Eugen von Böhm-Bawerk (February 12, 1851 – August 27, 1914) was an Austrian economist who made important contributions to the development of the Austrian school of economics. Böhm-Bawerk together with Carl Menger and Friedrich von Wieser were the three pillars that established the Austrian school. Böhm-Bawerk's contributions laid the foundation for the theory of capital, and in later development by others such as Knut Wicksell, the modern understanding of interest in terms of compensation for the use of capital. He emphasized the role of time in determining the value of goods, and developed marginal utility theory into a theory of prices. His work addressed significant economic questions such as how to increase capital, and what is the justification for charging interest.
Böhm-Bawerk was the first economist to refute Karl Marx's claim that capitalists exploit workers. He argued that in fact they provide a service to workers by paying them in advance of payment the owners receive for sale of the goods produced by workers. Böhm-Bawerk's view of economic processes included the actual situation and expectations of people involved, not just material measures of quantity of goods and hours of labor. In this way, his answers came closer to addressing the real situation of human society and how we can cooperate together to the benefit of all.
Eugen von Böhm-Bawerk was born on February 12, 1851 in Brünn, Moravia, then part of Austria-Hungary, later called Brno in the Czech Republic. He was trained in the University of Vienna as a lawyer. There he read Carl Menger's Principles of Economics. Though he never studied under Menger, he quickly became an adherent of his theories. Joseph Schumpeter said that Böhm-Bawerk "was so completely the enthusiastic disciple of Menger that it is hardly necessary to look for other influences."
During his time at the University of Vienna, he became good friends with Friedrich von Wieser, who later became Böhm-Bawerk's brother-in-law.
After completing his studies he entered, for a short period of time, the Austrian ministry of finance. Afterwards, he spent the 1880s at the University of Innsbruck (1881-1889). During this time he published the first two (out of three) volumes of his magnum opus, entitled Capital and Interest.
In 1889, he was called to Vienna by the finance ministry to draft a proposal for direct-tax reform. The Austrian system at the time taxed production heavily, especially during wartime, providing massive disincentives to investment. Böhm-Bawerk's proposal called for a modern income tax, which was soon approved and met with a great deal of success in the next few years.
He then became Austrian Minister of Finance in 1895. He served briefly in the position and then again on another occasion, although a third time he remained in the post for four years, from 1900-1904. As Finance Minister, he fought continuously for strict maintenance of the legally fixed gold standard and a balanced budget. In 1902, he eliminated the sugar subsidy, which had been a feature of the Austrian economy for nearly two centuries. He finally resigned in 1904, when the increased fiscal demands of the army threatened to unbalance the budget, and returned to teaching with a chair at the University of Vienna. Böhm-Bawerk taught many students including Joseph Schumpeter, Ludwig von Mises and Henryk Grossman. He died in 1914 in Kramsach, Tirol, now in Austria.
Böhm-Bawerk’s contribution to the field of economics involved insights into the nature of capital and its expansion, the theory of wages, prices, and interest. Additionally, he provided a devastating refutation of Marxist theories on capital.
"What must be done if there is to be an increase in capital?"
The answer to this key question, which distinguishes Austrian macroeconomics from what would later become mainstream macroeconomics, involves a change in the configuration of the concentric rings delineating goods according to their maturity with respect to being ready for consumption.
Considered with reference to the varying distances at which intermediate products lie from the goal of consumption, the total mass of capital divides itself into a number of annual classes or "stages of maturity," which may be very appropriately explained by imagining the set of concentric annual circles or “rings.” The outmost circle (“ring”) embraces those goods which will be transformed into goods ready for consumption within the coming year; the second circle represents those goods which will ripen into consumption goods in the year after; the third ring, those which will be ready the year after that, and so on.
In a community where production is not yet strongly capitalistic, the inner rings will rapidly contract, because, in such a community, very lengthy roundabout ways of production, such as turn out their finished goods only after many years, will be rare. In rich and well-developed communities, again, there will be a considerable number of comprehensive rings, and of these the inner ones will have a content that, although relatively smaller, is not inconsiderable.
Austrian macroeconomics suggests that increase in capital results from changes in the structure of the concentric rings. Several types of changes are suggested, each entailing the idea that real saving is achieved at the expense of consumption and of capital in the outer rings, and that the saving makes possible the expansion of capital in the inner rings. Böhm-Bawerk indicated that in a market economy it is the entrepreneurs who bring such structural changes about and that their efforts are guided by changes in the relative prices of capital goods in the various “rings.”
In any case, however, an expansion of the capital structure is not to be viewed as a simultaneous and equiproportional increase in capital in each of the maturity classes; it is to be viewed as a reallocation of capital among the maturity classes. Overlooked by his predecessors and largely ignored by the modern mainstream, this is the market mechanism that keeps the economy's inter-temporal production plans in line with the inter-temporal preferences of consumers (Böhm-Bawerk 1895).
Böhm-Bawerk claimed that economic theory necessarily needs to make a distinction between "the laborer's share of consumable goods," or "earnings," on the one hand, and "wages," on the other. This may be considered analogous to the distinction made by Adolf Wagner between capital as a "purely economic category" and capital "in a juridico-historical sense." Adolph Wagner (1835-1917) was a German economist and social reformer whose work prepared the development of the monetary and credit system in Germany and substantially influenced the central bank policy and financial practice before World War I.
Wages, in Böhm-Bawerk's this stricter definition, and private capital are both facts of usage, while the laborer's income, or earnings, and social capital both are facts intrinsic and fundamental to any theory of industrial society. The laborer, from the point of view of consumption of products, is no longer "laborer," he is simply a member of society, and his share of the product of industry is the share of an individual member of society. As a consumer, he is not a "laborer," and his share of consumable goods is not "wages," in the strict technical sense of the term.
Based on Böhm-Bawerk's analysis, wages may coincide with the laborer's share of the product—with earnings—but wages is a category having a different significance for economic theory from that of earnings or of goods consumed. While the laborer's earnings, or share of consumable goods, is his share of public capital, his wages are paid out of private capital. It is only then that the term "wages," in the strict technical sense, can properly be employed.
Böhm-Bawerk (1949) disproved three possible explanations regarding prices accepted by leading economists such as Leon Walras and William Stanley Jevons. One ascribes prices to the relationship of demand and supply of goods, another to the costs of production, and the third to the quantity of labor needed in the production.
In Böhm-Bawerk's formulation, where there is two-sided competition, price emerges at a point within a range of an upper and a lower limit:
The upper limit is determined by the valuation by the last buyer to come to terms and the valuation by that excluded willing seller who has the greatest capacity for exchange. The lower limit is determined by the valuation by the last seller among those to come to terms and the valuation of that excluded willing buyer who has the greatest capacity for exchange (Böhm-Bawerk 1959).
In short, the market price is established at a point within a range that is limited and determined by the valuations by the two marginal pairs. It is the product of subjective valuations.
Thus, the popular law of costs actually is no “general price law” but merely a particular part within the latter. It pertains to those economic goods that can be reproduced at will. In the long run, their prices can neither be much higher nor much lower than their costs. If their prices should fall below their costs, production would inflict losses on manufacturers who would soon curtail the output. According to the law of supply and demand, the reduction of the supply would tend to increase the price. Then, if prices should rise above their costs, their production would become profitable, which would encourage businessmen to expand production (Böhm-Bawerk 1959).
What Böhm-Bawerk also showed is that when the price of goods such as automobile fan belts, or anything else whose own, direct marginal utility is extremely high, is determined on the basis of cost of production, precisely then is its value determined on the basis of marginal utility—the marginal utility of the means of production used to produce it, as determined in other, less important employments. The buyer of a fan belt does not pay a price corresponding to the value he attaches to his car, but a much lower price corresponding to the marginal utility of the materials and labor required to produce fan belts—a marginal utility that in turn is determined by the marginal utility of products other than fan belts.
In other words, as Böhm-Bawerk developed the law of diminishing marginal utility, it is no more surprising that the price of vital components and parts, or any necessity, is in conformity with its cost of production rather than its own direct marginal utility than it is that the marginal utility of the water on which our physical survival depends is no greater than the utility of the marginal quantity of water we use. Determination of price by cost is merely a mechanism by means of which the value of supramarginal products is reduced to the value of marginal products. The only complication is that the marginal products in this case are physically different and lie in other lines of production.
Böhm-Bawerk built his academic career around the goals of understanding the relationship between capital and interest, and extending value theory to the context of intertemporal allocation. He claimed that economics was notorious for its inattention to capital in the sense of an intertemporal structure of intermediate goods. Production takes time, and the time that separates the formulation of multiperiod production plans and the satisfaction of consumer demands is bridged by capital. If mentioned at all in economics texts, these aspects of economic reality are introduced as "the thorny issues of capital," a tell-tale phrase that portends a dismissive treatment of this critical subject area.
Böhm-Bawerk took up the central question that was much discussed by his contemporaries and predecessors: Is there any justification for the payment of interest to the owners of capital? The justification, in his view, rests on a simple fact of reality: people value present goods more highly than future goods of the same quantity and quality. Future goods trade at a discount, or alternatively, present goods trade at a premium.
According to Böhm-Bawerk, and elaborated by his successors, interest harmonizes the quantities saved and invested. The "pure" or "natural" rate of interest depends upon individuals' time preference—that is to say, their willingness to exchange a given amount of present goods and services (those which can be consumed today) for a specified greater amount of future goods (intermediate or unfinished goods which will become present goods at some point in the future). Hence, the payment of interest is a direct reflection of this intertemporal value differential.
In other words, the greater (or less) the willingness to trade present for future goods, or to outlay a given amount of money today in order to receive a specified greater amount at a particular point in the future—the greater the preparedness to wait—the lower (or higher) the natural rate of interest (Hoppe 2002).
This interest, or agio, paid to capitalists also allows workers to receive income on a more timely basis than would otherwise be possible. Böhm-Bawerk's "agio theory" and its implications for the alternative "exploitation theory" were undoubtedly enough to win him recognition by historians of economic thought. With it he broke new ground and was able to parlay his refutation of socialist doctrine into a new understanding of the capitalist system.
The most significant element of his devastating critique of the exploitation theory, as embraced by Karl Marx and his forerunners, is as follows: Capitalists do not exploit workers; they accommodate workers-by providing them with income well in advance of the revenue from the output they helped to produce (Böhm-Bawerk 1949).
More than a decade later, Böhm-Bawerk was to revisit the issues raised by the socialists. He established that the question of how income is distributed among the factors of production is fundamentally an economic-rather than a political-question. This answer effectively rebutted the labor theory of value as well as the so-called "iron law of wages" (Böhm-Bawerk 1959).
Böhm-Bawerk discovered the error in Marx's system to have resulted from a self-contradiction in Marx's law of value, namely how the rate of profit and the prices of production of the third volume of Marx's Capital contradict Marx's theory of value in the first volume. He also attacked Marx for downplaying the influence of supply and demand in determining permanent price, and for deliberate ambiguity with such concepts.
Some of the criticism directed against Böhm-Bawerk concerning his insufficient subjectivity, backward-looking while reckoning the production time, and alleged overplaying of psychological consideration in the agio theory of interest, may have some merit. However, most of the problems were caused by attempts to restate his theory in the language of formal neoclassical theory and omitting his arithmetic illustrations.
Although he was a liberal, Böhm-Bawerk was not the radical libertarian that the label of Austrian economist came to suggest. Joseph Schumpeter praised Böhm-Bawerk's efforts toward "the financial stability of the country." In recognition of these efforts, Böhm-Bawerk's image was on the one-hundred schilling banknote between 1984 and 2002, until the euro was introduced.
The first volume of Böhm-Bawerk's (1959) Capital and Interest, entitled History and Critique of Interest Theories (1884), which is an exhaustive study of the alternative treatments of interest, including use theories, productivity theories, cost evaluation theories, wages, and so forth, was decreed by Ludwig von Mises as "the most eminent contribution to modern economic theory." Von Mises even indicated that "No one could claim to be an economist unless he was perfectly familiar with the ideas advanced in this book," and he even went so far as to suggest (as only Mises could) that "no citizen who takes his civic duties seriously should exercise his right to vote until he has read Böhm-Bawerk!"
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