitive behavior, and international trade.
However, as he wrote in the Lectures, it was due to his work on the
questions of money and economic stability, "to me the most interesting
part of economics," that "I can hope to be remembered as having made
any personal contribution" (Robertson, 1963, p. 325).
The central features of Robertson's analysis of "industrial fluctuations"
are discussed in the first part of Presley's text. Robertson advanced a
"real" explanation of cycles in the sense that they would occur in the
absence of money and that monetary phenomena in the real world are
secondary. Monetary factors "could magnify or diminish a trade cycle" but
they were "subsidiary to real forces." Accordingly, Robertson was "pessi-
mistic about monetary control" (O'Brien, 1984, p. 22). Presley writes that
Robertson was "the first British economist to stress the role of real factors
and not monetary factors in the trade cycle" (Presley, 1978, p. 30), a
claim that goes too far, as the counter-example of levonian sun spot theory
demonstrates. Although Robertson canvassed a range of potential deter-
mining variables and concluded that many factors could playa part, he
identified the behavior of investment as the main source of economic
cycles. The discontinuous flow of innovations, the time required to under-
take capital formation, and the durability of capital dictated the course of
economic activity. Economic cycles and the dislocation that accompanies
them are unavoidable features of economic progress. Efforts to suppress
cyclical fluctuations and maintain permanent high employment may carry a
price tag in terms of a reduced rate of economic advance.
Michael Danes reconstructs Robertsonian analysis in a more radical
fashion than most commentators. Robertson's procedure, he demons-
trates, was to build up "types of economy" starting with simple economies
and then adding more realistic features, examining economic behavior at
each stage and how it was altered by changes in the assumptions. The basic
types of economies are described along two dimensions: cooperative and
noncooperative, and monetary and nonmonetary (barter). In cooperataive
economies, production decisions are made by producers, while in non-
cooperative economies, workers are hired (Anyadike-Danes, 1985).
Economic cycles can occur even in the most simple cooperataive barter
economy, thereby disproving the necessity for a monetary theory of
fluctuations. Decisions are made collectively by economic agents on the
basis of the tradeoff between present and future consumption and leisure.
Demand for capital can rise because of a technological innovation. The
duration of the subsequent boom is determined by the gestation period of
capital, while that of the ensuing slump depends on the durability of
capital. When capital has been put in place, leisure is substituted for labor.
Economic activity falls off until the capital stock begins to wear out and
economic agents again choose to substitute capital formation (in the in-
terest of future consumption) for leisure. A fully endogenous cycle results.
When production is organized noncooperatively, Anyadike Danes goes
on to show, the cycle will be aggravated. Employers have greater income
elasticity of demand for leisure than workers and will tend to push produc-
tion more during the boom and contract it more in the slump. Policy makers
should aim for the "appropriate degree of cyclical fluctuation."
The addition of money into the cooperative "type" also serves to
aggravate the cycle. Working capital is financed by bank borrowing. When
demand for capital rises, bank lending is increased and, along with it, the
flow of monetary demand. The price level rises proportionately, rationing

available output. The rise in the price level induces further increases of
credit demand. In this environment, policy makers should adopt rules for
the banking system that make the cycle correspond to that induced by
changes in the demand for real capital formation and minimize that which
is merely consequent upon changes in the price level.
A monetary, noncooperative economy is the most realistic of the four
Robertsonian types in Danes's interpretation. Money wages tend to lag
behind prices and entrepreneurial income, further aggravating the cycle.
Again, the problem for policy makers is to limit the cycle to the appropri-
ate range based upon changes in the demand for capital.
In each type fluctuations are rooted in the nature of capital and the
rational calculations of economic agents. The challenge for the Robertso-
nian theory of the cycle (and for similar theories based on the demand for
new and replacement capital goods) is to provide a satisfactory account of
why demand for investment should be bunched in a cyclical pattern rather
than dispersed randomly over time. In a complex economy with many
industries, many different types of capital goods, each with its particular
gestation period and durability, and with innovation occurring on several
fronts at any time, it seems plausible that the demand for capital will not be
bunched, if other factors affecting the demand for capital are invariant. It
may be that some periods of economic history were dominated by the
introduction of key innovations, particularly in relatively simple econo-
mies; but it may also be argued that the pronounced cyclicality of fixed
capital formation in advanced economies is a result of other influences that
affect all or most sectors of an economy at the same time.
Robertson is also widely credited with bringing savings-investment
analysis to the fore in economics (Hicks, 1965). However, it is impossible
to discuss this contribution without acknowledging Keynes's participation.
Banking Policy and the Price Level occupies an important spot in the
development of economics. It was, in large part, a joint product of Keynes
and Robertson and an important signpost of Keynes' future development.
By Robertson's own acknowledgment, he had "had so many discussions
with Mr. J. M. Keynes" on an important part of the work "that I think
neither of us now knows how much of the ideas therein contained is his and
how much is mine" (Robertson, 1926, p. 5). The chapters cited in this
context dealt with "the kinds of saving" and the role of "short lacking" in
the cycle. Keynes and Robertson were conscious of working toward
something "new" and moving beyond the analysis of some of their close
colleagues, notably Pigou and Hawtrey.
Banking Policy and the Price Level began with the premise that both
monetary and psychological theories of economic fluctuations must be

accompanied by an appreciation of deeper, real causes. Robertson tried to
show that some fluctuations are desirable and that real forces will produce
fluctuations whatever monetary policy is adopted. Appropriate fluctua-
tions of output, those that are economically desirable, may be caused by
changes of real costs or by changes in underlying demand. The monetary
policy that facilitated the adjustment of the economy to the appropriate
level of output was not, in general, a policy aimed at a constant price level.
The first steps of the argument abstracted from money and assumed that all
exchanges take the form of barter. Money was introduced at a later stage
of the analysis. Robertson then explored the consequences of different
monetary responses to specific real shocks. The most effective policy must
acknowledge "that, under our existing wage-and-money system, a more
direct and immediate stimulus to increased output is afforded by rising
money receipts than by falling prices of the objects of expenditure"
(Robertson, 1926, pp. 26-27). Significantly, Robertson's assessment of
alternative monetary policies utilized the assumption that prices adjust
fully in each period so that all markets clear.
The key fifth chapter of Banking Policy and the Price Level consisted of
an analysis of saving, much of it geared toward providing a taxonomy of
saving. The closest of his categories to current understanding of saving was
lacking: short, long, and/or unproductive. An individual's lacking is the
difference between "the value of his current economic output" and his
consumption. Lacking may be applied, either directly or indirectly, in the
purchase of fixed or working capital, or hoarded, that is, added to cash
balances. Hoarding must be matched either by the increased consumption
of others or by a "creation of capital," if the production process is to be
uninterrupted. In the aggregate, hoarding need not imply lacking because
it may be offset by price level movements.
Lacking may be either spontaneous, automatic, or induced. Spon-
taneous lacking corresponds to a conscious decision to save. Automatic
lacking, better known as "forced saving," occurs when real consumption
differs from intended consumption because the price level changes or, in
some instances, because the change in the price level differs from expecta-
tions. Reduced consumption is called stinting, while increased consump-
tion is called splashing. Automatic stinting occurs when the price level rises
because of an increased flow of money resulting from either dishoarding or
from the expenditure of newly created money. Induced lacking occurs
when people reduce consumer expenditure in order to rebuild the real
value of cash balances after a rise in the price level. Robertson attributed
the idea of induced lacking to Keynes. Robertson's development of the
forced saving thesis along with a full account of its prehistory in economic
thought are discussed thoroughly in Presley's Robertsonian. Economics.
"Forced saving is the link between the Robertsonian theory of prices and
the theory of interest" (Presley, 1978, p. 103).
The significance of Robertson's recognition that savings and investment
are separate acts that must be reconciled in the adjustment of the economy
has been questioned. Eshag, though he saw it as an important contribu-
tion and a marked improvement over efforts to analyze macroeconomic
performance in terms of the quantity theory, described it as only one
of Cambridge's several tentative steps toward the theory of effective
demand in the General Theory. Milgate went further, arguing that mere
recognition of savings and investment as distinct operations carried out by
separate individuals was not an important discovery; what mattered was
the mechanism that "adjusted saving to investment" (Milgate, 1982, p.
83). "Had noticing the distinction between 'acts' of saving and 'acts' of
investment been sufficient, economics would have had a correct theory of
employment very much sooner than 1936. But this was certainly not
enough ... " (Milgate, 1982, p. 162). Robertson based his approach on
the behavior of savings only in a superficial sense. In practice all of
his categories of savings were governed by interest rates (Milgate, 1982,
pp.71-74).
Finally, Robertson employed a step-by-step, or period, analysis. The
dynamic links between one day and the next were crucial parts of his
analysis. The "Robertsonian lag" between income and expenditure
became a well-known and widespread amendment to Keynesian models.
By defining savings as the difference between consumption at time (t)
and income at time (t - 1) he was able to speak about differences
between savings and investment. And, because of his contributions to
period analysis Robertson is rightly seen as a major influence on the devel-
opment of modern dynamic models and growth theory (Gilbert, (1982),
pp. 65-67). Since many modern economists are affronted by the neg-
lect of time in economic analysis, including Keynesian analysis, Rober-
tson's dynamic method is frequently held up as one of the strengths
of his theories.
3. Robertson and Keynes
The major issues that divided Robertson and Keynes, including the
liquidity preference-loanable funds debate, the savings investment debate,
the relative merits of dynamic and static methods, and the historical
question of continuity versus revolution, have never vanished from the

secondary literature.
The background of these disputes was a long period of close collabora-
tion that reached its apex with the publication of Banking Policy and the
Price Level in 1926 (Presley, 1978, pp. 75-81). But, while writing the
Treatise, Keynes' views shifted from those of Robertson, and in the
ensuing debate the first public breach developed between them. Ironically,
the early friendship and cooperation may have added to the acerbity of the
later conflicts. In a later assessment, however, Robertson was to write, "I
am proud to have been Keynes's pupil, and to remember that, whatever he
thought of our lack of receptivity to his later doctrines, he once in print
described Hawtrey and myself as respectively his 'grandparent and parent
in the paths of errancy'" (Robertson, 1963, p. 326). In the interpretive
literature, the personaJities of Robertson and Keynes have been examined
to an extent that is atypical of the history of economic thought (Hicks,
1965; Johnson, 1978; and E. A. G. Robinson, 1975).
In the early fifties, articles by Wilson and Fellner addressed aspects of
Robertson's dealings with Keynes. (Both of these articles share a kinship
with Hicks (1942) which, rather arbitrarily, has been excluded on the
grounds that it is part of the contemporary literature rather than the
secondary literature. Hicks has commented extensively on Robertson and
has written that in the early 1940s, "I was feeling myself much closer to
Robertson than to any other economist who was my senior" (Hicks, 1982,
p. 127.) Wilson (1953) sympathetically appraised Robertson's debates with
Keynes, but gently chided Robertson for his reluctance to acknowledge
Keynes' achievements. The "very enlightenment" of Robertson's earlier
work seemed to prevent him from recognizing that anything new had
occurred in economics. Wilson presented his early refutation "with scorn"
of "Mr. Hawtrey's Treasury view" as an example of this enlightenment.
"The differences ... were therefore much less fundamental than those
which separated both of them from the defenders of Say's Law" (Wilson,
1953, p. 557).
Wilson did not confine his attention to Robertson as a controversialist.
He also praised Robertson's approach to the trade cycle, urging contem-
porary economists to take account of Robertson's emphasis on the role of
innovations in propagating economic fluctuations and to heed his scep-
ticism regarding the development of stripped-down mechanical models
of the cycle. Wilson was sympathetic to Robertson's doubts about the
extent to which economic policy could be used to maintain full employ-
ment and to his warnings against contemporary willingness to err on the
side of inflation.
Fellner's 1952 article also took a sympathetic approach to Robertson's

work. There was no Keynesian revolution, Fellner insisted, unless the
stagnationist thesis was the true message of the General Theory. If the
main message was to explain "discrepancies between full-employment
equilibrium and deficient-or-excessive effective demand" due to a mis-
match between saving and investment, then Keynes' advance was a con-
tinuation of the Wicksell-Robertson analysis. Not only was Keynesianism
in large part an extension of earlier economics, it "left unexploited much
that was significant in the Robertsonian and other pre-Keynesian contribu-
tions" (Fellner, 1952, p. 268). These contributions "will gradually have to
be collected again" (p. 277). Fellner was among those who considered
Robertson's dynamic picture of an economy moving from period to period,
a strong point in comparison to Keynes' method of comparing short-run
static equilibrium positions. Keynesian economics had to develop in a
Robertsonian (or Wicksellian) direction in order to explain how an eco-
nomy moves from one position to the next (Fellner, 1952, pp. 268-269). In
addition, Robertsonian analysis offered an account of the effect of structu-
ral adjustments on aggregate economic performance that was absent in
Keynesian economics.
Later, Samuelson agreed that much of Robertson's criticism of Keynes
was valid. Had the criticisms "come from within the Keynesian camp,"
they "would have been recognized as valuable contributions" (Samuelson,
1963, p. 520), particularly his views on the interest rate debate, in the
savings-investment controversy, and the definitional nature of the multi-
plier. On the other hand, Robertson underestimated the Keynesian con-
tribution and, although he was a founder of dynamic economic analysis, he
never understood "the difference between" his definition of saving and
a "dynamic causal sequence." For this reason, Samuelson concluded, he
was unable to see that his own system of identities linking current savings
to the previous period's income was as tautological as Keynes' equations
in the Treatise.
More recently, M. K. Anyadike-Danes offered a distinctive interpreta-
tion of the Robertson-Keynes linkage, examining the post-General Theory
debate through the eyes of Robertson's theory. The liquidity preference-
loanable funds controversy was not Robertson's main concern. His differ-
ences with Keynes were more fundamental. The crucial macroeconomic
policy issue for Robertson was the tradeoff between "full employment and
sustained progress in living standards." The tradeoff occurs because some
fluctuations are appropriate and economic performance is in some sense
better if policy permits or facilitates the ensuing unemployment.
Before the publication of the General Theory, Robertson believed that
the proper agenda for macroeconomics was to develop a more complete

and dynamic account of the relationship between economic trend and
cycle. This was not Keynes' path. Keynes' work was, for Robertson, "not
only ambiguous and misleading but ruso analytically flawed, paying insuf-
ficient theoretical attention to the basic mechanism which Robertson
believed to lie at the heart of aggregative theory, the relationship between
cycles and growth" (Anyadike-Danes, 1985, p. 120).
There is, as well, a recent body of interpretive literature concerned with
the debates surrounding the General Theory that sees Robertson's critique
as deeply flawed. Frequently, this view is accompanied by the idea that
Keynesian economics as it developed either proved capable of incorporat-
ing Robertson's criticisms as special cases or was weakened by unwar-
ranted reconciliations with those criticisms. For example, Fletcher (1986)
sees the Keynesian revolution against classical economics as the supplant-
ing of Say's Law with a radically different view in which the level of
employment is determined by aggregate demand. Neoclassical economists,
in which category he includes Robertson and Hawtrey, mistakenly clung
to a flawed theory that undermined their advocacy of changes in economic
policy. The major error resided in the loanable funds theory of interest rates
of which Robertson was the chief proponent.
Robertson, in Fletcher's account, is the weak-sister of the Keynesian
revolution, "not of the stuff that revolutionaries are made" (Fletcher,
1986, p. 39). He was aware of the flaws in orthodox economics, but he
attempted to build upon the old foundation rather than boldly construct
the new theory that was needed.
Fletcher's viewpoint requires that the version of Keynes attacked in
Robertson's critique was a straw man based on a misunderstanding of the
Keynesian revolution. Robertson was attempting to explain the General
Theory as if it were part of classical economics, an offspring with exagger-
ated pretensions. The points allegedly scored by Robertson against
Keynes' monetary theory of interest rates-the change in the rate of
interest caused by variation in savings or the productivity of capital, the
recantation over finance, the implausibility of the liquidity trap, and the
failure to explain the normal or safe rate of interest-were either not
inconsistent with Keynes' views or were his interpreters' unsanctioned
derivations.
This skeptical evaluation of Robertson's arguments is shared by Andries
Nentjes. Robertson's responses to both the Treatise and the General
Theory were distorted by misinterpretations. Robertson treats money
primarily as a means of exchange, implying that changes in the propensity
to hoard affect the demand for output directly. This link is severed in
Keynes' portfolio approach. Although Robertson was correct in forcing

Keynes to acknowledge "a direct influence of a change in the propensity to
consume or the propensity to invest on the market rate of interest," his
loanable funds theory was fundamentally different from his earlier model
and "quite a concession to the Keynesian vision" (Nentjes, 1979, pp.
557-559). Robertson did not succeed in integrating "loanable funds theory
in a general theory of interest and prices" and his consumption function
was "absorbed by Keynesianism" in the work of Machlup and Hansen.
Nentjes concludes that this "gives a clue to the question why Robertson did
not establish a school as Marshall and Keynes did. Sticking to Marshallian
long-run equilibrium theory, and leaving only a half-developed mone-
tary short-run theory ... he failed to offer a distinct paradigm capable of
inspiring the following generation of Cambridge Economists" (Nentjes,
1979, pp. 560-562).
Richard Kahn interpreted the Robertson-Keynes linkage in a different
fashion. Robertson was "in a somewhat perverse sense" an important
innovator in economics, especially during the 1920s, and he had a major
influence on Keynes throughout the writing of the Treatise. The analysis
introduced in Banking Policy and the Price Level was "all very ingenious.
It is difficult, however, to pretend that Robertson's tortured writing and
Keynes' tortured collaboration ... were conducive to clarity to thought"
(Kahn, 1984, p. 62). The main post-General Theory issues dividing Keynes
from Robertson did not concern liquidity preference but were over why
wages did not fall when there was involuntary unemployment and whether
employment would rise if wages did drop.
3. 1. Sham Disputes
No other part of the Keynes-Robertson disputes has had greater repercus-

sions in the secondary literature than the liquidity preference-loanable
funds argument, yet in Value and Capital, Hicks declared this a "sham dis-
pute" and proceeded to offer a reconciliation that showed the two theories
lead to the same result. Many economists concurred with Hicks. Yet the
dispute continues to resurface in articles arguing the relative merits of one
or the other position. The continuing debate, with its unfolding cast of par-
ticipants, has not yet been adequately studied from an historical perspec-
tive, and most historical accounts appear as volleys from one side of the net.
Klein (1947) from a thorough-going Keynesian perspective, dismissed
most of the previous demonstrations of equivalence as inadequate, a view
echoed by Tsiang (1956). However, the practical importance of the issue
was limited since economists were "coming to the view that the rate of
interest is not a very important variable in the modern economic world." It
was possible to collapse the loanable funds theory into the liquidity
preference theory if it was restated in terms of stocks and if the stocks were
defined comprehensively (in the manner of Fellner and Somers, 1941).
This, however, put the loanable funds approach in too favorable a light,
since its proponents normally argued in terms of flows (savings and
investment being given pride of place) rather than stocks. A theory that
determines prices or yield as the equilibrating mechanism for flows is
inadequate. Klein cited an argument by Scitovsky that the existence of
large stocks can prevent prices from adjusting to the extent necessary to
bring about flow equilibrium. Klein concluded that "interest is not the
allocating mechanism between the supply and demand for credit flows"
(Klein, 1947, p. 123).
Wilson endorsed Hicks' demonstration of equivalence between the two
theories of interest. Keynes' dogmatic denial that changes in savings or
investment could autonomously move the rate of interests was at the heart
of the basically bogus dispute. He ought to have acknowledged that it was a
practical issue whether changes in liquidity preference or shifts in the
supply of saving or demand for investment mattered most. Robertson was
less dogmatic, recognizing that factors other than the elemental forces of
productivity and thrift had to be taken into account. In Wilson's view,
however, Robertson's stance was not beyond reproach; he ought to have
acknowledged that pre-General Theory economics dealt inadequately with
the monetary determinants of interest rates (Wilson, 1953).
Fellner (1952) took the view that the liquidity preference and loanable
funds approaches were equivalent if proper "allowance is made for
finance." This is the "Keynes recanted" interpretation, fully exploited by
Tsiang. Tsiang argued that decisions to borrow or lend correspond to
decisions concerning holding money. "The perfect agreement between the
two theories is found to exist because the ex ante decisions to supply funds
to the market necessarily imply corresponding decisions ... as to the funds
required to finance one's own consumption and one's own demand for
'idle' money" (Tsiang, 1956, p. 551). Interest rates would fall or rise when
plans to consume or invest were raised or lowered, even before changes in
spending and income occurred. In a letter to Tsiang, Robertson endorsed
this interpretation of the debate, writing, "So far as I can judge, it really
clears these matters up completely. . .. Whether your article will relieve
Mrs. Robinson from the orgy of expectoration and self-stigmatization to
which she is reduced by any mention of the concept of loanable funds I
cannot tell ... " (Tsiang, 1980, p. 474).
Harry Johnson's 1951 article, Some Cambridge Controversies in Monet-

ary Theory, was originally circulated at Cambridge as a student's guide to
the debate. Johnson insisted that the fact that Robertson's method was
dynamic while the Keynesian method was static was irrelevant to the
question of which theory was superior. He also pointed out the formal
identity of the two theories and argued that the real issue was an empirical
one. Was it in practice more useful to focus on the role of interest rates in
equilibrating the supply and demand for money or in balancing the flow of
savings and investment? Leaning to the former view, Johnson examined
the debate using the Hicks-Hansen framework to sort out the issues
(Johnson, 1951).
Eshag was in the unique position of writing a history of Cambridge
monetary theory with the guidance of both Joan Robinson and Dennis
Robertson. He concluded that "the breach in question was more apparent
than real" (Eshag, 1963, p. 62), "that there was nothing of great signi-
ficance which could be regarded as wholly original in Keynes' formal
analysis of the rate of interest .... His basic contribution consisted of the
introduction of the variable income into ... the theory of interest" (p. 66).
In fact, Keynes' defense of liquidity preference theory detracted from his
own "powerful economic common sense" which did not support ascribing
much importance to interest rates (p. 68).
Conard took an evolutionist perspective. The loanable funds theories
recognized the monetary elements at play in the determination of interest
rates, although inadequately. Keynes, on the other hand, filled much
of the gap but did not duly acknowledge nonmonetary forces. "Both
sides ... contributed essential elements to the present synthesis" (Conard,
1959, p. 157). The basic difference between the theory of interest in
the General Theory and Robertson's theory was that the former was a
static equilibrium theory while the latter was dynamic (Conard, 1959,
pp. 181-182).
More recently, Fletcher interpreted the debate as another round in the
match between neoclassical and Keynesian economics. He accepted the
formal equivalence of the two approaches, but argued that the arithmetical
compatibility does not address crucial issues of causality. The loanable
funds approach is vitiated by the implication that prior savings or new
money creation are required to provide the funds for investment. The
Robertsonian analysis collapses into a flow-of-funds approach, concerned
merely with establishing a taxonomy of financial flows. The superiority of a
stock or flow approach is a side issue. The central point is that Robertson's
method, an attempt to avoid acknowledging the operation of the multi-
plier, fails because it cannot explain the paradox of thrift (Fletcher, 1986).
Presley's views are a mirror-image of Fletcher's. Keynes' introduction of

the liquidity preference theory of interest was a maneuver to shore up the
multiplier theory. The central issue in the debate, he argued, was the role
of productivity and thrift in determining interest rates. Robertson's case
against Keynes was a decisive refutation of the General Theory's attempt to
deny productivity and thrift a place in the determination of interest rates
(Presley, 1978, pp. 181-185). Furthermore, Keynes at least partially
recanted and moved toward Robertson's position as witnessed by his
"over-awed" surrender to Hicks' general equilibrium interpretation and
the introduction of finance for planned investment as an explanatory
variable in the demand for liquidity. The transmission mechanisms, fol-
lowed by each theory to their common conclusion, were, however, differ-
ent. Robertson's path led directly to interest rates through changes in the
supply or demand for loanable funds. Keynes' analysis required that
changes in saving or investment behavior exert their influence indirectly
through their effect on income.
4. Hawtrey's Economics
Davis offers perhaps the only readily available modern survey of Hawtrey's
economic theories, Hicks' essays being in a different category. The fea-
tures of Hawtrey's analysis which Davis emphasizes include, first, his role
as "foremost modern exponent of the virtues of Bank Rate." Bank rate
was the vehicle for the transmission of monetary policy. Changes in
short-term interest rates affected the economy primarily through their
impact on dealers' demand for stocks. Davis suggests that Hawtrey's
emphasis on the role of dealers in both domestic and international markets
may have been a conclusion based on "practical observation" of the role of
merchants "at the end of the Edwardian Age" and that the importance of
this class of economic actor has probably diminished in modern times,
reducing the scope of operation for Hawtrey's Bank Rate mechanism
(Davis, 1981, pp. 206-208).
Second, Davis directs attention to Hawtrey's theory of the business
cycle, focusing on his account on the particular dynamics of credit and
money under gold standard conditions. Hawtrey believed that the cycle as
such disappeared along with the pure gold standard. Subsequently, econo-
mic fluctuations followed an irregular pattern dictated by the hits and
misses of monetary policy (Davis, 1981, pp. 208-211).
Third, Hawtrey's theory of the price level was based on a combination
of the Marshallian cash balance variant of the quantity theory combined
with an income approach, the money streams of consumers' income and

outlay. Significantly, he reversed the orthodox picture of microeconomic
adjustment: a divergence from equilibrium results first in a change of
stocks, next in a change of production brought about by a change of
dealers' order, and, finally, a change in price. The same sequence aggre-
gates to become the representative behavior of the economy taken as a
whole (Davis, 1981, pp. 211-213).
Finally, Davis deals with Hawtrey's contribution to the development of
savings-investment analysis. He cites Hawtrey's underestimate of the
importance of fixed capital formation in modern economies as a crucial
error. Hawtrey held that for the most part discrepancies between savings
and investment would not be a problem. Normally, dealers in the invest-
ment market would ensure that what was "invested" by consumers would
be translated into capital spending. Davis describes how Hawtrey, in his
critique of the Treatise, developed an analysis of income and output
adjusting to equilibrate savings and investment (Davis, 1981, pp. 213-
217).
Davis' essay covers the central themes of Hawtrey's economic theory.
Based on their response, the aspects of Hawtrey's work that most inter-
ested his contemporaries were his ideas about the monetary origin of real
macroeconomic disturbances and about the possible use of monetary
policy to offset fluctuations in employment and output. The main elements
that, on my own reading, distinguished Hawtrey's economics included the
following:
1. The idea of circular flows of income and outlay linked by stocks of
money and goods.
2. The importance of cumulative processes. Deviations tend to be
self-amplifying, leading to vicious circles of inflation and deflation.
3. The necessity of dealing with modern economies as monetary
economies. Money matters in the sense that it is not legitimate to treat
money as a mere veil obscuring the real substance of economic events.
Monetary shocks of one sort or another are the most important source of
macroeconomic problems.
4. The transmission of monetary shocks through short-term interest
rates and especially through their impact on the demand for inventories.
Though Hawtrey insisted that this was not essential to his analysis, it was
characteristic of it.
5. The importance of dealers. Dealers play an essential role, acting as
market makers in goods, securities, and debts. Dealers set prices on the
basis of their assessment of current events. Thus, prices are not determined
by an anonymous market mechanism that ensures an approximation to
market clearing. The importance of the dealers' role underlies Hawtrey's

whole analysis of macroeconomic events. They provide the microrationale
for his fixed-price, quantity-adjustment analysis.
6. The importance of economic management. Economies do not tend
to positions of stable full employment equilibrium. Because disturbances
initiate self-amplifying cumulative processes, economic policy must be
used to provide stability and improve overall welfare (Deutscher, 1984,
pp. 14-76). Hicks, in his valuable essay, presents this as Hawtrey's key
contribution. Hawtrey was first to show "that they were dealing with a
system that had no automatic stabilizer: a system which needed to be
stabilized by policy" (Hicks, 1977, p. 120).
Taken together, these elements constituted Hawtrey's unique contribu-
tion to economic thought. However, he also left his imprint on economics
in a number of important terminological and conceptual innovations. He
was among the first explicitly to employ a fix-price quantity-adjustment
analysis, making use of this approach before Keynes adopted it in the
General Theory. Hawtrey was one of the first economists to make use of
the distinction between planned and unplanned investment. Finally, Haw-
trey introduced the widening and deepening concepts to the analysis of
investment. These ideas have become part of the arsenal employed by
economists and are frequently encountered in the modern literature.
Howson deals with the early development of Hawtrey's ideas in Good
and Bad Trade and Currency and Credit, explaining how his analysis
developed and how his emphasis changed in response to monetary devel-
opments in the real world. Good and Bad Trade explained the global
business cycle as a result of the working of the gold standard. Currency and
Credit, published during the post-war breakdown of the gold standard,
considered basic problems of the nature of money and credit and the
varieties of monetary regime that might be established to impart stability to
the price level (Howson, 1985, pp. 144-152).
Howson also deals with the question of the influences on Hawtrey.
Because of the Cambridge connection there has been a tendency to view
Hawtrey as one of Marshall's successors. Eshag includes Hawtrey as one of
Marshall's pupils. O'Brien writes that "Hawtrey clearly derived his monet-
ary analysis of the cycle from Marshall" (O'Brien, 1984, p. 31). While
Hawtrey's close contact with Cambridge, and with many important eco-
nomists who were either pupils of Marshall or of his pupils, clearly
influenced the style of Hawtrey's economics, he never studied with Mar-
,shall. His formal training in economics was confined to a preparatory
course for civil service entrance examinations. Good and Bad Trade was
apparently written without delving into the existing literature on the trade
cycle. The sole reference in that work was to Fisher to acknowledge a

connection pointed out by an economist friend (whom Howson speculates
was Keynes). Howson concludes that "his theory owes little or nothing to
Marshall's work" (Howson, 1985, p. 145); see also Guillebaud, 1964; and
Black, 1977. Certainly in one key respect, his theory of microeconomic
adjustment by the firm, his analysis is sharply anti-Marshallian.
4.1. Hawtrey and Economic Policy
Hawtrey spent most of his working career with the British Treasury. His
ideas on economic policy and his contribution to the making of contempor-
ary policy have figured prominently in historical commentary. Howson's
work on Hawtrey has primarily been concerned with his role in the
development of British economic policy in the interwar period, emphasiz-
ing the interaction between his theoretical and applied work. Spreng's
dissertation deals to a large extent with Hawtrey's commentary on con-
temporary economic concerns (Spreng, 1976). Davis' essay discusses
Hawtrey's views on public works programs, the return to gold in 1925,
his proposals for a gold exchange standard, and his diagnosis and prescrip-
tion for the dismal economic performance of the 1920s and 1930s (Davis,
1981, pp. 217-225).
Hawtrey was transferred to the Treasury from the Admiralty in 1904. In
1919, he was appointed to the post of Director of Financial Enquiries, a
position he occupied for the remainder of his Treasury career. From this
vantage point he devoted himself to some of the major British and inter-
national economic problems of his time.
Hawtrey's career in the Treasury was not an unqualified success. The
impression is that he was kept at a distance from the main process of policy
formation, and that although his ideas were respected, they were dis-
counted. because of his relatively strong bent for theory and a perceived
tendency to attribute outstanding importance to a narrow range of factors.
P. J. Grigg, in a frequently cited reminiscence, described Hawtrey "as a
sort of economic consultant. He was not a particularly good administrator,
but he had one of the most acute minds of the age." Grigg recalled how
Churchill, during his period as Chancellor of the Exchequer (1925-1929),
would ask on occasion "that the learned man should be released from the
dungeon in which we were said to have immured him ... " (Grigg, 1948,
pp. 81-82).
Hawtrey's relative isolation from the main currents of Treasury business
may have helped his development as an economist. He was permitted to
devote himself to important economic issues without being caught up in the

details of administration or the crafting of bureaucratic strategy. At the
same time, his post gave him greater access to official concerns than a
primarily academic economist would have had. As well, it gave him the
time and security necessary to write and to develop his ideas. The degree of
independence that Hawtrey was permitted was remarkable, and there
appears to have been little intervention in his public pronouncements.
Presumably, his freedom would have been more circumscribed had his
analysis been less congenial to his employers.
Hawtrey's contribution to the evolution of economic policy is linked,
often as his main claim to infamy, to the "Treasury View." According
to Mark Blaug, "Hawtrey alone of all British economists in the 1920s
opposed the case for public works on theoretical grounds." Blaug also
attributed policy significance to Hawtrey's views, for he wrote that
"despite the consensus of economic opinion, the Treasury followed
Hawtrey ... " (Blaug, 1978, p. 685). Howson and Winch wrote that "Haw-
trey ... provided theoretical justifications for Treasury policy when
needed. Hawtrey provided the strongest rationale for the 'Treasury view'
in an Economica article in 1925; but the presuppositions of the theory are
evident in many Treasury memoranda of the 1920s" (Howson and Winch,
1977, p. 27). Hawtrey gave his own view of the matter in a taped interview
with Cairncross, saying that he believed Keynes called this position the
Treasury View because it was his (Hawtrey's) view and that Treasury
officials, as such, had no view on the issues at all (Hawtrey Collection,
Churchill College Archives).
Howson argues that Hawtrey was not challenged by the persistent
unemployment of the 1920s to offer new theoretical explanations because
his monetary analysis already provided an explanation in terms of the
misconduct of monetary policy. His opposition to public works programs
followed from his analysis "since his macroeconomic theory, like any
'monetary' theory, implied that public works were useless in reducing
aggregate unemployment if unsupported by credit creation and redundant
otherwise" (Howson, 1985, p. 166). If monetary policy were conducted
correctly, the problem of unemployment would not arise. Although Haw-
trey saw monetary economies as unstable, only monetary hitches could
generate persistent unemployment. At one point he offered a breath-
taking testimony to Say's Law as (at least potentially) the way the world
could work: "Nature abhors unemployment as she abhors a vacuum. Every
producer is a purchaser; supply is itself demand; nothing but a shortage of
the means of payment can prevent the unemployed from entering into
economic activity as fast as organization can sort them out" (Hawtrey,
1926a, p. 161). In the post-General Theory literature of the 1940s at

least two important American Keynesians, Klein and Metzler, identified
Hawtrey's economics with acceptance of Say's Law while Samuelson
advised "young economists who disbelieve in the novelty of Keynesian
analysis, on the ground that no sensible person could ever have thought
differently might with profit read Hawtrey's testimony before the Mac-
millan committee" (Klein, 1947, pp. 45-46; Metzler, 1947a, p. 441; and
Samuelson, 1946).
Hawtrey's main concerns related to the behavior of money and credit.
Before World War I, his first major public work dealt with the problem
of the trade cycle. After the war, he was concerned with the causes of
inflation, and with the return to the gold standard. Theory and observation
led him to conclude, in opposition to prevailing orthodoxy, that monetary
policy could not be left to an automatic regime such as the independent
gold standard but must be governed by conscious management.
Hawtrey's proposals for international monetary cooperation to stabilize
the value of gold and to create an international gold exchange standard
were adopted at the 1922 Genoa International Economic Conference. The
proposals were never implemented, but they had lasting importance in
the spread of economic cooperation. This episode marked the peak of
Hawtrey's influence on policy (Howson, 1985, pp. 154-157).
Hawtrey favored Britain's return to the gold standard provided the
route back to gold did not involve deflationary measures, leading to further
unemployment. After Britain had returned to gold in 1925 at the pre-war
parity, he criticized the high interest rate policy with which the exchange
rate was defended. He argued that the Bank of England should have taken
a more stimulative stance and that any loss of gold entailed by this policy
would have led to monetary expansion in the rest of the world. In part, this
advice rested on an exaggerated belief in the continuing power of Britain to
set the tone of world financial markets.
Hawtrey attributed the 1929 collapse to monetary policy miscalcula-
tions. In particular, overreaction by the American authorities to the stock
market speculation of the late 1920s and excessive absorption of gold by
the French, beginning in early 1929, compounded the damage done by
persistently deflationary monetary policy in Britain. Mter the collapse,
recovery was obstructed and the world economy sank into a "trade
deadlock" due to the failure of monetary authorities to lower interest rates
rapidly to a stimulative level. The persistence of recession, however, was a
challenge to Hawtrey's analysis which recognized few limits to the stimula-
tive power of low interest rates. A significant part of his work in the 1930s
was devoted to examining this anomaly.
After World War II, Hawtrey continued to proclaim the importance of

monetary policy. He was critical of the Bretton Woods regime of interna-
tional financial cooperation for failing to provide an anchor for the "wealth
value of money." Following the devaluation of the British pound to $2.80
(U.S.) in 1949, he campaigned vigorously on the theme that the currency
was undervalued, resulting in overemployment and inflation. Davis argues
that Hawtrey's post-war views stand up well and that-at least as it stood
in the early 1980s-economic opinion would have given Hawtrey's recom-
mendations more support than did his colleagues in the 1940s and 1950s
(Davis, 1981, pp. 223-225).
5. Hawtrey, Keynes, and the Multiplier
The extent of his influence on Keynes is a major issue in much of the

historical literature on Hawtrey. His careful criticisms of the Treatise con-
tributed to Keynes' decision to replace it with a new analysis. In his assess-
ment of Hawtrey's criticisms, Patinkin emphasized Hawtrey's account
of the tautological savings-investment relation and of Keynes' failure to
incorporate output movements that are not caused by price movements.
His comments suggest that these were an important force inducing Keynes
to transfer attention to the set of problems that underlie the General
Theory: "the received version of the transition ... assigns too large a role to
the discussions of the Cambridge 'Circus', and correspondingly too small a
one to the criticisms of such individuals as Hawtrey, Robertson, and even
Hayek" (Patinkin, 1978, p. 6).
E. G. Davis has argued that Hawtrey was, in certain important respects,
a forerunner of the Keynesian Revolution and that his criticisms of the
Treatise "pointed to the direction in which Keynes began to move ... "
(Davis, 1980, p. 721). In Hawtrey's analysis, quantities adjust to shocks
before prices. Hawtrey also treated savings as a function to income (in
most instances in his writings, primarily as a function of profits). These two
ideas, absent from the Treatise, were prominent in the General Theory and
in later Keynesian models.
Davis also shows that in his Macmillan Committee working paper on the
Treatise, Hawtrey worked out a numerical example that embodied an
implicit multiplier analysis. His case for placing Hawtrey closer to center
stage in the influences on the development of Keynes' ideas is strong. To
put it in perspective, however, other events at the time must be considered.
Kahn began the work that culminated in his multiplier article in the
summer of 1930, and an early version was circulated to the Economic
Advisory Council (Howson and Winch, 1977, pp. 48-49). Hawtrey's

memorandum was dated January 1931. Keynes would have been familiar
with the multiplier concept before seeing Hawtrey's paper and, in terms of
probable influence, there were few to whom Keynes was more attuned at
that time than Kahn. On the other hand, Cain has emphasized that the
leakages from the spending stream that determined the value of Kahn's
multiplier consisted of import spending, reduced government expenditure,
and to a lesser extent unspent profits. The path from Kahn's initial
multiplier to the consumption function was obscured by a thick underbrush
of side issues and, as Cain points out, the Danish economist Jens Warming
(who published an article on the multiplier in the 1932 Economic Journal)
may have played a greater part in the story than has been acknowledged
(Cain, 1979).
Cain has also pointed to Hawtrey's work on economic models where
quantity variation is an equilibrating factor and to his analysis of the
equilibration of trade balances through a multiplier-like process as
instances where he presaged subsequent Keynesian work. Most of his
evidence is drawn from the 1928 edition of Currency and Credit (Cain,
1981). This seems to confirm independently that a pre-Kahn multiplier can
be found in Hawtrey's work. However, while subsequent researchers may
be able to "find" the multiplier in Hawtrey's text, it is unlikely that
Hawtrey ever spotted it.
The passage cited by Davis was excluded from the final printed version
in The Art of Central Banking. However, Hawtrey provided an equivalent
"algebraic analysis" in which he argued that "consumption will not be
independent of the consumers' income" and "we may assume for purposes
of illustration that the reduction of income is divided in a fixed proportion
(k: 1 - k) between consumption and investment." He then demonstrated
that "the condition of provisional equilibrium" is that the change in the
value of available output be equal to b'/(1 - k), where b' is an initial
autonomous reduction of consumer expenditure. This was not, however, a
"fix price" analysis (though, of course, it could be) since "it says nothing
as to how much of the adjustment is to come from the reduction of
output ... and how much from the fall of the price level" (Hawtrey, 1932,
pp. 351-352).
Hawtrey worked through these examples for the purpose of examining
Keynes' concepts. He relegated it to a secondary place in his own analysis
of the determination of aggregate income and did not incorporate it
into his central message because "the increased margin of incomes over
consumption expenditure (investment or, in ordinary language, savings)
would tend to encourage capital ouday" (Hawtrey, 1932, p. 352). Hawtrey
80 NEOCLASSICAL ECONOMIC rnEORY
arrived at the multiplier, without being aware that he had done something
special as a result of working out the consequences of given assumptions,
and did not bother to give special prominence to this exercise. Signifi-
cantly, Hawtrey did not lay claim to the multiplier (as he did in the case
of the accelerator) though he had many opportunities to do so in the course
of his subsequent responses to the General Theory. Hawtrey's multiplier
may be a further instance of "everything of importance" being "said
before by someone who did not discover it" (Whitehead, 1917, p. 127).
It is significant that Keynes passed Hawtrey's memorandum on to Kahn
for comments at the time when Kahn was writing the multiplier article,
begun in the preceding summer. Kahn did not recognize a "multiplier" in
Hawtrey's argument. That may be due to the limited direct resemblance
between Kahn's employment multiplier and Hawtrey's implicit income
multiplier.
Davis cites Keynes' post-General Theory letter to Harrod in which he
stressed the importance of arriving at the theory of effective demand for his
own progress. Keynes explained that a key step in his development was
uncovering "the psychological law that, when income increases, the gap
between income and consumption will increase" (Keynes, 1973, 85). But
this should be contrasted with Hawtrey's position, cited above, that the
excess of incomes over consumption will tend to encourage capital out-
lay. Hawtrey's formulation was not intended to lead to a theory of the
"demand for output as a whole."
Much ()f the most interesting debate between Hawtrey and Keynes dealt
with empirical issues. (The exchanges concerned with primarily theoretical
concerns is often heavy going through painful efforts to translate from one
set of definitions to another.) Hicks wrote of the "great debate" that
divided British economists into "Hawtreyeans and Keynesians": the issue
of the relative power of short- and long-term interest rates. He reviewed
this debate in his 1969 article on Hawtrey, concluding that each'fefuted the
other's interest rate mechanisms "and the way was cleared for the Age of
Fiscal Policy" (Hicks, 1977, p. 123).
6. Robertson, Hawtrey, and Monetarism
In apparent antithesis to the interpretive literature that proclaims Robert-

son and Hawtrey among the avant garde of Keynesian economics, argu-
ments have been advanced that place them among the forerunners of
monetarism. In an important sense, they did playa part in the origins of
monetarism. In the post-General Theory world, while a new economic
orthodoxy was dismissing monetary policy and interest rates as unimpor-

tant, both Hawtrey and Robertson, from their distinct vantage points,
persisted in a torrent of warnings that "money mattered" and that a policy
of permanent easy money contained within it a fatal inflationary flaw.
What influence their arguments had on the work of the monetarist counter-
revolutionaries is uncertain. The literature dealing with the issue has
attempted to define the degree of congruence between the theoretical and
policy views of Robertson and Hawtrey and those of monetarism.
Presley has examined the relationship to monetarism of the "Cambridge
School" (in which he includes Marshall, Pigou, Lavington, pre-General
Theory Keynes as well as Robertson and Hawtrey) (Presley, 1986). He
concluded that Cambridge monetary analysis shared a theoretical founda-
tion with monetarism particularly with respect to the demand for money
and the transmission mechanism. The factors considered in explaining the
demand for money correspond closely with those specified by Friedman.
The Cambridge School's transmission mechanism, whereby changes in the
quantity of money affect economic behavior, recognized many channels of
portfolio adjustment, rather than being confined to its influence through
changes in the rate of interest. Presley's position can be contrasted with
Patinkin's view that Friedman did not reformulate the classical quantity
theory but presented "a continuation of the Keynesian theory of liquidity
preference" (Patinkin, 1981, p. 242).
The Cambridge school did not present a united stance on issues of
economic policy, and Presley writes that Hawtrey and Robertson represent
the two extreme views within the group. Robertson, he argues, "at times
was the nearest, and at other times the farthest, from monetarism in policy
issues" (Presley, 1986, p. 206). Robertson dismissed the usefulness of
monetary stimulus in the depression conditions of the 1930s, arguing
instead for fiscal stimulus in the form of public works. To prevent inflation,
on the other hand, he advocated the implementation of strict monetary
control.
Wilson identifies Robertson's position as being intermediate between
Keynesianism and monetarism, describing Robertson as a "non-Wal-
rasian monetarist" because he would have rejected the core monetarist
principles of smooth market clearing and inherent general equilibrium
stability. In addition, Robertson did not believe that velocity is likely to be
stable. As Wilson points out, howcver, this does not imply that a stable
demand for money function cannot be identified. Robertson was in accord
with monetarism in his emphasis on the importance of maintaining control
of the money supply as demonstrated by his ongoing criticism of Keynesian
easy money policies as practiced in the United Kingdom following World
War II. In company with the monetarists, though for different reasons,
Robertson was skeptical about the feasibility of using discretionary monet-
ary policy to stabilize the economy (Wilson, 1980).
When he wrote that "the trade cycle was a purely monetary phe-
nomenon," Hawtrey bequeathed monetarism with half a slogan. Mog-
gridge and Howson describe Hawtrey as "the only monetarist" among the
Cambridge school before the First World War (Moggridge and Howson,
1974). While large parts of his analysis can be reconciled with monetar-
ism-for example, the long-run neutrality of money-other key elements
were nonmonetarist. He viewed the credit system as "inherently unstable"
and believed policy must be actively employed to prevent it from running
itself and the real economy off the rails. Hawtrey, in Presley's view, never
budged from the Treasury View that fiscal policy was useless and that
monetary control, through Bank rate, could be employed to steer the
economy. His account does not give due recognition to Hawtrey's grudging
acceptance of fiscal stimulus, preferably in the form of tax cuts, in the 1930s
as a response to a "credit deadlock" (Presley, 1985).
It is interesting to note that Hawtrey was not particularly impressed with
Friedman's restatement of the quantity theory. Referring to the demand
for money function, he wrote: "There is no advantage either of clarity or
precision in the mathematical approach. And it is apt to involve an artificial
simplification of the terms employed" (HTRY, 7-4) His misgivings der-
ived from an aversion to the use of mathematics in economics despite (or
because of) his academic background being in mathematics rather than in
economics. These concerns were shared to a large extent by Robertson and
Keynes. Once past the surface differences, however, Hawtrey's interpreta-
tion of the quantity theory resembled Friedman's. In the final fourth
edition of Currency and Credit, he rewrote the discussion of the quantity
theory "with the purpose of bringing out its very real significance as a
particular case of a demand function" (Hawtrey, 1950, p. vi).
7. Hawtrey-Robertson Debates
Hawtrey and Robertson were the leading British exponents of rival monet-
ary and real explanations of macroeconomic events in their time. They
debated the issues that divided them, in print and in personal correspond-
ence, throughout the better part of their working lives. I have reviewed this
debate in detail elsewhere (Deutscher, 1984, pp. 199-242). Two character-
istics of Robertson's early work brought him into conflict with Hawtrey's
monetary theory of the trade cycle. He began from the premise that
monetary phenomena were of secondary importance and that cycles were

"deeply embedded" in the structure of the capital-using economy. Second,
he stressed the importance of statistical investigations. Hawtrey's "obses-
sion with monetary phenomena" led him to ignore the "recurrent tendency
of the business community to ... over-investment ... the dominant charac-
teristic of modern fluctuations." In addition, "Mr. Hawtrey's work is
innocent of an appeal to facts.... If he had studied the figures of
production and consumption ... it might have been borne in upon him that
purely monetary influences are after all of secondary importance" (Robert-
son, 1913, p. 163).
By the early 1920s, Robertson began to accord greater attention to
monetary factors, though he maintained his belief in the primacy of real
forces. Along with this transition, he raised his opinion of Hawtrey's work.
Monetary Reconstruction was "a brilliant book, deeply intellectual in
design and distinguished in execution." He praised Hawtrey's analysis of
recent events and expressed broad sympathy with the prospects for monet-
ary reform and international cooperation along Hawtreyean line. Of
course, he maintained crucial differences of opinion with Hawtrey: he
doubted the potency of Bank rate policy, particularly as a means of
stimulating revival; he continued to urge that attention be paid to non-
monetary forces; and he suggested that interest rate policy should be
supplemented by credit rationing in the allocation of loans "between
different industries" (Robertson, 1923, pp. 166-167). Robertson's text-
book Money also revealed new similarities and old differences with
Hawtrey. One strong affinity was in the analysis of the "inherent tendency
of a modern banking-system" to excessive credit creation; this resembled
Hawtrey's "vicious circle" analysis of the "inherent instability of credit"
(Robertson, 1922, p. 93).
Hawtrey dismissed Robertson's new path in Banking Policy and the
Price Level. He saw this as an attack on his own advocacy of price stabiliza-
tion as the goal of monetary policy. He mocked the nonmonetary micro-
economic model with which Robertson analyzed decision making, rejected
the forced saving doctrine, and dismissed the use of banking policy to ease
the transition between different equilibrium levels of output. He argued
that banks could not have sufficient knowledge of the forces causing such
changes or of their consequences. He seized on Robertson's assumption of
automatic market-clearing price adjustment because it neglected the role
of inventories (Hawtrey, 1926b, pp. 417-433).
The rift that occurred between Robertson and Keynes over the Treatise
on Money was accompanied by side-debates between Hawtrey and Robert-
son. Robertson wrote that "Hawtrey was the first to show" him that saving
in the Treatise was not a "causal factor" but "simply a quantitative measure
of result" (Robertson, 1933, p. 709). The dispute between Hawtrey and
Robertson was concerned to a large extent with their mutual dissatisfaction
with each other's analytical techniques and language, along with old argu-
ments about the role of stocks and the potency of interest rates. They also
revealed the differences in their attitudes toward price theory, with
Robertson writing, "Perhaps I am unduly in thrall to the pure theory of
competitive value, according to which an individual producer's output
depends upon his cost function and the prevailing price: if neither of these
alters, nor can his output. Does your account entail some theory of market
imperfection?" (Robertson to Hawtrey, 2/11/34). Hawtrey responded that
his theory was "quite applicable to a perfect market, (though I dare say the
greater part of it would be superfluous in any such application) .... I hope
you will emancipate yourself completely from thralldom to the pure theory
of competitive value" (Hawtrey to Robertson, 10/11/34).
Robertson responded warmly to Capital and Employment: "As regards
the major point of judgement, I think I am (as usual) somewhere in the
middle between you and Keynes, Harrod & Co." While he continued to
question the importance of Hawtrey's "particular train of causation," he
concluded that "over a large part of the field of analysis, I am glad to walk
hand in hand with you, avoiding the various Bedlams that have opened up
to left and right, -though with a feeling that you have not yet provided (as
perhaps these Swedes have) a complete substitute for my own particular
Bedlam" (Robertson to Hawtrey, 31/3/37). A lively debate over the major
issues in Capital and Employment ensued.
Exchanges over economic policy and theory continued after the Second
World War. Significantly, a large part of their later correspondence was
devoted to making sense of what Keynes had really meant.
8. Conclusion
Over their long and productive careers, Hawtrey and Robertson each
maintained a personal loyalty to their early insights. Robertson's work,
however, changed and developed more over time. In part, this was a
matter of starting points. Robertson began by acknowledging a diverse
catalogue of factors that could affect macroeconomic developments. Haw-
trey, from the start, concentrated on monetary phenomena as being of
overriding importance. Thus, Robertson was able to maintain personal
consistency over time while altering the weight that he accorded to
different factors in his analysis, empirical investigations, and policy pre-
scriptions. That Robertson's analysis evolved more than did Hawtrey's

may also be partly due to Robertson's more continuous contact with the
stimulus and pressure of academic debate and to his greater attachment to
formal economic reasoning. Hawtrey had little patience with abstract
models. He considered the simplifications of his own analysis justified
because he believed the excluded factors were, in reality, unimportant.
This stance may have deprived him of an analytical advantage while
introducing unhelpful noise into his communication with other economists.
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Commentary by Thomas Wilson
In their respective studies of the business cycle, both Hawtrey and Robert-
son devoted much attention to the rate of interest. Both would therefore
appear to be open to criticism on the ground that "the rate of interest is not
a very important variable in the modem world"-to repeat Deutscher's
quotation from Klein. Is such criticism really valid? If so, the inference
would appear to be that a substantial proportion of macroeconomic
analysis has been of little practical relevance. This question is, therefore, a
basic one that raises some central issues, analytical as well as empirical,
and will serve to introduce what must, of necessity, be a selective commen-
tary on Deutscher's wide-ranging and very interesting review of the work
of Robertson and Hawtrey.
Skepticism about the importance of the rate of interest was largely
based on the experience of a long period of cheap money. Whether it was a
fair interpretation of that period may be disputed, but that need not
concern us here. For few economists would express such skepticism in the
latter part of the century, and it may now be simply tempting to dismiss it,
without further comment, as an example of rash empirical generalization.
But there are two reasons why more needs to be said.
First, the restoration of the rate of interest to a position of importance
among the variables does not in itself remove the doubt so widely felt
about Hawtrey's insistence on the key role played by fluctuations in
merchants' stocks in response to changes in short-term interest rates. I do
not think Hawtrey won many converts to this point of view. Admittedly the
importance of short-term rates will be seen to be larger when account is
also taken ofthe interest-cost of work-in-process. Moreover, Hawtrey laid
strong emphasis on the cumulative character of expansion and contraction,
and he was therefore using a model with high (implicit) coefficients that
88
could be set in motion by a small disturbance. Nevertheless the importance

that could be attached to interest rates is clearly reduced in his work by his
refusal to concede a disequilibrating role to the long-term rate and his
failure to perceive the link between short and long rates.
The second reason for referring again to this earlier skepticism about
interest rates is analytical rather than empirical. As applied to Robertson's
work, and to the work of Keynes himself, it betrayed what can only be
described as a basic misunderstanding. Although Robertson stoutly main-
tained that changes in "productivity" and "thrift" would have some effect
on the rate of interest, that effect would be insufficient to ensure that
voluntary or ex ante saving and investment would be equal at a given level
and given distribution of income. His theory rested-as Wicksell's had
done-not on the assumption that the actual variations in the rate of
interest (long or short) were of great quantitative importance but rather
that these variations were too small to preserve stability in total monetary
outlay. To a still greater extent, this was true of Keynes's own attitude. The
purpose of both the loanable funds theory and the liquidity preference
theory was to explain why the rate of interest did not vary enough to be an
effective stabilizer.
Hawtrey held that excessive instability in the rate of interest led to
instability in monetary expenditure. Robertson stressed the instability of
the rate of return on capital that required larger fluctuations in the rate of
interest if fluctuations in total expenditure were to be avoided. Here, then,
was one of the basic differences between our two authors.
Although Robertson used the old expression "natural rate of interest,"
He was well aware that there would be a different natural rate for differ-
ent levels of income and expenditure. There might have been less mis-
understanding if some different expression had been used, such as "the
expenditure-stabilizing rate of interest." The purpose of his analysis was to
show what would be required if fluctuations were to be avoided, but he did
not claim that such stability could, in fact, be achieved, or was even
desirable. Even if the money supply were controlled, changes in velocity
would constitute a largely unpredictable and uncontrollable variable,
Moreover, complete stability in expenditure-or in its rate of growth-
was not desirable. The trade cycle was part of the price of progress,
although its amplitude could be and should be reduced. After the Second
World War, he objected to a policy of cheap money, made possible by an
indefinitely elastic money supply, at a time when there was an intense
demand for funds. For this was a situation where monetary policy was
needlessly making matters worse.
It may be recalled that in his earlier work, he had offered an explanation
of instability in a nonmonetary economy where variations in the reward for

effort, caused by changes in technical possibilities, would cause changes in
output. By the 1930s, however, this explanation had dropped out of sight,
and the emphasis was rather on market and natural rates of return and
the various factors that determine them. Structural difficulties could also,
of course, be important.
Liquidity preference can be easily fitted into the loanable funds theory
and need not be regarded as a rival theory. The more extreme claims made
for liquidity preference can then be regarded as a special case where the
demand for liquid funds-Keynes' M2 balances -is perfectly elastic. In
specifying this special case, it is also necessary to assume that, even if M is
constant, any rise in investment demand can be met by switching from M2
to Ml, for it will be recalled that the income velocity of M1 is assumed to
be constant. The size of these M2 balances relatively to the demand for
active funds will then determine whether, given the amount of money, a
rise in investment will raise the rate of interest. Keynes' critics, including
Robertson, never denied the importance of liquidity preference, although
they often used a different terminology. Nor would there have been the
same kind of controversy if Keynes, instead of saying that the rate of
interest is determined by liquidity preference and the amount of money,
had simply claimed that, in practice, these are most important deter-
minants. For the issue would then have been empirical. But it was a differ-
ent matter to assert that, as a matter of principle, savings and investment
could have no effect at all.
In this particular context, it was Robertson, not Keynes, who was pre-
senting a general theory. In this general theory, changes in velocity were
included and could be caused both by switches between active and in active
balances and by changes in the turnover of the active balances themselves.
But the loanable funds theory also provided scope for changes in produc-
tivity and thrift. It was in attempting to explain-though in a different
terminology-the factors that may cause large changes in velocity that
Keynes, for his part, was making a contribution. His own explanation was
inadequate, but it stimulated others-initially Hicks and Kalecki-to
carry the carry the analysis further.
Robertson did not overlook the fact that savings, in real terms, would
change with real income. But a cyclical rise in real income could occur
only if there was a rise in monetary expenditure-unless unit costs were
changing anti-cyclically. That expenditure had to be financed somehow.
The assumption of a perfectly elastic supply of funds that underlies the
multiplier is not explained in that theory-nor even, one suspects, is
it always detected. Deutscher's review of the modern literature suggests
that the old Keynesian misunderstandings have not, even now, been
fully dispelled.
Robertson believed that, up to a point, instability was the price of
progress. Or, in more recent jargon, growth would be "unbalanced." But
he strongly deplored the secondary responses to changes in investment that
could lead to "a purposeless and obscene orgy of destruction." It would
therefore have been reasonable to expect him to be particularly interested
in models showing the possible interaction of multiplier and accelerator.
He did, in fact, accord a good deal of importance to the latter but little
to the former. It is true that the multiplier no longer occupies quite so
prominent a place in Keynesian macroeconomics as that once accorded to
it, but the explanation is a fuller recognition of the importance of leakages
in an open economy and in one with a high marginal net tax rate.
Robertson's skepticism could not, however, be adequately explained in
this way and was carried too far. In part this skepticism was an understand-
able response to the absurdity of the "instantaneous multiplier" -which
might be uncharitably described as an unsuccesful attempt to cover up the
confusion between the ex ante and ex post concepts. But Robertson's own
period analysis, or some variant of it, was ready to hand for a more
satisfactory approach, as Deutscher observes. His other reason for skeptic-
ism was his doubt about the assumption of a constant marginal propensity
to consume, unaffected by the cyclical changes in income distribution on
which he, himself, laid stress. Indeed changes in investment could be
matched, after a lag, by changes in savings that reflected not only a change
in income but also a change in the share of income going to profits. These
short-term distributional changes help to bring about a cyclical fall in the
propensity to consume, but it would clearly be rash to assume that this
propensity would decline over the trend when the profit share would
depend on other factors and might not increase. Keynes' mistake in this
context was one of the several errors on which his stagnation thesis was
based.
Hawtrey's interpretation of the cumulative process of expansion or
contraction included the role of the "Hawtrey multiplier." In a very
interesting passage, Deutscher refers to recent work on this topic by both
Davis and Cain. But that multiplier is not so fully a stabilizer as is the
Keynesian multiplier because Hawtrey avoided the error of supposing that
savings were nothing more than an offset to investment. On the contrary, a
large part of the saving done during an expansion would be in the form of
undistributed profits which would provide an incentive to further invest-
ment. Much later, Kalecki made the same point and it was taken up by
Robertson himself, as Presley records. Although Robertson deserves full
credit, as Deutscher observes, for emphasizing the difficulties that arise

when acts of saving and investment are done by different people, he did
not overlook the important fact that, to a large extent, these are the acts of
the same people.
As Deutscher again rightly observes, both Hawtrey and Robertson "did
play a part in the origins of monetarism." This was so in the broad sense
that they criticized the post-war orthodoxy that dismissed monetary policy
and interest rates as unimportant. This need not mean that their own
theories, or even their own policy recommendations, coincided at all
closely with monetarism in the modern sense as developed by Friedman
and his successors, or with the views of the later neoclassical school. It is
true that Hawtrey's skepticism about fiscal policy-though qualified a little
in the late 1930s in face of the "credit deadlock" -was consistent with the
monetarist attitude. Fiscal expansion would mean crowding out or, if that
were avoided by an accompanying increase in the money supply, this
monetary expansion itself would do the trick without adding the complica-
tion of fiscal policy. In a more fundamental way, his belief that the private
economy would be stable if not disturbed by faulty monetary policy was
consistent with monetarist claims. It is true that the monetarist/neoclassical
theory requires flexible market-clearing prices which seems, at first sight,
to conflict with Hawtrey's fixprice model. In fact the conflict may not be so
important because his fix price assumption related to the very short run as
goods were released from inventories during an upswing, and over a longer
period prices would change. There would, therefore, seem to be a good
deal of similarity between Hawtrey's views and those of the monetarist
school. In approach and temperament, however, he was very different.
He was unconvinced about the reliability of mathematical models, and
would probably have viewed with skepticism the claim that the right trend
rate of growth of the money supply could be determined or, if deter-
mined, maintained.
In the post-war years, Robertson was much concerned about inflation,
especially because it would no longer be possible to assume that falling
prices during a downswing would offset rising prices during an upswing. He
was also perturbed about inflationary developments in the labor market.
Moreover, as far back as Banking Policy and the Price Level, he had
developed a theory of real balances-with the approval of Keynes himself!
Nevertheless I believe he would have reacted against the more extreme
claims of the new school just as he had reacted, for different reasons,
against the more extreme Keynesian claims. I have given my reasons
elsewhere (Wilson, 1984), and will confine my comments here to two of the
central issues.
First, Robertson would clearly not have accepted the view that a steady
rate of growth of expenditure could be ensured by maintaining a steady
rate of growth of the money supply, for he laid much stress on the
importance of variations in the velocity of circulation. Admittedly the
monetarist school has conceded that velocity may fluctuate in the short run
and, furthermore, may change in the long run as institutional changes take
place. I suspect that Robertson would have derived some amusement from
teasing monetarists about the precise identification of the crucial inter-
mediate period that is neither short run nor long run.
Second, there is the conflict between Robertson's view that the private
economy is inherently unstable and the monetarist claim that it is inherent-
ly stable. It must be recognized, however, that the later claim does not, or
need not, rest on a rejection of Robertson's view that the inducement to
invest is liable to fluctuate, although monetarists have had little to say on
that subject. The central monetarist proposition is that changes of this kind
will not lead to general instability provided that the money supply con-
tinues to rise at its trend late and at no more than that rate. Even the
shocks caused by the oil crises of the 1970s could have been viewed with
some composure if a monetarist policy had been followed. For higher
prices in one sector would simply be offset by lower prices elsewhere. Oil
would be dearer but other things would be cheaper! Behind this bold
asertion lies the crucial assumption that prices are flexible and markets
clear. But Robertson, for his part, did not make that assumption. As we
have seen, the market for investible funds could be prevented from
clearing, in a sense consistent with equilibrium, by changes in the velocity
of circulation. In his later work, he was deeply concerned by the rigidities
in the labor market. He was also to adopt the view that the prices of goods
were often fixed by the sellers, although he did not fall into the usual trap
of supposing that price competition was therefore excluded. Monetarists
have, of course, been prepared to recognize that markets clear only
imperfectly and, as a result, the variations in investment demand of the
kind Robertson envisaged could also cause structural problems. But the
monetarist response would then be that the "natural rate of unemploy-
ment" had simply been altered and that the new level would be reached
after a short interval. The theory would remain intact and the economy
would be in equilibrium! I find it impossible to believe that Robertson, for
his part, would have been much impressed by reasoning of that kind. There
is the obvious danger that the monetary clamp would impede the upsurge
of investment which he believed to be a characteristic feature of econo-
mic development; for other prices would not obligingly subside and thus
release the monetary expenditure required. In the opposite circumstances
there might be deflation, and he was never indifferent to higher unemploy-

ment whether the cause was general deflation or structural adjustment. To
bundle all these complications together and then to label them casually as a
mere change in the natural rate is to evade issues which for Robertson, as
well as for Keynes, were always of central importance in economic policy.
References
Wilson, Thomas. 1980. "Robertson, Money and Monetarism." Journal of Econo-
mic Literature, 17(4; December); reprinted in Inflation, Unemployment and the
Market, Oxford University Press, 1984.
4 THE LAUSANNE TRADITION:
WALRAS AND PARETO
Claude Menard
Any discussion of the Lausanne tradition involves at least three major

questions. Is there such a thing as the Lausanne school? Can we speak of a
tradition? How do we delineate the interpretive literature?
That there is a school in the history of economic thought that would
have bloomed in Lausanne at the end of the nineteenth century is a very
seriously challenged interpretation. Though the expression is now com-
monly used, it is somehow difficult to talk of a school of only two men: one,
namely Walras, who felt so isolated that he went on from depression to
depression, his only hope being that posterity would be more generous
to him than his contemporaries were; the other, Pareto, progressively
acquired the conviction that there were too many dead ends in econo-
mics, and shifted to sociology and politics. On the other hand, their joint
impact on contemporary economic thought is of such magnitude that it
is worth reexamining more carefully what happened at the end of the last
century in Lausanne to generate such a transformation in our discipline.
But if this is so, can we legitimately speak of a tradition? The word
tradition may sound quite inappropriate to mathematical economists who
The author would like to thank 1. Backhaus, 1. S. Chipman, B. Guerrien, R. Hebert, W.

Samuels, and D. Walker for their help.
95
are still devoting most of their time to solving the major problems involved
in, and raised by, the Walrasian model. For them, what we are talking
about is the hard core of modern economics, and not an event that could be
described as historically closed and self-perpetuating. At the opposite end
of the spectrum there are also economists, though probably far fewer today
than 30 years ago, who argue that we can hardly identify a Lausanne
tradition per se, as distinct from, say, the classical paradigm, since what
was elaborated by Walras and Pareto was "a framework for organizing our
ideas," without any substantive content" (Friedman, 1955). At best we
could speak of a remodeling, barely of a revolution that would have
instigated a distinctive tradition.
Notwithstanding this opposition, if one looks at any textbook for
advanced students in microeconomics, one can hardly deny the major
importance of Walras and Pareto in modern analysis. But here is the
source of a new difficulty: writing on these authors today is almost never a
pure exercise in the field of the history of economic thought, or just
interpreting what Walras actually meant, let us say, when he introduced
the notion of entrepreneur. Almost each "historical" interpretation is the
source of, or interfers with, a theoretical debate within economic theory
today. It is therefore impossible most of the time to delineate interpre-
tive literature so as to isolate it from major advances in contemporary
economics.
What all these problems mean is that the Lausanne tradition is alive and
kicking, and accounts for a substantial part of our daily life as economists.
It also signifies that it will be impossible, in one single chapter, to review all
the reintrepretations and debates related to the reading of Walras and
Pareto. Our program is much less ambitious. Its aim is to identify some
major issues that were raised in the interpretive literature properly speak-
ing, as well as in some theoretical debates, so as to give a broad and general
picture of the importance of the Lausanne tradition for us today. We will
do so in three sections. The first part of the chapter has a more historical
nature and is focused on the Lausanne revolution. The second section is
devoted to the major theoretical contributions of Walras and Pareto as
they can be reevaluated almost one century later. In the third and final
part, we shall try to evaluate some controversial arguments on the empiri-
cal relevance and the normative biases of that tradition.
1. The Lausanne Revolution: What Really Did Happen?
Although Walras and Pareto are now jointly recognized as cofounders of

the so-called Lausanne school, there are several prerequisites necessary to
THE LAUSANNE TRADITION 97
the existence of a transformation radical enough to create a new tradition.

There must at least be: (1) a unifying approach, conceptually as well as
methodologically; (2) a group of followers who will establish and diffuse
the paradigm as a referential scheme in the scientific community; (3) a
clear differentiation from what already existed in economic thought.
Thanks to the pioneering works of Schumpeter, Bousquet, and Jaffe, we
are now in possession of much more information to enable a careful
examination of these questions; but there are also several problems still to
be clarified.
1.1. To Be or Not To Be . .. A School
As far as biographies of Walras and Pareto are concerned, there is not

much to be expected from further investigations. We are now in possession
of quite extensive information, a significant part of which was not available
to Schumpeter when he wrote his History of Economic Analysis some 40
years ago. Indeed, Schumpeter should be credited for having fully recog-
nized Walras as a major economist as early as 1910, and for having
identified the general equilibrium model as his achievement. This evalua-
tion developed over the years and culminated in 1954, when Walras was
qualified as "the greatest of all economists." One must add that Schumpe-
ter's judgment was much more balanced, if not suspect, as far as Pareto
was concerned (Schumpeter, 1949). This may be the first clear sign (with
the possible exception of Hicks, 1934,) of a differentiation between Walras
and Pareto that has been increasing over time.
One explanation of this may be found in the indisputable priority of
Walras, whose Elements of Pure Economics were published almost 30
years before Pareto's Manual. Thanks to Jaffe's seminal works, we now
have a quite clear picture of what Walras' motivations were, why he shifted
from literature in the late 1850s to social economics in the 1860s and finally
to pure economics in the 1870s (see particularly Jaffe, 1965, 1968, 1977a).
Dumez (1985) also explored carefully, through the correspondence edited
by Jaffe (1965), and through archives in Lausanne and Lyon, how Walras
finally obtained a nomination in Lausanne, with the help and support of
several Swiss radical politicians, among whom Ruchonnet was a dominant
figure; and how he failed in his efforts to come back to France as a faculty.
As for Pareto, the major sources are Schumpeter (1949, 1954), who had
already given several indications on how Pareto, whose activity was a
mixture of bureaucracy and business, had left a career as a successful
engineer to engage in prolific activity as an intellectual after 1893. Bous-
quet (1960) contributed significantly to our knowledge of Pareto, particu-
larly for the part of his life devoted to economics, where he developed the
core of the Walrasian model, and thereafter to his project of a general
sociology that he tried to implement from the early 1900s to the end of his
life, a sociology in which economics would be a nondominant com-
ponent (Busino, 1968; Wolff, 1981).
There is also another aspect of importance both for the understanding of
Walras' and Pareto's respective research programs, and for the explanation
of some differences in their evaluation by interpretive literature: their
politics. We will go into this further in our third part, but it is worth
mentioning here the emphasis that Walras always put on his socialism
(Peguy, 1897), while Pareto evolved from an elitist position to an anti-
parliamentary and a pro-fascist one. Walras' socialism has been analyzed
by Jaffe (see particularly 1971, and 1977b; and Zylberberg, 1987b). It was
intended to be scientific-that is, rooted in pure economics-and demo-
cratic. On the other hand, Pareto progressively developed an analysis of
the advantages of governance by an elite, which went as far as an explicit
support of the newly born fascist regime in 1922. This is well known by all
his biographers though almost always eluded, which is particularly surpris-
ing for someone like Bousquet who was sympathetic to Pareto's position.
There is still a lot of work to be done to understand the paradox that
Samuels (1974, 1981) grasped, of free-marketers and free-traders who can
be favorable to an authoritarian and centralized regime. And, clearly,
people like Hicks or Samuelson, who were to be so influential in the
diffusion of the general eqUilibrium model in the late thirties and the early
forties, felt very uncomfortable with the position adopted by Pareto, and
much more at ease with that of Walras (see Menard, 1985).
This may also have had some importance for the immediate followers of
the two authors, and for understanding their difficulties in diffusing the
ideas of the founding fathers. Though both, and particularly Walras, felt
quite isolated in their time, we now have many more precise indications on
their influence up to, say, the Hicks-Samuelson contributions. This direct
influence is distinctly geographical: mostly in France for Walras, mostly in
Italy for Pareto.
As for Wairas, a recent and careful study by Zylberberg (1987b, 1988)
shows that he directly influenced some brilliant French economists and
mathematicians. Aupetit, Laurent, and Rist understood quite clearly the
new research program, and the first two contributed to its development.
But Walras' theoretical ideas also found an echo through their extension to
politics: Antonelli in Paris and Bouvier in Lyon were attracted by the
democratic socialism of the Lausanne master and regarded the general
equilibrium model as its scientific foundation. On the other hand, several
TIlE LAUSANNE TRADITION 99
economic engineers (Cheysson, for example), who should have had

a better understanding of Walras because of their mathematical training
did not care much for the new ideas, either because they focused their
attention on more specific problems related to tariffs and so on. (Ekelund
and Hebert, 1978), or because of their allergy to the socialist ideal claimed
by Walras (Dumez, 1985). The issues still have consequences today: in
France, Walras has never been fully identified to free marketers, as he has
been in the Anglo-Saxon world.
The reverse may have happened to Pareto. His compromise with fascism
was to have some major consequences since several of his direct fol-
lowers, particularly Amoroso, became very influential in Mussolini's
regime (Menard, 1985). It would be unfair to reduce the "Italian school"
(Schumpeter, 1949, 1954), issued from the Manuale, to that dimension.
Pareto's economic ideas also found their way among people from distinct
opinions: Einaudi or Gini, for example. But on the whole, at least until
Hicks (1939), it may be more the sociologist than the economist who
generated a group of adepts (Busino, 1968).
It is therefore more than questionable to talk of a Lausanne school, at
least before World War II. But at the same time it appears, with retrospec-
tion through the interpretive literature, that Walras' ideas found their way
progressively in France (Aupetit, Divisia), in England and the United
States (Marget, Hicks, Samuelson), and in the Germanic world (Schlesin-
ger, Cassel). These may have been the germ of a school that was to bloom
only after 1940.
1.2. Breakthrough or Continuity?
Another aspect of the same question-whether there was a Lausanne

school or not-has been raised in the interpretive literature after Kuhn's
book, The Structure of Scientific Revolution (1962). Is it appropriate to talk
of a marginalist revolution or, more precisely here, of a Walrasian-Paretian
revolution? As a matter of fact, the problem was already present in
Friedman's provocative paper of 1955, in which he argued that if the form
of Elements were innovative, the substance was all but new. This judgment
has been reasserted, in almost the same terms, by Hebert and Link
(1988).
We can identify three dimensions to this problem: What is the relation
between the general equilibrium model and the state of economics before
1870? Are there major differences between Walras and Pareto on the one
hand, and their contemporary fellows on the other? And is there some-
thing radically different in their global representation of what economics is

about and what its methodology is?
As for the first point, it is now clear that the Walrasian-Paretian system
of references and conceptualization was not based on the then standard
classic analysis, as synthetized by J. S. Mill, but on several authors who
were either underestimated or ignored by most economists of the late
nineteenth century. Jaffe (1977c) showed that Walras misinterpreted
Adam Smith, and through him the whole classical tradition, attributing
to the author of the Wealth of Nation a narrow conception of political
economy based on its Book IV, and interpreting his theory as a pure labor
theory of value. Schumpeter (1910), Pirou (1933), and Hicks (1934) had
already noticed that the birth of Walras' Elements was rather rooted in
Auguste Walras' theory of scarcity and its related analogies between
mechanics and economics, and in Coumot's methodology as well as the
conceptualization of pure competition and of how market forces operate.
These intellectual filiations have been clarified by Walras' Correspondence
(1965) as well as by Jaffe's articles (1972, 1976, 1977a). Thanks to Jaffe, we
also have a better understanding of the influence of Isnard (Jaffe, 1969)
and Gossen (Jaffe, 1977b).
Such an orthodox approach to the economic tradition and to the
previous economists may explain the necessity to de-homogeneize the
so-called marginalist revolution and to distinguish Walras clearly from
Jevons and Menger as well as from Marshall. As Walker (1970) has
convincingly argued, the founder of the Lausanne school (and, to a lesser
degree, his successor Pareto) can be differentiated from his contempor-
aries by three major characteristics: the way in which he considered
economics as a positivistic theoretical discipline; his belief in the use of
mathematics at the very core of the economic analysis; his opposition to
any reduction of economics to a policy of laissez faire. Therefore, it is not
surprising if the more knowledgeable reactions to Walras' and Pareto's
research program were among young economists open to a systematic use
of mathematics, so as to remodel economics as an exact science: Barone,
Bortkiewicz, Pantaleone, and Edgeworth should be mentioned here. This
may also help to understand the very unusual relation, for the standard of
their time, of our two authors to mathematicians and physicists. Jaffe
(1977a), Menard (1978), and Walker (1970, 1987c) have shown how the
general equilibrium model was born from the reading of both Coumot and
Poinsot, and how Walras obtained decisive help from his scientific col-
leagues in Lausanne, namely Piccard and Arnstein, in solving some major
problems, though his very limited skill in mathematics was a fundamental
handicap (see also Leduc, 1971; Jaffe, 1972, 1977d; and Dumez, 1985).
What Walras was looking for, in his relations with mathematicians, was
not only help but guarantee: he expected from them an a posteriori
legitimation to his program. This may be the reason why he was so
troubled by Bertrand's (1883) review of his book, in which the French
mathematician pointed out some major problems in the tatonnement model
and questioned the validity of the model as an explanation of economic
phenomena. And this may also clarify, in conjunction with his technical
weaknesses, why he could not understand all that was involved in Poin-
care's comments on the use of arbitrary functions in economics (Jaffe,
1977d; Ingrao and Israel, 1985).
More important, the very nature of the Walrasian-Paretian transforma-
tion of economics and how it has changed our representation of economic
phenomena is here involved. The necessity to abandon the idea of a
marginalist revolution, where Walras, Menger, Jevons, and Marshall
would be equal participants (Black et aI., 1973), and to obtain a better
understanding of what the Lausanne tradition means today, is rooted in the
analogy question. The Walrasian-Paretian approach to economics has
revolutionized our discipline through the systematization of analogies
between physics and economics, and through the borrowing of mathema-
tical methods that it authorized.
1.3. Economics As If ...
Although the existence of analogies between economics and physics has

been identified as a major factor in the building of the general equilibrium
model as early as 1910 (Schumpeter, 1910), the recognition oftheir role in
shaping modern economics, and of their consequences on our representa-
tion of economic phenomena, is much more recent (see Menard, 1981;
Mirowski, 1984; Ingrao and Israel, 1985).
The idea that economics should be developed as a mathematical sci-
ence, or more precisely as a "physico-mathematical science" as it is men-
tioned in the Preface of Elements (Walras, 1926), was rather unusual in the
early 1870s. It was suggested to Walras by his father, Auguste Walras
(Jaffe, 1956), but much more significantly by the spectacular breakthrough
of Coumot, in his Researches into the Mathematical Principles of the
Theory of Wealth (1838), as was shown in Menard (1978). Inspired by these
examples, Walras wanted to go a step further: he intended his Elements to
be strictly equivalent for economics to Lagrangian "rational mechanics."
This was not just an introductory statment. It really shaped the whole
structure and conceptualization of the Elements. Walras himself made it
clear in a paper that he published late on, after having worked on it over
several years (Walras, 1909). Economics has to be built in a similar way to
mechanics, with general equilibrium the equivalent of universal gravita-
tion, virtually interchangeable quantities to be compared to virtual velo-
cities, and so forth. And Pareto later on emphasized that point, arguing
that the analogy is founded on the unity of science, and that "there is no
difference of any kind between the laws of economics and sociology and
the laws of the other sciences" (Pareto, 1907).
Now there are several controversial issues involved in these pregnant
analogies at the core of the Lausanne approach. First, there is the question
of the appropriateness of a representation of economic phenomena traced
from mechanics. Menard (1981) showed how these analogies have stimu-
lated new research, but that they are misleading if they are not criticized
and transformed. Mirowski (1984) judged such an approach much more
severely, arguing that it introduces questions that are inadequate· to their
object (see also Ingrao and Israel, 1985). Paradoxically this was the point
of view of Cournot, who became more and more critical of the use of
physical analogies, and of mathematics, in economics (see his correspond-
ence with Walras, in Jaffe, 1965; also Menard, 1988); and Walras may have
been shaken by the argument since in 1909 he talked no more of economics
as a physico-mathematical science, as he did in 1873, but as a psychico-
mathematical one.
The second controversial issue concerns the use of mathematics in
economics and its role. Deliberately, Walras and Pareto introduced the
analogy with rational mechanics because it allowed them to borrow their
method from exact sciences. Comparing competition with a system of
forces in the neighborhood of an equilibrium associated economics with
the prestige of a well-established science; it also suggested a pattern for
borrowing tools of investigation from exact sciences. Here again we are
confronted with the appropriateness of such an operation, and of the
mathematics used. Friedman (1955), for example, argued that introducing
mathematics is helpful in that it allows us to avoid contradictory statements
and provides economists with a unified language; but it cannot change the
substance of economic theory that must be elaborated on its own.
Zylberberg (1987b) emphasized the idea that the systematic introduction
of mathematics in Walras' model gave us a uniformized and standardized
vocabulary, a thesis that had already been developed in Schumpeter's
obituary of 1910; but he disagrees with Friedman by pointing out that this
was to transform economics into a demonstrative science and transmissible
knowledge (see also Allais, 1964).
There is no doubt regarding the last aspect, which largely explains how
successful the Walrasian-Paretian approach has been since World War II.
As for the first aspect, it is an old controversial issue that may go back
as far as Marshall (1891). The question may be formulated as follows
(Menard, 1980): in conceiving economics as rational mechanics, e.g., as
predominantly deductive, did Walras give our discipline an orientation that
constituted an obstacle to the introduction of inductive analysis and
empirical studies? Is there a bias toward ideal-type concepts rather than
real-type concepts in modern economics that would be deeply rooted in
Walras' contribution (Friedman, 1955; Leontief, 1970)? In a stimulating
paper, Ingrao and Israel (1985) suggested that Walras, and even more
Pareto, were conscious of the difficulty. In 1911 Pareto explicitly men-
tioned two distinct problems to be taken into consideration in economics:
a mathematical one (how should consequences of certain premises be
deduced?) and a practical one (what are the consequences of the pre-
mises on the analysis of concrete situations that economics is concerned
with?). But Ingrao and Israel explained that this complex approach of
the founding fathers was lost sight of in the thirties when there was a
shift to pure ideal-type models. Finally, another related aspect of the
"methodological revolution" (Jaffe, 1972) instigated by Walras has been
explored by Menard (1980): it is the fact that in distinguishing homo
oeconomicus from homo aleator and in giving a clear bias to the first one,
as testified by a letter to Herman Laurent (3/24/1899), Walras may have
contributed to the resistance opposed to the introduction of statistics and
probabilities in economics. (Menard, 1987). This may still be topical, to a
certain extent, if one looks at the contemporary dissociation between
mathematical economics and econometrics, with the correlated prejudices
among the two communities.
Whatever the issue is on the debate about the use of mathematics, and
of what type of mathematics, in economics, there was at least one major
consequence to the systematic modelization favored by the Lausanne
school: it largely explains why it took so long for their ideas to penetrate
the community of economists, either because there was an opposition to
the use of mathematics, based on other representations of economics
(Menard, 1978), as among French free-marketers, or because economists
were too ignorant of mathematics to understand what was going on
(Menard, 1978; Zylberberg, 1987b). It is probably the conjunction of the
two that may explain why the concepts and methods of Walras and Pareto
had to wait until the late 1930s to be introduced systematically at the very
core of economic theory. (Maybe we should add that they were done a
disservice by the fact that they wrote in French or Italian, which made
them privileged victims of British-American linguistic provincialism.)
104 NEOCLASSICAL ECONOMIC 1HEORY
But thereafter, the Lausanne school was to bloom. One may even
suggest that if there is such a thing as a Lausanne school, its expansion is
mostly a contemporary phenomenon.
2. Theoretical Issues and Controversies
Several aspects still need to be clarified as far as the historical environment

of the Lausanne breakthrough is concerned. As an example, there is much
to do on the relations between Walras and the political philosophers of the
seventeenth and eighteenth centuries, though one can find some major
indications in Jaffe (1977a). Similarly, the history of the renewal of general
equilibrium and its penetration in the Anglo-Saxon world in the thirties
should be explored. But these are fields of research in which major
controversies are not to be expected.
The situation is totally different if one looks at the theoretical content of
the "Lausanne revolution. "Not only is the label of revolution question-
able, as we saw in the previous section, but the very significance of the
contributions of Walras and Pareto is a controversial issue, both in the
interpretive literature and among contemporary economists. Three major
problems will be identified here: the characteristics of the general equilib-
rium model, and particularly of the tatonnement; the static or the dynamic
nature of the analysis; and the scope of validity of the model.
2. 1. A Crystal-Clear Theory?
Most interpretations of the general equilibrium theory these days are based
on the Arrow-Debreu-MacKenzie reading of Walras: it is seen as "the
model of a hypothetical economy of perfectly competitive spot and future
markets without any transaction and information costs" (Debreu, 1959),
where price signals are used to establish a coherent disposition of economic
resources in a decentralized economy (Arrow and Hahn, 1971). This can
be considered the "base camp" of the Lausanne tradition (De Vroey, 1987;
also Ingrao and Israel, 1985), as it is summarized in Walras' Elements of
Pure Economics (4th ed., 1926) and in Pareto's Manuel (though there was
a controversy on whether it is the Manuale (1906) or the Manuel (1909)
that should be considered the definitive version (see Jaffe, 1972b; Schwier
and Schwier, 1976).
As early as 1910, Schumpeter located several aspects of the Lausanne
tradition: "The theory of economic equilibrium is' Walras's claim to
universality, that great theory whose crystal clear train of thought has
illuminated the structure of purely economic relationship with the light of

one fundamental principle"-the theory of marginal utility. And he went
a step further in identifying Books II to VI as the "aere perennis" of
Elements with the fine structure of analysis: exchange, production, capita-
lization, and money (see also Kuenne, 1956).
So far, so clear. .
But almost all contemporary economists are now well aware that
Schumpeter's summary, as well as the more sophisticated one by Debreu,
are much more a synthesis of several major theoretical problems than that
of a completed theory.
It has been shown that the conjunction of free competition and marginal
utility gave Walras' model a decisive advantage over Jevons. Thanks to
Cournot, the choice of free competition as a point of departure allowed
Walras to overcome Jevons' problem of how to deal with the differences
between individual wills (Hicks, 1934). And thanks to Piccard who showed
him how to derive the demand curves from it (Walker, 1970; Jaffe,
1972a), the marginal utility principle introduced a rational foundation to
the theory of value while Jevons superimposed final utility and prices. Jaffe
(1972a) traced back the laborious genesis of the idea, which involved the
rejection of the labor theory of value as well as of the theory of production
costs. There were still several ambiguities in Walras' analysis, that Pareto
decisively contributed to clarify, introducing ordinal utility and the indif-
ference curves, while Hicks and Samuelson reformulated the whole theory.
The result was a clear statement of the axioms involved and of their
arbitrariness, as continuously criticized by Hayek, for example.
Based on this principle, Walras proceeded to develop a pure exchange
model, as early as 1873. He then extended it to an economy with produc-
tion, considering the factors of production as services to which a price ca~
be associated. His restrictive assumption of fixed coefficients of production
was relaxed by Pareto, though it has been suggested by Barone as early
as 1894 (Schumpeter, 1949, 1954, ch. 7, nr. 8). The third step was to
introduce capital forrriation and credit, which Walras analyzed as net savings
of capital, with the rate of interest identified to a net rate of income (Jaffe,
1953). A consistency problem then appears, related to the tatonnement as
we will see later on, that Walras overcame in considering that new capital
goods related to capital formation are not used in the period under
consideration (Walker, 1987c). Finally, Walras considered a monetary
economy, where individuals hold money as is a component of their
preferences functions: the very nature of this monetary economy (Marget,
1935) has been questioned by Lange (1942b), and defended by Kuenne
(1961) and Walker (1970).
The strength of the model, and its compulsory aspect, is related to the
106 NEOCLASSICAL ECONOMIC TIiEORY
facts that, as emphasized by Schumpeter, each floor of the building is

related to the others by the same unifying principle, and that the structure
of the analysis is always the same, though this was not clearly understood
before the late forties: existence, uniqueness, and stability of the con-
sidered equilibrium.
The existence problem is the basic one since it is a problem of consist-
ency: Is it possible for the plans of decentralized agents to be made com-
patible, e.g., is there a solution-and under what conditions-to the
system of equations describing these plans? Walras thought that the
existence question is answered as soon as we have counted equations and
unknowns, and found that they are equal in number. (There is also another
restriction, noticed by Cassel (1918) which is that Walras reasoned solely in
terms of equalities.) Withem Lexis noticed as soon as 1881, in a review of
Walras, that the Walrasian system of equations does not necessarily
possess either real positive solutions or unique solutions (Jaffe, 1971, note
58). Now, the problem is that if we cannot demonstrate the possibility that
an equilibrium, or a set of equilibria, could exist based on mathematical
hypotheses that are meaningful in economics and sound reasonable, then a
general eqUilibrium approach would be without any interest. This was a
major problem, and a very difficult one that was going to be solved half a
century later, through convexity hypothesis on consumption and produc-
tion sets, and with the help of Brouwer's and Kakutani's fixed point
theorems. We now know that we can find at least one set of nonnegative
prices, one for each market, such that if consumers and producers were to
optimize taking those prices as given, the demand and supply quantities
that would result would yield prices in markets identical to those taken as
given (Weintraub, 1977). The slow and progressive history of how solu-
tions were found has been carefully and convincingly analyzed by Wein-
traub (1983): It is a question with which several leading economists and
mathematicians-Cassel, Schlesinger, Wald, Von Neumann, Arrow, De-
breu, and MacKenzie-were involved. Finding a solution had some major
impacts on the economic profession. First, as noticed by Weintraub (1987),
in relating Walras eqUilibrium to Nash equilibrium, through the Arrow-
Debreu interpretation, it oriented researches on eqUilibrium prices as
related to agents' behavior rather than induced by market forces. Second,
it involved the clarification of some basic hypotheses and of their very
restrictive content, mainly convexity when production is considered. Re-
laxing these hypotheses is definitely on the theoretical agenda and it is not
clear if the attempt to do so will be successful (Dreze, 1985). If not, the
interest of the model for analyzing real economies would be severely
restricted.
But finding that there may be at least one solution to the set of equations
is not satisfying enough. From an economic point of view, that there is an
infinity of possible equilibria would not be very convincing. Even under the
restrictive assumption that the market mechanism is identified with pure
competition (Schumpeter, 1954, ch. 7, nr. 7), one would like to have one
solution, e.g., one set of prices that would satisfy the conditions of
equilibrium. This is the uniqueness problem that was explicitly dealt with
by Arrow, Hurwicz, and Block in 1958 and 1959. The result was already
disappointing since gross substitutability is required, which means that net
demand functions should be continuous, homogeneous to degree zero so
that agents must be perfectly rational, and that Walras' law be a link
between these net demands. The pessimism on a positive issue-that is, a
satisfying and convincing one-was clearly expressed by Arrow and Hahn
in their 1971 synthesis. It has unfortunately been confirmed by Sonnen-
shein (1972, 1973), and by Mantel (1974) and Debreu (1974): Gross
substitutability that is necessary to demonstrate uniqueness, is not justified
by any standard micro foundation. It is a property that is not deducible
from usual maximizing behavior, and that is very weakly justified in
realistic terms, particularly if we take production into consideration. What
these authors showed is that there is always a competitive economy that
can be associated with a demand function, whatever the form of this func-
tion is (for a summary of this research, see Guerrien, 1985, 1988). It is
unfortunate that this major result, a very negative one for sure, has not
been noticed in the interpretive literature.
2.2. Tatonnement as a process of Thought
The above lack of notice may have occurred because most of the attention
was attracted by the third problem, the stability. As originally formulated
by Hicks (1939) and Samuelson (1941,1942), it may be phrased as follows:
If there is such a thing as price equilibrium, what are the conditions
necessary for differential equations to guarantee that the system will
converge at that point? And what is the nature of the economic mechanism
involved? In theoretical literature, the problem was discovered to be an
acute one after Scarf's (1962) paper where he developed several examples
of global instability. The problem appeared to be so difficult to solve that
most theoreticians progressively abandoned the battlefield, and the few
remaining seem quite pessimistic about the possibility of finding a satis-
fying result within the Lausanne type of conceptualization (Hahn, 1984;
Guerrien, 1988). In the interpretive literature, the analysis of the problem
has been mostly developed through the debate over the nature of one
mechanism associated with the stability question, the tatonnement.
As originally formulated by Walras in Elements (particularly in Dr. 125),
the tatonnement was tentatively a description of the empirical mechanism
that could be the equivalent on real markets of the iterative procedure
necessary to find a mathematical solution to the system of equations
defining interdependent markets; it is therefore concerned with the central
issue of political economy (Hahn: 1982; De Vroey, 1987): How can we
define a mechanism that would reflect the capacity of the markets to make
plans of decentralized decision makers compatible? In other words, Walras
was confronted with the old Smithian problem of the "invisible hand."
How are prices adjusted in a competitive economy where agents are
price-takers? How can we get one coherent price system? What are the
procedures for producing and disseminating this price information? How
are individual demand and supply functions aggregated so as to know the
sign of excess demand, and how is excess demand adjusted so as to be nil?
As pointed out by Walker (1972), Walras' tatonnement is just one
among several other mechanisms that economists have suggested: Walker
listed three other forms, elaborated by Edgeworth, Marshall, and Knight.
But since World War II most of the attention of the theoreticians has been
devoted to tatonnement. Now it must be remarked, as emphasized by Jaffe
(1967), that Walras was all but clear on that mechanism. In the Elements
there is no explicit structural framework to generate the properties that
could answer the questions raised above. There is a refrence to the
impersonal mechanism of pure competition in a perfect market, associated
to a "computer-like intellectus-angelicus" (Jaffe, 1967). First developed in
the theory of pure exchange, the idea of tatonnement is then extended to
production, capital formation, and money: a development that Edgeworth
found redundant, and on which he was wrong (Walker, 1987b). But the
mechanism is not that precise: we have no explicit rules defining it, nor any
specific institution, and there is no explanation to the heroic assumption
that disequilibrium transactions will not occur while the system is groping
toward price equilibrium. Therefore, it is not surprising if much energy was
devoted to filling in the banks of the theory, and if the suggested answers
are controversial.
The tatonnement as a procedure associated to the stability problem, and
as distinct from existence and uniqueness, was suggested by Samuelson
(1947), but it is mainly after the seminal papers from Uzawa (1960) and
Hahn (1962) that the interpretive literature proliferated. In the sixties, the
discussion was mainly focused on whether there are transactions at "false"
prices in the tatonnement, since if there are transactions in disequilibrium,
the resulting changes in initial dotations would affect the condition of

equilibrium so that the possibility of a unique solution would no longer
exist (for a synthesis, see Jaffe, 1967). In the seventies, the attention
shifted clearly to the stability problem proper. First it was made clear by
Sonnenschein (1972) that even with no transactions at false prices, a
unique eqUilibrium is not that obvious. But it also appeared, as already
noticed by Samuelson (1947), that there is a logical anteriority of the
stability problem over comparative static since there is implicitly, in any
comparison of equilibrium points, an idea of how to get there and stay
there, what Walras called the probability of convergence (Elements, llf.
130; see also Weintraub, 1977). Two controversial issues then emerged:
the first, on the very nature of the tatonnement, e.g., whether it is a static
description or a dynamic process (more on this in a few pages), the second,
on how to give a specific content to this mechanism.
One possible answer is the auctioneer. Whatever his name is, auc-
tioneer, price setter, or monopolist (as in some disequilibrium models: see
Grandmont, 1977), the idea is that prices must be adjusted in one way or
another, so as to coordinate plans that are not compatible on an a priori
basis. Now, admitting the principle of a centralized procedure of adjust-
ment introduces several major inconsistencies in the Walrasian model.
First is that astonishing paradox of a decentralized economy that turns out
to be a planned system, where the auctioneer is both external to the system
(De Vroey, 1987), and its most powerful component, an idea that retro-
spectively illuminates Lange's (1938) analysis on market socialism. But
several other problems are involved. How will the price setter behave?
What are the rules guiding his action? Will he select the price closest to the
previous equilibrium price, which means that it depends on the initial
conditions? Or will he select the price maximizing the volume of transac-
tions? Or the amount of money that changes hands? (Walker, 1972). And
if we assume that the price setter is already informed of the excess demand,
as in Uzawa's interpretation of the auctioneer (Uzawa, 1960), what are the
rules and mechanisms so as to enforce the obligation for sellers and buyers
to reveal their true preferences and to not be allowed to transact while the
adjustment process is on?
Confronted with these difficulties, Jaffe (1978, 1981) argued that there is
no auctioneer at all in Walras' model. But if it is so, and if the economy is
purely competitive so that markets are for price-takers, how will prices
adjust? As pointed out by Arrow and Hahn (1971, p. 322), at least one
participant should have the capacity to change them. But it also means that
one at least is not a price taker. On the other hand, without the existence of
such a central authority, a solution suggested by Knight (1921) and by
Stigler (1957), there is the necessity to multiply ideal conditions, and to add
several new constraints. Still, the model would be incomplete since it
assumes an extended knowledge by traders, but without any procedure to
explain where it is coming from, and no means by which prices can be
changed (Walker, 1972).
We are then confronted with a cruel dilemma: either the tatonnement
is coupled with an auctioneer, and we have a market economy whose
consistency is guaranteed by the most powerful central agent one could
imagine; or there is no such a thing as an auctioneer, but the model is
largely an empty set, since there is no indication at all on how prices would
be adjusted. Recent research by Hahn and Fisher on the so-called non-
tatonnement models have shown that in such a situation, the structure of
the Walrasian model is deeply changed. And since the behavior of agents
would be different in the same way that constraints operating within the
system would be different, it is not yet clear how a competitive economy
would behave in such an environment (Guerrien, 1988).
This consistency problem is even more acute if one looks at the
tatonnement when there is production. As early as 1967, Jaffe noticed the
difficulty related to the extension of the tatonnement mechanism in such a
situation. If there is some production of goods at disequilibrium prices,
then we will have to change conditions that we assumed to be constants,
namely, the stock of goods available. Such a difficulty may explain why
Walras was so cautious in extending the tatonnement model, since he was
probably aware of a problem mentioned by Bertrand (1883) in his review
of the Elements. It is only in the fourth edition that Walras tried to
overcome the difficulty: he then introduced bons, so that there would be no
real production but only promises to produce up to the point where price
equilibrium would be reached. But in doing so, Walras was obliged to
confess that his model was fiction (Jaffe, 1967), something that he always
wanted to avoid. Moreover, as already mentioned by Schumpeter (1954)
and emphasized by Walker (1987a), it may not only be unrealistic but also
inconsistent, since it is quite difficult to figure a model where production
would be taken into consideration without time, and where nothing would
be allowed to change. Walker argued that this so-called "pledge model" or
"ticket model" was unrealistic and introduced tardily by Walras, more as
an afterthought than as a part of the hard core, and that it is preferable to
maintain an interpretation of tatonnement in production as a model of
disequilibrium, as a first step toward a dynamic analysis. The problem is
that Walras did not know how to deal with such a model; and it is not clear
at all, looking at contemporary literature, that we are well in advance of
Walras on these questions.
But if it is so, we are confronted with two distinct but interrelated

epistemological questions: Is the Walrasian-Paretian model a purely logical
construction, or does it claim a certain realism? And is it a purely static
view, or does it instigate a dynamic analysis? Although Walras himself
continously asserted that his model was both realistic and dynamic (Wal-
ker, 1987a), the point of view is a controversial one in recent literature,
and may even have changed significantly within different interpretations.
2.3. Static or Dynamic?
The problem was raised as early as 1890, when Bortkiewicz, in a very

impressive review of Walras' Elements, argued that its model was static in
that it assumes quantities possessed as constants and utility functions as
invariant, and dynamic in the exposition of the equations of exchange
intended to show how to attain a stable equilibrium. Ever since, there have
been two basic interpretations of Walras's model, one arguing that it
proposes a purely static view (Jaffe 1980, 1981), the other that it is mainly
concerned with the dynamic theory of equilibrating behavior on real
competitive markets (Walker, 1987a). But a more careful examination
shows that several authors, including the two already mentioned, have
fluctuated between the two interpretations.
Let us see some significant illustrations of this difficulty.
In his paper on Pareto in 1949, Schumpeter insisted on the static nature
of the Walrasian-Paretian model and emphasized that Pareto was well
aware of its limitations. But in his History of Economic Analysis, he wrote:
"Since the existence of these inventories presupposes a certain past
behavior of the people concerned and since their current reproduction
presupposes certain expectations, the system-even if perfectly stationary
-still depicts a process in time and might therefore be called <implicitly
dynamic>" (1954, p. 1002). As for Jaffe, in his biographical notice on
Walras in 1968, he described the tatonnement as "a quasi dynamic theory of
the emergence or establishment of equilibrium," an interpretation that was
already his in 1953 and in his discussion of tatonnement in production in
1967. But he progressively shifted to an analysis in terms of a pure static
model. It was already so in 1971, when he suggested that Walras' static
representation could explain some "fundamental inadequacies of the
whole conception." He accentuated this interpretation in his debate with
Morishima; while Morishima (1977, 1980) strongly supported the idea that
Walras' major contributions were his theories of growth and of money,
e.g., the dynamic extension of his model as developed in Parts V to VII,
Jaffe vigorously replied that Part VII, on economic progress, was no more
than "a coda" (Jaffe, 1980), that tatonnement was a purely timeless model
(Jaffe, 1981), and that any interpretation focused on Part VII was totally
misleading since tatonnement as discussed in that section is nothing more
than "an addendum that reaches beyond the (kernel)" of Walras' model
and a source of contradictions and confusions (Jaffe, 1981). At about the
same time, Walker changed his mind in exactly the opposite direction.
While in [1970], he described Walras' analysis as a "static certainty
analysis" that does not describe any dynamic path, he progressively went
on to a dynamic interpretation of tatonnement. In his superb synthesis for
the New Palgrave (1987c), he firmly supported the idea that in each of the
four basic models of the Elements, tatonnement was an instrument for
exploring the dynamic process of adjustment. He then agreed with
Morishima, which he did not do in 1980, suggesting that one basic
contribution of Walras was his idea of a "moving equilibrium," e.g., his
conception of a progressive economy where there is substitution of capital
services in place of land services in given production functions, and where
the~e are changes in these functions in relation to technical progress.
If we have put some emphasis on the contradictions or changes in the
interpretations by leading commentators of Walras' Elements, it is not
because we see them as expressions of personal inconsistencies, but clearly
because they are symptoms of a major difficulty that interpretive literature
has not yet overcome.
First there is a pure theoretical problem involved, which is to clarify
what dynamic is, as compared to static. One must remember the difficulty
had not even been noticed before Hicks (1939), when the question of
stability was pointed out· and related to the determination of the signs of
derivatives of net demand; and before Samuelson's major contributions
of 1941, 1942, and 1947 when he clearly identified the stability problem,
delineating it from existence and uniqueness problems, and tentatively
developing a typology so as to distinguish static, comparative static,
stationary, and dynamic regimes. This opened the road to stability proofs,
as developed by Arrow, Hurwicz, and Block (but probably demonstrated
by Yasui ten years earlier, as shown by Weintraub (1987), thanks to the
Liapunov method). Considerable research and several papers then illus-
trated how difficult it was to maintain a clear distinction between static and
dynamic, since the definition largely depends on the concept of equilibrium
that one is using, and since any static representation involves an implicit
dynamic mechanism because, as emphasized by Samuelson (1947), it
would be meaningless to identify static equilibria and to compare them if
we do not have in mind some idea of the path(s) from one state to another
and what the mechanisms involved are. This is exactly what we do when we
interpret supply and demand in terms of adjustment.
But the problem is that there is no satifactory model of this implicit
dynamic. This may be the second reason that could explain the inconsisten-
cies already noticed in interpretive literature. Ideally, we would like to
have a dynamic theory within the Walrasian framework. Some have argued
that there are no major difficulties in introducing a time structure in the
general equilibrium model: this is what Hicks would have done, quite
successfully, in his model of temporary equilibria (d'Autume, 1982; Zyl-
berberg, 1987a). But it is more generally admitted, among mathematical
economists, that there are some major, if not insoluable, problems in
introducing true dynamic factors, like anticipations that would not be
purely mechanistic extrapolations, in a Walrasian model. Explorations in
the field, as in Fisher (1983) or Hahn (1973) have shown how difficult it is,
so difficult that one may wonder if it is possible to do so within the
Walrasian framework (see Menard, 1979; Guerrien, 1988).
A good and precise illustration of the problem may be in the question of
profit, and therefore of entrepreneurial functions and the nature of firms in
general equilibrium models. As early as 1904, Edgeworth noticed that
Walras' doctrine "implies that the total income to the entrepreneur, in his
capacity as such, is zero in equilibrium." But if it is so, if we have the
well-known property that there is no profit at eqUilibrium (where profits
are distinct from normal returns to capital), what is the role of the
entrepreneur? And how can we describe firms? Schumpeter (1954) sug-
gested seeing the entrepreneur as a coordinator, buying and hiring inputs
and selling outputs (1954, ch. 7, Dr. 7). Let us assume that this is so, with
the entrepreneur's functions being those of coordination and supervision
(Hebert and Link, 1988)-which, by the way, means that there is a
hierarchy in the firm, an idea not that obvious in a general eqUilibrium
model-then what of remuneration? If it is either returns to capital or
wages, it means the entrepreneur is nothing other than a capitalist or a
worker, paid for his services as such. It also means that entrepreneurs are
pure fiction in expressing the firm and its secret hierarchy. This was almost
Schumpeter's conclusion in 1954, where he suggested replacing the term
entrepreneur with the impersonal expressionjirm (p. 1011); it is also Jaffe's
point of view when he wrote: "As for the role of the entrepreneur in
Walras's analytical model, the Elements restricted it to that of arbitrageur,
and nothing else" (1980), an interpretation already to be found in Wicksell
(1893, p. 95). Now, if this is so, and if the kernel of the Walrasian model is
static analysis, as suggested by many commentators and theoreticians, it
signifies that there is no possible analysis of entrepreneurs (Herbert and
Link, 1988) or of firms (Dreze, 1985), properly speaking within the

Lausanne framework. We must therefore go a step further: it would, at
least, spread some doubt over the capacity to develop a dynamic version of
such a model.
The only possibility to escape this trap is precisely to give a dynamic
interpretation of the notion of entrepreneur; the idea was suggested
by Jaffe (1980), and most brillantly developed by Walker (1986). Jaffe's
argument was that if one must admit that there is no possibility of justifying
the existence of entrepreneurs at eqUilibrium theoretically, there may be
some room for it while in disequilibrium: "Only when deviations from
equilibrium are signalled by differences between selling price and cost of
production does Walras' entrepreneur spring into action." Walker went
a step further, arguing that we must make a clear distinction between
coordination and supervision activities, which is managerial activity
retributed by wages, and the activity of demanding services and selling
products, which is typical of the entrepreneur function. If it is so, in
disequilibrium the entrepreneur will act as an adjustment mechanism on
one specific market (he will "bid the price up" if demand is higher than
supply, and "lower the price" in the opposite situation), and as an
"essential part" for "price adjustments between markets." That is, "their
behavior automatically gives rise to the tatonnement process in the markets
for services and products," and they carry risks associated with that
process, which may explain their rights to "benefices." But what if we are
at eqUilibrium, where profits (e.g., benefices) are equal to zero? There,
Walker goes on, entrepreneurs are intermediate between workers and
consumers, and their remuneations are dependent on their other functions,
as capitalists since they usually own parts of the capital, and as workers
since they participate in daily management.
This example clearly illustrates some of the major problems involved in
the Walrasian-Paretian model. Walker's interpretation, as well as that of
Jaffe, means that in disequilibrium, the entrepreneur is playing the role
of the auctioneer. This is quite puzzling since it would mean that the
entrepreneur-that is, the firm-is no more a price-taker but a price-
maker, which clearly contradicts one of the major assumptions of the
model. And at equilibrium there appears to be a consensus in the interpre-
tive literature to see the entrepreneur as "neutral," as "a fiction," or as
"formal," that is, nonexistent, theoretically speaking.
We are here confronted with the basic flaw of the Walrasian model
which is that its structure must be radically modified when we are shifting
from a static analysis to a dynamic approach. But the problem is that we
still don't know, in pure theory, how it should be changed so as to induce
interesting results.
This may explain why several authors (Jaffe, 1967, 1980; Menard, 1979;
Hicks, 1976; Dreze, 1985) think that it is wisest to clearly dissociate static
from dynamic. One problem is to look at the logical consistency of general
equilibrium, so as to explore several properties of the interdependence of
competitive markets under some heroic assumptions, that is: to develop
the Lausanne model as a "thought experiment." A totally different prob-
lem, still unsolved, is to examine how to introduce several modifications in
that theoretical pattern so as to look at how an economic system would
behave under conditions of disequilibrium.
Clearly this is not just a discussion about Walras' goals. That Walras
intended to extend his model beyond statics and to develop a true dynamic
analysis is without any doubt. The questions are: Was he able to do so?
Are there genuine developments of that type in the Elements? And is his
model appropriate to do so?
Here is the problem of realism of the model.
2.4. Scope of Validity
The question of whether the Walrasian-Paretian model is an adequate

point of departure for analyzing real economies can be split into two
distinct, though related, problems: Is it appropriate for describing and
explaining how economies with interdependent competitive markets
behave? And does it provide us with scientific laws that allow us to exam-
ine any economy, whatever its historical regime is?
Without developing any epistemological consideration here, it is already
clear through the controversies on tatonnement, on dynamics, or on the
entrepreneur that it is debatable to consider the Lausanne approach as a
realistic one. In the continuity of his interpretation of Elements as a purely
timeless and nonhistorical model, Jaffe argued that Walras' fundamental
preoccupation was about "how an imaginary system might work," so that
he would have been mainly concerned with the construction of a "realistic
utopia" based on the ideal of commutative justice, to be completed by an
analysis of distributive justice. Walras' claims to realism would be no more
than an expression of his will to be recognized and to be socially successful
(Jaffe, 1980; Dumez, 1985). But this is a difficult position to maintain if
one looks not only at the Elements but also at Walras' other publications
and at the importance he accorded them in the architectonic of his research
program (Menard, 1980). Even if one concentrates one's attention on
Elements, one can hardly marginalize Walras' well-known claim that "the
theoretical solution is identical to the solution worked out by the market"
(nr. 125), a constant preoccupation that is also attested to by his corres-
pondence (Jaffe, 1965). On that we would follow Schumpeter (1954) as

well as Walker (1987a), rather than Jaffe.
This realistic preoccupation, which is even more important in Pareto's
intellectual itinerary and can largely explain his shift from pure economics
to sociology (Wolff, 1981), is particularly acute on three questions, as far as
the theoretical model is concerned. First, as already mentioned, there is
the problem of the very nature of tatonnement: is it a purely timeless
representation of how ideal markets could function (Jaffe, 1967, 1981)? Or
is it a major step. toward understanding the adjustment of demand and
supply and the institutional mechanism involved (Walker, 1987a)? Look-
ing at the extension of the model to production makes it clear that Walras
intended to be "realistic." But in introducing the pure fiction of bons, he
shifted to an imaginary world.
Second is the theory of capital formation. Ambiguities in Walras'
analysis (Jaffe, 1953; Walker, 1987c) make it unclear whether he intended
to develop a dynamic approach to capital formation, or to extend his static
model to an economy with capital markets. Morishima (1977) argued in
favor of the first interpretation so as to present Elements as the cornerstone
of a dynamic theory of growth. Jaffe (1980) strongly denied such an
interpretation, pointing out that it would introduce some major inconsis-
tencies in the model and that Walras was aware enough of these difficulties
to avoid any dynamic interpretation. The truth might be in the middle of
the road and could be explained by the differences between what Walras
intended to do and what he actually could do. This is what Schumpeter
(1954) underlined when he noticed how inadequate to its purpose the
theory of capital formation is, with the creation of an imaginary commodity
representing a perpetual net revenue so that prices of capital goods can be
replaced by a single price readily identified with the rate of interest.
The same can be said of the theory of money. Although Morishima
(1977, 1980) and Walker (1987c) have argued that encaisses desirees is a
major step toward a dynamic theory of money and that money matters in
Walras' model since he "obviously allows for insurable risks," e.g., some
uncertainties, it must also be recognized that "he assumes a given state of
expectation of them" (Morishima, 1980). This is to substract with one hand
what was attributed to Walras by the other. Jaffe (1980) is probably more
consistent in putting the emphasis on the word desirees: Money is a unit of
account and a medium of exchange, necessitated by nonsynchronization
between incoming and outgoing deliveries. But it is by no mean a store of
value: Encaisses desirees are introduced so as to maintain the timeless
nature of the model; they are of no help in building a dynamic analysis.
It is easy to understand what a restriction it is to have such a representa-

tion, where market economies are not authentic monetary economies.
But was Walras concerned solely with market economies? This question
has also been argued contradictorily. The origin of the debate can be
traced back to the thirties and to the controversy on the feasability of
rational calculation in socialist economies. As a matter of fact, the problem
was already in Pareto (1896) and was consistently developed in Barone's
seminal paper of 1908. Both emphasized that equilibrium and, correlative-
ly, optimum, were not intrinsically related to market economies since they
are technical criteria that could be applied as well by the Ministry of
Production in a centralized economy. But it is mostly Lange (1938) who
instigated the controversy. Against von Mises (1921) who argued that
rational economic calculation would be impossible in a planned economy,
Lange used Taylor's paper of 1929 to show that the Central Planning
Bureau should be conceived as Walras' auctioneer, adjusting supply and
demand through an iterative process. If this is so, and if pricing at marginal
cost can be imposed by the Central Planner, than "market socialism"
would eliminate monopoly power, improving the efficiency of the economy
over a competitive one that could not totally eradicate monopoly power.
Hayek (1935, 1945) replied by arguing that competition solely could
produce adequate information since marginal cost is not known per-
manently but should be produced, and since there would be no incentive
under a planned economy for decentralized agents to reveal their informa-
tion. Moreover, Hayek suggested that Lange's demonstration was wrong
because it was based on an inherent bias of the Walrasian model-that is
to say, a static one, where information is free and perfect; while in real
economies information and pricing result from a dynamic proces. The
debate went on and raged, up to the forties.
It was an important one, not only because it generated the literature on
economics of information and strongly influenced welfare analysis but also
because it spread the idea that the Walrasian framework was involved as a
model and might be adequate, whatever the "institutional" conditions are.
This has been summarized by Cirillo (1976) who plainly stated that Walras
"succeeded in turning economics into a truly scientific discipline" since he
provided scientific laws for any economy, whether capitalist or socialist.
This has been challenged indirectly by Jaffe and more explicitly by
Morishima. In a highly underquoted paper of 1971, Jaffe developed an
analysis consistent with his interpretation of the Walrasian-Paretian model
as a pure theory of an "imaginary system" (1980). He went on as follows:
"Uon Walras, of petit bourgeois origin, detested change and froze within
his general equilibrium theory an idealized conception of the economic

organization of society with which he has been familiar in his childhood in
the 1830's and 40's in the sleepy town of Evreux in Normandy where he
was born. This was an organization more characteristic of the artisan stage
of production than of modem large scale factory production." In his effort
to protect Walras' purity against any compromise with the real world, Jaffe
may have gone too far; if the general equilibrium theory is typical of an
artisan stage of production, how appropriate is it to analyze modem
economies? But if this is so, the Lausanne tradition is nothing more than a
tradition; a monument in the history of economic thought. Morishima
strongly objected to this interpretation in his Walras Economics (1977),
since he justified his whole effort to give the emperor new clothes by the
basic idea that the general equilibrium theory is the theory of a capitalist
system, e.g., how the capitalist system works. Jaffe immediately replied
that Walras' model was a much more general theory, which specifies what
the general conditions under which a capitalist system might work are, in
conformity with principles of commutative justice (Jaffe, 1980).
One might suspect that there will be some more swings on whether the
Walrasian model is adequate, whatever the nature of the economy con-
cerned. Putting the emphasis on the generality of the model might mean
emptying it of empirical content. At the limits, to aU intents and purposes it
would then be a pure "thought experiment": a game or a language, not
knowledge. At the opposite end of the spectrum, underlining the model as
one on how capitalist economies work, or could work, means severely res-
tricting its scope of validity. It would be at best a local theory, the theory of
a specific economic system, and any extension would therefore convey a
normative bias.
3. Norms and Politics in the Lausanne Tradition
The appropriateness of general equilibrium models to analyze "real econo-

mies" scientifically is a question that cannot be isolated from the question
of its empirical content and of its capacity to deal with data related to
specific economic situations. The Lausanne tradition has been very serious-
ly challenged on that ground, both in theoretical as well as in interpretive
literature. It has also been argued that the model developed by Walras and
Pareto cannot be qualified as a scientific paradigm because of a strong
normative bias that might be explained, in the last instance, by the politics
of the authors. What we would be confronted with would not be the
"foundations of economic analysis" but the vision of social reformers or
liberals in the tradition of the nineteenth century. It would not be econo-

mics, but political ecOnomy.
3.1. Is the General Equilibrium Theory Testable?
Almost 20 years before John Neville Keynes (1893) codified the distinc-
tion, Walras strongly insisted on the differences between positive and
normative economics, and suggested that he would deal with the two
dimensions in different books. By positive economics, he clearly meant
both a pure rational construction, inspired by rational mechanics, and a set
of tools adequate to analyze problems as specific as railroad fares, bimetall-
ism, and so on. In other terms he did not understand economics as an
appendix to pure mathematics, as suggested by some of his followers
(Debreu, 1959; Zylberberg, 1987b), but as a theoretical framework firmly
articulated to applied economics. This is even clearer with Pareto, who
continuously emphasized the applicability of the theory, and looked for
expressions of general economic laws that would allow testability. This is
obvious when he formulates the law of demand iil terms that would
facilitate empirical investigations, or in his preoccupation to find a way to
analyze and explore empirically the utility. function, which may explain
why he always looked for an appropriate notion of cardinal utility (Chip-
man, 1976; Wolff, 1981).
That general equilibrium analysis is an adequate pattern for doing so has
been challenged from the very beginning. When he first presented his
model of pure exchange at the Academie des Sciences Morales et Politiques
in 1873, Walras immediately provoked reactions from several leading
French economists, who argued that his rational construction was without
any empirical content and, more important, could not have any, because of
fundamental biases in its axioms (Menard, 1978).
For sure, Walras' discussants were not very well equipped to appreciate
his contribution since their mathematical training, and thereafter their
capacity to understand what was at stake in the model, was almost nil. But
the argument that the general equilibrium theory is at best a formal
synthesis which is not adequate for stimulating empirical research has also
been developed by much more qualified economists. This is clearly what
Friedman (1955) had in mind when he emphasized that there was nothing
new "in substance" in Walras' Elements, and that a Marshallian framework
was much more appropriate as a support for empirical investigations. And
the same point of view is stated in Hebert and Link (1988).
Paradoxically one can find similar arguments among some followers or
commentators on Walras and Pareto. A large number of mathematical

economists in the Lausanne tradition do not feel concerned for empirical
investigations and real economies as they go. They may go as far as
suggesting that this is inappropriate as a problem (Debreu, 1959). The
same can be found in interpetive literature. In his desire to propel Walras'
Elements as "the great achievement" of modern analysis, Schumpeter
(1954) deliberately underrated the other books of the author, particularly
the one on applied economics qualified as: "from our standpoint of little
interest" (p. 829). And this attitude may also explain his very critical
judgment of Pareto, where it is strongly suggested that his empirical
contributions are sociology, not economics (Schumpeter, 1949). This may
also be said of Jaffe who so firmly defended the purity of the Walrasian
model, defined as pure static and timeless analysis, that he went as far as
characterizing Elements as "an ideal fiction" describing "how an imaginary
system might work" (Jaffe, 1980). In doing so, the interpretive literature,
or part of it, is enforcing an idea largely diffused among economists though
rarely formulated as such, which is that the empirical content of the general
equilibrium theory is weak, if at all existent.
There are two complementary interpretations of such a judgment, a
judgment that might be seriously challenged looking at recent works on
computational equilibria or on international trade inspired by the Lau-
sanne tradition (Weintraub, 1985c). First, there is the idea that this state
of affairs is the result of a distortion in what Walras and Pareto intended
to do. Ingrao and Israel (1985) summarized such a point of view in arguing
that there was "a paradigmatic shift," under the influence of Hicks and
Samuelson, that modified the structure of the basic model and weakened
its empirical value. Emphasis has also been put on the realistic intentions
and possibilities of the Walrasian-Paretian model by Wolff (1981) as well as
byWalker (1987c). Another interpretation is the one developed by Leon-
tief in his presidential address to the American Economic Association
(Leontief, 1970). It is an important one, since Leontief is probably one of
the very first followers of Walras to have proposed a significant empirical
model based on the theory. His arguments are of the sociological type: It is
the conjunction of the flow of mathematicians in mathematical economics
(mainly in the Lausanne tradition), with their formal bias, and a strong
demand for applied models oriented toward economic policies, with their
vague content, that could explain how poor the empirical content of
general equilibrium theory is.
Clearly, the question of the testability of the Walrasian-Paretian model
is not a purely interpretive question. It is one that concerns all modern
economists, an undubitable sign that the Lausanne tradition is still prosper-
ous. At best one can say, as did Schumpeter: "It remains true, however,
that both Walras himself and his followers greatly underestimated what
had and has still to be done before Walras' theory can be confronted with
the facts of common business experience" (1954, p. 1015). If one is more
pessimistic, one may suggest that there is no solution to the problem since
it is rooted in the normative bias of the model.
3.2. Is Lausanne Economics a Normative One?
The debate on whether general equilibrium analysis is normative has been

focused on two different aspects. As far as Walras is concerned, it is the
nature of the relation between his pure model and his social goals that is at
stake. As for Pareto, it is the conservative characteristic of the optimum
principle that became the focus of the controversy.
That Walras considered himself a visionary (Jaffe, 1978b) and a
social reformer (Allais, 1964; Jaffe, 1971) is without any doubt. The author
of Elements conceived his general equilibrium model as the analytical
expression of an ideal of a moralistic nature, that he called "commutative
justice": How can we define a rational system of production and exchange
that would satisfy social justice under constraints imposed by scarcity
(Jaffe, 1977)? He wanted to reconcile economic laws with the tenets of
social justice (Boson, 1951; Schaller, 1971), and to do so he developed a re-
search program in two dimensions. The first aspect, more rigorously elabo-
rated, was devoted to "commutative justice." This is the core of Elements,
since it can be satisfied through competitive markets, where the principle
of equal value for equal value in exchange can be realized. Pareto's prin-
ciple might be thought of as an extension of commutative justice. The
second dimension of Walras' program is what he called "distributive jus-
tice," which is the justice in the distribution of property (Jaffe, 1978b; 1980).
This would require social constraints on individuals and state interventions.
It is clearly less consistently developed in Walras' works, though the author
devoted much more time and wrote many more pages on this aspect of the
program than on the previous one.
Now, the question is: Is the second dimension, e.g., distributive justice,
inherently involved in the very construction of the pure theory related to
commutative justice? In other terms, is the model built in Elements of Pure
Economics specifically developed so as to be the foundation of distributive
justice? Is it structured by the goals to be attained?
Yes, answered Jaffe (1977b): One cannot understand the heroic assump-
tions that Walras imposed on his theoretical model if one does not have in
mind what the author of the Elements intended to do. In the ideal world
described by pure economics, wealth is distributed equitably, the state
owns the land and its resources, and government guarantees free competi-
tion through coercive measures (Cirillo, 1976): But, for sure, this must be
related to distributive justice. We can even go a step further and suggest
that Walras' research program, his attempt to find out how to make
compatible the plans of individualistic agents, is deeply rooted in the
moralistic political philosophy of the eighteenth century. Walras' model
should therefore be enlightened by its relations to Pufendorf, Bourlama-
qui, and so forth, and to Walras' father, Auguste (Jaffe, 1977c).
Not at all, argues Walker in a more recent paper (Walker, 1984). Walras
is the founder of modern economic analysis, not only because of his
decisive contribution to the general equilibrium theory but also because of
his sharp distinction between positive and normative economics. In Ele-
ments, Walker goes on, we have pure economics, and Wa:lras carefully
postponed his normative analysis, to be developed in books to come (that
he never finished). Walras never confused what is and what ought to be.
The debate is still open, and we can hope that the publication of Walras'
major works by the Centre Auguste et Leon Walras (Lyon, France) will
shed some light on these issues. Indeed, is it not surprising that the largely
predominant contributions of Walras, at least if one looks at the time he
spent on them and at the number of pages he devoted to them, have been
almost totally ignored in the interpretive literature?
One aspect, at least, is clear: Pareto had no sympathy at all for Walras'
"sentimental and metaphysical speculations" (Schumpeter, 1949; Cirillo,
1976); a position that may explain partially the difficult relations between
the two men. But on the other hand, it is Pareto who made the most
significant contribution to "commutative justice" in formulating the cele-
brated optimality criterion. This is why he has been identified as "the
patron saint of New Welfare Economics" (Schumpeter, 1949) as developed
by Lerner (1934), Kaldor (1939), and Hicks (1939a).
But the nature of Pareto's principle also appears to be a very debat-
able one. For a long period of time, the concept has been identified as a
rule of optimization in free competitive markets, related to conditions
of resources allocation, so as to characterize "movements which benefit
some people without damaging others" (Hicks, 1939) or, more precisely,
as "any change which harms no one and which makes some people better
off (in their own estimation)" (Baumol, 1965, quoted by Samuels, 1972). As
shown by Chipman (1976), this principle, explicitly formulated in Manuel
(Pareto, 1906), can be traced back to Cours (Pareto, 1897) and even earlier,
in 1894. But Pareto was well aware that it does not mean attainment of social
welfare and that there is a necessity for some other criteria to choose
between alternative Pareto optima (Samuels, 1972). This is what the theory
of collective goods, developed by Wicksell, Lindhal, and Samuelson,
intended to do by extending the Paretian principle so as to obtain a criterion
for evaluating measures adopted by political organizations. And it is a
similar purpose that Bergson had in mind while proposing his social welfare
function, in 1938. In 1983 Bergson pointed out that the concept was already
defined in the revised version of Manual, published in 1913-this had been
noticed already by Chipman (1976)-testifying that Pareto was well aware
of the difficulty.
In other words, we are here confronted with a problem that is symmet-
rical to the one already mentioned in Walras. If Pareto's initial principle is
closely related to "commutative justice," e.g., positive economics, the
extended version, where coefficients determined with regard to an objec-
tive goal with a clear social component are included in the function, is
much more on the side of distributive justice, e.g., normative economics.
Therefore, is it that easy to maintain a sharp distinction between the two?
Yes, answered Chipman (1976) and Backhaus (1980) for whom Pareto's
principle is without any normative attribute. No, argued Bergson (1983),
since it is because Pareto realized how inadequate his initial concept was
that he revised it in 1913. .
Samuels went even further in presenting Pareto's criterion as "the ethics
of a business society and the economic theology of that society" (Samuels,
1972). Although he subsequently recognized that as a characteristic of
equilibrium, the principle is a matter of positive economics (Samuels,
1981), Samuels developed the idea that there is a normative bias, and even
more, a conservative bias, at the very root of the principle. The argument
is twofold. First, there are the assumptions necessary for the criterion to be
defined. Samuels (1972) listed 17 of them, and, in a more recent paper
(1980), put some emphasis on one of them, the "survival" assumption
defined by Koopmans (1957) as the necessary condition that each trader
has the resources to "both survive and participate in the market." This
cannot be reduced to a purely technical condition because of its economic
significance. If survival depends on both income distribution resulting from
exchange and conditions such that this redistribution actually permits
survival, is that pure economics, or are the associated choices normative?
Should electricity be cut off in the winter for poor and elderly people, or
shall state interventions guarantee their survival so as to allow them to
participate in exchange?
Therefore, and this is the second aspect of Samuels' argument, Pareto's
optimality is a formal, contingent, and relative criterion of choice that
neglects the coercive impact of the behavior and choices of the other
participants in exchange, e.g., it ignores that choices are defined in a
system of mutual coercion.
Backhaus (1980) opposed this view, but in doing so redefined very
restrictively the Pareto principle. He suggested the following, negative
interpretation: "if a point is not Pareto optimal, then it cannot be said to be
[good] or [efficient]." A normative use, in Backhaus' viewpoint, would
require a well-characterized social welfare function that is not in Pareto.
But Chipman (1976) and Bergson's careful analysis (1983) showed that the
notion was already present. The difficulty may be related, as rightly
pointed out by Backhaus, to the fact that Pareto's principle defines an
optimum, or a set of optima, once individual or collective rights have been
defined. Now this is exactly why Samuels disagreed, as emphasized in
his reply (Samuels, 1981): The criterion is focused on so-called voluntary
exchanges within the status quo power structure, and neglects all changes
in the definitions and assignment of legal rights. It is not only normative, it
is conservative.
3.3. Politics of Pure Economics
Walras and Pareto were not isolated from the society of their time. They
felt deeply concerned by the new forms that developed in real economies
and did not hesitate to adopt some very controversial positions. But the
interesting point is that their politics were totally different, if not antag-
onistic. Looking at what they thought ought to be, and how they both
considered their convictions based on solid scientific ground, one cannot
ignore that there is not one single policy rooted in the Lausanne tradition,
but several. This may be worth remembering these days, when general
equilibrium is identified with a free trade and strictly market-oriented type
of analysis.
Very definitely, Walras and Pareto had almost opposite convictions as
far as the consequences of their common theoretical model were con-
cerned. Bompaire (1931) rightly summarized their differences when he
qualified Walras as an idealist, inspired in his research by a dream
where freedom and socialism would be reconciled, while Pareto is iden-
tified as an optimist, persuaded that economics has already discovered
natural laws-free trade and free competition-necessary for society to
grow harmoniously.
What is the "central message" conveyed in Walras' works (Patinkin,
1981)? From 1860 to his death, Walras consistently developed the idea and
the associated program that pure economics, which was understood as
mathematical economics, would give a rigorous foundation to a "scientific,

liberal and humanitarian socialism" (Walras, 1909). This has been noticed
by several commentators: Allais, 1964; Jaffe, 1971; Cirillo, 1976; and
Zylberberg, 1987b; among others. The scientificity would come from the
very fact that his socialism would be firmly established on the general
equilibrium model. As a liberal, Walras considered himself a follower of
Adam Smith in that he saw free competition as the most efficient mechan-
ism to guarantee "commutative justice." But he did not share Smith's
optimism regarding the interplay of forces in a free market system (Cirillo,
1976; Jaffe, 1977c). He saw severe limitations that a competitive economy
could not overcome, related to the existence of natural monopolies, of
public goods, of noncompetitive strategies of agents considered from a
dynamic point of view, and of unequal distribution in initial dotations
(Jaffe, 1965, letters to Coumot; also Jaffe, 1971; Zylberberg, 1987b). And
it is for similar reasons that he was against the policy of laissez faire as basic
to economics (Walker, 1970). This is where his socialist convictions were
rooted, so that he can be qualified not only as a "social reformer" (Jaffe,
1971), but even more appropriately as a "liberal socialist" (Cirillo, 1976).
This conjunction is a constant in Walras' life, from 1860, when he empha-
sized that "the distribution of social wealth among individuals in society
should be equitable," to his last years in Lausanne, when he maintained a
close friendship with Georges Renard, the editor of Revue Socialiste who
once reviewed Elements and qualified Walras as "the French Karl Marx"
(Zylberberg, 1987b). These socialist convictions and these friendships may
partially explain the hostile reactions of French free traders and free
marketers to his theory (Menard, 1978), as well as the support he found
among radicals in Switzerland (Dumez, 1985).
Pareto's position is clearly in the opposite direction on the political
spectrum. He consistently adopted positions favorable to entire free trade
and free market (Bousquet, 1960; Allais, 1968). He cultivated individualis-
tic values, deeply rooted in his personal history, in his social origin, and in
his career (Wolff, 1981). In the 1890s, he even got involved in a political
fight that may have changed his life and diverted him from economics, had
he been successful. He ran in parliamentary elections and was defeated as a
free trader vigorously opposed to protectionist and militarist groups (Chip-
man, 1976). There is some paradox though, to say the least, in seeing this
free trader and free marketer, which he was until the end of his life,
shifting to an authoritarian and anti-parliamentary position rooted in his
elite theory. He went as far as involving himself in the newly borned fascist
regime in Italy, where he was appointed to the Senate by Mussolini.
Italy, where he was appointed to Senate by Mussolini.
The political measures proposed by the two authors were consistent
with their different positions. Walras' socialism crystallized mainly on

the role of the state. He thought that energetic state interventions were
necessary to assure perfect competition when applicable, to control and
regulate production when free competition is not possible, and to redistri-
bute property so as to implement distributive justice (Jaffe, 1975, 1978b).
He was convinced that only an activist government could insure and
maintain equality of conditions, a necessary prerequisite for inequality of
positions to play its positive role through competitive markets (Jaffe,
1978b). How would this government activity be financed? Through
nationalization of land and natural resources. The arguments behind this
proposition, which sound provocative to many of his contemporaries, were
as follows. A powerful state apparatus is an insurmontable necessity, but
taxation is a spoliation in a regime of property rights. Therefore, the only
solution is for government to appropriate resources that are not the result
of work and cannot be associated to an adequate use of property rights by
individual agents.
Pareto's program is much closer to what one would expect, today, from
a tenant of free competition. There are some loopholes, however, in his
positions. He was clearly opposed to socialist doctrines, which Walras
regarded more favorably, and consistently maintained through his life that
inequality in the distribution of wealth and incomes depends on the nature
of man, not on the economic organization of society (Chipman, 1976). As
already mentioned, his criterion of optimality may also be considered as a
conservative rule in the sense that it intended to defend and reinforce the
position of existing property rights. It can be interpreted as a strategy
against legal changes that would affect the given distribution of rights
(Samuels, 1972, 1981). But it has also been argued that Pareto's principle is
incompatible with the liberal values that he defended (Sen, 1970). Since
most choices have to be made collectively because of conflicting individual
values, it will result in an opposition to liberal principles and institutions.
From that point of view it is worth remembering that the survival assump-
tion may be such that there will be a necessity for selective use of gov-
ernment powers to protect interests or participants to exchange and
maintain the possibility of trade (Koopmans, 1957; Samuels, 1972). And it
is most interesting to remember here that Pareto's principle was formu-
lated in the context of the existence of a centralized state, where the
Minister of Production would have to determine the coefficients of produc-
tion so as to produce maximum utility with a minimum of sacrifices, while
the Minister of Justice would have to allocate the resulting outputs among
individuals in such a way as to obtain maximum utility for each citizen
(Chipman, 1976).
We are therefore confronted with several paradoxes within the Lau-

sanne tradition. Walras always emphasized the necessity for a clear dis-
tinction between pure economics and normative economics. But from
the very beginning of his career he considered the second aspect, which
is today almost totally ignored (Berthoud, 1988), at least as important
as the first one. Pareto, on the other hand, severely criticized Walras'
metaphysical speculations on what ought to be, but significantly shifted
to a sociology full of normative values and judgments.
Walras considered that society is not an agreement between free indi-
viduals but a necessary condition for individuals to exist and to exert
their freedom of choice. Therefore, their full realization needs a well-
organized society in which there is a positive role for the government.
Pareto opposed such a view, in which he saw the roots of utopian socialism,
and defended a much more individualistic approach. However, his politics
developed progressively as that of an elite, the happy few, not that of a
democracy of individuals.
As a consequence of his analysis, Walras, who developed the most
consistent and rigorous model of a competitive economy still available,
argued that it was the scientific basis for humanitarian socialism. As for
Pareto, he defended the thesis that the same model rendered possible the
setting out of deductive proof of the optimality of free competition and free
trade, but he progressively coupled this to an authoritarian doctrine.
Therefore, they were both normative, in that they sought to establish
scientifically what ought to be. And they were probably both wrong, as
testified by their antagonistic conclusions, in that there is nothing in pure
economics as they formulated it that can give such a scientific foundation to
social choices and individual values (Arrow, 1951).
4. Conclusion
Several debates and controversies are still raging among economists on the
interpretations of the Lausanne tradition.
In this chapter we have argued that the major issues at stake are the
following. First is the question about whether there is a school that can be
attributed simultaneously to Walras and Pareto. Second is the problem of
the structure of the general equilibrium model as developed in Elements
and in Manual, and of what should be valued or eliminated in it. Third, the
nature of tatonnement, and the question of whether it is a dynamic pro-
cess, has been the object of crucial discussions. Fourth, it more generally
appears that the interpretation of the Walrasian model either as a purely
timeless representation or as an authentic theory of growth in time is highly

controversial. Fifth, a methodological problem can be raised about the
scope of the model, about the universality of the so-called laws that it is
defining, and about their adequacy for analyzing "real" economies. Sixth,
the consequences of the general equilibrium analysis, as formulated by
Walras and Pareto, have been contradictorily investigated since several
authors argued that there is a normative bias in it. Seventh, many opposite
propositions in terms of political economy and of economic policy have
been "deduced" from the "pure" model, so that it appears most debatable
to claim that there is any scientific foundation for such propositions. Does
it mean that the general equilbrium theory has nothing to say about the
world as it goes?
These issues are all highly controversial, and the debates are not
restricted to interpretive literature. It is so because the Lausanne tradition
still is the seed of our discipline, so that we economists are all concerned.
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Commentary by Donald A. Walker
Professor Menard has provided an accurate survey of most of the areas of

controversy over the general equilibrium theorizing of Leon Walras. There
are a few limitations to the survey, which can be mentioned briefly before
turning to other matters. Menard scarcely refers to Walras' writings, so his
evaluations of viewpoints, rather than being documented, are presented
as impressions that he has formed of their merits. He pays little or no
attention to Vilfredo Pareto's work or to the voluminous interpretative
literature on it, except in regard to his welfare economics. That leaves a
sizeable gap in the history of the founding of the Lausanne tradition,
because Pareto made other important additions to general equilibrium
theory, including a revision of demand theory, a revision of the theory of
production, and an extension of the theory of the entrepreneur. Menard
does not report fully on the history of interest in general equilibrium
theory. He writes that there was not much more than "the germ of a
school" of Lausanne before 1940 and it "was to bloom only after 1940 ....
"If there is such a thing as a Lausanne school, its expansion is mostly a
contemporary phenomenon." In fact, there has been an uninterrupted line
of vigorous investigation into the field of general equilibrium theory. After
Walras and Pareto, it was carried forward by the second generation of
Walrasian theorists, notably Knut Wicksell, who made contributions until
1926; Gustav Cassel, who was productive on the topic during the period
1918 to the early 19308; and Henry L. Moore, who made a major statement
on the topic in 1929. Their work was followed without a break by the
contributions of other scholars. Jacob Marschak was studying Walrasian
systems as early as 1928, and Hans Neisser, Heinrich von Stackelberg, and
Frederick Zeuthen were examining the existence of equilibrium in Walra-
sian systems in 1932 and 1933. Karl Schlesinger, who had written an
137
extension of Walras's monetary theory in 1914, presented a modification of

Walras' and Cassel's equations to a Viennese study group in 1931 and
published a seminal paper on inequalities and free goods in relation to
general eqUilibrium theory in 1933. In that same year, Abraham Wald
wrote one of his papers on the existence of a competitive equilibrium. He
wrote another one the next year, another the year after that, and published
yet another in 1936. In 1932 John von Neumann reported to a mathematics
seminar at Princeton that he was working on the problem of dynamizing a
Walrasian system by introducing continuous changes in the supplies of
economic resources. He finished a paper on the topic in 1935 and published
it in 1937. In 1939 Hicks attempted to extend the Walrasian system in
dynamic directions. These and many other contributions in the Walrasian
vein in the 1930s led without a hiatus to subsequent work. 1
Menard frequently does not make clear whether he is taking the role of
an objective reporter of interpretations that have been made or the role
of an advocate of interpretations, but the reader gets the impression
that he does both. Menard does not group the subject matter into broad
topics and SUbtopics, despite his statement that he identifies three major
areas of controversy: "the characteristics of the general equilibrium model,
and particularly of the tatonnement; the static or the dynamic nature
of the analysis; and the scope of validity of the model." The character of
the tatonnement is part of the topic of the static or dynamic nature of
the analysis, and that is included within the topic of the characteristics
of the general equilibrium model. Menard's statement, therefore, does
not serve well as a classificatory guide. Nevertheless, he identifies most
of the areas of controversy in the literature on Walrasian economics, pre-
senting them one after another rather than as parts of an architectonic
plan. Finally, Menard does not mention three of the major problems in
Walras' theoretical work. One is the problem of the two models, discussed
below. Another is that positive net saving and investment occur in Walras'
models of capital formation, but he nevertheless asserted that long-run
equilibrium is determined on the basis of given supplies of the economic
resources, including the capital stock. The other is that Walras did not
correctly identify the equilibrium values of the variables in his disequilib-
rium transactions model. For most of his career he thought that those
values were ones that exist in a pledges system.
There is scarcely a sentence in Menard's chapter that does not provoke a
response, of agreement or otherwise, but in order to stay within the limits
of available space I will select for review some issues that he raises about
which it may be possible to add something interesting.
The Problem of the Two Models

There must be some explanation for the interminable unedifying con-
troversies on many of the issues of interpretation of Walras' ideas that
Menard records, other than the character of those ideas. They are not
complicated, and they are not conveyed in obscure terminology. Why, for
example, 90 years after Walras' last theoretical work, is there still disagree-
ment over whether his treatment of tatonnement is static or dynamic?
Surely that should have been clear from the time it was written. The
explanation is to be found largely in the following situation.
Menard states that Walras "was probably aware of a problem men-
tioned by Bertrand (1883) in his review of the Elements," namely that
disequilibrium transactions change asset holdings and therefore change
demand functions, leading to a different set of solutions for the equations
of general equilibrium than the set that exists for the pledges model. He
knew that such transactions are associated with many other important
changes of conditions. Walras was not only aware of the problem long
before Joseph Bertrand mentioned it (see Walker, 1989b), and not only
replied to Bertrand about it, but he also developed two different models in
an effort to cope with it. In the first three editions of the Elements, he dealt
with disequilibrium transactions and production as well as some pledges
markets. In the 1900 edition, he assumed that all markets are pledges
markets. Unfortunately, he obscured his first model and detracted
from the presentation of the second one by mixing them together in that
edition.
That is the explanation for many of the controversies over Walras'
work. Readers of the 1900 and 1926 French editions and those who use
William Jaffe's English translation of the latter (which is virtually iden-
tical to the 1900 edition) obtain a confused view of what Walras was
saying about the pledges model. They also neglect the model in which dis-
equilibrium transactions and production occur. This will be called the
disequilibrium transactions model, since all disequilibrium phenomena
are associated with those transactions. Recognition of that model and
disentangling the pledges model from it will be the major factors that will
lead to a reinterpretation and reevaluation of his work. For example, it is
understandable that some scholars may think the pledges model has no
true dynamics, but the disequilibrium transactions model cannot accurately
be described in that way. It is understandable that the empirical usefulness
of the pledges model would be questioned, but the disequilibrium transac-
tions model, with suitable modifications, should be judged more favorably
on that score. The entrepreneur has a limited and artificial role in the
pledges model but is very busy in realistic ways in the disequilibrium

transaction model, and so forth.
Mechanical Analogies
Menard stresses that the analogies that Walras believed existed between
economics and theoretical mechanics "shaped the whole structure and
conceptualization of the Elements." No doubt Newtonian mechanics and
nineteenth century physics have inspired Walras' approach to economic
modeling. It has recently been shown, however, partially on the basis of his
notes on the topic deposited in the archives at Lausanne, that he identified
relationships in economics first, and only later found relationships in
physics to which they are analogous, not the other way around. Moreover,
he did not believe that the analogies between physics and the content of
economics are simple and straightforward (Jolink and van Daal, 1989).
The usefulness of a knowledge of the methods of the natural sciences, he
believed, was manifested on the levels of approach and attitude toward
theorizing, not on the substantive level of economic reasoning or practice.
This is reflected by Walras' abandoning his description of economics as a
physio-mathematical science. These issues are interesting from genetic and
antiquarian points of view. Nevertheless, it would be an error to judge the
worth of Walras' work by reference to the sources of his inspiration, or to
his philosophical notions, or to his ideas about methodology, or to his
beliefs about analogies between economics and physics. His work should
be judged on the basis of whether it is illuminating and useful in reference
to economic behavior.
The Existence of Equilibrium

Menard considers whether equilibrium exists in Walras' model. The prob-
lem of the two models is immediately manifested by the fact that Menard
does not mention the existence of equilibrium in relation to the disequilib-
rium transactions model. Instead, he tacitly selects the pledges model for
discussion, thus necessarily giving a partial account of Walras' work, its
virtues and deficiencies. This aspect of the issue will be put aside, however,
to examine the underlying basis of Menard's discussion. He and other
economists think it is possible to investigate the existence of equilibrium
in isolation from the question of the stability of equilibrium. The issue
of existence, modern general equilibrium theorists explain, is the mathe-
matical one of determining whether there is a set of solutions to thevari-
abIes of a general equilibrium system of equations, hereafter called "a
solution." If not, it is pointless to examine whether the system tends to
move toward equilibrium. That is the view that economists have been
persuaded to adopt by scholars who were mathematicians by training,

like Karl Menger, Abraham Wald, John von Neumann, Gerard Debreu,
and Kenneth Arrow.
Mathematical economists have not, however, recognized that the par-
ticular solution that exists for a system of equations in an economic model
depends upon the path of the system in disequilibrium. For example, to use
a system of equations with given asset holdings in a proof of existence is
implicitly to select the dynamics of a pledges model. The use of that
particular system of equations presumes that the characteristics of the
dynamic adjustment process generate a path that does not cause endo-
geneous changes in the parameters of the equations. Consequently, the
traders have to make pledges to trade rather than actually exchanging
commodities at disequilibrium prices. Otherwise the equations that are
examined for the existence of a solution are not the true equations of the
model, for if disequilibrium transactions and production were to occur,
many of the parameters would become endogenous variables determined
by additional functional relationships. The equations would therefore be
different, so the solution for the variables would be different, if it exists.
Thus it cannot be asserted that a competitive equilibrium exists without
specifying the type of dynamic path followed by the system, and therefore
the existence and the stability of equilibrium are indissociable.
That leads to the question of uniqueness. Menard deplores the fact that
there are many solutions to "the" system of equations-evidently the
pledges system-on the ground that it is not possible to say anything
definite about equilibrium in that case. Gross substitutability must be
assumed, general equilibrium theorists contend, in order for there to be a
unique equilibrium; and Menard expresses disappointment about that. He
believes that a unique solution is unlikely because of the unrealism of the
gross substitutability assumption. To some economists this implies that the
real economy is therefore not an equilibrating system or has no unique
equilibrium and that general equilibrium theory is thereby rendered use-
less in principle. That reaction might be appropriate if the real economy or
a reasonable model of it can be determined not to be an equilibrating
system. In actuality, the point of view on which Menard reports confuses
mathematical with economic properties. The existence of many possible
alternative solutions in an equilibrium model is a mathematical property of
the situation contemplated by the theoretician. His identification of multi-
ple possible equilibria does not alter the uniqueness of the equilibrium to
which a real economy or a well-specified model actually moves. If an
economy is an equilibrating system, its particular conditions and character-
istics will lead it inexorably toward a specific equilibrium, that is, a unique
equilibrium, no matter how many mathematical solutions there are, and

whether there is gross substitutability or not. An economist may not be
able to identify or predict that equilibrium, depending on the degree of
knowledge he possesses about the economy or the degree of detail of the
model by which it is described. If there is indeterminancy, is in the
theoretician's knowledge, not in rerum natura.
The Pricing Mechanism

Menard believes that all Walrasian traders are price takers and therefore
do not change the price. That is "one of the major assumptions of the
model." He therefore supports the received view that there is no mechan-
ism for changing prices in it. Like other economists, Menard believes that
as a result a central price setter is needed to perform the function of
changing prices. He also asserts that the assumption of that institution
leads to bad consequences: "Admitting the principle of a centralized
procedure of adjustment introduces several major inconsistencies in the
Walrasian model. First there is the astonishing paradox of a decentralized
economy which turns out to be -a planned system"-a comment that
manifests an unusual idea of planning, which ordinarily means the alloca-
tion of resources by government planners, not the acceptance by a central
authority of the responses of traders in a competitive market system.
Menard concludes that "we are then confronted with a cruel dilemma:
either the tatonnement is coupled with an auctioneer, and we have a market
economy whose consistency is guaranteed by the most powerful central
agent one could imagine; or there is no such a thing as an auctioneer, but
the model is largely an empty set, since there is no indication of how prices
would be adjusted." This is an accurate report on the prevailing opinion. It
is not, however, an accurate account of Walras' work.
Menard cites me as subscribing to the view that there are no means in
Walras' model by which prices can be changed. More precisely, I wrote
that Walras "did not state explicitly how or by whom the price is 'cried,'
nor did he describe the procedure by which it is changed" (Walker, 1972,
p. 347).2 I have already acknowledged that that statement is wrong and
identified the truth of the matter (Walker, 1988, p. 306). Walras assumed
that the traders in his models behave just like traders in real purely
competitive markets. He stated that entrepreneurs, professional traders,
and all other types of buyers and sellers initially are price takers at a quoted
price, but he consistently and many times asserted that they abandon that
role and change the price as soon as they find that they cannot buy or sell
all they want at the quoted price (see Walker, 1988, pp. 306-309; 1989b).
Therefore, contrary to writers such as Richard Goodwin, Kenneth Arrow,
and Frank Hahn, a central authority is not needed to change prices in

Walras' models. That is just as well, because the magnitude of that task
would constitute an insuperable obstacle to timely pricing adjustments.
At this point it is necessary once more to distinguish between Walras'
models. As in the real system of disequilibrium transactions markets, there
is no need for a central authority in Walras' disequilibrium transactions
model. In a pledges model, however, a central authority is needed, not to
change prices, but to collect and process information in order to determine
the sign of the market excess demand quantity in each market, and to
declare that trade can occur when it is simultaneously zero in every market.
Examination of these matters would lead far from the issues that Menard
raises in his chapter.
Statics or Dynamics
Menard considers the debate on whether the tatonnement in Walras' work
is "a static description or a dynamic process." Menard points out that an
obstacle to clarity in such discussions is that writers often do not indicate
which of the several meanings of dynamics and statics they have in mind in
a particular passage. It must have been lack of clarity in that regard on my
part in 1970 that led Menard to believe I subsequently reversed my view
that "Walras's model is a static certainty system" that does not describe a
dynamic path (Walker, 1970, p. 690). To advance understanding of the
point at issue rather than to draw attention to my own work, I will take this
opportunity to give an example of how undefined terms and "the problem
of the two models" conspire to introduce confusion. When I used the word
static in the particular passage to which Menard refers, I was describing the
pledges model-in 1970 my entire account was explicitly concerned with
the pledges model-although I did not use that apt and convenient term. I
meant that the pledges model has a set of equilibrium values that are
associated with unchanging technology, supplies of the factors, production
functions, and preference functions. I should have indicated in1970 that by
the word certainty I meant that in Walras' pledges model, economic agents
do not contemplate a probability distribution of future prices, but regard
each price, when it is first quoted, as the one that will rule during the day.
By writing that Walras did not describe a dynamic path for the pledges
model, I meant that he did not indicate the specific path that prices take on
the way to equilibrium. I have not changed my opinions on those matters.
I would now, however, also state explicitly that Walras should not have
violated the condition that net investment must be zero in stationary
equilibrium. Moreover, I would not now describe either ofWalras' models
as static without explicitly defining that word, lest it be thought that I
subscribe to Jaffe's view that they do not have a dynamic path, and that the
changes within them do not take place in time. In recent work I stressed
that the disequilibrium transactions and production model is not bereft of
dynamics, for in it Walras was trying to develop a theory of real markets
with a path of actualized disequilibrium magnitudes in real time (Walker,
1987,1988). My comments about that model probably explain why Menard
believes I changed my mind. He noticed a contrast between them and what
I wrote about the pledges model in 1970, but did not recognize that I was
dealing with two different models. Nevertheless, the pledges model is not
timeless either, and I never described it as such. The tatonnement adjust-
ment process is necessarily dynamic in that model, for that process
generates a path of the price through time, as happens in pledges markets
in the real world, such as auctions and the London gold price-fixing
market. They move toward equilibrium through a time-consuming dyna-
mic process that is ordinarily irreversible.
Menard reports that yet another basic problem in the Walrasian system
is that ifthe entrepreneur is just an arbitrager, and "ifthe Walrasian model
is static analysis"-presumably the pledges model-then there is "some
doubt over the capacity to develop a dynamic version of such a model."
"Weare here confronted with the basic flaw of the Walrasian model which
is that its structure must be radically modified when we are shifting from a
static analysis to a dynamic approach." It is true that Walras identified a
position of static equilibrium in his theory of the production of consumer
goods in the sense of an equilibrium state in which the output of each
commodity is constant. Does Menard mean that the equilibrium conditions
that Walras discussed in that connection cannot be supplemented by an
account of how they are reached, that Walras' model does not have
dynamic elements within it? Menard should not, for he emphasizes Paul A.
Samuelson's demonstration that the static equilibrium of a system always
implies an underlying dynamic process which justifies the assertion that the
system moves toward the equilibrium. No modifications are made to a
model by explicitly revealing its dynamics because its statics and its
dynamics are just different aspects of one and the same model. Perhaps
Menard means instead that there is no way of introducing innovation into
Walras' models. In answer it must be observed that Schumpeter did
precisely that in a Walrasian system, revealing its capacity to absorb
technological and other changes while retaining its fundamental structure.
Perhaps, then, in referring to "a dynamic approach," Menard means it
is difficult to dynamize Walras' system into a theory of growth. In fact,
Walras contemplated a moving equilibrium in a system that is dynamic in
the sense of undergoing continual endogenously induced changes in the
capital stock, and in which the supply of labor continually changes. He also
considered the impact of technological changes upon the coefficients of
production, changes that shift the trend line along which equilibrium
moves in a growing economy. If Menard's "true dynamic analysis" is
defined as "a growth model," a correct statement on this issue is that
"[beyond] any doubt" Walras believed it is possible "to extend his model
beyond statics and to develop a true dynamic analysis." Indeed, there is no
difficulty in constructing a growth model that leaves intact the basic
Walrasian structures, as has been abundantly demonstrated in principle by
Cassel, von Neumann, Hicks, Samuelson, and Michio Morishma. Thus the
alleged "basic flaw" becomes harder to detect the more closely Walras'
models and dynamizations of them are examined.
A Theory of Capitalism
Menard draws attention to the controversy about whether a socialist
system could solve the problems of allocation by pricing the way a market
system would, given the allocation commands of the planners. That is not
in itself a controversy about Walras' meaning, but it can be turned into a
debate over what sort of an economy he tried to model and therefore over
the sort to which his work is applicable. Morishima maintained that Walras
was trying to give an account of the capitalist system. Jaffe speculated in
one place that Walras' work describes the artisan stage of production
rather than large-scale factory production, and in another that Walras
elaborated a normative conception rather than an account of artisan
capitalism or any real economic structure, speculations that were more
related to Jaffe's changing interests than to Walras' system. Menard argues
that "if" Walras' system is "one on how capitalist economies work," its
scope of validity would be severely restricted. "It would be at best a local
theory, the theory of a specific economic system. " That is a strange reason
for criticizing it. Of course it is a local theory! Of course it is a theory of a
specific economic system! Walras developed a theory of capitalism, expli-
citly full of institutional detail, such as characteristic legal forms of business
organization, types of economic agents, business practices, types of mar-
kets, and market rules. He implicitly assumed many other institutional
features of capitalism, and explicitly dealt with the aspects of economic
behavior manifested in a capitalist economy (Walker, 1989a). "At best a
local theory"? What could be better? A theory of a capitalist economy is
what all theoreticians would dearly love to develop. A useful theory of any
special economic system would be an enormous achievement, and the fact
that Walras dealt with capitalism in his disequilibrium transactions and
production model is what makes it relevant and instructive. In contrast, a
general theory of economic systems would be so lacking in content as to

be useless.
Empirical Research
Menard notes the view that the Lausanne tradition should be seriously
challenged on the ground that it does not have empirical content or
capacity to deal with data related to specific economic situations, that it is
"not adequate for stimulating empirical research." Perhaps, he suggests,
the theory is simply a thought experiment, a game, or a language. In
response it should be said that a priori judgments should not be made on
this matter. The way to form a sound opinion on it is to find out whether
there have been any applications of Walrasian systems.
Once again it is necessary to distinguish between the two Walrasian
models. The opinions to which Menard refers are accurate as regards the
pledges model but contrary to fact as regards the disequilibrium transac-
tions and production model. There have been many applications of the
latter (see Walker, 1989a). Necessarily it is the model that, with modifica-
tions, is applied in statistical studies. All statistical work with Walrasian
models necessarily deals, explicitly or tacitly, with disequilibrium transac-
tions markets and related disequilibrium phenomena. Practitioners cannot
use the pledges model because all statistics, all real quantities, are dis-
equilibrium data from a general equilibrium point of view, whereas there
is no place for real disequilibrium statistics in the fictional economy of
the pledges model. Except for quoted prices, that model deals with inten-
tions, which come and go without leaving an empirical trace. Its ex post
magnitudes would materialize only in general equilibrium. The real eco-
nomy, in contrast, has never been in general equilibrium.
Menard refers to empirical studies that were "inspired by the Lausanne
tradition" (p. 43). He should have drawn upon his knowledge of those
studies, and of the work of econometricians such as Lawrence Klein, to
make a negative judgment on the views of those who allege that general
equilibrium theory has no applicability. They are in the ill-conceived
position of informing those who are making empirical applications of
general eqUilibrium theory that their accomplishments are impossible.
Normative Economics
Menard reviews the issue of whether Walras' theory of general eqUilibrium
is a normative scheme. In one place Menard mentions that Walras wanted
to develop a realistic description of economic behavior in the first three
editions of the Elements but Menard does not enrich his review with that
consideration. Menard may be implying that in contrast the motive that led
Walras to construct the pledges model was to develop a normative scheme

that would, if actualized, achieve his social goals. In any event, Menard
returns to his allegation that "there is a problem about" using Walras'
model for empirical purposes-presumably he means "cannot be so
used." He comments that "if one is more pessimistic, one may suggest that
there is no solution to the problem since it is rooted in the normative bias
of the model," and that Walrasian theory cannot be described "as a
scientific paradigm because of a strong normative bias which might be
explained, in the last instance, by the politics of the authors." Menard's
remarks are separated by So many pages from his statement about the first
three editions of the Elements that it is difficult to tell whether he includes
both models in this judgment. In fact, neither of Walras' models was a
normative scheme. Clearly the disequilibrium transactions and production
model was not, and clearly Walras introduced the pledges model at the end
of his career to solve the problem that disequilibrium transactions created
for his system of equations, not to embody a vision of Utopia.
In his consideration of the question of whether Walras' theory is
normative, Menard describes "commutative justice" as "positive econo-
mics." A strange terminology! The very association ofthe word justice with
commutative indicates a normative matter. Commutative justice is the
exchange of commodities conducted in such a way that the exchange is
just. To Aristotle and Aquinas, that meant the normative quality that
neither party is cheated; neither receives more value than he gives. Just, in
short, means the characteristics that the writer thinks ought to obtain.
Nevertheless, Menard goes on to assert his belief that the core of the
Elements is commutative justice, whereupon the reader is prepared to read
again that Menard is using the term commutative justice to mean positive
economic theorizing, despite the opposite implication of the terms. Chang-
ing either his opinion or his usage, however, Menard writes instead that the
core of the Elements is commutative justice because "it can be satisfied
through competitive markets, where the principle of equal value for equal
value in exchange can be realized." Menard is therefore now stating that
commutative justice really means normative economic theorizing. He is
aUeging that Walras dealt with competitive markets because they are just.
This erroneous notion has been examined elsewhere (Walker, 1984, pp.
460-461), and here it is necessary only to state that Walras dealt with
competitive markets because he thOUght they were nearly universal in
the economy of his time (see Walker, 1987, pp. 162-163). Moreover, the
properties he detected in competitive markets are not normative ideas. It
was not from normative goals that he derived the theorem of eqivalent
redistributions or the principle that there can only one price in equilibrium
in a competitive market. Those are true propositions whether he liked

them or not.
Socialism
Menard characterizes Walras as a socialist. His socialism, Menard asserts,
"crystallized mainly on the role of the state." Some of Walras' opinions on
that role, Menard accurately explains, were that "state interventions were
necessary to assure perfect competition when applicable," and that the
state should intervene "to control and regulate production when free
competition is not possible" (p. 53). By no reasonable stretch of terminolo-
gical use can those functions be called socialism. The first of those policy
principles is one to which conservatives and libertarians enthusiastically
subscribe, and as for the second, the regulation of noncompetitive produc-
tion is the approach to policy typically advocated by those who do not
believe in socialism as a solution.
Menard goes on to write that Walras also urged the government "to
redistribute property so as to implement distributive justice." In fact,
Walras believed the state should purchase all land and should own natural
monopolies, which is not redistribution in the sense of taking wealth from
some private persons and giving it to others. Walras did not believe in state
ownership of other property. As Menard is fully aware, to Walras social
justice meant not taking away wealth by taxation or expropriation from
those who, by the exercise of their abilities, have managed to acquire it, or
from their heirs. What sort of socialist believes that? Do socialists not
advocate state ownership of at least the important means of production?
The answer is yes, so Menard's characterization of Walras as a socialist and
Walras' description of himself as a "scientific socialist" are misleading.
Menard maintains that Walras and Pareto "sought to establish scien-
tifically what ought to be," and concludes that they were probably both
wrong in this effort. If they had made that effort, Menard's conclusion
would be apropriate, for as he remarks, "there is nothing in pure eco-
nomics as they formulated it which can give such a scientific foundation
to social choices and individual values." Those highly cultivated scholars
were not, however; so unsophisticated as to suppose that they could prove
their normative principles scientifically, and often criticized others for
trying to do so. Walras explained that in contrast his policy views were
scientifically based in the sense that they dealt with the realities revealed
by his theory, and would be efficacious because they were designed to
act upon the mechanisms and variables that the theory identified as
being important.
Conclusion
If one were to believe the negative opinions that Menard reports, one
would conclude that the entire legacy of Walras and Pareto is barren
and misleading. Menard refers to "the basic flaw," "not possible to say
anything definite," "this major result, a very negative one," "the cruel
dilemma," "incapacity to dynamize," "a thought experiment," "not
adequate for stimulating empirical research," "not a scientific paradigm,"
"strong normative -bias," etc. Menard describes the debates on Walrasian
general equilibrium theory as a field of lively controversy that has eventu-
ated in those harsh judgments on the value of Walras' work.
In fact, most of controversies have been generated by confusion over
Walras' two models, and that also explains why they have been repetitious
and unconstructive. When the disequilibrium transactions model is recog-
nized and the characteristics of the pledges model are disentangled from
it, many of the controversies will be seen to be ill-founded and will be
abandoned or resolved, and economists will reject their pessimism about
the value of Walrasian general equilibrium theorizing. It will be seen
clearly that most of the charges that Menard records are valid in reference
only to Walras' pledges model-that source of so much mischief and
wasted effort. Some of them are not true of either of his models. Most
of the charges are either false or not unqualifiedly accurate in reference
to the theory of economic behavior that he set forth in his disequilibrium
transactions model.
The body of investigation that Walras initiated and that Pareto contri-
buted to refining will not be relegated to antiquarianism. Examination
of their work will enter a new phase, free from the intellectual confines
imposed by the pledges model. Indeed, a new ferment is already beginning
to take place in thinking about the history of general equilibrium theory.
New perspectives on it are being achieved which will liberate great energies
in its study and reinterpretation. The old problems of interpretation will
be succeeded by new ones, and the debates on the new problems will
be constructive. They will add to an understanding of the work of
the founders of general equilibrium theory and to a better evaluation of
their contributions.
Notes
1. References to the publications of many of the economists mentioned in this paragraph
are given in Walker (1989a).
2. If a reference appears in Menard's bibliography, it is not repeated in the following
reference list.
References
Jolink, Albert, and van Daal, Jan. 1989. "Leon Walras's Mathematical Econo-
mics and the Mechanical Analogies." History of Economics Society Bulletin,
11 (Spring).
Walker, Donald A. 1988. "Iteration in Walras's Theory of Tatonnement." De
Economist, 136(3), 299-316.
Walker, Donald A. 1989a. "A Primer on the Walrasian Theory of Economic
Behavior." History of Economics Society Bulletin, l1(Spring).
Walker, Donald A. 1989b. "Walras's Model of Oral Pledges Markets," forth-
coming.
5 MENGER, BOHM-BAWERK, AND
WIESER: THE ORIGINS OF
THE AUSTRIAN SCHOOL
E. w. Streissler
1. Intellectual and Social Background
1. 1. The Austrian School Within the Marginalist Revolution
The Austrian School of Economics, created by Carl Menger and continued

by Eugen Bohm von Bawerk and Friedrich von Wieser, started as one of
the three branches of the marginalist or neoclassical revolution of econo-
mics, slightly over 100 years ago (1871-1874). The Austrian branch derives
its framework from one relatively slim volume, Menger's Grundsiitze
der Volkswirthschaftslehre (1871). Common to all three branches of the
"new" theorizing is the microeconomic approach to economic problems,
the stress placed on the individual decision-making process of economic
agents in general, and that of the consumer in particular, as the starting
point of all economic analysis; and, as to method, the use of a marginalist
calculus, particularly the extensive use of the concept of the marginal
utility of a commodity to the consumer. Although marginal utility plays
a decisive role in all three branches, the actual term marginal utility (at
least in German) and thus the first use of the word marginal stems from
Wieser. It is his felicitious German translation "Grenznutzen" of Wil-
151
liam St. levons' clumsy expression "final degree of utility," which-

according to Alfred Marshall (1890; 9th ed., 1961, p. 93)-was then
retranslated into English as "marginal utility." Wieser, a coiner of happy
phrases, prided himself on this verbal creation and, because of this and
also because the Austrian school placed the greatest emphasis on mar-
ginal utility, even tried to preempt the term Marginal Utility School for
the Austrian tradition.
Among the three competing traditions of the marginalist revolution-
the Austrian school, the Marhshallian partial equilibrium school (it was
this, rather than the direct trandition of levons, that became seminal), and
the Lausanne or general equilibrium school-the Austrian school has most
persistently and emphatically stressed its uniqueness. It should be recog-
nized, however, that these traditions are much closer to each other than
would sometimes appear from the polemic literature, and that they became
ever closer as time went by. For in the late nineteenth and early twentieth
centuries there were very few economists; they all were in correspondence
with each other; they read each other's works, mostly in the original
(knowledge of English, French, and even German was then very wide-
spread among social scientists of various extractions); and they opened
their particular journals to members of the other schools. Thus Wieser was
asked to introduce the English reader to the Austrian school in the first
volume of the Economic Journal (Wieser, 1891), and similarly Bohm wrote
in the first volume of the Annals of the American Academy (Bohm, 1890a)
and in the eighth volume of the French Revue d' economie politique (Bohm,
1894) and presented his theory of interest in the Quarterly Journal of
Economics a little later (Bohm, 1895a, 1895b, 1896a). The first book-
length introduction of Austrian economics to the English reader appeared
in Smart (1891). It is therefore inevitable that, even while stressing their
unique positions, the economists of these three schools, perhaps subcon-
sciously, assimilated ideas of the other schools as if by osmosis.
The unique aspects of the Austrian school can basically all be found in
Menger's slim founding volume. Friedrich A. von Hayek, with much
justice, has therefore called the Austrian school the Menger school
(Hayek, 1965). Menger held one of the two chairs of economics at the law
faculty of the University of Vienna from 1873 to 1903. Because the
incumbent of the other chair-the chair of economic policy-was at first
the already very old Lorenz v. Stein (1815-1885), then from 1893 onward a
man sympathetic to Menger's work, Eugen Philippovich von Philippsberg
(1858-1917), he could easily dominate economics at the University of
Vienna. Therefore the Austrian school is ve,ry appropriately also called the
Vienna school. If we want to capture the particular theoretical flavor
ORIGINS OF THE AUSTRIAN SCHOOL 153
Menger gave to his school we should best call the school the subjective
value school.
One feature common to all three founders of the marginalist tradition
(or four, if we include Marshall) was, perhaps, stressed most by Menger
and was explicitly announced as one of the aims of his work: the creation
of a unified theory of price (Menger, 1871, p. X). The large number of
different explanations of various types of prices in late classical economics,
different theories for commodity and factor prices, for international and
for national values, for reproducible and for so-called rare, e.g., nonrepro-
ducible commodities, had become a most confusing and complex maze.
With care, about ten different price theories could be gleaned from the
"definitive" classical text, John St. Mill's Principles of Political Economy
(1848). a chaotic state of affairs all the more shocking because Mill had
proclaimed dogmatically: "Happily, there is nothing in the laws of value
which remains for the present or any future writer to clear up; the theory of
the subject is complete" (Mill, 1848; ed. 1976, III/1I§2, p. 436). His and
his predecessors' basic cost-theoretical explanation of commodity prices
was evidently peppered with exceptions; among factor prices only wages
had been explained in cost-theoretical terms, and even this explanation
of the price of labor by the subsistence of workers was no longer con-
vincing in changed social circumstances (see Arrow-Starrett, 1973). Time
had become ripe for a simpler theory. And it may be relevant that the
academics, who now took over the lead in economics from the political
theorists (see Stigler, 1972), found this maze of classical price theory also
practically unteachable to their students. Thus, in the sense of Thomas
Kuhn (1962; 2nd ed., 1970), the paradigmatic test case of the new
economics of the marginalist revolution was the very provision of a simple,
unified theory of price. This also implied that a topic which had not been
really central to classical theory but rather somewhat peripheral, i.e., the
theory of "value," now became central, became the very core of reasoning.
And this unified theory of price had in particular to explain factor prices as
well, which were now seen just as other instances of prices and as nothing
else, while classical theory had treated them much more ambiguously.
Precisely this program of the revolution was announced by Menger when
he said in the introduction to his principles (Principles, 1950, p. 45) that he
wrote with "the purpose of establishing a price theory based upon reality
and placing all price phenomena (including interest, wages, ground rent,
etc.) together under one unified point of view."
1.2. The German ProtoneocJassical Tradition
Jevons explicitly proclaimed himself a revolutionary of economic thought,

and Leon Walras made it very clear that he intended a new start for
economics. Menger, on the other hand, in spite of the fact that he
enunciated many of the aims of the marginalist revolution particularly
clearly, is explicitly not revolutionary in intention but merely poses as a
reformer. At first sight, this may seem rather strange. But it becomes easily
comprehensible when one recognizes Menger's position within the all-but-
forgotten, but actually very highly developed, German economic tradition
around the middle of the nineteenth century. Quite correctly, Menger
could say of his founding volume: it was his pleasure, that it "is in no small
degree so truly the product of recent developments in German political
economy, and that the reform (!) of the most important principles of our
science here attempted is. therefore built upon a foundation laid by
previous work that was produced almost entirely by the industry of
German scholars" (Principles, 1950, p. 49).
This German economic tradition, which Menger copiously quoted, had
already developed three typical elements of the marginalist revolution long
before the actual revolution came about, in fact 40 to 45 years earlier: first,
a subjectivist outlook on the purpose of the economy and subjectivist
definitions of many central economic concepts, centering around utility or
"value in use"; second, opposition toward classical cost theory of value
(or the "objective" theory of value, as it was called), particularly as it
was propounded by Ricardo and his "school"; and finally, an attempt to
provide a unified theory of price, applicable to all commodities and all
factors of production alike. This scientific program may therefore be called
the protoneoclassical tradition of German economics in the second and
third quarters of the nineteenth century. To avoid confusion, however, it
must be stressed that this German tradition-in spite of the fact that it
already occasionally mentioned marginal utility, and not only in Hermann
H. Gossen (1854)-was not marginalist in argument and did not use the
same unified price theory as Menger. It was much more protoneoclassical
in terminology and general outlook than in method. A brief review of the
aspects of German economics relevant for Menger is therefore in order.
In the early nineteenth century the German academic world could
already boast of a score or so of professorial chairs explicitly and exclusive-
ly for economics, some going back to the early and the later eighteenth
century (the first being founded in Halle in 1727 and one in Vienna dating
from 1763). Consequently, German economics was unique in having a very
early and evidently commercially successful academic text book literature,
now unfortunately nearly forgotten: Karl Heinrich Rau (1792-1870,
teaching in Heidelberg) attained up to 1869 eight editions of his textbook

first published in 1826 (Rau, 1826; 8th ed., 1869); and Wilhelm Roscher
(1817-1894, teaching in Leipzig), the dominant figure of the next gen-
eration, to whom Menger (and apparently just about everybody else)
dedicated their books, attained a record 26 editions of his Grundzuge
(Roscher, 1854) from 1854 to 1922. Building on Hufeland's (1807)
highly subjectivist monograph on the theory of value and price, Rau's
Grundsiitze der Volkswirthschaftslehfe (note the identity of title with
Menger's founding volume) initiated the systematic treatment of the
German protoneoc1assicaf" manner in 1826 and Friedrich B. W. von
Hermann-(1795-1868, teaching in Munich) with his Staatswirthschaftliche
Untersuchungen (1832; 2nd ed., 1870) sounded the subjective value note
the most forcefully. When Menger published his book in 1871, he thus
stood in a recognized German tradition and was welcomed by Roscher in
his monumental history of German economics as one "who continued the
way of Hermann" (Roscher, 1874, p. 1039).1
From 1826 onward Rau began his treatise on economics by first setting
out three successive concepts: goods, human wants, and the economy as
the sum of all activities catering to these needs. This is the same succession
of topics that Menger takes up in his first two chapters 45 years later; Rau,
however, for the treatment of these basic concepts of a subjective value
approach, had at first used only one page, and later up to three pages;
Hermann had used 33 pages in 1832, and 50 pages in 1870; while it took
Menger, in 1871, 76 pages to deal with those subjects.
"Goods" (not commodities: note the subjective connotation of the very
term, in German Guter in contrast to Ware) are for Rau "means for the
achievement of manifold human purposes."
He thus defines goods by their subjective usefulness, not, as Adam
Smith, by the fact that they embody labor or "command" labor in the sense
of being exchangeable commodities. Even more subjectivist is Hermann's
definition in 1832 (Hermann, 1832, p. 1): "That which satisfies any of
his needs, man calls a good." Menger enlarges on the concept of goods
in 1871 as follows (Principles, 1950, p. 52): "If a thing is to become a
good ... all four of the following prerequisites must be simultaneously
present: (1) A human need. (2) Such properties as render the thing
capable of being brought into causal connection with the satisfaction of
this need. (3) Human knowledge of this causal connection. (4) Command
of the thing sufficient to direct it to the satisfaction of this need." This
formulation owes much also to Menger's predecessor, Albert Schaffle
(1867), and is original only in stressing-under heading (3)-the need
for human information.
Forty percent of Rau's treatise is concerned with the "distribution of
wealth"; and this subject is already treated in the new neoclassical mood.
While in classical economics distribution is the outflow of the organization
and laws of society, possibly of a class struggle, and with many classical
authors (particularly with Malthus and Ricardo) a consequence of the
constraints of the conditions of production on society, distribution is with
Rau just the effect of human valuation, just an outcome of the pricing
process. All prices, whether of commodities or of factors, are to be
explained in exactly the same way: by demand and supply, an idea
evidently enlarging on the treatment by the pre-Smithian Sir James Steuart
(1767). The prices of commodities and of the different factors are analyzed
in turn, and in each case demand is treated first and very extensively. Value
without a qualifying adjective is taken to be synonymous with utility and is
treated (most interestingly) along opportunity cost lines: "The value which
an object has to us is determined by the greatest sacrifice upon which we do
resolve in order to procure it" (Rau, 1826, p. 110). Different individuals
show different preferences. Thus Rau says: "Exchange in general is advan-
tageous for both parties due to the fact that the quantities exchanged are
not esteemed equally by them" (Rau, 1855, 6th ed., p. 179). This, again, is
a decisive neoclassical insight: in classical economics exchange is above all
due to divergent conditions of supply (because of the division of labor) and
equivalent values are exchanged (particularly with Karl Marx) because the
commodities exchanged embody equal quantities of labor.
From the differences in individual preferences Rau also derives the law
of demand: "As the price ... increases the number of those willing to buy
must diminish as all those refrain to purchase for whom the good has not as
much value as the price amounts to" (Rau, 1826, p. 110). In the appendix
to his edition of 1841 Rau depicted and explained a falling demand curve,
being the second economist after Cournot, whom he probably did not
know, to do so. (We know from Marshall's notes that Rau's demand curve
was one of the first Marshall ever saw; the standard German demand and
supply analysis of Rau and Roscher, with which Marshall became familiar
very early in his economic education, evidently influenced him; see Mar-
shall, 1961, 9th ed., vol. II, p. 534).
Rau's treatise was set out here in comparative detail because it was the
"old" standard textbook during Menger's youth, a book already digested
by dozens of teachers and thousands of students, roughly comparable for
Germany to Paul A. Samuelson's Economics today (remember Rau's eight
editions!). Roscher's more recent textbook (Roscher, 1854) treated these
subjects substantially in the same vein, and even more subjectivist notes
were struck by Mangoldt (1863) and Schaffle (1867), copies of whose dicta
can be found in Menger and later in Wieser. Even Menger's strictures on
classical price theory may, by 1871, be considered but a standard exercise

for a young German scholar. Hermann in 1832 was perhaps the first author
who attempted a full-scale refutation of Ricardo's price theory. His sum-
mary of 30 pages of reasoning sounds like a premature precis of neo-
classical thought and is worth quoting in full:
Even if one were willing to pass over in silence the large number of prices in the
determination of which no connection whatsoever with any costs of production
can be conceived of, it is evident that already for those goods that are brought
regularly and in any desired quantity to market the price is not at all determined
by cost alone, as ricardo and his school hold. Much rather the first and most
important factor determining prices is in all cases demand, the main roots of
which are the value in use of the good and the ability to pay of the purchaser.
Demand and the amount which those desiring a good are willing to bid for it
determine what quantity of goods they are willing to forego for the sake of the
desired good and this determines the costs to which the least productive sources
of its production may amount to (Hermann, 1832, p. 95).
Thus already in 1832 Hermann explained that all actually realized costs are
in their turn dependent upon demand and, in other statements, made all
factor prices solely demand dependent. This point is fully elaborated later
by Menger and is his signal achievement relative to the other formulations
of the ideas of the marginalist revolution by Jevons and by Walras. Her-
mann reached this conclusion because he assumed the cost curve for all
commodities (and not only for agricultural products, as with Ricardo) as
rising: There were always more and less efficient sources of production and
the latter were tapped only if demand was very high. No wonder, therefore,
that Hermann is copiously quoted by Menger! Hermann in 1832 also
originated the idea of "free" goods, goods having zero value because they
are in excess supply, and coined the terms objective and subjective theory of
value, constantly used later by the Austrians as well as their enemies. He
called costs the objective factors determining price, and utility and willing-
ness to pay the subjective factors. In German economics, therefore, no
revolutionary stance was called for to espouse a SUbjective value viewpoint
and to oppose cost theories of value. In fact, it was the other way around:
by the middle of the nineteenth century, to favor a pure cost theory of price
was next to "treasonable." Roscher ruled: "A truly national peculiarity is
the English (!) view that the equilibrium of prices must consist in an
equality of the value of all goods with the amount of labour they have cost"
(Roscher, 1864, 5th ed., § 107, pp. 200 ff.).
Even the idea of marginal utility and the "law" of diminishing marginal
utility with increasing supply were not at all unknown to German econom-
ists before Menger. It is well known that the laws of marginal utility were
formulated by H. H. Gossen (1854) and were later called Gossen's Laws.
But Gossen was a crank unrecognized by the German academic profession,
and we should therefore consider him nonexistent. In a speculative sci-
ence, as economics then was, a contribution only "exists" if it reaches
other scholars. Gossen was only discovered in the late 1870s by Jevons;
and Menger rightly wrote later to Walras that Gossen's work showed no
resemblance to his own "in the decisive questions" (in a letter, Jaffe 1965,
vol. II, p. 176, letter 765, which Emil Kauder, 1965, p. 100, unfortunately
wrongly construed as stating that there was only a superficial resemblance
between Menger's work and that ofWalras, the recipient of the lette-r). On
the other hand, diligent search can uncover many references to marginal
utility in the German academic literature of the time. Certainly Bruno
Hildebrand had stated (in italics) in 1848 in another of those manifold
German refutations of classical cost value theories: "The more the quantity
of a useful commodity is increased the more d6es the utility of each
individual piece of the commodity diminish if the need is unchanged"
(Hildebrand, 1848, p. 318). This sentence was well known to Menger, who
criticized the reasoning behind it (Menger, 1871, pp. 109 ff.; Hildebrand
thought that total utility for each commodity was constant). A concave
utility function, e.g, risk averseness, was furthermore explicitly assumed by
Mangoldt (1855) as the reason for the need for pure entrepreneurial profit,
an idea that might have triggered Bohm-Bawerk's first formulation of the
Neumann-Morgenstern utility concept in 1881 (Bohm, 1881, pp. 86-89)
but curiously was not appreciated by Menger (1871, p. 137), Wieser (1914;
2nd ed., 1924, p. 251), or even Schumpeter. Mangoldt's price theory is
altogether marginalist (see Mangoldt, 1863, pp. 46 ff., esp. pp. 54 ff.), and
in parts superior to Menger's, but ignored by him.
1.3. The Social Background of the Formulation of

the Austrian School
As this discussion has shown, Menger, quite in contrast to Jevons and

Walras, had all the elements and most of the typical viewpoints of the new
neoclassical tradition at hand in the German economic tradition, to whose
membership he aspired. He is distinguished from his German colleagues
only in striving for much greater logical consistency and in his one-track,
uncompromising line of argument. For him, demand alone, founded on
individual utility, was the sole explanation, not the German (or Marshal-
lian!) demand and supply. Thus he alone among the German authors was
able to create a scientific "paradigm" in the sense of Kuhn, a model to

mold future research.
But apart from the fact that he-and possibly also Bohm-Bawerk-
were one notch above their best German colleagues as to scientific
capacity, he was also the founder of a school of great cohesion and of the
longest duration ever achieved in economics (about three-quarters of a
century during four generations of scholars of world standing). The Ger-
man tradition did not achieve this degree of social cohesion. In fact, shortly
after Menger's appearance it was destined to peter out.
The ability to found a school, on the one hand, had to do with the
intellectual attractions and the charismatic abilities of the founders, in the
case of the Austrian school that of Menger, but also that of his immediate
pupils, Bohm-Bawerk and Wieser; but it had also to do with the social
framework in which the school could flourish. In central Europe economics
was very much a "public science" or a "science of the state" (in German:
Staatswissenschaft); and thus the state concerned itself very actively in its
development. In fact, the demise of the protoneoclassical tradition in
Germany was actively engineered by the new German Empire: The
Prussian Ministry of Culture called Gustav Schmoller to Berlin in 1882 and
from then on tried to install Schmoller's adherents of the opposing so-
called younger historical school in the German chairs of economics. The
younger historical school espoused the concept of the uniqueness of the
German people in their economic development and was hostile to the idea
that a people as great as the German nation could ever be bound by any
universal economic truths. It was thus very serviceable to the ideology of
the new Second German Reich. The protoneoclassical tradition, on the
other hand, had been that of the southern and middle German universities
in smaller German states (some of them politically close to the former
German center, Austria, e.g., Bavaria, Saxony, Baden, etc.).
Menger was thus disappointed in the originally not-at-all-impiausible
hope of placing his pupils in the economics chairs of Germany. And it has
to be stressed that one of the attractions of a successful scientific school was
that it promised prime university chairs, and these, as in economics, not
only conferred very high social status but were extremely remunerative
as well.
The first professor of economics ever to be appointed in Germany,
Simon Peter Gasser in 1727, was made a Prussian privy councillor
(Geheimrat) on the very occasion of his appointment. Rau was aulic
councillor (Hofrat) of the Grandduchy of Baden, Hermann state councillor
(Staatsrat) and head of the Statistical Office of Bavaria, Roscher aulic
councillor of Saxony, Menger himself was to become autic councillor in
Austria (in 1896), B6hm-Bawerk and Wieser both cabinet ministers (the
former three times and for an extended period), and consequently privy
councillors. All three were appointed Life Peers of the Upper House of
Parliament in Austria, and B6hm-Bawerk became President of the Impe-
rial Academy of Sciences as well. Menger, it should be remembered, was
one of the tutors of the Crown Prince Rudolf of Austria and, in the end,
the sale tutor who accompanied the Crown Prince on his tours through
Europe. He even published together with the Crown Prince. (This rela-
tionship was partly responsible for his appointment as full professor at the
University of Vienna.)
The social importance of the chairs of economics attached to the law
schools (as in Vienna) was due to the fact that the law schools were the
recruiting ground for the whole administrative section of the civil service
(apart from a few engineers). And the large student population of the law
schools made professorial appointments very remunerative. Each student
had to pay for every lecture hour a not-inconsiderable lecture fee which
went to the professor in addition to his salary. (This made it financially
attractive to be a star lecturer, as Menger was, and, in fact, created
competition between professors, with students changing universities fre-
quently.) Furthermore, the examination fees, in which both professors and
the university officers shared, were very steep. Professors were elected (for
one year) to the office of dean of the faculty and to that of rector of the
university in turn; and it was said that the fees of a deanship at the
University of Vienna during Menger's or Wieser's time earned one the
money to buy one tenement block and a rectorship the money for two
tenement blocks. At the University of Prague, where Wieser was rector in
1901-1902, the fees would not have been much less.
Thus a successful university career meant very much in material and
social terms. But even the least successful gained: in a title-conscious
society the entrance to any scientific career via the examination, called
the Habilitation, at least conferred a title (Privatdozent and later Profes-
sor) as a reward for scientific publications and unsalaried teaching at the
university.
A successful scientific "school" dealing with a socially important subject
therefore stood a good chance of becoming an "old boy" network; and this
possibility the Austrian school of economics evidently exploited to the full,
being headed, as it was, by three men as outstanding (both scientifically
and socially) as Menger, B6hm-Bawerk, and Wieser. Thus in Austria in
the late nineteenth century and up to the 1920s, if one already came from
the upper class and had both intellectual ambitions and the desire to rise to
a high government position, one seems to have turned to economics (as a
specialization within the law school). This social cachet of their school was
expressed in his memoirs by a notable social climber, the privy councillor
R. Sieghart, more or less the head of the Austrian civil service in the early
twentieth century, who was proud to be a member of the school. Most of
its 30 or 40 members came from civil service or at least professional class
parentage, and about one-half were already noble af the start of their
careers, though usually nobles of a very recent creation. In the first three
generations of the school, only Joseph A. Schumpeter was the son of a
"mere" manufacturer. Ludwig v. Mises was its only notable Jewish mem-
ber; but he was a noble already in the fourth generation; and his father was
already totally divorced from "trade" and a civil service engineer. The
relative paucity of Jewish members of the school is remarkable because of
the normally very high proportion of Jewish citizens in Austrian intellec-
tual and artistic life. This is proof of the social selectivity of the school, or
of a self-selection mechanism among entrants. It is a curious fact that a
scientific school which was evidently quite restrictive in recruitment could
achieve such a long duration of highest competence and of world renown.
Menger furthermore achieved his position at the University of Vienna at
a strategic moment. Austrian academic life had declined during the abso-
lutist period of the first half of the nineteenth century. All university
appointments in Austria were then and still are state appointments. In the
third quarter of the nineteenth century the state decided to invigorate
academic life in Austria by calling foreigners, Germans and Swiss, to all
the important Austrian chairs (in economics L.v. Stein is an example; also
A. Schaffie, Menger's immediate predecessor). By the fourth quarter of
the nineteenth century the Austrian ministry of education decided that by
then the foreign academic "imports" had taught enough to a promising
new generation of Austrian scholars. The academic chairs in Austria could
therefore once more be filled with Austrians. Menger was one of the first
of the new Austrian scholars appointed to a vacant chair, and in Vienna
at that.
The dominant position of the university in the capital of Austria, the
University of Vienna, in the highly centralized Austrian state of that time
can hardly be exaggerated. The holder of the chair of economic theory in
the University of Vienna had to see to the recruitment of the majority of
the candidates for an academic career in economics. After writing a thesis,
the young aspirant had to be appointed (by Habilitation) to the position of
an unpaid university lecturer by the faculty on the recommendation of the
professor of economic theory, then Menger. The Emperor could appoint
him to a salaried position in one of the professorial chairs of Austria; and
he was likely to follow the advice of, as it were, the principal professor, the
holder of the chair in Vienna. Menger's influence was enhanced by the fact
that, early in his career, he attracted two very able pupils, the coeval
friends, later brothers-in-law, Friedrich v. Wieser (1851-1926) and Eugen
Bohm v. Bawerk (1851-1914). Wieser even suggested, with a certain lack
of modesty, that the importance of Menger's Grundsiitze lay in the fact that
"I and Bohm-Bawerk read it" and were won over by it to economics-a
gross exaggeration, but still an exaggeration only. Besides Bohm-Bawerk
and Wieser, many lesser but still highly influential luminaries, four of
whom also gained ministerial office (Mataja, R. Meyer, Schumpeter,
Reisch), were among the other members of the Austrian school of econo-
mics. The others were top rank civil servants, bank and railway directors,
and in fact held mostly these key positions and not salaried professorial
appointments. Menger was thus at the hub of a very powerful network of
influence and patronage. Add to this the fact that his private library was by
far the most outstanding library of economics in Austria, so that any career
in economics had to start with his invitation to use this private library.
Forceful personality that he was, it is therefore-from the point of view of
the sociology of science-not at all surprising that he dominated Austrian
economics for two or three decades. The full extent of his intellectual
greatness is only to be gathered from his domination of Austrian econo-
mics for such a long period, i.e., up to the middle of the twentieth century.
As has already been hinted at, even the acerbity, if not to say scurrility
of the so-called "first Methodenstreit," the methodological controversy of
Menger with G. Schmoller, has to be seen partly along these lines as a fight
for influence and highly paid academic positions. After a period of import-
ing German academics to Austria, a reciprocal export of Austrians to Ger-
man professorial chairs seemed quite logical. But Menger had completely
misread the consequences of the political change that had taken place in
Germany since the foundation of the new German Empire in 1871.
Germany was now dominated by Berlin and no longer by Vienna, the old
capital. University teaching had an important role to play in the formation
of the new German national consciousness; and in economics this role was
played by the younger historical school, led by Schmoller, the professor in
Berlin. The mutual denigration of the two schools was to make it impossi-
ble for any university within each of the two fields of influence to appoint
any scholar belonging to the other competing group. The Methodenstreit
was a labelling device relieving the appointing bodies of the headaches of
personnel selection. Within the German language area, the Austrian
branch of economics- by a curious and mainly political incident- became
for half a century the theoretically much more advanced discipline, in spite
of the fact that it was really only a transplant and a further development of
a former German academic tradition.
After having set Menger, B6hm-Bawerk, and Wieser in their historical

and social background, we shall next briefly sketch their personal bio-
graphies and then turn to the examination of their individual scientific
contributions.
2. Biographical Summary
2.1. C. Menger
Carl Menger was born on February 23, 1840, in Neu-Sandetz in

Galicia. His father, Anton Menger, Edler von Wolfensgtiin, was an
attorney and came from a German Catholic family in Bohemia. The title of
nobility seems to have been somewhat dubious and was not used by Carl
and his two brothers, Anton, a prominent socialist and, as his elder
brother, professor in the Law School of the University of Vienna, and the
eldest Max, an attorney and prominent liberal member of Parliament. The
father of Menger's mother, Caroline Gerzabek, was a landowner who had
bought a landed estate from the state in Galicia. Carl Menger studied law
only briefly in Vienna, but in Prague extensively and received his doctor's
degree from the University of Cracow. He was thus more or less self-taught
in economics. He first worked as a journalist, then entered the Prime
Minister's Office in the press department, where he had to report on
economic developments. His stock exchange reporting is said to have
shaped his demand-oriented economic outlook (evidently, stock market
prices do not reflect cost of production values). He passed the Habilitation
in economics at the University of Vienna in 1872 with his Grundsiitze der
Volkswirthschaftslehre (1871), became associate professor of economics in
1873 in the chair vacated by the early retirement of A. Schaffle in 1871, and
was promoted to full professor in 1879. He was active in advising the
commission for monetary reform, preparing Austria's changeover to a gold
currency in 1892. In 1900, he became a Life Peer in the Upper House of
Parliament. In 1903, he had to retire prematurely from his professorship,
possibly because he had fathered an illegitimate son, the well-known
mathematician Karl Menger. He died in Vienna on February 26, 1921.
2.2. E. Bohm von Bawerk
Eugen Ritter Bohm von Bawerk was born on February 12,1851, in Brunn
in Moravia, as the son of the Statthalterei-Vize-priisident (Lieutenant
Governor) of Moravia, Hofrat von B6hm. His father had been ennobled as
the Chief of Police in Vienna during the revolution of 1848. Eugen's early
career parallels that of his friend, Friedrich von Wieser, a few months his
junior, whose sister Paula Bohm later married. Together they went to the
Benedictine Schotten-Gymnasium in Vienna; together they studied law at
the University of Vienna; together they worked for the inland revenue;
together they intensified their studies in economics in Germany on a leave
of absence in 1875-1877, studying with Karl Knies in Heidelberg, Roscher
in Leipzig, and Hildebrand in lena. (They were thus the last Austrian
economists to imbibe the old protoneoclassical German tradition at first
hand.)
Bohm passed his Habilitation in economics at the University of Vienna
in 1880, was shortly after called to a chair at the relatively unimportant
Austrian university of Innsbruck, where he was associate professor from
1881 to 1884 and became full professor in 1884. In 1889 he left the uni-
versity in order to enter the Ministry of Finance in a high civil service
position (Ministerialrat; roughly, Assistant Secretary). Few economists
realize that his academic career had only lasted for nine years and that
Bohm was during most of his life a top administrator and a high court
judge! He rapidly rose to the rank of Sektionschef (Permanent Secretary)
and above all prepared the introduction of the first progressive income tax
in Austria in 1896. In 1895, he was for the first time Minister of Finance for
a few months, 1897-1898 for a second time, and then for a third time for
the unusually long stretch of nearly five years, from 1900 to 1904.
Having once been a cabinet minister, status considerations made it impos-
sible for him to return to his civil service position in the Ministry of
Finance. He was therefore appointed President of a Senate in the High
Administrative Court, adjudicating above all on tax matters, in between
his first and second and his second and third ministry. He became a Life
Peer in 1897 (i.e., already before his teacher Menger). The signal service of
his third ministry was the conversion of the Austrian national debt from 4.2
to 4.0 percent annual interest. As his obituaries show, this achievement
and the others during his 15 years in administration were considered by his
contemporaries in Austria-particularly by Menger himself-as far out-
ranking his scientific achievements.
On his retirement from his third ministry in 1904, Bohm was appointed
(as a sort of retirement prebend) to a supernumerary professorship created
for him at the University of Vienna without any duties attached to it. But it
was not in his character to cease working studiously. Already during his
administrative career he had constantly taught for a few hours a week on
the side as an unpaid honorary professor in Vienna. Now it was especially
his seminar that gathered all the brilliant young minds in economics of both
the right and the left: Mises and Schumpeter on the one hand, Otto Bauer,
Rudolf Hilferding, and Emil Lederer on the other. From 1911 to his death,
B6hm was President of the Academy of Sciences. He died at his holiday
resort, Kramsach the Tyrol, on August 27, 1914, as the First World War
was about to start, which was to destroy all that he stood for as the
prototype of a loyal, extremely correct, and highly industrious and efficient
imperial civil servant.
2.3. F. von Wieser
Friedrich Freiherr von Wieser was born on July 10, 1851, as the son of the
later Privy Councillor and Vice President of the Supreme Court of Audit,
Leopold Freiherr von Wieser. His father had been Commissary General in
the war of 1859 and had the highest status (Geheimrat, or privy councillor)
and the highest rank of nobility (Freiherr, or baron) of the fathers of the
three scholars discussed; but he, too, had started life as a commoner and
only risen into the nobility by his own service. As titles brought little
money, B6hm and Wieser were, however, poor-particularly Wieser, who
had many brothers and sisters.
Wieser passed the Habilitation in economics at the University of Vienna
in 1883, somewhat later than B6hm, but was called in 1884 to a more
important university, that of Prague, as associate professor, becoming full
professor there in 1889. In 1903 he succeeded Menger in Vienna, B6hm
and Wieser together thus dominating economics there for the last peace-
ful decade of imperial Austria, from 1905 to 1914. In 1917 Wieser was
appointed a Life Peer, becoming in the same year Minister of Trade in the
last Austrian imperial cabinet. He died in his holiday resort, Brunnwinkel
am Wolfgangsee, on July 23, 1926.
Wieser, in contrast to B6hm, had thus been an academic most of his life.
He was a fascinating teacher, particularly of undergraduates, "a priest in
the service of truth," as his flattering obituary calls him. As a scholar he
was, however, not interested in scientific discussion and practically never
quoted his sources, making it appear that everything was his own. In
contrast to Menger and B6hm, who were outright classical liberals, he was
a political waverer and an economic interventionist, starting quite a bit
fascinated by socialism and ending next to fascism. His last work, Das
Gesetz der Macht (1926), to me a shocking book, demonstrates the
breakdown of moral values that many members of the old oligarchic
Austrian elite suffered when their lode star, the imperial order, broke
down. With ample admiring references to Mussolini, Primo de Rivera, and

even Hitler (in 1926!) and laced with antisemitic prejudices, it argued that
political power is justified by success alone!
3. Carl Menger's Scientific Contribution
3. 1. Menger's Contribution to the Central Neoclassical Issues
As we have seen, many of the protoneoclassical ideas had already been

formulated in the German tradition; and Menger-though with some
interesting variations, to be discussed under the next subheading-mainly
recounted and enlarged on these ideas in the first two chapters of his
Principles of Economics (1871), his only book on economic theory. (The
second edition was published posthumously and thus does not necessarily
convey the author's considered opinion.) These chapters are called "The
General Theory of the Good" and "Economy and Economic Goods." His
decisive innovation to mainstream economics comes in chapter 3, "The
Theory of Value." The German tradition had looked at the determination
of the price by demand and supply of each single commodity separately; in
fact, formally its general line of reasoning would be best expressed by
Marshall in his partial equilibrium analysis. Menger, on the other hand,
was basically interested in a general interactive framework. He tried to
analyze the "endeavour to satisfy ... needs ... as completely as possible"
(Principles, 1950, p. 114). His pivotal point was that "the magnitudes of
importance that different satisfactions of concrete needs ... have for us are
unequal" (p. 139): each need has its own utility scale. These utility scales
are "numerically expressed" by Menger in ten different schedules of
numbers. There are many needs to be balanced, and the quantity of each
good satisfying one particular need can also be varied: "Usually not a
single good but a quantity of goods stands opposite not a single concrete
need but a complex of such needs" (p. 129). In order to achieve maximum
satisfaction, each need has to be satisfied to the same degree. In numerous
examples the principle of equimarginal utility of satisfaction for all needs is
stated, and formulated generally for one commodity satisfying different
needs. The marginal utility (the term is, of course, not used by Menger)
of satisfaction reached determines total value: "The value of a particular
good or of a given portion of the whole quantity of a good ... is ... equal to
the least important of the satisfactions assured" (p. 139). Thus Menger,
in contrast to the German tradition, was, as he said, interested in the
change in values, or, as we would now say, not so much in absolute but in
relative prices.
This basically general interactive approach to price determination was

common to all three founders of the neoclassical tradition-Jevons, Wal-
ras, and Menger. Menger's own formulation was easy to grasp for his
German colleagues; and Roscher, in fact, immediately quotes him (appro-
vingly) as to the idea that one has to look at the different utility schedules
of several goods simultaneously . Yet the discussion is still rather verbose
and must be considered the least well-expressed statement of the equimar-
ginal principle of the triumvirate-in comparison with Jevons or Walras.
Partly this is due to the fact that, in spite of the mutual general interactive
approach to the determination of values, Menger alone of the three cannot
properly he counted a full general equilibrium theorist because he alone
does not postulate markets characterized by pure competition as typical
but rather, much like Edgeworth, argues in terms of the bargaining situa-
tion between two isolated individuals. He therefore, and quite appro-
priately for such a situation, never states the principle that the ratio of
marginal utilities must equal the ratio of prices of the respective goods, a
principle that Jevons and Walras propound. Under the subheading "The
Limits of Economic Exchange," he merely states that "this limit is reached
when one of the two bargainers has no further quantity of goods which is
of less value to him than a quantity of another good at the disposal of
the second bargainer who, at the same time, evaluates the two quantities
of goods inversely" (p. 187). In Menger the more general statement in
terms of inequalities thus replaces the more easily grasped equality of
Jevons or Walras.
But if Menger lacks clarity and simplicity in his explanation of relative
prices, he is, on the other hand, far ahead of Jevons or Walras in the
second central endeavor of the marginalist revolution, the formulation of
the new theory of factor prices. Factors are called by Menger "goods of
higher order"; and the value of each and every factor is, according to him,
determined in exactly the same way: by its indirect utility. Already in the
second chapter he states (in italics as a general principle): "the economic
character of goods of higher order depends upon the economic character of
the goods of lower order for whose production they serve" (p. 107). The
cost theory of value is rejected as irrelevant. Costs are always bygones,
unimportant for present valuation: "The measure of value is entirely
subjective in nature .... Comparison of the value of a good with the value
of the means of production employed in its production does, of course,
show whether and to what extent its production, an act of past human
activity, was appropriate or economic. But the quantities of goods em-
ployed in the production of a good have neither a necessary nor a directly
determining influence on its value" (pp. 146-147). Although consistent
with this point of view, it amounts to a cardinal weakness of his work that
Menger eschews any formulation of the theory of production whatsoever.

Yet, curiously, he is the only one of the three who presents a general
marginal productivity formulation for the valuation of all factors. He says:
We obtain a general law of the determination of the value of a concrete quantity
of a good of higher order. Assuming in each instance that all available goods of
higher order are employed in the most economic fashion, the value of a concrete
quantity of a good of higher order is equal to the difference in importance
between the satisfactions that can be attained when we have command of the
given quantity of the good of higher order whose value we wish to determine
and the satisfactions that would be attained if we did not have the quantity at our
command. This law corresponds exactly to the general law of value determina-
tion (pp. 164-165).
Menger adds: "The value of a good of higher order will be greater ... the
greater the prospective value of the product if the value of the other
complementary goods necessary for its production remains equal" (p.
165). Marginal productivity with Menger is thus expressed in terms of
expected utility. It had to be, because in this bargaining framework he
considered prices as indeterminate relative to marginal utilities. It is also
clear in this and other passages that Menger already knew perfectly well
the principle of opportunity cost, which should therefore not be attributed
to Wieser, as is frequently done; at most we should antedate this principle
before Menger to Hermann and Rau.
3.2. Menger's Specific Contributions
Menger's central themes, together with the parallel notions of Jevons and
Walras, changed economics in general. We have, however, to turn to his
specific notions in order to understand the particular flavor of his long-lived
school.
Menger first placed great stress on the importance of information in
economics, a theme not common in the German protoneoclassical tradi-
tion and in which his school only followed him later in the works of
Schumpeter on the one hand, Hayek on the other. The very "progress in
human welfare" is mainly due to better information: "The quantities of
consumption goods at human disposal are limited only by the extent of
human knowledge of the causal connection between things and by the
extent of human control over these things" (Principles, 1950, p. 74). With
Menger, entrepreneurial activity above all consists in obtaining and provid-
ing information about the economic situation. Social institutions, whose
ORIGINS OF TIlE AUSTRIAN SCHOOL 169
purpose it is to gather information, are examined. But their success is

partial. Menger identified the time-consuming nature of market supply
with the likelihood of forecasting errors. Production costs are irrelevant
once an entrepreneur has supplied a market whose conditions he has not
correctly foreseen. The only thing that counts is the subjective valuation of
the buyers at the moment and under the conditions of purchase. This
approach was seminal for the well-developed business cycle theory of the
Austrian school: Menger's stress placed on planning errors in production,
on the likelihood of mistakes caused by the time structure of production,
even on economic crises, opened the way.
Although Menger had no developed theory of the production process,
he had, as a second speciality, a well-developed theory of the time structure
of production. Indeed, it is the time structure of production much more
than marginal utility that is his and consequently the Austrian school's
basic idea: Menger's Principles start out with a discussion of the vertical
order of different types of goods, goods of lowest or first order being
consumption goods, inputs, or inputs of inputs, being goods of ever higher
order. Menger did not however, realize the problems of this approach, the
fact that a unique linear order of goods might not be established, that there
might be circularities, and that for a marginal productivity valuation of
inputs joint production and economies of scale cause problems which later,
among his successors, particularly by Wieser, were called the Zurechnungs-
problem, the problem of imputation. Nevertheless, it is due to Menger's
emphasis on the time structure of capital that the Austrian school became
the hot-bed for a theory of capital, a subject rather neglected in the other
marginalist schools.
A third important speciality is Menger's view of price determination and
of the market process. Menger alone among the three or four founders of
marginalist economics had a vision of social life according to which full
equilibrium is never reached. In Menger's view, only forces driving the
economy toward certain states could be assessed, only the economic
process could be analyzed which, in general, left room for a residual
indeterminacy of outcome. Consequently, he described price formation
(following his German predecessors) as "price conflict" (Preiskampf). The
bargaining element is strong in Menger (1871) and even stronger in the
theses written under his immediate or Bohm's supervision, particularly in
Gross (1884), who has an extensive bargaining theory of interest rates, but
also in Schullern-Schrattenhofen (1889). Menger, in fact, alone among the
marginalist founding fathers did not think in terms of a unique market
price and particularly not in terms of the equalization of rates of return on
capital (1888), and he thus did not assume one unique rate of interest. It is
therefore no accident that not only one of the neoclassical traditions but
also the theory of games-via Morgenstern and Menger's son Karl-stem
from Bohm-Bawerk and C. Menger. In line with modern game theoretical
argument, Menger approaches price theory by examining first the isolated
exchange between two individuals, progressing then to monopoly and
finally to competition as a rare, limiting case, reached if numbers get
very large.
Furthermore, both the explicit derivation of the Neumann-Morgenstern
utility index based on the comparison of lotteries and the idea of a certainty
equivalent can be found in Bohm's own thesis of Habilitation (Bohm, 1881)
written under Menger's (and L. v. Stein's) supervision. Utility as the
evaluation of an uncertain future event is altogether much closer to the
core of the subjective value notions of the Austrian school (see, for
example, Mataja's book (1888) on the assignment of damage than the
static and basically measurable idea of utility of the other marginalist
founding fathers. In contrast to these, Menger tried to formulate utility in
ordinal terms, not realizing, however, that his "scales of satisfaction" had,
in fact, to assume cardinality. Only Bohm-Bawerk after him and particu-
larly Wieser became full-scale cardinalists.
Probably because of the differences of information between individuals
assumed, Menger opposed aggregation for purposes of theory (in contrast
to practical purposes), particularly the aggregation of capital. He thus
bequeathed to his school a peculiar horror of macroeconomic concepts.
Again probably due to this line of thought, Menger also eschewed mathe-
matics in economic theorizing in spite of the fact that his family was of a
mathematical bent, with his son becoming a mathematician. Menger was
rather fascinated by the qualitative aspects of commodities and their
constant change, thus seeing goods basically as (at least subjectively)
inhomogenous and competition at best as imperfect competition. In fact, in
explicit contrast to a mere division of labor, Menger saw in what he called
"the division of commodities," the creation of an ever finer array of
commodities to suit all tastes and preferences, one of the main avenues
of economic development. This line of thought was later developed by
Schumpeter (1912).
The idea of the different "marketability" of commodities (we would
now say their different liquidity) led to Menger's theory of money; his
fourth important speciality. To Menger, money was the most marketable,
i.e., the most liquid commodity. Menger bequeathed to his school a
particular interest in monetary economics, both theoretical and practical.
He (Menger, 1892; 3rd ed., 1909) and his successor Wieser (1927) contri-
buted the articles on "Money" to four editions of the German language
Encyclopedia of the Social Sciences, up to the Second World War; and

both he and Bohm-Bawerk were active in the Austrian currency reform.
Menger's monetary theory is, even on the background of the German
tradition, original: he saw money above all as a reserve medium and placed
a demand for precautionary balances at center stage. In conformity with
most other authors of the German tradition, the velocity of circulation is
expressly stated to be unstable. Here again, we see subjective estimation
and provision for an unforeseeable future at work. Thus his monetary
theory is astonishingly close to Keynes' (see Streissler, 1973).
A last and fifth speciality of Menger are his methodological writings. He
distinguished, particularly in Menger (1883), between practical, historical,
and theoretical sciences, the latter having to do with general phenomena.
Theoretical research could, on the one hand, be empirical and realistic
and, on the other, "exact." By the exact method, laws that were valid
without exception, i.e., regularities in the temporal succession of phe-
nomena, could be discovered. In economics, such exact laws could be
derived by examining the elementary facts of human economizing, e.g.,
individual needs and the appropriateness of commodities to serve as
consumer or producer goods. Menger opted for such an exact method in
economic science and went so far as to say that its truths were so
compellingly evident to our mind that they needed no verification and even
that they could not be refuted. To this, Schmoller replied that the post-
ulated exact method was arid and vacuous and did not enlarge our
knowledge. The heated exchange that followed is called the first or older
Methodenstreit or methodological dispute. In their extreme formulations,
both Mengers antiempiricist and Schmoller's ultraempiricist positions
were, of course, untenable.
In his founding treatise, in his methodological discourses, and in fact in
all his works, Menger was a champion of methodological individualism, the
rule of taking as one's analytical starting point the decisions of the
individual and to use individual values as the measuring rod of all policy
recommendations. This meant that his school, even more than being
unified by the idea of subjective value, tended to be unified by the political
value judgments of strict liberalism in the old sense; or, as Blaug (1985, 4th
ed., pp. 302 ff.) puts it, stressing a distinctive feature of the Austrian
school: "The Austrian School ... was ... given over to attacks on socialism
and the espousal of laissez faire. The aversion to radical politics was a
characteristic note of economists trained in Vienna seminars." It must be
recognized, however, that there was a variety of libertarian views, even
within the Austrian School, with Menger and Bohm being much stricter
classical liberals than Wieser, Mises much more so than Schumpeter. Still,
economists with very similar theoretical views, who were decidedly not
libertarians, were excluded as members of the school, e.g., Philippovich
or Sax. This classical liberal orientation is all the more astonishing as Aus-
tria never had a powerful and continuous tradition of political liberalism.
The particular Marxist antagonism toward the Menger tradition is best
explained by the simple fact that the Austrians, much more so than the
other schools, came into conflict with Marxist ideas very early, Marx after
all writing in German; and that Wieser and Bohm-Bawerk were, in fact,
the most important mainstream economists to recognize Marxist thought
at all.
4. The Second Generation of the Austrian School:

Bohm-Bawerk and Wieser
4. 1. Menger's Pupils: An Overview
In the generation after Menger the Austrian school rapidly developed and
attracted a surprisingly large number of scholars. A number of men only
slightly younger than Menger came under his influence, such as Johann v.
Komorzynski (1843-1912) and Emil Sax (1845-1927). Robert Meyer
(1855-1914), Gustav Gross (1856-1935), Robert Zuckerkandl (1856-
1926), and Viktor Mataja (1857-1933) were important pupils of Menger in
his middle years; Hermann von Schullern-Schrattenhofen (1861-1931), a
contemporary early pupil of Bohm-Bawerk, Rudolf Sieghart (1866-1934),
and Richard Schuller (1870-1972), later an expert in international trade
policy, were Menger's last pupils in the Habilitation; finally, Richard
Reisch (1866-1938) entered academic life rather late. All these were, of
course, overshadowed by Eugen Bohm-Bawerk (1851-1914) and Friedrich
von Wieser (1851-1926). It is particularly due to these two men that the
Austrian school developed a theory of production, missing in Menger's
own treatise, and that it reinforced its interest in the theory of income
distribution to such an extent that Bohm could claim income distribution as
the particular field of the Austrians (Bohm, 1890).
The last ten years before the First World War, with both Bohm and
Wieser teaching at Vienna and with the sympathetic Philippovich as their
colleague, were the apogee of the school. Wieser was a much more strictly
neoclassical scholar than Menger, much closer to the thought of Walras or
Marshall. He showed no appreciation of Menger's notion of incomplete
information and the general absence of perfect competition but assumed in
the impersonal part of his economics full information of decision takers
and competitive market equilibrium. Bohm, on the other hand, was closer
to Menger's own thought. But even he had a conception of goods closer to
the classical tradition than Menger, for which the latter chided him not
without touches of acidity even in his obituary, charging him with having
mixed "the old and the new": Bohm, in contrast to Menger, considered the
good will of a firm and similar property rights not as goods (Bohm, 1881)
while the master had done so in a very modern way. They were goods as
complexes of information and lowered transaction costs. Thus even while it
grew, the school started to adapt to the general current of international
neoclassical economics.
4.2 Eugen Bohm von Bawerk's Specific Contribution
B6hm's seminal work deals with the theory of capital and interest (1884 and
1889; 4th ed., 1921; English 1959).
In his so-called agio theory, Bohm gives three reasons for the existence
of interest: first, momentary differences between demand and means of
satisfaction for certain individuals or, as we would say now, the lack of
synchronization between consumption and income streams; second, the
underestimation of future wants, or, as he said, the "telescopic" fore-
shortening of the future in utility terms, both because of lack of informa-
tion and because of lack of willpower (this is similar to arguments of
Jevons); finally, as a third reason, the productive returns to the degree of
roundaboutness of capitalistic production.
B6hm tried to measure capital by time, by the average time period of
roundaboutness in the use of capital goods. His idea that capitalist produc-
tion becomes monotonically more productive the more roundabout it is,
remained, of course, an unproven and unprovable assumption. A unique
time measure of capital independent of economic parameters could only be
derived in terms of Bohm's inadequate mathematics, his simple instead of
compound interest formulas. Still, recent years have witnessed endeavors
(Hirshleifer, 1967; Hicks, 1973; Faber, 1979; Orosel, 1979; Negishi, 1982)
to construct more complex, multidimensional "time" variables in terms of
which capital could be measured in the spirit of Bohm-Bawerk. (Naturally
none of them can get around the difficulties posed by the double switching
problem to any measure of aggregate capital.) B6hm's theory of capital
strongly influenced Knut Wicksell, who was the first to attempt to rectify
his mistakes. Therefore a particularly close affinity of thought exists
between the Austrian and the Swedish schools. In his own time, the first
volume of Bohm's monumental work (1884) on the history of thought
regarding interest was perhaps even more highly valued than Bohm's own
contributions to the theory of capital and interest. This volume comprised
the first academic attack, later to be enlarged (Bohm, 1896b), on Marx's
Das Kapital.
In his rather neglected thesis of Habilitation (1881) Bohm was the first to
pose explicitly the problem of the expected utility of an uncertain prospect
with different possible outcomes. As Oskar Morgenstern knew, the famous
lottery example, later the foundation of Neumann-Morgenstern utility, can
already be found there (in 1881!) and the certainty equivalent of the lottery
is discussed. Bohm also elaborated on Menger's bargaining approach to
price determination.
Highly original are B6hm's last two articles. The first (B6hm, 1914a)
tries to show that income distribution can in general only temporarily be
disturbed by the influences of outside "power." Power can be examined in
purely economic terms: it just changes demand and supply. But after some
time, the forces of substitution abolish its influence. The second article
(B6hm, 1914b) gives a macroeconomic explanation of balance of trade
deficits by the capital transactions necessary to finance budget deficits;
i.e., an explanation very close, to the present monetarist vein. Bohm's
dictum, "The capital transactions balance commands, the balance of trade
follows," seems to be very much in line with very recent theorizing
and a healthy contrast to the excessive concern with trade flows 20 years
ago. Still, B6hm was the first to see a connection between a budget deficit
and a balance of trade deficit. He had been an extremely orthodox Min-
ister of Finance, absolutely abhorring a budget deficit that would lead
to inflation and devaluation (before the times of the then only recently
established gold standard in Austria), that is to say: to monetary confu-
sion. Both these articles are therefore extremely libertarian in tone and
rabidly antistate: both in the exercise of "power" in the economy and in
budget deficits B6hm-Bawerk saw merely the cupidity of particular
interest groups.
4.3. Friedrich von Wieser's Specific Contribution
It is generally said-mostly in Wieser's own evaluation-that it was

Friedrich von Wieser who provided the full development of the marginal
productivity theory of the Austrian school centered on the idea of oppor-
tunity cost. The valuation of factors by the marginal utility of their least
important use was, in fact, called Wieser's Law of Valuation by the later
Austrian school. But Wieser was a very bad judge of his own original
contributions. As he never quoted his sources, he probably did not even

know them himself. And in assessing the adulation of his disciples it should
not only be remembered that Wieser had inherited Menger's power over
them but also that Menger's Principles were out of print and were
therefore difficult to check. (They were also translated into English later
than the main works of Wieser.) Personally I cannot see that Wieser's
statement of the marginal productivity principles themselves is much more
advanced than Menger's.
Wieser did, however, supply a theory of production, which Menger had
not done. Wieser introduced the idea of scarcity t6 the Austrian discussion
and constantly harped on the need to economize, on the necessary thrifti-
ness. For him it was production, not, as with Menger, information, that
improved human welfare. No less important was substitution, another
central neoclassical idea. His thesis of Habilitation (Wieser, 1884, pp. 54
(ff., p. 177) is the first well-known economic text to use an explicitly
substitutional neoclassical production function with diminishing partial
returns as an explicitly announced general instrument of analysis. In this
sense it is true that he did advance marginal productivity theory. As a
further contribution he was the first to pose the question, though without
answering it satisfactorily, whether marginal productivity remunerations
would exactly exhaust the full product (Zurechnungsproblem, the problem
of imputation).
In contrast to Bohm and also to Menger, Wieser was quite critical of
capitalism. In fact, he acknowledged the influence of Marx and Friedrich
Engels in the preface of his Habilitation thesis of 1884 (p. v). He consi-
dered the "natural value" of a commodity to be its price if all incomes were
distributed equally (Wieser, 1889), thinking that only with equal incomes
for all, marginal utility would assert itself. Marginal utility with him is
therefore a normative, not a descriptive notion. He fumigated against the
profits of large-scale enterprises as due to the exercise of unjust power
against which the state should offer protection. Toward the end of his life
he wrote a comprehensive text book-like treatise in the Austrian tradition
(Wieser, 1914). This is especially strong and interesting on institutional
points, e.g., on the importance of the large-scale "bureaucratic" firm. In
later life, Wieser's intellectual concerns turned from economics to social
philosophy (Wieser, 1926).
While what Wieser thought to be his main contribution to economics
was itself of only marginal productivity, he did, however, without realizing
their importance, contribute two new ideas, which shaped the school pos-
sibly even more than Bohm-Bawerk's internationally renowned ideas on
capital and interest. He did not appreciate Menger's notion of the likeli-
hood of incomplete information, but rather stressed the importance of com-

plete information for appropriate economic decision taking. His second
idea was at variance with this first topic, which essentially depended on the
existence of competitive markets. He created the notion of the central
importance of the innovative entrepreneur for economic development.
Wieser was obsessed with the need for accurate economic calculation.
To him accurate calculation was an ethical imperative and in that he did
not differ from Puritan thought of seventeenth century England that
influenced so strongly the ideas of classical economics. No wonder that
Wieser became a neoclassical author, an author who blended the old
classical tradition with the ideas of the marginal revolution! It may not be
totally irrelevant to this obsession with accurate calculation or computa-
tion, with the need for accountability, that Wieser's father achieved his
final rise in status by becoming Vice President of the Austrian Court of
Audit, of the RechnungshoJ, the court of calculation or computation, as it
was called.
Wieser explains how competition leads to one unique market price
(Wieser, 1914; 2nd ed., 1924, p. 132). Market imperfections that leave
markets without a single, unique equilibrium price are to him nearly
immoral. The market refuses to fulfill its paramount task of yielding one
sole computational figure. He speaks of a "disorderly" market-dis-
orderly conduct being just about the worst sin to a traditional Austrian
bureaucrat-and says that in this case "free market organization fails"
(Wieser, 1914; 2nd ed.,d 1924, p. 140). A "just" price, at which all parties
can "coexist" (Wieser, 1914; 2nd ed., 1924, p. 133), is justified above all
because it is a stable basis of calculation.
Accurate calculation for Wieser was not possible in the individual and
subjective sphere without consulting the measuring rod of utilities; and in
the objective, social sphere one had to use prices. Prices thus have above
all informative value; they enable the economizing subject to meet the
paramount precept of economic calculation. It is clear that Mises' idea,
that without prices a socialist economy is in effect no economy at all, was
only an obvious development from this position and the discussion ran
exactly under the title used for it by Wieser- WirtschaJtsrechnung, eco-
nomic calculation, under socialism. Just as clearly, the present idea that
prices have to be the sole informative parameters in all demand functions is
merely the formalization of Wieser's obsession. Evidently also Hayek's
ideas in The Use oj Knowledge in Society (1945) owe much to Wieser.
The second specific contribution of Wieser is his "leadership" mystique,
which, he said, he derived from the heroics of his history lessons at school.
"The leaders give any movement its aim and its plan, the masses give
it weight" (Wieser, 1926, p. 48). Such leaders are essential also to the
economic process. "Each larger group of cooperating individuals in a firm
requires a leader who unites them in a common purpose of action. His
economic leadership starts with the creation of the firm; he organizes it not
only by procuring the necessary capital but above all by conceiving the idea
and by implementing a plan" (Wieser, 1914; 2nd ed., 1924, p. 229). With
these ideas Wieser laid the foundation of Schumpeter's theory of innova-
tion (see Streissler, 1981). Schumpeter's terminology is nearly exclusively
derived from Wieser. To do justice to Schumpeter it has to be said,
however, that Wieser mainly hinted at the importance of innovation with-
out providing a full analysis. In his monumental textbook on economic
theory of 1914, Wieser characterizes the entrepreneurial position as a
combination of a "leading" kind of labor and the supply of a certain
amount of capital. Therefore, entrepreneurial leaders are subjected to a
double process of selection: they have to have capital, on the one hand,
and often very rare abilities, on the other.
Wieser adores anything that is big and therefore, above all, he exalts
the huge-firm. He sees the large firm-more precisely, the firm that has
become large through its success-as the source of innovation, as Schum-
peter only did after his American experiences (Schumpeter, 1942). The
pioneer is characterized by innate ability, technical know-how, market
experience, organization vigor, and the "audacity ofthe innovator." Trusts
are the creation of personalities "of a quite exceptional talent for business
who unite in themselves the perceptive ability, the knowledge and the
energy that are necessary for the technical and managerial organization of
the modern giant enterprise" (Wieser, 1914; 2nd. ed., 1924, p. 162).
Wieser thus takes a position somewhere between Marx and Schumpeter.
As with Marx, innovation is above all a technical process and one linked to
the application of capital on a large scale. Curiously enough, for a lead-
ing member of the Austrian school, Wieser does not explicitly mention
product innovation, which figures prominently in Schumpeter. On the
other hand, he stresses-against Marx-the importance of organization
and information, an idea derivable from Menger's characterization of
the entrepreneur.
These two central contributions of Wieser are somewhat contradic-
tory-a conflict of which Wieser was fully aware and which he traced to
different layers in the education he received. (Schumpeter was to rational-
ize this conflict-unsatisfactorily, it seems to me-as that between "sta-
tics" and "dynamics" in economics; Schumpeter, 1908.) In his purely
economic vein Wieser stresses abovc all the need for careful calculation as
the fulcrum of human action. His terminology on the creative entre-
preneur, on the other hand, strongly suggests that the innovator attempts
the incalculable; and Schumpeter brought this out explicitly. In 1884,
Wieser (p. 169) defined the entrepreneur as a mere instrument in satisfy-
ing predetermined wants of consumers. When explaining entrepreneurial
leadership he writes, on the other hand: "By and by demand accommo-
dates to the conditions of supply" (Wieser, 1926, p. 425).
Thus Menger and Bohm can be taken as examples of the logical
precision and high moral and political principles in the old Austrian school;
Wieser, on the other hand, is an example of the ambivalence, both
theoretical and political, due to an attempt to encompass the widest
possible angle of approach.
5. Menger, Bohm-Bawerk, and Wieser in Post-War

Economic Thought
From around 1900 to 1925, the stars of Bohm-Bawerk and of Wieser shone
much brighter than that of Menger; and around 1950 among Austrian
economists the brightest star was that of Schumpeter in whose work the
ideas and traditions of Bohm-Bawerk and Wieser were much more evident
than the immediate influence of Menger. This has changed drastically
within the last 20 years. As to nineteenth century economists, Menger's
influence today is second only to that of Leon Walras and David Ricardo
and curiously enough seems to have outdistanced even that of Alfred
Marshall. Among the three authors to which this article is devoted it is
above all Menger who inspires the "neo-Austrian" school or, as Vaughn
(1978) aptly put it, "Menger via Mises and Hayek." At present Bohm-
Bawerk ranks much behind Menger but by scholars is considered a first
rank economist of the past, who still stimulates a stream of disquisitions
in the field of capital theory. Wieser, finally, is by now only a dimly per-
ceived figure on whom only one or two specialist papers are published
every decade.
In a certain sense the Menger renaissance started with the seminal paper
of George J. Stigler (1937) on Menger (published on the occasion of the
edition of Menger's collected works by Hayek). Stigler deplores the fact
that the "barriers of inaccessibility and language have served effectively to
hide all but the barest outlines of Menger's work" (p. 229). He considers
Menger's Grundsiitze a book that was "systematic and profound .... it
generalized value theory to include a sound general theory of distribution"
(p. 230), and believes it to be a work "in fundamental respects unexcelled
by any other between the Wealth of Nations and Marshall's Principles" (p.
250). Furthermore, "one of Menger's greatest achievements, one which he

is not required to share with either Jevons or Walras" pp. 243 ff.) was that
Menger formulated the law of substitution. Stigler already stresses the
importance of time and incomplete knowledge for Menger and concludes
that, as Menger had no theory of cost and failed to treat the principle of
diminishing returns, "Menger's theory is applicable only to very short-run
'market' prices" (p. 243). Both Stigler's recognition that Menger was really
the first economist who fully recognized the fundamental principle of
substitution in economic processes and his opinion that Menger basically
gave only a short-run theory of price were acutely perceptive and owed
little to Hayek's own introduction (1934) to Menger's work.
In the thirties and forties (Bloch, 1940; Stigler, 1941) outstanding
scholars like Hayek and Stigler tried to show how much the neoclassical
revolution owed to Menger, and then, during the fifties and early sixties,
the roots and ramifications of the whole marginal utility theory were
examined (Kauder, 1953, 1957, 1965; Howey, 1960, 1972). From the late
sixties onward, the emphasis shifted to quite another aspect of the work of
Menger: it was now noted how much Menger differed from the other
neoclassical authors (see Jaffe, 1976), especially WaIras and Marshall. As
Blaug (1972) put it somewhat critically, "Menger is in any case the odd
man out." In fact, Menger's ideas were seen by the neo-Austrians (see,
e.g., Dolan, 1976; Spadaro, 1978; Kirzner, 1982) as supplying an alterna-
tive paradigm to the general competitive equilibrium analysis becoming
common at this time, which appeared somewhat arid to the neo-Austrians.
It was the "shared disdain for the dominant perfectly-competitive-equili-
brium view of price theory" (Kirzner, 1978, p. 31) that made a group of
scholars once more turn to Menger.
From the forties onward, Hayek had started to stress more and more
that Menger had not wanted to supply a fully determinate economic
picture with predictive power for every economic detail; much rather he
had seen that in a truly subjective perspective only pattern prediction was
possible. In terms of such pattern prediction Menger had, according
to Hayek (or Hayek in the tradition :of Menger), examined the use of
knowledge in economic society and elucidated the role of the market as a
discovery procedure (see also o 'Driscoll-Rizzo , 1985). From the sixties
onward, Israel Kirzner in New York devoted himself to an analysis of the
entrepreneur as a corrector of error, an economic equilibrator, a seeker of
profitable opportunities, and as such a prime mover of the economic
process (Vaughn, 1978)-in one phrase, as the pivot of the creation of
economic knowledge. Kirzner, again, found inspiration in Menger; for, as
he said: "One broad modern tradition in which the entrepreneur was never
squeezed out was that which drew its source from Carl Menger and his
followers" (Kirzner, 1978, p. 31).
In his understanding of entrepreneurial activity, Menger could once
more draw on a highly developed German economic tradition. He altered
the usual perspective of German economics marginally from a stress on the
entrepreneur's organizational effort and risk taking (with some informa-
tional aspects) to his mainly informational and calculatory role. Yet it is
still true that Menger himself was much less interested in the entrepreneu-
rial role than many of his German colleagues, e.g., Mangoldt (1855).
Kirzner thus may rightly puzzle why this was so. For he is well justified in
pointing to "Menger's .unique understanding of the crucial importance of
knowledge, error and uncertainty" (Kirzner, 1978, p. (32) and in saying,
"Menger's carefully constructed methodological individualism required
him at each turn to emphasize the decision maker's knowledge and
awareness of economic constraints." Or, as Lachmann (1978) put it:
"Menger's readiness to take the human mind with all its limitations as his
starting point is what really distinguishes Menger from Jevons and Wal-
ras." But for Menger, these limitations are those of all participants in
economic exchange, not only of entrepreneurs in the narrower sense. Thus,
Menger would consider all of us entrepreneurs in Kirzner's sense, and in
everyone of our economic actions at that; but, admittedly, we may act
either more or less entrepreneur-like so that "the" entrepreneur of Kirzner
may be an archetype and a limiting case for economic behavior in general
as seen by Menger.
Streissler (1969) identified as the distinguishing feature of Menger's
economics his tendency to look at structural aspects of economic magni-
tudes, i.e., in Menger's splitting up of economic categories into a wide
array or distribution of states of the world (more or less "marketable,"
e.g., liquid, commodities for instance or markets running the whole gamut
from individual exchange to perfectly competitive markets). Menger and
many of his followers were therefore averse to the idea of aggregation,
both for quantities and prices. Since Menger stressed the bargaining
element in price formation I thought it proper to call his price theory a
disequilibrium approach (Streissler, 1972).
That is, however, an infelicitous use of the term disequilibrium, as
Kirzner (1978, pp. 38 ff.), among others, pointed out. Menger's analysis
exactly foreshadowed price theoretic developments in the last ten years,
where in various circumstances embodying incomplete information, con-
jectures, and expectations, price equilibria are derived in terms of game
theory that are very far removed from fully competitive equilibria. Menger
described a market process "more in the spirit of Edgeworth than Mar-
shall" (Moss, 1978, p. 28). All Menger's notions, however, point to market
developments toward such equilibria in exchange; he would never have
suggested that the process of exchange between willing partners breaks
down, with no exchange taking place at all; or that prices never find a point
of rest, but tend to vary continually, situations that modern disequilibrium
analysis proper has found possible in certain circumstances of asymmetric
information. In a sense, Menger can thus even be said to be the most
general equilibrium theorist of the neoclassical revolution as he had by far
the widest frame of reference, including unintentional consequences of
past actions (Butos, 1985), but therefore also the least clear-cut results. It
is true, on the other hand, that Menger was more interested in price
formation and the patterns of behavior underlying it than in the points of
equilibrium; and that he was concerned with the evolution of exchange
institutions (Moss, 1978) as signs of economic progress. Or, as Gram and
Walsh (1978, p. 55) put it: The "best elements of his work (are) inconsis-
tent with ... the concept of allocation." To Menger, prices were altogether
accidental in an Aristotelian sense, the only essential economic facts being
the subjective economic values (Alter, 1982). And as he had a causal
framework in which the time taken by economic processes was an essential
feature, or, to put it differently, as he described irreversible and also slow
and costly adjustment processes (Alter, 1982), he was in another sense-in
the sense of the description of timeless states-no equilibrium economist.
Menger's ideas on the evolution of money as a social institution also
approximate present theoretical concerns and have met with much atten-
tion recently (repeatedly by O'Driscoll; or Butos, 1985). In common with
many German colleagues (especially Hermann), Menger basically used the
notion of positive external effects of certain social institutions to explain
the evolution of money; but in contrast to these Germans, Menger's money
is not the source of positive external effects created by the state but rather
of those created by individual actions within society: "As each economizing
individual becomes increasingly more aware of his economic interest, he is
led by this interest, without any agreement, without legislative compulsion
and even without regard to the public interest, to give his commodities in
exchange for other, more saleable, commodities, even if he does not need
them for any immediate consumption purpose" (Principles, p. 260). It has
not been stressed sufficiently that this passage of Menger's, while embody-
ing an essentially historical analysis, is, at the same time, a frontal attack
on the German historical school with its statist as well as holistic notions.
Most of the recent literature on Bohm-Bawerk has already been men-
tioned in section 4.2.
Recent literature on Wieser has noted his influence on the sociology of
Schumpeter and especially Schumpeter's theory of the creative entre-

preneur (Streissler, 1981; Samuels, 1983). Streissler (1986) credited Wieser
with introducing the notion of the informative nature of prices and even
that of the ubiquitous need for economic "planning," Wieser's power
mystique has also found some attention (Ekelund, 1970; Samuels, 1983;
Streissler, 1986).
Note
1. All translations from German sources are my own, unless otherwise stated.
References
Bohm, Menger, and Wieser
Bohm von Bawerk, Engen Ritter von:

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Wieser, Friedrich Freiherr von:

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Commentary by Robert F. Hebert
Introduction
Erich Streissler has ably surveyed the scope of Austrian economics begin-
ning with its founder, Carl Menger, and concluding with the second
generation of scholars, a group dominated by Bohm-Bawerk and Wieser.
In the process he has brought to light a number of important points: the
continuity of a protoneoclassical German tradition in economics that
preceded Menger; the differences between Menger and his famous dis-
ciples, Bohm-Bawerk and Wieser; and the uniqueness of the Austrian
contribution on a holistic level. Streissler correctly emphasizes the micro-
economic focus of the Vienna economists, for it is this area of economic
theory that they helped to reform. However, by concentrating exclusively
on this aspect and by implying that Menger's followers were (and are)
repulsed by macroeconomic concepts, Streissler may have created a dis-
torted picture.
I want to argue in the limited space provided here that third-generation
Austrian economists, particularly Mises, Hayek, and Schumpeter, formed
a bridge between the classical macroeconomic concerns with economic
growth and stability on the one hand and the neoclassical effort to redirect
economic inquiry toward microeconomic relationships on the other. This
attempt complements Streissler's survey by extending the story of the
Austrian tradition to the next generation of thinkers, but it also helps to
correct the misleading impression that all economists who follow in the
footsteps of Menger are repulsed by macroeconomic issues. My argu-
ment concentrates on the chief contributions of the "expatriates" -those
Austrian economists who fled their homeland in search of academic
posts elsewhere.
Austrian economics did not become a major export until many of the
most able third-generation Austrians fled their native land to escape Nazi
190
ORIGINS OF mE AUSTRIAN SCHOOL 191
oppression. Joseph Schumpeter, Ludwig von Mises, Fritz Machlup, Gott-

fried Haberler, and Oskar Morgenstern came to the United States. Fried-
rich Hayek went to England, where he mounted a major but unsuccessful
challenge against the formative macroeconomics of J. M. Keynes. From his
post at the London School of Economics, Hayek influenced a number of
able students (e.g., G. L. S. Shackle) who absorbed the basic tenets of
"Austrianism" along with the emerging Keynesian doctrine. In the United
States Mises had a difficult time securing an academic post, but eventually
he gathered a small group of loyal students around him at New York
University, where he was later joined by Fritz Machlup. Thus, in the 1930s,
the Austrian school put down sturdy British and American roots.
Partly as a consequence of these migrations, the term Austrian has been
shorn of its geographic meaning in economics. Instead, Austrian economics
has come to mean an approach to economic theorizing consistent with the
ideas of its original framers, especially Menger. The most vocal champions
of this approach (for lack of a better descriptive phrase we shall call them
neo-Austrians) have virtually no ties to Austria, nor even to Western
Europe. They are, for the most part, British and American scholars who
hold a particular view of what economics is, and of its realistic accomplish-
ments and limitations.
Streissler emphasizes the role of the core group of writers who com-
prised the Viennese school in forming one of three branches of neoclas-
sical economics, and he stresses the common ground between the three
branches. In a holistic sense, neoclassical economics represented a depar-
ture from the classical concern about economic development and a reorien-
tation toward the analysis of microeconomic efficiency at the level of the
individual decision unit. After 1870, questions of price formation and
resource allocation replaced considerations of national wealth and aggre-
gate income distribution. Emphasis was placed at the level of individual
decision making. More than anyone else, the Austrians were adamant in
championing methodological individualism.
The innovation wrought by third-generation Austrians is that while
accepting the idea of methodological individualism, they redirected the
new microeconomics toward the "old" classical problems of economic
growth and stability. In other words, they were pioneers in helping to
establish the microfoundations of macroeconomics. This is particularly
true of the three writers singled out for special treatment here: Mises,
Hayek, and Schumpeter.
Ludwig von Mises (1881-1973)

Although Menger fashioned a theory of the evolution of money that
stressed the unintended consequences of individual (self-interested) behav-
ior, he did not succeed in solving the question of what determines the value
of money. Monetary theory remained curiously separated from value
theory until the two were integrated by Mises, one of Bohm-Bawerk's
students at the University of Vienna. Mises achieved the integration of
monetary and value theory by founding both on the same principle, namely
the marginal utility of subjective individual wants.
Mises recognized that the marginal utility of money comes from two
separate sources. On the one hand, money has value derived from the
value of the goods it can buy. On the other hand, money has a subjective
use-value of its own because it can be held for future exchange. What we
call the value of money in common parlance springs from the ability of
money to be exchanged for other things. Mises called this characteristic
of money its objective exchange-value in order to distinguish it from
money's subjective use-value. Today we refer to it as the purchasing power
of money.
The problem Mises confronted is how to measure the purchasing power
of money. Conventional theory advanced the concept of a unitary (aggre-
gate) price level, whereby the purchasing power of money (the reciprocal
of the price level) is the outcome of the total volume of transactions in
society divided by the velocity of circulation. In terms of the familiar
equation of exchange where MV = PT, the price level, P, would be de-
rived as follows: P = MVIT, and its reciprocal (the purchasing power of
money), liP = TIMV. Mises (1952, p. 130) recognized the grain of truth in
the quantity theory, namely "the idea that a connexion exists between
variations in the value of money on the one hand and the supply of it on the
other hand," but he argued that "beyond this proposition, the Quantity
Theory can provide us with nothing. Above all, it fails to explain the
mechanism of variations in the value of money."
True to the Austrian tradition, Mises sought the answer to this question
in the actions of individuals. All valuation is done by individuals; there-
fore, the key to understanding the value of money mustbe in the mind of
the individual. The purchasing power of a dollar is the vast array of goods
that can be purchased with that dollar. This array is heterogeneous and
specific. At any point in time a dollar might buy three packs of chewing
gum, one pair of socks, two floppy computer disks, two sodas, one pack of
cigarettes, one-tenth of a haircut, and so forth and so on. The purchasing
power of money therefore cannot be summarized in some unitary price-
level figure. At all times a homogeneous good must be defined in terms of
its usefulness to the consumer rather than by its technological properties.
Likewise, price must be related to the specific usefulness ofa good, and not
to its technological properties. An apartment with the same technological
properties in Manhattan and in Peoria will not have the same price because
they are not equally useful to the purchaser. The apartment in New York
has a more desirable location with more extensive consumption possibili-
ties and hence will be priced higher on the market. Mises emphasized
locational (and temporal) aspects in explaining differences in the value of
technologically similar goods, a view that complements the Austrian
notion that the purchasing power of money is equal to an array of
goods.
Applying the theory of marginal utility to the price of money raises a
thorny analytical problem, however. When an individual ranks coffee. or
shoes or vacations on his value scale, he values those goods for their direct
use in consumption, and each valuation is independent of and prior to its
price on the market: However, people hold money not for its direct use in
consumption but because it can eventually be exchanged for goods that are
used directly. In other words, money is not useful in itself. It is useful
because it has a prior exchange value-a preexisting purchasing power.
The demand for money therefore depends upon money's existing market
price, as determined by its preexisting price in terms of other goods and
services. Therein lies the problem. If the demand for money, and hence its
utility, depends on its preexisting price (purchasing power), how can that
price be explained by the demand?
Mises attempted to avoid the apparent circularity in this argument by
means of a regression theorem. The demand for money on any given
day-say, day V-is equal to its purchasing power on the previous day,
V-I. The demand for money on the previous day, D-1, in turn, was equal
to the purchasing power of money on V-2, and so on. In other words, the
demand for money always has a historical (i.e., temporal) component. But
what keeps the problem from becoming an infinite regression backwards in
time? Mises claimed that the analysis need be carried backward only to
that point when the commodity used as money was demanded solely for its
own direct consumption use and not as a medium of (indirect) exchange.
Suppose we go back in time to the point that gold was introduced as
money. Further suppose that before this day, all trade took place by
barter. On the last day of barter, gold had value only for its direct
consumption use, but on the first day of its use as money, it took on an
additional use as a medium of exchange. In other words, on the first day of
its use as a medium of exchange, gold had two dimensions of utility: first, a
direct consumption use; and second, a monetary use that had a historical
component in its utility.
Murray Rothbard, a student of Mises, underscored the continuity
between Mises and Menger on this point. Menger, of course, emphasized
the evolutionary and institutional elements of money. Rothbard (1976,

p. 169) proclaimed:
Not only does the Mises regression theorem fully explain the current demand for
money and integrate the theory of money with the theory of marginal utility, but
it also shows that money must have originated in this fashion-on the market-
with individuals on the market gradually beginning to use some previously
valuable commodity as a medium of exchange. No money could have originated
either by a social compact to consider some previously valueless thing as a
'money' or by sudden governmental fiat. For in those cases, the money com-
modity could not have a previous purchasing power, which could be taken into
account in the individual's demand for money. In this way, Mises demonstrated
that Carl Menger's historical insight into the way in which money arose on the
market was not simply a historical summary but a theoretical necessity.
Mises further underscored an Austrian concern by analyzing the effect

of changes in the aggregate supply of money on relative prices. Once again,
he embraced methodological individualism. In the pre-classical era,
Richard Cantill on had argued that the result of an increase in the stock of
money will not be uniform across the economy but rather will cause prices
to rise at uneven rates in different sectors, thereby changing relative prices
in the process. Mises combined the marginal-utility theory of money with
this "Cantillon Effect" to elucidate the impact on the economy of changes
in the supply of money.
In modern societies, when governments or central banks increase the
supply of money they do not do so in a way that affects everyone equally.
Instead, new money is created by the government or by banks to be spent
on specific goods and services. The demand for these specific items rises,
thereby raising their prices first. (The elements of this in a Misesian
economy should now be clear: as money holdings increase, the marginal
utility of money declines so that certain goods are revalued ahead of money
on subjective preference scales, pushing the prices of these goods upward.)
Gradually the new money ripples through the economy, raising demand
and prices as it goes. Income and wealth are thereby redistributed to those
who receive the new money early in the process, at the expense of those
who receive the new money later, or those who live on fixed incomes and
receive none of the new money.
Recognizing these relative price effects and the ensuing wealth redis-
tribution they entail, Mises took a very strong stand against inflationary
expansion of the money supply. He argued that because the exchange
services of money are not increased by a higher stock of money, inflation
will always be a zero-sum game, benefitting some at the expense of others.
The services money renders are conditioned by the height of its purchasing
power. Nobody wants to have in his cash holding a definite number of pieces
of money or a definite weight of money; he wants to keep a cash holding of a
definite amount of purchasing power. As the operation of the market tends to
determine the final state of money's purchasing power at a height at which the
supply of and the demand for money coincide, there can never be an excess or a
deficiency of money. Each individual and all individuals together always enjoy
fully the advantages which they can derive from indirect exchange and the use
of money, no matter whether the total quantity of money is great or small.
Changes in money's purchasing power generate changes in the disposition of
wealth among the various members of society. From the point of view of people
eager to be enriched by such changes, the supply of money may be called
insufficient or excessive, and the appetite for such gains may result in policies
designed to bring about cash-induced alterations in purchasing power. How-
ever, the services which money renders can be neither improved nor impaired
by changing the supply of money. . .. The quantity of money available in the
whole economy is always sufficient to secure for everybody all that money does
and can do (Mises 1963, p. 418).
On the basis of his economic analysis, Mises came to believe that monetary
expansion is a method by which the government, its controlled banking
system, and favored political groups are able to partially expropriate the
wealth of other groups in society. Having witnessed firsthand the German
hyperinflation after World War I, Mises remained skeptical of any govern-
ment's willingness to show monetary restraint over long periods of time. It
is for this reason, and not because he attributed any "mystical" qualities to
gold, that Mises championed a gold standard as the best form of money.
Friedrich A. Hayek (1899- )

Mises' monetary theory spawned an Austrian theory of business cycles
based on changes in the supply of money, a theory elaborated most
effectively by Mises' student. F. A. Hayek. Like Mises, Hayek broke with
the quantity theory tradition because it ignored the effect of money on
relative prices. He continued the integration of monetary theory and value
theory that Mises had begun by exploring the effect of changes in the
supply of money on the composition of output, rather than upon the
quantity of output or the aggregate price level.
Hayek's business cycle theory is a blend of the Austrian theories of
money, capital, and prices. His explanation of the cycle runs as follows: a
monetary disturbance (e.g" an increase in the money stock) brings about a
reduction of interest rates below an equilibrium level, which stimulates
investment in capital, thereby reallocating resources away from the pro-
duction of consumption goods toward production of intermediate (capital)

goods. As a consequence, prices of capital goods rise and prices of con-
sumption goods fall. This change in relative prices alters the structure of
production. (Hayek viewed the entire process of production as a multistage
activity through which raw materials pass until they finally emerge as end
products. Therefore, a change in the number of stages or a reallocation of
resources among the different stages constitutes a change in the structure
of production.) Because of the longer time component of capital, a change
in the structure of production leads to overinvestment in "longer" or more
"roundabout" methods, thereby upsetting the coordination of plans
between consumers and producers, and between savers and investors.
Although Hayek's chief technical contribution to economic theory was
his monetary theory, his important conception of equilibrium as the
coordination of economic activities became the unifying theme in all of his
writings. Coordination is achieved when the plans of all economic decision
makers mesh. Hayek argued that decision makers look for signals, and the
appropriate signals are relative prices. If relative prices change due to
the "natural" forces of technology, tastes, time-preference, and so on,
the ensuing adjustments will reestablish a coordinated plan. But purely
monetary disturbances evoke perverse signals by artificially raising rates
of return on certain types of economic activity. These rates of return can
only be sustained as long as additional monetary stimulus is forthcoming,
so eventually every boom will be followed by a bust.
Hayek focused his business cycle theory on the market signals utilized
by savers and investors to make their decisions. He emphasized that
although these decisions are independently arrived at they are interdepen-
dent in terms of their implications for equilibrium. Cycles occur when a
general inconsistency of plans comes about. In the case of a monetary
stimulus, firms tend to switch to more capital-intensive methods at the
expense of consumption-goods production, despite the fact than no addi-
tional planned saving has taken place.
Hayek completed his researches on monetary theory and business-cycle
theory in the 1930s at a time when Keynesian macroeconomics was gaining
ground. Eventually his monetary theory was eclipsed by the so-called
Keynesian Revolution. More recently, Hayek has directed his attention to
other important analytical issues, especially, another Mengerian theme,
the role of information in economic activity. This latter contribution has
been received better than Hayek's business cycle theory by other econom-
ists. Indeed, Hayek has been in the forefront of a revival and reformulation
of contemporary theories of competition. Present space constraints pre-
clude a complete discussion of Hayek's contribution to this literature, but it
ORIGINS OF TIIE AUSTRIAN SCHOOL 197
must be noted in passing that his pioneer efforts have had a major influence
on the development of contemporary economic thought.
Joseph Schumpeter (1883-1950)

Although steeped in the Austrian neoclassical tradition of microeconomic
analysis, Schumpeter reopened a classic line of inquiry-the subject of
economic development. His contribution to this subject can be found in the
Theory of Economic Development (1911), a book that won critical acclaim
immediately but made little impact on English-speaking economists until it
was translated into English in 1934. Schumpeter followed his first success
decades later with a detailed inquiry into the nature and causes of econo-
mic stability, entitled Business Cycles, published in 1939.
Schumpeter blended ideas from Marx, Walras, and the German histo-
rian and sociologist, Max Weber, with insights from his Austrian fore-
bears, Menger, Wieser, and his teacher, Bohm-Bawerk. He shared Marx's
view that economic processes are organic and that change comes from
within the economic system, not merely from without. He admired the
general-equilibrium vision of Walras and the blend of sociology and
economics that characterized the theories of Marx and Weber. As Strei-
ssler has indicated, Schumpeter's terminology regarding the entrepreneur
derives from Wieser, although Schumpeter improved the concept and gave
it a place of central importance in his theory of economic development.
Reflecting the Austrian economists' interest in disequilibrium and in
market processes, Schumpeter made the entrepreneur the chief agent who
causes disequilibrium (Le., change) in a competitive economy.
To Schumpeter, development is a dynamic process, an endogenous
shock to the economic status quo. He regarded economic progress not
merely as an adjunct to the central body of orthodox economic theory, but
as a central process that had been squeezed from mainstream economics by
the static, general-equilibrium approach. The entrepreneur is a key figure
in this process because he is the persona causa of economic progress.
Like Menger, Wieser, and Bohm-Bawerk, Schumpeter viewed competi-
tion as a process involving mainly the dynamic innovations of the entre-
preneur. He used the concept of eqUilibrium the same way that Weber had
used the idea of the stationary state: it was for him a theoretical construct,
a point of departure. Schumpeter referred to this equilibrium state as "the
circular flow of economic life." Its chief characteristic is that economic life
proceeds routinely on the basis of past experience; there are no forces
evident for any change of the status quo. Time is meaningless in this
artificial economy and credit transactions do not exist because only goods
produced in the previous period are consumed in the current period, and
only goods which will be consumed in the next period are produced in the
current period. The individual firm is indifferent whether it produces
means of production or consumption goods, because in each case, the
product is paid for immediately and at full value.
In this hypothetical system, the production function is invariant,
although factor substitution is possible within the limits of known technolo-
gical horizons. According to Schumpeter (1934, p. 45), the only real
activity that must be performed in this state is "that of combining the
two original factors of production, and this function is performed in
every period mechanically as it were, of its own accord, without re-
quiring a personal element distinguishable from [mere] superintendence
.... " In this artificial situation, the entrepreneur is a nonentity. There
is nothing for him or her to do because equilibrium is automatic and
permanent.
Obviously, such a state of being does not apply to the dynamic world in
which we live. Schumpeter argued (1950, p. 84) that the really relevant
problem is not how capitalism administers existing structures, but how it
creates and destroys them. He called this process "creative destruction,"
and maintained that it is the essence of economic development. In other
words, development is a disturbance of the circular flow. It occurs in
industrial and commercial life, not in consumption. It is a process defined
by the carrying out of new combinations in production, and it is accom-
plished by the entrepreneur.
At the simplest level, Schumpeter's theory reduces to three elemental
and corresponding pairs of opposites: (1) the circular flow, or tendency
toward equilibrium, on the one hand, versus a change in economic routine
or data, on the others; (2) statics versus dynamics; (3) entrepreneurship
versus management. The first pair consists of two real processes; the
second, two theoretical issues; the third, two distinct types of conduct. The
theory maintained that the essential function of the entrepreneur is dis-
tinct form that of capitalist, landowner, laborer, inventor. According to
Schumpeter, the entrepreneur may be any and all of these things, but if he
is, it is by coincidence rather than by nature of function. In principle, the
entrepreneurial function is not connected with the possession of wealth,
even though "the accidental fact of the possession of wealth constitutes
a practical advantage" (Schumpeter, 1934, p. 101). Moreover, entre-
preneurs do not form a social class in the technical sense, although they
come to be esteemed for their ability in a capitalist society. In Schumpe-
ter's theory, successful innovation requires an act of will, not of intellect. It
depends, therefore, on leadership, not intelligence, and it should not be
confused with invention.
Schumpeter's emphasis on the entrepreneur as the dominant agent of

change in a dynamic economy established a bridge between the microeco-
nomics of the firm and the macroeconomics of government policy. In a
Schumpeterian framework, the transmission mechanism through which tax
and spending policies affect economic behavior is the alteration that such
policies have on individual incentives. The entrepreneur is the focal point
of such analysis. Schumpeter (1939, pp. 291-292) explored the effect of
taxes on the profit motive and on economic progress, and found a progres-
sive income tax to be potentially harmful:
Any tax on net earnings will tend to shift the balance of choice between 'to do or
not to do' a given thing. If a prospective net gain of a million is just sufficient to
over-balance risks and other disutilities, then that prospective million minus a
tax will not be so, and this is as true of a single transaction as it is of series of
transactions and of the expansion of an old or the foundation of a new firm.
Business management and enterprise ... will for its maintenance depend, at least
in the long run, on the actual delivery, in case of success, of the prizes which that
scheme of life holds out, and, therefore, taxes beyond a percentage that greatly
varies as to time and place must blunt the profit motive.
Although Schumpeter is regarded as something of an outsider by

contemporary Austrian economists, it is important to identify common
ground. Like Menger, Schumpeter always kept a watchful eye on the
competitive process, that maelstrom of economic activity comprised of
individual decisions based on reigning economic incentives. Moreover, he
approached macroeconomics from a typically Austrian perspective, name-
ly from the point of view that although macroeconomics consists of the
study of aggregates, the aggregates in question are the collective outcomes
of individual decisions. The causation runs from the individual to the
collective, as Menger taught, never the other way around.
As theories of economic change go, Schumpeter's analysis occupies the
middle ground between Marshall and Weber. Marshall's theory adapted
incrementally to shifts in preference and production functions, resulting
in a continuous improvement in moral qualities, tastes, and economic
techniques. Its shortcoming was that it did not explain business cycles,
a deficiency later addressed by Marshall's student, Keynes. Marshall's
approach also implied a theory of unilinear progress, which Schumpeter
rejected. Weber's theory developed its own set of moral imperatives and
used them to explain rapid social and economic transitions that punctuate
long periods of historical continuity. Schumpeter postulated the continuous
occurrence of innovations and waves of adaptation simply because entre-
preneurs are always present and are a persistent force for change.
Conclusion
Streissler's statement that Menger "bequeathed to his school a horror
of macroeconomic concepts" does not mean that Menger's followers
recoiled from the problems of the macroeconomy. On the contrary,
key third-generation Austrian economists grappled with the basic macro-
economic problems of economic growth and stability, and they made sub-
stantial headway toward meaningful solutions. The fact that Keynesian
macroeconomics dominated the minds of economists for so long may have
more to do with the sociology of knowledge than with the sturdiness of the
Keynesian theory. Indeed, the recent resurgence of interest in Austrian
economics is in large part symptomatic of a growing dissatisfaction with
many of the basic tenets of Keynesian economics.
References
Mises, Ludwig von. 1952. The Theory of Money and Credit, new English edition,
translated from the 2nd German edition (1924) by H. E. Batson. Irvington-on-
Hudson, N.Y.: Foundation for Economic Education, Inc.
Mises, Ludwig von. 1963. Human Action, rev. ed. New Haven: Yale University
Press.
Rothbard, M. N. 1976. "The Austrian Theory of Money." In The Foundations of
Modern Austrian Economics, edited by E. G. Dolan. Kansas City: Sheed &
Ward.
Schumpeter, J. A. 1934. The Theory of Economic Development, 2d ed., translated
by R. Opie. Cambridge: Harvard University Press.
Schumpeter, J. A. 1939. Business Cycles. New York: McGraw-Hili.
Schumpeter, J. A. 1950. Capitalism, Socialism, and Democracy, 3rd ed. New York:
Harper & Row.
6 THE AUSTRIAN TRADITION:
SCHUMPETER AND MISES
Stephan Boehm
Needless to say, no two Austrians ever thought alike.

-Simpson (1983)
1. Schumpeter and Mises and the Austrian School
It is by now commonplace to introduce an essay on the Austrian school

with the trite observation that Austrian economics 1 has staged a remark-
able comeback during the last decade or so. But who are the Austrians,
anyway?
Although the terms of this resurgence of interest in the Austrian
tradition have never been formally drawn up, it has been clear from the
very outset that the economics and politics of Ludwig von Mises and
Friedrich von Hayek were to provide the fertile soil from which further
work in this tradition should proceed. To the extent that the thought of
Hayek and Mises is seen to epitomize everything that is considered
"genuinely Austrian," other luminaries who, on a more generous note, are
commonly associated with Austrianism broadly conceived are pushed into
the background-in order to preserve, for better or worse, the identity of
the enterprise, as it were. One such "loose," at least from Mises' and
201
Hayek's point of view, exponent whose relationship with his Austrian

forebears and contemporaries defies clear-cut categorizations-indeed, it
appears to be notoriously difficult to pigeonhole his overall contribution-
is Joseph Schumpeter.
We have it on the authority of Gottfried Haberler (1951, p. 29) that
Schumpeter already in his early academic career displayed a remarkable
"intellectual independence" from his famed teachers in the University of
Vienna, and that in consequence there was "little specifically 'Austrian'
influence" in his early work. This point of view-namely, that Schumpeter
be numbered among the Austrians only with major qualifications, if at all;
and that he should be relegated to a group of "un-Austrian Austrians,"
along with, inter alios, Rudolf Auspitz and Richard Lieben, and Alfred
Amonn-surfaces in several influential accounts of both Schumpeter (e.g.,
Stolper, 1968, p. 71) and the Austrian school (e.g., Hayek, 1968, p. 461;
Hutchison, 1981, p. 204; Machlup, 1982, p. 41).2
There are any number of reasons that could be, and have been, adduced
in support of that sort of assessment: e.g., Schumpeter's famous debates
with Bohm-Bawerk over the nature of the rate of interest; the disparaging
treatment accorded to Menger's contribution in his History of Economic
Analysis; his profound admiration for Marx and Walras; his propagation
of mathematical, statistical, and econometric methods in economics; his
instrumental role in founding the Econometric Society; the alleged "posi-
tivism" suffusing his early work; his supposedly "socialist" inclinations;
and so on.
The post-war consensus pertaining to Schumpeter's non-Austrian
credentials has not in the least been dented by the current flurry of interest
in Schumpeterian ideas-on the contrary. Since a great deal of this recent
literature has either sought to identify (see Frisch, 1982), holding out the
prospect of the establishment of, a distinct "Schumpeterian economics"
(Nelson and Winter, 1982), or to secure a niche for Schumpeter in the
heterodox mansion already occupied by the likes of Marx and Keynes3
(doubtless encouraged by the coincidence of certain anniversaries), the
standard account seems to have gained a new credibility.
Given Schumpeter's well-known indignation at conducting discourse in
economics in terms of "schools" or "-isms" of any sort, feuding each other,
which he regarded as a symptom of science in its infancy, one can well
imagine him to mock at the very idea of seeking to locate him as a member
of the Marxist, institutionalist, or-for that matter-Austrian "school."
However hopeless, and even laughable, such an enterprise would appear
to Schumpeter, and however doomed it may seem-given the kaleidosco-
pic sweep of his work-there may yet be a strong case for calling seriously
into question, with all due deference to Professor Haberler's authoritative
THE AUSTRIAN TRADITION 203
judgment, received scholarship on Schumpeter's Austrian connection. In

this vein, and against "conventional wisdom," David Simpson (1983) and
Erich Streissler (1983) have in their own different ways urged a reappraisal
of Schumpeter's Austrian heritage. Simpson claims to have demonstrated
that "the minor differences which did exist between Schumpeter and his
colleagues on technical questions are more than outweighed by agreement
on the substantive issues of their economic analysis" (1983, p. 15); whereas
Streissler's findings are summed up as follows:
It is true that Schumpeter, the enfant terrible, diverged from tradition on many
points dear to the leaders of the Austrian school, which tends to support the
contention that he was not a member of the school. On the other hand, he took
up so many of the ideas then current only in the Austrian economic tradition
that any hypothetical historian of economic thought, not knowing Schumpeter
to be an Austrian, could immediately trace him to this school (Streissler, 1983,
p. 358).
More to the point of this chapter it would seem to be a worthwhile

question to ask whether the Mises-inspired revival of the Austrian school
is in any way, if at all, related to the recent outburst of research activity
on Schumpeterian themes. Israel Kirzner (1983, p. 1502; 1985, p. 37), in
particular, has perceptively suggested the possibility that the new-found
deeper appreciation of Schumpeter as a seminal economic theorist in his
own right-rather than as an encyclopedic, if somewhat eccentric, histo-
rian of economic thought (Perlman, 1982), and as a sociologist of the
economy and polity of the first rank (Berger, 1986; Brittan, 1975; Hirsch-
man, 1982; Kumar, 1983)-may eventually single out as lasting those
aspects of Schumpeter's contribution that are most congenial to modern
Austrian economics: the emphasis on the entrepreneurial nature of market
capitalism and the related dismissal of the still dominant model of perfect
competition as inappropriate for its analysis. In this way, Kirzner notes, a
distinct, yet-to-emerge body of Schumpeterian economics would link up
naturally with the somewhat narrower Austrian tradition stemming from
Mises, constituting "an economics in which processes of entrepreneurial
change occupy center stage, with models of circular-flow economies rele-
gated to the appendix" (Kirzner, 1983, p. 1502).
The merging of those two Austrian streams would indeed indicate "a
curious episode" in the history of thought, considering "the reservations
with which each of these two disciples of Bohm-Bawerk came, over the
years, to regard the other" (Kirzner, 1983, p. 1502).4 Just to illustrate
that point, and at the risk of being accused of indulging in amateur
psychology-surely the least reliable guide in intellectual history-here is
a characteristically strong-worded statement from Mises on Schumpeter:
Because Austrian economics is a theory of human action, Schumpeter does not

belong to the Austrian School. In his first book he significantly related himself to
Wieser and Walras, but not to Menger and Bohm-Bawerk. Economics, to him,
is a theory of "economic quantities," and not of human action. Schumpeter's
Theory of Economic Development is a typical product of the equilibrium theory
(Mises, 1978, pp. 36-37).
In that passage Mises refers, of course, to Schumpeter's as-yet-
untranslated habilitation thesis, Das Wesen und der Hauptinhalt der
theoretischen Nationalokonomie (1908), on the basis of which Schumpeter
is customarily excommunicated from the Austrian school. And in another
foray directed against Schumpeter, Mises (1981, p. 47) contends along
similar lines: "The view of behaviorism is just as untenable as the episte-
mological position taken by Schumpeter in his first book. All mechanistic
analogies are misleading. ,,5 (It is perhaps interesting to mention in passing
that Schumpeter's numerous references to Mises in his History of Eco-
nomic Analysis are in large measure approving.) Quite apart from the
dubious practice of passing such an apodictic and damning judgment on
Schumpeter's overall performance on the sole basis of his alleged "youth-
ful misdeed," his insensitivity toward, and his impatience with, his peers'
work6 prevented Mises from recognizing that both he and Schumpeter,
though sharply differing in their method of analysis and in their conclu-
sions, were getting at the same idea-viz. to unearth the entrepreneurial
role as the driving force of the capitalist system.? But in the glaring light of
history there may well be a case for establishing a belated "peaceful
coexistence" between those two erstwhile mavericks of Austrian aca-
demic life. 8
2. Schumpeter and Mises and Their Significance Today:

An Overview of Recent Assessments
2.1. Schumpeter
One of the many curious features surrounding the changing perception
of Schumpeter's status in twentieth century economics has to do with the
circumstance that his credentials as "one of the truly great economists of
our time" (Seligman, 1962, p. 694)-in fact, Schumpeter is invariably
billed as "that other great economist this century has produced," on a par
with Keynes-have always been beyond doubt, while at the same time it
has never been entirely clear on what sort of basis that judgment had been
reached. In addition, the negligible impact of his theoretical contribution,
in terms of reworking contemporary economics along lines envisaged by
THE AUSTRIAN TRADmON 205
him, has often been a source of lament (e.g., Helbum, 1986, p.'161). Justly
referring to Schumpeter's economic theories as occupying "a rather nebu-
lous place in economic theory," David St. Clair aptly circumscribes the
paradoxical situation in the following terms: "On the one hand, Schumpe-
ter is a 'great economist,' respected by one and all. On the other hand, his
essential contributions to economic theory remain largely curiosities. His
works are acclaimed, sometimes read, yet never integrated into economic
theory" (St. Clair, 1980, p. 62).
Almost three decades ago, Martin Kessler expressed a widely shared
sentiment with regard to Schumpeter's and Keynes' influence on public
debates when he observed:
Eleven years after his death, ecOnomists ... still ponder the paradoxes of Joseph
A. Schumpeter. While the contributions of the late Lord Keynes, not without
intriguing paradoxes of their own, are being rapidly assimilated into the "com-
mon sense" of statesmen, Schumpeter, the only other truly great economist the
twentieth century has produced, exerted no appreciable influence over public
policy. Apart from a few misunderstood cliches, such as "creative destruction,"
"obsolescence of entrepreneurial function," and so on, his ideas have generated
no "school" among young intellectuals. Indeed, it is doubtful that they ever will,
even though Schumpeter is a profound and honest thinker in the tradition of
Marx, Weber, and Tawney grappling with one of the crucial problems of our
age: the innovating and growth capacities of various social systems under an
advanced industrial technology (Kessler, 1961, p. 334).
But almost 40 years after his death, the tide appears to have been
reversed to some extent in Schumpeter's favor: Keynes' growing reputa-
tion, in certain segments of the profession, on the theoretical plane-
thanks in large measure to the tireless efforts of fundamentalist-minded
(hyphenless) Post Keynesians-has, on the whole, not been matched by
the results of so-called "Keynesian policies," however dubious their claim
to that label may be. On the other hand, while it is still true that one would
look in vain for a group of self-styled post-Schumpeterians, there are a
number of "external" factors that may be said to have contributed toward
the renewed interest in Schumpeterian ideas-albeit in somewhat muted
form, to be sure.
The severe unemployment and growth problems that have beset West-
ern economies in recent years once again alerted economists to the
long-run development perspectives of market capitalism. Concern with
conditions for the survival of "the system," or, more generally, with
"cosmological problems" (see Heilbroner, 1984, p. 682), rather than the
"small questions" customarily pursued in current orthodoxy, are congenial
to Schumpeter's way of thinking. Although the notion of technical change
as an engine of economic growth has been recognized for a long time-in

classical political economy in general, and by Karl Marx in particular-
economists have had precious little to say until fairly recently on the ways
in which science, invention, and innovation actually made their influence
felt on and in the economy. As Christopher Freeman aptly remarks:
"[A]lthough none denied the overwhelming importance of inventions and
innovations, few stopped to examine how these came about or how they
actually affected the behaviour of the system in specific cases. The 'ceteris
paribus' clause provided the ideal alibi for consigning these difficult
problems to a black box not to be opened except by natural scientists and
engineers or occasionally by economic historians" (Freeman, 1982, p. 1).
Freeman goes on to cite Keynes as "the typical example of this tendency"
and castigated him for the low priority he assigned to technical change.
"Typical, too, was Keynes dismissal of the 'long run' as a period when we
are all dead. Those Keynesians who are still alive are now experiencing the
Nemesis for this short-sighted approach to some of the most fundamental
problems of economic growth and development."
In view of these circumstances, it is hardly surprising that Schumpeter-
"the most influential single writer on technical change," according to Jon
Elster (1983, p. 112), or even "the undisputed godfather" in that area of
economics, according to Partha Dasgupta (1986, p. 519)-should have
been (re)discovered in the recent past. As is well known, Schumpeter
assigned to innovation -of which technical innovation is only one, albeit
very important, aspect-pride of place in his theories of entrepreneurship,
competition and monopoly, development and the business cycle. His
impact has perhaps been most marked in the theory of the firm (see the
work of Nelson and Winter, 1982, which represents the culmination of a
series of papers published in the seventies), and in the revival of the notion
of long rhythms in economic life in the wake of the significant change in the
momentum of economic growth since 1973 (van Duijn, 1983; Freeman,
1983; Kleinknecht, 1987; Maddison, 1982).
Furthermore, the accolades heaped on Schumpeter in the course of the
centenary celebrations, with their attendant glittering gatherings of sup-
posedly learned men and women pondering the "essence" of the man and
his work, seem to have dispelled any remaining lingering doubts,9 and to
have set the professional seal on his belated admittance to the pantheon of
the towering figures of the subject. Herbert Giersch (1984) even went so
far as to suggest that the fourth quarter of this century may well turn out to
be "the age of Schumpeter."
But for the more thoughtful observer the fantastic, and at times even
embarrassing, spectacle enacted in Schumpeter's honor in 1983, and a
good deal of the ensuing published evidence, raises a number of queries of

a more general nature. Is it conceivable, one wonders, that all this hustle
and bustle is merely the most natural way for the profession at large 10 to
make up for decades of almost total neglect-tormented by a guilty
conscience, as it were? Or, more seriously, is the mystifying aura of
Schumpeter's name invoked to distract from the deficient theoretical
foundations. of "supply-side economics," as suggested by Rajo Riese
(1986, p. 5) in his well-taken criticism of Giersch's views (see, e.g.,
Giersch, 1979)? Or, is the nowadays fashionable appeal to the innovative
entrepreneur merely "the appropriation," couched in Schumpeter's rhet-
oric, "by the defenders of property and its privileges, of the central
dynamic of Marxist theory" -albeit "domesticated, stripped of the menac-
ing ambivalence which marks capitalist accumulation in Capital, since
responsibility for all its destructive effects is transferred to society at large"
(Grahl, 1985, p. 220)? Is it not an odd feature of post-war economic history
that the dominating approaches to macroeconomic policy were, as a rule,
totally out of step with prevailing economic conditions? That is, old-
fashioned demand management Keynesianism ruled supreme at a time
which was distinguished by a productive dynamism on an unprecedented
scale (as predicted by Schumpeter); Marxism made some headway during
the (fading) years of the boom; and "market-oriented" policies made their
greatest impact at a time when it was conspicuous that "the market had
failed." That is, theories were at their lowest ebb, Riese (1986, p. 2)
triumphantly concludes, when they tallied best with the prevailing econom-
ic situation-the only major exception to that rule being monetarism.
There can be no doubt that reawakened interest in Schumpeter coin-
cided with the economic upheavals of the seventies and eighties. "In
retrospect, the long phase of neglect may seem a characteristically Schum-
peterian phenomenon-a long Kondratieff upswing stemming from fun-
damental innovations in the nineteen-thirties" (Grahl, 1985, p. 222). To be
sure, concern with Schumpeter's work was reinforced as a result of
centenary activities, as noted above. What is disturbing about all this
flurry of attention is that it may-completely detrimental to intentions-
ultimately deal a devastating blow to Schumpeter's aspirations toward
being appreciated as an original economic theorist in his own right. The
very same people who pronounced Keynes "to be dead," and who subse-
quently flocked around Schumpeter, may be trusted to turn to some other
icon for inspiration soon. And there may not be a self-styled group of
post-Schumpeterians ready to step in and to raise their voice in protest,
emphatically insisting on the distinction between "Schumpeterian econom-
ics" and "the economics of Schumpeter." There is really something
scandalous in the way some economists' stock on the bourse of intellectual

reputations is at the whim of academic speculators-as if their sole
contribution amounted to providing prescriptions for overcoming some
specific "crisis" situation of one sort or another (there always seems to be
one lurking around the corner), ready to be consigned to the obscurity of
the footnote underworld once that crisis has abated.
On a more pedestrian note, one may muse over some "internal" reasons
for the long neglect and sudden rise of Schumpeter's economic theories. In
a sense, the publication of Schumpeter's major theoretical works suffered
from bad timing. The Theory of Economic Development appeared at a time
(1911) when the early "neoclassical" theorists were busy spelling out the
conditions for the efficient allocation of given resources in a static equilib-
rium context. A theory that purported to explain economic change endo-
genously had to reckon with a lackluster reception. Considering that
Schumpeter was a lone figure in taking up the classical, especially Marxian,
theme of technical change as the propelling force of economic growth
under capitalism, this is hardly surprising. Thus, Paolo Sylos-Labini ven-
tures the intriguing thesis that "the dominance of the static neoclassical
analysis was such that Schumpeter's work appeared more original than it
was, and to some economists, it appeared as queer and eccentric" (Sylos-
Labini, 1984, p. 82).
Similarly, Business Cycles appeared at a time (1939) when the econom-
ics profession was immersed in trying to acquaint itself with Keynes'
General Theory. Moreover, "As even his warmest admirers would agree,
Business Cycles is a badly written book. It is inordinately long and the use
of statistics is poor .... Perhaps most important of all Schumpeter did not
satisfactorily explain why major innovations or clusters of innovations
should occur only every half century or so" (Freeman, Oark, and Soete,
1982, p. 22).
But even more significantly, the long neglect of Schumpeter's work in
mainstream economics reflects the potentially subversive purpose to which
the former may be put. Schumpeter threw down a gauntlet which the
profession, with good reason, only hesitantly picked up. The conven-
tionally adopted static framework, with its emphasis on optimization and
equilibrium, does not allow for the kind of large-scale, rapid, disruptive,
radical, structural, and qualitative changes on which Schumpeter centered
his attention. (On all this, see Elliott, 1985, pp. 27-29.) But, in a typically
Schumpeterian twist, he may himself have to take some of the blame for
the ascendancy of the post-Walrasian approachY By injecting what he
deemed to be the truly dynamic, entrepreneurial forces into a basically
Walrasian framework, Schumpeter took the sting out of a potentially
devastating blow for orthodoxy, and he may even, somewhat paradoxical-

ly, be held responsible, partly and indirectly, for the subsequent eclipse,
and neglect, of the former. But it is precisely the Walrasian core of
neoclassicism that has been, for better or worse, at the center of constant
attacks from various directions for the past two decades or so-and some
of those efforts hold the promise of a renewed emphasis on the dynamic
entrepreneurial forces envisaged by Schumpeter (see, e.g., Day and Elias-
son, 1986).
2.2. Mises
Compared with Schumpeter, an assessment of Mises' changing reputation

and standing in the profession over the last few decades is relatively
straightforward. Since about the time of Mises' demise in 1973, interest in
his thought may be said to have emerged from the doldrums. If one were to
look for a single, catalytic event one should, with the benefit of hindsight,
single out the publication of Competition and Entrepreneurship (1973) by
Mises' former student and colleague at New York University, Israel
Kirzner. To be sure, this revival of interest did not match the spectacular,
meteoric rise enjoyed by Schumpeter. There was no sudden outburst; the
renaissance proceeded at a more leisurely pace. Furthermore, in terms of
sheer volume of literary output stimulated by their respective centen-
aries-Mises' centenary in 1981 was marked, as far as I am aware, by
three pUblications12 -Schumpeter easily carried the day. But it would
be entirely misleading to infer from the relatively small number of full-
blown studies of Mises' economic thought-the recently published mono-
graph by Eamonn Butler (1988) may therefore fill an urgently felt lacuna in
the literature-that Mises' influence has been limited in scope. The
modern Austrian revival would be literally unthinkable without the
perseverance with which Mises pursued his cause against overwhelming
odds (Kirzner, 1982a, p. 2).
Mises' lifelong crusade against virtually everything that smacked of
socialism, interventionism, inflationism, egalitarianism, and trade union-
ism; his uncompromising championship of libertarianism; his scathing
criticism of the use of mathematical and econometric techniques in econom-
ics; his unconventional, to put it mildly, views on epistemology-anyone
or two of those features would have estranged him to an overwhelming
majority of his fellow economists who had been nurtured on believing
in the possibility of manipulating macroeconomic aggregates, and in
the desirability and efficacy of intervention into market processes; but
the combination of all of them stigmatized Mises' reputation indelibly

(see Machlup, 1981, p. 11). Mises' disparaging statements on the work
of others were not exactly suited to endear him to the profession either
(Mises, 1978, passim).
Considering the extent to which Mises' approach to economics ran
completely counter to prevailing views during his lifetime, recent interest
iIi his writings is nothing short of phenomenal. Two striking examples may
suffice. For a long time, the most celebrated controversy in comparative
economic systems theory-that is, the debate raging during the inter-war
period over "rational economic calculation" in a socialist society, which
was sparked off by a famous article by Mises-seemed to be a closed
chapter in the history of economic thought. Not least owing to Schumpe-
ter's influence, Mises and Hayek were commonly considered to have "lost"
the debate. Indeed, "victory" for the kind of market socialism espoused by
Lange and Lerner was held to be so overwhelming that modern treatments
of welfare economics do not even care to mention that there ever was such
a controversy. (Layard and Walters (1978, p. 27) is illustrative of a general
tendency.) Most recently, the standard account of the calculation debate
has been seriously called into question, largely as a result of its iconoclastic
reexamination by Don Lavoie (1985).
Another area where Mises' views appeared to be thoroughly discredited
concerns his a priorist conception of economics. Hardly a decade ago,
Mark Blaug's harsh strictures on Mises' methodological writings which he
dismissed as "so cranky and idiosyncratic that we can only wonder that
they have been taken seriously by anyone" (Blaug, 1980, p. 93) would have
met-outside strictly Austrian circles-with general approval, even
among those who were not, in principle, unsympathetic to Mises' views (as
long as they were not immediately related to the philosophy of economics,
that is). Nothing could indicate the change of climate more strikingly than
the fact that any book on the methodology of economics worth its salt that
is being published these days contains a chapter on Austrian methodology,
with particular emphasis accorded to Mises. Recent work by Patrick
O'Sullivan (1987) and John Pheby (1988) is a case in point.
Unfortunately, the widespread perception of Mises as a libertarian
doctrinaire-Seligman (1962) entitles his extensive section on Mises
"Libertarianism in 'Extremis'" -a view that Mises himself had fostered to
the best of his ability, to be sure (see, e.g., Mises, 1956), has tended to
denigrate his many original contributions to economic theory. In what is
perhaps the most incisive account of Mises' manifold contributions to
economics, Murray Rothbard, in appraising Mises' classic work in mone-
tary theory, The Theory of Money and Credit (originally published in 1912),
observes: "Mises set out on what is currently a familiar agenda: grounding

macroeconomics on a micro-base. The irony is that Mises succeeded, but
that his achievement is still unknown, much less integrated into the
mainstream of economic thought" (Rothbard, 1984, p. 287). Rothbard
goes on to credit Mises with having pioneered the cash balance approach to
money, and macro-expectation analysis. 13
A great deal of the influence that Mises exerted was of an indirect
nature-through the writings of, and the oral tradition cultivated by, his
students and followers. The so-called Austrian, or monetary, theory of the
business cycle (for updated statements, see Barry, 1984; Haberler, 1986;
O'Driscoll and Rizzo, 1985, ch. 9; Wood, 1984) originally propounded by
Mises,14 refined and propagated by Hayek, created quite a stir during the
"years of high theory" in the English-speaking world before it came to be
comprehensively eclipsed by the Keynesian Revolution. As Schumpeter
significantly notes in this connection, "The social psychology of this is
interesting' matter for study" (1954, p. 1120). Indeed!
Another area where Mises' impact made itself indirectly felt-albeit in
very muted ways-concerns the formulation of what is commonly referred
to as "the economic problem"; or, to put it differently, the standard
definition of the subject matter of mainstream economics that invariably
finds its way into introductory textbooks-unfortunately not necessarily in
the meaning intended by its originator, the late Lord Robbins of Clare
Market, who in the preface to the first edition of his highly influential An
Essay on the Nature and Significance of Economic Science (1932) recorded
his "especial indebtedness to the works of Professor Ludwig von Mises."
Addleson (1984) and Kirzner (1982b; 1986, pp. 140-144) have explored in
detail the intricate and subtle route through which the Austrian influence
on Robbins has been transmitted into mainstream economics.
As the foregoing remarks have already adumbrated, perhaps the key to
Mises' importance-not sufficiently stressed in the literature-lies in the
many brilliant students (this is not necessarily meant in the formal sense)
he attracted. It is to his lasting credit that he succeeded in surrounding
himself, in his Vienna privatseminar during the twenties and early thirties,
with a remarkable group of social scientists, who despite their many
differences of opinion with the master-chiefly on questions of methodol-
ogy and political and social philosophy-retained, in varying ways, a
distinctly Misesian "touch" in their outlook (see Boehm, 1984). Many of
the regular participants of the "private seminar" were to emerge as
towering figures in twentieth century economics in their own right-
Gottfried Haberler (b. 1900), F. A. Hayek (b. 1899), Fritz Machlup
(1902-1983), Oskar Morgenstern (1902-1977), and Paul Rosenstein-
Rodan (1902-1985)-constituting arguably one of the most important, if

not the most important, group of "quiet invaders" (Spaulding, 1968) of
American economic thought; others, such as Felix Kaufmann, the philos-
opher and legal theorist, Alfred Schutz, the philosopher and sociologist,
and Eric Voegelin, the philosopher and political scientist, made their
marks in other fields; still others, such as Walter Weisskopf, pursued an
economics all of their own. The seminar also served as a clearinghouse for
the international transmission of ideas; many eminent scholars from abroad
presented papers in the seminar. It is testimony to Mises' powerful
personality that he managed to establish himself, outside the university
system, as the doyen of the Austrian school during the inter-war years. It is
in large measure thanks to Mises that Vienna rose to one of the world's
foremost centers of research in economics at that time-a feat for which
his native Austria has, alas, never given him due credit.
During the fifties and sixties Mises gathered a small, but eagerly
devoted, group of students in his seminars at New York University, some
of whom published in the Misesian tradition (e.g., Kirzner, 1960; Roth-
bard, 1962) and continue to do so.
Toward the end of his life, Mises received the belated professional
recognition that had eluded him for such a long time. Festschriften were
published in his honor; he was awarded several honorary doctoral degrees;
and in 1969 he was named a Distinguished Fellow of the American
Economic Association (for a chronology of Mises' life, consult Moss, 1976,
pp. 119-122). Several factors acted in combination and contributed to the
germinating appreciation of Mises' oeuvre from the early seventies onward.
The following list is not necessarily in order of importance, and certainly
not meant to be exhaustive: the regained political and intellectual respec-
tability of classical liberalism (libertarianism); the Nobel award to Hayek
in 1974; the institutionalization of a distinct Austrian economics program
at New York University and other universities throughout the United
States, and the concomitant seminar series and conferences; the establish-
ment of institutes such as the Mises Institute at Auburn University and the
Center for the Study of Market Processes at George Mason University,
which are at the forefront of promoting Austrian (especially Misesian)
economics; the growing dissatisfaction with the almost exclusive emphasis
on equilibrium theorizing; the fashionable quest for "microfoundations of
macroeconomics"; a greater readiness on the part of the profession, fueled
by an increasing sentiment of disillusion with "the state of economics," to
search for alternate, in some cases defunct, theories and ideas, and so on.
Coming back to Schumpeter, it is interesting to note that Schum pete-
rians of all sorts have also felt the need to channel their diverse research
efforts through the establishment of organizational forms. In this vein, an

International Joseph A. Schumpeter Society was founded in 1986, with
Wolfgang Stolper serving as its first president. At the bi-annual con-
ferences a Schumpeter Award will be conferred; Christopher Freeman
has just been nominated as the first prizewinner. To my knowledge, there
is no International Ludwig von Mises Society as yet. But, as I have been
told, the spirit of his writings and teachings is very much alive at the
annual meetings of the Mont Pelerin Society-a fitting tribute to one
of its founders.
3. Some Schumpeterian and Misesian Themes
3.1. Two Conceptions of Equilibrium
There appears to be one area that glaringly suggests itself to be singled out
as encapsulating Schumpeter's and Mises' common concerns-the use of,
and the reliance upon, some variant of a general equilibrium construct
serving as the pivot of their respective systems. In keeping with the
Austrian habit of devising some concept of equilibrium as a reference point
for the analysis of "real-world change" (see Loasby, 1984, p. 77)-
Hayek's ingenious notion of social equilibrium as a set of perfectly
compatible, mutually reinforcing, individual plans (Hayek, 1937) is also
pertinent here-both Schumpeter and Mises invite us to consider "the
circular flow of economic life" and "the evenly rotating economy," respec-
tively, as the center of gravity of the economic cosmos. While much has
been written on the evenly rotating economy (ERE), and even more ink
has been expended on the circular flow (CF), it is a remarkable feature of
the interpretive literature that the number of commentators who have
delved into the subtle issue of the relationship between those two equilib-
rium concepts is so sparse. Indeed, hardly anybody (see, however, Hebert
and Link, 1988, p. 127; Lachmann, 1986, pp. 108-109; Reid, 1987, p. 109;
and Seligman, 1962, p. 333) seems to have noticed what at first glance
appears to be an interesting kinship of ideas. Hence, it might somewhat
prematurely be concluded, scholarship on Mises and Schumpeter has
proceeded along different tracks, it further confirmation was needed at all.
Closer inspection reveals, however, that the general reluctance to
bracket Mises and Schumpeter together in that respect reflects- whether
wittingly or unwittingly is beside the point here- a wise judgment on
the part of the commentators. To be sure, there are a number of impor-
tant features that are common to both the CF and the ERE; but some of
the assumptions underlying their construction, the appropriate domain
accorded to them in the overall theory, and, above all, the specific ways in
which they are linked to radically different visions of the systematic
functioning of a capitalist market economy warrant separate treatments.
Since the vexing problem of the status and purpose of equilibrium reason-
ing looms large in this context, an examination of these issues reaches far
beyond the "purely doctrinal" concerns.
What is interesting to note about both the ERE and the CF is that their
implied definition of equilibrium turns on the way decisions are taken,
rather than on prices and quantities (see Loasby, 1984, p. 77). For a
somewhat more eloquent notion one may turn to Frank Hahn: "[A]n
economy is in equilibrium when it generates messages which do not cause
agents to change the theories which they hold or the policies which they
pursue .... [A]n agent abandons his theory when it is sufficiently and
systematically falsified" (Hahn, 1984, p. 59). One of the virtues of defining
equilibrium in this way is that it throws sharply into relief the habitualness
of agents' behavior in equilibrium. "Equilibrium actions of agents will
reveal themselves in habitual behaviour" (Hahn, 1984, p. 59).
3.2. The Circular Flow
It is a well-known feature of Schumpeter's CF (see the elaborate· treat-

ments in Khan, 1957, ch. 1; and Clemence and Doody, 1950, chs. 2 and 5) .
that under its regime economic activity conforms to an established and
stable set of routines, which individuals have acquired through a mixture of
experience, custom, habit, tradition, and social conventions. The predilec-
tion to cling to familiar modes, the strong desire to resist change in all its
manifestations, and the very protracted adaptation under pressure are all
conducive to the essential tranquility of the CF. The repetitive nature of
economic life lulls everybody into a state of inertia; the adherence to
everyday routine, in turn, perpetuates the CF.
The persistent and rigid attention to "rules of behavior [which] have
stood the test of experience," and which have convinced individuals that
"on the whole they cannot do better than go on acting according to them"
(Schumpeter, 1934, p. 40), suggests that the CF-equilibrium "is arrived
at through some process of trial and error" (Loasby, 1984, p. 78).15 But
Schumpeter elects not to offer a detailed analysis of this process-that is,
to explain how the prevailing routines came to be what they are (this is
Loasby's topic); rather, he is content to fall back on "past experience" in

the explanation of the emergence of a coherent pattern of routines.
The assumption that conduct is prompt and rational is in all cases a fiction. But it
proves to be sufficiently near to reality, if things have time to hammer logic into
men. Where this has happened, and within the limits in which it has happened,
one may rest content with this fiction and build theories upon it (Schumpeter,
1934, p. 80; italics added).
The italicized passage appears, at first glance, to strike a familiar
Shacklean chord. Experience, expertise, and inertia will generally do as
a guide for conduct in matters of "immediate physical performance,"
Shackle concedes, but he also issues a solemn warning to the effect that
"business does not consist solely in hand to mouth operations" (Shackle,
1972, p. 96). On the contrary, Shackle's argument runs on, it is of the
essence of the human condition in general and of "economic life" in
particular that we try to catch a glimpse of a future which is fabricated by
those very glimpses. If economics proceeds on the convenient assumption
that men apply reason to their fully known circumstances, this can only be
achieved by emasculating novelty-bearing time. "It is only in the timeless
fiction of general equilibrium that reason can prevail alone" (Shackle,
1972, p. 96). Thus, Shackle reaches the defeatist (or liberating, depending
on one's preferences) conclusion-indeed, one could make a case that his
entire work is addressed to this conundrum-that there is an ineradicable
antagonism between "time" and "reason." Schumpeter's conception of
"empirical" rationality shows the way out of this apparent dilemma. A
number of commentators have rightly marked out this particular aspect of
Schumpeter's work, which, as it turns out, is crucial to an understanding of
his vision of the economic process, as a promising line for future research.
Paradoxically, Shackle's thesis concerning the incompatibility of time
and reason draws its force from the very same notion of rationality of
which he is arguably the most radical and profound critic. Just as in
standard, neoclassical economic theory, Shackle does not at all consider
choices that are not preceded by conscious deliberation, calculation, and
reflection on alternative courses of action; habitual and traditional forms of
behavior are thus conveniently removed from the picture. In Schumpeter's
CF, by contrast, no one is required to muster a "conscious and rational
effort" (Schumpeter, 1934, p. 10) to attain his or her desired ends. The
point is echoed by Richard Day when he maintains:
The formidable logical requirements of individual optimality and interagent
consistency would not tax the limited cognitive abilities of ordinary people or
the imperfect co-ordinative functioning of markets. Tradition, mere habit or

inertia would be enough to keep economic actors in line with their own best
interests (Day, 1984, p. 59).
In a similar vein, Robert Heilbroner remarks: "In Schumpeter's circular

flow, routine and custom provide the motive force for business behavior,
rather than a· never-ending search for advantage" (Heilbroner, 1988,
p. 169).
Hence, the behavioral content of Schumpeter's conception of equi-
librium-the "empirical way of acting"-has "a rational basis" (Schum-
peter, 1934, p. 40). But the "rationality" underlying individual behavior
within the accustomed channels of the CF is not of the neoclassical,
optimizing variety based on deductive certainty; it does not involve the
conscious, logically correct deduction of conclusions from explicitly stated
premises. It may, therefore, perhaps best be dubbed as "thoughtless
rationality" (Etzioni, 1988, ch. 1O)16-that is, relying upon "rules of
thumb" in decision making. 17 Recast in this way, rationality is no longer
seen as "the 'glue' that holds the system together" (Langlois, 1985, p.
312)-that is, individual rationality in the strict, neoclassical sense is no
longer required to ensure collective rationality18 in the Paretian sense;
rather, systemic coherence is facilitated by rule-following behavior and
social practices.
A closely related theme has been highlighted by another group of
authors. It is usually referred to, in the phraseology of the scientist-
philosopher Michael Polanyi, as "tacit knowledge" (Polanyi, 1966), or, in
the terminology of the sociologist Anthony Giddens, as "practical con-
sciousness." The essential idea is that our knowledge of the conditions
surrounding our actions is not exhausted by what we can say about them.
There are many actions which are carried out knowlegeably, but which are
not "necessarily available to the discursive awareness of the actor" (Gid-
dens, 1986, p. 536.) Schumpeter, for one, was well aware of the signif-
icance of tacit knowledge for a theory of agency (see Schumpeter, 1934, p.
85).
It is hardly surprising, then, that theorists who are exploring this issue
tum to Schumpeter's work as a major source of inspiration (e.g., see the
discussion on "skills and tacit knowledge" in Nelson and Winter, 1982, pp.
76-82). Following Nelson and Winter, Giovanni Dosi (1988, p. 123) notes
that a high degree of tacitness inherent in a technology-that is, embody-
ing idiosyncratic capabilities-tends to thwart its diffusion. "An implica-
tion is that, at any point in time, different companies and countries are
likely to be characterized by different technical coefficients and product
technologies" (Dosi, 1988, p. 123). Pavel Pelikan, in his comparative

studies of economic self-organization (see, e.g., 1985, 1986), extends the
idea of knowledge that cannot be communicated, such as skills and
"competence," to organizational structures. He is dealing with the impor-
tant and usually neglected problem of to what extent alternative economic
systems (institutions) are geared to modifying-that is, organizing and
reorganizing-their own structures in the course of, and as a result of,
their functioning. This line of research is, of course, strongly reminiscent of
Schumpeter's interest in the creation and destruction of economic struc-
tures under capitalism (for once, I refrain from quoting the relevant,
famous passage from Capitalism, Socialism, and Democracy), and detri-
mentally opposed to standard procedures focusing on the allocation of
scarce, given resouces among given contending units, mediated by already
given markets.
In a nutshell, Pelikan's argument runs something like this (see, in
particular, Pelikan, 1986, pp. 143-144). In stark contrast to the conven-
tional resource allocation problem, the allocation of tacit knowledge does
not leave organizational structures intact; or, put another way, a change
in the allocation of tacit knowledge necessarily generates a new organiza-
tional structure. Thus, the neat separation between the allocation mech-
anism and the resources being allocated by that mechanism collapses.
Consider the standard modeling of the agent and the concomitant assump-
tion of perfect rationality. Given that organizational structure (allocation
mechanism), the embodied tacit knowledge is not regarded as scarce. In
Pelikan's view, however, economic rationality is based on scarce tacit
knowledge, and consequently needs to be allocated itself. This raises, then,
the crucial question of how to allocate scarce rationality. "What makes this
problem most peculiar is the fact-and this is where the strange loop
appears-that there is nothing else with which to allocate scarce rationality
than scarce rationality" (Pelikan, 1986, p. 144).
3.3. Criticisms of the Concept of the Circular Flow
Two broad lines of criticism have been leveled at Schumpeter's CF, which
will be briefly taken up in turn (see Clemence and Doody, 1950, ch. 5).
The first concerns the question of whether the institutional arrange-
ments implied by the data of the CF could serve as an adequate starting
point for the analysis of "the generation of capitalist motion" (Oakley,
1985). This is a venerable line of inquiry initiated by Paul Sweezy (1943).
The question is deemed to be highly relevant because, "If capitalist society
is not tolerably approximated by the institutional arrangements underlying

the circular flow, then the Schumpeterian System is defective from the
beginning" (Clemence and Doody, 1950, p. 24).
Schumpeter himself is adamant that the CF, rather than referring to
some utopian fairyland, captures what he deems to constitute the essential
institutional ingredients of a capitalist market society. Early on in the
Theory of Economic Development Schumpeter leaves no doubt that in
deriving "the leading characteristics of a mental picture of the economic
mechanism" he has primarily in mind "a commercially organised state, one
in which private property, division of labor, and free competition prevail"
(Schumpeter, 1934, p. 10). Thus, the CF is held to represent an abstract
scheme concentrating on the operation of a few selected, real economic
forces (see Sweezy, 1943, p. 93).19
Given that sort of setting, laying bare the "law of motion" in capitalist
society would seem to require two logical steps-first, the identification of
the "causative factor" believed to be responsible for change; and, second,
the study of its interaction with the phenomena composing the CF. If it
could then be demonstrated that in the absence of the identified causa-
tive factor the economic system would indeed not harbor any tendency
toward "change," as understood by Schumpeter, the CF would be estab-
lished as an analytically sound reference point for an investigation of
economic change.
Proceeding in this way, Sweezy finds no fault with Schumpeter's argu-
ment as such; on the contrary, "on its own assumptions his theory of the
mechanism of economic change is unassailable" (Sweezy, 1943, p. 94).
Thus, the question turns on the adequacy of the assumptions. For example,
one might simply object to the CF on the grounds that it does not repre-
sent the only conceivable model of capitalism in the absence of change.
The model of the CF may be rejected as a first approximation of capita-
list reality for failing to provide room for a special class of agents-
"capitalists"-who are entrusted with functions other than disbursing
wages on payday. Furthermore, if the hypothesized class structure under-
lying the CF comprises not only landlords but also a class of agents who, by
definition, exercise exclusive control over produced means of production
as their owners, Schumpeter's conclusion concerning the absence of "capi-
talistic" incomes may no longer hold. In this alternative, "radical" vision of
capitalism, the existence of surplus income even under stationary condi-
tions would present both the opportunity and a strong incentive for
accumu!ation. On this view, the ordering of cause and effect is reversed;
surplus income and accumulation are no longer regarded as merely inci-
dental to change initiated by agents who have the strength and vision to
overcome the inertia of the CF; they are, rather, considered to be the very
forces pushing for disruption. Instead of being traced to some supernormal
personality traits associated with a particular set of agents, which is
tantamount to introducing a spontaneous, or voluntaristic, element,20 the
urge to transcend established patterns of behavior is embedded in the
systemic constraints and incentives of a capitalist class structure.
In one way or another, several authors have elaborated on this theme
first enunciated by Sweezy. Allen Oakley (1985) draws on the revived
classical-Marxian tradition in order to demonstrate that Schumpeter's
account of the generation of capitalist motion is seriously flawed. John
Elliott (1980) provides a comparative reappraisal of Schumpeter's and
Marx's version of capitalism's destructive power. John Grahl imputes to
Schumpeter the "formal dissolution of capitalist agency" and a "dynamic
purged of all its actual violence and antagonism: the human conflicts
through which the capitalist process passes do not belong to it-they result
from the extrinsic social milieu" (Grahl, 1985, pp. 217-218). Along the
same lines, Robert Heilbroner observes, "The conceptualization of profits
as a deus ex machina that upsets the circular flow, not as an inherent force
that stems from the restless efforts of capitalists to expand their socioeco-
nomic base, entirely removes any conflictual aspect from Schumpeter's
perception of capitalism" (Heilbroner, 1988, p. 179).
Shigeto Tsuru (1952), in exploring the perceived link between capital-
ism and the business cycle in Schumpeter, challenges the cogency of the
analysis on the basis of Schumpeter's own methodological prescriptions.
The fundamental problem of causation, as Schumpeter conceives it, is
the following:
If we have a set of "real" phenomena X [capitalism], which we try, for some

purpose, to handle by a conceptual schema, X' [the circular flow], then if an
event Y [the business cycle] occurs in X, it will not necessarily have meaning to
search for a single cause of Y; but there is always meaning to the question,
whether X' implies or not the occurrence of Y, and which of the properties of X'
are responsible for it (Schumpeter, 1939, p. 34).
Tsuru contends that by starting out from an abstraction of the capitalist

process that is devoid of the institutional ingredients considered to be
essential to it from a Marxian perspective, Schumpeter attributes the
occurrence of cyclical phenomena to a notion of change ("doing things
differently") which is in itself invariant to different institutional arrange-
ments, and that he thus ultimately fails to establish a necessary connection
between capitalism and business cycles. According to Tsuru, Schumpeter
does not succeed in distilling X' from X in such a way that the differentia
specijica of capitalism could serve as an explanatory principle of Y.
While giving full credit to the logic of Tsuru's reasoning, it remains
doubtful, however, whether Schumpeter was ever rash enough to consider
such a bold question. As Tsuru himself concedes, "It may be that in
Professor Schumpeter's scheme of explanation capitalism and business
cycles are related in such a way as not to permit the singling out of distinct
connecting links" (Tsuru, 1952, p. 136). Schumpeter was well aware that
the search for "single causes" would be in vain; rather, he was content to
establish sufficient conditions21 under which the "economic mechanism"
would of its own accord produce booms and depressions. Whether he was
successful at this, is an entirely different matter and is, it may be surmised,
still open to question.
Against the charge of neglecting all historical factors but one-the
individual traits of a class of agents called "entrepreneurs" -Schumpeter
quite rightly defended himself by pointing out that he had been seriously
misunderstood on that point; he did not consider one factor of change, but
none at all. His theory of economic development was "not at all concerned
with the concrete factors of change, but with the method by which these
work, with the mechanism of change. The 'entrepreneur' is merely the
bearer of the mechanism of change" (Schumpeter, 1934, p. 61n). Taking
all this for granted, one may, however, still question the soundness of
Schumpeter's procedure. Does it really make sense to analyze the entre-
preneur as a pure sociological type (see Sweezy, 1943), in abstraction from
the economic environment in which he or she performs the role attributed
to him or her? Drawing attention to the rich motivational structure
Schumpeter ascribes to entrepreneurs, Herbert Zassenhaus justly points
out that "their mentality and motivation grew on the soil that had been
prepared during a long intellectual history which was not of their crea-
tion." And he proceeds to observe, "It remains difficult ... to defend
Schumpeter against the accusation of introducing, in the shape of the
'entrepreneur,' a social miracle in the precise sense of the word: an event
beyond the laws of nature and society" (Zassenhaus, 1981, p. 181).
Among other, somewhat more technical, criticisms which have been
advanced against the conception of the CF, and which need not further
detain us here, its zero-interest-rate property has figured prominently.
Lionel Robbins, in what arguably constitutes the best-known repudiation
of Schumpeter's theory of interest, summarizes its two main propositions
in the following terms. First, under the stationary conditions of the CF the
value of the final product is fully swept back to the original factors of
production, land and labor, and, consequently, there is no room for an
interest share. Second-and this is the posltlve proposition-interest

represents an evolutionary ("dynamic") income category, the emergence
of which is inextricably bound up with economic development (see Rob-
bins, 1930, p. 211). As Friedrich Lutz notes, the validity of Schumpeter's
claims critically rests on a double assumption: first, that individuals' time
preference is zero; and second, that all investment opportunities have been
realized. Therefore, the acceptance of Schumpeter's views hinges on the
endorsement of those two assumptions (see Lutz, 1968, p. 132).
The reception of Schumpeter's theory of interest has been fraught with
misinterpretations and misunderstandings. A good deal of the comment-
aries (see Clemence and Doody, 1950, pp. 28-29, for an overview), by
focusing on the issue of the logical (im)possibility of a zero rate of interest
in a CF-economy, 22 has unfortunately deflected attention from Schumpe-
ter's positive contribution. First of all, as Schumpeter (1939, p. 41) himself
explains, the existence of a positive rate of interest in the stationary state
would not alter his system in an essential way. Furthermore, Schumpeter
nowhere states that in the CF the rate of interest is zero; rather, the interest
phenomenon (as conceived by him) doesn't exist-'''the "static" economy
knows no productive interest'" (Schumpeter, 1934, p. 158)-which is a
subtly and significantly different way of putting it.
As Schumpeter would be happy to acknowledge, there are cases of
interest, such as interest on consumptive loans, that can easily be sub-
sumed within the CF. "But they do not constitute the great social phe-
nomenon that needs explaining. This consists of interest on productive
loans" (Schumpeter, 1934, p. 157). Thus, for Schumpeter, the significant
kind of interest is the entrepreneur's payment to the capitalist for the use of
purchasing power. Put differently, interest concerns the payment by inno-
vating firms necessary to persuade banks to advance capital funds; it does
not refer to the expense required to entice savers to abandon their money
balances. Hence, invoking the traditional theory of the rate of interest as
the price coordinating saving and investment misses the point of Schumpe-
ter's intentions (see Graziani, 1988).
Interest is essentially a monetary phenomenon determined on the
market for money loans. Profits enable entrepreneurs to pay interest
to capitalists for the loan of purchasing power. How can interest be a
permanent flow of income when the profits from which it is derived are
only a fleeting phenomenon? Schumpeter's response to that apparent
conundrum rests on a categorical rejection of the classical identification of
profits with interest. Far from being synonymous with profits, interest acts
as a tax on profits, a withdrawal from them paid to another party, the
capitalist (see Conard, 1963, p. 91). Whereas profits arise temporarily from
specific goods, interest is earned on liquid purchasing power which can flow
from one source of profit to another in a constantly changing world.
3.4. The Evenly Rotating Economy
Any appreciation of Mises' theoretical structure has to grapple with his

conception of the ERE. Its pivotal role is akin to that occupied by the CF
in Schumpeter's scheme. Although one may confidently assume that
acquaintance with the notion of the ERE is not as widespread as with the
CF, there is a certain familiar ring to it.
The ERE is perhaps the most consummate example of what Mises
designates as "the method of imaginary constructions," which he considers
to be "the only method" germane to economic analysis. According to
Mises, "The main formula for designing of imaginary constructions is to
abstract from the operation of some conditions present in actual action.
Then we are in a position to grasp the hypothetical consequences of the
absence of these conditions and to conceive the effects of their existence"
(Mises, 1949, p. 238; italics added). Although the phrase may sound
unfamiliar to many economists, the method of imaginary constructions
certainly isn't; the commonplace exercise in comparative statics, with its
critical reliance on the ceteris paribus clause, is an effective illustration of
that procedure.
The ERE-construct may succinctly be specified as "a general equilib-
rium through time characterized by absence of change in the external data"
(White, 1982, p. 104). The notion of time inherent in that definition
deserves some comment. In stark contrast to the Arrow-Debreu general
equilibrium construct, in which the relevant decisions of all periods are
preordained once and for all "before the beginning of time," the ERE does
not posit that all contracts are struck at a single, initial date; rather, the
equilibrium is restored every "day." However, since in the absence of
unexpected change in the external data both the future and the past are in
all relevant aspects identical to the present, the ERE in effect does away
with "time" in any meaningful sense. Indeed, as Mises himself observes,
"The essence of this imaginary construction is the elimination of the lapse
of time and of the perpetual change in the market phenomena" (Mises,
1949, p. 248).
The construction of the ERE proceeds on the premise that given
conditions are allowed to work themselves out to the full-that is, before
change intervenes. The ERE is pictured as the result of a process of
convergence initiated by a freeze in the data-preferences, technology,
and resources (see Rothbard, 1962, p. 275). In the absence of change in

our data the economy would tend to establish "a final state of rest."
Although a state of affairs corresponding to that final equilibrium position
would-owing to the incessant emergence of new factors of disturbance-
never be reached in practice, the market is at every instance "disquieted by
a striving after a definite final state of rest" (Mises, 1949, p. 246). The
never-attained, ever-shifting position of final equilibrium may be visualized
by analogy with the familiar storf3 of the dog chasing its master, who is
riding on a bike. Although the dog may never quite catch its master, it is
moving in his direction.
As the very term evenly rotating suggests, an economic system thus cast
entails that all activities be repeated in an endless round. The system is in
constant flux, but it revolves evenly around a fixed center (see Mises, 1949,
p. 248). Goods of the same quality and in the same numbers are forth-
coming in each and every period; all prices remain constant; there is
no uncertainty; individual plans are perfectly consistent.
When "things have time to hammer logic into men" (Schumpeter, 1934,
p. 80), it would appear then that Mises' equilibrium construct may serve as
a reasonably close approximation to reality. However, in keeping with the
method of imaginary constructions, Mises vehemently denies this particu-
lar usage of the ERE (see Mises, 1949, p. 249). Whatever merit that
concept may be said to enjoy, it is emphatically not derived from the claim
that under certain conditions-in certain places, at certain times, for
certain purposes-equilibrium, in Schumpeter's words, is "sufficiently
near to reality" (see Littlechild, 1982, p. 87). On the contrary, as Don
Lavoie (1985, p. 110) notes, the ERE is deliberately utterly "unrealistic."
As Mises repeatedly insists, the ERE does not refer to "a real entity"; it
should be understood merely as "a limiting notion, a mental tool" (Mises,
1949, p. 251).
Its sole employment as a mere ancillary tool of reasoning notwithstand-
ing, the ERE is nevertheless claimed to possess "real" significance (Mises,
1949, pp. 250-251; Rothbard, 1962, p. 275-276)-that is, to be empirical-
ly usefuL It is precisely by conjuring up an image of an economy in which
the problems of the real would are conspicuously absent that the ERE
points to a research agenda. This nondescriptive, essentially negative
function of the general equilibrium construct is also emphasized by out-
standing practitioners of the Arrow-Debreu theory like Frank Hahn. Just
as we should look at Arrow-Debreu general equilibrium theory as encapsu-
lating an economic system in which "Keynesian problems", by definition,
cannot occur-in itself a first and "significant contribution to the under-
standing of Keynesian economics," according to Hahn (1984, p. 65)-
Mises' argumentum a contrario (1949, p. 251) "merely provides us with a

clue why certain results do not obtain" (O'Driscoll and Rizzo, 1985, p.
82)?4 A serious problem with that kind of argument is that in order to
provide a logically sound account of why certain results do not obtain, the
equilibrium conditions would have to be stated as necessary, and not
merely as sufficient, conditions (see Hausman, 1981, p. 152).25
In recent years, the significance of the ERE construct has been a source
of heated controversy among Austrians. Tyler Cowen and Richard Fink
(1985), in particular, have lauched a bitter attack calling for its abandon-
ment. One of their several points of criticism leveled at what they castigate
as "serious inconsistencies in both the nature of the ERE and its suggested
uses" (1985, p. 866) will be considered in the context of this chapter.
Cowen and Fink claim that using the ERE as a backdrop against which the
effects of exogenous changes are evaluated overstates their disruptive
impact because the ERE is devoid of coordination-enhancing market
institutions. Consequently, they conclude, "we are giving the market
economy an unfair test" (p. 868).
If valid, this would indeed constitute an illegitimate use of the ERE. But
it is doubtful whether Mises is guilty of this particular charge. There may
well be other inconsistencies involved in Mises' use of the construct, as
pointed out by Cowen and Fink, but losing sight of its fictitious character
and treating the equilibrium as if it had in fact been attained is not one of
them. In contrast to Schumpeter's CF, the ERE is not "an initial state for
an economy that is about to experience change"; such a usage would
bypass Mises' central concern with the problem of how real-world dise-
quilibrium states engender a systematic, determinate course of entre-
preneurially driven market events-regardless of the issue of whether
there is a "tendency" toward equilibrium (see Kirzner, 1979, p. 17).
To summarize Mises' and Schumpeter's position via-a-vis general
equilibrium as embedded in the ERE and CF, respectively (on this issue,
see also Rothbard, 1987, p. 102): Like Mises, who conceives of the ERE
as a foil against which the role of entrepreneurship and its associated
phenomena of profit and loss are compared (see Mises, 1949, p. 249),
Schumpeter appears, at times, to espouse a similar view-for example,
when he states that the phenomena constitutive of economic development
(profit, interest, capital, credit, business cycles) can most fruitfully be
grasped against the background of the CF (see Schumpeter, 1934, p. 63nl).
Similarly, Capitalism, Socialism, and Democracy in its entirety may be
construed as highlighting those dynamic forces that do not figure in the
placid picture of the CF. In Schumpeter's account, the real world of
capitalism, far from conforming to the model of perfect competition, seems
to be incessantly disturbed by technological revolutions transforming its

economic structure from within. Yet, in a significant and qualifying foot-
note to this passage, Schumpeter, in characteristic manner, explains that
those revolutions are not literally "incessant" because periods of turmoil
are always followed by periods in which their results have to be absorbed
(see Schumpeter, 1942, p. 83n).
In an extended discussion of the uses of the equilibrium construct,
Schumpeter stresses again that its "most important" use is "contingent on
the existence of a tendency toward equilibrium .... The thing that matters
to us, is ... this tendency considered as an actual force, and not the mere
existence of ideal equilibrium points of reference" (Schumpeter, 1939, p.
70). Despite occasional evidence scattered throughout his writings which
suggests that Schumpeter insisted on the purely instrumental character of
the equilibrium concept, the unifying thread -running through his work
is-pace Machlup (1963, p. 56n)-a commitment to the philosophical
tradition of "scientific realism" (see, in particular, Moss, 1987).
3.5. Entrepreneurship
The role of entrepreneurship in the work of Schumpeter and Mises has

spawned a massive literature; it is arguably its most popular aspect-no
doubt partly also for reasons spelled out above-both with the commenta-
tors and the general public. Indeed, a case could be made that the recent
concern with the function of the entrepreneur in the economic system is
intimately related to the resurgence of interest in Schumpeterian and
Misesian economics. Furthermore, this renewed emphasis on entre-
preneurship has to be gauged against its almost total neglect in post-World
War II mainstream economic thought-a lacuna that has prompted Mark
Blaug to speak of the "scandal that nowadays students of economics can
spend years in the study of the subject before hearing the term 'entre-
preneur'" (Blaug, 1986, p. 177); if they do so at all, one might add.
The following brief account is certainly not meant to do full justice to
the avalanche of research Schumpeter's and Mises' ideas on entre-
preneurship have generated. The problem here is not so much to guard
against the temptation to survey this area of inquiry (which would easily
call for a book-length treatment),26 as not to be daunted by the canonical
interpretations. Thus, only a few selected issues will be broached.
The picture of the Schumpeterian entrepreneur that has justly been
entertained is one of strong-willed men with vision; men of true grit
defying the "persistence of the old regime" (apologies to Arno J. Mayer)
and ready to take on the world. This romantic conception of the entre-
preneur as a rebel (albeit with a cause) has been seriously questioned by
Albert Hirschman on the grounds that the "ego-focused image of change"
(or, the "creative" component of entrepreneurship) tends to suppress the
other, admittedly less spectacular, aspect of entrepreneurship-its "coop-
erative" component, that is, the ability to enlist cooperation- among all
interested parties to a "breakthrough," which is held to be of critical
importance especially in underdeveloped countries (see Hirschman, 1958,
pp. 16-17).
Likewise, complaints have been aired by Fritz Redlich, to the effect
that, from a historical point of view, Schumpeter's categorical distinction
between innovation and invention doesn't hold water because these phe-
nomena tended to blend into each other; furthermore, Schumpeter's
eulogy of the innovating entrepreneur at the expense of the mere imitator
downgraded the latter's contribution to technological change, which in
many cases required as much ingenuity as the "original" innovation from
which it was derived. 27 .
Quite apart from the fact that Schumpeter would not have any qualms
with those points of criticism (which will not be considered further here),
the general issue underlying them deserves some further commentary. As
has been noted by Grahl (1985, p. 225), the entrepreneur is the sole actor
in Schumpeter's analytical scheme while "everyone else simply adjusts."
Familiar as this rough-and-ready classification is, to be sure, its import has
often been overlooked. The essential point to grasp is that in order to
perform the task assigned to him the entrepreneur has to be a cut above the
rest. Put differently, his exceptional quality is a necessary condition for his
existence. 28 The entrepreneur's imaginative conjectures concerning profit
opportunities are anchored in a stable environment, one condition29 of
which is that the overwhelming majority does not notice something that
somehow eludes the attention of others. As G. B. Richardson pointed out
long ago, a "profit opportunity, which is both known to everyone, and
equally capable of being exploited by everyone, is ... a profit opportunity
for no one in particular" (Richardson, 1960, p. 57). Although the entre-
preneur is portrayed as "taking the plunge" (Nelson, 1984, p. 646), it is not
a Shacklean leap into the void; the creative, or imaginative, element in
decision making30 is superimposed on, and anchored in, the real-world
analogue to the CF, which is held to provide the necessary stable
framework for performing entrepreneurial calculations. 31 The equilibrium
routines entailed in the general equilibrium framework of the CF enable
the prospective entrepreneur to do his or her partial disequilibrium calcula-
tions, without having to worry about the impact of his or her decisions on
others' choices. 32 The "mere businessmen's" reliance on, and perpetuation

of, the routines of the CF which enable the entrepreneur to do his or her
bit in the first place, is subverted in turn when challenged with something
new. The dialectical relationship between creation and destruction, which
is at the heart of Schumpeter's theory of qualitative, or structural,
change,33 has been felicitously designated as "daimonic destructiveness"
(Redlich, 1971, p. 34).
It is a well-known feature of Schumpeter's theory that entrepreneurial
activity is self-destructive in the sense that the profits reaped by the
successful innovator are continually eroded with the emergence of imita-
tors, whose activity causes the profits eventually to disappear and a new
equilibrium to be restored. Franklin Fisher notes that a convergence to
equilibrium can never be proved "unless we assume that new opportunities
do not keep on appearing" (Fisher, 1983, p. 88).
Schumpeter's theory of innovation has been taken to task for failing to
spell out the conditions that favor innovative activity, rather than being
attentive to its consequences. 34 Furthermore, despite the apparent central
role assigned to innovation in his scheme and all this rhetoric about the
dynamics of capitalism, Schumpeter paradoxically attenuates its import
in two ways-first, by pointing to the powerful adaptive forces equally
present in capitalism; and, second, by bolstering his thesis concerning
the withering away of capitalism (see Shionoya, 1986, p. 754).35 Similarly,
Nathan Rosenberg (1975, pp. 461-464) and, following his lead, Paul
Auerbach (1988, p. 266) have deplored the impact of the "Schumpeterian
heritage" in the study of technological change, which, according to them,
has led to a serious underestimation of the importance for technological
progreSs of "small" improvements, evolving gradually over the years.
What do these perceived tensions and lacunae add up to? One way to
make sense of all this is to respond that Schumpeter's theory of economic
development is (deliberately) "nothing more" than a sociological descrip-
tion of a particular type of agent cum an impressionistic discussion of
causal relationships among the building blocks constituting his theory of
the cycle (see Shionoya, 1986, p. 745). One could, and probably should,
even go further and argue that Schumpeter's analytic apparatus essentially
consists of a series of meticulously defined conceptual categories, rela-
tionships, and distinctions akin to Weberian ideal types-entrepreneur
and mere businessman; entrepreneur and capitalist (banker); invention,
innovation, and imitation; profit and interest; growth and development;
primary and secondary waves, and so on "they provide points of reference
for an interpretative historical study, not robust generalisations for the
comprehensive organisation of facts" (Grahl, 1985, p. 221, italics added;
see also Heertje, 1987, p. 264). One may safely submit that many a piece
critical of Schumpeter would have been redundant had the distinction
between his "theory" and his "prognosis" been heeded (see St. Clair,
1980).
It has been canon to assert that somewhere along the way from
Czernowitz via Graz and Bonn to Cambridge, Massachusetts, Schumpeter
changed his mind. The youthful "Austrian" Schumpeter, focusing on the
role of the entrepreneur, is juxtaposed with the aging, more pessimistic,
"American" Schumpeter, who was constantly talking about the obsoles-
cence of entrepreneurship and the demise of capitalism. 36 Apart from the
fact that non-German-reading scholars-the theme of the diminishing
future role of the entrepreneur is already broached in Schumpeter's early
work (in fact, a concern with the pending demise of the existing political
and economic order is, historically, common to Austrian economists)-
could have taken cognizance of Schumpeter's pertinent views by reading
his 1928 Economic' Journal article, "The Instability of Capitalism," this
tension raises an interesting issue. As Richard Langlois (1987) perceptively
notes, the difference of emphasis in the "early" and in the "later" Schum-
peter reflects not so much a change of mind as two irreconcilable views of
the kind of knowledge on the basis of which individuals are supposed to act.
In Langlois' terminology, the transition from the "early" to the "later"
Schumpeter-or, rather, the to and fro between them-rests on a confla-
tion of an "empiricist" with a "rationalist" theory of knowledge. In the
"early" stages of capitalism economic rationality is essentially empirical,
derived from entrenched habits and conventions; an entrepreneurial act is
tantamount to entering uncharted territory, and is therefore extrarational.
In "later" stages of capitalism (or, for that matter, under socialism) the
domain of conscious rationality is gradually extended; and what was pre-
viously unknown becomes amenable to explicit calculations (see Schum-
peter, 1934, pp. 85-86).
The problem of whether entrepreneurship would become obsolete, or,
at any rate, somehow less relevant under socialism, invites a comparison
with the Misesian conception of entrepreneurship.
Compared to the Schumpeterian entrepreneur, the Misesian entre-
preneur is certainly more prosaic, or less spectacular; but the role attributed
to him is perhaps more subtle then meets the eye, and has frequently not
been adequately understood. It is no exaggeration to say that the resur-
gence of interest in Mises' theory of entrepreneurship is due to the work of
Israel Kirzner, which represents a consistent elaboration and extension
of Mises' ideas. 37 Thus, most of the literature on Mises' theory of the
entrepreneur is really a discussion of Kirzner's work.
Schumpeter's and Kirzner's entrepreneur share a number of characteris-

tics, but they are outweighed by some important dissimilarities. Where
exactly the disagreements lie is not entirely clear, however.38
What do Schumpeter's and Kirzner's entrepreneur have in common? In
both cases, the entrepreneurial role is analytically distinct from the capital-
ist function; pure profit is emphatically not a return to factor services
rendered; the entrepreneur as such doesn't bear any risk. Both Schumpe-
ter and Kirzner consider only the successful entrepreneur (on this, see, in
particular, Loasby, 1984, pp. 80-81; 1985, pp. 22-23).
Turning to the differences, the most obvious point to note here is that
for Mises and Kirzner the entrepreneurial role is no longer confined to a
few selected, heroic personalities. In Mises' well-known words, "In any
real and living economy [as opposed to the imaginary construction of the
ERE] every actor is always an entrepreneur and speculator" (Mises, 1949,
p. 253). The entrepreneurial component of decision making is, as it were,
"secularized" (Witt, 1987, p. 75), or "democratized," and no longer refers
to revolutionary technological changes, but to the "alertness" to as-yet-
unperceived opportunities for pure entrepreneurial profit. The distinction
between these two views of entrepreneurship is often cast as turning on the
entrepreneur as an equilibrating (Kirzner) and as a disequilibrating force
(Schumpeter). 39 Perhaps a more useful way to contrast the two approaches
is to opine with Loasby (1984, p. 79) that Kirzner's entrepreneurs are
skillful at perceiving profit opportunities arising from changes in the
underlying data while Schumpeter's entrepreneurs initiate them in the first
place. "Kirzner's entrepreneur profits by assisting cohesion, Schumpeter's
by disruption. Each might be regarded as providing opportunities for the
other; yet they do not fit together all that well. They are linked to quite
different conceptions of profit, and to substantially different conceptions of
the working of the economy" (Loasby, 1982, p. 244).
Perhaps the essential point about Mises' theory of entrepreneurship,
also constantly stressed in Kirzner's work, is that it aspires to be much
more than another view of the role of the entrepreneur; it really is a theory
about how a market economy is supposed to work. If the terms of
exchange that we observe in the market place are more than random
phenomena; if there is any system to what appear to be haphazard market
events, it is to be attributed to the order-conferring capacity of entre-
preneurs, which ensures that market prices display a tendency toward a
configuration of prices ("final" prices, in Mises' terminology; or, "natural"
prices, in classical parlance) consistent with the imaginary state of the
ERE.
This view of the entrepreneurial market process is pivotal for an
appreciation of Mises' stance in the so-called calculation debate (see

Lavoie, 1985). The problem with market socialism, as Mises saw it, is that
it does not provide a mechanism for the correction of maladjustments.
"Profit, in the market system, is not merely the incentive to lure entre-
preneurs into grasping the opportunties they see, it is the incentive upon
whIch the market relies to ensure that these opportunities will be seen in
the first place" (Kirzner, 1979, p. 118). Schumpeter turned a blind eye to
the need for such a mechanism. 4O For him, the injection of spontaneous
innovations into the CF seems to be, in principle, equally relevant in a
nonmarket context (Kirzner, 1979, p. 119). Indeed, as Robert Heilbroner
maintains, not only does Schumpeter's socialism share with capitalism
many important characteristics,41 it is even a more rational-that is, more
efficient-form of capitalism (see Heilbroner, 1984, p. 685).
The problem with Schumpeter's approach is-and this relates back
to the above-mentioned objections leveled at the CF-that he doesn't
explain why the entrepreneurs intrude themselves on the CF. "They do
not intrude on the circular flow; they emerge in a disequilibrium ... eco-
nomy with the fundamental function of creating the mechanisms that allow
an economy to ~ork ... " (Day, 1984, p. 73). Instead of regarding entre-
preneurship as an exogenous push thrust upon the economy, it should be
seen as part and parcel of the market process. This is precisely what Mises
and Kirzner have urged all along.
4. Concluding Remarks
A critical assessment of the state of scholarship on Schumpeter and Mises

suggests the following summary observations.
The recent outburst of literature on Schumpeter is predominantly
predicated on the claim that Schumpeter be viewed as one of the very
foremost figures in twentieth century economics, and that his work had
been "unduly neglected." No doubt this communis opinio doctorum masks
substantial disagreements among scholars wherein (1) Schumpeter's per-
ceived "greatness" lies; and (2) which direction future research along
Schumpeterian lines should take (evolutionary theory, chaos theory, long-
range historical studies of technical change, etc.). But, in any case,
Schumpeter has certainly come a long way in the general perception of the
profession, considering "his early celebrity as the chap who believed that
the rate of interest would be zero in the stationary state" (Samuelson,
1983, p. 175); and bearing in mind the adage (attributed to Lionel

Robbins) that Schumpeter was "a very intelligent after-dinner talker."
It has been a persistent theme in many of the interpretations put
forward recently that Schumpeter's work offers a plethora of tensions and
inconsistencies. Instead of dismissing this as a drawback, my own prefer-
ence is to consider his oeuvre as forming an essential unity, in which the
paradoxical style of reasoning is elevated to an art form. Schumpeter's
penchant for presenting his arguments in terms of paradoxes clearly aligns
him to a group of celebrated social thinkers of the eighteenth century who
were intensely concerned with the long-term prospects of capitalist indus-
trial society (see Hirschman, 1982; Kumar, 1983).
Likewise, never-ending questions have been entertained as to the
unifying "essence" beneath Schumpeter's wide-ranging interests in theory,
history, mathematics, and econometrics. At the end of the day, however,
"the essence [surely] is an overpowering preoccupation, almost an obses-
sion, with historical analysis and interpretation" (Zassenhaus, 1985, p.
429); and that is where Schumpeter's greatness lies.
In Mises' case, a summary assessment of the present state and future
direction of scholarship is somewhat more straightforward. It may be
surmised that outside the relatively small, albeit rapidly growing, circle of
writers who are sympathetic to Austrian economics, Mises' work is still not
well known-as opposed to having been heard of. In that sense, the
perception of his overall contribution is closely intertwined with the fate of
Austrian economics. Having said that, it is equally clear, however, that
regardless of the future state of Austrian economics, Mises' powerful
stature in twentieth century economics is assured on account of at least two
major contributions-his vision of the entrepreneurial market process
and, intimately related, his challenge to market socialism. With regard to
the latter, it is really scandalous to observe how decades of ridicule poured
upon Mises' "impossibility thesis" suddenly give way to an appreciation of
his views as if they had been part of conventional wisdom all along. It may
be surmised that future research taking its inspiration from Mises will
further inquire into the role of entrepreneurship in varying institutional
contexts. Surely, the belated appreciation of what was once widely thought
to be his greatest blunder is Mises' ultimate intellectual triumph. The
existence of "stock markets," however embryonic, in China; their pro-
posed introduction in the Soviet Union; their scheduled international-
ization in Hungary-at a time when there is an increasing tendency in
some Western countries, most notably in the United States, to take com-
panies private-add further irony to the situation.
Notes
1. In keeping with the purpose of this book, the objective of the present chapter is to
survey and evaluate the literature on two Austrian-born economists; hence, it should not be
construed as an attempt to pass judgment on Austrian economics per se. In particular, it does
not seek to broaden the notion of Austrian economics, as currently understood in its
American connotation.
2. Heertje (1987) does not consider Schumpeter's Austrian connection at all; Kirzner
(1987) does not emphasize it. Cf., however, the work of Khan, who stresses Schumpeter's
indebtedness to the teachings of the Austrian school, especially those of Bohm-Bawerk.
"Walrasian influence on Schumpeter is particularly evident in his technique rather than ideas"
(Khan, 1957, p. 56).
On a rather different view, it may mutatis mutandis be argued that the particular brand of
libertarianism Mises had already espoused in the twenties was somewhat out of step with the
mainstream view of the founders of the Austrian school, which might be portrayed
as a kind of "enlightened conservatism" (in the European sense), or "paternalistic
conservatism" -allegations of laissez faire repeated ad nauseam notwithstanding (cf. Boehm,
1985).
3. Cf. the conference proceedings edited by Deleplace and Maurisson (1985); Helburn
and Bramhall (1986); and Wagener and Drukker (1986). Cf. also Heilbroner (1984) and
Samuelson (1983).
4. On this delicate issue, cf. the anecdote related by Paul Samuelson: "I have to report
that overpraise was a characteristic Schumpeter ploy-as when I heard him give a flowery
introduction at Harvard for Ludwig von Mises; a scholar whose merits could not have been as
low as Schumpeter privately placed them" (Samuelson, 1983, p. 177).
5. Cf. Kirzner (1960, p. 68), who attributes a "mechanical view of economics" to
Schumpeter. Rothbard (1987, p. 106n2) designates Schumpeter's first book as "an aggres-
sively Walrasian work."
6. Hugh Gaitskell (later to become leader of the Labour Party in Britain), in the course
of an extended stay in Vienna, attended Mises' seminars in the early thirties. Referring to
Mises' position in them, he recalled: "There is no discussion. He is just incapable of it.
There's one exception-the English are allowed to speak ... but if any Austrian or German
student raises his voice Mises shuts him up at once" (Williams, 1979, p. 53). In fairness to
Mises it should be pointed out, however, that this account is in stark contrast to other seminar
participants' reminiscences.
7. Let it be hastily added that Schumpeter, in turn, lacked an appreciation of Mises'
theory of the entrepreneurial market process.
8. To recall, neither Schumpeter nor Mises was granted a full professorship in the
University of Vienna. Schumpeter was sent to the provinces of the Empire, while Mises had
to content himself with the position of a professor extraordinarius (which was not as good as it
sounds) in the University of Vienna.
9. The dominant impression emerging from the conference book edited by Christian
Seidl (1984) is that Schumpeter failed at almost everything he laid his hands on: in his
attempts to acquire the kind of "mathematical literacy" that is considered standard fare
among contemporary economists; in his efforts to construct a "Schumpeterian system"; and,
finally, in his unfortunate forays into the arena of politics.
10. Obviously, there have been eminent exceptions to the general trend-Nicholas
Georgescu-Roegen, Richard Goodwin, Gottfried Haberler, Paul Samuelson, Wolfgang
Stolper, Paolo Sylos-Labini, Shigeto Tsuru, Herbert Zassenhaus, to mention only a few.
11. The label post-Walrasian approach is merely meant to convey temporal succession,
not necessarily a root-and-branch commitment to Walras' work. On Schumpeter's indebted-
ness to Walras for his conception of the entrepreneur, cf. Walker (1986).
12. Cf. Andrews (1981); Kirzner (1982c); and a special issue of Wirtschafispolitische
Blatter (no. 4, 1981) published by the Austrian Chamber of Commerce.
13. For a survey on the relationship between New Classical and Austrian business cycle
theory, cf. Scheide (1986).
14. For an early, excellent discussion of the Mises-Hayek analysis of business cycles, cf'
Ellis (1934, ch. 19).
15. This is the route toward the establishment of the CF favored in the Theory of
Economic Development; the Walrasian approach, although certainly present in the former, is
more centrally featured in Business Cycles.
16. Langlois (1985, p. 315) attributes "a theory of 'bounded' rationality" to Schumpeter:
"The agent acts rationally, but only within a limited sphere. Most of his behavior is informed
by habits and customs, built up over the years, that embody, as it were, useful knowledge the
agent cannot consciously command."
17. Behavior guided by "rules of thumb" could, of course, be subsumed within the
neoclassical theory of perfectly rational, optimizing choice by viewing them as the outcome of
the consciously rational application of some higher level meta-rule. Schumpeter's reliance on
"empirical" rationality as informing behavior, by contrast, seems to act as some kind of a
selection mechauism whereby inefficient decisions are weeded out with the mere passage of
time.
18. On the relationship between different assumptions on individual rationality and
different notions of collective rationality, cf. the illuminating account provided by Hamlin
(1986).
19. Elliott (1983, p. 282; 1985, pp. 9-10) contends that the CF is meant to be neither
descriptive, portraying the workings of an actual economy, nor pres'criptive, providing a
normative yardstick for the evaluation of capitalist performance; rather, the construction of the
CF is held to constitute some kind of a "mental experiment" by asking what capitalism would
look like if the forces making for spontaneous and discontinuous change were absent. (It
should be noted, in passing, that this conception of equilibrium as a foil is very much akin to
the role of equilibrium theorizing envisaged by Mises. This line of reasoning will be taken up
below in the discussion of the ERE.) Grahl (1985, p. 218) and Lachmann (1986, pp. 108-109)
appear to subscribe to a similar position.
No doubt, there is a certain intuitive plausibility and attractiveness to the sort of argument
advanced by Elliott. Certainly his claim could easily be documented and buttressed with
pertinent quotations from Schumpeter's major works. (With Schumpeter, that is hardly ever a
problem!) But citing the relevant passages, important and indispensable as it is, may not do in
Schumpeter's case. There is a serious problem with the kind of interpretation proffered
above, in the sense that it all too easily succumbs to the temptation held out by Schumpeter's
relentless insistence on the mesmerizing, creatively destructive dynamism of capitalism; the
thrilling spectacle of the "perennial gale," central as it is in Schumpeter's rhetoric, should not
blind one, however, to the equally present, admittedly less spectecular, strong adaptive forces
of capitalism that Schumpeter held to reside in the CF. As Yuichi Shionoya has recently
brilliantly argued, static and dynamic theory are complementary parts in Schumpeter's theory
of economic development. The dynamic part of his theory was not meant to "cover" what the
static part did not capture; rather, the dynamic theory is organically erected on the static
theory. Dynamic theory expands the domain of economics by incorporating new types of
agents ("entrepreneurs" and "bankers") and a new type of activity ("innovation"); but it is
not self-supporting. "Dynamics can add new propositions about economic development only
with the aid of statics. Schumpeter, therefore, does not have dual methods of statics and
dynamics; he has only the method of statics, i.e. equilibrium analysis, although he had dual
phenomena of static and dynamic economies" (Shionoya, 1986, p. 741).
20. Grahl (1985, p. 225) takes exception to Schumpeter's "elitism" on the grounds that it
"exaggerates the weight of conscious factors in capitalist development."
21. Schumpeter would be the first to acknowledge that (historical) initial conditions also
playa significant role.
22. Mises (1949, pp. 527-529) and Rothbard (1962, pp. 385-386; 1987, p. 100),
following Robbins, critize Schumpeter on the grounds that with a zero rate of interest
dis accumulation would ensue because there would be no incentive for capitalists to maintain
their capital equipment intact. Cf. also Samuelson (1943) and Warriner (1931), who side with
Schumpeter on this issue.
23. As is the case with all familiar stories, the originator of this charming image is
difficult to establish. But it is perhaps not too farfetched to attribute it to some Cambridge don
riding on his bike in one of the college courts.
24. But there remains one important difference. For Mises, the lack of direct operational
significance is inextricably tied to the equilibrium concept; for Hahn, this seems to be a defect
crying out to be remedied (cf. White, 1982, p. 107).
25. To be sure, Mises doesn't take too much trouble with stating the equilibrium
conditions.
26. The standard reference to state-of-the-art theory of entrepreneurship is Casson
(1982); a useful survey of the history of economic thought on the subject is provided by
Hebert and Link (1988).
27. a. the essays on entrepreneurship collected in Redlich (1971).
28. The following remarks draw heavily on Loasby (1984, p. 80-81; 1985, pp. 26-27).
29. Another condition concerns price stability of inputs. Cf. the critical observations in
Conard (1963, pp. 92-93).
30. Weisskopf (1984, pp. 354-355) likens this aspect of Schumpeter's work to what he
labels the "Heisenbergian paradigm."
31. a. the analogous argument on the relationship between "dynamic" and "static"
subjectivism deployed by O'Driscoll and Rizzo (1985, p. 28).
32. The entrepreneur acts, in Jon Elster's terminology, "parametrically rational," that
is, he treats his social environment as constant (see Elster, 1984, p. 18). Kirzner also notes
Schumpeter's "failure to stress the importance to decision makers of knowledge of the
decisions of others" (Kirzner, 1979, p. 111).
33. On this, cf. the illuminating account in Georgescu-Roegen (1977).
34. Shionoya (1986, p. 747) states that "innovation is exogenous to economic analysis";
cf. also Sahal (1981, pp. 62-63).
35. For an objection against Schumpeter's view that with the advent of "trustified
capitalism" innovation would become increasingly "automatic," cf. Elster (1983, p. 126).
36. Usually this discussion is couched in terms of "Schumpeter I" and "Schumpeter II."
The terminology is due to Phillips (1971, ch. 1).
37. Hebert and Link (1988, pp. 131-133); and Rothbard (1985) have cast suspicion on
this continuity of ideas-especially in relation to Kirzner's handling of uncertainty.
38. Cf. the comparative appraisals in Langlois (1985); Loasby (1982,1984,1985); and, in
particular, Ricketts (1987).
39. Cf. Kirzner (1979, p. 115); Ricketts (1987, pp. 60-61) notes that the distinction may
not be helpful.
40. It is interesting to note that Samuelson thinks that "Schumpeter was uncharacteristi-
cally naive in awarding Lange and Lerner victory over Ludwig von Mises on the issue of
whether rational economic calculation would be possible under socialism" (Samuelson, 1983,
p. 176).
41. On some vexing definitional problems, cf. Samuels (1985).
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Commentary by Israel M. Kinner
Dr. Boehm has written a chapter on Schumpeter and Mises with his
accustomed perceptiveness and scholarship. He has moreover laced his
account with numerous pungent asides on the pretensions and foibles of
contemporary commentators on the two economists. AU this adds up to a
lively, provocative and learned piece. Yet one leaves this chapter with a
vague sense of dissatisfaction-for which its author should, in all fairness,
probably not be held responsible. Consider the task that he confronted.
This chapter is in a book surveying the varieties of neoclassical econo-
mics from 1870 to 1930. The Austrian school has already been discussed in
an earlier chapter in the book, a chapter focused on the founding Aus-
trians, Menger, Bohm-Bawerk, and Wieser. Understandably enough,
however, the book's editors felt that this earlier chapter was not quite
enough. Since the overwhelming bulk of the significant published work of
Menger and Bohm-Bawerk dates back to the years before 1900, and since
Menger went into virtual seclusion after his retirement in 1903, and B6hm-
Bawerk died in 1914, the earlier chapter could hardly be held to cover the
period up until 1930. Moreover, although Wieser continued to teach until
his death in 1926, the mantle of intellectual leadership within the Austrian
tradition had clearly passed on by the 1920s. So an additional chapter on
the "younger Austrians" was assigned-and what could be more natural
than to ask its author to focus on the most eminent of Bohm-Bawerk's
pupils, Schumpeter and Mises, both of whom enjoyed international re-
putations by the 1920s?
. But there were problems associated with this assignment. Writing from
the perspective of 1989, it is clear that no discussion of the work of Mises
and Schumpeter could avoid taking account of the diverse paths taken by
242
these writers after 1930, nor could any such discussion avoid coming to
grips with recently revived interest in their respective works. The task of
writing about these two Austrians as a pair representing the continuity of
the Austrian tradition, when each of them was somewhat of a maverick,
not only from the perspective of the economics profession generally but
from that of the Menger-Bohm-Bawerk tradition, must have seemed a
most formidable one indeed.
Boehm has fulfilled his difficult assignment with competence and
wisdom, employing a variety of skillful strategies: he has assessed the
controversy surrounding Schumpeter's "Austrian" credentials; he has
reviewed the recent (separate) resurgences of interest in both Schum-
peter and Mises; he has analyzed points of similarity and of contrast in
their work; he discourses most learnedly and philosophically about the
roller-coaster gyrations in scientific reputation that have attended each of
these two writers during the past half-century. He has, in short, written a
fascinating chapter, taking account of an enormous array of recent con-
tributions to the literature. Yet, as indicated earlier, one feels a vague
sense of incompleteness. We have not been given an account of the
Austrian strand of neoclassical economics as it developed from Bohm-
Bawerk's death up until the 1930s. We have not been given an account of
the contributions Schumpeter and Mises made to that strand of economics.
Or, to put it somewhat differently, Boehm's erudite discussion somehow
has not presented Schumpeter and Mises as the mid-century protagonists
and continuators of an "Austrian tradition" -on the one hand, rooted in
the ideas of Menger and his colleagues, and on the other hand, capable of
generating a late-century resurgence of those ideas. Mises and Schumpeter
remain discrete individuals, rather than being seen as complementary
role-players in a coherently developing intellectual tradition.
To articulate in this way one's vague dissatisfaction with this chapter is
at the same time to exculpate both the editors and the author of any blame
for having stimulated that satisfaction. Surely the editors were right in
choosing Bohm-Bawerk's most distinguished disciples as the economists
upon whom to focus attention for the years after Bohm-Bawerk's death.
And surely Stephan Boehm can hardly be faulted for failing to find any
major complementary contributions which these two writers, viewed as a
pair, made toward the continuation and the development of the Austrian
tradition. In fact, from the perspective of the mid-century (say, at the time
of Schumpeter's death) one would have been compelled to conclude that
(1) the contributions of these two writers were sufficiently divergent in
spirit, purpose, and direction, to stamp them as being poles apart; (2) the
life's work of neither of them, appeared to have been both sufficiently
influential and sufficiently "Austrian" to contradict the impression, then

widespread in the economics profession, that the Austrian school had, in
effect, died with Bohm-Bawerk (or, at any rate, with Wieser).
What follows is an attempt-perhaps a not wholly disinterested
attempt-to suggest that, viewed from a 1989 perspective, matters might
be interpreted rather differently. From this perspective, I shall argue, the
writings of Schumpeter and Mises, divergent though these have certainly
been, nonetheless jointly constituted vehicles through which key Austrian
ideas were preserved and extended, during a period in the history of
economics in which these ideas might otherwise well have become com-
pletely lost from economics. From the perspective of the late-century
resurgence in Austrian economics (to which Boehm refers throughout his
paper), then, it can be argued that Schumpeter and Mises-despite their
doctrinal differences and despite the coolness with which each assessed the
other-in fact jointly contributed to an organic development of the Aus-
trian tradition, a development that should be credited with its subsequent
revival and resurgence. 1
Just as each new generation might be able to reconsider past history
in the light of more recent developments, so may later generations of
intellectual historians reinterpret and redefine groupings and/or sequences
of ideas identified by earlier historians of thought. What seemed important
about the early Austrians in 1930-or even in 1950-was their method-
ological individualism, their subjectivism, their emphasis on consumer
demand. In fact, it was largely as a result of this that, at mid-century, the
idea of a separate Austrian tradition in economics appeared a matter
strictly of the distant past. By mid-century everything considered valid in
these identified points of Austrian emphasis had arguably been absorbed
into mainstream microeconomics. But from our present 1989 perspective,
what appears uniquely important in the Austrian tradition can be seen
rather differently. If one is to account for the contemporary, late-century
Austrian revival, one must now recognize that the earlier Austrian tradi-
tion encompassed important ideas (or pointers toward ideas) that never
were absorbed into mainstream economics. These ideas-although easy to
overlook in 1950-somehow survived the decades-long, mid-century
eclipse of the Austrian tradition and subsequently sparked the present
Austrian revival. I shall argue that there were such ideas present, if only in
embryonic form, in the writings of Menger and his disciples, and that it was
the work of Schumpeter and Mises that kept these ideas alive. If this
reinterpretation of the essence of the Austrian contribution is valid, then
we must recognize Schumpeter and Mises as having maintained and
developed the Austrian tradition and-perhaps without recognizing it
themselves-as having jointly contributed to the extension and revival of

the Austrian school well into the closing decades of this century. To be
sure, much of the work of Mises and Schumpeter in this regard came after
1930. Nonetheless both of them had written enough, along the relevant
lines, before 1930 to justify our contention that they be now perceived as
having, in the post-Bawerkian era, importantly developed the Austrian
tradition along new lines (that would reach their fullest development much
later). Mises and Schumpeter do make up a chapter in the history of
Austrian economics after all.
The Thesis Developed

Stated briefly, our thesis is as follows. Neoclassical economics during the
first decades of this century was moving toward a dominantly general
equilibrium paradigm. While this paradigm became firmly installed only
after World War II, it is clear that the analytical steps refining earlier
marginal analysis toward that paradigm were being taken in the twenties
and thirties. We argue here that the Austrian tradition, rooted in Menger's
mode of "seeing" economic phenomena, was not taking these steps-and
would eventually be compelled to rebel vigorously and openly against the
subsequently dominant paradigm. During the decades between 1920 and
1950 it was surely the writings of Schumpeter and of Mises that contained
the clearest statements of dissociation from an exclusively eqUilibrium
understanding of markets. Moreover, while the late-century Austrian
revival took its cue primarily from the work of Mises (and of Hayek), it
is not to be denied that it was Schumpeter's writings on the dynami-
cally benign role of departures from perfectly competitive equilibrium that
kept such ideas from being entirely forgotten in the mainstream of the
economics profession.
To be sure, an outside observer of the intellectual scenery in Vienna
during the twenties would not have seen much to suggest our thesis. Such
an observer would not have found anything really significant separating
the economic theory of the Austrians from that of their Marshallian or
Walrasian cousins. In fact, the protagonists themselves would not have
suggested anything to support our thesis. As late as 1932 we find Mises
declaring:
We usually speak of the Austrian and the Anglo-American Schools and the
School of Lausanne .... {The fact is] that these three schools of thought differ
only in their mode of expressing the same fundamental idea and that they are
divided more by their terminology and by peculiarities of presentation than by
the substance of their teachings (Mises, 1933, p. 214).
But such statements, valid though they seemed at the time, do not
contradict our thesis. It is true that the Austrians of 1932 did not recognize
any significant difference between their theory and that of the Marshallians
and the Walrasians. In fact there was no such significant difference! All
economic theorists recognized a role for equilibrium, but all of them also
understood the equilibrating process as consisting of entrepreneurial steps
of dynamic competition. 2 All recognized the perfectly competitive state as
merely the limiting case that models the theoretical state of affairs that
might, in principle, be eventually attained if exogenous change were to be
indefinitely suspended. The difference between the Austrian version of this
commonly understood theory, and the version being refined in Marshallian
and Walrasian circles was, we argue, a most subtle one. The refinements
occurring in the Marshallian and Walrasian systems were pointing, we can
now see, in the direction of the subsequently dominant general equilibrium
paradigm. The work taking place in Vienna was, we argue, pointing in a
quite different direction-in the direction of the work of Mises and Hayek
in the forties, breaking sharply and clearly with the general equilibrium
paradigm.
Let us not forget that theorists of all schools had, up until the outbreak
of World War I, seen themselves as facing a powerful and common
intellectual foe, the German historical school. Although the German
historical school did not essentially survive after World War I, nonetheless
theorists of the twenties understandably still saw other theorists as their
comrades-in-arms. Given the versions of Marshallian and Walrasian eco-
nomics then being taught, we must not be surprised that the Austrian
economists saw their own economics as basically similar to that of their
fellow theorists in other schools. It was not until 1940, in fact, that Mises
recognized at all clearly how far distant his own economics was from that of
the neoclassical mainstream. 3
In the first decades of this century theorists of all neoclassical varieties
saw the market process as a systematic one, achieving a translation of the
underlying realities-resource constraints and consumer preferences-into
prices, incomes, and allocation patterns. This commonly held view differed
totally from that of the economists of the historical school (and also of
other schools dissenting from the mainstream). To those not accepting
economic theory, the prices, the distribution of income, and the allocation
of resources among industries do not benignly and rationally reflect the
relevant data. So sharply was this contrast felt that the early twentieth
century theorists were hardly aware of the differences separating the alterna-
tive statements being made of their commonly held central thesis. Yet
these differences existed, at least potentially, and in time they would be
revealed as being, in fact, highly significant.
Equilibrium theorists saw the translation of underlying realities into

appropriate market outcomes as occurring with reasonable smoothness
and rapidity. They tended to focus attention not on the process of
translation but on its results. As tools of analysis, geometrical and later
algebraic, became better formulated, it became possible to articulate these
theoretical results with greater and greater rigor and precision. This
development was eventually to lead to a special view of the real world-
that it represents at all times the equilibrium conditions appropriate to the
underlying economic realities. In the early decades of the century this
development had not proceeded very far. Equilibrium theorists recognized
that the real world presents us with the higgling and haggling, the tentative
steps of trial and error, the imaginative but hazardous competitive forays
of entrepreneurs, through which equilibrium may be thought of as being
continually approached. Yet the direction of analytical deVelopment was
clear, toward the eventual complete dominance of equilibrium analysis
over the understanding of process.
The Austrians drew their understanding of markets from a different
fount. Menger, it is widely recognized, had a theory of markets in which
disequilibrium was never far from the focus of attention. 4 Eventually
Wieser's student Hans Mayer (1932) would formulate with emphasis the
"causal-genetic" approach followed by the Austrians in contrast to the
"functional" approach followed by the equilibrium theorists. In the early
decades of the twentieth century this contrast was not clearly perceived by
the Austrians. It seemed quite natural to follow through the causal steps of
process analysis in order to see where it might, absent exogenous change,
eventually lead to. So that it is not difficult to grasp how, for Mises in 1932,
the Walrasians were seen as intellectual allies, rather than foes. Yet this
perception was eventually bound to change. .
As eqUilibrium theory came to be refined during the twenties and
thirties, with mathematical tools of greater rigor, its direction became
clearer. The notion of dynamic competition, integral to much of the earlier
neoclassical analysis, came to be replaced almost entirely by that of perfect
competition. 5 In other words, analysis of process came to be replaced
entirely by analysis of equilibrium results. Austrians came to be wary of
this newly apparent thrust of mainstream theory. Despite his own fascina-
tion with the Walrasian vision, Schumpeter continued to emphasize his
appreciation for the dynamics of markets. He hammered away at the role
of entrepreneurial innovation, continually disrupting the placid circular
flows of equilibrium. Eventually, in his Capitalism, Socialism and Demo-
cracy, Schumpeter would rebel against the dominance of the perfectly
competitive model as a portrayal of real-world capitalism, and at the
uncritical assignmenJ of benign normative significance to the perfectly
competItive state of affairs. Mises (who had in 1932 seen equilibrium

theorists as allies) came by the end of the decade to distinguish sharply
between Austrian economics seen as a science of human action, and the
dominant equilibrium paradigms (Mises, 1940, 1949). Hayek (who up until
the early thirties had seen no contradiction between the Austrian tradition
in which he had been trained and the Walrasian economics that was
becoming widely embraced) came, as a result of the debate on socialist
economic calculation, to point out the limitations of exclusive preoccupa-
tion with states of equilibrium, and of the associated shortcomings of the
model of perfect competition (Hayek, 1940, 1945, 1948).
It is true, as cited by Boehm, that Schumpeter did not have the highest
regard for Mises as a theorist. It is true that Mises did not view Schumpeter
as an Austrian economist (and, as cited by Boehm, indeed saw him as an
equilibrium theorist). And it is true that Hayek sharply criticized Schum-
peter (in regard to the socialist calculation problem) for taking the
entrepreneurial-competitive process for granted (Hayek, 1945). But the
fact remains that a student of economics searching, during the central
decades of this century, for voices dissenting from the dominant pre-
occupation with the perfectly competitive equilibrium paradigm, would be
bound, sooner or later, to bracket Mises and Schumpeter in this regard.
For each of these two scholars, this attention to the process of dynamic
competition must have appeared entirely consistent with the common
training they had received in Vienna. During the decades at mid-century,
with the Austrian school considered quite dead, and as simply a closed
chapter in the history of modern economics, not much significance could
have been attached to this attention to the process of dynamic competition
shared by Mises and Schumpeter-who were in every other respect so
different from each other. But, as the twentieth century draws toward its
close and economists are rediscovering the contributions of Schumpeter
and are witnessing the revival of the Mengerian tradition as transmitted by
Mises and Hayek, things must appear differently. It matters not, for our
thesis, whether Schumpeter is to be counted as a "genuine" Austrian.
What is important, from our present-day perspective, is that we may surely
say that Mises and Schumpeter kept alive those insights and approaches to
economic understanding that can now be seen as essential to the ongoing
Austrian tradition. In articulating these insights and in making them
explicit, Schumpeter and Mises were not just preserving ideas that could
subsequently nourish a revival in Austrian economics. In doing so, we
can now see, they were jointly contributing to a genuine enrichment and
deepening of the Austrian teachings, bringing to the fore of Austrian
self-awareness, an understanding of economic process that had been vir-
tually absent in the Austrian economics of the twenties.
mE AUSTRIAN TRADITION 249
The thesis advanced in this comment does not, in t~is writer's opinion,
contradict anything put forward in the lively and leatned chapter contri-
buted by Boehm. It does, however, perhaps permit us to see how this
chapter properly completes the story of the Austrian contribution to
neoclassical economics after World War I.
Notes
1. To assert this is, of course, not at all to assert that Schumpeter would have been
pleased to receive such "credit," or that Mises would have recognized Schumpeter as being in
any sense his intellectual ally.
2. On this see the doctoral dissertation of Frank M. Machovec (1986).
3. For an account of how Mises appears to have arrived at this later recognition as a
result of the debate on socialist economic calculation, see Kirzner (1988).
4. For a survey of the literature on this aspect of Menger, see Kirzner (1979, pp. 63-75).
5. The development of theories of imperfect or monopolistic competition tended in fact
to emphasize the centrality of perfect competition for neoclassical theory. Moreover, these
theories, too, were equilibrium theories; see Kirzner (1973, pp. 112-119).
References
Hayek, Friedrich A. 1940. "Socialist Calculation: The Competitive 'Solution'."
Economica n.s., 7, 125-149. Reprinted in Individualism and Economic Order.
Chicago: University of Chicago Press, 1948.
Hayek, Friedrich A. 1945. "The Use of Knowledge in Society." American Econo-
mic Review, 35, 519-530. Reprinted in Individualism and Economic Order.
Chicago: University of Chicago Press, 1948.
Hayek, Friedrich A. 1948. "The Meaning of Competition." In Individualism and
Economic Order. Chicago: Unversity of Chicago Press, 1948.
Kirzner, Israel M. 1973. Competition and Entrepreneurship. Chicago: University of
Chicago Press.
Kirzner, Israel M. 1979. Perception, Opportunity, and Profit. Chicago: University
of Chicago Press.
Kirzner, Israel M. 1988. "The Economic Calculation Debate: Lessons for Aus-
trians." The Review of Austrian Economics, 2, pp. 1-18.
Machovec, Frank M. 1986. "The Destruction of Competition Theory: The Per-
fectly Competitive Model and Beyond." Ph.D. Dissertation, New York Uni-
versity.
Mayer, Hans. 1932. "Der Erkenntniswert der Funktionellen Preistheorien." In Die
Wirtschaftstheorie der Gegenwart, Vienna: Julius Springer.
Mises, Ludwig. 1933. Epistemological Problems of Economics. Princeton, N.J.:
Van Nostrand, 1960. (Translation of Grundprobleme der Nationai6konomie,
Jena: Gustav Fischer.)
Mises, Ludwig. 1940. National6konomie: Theories des Handelns und Wirtschaftens.
Munich: Philosophia Verlag, 1980; first edition, Geneva: Editions Union.
Mises, Ludwig. 1949. Human Action. New Haven: Yale University Press.
7 The Swedish Tradition:
Wicksell and Cassel
Bjorn A. Hansson
1. Introduction
This chapter analyzes the interpretation of Wicksell's and Cassel's con-

tribution to economic analysis after Schumpeter's evaluation in History of
Economic Analysis. Wicksell has been given much more space than Cassel
since the former is still post-Schumpeter considered to be the more
important of the two.
The chapter is divided in two parts: the first deals with Wicksell and the
second with Cassel. Each part starts with a recapitulation of Schumpe-
ter's assessment, and the recent interpretations follow. In the conclusion
Schumpeter's views are compared with the more modern evaluations.
2. Knut Wicksell
2. 1. Schumpeter's Assessment of Wicksell
Schumpeter had an extremely high opinion of Wicksell as a person:

"No finer intellect and no higher character have ever graced our field"
251
(Schumpeter, 1954, p. 862). The strict scientific assessment of Wicksell's

influence was equally positive:
His international reputation ... was not commensurate with his achievement
until, in the late 1920s and the early 1930s, it began to dawn upon the pro-
fessional world that he had anticipated, to a very large extent, all that was most
valuable in the modern work on money and interest (Schumpeter, 1954, p. 863).
But once the profession got a more intimate knowledge of Wicksell's
writings, the belated response was strong: "Posthumously he acquired
even greater international reputation as a monetary theorist than either
Marshall or Walras" (Schumpeter, 1954, p. 1085).
Wicksell's contribution to economic analysis spanned three areas:
monetary theory, value theory, and public finance. Schumpeter picked out
Wicksell's monetary theory as his foremost contribution:
It had long been recognized, of course, that the two [the real and the money rate
of interest] may diverge from one another .... But nobody attached much
importance to it until Wicksell made it the center of his theory of the value of
money and the subj ect of an elaborate analysis that produced the Wicksellian
Cumulative Process ... (Schumpeter, 1954, p. 1118).
The analytical novelty was to treat the money rate as "a distinct variable in
its own right" (Schumpeter, 1954, p. 1118) in a system where the banks fix
the interest rate. In this sense Wicksell "opened the road" for "a monetary
interest theory" as well as "a monetary cycle theory" (Schumpeter, 1954,
p. 1120).
Within value theory Wicksell's novelty was mainly a lucid textbook,
Lectures in Political Economy volumes I and II (first Swedish edition 1901
and 1906, respectively; German edition 1913 and 1922; English edition
1934 and 1935) that presented the contribution of other economists:
Walras' value theory and Austrian capital theory (Schumpeter, 1954, pp.
908,913). However, the influence of the textbook was such as to speak of
"The Marshall-Wicksell System," which substituted for the system of the
classical economists, as represented in J. S. Mill's Principles of Political
Economy, the neoclassical system:
... another process of consolidation took place between 1890 and 1914, and a
theoretical system of apparatus emerged which is embodied in the standard
works of A. Marshall and K. Wicksell (Schumpeter, 1954, p. 1142).
Schumpeter did not finish the section on public finance for the neoclassical
period (just one page), but he still mentioned Wicksell and the unanimity
rule:
... both because of the eminence of the author and the originality of his idea
of making taxation semi-voluntary, I also mention Wicksell's doctoral thesis,
THE SWEDISH TRADITION 253
Finanztheoretische Untersuchungen (1896), the suggestions of which have been

partly developed by E. Lindahl in Gerechtigkeit der Besteuerung (Justice in
Taxation, 1919) Schumpeter, 1954, p. 946, n. 3).
The present analysis of the contemporary interpretation of Wicksell's
contribution starts with his monetary theory and the cumulative process.
The second subject is Wicksell's capital theory, since during the so-called
capital controversy his development of Austrian capital theory, and the
"Wicksell-effect" in particular, has been considered a most succinct state-
ment of the neoclassical theory of the interest rate and capital accumula-
tion. The third subject, the unanimity principle, belongs to public finance,
and Wicksell's discussion has been very influential in the development of
the new field of public choice.
2.2. Cumulative Processes
Wicksell's own formulation of the cumulative process is the background to

the exposition; it is then correlated with characteristics of the process that
have been highlighted by modern commentators.
2.2.1. Secular changes in the price level. Wicksell applied the cumula-
tive processes to long-run changes in the price level which is obvious from
his empirical object:
An upward movement of prices started in the fifties, which, interrupted by the

world crisis of 1857 and then by the crises of 1864-1866, did not really culminate
until 1873. Then began the gradual fall in prices, so often discussed, which has
continued up to the present time; so that the general price level of to-day is
lower than it was in the middle of the century (IP [abbreviation for Wicksell,
19361. pp. 173-174).
Wicksell also analyzed trade cycles, but he did not consider himself to have
an explanation of the same dignity to this phenomenon, which includes
changes in quantities and employment, as the analysis of secular price
changes in the cumulative process. 1 It is quite clear that Wicksell did not
apply the cumulative process to this problem:
... I have never tried to explain the turning points of the business cycle itself,
hausse and baisse, from the much quoted difference between the natural rate
and the loan rate, since I am of the opinion that their essential cause lies in the
sporadic nature of technical progress itself, supported by psychological moments
(Wicksell, 1909, p. 63, n. 1).2
However, the accomplishment of a stable price level via an interest rate

policy would also be beneficial for the trade cycle (LPE 2 [abbreviation for
Wicksell, 1935], p. 212). Of course, that did not hinder Frisch in taking up
strands of Wicksell's analysis of the trade cycle and the cumulative process
and developing it into a mathematical model of regular cyclical movements
(Frisch, 1933, p. 198; 1952, pp. 698-699).
2.2.2. Analytical Characteristics. Wicksell's analysis of the cumulative

process has three main characteristics (LPE 2, pp. 159-160):
1. Wicksell used the notions of aggregate pecuniary demand for goods
and aggregate supply of goods for analyzing changes in the general price
level. Schumpeter, therefore, named Wicksell "the patron saint of all those
economists who renounce Say's law at present" (Schumpeter, 1954, p.
1117, n. 1).
2. It is an analysis of a system out of equilibrium, i.e., a disequilibrium
analysis, that implies criticism of the quantity theory for analyzing and
comparing equilibrium situations only, leaving out the dynamic process
itself.
3. The analysis must take into account the fact of a developed banking
system and thereby the interest rate mechanism.
2.2.3. The Saving-Investment Approach. The cumulative process grew

out of a reformulation of the quantity theory of money. Wicksell consi-
dered the main proposition of the quantity theory, namely, that the value
of the purchasing power of money varies in inverse proportion to its
quantity, to be basically correct. At the same time the quantity theory was,
in its original formulation, too restrictive and in conflict with reality, since
it was based on the assumption that everybody uses their own cash, which
is both legal tender and the monetary base, for all transactions, and they all
have to keep a cash balance. Therefore the followers of the quantity theory
sometimes argued "as though the quantity of money, or of that part that at
any moment finds itself in the hands of the public, must act as a direct and
proximate price-determining force" (IP, p. 43). This is the so-called direct
mechanism, which works via a real-balance effect, and it is still stressed by
Friedman in his development of modern monetarism. However, in a
developed credit economy the keeping of individual cash-balances has
accounts and the use of claims of various kinds in monetary transactions.
The banks, in their turn, only hold a smaller part of the deposited sums as
cash, and due to "the concentration in their hands of private cash
holdings ... they possess a fund for loans which is always elastic" (LPE 2,
1HE SWEDISH TRADITION 255
p. 194). Hence, Wicksell developed the quantity theory for a banking

system based on fractional reserves.
Patinkin considers Wicksell's "primary contribution to monetary
theory" to be "his detailed analysis of the way changes in the quantity of
money affect prices through the interest rate in an economy with a
developed banking system" (Patinkin, 1952, p. 836), which implies that
"there exists no direct real-balance effect to drive prices upwards" (Patink-
in, 1965, p. 588). This was an important development of the saving-
investment approach, or in the direct mechanism, that later influenced the
Cambridge economists, the Stockholm school, and Mises and Hayek of the
Austrian school. Wicksell was actually the originator of this approach:
Use of the saving-investment approach to income fluctuations is predicated on
the hypothesis that the interest rate mechanism fails to coordinate saving and
investment decisions appropriately. This is where all the Wicksell Connetion
theories differ from Monetarism (Leijonhufvud, 1981, p. 132).
The Wicksell connection represents the interest rate as equating supply

and demand of credit, but it does not necessarily balance saving and
investment, i.e., total demand and supply of goods (Leijonhufvud, 1981,
p. 133).
In this institutional setting it is generally assumed that the banks fix the
money rate which implies that the money supply is determined by demands.
In particular for the pure credit system, "which means that all payments are
effected by transfer of bank credit" (Uhr, 1960, p. 141), where there is no
need for reserve ratios:
No matter what amount of money may be demanded from the banks, that is the
amount which they are in a position lend. . . . The "supply of money" is thus
furnished by the demand itself (IP, p. 110).
It is the application of a pure credit system that implies that a single interest
rate can represent the borrowing and lending rates, and it is "that rate of
interest which becomes the effective monetary regulator, not the Quantity
of Money, in any sense" (Hicks, 1977, p. 63). The reverse is true for the
pure cash economy where no credit is given.
The distinction between a pure cash economy and a pure credit eco-
nomy is a convenient place for a short digression on Wicksell's view on
method. It is apt to treat Wicksell's view in a digression since he very
seldom discussed methodological problems. 5 He seems to have considered
such discussions as fruitless, the best example being Menger's endless
debates with the followers of the historical school. Instead of taking part in
such debates, Wicksell considered that the real proof of the validity of
economic theory was in its results:
The ultimate criterion of the value of a method is provided by the results

derived from it, if one wishes to defend a method, the way to do so is to use it,
not to talk or write about it, or at any rate, no more than is absolutely necessary
(Wicksell, 1924, pp. 193-194).
Moreover, sometimes just in passing, he states explicitly the aim of eco-

nomic theory, which is to reveal the laws governing economic relations:
In reality every existing country's monetary system is a mixture, in different

proportions, of these two extremes of pure cash economy (Bartwirtschaft) and
pure credit economy. If we then investigate the manner in which prices would be
determined under one or the other of these two assumptions and if we succeed
in finding a law common to both of them, we shan also be able to maintain that
this law must apply to concrete reality in an its varying mainfestations (WickseU,
1898, pp. 75-76).
2.2.4. The Normal Rate of Interest. The analytical core of the cumula-
tive process is the relation between the actual rate of interest on loans, the
money rate, and the normal rate. The normal rate is related to "the real
yield of capital in production" (LPE 2, p. 205).3 In Wicksell's value theory
this rate is strictly defined only under the assumption of a stationary state;
the relative prices are therefore constant over time and the natural rate is
"determined as a part of this system of relative prices" (Hicks, 1965, p.
59).4 In his formal analysis of the cumulative process in Interest and Prices,
Wicksell thus assumed that the real capital is kept intact and no accumula-
tion is going on (IP, P. 136). But in the Lectures net saving and net
investment take place and the normal rate is defined as:
The rate of interest at which the demand for loan capital and the supply of
savings exactly agree and which more or less corresponds to the expected yield
on the newly created capital ... at the same time equilibrium must ipso facto
obtain .. .in the market for goods and services, so that wages and prices will
remain unchanged (LPE 2, p. 193).
The normal rate implies an unchanged price level since total demand is
equal to total supply, but it will also balance net savings and net invest-
ment. However, this simple relation will only apply to a system of "credit
as between man and man" (LPE 2, p._ 193). In a developed banking system
saving and investment are intermediated by the banks, and the act of
saving is not identical to the act of actual investment undertaken by the
entrepreneurs (LPE 2, p. 11). Hence, the money rate will influence saving
and investment.
The level of the money rate of interest is ultimately determined by the
normal rate. But in a credit economy the money rate of interest is in the
first instance a separate variable that is set by the banks in the market for
borrowing and lending of money:
... what is lent is money and nothing else; liquid real capital, in the forms of
goods, is bought and sold with money, but it is not lent. Negotiation concerning
the level of interest on loans is conducted with the owners of the money, not
with the owners of the real capital (Wicksell, 1898, p. 83; cpo IP, p. 108).
There are two separate markets: one is supply of capital goods versus
monied demand for such goods, and the other is supply of money versus
demand for money. It is therefore possible in a developed credit system to
have an equilibrium in the money market without at the same time having
an equilibrium in the goods market, i.e., the renouncing of Say's Law and
the Wicksell connection (sections 2.2.1 and 2.2.3).
For a stable price level it is necessary that the money rate is equal to the
normal rate, which means that demand and supply of credit are equal as
well as demand and supply of capital goods. This mode of linking the real
system and the monetary system is not without complications. The normal
rate is determined as an endogenous variable within the real system, but an
additional constraint has now been put upon this rate: it should be equal
to the autonomously fixed money rate, which means that the model is
overdetermined and there is no solution to the model (Haavelmo, 1960,
p. 200). In fact, the cumulative process is the "solution" to this problem:
Consider a dynamic system which is such that, if we omitted all the dynamic
elements in it, we should have an overdetermined static system. Then the
dynamic system may have a solution, but it can have no stationary solution. The
economic meaning of this is that the time-motion of prices and quantities may
serve as an outlet for the forces that press for fulfilment of the impossible
conditions for stationariness. (Haavelmo, 1960, p. 207).5
Wicksell hinted at this idea when he had left the case of "credit as between
man and man":
If ... we add organized credit, and especially the activity of the banks, the
connection between loan interest and interest on capital will become much less
simple; indeed, it will then only exist at all by virtue of the connecting link
o/price movements . .. (LPE 2, p. 194; as italicized in the Swedish edition).
There is no end to this process until the banks will set the money rate equal
to the normal rate, unless there is some equilibrating mechanism that will
force the banks to do so (section 2.2.6).
2.2.5. The Cumulative Nature of the Process. In the following example,

which is taken from the Lectures, it is supposed that the natural rate
increases, which may be due to an increase in productivity, while the
money rate as fixed by the banks stays that same:
If the banks lend their money at materially lower rates than the normal
rate ... then in the first place saving will be discouraged and for that reason there
will be an increased demand for goods and services for present consumption. In
the second place, the profit opportunities of entrepreneurs will thus be increased
and the demand for goods and services, as well as for raw materials already in
the market for future production, will evidently increase to the same extent as it
had previously been held in check by the higher rate of interest. Owing to the
increased income thus accruing to the workers, landowners and the owners of
raw materials, etc., the prices of consumption goods will begin to rise, the more
so as the factors of production previously available are now withdrawn for the
purpose of future production. Equilibrium in the market for goods and services
will therefore be disturbed. As against an increased demand in two directions
there will be an unchanged or even diminished supply, which must result in an
increase in wages (rent) and, directly or indirectly, in prices (LPE 2, pp.
194-195; footnote omitted).
Wicksell's analysis was in the first instance concerned with changes in the
price level and not with changes in quantities (section 2.2.9), and expan-
sion in real quantities is ruled out since full employment is assumed "as a
first approximation" (LPE 2, pp. 194-195). In any case, if capital accumu-
lates it would still take some time before the results accrue and there would
be no immediate counteracting effect.
In the reverse case, where the money rate is larger than the natural rate,
the process will be similar since Wicksell assumed that prices and wages
have the same flexibility in both directions. It is likely that full employment
could be preserved during the downward process:
... workers and landlords will respond [to the fall in entrepreneurial demand for
labour and land] by scaling down their claims for wages and rents, and on the
whole activity will be maintained at its former level (IP, p. 149).
It has to be remembered that Wicksell was referring to trends and not to

cycles, which makes the assumption of flexible wages and full employment
a bit more savory for the modern reader:
... Wicksell's long-term equilibrium, an equilibrium which left room for cyclical
fluctuations about it; fluctuations which would sometimes reduce employment
below its equilibrium level, but sometimes raise it above. In Wicksell's
equilibrium there is "normal employment" (Hicks, 1977, p. 73).
In both cases the new price level is the basis for the plans of the
entrepreneurs and for the case of an upward process:
If ... the banks maintain the lower rate of interest, it will act as a tempting extra
profit to entrepreneurs and by competition between them will force up still
further the price of labour and materials and indirectly of consumption goods,
and so on (LPE 2, p. 196).
The entrepreneurs will still have a surplus profit and the tendency for
expanding the output will persist despite the change in the price level. 6 If
the bank credit continues to expand, then the whole process will go on
repeating itself. As long as the difference between the normal rate and the
money rate exists, the price level will keep changing, i.e., the process is
cumulative. 7
2.2.6. The End of the Process. The cumulative process may come to an
end through internal causes. The changes in the price level will act as an
equilibrating mechanism via its effect on the level of bank reserves: the
increase in prices will lead to a higher requirement of means of exchange,
which implies that to maintain a rate of interest permanently below the
natural rate it is necessary to increase continously the amount of reserves.
Patinkin, in particular, has emphasized this point:
Wicksell's primary interest lies not In describing an unstable economy con-
tinuously moving away from equilibrium, but in giving a detailed account of how
a stable economy achieves equilibrium after an initial disturbance (Patinkin,
1952, p. 834; see also Frisch, 1952, p. 693).
Most commentators, according to Patinkin, have neglected this point: they
have just stressed that the difference between the market and the nonnal
rate gives rise to a cumulative process, and they have left out that the
process itself removes "the discrepany between these rates and thus restore
the system to equilibrium" (1952, p. 834). In this sense the cumulative
process is "the fundamental equilibrating mechanism" (1952, p. 839),
which forces the banks, due to changes in reserves, to change the loan rate
so it becomes equal to the normal rate.
In the case of a pure credit economy where this equilibrating mechanism
has no role to play, it is up to the central banks to change the interest rate
since it is "their manifest responsibility ... to stabilize the price level"
(Uhr, 1960, p. 234). It has to be taken into consideration that Wicksell saw
the pure credit system as a desirable state that would cut the relation
between price changes and the irregular changes in the gold supply (LPE 2,
p. 224; Uhr, 1960, p. 234). This comes out quite clearly when Wicksell,
under criticism, stated the central conclusions of his approach:
What is alone of importance is that it [the difference between the loan rate and
the real rate) is strong enough to explain actual price fluctuations which
mainfestly cannot be due to variations in the quantity of gold and to guarantee
the possibility of regulating the price level by the interest policy of the banks, if
metallic gold ceases, as at present [1915, this section is added to the second
edition of Volume II of Lectures], to be the measure of price (LPE 2, p. 200; see
also Uhr, 1951, pp. 857-858).
Hence, the process could be cut short if the banks would set the proper
interest rate.
Wicksell was aware of the fact that the changes in prices are not
"distributed uniformly over the whole range of commodities" (LPE 2, p.
195). But he did not mention that there is also a problem of which
price level to stabilize:
The most that could conceivably be stabilized would be an index number of
prices, but there are many possible index numbers ... (Hicks 1965, p. 60).
Faced with this problem, Myrdal chose to stabilize a price index made up
of the less flexible prices, the money wage in particular, since this choice
will make it possible for "the economy to function with smaller excesses, of
demand or of supply, in the markets where prices do not equate supply and
demand quickly and easily" (Hicks, 1977, p. 71).
2.2.7. The Passivity of the Banking System. Wicksell applied his recon-
struction of the quantity theory to Tooke's criticism of the quantity theory:
... that rising prices very rarely coincide with low or falling interest rates, but
much more frequently with rising or high rates (LPE 2, p. 202).
The object of this debate is the secular increase in the price level, e.g., the
period 1850-1873 (section 2.2.1). This problem was denoted "the Gibson's
Paradox" by Keynes in the Treatise on Money (cp. Keynes, 1930, p. 177).
Wicksell explained the paradox as follows:
... the loan rate does not adapt itself quickly enough to these changes [in the real
rate], so that the influence of the banks on commodity prices is in fact a
consequence of their passivity, and not of their activity, in the loan market (LPE
2, p. 205).
Changes in the natural rate often trigger the cumulative process and it is
therefore called primum movens (Wicksell, 1898, p. 82).
The saving-investment approach is suitable "for someone who believes
to begin with that "real" disturbances are responsible for observed income
fluctuations" (Leijonhufvud, 1981, pp. 156-157). In a developed banking
system these disturbances lead to variations in the demand for money that
is passively supported by changes in the money supply from the private
banks. It is generally not active changes in the monetary base engineered
by the Central Bank that is the source of the disturbance. Wicksell's
approach is therefore different from the monetarist approach since his
"theory of nominal income determination will focus on changes in the
flow of bank-intermediated credit rather than in the stock of money"
(Leijonhufvud, 1981, p. 152).
Wicksell drew one major lesson as far as institutional reform was
concerned: "he wanted to strengthen the credit control exercised by
discount policy and open-market operations of central banks over private
banks" (Uhr, 1951, p. 838). Hicks would consider this a suitable reform for
a polycentric banking system: the different banks provide "what is in effect
a common money" (Hicks, 1982, p. 273), and at the same time there are
fixed exchange rates between the promises to pay of each bank. In this
system convertibility can only work if the deposit rates are the same for all
banks. An attempt by any bank to lower the deposit rate would initiate a
loss of deposits, which means that no bank can take the lead for lowering
the interest rate. If it bank is increasing its deposit rate, on the other hand,
it might force the other banks to follow suit, whcih implies that such a
banking system would have "a natural deflationary bias" (Hicks, 1982,
p. 274). But his weakness can be overridden if one bank has such a strength
in relation to other banks "that it can face a withdrawal of funds with
equanimity" (Hicks, 1982, p. 274). In this case, the system is drifting
toward the monocentric model which has "just one 'central' entity, prom-
ises to pay by which have superior quality (in that they are more widely
acceptable) than promises by any other entity" (Hicks, 1982, p. 267).
2.2.8. The Cumulative Process and Short-run Analysis. The cumulative

process is an analysis of secular changes in prices. However, there are some
recent attempts to apply the cumulative process to short-run analysis of
prices and quantities, which are more related to a Keynesian perspective.
After the neo-Walrasian interpretations of Keynes (e.g., Clower and
Leijonhufvud), which imply a disequilibrium approach, there have been
attempts to reinterpret and develop Wicks ell's cumulative process from
this point of view. The neo-Walrasians discard Say's Law outside of full
employment equilibrium and allow a dynamic process with trading at

disequilibrium prices, i.e., there is no Walrasian tatonnement process with
an auctioneer and no possibility of recontracting, which implies income-
constrained aggregate demand functions. As a result they get:
A property of the dynamics of markets in which such disequilibrium trading
takes place is that, because of imperfections in the knowledge of traders, prices
adjust slowly, particularly when the required movement is a downward one, and
quantities adjust instead. Because quantities influence behaviour, such varia-
tions may produce cumulative forces that tend to move income and employment
further away from full employment eqUilibrium rather than back towards it
(Laidler, 1972, p. 101).
From this angle, Wicksell's modern element lies in the renouncing of

Say's Law and the explicit analysis of the behavior of an economy in
disequilibrium where the emphasis has shifted away from comparative
statics. His weak spot concerns the assumption of flexible wages and prices,
in the downward as well as in the upward direction, which only leads to a
cumulative process in the price level while output is constant, i.e., there is
no quantity adjustment. This weakness stems from the following oversight:
... an inadequate treatment of the role of price level expectations in determining
market behaviour in disequilibrium was responsible for his failure to develop the
theory of output fluctuations (Laidler, 1972, p. 105).
Wicksell took certainly entrepreneurial expectations on the demand side
into consideration, but he did not develop the expectations of the wage-
earners and the supply response of the entrepreneurs (Laidler, 1972, pp.
112-113). The labor force will accept any money wage rate rather than be
unemployed, and the traders will take any price to get rid of the entire
stock of goods. In fact, in the formal analysis of Interest and Prices the
relative prices are in equilibrium all the time, which implies that the real
wage remains constant during the cumulative process. If the assumption of
flexible money wages is dropped, then the introduction of the Keynesian
assumption of "a downward rigidity of the money wage ... immediately
generates unemployment in the Wicksellian model" (Laidler, 1972, p.
114). But this model would still not be identical to the multiplier; to mimic
the multiplier it is necessary also to assume "a reluctance on the part of
capitalists to lower the price of goods in the face of excess supply" (Laidler,
1972, p. 114).8 In this process, changes in quantities would adjust in
disequilibrium whcih would produce cumulative forces that tend to move
employment away from full employment equilibrium.
A further development of this approach is to substitute for the assump-
tion of flexible prices and wages in perfectly competitive markets "a model
of a monopolistically competitive economy" where the firms fix prices and
wages without knowing realized demands and supplies (Iwai, 1981, p. xviii;
Laidler, 1972, pp. 109-110). The cumulative process is then reconstructed
from "the perspective of the microeconomic process of price formation"
(Iwai, 1981, p. 6). In this perspective, the Keynesian economy is characte-
rized by sticky wages and prices and the principle of effective demand, and
Wicksell's cumulative process is relevant for an economy with flexible
wages and prices, but there is a particular relation between the two
approaches:
With sticky money wages, the system normally approaches a Keynesian equilib-
rium where employment is determined by effective demand.. .. It is only in
response to a macroeconomic disturbance large enough to break the inflexibility
of money wages that the system abandons Keynesian equilibrium and sets off a
cumulative process of inflation or deflation. A Keynesian principle of effective
demand is thus interpreted with a Wicksellian theory of cumulative process
(Iwai, 1981, p. xviii).
The particular "province of the Wicksellian approach" is therefore the

cases when the economy, due to large excess demand or supply of labor, has
jumped the barriers of inflexible money wages (cp. Iwai, 1981, p. 121).
2.2.9. Summing Up. The interest in the cumulative process is perhaps

not as great as it was in the early 1930s after the publication of Keynes'
Treatise on Money, since it concentrates on the dynamics of the price level.
But the renewed interest in price stability during the last 15 years has lead
to a revival of Wicksell's concerns, e.g., the analysis of the natural rate of.
unemployment and a situation with a non-accelerating inflation. However,
there has been no attempt to redefine the analysis of the normal rate of
interest for a nonstationary state and an open economy, which was the
case in the late 1920s and early 1930s in the works of Erik Lindahl and
Gunnar Myrdal.
2.3. The Wicksell Effect
The section starts with Wicksell's exposition of the background to the

Wicksell effect. Then follows a modern presentation of the effect and its
relation to the so-called capital-controversy, which has proven to give a
deeper understanding of the phenomenon.
The law of marginal.productivity, or von Thiinen's Law, as it was mostly
called by Wicksell, states that "the share of the product going to any
particular factor of production is determined by its marginal productivity"
(LPE 1, p. 147). This determination of distributive shares is basically
correct as long as it is applied to the factors of production labor and land,
i.e., the determination of wages and rent. But it was not correct of von
Thunen to apply this principle to aggregate capital:
If we consider an increase (or perhaps a decrease) in the total capital of society,

then it is by no means true that the consequent increase (or decrease) in the total
social product would regulate the rate of interest. In the first instance, new
capital competes with the old and thereby results, in the first place, in a rise of
wages and rent, possibly without causing much change in the technical composi-
tion of the product or the magnitude of the return (LPI 1, p. 148).
This is the fundamental cause to the Wicks ell effect, namely, that with
given supply of labor and land a part of the net real saving intended for
transformation into real capital is absorbed by rising real wages and rent.
The phenomenon was termed the Wicksell effect by Uhr in 1951. It stems
from the following difference between the three factors of production:
Whereas labour and land are measured each in terms of its own technical unit
(e.g., working days or months, acre per annum) capital, on the other hand, ... is
reckoned, in common parlance, as a sum of exchange value-whether in money
or as an average of products. In other words, each particular capital-good is
measured by a unit extraneous to itself. However good the practical reasons for
this may be, it is a theoretical anomaly which disturbs the correspondence which
would otherwise exist between all the factors of production (LPI 1, p. 149).
Hence, it is problematic to analyze the determination of the rate of interest

with capital measured as an exchange value, but, at the same time, there is
no common technical unit in which to measure the total capital. This gives
the rationale for Wicksell's treatment of capital "as a single coherent mass
of saved-up labour and saved-up land, which is accumulated in the course
of years" (LPI 1, p. 150).9
We will show the effect for the case of circulating capital. lO The
production function is of the point-input point-output variety: each pro-
duction period, a "year," a number of workers (N) are used to plant the
trees, which after a period of production (t) results in a final output (Q)
which is greater the longer the period of production. This case is particular-
ly simple, since if the total supply of labor and land are given then "the
length of time will ... be the only variable dimension of capital" (LPI 1,
p. 172; italics deleted). The production function shows output per unit of
labor as an increasing function f(t) of the period of production:
Q = N J(t) f(t) > O. (1)

From profit maximization it follows that the real wage rate (w) must be
equal to the present value of the discounted product per unit of labor using
instantaneously compounded interest (p):
(2)
The entrepreneurs, facing a given real wage, choose t so as to maximize p,
the rate of return, which implies:
p = f(t)/J(t). (3)
This is Jevons' formula for the rate of interest: "the rate of increase of the
produce divided by the whole produce" (LPE 1, p. 178).
The value of the stock of capital, i.e., timber of all ages, will be:
K = Nw J~ ePX dx = (Q - Nw)/p. (4)
If K and N are given, then the system of equations give solutions for Q, p,
w, t. Wicksell then differentiated Q with respect to K which gives:
dQldK = p + (K - Nwt) dp/dK. (5)
The parenthesis is positive, since K > Nwt if p > 0 and dp/dKis negative,
which implies that dQldK < p. Hence, the marginal productivity of capital
is always less then the rate of interest, which "proves that the ... theorem
of von Thunen is not correct, if by "the last portion of capital" is meant an
increase in the social capital" (LPI 1, p. 180), and it is due to the working
of the Wicksell effect. 11
The diagram shown in figure 7-1 gives a more detailed illustration of
the Wicksell effect. In equilibrium P is maximized, which is implied by the
tangency condition between the two curves, and t is optimal. Compare two
equilibrium situations A and B which differ only with respect to the
amount of capital, measured by the two areas Ot1AQl and OtzBQz, and
the technical characteristics, which are represented by the functionJ(t) and
the number of workers (N), are the same. The difference between the
values of the capital stocks can be separated into two elements: (1) the area
ABt2tl which is due to a longer period of production (tz> tl); (2) the area
QIQzBA which is due to the difference in factor prices where a higher
wage rate (wz > WI) is only partially compensated by a lower interest rate
(pz < PI)' The Wicksell effect is represented by the latter elementY
Wicksell proved, using the second~order maximization condition upon
J(t) , that in equilibrium (for give N) increasing K necessarily means
increasing w, decreasing P and increasing t. Hence, in spite of the Wicksell
.jJ
N
Q..
N
-.)J
o
o
lHE SWEDISH TRADITION 267
effect, the traditional proposition of capital theory is basically correct: for

any given N, accumulation is characterized by the increments to the capital
stock, which lead to increases in output, but the proportional change in
capital stock is greater than the similar ratio of output, which implies a
falling marginal productivity of capital (dQ/dK) and a falling rate of
interest/profit (p).
The full implications of the Wicksell effect were first realized during the
capital controversy. The effect was introduced right from the beginning by
Joan Robinson as a major critique against the use of an aggregate concept
of capital in the analysis of the effects of capital accumulation on the
relative prices of the factors of production:
Somehow or other, accumulation may be conceived to push down the rate of
profit, and raise the factor ratio. But the very notion of accumulation proceeding
under equilibrium conditions at changing factor ratios bristles with difficulties.
The rate at which the factor ratio rises is not governed in any simple way by the
pace at whcih accumulation goes on - it depends upon the extent to which the
rising wage rate causes capital to be absorbed by the Wicksell effect (Robinson,
1954, pp. 99-1(0).
Swan responded to Joan Robinson that the Wicksell effect was "nothing
but an inventory revaluation" (Swan, 1956, p. 355). The analysis of capital
accumulation should only take into account the increase in capital that was
due to an increment of capital goods at ruling prices (the area ABtztl),
since it corresponded "with the usual idea of investment, saving, or
accumulation" (Swan, 1956, p. 355). The analytical procedure to separate
out the pure revaluation effect is only possible as long as capital is assumed
to be made up of homogenous physical units like in Wicksell's case; it has
to be noticed that Wicksell never followed this procedure. However, Swan
went one step further: for the general case with heterogenous capital
goods, it was still possible, using Champernowne's chain index (Champer-
-nowne, 1954), to differentiate between changes in the physical amount of
capital, the accumulation proper, and the pure value change in the capital
stock due to associated marginal changes in wage and interest ratesY It
seemed, therefore, that von Thiinen's proposition could be saved if capital
just was measured in the correct way, i.e., to use an index that only
measured changes in physical capital which eliminated the Wicksell effect.
The discovery of reswitchings of technique changed the whole affair. It
implies the possibility that the same technique may be the most profitable
of a number of techiques at more than one rate of profits (p) even though
other techniques are more profitable at rates in between. The application
of Champernowne's chain index is then forced to give the same technique
two different capital/labor ratios, which destroys the basic principle of the
chain index: that each technique is characterized by one single capital/labor
ratio. Hence, for the general case with heterogenous capital goods, it was
proven that there is no such thing as a pure physical measurement of
capital stripped of all traits of the Wicksell effect. It also shattered the
traditional proposition of capital theory of an inverse monotonic relation
between the rate of profit and the amount of physical capital per man.
To conclude: Wicksell's discovery of the Wicksell effect has proven to be
an important contribution, which later became the stepping-stone for the
discovery of further complications and contradictions within traditional
capital theory. As such it has given a boost for two quite different modes of
analysis: on the one hand, the neo-Keynesian theories of growth and
distribution (e.g., Pasinetti, 1962), and, on the other hand, the applications
of intertemporal equilibrium to capital theory (e.g., Bliss, 1975).
2.4. Public Finance
Wicksell's main contribution to public finance is contained in his book

Investigations in Public Finance (Finanztheoretische Untersuchungen) from
1896. The book is made up of three more or less separate parts: (1) "On
the Theory of Tax Incidence," which was his doctoral thesis from 1895; (2)
"A New Principle of Just Taxation"; (3) "The Swedish Tax System." The
first part has been duly noticed, and Wicksell is nowadays regarded as one
of the major precursors of modern incidence theory. But it is the second
work, with "the principle of unanimity and voluntary consent in the
approval of public expenditures and taxes" (Wicksell, 1896, p. 116), that
has been noticed by recent commentators. Wrote Wicksell:
In the final analysis, unanimity and fully voluntary consent in the making of
decisions [on public finance] provide the only certain and palpable guarantee
against injustice in tax distribution. The whole discussion on tax justice remains
suspended in mid-air so long as these conditions are not satisfied at least
approximately (1896, pp. 90-91).
Wicks ell is now seen as "the first to link the potential for all to benefit from
collective action to the unanimity rule" (Mueller, 1979, p. 19). This idea
has been considered a foundation stone for the development of both nor-
mative and positive public choice.
The application of the principle of unanimity required, according to
Wicksell, a preexisting "justice in the existing distribution of property
and income" (Wicksell, 1896, p. 108). But that did not prevent Wicksell
mE SWEDISH TRADITION 269
from becoming the first to separate decisions of allocation and decisions

of distribution .
. . . his distinction between (1) the problem of securing a just state of distribution
and (2) of allocating the cost of public services in line with this distribution, is an
important methodological step ... (Musgrave, 1959, p. 72; cpo Wicksell, 1896,
p. 85).
This Wicksellian distinction, which was taken up and spread by Musgrave,
still constitutes "the natural conceptual boundary between positive and
normative public choice" (Mueller, 1979, pp. 3-4).
Two strands exist within public finance: the Pigouvian and the Wicksel-
lian. The Pigouvian line or the ability principle has taken the amount of
government expenditure as given, and the principle of marginal utility has
then been applied to the problem of the distribution of the tax burden. The
Wicksellian line or the benefit principle has moved beyond this problem;
it requires for its practical realization that the vote on public expendi-
tures and the means to finance them should always be simultaneous,
which implies an analysis of the optimal size and composition of govern-
ment expenditure:
With all its clumsiness the theory of Value and Countervalue had at least the
virtue of maintaining some sort of contact with the other, the expenditure, side
of the public economy. That theory provided something like an upper limit to
the concrete amount of taxes by rejecting any public expenditure, along with its
companion tax levy, which failed to render each taxpayer a service correspond-
ing to this payment. Justice would thereby have been done at least to the extent
that each man received his money's worth. In this respect the sacrifice theory
appears far weaker. It determines, and indeed can determine only the distribu-
tion of taxes but has nothing whatever to say on the absolute amount of the total
tax bill (and hence of the individual's tax bill) (Wicksell, 1896, p. 75).
The benefit principle became the solution of both problems, since it
guarantees that each member of society gets an increase in utility via his
exchange with the state and there will be a limit to the expansion of public
expenditures.
After Wicksell's endorsement of the unanimity rule it fell into oblivion;
besides Lindahl's treatment of the rule in his doctoral dissertation, Die
Gerechtigkeit der Besteuerung from 1919, it was forgotten for almost half a
century. In the late forties the unanimity principle was brought back to the
stage by Buchanan who saw the resemblance between the Wicksellian
voting rule and the Pareto criterion:
It [the unanimity rule] is no longer almost universally disparaged as a cranky
whim or at best a harmless curiosity, but regarded by many as a brilliant and
profound insight. They value the requirement of unanimo,us approval not only
as a logically valid solution to the free-rider problem, solidly based upon a
correct understanding of the conditions of welfare maximization, but also more
generally as the only rule which guarantees a Pareto-optimal outcome of policy
decisions concerning the allocation of economic resources (Hennipman, 1982,
p.58).
Buchanan takes a contractarian view of society that explains the close link
between the unanimity rule and the Pareto criterion:
If the polity is envisaged as a union of individuals, who, conceptually, have the
option of not joining, then unanimous agreement on basic choices is required.
But unanimity can be achieved, under individualist-egoistic assumptions, only
for Pareto moves (Mueller, 1979, p. 268).
In their well-known book Calculus of Consent, Buchanan and Tullock
considered Wicksell's contribution the most close to their own work, and
his particular merit was that "he states directly the implications of his
analysis for the institutions of collective choice, a subject upon which the
modem welfare economists have been rather strangely silent" (Buchanan
and Tullock, 1962, p. 8). Their starting point is the following:
When will it prove desirable to shift one or more sectors of human activity from
the realm of private to that of social choice, or vice versa? Implicit in our
discussion is the assumption that the criteria for answering such questions as this
can only be found in the conceptual unanimity among all parties in the political
group. Agreement among all individuals in the group upon the change becomes
the only real measure of "improvement" that may be accomplished through
change (Buchanan and Tullock 1962, pp. 6-7).
This quotation should be compared with Wicksell's formulation above,
and the similarity is obvious. Buchanan and Tullock have gone further than
Wicksell in their analysis of different decision-making rules, and the core
of their book is "an analysis of one of the most important rules for col-
lective choice-that of simple majority voting" (Buchanan and Tullock
1962, p. 7).
The main weaknesses of the unanimity rule are the time-consuming
nature of the decision-making process and the encouragement of strategic
behavior. This problem has motivated those favorable to the Wicksellian
line of thought to take the following route:
TIlls dilemma has led several writers to pursue new, more sophisticated prefer-
ence revelation mechanisms, which have the desirable properties sought by
Wicksell ... , Lindahl ... , and Musgrave ... in the development of the "volun-
tary exbange" approach, but involve more plausible incentive structures for
revealing individual preferences honestly than seem inherent in traditional

voting mechanisms (Mueller, 1979, p. 68).
In this sense the problems raised by Wicksell has spurned a still ongoing
research programs of the proper procedure for collective choice.
3. Cassel
3.1. Schumpeter's Assessment of Cassel
Schumpeter did not have a very high opinion of Cassel's contribution to

economic theory as summarized in his successful textbook Theoretische
SozialOkonomie (published in German 1918 and in English in 1922). The
book did not contain anything new, according to Schumpeter, and it was
"mainly a version-or popularization-of Walras' doctrine (minus utility)
in spite of the fact that Walras' name does not occur in it" (Schumpeter,
1954, p. 862, n. 3). However, he conceded willingly that Cassel was very
highly rated both outside and inside the academic field:
... the most influential international leader of our science in the 1920's-for
such he was, whatever his critics (including myself) may say .... Partly owing to
the advantage he held as a 'neutral', he rose into international fame during and
after the First World War-chiefly as an expert on money and international
relations and as an assiduous participant in international conferences on these
subjects ... (Schumpeter, 1954, p. 1154, n. 2).
Cassel's fame resides certainly to some extent on the book but a more
important factor was his bold application of a simple formula to the urgent
monetary problems after World War I:
In the period [the 1920s and the 1930s], more definitely than before, we find in
the neighborhood of the quantity theorem its old ally, the purchasing-power-
parity theory of foreign exchange .... It was repeatedly stated, for example, by
Marshall and Schlesinger, but when, in the discussion on the exchange troubles
that arose during and after the First World War, Cassel pressed it energetically
into service, it struck most people like a new discovery .... The excitement
sprang from the fact that Cassel linked it up with a strict quantity theory and, in
application, with the problems of war inflation (Schumpeter, 1954, p. 1106).
Cassel thus became famous, and it might have looked "like a new dis-
covery" to some people but to Schumpeter it was basicaly "an old ally"
to the quantity theory that had been revived.
I will demostrate that at least some contemporary economists have a
much higher opinion than Schumpeter of Cassel's use of the purchasing
power parity doctrine (PPP). They stress its simplicity as a theory, but the
PPP has also a role to playas a tool of analysis with a very practical
purpose. This function was not evaluated by Schumpeter, who concen-
trated on analytical contributions, but it might explain Cassel's fame
among his contemporaries.
Cassel brought the PPP doctrine back into prominence after the First
World War, but after the Keynesian revolution PPP together with the
quantity theory fell into oblivion. However, the PPP has lately reappeared
as ~ part of the monetary approach to the balance of payments. The
subsequent sections will first analyze the assessment of the PPP doctrine on
its own and then the relation between PPP and the monetary approach to
the determination of exchange rates.
3.2. The Purchasing Power Parity Doctrine as

an Operational Doctrine
The purchasing power parity theorem was used by Wheatley and Ricardo
as early as during the debates in the beginning of the nineteenth century,
but in 1918 Cassel gave the theory its name:
... the rate of exchange between two countries is primarily determined by the
quotient between the internal purchasing power against goods of the money of
each country .... At every moment the real parity between two countries is
represented by this quotient between the purchasing power of the money in the
one country and the other. I propose to call this parity 'the purchasing power
parity' (Cassel, 1918, p. 413).
The actual exchange rate would fluctuate around the PPP if there were no
major restrictions on the free trade of goods between countries. The
usefulness of the PPP depends on the origin of the disturbance and the
theory is best fitted to explain the exchange rate for monetary disturbances
(Frenkel, 1978, p. 171). Cassel was not so clear on this point, but most of
the time he applied the PPP to situations with major monetary disturb-
ances. After Cassel's reconstruction of the PPP there has hardly been any
further development of the theory (Officer, 1976, p. 51).
Cassel was not interested in daily variations in the exchange rate but to
determine the long-run equilibrium exchange rate:
The purchasing power parities represent the true equilibrium of the exchanges,
and it is, therefore, of great practical value to know these parities. It is in fact
to them we have to refer when we wish to get an idea of the real value of
currencies whose exchanges are subject to arbitrary and sometimes wild fluctua-
tions (Cassel, 1921, p. 38).
mE SWEDISH TRADITION 273
Cassel used the PPP to the urgent problem of calculating the proper
equilibrium values of the different currencies, which had been upset during
the war. It is important to keep in mind that Cassel always tried to apply
the PPP in this very practical manner, which has been noticed by contem-
porary commentators:
There were many predecessors of Cassel in developing the PPP approach, but
he was the first to place PPP within so systematic a framework that a clearly
operational theory resultated ... he was also the first to use PPP to obtain
estimates of exchange-rate disequilibria and to test the theory empirically
(Officer, 1982, p. 251).
This down-to-earth character of the PPP was not appraised by Schumpeter
but is was highly valuated by Cassel's contemporaries, in particular among
politicians and bankers.
Nowadays, those favorable to Cassel do agree on the usefulness of a
simple and practical criterion as the PPP. In fact, its simplicity as a theory of
exchange rate determination is "the principal virtue of the PPP approach"
(Officer, 1976, p. 51). It may therefore have its limitations as a comprehen-
sive theory, but it is valuable as a check on more sophisticated models and
"as a practical technique" (Officer, 1976, p. 52). In the same manner,
Frenkel considers the PPP doctrine as a useful and simple substitute for a
more complicated model:
... the PPP relationship should be viewed as a short-cut rather than a substitute
for a complete model of the determination of prices and exchange rates. It is
with this perspective that one should assess the policy usefulness of the doctrine.
Its main usefulness is in providing a guide as to the general trend of exchange
rates rather than the day-to-day fluctuations. It might be useful as a guide for
setting exchange rates in the face of monetary disturbances after a period of
massive dislocations (like that of World War I) (Frenkel, 1978, p. 188).
Hence, according to these proponents of the theory, Cassel's extensive use
of the PPP doctrine to determine the equilibrium values of the exchange
rates was quite a suitable application of the doctrine; some modem
interpreters argue that the doctrine even on its own has a value as "a first
approximation" (Frenkel, 1978, p. 188).
3.3. The PPP and the Monetary Approach to the Balance

of Payments
The monetary approach concentrates on the role of money and other assets
in the determination of the level of the exchange rate for a system with
flexible exchange rates and the balance of payment for fixed exchange
rates. In the former system the flexible exchange rate will function as an
equilibrating mechanism:
Being a relative price of two assets (moneys), the quilibrium exchange rate is
attained when the existing stocks of the two moneys are willingly held. It is
reasonable, therefore, that a theory of the determination of the relative price
of two moneys could be stated conveniently in terms of the supply of and the
demand for these moneys (Frenkel, 1976, pp. 201-202).
The "monetarist" twist to this approach is the common assumption of a

stable demand function for money (Frenkel and Johnson, 1976, pp.
24-25), which implies a concentration on money market equilibrium to the
exclusion of other assets.
Cassel, as a proponent of the quantity theory (Cassel, 1921, p. 20),
considered changes in the money supply to be one of the most important
determinant of the exchange rate:
During the war the buying capacity of the different monetary standards has,
owing to the over-abundant supply of means of payment, been much reduced,
though in very different proportions. Consequently the purchasing power
parities have undergone very important alterations and are now quite different
from the parities which were in force before the war (Cassel, 1921, p. 37).
An increase in the money supply of a particular currency will lead to a fall

in the purchasing power and an increase in the exchange rate until demand
and supply of money is equal, i.e., the exchange rate is the equilibrating
mechanism. Cassel was always explicit on the role of the money supply, but
he did not dwell very much on the demand side, which has been the
hallmark of Friedman's development of monetarism.
The association with the monetary approach is strengthened by the fact
that his calculations of the parity was explicitly based on the general price
level and not on the price index of tradable goods:
... the whole theory of purchasing power parity essentially refers to the internal
value of the currencies concerned, and variations in this value can be measured
only by general index figures representing as far as possible the whole mass of
commodities marketed in the country (Cassel, 1928, p. 3).
The monetary approach concentrates analysis on the asset markets, and

therefore "the general price level does playa central role, since it deter-
mines the real value of nominal assets" (Frenkel and Johnson, 1976, p. 23;
italics omitted), a most important argument in the demand function for
money. Cassel's insistence on the general price level as the correct index
TIIE SWEDISH TRADITION 275
to calculate the parity implies the same equilibrium mechanism as the

monetary approach:
Those who advocate the use of [the] traded goods index emphasize the role of
commodity arbitrage while those who advocate the broader price index empha-
size the role of asset equilibrium as determining the rate of exchange. If the role
of the exchange rate is to clear the money market by equating the purchasing
power of the various currencies, then the relevant measure should be a con-
sumer price index (Frenkel, 1976, p. 202).
Modem commentators have interpreted Cassel's version of the PPP as
using the exchange rate as the equilibrating mechanism in asset markets.
It is the concentration on changes in the money supply, which is the
monetary factor par excellence, and the explicit use of the general price
level that have interested the followers of the monetary approach. From
this perspective Frenkel considers Cassel as having a similar general
framework as the monetary approach:
The original formulation of Cassel (1916) was stated in terms of the relative
quantities of money. The formulation was then translated into a relationship
between prices via an application of the quantity theory of money. Concep-
tually, however, it seems clear that the role of prices in Cassel's computation
of the equilibrium exchange rate serves only to proxy the underlying monetary
conditions. The determination of exchange rates does not seem to rely,
directly or indirectly, on the operation of arbitrage in goods (Frenkel, 1976,
p.203).
The main missing feature of Cassel's theory is a detailed analysis of the
transmission mechanism between exchange rates and prices (Frenkel,
1976, p. 205), and most of the debates on the practical applicability of the
PPP doctrine center around this problem (Frenkel, 1978, p. 169). The
doctrine can therefore be looked upon "as a shortcut; it specifies a
relationship between two variables without providing the details of the
process which brings about such a relationship" (Frenkel, 1978, p. 169).
This shows the nature of the PPP as "a first approximation," as has already
been emphasized in the section above, and the need to develop the
doctrine into the full-fledged monetary approach to the determination of
the exchange rate. But the PPP condition is still an important building
block of the monetary approach (Frenkel, 1978, p. 208).
4. Conclusions
Schumpeter's positive assessment of Wicksell has not been challenged by

modem economists. On the contrary, Wicksell's reputation is now prob-
ably greater than ever before: to the cumulative process, which is still held
in high esteem, has been added his lucid exposition and development of
capital theory and his provocative ideas within public finance.
Schumpeter's negative estimate of Cassel was certainly due to the
trough in the prestige of the quantity theory at the time of the writing
of History of Economic Analysis. However, with the resurgence of the
quantity theory lead by Milton Friedman and the success of its offspring,
the monetary approach to the balance of payment, the respect given to
Cassel's development of the PPP has definitely improved. It has lead to a
renewed interest in his work on monetary problems, which always had an
instrumental nature. But Schumpeter's evaluation still holds in the sense
that Cassel's works within value theory remains forgotten.
All in all, Wicksell and Cassel have withstood the attrition of time fairly
well. Wicksell's contribution, in particular, is aging like the wine in his
famous wine example: it shows new qualities with time.
Notes
1. Wicksell analyzed this problem in the article "The Enigma of Business Cycles" from
1907, which was an elaboration of an earlier and shorter version added as an appendix to the
analysis of the cumulative process in the first edition of Lectures, and it was slightly revised in
the second edition (LPE 2, pp. 209-214).
2. Trade cycles, business cycles, good and bad times are used as synonyms.
3. The normal rate, the natural rate, and the real rate are used as synonyms. The exact
interpretation of the normal rate is the level of the equilibrium value of the real or the natural
rate.
4. Frisch tried to analyze the cumulative process by tying it closer to Wicksell's value
theory. He defined a productivity rate of interest as a substitute for the natural rate (cp.
Frisch, 1952, pp. 683-684). The analysis was built on the assumption that there is a
down-sloping curve that connects the productivity rate and the volume or real value of
physical capital. However, that seems a bit daring after the outcome of the capital controversy
(section 2:3), and Wicksell was quite careful not to use such a relation .
.5. This argumentation has been influenced by Andvig's study of Frisch (Andvig, 1986,
pp. 166-167).
6. If it assumed that the entrepreneurs always anticipate that the price level for consumer
goods will be the same at the beginning as well as the end of the period, then we can imagine
"a steady, and more or less uniform rise in all wages, rents and prices (as expressed in
money)" (IP, p. 148). In the case of entrepreneurs expecting future rises in prices, then the
actual rise will be higher and the cumulative process will be more and more rapid.
7. Several authors have tried to develop the formal exposition of the cumulative process
in Interest and Prices (e.g., Bailey, 1976; Honhohan, 1981). This is quite interesting as a
development of Wicksell's analysis for a more short-run perspective (section 2:2:8); the
sequential relations between different economic groups are then crucial for the nature of the
ensuing dynamic processes. But it seems a bit oversophisticated in relation to the cumulative
process as an analysis of secular changes in the price level.
8. To be fair to Wicksell: it has to be reminded that Laidler's analysis permits changes in

employment and thereby variations in real capital without any effects on the natural rate of
interest, which, of course, would be alien to Wicksell.
9. Uhr has given a comprehensive analysis of Wicksell's notion of capital (Uhr, 1960,
ch. V).
10. The exposition builds mainly on Pasinetti (1978), Sandelin (1975), and Swan (1956).
11. For the case of fixed capital, the so-called Akerman's problem, Wicksell found that
the divergence between marginal productivity of capital and the rate of interest could be both
positive and negative (cp. Wicksell, 1923; Pasinetti, 1978, pp. 183-184). Sandelin (1975) has
shown that the effect does not depend on the confusion, on Wicksell's part, of equating the
rate of interest with the average productivity of investment.
12. This is an example of the price Wicksell effect that analyzes changes in the value of
capital when wand p change their values but the technique is unChanged. The real Wicksell
effect refers to changes in the value of capital when the technique changes due to different
values of wand p (Harcourt, 1972, pp. 39-45).
·13. Frisch followed a similar analytical procedure in an earlier paper (Frisch, 1952,
pp. 662-663).
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Sons.
Commentary by Carl G. Uhr
In his chapter, Professor Bjorn Hansson has presented a very informative

study, executed to high standards of scholarship and delivered in a lucid
and appealing exposition.
Especially interesting fo!' younger scholars and students who have not
waded through the flood of journal literature devoted to the capital theory
controversies between the "two Cambridges" in the late 1960s will be
section 2.3 of this chapter on the Wicksell effect and its aftermath, where
Hansson has masterfully presented the gist of it.
In general Hansson has succeeded remarkably well in linking and
concisely comparing various facets of the Wicksell-Cassel-Stockholm
school theories with those of Keynes, the various brands of "Keynesians"
and "post-Keynesians," the neo-Austrians and other libertarians, the
Friedmanian and other less orthodox monetarists, and James Buchanan
and his colleagues among the "public choice" theorists, whose concern lies
largely with the proper economic role and scope of the public sector and
with public finance. Since it throws light on these several doctrinal inter-
connections, Professor Hansson's study offers the reader a useful map for
orientation among most of the contending contemporary schools of econo-
mic thought other than those associated with Marx and the several varieties
of socialists.
Before entering into Professor Hansson's treatment of Wicksell and
Cassel, it seems appropriate to consider David Davidson, 1854-1942,
however briefly, because of his influence on Wicksell's career. One might
say Davidson was at least partly responsible for Wicksell's change of career
from mathematics to economics.
In February 1880 Wicksell, then a graduate student at University of
Uppsala, gave a couple of public lectures to a temperance society. Among
280
the causes of alcoholism he pointed to the poverty and dreariness of home

life for many working class families, a poverty he attributed to their hav-
ing too many children. As a remedy he urged that the medical profession
take the responsibility for perfecting safe and sanitary methods of birth
control, and instruct the people in their use. An account of his lectures
reported in the Uppsala newspaper raised a storm of protest, and Wick-
sell found himself labeled as a "moral nihilist." In defending his position
in a pamphlet, he turned to Davidson, then since 1878 a docent in econo-
mics at the University, who had also criticized him but on grounds of
his not having adequate background in these matters rather than for
moral reasons. As a result, Davidson lent Wicksell a copy of Malthus'
Essay on Population.
This work so impressed Wicksell as to induce him to make a systematic
study on his own of the classical economists, and especially of J. S. Mill,
and later to pursue studies of contemporary economics, 1885-1890, at
German, French, and British universities supported by grants from a
Swedish foundation.
Davidson became a firm and lifelong friend of Wicksell from 1880, and
at the same time he remained an equally firm critic of certain aspects of
Wicksell's monetary and taxation theories and policies. In fact, Davidson
was the only persistent critic of Wicksell's monetary policy norm to
stabilize the price level, to whom Wicksell was moved to make some
significant concessions in the 1920s, when evidence from the monetary
upheavals of World War I and its aftermath had given support to some of
the points Davidson had raised. For a long time (since 1899), Davidson had
contended, and in an article of 1925 Wicksell finally conceded, that his
price stabilization norm would be inappropriate in conditions of (1) severe
commodity shortages, (2) in periods of rapid and great change in produc-
tivity, and (3) in times of fiscal domination over monetary policy by large
issues of fiat currency and/or by deficit finance of large public expenditures.
Davidson's own contributions to economics in Sweden are partly in
capital theory, in theory of taxation, and in his neo-Ricardian approach to
value theory. His Bidrag till taran om de ekonomiska lagarna for kapital-
bildningen (A Contribution to the Theory of the Economic Laws for Capital
Formation, 1878) anticipated, in very concise exposition, by a decade much
of what Bohm-Bawerk had to say on the same subject at much greater,
prolific length. His Beskattningsnormen vid inkomstskatten (Taxation
Norms for the Income Tax, 1889), a subject to which he returned time and
again in articles in his journal Ekonomisk Tidskrift and in reports to the
government, had an effect and left a permanent mark on Sweden's tax
system. Income and wealth, as measured by net worth, are taxed simul-
taneously. This means that since the legislation of 1910, where Davidson's
rather than Wicksell's proposals were enacted, Swedish taxpayers, except
in the lowest brackets, have to declare both their income and net worth.
As for his value theory, all that can be said in short space is that he was
trying to achieve a synthesis between his neo-Ricardian value theory and
that of the subjective or marginal utility theory. If he had expanded on and
formalized his own approach it seems likely that it would have eventuated
in a work that foreshadowed the theory embodied in Sraffa's Production
of Commodities by Means of Commodities (1960). Wicksell, on the other
hand, was a thorough-going and decidedly social-reform-oriented neo-
classicist, or, if the expression be permitted, a marginal utilitarian. Finally
Cassel took pride in and made on of his claims of fame on the basis of
rejecting outright as metaphysics all considerations of utility in his theory
of price, with prices enforcing his "scarcity principle" on consumers and
producers alike in the allocation of resources and distribution of products.
Consequently, as far as a "Swedish tradition" in economics is con-
cerned, Davidson was one of its founders. While his influence and fame
was less than that of Wicksell and Cassel, this was at least partly due to the
fact that, unlike them, Davidson published all of his writing in Swedish
rather than in German, French, or English. Still, while it is impossible to
estimate his influence because so much of it is indirect, there can be no
doubt about its being significant. It was Davidson who, at personal expense
and risk, launched Sweden's first economic journal, Ekonomisk Tidskrift
in 1898. He remained its editor and sole owner for 40 years until 1938,
when he turned it over to Erik Lundberg and Ingvar Svennilson. It was in
that journal he published all of his contributions as a mature economist
along with numerous contributions from Wicksell, Cassel, and others.
Professor Hansson first gives the reader a synopsis of Schumpeter's very
high appraisal of Wicksell as a creative economic theorist and a much
lower, though still a positive, evaluation of Cassel as mainly a popularizer
of received economic theory and a widely read economic journalist. It is
true that from the mid-1890s Cassel published short weekly articles on a
variety of current economic problems in one of Sweden's leading news-
papers. Also from 1920, when the Skandinaviska Banken Quarterly Review
was started, Cassel contributed fairly long articles to almost every number
of that journal up to the time of his death in 1945. Since that Review was
published both in a German and an English as well as in a Swedish edition,
Cassel's input in it became widely read. Still it is certain that he was a
creative economic theorist over and above these journalistic activities. But
it is doubtful that a current appraisal of Wicksell and Cassel would have
been very different if instead of Schumpeter it had been made by either
one of such well-known doctrinal historians as Mark Blaug or Henry

Spiegel, for ever since the 1930s Cassel's work has drifted deeper and
deeper into oblivion.
Professor Hansson also has devoted the lion's share of his chapter to
Wicksell. Whether this greatly underrates Cassel relative to Wicksell is a
matter that cannot and need not be decided here. There are, however,
distinguished members of our profession, among them persons of the
caliber of the late Professor Erik Lundberg (1970-September 1987) and
Professor Hans Brems, who hold that Cassel, well known internationally in
the 1920s, has undeservedly become forgotten since then. They point to
signs of a revival or comeback of Cassel to prominence among the leading
economists of the first half of the twentieth century.
In his article, "The Influence of Gustav Cassel on Economic Doctrine
and Policy" (Skandinaviska Banken Quarterly Review, p. 1), Lundberg
said: "It is with a view to correcting the prevalent gross underrating
of Cassel's significance as an economist ... that this article is written."
There he pointed out that ever since the mid-1930s students of econo-
mics in Sweden had come to know much about Wicksell and his theories
but had only vague and negative recollections of Cassel, sometimes based
on a very critical review Wicksell wrote in 1918 about Cassel's newly
published magnum opus, The Theory of Social Economy (first published
in German, 1918).
One may assume, though Lundberg did not say so, that the reason for
the neglect of Cassel was that he reacted negatively both to the Stockholm
school theories and to the economic recovery program of its leaders,
Myrdal, Ohlin, and Lindahl, espoused from 1932, when the Social Demo-
cratic Party came to power, which it held for an unusually long tenure of 44
years unti11976. Subsequently-1936 and later-Cassel was equally if not
more opposed to the theories of Keynes and to Keynesian policies. Thus in
an epoch of great disturbance and hardships, the Great Depression fol-
lowed by World War II, Cassel was perceived by very many as a hard-
sheell conservative or a reactionary.
Lundberg emphasized that a major, if not the major, contribution of
Cassel was his publication, alone among economists of that time, of a
macroeconomic theory of potentially steady-state economic growth in his
Theory of Social Economy (1932, 1967, pp. 61-63). On data he had
gathered from insurance records and from a parliamentary survey and
inquiry into national defense expenditures and requirements, Cassel esti-
mated that Sweden's economic growth rate was about 3 percent per
annum. Lundberg summarized Cassel's theory and his estimates in an
equation: g = s(Y/K), where g is the rate of economic growth, s is the rate
of net saving out of income, Y,and YI K is the output/capital ratio. Thus

Cassel anticipated the Harrod-Domar growth theory by about 30 years,
where in slightly different terminology and notation the same essential
relations are stated.
But, since Cassel himself did not strongly emphasize and elaborate on
this insight, it was mostly not understood at that time or else was received
as just another abstract academic conception. As a result it was soon for-
gotten, although Cassel made further use of it in his later research and
in his efforts to arrive at an empirically based and supported theory of
business cycles.
To this we hasten to add that Professor Hans Brems not only shares
Lundberg's appraisal of Cassel as the first to generate a macroeconomic
theory of economic growth, but goes beyond that. In an as-yet-unpublished
paper, probably the harbinger of a more definitive work Brems may bring
out on Cassel, "Gustav Cassel Revisited" (a manuscript of 28 pages written
in September 1987), Brems shows, in his characteristic concise and clear
mathematical treatment, that Cassel made at least three important con-
tributions to economic theory, other than his purchasing power parity
doctrine and his efforts in monetary theory and policy.
Cassel published a general equilibrium microeconomic growth theory
for what he referred to as (1) "the progressive economy" (Theory of Social
Economy, pp. 32-41 and 137-155). That achievement naturally led to (2)
his macroeconomic growth theory (pp. 61-63). Relatively independent of
(1) and (2), since it arose in a very different context, was (3) his third major
achievement, a theory for determining the optimum rate of depletion of
mines (pp. 289-297). The latter has significant implications for the econo-
mics of depletable natural resources and/or for their conservation.
Since we have already considered Cassel's macroeconomic growth
theory as appraised by Lundberg, whose formulation of it does not differ
from that of Brems on any significant point, we shall leave it at that, and
turn to Brems's appraisals of Cassel's achievement (1) and (3).
As a preliminary to presenting a series of (n by n) matrix equations to
demonstrate his microeconornic growth theory, Cassel made the following
general statements:
In the uniformly progressive state, production has three main tasks to fulfill: (i)
The continuous supply of goods and services to consumers and the resulting
necessity of maintaining the. circulating real capital at the same level. (ii)
Maintenance of fixed real capital. (iii) The steady increase in total real capital.
As to where the increase in total capital was to come from, Cassel stressed
that:
... the condition for economic progress is saving and the utilization of produc-
tive resources thus liberated in production of real capital. ... Application of a
certain proportion of the available factors of production to a steady increase of
real capital thus involves sacrifice, namely a voluntary restriction of wants that
could be satisfied. This reduction of satisfaction of wants to enable production of
real capital to increase its present supply ... is saving which results in the material
creation of real capital (pp. 34-35; emphasis by Cassel).
Then to demonstrate the consistency of his microeconomic growth
theory Cassel wrote a series of (n by n) matrix equations (pp. 139-145).
There he showed how a general micro-growth-equilibrium would emerge
when, starting from given supplies of Rb R 2 , ••• , Rn factors of production,
used in given "technical" quantities and combinations for producing Sl, S2,
... , Sn consumer and producer goods and services, at prices Ph Pz, ... ,
P n per unit (which prices, under competition, correspond to costs of
production per unit), these commodities being demanded in quantities D 1 ,
D 2 , ••• , Dn as functions of consumer and producer preferences, subject to
budget constraints determined by the P 1 , P2 , . . . , Pn commodity and factor
prices.
Brems reformulated and systematized these several interdependent
relationships in a clear-cut input-output model, which shows more expli-
citly than Cassel's own treatment how the growth rate g is incorporated
into key equations 6, 7, and 8 of that input-output model (pp. 3-6 of
Brems' paper).
Cassel's third major achievement involves a distinction between Ricar-
dian land rent and "rent" of mines, which yield finite amounts of "natural
products." Ricardo had drawn this distinction in 1817, saying: "In the rent
of coal mines and stone quarries ... , the compensation given for the mine
or quarry is paid for by the coal or stone which can be removed, ... and it
has nothing to do with the original and indestructible powers of land" (On
the Principles of Political Economy and Taxation, 1951, p. 68). As Brems
put it, " ... such rent (of mines) was not income but depletion allowance,"
a subject that "had remained dormant for a century until Cassel took it up
and showed that in a free market optimal depletion will depend on the rate
of interest and the future price of the mineral" (Brems' paper, pp. 17-18).
Cassel had used his insight into these matters to urge the removal of an
export duty on Sweden's iron ore, which had been enacted as a conserva-
tion measure. In essence Cassel's argument was that are in the ground paid
neither rent nor interest, and yet implicitly its own potential asset value
was enhanced with time at the compound rate of interest. On the other
hand, each ton of mined ore has market value and is used to produce
commodites, in which the value of that ore enters as a component. Then it
actually increases in asset value at the going interest rate until the goods
into which the ore has entered are used up. That would involve at least a
time interval equal to the length of the production period, and often a
much longer period for durable goods until they are used up. The value
that would therefore accrue over time would be lost by keeping ore that
otherwise would be mined underground. At the same time under con-
tinuous mining finite stocks of ore are eaten into. At a given demand, the
price per ton of ore, and along with it, the cost of mining, will increase,
while the interest rate may go one way or the other. How much ore will be
mined per annum will depend on there being a positive margin to be
maximized between the price per ton of ore and the sum of mining costs
per ton and of interest on the capital invested on equipping the mine. The
higher the rate of interest, the more intensively the mines will be worked
and the shorter will be their useful life or the optimal depletion period.
But, given the interest rate, the higher the price per ton of ore and the
accompanying mining costs go, the longer will be the useful life of mines.
Brems systematized Cassel's discussion of these matters by visualizing
an entrepreneur who has acquired a mine and has the option of operating it
more or less intensively for a shorter or longer useful life. In a series of
equations that describe the production, price, and cost conditions such an
entrepreneur would face, and particularly the rates of change in the price
and cost conditions, Brems brings the several strands of this analysis to a
common focus in the form of an elasticity equation. That equation relates
the optimum useful life of the mine, U, to the ore's price and cost
conditions, the factor (r - g), where r is the nominal interest rate and g the
rate of inflation. His equation is:
r - g. du =-1
U d(r - g) .
This indicates, as Brems put it, that: "The optimal useful life of mines is
always in inverse proportion to the factor (r - g). As a result, given the
rate at which prices and cost per ton are inflating, optimum useful life will
be shorter the higher the rate of interest. And given the rate of interest,
optimum useful life will be longer the higher the rate at which price and
cost per ton are inflating" (Brems' paper, pp. 20-21).
In addition to Hansson's treatment in sections 3.0-3.3 of his chapter,
the foregoing paragraphs may suffice to place Cassel's contributions to
economics in a stronger and truer perspective.
Let us then return briefly to Hansson's analysis of Wicksell's cumulative
process and premises for monetary eqUilibrium. The main ones (among the
many different interpretations Wicksell's work on this phenomenon has

received over the years) have been covered very well in sections 2.2-2.2.7.
And it is the discussion in section 2.2.8, "The Cumulative Process and
Short-Run Analysis," that seems more novel and challenging than that of
the earlier sections of part 2 of this study.
Space limitations have most likely prevented Hansson from entering on
a more detailed treatment, for instance, of Laidler's interpretation, which
is said to claim that: " ... in the formal analysis in Interest and Prices the
relative prices are in equilibrium all the time, which implies that the real
wage remains constant during the cumulative process."
Let it be agreed that Wicksell focused more on price movements than on
quantitative changes in his cumulative process and that he continued to
assume downward as well as upward flexibility of both wage rates and
prices. Still, it seems extreme to claim that the considered "relative prices
to be in equilibrium all the time" in the cumulative process. One would like
to see on what grounds such a statement is justified.
Also in view of the great institutional changes affecting monetary, fiscal,
and economic or social security policies that have developed since Wick-
sell's time, one may wonder, contrary to Iwai's belief, whether there is any
"particular province of the Wicksellian approach" left even if and after
"the economy has jumped the barriers of inflexible money wages due to
large excess demand or supply of labor?"
Finally, (1) in view of Wicksell's statement that: " ... the very concept of
political economy ... implies strictly speaking a thoroughly revolutionary
programme" (Lectures on Political Economy, vol. 1, pp. 3-4) and (2) in
view of Marquis Childs' designation of Sweden, The Middle Way (1936), as
a proxy for "the Swedish Tradition," one may wonder why those parts of
the social reform programs, respectively of Wicksell and Cassel, that
followed more directly from their contributions to economic theory have
received so little attention in this generally admirable chapter:
References
Brems, H. 1987 "Gustav Cassel Revisited." Unpublished manuscript, September.
Cassel, G. 1967. The Theory of Social Economy, reprinted by August Kelley, N. Y,
1967).
Childs, M. 1936. Sweden, The Middle Way. New Haven: Yale University Press.
Davidson, D. 1878. Bidrag tillliiran om de ekonomiska lagarna for kapitalbild-
ningen (A Contribution to the Theory of the Laws for Capital Formation),
Uppsala.
Davidson, D. 1889. Beskattningsnormven vid inkomstskatten (Taxation Norms for
the Income Tax), Uppsala.
Lundberg, Erik. 1967. "The Influence of Gustav Cassel on Economic Doctrine and
Policy." Skandinaviska Banken Quarterly Review, No.1, 1-6.
Ricardo, D. 1951. On the Principles of Political Economy and Taxation, vol. Iof
Collected Works and Correspondence of David Ricardo, edited by P. Sraffa and
H. M. Dobb. Cambridge, England.
Sraffa, P. 1960. Production of Commodities by Means of Commodities. Cambridge,
England.
Uhr, C. G. 1960. Economic Doctrines of Knut Wicksell. Berkeley, Ca.: University
of California Press.
Uhr, C. G. 1975. Economic Doctrines of David Davidson. Uppsala, Sweden:
Uppsala U. Press.
Wicksell, K. 1919. "Professor Cassel's System of Economics," originally in Eko-
nomisk Tidskrift, No.9, now translated and appended to Lectures on Political
Economy, Vol. I, 1938, pp. 219-257.
Wicksell, K. 1925. "Valutaproblemet i de skandinaviska landerna," originally in
Ekonomisk Tidskrift, now translated and appended to Wicksell's Interest and
Prices (1936) as "The Monetary Problem of the Scandinavian Countries," pp.
199-219.
Index
Biography, 14-18,95-104,158-166 General equilibrium theory, 95-150,167,

Bohm-Bawerk, Eugene von, 151-200 245-249
Brems, Hans, 284-286 Growth theory, 27
Capital theory, 19,33-34,36,63,116,173, Hawtrey, Ralph, 59-94

263-268 Hayek, Friedrich A. von, 195-197
Cassel, Gustav, 251-288 Hermann, Friedrich B. W. von, 157
Circular flow (Schumpeter), 214-222
Clark, John Bates, 33-35
International trade theory, 272- 275

Interpretation, Problem of, 2-12, 95-104,
Davidson, David, 280-282 242-249
Demand theory, 19-21,29-30,36
Distribution theory, 27,121-124
Jevons, William Stanley, 18-23

Edgeworth, Francis Ysidro, 31-33
Entrepreneur, 113-114, 179-180, 197,220,
225-230
Equilibrium, 213-214; see also General Keynes, John Maynard, 65-75, 78-82, 88-
equilibrium theory 94,205-209
Evenly rotating economy (Mises), 222-225 Kirzner, Israel, 228-230
Fisher, Irving, 35-36 Lundberg, Erik, 283-284
289
290 INDEX
Macroeconomic theory, 59-94, 251-288 Rau, Karl Heinrich, 154-156

Marginalism, 5-6, 27-29, 30-31, 32-33, Robertson, Dennis, 59-94
100, 151-153
Marginal productivity theory, 34- 35,
174-176
Marshall, Alfred, 23-29 Schumpeter, Joseph Alois, 197, 201-249,
Menger, Carl, 151-200 251-253,271-272
Methodological individualism, 171-172 Sociology of economic thought, 10,26,
Microeconomic theory, 13-58, 151-200 158-166
Mises, Ludwig von, 191-195,201'-249
Monetarism, 80-82, 92-94
Monetary theory, 62-78, 82-85, 88-94,
191-197,253-263,274-275
Utilitarianism, 21-22, 32, 37, 39, 55
Multiplier, 78-80, 91-92
Neoclassical economics, Definition of, 3-12 Value theory, 13-58
Pareto optimality, 122-128 Walras, Leon, 95-150

Pareto, Vilfredo, 95-150 Weber, Max, 197-200
Pigou, Arthur Cecil, 36-38 Welfare economics, 38; see also Pareto
Political economy, 23-24, 34-35,118-128 optimality
Professionalization of economics, 26 Wicksell, Knut, 251-288
Public finance, 268-271 Wicksteed, Philip Henry, 29-31
Purchasing power parity, 272- 275 Wieser, Friedrich von, 151-200

Neoclassical Economic Theory, 1870 To 1930 (Warren J. Samuels, Klaus Hennings & Warren J. Samuels)

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Neoclassical Economic Theory, 1870 To 1930 (Warren J. Samuels, Klaus Hennings & Warren J. Samuels)

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NEOCLASSICAL ECONOMIC THEORY,

Previously published books in

0istrIM0rs lor all 0Iher eoo.ntrIes:

U>rary 01 Congress c.taIoging ......P\rIlIication Os1a

Copyright 01990 by lOuwer Academic; Publishers

All rights reserved. No part ollhis puDtica1ion may be rep<Oducod, s10red

Professor Stephan Boehm

Professor John Creedy

Professor Peter Groenewegen

Professor Bjorn Hansson

Professor Robert F. Hebert

Professor Israel Kirzner

Professor Claude Menard

Professor Carl Uhr

Professor Donald A. Walker

Professor Thomas Wilson

Several topics must be discussed to place such work in perspective, in

with other schools of twentieth century economics; and Samuelson and

early macroeconomists: Hawtrey and Robertson; the great Keynes, among

6. If neoclassicism encompasses all of the economists discussed here,

possible historical interpretation and reinterpretation of neoclassical eco-

status of the Western economic system, particularly in view of the chal-

ty (radical indeterminacy), under the aegis of seeking determinate (and

demand? Furthermore, is it a theory of price (or of value) at all, or is it a

partial equilibrium solutions as proxies for solutions to general equilibrium

of the relation of money to uncertainty; the limits upon originality; the

1. Arjo Klamer, "Review of Donald M. McCloskey, The Rhetoric of Economics," in

A new economics of market prices and resource allocation was developed

marginaUst method to problems of choice and generalized price determina-

Jevons, W. S. 1835 1882 University Teaching 1871

a These works are:

in addition to his work on economics which concentrated on value and

pioneers. A final section provides conclusions largely devoted to more

Despite controversy over the role of biography in the history of economic

Hutchison, 1982) and the manner in which he came to develop his

William Stanley Jevons (1835-1882)

of Political Economy. In addition, the centenary of his death, as had earlier

to Keynes' (1912) review of the fourth edition of levons' Theory, that

Alfred Marshall (1842-1924)

As befits the undoubtedly key figure in the development of the marginal

Marshall,,,lO a task greatly facilitated by the publication of many of

renewed investigation of the origins of Giffen's "hint" in Marshall and its

A second type of Marshall studies that can be identified concern his

The most important of Whitaker's interpretative studies published so far

by businessmen. Furthermore, the breadth of Marshall's concerns in eco-

Philip Henry Wicksteed (1844-1927)

Wicksteed's work is in sharp contrast with Marshall's ambiguous attitude

processes, presents price makers as the market norm, while it resembles

behavior. In addition, his concessions to some lexical ordering makes the

Francis Ysidro Edgeworth (1945-1926)

Edgeworth, like Wicksteed, has been totally eclipsed by Marshall's work.

celestial mechanics where maximum pleasure in the first, like maximum

in practice a widespread tendency to indeterminacy existed formed the

John Bates Clark (1847-1938)

As Stigler (1941, pp. 196-197) points out, "Clark independently dis-

theoretical pronouncements-cannot be sustained in my view; only logical

Irving Fisher (1867-1947)

by his apparent ability to sidestep the problem of defining a real capital

Arthur Cecil Pigou (1877-1959)

Pigou, the other second generation marginalist economist to be considered

settling industrial conflict. This is presumably why Hutchison (1953), after

This survey of the literature on the early English marginalists suggests a

something of value to offer to successive generations of economists.