How Consumers Rule In A Free Economy

by Christopher Westley, Mises.org

One of my favorite economists in the history of economic thought is the great Austrian, Carl Menger (1840-1921). While the mainstream of the economics profession acknowledges Menger’s place due to his contribution to the Marginalist Revolution in the 1870s, it otherwise ignores him because his theoretical framework does not lend itself to policy prescriptions.

In an era in which the economics profession largely views itself as a shadow branch of government which is itself charged with managing the economy, thinkers like Menger (and those who work in his tradition) are not going to be extolled or studied in the same way that thinkers like Irving Fisher, John Maynard Keynes, Milton Friedman, or Paul Krugman have been.

This is true if only because the government tends not to fund academics or economic schools of thought that do not promote its central role in the economy or provide economic justifications for its interventions in market forces. Absent this connection, the study of Chicago-School Monetarism or Ivy-League Keynesianism would have much less prominence in economic science today.

Menger’s theoretical framework differs from so many of the modern interpretations of economics because he represented the culmination of a pre-Progressive Era development of economic thinking that had occurred over centuries mostly in continental Europe by scholastic thinkers in the Middle Ages as well as French liberals such as Turgot, Cantillon, and Say. Such people may have studied economics as a form of what was known as the Moral Sciences in the nineteenth century, but their impetus for doing so was often due to the innate human desire to better understand the world and the natural laws that govern it. Their interest was in economics as economics, and not simply as a policy tool to make government appear more scientific, efficient, or benign. (It is actually the exact opposite of these things.)

So to study economics as a science, pure and simple, especially in an era in which it seems economic confusion reigns, it is not a bad choice to start with Carl Menger.

Menger was born in Galicia, a then-Austrian region that is now in Poland, to a wealthy family with roots in Bohemia. During breaks from the study of law at the Universities of Prague and Vienna, Menger worked as a financial journalist who developed some degree of prominence for writing novels and comedies that were serialized in newspapers.

It was during his time as a journalist that Menger first noticed the significance of the discrepancies between Classical economic doctrines on market phenomenon and the actual business market that he covered over the course of his profession. Soon after receiving his law degree from the University of Krakow in August 1867, Menger embarked on the formal study of political economy in an attempt to better understand and resolve these discrepancies — an effort that resulted in the 1871 publication of Principles of Economics.

While Menger recognized that the Classical economists had made significant contributions to the development of economic theory, he believed one of their primary shortcomings was in their analyses of the consumer, a shortcoming which was perhaps epitomized by the Classicals’ emphasis on the labor theory of value and their rudimentary and even shallow price theory that explained prices as phenomena resulting mostly from the economic calculation of businessmen. Menger’s primary contribution in Principles was to insert the primacy of the consumer in determining value and (by extension) price, not only in the marketplace but in all economic activity.

The Mengerian approach, which we today call the science of praxeology, emphasized the importance of individual human action resulting from the desire to satisfy felt needs and the relationship of those needs to the external world. Having a felt need and the knowledge that the external world possesses some characteristics that allow the individual to satisfy it provide the basis for logical human action and the subjective valuation of goods and services both within and apart from the market. Menger further noted that as our knowledge about the external world changes, so do individually-felt needs. Efforts to satisfy felt needs presuppose recognition of cause-and-effect relationships that provide the basis for all of human action.

Note how completely irrelevant such a framework is to modern adherents of the Keynesian or Chicago Schools. The major difference is that both schools view the individual person (or actor) as an object that needs to be manipulated in the name of policy success. For Chicagoans, this success is based on market outcomes that are closer to their pre-conceived ideals regarding market efficiency, while for Keynesians, this success is based on the achievement of arbitrary short-run employment levels that are achieved in practice by penalizing saving and rewarding consumption. To both schools, the human person is a cog in an economic machine that must be coerced to act in ways that make their systems work. Such a view is modern — its roots are in the Progressive Era — and contrasts with economics as it developed from Aristotle through Menger (and beyond through those who developed Menger’s system).

But in the 1870s, Menger boldly applied its implications to the determination of value. He noted that since goods are external to the human person and recognized subjectively as possessing qualities that allow for need satisfaction, they could be differentiated between goods of different order. In Principles, he described first-order goods as being goods that we consume to satisfy needs. These are consumption goods.

Second-order goods are goods required to produce the first-order good, so that while a car may be a first-order good satisfying a felt need for transportation, the second-order goods would include the glass, rubber, chrome, and all the other inputs which make up the car. The third-order goods are all of the goods that are required to produce the second-order goods, and so on, with more complex forms of production being characterized with more distant orders of production.

Nonetheless, the values of all of the goods of whatever order are derived from the initial subjective desire on the part of the individual to satisfy a felt need, so that rubber has value not in itself or in the work effort going into its production, but because of the initial human desire for transportation, leading to a human preference for cars. This understanding of goods contrasted greatly with the Classical economist’s notion that the value of economic inputs is based on their technical usefulness in production. Menger’s value theory represents an expansion of Say’s Law that supply creates its own demand, and is the proper theoretical response to the monetary and credit cranks (of Menger’s time as well as today) who see no difference between government-created and -directed capital and privately-created and -directed capital.

In truth, government-created capital satisfies the needs of the political classes and the special interests connected to it, whereas privately-directed capital is directed at the satisfaction of consumer wants.

Absent the state’s influence in the development of twentieth-century economic thought, it is likely Menger would be known today as an important Classical economist who corrected known shortcomings of the Classical School, and it would never have been deemed necessary for Classical economics to morph over time into various neoclassical schools characterized by tools appropriate for the hard sciences.