The Conditions Necessary to an Intensive Division of Labor

by Röpke, Wilhelm

In order that money may properly fulfill its function of making possible an extended social division of labor it must possess various attributes (which will be considered later in detail), especially uniformity and constancy of value. It is the business of the state to establish a disciplined and stable monetary system so that money will enjoy general confidence and unite the disparate operations of the division of labor in a single payment community. To this is related another condition required for a wide extension of the social division of labor. The great risks implicit in an extreme dependence of all individuals in society upon each other are tolerable in the long run only where an efficiently administered legal system and an unwritten but generally accepted code of minimum moral precepts assure to the participants in the division of labor that they will be able to carry on their activities in an atmosphere of mutual confidence and security. Economic history is a constant illustration of the truth that the intensity of economic activity rises or falls in the degree to which these conditions are fulfilled. Likewise, the spatial extension of economic activity is limited as a rule to the radius within which such conditions, i.e., monetary and legal security, obtain. This is nothing less than the first principle underlying the rise and fall, the expansion and contraction of the economic system itself.
A significant division of labor can develop only in the degree to which the prerequisites of a monetary system, a legal system, and an appropriate moral system are met. History records frequent instances in which these conditions have been maintained for considerable periods within the frontiers of a single state. The intensification of international economic activity, however, has always encountered special difficulties because the creation of an international monetary and legal community has invariably collided with and will in the foreseeable future continue to collide with the unyielding sovereignty of the individual states. This is the chief reason why the progress of the international economy has, even under the most favorable circumstances, lagged behind the development of the several national economies. Because there is no world state, the world economy has lacked a homogeneous monetary system: for such a system depends necessarily upon the existence of a homogeneous international legal order.
It is worthy of note, nonetheless, that the international economy has flourished over the past hundred years in spite of these lacks because substitutes were found for what was lacking. The lack of a uniform international monetary system was offset by the gold standard. Scrupulously observed by the principal nations, it resulted in the whole world becoming a single payment community; it banished distrust in the solidity of the monetary foundations of international trade and international capital movements. The obligations imposed on all the participating countries by the scrupulous observance of the gold standard formed a part of the network of written and unwritten rules which made up for the lack of a single international juridical system. The whole world was encompassed in a system of long term agreements based on a universally recognized international law and upon a high degree of accord in respect to the interpretation of such law and of the legal codes of the individual states. International transactions were conducted in an atmosphere of loyalty and fair play in which the disregard of the obligations imposed by the international legal and moral system was regarded as the act of men without honor, honesty, or scruples.
The actual world crisis is from this point of view instructive in the highest degree. For the very disappearance of the aforementioned conditions has shown how exceptionally important and necessary they are. The nineteenth century’s network of guarantees in respect to security, uniformity, continuity, and fair play, and the adjustment of national policies to the requirements of international order, resulted in an approximate substitute for world government. But all of this was the creation of an epoch, of a state of mind from which the modern world has far removed and from which it in the future may remove still farther.
The foundations of the world economy have been chipped away to the point where the whole structure has become highly unstable. Less and less are nations disturbed by the flaunting of the international proprieties. Almost as a matter of course, governments manipulate their monetary systems for exclusively national ends, block foreign assets, interfere with international payments, practice dumping, expropriate private property, direct the flow of imports and exports now here, now there, at the whim of almost daily changing enmities and friendships, and impose without let or hindrance tariffs, quotas, and prohibitions of all kinds.
The dangerous feature of this process of disintegration is that it is accelerated by its own momentum. In international relations, as elsewhere, “marginal morality” has a tendency to become the dominant morality. If one country can, with impunity, disregard the rights of its neighbors, other countries, unwilling to be dupes, will follow suit. But it is not alone the contagious effects of bad example which foster international disintegration. Every country may legitimately question whether in the light of growing monetary, legal, and moral insecurity it ought not to revise its relations with the world economy. Because there is no world state, the international division of labor, unlike the national division of labor, is a precarious and relatively unstable system. Where a country is significantly involved in the international division of labor, it entrusts a part of its economic life to factors over which it wields only a very slight control and which consequently can cause it disagreeable surprises. In fairness to its own citizens, such a country can adhere to the international division of labor only if the risks implicit in such adherence are reduced to the minimum we have described. During the last hundred years, thanks to the gold standard and to the legal and moral obligations assumed by the gold standard countries, participation in the international division of labor was both possible and profitable. In the changed circumstances of the present, and with the probability of even more radical changes in the future, it has become suddenly obvious that the whole of international trade, with its immense material advantages, depends on conditions which formerly were so taken for granted they were hardly ever mentioned. It is only now, when they have begun to disappear, that the full importance of these conditions is revealed.4
It may be assumed that there are few persons today who take the plight of the world economy lightly and who do not recognize the tragic character of the disintegration of the international division of labor, the underlying cause of which has been the gradual weakening of the extra-economic framework of the international society. The true visage of the world economy is now visible: an economy minus its essential monetary, legal, and moral foundations. A genuine restoration of the world economy will prove impossible so long as these foundations are not reestablished. Till then, we must content ourselves with the patchwork aids and ad hoc institutional arrangements whose services to this date, it is conceded, have been considerable.
A fact which it is necessary to emphasize in this connection is that the shock to the foundations of the world economy has not been of equal intensity throughout the globe. Thus, the greatest damage has been done where Communist collectivism has swallowed significant parts of the former world economy. This loss is due not alone to the irreconcilability of the political and moral beliefs of the Communist and the free world countries, but to the incompatibility of the dominant economic systems in their respective spheres of influence. Even within the non-Communist world there exists a sharp line of demarcation between the developed countries and the “underdeveloped” countries, due primarily to the fact that the latter countries lack the conditions which inspire the trust so necessary to normal international movements of commodities and capital. In spite of all the disorders to which in our time a country such as Belgium was exposed following its liberation of the Congo, we continue to make available to this country, i.e., Belgium, loans at 4½ per cent interest. We do so because it never occurs to us to doubt the Belgians’ word that they will live up to their contracts. But there is no rate of interest under today’s conditions capable of opening the private capital markets of the developed countries to the Congo or to most of the other underdeveloped countries. This is the essence of the much discussed contemporary problem of the “underdeveloped countries.”5
That is the one facet of the situation. The other is that in spite of the defects of the world economy, we can expect some countries which are linked to each other by geographic contiguity and common cultural and political interests and traditions to attain a degree of international ‘‘economic integration” which can hardly be hoped for in the world at large. This is the justification and the explanation for the regional economic consolidations of recent years, among which the Common Market and the European Free Trade Zone, are the most significant;6 these very blocs, however, and their exclusive character, testify to the continuing lack of worldwide coordination.
But the most important and all too frequently ignored international fact of our time is that the unprecedented extension of the division of labor beyond national frontiers over the past one hundred years has been accompanied by an equally unprecedented increase in the world’s population. A severe contraction of the division of labor would mean, therefore, that millions of people who owe their lives to the division of labor would have the door of life, so to speak, shut in their faces, inasmuch as the conditions which made possible their birth, their existence, and their livelihood, would suddenly have vanished. We are thus bound in this case-to employ a much abused term of speech—to an inexorable destiny which no longer permits us the liberty of glorifying a policy of heroic retreat. Given the immense increase in population of the nineteenth and twentieth centuries (the reasons for which we shall consider presently), we have no alternative—unless we would willingly provoke a frightful catastrophe—other than to maintain the economic apparatus which alone has made possible this growth in population, whether or not this apparatus, for one reason or another, is to our liking. We simply cannot turn back the economic clock to 1700, or even to 1800, without thereby reducing the population capacity of the world to the lowest level of those times. To turn back the clock would be tantamount to ordering the destruction of millions of lives.

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The Social Division of Labor and the Role of Money

by Röpke, Wilhelm

The complex ramifications of the division of labor—horizontal as well as vertical—lead us to consider how the various operations occurring under the division of labor are coordinated with one another. There are alternative methods of achieving such coordination, each of which leads to a different form of the division of labor. Consider, for instance, the internal organization of a factory. The management of the factory divides the process of production into various partial operations and assigns these operations to the appropriate workers. Management then sees to the coordination of the whole by means of continuous instructions. This is what we may call the industrial division of labor.
Now division of labor exists not only in the interior of this factory, but also between this factory and other factories, between one artisan and another, between a farmer and a physician. We see at once that this kind of division of labor differs sharply from the first. The different operations are here independent and are not submitted to the control of a central authority charged with the coordination of the actions of each individual segment of the total economic system with all the others. We have already seen that it is the process of exchange (the market mechanism) which assumes the task of coordinating the activities of these independent units. We may speak, in this case, of a social division of labor.
In our contemporary economic system, the two kinds of division of labor coexist: the industrial division of labor within a plant, a factory, etc., and the social division of labor among the different independent plants and factories. Notwithstanding, it is precisely this social division of labor which distinguishes our economic system from a wholly socialist system. For in the latter system, the industrial division of labor prevails throughout the entire economy, displacing the social division of labor. This characteristic feature of socialism is at the same time a clue to one of its principal weaknesses. It is well known that certain enterprises have attained such excessive size that the managements of these enterprises are no longer able to control and coordinate their operations with efficiency. And many a giant concern has been ruined for not having observed the limitations of size which the requirements of efficiency impose. Imagine the result should the whole economy of a country be transformed into a single huge enterprise!
The concept of the social division of labor embraces most of the essential features of our economic system. It connotes not only the independence of the producer, but also the whole series of rights and liberties associated with such independence: private ownership of the means of production, right of inheritance, freedom of contract, freedom to choose one’s occupation, and many others.2 To think in terms of the social division of labor is to assume that exchange dominates economic life, not the direct exchange of one good for another, but the indirect exchange of a good for money (sale) and of money for a good (purchase). Money, in short, is the indispensable lubricant of a developed exchange economy; and by the same token it is essential to a system founded upon an extensive social division of labor. It is useful to inquire into the reasons why this is so.
Any school boy who has ever swapped stamps with his friends knows that an exchange can take place without money. But he will remember equally well that these primitive exchanges did not take place without some difficulty. He will recall that an exchange of postage stamps could take place only if just the duplicates he possessed were lacking to his friend and vice versa, and if the value of the exchanged duplicates was approximately the same. These conditions lacking, the limit of barter (exchange in kind) was reached. The youthful collector was then obliged to do business with a stamp dealer, whose existence is predicated upon the imperfection of exchanges in kind.
By way of further illustration, consider the plight of a butcher who wishes to exchange meat for a chair. Assume that through some ill luck the local carpenter is a vegetarian, and that he wants bread instead of meat for his chair. If we imagine this situation as arising in some period before the invention of money, it is clear that the butcher will be forced to go to the baker and to exchange his meat for bread. Suppose further that at this moment the baker does not require meat but a pair of shoes. Even were we to put a stop at this point to our butcher’s travails, this simple example shows that the butcher will be required first to exchange his meat for shoes, then the shoes for bread, and finally the bread for the chair which he originally wanted. He would be required in effect to make an extended detour in order to arrive at his goal. The longer this detour and the longer the associated chain of exchanges, the more difficult does the process of moneyless exchange become until it ends by being completely impossible. During the severe housing shortage which existed in Germany in the inter-war period, there were few persons who were not compelled to participate in a so-called “housing exchange ring”—a chain of exchanges of rent-controlled dwellings which frequently extended throughout all Germany. For the system to succeed, it was necessary that no link in the chain of exchanges be missing, and that the individual who wished to move from Breslau to Hamburg be not seized at the last moment with an attack of appendicitis. The participants in these transactions could never thereafter conquer their instinctive repulsion for the word “exchange,” nor could they find enough words of praise for the invention of money which, as a medium of exchange and as a common denominator of the values of all goods, does away at one stroke with the difficulties of exchange in kind. This is, of course, not the only service rendered by money, but it is the earliest and the most important. Money emerges in consequences as an indispensable element in our economic system, one which is inseparable from all economic processes and which gives rise to many special problems. A full discussion of money and of monetary problems is reserved for the next chapter. Our chief concern at this point is to make clear the role of money in the social division of labor.
From my childhood, I recall a strange contract which my father, a country doctor, had concluded with the village barber. Both had agreed not to send bills to each other but instead to pay in kind what one owed to the other. In today’s international trade, this would be called a clearing agreement. After some time, a prolonged illness of the barber resulted in my father having an excess of credit (clearing surplus). This credit was used up by compelling us children to have our hair cut rather oftener than we liked. The moral of the story is simple: the elimination of money had provoked a disequilibrium of supply and demand. The process of exchange, which if effected by means of money would have extended over many intermediate links, was now reduced to two links only. And this “short-circuiting” of the exchange process entailed a shifting of accustomed expenditures which upset the private mechanism of choice and of limitation of demand. “Multilateral trade,” as it is called in international economics, had in our case become “bilateral,” with results which corresponded in small to the results of international clearing agreements.3 A multilateral exchange without money is a technical impossibility; a moneyless bilateral exchange is possible, but it is uneconomic in the highest degree. The exceedingly complex exchange transactions of the present day (which depend upon money as intermediary) yield us, precisely in virtue of their multilateral character, the priceless advantages of a rational system for achieving both national and international equilibrium. To the extent that it represents genuine economic integration, the world economy presupposes the existence of multilateralism. But multilateralism requires, in turn, that the international circulation of the different national monies (convertibility) be not hindered by the prohibition of convertibility (exchange control).
But rendering multilateral exchange possible is not the only service money provides. As the common denominator of all goods, it is an objective unit of measurement applicable to everything which enters the market. It makes similar, things which are different; and it solves the problem, otherwise insoluble, of adding together apples and pears. Thanks to the continuous exchange of goods against money and to the social division of labor upon which such exchange is contingent, prices are formed without which there can be no rational economic calculation. If we pass the whole of economic history in review and sift the experiences of every age and of every locale, we shall find that no economy, however rudimentary, has been able to function without calculation in prices and money. Year in and year out proposals are made for replacing calculation in money by some other “natural economic” calculation (for example, in the form of hours of work or in units of physical energy). All such schemes must be viewed by the economist as the mathematician views “solutions” to the problem of squaring the circle, or as the Patent Department views designs for the construction of a perpetual motion machine, namely, with a shrug of the shoulders and regret for such vain employment of effort.

To resist the logic of the indispensability of money is simply to indicate that one has not yet understood that things economic have quite a different dimension than things physical, technical, and physiological, and that in economics we are not concerned with volumes or weights or horsepower, but with subjective estimates of value which assume an objective and measurable form only in an act of exchange accomplished with money.
This is a fact to keep clearly in mind in judging the performance of a Communist system. Where this performance is measured in terms of the increase in production of one or the other commodity, it is unscientific to conclude from the addition of such numbers that the Communist economic system’s accomplishments for the welfare of the masses can be even distantly compared with those of the non-Communist (market) systems. The point at issue is not the physical, but the economic productivity of a system. This can be measured only by means of real prices, and these are by definition excluded in a Communist system. Moreover, increases in genuine economic productivity can only be promoted within a system of genuine prices (market economy) formed according to the processes which are peculiar to the free society.

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THE STRUCTURE OF THE DIVISION OF LABOR

by Röpke, Wilhelm

“Because it is my social function to supply the world as well as I can with a certain thing, therefore I dread the world’s being so well supplied with it that I shall be able to get little or nothing for supplying more. It is impossible to exaggerate the importance of this consideration, or the penetrating and intimate nature of its bearing on every aspect of the social question.”

PHILIP H. WICKSTEED
The Common Sense of Political Economy (1910)

 The Meaning of the Division of Labor

Our economic system is distinguished from its primitive prototypes before all else by its extreme specialization of labor, or what we call the division of labor. It is this central fact to which we must return again and again for an understanding of the modern world. Today, most people are engaged almost exclusively in the production of goods and services intended not for themselves but for others, with each one producing always the same goods and the same services. Except for some sectors of the agricultural economy—and even these have diminished rapidly in importance—the modern producer personally consumes only a fraction, if anything, of his specialized output. In some instances, it is true, the small farmer will produce first for his own needs and then exchange his surplus for other products. But it is difficult to imagine a Ford or a Krupp producing automobiles and cannon first for themselves and their families and then supplying to others the surplus which they cannot use. Even the worker in a shoe factory will buy his shoes, as a rule, in a shop, and it is improbable that he will recognize the pair that he buys as the one he himself has made.
To estimate correctly the role of the division of labor in the building of our civilization is the business of the sociologist and the economic historian. What is important for us to note here is the fact that the division of labor has enormously increased the productivity of human labor. The reasons for this are as follows:
(1) The division of labor allows each man to specialize in the kind of work best suited to his capacities.
(2) The division of labor tends to concentrate the production of each commodity in the place where natural conditions are most favorable (the spatial division of labor), a fact which is of great importance in connection with the international division of labor. It is the division of labor alone which brings it about that every type of production, within the national economy or within the world economy, can be established in the most favorable location.1
(3) It is specialization alone which permits the complete development of professional skill and the acquisition of that experience which distinguishes the specialist from the mere amateur. Thanks to the division of labor, a fund of experience, of knowledge, and of skill can be preserved and increased throughout the generations.
(4) The division of labor avoids the loss of output which ordinarily accompanies the change from one type of work to another.
(5) The division of labor—and here we touch on a most important point—makes possible the use on a vast scale of tools and machines. Because of the large outlays which are required for the purchase of such equipment, it can be profitably used only when it is fully used. It is not worthwhile to make a hammer to drive a single nail into a wall and many a handyman has had to have recourse to the carpenter rather than buy an expensive tool for which he could find only occasional use. Those familiar with farming know that the principal obstacle to the use of farm machinery lies in the peculiarities of agricultural production which prevent maximum use of the equipment. The economic principle in question is this: the use of machines is more limited and thus more dependent on an advanced division of labor, the more specialized are such machines; at the same time, the yield of a machine ordinarily increases with its degree of specialization. The secret of the low-priced automobiles which Henry Ford was the first to put on the market after World War I lay in the huge number of units produced; for these made possible the mechanization and automation of the entire Ford operation. The specialized machines required for this type of production are extravagantly expensive but they produced, thanks to the volume of output, a car which was at one time the cheapest in the world.
To achieve such high levels of output Ford was required, it is true, to limit production to a single model and to leave this model unchanged year in and year out. Ultimately, the exigencies of public taste forced him to replace the outmoded model by more fashionable ones. To this end, he spent millions for completely new machinery and tools.
A good example of the interrelationships between advanced specialization of the machine and greater output and of the resulting concentration of production in the hands of specialists is the manufacture of automobile bodies by means of special presses. So costly are these tools that only a very large number of orders can yield lower costs and, ultimately, lower prices. The consequence has been the emergence of a special body-building industry serving the automobile manufacturers.
From the last mentioned advantage of the division of labor is deduced an important economic principle. The use of tools and machinery in production means that consumption goods are not produced directly, but via the preceding manufacture of production goods (raw materials, machines, transport facilities, etc.). The more there is of this roundabout production and the larger the quantity of capital employed, the more “capital-intensive” will such production become. This introduces a new complication into the division of labor. For, given the difference between consumption goods and production goods (capital goods), it is apparent that a large part of a country’s total production serves for the production of capital goods and not for the production of consumption goods, and that the production of capital goods must itself become a specialized branch of manufacturing. We must picture the entire process of production as a series of descending levels. At the highest level, raw materials are procured; at a lower level, capital goods are manufactured; and at the lowest level, consumption goods are produced. Just as specialization and division of labor characterize production on any one level (horizontal division of labor), so also we find a division of labor between the different levels of production (vertical division of labor). In other words, there is not only a division of labor between the production of shoes and the production of paper, but also a division of labor between the production of shoes and the production of the fore-products (tools, machines, leather, hides, etc.) which enter into the manufacture of shoes.

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Economic Equilibrium: the Possible Systems

by Röpke, Wilhelm

We have now, perhaps, established the truth that in every economic system man is bound by the necessities of choice and limitation. Every economic system consequently must have available to it a device for balancing means with ends. We already have gained some idea of the equilibrium mechanism which is peculiar to our economic system. But for a still clearer apprehension of how this mechanism functions, we must examine briefly the several possible systems of equilibrium:
(a) System of the queue, which could as well be called the system of elbowing one’s way through the crowd, or the system of first come, first served. It is the simplest and most brutal form of equating supply with demand. It consists in offering the available supply to the public gratis and it invariably results in a more or less violent use of fist and elbow. This system is so unsatisfactory and so little able to guarantee that the most urgent needs of the community will be met that recourse to it is had only in exceptional cases. We are reminded, perhaps, of those occasions on which the beer runs out at “free beer” parties, or of neighborhood get-togethers at which the refreshments set out are quickly devoured by the first wave of guests to the dismay of those who come after. The experiment undertaken by the Soviet dictatorship in its early years is very instructive in this connection. The streetcars and other means of transport were placed at the disposal of the public free of charge. The result, as was to be expected, was such a crush of passengers that the government was soon compelled to return to the “capitalist” equilibrium mechanism (price system). Anyone who has ever tried to watch a parade through the head of the man in front of him knows that the best viewing spots must be preempted well ahead of time. Indeed, when the crowd is very large—as, for example, at the coronation or the funeral of a monarch—it is common practice to resort to the price system for the disposal of the better places. It is to be noted that the system of the queue is the more undesirable the greater the elasticity of demand for a good or service (see pp. 10 ff.). Hence, it will prove easier to put the water of the public fountains at the free disposal of the citizens than to allow them, as in the Russian case, to use the streetcars without paying. The proposal to have free medical services supplied by nationalized doctors should be examined in the same light. The experiences of the British with their National Health Service provide a costly lesson of what may be expected from such an arrangement.
(b) A rationing system shows a certain advance over the system of the queue. Here, too, goods are supplied gratis, but equilibrium is obtained by a systematic distribution of the available goods (rationing). It is such a mechanism which would operate in a pure Communist economy. Even in our economic system, however, it is occasionally necessary to have recourse to this method. Every soldier will recall that in the field not only was food rationed, but also cigars, cigarettes and pipe tobacco. The distribution of food did not involve any great difficulties since individual wants were fairly uniform. But the distribution of tobacco, cigarettes, etc., given the pronounced differences in individual preferences, was regularly followed by a lively private exchange where, under a primitive form, the price system again prevailed. This example shows that under a system of rationing (as well as under the queue system), the difficulties increase with the increase in the elasticity of demand for the rationed product.5
(c) The mixed system. Where prices are introduced, as in a mixed system, the disadvantages of queueing and rationing are somewhat mitigated. Generally, in such cases, the prices are fixed at levels insufficient to balance supply and demand. Nevertheless, the very existence of these prices tends to bring about a certain limitation of demand. What results, therefore, is a mixture of the price system with one or the other of the systems already described. During both World Wars the mixed system, under the names of “ceiling prices” or “price control,” was regularly imposed by the belligerent governments on their respective economies. Experience with this system, however, soon compelled abandonment of the queue-price system in favor of a rationing-price system. For it had become apparent that once the maximum prices were established, the equilibrium mechanism of the price system refused to work. When prices were prevented from rising to the point where supply and demand exactly balanced, a part of demand necessarily remained unsatisfied. The people who were ready to pay the maximum price queued up before the shops, but invariably those at the end of the line went away empty-handed. So intolerable did this situation become that recourse was finally had to a system of ration tickets for a list of selected goods.
Ultimately, of course, the disturbances which price controls provoked on the supply side, required government intervention in production itself. Indeed, during World War II, such intervention was universally practiced. The result was that each day that went by saw a further disappearance of the regulating principles of our economic system, ending in a veritable economic muddle. Following World War I, most countries hastened to put an end to the confusion by reestablishing a free economy, i.e., the unhindered price system. And in the post-World War II era, all advanced countries have sought, and rightfully so, to dismantle the system of wartime controls.
Rent controls, the most durable of the wartime price-ceilings, offer a good example of the evolution we have described, beginning with the queue-plus-price system and ending with the rationing-plus-price system. Our experiences with rent control have shown how intolerable in the long run is the situation created by the mixed system. Even in its less noxious form of prices combined with rationing, the marked inferiority of the mixed system vis-à-vis the price system is obvious. This has been publicly acknowledged even in the Soviet Union where the ending of rationing on certain classes of goods was celebrated as an example of progress on the road leading to a more normal situation.
The thoroughly abnormal circumstances of the Great Depression and later of World War II pushed many countries to new experiments with the mixed system. Thus, exchange control is in reality only a variant of the rationing-plus-price system, as is also the control and distribution by government of imported raw materials. The system of ceiling prices was also revived in the foodstuffs markets both under the form of the queue-plus-price system and the rationing-plus-price system. And here again the consensus was that the mixed system is at best only a temporary expedient. The continued repression of a natural force builds up explosive pressures with the result that the price system in one form or another inevitably breaks through the unnatural tensions and rigidities of the mixed system. The greater the amount of unsatisfied demand, the more numerous will be the subterfuges used to circumvent the maximum prices and the bolder will become the disregard for the law. Black markets, under-the-counter deals, illegal currency transactions—a thousand years’ experience has shown that these things accompany price control as shadows do the light. Such activities, customarily denounced as “fraud,” “smuggling,” etc., appear from the objective standpoint of economics merely as corrections of the mixed system by the price system. From the standpoint of ethics these “corrections” are less than edifying and are certainly not the work of the better members of society. Economically speaking, however, they are not always and necessarily harmful.
The United States’ experience with Prohibition in the pre-war era and in the postwar period the collapse of the command economy in Germany, Austria, and France prove that the maintenance of economic regulations to which the bulk of the population is opposed in conscience ends by exercising a strong demoralizing influence. A sort of respectability is attached to breaking the law. An economic system which continues to function thanks only to bootleggers, black marketeers, and smugglers becomes a focus of corruption which, little by little, poisons all the arteries of society. Here is a bitter lesson for those who continually petition for state control of economic life out of their moral indignation at the workings of the free economy.
All too often we hear a system of rationing being justified on the grounds that the goods in question are in “short supply” and that their distribution ought not to be left to the working of the price system. The reader is already aware that this point of view rests on a fundamental misconception. All goods which are not “free goods” are “scarce goods,” meaning that not everyone can get as much of them as he would like. To say that a “scarce good” is one for which the demand exceeds the supply can have meaning only in relation to a specific price, namely the price which is held by the public authorities below the so-called equilibrium price at which supply and demand are in equality and whose function it is to bring about this equality. Hence, demand can really exceed supply only in those extraordinary situations in which the shortage of essential commodities is so acute that it is considered advisable to ration the available goods equally among the citizens rather than to permit distribution to take place on the basis of the unequally distributed dollars.
Consider, in this connection, the extreme scarcities which prevailed in practically all types of goods during World War II. The plight of the economy is then comparable to that of a besieged fortress whose commander is compelled to ration bread and water with the utmost severity. In such case, everyone will approve the rationing of the vital commodities. But it is extremely doubtful whether this notion of the “besieged fortress” can be validly applied to the economy in peacetime. We should not forget that what we are concerned with in peacetime is not only fair distribution, but an increase in production itself. The dilemma inherent in any system of rationing thus becomes clear: in seeking to distribute the available supply as fairly as possible we run the risk of causing a constant diminishment of the amount available for distribution until, in the end, we get a system of rationed poverty, or “poorhouse socialism.” The more we depart from the situation of the “besieged fortress,” the more necessary it is to recommence production and the more self-defeating, therefore, does a policy of rationing with price control become. Keeping the prices of commodities as low as possible for reasons of social justice discourages their production precisely in the degree to which the price-controlled goods are essential. Such a policy ends by requiring the scarcest goods to be sold at the lowest prices. If the policy is not applied uniformly to all goods and services, it amounts to the conferring of a premium for nonproduction of the very goods most needed. The result is that in countries where such a policy is pursued, the stores are filled with the most nonessential and useless goods, the prices of which, precisely on this account, the authorities have left uncontrolled.
From the above it might assumed that a discussion of the mixed system should be reserved for a chapter on economic pathology. But this assumption would be incorrect. For although it is true that this system, when extensively applied, is dangerous and sometimes fatal, in small doses it is relatively harmless. We find it operative in an astonishingly large number of normal economic processes where it appears inopportune, for one reason or another, to use the price system in its pure form. Railroad, bus, and taxi fares, the prices of theatre and movie tickets, as well as many other prices, are ordinarily rigidly fixed, in spite of daily fluctuations in demand (institutional prices). The consequence is that these prices under certain circumstances fulfill only imperfectly their equilibrium function; such prices, for all practical purposes, become maximum prices, proof of which is seen in the block-long queues in front of movie houses and theatres where a hit show is playing, in the throngs that pack trains and busses, in the desperate mien of some paterfamilias as, homeward bound from vacation with his numerous offspring and equally numerous valises, he stands before the railroad station waving frantically (and vainly) at passing taxis. Even in these cases, there is a tendency for the price system to reassert itself. So we have the perennial ticket scalper, reserved seats on trains and . . . tips. If even these devices fail to correct the disequilibrium in demand, the institutional prices themselves will be changed in the end.
(d) The price system. The systems analyzed so far show so plainly the nature of the price system that a long explanation seems unnecessary. Its principal characteristic is that equilibrium (choice and limitation) is attained by leaving prices free to adapt themselves to the market situation, so that there is neither an excess of unsatisfied demand nor an excess of unabsorbed supply (equilibrium price). In the systems previously described, the question of who will bear the costs is distinct from the question of whose needs will be satisfied. In the price system, these elements are fused. The cost of satisfying a given want is imposed on the demanding individual in the price itself. But, as we have already seen, the existence of costs shows that the factors of production which are used for one purpose might have been used with equal advantage for some other purpose. Thus, the price system allocates the factors of production in a way which allows us to perceive, in broad outline, the process by which general economic equilibrium is attained.
Since, in a free price system, costs are necessarily borne by consumers, it is the consumers who decide what and how much shall be produced. Hence, it is the consumers who decide how the factors of production themselves are to be used. This mechanism functions ideally when not an iota of productive resources is employed in a way which yields less utility than if it were used in some other way. The tying of prices to costs, which many regard as one of the stupid quirks of “capitalism,” thus assumes a function which is central to any economic system, whatever its organization: the function, namely, of effecting the best possible allocation of the nation’s productive resources. This does not in the least imply that our economic system, founded for the most part on the price system, is perfect. For in the price system, only those individual demands count which are backed up by the requisite purchasing power. Even if the price system functioned ideally, the factors of production would be employed in the “best possible” manner only in relation to the existing (and unequal) distribution of income. No one will seriously pretend that our present distribution of income is the best possible. As the result of such unequal distribution a rich cat fancier, to take one example, can buy milk to feed her animals while milk is denied to the mother of a family of poor children because she cannot pay for it. We should not make the mistake of equating the explanation of the price system with a glorification of it, for this would be to fall into the error of the classical school which derived from such explanation premature conclusions with respect to economic policy (laissez-faire liberalism).
When we consider economic history, on the other hand, and in particular the recent history of the Soviet Union, we must conclude that the price system, in spite of all its imperfections and in spite of the situations in which it is inapplicable, remains the most natural method of solving the problem of economic equilibrium. Indeed, its essential irrepressibility is shown in the spectacular failure of the efforts to displace it and to frustrate it. An extremely differentiated society such as our own, resting on an intensive division of labor, is inconceivable outside the framework of the price system. Indeed, if the Communist economic experiment, and the National Socialist economic experiment which so closely resembled it, have proven one thing, it is that the most resolute will to impose collectivism is forced, in the end, to capitulate to the elemental equilibrium forces of the price system.
(e) The system of collective economy. To understand this last of the possible equilibrium systems, we must take account of a group of special needs to which none of the systems of which we have spoken thus far can be applied. Up to now, we have tacitly supposed that we were concerned only with the needs of individuals which are satisfied by an act of individual consumption (individual demand). But there are still other wants which are experienced by the members of society collectively (collective demand), without it being possible to distinguish the specific utility accruing to individuals from the satisfaction thereof. Some familiar examples are the collectively felt wants for armed forces, for a police force, for protection against epidemics, for street lights. The street light is an indivisible good which cannot be distributed individually to those who declare themselves ready to pay their “share” of the cost. Neither can we deny street lights to the general public because some people, such as lovers or burglars, are annoyed by them. It is the business of the state to satisfy these collective demands. It is the state which assumes the task of choosing and of limiting; it must procure the means of meeting costs in a manner which, contrary to the price system, is completely divorced from benefits accruing to individuals as such. The equity of the procedure resides rather in basing the collection of funds for the given collective demand on the ability of individuals to pay (taxation) . All the questions which arise with respect to this collective method of achieving equilibrium belong to the sphere of public finance which is consequently properly studied as part of general economics.6
The system of collective economy frequently finds application in cases where collective needs do not actually exist. Although in these cases the other equilibrium mechanisms could be employed, it is regarded as desirable on various grounds to treat the want in question as a collective want. Bridges and roads, for example, are, as a general rule, paid for on a collective basis out of taxes, although there is no reason why the price system would not work equally well in such cases. For proof, we need only recall the practice, common enough in former times and now revived in some countries, of charging tolls for the use of highways and bridges. It is our modern concern for social justice that has resulted in the placing of many hitherto individual needs in the category of collective needs. Primary education, for example, is today almost universally supplied on a collective basis. Other wants have become partly collective, such as secondary and university education, the cost of which is met for the greater part by the state.
The case of secondary and university education is particularly instructive. For in the degree in which the state assumes the costs, there arises a danger of oversupplying candidates for the professions, unless a method of limiting the admission of students is developed to replace the older ability-to-pay criterion (for example, numerus clausus, or better, a rigorous examination of students’ intellectual aptitudes). Hence, the cheaper higher education becomes, the more necessary it will be to increase the difficulty of examinations.
It should be noted, finally, that a system of complete “Communism” is reached when all needs are treated as collective needs and hence are satisfied in accordance with the system of collective economy (“from everyone according to his capacity, to everyone according to his needs”). The continued enlargement of the collective sector of the national economy, which is characteristic of the economic evolution of the last one hundred years, must therefore be considered as an enlargement of the “Communist” element in our economic system. The continued growth of the public sector (system of collective economy) at the cost of the private sector (price system) must, by the same token, be taken as an indication that an increasing number of economic processes are taking place in accordance with laws radically different from those which regulate the market economy.

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What Are Costs?

by Röpke, Wilhelm

The perpetual tension between means and wants (scarcity) at once explains the meaning and fixes the goal of our economic system founded on exchange and the division of labor (business principle). Since we possess only limited means of satisfying our unlimited desires, we are compelled, as we have seen, to make a rigorous selection from among many competing wants and to limit the satisfaction of any one such want in order to make the best use of the means at hand (economic principle). Some will say that this view of economic behavior is quite appropriate to the conduct of the housewife who must hold her expenditures within the limits of a fixed sum of money (use of income, economics of consumption), but that it does not apply either to individual economy insofar as it is economy of acquisition (procuring of income), nor to the national economy since, in these two cases, the means are not fixed but may be increased by production.
Further reflection shows, however, that production changes nothing with respect to the need for practicing economy in the use of means, but that it simply results in the transfer of the problem to a higher level (or levels). Why, for instance, do we not produce as much chocolate or paper as we can consume? Why is production stopped at a certain point—which in our business economy is determined by profitability—when there is still a large and unsatisfied need of paper and chocolate? Is this the result of a stupid organization of our economic system from which socialism will deliver us? Such questions do not merit serious reply, for it is clear that production is tied to “costs.” But “costs of production” mean simply that while the quantity of a given consumption good may be increased by production, we encounter a scarcity of certain ultimate factors of production whose quantity cannot be so increased. Ultimately, we are compelled to acknowledge the harsh facts that our capacity for work and our time are strictly limited; that the location and the fertility of the soil are immutable data of Nature; and that even tools and machinery cannot be increased in quantity according to our good pleasure. In using these ultimate factors of production for the production of one good, we thereby renounce the use of the same factors for the production of another good. When we draw a coverlet by one end, the other end does not become longer. We have, then, no other alternative but by means of choice and limitation to allocate the factors of production to the producing of the kinds and quantities of goods which will procure the maximum advantage from the available means.
It follows that the need to make the most economical use of a given supply of means is not the less urgent simply because we can increase this supply by production. The process of equating means and wants takes place in this case merely on a higher level. It is distinguished from the simple process of determining what use is to be made of a given supply of means in the same manner as the traveler’s estimation of the relative utilities of taking more and bigger bags on a journey is distinguished from the case of the soldier who must pack his sack with foreknowledge of exactly what articles he must get into it. In the case of the traveler, more trunks and suitcases are taken along only “at the cost” of other pleasures of the trip. Just so, the costs of production are nothing more, in the final analysis, than a faithful reflection of the utility that the factors of production would have furnished had they been otherwise employed—a utility which we renounce in favor of the one we have chosen. The costs of production, in sum, owe their existence and their amount to the competition of alternative uses for the factors of  production.4 They stand for utilities which escape us at some other point in the national economy.
This is a principle of such overriding importance that it is worth dwelling on it in some detail. Suppose, for example, that it is planned to build a bridge. What are the problems that must be faced here? The first order of business is, generally, for technicians and engineers to calculate the costs of building a bridge of a given type and quality. These costs are subsequently compared with the traffic needs of the projected bridge site on the one hand, and on the other, with the possibility of financing the bridge out of the public purse. That is to say, we take into account the urgency of other public needs as this urgency is reflected in the possibility or impossibility of diverting a part of current tax revenue to the construction of the bridge or of increasing taxes in general. Taxes, on their side, represent the personal utility which the taxpayers must renounce in transferring a part of their purchasing power to the state. Thus we see that the “costs” of building a bridge are simply an indication that for the land which must be preempted, for the workmen who must be hired, and for the steel which must be used (including all the resources required in the making of the steel), there are still other uses. And it is the intensity of the competition among these alternative uses which determines the costs, greater or less, of the aforementioned factors of production. The process of production then, analyzed to its foundations, clearly shows the alternative nature of costs. In fine, the construction of the bridge will be justified from an economic point of view if it can be shown that it will result in the best possible use being made of the given means with relation to the national economy.
Our example—the building of a bridge—makes clear the important difference between the economic and the technical (or engineering) point of view. The job of the economist is to decide, first, whether the bridge should be built at all; secondly, whether it should be built on one site rather than another. For the economist the total quantity of means is fixed; his task is to discover the best use that can be made of them. The job of the engineer, on the other hand, is to achieve a given end—in our example, the construction of a bridge of a given quality in a given location—with the least means (technical principle). Here, differently than in economics, the end is given, while the means must be found. The successful solution of the technical problems involved in building a bridge does not in the least imply that its construction is justified economically. Economic justification follows only after costs have been entered on the ledger; only, that is, after the proposed use of means is compared with alternative possible uses and a satisfactory balance established among them. For all of this, confusion of technical with economic problems remains a tenacious undergrowth in the economic thought of our time. Fallacies stemming from it are particularly rife in the field of foreign trade (which is a fertile breeding ground for error in any case).
It is almost an idée fixe of contemporary economic policy to see economic advantage for the nation in the exploitation of technical discoveries and inventions and to support the production of synthetic foods or raw materials, even though the synthetic product costs more than the imported natural product and requires special measures to make it “competitive.” Apparently, only a minority comprehends that the same reasoning which is used to defend the production of synthetics can be used to justify cotton growing in the Arctic Circle so long as the engineers can supply the necessary greenhouses and artificial heat. Although the manufacture of synthetic materials has registered some notable successes and shows promise, in some cases, of even greater success in the future, the role of costs in this field cannot be ignored. Every so often, the complaint is heard that the limitations set on production by costs are the result of our stupid “capitalist” system, a ball and chain which we ought to shake off once for all and thereby win both riches and freedom. Such naive assumptions would quickly wither, were it more energetically made known that the problem of costs is nothing other than the problem of deciding whether the productive forces of a country will be better employed in one direction than in another. Here, certainly, is the most elementary problem confronting any economy, whatever be its organization.

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The Moral Foundation (the Business Principle)

by Röpke, Wilhelm

THE BASIC DATA OF ECONOMICS

“Je ne connais que trois manières d’exister dans la société: il faut être mendiant, voleur ou salarié.”
MIRABEAU

1. The Moral Foundation (the Business Principle)

The struggle against scarcity (deficiency of means) is the eternal basis of every human economy. It characterizes all ages, all climates, all social systems. The forms which this struggle assumes, however, show the greatest diversity. We may divide them into two principal groups: the individual forms and the social forms. The individual form of this struggle is exemplified in the isolated, exchangeless economy of a Robinson Crusoe with which we are here not concerned. We shall give our attention, therefore, only to the social form of the struggle against scarcity.

The social form of the struggle is manifested in the different methods men use to obtain those things which nature has not freely supplied. There are, in principle, three such methods, as a result of which we see three kinds of struggle. There is, first, the ethically negative method of using violence and/or fraud to procure for ourselves, at others’ expense, the means of overcoming scarcity. The second method is the ethically positive one of altruism, thanks to which goods and services are supplied to us without our being required to give anything in return. The third method does not lend itself easily to such brief description. It is not founded on egoism, if this implies that individual well-being is achieved at others’ expense. Neither is it founded on a selfless altruism, if this implies that individual well-being is neglected in order that others may benefit. It is, rather, an ethically neutral method by which, in virtue of a contractual reciprocity between the parties to an exchange, an increase of one’s own well-being is achieved by means of an increase in the well-being of others. This method, which may be termed “solidarity,” means that an increase in my well-being is achieved in a way which not only does not deprive others of well-being but which yields them, as a by-product of my gain, an increase in their own well-being.

In concrete terms, I may obtain the wherewithal to live either: by selling adulterated butter (first method); or I can be the object (or subject) of a gift of butter (second method); or, by following the axiom “honesty is the best policy,” I can acquire a fortune by attracting more and more customers with butter of irreproachable quality, kind and courteous service, finding out where I can buy butter cheapest, keeping a neat and attractive shop, etc. (third method). Whereas people are “handled” in a public facility such as the post office, in our shop they are “served.” In this last case I obtain the means which allow me to satisfy my needs neither by violence, exploitation, fraud, nor illicit profit, nor by accepting alms or gifts, but through the supplying of an equivalent service or good (performance principle). It is this method, based on the principle of reciprocity, of value given for value received, which is commonly referred to as “business.” It is the business method which characterizes that form of the struggle against scarcity which is based on exchange and the division of labor. Regarding the economic system in this way, however, raises several important questions and it is upon these that we must focus our attention.

In the first place, the three methods are by no means rigorously separated, but, on the contrary, overlap to a degree. Plainly, there is an essential distinction between defrauding your neighbor in the struggle for survival and accepting a charitable gift from him for the same end: the first and second methods are incompatible and cannot be employed simultaneously. But it is possible to combine the first method (fraud and/or violence) with the third (business), and also the second method (altruism) with the third. “War, trade, and piracy—an inseparable trinity,” declares Goethe’s Mephistopheles (Faust, II, 5), and, in truth, the history of the trading and colonizing nations is a history of invasions, piracies, and oppressive exploitation. It offers us a depressing demonstration of the truth that when left to our own devices, we tend to choose the first method and return nothing in exchange for a service received. Only the powerful influences of religion, morality, and law appear able to induce us to adhere scrupulously to the third method.
There are a variety of procedures for avoiding the rendering of a service equal to one received. Leveling a revolver at someone is one of the quickest but also one of the riskiest ways of getting something for nothing. Much safer and more efficient are the devices of special privilege and monopoly for they can be tricked out in ideological trappings which may make them seem not only innocuous but even beneficial to the general interest. The modern problem of monopoly can ultimately be defined in no other way than as a distortion of the principle of equivalence or reciprocity in exchange effected by means of the method of exploitation. Solving the monopoly problem, therefore, means nothing other than finding a way to eliminate this distortion.

If, as unfortunately happens, the method of “pure business” is often combined with fraud and exploitation, it is just as frequently commingled with elements of altruism. Indeed, business in the real world is not as ethically neutral as we at first supposed. There are businesses which embrace more or less an element of self-sacrifice (and, therefore, of uncompensated “giving”) and of genuine service. The medical profession is one example. Then, too, we expect of the scholar and of the artist that they put devotion to their vocations before mere gain, and that in practicing their profession they be not motivated by the principles of the delicatessen-owner. In these cases, the pure business principle is subordinated to a certain moral standard which we may call professional ethics. Members of such professions frequently have or are expected to have a strong service instinct. Expressions such as “trade” or “business,” applied to the professions of medicine or law, are felt to be out of place and demeaning. But even the pure businessman who adheres unbendingly to the principle of exact reciprocity in exchange does not, by so doing, remain completely neutral in an ethical sense. His unbending conduct, and the conduct of those with whom he does business, is at bottom conditioned by the acceptance of certain ultimate principles, for the lack of which the business society itself will in the long run founder. It is, therefore, of great importance not to forget the moral reserves which nourish the prosaic and in itself ethically neutral world of pure business, and with which it stands or falls.1
The proportions in which the three methods are found and in which they are combined determine in the final analysis what we call the economic spirit of an age. The evolution of our own times can be better understood in the light of the double moral standard which has for so long prevailed: a sterner code is applied within the narrow circle of our own family and friends (internal morality) and a laxer one is employed in our dealings with strangers (external morality). For a soldier to steal from his bunk-mates is regarded as a low form of treachery, while to practice the same theft upon the occupants of a neighboring barrack passes for a feat of cunning. And let the same soldier return laden with loot taken from the citizens of a conquered country and his mates will give him a hero’s welcome. The evolution of the last few centuries can then be regarded as a process in which the domain of internal morality has been continuously enlarged while its content has been simultaneously diluted. In the Middle Ages, trade among the small group of provincial guilds was rigidly circumscribed while a large place was reserved to charity—a natural outgrowth of the deeply religious spirit of that time. But beyond these confines there was much unscrupulous and unrestrained exploitation. In the course of the development which saw the rebirth of ancient morality (humanism) and the secularization of the substance of Christian morality, the principle of sacrifice lost much of its force, even among members of the same family. In its stead appeared a new principle, and one which served at the same time to reduce the practice of violence and exploitation to negligible proportions, viz., the selfsame business principle we have been discussing.

Not all of the consequences of this development were happy ones. “Business” has occasionally lain its cold and impersonal hand on the family, requiring children to pay their parents for room and board; and science, art, even religion itself, have become commercialized to a lamentable extent. On the other hand, the general use of the business method has had the effect of narrowly circumscribing the area in which violence and exploitation can be profitably employed and of enlarging the sphere of activities yielding equal benefits to the participants.

A proper appreciation of the differences among the three methods aforementioned will prove helpful in dispelling a double confusion met with today at almost every turn. On the one hand, there is the common mistake of attributing to the third method (business) acts which properly should be put to the account of the first (fraud, exploitation, etc.). Some of us still cling tenaciously to the belief that business is nothing else than a shameless picking of other people’s pockets, especially so when it is a question of as abstract and mysterious a business as the modern stock exchange. Just as deeply ingrained is the habit of describing business operations in terms suited only to acts of the first category. People speak of the “conquest” of markets and of the “imperialist exploitation” of foreign countries without realizing that they are confounding two entirely distinct categories of acts. The myth that the employer always necessarily exploits his employees is another of the same series of errors.

On the other hand, the second and third methods (altruism and business) are also frequently confused. It is a confusion deliberately encouraged by a certain breed of businessman who desires to have people see in him the devotee of self-sacrifice and disinterested service, though in reality he is motivated solely by business considerations. He speaks of “serving the customers,” he puts himself “at their disposal,” he bids us “be at home,” as if, like St. Francis of Assisi, he had nothing in his heart but the disinterested love of his fellow man. Each shop, each factory, becomes a kind of “studio” where work, relieved of its grosser motivations, is carried on on a higher and nobler plane. Cloaking ordinary business operations with such pious phraseology serves not only as effective advertisement, but is in the vanguard of the democratic instincts of our time. There is still, perhaps, unconscious resentment of the old contempt attaching to “people in trade,” and it is comforting if the illusion can be created that one is not simply working out his life within the drab business framework but that he is a dedicated being, a member even of a superior class. The “canonization” of business, if we may use the term, is particularly noticeable in the United States (witness the emergence of the peculiarly American doctrine of the “social responsibility” of business). It is accompanied by a tendency to relegate to a lower class all the professions which do not originate in business (scholars, civil servants, artists, career military officers). It is a process which has been made easier by the commercialization of these professions and the consequent perversion of the true hierarchies of rank and value—a grave American malady and one of which Europe, too, is beginning to exhibit the symptoms.

This complex of problems is one which properly should be of the greatest concern to economists. Indeed, before we pursue our inquiry any farther, it is necessary to stress the artificiality and extreme fragility of the pure reciprocity principle (business principle). “Business” is a product of civilization and it cannot exist for long in the absence of a specific constellation of conditions, chiefly moral, which support our civilization. The economic ingredient in the constellation is, as we shall see, free competition. But free competition cannot function unless there is general acceptance of such norms of conduct as willingness to abide by the rules of the game and to respect the rights of others, to maintain professional integrity and professional pride, and to avoid deceit, corruption, and the manipulation of the power of the state for personal and selfish ends. The big question of our time is whether we have been so heedless and unsparing in the use of our moral reserves that it is no longer possible to renew these vital props of our economic system and whether it is yet possible to discover new sources of moral strength.

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Choice and Limitation: the Essence of Economics

by Röpke, Wilhelm

We have now reached a point in our inquiry where we can begin to grasp the fundamental nature of economics. On every hand we are hemmed in by scarcity: by scarcity of goods, scarcity of time, scarcity of physical strength. We cannot fill one hole without opening another somewhere else. In this world of scarcity we are faced with a twofold task. In the first place, we must choose from among our several wants those which are in most urgent need of satisfaction. In the second place, since marginal utility decreases with the increasing satisfaction of a want, we are compelled to interrupt this satisfaction sooner or later. We are under the continual necessity of achieving some kind of balance between our unlimited wants and our limited means. This we do by making a choice from among our wants and by limiting the extent to which any one of these wants is satisfied.
On what basis shall we make these decisions? It is certain that we shall arrange our purchases in such fashion that the satisfaction procured by the last increment of one commodity will be approximately equal to that afforded by the last increment of any other commodity. This is the abstract explanation of what is, in reality, a very simple process, something we do at every hour of the day without waiting on the proper formula. A very clear illustration of what is involved here is to be found in the otherwise trivial act of packing one’s bag for a journey. Since we cannot take all of our possessions with us, we first decide upon the things which we most urgently require (choice). At the same time, we proceed to balance a plus in shirts by a minus in shoes, a plus in books by a minus in suits, in such a way as to arrive at a reasonable proportion among the several items (limitation). Silly as it may sound, it is really true that the traveling bag is ideally packed when the marginal utilities of suits, shirts, socks, handkerchiefs, shoes and books are at the same level and higher than the utilities of the things left behind.
Our example may be objected to on the grounds that it omits the possibility of taking along more and bigger bags. This complicates our problem somewhat, but changes nothing with respect to the principle involved. For how would the size and number of bags be decided on unless by all sorts of utility comparisons between more and bigger bags? Those to whom such an objection occurs have only to consider the plight of the soldier in the field who is restricted to one haversack and consequently must take very seriously indeed the operations of “choosing” and “limiting.” Who would have thought that the whole of economic activity is only an endless series of very complicated variations on the simple and fundamental theme of packing a bag? Our whole life is made up of an immense number of similar decisions serving to balance continuously means with wants. Choice, limitation, equalization of marginal utilities—these are the concepts to which we must repeatedly return. They determine how we use our incomes, how we direct our businesses, how we organize production, how we divide up our time between work and leisure, and even between sleep and wakefulness. The utility we renounce constitutes the “costs” of the utility we realize in our private economy as well as in the national economy. To economize is simply to be constantly making a choice from among different possibilities. Economics is at bottom nothing other than the science of alternatives. Choosing and limiting are the eternal functions of every human economy, whatever its organization, be it the isolated economy without exchange or our highly developed market economy founded on the division of labor and the circulation of money.

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Marginal Utility

by Röpke, Wilhelm

The preceding examples, which were intended to give us some idea of the tasks of economics, have turned our attention from the narrow confines of our personal experiences to a consideration of the larger fabric of society with which they are mysteriously interwoven. It is as if, all this time, we had been unconcernedly and thoughtlessly drawing water from a brook for our own private needs when, of a sudden, we look up and perceive that our brook is, in reality, a broad and majestic river stretching away upstream into illimitable distances. A recognition of the existence of the great social problems is a long step forward on the road to an understanding of economics.
But we would be traveling, ultimately, in a wrong direction were we not to consider another circumstance which leads us back to ourselves and to our own individual experiences. For it is imperative that we keep clearly in mind that the economic system is not an objective mechanical thing which functions whether we will or no, but a process to which we all contribute in the totality of our reflections and our decisions. At bottom, it is the millions upon millions of subjective events taking place in the mind of each individual which form the substrata of economic phenomena. It is the feelings, judgments, hopes and fears of men which are manifested objectively in such things as prices, money, interest, prosperity and depression. But around what axis do these movements of the human psyche revolve? An answer to this question will provide us with the key to an understanding of all the objective events of economic life—to an understanding, in brief, of the “phenomena of the market.”
The meaning of all economic decisions and actions can be summed up in the word economize. When we have only a limited quantity of an important or useful commodity, we invariably tend to husband the inadequate supply. When we cannot have as much as we would like of a thing, there must be a certain order in our use of it if “waste” is to be avoided—if we wish, that is, to forestall our acting in an uneconomic manner. Unhappily, we do not live in Cockaigne; there are only a few goods of which there is an inexhaustible supply (free goods). Under normal circumstances, the air of our atmosphere is a free good, though it is at the same time the most essential commodity we know. A calisthenics addict may fill his lungs to bursting with air and no one will label him a glutton. But if he continues his exercise too long, a glance at the gymnasium clock and his own increasing fatigue will soon alert him to the fact that at least two things do not exist in unlimited quantities: time and physical strength. These things must be husbanded. However important and useful breathing exercises are, they cannot be kept up indefinitely without neglecting even more important things. Because time and physical strength are limited in quantity, they are not free goods, but economic goods. We are forced to economize them no matter how little importance we attach to life’s other activities.
Economic goods and not free goods determine our behavior. Our whole life is made up of decisions which seek to establish a satisfactory balance between our unlimited wants and the limited means at hand to satisfy them. To say that economic goods are limited in quantity is simply to say that the existing stocks of such goods are unable to satisfy the total subjective demand for them. It is important to note that this is not the same thing as objective scarcity. Rotten eggs are, happily, scarce, but even so, there are too many of them, economically speaking (Robbins). Not only do we not want them, but energetic efforts are made to see that as few as possible come into existence. They have no value for us, indeed, they are an inconvenience, which is to say that they have a negative value. On the other hand, an economic good which is not objectively scarce can increase infinitely in value, if life itself depends upon its possession. So the sorely-beset hero of Shakespeare’s Richard III feels compelled to offer his kingdom for a horse. The scale of values of things encompasses, then, all values from minus (negative value) through zero (free goods), through a range of finite values (economic goods) to infinite values (meta-economic goods). The place of any good in this scale of values is determined ultimately by the strength of the subjective demand for it.
Air and water are ordinarily ranked very low on our scale of values, though they are essential to life. On the other hand, a diamond is valued very highly, though it is not in the least an object of vital importance. This circumstance leads us to a further important concept which is indispensable for an understanding of the subjective foundations of economic life. Our preceding discussion has made tacit use of this concept; it behooves us now to give it the most careful scrutiny.
When it comes to assigning a good its place on the scale of values, the determining factor is utility—not a general utility based on the degree of the good’s vital importance, but the specific, concrete utility of a definite quantity of the good. The larger the supply of a good at our disposal, the smaller is the amount of satisfaction procured by its individual units, and hence the lower is such a good ranked on our scale of values. The reason for this is that with increasing satisfaction of a want, the utility (satisfaction or enjoyment) furnished by each successive dose diminishes. Moreover, take away any one of a number of identical units and the loss of utility or satisfaction will be the same as if any other had been taken away. It follows that the minimum utility of the last dose or increment determines the utility of every other unit of the supply and therefore the utility of the whole supply. The value we attach to water is not determined by the infinite utility of the single glass of water needed to save us from perishing of thirst; it is determined by the utility of the last dose used to bathe ourselves or to sprinkle the flowers. We call the utility of this last dose final or marginal utility.
We may now affirm the following theses: (1) marginal utility diminishes with increasing supply, that is, with the increasing possibility of satisfying a want; (2) marginal utility determines the utility of all other units of the supply; (3) as the quantity of a good is increased, there is a corresponding fall in its place on our scale of values, providing our taste (scale of preferences) has not changed in the meantime; (4) the utility of the whole supply (total utility) increases as quantity increases, but at a decreasing rate due to the absolute decline of marginal utility. In fact, if marginal utility diminishes faster than quantity increases, total utility may decline absolutely.
Now it is readily apparent that marginal utility will fall at a different rate for different commodities. Oddly enough, the rate of fall is greater the more vital the commodity. Let us reconsider the example of water. Each of us can remember a long walk on a hot summer’s day when we had only one thought in mind: water. We at least reach a spring and, consumed by thirst, fling ourselves down to drink. The first mouthful of water is swallowed greedily, but with the second there is an abrupt lessening of satisfaction. Finally, we bathe our faces, we refill our canteens, and then forget both thirst and water to stretch out on the grass in leisurely contemplation of the countryside of which “we can’t get enough.” We will observe that as the result of the extremely rapid fall in the marginal utility of water, its total utility can easily become negative. Those unfortunates who, during the Middle Ages, were tortured by forceful infusions of water, could have furnished convincing proof on this point. Or consider the proverbial discontent of the farmer with the weather. He complains as often that it rains too much as that it rains too little—a further proof that water is characterized as much by the urgent need we have for it, as by the extremely rapid fall in its marginal utility.
From the concept of diminishing marginal utility may be deduced still another: elasticity of demand. In general, the elasticity of demand for a good varies inversely with the urgency (intensity) of the demand for it. Later, we shall see how this principle underlies important phenomena of the price structure, especially on the markets for agricultural goods. With low elasticity of demand (rapid rate of fall in marginal utility), the total utility of a supply may decrease absolutely, as illustrated in the well-known fact that the income derived from grain production in a given year may be smaller for an abundant harvest than for a lean one.
The meaning of “rapidity of fall in marginal utility” and of “elasticity of demand” will become clearer if we apply these concepts to certain considerations of a practical nature.
Remembering that elasticity of demand varies for different commodities, it is obvious that individuals will tend to consume more nearly the same amounts of a given commodity the less elastic is the demand for it—and this despite differences in income. And inelasticity of demand, we will recall, is the greater, the more essential to life is the commodity in question. Another outcome of these relationships is this: the smaller is one’s income, the larger is the share of it which is expended on foodstuffs. This fact was first demonstrated by the Prussian statistician Engel in 1857 (Engel’s law). Somewhat later, another statistician, Schwabe, arrived at identical conclusions for housing expenditures (Schwabe’s law). We may conclude, therefore, that taxes on basic consumption goods hit the poor more severely than the rich.
A closer scrutiny of the expenditures of the rich will show that the notion of the rich gluttonously stuffing themselves is inexact, the stomach capacity of most individuals being approximately the same. Of course, the larger is a man’s income, the greater will be his consumption of luxury goods, such goods having a high elasticity of demand (slow fall in marginal utility). But even such luxury wants are not sufficiently elastic to absorb the whole of a very large income. The result is that the unspent portion of the very large income is saved. This gives us an inkling as to how important is the function of the rich in the formation of capital. It follows that very little can be expected from a redistribution of the large incomes among the poorer classes. For if the rich spend for their vital needs but little more than the poor, the poor will hardly be benefited by such redistribution. Moreover, the amount of money which the rich spend on luxuries is relatively insignificant, in spite of what the lay mind imagines. The rich are so few in number that the amount they expend on luxuries is trifling in comparison with the total expenditures of the rest of the citizens. (For example, of the 58,701,000 individual income tax returns filed in 1958 in the United States, only 236 showed incomes of $1,000,000 or more; only 115,000 income units earned $50,000 or more [Statistical Abstract of the United States for 1961]). As for that part of the large income which is saved, it cannot figure in any scheme for the redistribution of the wealth since the cessation of saving will invite general economic decline. It should be remembered that the wealth of a Henry Ford consisted not of money but of factories which were built with his savings, factories which even a Communist state would have built had it the necessary means. Looked at in this light, people like Henry Ford are really public servants who administer our productive resources after the manner of trustees and who, if their trusteeship is bad, undergo the immediate and heavy punishment of financial loss. The problem, then, is not whether the fate of the poor will be appreciably better in a society where there are no rich. The problem is, rather, whether it is preferable to put state functionaries in the place of private entrepreneurs and to convert private enterprises into state enterprises; and further, whether the economic, social, and political power wielded by the rich is such as to result in economic evil or social injustice.
Let us clarify this point by still another illustration. Let us suppose that a poor street cleaner wins first prize in a lottery. How will he dispose of his sudden wealth? We see at once that it is the elasticity of his wants which will play the decisive role. Obviously, he will first satisfy his pressing needs for food, clothing, and shelter. But it is soon apparent that for these inelastic needs the point of satiety is quickly reached. The larger the winnings from the lottery and the richer the individual before his winnings, the smaller will be the percentage of his total income expended on inelastic or vital needs. However, while it is certain that all men will spend a part of their incomes for the basic subsistence goods, we cannot predict how they will distribute the remainder of their incomes among other wants. People will consume more nearly the same amounts of a given commodity the more inelastic is the demand for it. The more elastic is the demand for a commodity, the more probably will its consumption vary with the fluctuations of individual taste. It has been shown, for instance, that during the years 1926-27 the percentage of national income spent for food in Canada, Switzerland, and England was, surprisingly, the same (30-31 per cent), while expenditures on other items varied considerably among the three countries.
If it is now the whole population instead of the street cleaner which is enriched, the same sequence of cause and effect will be operative. The percentage of income expended on food (inlastic demand) diminishes, while other needs assume increasing importance. This means that the relative importance of agriculture will ultimately diminish, and that within the agricultural domain itself grain production will become relatively less important than the production of more highly valued foods (milk products, meat, eggs, fowl, vegetables and fruit). Similarly, non-agricultural branches of production satisfying ‘luxury” wants of a still higher type (“tertiary production”) will increase in importance as the general standard of living rises. Trade, transportation, tourism, motion pictures, radio, television, the legitimate theatre, books, art works, concerts, etc. absorb an ever-larger share of the national income as the standard of living rises. Otherwise expressed, rises in living standards go hand in hand with increased production, in the agricultural domain, of butter, meat, fruit, etc. As incomes rise still further, the ultimate stages in the developmental process—urbanization and industrialization—are attained. Our own age clearly reflects this evolution.
Thus far we have sketched the broad outlines of the principle of marginal utility, a clear apprehension of which will show it to be almost a commonplace. But as the above examples indicate, it is a commonplace which is indispensable to an understanding of economics. Indeed, it is upon this principle that the whole edifice of modern economic theory has been built. It is to a group of economists who initiated their researches within the last fifty years that we must assign the credit for this accomplishment.

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