Economic Theory in the Twentieth Century, An Intellectual History―Volume II: 1919–1945. Economic Theory in an Age of Crisis and Uncertainty 3030809862, 9783030809867

Citation preview

Roberto Marchionatti

Economic Theory in the Twentieth Century, An Intellectual History—Volume II

1919–1945. Economic Theory in an Age of Crisis and Uncertainty

Economic Theory in the Twentieth Century, An Intellectual History—Volume II

Roberto Marchionatti

Economic Theory in the Twentieth Century, An Intellectual History—Volume II 1919–1945. Economic Theory in an Age of Crisis and Uncertainty

Roberto Marchionatti Department of Economics and Statistics University of Turin Turin, Italy

ISBN 978-3-030-80986-7 ISBN 978-3-030-80987-4 https://doi.org/10.1007/978-3-030-80987-4

(eBook)

© The Editor(s) (if applicable) and The Author(s) 2021 This work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publisher, the authors and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, expressed or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations. This Palgrave Macmillan imprint is published by the registered company Springer Nature Switzerland AG The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland

This Book is dedicated to my parents Mario and Paola

Acknowledgments

This volume arises out of the author’s long-standing reflection on the history of economic thought in the twentieth century and in particular in the decades between the two world wars. It builds on previous published and unpublished work produced since the early 1980s. It has thus benefited greatly from the suggestions of colleagues and researchers as well as from feedback received at a number of conferences, workshops and seminars. In particular, I would like to thank, for discussions and comments on issues covered in this book at different times, Anna Carabelli, Mario Cedrini, Terenzio Cozzi, John Davis, Riccardo Faucci, Francesco Forte, Stefano Fiori, Geoffrey Harcourt, Bruna Ingrao, Maria Cristina Marcuzzo, Fiorenzo Mornati, Arnaldo Orlandini and the late Alves Marchi, Claudio Napoleoni and Fabio Ranchetti. I also express my gratitude to Scott Kraemer for his revision of the text. Lastly I gratefully acknowledge the support of national funds of the Italian Ministry of University and Research within the programme PRIN 2017MPXW98.

vii

Contents

1

2

Introduction 1.1 The Historical Scenario: Capitalism in Crisis 1.2 Economic Theory Between the Two World Wars: Dealing with New Problems and New Theoretical Challenges 1.3 The Map of Economic Theory Between the Two World Wars References Economics in Cambridge and Oxford in the Age of John Maynard Keynes 2.1 Prologue: Between the Old and the New Cambridge School 2.2 Arthur C. Pigou and Marshallian Economics in the 1920s and Its Decline 2.3 John Maynard Keynes (1883–1946)

1 1

10 16 19 21 21 23 29

ix

x

Contents

2.4 The New Cambridge School: Keynes’s Close Circle (Richard Kahn, 1905–1999; Austin Robinson, 1897–1993; Joan Robinson, 1903–1983) and Their Fellow-Travelers (Piero Sraffa, 1898–1983; Maurice Dobb, 1900–1976; Michał Kalecki, 1899–1970; and Roy Harrod, 1900–1978) 2.5 Critical Developments in Oxford: The Oxford Economists’ Research Group References 3

4

Economics in London: The London School of Economics (LSE) 3.1 Prologue: LSE Under Lionel Robbins’s Leadership 3.2 Lionel Robbins (1898–1984) 3.3 Friedrich August von Hayek (1899–1992), the LSE Years 3.4 John Hicks (1904–1989), Between LSE and Cambridge 3.5 Abba Ptachya Lerner (1903–1982), the LSE Years References Economics in Berlin, Vienna and Other Minor German Centers 4.1 Prologue 4.2 Economics in Berlin, I: The Development of a Classical Conception of General Economic Equilibrium in Bortkiewicz’s Circle: Robert Remak (1888–1942) and the Young Wassily Leontief (1905–1999) 4.3 Economics in Cologne and Berlin, II: The Analysis of Oligopolistic Market Forms by Heinrich von Stackelberg (1905–1946) 4.4 Economics in Minor German Centers: Kiel and Freiburg 4.5 Economics in Vienna. I: Ludwig von Mises (1881–1973) and the Neo-Austrian School

61 87 90 99 99 106 117 131 145 152 159 159

163

167 170 177

Contents

4.6 Economics in Vienna. II: Oskar Morgenstern (1902–1977), “a Reluctant Austrian” 4.7 Economics in Vienna. III: Carl Menger’s “Second Edition” of the Grundsätze, 1923. A Note 4.8 Economics in Vienna. IV: Philosophy, Economics and Mathematics in the Wiener Kreis and in the Mathematische Kolloquium References 5

6

Economics in the Rest of Europe 5.1 Introduction 5.2 New Developments in the Northern-European Countries, I: Economics in Sweden—Gunnar Myrdal (1898–1987) and the Stockholm School 5.3 New Developments in the Northern-European Countries, II: Ragnar Frisch (1895–1974) in Oslo, Jan Tinbergen (1903–1994) in Rotterdam and the Birth of the Econometric Movement Between Europe and the United States 5.4 Economics in France, Italy and the USSR References Economics in the United States: New York, Harvard, Chicago and Princeton 6.1 Prologue 6.2 Economics in New York: Columbia and the New School for Social Research, and the Leadership of Wesley Mitchell (1874–1948) 6.3 Economics at Harvard: Development of a Great Intellectual Community 6.4 Economics in Chicago: A “Mixed Bag” 6.5 Economics at Princeton: John von Neumann, Oscar Morgenstern and the Birth of Game Theory References

xi

187 194

196 206 215 215

216

226 239 246 253 253

255 269 301 328 333

xii

7

8

Contents

Great Controversies 7.1 The Controversy on Marshall and the Marshallian Orthodoxy in England and the United States in the 1920s 7.2 The Socialist Calculation Debate, 1919–1940 7.3 The Keynes–Tinbergen Controversy on Econometric Method References

391 406

Between the Two World Wars: The Years of High Theory? References

415 420

Author Index

343

343 368

421

List of Figures

Fig. 3.1 Fig. 3.2

Relation between income and rate of interest Relation between income and interest

143 143

xiii

1 Introduction

1.1

The Historical Scenario: Capitalism in Crisis

In November 1918, when Austro-Hungary and Germany signed the armistice, World War I came to an end. The terms of the peace were defined at the 1919 Paris Peace Conference. As a result of the treaties signed there, the Austro-Hungarian, German and Ottoman Empires ceased to exist, with numerous new states created from their remains— while the Russian empire had dissolved in 1917 with the two revolutions of February and October of that year, followed by the civil war, which lasted until 1923. The Peace Conference required all the defeated powers to pay reparations for the damage done to civilians. The burden fell largely on Germany, according to the Treaty of Versailles, which applied specifically to Germany. In The Economic Consequences of the Peace (Keynes 1971 [1919]), Keynes called the Peace of Versailles a “Carthaginian peace” and was extremely critical of its lack of attention to the economic future of Europe. He wrote: © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 R. Marchionatti, Economic Theory in the Twentieth Century, An Intellectual History—Volume II, https://doi.org/10.1007/978-3-030-80987-4_1

1

2

R. Marchionatti

The Treaty includes no provisions for the economic rehabilitation of Europe—nothing to make the defeated Central Powers into good neighbours, nothing to stabilise the new states of Europe, nothing to reclaim Russia; nor does it promote in any way a compact of economic solidarity amongst the Allies themselves; no arrangement was reached at Paris for restoring the disordered finances of France and Italy, or to adjust the systems of the Old World and the New. The Council of Four [Woodrow Wilson of the United States, David Lloyd George of the United Kingdom, Vittorio Emanuele Orlando of Italy, and Georges Clemenceau of France] paid no attention to these issues, being preoccupied with others—Clemenceau to crush the economic life of his enemy, Lloyd George to do a deal and bring home something that would pass muster for a week, the President [Wilson] to do nothing that was not just and right. It is an extraordinary fact that the fundamental economic problems of a Europe starving and disintegrating before their eyes, was the one question in which it was impossible to arouse the interest of the Four. Reparation was their main excursion into the economic field, and they settled it as a problem of theology, of politics, of electoral chicane, from every point of view except that of the economic future of the States whose destiny they were handling. (Keynes 1971 [1919], pp. 211–212)

Keynes added some prophetic words which proved true by the mid1930s: Men will not always die quietly. For starvation, which brings to some lethargy and a helpless despair, drives other temperaments to the nervous instability of hysteria and to a mad despair. And these in their distress may overturn the remnants of organisation, and submerge civilisation itself in their attempts to satisfy desperately the overwhelming needs of the individual. This is the danger against which all our resources and courage and idealism must now co-operate. (ibid., p. 228)

And he went on to say: If we aim deliberately at the impoverishment of Central Europe, vengeance, I dare predict, will not limp. Nothing can then delay for very long that final civil war between the forces of Reaction and the despairing convulsions of Revolution, before which the horrors of the late German

1 Introduction

3

war will fade into nothing, and which will destroy, whoever is victor, the civilisation and the progress of our generation. (ibid., p. 268)

Unsurprisingly, Europe’s poor economic performance in the interwar period was closely linked with the economic consequences of World War I. In the years after the war, in many cases in the whole decade of the 1920s, all countries—though Central and Eastern Europe were hardest hit—had to face great economic problems, of a severity never known before: unemployment, inflation and currency depreciation, public and inter-government debts, overcapacity, as well as social instability and widespread poverty, in an international economy where economic connections were largely weakened and international cooperation for reconstruction was scarce. Poor economic performance gave rise to relative economic decline in Europe, particularly by comparison with the United States, where growth was intense throughout the 1920s, thus bolstering American international economic power. Politicians were in general largely unable to understand the seriousness of economic problems, their predominant feelings being that matters would be rapidly resolved with the return to normality, or in other words to the point at which the hands of the clock had stopped in 1913–1914. Indeed, by the mid-1920s, the major economic perturbations induced by the war, the treaty of peace and the readjustments of economic relations seemed to have come to an end and, despite the international system’s acknowledged fragility, the resurgence of stable economic development seemed possible. Actually, however, the world economy had never returned to full health after 1919, but the buoyant American boom of the 1920s had masked the underlying problems. But, contrary to the hopes and expectations of the majority, in a few years the entire capitalist system fell into the greatest crisis ever known, the Great Depression. After the war ended, some European countries and the United States had experienced a short but intense boom between 1919 and 1920, partly supported by expansive monetary and fiscal policies, but a severe recession affected them in 1921–1922, when the global economy fell sharply. Britain’s economy suffered most—with unemployment reaching 17%, and overall exports at only half of their pre-war levels—and of course recession was hard in Central Europe and particularly in

4

R. Marchionatti

Germany, due to the Treaty’s harsh terms. As indicated above, the greatest burden of reparation was borne by Germany—33 billion dollars, an amount considered by Keynes (and many other economists) unsustainable, in a series of annuities to be paid quarterly. In fact, Germany’s ability to pay deteriorated rapidly, while the authorities took measures which accelerated inflation—sparking uncontrollable hyperinflation— and currency devaluation: in early 1922, 160 German marks was equivalent to one US dollar; by November 1923, the currency would depreciate to 4,200,000,000,000 marks to the dollar. Hyperinflation continued until 1924, when the government introduced a new currency (the Rentenmark), renegotiated debt repayments to the Allies through the Dawes Plan, which subjected Germany to a deflationary policy and secured new American loans to finance government institutions and reparation payments. At the end of the decade a new plan, the Young Plan, was introduced, but a further financial crisis in Germany precluded the payments, and the moratorium on the payments proposed by the American president Herbert Hoover put a substantial end to the issue. After the 1921–1922 recession, world industrial production had increased again, more slowly in Europe—Europe as a whole restored activity levels only in the middle of the new decade, but the pace of recovery among countries was uneven—faster outside Europe, in particular in the United States. The year 1925 is generally considered the end of the period of reconstruction and recovery from recession. European growth was slowed by austerity policies introduced in order to fight inflation and currency devaluation. In fact, the mid-1920s is also the period when a new international gold standard was put in place. Restoration of monetary stability was considered a crucial goal in order to return to the pre-1914 world. It was generally thought to be highly desirable to return to the gold standard, and the costs of doing so were considered in most quarters to be largely counterbalanced by the advantages of greater international confidence. However, no systematic common plan was adopted, as each country acted separately to achieve that goal. Between 1924 and 1928 most countries returned to the gold standard, many of them after a currency depreciation—the United States, which had already come back to the gold standard in 1919—was the benchmark for monetary alignment. In an attempt to

1 Introduction

5

maintain its central role as the world’s main financial center, Britain returned to the gold standard at the pre-war parity value in 1925. Many countries thus pinned their hopes of reviving the old international order on the gold standard. However, it was not the same gold standard as before. The gold specie standard—the pure standard—was maintained only in the United States and a few other nations, while most countries adopted a gold exchange standard, or in other words a system under which gold-based assets would serve as reserve assets and the dollar and the pound were the two key currencies. While the pre-World War I gold standard is usually described as a model of international monetary and price stability, its interwar version, the new gold standard, is associated with foreign exchange market turbulence, due to speculation and the prevalence of deflationary policies. Despite these policies, however, most countries did not manage to adjust costs and prices, so their currencies were over-valued—as was the case of the United Kingdom. Deflation and overvaluation entailed slow growth and poor economic performance, leaving the problems of unemployment and poverty unresolved. Such was the widespread situation in Europe in the second part of the 1920s. By 1929 Europe had recovered much of the lost ground, essentially thanks to the economic expansion—slow and onerous but in any case real—of the period 1925–1928. By contrast with the European situation, economic growth in the United States, which had already been rapid during the war, continued to be high in the 1920s, powered by industries like construction, transport, services and the new consumer durable goods—automobiles above all—some of which (cars, electrical appliances and radios) made rapid technical advances which brought large profits. In this period, the United States emerged as the world’s biggest creditor country, generating sizeable investment flow toward Europe (direct investments and purchases of sovereign bonds) that supported European recovery. But it was the frenetic stock market speculation which characterized the American boom of the 1920s. After a decade of intense growth, however, investments and economic activity suddenly slowed in the second part of 1929, and at the end of October share prices on the New York Stock Exchange collapsed. By the fall of 1929, US stock prices had reached levels that could not be justified by reasonable anticipations of future

6

R. Marchionatti

earnings. Their decline in October caused investors to lose confidence, and the stock market bubble burst. On Thursday, October 24, 1929, the Dow Jones Industrial Index plunged, falling further the next day. By the end of trading on the 25th, the index had shed over 20% of its value. This created a panic on Wall Street. Many stocks had been purchased on margin, i.e., using loans secured by only a small fraction of the stocks’ value. As a result, the price decline forced some investors to liquidate their holdings, thus exacerbating the fall in prices. Between their peak in September and their low in November, stock prices declined 33%. This event is referred to as the Great Crash of 1929. The financial crisis generated considerable uncertainty and substantially reduced aggregate demand. As a result, real output and employment fell rapidly. Doubts in the banking system’s solvency increased and a wave of banking panics followed in 1930, 1931 and 1932, continued through the winter of 1933 and culminated with the national “bank holiday” declared by the new American President Franklin D. Roosevelt on March 6, 1933.1 The panics exacerbated the decline in spending by generating pessimism and a loss of confidence. Furthermore, the failure of so many banks disrupted lending, thereby reducing the funds available to finance investment. The Federal Reserve did little to try to stem the banking panics. It deliberately contracted the money supply and raised interest rates. The Great Depression began in the summer of 1929 and reached its peak in 1933. Real output and prices fell dramatically. Between the peak and the trough of the downturn, industrial production in the United States declined 47% and real GDP fell 30%. The wholesale price index declined 33%. The unemployment rate was 25% at its highest point—about 15 million people were unemployed. Poverty and hunger were widespread. Agricultural areas were in a profound crisis, and prices dropped so low that many farmers went bankrupt and lost their land. Moreover, the Southern Plains region of the United States suffered 1 Economic historians believe that the increase in farm debt in the 1920s, together with US policies that encouraged small, undiversified banks, created an environment favorable to the spread of panic. The heavy farm debt stemmed in part from the response to the high prices of agricultural goods during World War I. American farmers borrowed heavily to purchase and improve land in order to increase production. The decline in farm commodity prices following the war made it difficult for farmers to keep up with their loan payments.

1 Introduction

7

severe dust storms: the so-called Dust Bowl intensified the crushing economic impacts of the Great Depression and drove many farming families on a desperate migration in search of work and better living conditions.2 Originating in the United States, the great depression became a worldwide economic downturn, the longest and most severe depression ever experienced by the industrialized Western world, resulting in drastic declines in output, unemployment and acute deflation in almost every country of the world. The depression stemmed from a multitude of causes. Declines in consumer demand, financial panics and misguided government policies caused economic output to fall in the United States. As recent studies have shown, the gold standard, which linked nearly all the countries of the world in a network of fixed currency exchange rates, played a key role in transmitting the American downturn to other countries (see Eichengreen 1992).3 However, there is no single cause or obvious set of factors that can explain why the depression occurred. Since the 1930s historians, economists and political scientists have come up with various explanations that place varying degrees of emphasis on different factors and events. Many factors influenced the transmission of the depression from the United States to the rest of the world, a world still vulnerable to shocks—and even more weakened by the curtailment of American foreign lending in 1928, which had serious implication for debtor countries. Undoubtedly, one fundamental factor in the transmission of the American crisis to the rest of the world was the gold standard. Once the United States economy began to contract 2

The “Dust Bowl” captured the imagination of American artists and writers. John Steinbeck memorialized the plight of the Dust Bowl refugees (called “Okies”) in his 1939 masterpiece The Grapes of Wrath (Steinbeck 1992 [1939]). Photographer Dorothea Lange documented rural poverty with a series of photographs for the Farm Security Administration. In general, the arts, and the cinema in particular, give us a rich representation of real life during the Great Depression. 3 At the time, liberal economists did not consider the existence of the gold standard as a cause of the Great Depression. On the contrary, they attributed most of the blame—as Lionel Robbins (1934) did—for the depression on the collapse of the gold standard itself. Although restoring the gold standard may have had deflationary consequences on the global economy and accentuated the depression, it also provided a monetary discipline, a compass for all other countries to follow and to coordinate their policies. The demise of the gold standard meant that there was no longer a basis for pursuing coordinated economic policies internationally.

8

R. Marchionatti

severely, the tendency for gold to flow out of other countries and toward the United States intensified. This took place because deflation in the United States made American goods particularly desirable to foreigners, while low income reduced American demand for foreign products. To counteract the resulting tendency toward an American trade surplus and foreign gold outflows, central banks throughout the world raised interest rates. Maintaining the international gold standard, in essence, required a massive monetary contraction throughout the world to match the one occurring in the United States. The result was a decline in output and prices in countries throughout the world. A second key factor was the increase of protectionism. International collaboration dropped drastically and national economies were protected by new barriers. And the two largest trading economies were the first to introduce barriers to competition in order to avoid further risk of domestic political crisis: in the United States, the 1930 Smoot-Hawley Tariff Act (named after the two congressmen who introduced it) placed severe limits on imports; two years later, Britain adopted a system of Imperial Preference, giving a privileged position to empire traders. The decades before 1913 had been the time of the first globalization, while the postwar years witnessed a “globalization backlash”. World trade fell by 60% from 1928 to 1932, and unemployment worldwide reached an estimated 40 million workers. The weaker economies, already hit by wartime losses and the inflation crisis, suffered most. Last but not least, the absence of an international leadership played a key role. As Kindleberger (1986, p. 290) wrote, between 1929 and 1931 “Britain could not act as a stabilizer, and the United States would not”: “When every country turned to protect its national private interest, the world public interest went down the drain, and with it the private interests of all” (ibid., p. 291). Both Britain and especially the United States—by now the most important economic power in the world and so, de facto, the international economic leader—failed to act in a decisive and meaningful way as lender of last resort and as guarantor of the international monetary system. This situation forced Britain to abandon the gold standard in May of 1931, which started the cycle of competitive devaluations and “beggar-thy-neighbor” policies that are

1 Introduction

9

such a defining feature of this period. By 1932, the British pound sterling had not only depreciated by 33%, but Britain also abandoned its traditional policy of free trade and introduced a 10% import tariff. The recovery from the Great Depression was spurred largely by the abandonment of the gold standard and the ensuing monetary expansion, as well as, of course, Roosevelt’s New Deal policies in the United States.4 The New Deal introduced increasing state intervention and management in the economy and society, with a set of policies, from electrification and transport infrastructure to housing policy and the 1935 Social Security Act, which profoundly reshaped the United States. The US recovery began in the spring of 1933. Output grew rapidly in the mid-1930s: real GDP rose at an average rate of 9% per year between 1933 and 1937. Output had fallen so deeply in the early years of the 1930s, however, that it remained substantially below its long-run trend level throughout the whole of this period. In 1937–1938 the United States suffered another severe downturn, but after mid-1938 the American economy grew even more rapidly than in the mid-1930s. US output finally returned to its long-run trend level in 1942. It was the spending on rearmament for World War II which reflated the national economies. The Great Depression had a tremendous impact on economies and societies: it ratified the end of “the world of yesterday” and quashed all hope that it could return, giving rise to an age of uncertainty. As a result, the Great Depression brought fundamental changes in economic theory and macroeconomic policies.

4 For a recent interpretation of the New Deal from the perspective of the global history approach, see Patel (2016), who views the New Deal as a key element in America’s repositioning in the world following the Great Depression.

10

1.2

R. Marchionatti

Economic Theory Between the Two World Wars: Dealing with New Problems and New Theoretical Challenges

On the threshold of World War I, at the end of the golden age of capitalism, economics was a rich and diversified system of theories where the international mainstream of marginalist and neoclassical theories coexisted with historicist, institutionalist and Marxist positions and approaches (see Vol. I). Alfred Marshall’s and the old Cambridge School’s economics were the dominant version of mainstream thinking (the “classical situation”, in Schumpeter’s words [Schumpeter 1954]), the other versions being Vilfredo Pareto’s Lausanne School and the Austrian School of Böhm-Bawerk and Wieser (but also the younger Joseph Schumpeter and Ludwig von Mises), to which we may add some contributions from the peripheries, first of all those made by Irving Fisher at Yale and Knut Wicksell in Sweden. That mainstream edifice, however, had to some extent disappointed the great expectations of its builders in the 1870s and showed some theoretical cracks and unsolved issues—from the increasing returns and competition issue in Marshall’s theoretical system to the issue of dynamics in Pareto’s system. Then World War I brought the golden age of classical liberal capitalism to an end and caused a profound social and economic crisis that ushered in an epoch of uncertainty, structural changes, increasing conflicts and de-growth for most countries. In this situation, economists had to deal with new problems (certainly new in their magnitude)—above all the problem of unemployment—against a backdrop of profound changes in capitalism’s structure and increasing disequilibria, which, intermingling with the internal problems of the theoretical systems, showed that the mainstream was inadequate or even obsolete, unable to interpret and cope with those problems, or provide appropriate practical solutions. Economists were thus up against the difficulty, as Keynes wrote in the preface to the General Theory, of “escaping from the old [ideas], which ramify … into every corner of our minds”, and of building more appropriate theoretical approaches.

1 Introduction

11

Under these stimuli and difficulties, the years between the two world wars were characterized by increasing criticisms of the traditional theoretical apparatus, as well as attempts to defend, readjust and rejuvenate it, and then, particularly in the 1930s, new lines of thought and a new strand of theoretical innovations. In the 1920s, the attempts to readjust the old theories predominated, above all along the lines of Pigou’s Marshallianism, at least in the English-speaking world. The picture changed in the 1930s: the new lines of thought were certainly influenced by the drastic social and economic change brought by the Great Crisis and world depression, but it is important to emphasize that the change was possible because by then the old theoretical system seemed to the new generations of economists to be on the ropes. This perceived weakness was principally the result of the first great theoretical controversy of that time, the controversy on Marshall’s theory, in particular on the theory of value, that began with Sraffa’s 1926 article in the Economic Journal—“the Sraffian Manifesto, demanding the revision of value theory”, as Shackle (1967, p. 12) called it—and some contributions by Frank Knight in the United States. This controversy was crucial in giving rise, on the one hand, to new theories of market structure and firm behavior in England and the United States—from Joan Robinson’s imperfect competition and Edward Chamberlin’s monopolistic competition, to various oligopoly theories, to Cambridge’s and Oxford’s industrial economics and Harvard’s industrial organization, to the institutionalist theories of firm behavior—and, on the other hand, to a radical shift in perspective in most economists’ conceptions and methodological approaches, which laid the foundations for the mainstream of economic science in the second part of the twentieth century. This shift was essentially the result of the criticism of the “classical situation” represented by Marshall’s work and legacy, by a new generation of economists who called for a reconstruction of economic science along more “rigorous” lines: they saw economic theory as a field where exact logic applied and adopted the methods of natural science (physics first of all), which they thought would alone guarantee the clarity and rigor needed for both theory and empirical research in economics. This reconstruction was successful, but came at a cost: the richness of Marshall’s theoretical system, as well as that of Pareto’s sociological work, was

12

R. Marchionatti

inevitably sacrificed and simplified to make it consistent with the new theoretical context. The great questions about economics’ conception and method raised above all by Marshall in his Principles and by Pareto in his Sociologia—essentially, in a nutshell, the methodological and analytical question of dealing with complex phenomena, were set aside by most economists, with the significant exception of John Maynard Keynes, the Cambridge economist who, more than anyone else, was able to grasp the essence of Marshall’s legacy, and also with the partial exception of his Viennese opponent, Friedrich Hayek, in his attempt to construct a neo-Austrian theory from an anti-Keynes perspective. Of course, the General Theory, Keynes’s “revolutionary” book, was at the heart of the economic debate of the second half of the 1930s— no economist could exempt himself from dealing with it in some way. Keynes’s clear-eyed view of the epoch-making change capitalism was going through prompted him to develop a theoretical structure which emerged in 1936 from a profound reflection on the deficiencies of Marshall’s theory, though it still took a Marshallian methodological and epistemological perspective which addressed the issue of complexity and rejected formalistic reductionism. However, although there were some cases of theoretical convergence toward Keynes’s theory, for example with some of the Stockholm School’s contributions, most of the new generation of economists, above all beyond the confines of Cambridge, considered Keynes’s approach methodologically old-fashioned and the formulation of the model vague and tried to incorporate Keynes’s insights and his analytical model in the new, fundamentally neo-positivist, “more rigorous”, theoretical pattern—an assimilation that will prove to be a misrepresentation. It was John Hicks, a brilliant young scholar trained at Robbins’s London School of Economics but attracted by Keynes’s work and a crucial figure in the transformation of economic theory in the 1930s, who “translated” Keynes’s theory into a formal language, giving it its first Walrasian formalization just a year after the publication of the General Theory, in 1937. Hicks’s effort was at the origin of the neoclassical synthesis which was destined to become the mainstream interpretation of Keynes in the postwar years and the essence of Keynesian macroeconomics. And, again, it was Hicks who led the “Pareto revival” of the 1930s and 1940s at the London School of Economics,

1 Introduction

13

a revival where Hicks’s work was flanked by that of economists like R. G. D. Allen, Abba Lerner and Oskar Lange, who redefined the theoretical economic approach—the latter two also participating in one of the most important debates of the time, on the socialist calculation in opposition to Mises and Hayek. This new generation of economists—the new Paretians were active not only at the London School of Economics in the United Kingdom but also at Harvard in the United States— concentrated on some of the main themes outlined in Vilfredo Pareto’s Manuale—i.e., the analysis of individual behavior, market efficiency and welfare economics—whereas Pareto’s post-Manuale thinking and that presented in the Sociologia were largely ignored. In those years, the dissemination, and influence, of Pareto’s ideas was wider than traditionally recognized in the literature of the history of economics. In fact, in addition to the LSE and Harvard, Paretian theory and methodological discourse played an important, and in some respects crucial, role in Vienna. For some years Vienna was one of the most creative places in the world—in economics we have the contributions of the neo-Austrians in Mises’s circle; the emergence of neo-Walrasian General Economic Equilibrium theory in Menger’s Mathematische Kolloquium with the path-breaking contributions of Abraham Wald and John Von Neumann; and last but not least the epistemological thinking in the neopositivist Wiener Kreis. In fact the Viennese discussion in the Kreis can be said to be the epistemological basis of the Pareto revival, giving a neopositivist formulation to Pareto’s program of complementing theoretical and empirical-quantitative analysis. This neo-positivist formulation was also at the basis of the program of the Econometric Society, the new international movement which attracted mathematical economists and statisticians from around the world in order to find new theoretical and statistical tools for addressing the great practical issues of the time.5 Econometrics emerged among the “modern models”—as Jan Tinbergen 5 In fact, the Wiener Kreis’s epistemological thinking converged with that of the new econometric movement. Both movements counted on physicalism—a concept for the unification of natural and social sciences introduced by Otto Neurath and Rudolf Carnap, members of the Kries—and verificationism, the philosophical doctrine that emerged in Hans Reichenbach’s Berliner Gruppe and in the Wiener Kreis, which maintains that only statements that are empirically verifiable are cognitively meaningful.

14

R. Marchionatti

(1949) called them—which adopted the neo-positivist approach to guarantee rigor in theoretical as well as empirical research in economics. These “modern models” were explicitly conceived as developments of Walras’s and Pareto’s mathematical economics by many scholars, even though many of the younger generation, who did not have a great knowledge of the history of economics, believed that the combination of theoretical and statistical analysis was largely new in economics, which they considered essentially a deductive discipline.6 From the pioneering work in Europe of Ragnar Frisch and Jan Tinbergen to the foundation of the Econometric Society (with the decisive support of Irving Fisher and Joseph Schumpeter in the United States) and, at the end of the 1930s, the Cowles Commission in Chicago, econometrics grew rapidly and was a fundamental pillar in the making of a new mainstream. Econometric research reflected and gave a new shape to two important trends in economic thought between the two World Wars: Keynes’s contribution—in its Hicksian version of general equilibrium analysis— and the dynamic business cycle theories. In fact, the Keynesian system was considered particularly suitable for statistical application. As Leontief (1948, p. 403) wrote in a survey of econometrics at the end of the 1940s, this was due to “the aggregative character of the Keynesian system, its actual or apparent ability to cut through the maze of individual facts and figures and reduce the description of the basic economic reality to a small number of structural relationships involving only a few strategic variables”. Significantly, Leontief added that “[t]he characteristic vagueness of its original formulation provides room for many different interpretations and thus makes possible the choice of a particular theoretical model to suit the available store of primary statistical information” (ibid.). As regards the business cycle theories, empirical business cycle research was one of the approaches to economic fluctuation analysis, the other being that of strict theoretical research, pursued in the 1920s in particular, by the Austrian school (with Hayek), by the members of the Cambridge 6 In fact, the fundamental importance of Pareto’s main methodological problems—in particular the relationship between the mathematical formulation of the models and experimental reality— was explicitly emphasized by the mathematical economists of the old generation, both in Europe and in the United States, for whom the econometric movement was the culmination of much previous work.

1 Introduction

15

school (especially Pigou and Robertson) and by the Stockholm school. Empirical business cycle research was initially represented by the institutional approach of Wesley Mitchell and his group at NBER in New York, and by the numerous research institutions created in Europe and the United States, above all in the 1920s. At the beginning of the 1930s, however, an alternative empirical program for analyzing the business cycle was constructed by Frisch and Tinbergen as part of the econometric program which they proposed in opposition to both the theoretical and the institutional approaches—in the first case because the theoretical approach did not verify theoretical results by statistical analysis; in the second case because quantitative economics had to be considered substantially different from what they felt was simple empirical manipulation of data, proposing a new framework which combined economic theory, mathematics and statistics. It was Tinbergen who introduced econometric analysis in applied macroeconomics, combining the Keynesian model with the use of dynamic relationships. Doubts and criticisms of this approach emerged—the most significant being the reservations that Keynes expressed in his harsh criticism of Tinbergen’s work. Those criticisms were put aside by Haavelmo’s “probabilistic revolution” at the Cowles Commission—in fact, his work was thought of as a rebuttal of Keynes’s criticism—which was a watershed in the history of econometrics, the new methodological approach which founded contemporary econometrics. At the end of the 1930s the foundations of the postwar mainstream, as a European-American construction, were laid. Some other bricks were added in the early 1940s—first of all the theory of games formulated by Oskar Morgenstern and John von Neumann at Princeton. Then, at the end of that decade, we will have the theoretical synthesis by Paul Samuelson which will open the postwar American era: but that is another story. It should be emphasized that these events and the success of the new trends implied the marginalization, if not the substantial disappearance, of other strands of thought which had been relevant before the war and in the 1920s: historicism, of course, but also American institutionalism at the end of the Mitchell “era” and Marxism—although some issues of the great Marxist debates between 1894 and 1914 remained in

16

R. Marchionatti

the structural theories of growth developed at Kiel Institute in Germany and then at the New School of Economic Research in New York.

1.3

The Map of Economic Theory Between the Two World Wars

In the period prior to World War I, the world’s leading centers were in Europe: Cambridge, Lausanne, Berlin and Vienna. Of these, only Cambridge maintained its importance throughout the post-World War I period, while Berlin and Vienna, extremely active in the 1920s, substantially vanished in the late 1930s when the Nazis came to power. Lausanne gradually declined as a center of intellectual attraction after the war,7 while the Paretian tradition moved elsewhere, first of all to London, but also to Vienna and the United States, spreading its influence internationally. Cambridge maintained its position of preeminence. In the early years after the war and until the second half of the 1920s, Pigou’s Marshallian economics was still dominant, but after the mid-1920s, when Marshallian economics weakened under the blows of criticism, Cambridge economics changed significantly, with the increasing influence of Keynes and his leadership: in the mid-1930s “Keynes became economics” in Cambridge, when his epoch-making book, the General Theory of Employment, Interest and Money was published. A new generation of young economists gradually emerged around him, forming the New Cambridge School. Some of them were close pupils and colleagues of Keynes— Austin and Joan Robinson, Richard Kahn, and, during the war, Nicholas Kaldor—and some of them were fellow-travelers, including Piero Sraffa 7

The University of Lausanne launched a search procedure to fill the post of professor of economics after Pasquale Boninsegni’s retirement in 1939 and received many expressions of interest—among others, from Nicholas Kaldor, John Hicks, Jacob Marschak and Tjalling Koopmans, that is, from economists who then had a crucial role in economics and could have made Lausanne a leading center once again. Due to the increasing international political tension, the university decided to narrow down the list to the French-speaking candidates, and at the end a little-known French economist, Firmin Oulès (1904–1992) was appointed, who held the chair for thirty years. I thank Fiorenzo Mornati for this information found in the archives of the University of Lausanne.

1 Introduction

17

and Michał Kalecki, from Italy and Poland, respectively, and Roy Harrod from Oxford. In Vienna and Berlin, the picture changed significantly compared with the pre-war period. In Vienna the dominant role of the Austrian school declined, as did the relevance of Austro-Marxism. In general we can say that Viennese economics developed principally along neo-Austrian and neo-Walrasian lines. The Neo-Austrian school was represented by Ludwig von Mises, whose Privatseminar was where a number of young economists like Friedrich Hayek, Oskar Morgenstern and Gottfried Haberler were educated—Hayek and Morgenstern also managed the Österreichisches Institut für Wirtschaftsforschung (Austrian Institute for Economic Research). As regards neo-Walrasian theory, its basis was laid down in Menger’s Mathematische Kolloquium with the contributions of the mathematicians Abraham Wald and John Von Neumann. And as mentioned earlier, the Wiener Kreis was notable for its methodological reflection on the relationship between philosophy, mathematics and economics. In Berlin, as in the rest of the German-speaking area, the Historical School dramatically lost its dominant position— Max Weber’s premature death was undoubtedly a factor—and the Marxist debate faded, while mathematical economics, in its classical/neoRicardian version, gained importance in the 1920s essentially due to the presence of Ladislaus von Bortkiewicz and his circle at the University of Berlin, where the mathematician Robert Remak and the young economist Wassily Leontief made important contributions—Leontief ’s Ph.D. dissertation was the first step of the input–output theory he developed later in the United States. Moreover, systematic empirical research on business cycles advanced in Berlin, with Ernst Wagemann’s Institut für Konjunkturforschung. Outside Berlin, some minor centers arose in the dynamic Weimar years: the Kiel Institut für Weltwirtschaft under the direction of Adolph Lowe around whom the so-called Kieler Schule was formed to investigate growth and the business cycle with a “structural” approach, and the University of Freiburg where Walter Eucken and Franz Böhm founded the “Freiburg School of Law and Economics” and ordoliberalism took shape. However, the picture in Germany and Austria changed significantly after 1933, when Nazis and Austro-Fascists seized

18

R. Marchionatti

power, reducing the voices of most intellectuals to silence and forcing many of them to emigrate. At the same time, new European centers emerged, first in London, and then in Northern Europe. The London School of Economics, which had been founded in the mid-1890s, achieved a prominent position in the years after the war under the strong leadership of Lionel Robbins, head of the department of economics. Robbins transformed the School into an anti-Marshallian and then anti-Keynesian center—in an Austrian and Walras-Pareto theoretical perspective—making it for a decade the main opponent of Cambridge economics in England and one of the world’s most influential new centers in economic theory. Around Robbins and the Viennese Friedrich Hayek (in London from the early 1930s), a group of young economists—most notably John Hicks and Abba Lerner— gave life to the “Robbins circle”. In Northern Europe, original economic thinking developed in Sweden, with the neo-Wicksellian Stockholm School made up of economists like Gunnar Myrdal, Bertil Ohlin and Eric Lindahl. From the second half the 1920s, new centers formed around Ragnar Frisch and Jan Tinbergen at the universities of Oslo and Rotterdam, where the econometric movement started. The picture also changed in the other important European peripheries of the previous period, France, Italy and Russia. The French situation was essentially characterized by the development and increasing international significance, essentially as part of the econometric movement, of the group of engineer-economists of the Grandes Écoles, François Divisia being the most representative scholar. In Italy there was a substantial consolidation of the discipline, but Italian economists participated in a relatively minor degree in the international development of new ideas, clinging to the neoclassical orthodoxy of the pre-war years. In the new URSS, in spite of the rather rigorous ideological control, research was lively in the 1920s—as witnessed by the work, among the others, of Nikolai Kondratieff and Eugen Slutsky. But soon, as in the Germanspeaking area in the 1930s as well as in Italy, the tragic authoritarian turn due to Stalin’s purges made it more and more difficult to carry out scientific research. On the other side of the ocean, the United States, which in the late 1890s had been a rapidly growing periphery in the field of economics,

1 Introduction

19

saw intense expansion after the war. This was especially true in the 1930s, with the increasing consolidation of three of the leading centers of economic studies, Chicago, Harvard and New York. In New York, Columbia University became the hub of American institutionalism, under the leadership of Wesley Mitchell, and, together with the recently founded New School of Social Research and the National Bureau of Economic Research (NBER), was a powerful attraction for nonneoclassical scholars. The Harvard department of economics thanks to the arrival of such eminent European economists as Joseph A. Schumpeter and Wassily Leontief at the beginning of the 1930s, and the innovative work of Harvard-trained scholars like Edward Chamberlin and Edward Mason, as well as Alvin Hansen’s contribution to the development of Keynesian economics, became an increasingly influential intellectual community. The situation in the other great center, the University of Chicago, was quite different. Here, economics was the intellectual result of a mix of different individuals, representatives of different conceptions of economics: alongside the precursors (in part) of the future Chicago school, like Frank Knight, Jacob Viner and Henry Simons, there were the small group of the institutionalists, and the group of quantitative economists, such as the émigré economist Oskar Lange, close to the Cowles Commission for Economic Research, which moved to Chicago as an independent institution connected with the university’s department of economics in the late 1930s, where the econometric revolution fully developed thanks to European imports like Jacob Marschak, Trygve Haavelmo and Tjalling Koopmans. Another of these leading centers was Princeton—both the university and the Institute of Advanced Studies—where two other European émigrés, John von Neumann and Oskar Morgenstern, created the new field of game theory.

References Eichengreen, Barry. 1992. Golden Fetters: The Gold Standard and the Great Depression, 1919–1939. Oxford: Oxford University Press.

20

R. Marchionatti

Keynes, John Maynard. 1971 [1919]. The Economic Consequences of the Peace. Reprinted in The Collected Writings of J. M. Keynes, vol. 2, ed. Don Moggridge. London: Macmillan and Cambridge University Press. Kindleberger, Charles.1986. The World in Depression, 1929–1939. Enlarged ed. Berkeley, CA: University of California Press. Leontief, Wassily. 1948. Econometrics. In A Survey of Contemporary Economics, ed. Howard S. Ellis. Philadelphia: The Blakiston Company for The American Economic Association. Patel, Kiran Klaus. 2016. The New Deal: A Global History. Princeton: Princeton University Press. Robbins, Lionel. 1934. The Great Depression. London: Macmillan. Schumpeter, Joseph A. 1954. A History of Economic Analysis. London: Allen & Unwin. Shackle, G.L.S. 1967. The Years of High Theory: Invention and Tradition in Economic Thought 1926–1939. Cambridge: Cambridge University Press. Steinbeck, John. 1992 [1939]. The Grapes of Wrath. New York: Penguin. Tinbergen, Jan. 1949. Du Système de Pareto aux modéles modern. Revue d’économie politique 59: 642–652.

2 Economics in Cambridge and Oxford in the Age of John Maynard Keynes

2.1

Prologue: Between the Old and the New Cambridge School

Joan Robinson (1973, p. ix) remembers that when she arrived in Cambridge in 1921 as a student, “Marshall was economics” and his “Principles was the Bible”. Actually, in the early years after the war and until the second half of the 1920s, Marshallian economics was economics in Cambridge and Arthur Cecil Pigou, the “Prof ”, who held the chair of Political Economy from 1908 to 1943 (see Vol. I, Chap. 3.2), was its main exponent, as his work aspired to represent the theoretical basis of Cambridge economics. After the mid-1920s, however, Marshallian economics was at the center of an international critical debate which weakened it as the general orthodoxy. Already anticipated by an article by the Cambridge economic historian John Clapham in 1922, the debate unfolded in the pages of the Economic Journal between 1924 and 1930, and involved some of the most important Cambridge economists like Pigou himself, Denis Robertson, Gerald Shove and Piero Sraffa—with important critical connections with some American © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 R. Marchionatti, Economic Theory in the Twentieth Century, An Intellectual History—Volume II, https://doi.org/10.1007/978-3-030-80987-4_2

21

22

R. Marchionatti

contributions of the mid-1920s—which marked the crisis of the analytical core of Marshallian pure economics (see Chap. 7.1). Cambridge economics changed—a change less evident in Oxford where the links with the Marshallian tradition remained in a certain sense stronger—in the early 1930, when a new generation of young economists gradually emerged around the leading figure of John Maynard Keynes. They formed, according to a well-established tradition in the literature, the New Cambridge School. But the theoretical framework of this school was less homogeneous than before. In fact, economics in Cambridge between the two world wars lost the unitary character it had had before World War I. Marcuzzo et al. (2008) maintain that in the interwar years the Cambridge school dissolved into a “Cambridge group”, without a common corpus of accepted ideas to defend, whose identity stemmed from motivations, values, life-styles and work-styles.1 Certainly, after the conclusion of the debate on Marshall and the new path of research followed by Keynes after the Treatise on Money, a Cambridge School strictu sensu did not exist in the 1930s, due to important differences in the various economists’ theoretical approach. However, we adopt the traditional term of “New Cambridge School” for several reasons. First, the term school is appropriate because many of the defining criteria of a school appear to be present: a strong intellectual leadership—that of Keynes, of course—the existence of a journal, the Economic Journal , edited by Keynes himself (he was editor between 1912 and 1944, alongside Edgeworth between 1918 and 1925, Austin Robinson from 1934 and in partnership with Roy Harrod from 1945), which published the papers of Keynes’ entourage and provided a channel for the international dissemination of Cambridge economists’ ideas. Yet another criterion was the existence of a methodological and theoretical discussion undertaken collectively, sometimes in informal institutions like the “Cambridge Circus”, where Keynes’s Treatise on Money was discussed by the group of young economists consisting of Piero Sraffa, Austin and Joan Robinson, Richard Kahn and James Meade.2 This discussion did not lead to a 1

Marcuzzo and Rosselli (2005) explores the dynamics of this “group” through a study of Cambridge economists’ correspondence. 2 James Meade (1907–1995) came to Cambridge from Oxford for a year, invited by Robertson. Keynes judged him to be one of the most promising of the Oxford economists. Years later,

2 Economics in Cambridge and Oxford in the Age …

23

monolithic unitary conceptualization but to an articulated construction, open to contributions from outside. In fact, the school was a mixture of a core group of economists around Keynes and several fellow-travelers who did not become integral members of the school but maintained significant relations and intellectual interchange with the core group. Second, as Becattini (1990, p. 306) wrote: “Cambridge, with its more typical exponents, continues, à la Marshall, to speak to the world, about its problems and opportunities” (our translation), thus adopting a common “intellectual” approach: in this sense, the use, in a broad sense, of the term Cambridge School continues to be appropriate in order to stress Marshall’s essentially methodological and ethical-philosophical legacy. This legacy left its imprint on the young economists, like Richard Kahn and the Robinsons, not to mention Keynes, in many ways Marshall’s true heir.

2.2

Arthur C. Pigou and Marshallian Economics in the 1920s and Its Decline

It was Pigou, more than any other, who brought up a generation of Cambridge economists in the conviction that (in his often-repeated words) “it’s all in Marshall” and the belief that if they were in error, it was because they had misunderstood Marshall or had overlooked some essential passage in the holy writ. (E.A.G. Robinson 1968, p. 91)

Pigou’s theoretical work defined, more than that of any other economist, Marshallian economics, i.e., the orthodoxy in the English-speaking world. The theoretical pillar of this construction was certainly the Economics of Welfare (Pigou 1920), which was based on the framework of Wealth and Welfare (see Vol. I, Chap. 3.2), with a large addition of

Meade returned to Cambridge as Professor of Political Economy in succession to Robertson, after a period at the London School of Economics. He was awarded the 1977 Nobel Memorial Prize in Economic Sciences jointly with the Swedish economist Bertil Ohlin for their “pathbreaking contribution to the theory of international trade and international capital movements”.

24

R. Marchionatti

material. Published in four editions until 1932, it became the most representative book of this old Cambridge tradition in economics. It encompassed the old welfare economics based on a cardinalist conception of welfarism.3 Strictly related to this book were two other works by Pigou: Industrial Fluctuations (Pigou 1927), which re-examined his considerations on the variability of the national dividend, and A Study in Public Finance (Pigou 1928), where he transposed his writings on financing the war into a general analysis of public finance (see Aslanbeigui and Oakes 2015, 2016), designed by Pigou to supplement the other two volumes—the three books together embodying the core of his conception of Marshallian general economics. A crucial part in the completion of this Marshallian theoretical construction was Pigou’s interpretation and systematization of Marshall’s theory of value under competitive conditions—presented in two articles published in the Economic Journal in 1927 and 1928 on the law of costs and the analysis of supply, and substantially incorporated in the third edition of the Economics of Welfare (see Chap. 7.1). In these papers, Pigou followed a formally rigorous approach to completing and refining Marshall’s theory. To complete the picture of Marshallian economics in the 1920s, we must remember that Marshall’s style and subjects of interest, in particular his late industrial economics work, Industry and Trade, continued in two ways. On the one hand, there was the work of some Marshall’s pupils, who studied economics under him at Cambridge and then taught Economic History there—as is the case of John Harold Clapham (1873–1946), or, outside Cambridge, Sydney Chapman (1871–1951) in Manchester and David H. Macgregor (1877–1953) in Oxford—and of the American-born but Cambridge-trained Philip Sargant Florence (1890–1982), in 1929 at the University of Birmingham. With the exception of Sargant Florence’s Logic of Industrial Organization (1933), their 3

As Myint (1948, p. 173) wrote, “Prof. Pigou’s Economics of Welfare occupies a unique position in the history of economic thought. It is the culmination of the great Neo-classical tradition; and yet at the same time it marks a departure from it. For in his attempt to systematize his predecessors’ concrete ad hoc approach to welfare economic problems Prof. Pigou has arrived at a concept of the general optimum; and this concept of the optimum, […] represents a significant intermingling of the concrete particular approach of the English economists and the formal general approach of the continental economists”. See also Backhouse and Nishizawa (2010).

2 Economics in Cambridge and Oxford in the Age …

25

more important works were published in the two first decades of the century, when industrial economics was a strong subject of research in Cambridge. After the war, the general opinion of the descriptive nature of Industry and Trade made their work of little relevance from the theoretical standpoint and irrelevant for the development of economic theory (see Raffaelli 2004). On the other hand, as Raffaelli (2004) writes, “some relics of Marshall’s program” survived in the work of two important Cambridge economists, Dennis Robertson—whose The Control of Industry (1923) relies on central issues of Industry and Trade—and above all, in the 1930s, Austin Robinson (see section “Theoretical Contributions, I: Austin Robinson’s Industrial Economics”), one of the exponents of the new generation close to Keynes. Cambridge economics in the 1920s—the framework of what can be considered the “old Cambridge School” in Pigou’s era—cannot be understood in its entirety if we do not consider the main channel through which the Marshallian word spread, viz., the teaching structure of the Economic Tripos. The main economic theory course was given by Pigou on the basis of Marshall’s Principles, while the three lecturers were Gerald Shove, Frederick Lavington and Dennis Robertson; John Maynard Keynes and Hubert Henderson (1890–1952)—economist and politician lecturer in economics at Cambridge from 1919 to 1923, and later at in Oxford—lectured on monetary economics. Other courses on trade and finance, monetary systems, credit and entrepreneurship were held by Claude W. Guillebaud (1890–1971), Alfred Marshall’s nephew, Marjorie Holland (née Tappan) (1895–1977), the first female member of the Faculty of Economics, Maurice Dobb (1900–1976) and Austin Robinson (1897–1993), the latter two being representatives of the younger generation. This teaching structure is essentially that of the “Old Cambridge School”. From the early 1930s the situation of the Tripos changed, reflecting the new theoretical stance: Robertson became reader and Shove lecturer and gave, respectively, the course on money and courses on Production, Value and Distribution. Keynes taught “the Pure Theory of Money” and then “the Monetary Theory of Production”, while the younger Dobb, Austin Robinson and Richard Kahn were involved in teaching different issues, from short-period analysis to the problems of labor and of money, banking and international trade.

26

R. Marchionatti

Another important, highly selective and increasingly important institution of Cambridge’s cultural environment was the Political Economy Club, which Keynes had founded in 1909. An invitation-only club, it initially met weekly in Keynes’ rooms at King’s College, where attendance was reserved for those whom Keynes judged to be “the best of Cambridge’s aspiring economists” (Shenk 2013, p. 26). It gradually came to signal membership in Keynes’s inner circle and was a powerful vehicle of influence for his thought. A new generation of economists emerged after the mid-1920s and the criticism of Marshall and Marshallianism mentioned above. This new generation was certainly critical of Marshallian economics, but did not break with it entirely. In particular, it did not represent a real anti-Marshall turn on every level—analytical, methodological and ethical-philosophical. Rather, it was to some extent a development of parts of Marshall’s and Pigou’s thought with substantial departures from the old Cambridge intellectual atmosphere. In this connection, Joan Robinson showed an understanding of what was coming to be the prevailing feeling when she remarked: “The more I learn about economics the more I admire Marshall’s intellect and the less I like his character” (Robinson 1973, p. 259).4 The new school broke ground in criticizing the Marshallian theory of value and constructing a theory of imperfect competition, with vital contributions from Sraffa—his 1926 article was a benchmark for the younger group. Though the international debate on the Marshallian theory of value in the second part of the 1920s was a major cause of the significant change in economic thinking of which the new Cambridge exponents were authors and witnesses, the crucial factor in making this possible was the reflection on the structural changes in the real economy and above all on the world crisis and depression of those years. It was in 4 Joan Robinson wrote: “Marshall had a remarkable intuitive genius and he knew by instinct how to find out the one case where you can say something without the arrow getting you all mixed up. The short period supply curve, under strictly perfect competition, when demand always rises, never falls … One hop up in time, and you have a position where the arrow will not worry you laterally, so long as you are in the short period. What did he do? The more I learn about economics the more I admire Marshall’s intellect and the less I like his character. He worked out his short period for forward movements with great lucidity and then he filled the book with tear gas, so that no one would notice that he had fudged the whole of the rest of the argument. Just read Marshall’s Principles through again with a gas mask on and you will see how right I am” (Robinson 1973, pp. 258–259).

2 Economics in Cambridge and Oxford in the Age …

27

this context that Keynes’s revolution broke out. Keynes’s preeminence in the Cambridge of the 1930s, above all when he moved decisively toward the macroeconomic revolution of the General Theory, brought about an anti-Pigouvian shift. Pigou’s The Theory of Unemployment (Pigou 1933), where analysis concentrated on the aggregate demand for labor, was strongly criticized by Keynes who argued that it seemed “to get out of the Classical Theory all that can be got out of it” (Keynes 1973b [1936], p. 260).5 Keynes’s intellectual predominance and “theoretical radicalization” in the 1930s had another crucial effect: the progressive marginalization in Cambridge of authors like Robertson and Shove. Dennis Robertson had returned to Cambridge after the war and worked on the role of monetary factors in the trade cycle, at the same time beginning a fruitful collaboration with Keynes which resulted in closely connected (Marshallian) works, in particular Robertson’s Banking Policy and the Price Level (Robertson 1926), where he extended the real analysis of the Study of Industrial Fluctuations by analyzing the role of monetary forces in the trade cycle, and Keynes’s A Tract on Monetary Reform (Keynes 1923) and A Treatise on Money (Keynes 1930).6 But in the 1930s their collaboration gradually slowed, and after the publication of Keynes’s General Theory they were involved in controversies over aspects of Keynes’s theory.7 This situation probably induced Robertson to move in 1938 to the London School of Economics—but after several years during the war as economic adviser to the Treasury, he came back to 5 Keynes’ negative judgment was shared by Shove and the young Keynesians, but according to Collard (1981) some criticisms were misplaced, and certainly they were too sharp. In any case, the theoretical controversies between Pigou and Keynes continued throughout the 1930s and 1940s. Pigou analyzed the issues raised by Keynes in The General Theory in several works, from his immediate response on Economica (Pigou 1936) to “Real and Money Wage Rates in Relation to Unemployment” (Pigou 1937), an article which Keynes viewed as “the work of a sick man” (Keynes quoted in Collard 2011, p. 27), and on to Employment and Equilibrium: A Theoretical Discussion (Pigou 1941), as well as the article “The Classical Stationary State” (Pigou 1943), which outlined Pigou’s real balance effect (now generally known as the “Pigou effect”). Pigou’s interest in Keynes’s macroeconomics continued with the pamphlet Keynes’s ‘General Theory’: A Retrospective View (Pigou 1950), in which Pigou accepted some elements of Keynes’s work and acknowledged that he had not grasped the significance of Keynes’ theory of effective demand (see Collard 1981). 6 On the working relationship between Keynes and Robertson in the 1920s, see Presley (1992). 7 On the issues that divided Robertson and Keynes, see Presley (1981), Bibow (1995), and Fletcher (2008).

28

R. Marchionatti

Cambridge in 1944 when he succeeded to the chair of economics on Pigou’s retirement. Gerald Shove also returned to his career in Cambridge after the war, when he had been a conscientious objector. He became lecturer in 1923 and fellow in 1926. He participated actively in the debates that took place in the 1920s and 1930s; in particular, he made contributions to the debates on increasing returns and imperfect competition as a non-dogmatic and sophisticated defender of Marshall. His position was innovative, but inside Marshallian lines, and was presented in an article (Shove 1930) in the Economic Journal symposium on increasing returns and competition organized by Keynes (see Chap. 7.1). Shove was involved in the debate on imperfect competition and, in his review of Joan Robinson’s book (Shove 1933), he expressed a kind but strong criticism of her static approach and of what he considered the insufficient realism of her analysis. Shove reconsidered the issue of the lack of realism of the economics of imperfect competition in 1942, in an important essay on Marshall (Shove 1942) where he contrasted Joan Robinson’s analysis with Marshall’s approach. He argued that Marshall was aware of the relevance of non-competitive market forms in reality and their theoretical indeterminateness—Marshall, Shove (1942, p. 320) writes, “accepted the view that value under monopolistic competition is theoretically indeterminate, and concluded accordingly that pure analysis could not accomplish much in that field”. Shove concluded that younger economists refined Marshall’s concepts and made them “more precise”, but this was accomplished at a considerable cost to the realism of the analysis: The attempt to fuse realistic study with theoretical analysis has, on the whole, not been followed up … Partly no doubt this has been due to the itch for precise results: not all of us are content to act on the late Prof. Wildon Carr’s [a British philosopher, author’s note ] admirable motto (which might well have been Marshall’s), “It is better to be vaguely right than precisely wrong”. (Shove 1942, p. 323)

2 Economics in Cambridge and Oxford in the Age …

29

Shove was not a protagonist of the Keynesian revolution. He was a close friend of Keynes, and, as their correspondence testifies, he had a sympathetic attitude toward the General Theory (see Sardoni 2004), without contributing to it in his writings. This explains why, after 1933, he was in an increasingly marginal position in the Cambridge economists’ environment. Certainly, in the second part of the 1930s “Keynes was economics” in Cambridge.

2.3

John Maynard Keynes (1883–1946)

John Maynard Keynes can be considered the most important economist of the twentieth century. One of “the sharpest and clearest” intellects of his time according to the great philosopher Bertrand Russell (2000 [1968], p. 69), he was part of the English establishment and at the same time one of its harshest critics, as well as a member of the culturally influential Bloomsbury group. He was the author of many seminal books, and in particular the author of the most impactful book of economics of his epoch, the General Theory of Employment, Interest and Money: as many scholars have emphasized, its influence has been matched only by Smith’s Wealth of Nations and Marx’s Das Kapital and, we could add, by Ricardo’s Principles and Marshall’s Principles. Keynes’s book inaugurated a new era of economic theory and greatly influenced the birth of a new economic policy. Keynes was more than a great economist, as Schumpeter (1954, p. 1170) recognized: Like most of the great economists whose messages reached the general public, … Lord Keynes was much else besides being a worker in the field of economic analysis. He was a forceful and dauntless leader of public opinion, a wise adviser to his country … and a successful representative of her interest.

Keynes was a Cambridge man: born, educated and teaching in Cambridge, he was the undisputed leader of the Cambridge School in the 1930s and an Englishman who represented the United Kingdom’s

30

R. Marchionatti

interests internationally. But he was also a man who thought in a universal perspective: he was a harsh critic of European nationalism and the architect of the reform of the postwar international system (see, e.g., Steil 2013) which would avoid a repetition of the errors of the interwar period and the re-emergence of a global depression, enabling every country to be prosperous in a prosperous world economy.

Biographical Note8 John Maynard Keynes was born on June 5, 1883, in Cambridge. His father was the eminent Cambridge economist and methodologist John Neville Keynes (see Vol. I, Chaps. 3.2 and 8.1). His mother was Florence Ada Brown, an early member of Newnham College and a social reformer who, in 1914, was the first woman elected to Cambridge town council, and in 1932 was the first woman to become major. The environment where John Maynard grew up was extremely rich from the intellectual standpoint: the Keynes’s home was frequented by such eminent Cambridge scholars as Henry Sidgwick and Alfred Marshall. He was educated at the prestigious school of Eton, entering in 1897 with a scholarship, and, from 1902, at King’s College, Cambridge. In the early 1900s, Keynes’s cultural formation and weltanschauung was influenced in particular by two great Cambridge intellectuals: the philosopher George Edward Moore (1873–1958) and the philosopher and logician Bertrand Russell (1872–1970), the founders, together with Ludwig Wittgenstein (1889–1951)—who studied under Russell at Cambridge in 1911–1912 and returned to Cambridge in 1929, remaining until his death and establishing a close friendship with Keynes and Sraffa— of the analytic tradition in British philosophy. Later, Alfred Marshall’s influence on Keynes became increasingly important. Moore and Russell were both members of the Cambridge secret society of the Apostles, the most exclusive and influential intellectual circle in Cambridge, of which Keynes became a member in 1903. Both men, and Moore in 8

For the biography of Keynes see: Harrod (1951), Moggridge (1992), and Skidelsky (1983, 1992, 2000). For a history of the Keynesian revolution, see Clarke (1988), see also Clarke (2009).

2 Economics in Cambridge and Oxford in the Age …

31

particular, influenced the Bloomsbury Group.9 In 1903, one year after Keynes went up to Cambridge, Moore published Principia Ethica— where ethics is the inquiry into what is good, including what is good in human conduct—and Russell his Principles of Mathematica, followed in 1910–1913 by the Principia Mathematica (written together with the Cambridge philosopher and mathematician Alfred N. Whitehead (1861–1947), two books that were fundamental in developing modern mathematical logic. Remembering those years in his 1938 autobiographical sketch My Early Beliefs, Keynes writes: “I went up to Cambridge at Michaelmas 1902, and Moore’s Principia Ethica came out at the end of my first year … Its effect on us … dominated, and perhaps still dominate, everything else” (Keynes 1972b, pp. 435–436). In fact, Moore’s book was essential to Keynes’s early intellectual formation. Keynes described the influence of Principia Ethica on the young members of the Bloomsbury group and of the Apostles as “overwhelming, exciting, exhilarating, the beginning of a renaissance, the opening of a new heaven on a new earth” (ibid., p. 435). In 1905 Keynes graduated with a degree in mathematics, coming out as twelfth wrangler. In his thesis on probability Keynes blended together Moore and Russell—“I was writing under the joint influence of Moore’s Principia Ethica and Russell’s Principia Mathematica” (ibid., p. 445). In the preface to the Treatise of Probability, he writes that Russell’s book furnished a method for handling the material provided by Moore’s book. He spent 1905–1906 preparing for the civil service examination—including a term attending Marshall’s lectures and reading a great amount of economics—in which he came second overall. In 1907, Keynes entered the Civil Service and worked for two years in the India Office, work which resulted in his first book on economics, Indian Currency and Finance published in 1913, essentially a study on 9

The Bloomsbury group was a group of intellectuals (mainly writers, philosophers and artists) including the novelists Virginia Woolf and Edward M. Forster, the publisher and political thinker Leonard Woolf (Virginia’s husband), the historian and biographer Lytton Strachey, the poet Rupert Brooke, the artists and art critics Duncan Grant, Roger Fry, Clive and Vanessa Bell and John Maynard Keynes himself. Closely associated with the University of Cambridge and its new intellectual climate, the group was extremely influential in shaping the intellectual atmosphere of those times. The “Bloomsberries” developed a range of ideas, attitudes and practices founded on what were at the time unconventional principles of friendship and aesthetics and rejected the dominant values of the Victorian age.

32

R. Marchionatti

the working of the gold exchange standard, according to Schumpeter “the best English work on the gold exchange standard”. After the publication of the book, he became member of the Royal Commission on Indian Finance and Currency. In London Keynes lived in Bloomsbury, a district in central London, together with his group of Bloomsbury friends. Keynes returned to Cambridge in 1908 at Marshall’s invitation to lecture in the Economics Tripos. At the same time he continued his work on probability. He became a Fellow of King’s in March 1909 with a dissertation on probability (which was published in a revised form as A Treatise on Probability in 1921) and Girdlers’ Lecturer in Economics in 1910. In 1911, he became Editor of the Economic Journal , a post he held until 1945. In January 1915, after the outbreak of World War I, Keynes entered the Treasury, where he dealt with Britain’s overseas financial affairs. In 1919, he was the Principal Treasury Representative at the Paris Peace Conference. He resigned and left Paris in June 1919 in disagreement with the clauses imposed by the Peace Treaty. On his return to England, he wrote The Economic Consequences of the Peace (Keynes 1971a). In it he strongly criticized short-sighted politicians, condemned the harsh terms of the treaty and outlined alternative proposals for peace: limitation of German damages, cancelation of inter-Ally debts, creation of a European free trade area and an international loan to stabilize the exchanges. Moreover, he prophesied doom if the treaty were carried out and Germany kept poor for a generation. Translated into many languages, the book gave Keynes international fame. In 1923, Keynes wrote A Tract on Monetary Reform (Keynes 1971b). A Tract explored the consequences of the change in the value of money (i.e., its instability) on society, or in other words the deleterious effects of inflation and deflation, and proposed remedies to enhance price stability, including central bank regulation of the interest rate. For internal policy, Keynes recommended that the discount rate should be aimed at credit control. The domestic money supply would, as a consequence, be disengaged from gold. He rejected the gold standard as a system for the regulation of the economy. Thus in the 1920s Keynes struggled politically and intellectually for stable money and full employment, and against deflation, overvalued exchange rates and the sacrifice of populations in the hopes of regaining the imagined benefits of the classical

2 Economics in Cambridge and Oxford in the Age …

33

gold standard at some time in the distant future, trying to prevent, without success, Britain’s return to the gold standard in 1925 at an overvalued exchange rate. In the second half of the 1920s, Keynes’s thinking delved deeper into monetary issues, developing an original theoretical framework. The result of his work was the Treatise on Money published in 1930, the summa of his thought in the 1920s (Keynes 1971c). In the book he explained the forces that caused the fluctuation of output but not what determines its actual level. At the same time in the 1920s, Keynes—who married the Russian dancer Lydia Lopokova (1892–1981) in 1925—continued as an adviser to governments. He did so more regularly, together with Pigou, Lionel Robbins, Joseph Stamp and Hubert Henderson, after the formation in 1930 of the Economic Advisory Council (EAC) which provided advice to the Prime Minister, and its various committees, notably the Committee on Economic Information, which met regularly between 1931 and 1939 and became an important influence on government thinking. Keynes was also a member of the Macmillan Committee on Finance and Industry created by the Labour government in November 1929 after the Wall Street Crash. The Committee’s report was published in June 1931. It adopted the so-called Treasury view that expenditure on public works was not the answer, even though some of its leading members, including Keynes, signed Addendum 1, which advocated a program of public works and import restrictions. However, the committee insisted that monetary policy should be concerned with the maintenance of the parity of the foreign exchanges before the avoidance of the credit cycle and the stability of the price level. Only a few weeks after the publication of the Macmillan Report, the financial crisis that had begun in continental Europe hit the financial markets in London. The subsequent political and economic chaos led to the replacing of the Labour-led coalition Government with the “National Government”, and on September 21, 1931, Britain suspended membership of the gold standard. Keynes considered the impact of the 1929 crisis and the following worldwide slump to be unprecedented. From the theoretical standpoint, his initial interpretation of the facts and policy guidelines were based on the Treatise. But a short time after the appearance of the Treatise, Keynes began to work on a new book which was completed in late 1935 and published

34

R. Marchionatti

at the beginning of 1936: The General Theory of Employment Interest and Money. After the outbreak of war in 1939, Keynes’s influence grew larger as regards both domestic and overseas finance, both in the prosecution of the war and planning for the postwar world. He was appointed adviser to the Chancellor of the Exchequer. He began to concern himself with postwar problems in 1941 and then played a leading role in the negotiations with the United States government for lend-lease support in 1941, and again in 1944 and 1945 as one of the architects of the Bretton Woods Agreement. Keynes died of a heart attack at his country home in Tilton, Sussex, on April 21, 1946.

Keynes’s Epistemology: The Treatise on Probability, 1921, and the Development of His Philosophical Thought The Treatise on Probability (Keynes 1973a [1921]) is at the roots of Keynes’s epistemological reflections (see Carabelli 1988). It is the result of a long intellectual tour that originates in Keynes’s critical reaction to G. E. Moore’s Principia Ethica at the beginning of the century (Moore 1903). In fact, considerations of probability played a large part in Moore’s theory of the justification of general rules of conduct.10 This was indeed, Keynes writes, “an important contributory cause to my spending all the leisure of many years on the study of that subject” (Keynes 1921, p. 445). Keynes proposed a theory of behavior under uncertainty that emphasizes the superiority of individual judgment to general rules. This theory was influenced by the work of Bertrand Russell. In his work on the foundations of mathematics, Russell’s aim was to give a logical 10

Moore’s conception of ethical human conduct is presented in Chap. V of his book, on “Ethics in relation to conduct”. Moore thinks that the best course of action is the one with the highest expected (or most probable) goodness. However, he writes, we do not have the knowledge needed in order to calculate the goodness and we cannot know all the future effects of an action. Therefore, we should follow the general rules adhered to in society. Since these rules represent accumulated knowledge, they would result in the greatest frequency of good outcomes. This conception of practical ethics was at odds with that professed at that time by Keynes, who opposed general rules of conduct and, instead, relied on personal judgment.

2 Economics in Cambridge and Oxford in the Age …

35

basis to mathematics and determine the logic of deduction. Analogously, Keynes’s aim was to establish and evaluate the logic of induction. In this perspective, probability is defined as “the degree of belief which it is rational to entertain in given conditions” (ibid., p. 4), i.e., the degree of rational belief in a proposition on the basis of the available evidence. The inductive hypothesis, Keynes writes, is logically founded on the principle of limited independent variety—i.e., it depends on the assumption that only a finite number of characteristics are relevant to the proposition under examination. Therefore the inductive argument becomes less applicable the greater the number of independent constituents of a system. In other words, an object of inductive inference should not be complex. This implies assuming the hypothesis of atomism: the system under examination consists of atoms whose effects are distinct, independent and invariable. This is an assumption about the character of material laws upon which scientists appear commonly to act, Keynes writes. However, a system may have a different degree of complexity and thus be organic. If so, the inductive method is invalid. Here Keynes used Moore’s definition of organic, which he uses to denote the fact that “a whole has an intrinsic value different in amount from the sum of the values of its parts” (Moore 1903, p. 36). Keynes stressed two other limits and difficulties from the standpoint of the student of probability. First, the problem of measurability: the assumption that probabilities are always quantitative and measurable is not correct, Keynes says, and maintains that, so far from our being able to measure them, it is not even clear that we are always able to place them in an order of magnitude. Second, the issue of whether the probability is knowable: even though there is a probability, Keynes writes, it may remain unknown because our knowledge can be vague, where vagueness is defined as knowledge that is not susceptible of “strict logical treatment” (Keynes 1973a [1921], p. 17). Keynes criticizes the mathematical symbolism of Principia Mathematica, considered as the language of scientific inquiry, and brings up the issue of whether symbolic analysis is more precise and less ambiguous than everyday language. He answers:

36

R. Marchionatti

There are occasions for very exact methods of statement, such as are employed in Mr. Russell’s Principia Mathematica. But there are advantages also in writing the English of Hume. Mr. Moore has developed in Principia Ethica an intermediate style which in his hands has force and beauty… Confusion of thought is not always best avoided by technical and unaccustomed expressions, to which the mind has no an immediate reaction of understanding; it is possible, under cover of a careful formalism, to make statements, which, if expressed in plain language, the mind would immediately repudiate. There is much to be said, therefore, in favour of understanding the substance of what you are saying all the time, and of never reducing the substantives of your argument to the mental status of an x or y. (ibid., p. 20, fn. 1)

Keynes’s position in the Treatise was neither atomistic nor organicist but a sort of middle ground.11 Keynes’s position changed some years later in the mid-1920s. In his 1926 biographical essay on Edgeworth, Keynes criticized the use of the atomistic hypothesis in mathematical psychics (i.e., in the application of mathematics to social sciences). He wrote that “the atomic hypothesis … has worked so splendidly in Physics”, but it “breaks down in Psychics”. In fact, he writes: We are faced at every turn with the problems of Organic Unity, of Discreteness, of Discontinuity—the whole is not equal to the sum of the parts, comparisons of quantity fail us, small changes produce large effects, the assumptions of a uniform and homogeneous continuum are not satisfied. (Keynes 1972b, p. 262)

Several reasons explain Keynes’s switch.12 In the mid-1920s, Keynes had become an economist, trained in Marshall. Tackling the problems 11 There has been a wide debate among scholars trying to identify Keynes’s position in the Treatise as atomistic or as organicist. The thesis of the middle ground is maintained by Marchionatti (2010). 12 It also stemmed from a controversy with Frank P. Ramsey (1903–1930), a brilliant young philosopher and mathematician, friend of Wittgenstein and translator of his Tractatus, who was involved with such important economists of his time as Pigou, Keynes and Sraffa. He made seminal contributions to philosophy, mathematics and economics about taxation and optimal saving. The most significant contribution to the debate in Cambridge was his first work, “Truth and Probability” (written in 1926, but published in 1931): it was the first paper to lay out the theory of subjective probability and begin to axiomatize, a task completed decades later

2 Economics in Cambridge and Oxford in the Age …

37

of the economic conditions of his time, Keynes went on to consider that the characteristics of the universe of social phenomena were not reducible to the hypotheses of atomism and limited variety. He raised the methodological issue of dealing with a complex phenomenon— i.e., a phenomenon characterized by “problems of Organic Unity, of Discreteness, of Discontinuity”. He inevitably had to come to terms with Marshall’s conception of economics and hence with Marshall’s idea that the economic subject is fundamentally complex (see Vol. I, Chap. 3). Keynes turned his theory of human conduct into a more “general” theory of human behavior, something that is able to take in the organic nature of social relations and complex human logic. Here, a central topic in Keynes’s writings emerges: conventions. As Davis (1997) writes, the concept of convention is the primary philosophical concept of Keynes’s later philosophical thinking. This came to the fore as a result of Keynes’s relationship with Wittgenstein from the end of the 1920s (see Davis 1994, 1997; Coates 1996, 1997). The 1938 memoir My Early Beliefs also illustrates the point. There Keynes asserts his personal adherence to what he still considers the positive aspects of the credo of his youth—especially, his philosophical individualism, his anti-utilitarianism and his personal immoralism (in the sense of freedom from rules and conventions)—while at the same time illustrating the serious limits of that credo: “We were not aware that civilisation was a thin and precarious crust erected by the personality and the will of a very few, and only maintained by rules and conventions skillfully put across and guilefully preserved” (Keynes, 1972a, pp. 447–448). Above all, Keynes emphasizes the mistake in attributing “an unreal rationality to other people’s feelings and behaviour” and in having “an a priori view of what human nature is like” as well as “a pseudo-rational view of human nature”, ignoring “certain powerful and valuable springs of feeling”, “some of the spontaneous, irrational outbursts of human nature” (ibid.) and many of the “deeper and blinder passions” of the human heart (ibid., p. 449). Keynes now criticized his negation that general rules, convention and traditional wisdom had a significant role in judgment. by Bruno De Finetti and Leonard Savage. This was written “in opposition” to John Maynard Keynes’s Treatise on Probability. He died at 26 after an abdominal operation.

38

R. Marchionatti

He later thought that we had to take these hitherto neglected factors in account in order to fully understand individuals’ behavior. There are two fundamental implications of this new vision aimed at incorporating the organic nature of social relations and complex human behavior. First, there is a critique of the concept of rationality that had been elaborated at the beginning of the century and formalized in the Treatise, and there is the adoption of the concept of reasonableness—an issue discussed in the General Theory mainly in relation to the entrepreneurial expectations on investments.13 Second, there is the critique of the reductionist formalism à la Russell, which had already been mentioned in the Treatise. This issue was developed from 1932 to 1939—i.e., from the years that the General Theory was being prepared to the years of reflection inspired by the response to the book (see Keynes 1973c). Here, Keynes applied Marshall’s methodological teachings to define the method and the language of his economics. In fact, his methodological program falls in line with his Marshallian beliefs on the characteristics and requirements of economic interpretation. He tended to accept Marshall’s conception of economics as an amalgam of “logic and intuition and wide knowledge of facts” and pursued it philosophically along the post-Treatise lines. In the early 1930s, this program was translated to an analytical level and rid of the schemes of the “classical economists”— Keynes’s designation of the tradition from Ricardo to Pigou. This process led to the construction of the General Theory.

Keynes’s Economics: From the Tract on Monetary Reform, 1923, to the Treatise on Money, 1930 A Tract originated in the articles written in a series of supplements to the Manchester Guardian on “Reconstruction in Europe” edited by Keynes from April 1922 to January 1923.14 The first three chapters are 13

Marchionatti (1999) shows that in the analysis of human behavior in the General Theory, Keynes stressed some points which are at the heart of the contemporary microeconomics of bounded rationality. See also Carabelli et al. (2017). 14 These supplements included contributions by the most influential and prestigious policymakers, economists, political theorists and writers in Europe. Among the economists: Walter Layton, Arthur Pigou and Denis Robertson from Britain; Rudolf Hilferding from Germany;

2 Economics in Cambridge and Oxford in the Age …

39

based on these articles—“The Consequences to Society of Changes in the Value of Money”; “Public Finance and Changes in the Value of Money”; “The Theory of Money and the Exchanges”. Chapters 4 and 5 are new and devoted to “Alternative Aims in Monetary Policy” and “Positive Suggestions for the Future Regulation of Money”. In the Preface Keynes states that market economy cannot work properly “if money … is undependable” (Keynes 1971b [1923], p. v). “Unemployment, the precarious life of the worker, the disappointment of expectation, the sudden loss of savings, the excessive windfalls to individuals, the speculator, the profiteer—all proceed, in large measure, from the instability of the standard of value” (ibid.)—and emphasizes the need for innovation in the theory of money. Chapter 1 discusses the consequences of changes in the value of money on the distribution of wealth and on production in the short period, examining inflation and deflation processes in European countries from 1914 to 1920. These processes have inflicted “great injuries”: “each has an effect in altering the distribution of wealth between different classes … Each has also an effect in overstimulating or retarding the production of wealth” (ibid., p. 4). Inflation is “unjust”, Keynes maintains, and deflation is “inexpedient”, but “of the two perhaps Deflation is … the worse; because it is worse, in an impoverished world, to provoke unemployment than to disappoint the rentier ” (ibid., p. 40). Chapter 3 is devoted to the theory of money and the exchanges. It deals with the causes of the changes in the value of money within the Cambridge (Marshall-Pigou) tradition of the quantity theory of money. Keynes considers the quantity theory “fundamental” but often “misstated” and “misrepresented”. He represents the theory in   terms of the equation n = p k + r k  where n is the number of currency notes, p the price of each consumption unit, k the number of consumption units of cash held by the public, k  the number of consumption units of purchasing power held in checking accounts and r the proportion of bank reserves of cash to the deposit liabilities of banks to the public. The theory has often been interpreted as holding that an arbitrary change in the amount of currency would change the price level Irving Fisher and John H. Williams from the United States; Luigi Einaudi and Piero Sraffa from Italy; and Gustav Cassel from Sweden.

40

R. Marchionatti

in the same proportion, so long as with other variables are unaltered, Keynes writes, and adds that “in the long run” “this is probably true” (ibid., p. 80), but this long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again. (ibid.)

The last two chapters included some unconventional proposals for managed currency policy in order to stabilize price levels, which entailed stabilizing the demand for money through credit control. For this purpose Keynes believed that it was necessary to abandon the gold standard, which he described as “a barbarous relic”.15 In any case, the Tract made managed currency a topical issue. In the debate, Keynes’s exploration of the economic consequences of the gold standard led him to maintain that “we have to invent a new wisdom for a new age”, as he wrote in Am I a Liberal? (1925), a famous talk given at the Liberal Summer School at Cambridge University. The summa of Keynes’s thought of the 1920s was A Treatise on Money, written between 1924 and 1930 and published in October 1930 in two volumes. The first is dedicated to the pure theory of money, while the second, dealing with the applied theory of money (on the basis of statistical data for the United Kingdom and the United States), expounded the implications of monetary analysis for economic policy. The aim of the book was to offer a theoretical remedy to the unsatisfying state of monetary theory denounced in the Tract, by going beyond the comparative statics of the quantity theory. Book I of Vol. I deals with the nature of money and Book II with the description of index numbers. Books III and IV are the core of the Treatise. Here Keynes proposes a new approach to “the fundamental problem of monetary theory” (Keynes 1971c [1930], p. xvii) that can describe the characteristics of disequilibrium and “discover the dynamical laws governing 15 These unorthodox proposals were almost unanimously judged to be unfeasible or harmful: even economists like Pigou and Hawtrey who at that time were very close to Keynes shared this critical opinion.

2 Economics in Cambridge and Oxford in the Age …

41

the passage of a monetary system from one position of equilibrium to another” (ibid.). Book V considers the empirical magnitudes of his key variables, while Book VI is concerned with the institutional features of the banking system. Book VII discusses the implications of the analysis for stabilization policies at the national and international levels. The central issue of the book is the instability of the economic system or market fluctuations. The initial and most important cause of these fluctuations is the change in the level of investment. Keynes’s key idea is that profit is the driving force of this change. And profit—this is Keynes’s explanation—is created by the disequilibrium due to the possible divergence between saving and investment. Saving is made by consumers and investment by entrepreneurs and, according to Keynes, there is no spontaneous mechanism that guarantees that saving and investment balance: “the performance of the act of saving is in itself no guarantee that the stock of capital goods will be correspondingly increased” (ibid., p. 158). The changes in the level of prices are the mechanism of reconciliation between the investment decisions of entrepreneurs and the distribution of income between wages and profits. These price movements are explained by means of the “fundamental equations” presented in Book III. Keynes starts “with the flow of the … money-income, and with its twofold division (1) into the parts which have been earned by the production of consumption-goods and of investment-goods respectively, and (2) into the parts which are expended on consumption-goods and on savings respectively” (ibid., p. 121). Keynes finds that: …if the first of these divisions of the community’s income is in the same proportion as the second, i.e. if the output measured in cost of production is divided between consumption-goods and investment-goods in the same proportion as expenditure is divided between current consumption and savings, then the price-level of consumption-goods will be in equilibrium with their cost of production. But if the proportionate divisions are not the same in the two cases, then the price-level of consumption-goods will differ from their cost of production. The price level of investment-goods, on the other hand, depends on a different set of considerations. (ibid.)

In analytical terms, Keynes’s reasoning is as follows. With E being the total of money earnings or income, I  the part of income earned in the

42

R. Marchionatti

investment-goods industries (or cost of production of new investments) and E − I  the cost of production of the current output of consumption goods, S the part of E not spent on consumption goods or the amount of savings, O the total output of goods, R the output of consumption goods and P the price level of consumption goods, we can write the first fundamental equation: P = E/O + (I  − S/R) With W being the rate of earnings per unit of human effort (the inverse of W measures the labor power of money), W 1 the rate of earnings per unit of output and e the coefficient of efficiency so that W = eW 1 , Keynes rewrites the above equation in this form: P = W1 + (I  − S/R) = (1/e)W + (I  − S/R) It follows that the stability of the price level involves the two conditions: “that efficiency earnings should be constant and that the cost of new investment should be equal to the volume of current savings” (ibid., pp. 122–123). Thus the price-level … is upset by the fact that the division of the output between investment and goods for consumption is not necessary the same as the division of the income between savings and expenditure on consumption. For workers are paid as just much when they are producing for investment as when they are producing for consumption; but having earned their wages, it is they who please themselves whether they spend or refrain from spending them on consumption. Meanwhile, the entrepreneurs have been deciding quite independently in what proportions they shall produce the two categories of output. (ibid., p. 123)

Changes in the price level of consumption goods reconcile the production decisions of entrepreneurs with the expenditures of wage earners. Given the price level of investment-goods P ’, Keynes can introduce the second fundamental equation which defines the price level of output as

2 Economics in Cambridge and Oxford in the Age …

a whole

43

 : 

= E/O + (I −S)/O

 which can be rewritten = W1 +(I −S)/O = (1/e)W +(I −S)/O. Thus fluctuations (booms and slumps) derive from the difference between saving and investment. In Book III, Chap. 12, Keynes argues also that “voluntary abstention from consumption” is no guarantee of prosperity. Keynes illustrates this idea with a parable, known as the “banana parable”: Let us suppose a community owning banana plantations and labouring to cultivate and collect bananas and nothing else; and consuming bananas and nothing else. Let us suppose, further, that there has been an equilibrium between saving and investment … Into this Eden there enters a Thrift Campaign, urging the members of the public to abate their improvident practices of devoting nearly all their current incomes to buying bananas for daily food. But at the same time there is no corresponding increase in the development of new plantations … What, in such a case, will happen? The same quantity of bananas as before will continue to be marketed, whilst the amount of current income devoted to their purchase will, by reason of the thrift campaign, be diminished. [Bananas’] price must fall; and it will fall proportionately to the amount by which saving exceeds investment. Thus, as before, the public will consume the whole crop of bananas, but at a reduced price-level. This is splendid, or seems so. The Thrift Campaign will not only have increased saving; it will have reduced the cost of living. The public will have saved money, without denying themselves anything. They will be consuming just as much as before, and virtue will be sumptuously rewarded. But the end is not yet reached. Since wages are still unchanged, only the selling-price of bananas will have fallen and not their cost of production; so that the entrepreneurs will suffer an abnormal loss. Thus the increased saving has not increased in the least the aggregate wealth of the community; it has simply caused a transfer of wealth from the pockets of the entrepreneurs into the pockets of the general public. The savings of the consumers will be required … to make good the losses of the entrepreneurs. The continuance of this will cause entrepreneurs to seek to protect themselves by throwing their employees out of work or reducing

44

R. Marchionatti

their wages. But even this will not improve their position, since the spending power of the public will be reduced by just as much as the aggregate costs of production. By however much entrepreneurs reduce wages and however many of their employees they throw out of work, they will continue to make losses so long as the community continues to save in excess of new investment. (ibid., pp. 158–160)

Keynes drew policy implications from his analysis: the bank system, Keynes suggests, should try to eliminate fluctuations and stabilize the purchasing power of money by keeping the market rate of interest equal to the natural rate of interest—this being the term he, following Wicksell, uses for the rate of interest at which “saving and the value of investment  are exactly balanced, so that the price-level of output as a whole ( ) exactly corresponds to the money-rate of the efficiency-earnings of the factors of production” (ibid., p. 139). The reception of the Treatise on Money was mixed. In the pages of the Economic Journal Josiah C. Stamp, at that time director of the Bank of England, wrote that “In many respects I regard Mr. Keynes’ work as the most penetrating and epoch-making since Ricardo” (Stamp 1931, p. 243). The American economist John H. Williams, professor of economics at Harvard, called it a “substantial contribution” (Williams 1931, p. 547), writing that by “Turning away from old versions of the quantity theory, including that which he had set forth in his earlier book ‘A Tract on Monetary Reform’, Keynes seeks an understanding of the price level in a study of the purposes and processes of spending, a point of view which in general suggests such writers as Hawtrey, Robertson, the ‘over-savings’ theorists” (p. 549). By contrast, F. Hayek, at that time at the LSE, wrote a critical review of the Treatise (in two parts) in Economica (Hayek 1931, 1932). The discussion in Cambridge was wide and indepth, and involved Robertson, Pigou, Hawtrey and above all the young members of the Cambridge Faculty. In fact, for several months during the 1930–1931 academic year, a group of young economists—known as the Cambridge Circus, and consisting of Richard Kahn, Joan and Austin Robinson, James Meade and Piero Sraffa—came together to discuss the book. The main point emphasized in the Circus’s meetings was that the fundamental equations were static, resting on the assumption of a given

2 Economics in Cambridge and Oxford in the Age …

45

output (implicitly at the full-employment level) and thus ill-equipped to analyze dynamic processes involving changes in production (see Dimand 1989). In fact, in the preface to the General Theory, Keynes emphasized that point when describing the relationship of this new book with the Treatise: When I began to write my Treatise on Money I was still moving along the traditional lines of regarding the influence of money as something so to speak separate from the general theory of supply and demand. When I finished it, I had made some progress towards pushing monetary theory back to becoming a theory of output as a whole. But my lack of emancipation from preconceived ideas showed itself in what now seems to me to be the outstanding fault of the theoretical parts of that work (namely Books III and IV), that I failed to deal thoroughly with the effects of changes in the level of output. My so-called ‘fundamental’ equations were an instantaneous picture taken on the assumption of a given output. They attempted to show how, assuming the given output, forces could develop which involved a profit-disequilibrium, and thus required a change in the level of output. But the dynamic development, as distinct from the instantaneous picture, was left incomplete and extremely confused. (Keynes 1973b [1936], p. xxii)

Keynes’s Economics: The General Theory of Employment, Interest and Money, 1936 This book—Keynes writes in his preface—“is primarily a study of the forces which determine changes in the scale of output and employment as a whole” (ibid.). It is “a more general theory, which includes the classical theory with which we are familiar, as a special case” (ibid., p. xxiii). The book represents, as he writes in the preface to the German edition, a “reaction, a transition away from the English classical (and orthodox) tradition” (ibid., p. xxv). The book, Keynes emphasized, deals “with difficult questions of theory”, and “only in the second place with the application of this theory to practice”. “The composition of this book— Keynes writes—has been for the author a long struggle of escape … from habitual models of thought and expression” and he concludes: “The

46

R. Marchionatti

difficulty lies, not in the new ideas, but in escaping from the old ones, which ramify … into every corner of our minds” (ibid.). By the “habitual models of thought and expression” of classical economics, Keynes means an analysis which is concerned mainly with long-period equilibrium, assumes that the amount of the factors employed is given and the other relevant facts are known more or less for certain, and assumes that facts and expectations are given in a calculable form (i.e., the calculus of probability is supposed to be capable of reducing uncertainty to the same calculable status as that of certainty itself ).

The Starting Point: The Criticism of Classical Postulates and the Principle of Effective Demand In the introduction (Book 1), Keynes writes that The postulates of the classical theory are applicable to a special case only and not to the general case, the situation which it assumes being a limiting point of the possible positions of equilibrium. Moreover, the characteristics of the special case assumed by the classical theory happen not to be those of the economic society in which we actually live. (ibid., p. 3)

In presenting the two fundamental postulates of the classical theory of employment Keynes refers to their formulation in Pigou’s Theory of Unemployment. The first states that “the wage is equal to the marginal product of labour”—it expresses the condition of profit maximization— which determines, given the capital stock, a single firm’s demand for labor curve. In aggregate terms, this first postulate says that the aggregate level of employment is an inverse function of the real wage. The second postulate states that “the utility of the wage when a given volume of labour is employed is equal to the marginal disutility of that amount of employment”. Given these postulates, the amount of employment is determined at the point of full employment. The postulates are compatible only with frictional and voluntary unemployment. But, Keynes says, “Ordinary experience tells us … that a situation where labour stipulates (within limits) for a money-wage … is the normal case” (ibid., p. 9).

2 Economics in Cambridge and Oxford in the Age …

47

Moreover, Keynes continues, “The contention that the unemployment which characterises a depression is due to a refusal by labour to accept a reduction of money-wages is not clearly supported by the facts” (ibid.). If the wage bargain does not determine the real wage, then “there is no longer any reason to expect a tendency towards equality between the real wage and the marginal disutility of labour” (ibid., p. 11). Therefore, Keynes refuses the second postulate. This refutation makes it necessary to consider a third category of unemployment, namely involuntary unemployment: Men are involuntarily unemployed if, in the event of a small rise in the price of wage-goods relatively to the money-wage, both the aggregate supply of labour willing to work for the current money-wage and the aggregate demand for it at that wage would be greater than the existing volume of employment. (ibid., p. 15)

In other words, involuntary unemployment occurs when there are laborers willing to work at the current real wage but the aggregate demand for labor is not enough to absorb the entire supply. Keynes’s conclusion is: “if the classical theory is only applicable to the case of full employment, it is fallacious to apply it to the problems of involuntary unemployment—if there be such a thing (and who will deny it?)” (ibid., p. 16). And he continues: The classical theorists resemble Euclidean geometers in a non-Euclidean world who, discovering that in experience straight lines apparently parallel often meet, rebuke the lines for not keeping straight—as the only remedy for the unfortunate collisions which are occurring. Yet, in truth, there is no remedy except to throw over the axiom of parallels and to work out a non-Euclidean geometry. Something similar is required to-day in economics. We need to throw over the second postulate of the classical doctrine and to work out the behaviour of a system in which involuntary unemployment in the strict sense is possible. (ibid., pp. 16–17)

Keynes then attacks another central point of the classical theory, the socalled Say’s law, which states that “supply creates its own demand”. As a corollary of this doctrine, “it has been supposed that any individual

48

R. Marchionatti

act of abstaining from consumption necessarily leads to … causing the labour and commodities thus released from supplying consumption to be invested in the production of capital wealth” (ibid., pp. 18–19). Contemporary economists, Keynes continues, have difficulty in maintaining the idea that if people do not spend their money in one way they will spend it in another, because the facts of experience are not consistent with that idea, but “they have not drawn sufficiently far-reaching consequences; and have not revised their fundamental theory” (ibid., p. 20). The error, Keynes says, is in supposing that: two essentially different activities appear to be the same. [Economists] are fallaciously supposing that there is a nexus which unites decision to abstain from present consumption with decisions to provide for future consumption; whereas the motives which determine the latter are not linked in any simple way with the motives which determine the former. (ibid., p. 21)

These assumptions—the two postulates and Say’s law—“all amount to the same thing in the sense that they all stand and fall together, any one of them logically involving the other two” (ibid., p. 22). The fundamental fact is that aggregate supply does not always automatically equal the aggregate demand but the level of supply is determined by the level of aggregate demand. Keynes offers an explanation introducing the principle of effective demand. First of all, Keynes presents the aggregate supply function Z = ø(N ), where Z = the aggregate supply price of the output from employing N men, and the aggregate demand function D = f (N ), where D = the proceeds which entrepreneurs expect to receive from the employment of N men. Keynes writes: if for a given value of N the expected proceeds are greater than the aggregate supply price, i.e. if D is greater than Z , there will be an incentive to entrepreneurs to increase employment beyond N … up to the value of N for which Z has become equal to D. Thus the volume of employment is given by the point of intersection between the aggregate demand function and the aggregate supply function; for it is at this point that the entrepreneurs’ expectation of profit will be maximised. The value of D

2 Economics in Cambridge and Oxford in the Age …

49

at the point of the aggregate demand function, where it is intersected by the aggregate supply function, will be called the effective demand . (ibid., p. 25)

Note that, according to the classical doctrine, “Supply creates its own Demand”, that is “f (N ) and ø(N ) are equal for all values of N , i.e. for all levels of output and employment”. Instead, effective demand “is an infinite range of values all equally admissible”. Keynes summarizes his theory in the following propositions: (1) In a given situation of technique, resources and costs, income … depends on the volume of employment N . (2) The relationship between the community’s income and … consumption, … will depend on the psychological characteristic of the community, which we shall call its propensity to consume … (3) The amount of labour N which the entrepreneurs decide to employ depends on the sum (D) of two quantities, namely D 1 the amount which the community is expected to spend on consumption, and D 2 , the amount which it is expected to devote to new investment. D is … the effective demand. (4) Since D 1 + D 2 = D = ø(N ), where ø is the aggregate supply function, and since … D 1 is a function of N , which we may write χ(N ), depending on the propensity to consume, it follows that ø (N ) − χ(N ) = D 2 . (5) Hence the volume of employment in equilibrium depends on (i) the aggregate supply function, (ii) the propensity to consume, and (iii) the volume of investment, D 2 . This is the essence of the General Theory of Employment. (ibid., pp. 28–29)

Thus Keynes can conclude that: the volume of employment is not determined by the marginal disutility of labour … The propensity to consume and the rate of new investment determine between them the volume of employment, and the volume of employment is uniquely related to a given level of real wages—not the other way round. If the propensity to consume and the rate of new investment result in a deficient effective demand, the actual level

50

R. Marchionatti

of employment will fall short of the supply of labour potentially available at the existing real wage. (ibid., p. 30)

He comments: This analysis supplies us with an explanation of the paradox of poverty in the midst of plenty. For the mere existence of an insufficiency of effective demand may … bring the increase of employment to a standstill before a level of full employment has been reached. The insufficiency of effective demand will inhibit the process of production in spite of the fact that the marginal product of labour still exceeds in value the marginal disutility of employment. (ibid., pp. 30–31)

This analysis calls for a methodological approach that differs from that of the classical analysis.

The Methodological Framework: On the Nature, Method and Language of Economics Keynes considered economics “a branch of logic, a way of thinking” (letter to R. Harrod of July 4, 1938, in Keynes 1973d, p. 296), “a science of thinking in terms of models joined to the art of choosing models which are relevant to the contemporary world” (ibid., p. 297). Keynes considers it a moral (human) science that deals with human beings in their social environment. In particular, economics deals with changing and unstable factors like “motives, expectations, psychological uncertainties” (ibid., p. 300), i.e., a “material” that is “not homogeneous through time” (ibid.). This non-homogeneity through time compels economics to make a limited use of deductive analysis and to take the particular characteristics of the historical world into account. In examining this material, economics uses introspection and value judgments in order to discover “in a study so complex as economics” the relevant factors needed for building a model or a sample—i.e., the object of The General Theory where Keynes develops a model which presents “the factors whose changes mainly determine our quaesitum” (Keynes 1973b [1936], p. 247): the determination of “the national income of a given

2 Economics in Cambridge and Oxford in the Age …

51

economic system and … the amount of its employment” (ibid.). Keynes had raised the issues of the precision of definitions and the level of generalization in economic inquiry in his Cambridge lectures of November 1933 (Rymes 1989). He maintained that “on the matter of precise definition of terms, there is some question as to the utility and propriety of the scholastic exercise in trying to define terms with great precision in a subject like economics” (Rymes 1989, p. 102). The danger of doing so “is that you may ‘precise everything away’ and be left with only a comparative poverty of meaning” (ibid.). In other words, “there is the danger of falling into scholasticism, the essence of which is treating what is vague as what is precise” (ibid.). Keynes maintains that “a generalisation to cover everything is impossible and impracticable”. He adds that “generalising in economics is thinking by sample, not by generalization”. The influence of Marshall is clearly present here in Keynes’s criticism of scholasticism.16 When he asks what level of precision is useful in economics, he notes with approval that Marshall’s definitions were very loose and that many terms were not defined, but that much was provided that would allow the reader to infer the required definitions. In contrast, many other economists, in making their definitions precise, make them too rigid. In a 1935 draft of General Theory, Keynes writes that “Much economic theorising to-day suffers … because it attempts to apply highly precise and mathematical methods to material which is itself much too vague to support such treatment” (Keynes 1973d, p. 379). Economics must thus follow a quasi-formal method of exposition. If “we cannot hope to make completely accurate generalisations” (Keynes 1973b [1936], p. 247), Keynes writes, the correct language for constructing a model must not be exclusively symbolic but must also be ordinary language, as in Marshall. Keynes appreciated the use of mathematics when mathematics makes it possible to shed light on economic problems—i.e., when the subject

16

Another important connection is pointed out by Coates (1996, 1997). He associates these reflections with Keynes’s involvement with Wittgenstein’s criticism of analytical philosophy beginning in the late 1920s. According to Coates, Keynes pointed out the problems that ensue from employing artificially precise definitions for concepts that are characterized by what Wittgenstein called combinatory vagueness: “for the precise definition will leave out of account too much of what we intuitively intend when using the concept” (Coates 1997, p. 249).

52

R. Marchionatti

matter makes its use appropriate. Mathematics is especially useful to “disclose gaps and imperfections in your thought” (ibid., p. 305). Ordinary language seems to be more efficient in handling the complexity of the economy. The essential consequence of this argument is that economic thinking cannot be reduced simply to “blind manipulation”. Keynes writes: The object of our analysis is, not to provide a machine, or method of blind manipulation, which will furnish an infallible answer, but to provide ourselves with an organised and orderly method of thinking out particular problems; and, after we have reached a provisional conclusion by isolating the complicating factors one by one, we then have to go back on ourselves and allow, as well as we can, for the probable interactions of the factors amongst themselves. This is the nature of economic thinking. (ibid., p. 297, my italics)

The “method of blind manipulation” is that of the “recent mathematical economics”. It assumes “strict independence between the factors involved” (ibid., p. 298)—i.e., it assumes the atomistic hypothesis. It permits us “to lose sight of the complexities and interdependencies of the real world in a maze of pretentious and unhelpful symbols” (ibid.). Constructing the “relevant” model is the key problem. A “relevant” model does not emerge automatically out of empirical study as a result of the blind manipulation of data. How adequate the model is, depends on its ability to concentrate attention on the relevant factors. We have to make a decision as to what part of concrete reality to incorporate into a model. Keynes terms this decision a “judgement of value”. This is what makes economics an art, because it is necessary to exercise the art of introspection in order to study psychic processes, and judgments of value, in order to construct models that are relevant.

2 Economics in Cambridge and Oxford in the Age …

53

The Theoretical Framework of the General Theory or the Relevant Model Book III and Book IV of the General Theory are devoted, respectively, to “The Propensity to Consume” and “The Inducement to Invest”, or the aggregate demand function overlooked by classical analysis. In Book III Keynes examines the factors which determine the sum of money which will be spent in consumption and defines C = ƒ(Y). “The fundamental psychological law”, Keynes says, is that men are disposed on average to increase their consumption as their income increases, but not by as much as the increase in their income, i.e., dC/ dY or c, the marginal propensity to consume, is positive and less than unity. For dY = dC + dI , respectively, the increments of consumption and investment, we can write dY = 1/(1 − c ) dI , where 1/(1 − c ) = k is the “investment multiplier”: “It tells us that, when there is an increment of aggregate investment, income will increase by an amount which is k times the increment of investment” (p. 115). The conception of investment multiplier, as Keynes writes, originated with Richard Kahn who introduced the concept of employment multiplier in economic theory in his article on “The relationof Home Investment to Unemployment” (Kahn 1931). In Book IV Keynes examines the factors which determine the sum which will be devoted to investment. First he introduces the concept of the marginal efficiency of capital: I define the marginal efficiency of capital as being equal to that rate of discount which would make the present value of the series of annuities given by the returns expected from the capital-asset during its life just equal to its supply price. (ibid., p. 135)

Keynes writes that the marginal efficiency of capital is … defined in terms of the expectation of yield and of the current supply price of the capital-asset. It depends on the rate of return expected to be obtainable on money if it were invested

54

R. Marchionatti

in a newly produced asset; not on the historical result of what an investment has yielded on its original cost if we look back on its record after its life is over. (ibid. p. 136)

And continues: The schedule of the marginal efficiency of capital is of fundamental importance because it is mainly through this factor (much more than through the rate of interest) that the expectation of the future influences the present. The mistake of regarding the marginal efficiency of capital primarily in terms of the current yield of capital equipment, which would be correct only in the static state where there is no changing future to influence the present, has had the result of breaking the theoretical link between to-day and to-morrow … The fact that the assumptions of the static state often underlie present-day economic theory, imports into it a large element of unreality. (ibid., pp. 145–146)

The following Chap. 12 is the central locus of economic complexity in The General Theory: the analysis of long-term expectations. Keynes analyzes a “monetary economy”—“one in which changing views about the future are capable of influencing the quantity of employment and not merely its direction” (ibid., p. xxii). Thus expectations play a leading role, at the center of the model. Long-term expectations concern investment and have a special nature because unlike short-term expectations, they “cannot be checked at short intervals in the light of realised results” (ibid., p. 51). Keynes maintains that long-term expectation depends on the most probable forecast that agents can make and upon the confidence with which they make that forecast. The state of confidence is the shape that the weight of arguments—the concept in the Treatise on Probability—took in the General Theory. It is defined in terms of “how highly we rate the likelihood of our best forecast turning out quite wrong” (ibid., p. 148). Consequently, confidence depends on the “fluctuating, vague and uncertain” knowledge of the future (ibid., p. 113), where uncertain does not mean improbable, because it refers to a situation where “there is no scientific basis on which to form any calculable probability whatever” (ibid.). In other words, we cannot use a probabilistic

2 Economics in Cambridge and Oxford in the Age …

55

theory of expectations.17 Rational calculation is scarcely useful in the presence of such radical uncertainty and “it is reasonable … to be guided to a considerable degree by the facts we feel somewhat confident about” (ibid., p. 148), because “it would be foolish, in forming our expectations, to attach great weight to matters which are very uncertain” (ibid.). How do we get around this shortage of information and knowledge? We can answer this question by observing market and business psychology, Keynes maintains. In fact, “there is … not much to be said about the state of confidence a priori”. This makes the digression “on a different level of abstraction” (ibid., p. 149) from that of most of the General Theory. In practice, agents have to fall back on conventional judgment and animal spirits, motives which are neither rational nor irrational. If we pretend that we are acting as perfectly rational men under radical uncertainty we are, paradoxically, following “a pseudo-rationality”, using “a mythical system of probable knowledge” (ibid.). Keynes splits his analysis of entrepreneurial behavior in getting around the informational and cognitive shortage into two parts, corresponding to the two phases of capitalism—old-fashioned competitive capitalism and mature capitalism (that characterized by the separation between the ownership and the management of the firm and by the development of organized investment markets). In old-fashioned competitive capitalism, the leading actor is the entrepreneur, who both owns and manages his own firm. Here the expectations depend on his “genuine expectations”. Keynes defines these entrepreneurs as “individuals of sanguine temperament and constructive impulses who embarked on business as a way of life, not really relying on a precise calculation of prospective profit” (ibid., 150). Entrepreneurial activity resembles “a mixed game of skill and chance” (ibid.), where investment is the result not only of “cold calculation” but also of “temptation to take a chance”, as well as “satisfaction (profit apart) in constructing a factory, a railway, a mine or a farm” (ibid.). Here the entrepreneur acts on the basis of animal spirits—“a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied 17

In contemporary economic language, this means that we cannot adopt a rational expectation hypothesis à la Muth which assumes that expectations correctly identify the mean and variance of stochastic variables affecting future contingencies.

56

R. Marchionatti

by quantitative probabilities” (ibid., p. 161; see Marchionatti 1999). Actually, Keynes adds, individual initiative is adequate only if cold calculation is “supplemented and supported by animal spirits”, so that “the thought of ultimate loss which often overtakes pioneers … is put aside as a healthy man puts aside the expectation of death” (ibid., p. 162). In mature capitalism, on the other hand, the leading actor is the stock market investor, and investment depends on “the average expectation of those who deal on the Stock Exchange as revealed in the price of shares” (ibid., p. 151). In their decisions, investors draw on conventions. The essence of conventions lies “in assuming that the existing state of affairs will continue indefinitely, except in so far as we have specific reasons to expect a change” (ibid., p. 158). Keynes defines conventions more generally in an article devoted to his answers to the critics of General Theory published in the Quarterly Journal of Economics in 1937, where he refers to three types of assumptions: (1) We assume that the present is a much more serviceable guide to the future than a candid examination of past experience would show it to have been hitherto. In other words we largely ignore the prospects of future changes about the actual character of which we know nothing. (2) We assume that the existing state of opinion as expressed in prices and the character of existing output is based on a correct summing up of future prospects, so that we can accept it as such unless and until something new and relevant comes into the picture. (3) Knowing that our own individual judgement is worthless, we endeavour to fall back on the judgement of the rest of the world which is perhaps better informed. That is, we endeavor to conform with the behavior of the majority or the average. The psychology of a society of individuals each of whom is endeavouring to copy the others leads to what we may strictly term a conventional judgement. (Keynes 1973d, p. 114)

In financial markets the evaluations in investment depend on the “judgement of the rest of the world” or on the attempt “to conform with the behaviour of the majority or the average” (ibid.). This technique is compatible, according to Keynes, with a considerable measure of

2 Economics in Cambridge and Oxford in the Age …

57

continuity and stability in our affairs, so long as we can rely on the maintenance of the convention. However, Keynes says, this type of convention is fundamentally arbitrary—because of the ignorance about the future, which cannot be filled up by experience and rules—and consequently precarious. This precariousness increases in proportion to the number of people owning equities who are ignorant of the prospects of a particular investment. Professional speculators possess more knowledge and information than private investors, but they do not act in order to counteract those factors of market fragility and precariousness because they deal in speculation—i.e., forecasting the psychology of the market and of anticipating the basis of conventional valuations a short while ahead. The coexistence of these two types of property-management relationship and the existence of organized financial markets makes business activity a mix of enterprise, stock market evaluation and speculation. Enterprise is based on reasonable calculation, as far as is possible, and is supplemented by a particular “way of life”, “spontaneous optimism” and animal spirits. By contrast, investor activity is fundamentally guided by conventional judgment. In order not to end up like Buridan’s ass, business people must draw on motives which are, “not ‘rational’ in the sense of being concerned with the evaluation of consequences”, but are rather “decided by habit, instinct, preference, desire, will, etc.” (Keynes 1979, p. 294). These factors determine people’s state of confidence and therefore the magnitude of investment. Conventional judgments and animal spirits act together to make up a fundamental determinant of the rate of confidence. They are a substitute for reasonable calculation when confidence is low or absent. They act as a mechanism for fulfilling expectations on the basis of successful rules and spontaneous optimism. Only a set of repeated failures can cause a particular belief model to be rejected. Long-term expectations are very important in business cycle phenomena. According to Keynes, they are determined by fluctuations in investment. Investment itself depends upon the relationship between the rate of interest and the schedule of the marginal efficiency of capital. This, in turn, depends upon the relationship between the supply price of a capital-asset and its prospective yield, which is determined by the state of the psychological expectation or state of long-term expectation. The state of long-term expectation is a fundamental case in the General Theory

58

R. Marchionatti

where the non-homogeneity of the material is the key feature. This is what makes the business cycle a “highly complex” phenomenon (Keynes 1973b, p. 313). Since expectations and investment cannot be modeled by using probabilistic relationships, the business cycle is beyond the domain of probabilistic inference. This is the key reason why Keynes criticized the statistical testing of business cycle theories, like that of Tinbergen (see Chap. 7.3). Chapter 13 is devoted to the theory of the rate of interest. While “the marginal efficiency of capital may be said to govern the terms on which loanable funds are demanded for the purpose of new investment …, the rate of interest governs the terms on which funds are currently supplied” (Keynes 1973b, p. 165). What determines the rate of interest? The inquiry starts by analyzing the psychological time-preferences of an individual. These time-preferences require two distinct sets of decision. “The first is concerned with … the propensity to consume, which, … determines for each individual how much of his income he will consume and how much he will reserve in some form of command over future consumption” (ibid., p. 166). The individual’s second decision concerns “in what form he will hold the command over future consumption which he has reserved … Does he want to hold it in the form of immediate, liquid command … ? Or is he prepared to part with immediate command for a specified or indefinite period? … In other words, what is the degree of his liquidity-preference …?” (ibid.). The accepted theories of the rate of interest, Keynes maintains, neglect the second constituent. The rate of interest, Keynes writes, is not a return to saving or waiting as such, but “the reward for parting with liquidity for a specified period” (ibid., p. 167): … the rate of interest at any time, being the reward for parting with liquidity, is a measure of the unwillingness of those who possess money to part with their liquidity control over it. The rate of interest is not the “price” which brings into equilibrium the demand for resources to invest with the readiness to abstain from present consumption. It is the “price” which equilibrates the desire to hold wealth in the form of cash with the available quantity of cash … Liquidity-preference is a potentiality …

2 Economics in Cambridge and Oxford in the Age …

59

which fixes the quantity of money which the public will hold when the rate of interest is given. (ibid., pp. 167–168)

In fact, given that the rate of interest is never negative, “why should anyone prefer to hold his wealth in a form which yields little or no interest to holding it in a form which yields interest?” (ibid.). The reason or “necessary condition” is “the existence of uncertainty as to the future of the rate of interest” which creates a “risk of a loss being incurred in purchasing a long-term debt and subsequently turning it into cash, as compared with holding cash” (ibid., 169). But there is also a further ground for liquidity-preference, when there are organized financial markets, that is “the speculative motive”, “the object of securing profit from knowing better than the market what the future will bring forth” (ibid., p. 170). As Keynes (1973d, p. 116) writes “Our desire to hold Money as a store of wealth is a barometer of the degree of our distrust of our own calculations and conventions concerning the future”.

The Social Philosophy of the General Theory The final chapter of the book, Chap. 24 (in Book VI), is devoted to “the social philosophy towards which the general theory might lead”. Keynes begins by writing that the “outstanding faults of the economic society in which we live are its failure to provide for full employment and its arbitrary and inequitable distribution of wealth and income” (Keynes 1973b, p. 372). One of the chief social justifications of this great inequality of wealth was that wealth depends essentially on the abstinence of the rich (i.e., their saving), Keynes writes, but “our argument leads towards the conclusion that in contemporary conditions the growth of wealth, so far from being dependent on the abstinence of the rich, as is commonly supposed, is more likely to be impeded by it”. So “one of the chief social justifications of great inequality of wealth is, therefore, removed” (ibid., p. 373). Keynes continues: There is, however, a second … inference from our argument which has a bearing on the future of inequalities of wealth; namely, our theory of the rate of interest. The justification for a moderately high rate of interest has

60

R. Marchionatti

been found hitherto in the necessity of providing a sufficient inducement to save. But we have shown that the extent of effective saving is necessarily determined by the scale of investment and that the scale of investment is promoted by a low rate of interest … Thus it is to our best advantage to reduce the rate of interest to that point relatively to the schedule of the marginal efficiency of capital at which there is full employment. There can be no doubt that this criterion will lead to a much lower rate of interest than has ruled hitherto … This state of affairs … would mean the euthanasia of the rentier, and, consequently, the euthanasia of the cumulative oppressive power of the capitalist to exploit the scarcity-value of capital. (ibid., pp. 374–376)

Keynes thinks that the only means of securing an approximation to full employment is “a somewhat comprehensive socialisation of investment” (ibid., 378), but without establishing a state socialism which would embrace most of the economic life of the community. “But there will still remain a wide field for the exercise of private initiative and responsibility. Within this field the traditional advantages of individualism will still hold good” (ibid., p. 380)—advantages to efficiency and as a “safeguard of personal liberty” (ibid.). The enlargement of the functions of government is “the only practicable means of avoiding the destruction of existing economic forms in their entirety and as the condition of the successful functioning of individual initiative” (ibid.).

2 Economics in Cambridge and Oxford in the Age …

2.4

61

The New Cambridge School: Keynes’s Close Circle (Richard Kahn, 1905–1999; Austin Robinson, 1897–1993; Joan Robinson, 1903–1983) and Their Fellow-Travelers (Piero Sraffa, 1898–1983; Maurice Dobb, 1900–1976; Michał Kalecki, 1899–1970; and Roy Harrod, 1900–1978)

Prologue The New Cambridge School of the 1930s was made up of a heterogeneous set of economists: a small number of close pupils and colleagues of Keynes—the core of the School, consisting of Austin and Joan Robinson and Richard Kahn, joined during the war by Nicholas Kaldor (1908–1996) from the London School of Economics—and a number of fellow-travelers, among them Piero Sraffa, Roy Harrod and Michał Kalecki. Edward Austin Robinson (1897–1993), the oldest of this group, was born on November 20, 1897, at Farnham in Surrey. He came to Cambridge in 1916 to study Classics but soon became interested in economics under the influence of Keynes’s The Economic Consequences of the Peace. He studied under the supervision of C.R. Fay, followed by Dennis Robertson and Gerald Shove, graduating in 1922 and becoming a Fellow of Corpus Christi in 1923. In 1926 he married Joan Maurice, who had been his pupil. After two years in India, where Austin tutored the young Maharajah of Gwalior, the Robinsons returned to Cambridge in 1928 where Austin became a University Lecturer. In 1931 he published The Structure of Competitive Industry and in 1941 Monopoly for the Cambridge Economic Handbooks series. The two books were an important contribution to industrial economics conceived à la Marshall as a mix of theory, facts and policy. Close to Keynes, who in 1934 asked him to be Assistant Editor of the Economic Journal and then, in 1944, joint editor with Roy Harrod—actually, he was its editor

62

R. Marchionatti

for 36 years—Austin Robinson was involved in Keynes’s construction of his theoretical revolution. During the war Robinson worked for the British government, first in the Offices of the War Cabinet, and then in the Economic Section. As Cairncross (1994, p. 907) wrote: “It was during the second world war that Austin found his true vocation. He had always been more interested in applying economics than in contributing to economic theory; and once in the Offices of the War Cabinet he found himself very much at home as an economic adviser”. In 1947 he returned to Cambridge where he stayed for the rest of his long life. In the 1960s and 1970s Robinson was deeply involved in problems of economic development in Asia as well as in a number of other subjects: economic planning, energy and balance of payments problems. His approach to all these subjects, Cairncross (1994) wrote, had a common element: an emphasis on problems of structural adjustment. He died in Cambridge in 1993. Richard Kahn (1905–1989) contributed probably more significantly than anyone else in the circle around Keynes to the Keynesian revolution in those years—he was Keynes’s “favourite pupil” (Marcuzzo 2002). Kahn was born on August 10, 1905, in London. He initially studied mathematics and physics at King’s College. He then moved on to the study of economics under the guidance of Gerald Shove and John Maynard Keynes, brilliantly passing the Economics Tripos in 1928. He completed his Fellowship dissertation at the end of 1929: it secured him election as a Fellow of King’s College, where he spent the rest of his life. Following a suggestion by Shove and Sraffa, the dissertation was devoted to “The Economics of the Short Period” (Kahn 1989 [1929]; see Marris 1992 and O’Shaughnessy 1994) and established a connection between market imperfections and economic depression. In the following years he became a close collaborator of Keynes, in particular as a member of the Cambridge Circus. He was then intensely involved with Joan Robinson’s Economics of Imperfect Competition. Kahn investigated a wide range of topics—employment, money, market structure, international trade and systems of payments, some of them collected in his Essays on Employment and Growth (Kahn 1972)—but he did not publish much. His fame is mainly associated with the concept of the multiplier, which he

2 Economics in Cambridge and Oxford in the Age …

63

presented in an article “The Relation of Home Investment to Unemployment”, published in the Economic Journal (Kahn 1931), and mentioned by Keynes in The General Theory. In fact, Kahn had a great influence in Cambridge, as attested by the two most important books produced by Cambridge economists in the 1930s, Keynes’s General Theory and Robinson’s Economics of Imperfect Competition. He died in Cambridge on June 6, 1989. Joan Robinson (1903–1983) is the most famous theoretical economist of this group of young economists.18 Grandniece of the Christian socialist F. D. Maurice and daughter of a general, Joan was educated at Girton College, Cambridge, and completed the Cambridge Economics Tripos in 1925. Joan developed an informal relationship with the Faculty of Economics and Politics, attending some lectures and taking some college supervisions. In 1933 she published The Economics of Imperfect Competition (Robinson 1933), the book which secured her an international reputation and permitted to be appointed to a Faculty position as University Lecturer and then Reader. She became professor in 1965, when her husband Austin retired from his chair. Toward the end of the 1930s, Robinson focused on Keynesian theory—as mentioned earlier, she was a member of the Circus—and after the publication of the General Theory she played a fundamental role in carrying through the Keynesian revolution, supplementing it with theoretical elements from external sources (in particular with Kalecki’s macroeconomic theory). In 1937, she published An Introduction to the Theory of Employment (Robinson 1937a) and the Essays in the Theory of Employment (Robinson 1937b), two books which represented an attempt to simplify Keynes’s main argument (the former) and to apply Keynes’ principles to a number of particular problems (the second). The collection also contains the paper “The long-period theory of employment” which dealt with Keynesian analysis in the theoretical framework of long-term macroeconomic equilibrium. Around that time, Michał Kalecki had arrived in Cambridge and Robinson rearranged her understanding of the theory of effective demand into a Kaleckian–Marxist context (see also Robinson 1942). After the war the outcome of this program of development of Keynes’ 18

On Joan Robinson, see Harcourt and Kerr (2009) and Harcourt (2001).

64

R. Marchionatti

General Theory into a long-run theory of growth was completed with the book The Accumulation of Capital (Robinson 1956). She died in Cambridge in August 1983. In the group of fellow-travelers, more or less connected with the core group, we find first-rate economists like Piero Sraffa, Maurice Dobb, Michał Kalecki and Roy Harrod.19 Piero Sraffa (1898–1983) arrived in Cambridge in 1927 from Italy, where he had studied under Luigi Einaudi and Attilio Cabiati at the University of Torino. He was already famous for his 1926 criticism of the Marshallian theory of value published in the Economic Journal (Sraffa 1926; see Chap. 7.1), and from that time he exerted a considerable influence within the faculty through his lectures held in 1928–1931 on “Advanced Theory of Value”, a reconstruction of the early stage of his inquiry into the history of pure economic theory where he presented his interpretation of classical economics based on the concepts of surplus and physical costs and criticized Marshall’s interpretation.20 These lectures were also attended by two “special students”, Richard Kahn and Joan Robinson (see Signorino 2005 and Trezzini 2019). In 1930 he was one of the members of the “Cambridge Circus”. Sraffa was born in Torino on August 5, 1898, to a Jewish family of the upper bourgeoisie. His father, Angelo Sraffa, was a professor of commercial law in many Italian universities, among them the University of Torino and the Bocconi University in Milano, of which he was rector from 1919 to 1926. Sraffa graduated in 1920 and in 1923 he became professor 19

Among the fellow-travelers we should also mention those statisticians who collaborated mainly with Keynes. Colin Clark (1905–1989), educated in Oxford, met Keynes in 1930 when he was appointed a research assistant to the National Economic Advisory Council. Keynes, impressed by him, offered him an appointment as a lecturer in statistics in Cambridge, where Clark stayed from 1931 to 1938. In Cambridge he acquired a reputation for his original statistical work, especially in the development of national income statistics, in particular his first major book (Clark 1932), of which Keynes made use (and Kahn too in his estimate of the multiplier) in the General Theory and on other occasions. Clark greatly influenced Richard Stone (1913–1991), then the first director of the Cambridge Department of Applied Economics in 1945, an institution strongly promoted by Keynes. Last but not least, there was Erwin Rothbarth (1913–1944), a German economist who had emigrated to England after Hitler’s rise to power. After graduating from the LSE he moved to Cambridge in 1938, where he taught economic statistics and worked very closely with Keynes (Cuyvers 1983). When war broke out he volunteered for the British Army and was killed on the battlefield in the Netherlands. 20 On Sraffa’s influence on Cambridge economists see Marcuzzo (2001).

2 Economics in Cambridge and Oxford in the Age …

65

of political economy at the University of Perugia. In the meantime his early interest in applied and monetary issues gradually switched to more theoretical issues. His criticism of Marshall and Marshallianism published in 1925 in the Italian journal Annali di economia (Sraffa 1925) attracted the interest of Edgeworth, who at that time was co-editor of the Economic Journal with Keynes. Prompted by Edgeworth, Keynes asked Sraffa to contribute an article on the same theoretical issues to the British journal: published in 1926, it had considerable impact, especially in Cambridge (Sraffa 1926). Confronted with the increasing authoritarianism of the Fascist regime and with an invitation from Keynes, in 1927 Sraffa moved to Cambridge where he spent the rest of his life, first as Lecturer and Assistant Director of Research, then as Librarian at the Marshall Library (see Marcuzzo 2005). In Cambridge Sraffa developed his research along two fundamental lines: the work on the critical edition of Ricardo’s writings, entrusted to him in 1930 by the Royal Economic Society on Keynes’s initiative, and research in the field of the theory of value, which was to culminate in his book Production of Commodities by Means of Commodities in 1960. This book was the result of the neo-Ricardian program of research followed by Sraffa after 1926. Considering the “Cournotian route” of imperfect competition to be unsatisfactory, he maintained that a foundation of the theory of normal value under competitive conditions must refer to the classical approach that assumed the invariability of costs. From the end of 1927 onwards, Sraffa followed the neo-Ricardian path and developed several sets of homogeneous linear equations in terms of physical quantities.21 These equations are the roots of the final version of the corresponding equations in Production of Commodities (Sraffa 1960). One of Sraffa’s collateral interests during the early 1930s was in supporting and developing Keynes’ theory. As part of this effort, he wrote a markedly critical review of Prices and Production by Hayek (Sraffa 1932), who had found 21

Initially, Sraffa made the assumption of constant returns, but he abandoned it in 1928 when he recognized, in a draft of the “central propositions” of Production of Commodities by Means of Commodities, that prices and distribution could be determined even if no assumptions on returns were made. This standpoint was essentially different from the marginal approach, which “requires attention to be focused on change” (Sraffa 1960, p. v). Sraffa’s early work has been reconstructed on the basis of his unpublished notes (see Kurz and Salvadori 2001; Gehrke and Kurz 2006; Sinha 2016; Naldi 2018; see also Marchionatti 2019).

66

R. Marchionatti

fault with Keynes’ Treatise. In fact, Sraffa was highly valued for his critical capacity, whereby he contributed indirectly and informally to the work of the Cambridge economists. This capacity was also recognized outside economics: it is well known that Wittgenstein acknowledged Sraffa’s contribution in bringing about his change of mind from the Tractatus logico-philosophicus to the Philosophical Investigations. Sraffa died in Cambridge on September 3, 1983. The London Marxist Maurice Dobb (1900–1976) arrived in Cambridge in 1919 as an undergraduate to study economics and was immediately involved in Keynes’s Political Economy Club. He stayed in Cambridge until his retirement in 1967, holding different positions. He was a close friend of Sraffa, and like Sraffa he was a critic of neoclassical economics and a supporter of classical, above all Marxian, tradition as a theoretical alternative. His most important book in this area was Political Economy and Capitalism (Dobb 1937). In the 1930s, Dobb participated in the so-called calculation debate concerning the political economy of socialism (see Chap. 7.2). His main interests gradually began to center on economic history and the history of economic thought: here, mention should be made of two books: his Studies in the Development of Capitalism (1946) and his last published book, Theories of Value and Distribution since Adam Smith (Dobb 1973). After the war he collaborated with Piero Sraffa in assembling the selected works and letters of David Ricardo, the first volume of which was published in 1951 (Sraffa 1951–1973). He died in Cambridge on August 17, 1976. The Polish economist Michał Kalecki (1899–1970) was introduced to Keynes by Joan Robinson in late 1936, when a Rockefeller Foundation Fellowship brought him to England—first to the LSE and then to Cambridge—after a short stay in Sweden (for an account of Kalecki in Cambridge see Toporowski 2013 and Marcuzzo 2020). He was born on June 22, 1899, in Lodz, Poland. In Poland he had studied civil engineering at the Warsaw Polytechnic, later attending the Polytechnical School in Danzig. But he had to break off his studies because his father’s business, a textile manufacturing company, failed in 1923. In 1929 he began to work at the Polish Institute of Research on Business Cycles and Prices in Warsaw, staying until 1936 when he resigned his post. Trained in engineering and self-taught in economics, as an economist

2 Economics in Cambridge and Oxford in the Age …

67

Kalecki grew up in the Marxist tradition of the late nineteenth- early twentieth-century debate in the German-speaking world, influenced in particular by the work of Tugan-Baranovsky and by Rosa Luxemburg’s under-consumption theories.22 In his home country Kalecki developed a macroeconomic model published in 1933 in an article in Polish entitled Próba teorji koniunktury (“An Essay on the Theory of the Business Cycle”) (Kalecki 1933), which he presented at the International Econometrics Association in Leiden, and whose content became known to Western economists through two papers in English published in the newly established journal Econometrica (1935b) and in the Revue d’Economie Politique (1935a). In Leiden, Kalecki had come to know Ragnar Frisch, who influenced his theory from the mathematical standpoint: certainly, as his pupil Josef Steindl (1981, p. 593) wrote, his analysis was “scientific in spirit; his way of thinking is mathematical, though sprinkled with only a sparing use of the pretentious symbolic tools of mathematics”. But what was remarkable from the point of view of the analytical approach is that in those papers Kalecki anticipated some aspects of Keynes’s theory on the role of effective demand. Two years after the General Theory was published, Kalecki reviewed it, recognizing that the book was a turning-point in the history of economics. It was this interest that pushed him to go to Cambridge where he stayed until 1940, holding research positions but having only a professional relationship with Keynes (see Toporowski 2013). In this regard, Joan Robinson (1977, p. 9) wrote that Keynes was not much impressed by him and “did not sympathize with Kalecki’s political presupposition and by background and temperament they could not have been further apart”, however, she added, “Keynes took the trouble to get a research project set up to provide Kalecki with a job”. In fact, Keynes had mixed feelings about Kalecki. He appreciated his work and published several of his papers in the Economic Journal . But sometimes he was very critical toward him, not so much for the reasons raised by Mrs. Robinson but rather for his mathematical approach to macroeconomic issues which Keynes criticized in the General Theory. Nevertheless, Kalecki soon became a member of the Keynesian group in Cambridge and was a 22

On Kalecki, see López and Assous (2010) and Toporowski 2013 and 2018.

68

R. Marchionatti

close friend of Joan Robinson, Richard Kahn, Maurice Dobb and Piero Sraffa. He was very influential in Robinson’s development and extension of Keynes’s General Theory and then on post-Keynesian theory in the postwar years. Joan Robinson was the first of the members of Keynes’s closest circle to recognize Kalecki’s anticipation of the main ideas of Keynes’s General Theory, and throughout her life she would call attention to the importance of Kalecki’s economic theories. In 1939, his last year in Cambridge, Kalecki published the Essays in the Theory of Economic Fluctuations (Kalecki 1939). In 1940 he moved to Oxford to work at the Institute of Statistics for five years—the Institute had become, as Steindl (1981) remembered, “a haven for economists from the continent”—and gave occasional lectures at Oxford University. In that period he also wrote a short paper on what he called the “political business cycle” (Kalecki 1943), where he showed that the difficulties of maintaining full employment lay in the political field and in the opposition of interests it created. After the war he left Britain and went first to Montreal, Canada, where he worked at the International Labour Office, and then to New York where he assumed the job of Deputy Director in the United Nations Department of Economic Affairs. In the McCarthyist period, denounced as a supporter of communism, he resigned his position and in 1955 returned to Poland, first as government economic advisor and then as professor at the University of Warsaw until his retirement in 1968. He spent the last years of his life marginalized by his country’s political authorities. In 1969, one year before his death—Kalecki died on April 18, 1970— his seventieth birthday was celebrated in Cambridge. After his death the Selected Essays on the Dynamics of the Capitalist Economy 1933–1970 was published, a collection of the best of Kalecki’s scientific work (Kalecki 1971). Oxford economist Henry Roy Forbes Harrod (1900–1978)23 came to Cambridge in the early 1920s to study economics under Keynes’ guidance. He was born in Norwich on February 13, 1900. He had been educated in Oxford, where he returned after the short interlude in Cambridge and there spent the rest of his academic life until his retirement in 1967. He had a long intellectual relationship with Keynes 23

On Harrod, see Phelps Brown (1980).

2 Economics in Cambridge and Oxford in the Age …

69

who asked him to read the final draft of the General Theory: as Besomi (2019, p. 389) writes, although Harrod was an outsider to the close circle of Keynes’s Cambridge fellows, and “very much in the dark as to the evolution of the author’s view from the Treatise to the 1936 book”, Keynes probably considered him “an insightful and reliable critical reader” (on Keynes and Harrod on the General Theory see also Besomi 2000, 2005). On the other hand, Keynes’s comments had an influence on Harrod’s work on economic dynamics, the field in which Harrod wrote his most famous contributions in the 1930s: The Trade Cycle (Harrod 1936)—published almost immediately after the appearance of the General Theory—in which he proposed an explanation of the business cycle which combined the accelerator and multiplier principles, and “An Essay in Dynamic Theory” (Harrod 1939), the re-statement of his dynamic theory, where he introduced the idea of a moving equilibrium growth path for the economy. After the war he developed his growth theory further in the book Towards a Dynamic Economics (1948) and other articles. But Harrod’s interests also concerned imperfect competition—his articles in the early 1930s were important in the construction of the new economics of imperfect competition (Harrod 1930, 1931, 1934) as well as methodology and international economics, where his work on international monetary problems occupied a good deal of his time and attention in the postwar decades. After Keynes’s death, his brother Geoffrey Keynes encouraged Harrod to write a biography of Keynes. Published in 1951, The Life of John Maynard Keynes became a classic. From 1945 to 1961, Harrod was Joint Editor of the Economic Journal . He died in Holt, Norfolk on March 8, 1978.

Theoretical Contributions, I: Austin Robinson’s Industrial Economics At the beginning of the 1930s, Robinson wrote The Structure of Competitive Industry (A. Robinson 1931), followed ten years later by Monopoly (Robinson 1941). The Structure of Competitive Industry examined “the forces which determine the size and structure of firms, and those further forces which

70

R. Marchionatti

determine the minimum efficient scale of an industry” (A. Robinson 1931, p. 6) using an approach which blended, à la Marshall, theory and facts. The book is organized into 12 chapters. In the introduction Robinson deals with the problem of how to define an industry and recognizes the difficulty in real life of determining what an industry is— “When we speak of the cotton industry … we are referring not to a group of firms producing what we may regard as a single commodity, but to many firms producing all sorts of different commodities” (ibid.)— and he states that “competition is hardly anywhere now perfect” (ibid., p. 9), inasmuch each producer “tries to create a separate market and a separate demand for his own goods by making them … slightly different” (ibid., p. 7). The following five chapters examine the effect upon the size of business units of various factors in terms of efficiency—technical, managerial, financial and marketing—and in the assumption of risks. The next three chapters discuss alternative methods of reconciling the different optimum sizes dictated by these factors. Two chapters then deal with the location of industry. Rationalization is the topic of the final chapter. Robinson’s view is that economic efficiency is not just a matter of technically correct choices of production techniques, but the result of many factors, technique, management, marketing, etc. In this way his analysis anticipates the role of internal organization emphasized in the postwar literature on the theory of the firm. As Sargant Florence (1932) in his review of the book wrote, the book is “an original contribution” in the field then called industrial economics. In the same vein as the first book, Monopoly (A. Robinson 1941) investigates the world of monopoly, considering the “conditions in which monopolies can be created and can continue to exist, the forms that they take, their virtues and vices, and the attitude to them of the law and of public opinion in different countries”. The book consists of 12 chapters where, using an amazing amount of material, descriptive as well as theoretical, Robinson analyzes the different forms of monopoly, the different effects of these forms upon industrial efficiency, and provides a theoretical basis for comparing monopoly and competition from the point of view of efficiency, stability and the distribution of income. Chapter I, “Monopoly price”, examines the theoretical

2 Economics in Cambridge and Oxford in the Age …

71

behavior of a profit maximizing perfect monopolist. Chapter II, entitled “Quasi-Monopoly”, deals with oligopolistic cases, the problem of entry into the industry and the instability of imperfect competition. Chapter III classifies the types of monopoly in four categories, according to their duration: long-term unconditional monopolies (legal monopolies, radium, diamonds), long-term conditional monopolies (coal, sewing cotton), short-term unconditional monopolies (international cartels, rubber) and short-term conditional monopolies (many local businesses), while Chap. IV describes the “devices for establishing or prolonging monopolies”, mainly methods of preventing or impeding the entry of new firms into the industry, i.e., the sources of monopoly power. Chapter V describes the “Forms of Monopoly Organization”, with an analysis of the conditions which make adopting particular forms of organization suitable for different industries’ special situations. Chapter VI presents a deductive analysis of the problem of the efficiency of monopoly. The analysis divides the possible economies of monopoly into technical economies, economies of management, economies of a financial character and economies of buying raw materials and marketing the finished product, and concludes by balancing the possible technical economies with the managerial diseconomies. Chapter VII deals with the problem of “Monopolies and Industrial Stability”, where after a careful analysis Robinson concludes that there is little evidence that monopolies contribute to industrial stability, and believes that most of his findings point in the opposite direction. Chapter VIII, on “The Control of Monopoly”, maintains that evaluating the alternatives—suppressing certain monopolistic devices, breaking up monopolistic organizations, regulating monopolistic policies or socializing monopolistic industries— requires us to bring our ethical and political values into play, an issue which is also discussed in the last chapter on future policy. Chapters IX– XI are devoted to analyzing the relationship between law and monopoly in the United States, Germany and the United Kingdom, in order to learn what policies are likely to succeed from the experience of different countries.

72

R. Marchionatti

Theoretical Contributions, II: Joan Robinson and The Economics of Imperfect Competition Prologue: Sraffa, Kahn, Harrod, J. Robinson and the Birth of Imperfect Competition Theory in England Sraffa (1926) showed that the Marshallian-Pigouvian theory of value under perfect competition was logically weak because of its inadequate treatment of variable costs and the difficulties of coordinating the laws of returns under competitive conditions in partial equilibrium (see Chap. 7.1). According to Sraffa, there were two theoretical routes out of the impasse: (a) the simultaneous equilibrium of all industries (“Pareto’s route”) and (b) abandoning the assumption of perfect competition (“Cournot’s route”). Sraffa argued that the Paretian conception was not fruitful because of its complexity (a judgment shared with many Italian economists, Pantaleoni for example), and Cournot’s route thus seemed to be the only viable research direction: it was a further approximation, Sraffa wrote, which makes it possible to consider the case of increasing returns. The impact of Sraffa’s articles of 1925–1926 was tremendous, particularly in Cambridge. His criticism of Marshall was widely discussed. According to Kahn (1984, p. 26): Economists throughout the world owe to Sraffa’s articles and to Sraffa himself the idea that if economics is to become more realistic it is most important to develop the economics of imperfect competition.

In Cambridge this view was soon adopted by Kahn himself in his 1929 fellowship dissertation, and by other representatives of the Cambridge and Oxford economics, in particular Harrod, but without discarding Marshall’s apparatus as Sraffa had suggested. Kahn’s The Economics of the Short Period 24 was a theoretical essay based on a case study of the Lancashire cotton industry. Its purpose was to explain the behavior of firms using the statistics of the cotton industries in Great Britain in 24

Kahn’s dissertation remained unpublished at the time and was published only recently, first in Italian in 1983, then in English in 1989 (Kahn 1989 [1929]). On Kahn’s dissertation, see Marcuzzo (1994).

2 Economics in Cambridge and Oxford in the Age …

73

the second part of the 1920s, a case that had already been examined by Keynes in order to promote a restructuring of the industry (see Marchionatti 1995). The information Kahn collected raised a number of questions about the received Marshallian approach, in particular the fact that excess capacity continued to exist in the industry for several years, even in a depression, which was impossible to explain on the assumption that firms were operating in a perfectly competitive market. Kahn’s solution to this problem was to abandon the assumption of perfect competition: the typical firm analyzed by Kahn is facing a downwardsloping demand curve. In this way Kahn explains why the degree at which productive capacity is exploited during a period of economic downturn falls below full capacity for all existing firms (see Marcuzzo 1994). Harrod (1930, 1931) developed an important analytical tool to deal with the problem of monopoly and imperfect competition, the “marginal revenue”, a concept that was already known (by Cournot and Marshall but not yet specifically identified) and in those years explored by other economists in the United States, in United Kingdom and Germany. Joan Robinson’s Theory of Imperfect Competition (1933) is the culmination of this line of thought. The book was preceded by an important article (J. Robinson 1932). Here, in presenting the “double” condition of equilibrium of the industry (marginal revenue = marginal cost and price = average cost) as the tangency of the individual demand curve of the firm to its average cost curve, she wrote the following footnote: “I am indebted for this proposition to Mr. R. F. Kahn, who, in turn, derived it by pursuing Mr. Sraffa’s argument to its necessary conclusion”. Again, in the 1933 Foreword to the Economics of Imperfect Competition, she wrote: “I have had the constant assistance of Mr. R. F. Kahn. The whole technical apparatus was built up with his aid, and many of the major problems … were solved as much by him as by me”.

Joan Robinson’s Economics of Imperfect Competition The Economics of Imperfect Competition was, as Schumpeter (1934, p. 251) defined it, “an admirable performance”. It was the result of a line of research that sought to answer the challenge posed by Sraffa. Various

74

R. Marchionatti

economists, from Cambridge and elsewhere, had accepted this challenge: the difference between Joan Robinson and the others lays in the fact that she was determined “to follow the Sraffian path without distraction” (Shackle 1967, p. 47). In her foreword (J. Robinson 1969 [1933], pp. xiv–xv) she writes: In general I have endeavoured to build on the foundations laid by Marshall and by Professor Pigou …. Of more recent work, my chief debt is to Mr. Piero Sraffa’s article in the Economic Journal of December 1926, to Mr. E. A. G. Robinson’s Structure of Competitive Industry, and to Mr. G. F. Shove’s articles in the Economic Journal of June 1928 and March 1930. Mr. Sraffa’s article must be regarded as the fount from which my work flows, for the chief aim of this book is to attempt to carry out his pregnant suggestion that the whole theory of value should be treated in terms of monopoly analysis. Mr. Robinson’s work on the optimum size of firms is the foundation of my treatment of competitive equilibrium, and plays an important part in the Appendix on Increasing and Diminishing Returns. Mr. Shove’s articles form the basis of my treatment of rent and of the four cost curves. A moment has been reached in the development of economic theory when certain definite problems require to be solved, and many writers are at work upon them independently. There are many occasions, therefore, when several explorers are surprised, and somewhat pained, on meeting each other at the Pole. Of such an occasion the history of the “marginal revenue curve” presents a striking example. This piece of apparatus plays a great part in my work, and my book arose out of the attempt to apply it to various problems, but I was not myself one of the many explorers who arrived in rapid succession at this particular Pole. I first learnt of it from Mr. C. H. P. Gifford, of Magdalene College, who was then reading for the Economics Tripos. Shortly afterwards Mr. P. A. Sloan, of Clare College, showed me an unpublished essay in which it occurred. Next it was published by Mr. R. F. Harrod in the Economic Journal of June 1930, in an article which must have been written almost simultaneously with Mr. Sloan’s paper. In a later article (Economic Journal , December 1931) Mr. Harrod set out in an analytical form some of the relations between marginal and average curves which I had discovered by geometry. At this Pole I can claim to have arrived by a route of my own, but his analytical formulation of the fundamental relation between average and marginal

2 Economics in Cambridge and Oxford in the Age …

75

value has been of very great service to me since it appeared. Meanwhile a number of explorers were added to the rapidly growing crowd at the Marginal Revenue Pole. Professor T. O. Yntema. (who also anticipated Mr. Harrod’s formula for the relation of average to marginal value) had, unknown to me, arrived there long before (Journal of Political Economy, December 1928). Dr. E. Schneider, Dr. H. v. Stackelberg, and Professor Mehta, amongst many others, appear to have discovered it independently.

All these economists shared the idea that Marshall’s theory of competition was imprecise. In her preface to the 1969s edition of the book Joan Robinson writes: Marshall’s view of competition was not very precise. An unforeseen rise in the demand for a particular commodity would lead to a rise of output, higher marginal cost being accompanied by a higher price. When demand was low, “fear of spoiling the market” would prevent prices from being cut. As time goes by, firms grow in size and enjoy economies of scale. Economies internal to the firm reduce average cost of production (which includes profits at the normal rate on the capital invested) and the benefit is passed on to the public in lower prices. To meet the objection that the firm which first begins to grow can undersell the rest and gradually establish a monopoly, Marshall fell back on the analogy of trees in the forest. A firm is identified with a family. The sons of the founder are enervated by being brought up in the comfort that his money provides so that the expansion of the firm that he began will peter out. It is true that a joint-stock company is not bound to the life of a family but, says Marshall, joint-stock companies stagnate. (J. Robinson 1969 [1933], p. v)

She continues: Pigou transformed all this into a neat, logical system. Perfect competition means that the individual producer can sell as much or as little as he likes at the ruling price. Each firm continuously produces the amount of output of which the marginal cost is equal to price. There are internal economies of scale only up to a certain size, at which average cost (including a normal profit) is at a minimum. When demand is such as to call forth output beyond this size from a particular firm, marginal

76

R. Marchionatti

cost, and therefore price, exceeds average cost. Super-normal profits call in fresh competition which brings down the market price and pushes back the output of the firm. When price is below average cost, some firms are driven out of business, and those that remain expand. Thus the optimum size of firm, with minimum average cost, is always tending to be established. Here we were, in 1930, in a deep slump, and this is what we were being asked to believe. (ibid., pp. v–vi)

The book is organized as follows. In Book I, the assumptions which establish “the level of abstraction at which our discussion must be carried on are set out in all their naked unreality”. Book II is devoted to monopoly equilibrium and Book III deals with competitive equilibrium. This is the part concerned with cases intermediate between monopoly proper and simple competition (also discussed in portions of Books II and VII). The subject matter of Book IV, “The Comparison of Monopoly and Competitive Output”, is “an analysis of the effect upon the output of a perfectly competitive industry when the number of independent producers in it is reduced to one, everything else remaining the same” (p. 9). Books V and VI are devoted to price discrimination and monopsony respectively. Books VII–XI extend the analysis to input factors: the demand for a factor of production, the comparison of monopoly and competitive demand for labor, and “exploitation”, in conditions of monopoly and monopsony. Book X, “A World of Monopolies”, is a “tentative attempt to show how the monopoly analysis of value may be linked up with the work of Professor Pigou on the Economics of Welfare”. As in the case of Kahn’s dissertation, the starting point of The Economics of Imperfect Competition is Sraffa’s proposal “to re-write the theory of value, starting from the conception of the firm as a monopolist” (J. Robinson 1969, p. 6). The aim of the book was to extend the technique based on average and marginal curves, enriched by the rediscovery of the concept of marginal revenue and to provide an answer to the challenge posed by Sraffa in questioning the consistency of the Pigou apparatus. Fundamentally, Joan Robinson’s book remained within the traditional Marshallian framework, relying on the notions of the firm

2 Economics in Cambridge and Oxford in the Age …

77

and the industry, strictly an analysis of partial equilibria in the short and in the long run. In fact, as Schumpeter wrote: the book is Marshallian to the core. Everything about it is Marshallian: the approach, the fundamental “conceptual scheme,” the manner of reasoning, the starting-points as well as the goals, even the general social vision (although somewhat “modernized”) which floats about it. The author steps out of the Cambridge circle only as far as the marginal revenue curve makes it necessary to do so by virtue of the fact that it was simultaneously discovered by a number of economists outside of Cambridge. (Schumpeter 1934, p. 253)

Shove (1933, p. 658) commented in a similar way: “That is a welcome and illuminating departure from the conventional method of presentation. But the whole mechanism of analysis, with its cost-curves and receipt-curves, supply-curves and demand-curves, is of the traditional classical type. The originality of the work is to be found, not in any bold and far-reaching innovation, but in its detail”. In fact, Robinson’s intellectual debt to Pigou is in general notable, but it is so in particular in regard to method. She herself presented her book as “a box of tools [that] can make only an indirect contribution to our knowledge of the actual world” (J. Robinson 1969 [1933], p. 1). Perfect competition is then defined as a market condition characterized by a perfectly horizontal demand curve; that is, with infinite elasticity. An imperfect market is characterized by a downward-sloping demand curve facing each firm. On the supply side, various assumptions are allowed for in the behavior of costs, corresponding to increasing, decreasing and constant cost cases. Full equilibrium conditions for any given industry are derived in both a perfect and an imperfect market: “An industry is said to be in full equilibrium when there is no tendency for the number of firms to alter. The profits earned by the firms in it are then normal” (ibid., p. 93). Since profits are normal when price (average revenue, AR) is equal to average cost (AC) and firms are in individual equilibrium when marginal revenue (MR) equals marginal cost (MC), it follows that full equilibrium requires the double condition that MR = MC and AR = AC. Proof is then given that the “double condition” can

78

R. Marchionatti

only be fulfilled when the individual demand curve of the firm is tangent to its average cost curve. Hicks (1935) neatly summarizes the main point: Since the demand curve is downward sloping, the average curve must also be downward sloping at the equilibrium point. Equilibrium under monopolistic competition is only possible when average costs are diminishing; that is to say, the equilibrium output of a firm will be less than the output which would give minimum average costs—the output which would actually be reached under conditions of perfect competition. (Hicks, 1935, p. 9)

Therefore, comparison between equilibrium conditions of perfect and imperfect competition had a dismal welfare implication: in the former case marginal and average cost are equal at the point at which average cost is at a minimum, while in the latter case “the double condition of equilibrium can only be fulfilled for some output at which average cost is falling. The firms will therefore be of less than optimum size when profits are normal” (J. Robinson 1969 [1933], p. 97). Schumpeter (1934, p. 252) maintains that the originality of the book lies essentially in the fact that “the whole analysis of the pricing process acquired an unexpected unity covering the limiting cases of perfect competition and perfect monopoly, and ceased to be the patchwork it was for such a time. A single formula now gives the price for all cases (price equal to marginal revenue times η/η − 1)”. However, it should be emphasized that Joan Robinson’s book pointed to the economic realities in the 1930s and argues that the imperfect competition theory may be more useful in explaining what was happening than the existing theory of perfect competition: Imperfect competition came in to explain the fact, in the world around us, that more or less all plants were working part time. The notion that every firm is facing a falling demand curve for its own product and that profits are maximised at the output for which marginal revenue is equal to marginal cost, provided an explanation for a situation in which firms could work their plants at less than full capacity and still earn a profit. (ibid., p. vi)

2 Economics in Cambridge and Oxford in the Age …

79

Actually, the book changed the way of thinking about economic problems. In Robinson’s own words: It is customary, in setting out the principles of economic theory, to open with the analysis of a perfectly competitive world, and to treat monopoly as a special case. It has been the purpose of the foregoing argument to show that this process can with advantage be reversed and that it is more proper to set out the analysis of monopoly, treating perfect competition as a special case. (ibid., p. 307)

Robinson showed that if one attempts to construct a logically coherent marginalist theory of the firm, a conclusion will be reached which is in contrast to the neoclassical view of the world: that the free operation of market forces leads to an economic structure in which unsatisfied consumers’ needs and excess capacity of firms can coexist. The implications for welfare economics are worrying: the market mechanism operates in such a way that not only are the workers not paid according to the full value of their marginal productivity, but even the principle of consumer sovereignty is impaired.

Theoretical Contributions, III: Michał Kalecki’s Essays in the Theory of Economic Fluctuations The Essays are the last step of Kalecki’s theoretical construction in the 1930s. Kalecki arrived at his final theory of income determination in a four-step process (see López and Assous 2010): from his 1933 paper to the 1939 Essays through a series of other papers. Kalecki’s first paper was “Próba teorji Konjunktury”, published in Polish in 1933 and presented at that year’s meeting of the Econometric Society in Leiden. A shorter version was later published in Econometrica (Kalecki 1935b), entitled “A Macroeconomic Theory of Business Cycle”. It contains the essential framework of Keynes’ theory of effective demand: the relationship between saving, consumption and investment and the multiplier offered a theory of the level of income that was very similar to Keynes’s, in particular considering full employment as a borderline case. The mechanism of cyclical fluctuations, however, is

80

R. Marchionatti

at the center of the analysis: in fact the purpose of his mathematical model is to explain cycles endogenously. Many years later, in writing about his early work in business cycle theory published in Poland in the years 1933–1939—and in particular his 1933 paper translated as “An Essay on the Theory of the Business Cycle”—Kalecki (1966) notes that it reflected the most essential features of his theory. The principle of effective demand took on a more significant role in the following essays. In particular, Kalecki (1934) demonstrated that the economy could reach a stable position with unemployment which he called quasiequilibrium. This explains why Kalecki was particularly receptive to the General Theory and to Keynes’s work and its conceptual framework: this is the perspective from which Kalecki’s articles of 1937 and 1938 must be considered. The Essays in the Theory of Economic Fluctuations (1939) consists of six essays, three being revised versions of the articles published in 1937 and 1938 on the distribution of the national income, the principle of increasing risk and the business cycle. The other three, on investment and income, money and real wages and the long-term rate of interest, were written expressly for the book. They each deal with some aspects of fluctuations and so give unity to the study. In the foreword, Kalecki writes that: These essays, though formally independent, nevertheless constitute a whole. Each of them treats a problem which is interesting in itself, but at the same time it prepares the ground for the succeeding essays. In particular the first five essays lead up to the sixth, which contains a theory of the business cycle.

The first essay begins with an empirical generalization regarding the stability, over long and short periods, of the share of manual labor in the total of gross national income. Kalecki argues that under conditions of imperfect competition the average degree of monopoly measures the share in the gross national income of the income of capitalists and salary earners and thus determines the share of manual labor. The stability of the share of labor income is then attributed to the fact that over the historical period studied the degree of monopoly and the ratio of raw

2 Economics in Cambridge and Oxford in the Age …

81

material prices to wage-costs moved slowly. Kalecki emphasizes that a world in which the degree of monopoly determines the distribution of the national income is a world far removed from the pattern of free competition. He maintains that monopoly appears to be deeply rooted in the nature of the capitalist system: free competition, as an assumption, may be useful in the first stage of certain investigations, but as a description of the normal state of capitalist economy it is merely a myth. The second essay proceeds with the analysis of investment and income; it assumes that savings come only from incomes other than those of wage earners; it posits a relation between savings, consumption and income of the non-wage earning group. And, since the latter income is a constant proportion of gross national income, and savings are identical with investment, the result is to establish a connection between changes in investment and changes in national income. The third essay deals with money and real wages and concludes that “on balance… a wage reduction may change employment in either direction, but this change is likely to be small; … it tends to redistribute income to the disadvantage of the workers…”. The fourth essay introduces the principle of increasing risk, viz., that as the size of investment increases, the effects of unfavorable developments upon the net return to the entrepreneur-borrower are likely to be greater because of the lower ratio of the entrepreneur’s equity to total commitments. The fifth essay discusses the long-term rate of interest and attributes its stability over time to the sensitiveness with which holders of deposits respond to minor changes in bond yields. The sixth essay, the most important of the book, is devoted to the theory of the business cycle. “A Theory of the Business Cycle”, Kalecki says, is “an altered version” of the article with the same title published in the Review of Economic Studies in February 1937. The business cycle is considered under simplifying assumptions, Kalecki emphasizes, regarding this as the first step to approaching the dynamic process in all its complexities. The essay utilizes the various threads of earlier discussion and presents a highly simplified model of the business cycle, in which the cyclical movement is derived from a combination of a self-stimulating curve of investment decisions and the upward and downward shift of this curve in response to changes in the existing stock of capital equipment. It is a paper, in

82

R. Marchionatti

Kalecki’s intention, as he wrote in the introduction to the 1937 article, that was “closely allied to the Keynesian theory”. Under the assumption that “the sole type of investment is private expenditure on fixed capital equipment”, and “the workers and rentiers are supposed not to save, and thus all saving is done by entrepreneurs”, and on the basis of the analysis presented in the second essay on investment and income, Kalecki postulates that capitalists’ incomes are determined by the national income. Considering the relationship between investment decisions and investment, where investment is equivalent to the work actually performed in the industries producing fixed capital equipment, i.e., is equal to the volume of their output, he establishes that its actual level is the result of past investment decisions. Kalecki then turns to the analysis of the determinants of the investment decisions or the inducement to invest. His argument is based on the results of the essay on “The Principle of Increasing Risk”. This principle is the result of Kalecki’s criticism of Keynes’s assumption of exogenous long-term expectations. According to Kalecki, if expectations have to be taken into account for the determination of equilibrium, expectations must be determined endogenously. Kalecki established that the entrepreneur’s commitments are an increase function of net profitability, i.e., of the difference between the marginal rate of profit and the rate of interest. It follows that the rate of investment decisions is also a function of the difference between the prospective rate of profit and the rate of interest. At this point Kalecki is able to describe the dynamic process of the economic system. He examines this process in two stages: in the first he ignores the changes in capital equipment; in the second stage he allows for the effect of these changes which result from investment and wear and tear. He identifies a position of equilibrium on the assumption of a constant equipment. The change in the capacity of equipment disturbs this equilibrium and determines an endogenous business cycle. He summarizes the phenomenon as follows: We start from a position in which the requirements of wear and tear are just covered by investment activity, and in which investment decisions are at such a level that they tend to cause a higher level of income in the future … Thus equipment is initially stationary while national income tends to rise. The result is a further rise in investment decisions,

2 Economics in Cambridge and Oxford in the Age …

83

and later in income, and so on cumulatively. However, capital equipment also expands, because investment activity increases above the level of maintenance. This hampers the “self-stimulating” process of the rise in investment decisions and national income. After a certain time a position is reached in which national income ceases to grow … But investment activity, which is now at its maximum, continues to add to the stock of capital equipment. Income being stationary, this brings the first fall in investment decisions, and thus breaks the boom. The fall of investment decisions causes a fall in income, which in turn depresses investment decisions. So long as investment activity is higher than the level of maintenance, the downward movement is aggravated by the continued expansion of capital equipment. The effect of the latter is reversed when investment activity falls below the level of wear and tear …, i.e. capital equipment shrinks, and thus hampers the downward movement. Eventually the position is reached at which national income ceases to fall … The shrinkage of capital equipment continues, however, and, as income is stationary, this starts a rise in investment decisions. Thus the bottom of the slump is passed. The rise in investment decisions causes a rise in income, which in turn further stimulates investment decisions. This upward process is accelerated by the shrinkage of capital equipment until investment activity reaches the level of maintenance …, and a new cycle begins. (Kalecki 1939; ibid., pp. 146–147)

In conclusion Kalecki presents his view of what causes the business cycle: We see that the question, “What causes periodical crises?” could be answered shortly: the fact that investment is not only produced but also producing. Investment considered as capitalists’ spending is the source of prosperity, and every increase of it improves business and stimulates a further rise of spending for investment. But at the same time investment is an addition to the capital equipment and right from birth it competes with the older generation of this equipment. The tragedy of investment is that it calls forth the crisis because it is useful. I do not wonder that many people consider this theory paradoxical. But it is not the theory which is paradoxical, but its subject—the capitalist economy. (ibid., p. 148)

Investment—and Kalecki considered this paradoxical—has a twofold effect: it increases the volume of aggregate profits, but at the same time it

84

R. Marchionatti

adds to the volume of capital. Two opposite effects on the current rate of profits follow. As Besomi (2005, p. 5) notes, here Kalecki wants to point out that investment has the potential to fulfill human needs, but instead of doing so it causes widespread misery, so offering his “version of the Keynesian paradox of poverty in the midst of plenty”.

Theoretical Contributions, IV: Roy Harrod’s an Essay in Dynamic Theory Harrod published “An Essay in Dynamic Theory” in the Economic Journal for March 1939, thus ushering the modern long-period growth theory25 based on Keynes’ General Theory. In fact, Harrod used Keynes’s theory to define an equilibrium growth rate, the “warranted rate of growth”, which corresponds to continuous equality between growth rate of productive capacity and growth rate of aggregate demand. Harrod’s interest in dynamics dated back to the early 1930s and led to The Trade Cycle (Harrod 1936), a book which was published just after the General Theory, but which relied on Keynes’ Treatise on Money. Harrod introduces the “Fundamental Equation”, constituting “the marriage of the acceleration principle and the multiplier theory” (Harrod 1939, p. 14): G w = ΔY /Y = s/C , where G w is the warranted rate of output growth (or equilibrium rate of growth), Y is the income, s is the fraction of income which individuals choose to save (i.e., S/Y ), and C is the value of the capital goods required for the production of a unit increment of output (i.e., I/ΔY , I being the investment). C is that particular value which corresponds to no undesired accumulation of stocks. The warranted rate of growth of the system is determined by certain fundamental conditions, namely the propensity to save and the state of technology. Harrod summarizes his dynamic theory in two propositions:

25

A similar model was proposed in 1946 by the American (of Russian-Polish origin) Evsey Domar (1914–1998). A considerable literature emerged in the next 15 years on the stability conditions and other important features of what came to be known as the Harrod–Domar growth model (see the summary presented in Hahn and Matthews 1964).

2 Economics in Cambridge and Oxford in the Age …

85

(i) A unique warranted line of growth is determined jointly by the propensity to save and the quantity of capital required by technological and other considerations per unit increment of total output. Only if producers keep to this line will they find that on balance their production in each period has been neither excessive nor deficient. (ii) On either side of this line is a “field” in which centrifugal forces operate, the magnitude of which varies directly as the distance of any point in it from the warranted line. Departure from the warranted line sets up an inducement to depart farther from it. The moving equilibrium of advance is thus a highly unstable one. (ibid., p. 23)

In other words, the warranted rate of output growth is unstable: any deviation from it would tend to be amplified. Over-production or underproduction takes place. Alongside the concept of warranted rate of growth, Harrod introduces another concept, that of the natural rate of growth: This is the maximum rate of growth allowed by the increase of population, accumulation of capital, technological improvement and the work/leisure preference schedule, supposing that there is always full employment in some sense (ibid., p. 30).

Harrod comments that “there is no inherent tendency for these two rates to coincide” (ibid.). The model is based on three equations: the first defines savings as a function of income, the second follows accelerator theory in setting investments equal to the product between change in income and capitaloutput ratio, the third expresses the condition of equilibrium between aggregate supply and demand as equality between savings and investments. Substitution in the third equation of the expressions for savings and investments defined by the first two equations makes the “warranted” rate of growth equal to the ratio between propensity to save and capital-output ratio. Here Harrod, still using the multiplier-accelerator interaction, tackled the problem of the instability of growth. It is based on three equations: St = sYt

86

R. Marchionatti

It = a DYt∗ St = It ∗ − Y where s = 1 − c is the propensity to save, and Yt∗ = Yt+1 t is the expected change in demand. The multiplier principle is hidden in the first equation, while the second incorporates the accelerator principle and the third sets out the condition of macroeconomic equilibrium. The equilibrium solution is obtained by substituting from the first and second equations into the third and assuming that the variation in the expected demand coincides with the actual one, i.e., DYt∗ = DYt . The warranted rate of growth, G, which guarantees equilibrium, is determined as:

G = DYt /Yt = s/a The solution is unstable: each disequilibrium solution will tend to diverge from the warranted growth path, and no automatic adjustment mechanism is capable of rebalancing the economic system. For example, if the growth of expected demand is higher than warranted growth, the accelerator will increase investments more than necessary. The multiplier, in turn, will increase the demand at a rate higher not only than the warranted rate but also than the expected rate. Thus the expectations will be adjusted upwards and the disequilibrium will be aggravated. Furthermore, given the growth rates of population and labor productivity, the model shows that warranted growth, being unstable, is incapable of ensuring full employment and price stability. The sum of the rates of growth of population, n, and labor productivity, π, gives the natural rate of growth, G n . This is the maximum rate at which the economy can grow. If demand grows at a rate higher than the natural one, this creates inflationary impulses, as actual production is not able to keep pace with demand. On the other hand, if demand grows at a rate lower than the natural one, unemployment is created. The economy will grow in a steady state, without generating inflationary or deflationary impulses, if and only if it grows at a rate coinciding with both the warranted and

2 Economics in Cambridge and Oxford in the Age …

87

the natural rates: G = s/a = n + π = G n But as s, a, n, and π are all exogenous magnitudes, it is difficult to see how this equality can hold true, if not by chance. Growth in a capitalistic economy is intrinsically unstable.

2.5

Critical Developments in Oxford: The Oxford Economists’ Research Group

After the war Oxford economics was a melting pot of different approaches—historically oriented or more theoretically oriented, with the latter becoming predominant in the 1930s—but always strongly influenced by Cambridge economists. In the 1930s a group of economists was carrying out an original program of research on businessmen’s behavior, connected with research on the trade cycle and on imperfect competition, with a view to giving a more factual basis to those theories. At the initiative of Hubert Henderson (1890–1952), who came to Oxford from Cambridge in 1934, a number of economists formed the Oxford Economists’ Research Group in 1935 (see Harrod 1953; see also Lee 1981 and Young and Lee 1993). Among others, the Group included Roy Harrod, James Meade, Henry Phelps Brown (1906–1994), Redvers Opie (1900–1984), the Australian-born Robert Hall (1901–1988), the American-born Charles J. Hitch (1910–1995) and a young member destined to become an important Oxford economist in the field of industrial economics after World War II, P. W. S. Andrews (1914–1971). The issue faced by the Group was to find out how businessmen behave following changes in interest rates and in response to varying marketing positions, i.e., their price policy. The Group held meetings where businessmen were invited to answer and discuss questions the economists posed to them. To the economists’ surprise, the businessmen indicated that changes in the interest rate had a negligible effect on their investment decisions, and that pricing policies were generally insensitive to changes in the state of demand over the trade cycle. Each conclusion

88

R. Marchionatti

implied that the neoclassical framework seemed to be inconsistent with the empirical evidence which appeared to conflict with the received doctrine of the time. Firms’ pricing behavior was the Group’s chief area of interest, and the most important study on it was by Hall and Hitch (1939) in an article in the new journal Oxford Economic Papers. They write: The purpose of the paper is to examine, in the light of the interviews, the way in which business men decide what price to charge for their products and what output to produce. It casts doubt on the general applicability of the conventional analysis of price and output policy in terms of marginal cost and marginal revenue, and suggests a mode of entrepreneurial behaviour which current economic doctrine tends to ignore. This is the basing of price upon what we shall call the “full cost” principle. (Hall and Hitch 1939, p. 12)

“The most striking feature of the answers”, Hall and Hitch write, “was the number of firms which apparently do not aim, in their pricing policy, at what appeared to us to be the maximization of profits by the equation of marginal revenue and marginal cost” (ibid.). The explanation of this behavior is, according the two authors, that “they are thinking in altogether different terms; that in pricing they try to apply a rule of thumb which we shall call ‘full cost’” (ibid., p. 18), that is, the firms would make an ex ante estimate of average cost, as determined by some notion of their “normal” output, and then add a mark-up to it. Hall and Hitch present an alternative account of firm pricing, based on the “kinked demand curve”, in a context of oligopolistic competition.26 They write: If it is desired to illustrate the position of equilibrium geometrically, this may be done for the typical case where oligopoly elements are present by the use of a kinked demand curve, the kink occurring at the point 26

In the same year, the American economist Paul M. Sweezy (1910–2004), then at Harvard, employed kinked “imagined” demand curves in an article in the Journal of Political Economy (Sweezy 1939) to account for the fact that under one set of conditions a rational oligopolist would neither increase nor decrease his price whereas under another set of conditions he might either elevate or reduce his price. Each of these curves depicts the oligopolist’s estimate of what can be sold at various prices, making the best allowance he can for the probable reactions of his rivals.

2 Economics in Cambridge and Oxford in the Age …

89

where the price, fixed on the ‘full-cost’ principle, actually stands. Above this point the curve is elastic, because an increase in price will not be followed (or so it is feared) by competitors, who will be glad to take any extra sales. Below the point the demand is much less elastic because a reduction in the price charged will be followed eventually by competitors who would otherwise lose business. If this is the character of the demand curve it follows that over a wide range of marginal costs the existing price is the most profitable. It also follows that, with given costs, this price is most profitable over a wide range of possible fluctuations of the demand curve, since wherever the demand curve may be the kink will occur at the same price. (ibid., p. 22)

In this way Hall and Hitch formalize a peculiarity of firm behavior in oligopolistic markets, i.e., the fact that a price raise is not normally followed by competitors and should thus be accompanied by a fall in demand; by contrast, a price cut is normally followed by competitors and can then bring about only a limited rise in demand; accordingly, the demand to the firm exhibits a kink at the prevailing market price. This explanation was able to account for price rigidity with output flexibility on the real oligopolistic markets in the 1930s. The authors argued that this was consistent with a profit-maximization assumption, and though the traditional framework of analysis was not irrelevant, their own analysis offered a more realistic description of market behavior. Hall and Hitch drew the following conclusions: (i) A large proportion of businesses make no attempt to equate marginal revenue and marginal cost … (ii) An element of oligopoly is extremely common in markets for manufactured products; most businesses take into account in their pricing the probable reaction of competitors and potential competitors to their prices. (iii) Where this element of oligopoly is present … there is a strong tendency among business men to fix prices directly at a level which they regard as their “full cost”. (iv) Prices so fixed have a tendency to be stable. They will be changed if there is a significant change in wage or raw material costs, but not in response to moderate or temporary shifts in demand. (v) There is usually some element in the prices ruling at any time which can only be explained in the light of the history of the industry. (ibid., pp. 32–33)

90

R. Marchionatti

References Aslanbeigui, Nahid, and Guy Oakes. 2015. Arthur Cecil Pigou. London: Palgrave Macmillan. ———. 2016. The Great War and the Genesis of Pigou’s. A Study in Public Finance, Oeconomia 6 (4): 487–513. Backhouse, Roger, and Tamotsu Nishizawa, eds. 2010. No Wealth but Life: Welfare Economics and the Welfare State in Britain, 1880–1945. Cambridge: Cambridge University Press. Becattini, Giacomo. 1990. Alfred Marshall e la vecchia scuola di Cambridge. In Il pensiero economico: temi, problemi e scuole, ed. Giacomo Becattini, 275– 310. Torino: UTET. Besomi, Daniele. 2000. Keynes and Harrod on the Classical Theory of Interest: More on the Origin of the Only Diagram in the General Theory. Journal of the History of Economic Thought 22 (3): 367–376. ———. 2005. The Goodwilling Outsider: The Correspondence Between Keynes and Harrod. In Economists in Cambridge: A Study of their Correspondence, ed. Maria Cristina Marcuzzo and Annalisa Rosselli, 92–118. London: Routledge. ———. 2019. Roy Forbes Harrod. In The Elgar Companion to John Maynard Keynes, ed. Robert W. Dimand and Harald Hagemann, 388–392. Cheltenham: Edward Elgar. Bibow, Jörg. 1995. Some Reflections on Keynes’s ‘Finance Motive’ for the Demand for Money. Cambridge Journal of Economics 19 (5): 647–666. Cairncross, Alec. 1994. Austin Robinson. The Economic Journal 104: 903–915. Carabelli, Anna. 1988. On Keynes’s Method . London: Macmillan. Carabelli, Anna, Mario Cedrini, and Roberto Marchionatti. 2017. J.M. Keynes: The Modernity of an Un-modern Economist. Annals of the Fondazione Luigi Einaudi 51: 17–54. Clark, Colin. 1932. The National Income, 1924–31. London: Macmillan. Clarke, Peter. 1988. The Keynesian Revolution in the Making, 1924–1936 . Oxford: Clarendon Press. ———. 2009. Keynes. The Twentieth Century’s Most Influential Economist. London: Bloomsbury. Coates, J. 1996. The Claims of Common Sense: Cambridge Philosophy and the Social Sciences. Cambridge: Cambridge University Press.

2 Economics in Cambridge and Oxford in the Age …

91

———. 1997. Keynes, Vague Concepts and Fuzzy Logic. In A Second Edition of the General Theory, ed. G.C. Harcourt and P.A. Rich, vol. 2, 244–260. London: Routledge. Collard, David A. 1981. A.C. Pigou, 1877–1959. In Pioneers in Modern Economics in Britain, ed. D.P. O’Brien and J.R. Presley. London: Macmillan. ———. 2011. Generations of Economists. London: Routledge. Cuyvers, Ludo. 1983. Erwin Rothbarth’s Life and Work. Journal of Post Keynesian Economics 66 (2): 305–312. Davis, John. 1994. Keynes’s Philosophical Development. Cambridge: Cambridge University Press. ———. 1997. J. M. Keynes on History and Convention. In A Second Edition of the General Theory, ed. G.C. Harcourt and P.A. Riach, vol. 2, 203–221. London: Routledge. Dimand, Robert W. 1989. The Reception of Keynes’ Treatise on Money: A Review of the Reviews. In Perspectives on the History of Economic Thought, ed. Donald A. Walker, vol. 2, 87–96. Twentieth-Century Economic Thought. Aldershot: Edward Elgar. Dobb, Maurice. 1937. Political Economy and Capitalism: Some Essays in Economic Tradition. London: Routledge. ———. 1946. Studies in the Development of Capitalism. London: Routledge. ———. 1973. Theories of Value and Distribution since Adam Smith: Ideology and Theory. Cambridge: Cambridge University Press. Domar, Evsey. 1946. Capital Expansion, Rate of Growth and Employment. Econometrica 14 (2): 137–147. Fletcher, Gordon. 2008. Dennis Robertson. London: Palgrave Macmillan. Gehrke, Christian, and Heinz D. Kurz. 2006. Sraffa on von Bortkiewicz: Reconstructing the Classical Theory of Value and Distribution. History of Political Economy 38: 91–149. Hahn, Frank H., and R.C.O. Matthews. 1964. The Theory of Economic Growth: A Survey. The Economic Journal 74: 779–902. Hall, Robert L., and Charles J. Hitch. 1939. Price Theory and Business Behaviour. Oxford Economic Papers 1: 12–45. Harcourt, Geoffrey C. 2001. Joan Robinson and Her Circle. History of Economic Ideas 9 (2): 59–71. Harcourt, Geoffrey C., and Prue Kerr. 2009. Joan Robinson. London: Palgrave Macmillan. Harrod, Roy. 1930. Notes on Supply. The Economic Journal 40: 232–241. ———. 1931. The Law of Decreasing Costs. The Economic Journal 41: 566– 576.

92

R. Marchionatti

———. 1934. Doctrines of Imperfect Competition. Quarterly Journal of Economics 48 (3): 442–470. ———. 1936. The Trade Cycle. Oxford: Clarendon Press. ———. 1939. An Essay in Dynamic Theory. The Economic Journal 49: 14–33. ———. 1948. Towards a Dynamic Economics. London: Macmillan. ———. 1951. The Life of John Maynard Keynes. New York: Harcourt, Brace and Co. ———. 1953. The Pre-War Faculty. Supplement: Sir Hubert Henderson 1890–1952, New Series, Oxford Economic Papers 5: 59–64. Hayek, Friedrich A. 1931. Reflections on the Pure Theory of Money of Mr. J. M. Keynes. Economica 33: 270–295. ———. 1932. Reflections on the Pure Theory of Money of Mr. J. M. Keynes (continued). Economica, 35: 22–44. Hicks, John. 1935. Annual Survey of Economic Theory: The Theory of Monopoly. Econometrica 3 (1): 1–20. Kalecki, Michal. 1933. Proba Teorii Koniunktury. Warsaw: ISBCP. English translation in Kalecki (1990) under the title “Essay on the Business Cycle Theory”, 65–108. ———. 1934. Trzy uklady. Ekonomista 34: 54–70. English translation in Kalecki (1990) as “Three Systems”, 201–219. ———. 1935a. Essai d’une Theorie du Mouvement Cyclique des Affaires. Revue d’Economie Politique 2: 285–305. ———. 1935b. A Macrodynamic Theory of Business Cycles. Econometrica 3 (3): 327–344. Reprinted in Kalecki (1990), 120–138. ———. 1937. A Theory of the Business Cycle. The Review of Economic Studies 4 (2): 77–97. ———. 1939. Essays in the Theory of Economic Fluctuations. London: Allen & Unwin. ———. 1966. Studies in the Theory of Business Cycles: 1933–1939. London: Basil Blackwell. ———. 1971. Selected Essays on the Dynamics of Capitalist Economy, 1933– 1970. Cambridge: Cambridge University Press. ———. 1990. Collected Works of Michal Kalecki. Volume I: Capitalism, Business Cycles and Full Employment, ed. Jerzy Osiatynski. Oxford: Clarendon Press. Kahn, Richard F. 1931. The Relation of Home Investment to Unemployment. The Economic Journal 41: 173–198. ———. 1972. Essays on Employment and Growth. Cambridge: Cambridge University Press.

2 Economics in Cambridge and Oxford in the Age …

93

———. 1984. The Making of Keynes’ General Theory. Raffaele Mattioli Lectures. Cambridge: Cambridge University Press. ———. 1989 [1929]. The Economics of the Short Period . London: Macmillan. Kalecki, Michal. 1943. Political Aspects of Full Employment. Political Quarterly 14 (3): 322–331. Keynes, John Maynard. 1971a [1919]. The Economic Consequences of the Peace, vol. 2 of The Collected Writings of John Maynard Keynes [hereafter CW ], ed. E. Johnson and D.E. Moggridge. London: Macmillan. ———. 1971b. [1923]. A Tract on Monetary Reform, CW , vol. 4. ———. 1971c. [1930]. A Treatise on Money, 2 vols., CW , vols. 5 and 6. ———. 1972a. [1931]. Essays in Persuasion, CW , vol. 9. ———. 1972b. [1933]. Essays in Biography, CW , vol. 10. ———. 1973a. [1921]. A Treatise on Probability, CW , vol. 8. ———. 1973b. [1936]. The General Theory of Employment, Interest and Money, vol. 7. ———. 1973c. The General Theory and After. Part I: Preparation, CW , vol. 13. ———. 1973d. The General Theory and After. Part II: Defence and Development, CW , vol. 14. ———. 1979. The General Theory and After. A Supplement, CW , vol. 29. Kurz, Heinz D., and Neri Salvadori 2001. Sraffa and the Mathematicians: Frank Ramsey and Alister Watson. In Piero Sraffa’s Political Economy: A Centenary Estimate, ed. Terenzio Cozzi and Roberto Marchionatti, 254–284. London: Routledge. Lee, Frederic S. 1981. The Oxford Challenge to Marshallian Supply and Demand: The History of the Oxford Economists’ Research Group. Oxford Economic Papers 33 (3): 339–351. López, Julio, and Michaël Assous. 2010. Michal Kalecki. London: Palgrave Macmillan. Marchionatti, Roberto. 1995. Keynes and the Collapse of the British Cotton Industry in the 1920s: A Case Against Laissez-Faire. Journal of Post Keynesian Economics 17 (3): 427–445. ———. 1999. On Keynes’s Animal Spirits. Kyklos 52 (3): 415–439. ———. 2010. J.M. Keynes. Thinker of Economic Complexity. History of Economic Ideas 18 (2): 115–146. ———. 2019. Between Berlin and Cambridge: Classical Conceptions of the General Economic Equilibrium in the Late 1920s. Cambridge Journal of Economics 43 (5): 1377–1395. Marcuzzo, Maria Cristina. 1994. R. F. Kahn and Imperfect Competition. Cambridge Journal of Economics 18 (1): 25–39.

94

R. Marchionatti

———. 2001. Sraffa and Cambridge Economics, 1928–1931. In Piero Sraffa: A Centenary Estimate, ed. Terenzio Cozzi and Roberto Marchionatti, 81–99. London: Routledge. ———. 2002. The Collaboration Between J.M. Keynes and R.F. Kahn from the Treatise to the General Theory. History of Political Economy 34 (2): 421– 447. ———. 2005. Sraffa at University of Cambridge. European Journal of the History of Economic Thought 12 (3): 425–452. ———. 2020. Kalecki and Cambridge. Review of Political Economy 32 (4): 500–510. Marcuzzo, Maria Cristina, and Annalisa Rosselli, eds. 2005. Economists in Cambridge: A Study Through Their Correspondence, 1907–1946 . London: Routledge. Marcuzzo, Maria Cristina, Nerio Naldi, Annalisa Rosselli, and Eleonora Sanfilippo. 2008. Cambridge as a Place in Economics. History of Political Economy 40: 469–592. Marris, Robin L. 1992. R. F. Kahn’s Fellowship Dissertation: A Missing Link in the History of Economic Thought. The Economic Journal 102: 1235–1243. Moggridge, Donald. 1992. Maynard Keynes: An Economist’s Biography. London: Routledge. Moore, George E. 1903. Principia Ethica. Cambridge: Cambridge University Press. Myint, Hla. 1948. Theories of Welfare Economics. Cambridge, MA: Harvard University Press. Naldi, Nerio. 2018. On the Earliest Formulations of Sraffa’s Equations. In Classical Economics Today: Essays in Honor of Alessandro Roncaglia, ed. Marcella Corsi, Jan Kregel and Carlo D’Ippoliti, 129–151. London: Anthem Press. O’Shaughnessy, Terry J. 1994. Kahn on the Economics of the Short Period. Cambridge Journal of Economics 18 (1): 41–54. Phelps Brown, Henry. 1980. Sir Roy Harrod: A Biographical Memoir. The Economic Journal 90: 1–33. Pigou, Arthur Cecil. 1920. The Economics of Welfare. London: Macmillan. ———. 1927. Industrial Fluctuations. London: Macmillan. ———. 1928. A Study in Public Finance. London: Macmillan. ———. 1933. The Theory of Unemployment. London: Macmillan. ———. 1936. Mr. J.M. Keynes’ General Theory of Employment, Interest and Money. Economica 3 (10): 115–132. ———. 1937. Real and Money Wage Rates in Relation to Unemployment. The Economic Journal 47: 405–422.

2 Economics in Cambridge and Oxford in the Age …

95

———. 1941. Employment and Equilibrium: A Theoretical Discussion. London: Macmillan. ———. 1943. The Classical Stationary State. The Economic Journal 53: 343– 351. ———. 1950. Keynes’s General Theory: A Retrospective View. London: Macmillan. Presley, John R. 1981. D.H. Robertson 1890–1963. In Pioneers of Modern Economics in Britain, ed. D.P. O’Brien and John R. Presley, 175–202. London: Macmillan. ———. 1992. J. M. Keynes and D.H. Robertson: Three Phases of Collaboration. In Essays on Robertsonian Economics, ed. John R. Presley, 80–96. London: Palgrave Macmillan. Raffaelli, Tiziano. 2004. Whatever Happened to Marshall’s Industrial Economics. European Journal of the History of Economic Thought 11 (2): 209–229. Robertson, Dennis. 1923. The Control of Industry. London: Nisbet & Company. ———. 1926. Banking Policy and the Price Level: An Essay in the Theory of the Trade Cycle. London: P. S. King. Robinson, Edward Austin G. 1931. The Structure of Competitive Industry. Cambridge: Cambridge University Press. Revised edition, 1953. ———. 1941. Monopoly. Cambridge: Cambridge University Press. ———. 1968. Arthur Cecil Pigou. In International Encyclopedia of the Social Sciences, ed. D.L. Sills, vol. 12. New York: Macmillan and Free Press. Robinson, Joan V. 1932. Imperfect Competition and Falling Supply Price. The Economic Journal 42: 544–554. ———. [1933]. The Economics of Imperfect Competition. London: Macmillan. 2nd ed., 1969. ———. 1937a. An Introduction to the Theory of Employment. London: Macmillan. ———. 1937b. Essays in the Theory of Employment. Oxford: Basil Blackwell 2nd ed., 1947. ———. 1942. An Essay on Marxian Economics. London: Macmillan. 2nd ed., 1966. ———. 1956. The Accumulation of Capital . London: Macmillan. ———. 1973. Collected Economic Papers. Vol. IV. London: Macmillan. ———. 1977. Michal Kalecki. Oxford Bulletin of Economics and Statistics 39 (1): 7–17. Reprinted in Joan Robinson, Collected Economic Papers Volume V , 184–196. Oxford: Blackwell, 1979.

96

R. Marchionatti

Russell, Bertrand. 2000 [1968]. Autobiography. London: Routledge. Russell, Bertrand (with Alfred North Whitehead). 1910–1913. Principia Mathematica. Cambridge: Cambridge University Press. Rymes, T.K. 1989. Keynes’s Lectures 1932–1935: Notes of a Representative Student. London: Macmillan. Sardoni, Claudio. 2004. The Contribution of Gerald Shove to the Development of Cambridge Economics. Review of Political Economy 16 (3): 361–375. Sargant Florence, Philip. 1932. Review of The Structure of Competitive Industry by E. A. G. Robinson. The Economic Journal 42: 66–70. ———. 1933. Logic of Industrial Organization. London: K. Paul, Trench, Trubner & Company. Schumpeter, Joseph A. 1934. Robinson’s Economics of Imperfect Competition. Journal of Political Economy 42 (2): 249–259. ———. 1954. A History of Economic Analysis. London: Allen & Unwin. Shackle, George L.S. 1967. The Years of High Theory: Invention and Tradition in Economic Thought 1926–1939. Cambridge: Cambridge University Press. Shenk, Timothy. 2013. Maurice Dobb: Political Economist. London: Palgrave Macmillan. Signorino, Rodolfo. 2005. Piero Sraffa’s Lectures on the Advanced Theory of Value 1928–31 and the Rediscovery of the Classical Approach. Review of Political Economy 17 (3): 359–380. Sinha, Ajit. 2016. A Revolution in Economic Theory: The Economics of Piero Sraffa. London: Palgrave Macmillan. Skidelsky, Robert. 1983. John Maynard Keynes, Vol. 1: Hopes Betrayed 1883– 1920. London: Macmillan. ———. 1992. John Maynard Keynes, Vol. 1I: The Economist as Saviour, 1920– 1937 . London: Macmillan. ———. 2000. John Maynard Keynes, Vol. II1: Fighting for Britain 1937–1946 . London: Macmillan. Shove, Gerard. 1930. Increasing Returns and the Representative Firm. The Economic Journal 40: 79–116. ———. 1933. Review of The Economics of Imperfect Competition, by Joan Robinson. The Economic Journal 43: 657–661. ———. 1942. The Place of Marshall’s Principles in the Development of Economic Theory. The Economic Journal 52: 294–329. Sraffa, Piero. 1925. Sulle relazioni fra costo e quantità prodotta. Annali Di Economia 2: 277–328.

2 Economics in Cambridge and Oxford in the Age …

97

———. 1926. The Laws of Returns Under Competitive Conditions. The Economic Journal 36: 535–550. ———. 1932. Dr. Hayek on Money and Capital. The Economic Journal 42: 42–53. ———, ed. 1951–1973. Works and Correspondence of David Ricardo (with the collaboration of M. Dobb), Vols. I–X, 1951–1955, and Vol. XI (index), 1973. Cambridge: Cambridge University Press. ———. 1960. Production of Commodities by Means of Commodities. Cambridge: Cambridge University Press. Stamp, Josiah C. 1931. Mr Keynes’s Treatise on Money. Economic Journal 162: 241–249. Steil, Benn. 2013. The Battler of Bretton Woods: John Maynard Keynes, Harry Dexter White and the Making of a New World Order. Princeton: Princeton University Press. Steindl, Josef. 1981. A Personal Portrait of Michal Kalecki. Journal of Post Keynesian Economics 3 (4): 590–596. Sweezy, Paul M. 1939. Demand Under Conditions of Oligopoly. Journal of Political Economy 47: 568–573. Toporowski, Jan. 2013. Michal Kalecki: An Intellectual Biography, Volume I. Rendezvous in Cambridge 1899–1939. London: Palgrave Macmillan. ———. 2018. Michał Kalecki: An Intellectual Biography: Volume II. By Intellect Alone 1939–1970. London: Palgrave Macmillan. Trezzini, Attilio. 2019. Sraffa on Marshall’s Theory of Value in the Cambridge Lectures: Achievements in an Unfinished Criticism. Centro Sraffa Working Papers No. 34. Young, W., and F.S. Lee. 1993. Oxford Economics and Oxford Economists. London: Macmillan. Williams, John H. 1931. The Monetary Doctrines of J. M. Keynes. Quarterly Journal of Economics 45 (4): 547–587.

3 Economics in London: The London School of Economics (LSE)

3.1

Prologue: LSE Under Lionel Robbins’s Leadership

LSE was founded in 1895 by four members of the Fabian Society, Sidney Webb, his wife Beatrice Webb, the political scientist Graham Wallas and the writer George Bernard Shaw.1 Initially established as an independent institution, it would later be incorporated into the University of London. In the years after World War I, the School reached a prominent position in economics (as well as in the fields of political science and anthropology2 ). These years are known as the “Beveridge years”—from William Beveridge (1879–1963), social scientist and social reformer close to the Webbs and the author of the famous Beveridge Report in 1942, which inaugurated the era of the welfare state in the United Kingdom. In 1919, Beveridge was appointed Director of LSE. The rich cultural 1

For the history of LSE, see Dahrendorf (1995). See also Hayek (1946). Harold Laski (1893–1950) in the field of political science and Bronislaw Malinowski (1884– 1942) in that of anthropology were the most eminent figures. 2

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 R. Marchionatti, Economic Theory in the Twentieth Century, An Intellectual History—Volume II, https://doi.org/10.1007/978-3-030-80987-4_3

99

100

R. Marchionatti

climate developed at the School in this period is also witnessed by the creation of new journals—two in the field of economics, Economica in 1921 and the Review of Economic Studies, founded by several students in 1933 (Abba Lerner, Paul Sweezy and Ursula Webb): it is noteworthy that the latter journal’s declared purpose was to publish the promising works of young economists, from research students up to lecturers. In 1919, the Professor of Political Economy was Edwin Cannan (1865–1935), an Oxford-trained economist who had joined LSE in 1895, known above all for his work in the history of economics and in particular his A History of the Theories of Production and Distribution (1894) and his critical edition of Adam Smith’s Wealth of Nations in 1904. Although not hostile to Marshall, Cannan encouraged his students to read widely and beyond British economics, “with the result that LSE teaching was more ‘cosmopolitan’ than that at Cambridge or Oxford” (Howson 2018, p. 366).3 Cannan retired in 1926 and was replaced by the American economist Allyn Young (see Chap. 6.3), whose time at LSE was unfortunately short because he died suddenly, aged 52, from pneumonia. To replace him, Lionel Robbins (1898–1984), who had studied at the LSE and was then at New College, Oxford, was appointed professor of economics and head of the department of economics in 1929—at that time he was only 31. Robbins was not a Marshallian but a follower of Wicksteed and a scholar of the Continental European economists. As a result, Robbins’s arrival brought about considerable changes to the type of economics practiced at LSE, in an anti-Marshallian perspective which drew essentially on the theoretical contributions of the Lausanne and Austrian schools. Robbins’s program of criticism of the current 3 The two other main economists in the LSE of the 1920s were Hugh Dalton (1887–1961) and Theodore Gregory (1890–1970). Hugh Dalton was educated at Eton and then at Cambridge, where he became a socialist and joined the Fabian Society. He took a doctorate at the London School of Economics, where he was, after the war, lecturer from 1920 to 1935. Dalton published important work on public finance, the distribution of income and wealth and the economics of socialism, along Pigouvian lines: his reputation is mainly connected with the publication of The Principles of Public Finance in 1923. In 1935, he resigned in order to devote himself to politics. Theodore Gregory studied at the LSE where he taught from 1913 to 1937, first as assistant and lecturer between 1913 and 1919, then as reader and professor in International Trade between 1920 and 1937. He published essentially in the field of monetary economics, with a historical and institutional approach, his main publications being Gold, Unemployment and Capitalism (1933) and The Gold Standard and Its Future (1932, 1935).

3 Economics in London: The London School …

101

state of economic theory, in particular in its Marshallian version, was synthetized in his inaugural lecture at the LSE on January 1930, entitled “The Present Position of Economic Science”. In the lecture, he laid out what he considered the main deficiencies in economic theory, led by gaps in the body of theory, in particular in price theory and in the analysis of macroeconomic phenomena such as industrial fluctuations. This criticism was pursued in his course on “General Principles of Economic Analysis” which concentrated on value and distribution and had a significant impact on the young generation of students at LSE (see Coase 1982; Howson 2011). His main writings of that period centered on his critique of the Marshallian theory of value (Robbins 1928, see Chap. 7.1) and Pigouvian welfare economics. His book Essay on the Nature and Significance of Economic Science (Robbins 1932) offered a methodological framework which systematized marginalist continental contributions, departing entirely from the Marshallian canon. From the end of the 1920s, under Robbins’s leadership, the LSE became the main opponent of Cambridge economics in England and one of the world’s most influential new centers in economic theory. This was the result of the joint action of Robbins and Friedrich Hayek, and the group of young economists around them, in an “atmosphere of creative tension and excitement” (Kaldor 1986, p. 14). Hayek arrived at LSE in 1931. His work, in particular his 1929 monograph Geldtheorie und Konjunkturtheorie and his essay “The Paradox of Savings”, had drawn Robbins’s attention, and Hayek was invited to give the University of London Advanced Lectures in Economics for 1930/1931 in January 1931: as Robbins would write in his autobiography, “the lectures were a sensation”, and “they conveyed such an impression of learning and analytical invention” (Robbins 1971, p. 127).4 Hayek was 4

The lectures were well received by the London audience.Hayek had also accepted an invitation from Cambridge to address the Marshall Society. There the impression created was rather different. Richard Kahn describes the evening as follows: “[t]he members of the audience—to a man—were completely bewildered. Usually a Marshall Society talk is followed by a barrage of discussions and questions. On this occasion there was complete silence. I felt I had to break the ice. So I got up and asked: ‘Is it your view that if I went out tomorrow and bought a new overcoat, that would increase unemployment?’ ‘Yes’, said Hayek. ‘But’, pointing to his triangles on the board, ‘it would take a very long mathematical argument to explain why’” (Kahn 1984, p. 182).

102

R. Marchionatti

offered a visiting professorship and, after two terms as a visitor, the Tooke Chair permanently.5 As indicated earlier, an impressive group of young economists gathered around Robbins and Hayek in the first half of 1930s. In addition to their contemporaries Ursula Webb (1896– 1985) and Arnold Plant (1898–1978), this group included Abba Lerner (1903–1982), G. L. S. Shackle (1903–1992), John Hicks (1904–1989), Roy Allen (1906–1983) and other younger scholars such as Nicholas Kaldor (1908–1986), Victor Gregory Edelberg (1909–2005) and Ronald Coase (1910–2013): this group was also called “the Robbins circle”. From the theoretical standpoint, Hicks and Lerner were undoubtedly the most productive scholars in the group, publishing some of their major works which must be considered products of the LSE cultural environment of those years: they represented what is known as the Paretian Revival in England. Hicks was closely connected with Roy George Douglas Allen (see Thomas 2018), whose most important contributions in economics—on value theory—were made together with Hicks (see Hicks and Allen 1934). Allen had arrived at the LSE in 1928, after studying mathematics, economics and philosophy at Cambridge, where he became a Wrangler in 1927. He spent his entire career at LSE, teaching mathematical economics, statistics and econometrics. He was also heavily involved in public service. Ursula Kathleen Webb (see Creedy 2011), later Lady Hicks, had gone to study economics at LSE at the end of the 1920s, after an education in history at Somerville College, Oxford. She gained first class honors in 1932, continuing as a research student and receiving her Ph.D. in 1935. She was appointed Assistant Lecturer at LSE but on her marriage to John Hicks, who had been elected to a Cambridge Fellowship, she resigned her position, although she continued to be an active researcher in public finance and development economics. Arnold Plant (see Cord 2018) had enrolled at LSE in 1920, choosing to specialize in economic history. After some years at the University of Cape Town, he returned to the School in 1930, 5 Although Hayek much later told interviewers that Robbins brought him to the LSE to serve as an intellectual opponent to Keynes, Howson (2011) reveals that the facts were different. Robbins’ first choice for the vacant Tooke Chair was Jacob Viner, but the American economist received a counteroffer persuading him to stay at the University of Chicago. It was Beveridge who then came up with the idea of offering Hayek a visiting professorship.

3 Economics in London: The London School …

103

invited by Beveridge and Robbins, as the Sir Ernest Cassel Professor of Commerce. Plant is known above all for his work on copyright on books and patents for inventions, writing two important articles on these issues in the mid-1930s (see Plant 1934a, b). George Lennox Sharman Shackle, after studying in Cambridge, where he was born, and after a period of work as a bank clerk, enrolled at LSE and took his degree in economics in 1931 (on Shackle see Ford 1989, 1994). He started work on a Ph.D. under the supervision of Friedrich Hayek but, increasingly influenced by the work of Keynes and the new Stockholm School, he devoted his dissertation to a business cycle theory of Keynesian inspiration, where expectations and uncertainty played the key role in the theoretical structure: due to these influences and initial stimuli, Shackle called his work “a study of the new Keynesianism in the light of the new Wicksellianism” (see Ford 1989, p. 27). The revised dissertation appeared as a book under the title Expectations, Investment and Income (Shackle 1938). It was at the basis of Shackle’s future works which made him one of the most important exponents of the post-Keynesian school (see Vol. III of this book). Nicholas Kaldor (born in Budapest as Káldor Miklós), after his early studies in Budapest and Berlin, went to LSE where he graduated in 1930 and became “the favourite pupil of Robbins” (Thirlwall 1996, p. 151; on Kaldor see King 2009). At the same time, he was also strongly influenced by Hayek, translating the latter’s Monetary Theory and the Trade Cycle and “The Paradox of Saving” from the German. From the mid1930s, however, he became uneasy with Hayek’s theories, developing an interest, first in Lausanne economics to which he was introduced by Hicks and then in Keynes’s theory. He showed his precocious talent in this first phase of his career—he was probably the most brilliant of the younger generation at the LSE—with a series of papers criticizing existing theories. This early work included a fine paper on the existence and stability of equilibrium (Kaldor 1934a); his articles on the theory of the firm and on imperfect competition (Kaldor 1934b, 1935), in which he emerged as a “sympathetic critic” of both Joan Robinson and Chamberlin (Harcourt 2006, p. 174; see also Harcourt 1993); and his survey on capital theory (Kaldor 1937). After the publication of the General Theory, he was converted to Keynes’s doctrine, and this shift marked the

104

R. Marchionatti

beginning of his subsequent career in Cambridge as a leader of the postKeynesian school after World War II. A relatively minor figure in the group was Victor Gregory Edelberg (1909–2005). Of Russian origin, he was at LSE from 1928 to 1936 and is considered one of Robbins’s best students, publishing a series of articles in Economica, Econometrica and The Review of Economic Studies. Unfortunately, a mental breakdown in the late 1930s forced him to spend most of his life in a psychiatric institution (see Thomas 2020). Lastly, mention should be made of a young member of the group who was destined to become one of the most important economists of the second part of the century, Ronald Coase (see Marciano 2018). Coase enrolled at LSE in 1929 and studied for the Bachelor of Commerce degree from 1929 to 1932. He was strongly influenced by Arnold Plant, attending the latter’s lectures and seminar on business administration in the second year. On Plant’s suggestion and with his help, Coase spent his third year in the United States. There he visited factories and carried out interviews on the structure of American firms and industries. When he came back, he secured teaching positions first at the Dundee School of Economics and Commerce, then at the University of Liverpool and from 1935 until 1951 at LSE. In 1937, he published in Economica his famous article “The Nature of the Firm” (Coase 1937), essentially based on his American interviews: what came out of his enquiries was the introduction of the concept of transaction costs, useful to explain why there are firms. In 1951, Coase earned his Ph.D. from the University of London and was offered the Tooke Chair at LSE by Robbins. At the same time, Coase received a proposal from Ralph C. Epstein, dean of the School of Business Administration at the University of Buffalo (now the State University of New York at Buffalo). To Robbins’s disappointment, Coase accepted that proposal and went back to the United States where he settled permanently, first in Buffalo and then in Chicago. All these economists were members of a seminar jointly held by Robbins and Hayek between 1931 and 1940, attended by students and faculty members, with a flow of foreign—chiefly American—visitors and students. In addition to being a fundamental vehicle of Robbins’s and Hayek’s thought, the seminar led to much important research, and

3 Economics in London: The London School …

105

more generally fostered an intellectual environment for the transmission and incorporation of Austrian and Paretian economics in England.6 For example, as Robbins writes in his Autobiography (Robbins 1971, pp. 131–132): Chapters from Hayek’s Pure Theory of Capital , Hicks and Allen’s Reconsideration of the Theory of Value, Plant’s Economics of Patents, Lerner’s Factor Prices in International Trade, Kaldor’s Classificatory Note on Conceptions of Equilibrium, Victor Edelberg’s Ricardian Theory of Profits—these are specimens of the sort of material which was presented to our discussions. It was all very exciting. The feeling was general that after a period of relative stagnation, economics was on the march again and that we were participating in active operations.

Several events, however, would substantially end the intellectual ferment that took place at the LSE during the 1930s. As we mentioned earlier, Keynes’s General Theory did much to draw many of the younger members of LSE away from the Robbins-Hayek sphere of influence, in particular Kaldor, Lerner and Shackle.7 Moreover, as Robbins wrote, “the successive years of the thirties, at L.S.E. as elsewhere, were darkened more and more by the growing shadow of the Nazis” (Robbins 1971, p. 142). The outbreak of war led to the removal of the LSE to Cambridge. Here, while Robbins departed for government service and progressively changed his theoretical positions, Hayek taught and edited Economica, but in his research, he gradually moved away from pure theory and into more political and philosophical areas.

6

The seminar was the continuation of a seminar for research students initially introduced by Allyn Young between 1926 and 1929. 7 Joan Robinson remembers: “A delegation led by Abba Lerner (then a graduate student at LSE) came to Cambridge to suggest that the young generation on each side should get together and settle the debate amongst themselves. The Review of Economic Studies was founded as a forum for discussion (it later evolved into something quite different) and a weekend meeting was arranged at an inn half-way between London and Cambridge. … Abba came to spend a term in Cambridge” (J. Robinson 1978, p. xv).

106

3.2

R. Marchionatti

Lionel Robbins (1898–1984)

Lionel Charles Robbins was an important figure in the economics of the twentieth century, influencing it through his Essay on the Nature and Significance of Economic Science. In the Essay, the conception of economics developed in the period of the marginalist or neoclassical revolution and then reorganized along non-utilitarian lines essentially by Pareto is methodologically systemized as a universal approach. It gives what is still the most widely used definition of economics: “Economics is the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses” (Robbins 1932, p. 15), which since then has been adopted in all standard economics textbooks.

Biographical Note8 Lionel Charles Robbins was born on November 22, 1898, in Sipson, Middlesex, England, in a farmers’ family, the first child of Rowland Richard Robbins and Rosa Marion Robbins (née Harris). After attending the local grammar school, he entered University College London but his studies were interrupted by the war. During the war, he served as an artillery officer on the Western front. After the war, he entered LSE, where he studied under the influence of Hugh Dalton, Edwin Cannan and Theodore Gregory—and, as Howson (2011, p. 1079) writes, at the LSE “he encountered the academic discipline of economics, which attracted him because it was rational and scientific: its findings were not dictated by political presumptions and it was value-free compared with political science”. In the environment of the LSE, he became also a liberal economist, “a stance from which he never budged” (ibid., p. 1080). He graduated in the autumn of 1923. After graduation, Robbins worked as research assistant to Beveridge, the director of the School. In 1924, thanks to Cannan, he was offered a temporary position at New College, Oxford, to teach economics. Robbins then returned to LSE as assistant 8 For the biography of Robbins see, in addition to Robbins’s autobiography (Robbins 1971), O’Brien (1988), and Howson (2011).

3 Economics in London: The London School …

107

lecturer for two years before accepting a permanent fellowship at New College in 1927. However, in June 1929, at the unexpected death of Allyn Young, he was appointed professor and head of department at LSE, a position he held until his retirement in 1961. By the middle of the 1920s, his formation was strongly influenced by his reading (facilitated by his knowledge of the German language) of the work of German-speaking economists, mainly the new Austrians, in particular Mises and Hayek, as well as his reading of Wicksteed’s Common Sense.9 As a result of these influences, Robbins published his most important works of the 1930s: his classic 1932 essay The Nature and Significance of Economic Science—as its preface acknowledges, it principally synthesized methodological ideas from Mises and Wicksteed—and his 1934 The Great Depression—fundamentally “an Austrian work in that an Austrian monetary overinvestment theory is used to explain the downturn of 1929–1930 and to criticize most policy reactions to the slump” (Howson 2011, pp. 1081–1082).10 In those years, he was the leader and organizer of intellectual activity at LSE. His interest in theoretical economics was not separate from that in economic policy issues, a field where he clashed with Keynes. The conflict between Keynes and Robbins started when Robbins was appointed in July 1930 together with Henderson, Pigou and Josiah Stamp (at that time director of the Bank of England) to the Economic Advisory Council’s Committee of Economists, which was chaired by Keynes and had been set up to suggest an appropriate policy for the depression. When the final report was drafted, Robbins 9 Kaldor remembers in his reminiscences of those years that: “Robbins’ economics (much influenced by his contacts with Viennese economists, mainly von Mises) was the general equilibrium theory of Walras and the Austrians, rather than of Marshall, and his lectures followed the method of presentation of Wicksell and of Knight’s Risk, Uncertainty and Profit … Robbins as a young economist absorbed this theory—the keystone of which is the marginal productivity theory of distribution in its generalised form, as expounded by Wicksell and Wicksteed—with the fervency of a convert and propounded it with the zeal of a missionary (Kaldor 1986, pp. 14–15). 10 Robbins would later express a strong critical evaluation of this book’s political implications. In his autobiography, he writes: “Confronted with the freezing deflation of those days, the idea that the prime essential was the writing down of mistaken investments … was completely inappropriate … I shall always regard this aspect of my dispute with Keynes as the greatest mistake of my professional career, and the book, The Great Depression, which I … wrote partly in justification of this attitude, as something which I would willingly see forgotten” (Robbins 1971, p. 154).

108

R. Marchionatti

firmly opposed some of the points proposed by Keynes, in particular the recommendations that the government should introduce public investment policies to revive industry, and if necessary promote protectionist measures to improve the balance of payments. His internationalism led him to argue for a federal international economic order in his Economic Planning and International Order (Robbins 1937) and in The Economic Causes of War (Robbins 1939). During World War II, Robbins entered government service and played an important role in economic policy-making. Howson notes (2011, p. 1084) that during these years “Robbins was one of Keynes’ most powerful allies within the government machine”. Robbins’s greatest collaboration with Keynes, however, was over international postwar economic planning. He was a member of the British delegations to the Bretton Woods conference where postwar monetary and trade policies were laid out. After his return to the LSE, he resumed his role as “intellectual focus for the economists” (Baumol 1989, p. 12) and, in the latter part of his life, turned to the history of economic thought and policy, publishing various classic studies on English history, including The Theory of Economic Policy in Classical Political Economy (1952), The Theory of Economic Development in the History of Economic Thought (1968) and The Evolution of Modern Economic Theory (1970). He retired in 1961 as Professor at LSE, though he continued to lecture at the school for two decades thereafter. On retirement from the LSE, he was chairman of the Financial Times until 1970 and, from 1961 to 1964, he served as Chairman of the Committee on Higher Education which laid the foundations for improving and extending the British university system. He died on May 15, 1984, in London.

Robbins’s Economics: An Essay on the Nature and Significance of Economic Science, 1932 In 1932, Lionel Robbins published An Essay on the Nature and Significance of Economic Science, a fundamental contribution to methodology

3 Economics in London: The London School …

109

in the history of modern economics.11 , 12 It was, as Hutchison wrote, “a resuscitation of methodological discussion” (Hutchison 2009, p. 299) in economics after forty years of “silence” on methodological questions that had lasted, at least in Britain, since Keynes’ The Scope and Method of Political Economy (see Vol. I, Chap. 8.1)—together with, we add, Mises’ work published one year later. The sources of the Essay were manifold (see O’Brien 1988; Howson 2004). Above all, they included Mises’s previous works and Wicksteed, to whom Robbins acknowledges “especial indebtedness” in the preface of the book (Robbins 1932, p. vii). The book is organized in six chapters devoted to the subject matter of economics, a discussion of many topics relating to ends and means, the concept of scarcity and the nature of economic generalizations. The main purpose of Robbins’s essay is “to arrive at precise notions concerning the subject-matter of Economic Science and the nature of the generalisations of which Economic Science consists” (ibid., p. xiv). Robbins rejects the definition of economics which “relates it to the study of the causes of material welfare”, because, he maintains, there is still an economic problem, for both society and the individual, “of deciding between the ‘economic’ and the ‘non-economic’”—that is, the problem of choosing between these two kinds of activity. Solving this problem requires an analytical definition of economics: “[the book] does not attempt to pick out certain kinds of behavior, but focuses attention on a particular aspect of behaviour, the form imposed by the influence of scarcity” (ibid., pp. 16–17). The fundamental implication is that any kind of human behavior falls within the scope of economic generalizations. From the point of view of the economist, Robbins writes, the conditions of human existence exhibit four fundamental characteristics: The ends are various. The time and the means for achieving these ends are limited and capable of alternative application. At the same time the ends have different importance. (ibid., p. 12)

11

It is considered a novel contribution to methodological individualism (see Oliveira and Suprinyak 2018 and the literature there cited). 12 A second edition, with “alterations and improvements”, was published in 1935. On this edition, see Hutchison (2009).

110

R. Marchionatti

Human action assumes the form of choice only when these conditions all exist at the same time. Scarcity is the fundamental principle: Scarcity of means to satisfy ends of varying importance is an almost ubiquitous condition of human behaviour. Here, then, is the unity of subject of Economic Science, the forms assumed by human behaviour in disposing of scarce means. (ibid., pp. 13–15)

It follows that “economics is the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses” (ibid., p. 16). Economics is essentially a deductive science: “the propositions of economic theory … are deductions from a series of postulates” (ibid., p. 78). The three basic postulates, according to Robbins, are: that individuals can order their preferences, that there is more than one factor of production, and that there is uncertainty about future scarcities. They only need “to be stated to be recognised as obvious”, as they are all “assumptions involving … simple and indisputable facts of experience” (ibid.), which do not need to be verified. They are related, Robbins writes, “to the way in which the scarcity of goods … actually shows itself in the world of reality” (ibid.). In fact, pure economics examines “the implications of the existence of scarce means with alternative uses” (ibid., p. 83), just as pure mechanics explores the existence of certain given properties of bodies. However, applying economic analysis to modern market society “involves the use of a great multitude of … postulates regarding the condition of markets, the number of parties to the exchange, the state of the law” (ibid., p. 79): drawn from the examination of historical material, they are designated “historico-relative” (ibid., p. 80). Thus, the laws of economics are not limited to some particular conditions of space and time; rather, they have universal validity. Robbins writes: The generalisations of the theory of value are as applicable to the behaviour of isolated man or the executive authority of a communist society, as to the behaviour of man in an exchange economy. (ibid., p. 20)

3 Economics in London: The London School …

111

Of course, economic analysis “has most interest and utility in an exchange economy” (ibid., p. 19), but its subject matter is not limited to such phenomena. In fact, “the exchange relationship is a technical incident”, but a technical incident “which gives rise to nearly all the interesting complications, but still … subsidiary to the main fact of scarcity” (ibid.). The laws of choice in conditions of scarcity are, for Robbins, the key to explaining both the workings of the exchange economy and the behavior of the isolated man. It follows that the purpose of economic science is to furnish awareness of the consequences of individuals’ actions without making any value judgments—“economic analysis is wertfrei in the Weber sense”, Robbins writes (ibid., p. 91). Economic analysis judges the consistency of behavior and the adequacy of means to ends, or, we may say, the economic rationality of behavior. The concept of “rational”, as synonymous with “consistent and adequate”, is central to Robbins’s argument. It is a fundamental postulate, but not in the sense that economic science is applicable only when the action is completely consistent: it is not true, Robbins writes, that “the generalisations of economics are limited to the explanation of situations in which action is perfectly consistent. Means may be scarce in relation to ends, even though the ends be inconsistent” (ibid., p. 92). In other words, it is the (neoclassical) economic analysis which represents the point of view of rationality. It is used to explain real situations where economic action may be inconsistent. Robbins adds that we may nevertheless argue that human behavior always has some degree of rationality in order to acquire an economic aspect. In this sense, it is “purposive”. He writes: Of course there is a sense in which the word rationality can be used which renders it legitimate to argue that at least some rationality is assumed before human behaviour has an economic aspect—the sense, namely, in which it is equivalent to “purposive”. As we have seen already, it is arguable that if behaviour is not conceived of as purposive, then the conception of the means-end relationships which economics studies has no meaning. So if there were no purposive action, it could be argued that there were no economic phenomena. (ibid., p. 93)

112

R. Marchionatti

Economic rationality essentially corresponds to consistency, that is, the ability to choose the means adequate to the ends. Economic science, Robbins writes, does not require human action to be always perfectly rational. The assumption of “perfect rationality in the sense of complete consistency” (ibid., p. 94)—which corresponds in economic analysis to the mathematical concept of maximization—is simply “one of a number of assumptions of a psychological nature which are introduced into economic analysis at various stages of approximation to reality”, in order “to study, in isolation, tendencies which, in the world of reality, operate only in conjunction with many others” (ibid.). Economic Man is only … an expository device—a first approximation used very cautiously at one stage in the development of arguments which, in their full development, neither employ any such assumption nor demand it in any way for a justification of their procedure—it is improbable that he would be such a universal bogey. (ibid., p. 97)

In Robbins’s perspective, economic science is the rational point of view on the world. The universal character of economic analysis in Robbins’s methodological approach derives from the fact that wherever scarcity exists—and according to Robbins “scarcity of means to satisfy ends of varying importance is an almost ubiquitous condition of human behaviour” (ibid., p. 15), because “we have been turned out of Paradise” (ibid.)—man must choose. And he can choose in a more or less economic way, where “economic” means rational and consistent.

A Reply to Robbins: Hutchison’s The Significance and Basic Postulates of Economic Theory, 1938 In 1938, the young English researcher Terence Hutchison (who at the time was 26) published The Significance and Basic Postulates of Economic Theory, a book which can be read “as a point by point critique of Robbins’s ‘pseudo-scientific methodology’”, “though Hutchison does not specifically single out Robbins as the target of his criticism” (Caldwell 1982, pp. 106–107). Terence Wilmot Hutchison (1912–2007), today

3 Economics in London: The London School …

113

known above all as one of the finest historians of economics of the twentieth century, had graduated in economics at Cambridge in 1934, under the tutorship of Joan Robinson who stimulated his interest in economic methodology. He read Robbins’s Essay but he was not convinced by its approach, so that “both its apriorism and its immense confidence in the powers of economic theory seem to have pushed Hutchison in the opposite direction” (O’Brien 2009, p. 181). He registered as an occasional student at LSE, and in this position, he had the opportunity to hear Rudolf Carnap’s lectures in 1934, to read Karl Popper’s Logik der Forschung and to become familiar with the Vienna circle’s philosophical discussion, as well as to discuss with Robbins and Hayek (see O’Brien 2009). In 1935, he went to Germany where he pursued his studies of methodology and wrote his The Significance and Basic Postulates of Economic Theory, before returning to the United Kingdom in 1938. The book was published in the same year. With it, according to Blaug (1980, p. 83), we have “the explicit introduction of Popper’s methodological criterion of falsifiability into economic debates”. This is true, but we think, with Hart (2002), that there has been an overemphasis on the positivist and Popperian elements in Hutchison’s essay, and must also stress—a point disregarded by the literature—that Hutchison’s avowed methodological reference is the Pareto of Trattato di Sociologia: hence the general motto chosen for his book and for his conclusions. Actually, Pareto is for Hutchison the main economist—but not the only one, as he also frequently casts Marshall and Schumpeter in this light— who can offer the mix of deductive mathematical analysis and inductive historical inquiry needed to deal with the complex subject matter of economics. In this sense, Hutchison’s essay must be considered as a modern restatement of the inductivist-empirical-historical, as opposed to the deductivist-apriorist-formalist, approach in the long-standing methodenstreit in economics (Hart 2002). Hutchison writes that “the purpose of this essay is to help in elucidating the significance of that body of ‘pure theory’ the possession of which distinguishes Economics from the other social sciences” (Hutchison 1938, p. 3). Hutchison maintains that economics is a science and as such must appeal to facts. He writes:

114

R. Marchionatti

The scientist proceeds by means of the two inextricably interconnected activities of empirical investigation and logical analysis, the one, briefly, being concerned with the behaviour of facts, and the other with the language in which this is to be discussed … But if the finished propositions of a science, as against the accessory purely logical or mathematical propositions used in many sciences, including Economics, are to have any empirical content, as the finished propositions of all sciences except of Logic and Mathematics obviously must have, then these propositions must conceivably be capable of empirical testing or be reducible to such propositions by logical or mathematical deduction. They need not, that is, actually be tested or even be practically capable of testing under present or future technical conditions or conditions of statistical investigation, nor is there any sense in talking of some kind of “absolute” test which will “finally” decide whether a proposition is “absolutely” true or false. But it must be possible to indicate intersubjectively what is the case if they are true or false: their truth or falsity, that is, must make some conceivable empirically noticeable difference, or some such difference must be directly deducible therefrom. (ibid., pp. 8–9)

Hutchison classifies economic propositions into two classes, according to whether they are or are not conceivably falsifiable by empirical observation: falsifiable and non-falsifiable. “Propositions of pure theory” is Hutchison’s term for those propositions that are not conceivably falsifiable empirically. The same is largely true of the so-called “laws” in economics, because the ceteris paribus assumption makes falsification impossible. To call propositions of pure theory “laws” is, according to Hutchison, a misconception of the task of a science, and he suggests that the term law should be reserved only for those empirical generalizations such as Pareto’s or Gresham’s law or the law of diminishing returns: it is such laws as these that it is the central object of science to discover. Chapter IV is the most important of the book. It is devoted to the critical examination of the “basic postulates” of economic science. Hutchison begins to consider the concept of maximizing behavior, the first fundamental assumption of pure theory. It is applicable, Hutchison maintains, if a further postulate is made that all expectations are perfectly correct. But in this way all the problems of economy in the world as it is are neglected, “which may be said to arise from precisely this factor

3 Economics in London: The London School …

115

of uncertainty and imperfect foresight” (ibid., p. 85). In fact, Hutchison writes: Where uncertainty is present, as is in principle the case with any piece of conduct in this world, economic or otherwise, one cannot, strictly speaking, seek the most advantageous employment for one’s capital or act so as to maximise one’s returns. One can only act in accordance with one’s expectations as to the “maximum” conduct, and the expectations of the most clever and “rational” may, in the world as it is, turn out to be incorrect. (ibid., p. 86)

Conversely, when uncertainty is absent, “economic life is ‘problemless’ and automatic, and people would become more or less automata” (ibid., p. 88). The maximizing Economic Man, who has perfect expectation, Hutchison continues, is simply a pleasure machine with a purely mechanical life: To say that this sort of conceptual marionette manipulated by the theoretical economist as a preliminary thought clearing exercise is “rational” or “has perfect foresight” is apt to be misleading. One might as well speak of the parts of a mechanical model “acting sensibly” or “having perfect expectation” when the mechanism works smoothly as designed. (ibid.)

Hutchison then considers the relationship between perfect expectation and equilibrium. Against the writers who “have argued that some such postulate as ‘perfect expectation’ is necessary for equilibrium theory” (ibid., p. 94), Hutchison uses Morgenstern’s (1935) criticism: Professor Morgenstern has shown that such a postulate may give a nonsensical indeterminate situation the very reverse of equilibrium. … Professor Morgenstern goes on to argue that the theory of equilibrium must somehow get on without this postulate if it is not to collapse in a contradiction. (Hutchison 1938, p. 94)

In his conclusions, Hutchison argues, against Robbins who considered empirical regularities useless, that, “apart from pure Logic and Mathematics, scientific knowledge, explanation, and prognosis can only be

116

R. Marchionatti

based ultimately on empirical regularities” (ibid., p. 163). In economics, these are regularities as to how, in different situations, economic agents “react and behave” (ibid., p. 164). In fact, he stresses, an economic problem is a problem as to how people behave. By contrast, “equilibrium Economics describes a community without economic problems, because so far as it affects him everybody knows how everyone else is going to behave” (ibid.). However, he writes: Advance in economic knowledge depends ultimately on discovering, however limited, provisional, and tentative they may be, such regularities, and if such discoveries cannot be made—and we reject such a pessimistic view—Economics as an empirical science can go no further. No sort of deductive manipulation can ultimately get round the difficulties. (ibid.)

Hutchison notes that, as “scientists in all departments have long been tending to abandon claims to ‘absolute truth’, certainty, and exactness for their conclusions” (ibid., p. 164), economists also must abandon “often completely misconceived notions and standards of the ‘exactness’ and ‘necessity’ of their conclusions” (ibid.). If they do so and “strive, rather, after more practical and ‘realistic’ applicability” (ibid.), “they must be prepared to extend the range of their conclusions to include political and sociological factors” (ibid., p. 165). Hutchison notes that there are several great economists—he mentions Pareto, Wieser and Weber—who “have treated their work on Economics as essentially a preliminary to wider sociological investigations” (ibid.). He ends with some conclusions à la Pareto of the Trattato di Sociologia: Exclusively “economic” conclusions are vitiated by the same neglect of relevant factors as is “static” economic analysis. This is not to argue that the only useful work is the production of vast and comprehensive sociological treatises like The Mind and Society, but that any particular advice or estimate as to the effects of different policies with regard to a particular issue will only be useful when it is not exclusively economic but is politico-economic. Those who wish to arrive at propositions usefully applicable to policy must usually be considerably more than economists. (ibid., p. 166)

3 Economics in London: The London School …

3.3

117

Friedrich August von Hayek (1899–1992), the LSE Years

Economist and moral philosopher, Friedrich von Hayek is a controversial figure in the history of ideas, as the huge literature on him testifies. Hayek made contributions over seven decades in many fields, from economics to psychology, political philosophy and the history of ideas. His thinking changed over time: as Caldwell (2004, p. 12) writes, “Where Hayek began was with the Austrian presuppositions, but, after decades of study, where he ended up was in a place that was unique”. In the period between the two world wars, and mainly in his London School of Economics years, he was the leader of the new Austrian economics developed between Vienna and London and, together with Robbins, provided a theoretical bulwark against Keynes’s new Cambridge School and the political implications of Keynes’s and Keynesian theories. Later, he gradually abandoned his interest in economic theory to focus on economic liberalism, particularly in his Chicago years. As Backhouse (2006, p. 35) writes: “By the 1970s he was, in the minds of most economists, at best a political philosopher in a world where economics had become highly technical, and at worst an ideologue” and “though this work may have influenced politicians such as Margaret Thatcher and Ronald Reagan, it was never taken seriously by economists”. However, his thought has aroused new interest in recent decades.

Biographical Note13 Friedrich August von Hayek was born in Vienna on May 8, 1899, to August von Hayek, a physician and privatdozent of botany at the University of Vienna, and Felicitas Hayek (née von Juraschek), daughter of a Professor of Civil Law at the University of Innsbruck. In 1917, shortly before his eighteenth birthday and before completing Gymnasium, Hayek joined the army: during the war he served in an artillery regiment in the Austro-Hungarian army and fought on the Italian front. Like many 13

For a biography of Hayek, see Caldwell (2004). See also Boettke (2018).

118

R. Marchionatti

young soldiers, he completed Gymnasium during a leave. On returning to Vienna at the end of 1918, he enrolled at the University of Vienna, where he studied law, psychology and economics, eventually receiving his doctoral degrees in law (1921) and in political science (1923) under Wieser’s supervision with a dissertation on imputation. At the end of 1919, he also attended Constantin von Monakow’s Institute of Brain Anatomy in Zurich, where, influenced by Ernst Mach’s work, he started to develop his project published, thirty years later, as The Sensory Order (Hayek 1952). At that time, he presented his preliminary work to the Geistkreis, the private seminar he had created with Herbert Fürth in 1921 (see Chap. 4.4). Equally interested in economics and psychology, he decided on economics: I finally had to choose between the things I was interested in. Economics at least had a formal legitimation by a degree, while in psychology you had nothing. And since there was no opportunity for a job, I decided for economics. (Hayek 1994, p. 48)

If the meeting with Wieser was certainly important in his early formation, the decisive meeting was that with Ludwig von Mises. Upon completing his examinations, Hayek, on Wieser’s recommendation, was hired by Mises for a government agency working on international legal and economic debt issues. Initially sympathetic to democratic socialism, Hayek shifted away from socialism toward classical liberalism after reading von Mises’ book Socialism.14 In March 1923, after completing his second degree, Hayek left for the United States where he stayed for little over a year at New York University, mainly as a research assistant to the American economist Jeremiah Jenks (1856–1929), with a scholarship to study business cycles in Europe and the new techniques of time series analysis, as well as monetary policies in the United States. During his New York stay, he attended Wesley Mitchell’s and J. B. Clark’s lectures at Columbia. When Hayek returned to Austria in 1924, Mises again supported him in organizing a research center for the study of business cycles, the Austrian Institute for Business Cycle 14

On the Hayek-Mises relationship, see Caldwell (2004), particularly pp. 143–149.

3 Economics in London: The London School …

119

Research, which was established in 1927, thanks to the help of the leading Austrian business associations. Hayek (who in the meantime had married) took over its direction, with the collaboration of Oskar Morgenstern. In 1929, Hayek published Geldtheorie und Konjunkturtheorie (Beiträge zur Konjunkturforschung, herausgegeben vom Österreichisches Institut für Konjunkturforschung )—this work, which served as his Habilitation thesis, was translated into English in 1933 (Hayek 1933) and published under the title Monetary Theory and the Trade Cycle—while at the same time he began lecturing at the University of Vienna. In 1930, there was a turning point in Hayek’s life: Lionel Robbins invited him to hold some lectures on the trade cycle at the LSE. In these lectures, he developed the ideas he had briefly presented in his paper “Gibt es einen Widersinn des Sparens?”, which was translated into English as “The Paradox of Saving” and then published in Economica (Hayek 1931a). In 1931, the text of his lectures was published in a volume entitled Prices and Production (Hayek 1931b, revised version 1935) which must be considered as an essential complement of the 1929 book. There Hayek emphasized the monetary causes that start the trade cycle’s fluctuations, while in the 1931 book he concentrates on the successive changes in real structure of production which constitute those fluctuations. In 1931, Hayek was invited to teach at the LSE, an invitation which Hayek accepted with enthusiasm. Unwilling to return to Austria after the Anschluss, Hayek remained in Britain and became a British subject. The two decades he stayed at LSE were an extremely productive period: among the many works he published, three in particular are worthy of mention: Collectivist Economic Planning: Critical Studies on the Possibilities of Socialism (Hayek 1935), “Economics and Knowledge” (Hayek 1937) and The Pure Theory of Capital (Hayek 1941). The article “Economics and Knowledge” is particularly important because it marked Hayek’s turning away from Mises’s methodological apriorism and toward Karl Popper’s falsificationism (Hutchison 1981). The Pure Theory of Capital is the conclusion of Hayek’s inquiry into BöhmBawerk’s theory of capital, which arrived at the quite negative conclusion that the complexity of the economic process can be only partially addressed by the available theory—general intertemporal equilibrium must be considered simply an intellectual tool—and Böhm-Bawerk’s goal

120

R. Marchionatti

of making capital theory useful for the analysis of monetary phenomena in the real world was substantially not achieved (see Ingrao 2013). On the outbreak of World War II, the LSE was evacuated to Cambridge. Here, Hayek wrote The Road to Serfdom (Hayek 1944)— a title taken from Alexis the Tocqueville’s phrase, “the road to servitude”— a classic in the history of liberal ideas and a fundamental text in his subsequent intellectual evolution. In 1947, he was the principal organizer of the Mont Pèlerin Society, a scholarly community arguing ideas against collectivism. In 1950, Hayek left the London School of Economics and, after spending the 1949–1950 academic year as a Visiting Professor at the University of Arkansas in the United States, he was brought on by the University of Chicago, where he became a professor of social and moral science in the Committee on Social Thought, an interdisciplinary institution founded in 1941 by the historian John Ulric Nef, the economist Frank Knight, the anthropologist Robert Redfield and Robert M. Hutchins, then President of the University of Chicago. Here, Hayek devoted himself to studies of epistemology, philosophy of politics and the social sciences. In 1961, Hayek left Chicago, and from 1962 until his retirement in 1968, he taught at the University of Freiburg, West Germany, where he began to work on his book Law, Legislation and Liberty, published between 1973 and 1979 (Hayek 1973–1979). In 1974, he received the Nobel Memorial Prize in Economic Sciences, shared with Gunnar Myrdal. He died in Freiburg, where he had spent the rest of his days, on March 23, 1992.

Hayek’s Economics: Prices and Production, 1931 Prices and Production (1931, revised and enlarged edition, 1935), which reproduced the lectures delivered at the LSE in 1930–1931, is the most significant of Hayek’s contributions to monetary and trade cycle theory. The successive works in the 1930s are attempts to improve the 1931 theses. The aim of Prices and Production is to give the outlines of a theory of industrial fluctuations. It is organized in four lectures.

3 Economics in London: The London School …

121

Lecture 1 deals with the theories of the influence of money on prices. Hayek’s starting point is that, although it is widely recognized that “monetary influences play a dominant role in determining both the volume and direction of production” (Hayek 1931b, p. 1), the theoretical understanding of the connection between money and prices has not made great progress “in recent years”. Hayek criticizes in particular Fisher’s equation of exchange, which he sees as a resuscitation of the more mechanistic forms of the quantity theory of money. A particularly harmful effect of this theory, he notes, is “the present isolation of the theory of money from the main body of general economic theory” (ibid., p. 4). In attempting to establish causal relations between aggregates, this dominant monetary theory “lags behind the development of economics in general” which Hayek identifies with the subjective or new Austrian theory. The major limitation of traditional theory is that it assumes that it is possible to “neglect the influence of money so long as the value of money is assumed to be stable, and apply without further qualification the reasonings of a general economic theory which pays attention to ‘real causes’ only”—and that it is a general theory to which we have only to add “a separate theory of the value of money and of the consequences of its changes in order to get a complete explanation of the modern economic process” (ibid., p. 7). The subsequent lectures seek to explain “how and when money influences the relative values of goods” and under what conditions “it leaves these relative values undisturbed, or, to use a happy phrase of Wicksell, when money remains neutral relatively to goods” (ibid., p. 31). The first object of monetary theory should be “to clear up the conditions under which money might be considered to be neutral in this sense” (ibid.). Lecture II is devoted to an analysis of the conditions of equilibrium between the production of consumers’ goods and the production of producers’ goods. Hayek deals with “the nature of the immediate causes of a variation of industrial output” (ibid., p. 32), a question preliminary to that of the influence of prices on production, and a question which he argues is incompletely explained by contemporary theory. Hayek defines equilibrium as the condition in which no unused resources exist. After emphasizing that an essential feature of our system of production is that “at any moment a far larger proportion of the available original means of

122

R. Marchionatti

production is employed to provide consumers’ goods for some more or less distant future than is used for the satisfaction of immediate needs” (ibid., p. 37)—“the raison d’être of this way of organizing production [being] that by lengthening the production process we are able to obtain a greater quantity of consumers’ goods out of a given quantity of original means of production (ibid., p. 38)—Hayek discusses the main problem of the second lecture, viz. “how a transition from less to more capitalistic methods of production, or vice versa, is actually brought about, and what conditions must be fulfilled in order that a new equilibrium may be reached” (ibid., pp. 49–50). A transition to more (or less) capitalistic methods of production, Hayek writes, will take place if the total demand for producers’ goods increases (or decreases) relatively to the demand for consumers’ goods. This may come about, he adds, in one of two ways, “either as a result of changes in the volume of voluntary saving”, or “as a result of a change in the quantity of money which alters the funds at the disposal of the entrepreneurs for the purchase of producers’ goods” (ibid., p. 50). Hayek first considers the case of changes in voluntary saving, that is, simple shifts of demand between consumers’ goods and producers’ goods, the amount of money remaining unchanged. He supposes that consumers save and invest a certain amount of money so that the proportion of the demand for consumers’ goods to the demand for intermediate products changes by a certain amount. As a consequence, Hayek shows with an example, the structure of production will change and, when the initial variation becomes permanent, “a new equilibrium may establish itself ” (ibid., p. 54). At this point, Hayek asks: “does this remain true if we drop the assumptions that the amount of money remains unchanged”? (ibid.). He analyzes the effect of a change of money in circulation in the form of credits granted to producers. He shows, again with an example, that “the changes in the structure of production which will be necessary in order to find employment for the additional means which have become available will exactly correspond to the changes brought about by saving” (ibid., p. 55). Though at first the only difference compared to the previous case is that the money values of the goods will have grown, Hayek writes, there is “another and far more important difference” (ibid.). When a change in the structure of production

3 Economics in London: The London School …

123

was brought about by saving, it was correct to assume that “the changed distribution of demand between consumers’ goods and producers’ goods would remain permanent, since it was the effect of voluntary decisions on the part of individuals” (ibid.). However, in the second case: the use of a larger proportion of the original means of production for the manufacture of intermediate products can only be brought about by a retrenchment of consumption. But now this sacrifice is not voluntary, and is not made by those who will reap the benefit from the new investments. It is made by consumers in general who, because of the increased competition from the entrepreneurs who have received the additional money, are forced to forego part of what they used to consume. It comes about not because they want to consume less, but because they get less goods for their money income. There can be no doubt that, if their money receipts should rise again, they would immediately attempt to expand consumption to the usual proportion … Then the structure of production too will have to return to the old proportion … That is to say production will become less capitalistic. (ibid., pp. 57–58)

Such a transition to less capitalistic methods of production “necessarily takes the form of an economic crisis” (ibid., p. 58), Hayek maintains. This process is illustrated in Lecture III, devoted to the working of the price mechanism in the course of the credit cycle, where Hayek presents his version of the Austrian business cycle theory. Hayek assumes that in a state of equilibrium with no unused resources the banks increase the money supply, causing the rate of interest to fall below the equilibrium rate. The borrowers, Hayek says, will use the borrowed sums for buying producers’ goods and will be able to obtain such goods “by outbidding the entrepreneurs who used them before” (ibid., p. 86). A transition to more capitalistic methods “will take place” (ibid., p. 87). Initially, this process can happen without any reduction of consumption, but “this cannot go on” (ibid.) and “a scarcity of consumers’ goods will make itself felt, and the prices of those goods will rise” (ibid., p. 88): “as things are, for some time, society as a whole will have to put up with an involuntary reduction of consumption” (ibid.). Then, Hayek describes the process thus induced:

124

R. Marchionatti

But this necessity will be resisted. It is highly improbable that individuals should put up with an unforeseen retrenchment of their real income without making an attempt to overcome it by spending more money on consumption. It comes at the very moment when a great many entrepreneurs know themselves to be in command—at least nominally—of greater resources and expect greater profits. At the same time incomes of wage earners will be rising in consequence of the increased amount of money available for investment by entrepreneurs. There can be little doubt that in the face of rising prices of consumers’ goods these increases will be spent on such goods and so contribute to drive up their prices even faster. … [t]his is the fundamental point: it will mean a new and reversed change of the proportion between the demand for consumers’ goods and the demand for producers’ goods in favour of the former. The prices of consumers’ goods will therefore rise relatively to the prices of producers’ goods. … [t]his must mean a return to shorter or less roundabout methods of production if the increase in the demand for consumers’ goods is not compensated by a further proportional injection of money by new bank loans granted to producers. And at first this is probable. The rise of the prices of consumers’ goods will offer prospects of temporary extra profits to entrepreneurs. They will be the more ready to borrow at the prevailing rate of interest. And, so long as the banks go on progressively increasing their loans it will, therefore, be possible to continue the prolonged methods of production or perhaps even to extend them still further. But for obvious reasons the banks cannot continue indefinitely to extend credits; and even if they could, the other effects of a rapid and continuous rise of prices would, after a while, make it necessary to stop this process of inflation. (Hayek 1935, pp. 88–90)

What will happen? Hayek asks. The immediate effect of the banks ceasing to make new loans is that the demand for producers’ goods falls, and producers will want to shift back to producing consumer goods. As a consequence, producer’s goods will fall in price and the process will shift from boom to bust. In conclusion, Hayek comments: we are forced to recognize the fundamental truth, so frequently neglected nowadays, that the machinery of capitalistic production will function smoothly only so long as we are satisfied to consume no more than that

3 Economics in London: The London School …

125

part of our total wealth which under the existing organisation of production is destined for current consumption. Every increase of consumption, if it is not to disturb production, requires previous new saving, even if the existing equipment with durable instruments of production should be sufficient for such an increase in output. If the increase of production is to be maintained continuously, it is necessary that the amounts of intermediate products in all stages is proportionately increased. (ibid., p. 95)

This theory can explain, Hayek maintains, “how it comes about at certain times that some of the existing resources cannot be used, and how, in such circumstances, it is impossible to sell them at all—or, in the case of durable goods, only to sell them at very great loss. To provide an answer to this problem has always seemed to me to be the central task of any theory of industrial fluctuations” (ibid., p. 96). Moreover, Hayek writes, the theory explains why: the granting of credit to consumers, which has recently been so strongly advocated as a cure for depression, would in fact have quite the contrary effect; a relative increase of the demand for consumers’ goods could only make matters worse. Matters are not quite so simple so far as the effects of credits granted for productive purposes are concerned. In theory it is at least possible that, during the acute stage of the crisis when the capitalistic structure of production tends to shrink more than will ultimately prove necessary, an expansion of producers’ credits might have a wholesome effect. But this could only be the case if the quantity were so regulated as exactly to compensate for the initial, excessive rise of the relative prices of consumers’ goods, and if arrangements could be made to withdraw the additional credits as these prices fall and the proportion between the supply of consumers’ goods and the supply of intermediate products adapts itself to the proportion between the demand for these goods. And even these credits would do more harm than good if they made roundabout processes seem profitable which, even after the acute crisis had subsided, could not be kept up without the help of additional credits. Frankly, I do not see how the banks can ever be in a position to keep credit within these limits. And, if we pass from the moment of actual crisis to the situation in the following depression, it is still more difficult to see what lasting

126

R. Marchionatti

good effects can come from credit-expansion. The thing which is needed to secure healthy conditions is the most speedy and complete adaptation possible of the structure of production to the proportion between the demand for consumers’ goods and the demand for producers’ goods as determined by voluntary saving and spending. If the proportion as determined by the voluntary decisions of individuals is distorted by the creation of artificial demand, it must mean that part of the available resources is again led into a wrong direction and a definite and lasting adjustment is again postponed. And, even if the absorption of the unemployed resources were to be quickened in this way, it would only mean that the seed would already be sown for new disturbances and new crises. The only way permanently to “mobilize” all available resources is, therefore, not to use artificial stimulants—whether during a crisis or thereafter—but to leave it to time to effect a permanent cure by the slow process of adapting the structure of production to the means available for capital purposes. (ibid., pp. 97–99)

Hayek concludes his analysis with a “liquidationist” thesis: “we arrive at results which only confirm the old truth that we may perhaps prevent a crisis by checking expansion in time, but that we can do nothing to get out of it before its natural end, once it has come” (ibid., p. 99). Lecture IV deals with a monetary policy suitable for the prevention of crises. From this perspective, he considers the arguments for and against an elastic money supply. His thesis is that, on the basis of his considerations in Lecture III: the reasons commonly advanced as a proof that the quantity of the circulating medium should vary as production increases or decreases are entirely unfounded. It would appear rather that the fall of prices proportionate to the increase in productivity, which necessarily follows when, the amount of money remaining the same, production increases, is not only entirely harmless, but is in fact the only means of avoiding misdirections of production. (ibid., p. 105)

In other words, Hayek rejects the idea that money supply should change in relation to the volume of production. He concludes: “It is probably an illusion to suppose that we shall ever be able entirely to eliminate industrial fluctuations by means of monetary policy” (ibid., p. 125).

3 Economics in London: The London School …

127

The critical point of Hayek’s model was, as Sraffa showed, the determination of the natural rate of interest. In a harsh review of Prices and Production in the Economic Journal (Sraffa 1932) devoted to the logical foundations of Hayek’s theoretical construction, Sraffa argued that in disequilibrium processes there are many “natural rates of interest”, that is, each good could have its own particular natural rate of interest, and consequently, the transition between positions of long-term equilibrium could not be examined by examining the divergence between the natural and the money rate of interest.

Hayek’s Economics: “Economics and Knowledge”, 1937 On November 10, 1936, Hayek delivered his presidential address before the London Economics Club. The address was published the next February in Economica as “Economics and Knowledge”. Many years later, Hayek would claim that the paper played an important role in the development of his thought.15 It is the first of a series of papers published in the late 1930s and throughout the 1940s. The ideas presented in his 1937 paper were further refined and developed in later works, in particular in his 1945 “The Use of Knowledge in Society”. The paper offers a critical reflection on the concept of equilibrium and foresight in Walrasian theory, not unlike Morgenstern’s (1935) (see Chap. 4.5), but coming to “rather less drastic conclusions” (Ingrao 2013, p. 501).16 In “Economics and Knowledge”, Hayek explored the process whereby the state of equilibrium is reached, focusing on the role of knowledge in competitive markets. The arguments presented were “seminal … both

15

Hutchison (2009, p. 307) writes: “It announced a profound transformation of his philosophical and methodological views, but the special interest of this methodological transformation is that it forced on Hayek a fundamental recasting of his arguments on the relative merits of market and centrally planned economies.” 16 “The difficulties that Hayek saw in the idea of equilibrium with perfect foresight were not … Morgenstern’s paradoxes on the quasi-divine knowledge that firms and consumers should enjoy” (Ingrao 2013, p. 501). Note that Hayek did not equate correct foresight with perfect foresight as Morgenstern did, correct foresight not implying limitless knowledge.

128

R. Marchionatti

in development of Hayek’s ideas and in [their] implications for the calculation debate” (Caldwell 1997, p. 1865). The main subject of the paper is “the role which assumptions and propositions about the knowledge possessed by the different members of society play in economic analysis” (Hayek 1937, p. 33). Economists must be able “to fill those formal propositions with definite statements about how knowledge is acquired and communicated” (ibid.). In fact, “the concept of equilibrium has a clear meaning if applied to the actions of a single individual” (ibid., p. 35)—i.e., the concept of equilibrium is not problematic when applied to the individual using the pure logic of choice—but “the tautological propositions of pure equilibrium analysis as such are not directly applicable to the explanation of social relations” (ibid.), they are unable to explain the real world. He maintains that “we are really passing into a different sphere and silently introducing a new element of altogether different character when we apply it to the explanation of the interactions of a number of different individuals” (ibid., p. 2). The question is: what does equilibrium mean when applied to a system as a whole? Individuals, Hayek writes, are in equilibrium with respect to their plans, which they make on the basis of their subjective perceptions of the external world: In the first instance, in order that all these plans can be carried out, it is necessary for them to be based on the expectation of the same set of external events, since, if different people were to base their plans on conflicting expectations, no set of external events could make the execution of all these plans possible. And, secondly, in a society based on exchange their plans will to a considerable extent refer to actions which require corresponding actions on the part of other individuals. This means that the plans of different individuals must in a special sense be compatible if it is to be even conceivable that they will be able to carry all of them out. Or, to put the same thing in different words, since some of the data on which any one person will base his plans will be the expectation that other people will act in a particular way, it is essential for the compatibility of the different plans that the plans of the one contain exactly those actions which form the data for the plans of the other. (ibid., pp. 37–38)

3 Economics in London: The London School …

129

In the traditional treatment of equilibrium analysis, Hayek writes, “part of this difficulty is apparently avoided by the assumption that the data, in the form of demand schedules representing individual tastes and technical facts, will be equally given to all individuals and that their acting on the same premises will somehow lead to their plans becoming adapted to each other” (ibid., p. 38). Hayek emphasizes that this procedure involves a confusion due to “an equivocation of the term ‘datum’” (ibid.). There are two concepts of data, Hayek maintains: in the sense of objective real facts, and in the subjective sense, “as things known to the persons whose behaviour we try to explain” (ibid., p. 39). For a society, Hayek writes: we can speak of a state of equilibrium at a point of time—but it means only that compatibility exists between the different plans which the individuals composing it have made for action in time. And equilibrium will continue, once it exists, so long as the external data correspond to the common expectations of all the members of the society. The continuance of a state of equilibrium in this sense is then not dependent on the objective data being constant in an absolute sense, and is not necessarily confined to a stationary process. (ibid., p. 41, my italics)

These considerations throw light on the relationship between equilibrium and foresight—here the reference to Morgenstern’s criticism: It appears that the concept of equilibrium merely means that the foresight of the different members of the society is in a special sense correct. It must be correct in the sense that every person’s plan is based on the expectation of just those actions of other people which those other people intend to perform, and that all these plans are based on the expectation of the same set of external facts, so that under certain conditions nobody will have any reason to change his plans. Correct foresight is then not, as it has sometimes been understood, a precondition which must exist in order that equilibrium may be arrived at. It is rather the defining characteristic of a state of equilibrium. (ibid., pp. 41–42)

In this analysis, the concept of tendency toward equilibrium means that “the expectations of the people and particularly of the entrepreneurs will become more and more correct” (ibid., p. 44). What has to be

130

R. Marchionatti

explained is the process whereby individuals will acquire the necessary knowledge—clearly an empirical fact, capable of verification as Hayek emphasizes. Of course, we cannot presuppose that everybody knows everything, if the concept is to have empirical relevance. The question must be interpreted as a problem of coordinating the knowledge dispersed among the agents in the market. Here, there is an analogy with the Smithian division of labor: Clearly there is here a problem of the Division of Knowledge which is quite analogous to, and at least as important as, the problem of the division of labour. But while the latter has been one of the main subjects of investigation ever since the beginning of our science, the former has been as completely neglected, although it seems to me to be the really central problem of economics as a social science. The problem which we pretend to solve is how the spontaneous interaction of a number of people, each possessing only bits of knowledge, brings about a state of affairs in which prices correspond to costs, etc., and which could be brought about by deliberate direction only by somebody who possessed the combined knowledge of all those individuals. (ibid., p. 49)

This knowledge is a learning process, in which the relevant knowledge which an individual must possess in order that equilibrium may prevail is “the knowledge which he is bound to acquire in view of the position in which he originally is, and the plans which he then makes” (ibid., p. 51). Therefore, “it is only relative to the knowledge which a person is bound to acquire in the course of the carrying out of his original plan and its successive alteration that an equilibrium is likely to be reached” (ibid.). Such a position, Hayek emphasizes, is a position of equilibrium, but not “an equilibrium in the special sense in which equilibrium is regarded as a sort of optimum position” (ibid.). Economics, Hayek concludes, has come nearer than any other social science to an answer to that central question of all social sciences: “how the combination of fragments of knowledge existing in different minds can bring about results which, if they were to be brought about deliberately, would require a knowledge on the part of the directing mind which no single person can possess” (ibid., p. 52). The answer to this central question lies in showing that “the spontaneous actions of individuals

3 Economics in London: The London School …

131

will, under conditions which we can define, bring about a distribution of resources which can be understood as if it were made according to a single plan, although nobody has planned it” (ibid.).

3.4

John Hicks (1904–1989), Between LSE and Cambridge

From the 1930s onward, John Hicks was for many decades a major figure in the development of economics, a prolific writer making important contributions to both macroeconomics and microeconomics. As a macroeconomist, Hicks is known for his 1937 “Walrasian” formalization of Keynes’s General Theory—which later in life he considered to be a misinterpretation of Keynes—which launched the so-called neoclassical synthesis in macroeconomics. As a microeconomist, his work in general equilibrium and welfare economics was awarded with the Nobel Prize in economics, given to Hicks and Kenneth Arrow in 1972. In fact, as Baumol (1972, pp. 524–525) writes: the main strength of Sir John’s theoretical work resides in his mastery of general equilibrium methods. He is one of the few theorists working in the area who have actually been able to make general equilibrium models produce interesting results about the workings of the economy.

Biographical Note17 John Hicks was born on April 8, 1904, in Warwick, England. His father Edward Hicks was a newspaper journalist and editor; his mother Dorothy Catherine (née Stephens) died when he was 21. Hicks received a good education at private British schools and earned a mathematical scholarship to Balliol College, Oxford University. Here, he received mathematical training, as well as a grounding in literature, philosophy and history, but he soon shifted to economics. He remembers: 17

For the biography of Hicks, see Hicks (1979), chapter one of Hamouda (1993) and Creedy (2011, 2012).

132

R. Marchionatti

But I was not contented with mathematics; I had interests in literature and in history which I needed to satisfy. My move (in 1923) to “Philosophy, Politics and Economics”, the “new school” just being started at Oxford, was however, not a success. I finished with a second-class degree, and no adequate qualification in any of the subjects I had studied. (Hicks 1972 [1973], p. 133)

After graduating in 1926, Hicks obtained a position as a temporary assistant lecturer and then a lectureship at the LSE, where he remained until 1935. In this LSE period, mainly from 1929 to 1933, he was a regular member of Robbins’s group. He started as a labor economist, doing descriptive work on industrial relations, but gradually moved over to theoretical economics: as Baumol (1972) writes, the theoretical materials that Robbins called to Hicks’s attention were primarily continental and Scandinavian rather than English. His interest in Pareto was due to Hugh Dalton who got Hicks to read Pareto’s (1906) Manuale. When he got to the mathematical appendices, Hicks realized Pareto had not finished what he had set out to do—make economic analysis clearer and more precise by translating it into mathematics. At that moment, Hicks decided to devote his career to completing what Pareto had begun (Klamer 1989). Hicks’s first theoretical contributions were The Theory of Wages (1932), which introduced the concept of the elasticity of substitution between factors of production, and, above all, his work on the theory of value starting from his joint work with R. G. D. Allen (Hicks and Allen 1934). By 1935, the year of his marriage to Ursula Webb, he had the opportunity to have a university lectureship at Cambridge. Encouraged by Pigou, he obtained a Fellowship at Gonville and Caius College in Cambridge, which he held until 1938. Hicks did not like Cambridge’s intellectual climate: as he remembered many years later, the sociable atmosphere of LSE was replaced by one in which, “people are terribly prone to quarrelling with each other. At that time the Cambridge faculty was divided into parties which wouldn’t talk to each other. I didn’t enjoy that at all” (in Klamer 1989, p. 170). Cambridge, Hicks remembers, was riven by disputes between Keynesians and anti-Keynesians, and since he was associated with Pigou and Robertson, he was regarded by some Keynesians

3 Economics in London: The London School …

133

as being in the “anti” camp. And his theoretical interests were focused on Austrian and Swedish authors, like Wicksell and Gunnar Myrdal, whose Monetary Equilibrium he read in German. His years at Cambridge (1935–1938) were mainly occupied in writing Value and Capital, which was based on the work he had done in London. At the appearance of Keynes’s General Theory Hicks reviewed it, and in 1937, he wrote the paper, “Mr. Keynes and the ‘Classics’”, where Hicks introduced the IS-LM model, then considered, together with Value and Capital , the beginning of the neoclassical synthesis. In 1938, he obtained his first Chair (the Jevons Professorship) at the University of Manchester, holding it until 1946. It was at Manchester that he did his main work on welfare economics, with its application to social accounting. In 1946, he returned to Oxford, first as a research fellow of Nuffield College (1946–1952). In 1952, he was appointed Drummond Professor of Political Economy, a position he held until taking early retirement in 1965, becoming a research fellow of All Souls College until 1971. Following his retirement, he concentrated on theoretical work. This period saw a large output, including two books on capital theory and a book on causality in economics. In the 1960s and 1970s, Hicks devoted his studies to growth and capital theories. He wrote Capital and Growth (Hicks 1965) and then turned to Austrian capital theory with Capital and Time (Hicks 1973), which completed the trilogy that began with Capital and Value. In his 1974 Crisis in Keynesian Economics, in his 1980 paper “IS-LM: An explanation” and elsewhere, Hicks criticized the neoclassical synthesis he had helped create and pointed the way to new developments along post-Keynesian lines. These and other works on methodology and the history of economics dominated the rest of his life. He died on May 20, 1989, in his home in the Cotswold (Gloucestershire) village of Blockley, four years after the death of his wife Ursula.

134

R. Marchionatti

Hicks’s Microeconomics: From “A Reconsideration of the Theory of Value”, 1934, to Value and Capital, 1939 “A Reconsideration of the Theory of Value” and the Beginning of the “Paretian Revival” in the United Kingdom In 1934, Hicks, in collaboration with Roy G. D. Allen, wrote “A Reconsideration of the Theory of Value” a soon-to-become-famous paper published in Economica. In writing the paper, Hicks was influenced by his reading of Pareto’s Manuale. Pareto’s work is considered “a beginning”, Hicks writes, Pareto’s work, important as it is, and influential as it has been, is only a beginning; it is limited by a lack of attention to problems of capital and interest; and even on value theory, where it is strongest, it is vitiated by a lack of clearness on some vital points. (Hicks 1939, p. 3)

According to Hicks, this incompleteness or lack of clearness in Pareto’s work lies in the fact that the Italian economist “continued to use concepts derived from the earlier [cardinalist] set of ideas” even after he had established his ordinalist propositions (ibid., p. 19). Hicks and Allen’s (1934) paper is in the authors’ intentions a further development of Pareto’s program. The paper is based on the use of the concept of indifference curves. The authors introduce the concepts of income and substitution effects as well as the principle of marginal substitution.18 This paper (with Hicks’s subsequent contributions to the theory of consumer behavior) marked the beginning of the anti-utilitarian shift in England 18 These concepts had been introduced by Slutsky’s (1915) paper in Italian (see Vol. I, Chap. 2.3), at that time not known to the two English economists. Hicks and Allen—together with Schultz at Chicago—then recognized that their paper was essentially Slutsky’s theory. As Schultz (1935) wrote, the solution of the problem of the reaction of consumers to a change in income and prices “was first given by Pareto in 1892, but was simplified, extended, and put in more elegant form by Professor Eugen Slutsky, the Russian statistician and economist, in a remarkable paper in 1915” (Schultz 1935, pp. 439–440). Allen (1936) published a summary of Slutsky’s paper in the Review of Economic Studies.

3 Economics in London: The London School …

135

from cardinalism to ordinalism. In Value and Capital (Hicks 1939), Hicks writes: If one is a utilitarian in philosophy, one has a perfect right to be a utilitarian in one’s economics. But if one is not (and few people are utilitarians nowadays), one also has the right to an economics free of utilitarian assumptions. From this point of view, Pareto’s discovery only opens a door, which we can enter or not as we feel inclined. But from the technical economic point of view there are strong reasons for supposing that we ought to enter it. The quantitative concept of utility is not necessary in order to explain market phenomena. Therefore, on the principle of Occam’s razor, it is better to do without it. For it is not, in practice, a matter of indifference if a theory contains unnecessary entities. Such entities are irrelevant to the problem in hand, and their presence is likely to obscure the vision. (Hicks 1939, p. 18)

In this sense, according Hicks, Pareto missed an opportunity. This was the opportunity that Slutsky (1915) is considered the first to have taken, followed by Hicks and Allen (1934) and Hicks (1939). Hicks’s Value and Capital is a “systematic exploration of the territory which Slutsky opened up” (Hicks 1939, p. 19). In fact, the book was the most ambitious outcome of the neo-Paretian approach launched in microeconomic theory at LSE between 1934 and 1939.

Value and Capital , 1939 Value and Capital is a work on theoretical economics based on the idea that the problem of economic theory at that time was the construction of “a technique for studying the interrelations of markets” (Hicks 1939, p. 2) assuming as a starting point Walras’s and Pareto’s work (and Wicksell’s for his consideration of the dynamic problem of capital): “our work”, Hicks writes in the introduction, “is bound to be in their [Walras’s and Pareto’s] tradition, and to be a continuation of theirs” (ibid.). Organized in four parts (the theory of subjective value, general equilibrium, the foundations of dynamic equilibrium and the working of the dynamic system), the book begins by presenting the new theory

136

R. Marchionatti

of subjective value based on the concept of ordinal utility and then applies the result to reworking Walras’s and Pareto’s GEE static analysis. In the first two parts, Hicks grounds the static theory of general economic equilibrium of perfect competition on a theory of demand which is a development of Pareto’s theory of choice and a theory of production which is an adaptation of demand theory to the study of firm behavior. Hicks focuses on the static theory of exchange (formally presented in Chaps. I–IV and in the Mathematical Appendix of the book), because, he states, in both the static equilibrium and the dynamic equilibrium of production “almost exactly the same questions” of the exchange theory come up: “this is why the theory of exchange is an essential part of the study of the economic system in general” (ibid., p. 77). Hicks starts from the equilibrium of the consumer in conditions of perfect competition. The rule for equilibrium is that the marginal rate of substitution between any two goods must be equal to their price ratio. The stability condition for equilibrium is that du = 0 and d 2 u < 0, i.e., in order that u (the utility function) be “a true maximum” (ibid., pp. 305–306). Hicks emphasizes that these conditions do not depend on the existence of a particular utility function: they can be deduced from any arbitrary utility function ϕ(u) provided that ϕ  (u) > 0. After examining the effect on demand of an increase in income and the effect of a change in price with constant income, Hicks defines the well-known equation, originally formulated by Slutsky, which he regarded as “the Fundamental Equation of Value Theory”, which divides the effect of any price change on demand into two terms: the income effect and the substitution effect. Hicks then considers the existence of the equilibrium of exchange in a world where there are N individuals, “bringing to the market various quantities of n goods, and exchanging them under conditions of perfect competition” (ibid., p. 314). After showing that there are n − 1 equations to determine the n-1 prices, Hicks maintains that equilibrium exists. According to Hicks, having shown “the mechanism of the interrelation of markets…. was a great achievement”, but of a certain sterility, because it is not clear how this mechanism works, i.e., the laws of change are not discussed: the mechanism does not explain, Hicks writes, “what would happen if tastes and resources changed” (ibid.,

3 Economics in London: The London School …

137

p. 61). But, he believes, “with the technique now at our disposal [that is, the new theory of demand], we can make a similar investigation for the general case” (ibid.). The laws of change of the price system— writes Hicks—“like the laws of change of individual demand, have to be derived from stability conditions” (ibid., p. 62). First, we must examine what conditions are necessary in order that a given equilibrium position will be stable; then, we must make “an assumption of regularity, that positions in the neighbourhood of the equilibrium position will be stable also” (ibid.). According to Hicks, the general equilibrium is stable if a slight movement away from the equilibrium position “should set up forces tending to restore equilibrium” (ibid.). He calls the difference between the demand and supply at any price “the excess demand” for a good. He then reformulates the equilibrium condition of a market as the condition in which excess demand is zero, and the stability condition as the condition in which the excess demand increases when the price falls and decreases when the price increases. Taking the supply of any goods as constant, in order for equilibrium to be stable, the market demand of a good must vary in the opposite direction to its price, and the other prices must vary so as to maintain the other markets in equilibrium. The stability conditions enable us to study the variation of prices following a change in consumer preferences toward a certain good. First, the stability conditions show that the variation needed to induce the owner of a certain good to sell it, in a sufficient quantity, to the potential buyer is an increase of the price of the good such as to induce a fall in his excess demand, i.e., an increase in his supply. As regards the other goods, assuming the existence of two goods, we obtain, for the equilibrium of the market of the other good, that if the good is normal, the ratio between the two prices increases if the two goods are substitutes and decreases if they are complementary. The analysis of the “foundations of dynamic economics” follows. Here, Hicks discusses the problem of intertemporal equilibrium and presents his model of temporary equilibrium following the path laid down by Hayek (1933). He then deals with the working of a dynamic system in order to create a theory of the economic process over time. The dynamic parts of the book are an innovative contribution. The time dimension was dealt with by considering expectations and plans over

138

R. Marchionatti

future time horizons. Hicks proposes a temporary equilibrium model19 where the path of the economy follows a sequence of temporary equilibria—the idea proposed by Pareto in his Manuale—and introduces the idea of “pure futures economy”.20 However, these parts are not organically connected with the previous parts, due primarily to Hicks’s subjective requirement of describing the dynamics of real economies as well as the statics. In general, Hicks’ aim was to respond to the criticism of providing a static and highly abstract representation of the economy, and the accusation of sterility brought against the Lausanne theory by Marshallian economists in England. The aim of his theoretical project was thus to find a way out of the impasse in which the GEE theory had become trapped during its classical era, while at the same time maintaining continuity with that work. In this project, reworking that theory in line with the LSE perspective was fundamental because it was considered to be the foundation of the economic laws operating in reality. At the time of its publication, Value and Capital was widely considered to reconcile the theory of equilibrium and the theory of real dynamics, a revolutionary book in the Paretian perspective (for a synthesis of the reviews, see Young 1991). It inspired the work of many English-speaking economists, in particular Paul Samuelson in the United States, who in the Preface to the Foundations of Economic Analysis recognized the similarity of points of view with Value and Capital and, fifty years later, confirmed that Hicks was one of the few economists of the 1930s who received his “attention” (Samuelson 1998, p. 1381).21 19

Hicks’s concept of temporary equilibrium was inspired by Hayek, but later it was credited by Hicks himself (1965) to Erik Lindahl (see Chap. 5.2). 20 The idea of “pure futures economy” inspired the axiomatic model of intertemporal general equilibrium then developed by Arrow and Debreu. 21 Samuelson maintained that the most important advance made by Value and Capital , from the analytical standpoint, was “the enunciation of the principle that a group of commodities has the property of a single commodity if their prices all change in the same proportion” (Samuelson 1948, p. 130). It was, according to Samuelson, “the cornerstone of his exposition” (Samuelson 1998, p. 1381). On the other hand, Samuelson was also critical of Value and Capital . In particular, he showed that the Hicksian stability conditions are not, in general, necessary nor sufficient to satisfy the stability of equilibrium in a dynamic system (Samuelson 1941). For his part, Hicks later wrote that Samuelson, Arrow et al. recognized that Value and Capital was the starting point of their work on GEE, which they accomplished “with far

3 Economics in London: The London School …

139

On the other hand, a highly critical examination of the book was conducted in 1941 by Oskar Morgenstern, at that time Professor at Princeton, in a long review published in the Journal of Political Economy. Morgenstern’s criticism focused on the formal problems of the book22 : he accused Hicks of lacking rigor and of being outdated. The main point raised by Morgenstern “is the question as to whether the determinateness of any given economic system … is assured when the number of unknowns involved equals the number of equations that can be set up” (Morgenstern 1941, p. 368). He observed that relatively scant attention was paid to this question in the mathematical treatment of economic theory: the mathematical economists of the classic era (from Walras to Fisher, Cassel and Pareto) had failed, Morgenstern maintained, “even to see the task that was before them”, and, he declared, “Professor Hicks has to be added to this list” (ibid., p. 369). Only very recently, Morgenstern notes, had “an important step forward … been made, due exclusively to mathematicians and not to economists” (ibid.). He was referring to the work of John von Neumann and Abraham Wald in Vienna, which Hicks had ignored (see Chap. 4.7).23 more skill in mathematics” than himself. On the other hand, Hicks regarded those “great” results as extraneous to his way of thinking, which did not espouse either econometrics or theory for its own sake (Hicks 1979, pp. 201–202). Roy Allen, who was at that time in constant intellectual dialog with both Hicks and Samuelson, wrote (Allen 1949) that the two authors “have now come together on essentials” so that “future development…will flow from an agreed combination of the two expositions” (ibid., p. 112). This judgment became a common opinion: Arrow (1974, pp. 255–260) speaks of a “Hicks-Samuelson Model of General Equilibrium” whose “primary interest… was rather in the laws of working of the general equilibrium system…than in the questions of existence and the like”. Allen was also able to show the differences, not trivial, between Hicks and Samuelson: whereas Hicks, he wrote, wanted to present “a full development of one particular line of approach”, Samuelson wanted “to unify diverse fields of economic theory by showing up the common, underlying mathematical basis” (ibid.). Actually, this means a different conception of the use of mathematics in economics. 22 On the formal shortcomings of Hicks’s GEE, see Collard (1993, pp. 334–335). 23 When he wrote his review, Morgenstern was “under von Neumann’s spell” (Leonard 2010). Morgenstern (1976) recounts von Neumann’s irreverent opinion of the productions of mathematical economics at the end of the 1930s, and the following quotation refers particularly to Hicks (see Ingrao and Israel 1990, p. 197 and note 60, p. 410): “You know, Oskar, if those books are unearthed sometime a few hundred years hence, people will not believe they were written in our time. Rather they will think that they are about contemporary with Newton, so primitive is their mathematics. Economics is simply still a million miles away from the state in which an advanced science is, such as physics”. Substantially, the same judgment was passed

140

R. Marchionatti

Hicks’s Macroeconomics: “Mr. Keynes and the ‘Classics’”, 1937, or the Beginning of the Neoclassical Synthesis Hicks’s paper “Mr. Keynes and the ‘Classics’” published in Econometrica was based on a version originally read at a meeting of the Econometric Society at Oxford in September 1936 during the Symposium on Keynes’ General Theory to which Meade and Harrod also contributed. The paper contains the then-famous IS-LL (later IS-LM24 ) model. In it, Hicks tried to translate Keynes into the General Economic Equilibrium model of Value and Capital , as he recognized later: the idea of the IS – LM came to me as a result of the work I had been doing on three-way exchange, conceived in a Walrasian manner. I have already found a way of representing three-way exchange on a twodimensional diagram (to appear in due course in chapter 5 of Value and Capital ). As it appears there it is a piece of statics; but it was essential to my approach … that static analysis of this sort could be carried over to “dynamics” by redefinitions of terms. So it was natural for me to think that a similar device could be used for the Keynes theory. (Hicks 1980 [1981], pp. 141–142)

The starting point of Hicks’s paper is that the “classical system” that Keynes set up as a target for attack, based on Pigou’s Theory of Unemployment, was not representative of the classical theory and ignored those aspects of the writings of the classics that were concerned with Keynes’s sort of problems. For this reason, he writes, it seems worthwhile to try to construct a typical “classical” theory, built on an earlier and cruder model than Professor Pigou’s. If we can construct such a theory, and show that it does give results which have in fact been commonly taken for granted, but which do not agree with Mr. Keynes’ conclusions, then we shall at last have a satisfactory basis of comparison.

on Samuelson: Leonard (2010, p. 244) writes that von Neumann felt a private disdain for the “primitivity” of the Samuelsonian mathematical economics of Foundations. 24 On the history of IS-LL and IS-LM, see Young (2010).

3 Economics in London: The London School …

141

We may hope to be able to isolate Mr. Keynes’ innovations, and so to discover what are the real issues in dispute. (Hicks 1937, p. 148)

As Coddington (1979, p. 973) writes, the result of Hicks’s paper is that “if ‘classical’ economics is sympathetically understood and properly applied”, it follows that “the conflict between it and Keynesian economics reduces to a matter of analytical procedure or, at most, emphasis”. In order to make the comparison, Hicks set out a typical classical theory model in a form similar to that in which Keynes set out his own short period theory. Hicks presents the “classical” theory through three equations: M = k I, I x = C(i), I x = S(i, I ) where in Hicks’s notation, M is the quantity of money, k = 1/V , where V is the velocity of money, I x the investment, i the rate of interest, I the total income, in order to determine three unknowns, I , I x , i.25 Hicks sums up: … we have here a quite reasonably consistent theory, and a theory which is also consistent with the pronouncements of a recognizable group of economists ... Historically this theory descends from Ricardo ... it is probably more or less the theory that was held by Marshall. (Hicks 1937, p. 150)

After a discussion of industrial fluctuations in the classical theory, Hicks presents “Mr. Keynes’s ‘special’ theory”. He contrasts the three equations of “classical” theory with the following system of equations: M = L(i), I x = C(i), I x = S(I ) This system differs from the classical one in two ways: 25

Hicks also introduces another version of the classical theory, the so-called Treasury view, which assumes that saving is inelastic to the rate of interest.

142

R. Marchionatti

On the one hand, the demand for money is conceived as depending upon the rate of interest (Liquidity Preference). On the other hand, any possible influence of the rate of interest on the amount saved out of a given income is neglected. (ibid., p. 152)

It is the liquidity preference doctrine which is “vital”, Hicks adds, because now it is the rate of interest which is determined by the quantity of money. This rate of interest “determines the value of investment; that determines income by the multiplier” (ibid.). Hicks comments: It is this system of equations which yields the startling conclusion, that an increase in the inducement to invest, or in the propensity to consume, will not tend to raise the rate of interest, but only to increase employment. (ibid.)

In spite of this, Hicks continues, and “in spite of the fact that quite a large part of the argument runs in terms of this system” (ibid.), “it is not the General Theory”: “We may call it, if we like, Mr. Keynes’ special theory” (ibid.). The General Theory, Hicks maintains, “is something appreciably more orthodox. (ibid.). In fact, Hicks thinks that: Keynes [like Pigou] does not in the end believe that the demand for money can be determined by one variable alone—not even the rate of interest. He lays more stress on it than they did, but neither for him nor for them can it be the only variable to be considered. (ibid.)

Keynes’s “general” theory is represented with this set of equations: M = L(I, i), I x = C(i), I x = S(I ) In this way, Hicks comments, Keynes’s theory “becomes hard to distinguish from the revised and qualified Marshallian theories” (ibid., p. 153). At this point, Hicks asks: “Is there really any difference between them, or is the whole thing a sham fight?” (ibid.), and, in order to ask this question, he has recourse to a diagram, the IS-LL diagram (Figs. 3.1 and 3.2).

3 Economics in London: The London School …

143

Fig. 3.1 Relation between income and rate of interest (Source Hicks 1937, p. 153)

Fig. 3.2 Relation between income and interest (Source Hicks 1937, p. 153)

In Fig. 3.1, the first equation, M = L (I, i), gives us a relation between income (I ) and the rate of interest (i): “This can be drawn out as a curve (LL) which will slope upwards, since an increase in income tends to raise the demand for money, and an increase in the rate of interest tends to lower it” (ibid., p. 153). The second two equations taken together give us another relation between income and interest: “The curve IS [sloping downwards] can … be drawn showing the relation between Income and

144

R. Marchionatti

interest which must be maintained in order to make saving equal to investment” (ibid.). The intersection of the curves LL and IS, the point P, determines income and rate of interest together. “They are determined together; just as price and output are determined together in the modern theory of demand and supply” (ibid.), Hicks comments. Keynes’s remark about an increase in the inducement to invest not raising the rate of interest can be explained with the shape of the curve LL—here the crucial difference between Classics and Keynes according to Hicks: It will probably tend to be nearly horizontal on the left, and nearly vertical on the right. This is because there is (1) some minimum below which the rate of interest is unlikely to go, and (though Mr. Keynes does not stress this) there is (2) a maximum to the level of income which can possibly be financed with a given amount of money. If we like we can think of the curve as approaching these limits asymptotically (Fig. 3.2). (ibid., p. 154)

Therefore, if the curve IS lies well to the right (either because of a strong inducement to invest or a strong propensity to consume), P will lie upon that part of the curve which is decidedly upward sloping, and the classical theory will be a good approximation, needing no more than the qualification which it has in fact received at the hands of the later Marshallians. (ibid.)

But if the point P lies to the left of the LL curve, then the special form of Mr. Keynes’ theory becomes valid. A rise in the schedule of the marginal efficiency of capital only increases employment, and does not raise the rate of interest at all. We are completely out of touch with the classical world. (ibid.)

So Keynes’s special model represents the special case in which the IS and LL curves intersect at the point where the LL curve is almost horizontal—this means that monetary means cannot force down the rate of interest any further: The General Theory of Employment, Hicks concludes, “is the Economics of Depression” (ibid., pp. 154–155).

3 Economics in London: The London School …

145

The final part of the paper presents a “Generalized General Theory” (ibid., p. 156), represented by the following set of equations: M = L(I, i), I x = C(I, i), I x = S(I, i) Therefore, the previous cases can be presented as particular cases included in this generalized theory.

3.5

Abba Ptachya Lerner (1903–1982), the LSE Years

“Abba Lerner has been a great theoretical economist in a vintage epoch for theorists” (Samuelson 1964, p. 169). In so saying, Samuelson expressed a widely held opinion. Scitowski (1984) explained that “Abba P. Lerner … initiated more of the concepts, theorems and rules that today constitute our profession’s workaday tools than anyone else” (Scitowski 1984, p. 1547). In fact, as Scitowski summarizes: Lerner introduced the idea that monopoly is a matter of degree, measured by the ratio in which the divergence between price and marginal cost stands to price; he was the first to establish the “Lerner-Hotelling condition” that marginal cost pricing is a universal welfare-maximizing rule, which extends even to decreasing-cost industries; he and Oskar Lange were the main architects of the theory of market pricing in socialist economies; and he was the one to base the ethical argument for greater income equality on a logical footing. In the field of international economics, Lerner was the first to assert and prove the complete equalization of factor prices by free trade in products; he established definitively that export and import duties have identical consequences; he seems to have been the first to raise the question of what might be the optimum currency area and what factors determine it; he was among the earliest advocates of variable exchange rates, probably being the first to advocate them in conjunction with counterspeculation (market intervention) by monetary authorities to smooth excessive fluctuations. In the area of macroeconomics, Lerner provided the logical framework (functional finance) for Keynes’s policy recommendations; he noted and expressed

146

R. Marchionatti

concern over the intolerably high unemployment needed to assure price stability, decades before the rest of us did and many years before Milton Friedman presented the idea of a natural rate of unemployment; he introduced the concept and stressed the importance of sellers’ inflation; he was probably the first to argue that only unexpected inflation has harmful effects, and the first to advocate the indexation of bonds. Many of Lerner’s contributions were so fundamental that today all economists know and constantly use them without knowing or caring who introduced them. (ibid.)

Biographical Note Abba Ptachya Lerner was born in Bessarabia (a region in Central-Eastern Europe at that time part of the Russian Empire and now divided between Moldavia and Ukraine) on October 28, 1903. In 1906, he came to England with his family as Jewish refugees and lived in London’s East End. From the age of sixteen, he worked as a machinist, capmaker and teacher at Hebrew school after undertaking Rabbinical studies and also operated a small business. He entered the London School of Economics in 1929 at the age of 26, after his business went bankrupt. He took his bachelor’s degree in 1932 and then went on to graduate study, first at LSE, then at Cambridge and Manchester. While he was still a graduate student at LSE in 1933, Lerner was one of the founders of The Review of Economic Studies. In 1934, he received a postgraduate fellowship which financed his studies at Cambridge and put him in close contact with J. M. Keynes. Those were the years when the General Theory was presented in draft form and discussed before an audience of young graduate students and fellows. At Cambridge, Lerner thus had the opportunity to attend the lectures that Keynes based on the proofs of the General Theory. He was strongly influenced by Keynes’s thought: in particular, in Lerner’s theoretical neoclassical framework, it influenced the idea that the aggregative welfare losses attributable to departures from full employment were greater than any conceivable losses which might be attributed to allocative inefficiency. He concluded that Keynes’s analysis provided a practical basis for solving the most crucial problem confronting democratic societies. Thus, in October 1936, Lerner wrote his first paper to

3 Economics in London: The London School …

147

receive worldwide attention, “Mr. Keynes’ ‘General Theory of Employment, Interest and Money’” in the International Labour Review, where he labeled Keynes’s work a policy, rather than a theoretical revolution. From 1935 to 1937, he was Assistant Lecturer at LSE. He then came to America, where he was to spend the rest of his life teaching and writing at many institutions—Columbia University (1939–1940), the University of Kansas City (1940–1942), the New School for Social Research (1942– 1947), Roosevelt University in Chicago (1947–1959), Michigan State University (1959–1965), the University of California at Berkeley (1965– 1971) and Florida State University (1971–1982). After he retired from Berkeley in 1971, he served as Distinguished Professor of Economics at Queens College of the City University of New York until 1978 (he was then seventy-five) and then took a chair at Florida State University, which he held until his death on October 27, 1982. In addition, he served as consultant or adviser at various times to the Rand Corporation (1949), the Economic Commission for Europe (1950–1951), the Economic Advisory Staff in Jerusalem (1953–1955), the Institute for Mediterranean Affairs (1958–1959) and the Treasury and the Bank of Israel (1955–1956). He died on October 27, 1982, in Tallahassee, Florida.

Theoretical Contributions in the LSE Years In the LSE years, Lerner published a large number of papers devoted to many different areas of the discipline—trade theory, microeconomics, the socialist calculation debate (analyzed in Chap. 7.2) as well as Keynesian economics—which, from the theoretical point of view, can be essentially inserted in the framework of the Paretian revival. With his LSE colleagues Hicks and Allen, Lerner thus contributed to the development of neoclassical microeconomics in the English-speaking world, concentrating on the themes of market efficiency and welfare economics. In 1932, when he was still an undergraduate, Lerner published in Economica “The Diagrammatical Representation of Cost Conditions in International Trade”, an important paper in the field of trade theory which combined the concept of the production-possibility frontier (a

148

R. Marchionatti

concept first introduced by Haberler in 1930) with the collective indifference curves to derive a two-country equilibrium of international trade—an issue then developed in Wassily Leontief ’s (1933) essay in the Quarterly Journal of Economics on “The Use of Indifference Curves in International Trade”. At an LSE seminar in the following year, Lerner presented a paper on factor price equalization, published many years later in Economica (Lerner 1952). It was a proof of the conditions under which free trade in goods equalizes international factor prices. Samuelson remembered that once Robbins “mentioned to me that he thought he had a seminar paper in his files by Lerner of a similar type” of that published by Samuelson in 1948: “he exhumed this gem, which appeared 17 years later in the 1950 Economica” (Samuelson 1964, p. 172). In 1934, when he was at his first year as a graduate student, Lerner published “The Concept of Monopoly and the Measurement of Monopoly Power” in the Review of Economic Studies (Lerner 1934), a paper later considered a classic in imperfect market economics and allocative efficiency. In it, he showed that the condition “price equals marginal cost” was a necessary and sufficient condition of an optimum allocation of resources and introduced the concept of degrees of monopoly, measured by the extent of deviation of price from marginal cost, i.e., a measure of market power under monopoly. This divergence between price and marginal cost identifies the social loss from monopoly, and in this way, Lerner emphasized the allocative inefficiency created by the monopolist’s profit, the social optimum being a Pareto-optimal state of affairs. According to Samuelson, this insight was a significant advance; he observed that it “may seem simple, … I can testify that no one at Chicago or Harvard could tell me in 1935 exactly why P = MC was a good thing” (Samuelson 1964, p. 173). In the same period, Lerner joined Oskar Lange in the “socialist calculation debate” with several “Paretian” contributions between 1934 and 1938 (see Chap. 7.2). His work of the LSE years culminated in his magnum opus, The Economics of Control. Principles of Welfare Economics (Lerner 1944). Though not published until 1944, the book was based on his Ph.D. dissertation at LSE, with some significant differences: whereas in the mid-1930s and at the time of the socialist debate he considered himself a socialist and was to develop marginal analysis for the solution of

3 Economics in London: The London School …

149

economic problems of socialism, and in his dissertation, his aim was to write a treatise on socialist economics, in the Economics of Control , as Lerner writes in the Preface, the scope and direction of his inquiry changed—Seligman (1962, p. 113) writes that “in the process of composition British Fabianism gave way to American New Dealism” and the emphasis shifted to the theory of control in a capitalist society: Originally it was to be a development of the theory of the price mechanism of a socialist society … In the course of the development of my ideas on the subject … it gradually became clear to me that the maintenance and further development of the democratic way of life, as it grew under capitalism and was extended by the labor movement within the capitalist society, not only formed a far more essential part of the socialist ideal than the negative “abolition of private property in the instruments of production” but was in much greater need of careful tending … If socialism is to be identified with the belief that the abolition of private property would automatically establish the brotherhood of man … then socialism must be counted out as false. State control or ownership of the instruments of production where the State itself is not thoroughly democratic is not socialism and is much further removed from socialism than socialism’s “opposite”, capitalism. (Lerner 1944, p. vii)

The economics of control contrasts with the economics of laissez-faire, Lerner writes, “but control does not necessarily mean collectivism”. “It suggests—he maintains—the deliberate application of whatever policy will best serve the social interest, without prejudging the issue between collective ownership and administration or some form of private enterprise” (ibid., p. viii). In this way, “the stress is taken from collectivism and applied to the idea of conscious recognition of the problems of social organization and the exercise of conscious control over the economic system” (ibid., pp. vii–viii). He comments: In my original plan I had intended to provide a theoretical solution for each economic problem of a completely collectivized economy and then see to what extent, if at all, and by what means the problem is in fact solved by a capitalist society. But the abandonment of the dogmatically, and therefore completely, collectivist economy as identical with the ideal

150

R. Marchionatti

of a society organized in the social interest still permits a similar procedure to be followed with slight modifications. (ibid., p. viii)

Lerner supposes the existence of a government whose objective is to maximize the economic welfare of the community. He maintains that the fundamental aim of socialism is not the abolition of private property but the extension of democracy and that a controlled economy can provide the benefits of both the capitalist and the collectivist economies. The principal problems to be faced in order to obtain an optimal position in terms of welfare are employment (full employment), monopoly (to be eliminated because it distorts the allocation of goods) and the distribution of income (to diminish inequality). An equal division of income is considered a condition for maximizing total satisfaction.26 The fundamental rule for efficient production is that the value of the marginal product of a factor must equal the price of the factor. If this rule is not fulfilled, and under private enterprise, it is fulfilled only in conditions of perfect competition, the state must secure its realization by (i) socializing industries where competition is technologically impossible and (ii) “counterspeculation”: Lerner imagines that the government through a special board estimates what would be the price of the good that would make demand equal to supply if there were no monopolistic restrictions and guarantees this price to all sellers and buyers. The most significant part of the book is the discussion of the maintenance of full employment and the stabilization of the business cycle. First Lerner shows that it is unlikely that automatic adjustment can take place, which makes government action necessary. The government can achieve these ends with many instruments, by “taxing and spending, borrowing and lending, and buying and selling”, in such a way as to counteract the ups and downs of private business. Debts are not bad, if owed to domestic creditors, and the government should make no effort to keep the budget balanced at all times. Indeed, the government 26

Lerner overcomes the difficulty of comparing the wellbeing of different individuals by introducing two assumptions: (1) the similarity in kind of the satisfactions experienced by different people and (2) the principle of diminishing marginal utility of income. On the basis of these assumptions, he argues that equalization of income will maximize the probable sum of satisfactions in the community.

3 Economics in London: The London School …

151

should purposely unbalance the budget when necessary to stabilize business conditions. This method is that of “functional finance” presented in a 1943 paper, but formulated in 1939 and viewed positively by Keynes. Functional finance—the principle of judging fiscal measures by the way they work or function in the economy (Lerner 1943, p. 39)—actively promotes government deficit spending as an effective way of reducing unemployment. Lerner went on to say that the “first law” of functional finance is that “total spending can be kept at the required level, where it will be enough to buy the goods that can be produced by all who want to work, and yet not enough to bring inflation by demanding (at current prices) more than can be produced” (ibid., p. 40). Regarding the “second law”, Lerner wrote: The second law of Functional Finance is that the government should borrow money only if it is desirable that the public should have less money and more government bonds, for these are the effects of government borrowing … When taxing, spending, borrowing and lending (or repaying loans) are governed by the principles of Functional Finance, any excess of money outlays over money revenues, if it cannot be met out of money hoards, must be met by printing new money, and any excess of revenues over outlays can be destroyed or used to replenish hoards. (ibid., pp. 40–41)

Thus, as Lerner put it: In brief, Functional Finance rejects completely the traditional doctrines of “sound finance” and the principle of trying to balance the budget over a solar year or any other arbitrary period. In their place it prescribes: first, the adjustment of total spending (by everybody in the economy, including the government) in order to eliminate both unemployment and inflation, using government spending when total spending is too low and taxation when total spending is too high; second, the adjustment of public holdings of money and of government bonds, by government borrowing or debt repayment, in order to achieve the rate of interest which results in the most desirable level of investment; and third, the printing, hoarding, or destruction of money as needed for carrying out the first two parts of the program. (ibid., p. 41)

152

R. Marchionatti

In the April 1945 issue of the Economic Journal , Meade reviewed Lerner’s “LSE book”, focusing on its welfare economics aspects. Meade’s review was overall positive. He wrote that Lerner’s approach constituted a “third school of thought” as against the “battle royal between Planning and Laissez-faire”. He writes: Mr. Lerner believes passionately in the principles of the economic calculus, in the use of the price mechanism, in the avoidance of arbitrary centralized planning, and in freedom of choice for consumers and workers; but he does not believe in unqualified laissez faire. He preaches the “controlled economy” by which he means an economic system in which the price mechanism is made to work at the dictation of the free choice of the individual consumer, in such a way as to attract factors of production to the uses in which the valuation set by the consumers on their marginal product is higher. In many cases, according to Mr. Lerner, this can best be achieved by competition; in other cases it is necessary to institute socialist production to achieve this end by equating prices to marginal costs. The “controlled economy” is the economy in which controls are introduced of a kind and on a scale necessary to achieve just this object of making the price system work, and from which all other regulations are removed. (Meade 1945, pp. 47–48)

References Allen, Roy G. D. 1936. Professor Slutsky’s Theory of Consumers’ Choice. The Review of Economic Studies 3 (2): 120–129. ———. 1949. The Mathematical Foundations of Economic Theory. Quarterly Journal of Economics 63 (1): 111–127. Arrow, Kenneth J. 1974. General Economic Equilibrium: Purpose, Analytic Techniques, Collective Choice. American Economic Review 64 (3): 253–272. Backhouse, Roger. 2006. Hayek on Money and the Business Cycle. In The Cambridge Companion to Hayek, 34–50. Cambridge: Cambridge University Press.

3 Economics in London: The London School …

153

Baumol, William. 1989. Lionel Robbins, 1898–1984. In Pioneers of Modern Economics in Britain, ed. David Greenaway and John R. Presley, vol. II, 11–23. London: Palgrave Macmillan. ———. 1972. John R. Hicks’ Contribution to Economics. The Swedish Journal of Economics 74 (4): 503–527. Blaug, Mark. 1980. The Methodology of Economics, or, How Economists Explain. Cambridge: Cambridge University Press. Boettke, Peter J. 2018. F. A. Hayek: Economics, Political Economy and Social Philosophy. London: Macmillan. Caldwell, Bruce J. 1982. Beyond Positivism: Economic Methodology in the Twentieth Century. London: Allen & Unwin. ———. 1997. Hayek and Socialism. Journal of Economic Literature 35 (4): 1856–1890. ———. 2004. Hayek’s Challenge: An Intellectual Biography of F. A. Hayek. Chicago: University of Chicago Press. Cannan, Edwin. 1894. History of the Theories of Production and Distribution. London: Rivington, Percival & Company. Coase, Ronald H. 1937. The Nature of the Firm. Economica 4 (16): 386–405. ———. 1982. Economics at LSE in the 1930s: A Personal View. Atlantic Economic Journal 10 (1): 31–34. Coddington, Alan. 1979. Hicks’s Contribution to Keynesian Economics. Journal of Economic Literature 17 (3): 970–988. Collard, David A. 1993. High Hicks, Deep Hicks, and Equilibrium. History of Political Economy 25 (2): 331–350. Cord, Robert A. 2018. Arnold Plant. In The Palgrave Companion to LSE Economics, ed. Robert A. Cord, 329–346. London: Palgrave Macmillan. Creedy, John. 2011. John and Ursula Hicks. Research Paper Number 1123, University of Melbourne. ———. 2012. Sir John Hicks. Research Paper Number 1165, University of Melbourne. Dahrendorf, Ralf. 1995. LSE: A History of the London School of Economics and Political Science 1895–1995. Oxford: Oxford University Press. Dalton, Hugh. 1923. The Principles of Public Finance. London: George Routledge and Sons. Gregory, Theodore. 1933. Gold, Employment and Capitalism. London: P.S. King & Son. ———. 1935. The Gold Standard and Its Future. London: Methuen.

154

R. Marchionatti

Ford, James L. 1989. G.L.S. Shackle. In Pioneers of Modern Economics in Britain, ed. David Greenway and John R. Presley, vol. 2, 24–68. London: Palgrave Macmillan. ———. 1994. G.L.S. Shackle: The Dissenting Economist’s Economist. Cheltenham: Edward Elgar. Hamouda, Omar F. 1993. John R. Hicks: The Economist’s Economist. Oxford: Blackwell. Harcourt, Geoffrey C. 1993. Post-Keynesian Essays in Biography: Portraits of Twentieth-Century Political Economists. London: Macmillan. ———. 2006. The Structure of Post-Keynesian Economics: The Core Contributions of the Pioneers. Cambridge: Cambridge University Press. Hart, John. 2002. Terence Hutchison’s 1938 Contribution to Economic Methodology. PhD Thesis, University of South Africa. Hayek, Friedrich von. 1929 [1933]. Geldtheorie und Konjunkturtheorie. Wien: Holder-Pichler-Tempsky. English translation: Monetary Theory and the Trade Cycle. London: Jonathan Cape. ———. 1931a. The “Paradox” of Saving. Economica 32: 125–169. ———. 1931b. Prices and Production. London: Routledge (revised edition 1935). ———, ed. 1935. Collectivist Economic Planning: Critical Studies on the Possibilities of Socialism. London: Routledge. ———. 1937. Economics and Knowledge. Economica 4: 33–54. ———. 1941. The Pure Theory of Capital . London: Routledge. ———. 1944. The Road to Serfdom. London: Routledge. ———. 1945. The Use of Knowledge in Society. American Economic Review 35 (4): 519–530. ———. 1946. The Meaning of Competition. In Individualism and Economic Order. Chicago: The University of Chicago Press. ———. 1952. The Sensory Order: An Inquiry into the Foundations of Theoretical Psychology. London: Routledge. ———. 1973–1979. Law, Legislation and Liberty: A New Statement of the Liberal Principles of Justice and Political Economy. 3 vols. London: Routledge. ———. 1994. Hayek on Hayek: An Autobiographical Dialogue, eds. Stephen Kresge and Leif Wenar. Chicago: The University of Chicago Press. Hicks, John. 1932. The Theory of Wages. London: Macmillan. ———. 1937. Mr. Keynes and the Classics. Econometrica 5: 147–159. ———. 1939. Value and Capital . Oxford: Oxford University Press. ———. 1965. Capital and Growth. Oxford: Clarendon Press.

3 Economics in London: The London School …

155

———. 1972 [1973]. Autobiography. Nobel Prize in Economics documents, Nobel Prize Committee. ———. 1973. Capital and Time: A Neo-Austrian Theory. Oxford: Clarendon Press. ———. 1974. The Crisis in Keynesian Economics. Oxford: Basil Blackwell. ———. 1979. The Formation of an Economist. Banca Nazionale del Lavoro Quarterly Review 130: 195–204. ———. 1980. IS-LM: An Explanation. Journal of Post Keynesian Economics 3 (2): 139–154. Hicks, John, and Roy G. D. Allen. 1934. A Reconsideration of the Theory of Value. Economica 1 (February): 52–76, (May): 196–219. Howson, Susan. 2004. The Origins of Lionel Robbins’s Essay on the Nature and Significance of Economic Science. History of Political Economy 36 (3): 413–443. ———. 2011. Lionel Robbins. Cambridge: Cambridge University Press. ———. 2018. Lionel Robbins. In The Palgrave Companion to LSE economics, ed. Robert A. Cord, 347–371. London: Palgrave Macmillan. Hutchison, Terence. 1938. The Significance and Basic Postulates of Economic Theory. London: Macmillan. ———. 1981. The Politics and Philosophy of Economics: Marxians, Keynesians, and Austrians. Oxford: Blackwell. ———. 2009. A Formative Decade: Methodological Controversy in the 1930s. Journal of Economic Methodology 16 (3): 297–314. Ingrao, Bruna. 2013. Portraits of European Economists. Roma: Aracne. Ingrao, Bruna, and Giorgio Israel. 1990. The Invisible Hand: Economic Equilibrium in the History of Science. Cambridge, MA: MIT Press. Kahn, Richard. 1984. The Making of Keynes’ General Theory. Raffaele Mattioli Lectures. Cambridge: Cambridge University Press. Kaldor, Nicholas. 1934a. A Classificatory Note on the Determinateness of Equilibrium. Review of Economic Studies 1: 122–136. ———. 1934b. The Equilibrium of the Firm. The Economic Journal 44: 60– 76. ———. 1935. Mrs. Robinson’s Economics of Imperfect Competition. Economica 1 (3): 335–341. ———. 1937. Annual Survey of Economic Theory: The Recent Controversy on the Theory of Capital. Econometrica 5 (3): 201–233. ———. 1986. Recollections of an Economist. BNL Quarterly Review 39 (156): 3–26. King, John E. 2009. Nicholas Kaldor. London: Palgrave Macmillan.

156

R. Marchionatti

Klamer, Arjo. 1989. An Accountant Among Economists: Conversations with Sir John R. Hicks. Journal of Economic Perspectives 3 (4): 167–180. Leonard, Robert. 2010. Von Neumann, Morgenstern and the Creation of Game Theory. Cambridge: Cambridge University Press. Leontief, Wassily. 1933. The Use of Indifference Curves in International Trade. The Quarterly Journal of Economics 47 (3): 493–503. Lerner, Abba Ptachya. 1932. The Diagrammatical Representation of Cost Conditions in International Trade. Economica 37: 346–356. ———. 1934. The Concept of Monopoly and the Measurement of Monopoly Power. Review of Economic Studies 1 (3): 157–175. ———. 1936. Mr. Keynes’s General Theory of Employment, Interest and Money. International Labour Review 34 (4): 435–454. ———. 1943. Functional Finance and the Federal Debt. Social Research 10 (1/4): 38–51. ———. 1944. The Economics of Control: Principles of Welfare Economics. New York: Macmillan. ———. 1952. Factor Prices and International Trade. Economica 19 (73): 1–15. Marciano, Alain. 2018. Ronald H. Coase (1910–2013). In The Palgrave Companion to LSE Economics, ed. Robert A. Cord, 555–577. London: Palgrave Macmillan. Meade, James E. 1945. Mr. Lerner on ‘The Economics of Control.’ The Economic Journal 55: 47–69. Morgenstern, Oskar. 1935. Vollkommene Voraussicht und wirtschaftliches Gleichgewicht. Zeitschrift für Nationalökonomie 6 (3): 337–357. English translation: Perfect Foresight and Economic Equilibrium. In Selected Economic Writings of Oskar Morgenstern, ed. Andrew Shotter, 169–183. New York: New York University Press, 1976. ———. 1941. Professor Hicks on Value and Capital. Journal of Political Economy 49 (3): 361–393. ———. 1976. The Collaboration Between Oskar Morgenstern and John von Neumann on the Theory of Games. Journal of Economic Literature 14 (3): 805–816. O’Brien, Denis P. 1988. Lionel Robbins. London: Macmillan Press. ———. 2009. Terence Wilmot Hutchison 1912–2007. Proceedings of the British Academy 161: 179–203. Oliveira, Thiago D., and Carlos Eduardo Suprinyak. 2018. The Nature and Significance of Lionel Robbins’s Methodological Individualism. Economia 19 (1): 24–37.

3 Economics in London: The London School …

157

Pareto, Vilfredo. 1906. Manuale di economia politica. Milano: Società editrice Libraria. French Translation (revisited): Manuel d’économie politique. Paris: Giard et Brière, 1909. English Translation: Manual of Political Economy, ed. A.S. Schweir and A.N. Page. New York: August M. Kelley, 1971. Plant, Arnold. 1934a. The Economic Aspects of Copyright in Books. Economica 1 (2): 167–195. ———. 1934b. The Economic Theory Concerning Patents for Inventions. Economica 1 (1): 30–51. Robbins, Lionel. 1928. The Representative Firm. The Economic Journal 38: 387–404. ———. 1932. Essay on the Nature and Significance of Economic Science. London: Macmillan. ———. 1934. The Great Depression. London: Macmillan. ———. 1937. Economic Planning and International Order. London: Macmillan. ———. 1939. The Economic Causes of the War. London: Jonathan Cape. ———. 1952. The Theory of Economic Policy in Classical Political Economy. London: Macmillan. ———. 1968. The Theory of Economic Development in the History of Economic Thought. London: Macmillan. ———. 1970. The Evolution of Modern Economic Theory and Other Papers on the History of Economic Thought. London: Macmillan. ———. 1971. Autobiography of an Economist. London: Macmillan. Robinson, Joan. 1978. Contributions to Modern Economics. Oxford: Blackwell. Samuelson, Paul. 1941. The Stability of Equilibrium: Comparative Statics and Dynamics. Econometrica 9 (2): 97–120. ———. 1948. International Trade and the Equalisation of Factor Prices. The Economic Journal 58: 163–184. ———. 1964. A. P. Lerner at Sixty. The Review of Economic Studies 31 (3): 169–178. ———. 1998. How Foundations Came to Be. Journal of Economic Literature 36 (3): 1375–1386. Schultz, Henry. 1935. Interrelations of Demand, Price and Income. Journal of Political Economy 43: 433–481. Scitowski, Tibor. 1984. Lerner’s Contribution to Economics. Journal of Economic Literature 22 (4): 1547–1571. Seligman, Ben B. 1962. Main Currents in Modern Economics: Economic Thought Since 1870. Vol. I. Glencoe: The Free Press.

158

R. Marchionatti

Shackle, George L.S. 1938. Expectations, Investment and Income. Oxford: Oxford University Press. Slutsky, Eugen. 1915. Sulla teoria del bilancio del consumatore. Giornale Degli Economisti 51: 1–26. Sraffa, Piero. 1932. Dr. Hayek on Money and Capital. The Economic Journal 42: 42–53. Thirlwall, Anthony P. 1996. Nicholas Kaldor: A Biography. In Causes of Growth and Stagnation in the World Economy, ed. Anthony P. Thirlwall, 143–190. Raffaele Mattioli Lectures. Cambridge: Cambridge University Press. Thomas, Jim. 2018. R.G.D. Allen (1906–1983). In The Palgrave Companion to LSE economics, ed. Robert A. Cord, 515–531. London: Palgrave Macmillan. ———. 2020. Victor Edelberg: LSE’s Forgotten Econometrician. Oxford Economic Papers 72 (4): 1006–1031. Young, Warren. 1991. The Early Reactions to Value and Capital : Critics, critiques and Correspondence in Comparative Perspective. Review of Political Economy 3 (3): 289–308. ———. 2010. The IS-LM Diagram. In Famous Figures and Diagrams in Economics, ed. Mark Blaug and Peter Lloyd. Cheltenham: Edward Elgar.

4 Economics in Berlin, Vienna and Other Minor German Centers

4.1

Prologue

The aftermath of World War I in Germany and Austria saw drastic political, economic and social changes, followed by a limited economic recovery interrupted by the great crisis. However, what also marked this troubled period until the Nazi takeover in both countries was a surprising cultural resurgence, mainly concentrated in the two capitals. Immediately after the war, Berlin was the scene of revolutionary riots and their bloody suppression in which Rosa Luxemburg, an important figure in the Marxist debate of the century’s first decade (see Vol. I), was killed together with her partner, the communist leader Karl Liebknecht in January 1919. During the Weimar Republic—Germany’s democratic experiment from 1919 to 1933—almost permanent political instability was accompanied by a long social and economic crisis marked by unemployment, poverty and (hyper)inflation, but also by new social freedoms and lively artistic movements which made Berlin a worldwide cultural leader. In that complex period, Berlin became one of the most socially liberal places in Europe, a cosmopolitan city that was © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 R. Marchionatti, Economic Theory in the Twentieth Century, An Intellectual History—Volume II, https://doi.org/10.1007/978-3-030-80987-4_4

159

160

R. Marchionatti

home to famous writers and artists from the whole world in different fields: architecture and design, painting, literature, film and music, as well as in philosophy, psychology and the natural sciences. One among many important figures was Albert Einstein, who rose to public prominence during his years in Berlin, as he was awarded the Nobel Prize for Physics in 1921. In the field of economics, the picture changed considerably compared with the pre-war period. After the end of the war, the Historical School lost its dominant position, although two major figures of the Youngest Historical School—Spiethoff and Sombart—still occupied important university chairs in Bonn and Berlin, respectively, whereas Max Weber died suddenly in 1920 (on Weber see Vol. I, pp. 140–146), and Gustav Schmoller had died in 1917. The situation that emerged was highly diversified. Mathematical economics increased its importance in the 1920s essentially due to the presence of Ladislaus von Bortkiewicz’s circle at the University of Berlin (on Bortkiewicz see Vol. I, Chap. 3)—and then with Heinrich von Stackelberg in the 1930s. Although an actual school was never formed, many young scholars were influenced by Bortkiewicz and became his pupils. Two of them, whose work was particularly important in the classical/neo-Ricardian approach, were Wassily Leontief and Robert Remak, who had a close relationship with Bortkiewicz. Moreover, systematic empirical research on business cycles began, with the foundation of the German Institute for Business Cycle Research in Berlin in 1925, with Ernst Wagemann (1884–1956) as director (see Tooze 1999). Outside Berlin, three minor centers must be mentioned: in addition to Heidelberg—where the German AustroMarxist Emil Lederer (from 1931 in Berlin as Sombart’s successor, see Hagemann 2000) and Alfred Weber, Max’s brother, were the founding directors of the interdisciplinary Das Institut für Sozial-und Staatswissenschaften (Institute for Social and State Sciences) during the Weimar years—two places are particularly important in characterizing the lively German environment in economics and social sciences: the Kiel Institute for the World Economy (Institut für Weltwirtschaft ), founded by Bernhard Harms in 1914 and headed by Adolph Lowe from 1926 to

4 Economics in Berlin, Vienna and Other Minor …

161

1931, around whom the so-called Kieler Schule was formed,1 and the University of Freiburg where Walter Eucken and Franz Böhm founded the “Freiburg School of Law and Economics” and the ordo-liberalism took shape. Vienna’s story was similar to Berlin’s. Between 1918 and 1934, Vienna was the only Austrian municipality governed by the Social Democrats— “red Vienna” as it was called—in a country that after the proclamation of the republic was mostly governed by right-wing coalitions in a climate of civil war and economic crisis, with runaway inflation, high unemployment and poverty. As in Berlin, however, intellectual life in Vienna was exciting. Several intellectual groups had numerous interconnections in different fields: from Sigmund Freud’s psychoanalytic group to Hans Kelsen’s group in law studies—Kelsen was widely known because he drafted the Austrian Constitution at the behest of the Austro-Marxist chancellor Karl Renner—to the philosophical and scientific circles such as the Wiener Kreis created at the beginning of the 1920s by the physicist and philosopher of science Moritz Schlick (1882–1936) and the Mathematischen Kolloquium founded in 1928 and conducted by the mathematician Karl Menger, son of the Austrian School’s founder Carl Menger. In economics, the Austrian School survived, though weakened, in the Privatseminar of Ludwig von Mises, where a number of young economists destined to became famous were educated, including Friedrich Hayek, Oskar Morgenstern, Gottfried Haberler and Fritz Machlup, and in Hans Mayer’s less important seminar.2 But noteworthy work on economic theory was also carried out in the Wiener Kreis and above all in the Mathematische Kolloquium: although economic discussion was only a small part of the debate in these two scientific circles, it was a stage of crucial importance in the relationship among economic

1 Emil Lederer, though not formally associated with the University of Kiel, can also be considered a member of the group, as he worked along similar lines of research in the field of growth and business cycles. 2 We should also mention the role played by Othmar Spann (1878–1950), supporter of German nationalism, whose romantic universalist philosophy attracted many young students, including economists such as Hayek and Morgenstern (though they soon left Spann’s circle). Spann was able to exert influence over these young students because he held one of the professorships in economics at the University of Vienna (see Craver 1986).

162

R. Marchionatti

theory, philosophy and mathematics in the twentieth century (on Vienna circles, see Dekker 2014). The picture changed again after 1933 when Nazis and Austro-Fascists seized power in Germany and Austria. Hitler’s 1933 takeover marked a dramatic turning point for German intellectuals, particularly those of Jewish origin. As regards the economists, many university professors (around 25%) were dismissed, and some died—Remak escaped to Holland, but was arrested and died in Auschwitz in 1942, while Bortkiewicz had died earlier, in 1931. Many left Germany, as did many Jewish members of the Kiel Institute, who were forced to leave it and emigrated mainly to the United States, many going to New York’s New School for Social Research where they resurrected the Kiel Institute (see Chap. 6.2). Lederer too left Germany and went to the New School, while Leontief had reached Harvard in 1932 (see Chap. 6.3). Arthur Spiethoff and Werner Sombart were among the few internationally renowned economists who continued teaching after the rise of the Nazis, together with the most important economic theoretician in Nazi Germany, Heinrich von Stackelberg who taught at the University of Berlin for several years. Alfred Weber also remained in Nazi Germany, but became a leader of the intellectual resistance. Also involved in the intellectual resistance were the Freiburg school members, like Böhm, suspended from teaching in 1937, and Eucken, arrested, but then released, after the attempted assassination of Hitler in 1944, while Wilhelm Röpke emigrated in 1933 to Turkey and then to Geneva, where he worked at the Graduate Institute of International and Development Studies. As regards Austria, when Nazi Germany occupied and annexed the country in a process known as the Anschluss in March 1938, the Neo-Austrian School around Mises’s leadership in Vienna had already dissolved. The general uncertainty, the political climate (in particular when the Austro-Fascist Dollfuss rose to power in 1934) and the lack of official positions had induced many scholars to migrate since the beginning of the decade. Hayek migrated in 1931, when he was invited to the London School of Economics. Machlup left Austria for the United States in 1933. Mises went to Geneva’s Graduate Institute of International and Development Studies in 1934, leaving Europe for the United States in 1940. Haberler went to the League of Nations in Geneva and then moved to Harvard in 1936.

4 Economics in Berlin, Vienna and Other Minor …

163

Morgenstern remained until the proximity of the tragedy: he was visiting Princeton University at the time of the Anschluss in 1938 and decided to remain. As regards the other Viennese figures of our story, the members of the Wiener Kreis and the Mathematische Kolloquium followed a route similar to that of the other Austrians. The Wiener Kreis rapidly disintegrated, as the circle’s meetings ended after the murder of Moritz Schlick in 1936 by a former student and the death of one of the most important members, the mathematician Hans Hahn. Many members emigrated to the English-speaking world. The “economist” of the group, Otto Neurath, fled to Holland and then to Britain, where he died suddenly in 1945. As regards the members of the Kolloquium, Karl Menger emigrated to the United States, first to the University of Notre Dame (Indiana) and later to Chicago, while Abraham Wald received a fellowship at the Cowles Commission and later a position at Columbia.

4.2

Economics in Berlin, I: The Development of a Classical Conception of General Economic Equilibrium in Bortkiewicz’s Circle: Robert Remak (1888–1942) and the Young Wassily Leontief (1905–1999)

Biographical Foreword In the second part of the 1920s, the young scholar Wassily Leontief went to the University of Berlin to study with Sombart and Bortkiewicz (on Leontief in Germany see Bjerkholt 2016). Born to a Russian family in Munich on August 5, 1905, he grew up in St Petersburg (from 1914 Petrograd and from 1924 Leningrad) where he entered university in 1921 and obtained a degree in economics in 1925. In that year, he left the Soviet Union and settled down in Berlin. There, he obtained his Ph.D. in economics in 1928 with a dissertation entitled “Wirtschaft als Kreislauf ” (with Bortkiewicz and Sombart as advisors), which was the

164

R. Marchionatti

first step in the line of research culminating in the input–output analysis developed in his American period. In fact, after a period of research at the University of Kiel, Leontief moved to Harvard University in the United States (for his American period, see Chap. 6.3). The mathematician Robert Erich Remak (see Hagemann and Punzo 2007; Parys 2014) established a relationship with Bortkiewicz in the second part of the 1920s due to his interest in economics. He was born on February 14, 1888, in Berlin, in a wealthy Jewish family of important scientists—his father was a neurologist and his grandfather an embryologist. He studied mathematics and physics at Friedrich-Wilhelms University in Berlin under the mathematicians Ferdinand Georg Frobenius and Herman A. Schwarz. His doctorate was awarded in 1911. During the war, he served as a soldier. After the war, he returned to his mathematical studies and obtained the Habilitation in 1929.3 In Berlin, he became privatdozent in 1929, but he lost his right to teach in 1933, when the Nazis seized power. In November 1938, he was arrested and interned in a concentration camp for several weeks. Released, he moved to Amsterdam where he was again arrested in 1942 by the German occupational authorities and deported to Auschwitz (see Siegmund-Schultze 2009, Chap. 5). Here, he died on November 13 of the same year.

Theoretical Contributions4 In his 1928 dissertation, “Wirtschaft als Kreislauf ” (“The economy as a circular flow”), Leontief presented the economy as “a closed causal chain” (Leontief 1991 [1928], p. 182), i.e., a system of circular interrelationships, based on an objective technological framework, and he investigated which set of relative prices support this system. He outlined a model to solve the problem of the “general conditions which must be fulfilled within the framework of a circular flow” (ibid., p. 193). In it, he assumes a circular system of a two-branch simple exchange economy without profits, under conditions of constant return to scale, 3 He submitted his Habilitation thesis many times but it was rejected each time until 1929 (see Marchionatti 2019). 4 This paragraph is based on Marchionatti (2019).

4 Economics in Berlin, Vienna and Other Minor …

165

where the total quantities of each product and their distribution between the various uses are known. He obtains two “general exchange formulae”: Ap1 = k(a Ap1 + bBp2 ) + m[(1 − a)Ap1 + (1 − b)Bp2 ] Bp2 = l(a Ap1 + bBp2 ) + r [(1 − a)Ap1 + (1 − b)Bp2 ] where A and B are the quantities produced of two commodities, a and b the shares of these commodities used in the production as means of production and consumption, and k, l , m, r are the unknown productive coefficients. In 1929, Robert Remak—following Bortkiewicz’s suggestions, as he later wrote (Remak 1933)—carried out a study on the determination of “rational prices” for a centrally planned economy, presented in a seminar at the Berlin Institute of Mathematics and then published under the title “Kann die Volkswirtschaftslehre eine exakte Wissenschaft werden?” (Can economics become an exact science?). In starting his research on this subject, his socialist interests and the debates on socialist calculation (see Chap. 7.2) undoubtedly played an important role—as Hagemann and Punzo (2007) maintain—as did Bortkiewicz’s suggestions on the issue of the theory of different socioeconomic systems (see Remak 1933; Wittmann 1967). His model represented the economy as a classical circular process of production. He considered a closed economy without wages and profits in which the quantities of the various commodities produced and consumed are known. The problem for such a system is the determination of a set of prices which would “provide the basis for a financially viable economy” (Remak 1929, p. 271). Under the assumptions that the production process is circular, the total quantities of each product and the productive technology are given, the period of production is the year, and the system is in a stationary state, the problem to solve is the following: given the technical coefficients of production, a ij ≥ 0 (i, j = 1, …, n), i.e., the quantity of each commodity that the industry i furnishes to the industry j to produce a unit of the commodity j (which could be positive or zero in the case where the industry i does not supply anything to the industry j ), to determine the prices of the commodities y i (i = 1, …, n) so that each industry’s income from the

166

R. Marchionatti

supplied commodities is equal to its expenditure on the received goods. This system is called a “superimposed price system” or “rational price system”.5 Remak demonstrates the existence of an economically relevant solution, i.e., where prices are ≥0, unique up to a factor of proportionality. Remak’s paper attracted the interest of economists, and Leontief in particular—he acknowledged that Remak’s work had applied a mathematical point of view to the same problems he himself had analyzed —and mathematicians—it is noteworthy that Remak’s representation is the one adopted by von Neumann in his 1937 paper (see Chap. 4.7). Both Remak and Leontief adopted a concept of value referring to the exchange relations deduced from the relation of production (having nothing to do with consumer’s judgments and tastes), and in their description of the economic process, both scholars used the classical idea of circular flow. There were numerous sources of this idea: the classics— Leontief remembers that, when he was a student, he read the works of economists of the seventeenth and eighteenth centuries, François Quesnay included—the German debate on classics, Marx and Walras in which Bortkiewicz had been involved, and the 1920s debates on planning in the USSR.6

5

As Parys (2014) notes, Remak seems to sustain the idea that “his system of superposed prices provided an ‘exact’ criterion to judge the extremal character of an economic system”, where the notion of an extremal economy “refers to a system with Pareto efficient output, where it is impossible to increase the output of any good, except by decreasing the output of at least one other” (Parys 2014, p. 58). 6 In fact, at the beginning of the 1920s, the Soviet planners P. I. Popov and L. N. Litoshenko (see Chap. 5.4) referred to both Quesnay’s Tableau and Marx’s schemas of reproduction in their development of a sort of primitive input–output matrix of the Soviet economy as a whole. Leontief was marginally involved in that debate, writing an article in 1925, when he was a student in Berlin, on “the balance of the national economy of the USSR”, a critical commentary on the Popov report (see Leontief 1966).

4 Economics in Berlin, Vienna and Other Minor …

4.3

167

Economics in Cologne and Berlin, II: The Analysis of Oligopolistic Market Forms by Heinrich von Stackelberg (1905–1946)

Biographical Note Heinrich von Stackelberg was born on October 31, 1905, in Kudinovo, near Moscow, into an aristocratic German Baltic family (on his father’s side, while his mother was from Argentina) which escaped to Germany after the Bolshevik revolution in Russia. He attended the humanistic gymnasium, first in Ratibor (Upper Silesia) and later in Cologne. He enrolled in the University of Cologne, choosing economics and mathematics as his main fields. After graduation in 1927, he continued his Ph.D. studies in economics and in 1930 graduated with a dissertation on the theory of costs (entitled “Die Grundlagen einer reinen Kostentheorie”) which was published in 1932. He continued his studies abroad, in Vienna and then in Italy, where he worked with the Paretian mathematical economist Luigi Amoroso on imperfect competition, also publishing an article on duopoly and polypoly in the Rivista italiana di statistica, economia e finanza (Stackelberg 1933). In 1934, he obtained his habilitation with a thesis on market structure and equilibrium, and published it as Marktform und Gleichgewicht (Market Structure and Equilibrium). While at university, he was active in nationalist conservative political movements: in 1931, he joined the Nazi Party and became a member of the SS—a choice that according to Niehans (1991, p. 4) has to be explained “in terms of his family background, his childhood experiences and … a certain immaturity of judgement”, and it seems that later he tried to quit the SS. He became a privatdozent at the University of Cologne in 1935, but after a term he became a lecturer at the University of Berlin, where he was later appointed associate professor. He stayed at Berlin for six years, until 1941, when he became Professor of Economics at the University of Bonn. In those years, it seems that he became close to Walter Eucken’s Freiburg Group (see Chap. 4.3). In 1943, after a period of a few months at the front, he was exempted from military service and accepted an offer of a Visiting Professorship at the University of Madrid

168

R. Marchionatti

where he worked for three years. There he died from cancer, after a long illness, on October 12, 1946.

Stackelberg’s Economics: Marktform und Gleichgewicht, 1934 Schumpeter (1954) considered Marktform und Gleichgewicht one of the most important contributions to economics in the “Totalitarian” countries. It was certainly the most comprehensive and original work that had yet appeared on the theory of oligopolistic competition, and attracted international attention. At the beginning of the book, Stackelberg writes that classical and marginalist theories have focused primarily on a market structure characterized by a large number of independent economic agents competing with one another, where price is considered as a variable independent of the behavior of the individual, and secondarily on monopoly. In both cases, he emphasizes, a well-defined equilibrium can be derived. On the contrary, he writes, “there is also no systematic investigation of the problem that encompasses all conceivable market structures and analyses the relationships of mutually interdependent markets” (Stackelberg 2011 [1934], p. 1), where the definition of the equilibrium is more problematic. In his work, Stackelberg seeks “to establish the principles to fill in these gaps” (ibid.). Four of the six chapters of the book are devoted to systematic exposition of the theory of oligopolistic competition, using reaction functions expressing individual profit maximization for given values of the rival’s variable, while one chapter gives a critical survey of its development from Cournot up to Robinson and Chamberlin, and the last chapter deals with questions of market disequilibrium as the object of economic policies. The mathematical groundwork of the theoretical discussion is presented separately in the Appendix. The basis of the theory is to be found in the discussion of simple duopoly: “The complexity of the subject”, Stackelberg writes, “makes it necessary to initially discuss a special kind of oligopoly, namely duopoly” (ibid., p. 15). All the other imperfect market situations can be considered as modifications of this fundamental form. Stackelberg’s main interest is

4 Economics in Berlin, Vienna and Other Minor …

169

in analyzing the stability of oligopolistic markets. He starts by considering two situations: in the first, the duopolist assumes that his rival will not react to his behavior, that is, the rival’s quantity supplied is taken as given. In the second case, the duopolist assumes that his rival’s behavior depends on his own decision. There are three main cases to consider: (1) both firms believe the rival’s behavior to be independent of its own; (2) both firms believe the rival’s behavior to be dependent on his own choice; and (3) one firm is dependent while the other is independent (asymmetric situation). In the first case, each firm will maximize its profits, given the other firm’s reaction function. According to Stackelberg, this situation is unstable since one of the firms could increase its profit by reducing its quantity supplied. In the second case, each firm assumes that the other reacts to its behavior: this is the Cournot case. The expectations on the rival’s quantity are confirmed, since one firm’s quantity corresponds to the other’s supply according to its reaction function. However, this situation is not an equilibrium either, since, given the dependent position of one firm, the other would prefer to be independent. The third case, the asymmetric oligopoly, may constitute an equilibrium since it is in one firm’s interest to act according to the other firm’s will. However, according to Stackelberg, the equilibrium position must be considered an exception, because in general, oligopoly is a market form without equilibrium: oligopolies are unstable and even “completely chaotic, confused market conditions” (ibid., p. 21). A fundamental instability characterizes oligopolistic markets according to Stackelberg, making the existence of free market capitalism impossible. Cartel-agreements and trusts cannot be a remedy to this but merely transform the game into a battle of giants. It follows that there is a need for state intervention. In fact, Hicks (1935, p. 336) considered this idea of the instability of monopoly “exaggerated” in order to show the inevitability of price control and the corporate state.

170

4.4

R. Marchionatti

Economics in Minor German Centers: Kiel and Freiburg

Statistical Economics and Business Cycle Theory at the Kieler Schule Work in business cycle and development theory along classical Marxist and Historical School lines gained fresh impetus at the University of Kiel—a small city at the Western end of the Baltic—where the Institut für Weltwirtschaft (Institute for the World Economy) was founded by Bernhard Harms (1876–1939), “one of the most efficient organizers of research who ever lived” (Schumpeter 1954, p. 1121) in 1914. In 1926, the Institute established a department for statistical economics and business cycle research—the Abteilung für statistische Weltwirtschaftskunde und internationale Konjunkturforschung, nicknamed Astwik from the acronym of the German name. It published Weltwirtschaftliches Archiv, a German language economics journal, which was highly regarded at the international level and served as a conduit for promoting research conducted at the Institute. The Institute was headed by Adolph Löwe (1893–1995) from 1926 to 1931 (see Hagemann 2021; on Löwe see Mongiovi 1998). Adolph Löwe was born on March 4, 1893, in a liberal Jewish family in Stuttgart. From 1911 to 1915, he had studied law, economics and philosophy at the universities of Munich (with Lujo Brentano, who influenced his decision to become an economist), Berlin and Tübingen, receiving his doctorate in law from the latter university in November 1918. During the war, Löwe became an active supporter of the Social Democratic movement and, after the war, economic adviser to the young Weimar Republic. From 1919 to 1924, he served in the Federal Ministry of Economic Affairs, where he was involved with issues of reparation policy and drafting the memoranda which the German government presented at the conferences in Genoa and Paris. From 1924 to 1926, he was Head of the International Division of the German Bureau of Statistics and assisted Ernst Wagemann in founding the first German Institute for Business Cycle Research in Berlin. In early 1926, Löwe accepted an offer by Bernhard Harms, the President of the Kiel Institute of World Economics,

4 Economics in Berlin, Vienna and Other Minor …

171

to become Director of Research of the new department of statistical international economics and international trade cycles. In 1930, he was appointed Professor of Economic Theory and Sociology at the University of Kiel. In 1931, Löwe moved to the Goethe University in Frankfurt. In 1933, dismissed by the Nazis for racial and political reasons, he went to Geneva and then England, where he spent the next half decade at the London School of Economics and the University of Manchester. In 1939, Löwe became a naturalized English citizen and changed his surname to Lowe. In summer 1940, he accepted an offer from the New School for Social Research in New York where he served as Professor of Economics and also as Director of Research at the Institute of World Affairs between 1943 and 1951. Löwe played a major role in the debates on business cycles in the 1920s with his Kiel habilitation thesis, “Wie ist Konjunkturtheorie überhaupt moglich?” (How is business cycle theory possible at all?), which was published in Weltwirtschaftliches Archiv in 1926. In it, Löwe pointed out a problem of business cycle theory: how can the traditional equilibrium concept in economics—i.e., a static theoretical economics—cope with a disequilibrium phenomenon such as cyclical fluctuations?7 He thus raised the problem of incompatibility of business cycle theory with the dominant equilibrium approach in economics. Löwe was probably inspired by the fundamental distinction between statics and dynamics in Schumpeter’s theoretical system and Schumpeter’s view that a Walrasian system of general economic equilibrium was inappropriate for the analysis of business cycles, when he made his claim for a new dynamic theory: in which the polarity of upswing and crisis arises analytically from the conditions of the system just as the undisturbed adjustment derives from the conditions of the static system. Those who wish to solve the business cycle problem must sacrifice the static system. Those who adhere to the static system must abandon the business cycle problem. (Löwe 1926, p. 267) 7 Löwe had already examined the existing body of theoretical and empirical work on business cycles in his survey “Der gegenwartige Stand der Konnjunkturforschung in Deutschland” (The present state of research on business cycles in Germany) (Löwe 1925).

172

R. Marchionatti

He argued that static economics is “based on the idea of tendency to equilibrium” (ibid., p. 251), and for this reason, it is incompatible with the trade cycle. Löwe goes on to analyze the current business cycle theories to see whether the solutions they offer are within the bounds of the theoretical system of economics. The conclusion is that all business cycle theories, unless they attribute the fluctuations to some factors outside the economic system itself—and in this case they confess the failure of economic science to explain the phenomenon—explain them in a way which denies in its root some basic assumptions of theoretical economics: either the rationality of economic behavior or the strict interdependence of all the economic elements in the system. It is obvious that if these explanations of business cycles throw light on the processes of reality, equilibrium economics was barring the way to this light by denying the possibility of general over-production and adding the dead weight of a barren doctrine to the burdens of a complex reality. Löwe concludes his article with a call to build up a body of dynamic economic theory in which business cycles would be explained as part of a system. In fact, “the structure of a process which is always in equilibrium over time cannot undergo any change by definition” (ibid., p. 269). An appropriate theoretical framework must be a “dynamic system” (ibid.) where the polarity of upswing and crisis will acquire the same status as a data constellation which the equilibrium has in the static system … As opposed to it in the dynamic system the total movement of the business cycle is the quintessential movement form (ibid., pp. 268–269).

Löwe was able to attract a group of talented researchers—what is called the Kieler Schule—including Gerhard Colm (1897–1968), Hans Philipp Neisser (1895–1975), the Russian-born Jacob Marschak (1898–1977) and Wassily Leontief after his Berlin period. Gerhard Colm arrived at the Institute in 1927 (see Neisser 1969). He was born in Hanover in 1897 and had received a degree in 1921 from the University of Freiburg. After postgraduate work at the universities of Munich and Berlin, he moved into government, serving as an economist at the Federal Statistics Bureau in Berlin from 1921 to 1927. At the Institute, he served as Deputy Director and then Director when

4 Economics in Berlin, Vienna and Other Minor …

173

Löwe was appointed Professor at the University. He was an expert on public finance and financial statistics, and was considered a pioneer in national income accounting. He worked closely with Hans Neisser, with whom he published in 1932 a contribution on German foreign trade under the influence of structural changes in the world economy. Neisser was born on September 3, 1895, in Breslau (now Wrocław, Poland), which at the time of his birth was in the German Empire, in a family of Jewish origin. He studied law and political economy at the universities of Breslau, Freiburg and Munich. After the war, where he fought on the Western front in Northern France, he took a doctoral degree at the University of Breslau in law and in economics. He then moved to Berlin where he worked as research assistant in a state commission on industry. In 1927, he moved to the Kiel Institute, called there by Löwe. During the years at Kiel, Neisser was highly productive and monetary topics were his main interest. His first publication was a treatise, Der Tauschwert des Geldes (The Exchange Value of Money, 1928), which he submitted as a habilitation thesis at the University of Kiel. Both Hayek and Keynes referred positively to the treatise, respectively in Monetary Theory and the Trade Cycle and in the Treatise on Money, while Neisser published a favorable review of Keynes’s work. Jacob Marschak arrived at the Institute in 1928. He was born in Kiev, Russia, on July 23, 1898. In 1919, after the Bolshevik revolution, he came to Germany, where he attended Bortkiewicz’s lectures in Berlin and then went to the University of Heidelberg, where he studied with Emil Lederer. From 1924 to 1926 Marschak worked as an economic journalist, while from 1926 to 1928 he was on the staff of the Research Center for Economic Policy, sponsored by the German trade unions and the Social-democratic parliamentary group of the Reichstag in Berlin. From 1928 to 1930, Marschak worked in the department of business cycles at the Kiel Institute. Here, he became increasingly interested in the new econometric movement and wrote his habilitation thesis Elaztizität der Nachfrage (Elasticity of Demand ) (Marschak1931), which he submitted to the University of Heidelberg. There he became privatdozent on February 22, 1930. Wassily Leontief, the youngest of the group, was at the Kiel Institute from 1928 to 1931, in two separate sub-periods. The first period was through 1928, after which Leontief took up an assignment in China. He

174

R. Marchionatti

came back to Germany one year later. During his period in Kiel, Leontief developed a theoretical framework for applied demand and supply analysis which resulted in several papers in German (see Bjerkholt 2016). These economists worked together rather briefly, as the school was essentially dissolved after 1933 when the Nazi Party seized power in Germany, but it was revived in the United States in the following years. In fact, many of the Institute’s members emigrated to the United States, where they joined the New York School of Social Research. Lowe, Colm and Neisser moved to the United States in 1933, Lowe and Colm going to the New School and Neisser to the University of Pennsylvania but gravitating to the New School. Marschak went first to Oxford at the end of 1933—as did another member of the Institute, Fritz Burchardt (1902–1958)—where he became the Director of the Oxford Institute of Statistics (OIS), and then went to the United States in 1938 (Burchardt replaced him as director). In September 1939, he was appointed Professor at the New School for Social Research as the successor of Gerhard Colm who had joined the Roosevelt administration. Leontief had reached the United States one year earlier, in 1932, having obtained a research associate fellowship with the National Bureau of Economic Research in New York.

Economics and Law at the Freiburger Schule, or the Birth of Ordo-Liberalism In the 1930s, the Freiburger Schule der Nationalökonomie (Freiburg School of Political Economy) was created in the old German University of Freiburg by the economist and philosopher Walter Eucken (1891–1950) and two jurists, Franz Böhm (1895–1977) and Hans Großmann-Doerth (1894–1944).8 They provided the theoretical framework of the so-called ordo-liberalism,9 a German version of liberalism 8

See Vanberg (2004) for a thorough presentation of Eucken and the Freiburg school. The group also includes scholars who did not teach in Freiburg but were influential in the development of ordo-liberalism, including the economists Alfred Müller-Armack (1901–1978), who coined the term “social-market economy”, Wilhelm Röpke (1899–1966) and Alexander Rüstow (1885–1963).

9

4 Economics in Berlin, Vienna and Other Minor …

175

which provided a major part of the theoretical foundations for the Social Market Economy in post-World War II Germany. Walter Eucken was the leading theorist of this group. He was born in Jena on January 17, 1891, the son of the neo-Kantian philosopher and Nobel laureate for literature in 1908 Rudolf Christoph Eucken. He studied economics at the University of Bonn, where he was influenced by two members of the Historical School, Heinrich Dietzel and Hermann Schumacher (1868–1952). It was Schumacher who supervised his habilitation at the University of Berlin in 1921, where he became a reader.10 He was appointed to a professorship in Tübingen in 1925, and in 1927, he had a chair in economics in Freiburg, where he remained until 1950. In Freiburg, he elaborated his mature thinking—see in particular Eucken (1934, 1940)—starting from a critique of the Historical School’s empiricism, while at the same time arguing that the Historical School’s criticism of economic theory’s excessive use of extreme abstractions and failure to consider historical diversity was justified. As Vanberg (2004) emphasizes, Eucken wanted to provide an alternative to the Historical School’s a-theoretical approach to economic analysis and to its unprincipled discretionary approach to economic policy. The encounter with Böhm turned his thinking to a collaboration between economics and law. Franz Böhm arrived in Freiburg in 1933 to teach law. Born in Konstanz, after the war he studied law at Freiburg and, before finishing his dissertation, left for Berlin in 1925 to join the antitrust section of the Ministry of the Economy where he worked as legal adviser from 1925 to 1932. In the meantime, Böhm returned to Freiburg where he worked on his habilitation thesis on competition and monopoly. It was submitted in 1933 and reviewed by Eucken and by Hans Großmann-Doerth, who had just become Professor of Law at Freiburg. Großmann-Doerth had studied law in Munich and Hamburg, where he graduated in 1923, and became a university lecturer in 1928. In 1930, he was appointed Professor of Civil and Commercial Law at the German University of Prague before going to the University of Freiburg.

10

On the relationship between Eucken and the historical school, see Peukert (2010).

176

R. Marchionatti

In the following years, a close collaboration between the three scholars developed, giving rise to a cross-fertilization between the disciplines of law and economics. The initiators were soon joined by other, mainly younger, legal and economic scholars who began to make their own contributions to the central themes being developed by their mentors. In 1936, they began to publish the collection entitled Ordnung der Wirtschaft, a series of volumes preceded by a statement of principle that appeared retrospectively as the manifesto of ordo-liberalism, which set forth an interdisciplinary program under the title “Unsere Aufgabe” (Our Mission) (Böhm et al. 1989 [1937]). They maintain that: In Germany during the nineteenth century law and political economy were affected by that intellectual movement which permeated the whole of scientific and non-scientific thought: historicism … Historicism is much more than a scientific point of view—it denotes a specific scientific attitude. Romanticism and the school of historicism have destroyed the belief in a natural system in both law and political economy. (ibid., p. 19)

Accordingly, the authors consider that the most urgent task for the representatives of law and political economy, is to work together in an effort to ensure that both disciplines regain their proper place in the life of the nation … in the interests of the economic life of the German nation. (ibid., p. 16)

Their guiding principle was that the “treatment of all practical politicolegal and politico-economic questions must be keyed to the idea of the economic constitution” (ibid., p. 23). As Vanberg (2004, p. 9) emphasizes, the term Oordnung (order), the central concept in the Freiburg school’s research program, “is systematically related to the concept of the economic constitution, in the sense of the rules of the game, upon which economies or economic systems are based”. In this perspective, the collaboration of law and economics “is clearly essential” (Böhm et al. 1989 [1937], p. 25). In other words, they posed the question of the constitutional foundations of a free economy and society. The premise of ordo-liberalism is that the market order is a constitutional order, defined by its legal-institutional framework. The joint efforts of law

4 Economics in Berlin, Vienna and Other Minor …

177

and economics were considered an indispensable prerequisite for what they called “Wirtschaftsverfassungspolitik” (ibid., p. 242), a policy that seeks to improve the resulting economic order in an indirect manner, by reforming the rules of the game. As Vanberg (2004, p. 12) stresses: While the founders of the Freiburg School placed themselves firmly in the tradition of classical liberalism, they emphasized, in contrast to some varieties of liberalism, that a free market order is not simply what one would find if and where government is absent, that it is not a natural event but a political-cultural product, based on a constitutional order that requires careful “cultivation” for its maintenance and proper functioning. … In this regard they found it necessary to distance themselves from a laissez-faire liberalism that failed to appreciate the essential positive role that government has to play in creating and maintaining an appropriate framework of rules and institutions that allows market competition to work effectively.

4.5

Economics in Vienna. I: Ludwig von Mises (1881–1973) and the Neo-Austrian School

Prologue: The Mises Kreis In the early postwar years, the Austrian School was considerably weakened: Böhm-Bawerk had died in 1914; Menger was living in retirement and devoting himself to completing his new treatise, but he died in 1921, his book still unpublished; Wieser, after serving as Minister of Commerce during the war, had returned to his studies (but his interests turned to sociology), retired in 1923 and died in 1926 (see Vol. I, Chap. 5.3); Schumpeter was attracted by political involvement and then left Austria in 1932 (see Vol. I, Chap. 5.3). In the 1920s, Austrian economics fell largely upon the shoulders of the two leaders of the new Austrian School: Hans Mayer, who succeeded to Wieser’s chair in 1923

178

R. Marchionatti

and carried on the Wieserian tradition11 but without the qualities of his predecessor, and Ludwig von Mises (see Vol. I, Chap. 5.3). Mises was the undisputed leader of the new Austrian School as long as he remained in Vienna, taking “a more guarded attitude toward liberalism, in theory as in practice” (Klausinger 2006, p. 26). The most prominent scholars among the younger members of Mises’s group were Friedrich von Hayek (1899–1992), Gottfried von Haberler (1900–1995), Fritz Machlup (1902–1983) and Oskar Morgenstern (1902–1977). At the University of Vienna, Mises only held the position of privatdozent, his professional work being chief economist in the Austrian Chamber of Commerce and Industry. Nonetheless, he ran a highly influential seminar for two decades, the so-called Mises Kreis, which attracted many brilliant economists and social scientists. In it, as well as in the Geistkreis, launched in the early 1920s by the young Hayek together with his friend, the social scientist Herbert Fürth (1899–1955), the discussions were interdisciplinary. This was especially true of the Geistkreis, which included the philosophers Alfred Schutz (1899–1959) and Felix Kaufmann (1895–1949). Mises was clearly the “primus inter pares” of this intellectual community. As he himself describes it, the participants: “came as pupils, but over the years became my friends” (Mises 1978 [1942], p. 97). On Mises’s seminar, Haberler remembers: The Seminar met every Friday at 7 p.m. in Mises’ office in the Chamber of Commerce. Mises sat at his desk and the members of the group around him. The meeting would be introduced by a paper by Mises himself or by another member on some problem of economic theory, methodology of the social sciences or economic policy. Sociology, especially the “Verstehende Soziologie” of Max Weber and related problems were favorite topics. The always lively discussion lasted until 10 p.m. when the group walked over to the nearby Italian Restaurant “Ancora Verde”—“Der grune Anker” in Kaufmann’s song—where dinner was served. There the discussion continued on finer points of theory and later usually took on lighter tones. At eleven thirty or so those members who were not yet exhausted

11

Mayer’s pupil and assistant at the University of Vienna was the Polish-born Paul RosensteinRodan (1902–1985), but he left Vienna in 1931 when he obtained a position as a lecturer at the University of London.

4 Economics in Berlin, Vienna and Other Minor …

179

went to the Cafe Kunstler, opposite the University, the favorite meeting place of economists in Vienna in those days. Mises was always among the hardy ones who went to the Kunstler Cafe and was the last one to leave for home, never before 1 a.m.” (Haberler 1961, pp. 20–21)

Friedrich von Hayek was the first and the most important of Mises’s disciples, although he was not among Mises’ students. He was the first director of the Institut für Konjunkturforschung (Institute for Business Cycle Research)—founded in 1927 on the initiative of Mises and under the umbrella of the Chamber of Commerce—with Morgenstern as his assistant. When Hayek moved to the London School of Economics in 1931 and left Austria—at the LSE Hayek, building on the research developed in Vienna, published his major works of the period (see Chap. 3.3)— the younger Morgenstern, just returned from a three-year period abroad with a Rockefeller fellowship, took over the directorship of the Institute. Of all Mises’s disciples, Haberler and Machlup were probably the closest to their master in those years. Gottfried Haberler, born on July 20, 1900, in the small Austrian city of Purkersdorf, studied at the University of Vienna, where he earned his degrees in political science (1923) and law (1925). Mises helped him to receive a two-year Spelman Fund (later Rockefeller Foundation) grant that enabled him to study in Great Britain and the United States, at Harvard University. After returning to Austria, Haberler became a privatdozent at the University of Vienna, teaching a joint seminar with Hayek and Morgenstern. Mises arranged a paid position for him in the library at the Austrian Chamber of Commerce, where Mises was employed. In 1934, Haberler went to Geneva, to work as an expert at the financial section of the League of Nations, as did Mises. As Earlene Craver (Craver 1986, p. 26) suggests, it was probably the publication in 1933 of his volume on trade theory—The Theory of International Trade, in which he reformulated the traditional theory of comparative advantage on an Austrian School view of opportunity cost and introduced the concept of production-possibility frontier— which brought Haberler international fame and led to his appointment in Geneva. Here, he conducted a study on the state of business cycle theory, defined as “an inquiry of the recurrence of periods of economic depression”, financed by a grant from the Rockefeller Foundation. The

180

R. Marchionatti

study was published in 1937 as Prosperity and Depression: A Theoretical Analysis of Cyclical Movements. Two years younger than Haberler, Fritz Machlup was born in 1902 in Wiener Neusstadt, near Vienna. His first major university teacher was Wieser, but from his second year he attended Mises’s seminar. Machlup’s dissertation was supervised by Mises (but formally graded by Mayer and Spann) and published as Die Goldkernwährung (The Gold Exchange Standard) in 1925, as the first of many works in his favorite field of research, international currency issues (see Machlup 1980). In 1931 he published Börsenkredit, Industriekredit und Kapitalbildung (a revised version of which was published in English in 1940 as The Stock Market, Credit and Capital Formation). In 1933, he came to the United States on a Rockefeller scholarship and visited Columbia, Harvard and the University of Chicago.12 At this time, he probably applied for a habilitation at the University of Vienna, “however, his chances must have been nil from the outset” (Klausinger 2013, p. 14), essentially because of his Jewish origin. The Neo-Austrian School led by Mises in Vienna was short-lived. The general uncertainty, the political climate and the lack of official positions induced many scholars to migrate. Hayek migrated at the beginning of the 1930s, invited to the London School of Economics. The domestic situation became particularly problematic in 1934 when the AustroFascists rose to power. Mises went to Geneva’s Institute of International Studies in 1934, and in 1940, he left Europe for the United States. Haberler went to the League of Nations in Geneva and then moved to Harvard in 1936. Machlup left Austria for the United Kingdom and then the United States in 1935, going first to the University of Buffalo and then, after serving in the US government during the war, to Johns

12

In his long American period, Machlup made important contributions to three other areas of economics, the imperfect competition theories—with two books: The Political Economy of Monopoly (1952a) and the companion volume The Economics of Sellers’ Competition (1952b)— the methodology of economics, an interest which went back to the Viennese years, when he published his methodological writings in the Essays on Economic Semantics (first edition 1962a, second edition 1977), and the economics of knowledge, where in 1962 he published an important book entitled The Production and Distribution of Knowledge in the United States (Machlup 1962b).

4 Economics in Berlin, Vienna and Other Minor …

181

Hopkins University and finally, in 1960, to Princeton University to succeed Jacob Viner. After the emigration of the other members of the Mises group, Morgenstern assumed a prominent position and a highly influential role. His position as director of the Institut für Konjunkturforschung allowed him to influence the direction of research and play an important role as a policy advisor (actually, a quite ambivalent role) and cultural organizer. As director of the Institute, he was responsible for the monthly bulletins and the book series, which included contributions by Hayek, Machlup, Wald and Morgenstern himself. In this capacity, he was able to provide fellowships and employment opportunities for young scholars outside the universities—among them the economists Josef Steindl (1912–1993), who worked with Kalecki at Oxford from 1938 to 1944, and Gerhard Tintner (1907–1983), from the end of 1936 in the United States at the Cowles Commission, and the mathematician Abraham Wald (1902–1950). Morgenstern’s role as managing editor of the Zeitschrift für Nationalökonomie, the only German language economics journal of international standing in the 1930s, was crucial in moving the journal toward a position rather critical of Mises’s theory. As Klausinger (2006, p. 34) writes “the transition of the leading position from Mises to Morgenstern was more significant than just an exchange of persons, for it brought to light diverging theoretical positions”. In 1938 Morgenstern, as mentioned earlier, also left Austria for the United States.

Mises’s Economics: “Die Wirtschaftsrechnung im Sozialistischen Gemeinwesen” (Economic Calculation in the Socialist Commonwealth), 1920 After World War I, Mises developed his ideas about monetary calculation, first in his critique of war planning in Nation, Staat, und Wirtschaft (Nation, State and Economy) (Mises 1919)—where he criticizes war socialism, defined as increased state control of the economy during wartime, in Germany and Austria, claiming that it hastened their final collapse—and then with the theory of economic calculation in

182

R. Marchionatti

a socialist state developed in “Die Wirtschaftsrechnung im sozialistischen Gemeinwesen” (“Economic Calculation in the Socialist Commonwealth”) (Mises 1920), originally published in Archiv für Sozialwissenschaften und Sozialpolitik and later expanded in Die Gemeinwirtschaft (Socialism) (Mises 1922). The 1920 article was republished in English by Hayek in 1935, giving rise to the famous controversy on economic calculation in a socialist economy (see Chap. 7.2). In it, Mises sought to respond to socialist proposals, especially to Otto Neurath, sociologist and economist (on Neurath see Nemeth et al. 2007), one of the leading figures of the Wiener Kries (see Chap. 4.7), who in 1919 had written a book, Durch die Kriegswirtschaft zur Naturalwirtschaft, outlining a calculation theory based upon the example given by “war economy”. Neurath argued that during wartime, government assumes responsibility for the planning of material distribution, suppressing the market price system characteristic of peacetime. Moreover, production in wartime is not profit-seeking—which led to recurrent periods of over-production and unemployment—but rather works to achieve maximum productive capacity. Neurath asserted that the central planning that occurred during war should continue during peace, with the government acting as a central giant enterprise. He then went so far as to argue that money would be unnecessary in this new society in which all calculation regarding the appropriate levels of inputs and output could be handled in “natural” physical terms. Mises especially disagreed with Otto Neurath’s plans for the dissolution of the monetary system.13 Mises observes: [Neurath] advances the view that every complete administrative economy is, in the final analysis, a natural economy. “Socialization,” he says, “is thus the pursuit of natural economy.” Neurath merely overlooks the insuperable difficulties that would have to develop with economic calculation in the socialist commonwealth (Mises 1935 [1920], p. 108 note).

In his article, Mises tried to demonstrate that the possibility of rational calculation in our economic system was based on the fact that prices 13 The controversy between Mises and Neurath continued in the following years, when it also involved Jacob Marschak and the Austro-Hungarian historian, economist and anthropologist Karl Polanyi (see Chap. 7.2).

4 Economics in Berlin, Vienna and Other Minor …

183

expressed in money provided the essential condition which made such reckoning possible. As Hayek (1935, p. 33) wrote: The essential point where Professor Mises went far beyond anything done by his predecessors was the detailed demonstration that an economic use of the available resources was only possible if this pricing was applied not only to the final product but also to all the intermediate products and factors of production, and that no other process was conceivable which would take in the same way account of all the relevant facts as did the pricing process of the competitive market.

Dealing with the nature of economic calculation, Mises writes that in an exchange economy the objective exchange value of commodities enters as the unit of economic calculation, and this entails a threefold advantage: In the first place, it renders it possible to base the calculation upon the valuations of all participants in trade. The subjective use value of each is not immediately comparable as a purely individual phenomenon with the subjective use value of other men. It only becomes so in exchange value, which arises out of the interplay of the subjective valuations of all who take part in exchange. But in that case calculation by exchange value furnishes a control over the appropriate employment of goods. Anyone who wishes to make calculations in regard to a complicated process of production will immediately notice whether he has worked more economically than others or not; if he finds, from reference to the exchange relations obtaining in the market, that he will not be able to produce profitably, this shows that others understand how to make a better use of the goods of higher order in question. Lastly, calculation by exchange value makes it possible to refer values back to a unit. For this purpose, since goods are mutually substitutable in accordance with the exchange relations obtaining in the market, any possible good can be chosen. In a monetary economy it is money that is so chosen (Mises 1935 [1920], pp. 97–98).

Mises specifies that monetary calculation only has meaning within the sphere of economic organization: “It is a system whereby the rules of economics may be applied in the disposition of economic goods. Economic goods only have part in this system in proportion to the extent

184

R. Marchionatti

to which they may be exchanged for money” (ibid., p. 100). In this context, “monetary calculation fulfils all the requirements of economic calculation” (ibid., p. 101). In particular “it enables us to extend to all goods of a higher order the judgment of value, which is bound up with and clearly evident in the case of goods ready for consumption … It renders their value capable of computation” (ibid.). Without it, “all production involving processes stretching well back in time and all the longer roundabout processes of capitalistic production would be gropings in the dark” (ibid.). He stated that the two conditions governing the possibility of calculating value in terms of money are that, firstly, both goods of a lower and goods of a higher order must come within the ambit of exchange—“if they do not do so, exchange relationships would not arise” (ibid.). The second condition is “that there exists in fact a universally employed medium of exchange—namely, money—which plays the same part as a medium in the exchange of production goods also” (ibid., p. 102), in order “to reduce all exchange-relationships to a common denominator” (ibid.). Mises deals with economic calculation in a socialist state. First of all, he maintains that in a socialist state calculation in natura cannot take the place of monetary calculation, because, Mises claims, “calculation in natura, in an economy without exchange, can embrace consumption goods only; it completely fails when it comes to dealing with goods of a higher order” (ibid., p. 104). Under socialism, production-goods (i.e., factors of production) are owned by the state, so there is no market for them. Then, he continues: “as soon as one gives up the conception of a freely established monetary price for goods of a higher order, rational production becomes completely impossible” (ibid.). So he concludes: “Every step that takes us away from private ownership of the means of production and from the use of money also takes us away from rational economics” (ibid.). Mises admits that “monetary calculation has its inconveniences and serious defects” (ibid., p. 109), but he emphasizes that “we have … nothing better to put in its place, and for the practical purposes of life monetary calculation as it exists under a sound monetary system always suffices” (ibid.). Without it, “any economic system of calculation would become absolutely impossible” (ibid.). Mises thus concludes that “Socialism is the abolition of rational economy” (ibid., p. 110): “where

4 Economics in Berlin, Vienna and Other Minor …

185

there is no free market, there is no pricing mechanism; without a pricing mechanism, there is no economic calculation” (ibid., p. 111). In summary, in his article, Mises tries to demonstrate that the only way to rationally allocate society’s scarce means among competing ends—i.e., the only way to solve society’s economic problem—was for entrepreneurs in the private-property market economy to rely upon the knowledge provided by the profit-and-loss signals indicated by changes in money prices. According to Mises, private property offers not only incentives to husband resources efficiently, but also provides the basis for exchange. It is in the market for the means of production that exchange ratios are formed which constitute the money prices that, by forming the basis for profit-and-loss accounting, guide economic decisions. In a socialist society, economic calculation is rendered impossible because the abolition of private property in the factors of production means that there is no market for these factors. Without a market, there will be no money prices that reflect the relative scarcities of the factors. As a result, economic calculation will be absent.

Mises’s Economics: Grundprobleme der Nationalökonomie: Untersuchungen über Verfahren, Aufgaben, und Inhalt der Wirtschafts und Gesellschaftslehre (Fundamental Problems of Political Economy: Investigations on Methods, Tasks, and Contents of Economy and Sociology), 1933 Grundprobleme der Nationalokönomie (1933) (translated in English much later, in 1960, as Epistemological Problems of Economics) collects philosophical and methodological papers published in German between 1928 and 1931, to which Mises added two chapters, the first of which, entitled “The Task and Scope of the Science of Human Action”, is of particular relevance. According to Mises, the classics and the older Austrians had constructed economics on the proper methodology, but had been unable to resist the attack of positivism or institutionalism. Mises’s aim in this

186

R. Marchionatti

book is to systematize the classical and Austrian philosophical groundwork and methodology for economics and social sciences in opposition to institutionalism and positivism, which he believed proposed unsound methodologies. Observing the increasing importance of positivism in the German cultural world of his time, Mises set himself strongly against the positivist method which was, according to him, particularly suited to the conception of a socialist economy planned by social engineers. As he writes in the preface to the English edition (Mises 1960 [1933], p. lxv): The popular epistemological doctrines of our age do not admit that a fundamental difference prevails between the realm of events that the natural sciences investigate and the domain of human action that is the subject matter of economics and history. People nurture some confused ideas about a “unified science” that would have to study the behavior of human beings according to the methods Newtonian physics resorts to in the study of mass and motion. On the basis of this allegedly “positive” approach to the problems of mankind, they plan to develop “social engineering,” a new technique that would enable the “economic tsar” of the planned society of the future to deal with living men in the way technology enables the engineer to deal with inanimate materials. These doctrines misrepresent entirely every aspect of the sciences of human action.

Mises developed his theory, which he later called “praxeology” (a term he had adopted from the French thinker Alfred Espinas [1844–1922]), or simply the general theory of human action, on the basis of the deductive analysis of the classical and Austrian economists. He argues that the Austrian theory of value is the core element of a general theory of human behavior that goes beyond the traditional confines of economic science, in the sense that this value theory applies to human action at all times and places. This general social science has a unique logical and epistemological nature. In distinct contrast to the natural sciences, it is not based on observation and empirical observations, but relies on insights about certain structural features of human action, such as the fact that human beings make choices to attain self-chosen ends. In this approach, economic laws are a priori laws that cannot be confirmed or refuted by

4 Economics in Berlin, Vienna and Other Minor …

187

the methods of the natural sciences. They are independent of the particular conditions of time and place, and the social scientist comes to know them through pure deductive reasoning. The essays included in the book, as Mises writes in the preface to the first English-language edition in 1960, represent “the necessary preliminary study for the thorough scrutiny of the problems involved such as I tried to provide in my book Human Action. A Treatise of Economics” (p. xv) in 1949. In the meantime, Mises’ ideas on methodology were brought to the English-speaking world by Lionel Robbins in his Essay on the Nature and Significance of Economic Science (1932), where the author acknowledges his “especial indebtedness” to Mises (see Chap. 3.2). And Robbins’s book was quoted with approval by the Austrian economist in the first chapter of his 1933 book.

4.6

Economics in Vienna. II: Oskar Morgenstern (1902–1977), “a Reluctant Austrian”

Biographical Note Oskar Morgenstern was born in Görlitz, Germany, on January 24, 1902. When he was 14, his family emigrated to Vienna where he completed his secondary school education. In 1922, he enrolled at the University of Vienna to study political science and economics. In 1925, he graduated with a thesis on marginal productivity. He won a three-year Rockefeller scholarship which gave him the opportunity to study abroad, mainly in England at the LSE, and in the United States, at Harvard and Columbia universities, where he prepared for his Habilitation. He chose the business cycle as his main topic of study and wrote a book entitled Wirtschaftsprognose (Economic Forecasting ), published in 1928, which he presented as his Habilitation thesis in 1929. From 1929 to 1934, he taught at the University of Vienna as a privatdozent. During these years, he attended the Mises Seminar and worked alongside Hayek at the Austrian Institute for Business Research. He became director of the Institute in 1931 when

188

R. Marchionatti

Hayek left Austria for the LSE, a position he kept until 1938. In this period, he assumed a preeminent position in the economists’ community in Vienna and was economic advisor to the Austrian National Bank and the Ministry of Commerce. Morgenstern was also appointed managing editor of the Zeitschrift für Nationalökonomie, the journal edited by Hans Mayer. In 1935, he became a Professor of Economics at the University of Vienna. As Klausinger (2006, p. 34) writes, “the more Morgenstern acquired the leadership within the Austrian community of economists, the less did he still consider himself (and was considered by others) an Austrian Economist”: in fact, in the 1930s “Morgenstern attempted to formulate an independent theoretical position critical of the approach of Mises and Hayek—thereby questioning the leadership of Mises [essentially at the epistemological and methodological level] as well as the principally liberal orientation of Austrian Economics” (ibid.). In this period, Morgenstern began to extend his interests in the philosophy of science and attended Schlick’s Wiener Kries and Menger’s Mathematische Kolloquium, which deeply influenced his thought. In this process of change, according to Leonard (2010) a talk given by Menger in 1927 at the Vienna Economic Society was crucial in influencing Morgenstern: It marked the beginning of a decade during which he gradually distinguished himself from his Austrian mentors, actively promoting the development of mathematical economics and learning to question the necessity of any connection between liberal politics and economic analysis. (Leonard 2010, p. 141)

The main results of this reflection were his book Die Grenzen der Wirtschaftspolitik (Morgenstern 1934, translated in English in 1937 as The Limits of Economics), which was critical of Mises’s and Robbins’s methodological line, and “Vollkommene Voraussicht und Wirtschaftliches Gleichgewicht” (Morgenstern 1935, translated in English as “Perfect Foresight and Economic Equilibrium”) where he criticized the General Economic Equilibrium theorists for the assumption of perfect foresight and emphasized the paradoxes of rationality, substantially critical of the concept of equilibrium without a logicalmathematical consideration of the interaction between agents. When the

4 Economics in Berlin, Vienna and Other Minor …

189

Third Reich annexed Austria in March 1938, Morgenstern was in the United States as a visiting professor. But as a politically suspect person, he was banned from the University of Vienna and dismissed, together with most of the staff, from his post as director of the Institut für Konjunkturforschung. The Institute came under the supervision of the German economist Ernst Wagemann. Morgenstern did not return to Austria and was appointed to Princeton University thanks to a Rockefeller Foundation grant: here his collaboration with von Neumann marked the climax of his scientific work and his career. Their collaboration on game theory resulted in a book completed at the end of 1942 but published in 1944, Theory of Games and Economic Behavior (von Neumann and Morgenstern 1944). In Princeton, he had become an associate professor in 1941 and full professor in 1944; in the same year, he became a US citizen. In 1948, he founded the Econometric Research Program of Princeton University. Again, he acted as an advisor for various institutions, e.g., the RAND Corporation, the Atomic Energy Commission, NASA, the US Congress and the US Government. In 1962, he was a co-founder and chairman of the board of Mathematica, a company using advanced new methods to analyze business and governmental problems. He retired from Princeton University in 1970 and for some years taught game theory and mathematical economics at New York University, where in 1972 he founded the Center for Applied Economics. He died at Princeton on July 26, 1977.

Theoretical Contributions in the Viennese Years, 1928–1935 Ingrao (2013, p. 627) writes that “Morgenstern’s works fall into two distinct phases, before and after the Theory of Games and Economic Behavior ”. Certainly, the epistemological interests of the first phase were abandoned with the collaboration of von Neumann, but that turn was already foretold in Morgenstern’s writings of the second part of the 1930s. In any case, the critical reflection of the period 1928–1935 should

190

R. Marchionatti

not be neglected.14 In this period, as Leonard (2010, pp. 108–109) writes, “although Morgenstern’s theoretical concerns were still those of the ‘Austrian’ economist … he was, in certain respects, becoming a reluctant Austrian, trying to reconcile his mentors’ interests [i.e., Mises’ and Mayer’s] with a style of scientific argument that they had rejected”. His first book, Wirtschaftsprognose, published in 1928, was an inquiry into the subject of economic forecasting. Morgenstern considered that the difficulties of forecasting were due to the complications arising from the fact that action can be affected by the interdependencies of economic agents’ actions and beliefs. These complexities can make full prediction impossible. He illustrated this idea with the example of the pursuit of Sherlock Holmes by his enemy Professor Moriarty in the story “The Final Problem” written by Conan Doyle in 1893. In the original, Holmes, chased by Moriarty, leaves London for Dover on a train which stops at an intermediate station. He has seen Moriarty at the station and thus expects that Moriarty will take a faster train and await him in Dover. Consequently, Holmes gets off the train at the intermediate station. Holmes’s expectation turns out to be right. But what, Morgenstern asks, if Moriarty had predicted Holmes’s action? In this case, Moriarty would have gone to the intermediate station. Had Holmes calculated this action, he would have gone to Dover. Again, Moriarty would also have acted differently. In conclusion, Morgenstern writes, no action would have been taken. Morgenstern (1976) summarizes the essence of his 1928 book as follows: In my book I showed among other things that one is confronted in economics with two kinds of variables, which I called “dead” and “live”, the former being those that do not reflect decisions by other economic subjects, the second, those that do. In that connection, even the word “game” occurs. I also showed that the mere increase in the size of an 14 The question of foresight came up again in a volume of 1970, The Predictability of Stock Market Prices written with the British econometrician Clive W. Granger (1934–2009), Nobel Prize in economics in 2003 (Granger and Morgenstern 1970). The two authors concluded their inquiry by maintaining that the share prices were unpredictable because they followed a random walk path. Ingrao (2013, p. 661) comments: “At the end of a long journey that took him in unexpected directions, Morgenstern arrived at final confirmation of the radical doubts he had been voicing since 1928”.

4 Economics in Berlin, Vienna and Other Minor …

191

isolated “simple economy” (in the sense of the Austrian School, meaning a household isolated by itself ) was a less complicating factor than complications encountered by a simple economy, no matter what size, when involved with others; the latter, and the latter alone, would have to deal also with “live” variables, as I called them, i.e., with decisions made by others. This states exactly one of the basic tenets of game theory where one can maximize only in the first case when the variables of nature are “dead”, but one is confronted with a conceptually different matter in the second case, since the “live” variables represent other “wills”, other “economic acts”, which may interfere with, or enhance, one’s own plans, as I expressed the matter then. One of the problems that naturally sprang to my attention was that of the influence of predictions on the predicted events, a typical case in the social sciences. I examined this area from many points of view. I analyzed several cases of predictions: the first a single prediction becoming known to, and being believed by, everyone, with their reactions influencing the predicted events; then the case of several differing predictions with different distributions of acceptance and consequently different influences upon the behavior of individuals and therefore upon the future events, etc. In the course of these studies I produced the example of the pursuit of Sherlock Holmes by Professor Moriarty. I showed in some detail in particular that the pursuit developing between these two could never be resolved on the basis of one of them out-thinking the other (“I think he thinks that I think! …”), but that a resolution could only be achieved by an “arbitrary decision,” and that it was a problem of strategy. (Morgenstern 1976, p. 806)

Morgenstern goes on to say that the problems touched in that book never left him, in spite of his involvement in business cycle theory and statistics: in 1935, he published a paper in the Zeitschrift für Nationalökonomie entitled “Vollkommene Voraussicht und Wirtschaftliches Gleichgewicht” (immediately translated by Frank Knight into English) in which “the same illustration of Sherlock Holmes and Moriarty was used once more, but the whole matter of prediction and foresight was put into a wider frame” (ibid.). Morgenstern (1935) examines the idea of full or perfect foresight in relation to the theory of general equilibrium. He starts his article by writing that “The theory of general economic equilibrium, which has been developed in different forms, constitutes the pride of theoretical economics” (Morgenstern 1976, p. 169) but, he continues,

192

R. Marchionatti

“it is all the more curious that, in the whole body of literature, there can be found systematically compiled neither exact nor complete statements about the assumptions underlying the theory of general equilibrium” (ibid.).15 In particular, his examination is about “the assumption … of ‘full foresight ’ or ‘perfect foresight ’, which is ostensibly one of the preliminary conditions of equilibrium” (ibid.). In fact, “the opinion prevails that the theoretical perfection of equilibrium could not be obtained without the assumption of complete foresight by the economic subjects and the entrepreneurs” (ibid., p. 171). Morgenstern explains the issue in this way: Foresight is spoken of … simply as “full” or “perfect”, without … making a closer examination of what is actually meant thereby … ln the first place, the formulation of the question is incomplete, since there needs to be asked: the foresight of whom? of what kind of matters or events? for what local relationships? for what period of time? These basic questions, from which a meaning of perfect foresight may, for the first time, be obtained, lead to a whole variety of problems. (ibid., pp. 171–172)

Morgenstern emphasized that the temporal dimension was not treated with due accuracy. As for the temporal horizon of prediction, perfect foresight might apply to a limited or an unlimited horizon. In the first case, the assumption is inconsistent with the assumption of complete foresight; in the second case, the assumption means that the agents have unlimited knowledge of all the future. These agents are then supposed to be not ordinary men but “demi-gods”: The impossibly high claims which are attributed to the intellectual efficiency of the economic subject immediately indicate that there are included in this equilibrium system not ordinary men, but rather, at least to one another, exactly equal demi-gods, in case the claim of complete foresight is fulfilled. (ibid., p. 173)

15

Actually, the question of the theoretical assumptions of pure theory was at that time discussed by many economists: in particular, we may cite the American economists Henry L. Moore (1906) and Frank Knight (1921) Morgenstern’s point of view is certainly original.

4 Economics in Berlin, Vienna and Other Minor …

193

The problematic relevance of the issue is even greater when interdependence of the agent’s actions is considered: I am now going on to examine somewhat more closely the conditions which result if full foresight is posited, and especially if there results reciprocal inclusion of foresight about the probable behavior of others resulting from their analysis of complex quantities, such as prices, etc. The fact is that a calculation of the effects of one’s own future behavior always rests on the expected future behavior of others, and vice versa. This can be observed empirically every time. However, the chain of surmised mutual “reactions” breaks off comparatively soon; often, too, they play no excessive role because of the power of the external data of a physical nature. This may be the case on certain markets, for example, as the stockexchange. With unlimited foresight, it is something else. On another occasion, 1 gave an example of this paradox, involving two individuals [the Holmes-Moriarty paradox] … One may be easily convinced that here lies an insoluble paradox. And the situation is not improved, but, rather, greatly aggravated if we assume that more than two individuals—as, for example, is the case with exchange—are brought together into a position, which would correspond to the one brought forward here. Always, there is exhibited an endless chain of reciprocally conjectural reactions and counterreactions. This chain can never be broken by an act of knowledge but always only through an arbitrary act—a resolution. This resolution, again, would have to be foreseen by the two or more persons concerned. The paradox still remains no matter how one attempts to twist or turn things around. Unlimited foresight and economic equilibrium are thus irreconcilable with one another. But can equilibrium really take place with a faulty, heterogeneous foresight, however, it may be disposed? This is the question which arises at once when an answer is sought. One can even say this: has foresight been truly introduced at all into the consideration of equilibrium, or, rather, does not the theorem of equilibrium generally stand in no proven connection with the assumptions about foresight, so that a false assumption is being considered? (ibid., pp. 173–174)

Morgenstern’s conclusion is that the assumption of perfect foresight, the foresight of how other agents in economy will react to our own actions, is incompatible with the notion of a general economic equilibrium.

194

R. Marchionatti

Morgenstern outlines routes along which the research has to proceed— viz., considering different degrees of expectations and examining whether they correspond to the conditions of Walrasian equilibrium, and making empirical studies of a very detailed character, in order to obtain some kind of a picture about the range of the element of expectation—but the main point is Morgenstern’s discomfort with “the common logical carelessness in expression which characterizes theoretical economics” (Morgenstern 1935, p. 169) of which the issue of perfect foresight and general equilibrium is a crucial example. The path followed by Morgenstern is, under Menger’s influence, the axiomatic method. If the 1935 paper still has “an Austrian flavor” (Sturn 2017), the next step—the essay “Logistik und Sozialwissenschaften” (Logistics and the social sciences) (Morgenstern 1936) of one year later—marks his explicit endorsement of the axiomatic method: “In order to gain rigorous insight into the state of any science, the use of the axiomatic method cannot dispensed with” (Morgenstern 1936, p. 396). This shift of approach will culminate in The Theory of Games and Economic Behavior (see Chap. 6.5).

4.7

Economics in Vienna. III: Carl Menger’s “Second Edition” of the Grundsätze, 1923. A Note

In 1923, two years after the death of Carl Menger, the second edition of his Grundsätze was published. It was edited by his son Karl, but was substantially ignored by the new generation of Austrian economists (see Becchio 2014). It included some parts of Menger’s manuscripts containing his reflections from the many years following the first edition. These reflections testify to Menger’s interest in the nature of economic action and the rationality of economic man, and in the diversity of economic phenomena supplied by ethnographic works. As Yagi (2010) notes in his reconstruction, though the edition was a disappointment for those who were interested in the refinement of the economic theory, it inspired an interest in economic anthropology among social scientists such as the Austro-Hungarian Karl Polanyi (1886–1964). Polanyi (1971)

4 Economics in Berlin, Vienna and Other Minor …

195

noted that in this second edition Menger distinguished two basic directions of the economy, as if he desired “to limit the strict application of his Principles to the modern exchange economy”. One direction is “the economizing direction stemming from the insufficiency of means, while the other is the techno-economic … deriving from the requirements of production regardless of the sufficiency or insufficiency of means” (Polanyi 1971, p. 18). In the second direction, Polanyi finds an element of the substantive meaning of economic. According to Polanyi, Menger tried to go beyond the boundaries of economics considered as the theory of the market system to find a more general theory in order to “make a place for history, anthropology and sociology”. For this reason, “he stated that there are two meanings of economic” (ibid., p. 21). In fact, as Cangiani (2010) stresses, “the first four chapters of the 1923 edition of Menger’s Grundsätze seem as a whole to deal with a general theory of the economy, with the economy in general” (Cangiani 2010, p. 144), or, as Polanyi writes, in these early chapters Menger attempts to distinguish “between the economy as the sphere of man’s livelihood and the different forms of integration through which the economy as a unit was institutionalized” (Polanyi 1971, p. 22). Menger’s reflections show appreciation of a range of problems which go beyond the marginalist-neoclassical theory, not considered by the neo-Austrians of the postwar generations. This is confirmed by the fact that the edition of Grundsätze published in 1933 with Friedrich Hayek’s introduction was a reprint of the original 1871 version, while its first English edition in 1950 with Frank Knight’s introduction was a translation of the same 1871 book.16

16

Noteworthy, as Karl Polanyi observed, is the fact that the German term wirtschaftend , which means “exercising an economic activity”, was translated in the 1950 English edition as “economizing”, a “surprising”, ideological, choice. In fact, in the 1923 German edition, Menger used another term, sparend, to indicate economizing.

196

4.8

R. Marchionatti

Economics in Vienna. IV: Philosophy, Economics and Mathematics in the Wiener Kreis and in the Mathematische Kolloquium

Prologue Traditionally, the literature on the history of economic ideas emphasizes the intellectual interchange between the Kreis and the Kolloquium without distinguishing between their conceptions (see Weintraub 1983, 1985, 2002; Ingrao and Israel 1990; Punzo 1989, 1991; Golland 1996; Mutoh 2003). In fact, the two Viennese circles came to express different conceptions of the scientific discourse as well as of economic theory (see Marchionatti and Mornati 2016). The Kreis’s members adopted Bertrand Russell’s logicism and the experimental approach to reality taken by physics. By contrast, the Kolloquium’s members adhered to David Hilbert’s mathematical formalism and adopted a deductive and highly formalized method; they rejected the Kreis’s “physicalism” (a term introduced by Otto Neurath and Rudolf Carnap, and synonymous with materialism) and tended to downplay the importance of the verificationist paradigm. These different philosophical conceptions were reflected in different conceptions of economic theory: a conception of economics as empirical science supported by the Wiener Kreis and a conception of economics as a mathematical science supported by the Mathematische Kolloquium. This difference in the conception of economics and its method echoed the disagreement between Léon Walras and Vilfredo Pareto over the nature and method of political economy—the “rational method” versus the “experimental [expérimentale] method” (see Vol. I, Chap. 4). Not surprisingly, the two Viennese circles stand at the origin of two fundamental paths of economic theory that were fully developed in the post-World War II years: econometrics, which from the philosophical point of view, was close to the Kreis’s logical empiricism at the moment of its foundation, and the neo-Walrasian theory of general equilibrium, which derived from the Kolloquium’s discussions and writings.

4 Economics in Berlin, Vienna and Other Minor …

197

Economics and Philosophy in the Wiener Kreis The Wiener Kreis founded the so-called logical empiricism, a new form of empiricism which shared with the old empiricism the assumption that knowledge starts from observation of empirical data, adding that the statements made by empirical sciences are connected by logical analysis and stressing that unverifiable statements are meaningless. This scientific view is described in the Manifesto of the circle published in 1929 by the Austrian-born sociologist and economist Otto Neurath (1882– 1945) along with the Austrian mathematician Hans Hahn (1879–1934) and the German philosopher of science Rudolf Carnap (1891–1970) (Hahn 1929). This view was then developed in the concept of unified science (criticized by Mises 1933) whose language was physicalism, i.e., the application of the language of physics to the other sciences. In the Manifesto, economics was placed among the five branches of science that must conduct an epistemological examination of its foundations, a logical analysis of its concepts in order to purify it of metaphysical residuals. This proposal explicitly recalled crucial points of Pareto’s research program of the 1890s: the conception of the scientific nature of economics, the aim of creating a unified science and the importance of the verificationist paradigm. In fact, Pareto’s thought played an influential role in the Wiener Kreis, essentially through Otto Neurath’s writings. From an epistemological point of view, Pareto—the pre-Sociologia Pareto—may be considered a precursor of Viennese neo-positivism in economics. In fact, by considering economics a science that uses the experimental method peculiar to the natural sciences, Pareto opened a research program where defining assumptions and verifying theories empirically were fundamental. The idea of empirical-quantitative analysis as a necessary complement to theoretical analysis reveals the close link between Viennese neo-positivism and the program of the Econometric Society (see Chaps. 5.3 and 6.4).

198

R. Marchionatti

Economics as a Mathematical (Formal) Science in Karl Menger’s (1902–1985) Mathematical Colloquium: Abraham Wald (1902–1950), John von Neumann (1903–1957) and the Foundation of Neo-Walrasian Economics Biographical Overview Born in Vienna on January 13, 1902, Karl Menger was the son of the founder of the Austrian School Carl Menger.17 After his graduation from the Döblinger Gymnasium, he entered the University of Vienna in 1920 to study physics. He was a student of the mathematician Hans Hahn and received his Ph.D. from the University of Vienna in 1924. In 1925, he went to teach at the University of Amsterdam, invited by the Dutch mathematician Luitzen E. Brouwer, the founder of the intuitionistic mathematical school. In 1927, he returned to Vienna to become professor at the university. During that time, he published an influential paper on the St. Petersburg paradox with applications to the utility theory in economics. Menger left Austria in 1937, a year before the Anschluss. From 1937 to 1946, he was a Professor at the University of Notre Dame, Indiana, and then, from 1946 to 1971, at the Illinois Institute of Technology in Chicago. He died on October 5, 1985, in Chicago. In Vienna Karl, Menger had been a regular participant in the Kries, but he soon had reservations about developments in the Kries’s empiricism (Menger 1994; Kass 1996), and the Manifesto left him skeptical. He consequently founded the Matematische Kolloquium. Its meetings included a mixture of lectures, discussions and reviews of recent works, which were published in the Ergebnisse (the Proceedings) eines Mathematischen Kolloquiums between 1929 and 1937. Menger wrote that in the Kolloquium, studies on the contemporary development of geometry and logic as well as “studies concerning the new applications of exact 17

As Karl’s father was Roman Catholic and his mother, Hermine Andermann, was Jewish, the two could not marry. When Karl was born, due to the social conventions of that time, his father was forced to stop teaching at the University of Vienna and then resigned his chair. Carl then applied to Emperor Franz Joseph to have his son Karl made legitimate and his request was eventually granted (see Scheall and Schumacher 2018).

4 Economics in Berlin, Vienna and Other Minor …

199

sciences to problems of sociological character” were carried out: “for example on the existence and uniqueness of solutions for the production of equations in mathematical economics” (Menger 1935, p. 327). In fact, the mathematical problem of the General Economic Equilibrium model was central to the discussion held at the Mathematische Kolloquium: this makes a clear and significant difference from the classical mathematical economics of the beginning of the twentieth century, where the key problem was the correspondence between the theoretical model and empirical reality, considering the mathematical side of the static model completed to a large extent and the analytical problems essentially solved (see Vol. I, Chap. 4.3). In this regard, the new approach was an anticipation of the neo-Walrasian General Economic Equilibrium theory. In addition to Menger, its founders were Karl Schlesinger (a banker and economist) and above all Abraham Wald and John von Neumann (for the rich literature on this mathematical development, see Morgenstern 1951; Menger 1952, 1994; Tintner 1952; Weintraub 1983; Ingrao and Israel 1990; Punzo 1989). Karl (Karol) Schlesinger (1889–1938) was born in Budapest into a Jewish family. He studied law and economics at the University of Vienna and obtained a doctorate under Böhm-Bawerk in 1914 with a dissertation entitled Theorie der Geld—und Kreditwirtschaft (The Theory of Money and Loans) where he analyzed the role of money in a Walrasian general equilibrium model (Schlesinger 1914). In 1919, after Bela Kun’s communist revolution in Hungary, he moved to Vienna where he became a banker and influential member of the financial community, at the same time cultivating his theoretical interests as a member of the Mises seminar and Menger’s Kolloquium. He was, as Weintraub (1983, p. 6) wrote, “The real link between Walras … and the nascent developments”. Together with Abraham Wald, he addressed the issue of the existence of economically meaningful (positive) solutions in the Walrasian model in a short paper entitled “Über die Produktionsgleichungen der ökonomischen Wertlehre” (Schlesinger 1935) presented to the Kolloquium and then published in the Ergbenisse. The model considered by Schlesinger was the so-called Walras-Cassel system based on Gustav Cassel’s simplified reformulation of the Walrasian general

200

R. Marchionatti

economic equilibrium (see Vol. I, Chap. 6.2).18 Schlesinger paper, like those of the German economists Heinrich von Stackelberg (1933) and Hans Neisser (1932) and of the Danish economist Frederik Zeuthen (1932) before him, emphasized that the equality between the number of equations and the number of unknowns does not necessarily mean that the system possesses positive solutions in prices. He reformulated Cassel’s system in terms of inequalities, but without going on to its mathematical solution. His life ended prematurely when Hitler’s army invaded Austria in 1938: for fear of persecution, he committed suicide on March 12, 1938. Schlesinger’s (1935) paper paved the way for Abraham Wald’s work. Abraham Wald (1902–1950) was born in 1902 in Cluj, Transylvania, in the Austro–Hungarian Empire (now in Romania) in a Jewish family. In 1927, he entered the University of Vienna, from which he graduated in 1931 with a Ph.D. in mathematics under Karl Menger’s tutorship. Despite Wald’s brilliance, he could not obtain a university position because of the discrimination against Jews. He became a member of Menger’s seminar where, in the autumn of 1935, he presented an existence proof for a general equilibrium of exchange model. In a series of papers (1935, 1936a, b), he demonstrated the existence of an equilibrium for the Walras-Cassel system.19 In 1938, when Nazi Germany annexed Austria, Wald was able to emigrate to the United States at the invitation of the Cowles Commission for Research in Economics, to work on econometrics research. During World War II, Wald was a member of the Statistical Research Group (SRG) at Columbia University, where he applied his statistical skills to various wartime problems.

18

Cassel’s system was adopted as the starting point for the discussion for a series of reasons: Cassel’s (1918) book was widely used as a textbook in Central European countries (Weintraub 1983); the Viennese scholars thought that Cassel’s formulation gave the proper solution to the price imputation problem they investigated (Punzo 1991); Hans Mayer’s seminar, where the imputation problem (Zurechnungsproblem) was discussed, was the occasion when Menger and Schlesinger became familiar with the Walras-Cassel system (Mutoh 2003). 19 It seems that another paper by Wald would have been published in the same volume, one in which the proof of the existence of an equilibrium had been reformulated using more “modern methods” than in the 1935 paper. For lack of space, the publication was postponed to Volume 9. However, this volume was not published because of the dramatic political change of April 1938. Wald’s paper disappeared (see Arrow 1989). See also Duppe and Weintraub (2015).

4 Economics in Berlin, Vienna and Other Minor …

201

His work is considered seminal in the then-fledgling discipline of operational research. Wald and his wife died when the Air India plane in which they were traveling crashed in the Nilgiri Mountains, in southern India, while on an extensive lecture tour at the invitation of the Indian government. Wald’s 1935 paper was followed by a path-breaking contribution by John von Neumann on general economic equilibrium dynamics entitled “Über ein ökonomisches Gleichungssystem und eine Verallgemeinerung des Brouwerschen Fixpunktsatzes”. It had already been presented in 1932 to the Princeton Mathematical Club. On Wald’s invitation, it was published in 1937 in the Ergebnisse and then translated into English in 1945–1946 for the Review of Economic Studies (for historical reconstructions of these events, see Weintraub 1983; Arrow 1989). This paper was a more advanced mathematical formalization, from the technical standpoint, of the problem of the existence of an equilibrium, and it freed the model from any bond with the real world, which still existed in Wald’s methodological premise. The author, János Lajos Neumann, later John von Neumann (1903–1957), one of the greatest mathematicians of his time, but also a physicist, computer scientist and game theorist who made major contributions to an impressive number of fields, was born in Budapest, Hungary, in a wealthy and acculturated Jewish family.20 In 1911, he entered the Lutheran Gymnasium, then studying chemistry at the prestigious ETH Zurich and, at the same time, mathematics at the University of Budapest. He graduated as a chemical engineer from ETH Zurich in 1926 and passed his final examinations for his Ph.D. in mathematics simultaneously. He then went to the University of Göttingen on a grant from the Rockefeller Foundation to study mathematics under David Hilbert, one of the most influential and universal mathematicians of those times. He completed his habilitation on December 1927 and in 1928 started his lectures as a privatdozent at the University of Berlin. In 1929, thanks to his already numerous important contributions in mathematics, he was invited to Princeton University, and in 1933, he became Lifetime Professor at the Institute for Advanced Study. During World War II, he worked on the Manhattan Project. In the same period, he 20

For a biography of von Neumann, see Macrae (1992).

202

R. Marchionatti

founded the field of game theory, publishing in 1944 Theory of Games and Economic Behavior, written with Oskar Morgenstern (see Chap. 6.5). He died at age 53.

Abraham Wald’s Contribution Wald published two papers on the existence of an equilibrium for the Walras-Cassel General Economic Equilibrium system (1935, 1936a). In 1936, he wrote an important expository article for Morgenstern’s Zeitschrift für Nationalökonomie (1936b), translated into English in 1951, in Econometrica. From a methodological standpoint, Wald’s 1936 paper took as its premise Menger’s 1936 paper entitled “Bemerkungen zu den Ertragsgesetzen” (later translated into English as “Remarks on the Law of Diminishing Returns. A Study in Meta-Economics”).21 Here, Menger claimed that “from the point of view of methodology”, his paper was “the first instance in economics of a clear separation between the question of logical interrelations among various propositions and the question of empirical validity” (Menger 1936, p. 300). According to him, it was the key point needed to transform economics into a science. This “clear separation” between the question of logic and the question of empirical validity, which Schumpeter described as “a shining example of the general tendency toward increased rigor that is an important characteristic of the economics of our own period” (Schumpeter 1954, p. 1037), is, from the methodological point of view, at the basis of Wald’s work and of the program for the new mathematization of Walrasian general economic equilibrium theory. Wald started by maintaining that “mathematical economics” is “a new method” (Wald 1936b, p. 368), and “an indispensable tool for many subtle investigations of various areas of economic phenomena” (ibid.). Unfortunately, he added, “sins have been committed in mathematical economics”: unawareness of the assumptions and their implications, and of their conditions of validity. These sins cannot be blamed on mathematical method itself, Wald claimed, for “they have their origin in inappropriate, even erroneous, applications of mathematics” (ibid.). He thought that for a “fruitful application of 21

The role of Menger in the economic theory is discussed by Becchio (2008, 2009).

4 Economics in Berlin, Vienna and Other Minor …

203

mathematics in economics” it was essential that all the assumptions “be enumerated completely and precisely” (ibid.). These recommendations had already been strongly emphasized by Menger in his 1936 paper. According to Wald, “if these directions are strictly adhered to”, then “the only objection which can be raised against a theory is that it includes assumptions which are foreign to the real world and that, as a result, the theory lacks applicability” (ibid., p. 369). Wald recognized that “in many areas of mathematical economics very substantial abstractions are being used, so that one can hardly speak of a good approximation to reality” (ibid.), but he defended the adoption of “far-reaching abstractions” using some arguments that had already been used by mathematical economists of past generations—i.e., “mathematical economics is a very young science” (ibid.) and “economic phenomena are of such a complicated, involved nature that far-reaching abstractions must be used at the start merely to be able to survey the problem” (ibid.). These problems required adopting the method of successive approximations—“more realistic assumptions must be carried out step by step”. Wald optimistically concluded that if these “directions are strictly adhered to”, then “it will always be known precisely just where the assumptions are still so simplified and unrealistic that they must be replaced with better ones, so that ultimately theories will be derived that are well applicable to the real world” (ibid.). Wald was the first to deal systematically with the mathematical questions of existence and uniqueness. He continued by criticizing the assumptions made by the old mathematical economics on the equality of the number of equations and unknowns, recalling that: “the equality of the number of equations and unknowns does not prove that a solution exists, much less the uniqueness of a solution” (ibid., pp. 369–370). The assumption that this equality may be a sufficient condition for the solution of the system of equations is inadequate in the economic field because solutions have economic meaning only if they are non-negative in the prices of goods and services. Accordingly, Wald investigated the conditions of non-negativity. He adopted the simplified version of Walras’s equations proposed by Cassel with the modifications introduced by Schlesinger (1935). Schlesinger suggested that all the factors—both scarce (those considered by Walras and Cassel) and not scarce, or free—be considered as production factors. This entails

204

R. Marchionatti

transforming the equations into inequalities: the condition of equality between the available quantities of each factor of production and the sum of the quantities employed for their production is no longer verified because there may be an excess of some (non-employed) inputs. Wald demonstrated the existence of economically meaningful solutions under a set of (limitedly realistic, according to himself ) hypotheses.

John von Neumann’s Contribution Von Neumann’s model assumes a linear set of processes of production and goods. It is a “closed” circular model because there is no distinction between resources and final uses—“goods are produced not only from natural factors of production, but in the first place from each other” (von Neumann 1945–1946 [1937], p. 1). Equilibrium is defined as the state “where the whole economy expands without change of structure” (ibid., p. 2). In order to solve the system of equations, von Neumann made use of much newer mathematical methods than Wald’s: rather than using differential techniques, he employed topological techniques for the first time in economics. He noted that the connection with topology may be “very surprising at first”, but he thought that “it is natural in problems of this kind” (ibid., p. 1). The demonstrative technique transformed the problem of determining an equilibrium into a minimax problem: that is, the conditions of existence of an equilibrium are equivalent to the condition necessary for a minimax solution. The system of equations can be solved, von Neumann wrote, “only by means of a generalization of Brouwer’s Fixed-Point Theorem, i.e., by the use of very fundamental topological facts” (ibid.). This connects the solution of systems of linear inequalities to the minimax solution of a two-person zero-sum game of a previous 1928 article (von Neumann 1928) where he laid the mathematical foundations of game theory and proved the first minimax theorem. In a note to the 1937 paper, von Neumann emphasized the connection: “the question whether our problem has a solution is oddly connected with that of a problem occurring in the Theory of Games dealt with elsewhere (Math. Annalen, 100, 1928)” (von Neumann 1945–1946 [1937], p. 5).Whereas von Neumann proved the existence of a saddle point for a

4 Economics in Berlin, Vienna and Other Minor …

205

certain function in the 1928 paper, in the later paper he proved a “fixed point lemma” that generalizes Brouwer’s theorem, from which the existence of a saddle point for the equilibrium function follows. The use of a fixed-point theorem in the proof of existence of equilibrium became a standard tool in general equilibrium analysis, one of the technical cornerstones of the modern approach. As many scholars have emphasized (e.g., Ingrao and Israel 1990; Punzo 1991), the axiomatic approach in economics is applied in von Neumann’s paper in a totally coherent way, in the sense that the concern for the economic interpretation of the model disappears. By contrast with Wald, concern for the issue of the connection between the theory and the real economic world was substantially abandoned. In fact, von Neumann dealt with the economic question as a mathematician who aspires to find solutions characterized by elegance, logical completeness, concision and rigor, and for this purpose, he adopted artificial assumptions. A question raised in the literature regards the intellectual origin of von Neumann’s paper. Arrow (1989) thought that there was a Walrasian influence in von Neumann’s model and this has been the prevailing interpretation in the literature.However, subsequent historical research has shown that the intellectual origins of the model seem to lay, at least in part, in the Berlin discussion in Bortkiewicz’s circle (see Chap. 4.2). In fact, according to some scholars (Wittmann 1967; Kurz and Salvadori 1993; Leonard 1995), von Neumann may have been influenced by the price model in a planned economy formulated by Robert Remak (1929) who was privatdozent at the University of Berlin in more or less the same period Von Neumann was there. The simultaneous presence in Berlin of von Neumann and Remak gave rise to the conjecture that in preparing his model, the young von Neumann had in mind the model that his older colleague had presented at a Berlin Mathematical Society seminar.22 22 The objective affinity between von Neumann’s view of the economy and the classical economists’ approach was emphasized for the first time by Champernowne (1945–1946) in his paper accompanying the English publication of von Neumann’s paper and discussed by the Italian economist Claudio Napoleoni (1965). See also Marchionatti and Mornati (2016) and Marchionatti (2019).

206

R. Marchionatti

References Arrow, Kenneth J. 1989. Von Neumann and the Existence Theorem for General Equilibrium. In John von Neumann and Modern Economics, ed. Mohammed Dore, Sukhamoy Chakravarty, and Richard Goodwin, 15–28. Oxford: Clarendon Press. Becchio, Giandomenica. 2008. The Complex Role of Karl Menger in the Viennese Economic Theory. Review of Austrian Economics 21: 61–79. ———, ed. 2009. Unexplored dimensions: Karl Menger on Economics and Philosophy (1923–1938). Advances in Austrian Economics. Vol. 12. Bingley: Emerald Group Publishing. ———. 2014. Social Needs, Social Goods, and Human Associations in the Second Edition of Carl Menger’s Principles. History of Political Economy 46 (2): 247–264. Bjerkholt, Olav. 2016. Wassily Leontief and the Discovery of the Input-Output Approach. Memorandum No. 18/2016, University of Oslo, Department of Economics, Oslo. Böhm, Eucken, and Hans Großmann-Doerth. 1989 [1936]. The Ordo Manifesto of 1936. In Germany’s Social Market Economy: Origins and Evolution, ed. Alan Peacock and Hans Willgerodt. Basingstoke: Palgrave Macmillan. Cangiani, Michele. 2010. From Menger to Polanyi: The Institutional Way. In Austrian Economics in Transition, ed. Harald Hagemann, Tamotsu Nishizawa, and Yukihiro Ikeda. London: Palgrave Macmillan. Cassel, Gustav. 1918. Theoretische Sozialökonomie. Leipzig: C. F. Winter. Champernowne, David. 1945–1946. A Note on J. v. Neumann’s Article on a “Model of Economic Equilibrium”. Review of Economic Studies 13: 10–18. Craver, Earlene. 1986. The Emigration of the Austrian Economists. History of Political Economy 18 (1): 1–32. Dekker, Erwin. 2014. The Vienna Circles: Cultivating Economic Knowledge Outside Academia. Erasmus Journal for Philosophy and Economics 7 (2): 30– 53. Duppe, Till, and Roy Weintraub. 2015. Losing Equilibrium: On the Existence of Abraham Wald’s Fixed-Point Proof of 1935. Economic Research Initiatives at Duke (ERID), Working Paper No. 191. Eucken, Walter. 1934. Staatliche Strukturwandlungen und die Krise des Kapitalismus. Weltwirtschaftliches Archiv 36: 297–323. ———. 1940. Wissenschaft im Stile Schmollers. Weltwirtschaftliches Archiv 52: 468–506.

4 Economics in Berlin, Vienna and Other Minor …

207

Golland, Louise A. 1996. Formalism in Economics. Journal of the History of Economic Thought 18 (1): 1–12. Granger, Clive W.J., and Oskar Morgenstern. 1970. Predictability of Stock Market Prices. Lexington, MA: Heath Lexington. Haberler, Gottfried. 1933. The Theory of International Trade. London: William Hodge. ———. 1937. Prosperity and Depression: A Theoretical Analysis of Cyclical Movements. Geneva: League of Nations. ———. 1961. Mises’s Private Seminar. The Mont Pelerin Quarterly 3 (3): 20– 21. Hagemann, Harald. 2000. Emil Lederer (1882–1939): Economical and Sociological Analyst and Critic of Capitalist Development. In The Theory of Capitalism in the German Economic Tradition: Historism, Ordo-Liberalism, Critical Theory, Solidarism, ed. Peter Koslowski, 26–51. Berlin: Springer. ———. 2021. The Formation of Research Institutes on Business Cycles in Europe in the Interwar Period: The “Kiel School” and (In)Voluntary Internationalization0 In Political Economy and International Order in Interwar Europe, ed. Alexandre Mendes Cunha and Carlos E. Suprinyak, 361–382. London: Palgrave Macmillan. Hagemann, Harald, and Lionello Punzo. 2007. Robert Remak’s Superposed Price Systems: Before Axiomatization. European Conference on the History of Economics, Siena, 4–6 October. Hahn, Hans, Otto Neurath, and Rudolf Carnap. 1929. Wissenschaftliche Weltauffassung. Der Wiener Kreis, Wien, Artur Wolf Verlag. English translation in Wissenschaftliche Weltauffassung. Der Wiener Kreis. Reprint of original Edition with Translations, ed. Friedrich Stadler and Thomas Uebel, 75–116. Vienna: Springer, 2012. Hayek, Friedrich A. 1935. The Nature and History of the Problem. In Collectivist Economic Planning: Critical Studies on the Possibilities of Socialism, ed. Friedrich A. Hayek, 1–40. London: George Routledge. Hicks, John. 1935. Review of Marktform und Gleichgewicht by H. von Stackelberg. The Economic Journal 45: 334–336. Ingrao, Bruna. 2013. Portraits of European Economists. Roma: Aracne. Ingrao, Bruna, and Giorgio Israel. 1990. The Invisible Hand: Economic Equilibrium in the History of Science. Cambridge, MA: MIT Press. Kass, Seymour. 1996. Karl Menger. Notices of the AMS 43 (5): 558–561. Klausinger, Hansjörg. 2006. From Mises to Morgenstern: Austrian Economics During the Ständestaat. Quarterly Journal of Austrian Economics 9 (3): 25– 43.

208

R. Marchionatti

———. 2013. Academic Anti-Semitism and the Austrian School: Vienna, 1918–1945. Department of Economics Working Paper Series 115, WU Vienna University of Economics and Business. Knight, Frank. 1921. Risk, Uncertainty and Profit. Boston and New York: Houghton Mifflin Co. Kurz, Heinz D., and Neri Salvadori. 1993. Von Neumann’s Growth Model and the ‘Classical’ Tradition. The European Journal of the History of Economic Thought 1 (1): 129–159. Leonard, Robert. 1995. From Parlor Games to Social Science: Von Neumann, Morgenstern, and the Creation of Game Theory 1928–1944. Journal of Economic Literature 33: 730–761. ———. 2010. Von Neumann, Morgenstern and the Creation of Game Theory. Cambridge: Cambridge University Press. Leontief, Wassily. 1991 [1928]. The Economy as a Circular Flow. Structural Change and Economic Dynamics 2 (1): 181–212. ———. 1966. Essays in Economics: Theories and Theorizing. New York: Oxford University Press. Löwe, Adolph. 1925. Der gegenwartige Stand der Konnjunkturforschung in Deutschland. In Festgabe fur Lujo Brentano, vol. 2, 329–377. Munich and Leipzig. ———. 1997 [1926]. Wie ist Konjunkturtheorie überhaupt möglich? Weltwirtschaftliches Archiv 24: 165–197. English translation: How Is Business Cycle Theory Possible at All? Structural Change and Economic Dynamics 8 (2): 245–270. Machlup, Fritz. 1925. Die Goldkernwährung. Halberstadt: H. Meyer. ———. 1931. Börsenkredit, Industriekredit und Kapitalbildung. Wien: Julius Springer. English translation from a revised version: The Stock Market, Credit and Capital Formation. London: William Hodge and Company, 1940. ———. 1952a. The Political Economy of Monopoly: Business, Labor and Government Policies. Baltimore: The John Hopkins Press. ———. 1952b. The Economics of Sellers’ Competition. Baltimore: The John Hopkins Press. ———. 1962a. Essays on Economic Semantics. Englewood Cliffs: Prentice-Hall. London: Routledge, 2nd ed., 1977. ———. 1962b. The Production and Distribution of Knowledge in the United States. Princeton: Princeton University Press. ———. 1980. My Early Work on International Monetary Problems. Banca Nazionale del Lavoro Quarterly Review 133: 115–146.

4 Economics in Berlin, Vienna and Other Minor …

209

Macrae, Norman. 1992. John von Neumann: The Scientific Genius. New York: Pantheon Books. Marchionatti, Roberto. 2019. Between Berlin and Cambridge: Classical Conceptions of the General Economic Equilibrium in the Late 1920s. Cambridge Journal of Economics 43 (5): 1377–1395. Marchionatti, Roberto, and Fiorenzo Mornati. 2016. Economic Theories in Competition: A New Narrative of the Debate on the General Economic Equilibrium Theory in the 1930s. Panoeconomics 63 (5): 503–523. Marschak, Jacob. 1931. Elastizität der Nachfrage. Zur empirischen Feststellung relativer Marktkonstanten durch Beobachtung von Haushalt, Betrieb und Markt. Tübingen: J.C.B. Mohr. Menger, Carl. 1923. Grundsätze der Volkswirtschaftslehre, ed. Karl Menger, 2nd enlarged ed. Vienna: Hölder-Pichler-Tempsky. Menger, Karl. 1935. Sull’indirizzo di idee e sulle tendenze principali del colloquio matematico di Vienna. Annali della Scuola Normale Superiore di Pisa 4 (4): 327–339. ———. 1936. Bemerkungen zu den Ertragsgesetzen. Zeitschrift für Nationalökonomie 7 (3): 388–397. ———. 1952. The Formative Years of Abraham Wald and His Work in Geometry. The Annals of Mathematical Statistics 23 (1): 14–20. ———. 1994. Reminiscences of the Vienna Circle and the Mathematical Colloquium. Dordrecht: D. Riedel. Mises, Ludwig von. 1919. Nation, Staat, und Wirtschaft: Beiträge zur Politik und Geschichte der Zeit. Wien: Manz. English translation: Nation, State, and Economy: Contributions to the Politics and History of Our Time. Indianapolis: Liberty Fund, 2006. ———. 1922. Die Gemeinwirtschaft: Untersuchungen über den Sozialismus. Jena: Gustav Fisher. ———. 1935 [1920]. Die Wirtschaftsrechnung im sozialistischen Gemeinwesen, Archiv für Sozialwissenschaft und Sozialpolitik 47 (1): 86–121. English translation: Economic Calculation in the Socialist Commonwealth. In Collectivist Economic Planning, ed. Frederick A. Hayek, 87–130. London: George Routledge. ———. 1960 [1933]. Grundprobleme der Nationalökonomie. Jena: Gustav Fischer. English translation: Epistemological Problems of Economics. Princeton, NJ: Van Nostrand. ———. 1978. Notes and Recollections. Spring Mills, PA: Libertarian Press. Mongiovi, Gary. 1998. Adolph Lowe’s Political Economics: A Review Essay. Social Research 65 (4): 953–966.

210

R. Marchionatti

Moore, Henry. 1906. Paradoxes of Competition. The Quarterly Journal of Economics 20 (2): 211–230. Morgenstern, Oskar. 1928. Wirtschaftsprognose, Eine Untersuchung ihrer Voraussetzungen und Möglichkeiten. Wien: Julius Springer. ———. 1934. Die Grenzen der Wirtschaftspolitilk. Vienna: Julius Springer. English translation: The Limits of Economics. London: William Hodge, 1937. ———. 1935. Vollkommene Voraussicht und wirtschaftliches Gleichgewicht. Zeitschrift für Nationalökonomie 6: 337–357. English translation: Perfect Foresight and Economic Equilibrium. In Morgenstern 1976a, 169–183. ———. 1936. Logistik und Sozialwissenschaften. Zeitschrift fur Nationalökonomie 7: 1–24. ———. 1951. Abraham Wald, 1902–1950. Econometrica 19 (4): 361–367. ———. 1976a. Selected Economic Writings of Oskar Morgenstern, ed. Andrew Schotter. New York: New York University Press. ———. 1976b. The Collaboration Between Oskar Morgenstern and John von Neumann on the Theory of Games. Journal of Economic Literature 14 (3): 805–816. Mutoh, Isao. 2003. Mathematical Economics in Vienna Between the Wars. In Advances of Mathematical Economics, ed. Shigeo Kusuoka and Toru Maruyama, 167–195. Tokyo: Springer-Verlag. Napoleoni, Claudio. 1965. L’equilibrio economico generale. Torino: Boringhieri. Neisser, Hans. 1928. Der Tauschwert des Geldes. Jena: Verlag von Gustav Fischer. ———. 1932. Lohnrohe und Beschäftigungsgrad in Marktgleichgewicht. Weltwirtschaftiches Archiv 36: 415–455. ———. 1969. In Memoriam: Gerhald Colm 1897–1968. Social Research 36 (1): 1–3. Nemeth, Elisabeth, Stefan W. Schmitz, and Thomas E. Uebel, eds. 2007. Otto Neurath’s Economics in Context. Dordrecht: Springer. Neumann, John von. 1928. Zur Theorie der Gesellschaftsspiele. Mathematische Annalen 100: 295–320. ———. 1937. Uber ein ökonomische Gleichungssystem und eine Verallgemeinerung des Brouwerschen Fixpunktsatzes. Ergebnisse eines Mathematischen Kolloquiums 8: 73–83. ———. 1945–1946 [1937]. A Model of General Economic Equilibrium. The Review of Economic Studies 13 (1): 1–9. Neumann, John von, and Oskar Morgenstern. 1944. Theory of Games and Economic Behavior. Princeton: Princeton University Press.

4 Economics in Berlin, Vienna and Other Minor …

211

Neurath, Otto. 1919. Durch die Kriegswirtschaft zur Naturalwirtschaft. Munich: G.D.W. Callwey. Parys, Wilfied. 2014. Why Didn’t Charasoff and Remak Use Perron-Frobenius Mathematics? The European Journal of the History of Economic Thought 21 (6): 991–1014. Niehans, Jürg. 1991. Relinking German Economics to the Main Stream: Heinrich von Stackelberg. Cesifo Working Paper No. 10. Peukert, Helge. 2010. Walter Eucken (1891–1950) and the Historical School. In The Theory of Capitalism in the German Economic Tradition, ed. Peter Koslowski. Berlin: Springer. Polanyi, Karl. 1971. Carl Menger’s Two Meanings of “Economic.” In Studies in Economic Anthropology, ed. George Dalton, 16–24. Washington, DC: American Anthropological Association. Punzo, Lionello. 1991. Karl Menger’s Mathematical Colloquium. In John von Neumann and Modern Economics, ed. Mohammed Dore, Sukhamoy Chakravarty and Richard Goodwin, 129–165. Oxford: Clarendon Press. ———. 1991. The School of Mathematical Formalism and the Viennese Circle of Mathematical Economists. Journal of the History of Economic Thought 13 (1): 1–18. Remak, Robert. 1929. Kann die Volkswirtschftslehre eine exacte Wissenschaft werden? Jahrbücher für Nationalökonomie und Statistik 131: 703–735. ———. 1933. Konnen superponierte Preissysteme praktisch berechnet warden? Jahrbücher für Nationalökonomie und Statistik 138: 839–842. Scheall, Scott, and Reinhard Schumacher. 2018. Karl Menger as Son of Carl Menger. The Center for the History of Political Economy at Duke University Working Paper Series. Schlesinger, Karl. 1914. Theorie der Geld- und Kreditwirtschaft. München: Duncker & Humblot. ———. 1935. Über die Produktionsgleichungen der bkonomischen Wertlehre. Ergebnisse eines mathematischen Kolloquiums 6: 10–11. Schumpeter, Joseph A. 1954. History of Economic Analysis. London: Allen & Unwin. Siegmund-Schultze, Reinhard. 2009. Mathematicians Fleeing from Nazi Germany: Individual Fates and Global Impact. Princeton and Oxford: Princeton University Press. Stackelberg, Heinrich von. 1932. Die Grundlagen einer reinen Kostentheorie. Zeitschrift für Nationalökonomie 3: 333–367. ———. 1933. Sulla teoria del duopolio e del polipolio. Rivista italiana di statistica, economia e finanza 5: 275–289.

212

R. Marchionatti

———. 2011 [1934]. Marktform und Gleichgewicht. Wien und Berlin: Verlag von Julius Springer. English translation: Market Structure and Equilibrium. Berlin and Heidelberg: Springer-Verlag. Sturn, Richard. 2017. “I Don’t Want Ever to Have Anything to Do with Them.” Migration and the Irreversible Fragmentation of Austrian Economics. In Return from Exile—Rückkehr aus dem Exil. Exiles, Returnees and Their Impact in the Humanities and Social Sciences in Austria and Central Europe, ed. Waldemar Zacharasiewicz and Manfred Prisching. Vienna: Austrian Academy of Sciences Press. Tintner, Gerhard. 1952. Abraham Wald’s Contributions to Econometrics. The Annals of Mathematical Statistics 23: 21–28. Tooze, Adam. 1999. Weimar’s Statistical Economics: Ernst Wagemann, the Reich’s Statistical Office, and the Institute for Business-Cycle Research, 1925–1933. The Economic History Review 52 (3): 523–554. Vanberg, Viktor J. 2004. The Freiburg School: Walter Eucken and Ordoliberalism. Freiburger Diskussionspapiere zur Ordnungsökonomik, No. 04/11, Albert-Ludwigs-Universität Freiburg. Wald, Abraham. 1935. Über die eindeutige positive Lösbarkeit der neuen Produktionsgleichungen. Ergebnisse eines mathematischen Kolloquiums 6: 12–18. English translation: On the Unique Non-Negative Solvability of the New Production Functions (Part I). In Precursors in Mathematical Economics, ed. William J. Baumol and Stephen M. Goldfeld. LSE Series of Reprints of Scarce Works on Political Economy. London: London School of Economics,1968. ———. 1936a. Über die Produktionsgleichungen der ökonomischen Wertlehre (2. Mitteilung). Ergebnisse eines mathematischen Kolloquiums. English translation: On the Production Equations of Economic Value Theory (Part 2). In William J. Baumol and Stephen M. Goldfeld, eds., op. cit. ———. 1936b. Über einige Gleichungssysteme der mathematischen Ökonomie. Zeitschrift für Nationalökonomie 7: 637–670. English translation: On Some Systems of Equations of Mathematical Economics. Econometrica 19 (4): 368–403, 1951. Weintraub, Roy. 1983. On the Existence of a Competitive Equilibrium: 1930– 1954. Journal of Economic Literature 21 (1): 1–39. ———. 1985. Appraising General Equilibrium Analysis. Economics and Philosophy 1 (1): 23–37. ———. 2002. How Economics became a Mathematical Science. Duhram: Duke University Press.

4 Economics in Berlin, Vienna and Other Minor …

213

Wittmann, Waldemar. 1967. Die extremale Wirtschaft. Robert Remake in Vorlaufer Der Aktivitatsanalyse. Jahrbucher fur Nationalokonomie und Statistik 180: 397–409. Yagi, Kijchiro. 2010. Carl Menger After 1871: Quest for the Reality of ‘Economic Man’. In Austrian Economics in Transition: From Carl Menger to Friedrich Hayek, ed. Harald Hagemann, Tamotsu Nishizawa, and Yukihiro Ikeda. London: Palgrave Macmillan. Zeuthen, Frederik. 1932. Das Prinzip der Knappheit, technische Kombination und Okonomische Qualität. Zeitschrift Der Nationalökonomie 4 (1): 1–24.

5 Economics in the Rest of Europe

5.1

Introduction

Before the First World War, European economic thinking made important advances in Sweden (with Wicksell, who was one of the most important economists of his epoch, and Cassel), while Italy (particularly in the universities of Rome and Turin), France and Russia maintained a quite important, even if less original, theoretical level. In Volume One, we referred to these countries as the peripheries, albeit important ones with various connections with the main centers. The picture changed substantially between the two world wars: along with the development of original economic thinking in Sweden with the formation of the neo-Wicksellian Stockholm School, new centers began to emerge at the universities of Oslo and Rotterdam in the second part of the 1920s and above all in the 1930s. Under the guidance of a few eminent figures, these small but extremely active groups gave a fundamental impetus to the new econometric movement through their connections with other economists and mathematicians in the United States, in a theoretical project which also attracted scholars from other European countries, © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 R. Marchionatti, Economic Theory in the Twentieth Century, An Intellectual History—Volume II, https://doi.org/10.1007/978-3-030-80987-4_5

215

216

R. Marchionatti

France in particular. For their part, Italy and Russia, like the Germanspeaking area in the 1930s, suffered from the tragic political changes which curtailed free research and teaching in these countries, where many scholars were persecuted and forced to emigrate. As long as possible, these countries strove to maintain relationships and connections with the international theoretical movements, though with mounting difficulty after the 1920s.

5.2

New Developments in the Northern-European Countries, I: Economics in Sweden—Gunnar Myrdal (1898–1987) and the Stockholm School

An Overview In the early 1920s, the economic debate in Sweden was still dominated by the two most important figures of the previous period: Knut Wicksell and Gustav Cassel, who made frequent contributions to the debate on the policy issues of the post-First World War period. As Lundberg (1996, p. 9) writes, Wicksell participated in this debate “from a position of great prestige, as the grand old man of economics and an outstanding theoretician”, and substantially the same applies for Cassel: Schumpeter (1954, p. 1120) considers him “the most influential international leader of our science in the 1920s”, his reputation built on his analysis of the international monetary situation and his position in favor of restoring the gold standard. However, the lively debate of the first part of the 1920s “did not produce any new theoretical insights or innovations” (Lundberg 1996, p. 18). Rather, “it was just a matter of applying older and well-tried approaches to the dramatic new circumstances” (ibid.). It was the new generation of young economists who, coping with the problem of economic depression and persistently high employment, called for changed theoretical and policy attitudes, giving rise to the so-called

5 Economics in the Rest of Europe

217

Stockholm School of economics in the 1930s.1 Its members created a macroeconomic approach resembling Keynes’s at the theoretical level, as well as at the political level with their emphasis on fiscal policies. The senior members and leaders, of the School were Erik Lindahl, Gunnar Myrdal and Bertil Ohlin—the latter two were awarded the Nobel Prize in economics in the 1970s. Erik Robert Lindahl (1891–1960) was born on November 21, 1891 in Stockholm. He obtained his Ph.D. from Lund University in 1919 with a thesis entitled Die Gerechtigkeit der Besteuerung (The Justice of Taxation), based to a great extent on Wicksellian ideas. He became a reader in public finance at Lund University from 1920 to 1924, and a reader in economics and fiscal law at Uppsala University from 1924 to 1926. In 1926, he was responsible for planning an extensive empirical study on “Wages, Cost of Living and National Income in Sweden 1860– 1930” at Stockholm University, financed by the Rockefeller Foundation. In 1932, he was appointed Professor of Political Economy at the Göteborg School of Economics and Business Administration, later moving to professorships at Lund and, in 1942, at Uppsala. In the 1930s, he was a consultant to the Swedish central bank and to the Swedish ministry of finance, an economic adviser to the League of Nations and, after the war, to the United Nations. Lindahl’s publications covered many areas, but his main writings contributing to the Stockholm School were in the areas of dynamic economic theory and macroeconomics, in an attempt to extend Wicksell’s cumulative process into a dynamic theory (see Boianovsky and Trautwein 2006). In his contributions to the development of dynamic methods, he introduced the concept of sequence of temporary equilibria, later adopted by John Hicks in Value and Capital (see Chap. 3.4), and then replaced by Lindahl with sequence analysis by incorporating Myrdal’s concepts of ex ante and ex post (see his Studies [1939], his last major work). He died on January 6, 1960 in Uppsala. Gunnar Myrdal (1898–1987), one of the twentieth century’s outstanding intellectual figures (see Barber 2008), was born on December 6, 1898, in a village in the Swedish province of Dalarna. 1 Stockholm School is an expression that Bertil Ohlin used in 1937 in two articles in the Economic Journal (Ohlin 1937a, b). In spite of the differences between its members’ positions, the expression has gained broad acceptance in the literature.

218

R. Marchionatti

In 1918, he enrolled at Stockholm University, obtaining a degree in law in 1923. He began practicing law while continuing his studies at the university: he had decided to take up the study of economics and began a doctoral degree program under Cassel. In the meantime, in 1924, he married Alva Reimer (1902–1986), then a prominent leader of the disarmament movement who received the Nobel Peace Prize in 1982. His doctoral dissertation—entitled Prisbildningsproblemet och föränderligheten (The Problem of Price Formation and Changeability) (Myrdal 1927)—was an attempt to transform Cassel’s static framework of general equilibrium analysis into a dynamic theory. Myrdal’s innovation was to include expectations in the theoretical framework as one of the factors that determine prices, in addition to tastes, technology and factor endowments. From 1925 to 1929, he studied for periods in Germany and Britain, then going to the United States as a Rockefeller Fellow in 1929–1930. During this period, he published his first book, Vetenskap och politik i nationalekonomien (Science and Politics in Political Economy) (Myrdal 1930) which many years later was published in English as The Political Element in the Development of Economic Theory (Myrdal 1953). It was a book of an institutionalist stamp—Myrdal himself (1953, p. vi) described it as “a frontal attack on the dogmas of the older generation”—which anticipated the multidisciplinary approach of many of his future works in the post-war period (on Myrdal’s institutionalism see Dostaler 1990). In 1931, Myrdal published the essay “Om penningteoretisk jämvikt. En studie över den “normala räntan” i Wicksells penninglära”, translated in German in 1933 in a book edited by Hayek as “Der Gleichgewichtsbegriff als Instrument der geldtheoretischen Analyse” and in English in 1939 under the title Monetary Equilibrium, a book which greatly influenced the development of the Stockholm School and can be considered its main product. In the German version, Myrdal coined the famous twin term “ex ante – ex post”. In 1933, he was appointed to the chair of Political Economy and Public Finance at Stockholm University as the successor of Gustav Cassel. In addition to his academic activities, Myrdal was active in Swedish politics—together with his wife Alva he propagated welfare-state policies, contributed to debates on population policies and education and became active in the Social Democratic Party—and was elected to the Senate in 1934. In the

5 Economics in the Rest of Europe

219

following years, his interests shifted from macroeconomics to studies of poverty and underdevelopment (see Myrdal 1957, 1968). These issues were the main focus of his production in the postwar years, which contributed to development economics (see Vol. III). From 1961, he was Professor of International Economics at Stockholm University. In 1974, Myrdal was awarded the Nobel Prize in Economic Sciences, together with Friedrich Hayek. As the Prize Committee put it, they had been selected jointly “for their pioneering work in the theory of money and economic fluctuations and for their penetrating analysis of the interdependence of economic, social and institutional phenomena”. Myrdal died in Stockholm on May 17, 1987. Bertil Ohlin (1899–1979), the third of the senior members of the School, was born on April 23, 1899 in Klippan, Sweden. He took a degree in mathematics, statistics and economics at Lund University in 1917, and a degree in economics under Heckscher at the Stockholm School of Business Administration in 1919. Ohlin spent the 1922–1923 academic year at Harvard, where he had close relationships with Taussig, Williams and Viner. In 1924, he received a Ph.D. under Cassel at Stockholm University. He then taught at the University of Copenhagen in 1925–1929 and, as Eli Heckscher’s successor, at the Stockholm School of Business Administration from 1930. Ohlin’s dissertation was on the theory of international trade and was the basis of his most important book, Interregional and International Trade published in 1933 (Ohlin 1933). In fact, Ohlin’s formal contribution to economics is dominated by the model of international trade which he developed in this book (on Ohlin’s contributions see Caves 1978; Findlay et al. 2002). In it he integrated Heckscher’s contribution of 1919 (translated in English only at the end of the 1940s) with Cassel’s version of a Walrasian general equilibrium of a closed economy, building a general equilibrium approach to the theory of international trade (to be coupled with Haberler’s contribution). International trade is considered as the commercial interaction of two (or more) economic regions, each endowed with a stock of factors of production and capable of producing different commodities. Each region tends to export those goods which would be relatively cheap in the absence of trade. This is now called the “weak version” of the

220

R. Marchionatti

Heckscher-Ohlin theorem. On its appearance, Ohlin’s book was immediately recognized as a major contribution, and the model presented was the framework of the majority of work published in the pure theory of international trade after World War II, innovating the theory2 and providing an operational base for empirical research on the structure of trade and production (see Caves 1978). It should be noted that, as Caves (1978, p. 87) writes, “in its operational and empirical content, however, Ohlin’s contribution did not displace the earlier Ricardian model (as developed by Mill, Edgeworth, Taussig, etc.) but rather supplied a richer and more general model resting on different assumptions”. At the beginning of the 1930s, Ohlin worked for the League of Nations and the Swedish government, preparing reports on the world depression and unemployment. It was in this context that he contributed to the Stockholm School’s macroeconomic approach. In a work of 1934,3 never translated in English and inspired by Wicksell and Lindahl, Ohlin built a dynamic feedback mechanism between consumption, investment and output. At the same time he began an important political career: for 23 years, he was head of the Liberal Party and became a member of the Swedish parliament and Minister of Commerce in 1944–1945. In 1977, he was awarded the Nobel Prize in economics—jointly with James Meade—for his contribution to the theory of international trade. He died on August 3, 1979 in Stockholm. A number of remarkable younger scholars joined the senior members: among them we may mention Dag Hammarskjöld (1905–1961), Ingvar Svennilson (1908–1972) and, above all, Erik Filip Lundberg (1907– 1987). The first two, both pupils of Myrdal at Stockholm University, became important personalities in Swedish and international public life and made only few academic contributions to economics. Dag Hjalmar Agne Carl Hammarskjöld received his Ph.D. in 1933. After teaching economics at Stockholm University for some years, he abandoned academia in 1936 and became a civil servant in the Ministry of Finance and served as chairman of the Board of Governors of the Bank 2

The theorem was first rigorized by Stolper and Samuelson (Samuelson and Stolper 1941). For an analysis of the work building on the Heckscher-Ohlin theory see Chipman’s (1966) survey of the theory of international trade. 3 The work is largely summarized in Brems (1978).

5 Economics in the Rest of Europe

221

of Sweden from the latter half of the 1930s to the end of the 1940s. In 1953, he was made Secretary-General of the United Nations—dying in an air crash while on an official mission in 1961—and was posthumously awarded the Nobel Peace Prize. Ingvar Svennilson took his Ph.D. in 1938 with a dissertation on economic planning, an issue on which he wrote extensively in the following years, when he was the head of the Industrial Institute of Economic and Social Research, founded by Swedish industry (see Lundberg 1972; Carlson and Lundhal 2017). His most internationally famous work, the United Nations report on Growth and Stagnation in the European Economy during the interwar period, was published in 1954. Erik Filip Lundberg, a student of Cassel, took his Ph.D. at Stockholm in 1937 and in the same year became the first director of the Government Economic Research Institute, the Konjunkturinstitutet. In 1946, he was appointed Professor of Economics at Stockholm University and later, in 1965, at the Stockholm School of Economics. His major contributions are in the theory of inter-temporal economic behavior and are contained in his first book, Studies in the Theory of Economic Expansion (Lundberg 1937). (On the importance of Lundberg’s work see Baumol 1990.) The theoretical tradition of the Stockholm School was exhausted very early, by the end of the 1930s, for several reasons. First, almost all of these economists were attracted to other careers and maintained weak links with academic life. This was, above all, the case of Gunnar Myrdal, Bertil Ohlin and Dag Hammarskjöld. Erik Lundberg and Ingvar Svennilsson had distinguished academic careers but did not further develop the School’s theory and were engaged in various non-academic activities. Erik Lundberg still wrote on macroeconomic issues in the 1950s and 1960s but his work dealt with empirical, rather than theoretical, questions. The other important reason was the Keynesian revolution, whose international success overshadowed the Swedish contributions, which in many cases were known only in Sweden for many years. With few exceptions, in fact, the Stockholm School did not have a significant impact on the theoretical discussion outside Sweden. The most important example of its influence is Myrdal’s ex ante-ex post analysis which was rather soon applied to Keynesian economics. Another example is Lindahl’s (1939) temporary equilibrium method which Hicks, as noted above, adopted

222

R. Marchionatti

in his Value and Capital . Lundberg’s (1937) sequence analysis also had some influence on the development of the business cycle theory. Very soon the connection with the Keynesian school was recognized. Barber (2008) reviewed the debate as to whether Swedish economists of the 1920s and early 1930s anticipated Keynes, and whether the Keynesian revolution should more properly be termed the “Myrdal-Keynes revolution”. He seemed to suggest that Myrdal is entitled to a share in this revolution’s authorship. But Don Patinkin’s work on anticipations of the General Theory (Patinkin 1982) had convincingly argued that Keynes’s General Theory was not anticipated by the Stockholm School and that it was Keynes who made the decisive breakthrough by focusing on changes in output as the equilibrating mechanism between saving and investment, rather than changes in prices. Actually, the two scholars’ theories were formulated in parallel and independently of each other, a conclusion that, after years of debate, has been authoritatively sustained by Lundberg (1996).

Theoretical Contributions in Macroeconomics: Gunnar Myrdal’s Neo-Wicksellian Monetary Equilibrium, 1931–1939 The essential features of Stockholm School macroeconomics are its development of a dynamic method and the use of period analysis and the concepts of ex ante and ex post in the analysis of saving and investment (see Hansson 1982). In this field, Lindhal’s and Myrdal’s contributions are considered to be the landmarks (see Trautwein 2016). Myrdal’s Monetary Equilibrium, however, can be considered, more rightly, to represent the essence of the Stockholm School’s theories: it is basically an attempt at a critical reconstruction of Wicksell’s theory of monetary equilibrium and cumulative process in order to emphasize the Swedish contributions to upholding the Wicksellian legacy. Moreover, it had a significant impact on the theoretical discussion outside Sweden as the main Swedish contribution to Keynesian economics (even if it was rejected by Keynes

5 Economics in the Rest of Europe

223

in writing the General Theory).4 Its originality and importance had been grasped by John Hicks who, on the occasion of the publication of the German edition of Myrdal’s essay, wrote that it was “the most exciting work on monetary theory which has appeared since Mr. Keynes’s Treatise and Professor Hayek’s Prices and Production” (Hicks 1934, p. 481). The book, as Myrdal writes in the preface to the 1939 English edition, “belongs among the attempts made during the early years of the great depression to reach a basis for a deeper and more comprehensive monetary theory” (p. v), in the framework of Wicksell’s theory. It is essentially a study of the concept of monetary equilibrium. The starting point of Myrdal’s analysis is a sketch of the theoretical background of the new beginnings of monetary theory that starts with Wicksell. According to Myrdal, Wicksell had the merit of founding a critique of the quantitative theory of money and above all of undermining the validity of Say’s law. In his reconstruction, the contribution of the new generation of Swedish economists consisted in continuing Wicksell’s heterodox legacy to address the issues of the postwar economic situation. Wicksell’s theory, Myrdal maintains, “stands or falls on the notion of monetary equilibrium” because: the essential content of the theory is that a Wicksellian cumulative process starts in one or the other direction if the system is out of equilibrium. Any analysis according to the Wicksellian scheme presupposes knowledge of whether a certain price situation is or is not a position of monetary equilibrium, and, if not, on which side of the equilibrium that situation lies. The concept of monetary equilibrium has, therefore, central importance for the whole Wicksellian monetary theory. (Myrdal 1939, p. 30)

4

In a letter to Bertil Ohlin in January 1937 (Keynes 1973, p. 184), Keynes wrote that he had been thinking in a similar vein in the early 1930s, but he had finally rejected this form of reasoning: “So, after writing out many chapters along what were evidently the Swedish lines, I scrapped the lot and felt that my new treatment was much safer and sounder from the logical point of view”.

224

R. Marchionatti

Myrdal adopted a methodological procedure known as the immanent methodological approach that he explained as follows: My analysis will be of an immanent nature in so far as I shall take over in the beginning the fundamental features of Wicksell’s monetary theory and shall develop my own arguments under the assumption of the fundamental correctness of his explanation. The Wicksellian formulation, we shall find, will need modification in several directions. The reasons for choosing this immanent method for the analysis and for presenting my own results as a development of Wicksell’s theory instead of arranging my exposition more directly and systematically according to positive theoretical principles, are, first, my belief that particularly in the present state of economic theory, we should clearly trace the lines of tradition—positive as well as negative—from the older generations of economists in order to prevent our literature from falling any more than necessary into Babylonic barbarism. (Myrdal 1939, pp. 30–31)

Wicksell’s method, Myrdal notes, consisted in choosing a stationary economic state as the starting point for the argument. Wicksell’s theory, however, is an attempt to analyze a dynamic process, which cannot be stationary. Myrdal critically discusses Wicksell’s three equilibrium criteria. The central problem is the following: From the standpoint of the fundamental idea of Wicksell’s monetary theory, what do the properties of a price situation in a non-stationary course of events have to be in order that this situation can be characterized as a position of monetary equilibrium? (ibid., p. 42)

Myrdal maintains that his essay is confined to the study of the tendencies existing at a point of time, considered as a preparatory step to the dynamic (period) analysis. Stating the point of time at which the flows of returns and costs are calculated is not necessary, he writes, when a stationary analysis in the absence of uncertainty is adopted: “[a]s there was no uncertainty in the system, returns, costs and incomes, &c., could be talked of without it ever being made clear whether they were looked at from the beginning or from the end of the period” (ibid., p. 45). But it

5 Economics in the Rest of Europe

225

becomes a necessity if the analysis is developed in the presence of uncertainty. For this purpose, Myrdal introduces the concepts of ex ante and ex post, which he considers his “chief contribution” (ibid., p. 47). He writes: an important distinction exists between prospective and retrospective methods of calculating economic quantities such as incomes, savings, and investments; and [...] a corresponding distinction of great theoretical importance must be drawn between two alternative methods of defining these quantities. Quantities defined in terms of measurements made at the end of the period in question are referred to as ex post; quantities defined in terms of action planned at the beginning of the period in question are referred to as ex ante. (ibid., pp. 46–47)

This ex ante–ex post distinction makes it possible to introduce the time dimension in the analysis. In this way, Myrdal can re-examine and re-formulate Wicksell’s conditions of monetary equilibrium in Chaps. IV–VI of the book. He identified Wicksellian monetary equilibrium as follows: the “normal rate of interest” must (1) equal the marginal technical productivity of real capital (natural rate of interest); (2) equate the supply of and the demand for savings and (3) guarantee a stable price level, primarily of consumption goods. “Wicksell—Myrdal writes— assumes that these three criteria for the normal rate of interest are equivalent—i.e. never mutually inconsistent” (p. 38), but Wicksell’s formulations are “too loose and contradictory” (ibid.), and therefore they should be reformulated. The theoretical result Myrdal reached through long and rather complicated reasoning was significant: it overcame the dichotomy between real and monetary economy, whose presuppositions were in Wicksell and brought him close to Keynes’s theory. “[A]n ‘engine room’ which contains the power of the whole argument”, as Shackle (1967, p. 124) writes, is Chap. IV, where Myrdal reformulates Wicksell’s concept of natural interest rate, interpreting it as an expected rate of yield, in monetary terms, thus making the natural rate dependent on psychological elements.

226

5.3

R. Marchionatti

New Developments in the Northern-European Countries, II: Ragnar Frisch (1895–1974) in Oslo, Jan Tinbergen (1903–1994) in Rotterdam and the Birth of the Econometric Movement Between Europe and the United States

Prologue In a paper in the Proceedings of the American Philosophical Society in memory of Jan Tinbergen, the Nobel laureate James Tobin writes that Tinbergen and Ragnar Frisch were “the leading intellectual inspirations for the new quantitative methods of economic analysis” (Tobin 1997, p. 511), which Tobin considers the major advance in economics during the twentieth century. Frisch and Tinbergen were leaders of this development which led in 1931 to the foundation of the Econometric Society, and in 1969 were jointly awarded the first Nobel Prize in Economics. Their professional careers closely overlapped. Dekker (2019, p. 66) writes: Frisch was eight years Tinbergen’s senior, and perhaps for that reason appeared to be a small step ahead of Tinbergen throughout their long coevolution. But it was Tinbergen who often made the ideas prominent and who developed much more of a public persona. In fact, many of Frisch’s most important contributions remained unpublished, appeared only as memoranda from his research institute (or other institutions), and were known only to relevant insiders. Tinbergen’s contributions, on the other hand, often became standard reference works.

It should also be emphasized that they were the supporters of a particular conception of econometrics, quite widespread in the 1930s but increasingly vanishing in the postwar period, which was closely linked to their strong idea of social justice: for them econometric thinking should be a scientific tool for introducing the reforms needed to prevent new

5 Economics in the Rest of Europe

227

wars, poverty and unemployment, the great evils of the world, and not, as Frisch polemically was to say, “playometrics”, i.e., a degeneration of econometrics without relevance for concrete realities (see Frisch 1970a, b). From the scientific standpoint, the goal Tinbergen and Frisch pursued in the late 1920s and in the 1930s was essentially the development of a dynamic apparatus for the analysis of the economy. Frisch developed the now classic distinction between static and dynamic economics and the concept of a macroeconomic quantitative model, and described the way in which the (then) new technique of multiple regression analysis could be used to estimate the parameters in systems of equations. For his part, Tinbergen presented the first system describing an entire (national) economy. Whereas Tinbergen’s approach was more pragmatic and aimed at practical results, in part driven by the economic circumstances of the 1930s, Frisch appeared to be increasingly committed to the scientific soundness of the method, while both of them always bore the social purposes of their econometric program in mind.

Ragnar Frisch “Ragnar Frisch belongs to that handful of pioneers who have brought rigorous thinking to bear on the examination of economic data and so have begun a transformation of all economics with respect to the standards of scientific inquiry”, so the Nobel laureate in economics Kenneth Arrow wrote in an article devoted to Frisch’s work (Arrow 1960, p. 175). In fact, Frisch is widely considered a pioneer of that type of economics which established itself as the mainstream after World War II. As emphasized earlier, Frisch’s legacy (as well as Tinbergen’s), however, is not only a way of working and doing research but also a “humanitarian radicalism” (Louçã 2007, p. 23), because for him science has a moral purpose.

Biographical Note Ragnar Anton Kittil Frisch was born in Oslo on March 3, 1895, into a family that had been jewelers for generations, and he was destined to take

228

R. Marchionatti

over the family business (for a biographical profile of Frisch see Bjerkholt 1994). After finishing school he apprenticed to become a silversmith, but at the same time followed a university program in economics, a field that would become his exclusive interest. In 1916, he enrolled at the University of Oslo in the recently opened two-year economics program at the Faculty of Law, completing his degree in 1919. Between 1921 and 1924, he traveled in France, Britain, Germany and Italy in order to expand his knowledge of economics, mathematics and statistics, and after his return to Norway, he decided to pursue his scientific interests further. In 1926, he defended his doctoral dissertation in statistics. In 1927, he received a three-year Rockefeller fellowship which enabled him to spend another couple of years abroad, in France, Italy and above all in the United States. In 1928, he was appointed Associate Professor, receiving a full professorship in 1931 after a period as a Visiting Professor at Yale University at the invitation of Irving Fisher, a visit of decisive importance for the foundation of the Econometric Society. In 1932, Frisch founded the Institute of Economics at the University of Oslo (Universitetets Økonomiske Institutt ), of which he was the director of research until he retired at the age of seventy in 1965. In the early 1930s, the Institute attracted many young scholars, often physicists turned economists, including the Dane Jan Tinbergen, the Dutchman Tjalling Koopmans and the Norwegian Trygve Haavelmo, all of whom were destined to become central figures in the early decades of the econometric movement. At the same time, Frisch became the editor of Econometrica, the journal of the new-born Econometric Society—he was its editor for a period of 22 years from its first issue in January 1933, and continued to serve as chairman of the editorial board for another decade—and in this journal published a large number of articles in the period before the war (see Bjerkholt 1995, 1998). During Nazi Germany’s occupation of Norway, Frisch was arrested in October 1943 and imprisoned in concentration camps for about a year. After the Second World War, Frisch worked chiefly on macroeconomic planning. He was appointed Chairman of the United Nations Economic and Employment Commission when it was established in 1947, and in the 1950s and 1960s was involved in planning for developing countries and in mathematical optimization models. He died in Oslo on January 31, 1973.

5 Economics in the Rest of Europe

229

Frisch’s Contributions to Economics and Statistics in 1920s and 1930s: The Foundation of Econometric Research From the mid-1920s, Frisch pursued a number of fields more or less simultaneously: production theory, time series analysis, utility measurement, dynamic modeling, econometric methods and national accounts. Frisch’s early economic work (Frisch 1926) was devoted to demonstrating that marginal utility could be “quantified” as a theoretical concept, establishing a set of choice axioms from which the existence of a utility indicator could be derived. This issue was pursued further in New Methods of Measuring Marginal Utility (Frisch 1932). In his important contribution to the Cassel Festschrift, “Propagation Problems and Impulse Problems in Dynamic Economics” (Frisch 1933a), he dealt with business cycle analysis (see Bjerkholt 2007). The explanation provided in the propagation-impulse model relied on the accelerator principle and the time lags occurring between the production of consumption goods and capital goods, the latter depending on the former and adjusting itself to the former with some delay. He presented a model which reflected a suggestion by Wicksell, who had compared economic fluctuations with the movement of a rocking horse, which when hit with a stick will move rhythmically in a pattern largely independent of the stick. Frisch’s development of this idea, for which he introduced the terms propagation and impulse, was also influenced by a paper by Slutsky (Slutsky 1937 [1927]) where the Russian economist introduced the idea that erratic shocks may cause more or less regular cyclical movements. Both contributions represented the economy by a (linear) dynamic structural model exposed to stochastic shocks. Frisch’s contribution is based on the distinction between exogenous random disturbances (impulses) and the intrinsic structure or propagation mechanism whereby the economy transforms them into cyclical fluctuations. He assumes the economy to be dynamically stable so that the intrinsic structure is dampening the oscillation caused by a single shock. However, shocks occur quite frequently, so the economy keeps on fluctuating. While the amplitude of the cyclical swings is determined mainly by the strength of the exogenous impulse, the propagation mechanism accounts for the regularity of alternating movements of expansion and contraction.

230

R. Marchionatti

In the 1930s, Frisch’s work was devoted to the microeconomic issues of the consumer’s demand theory and producer’s theory (note that the terms microeconomics and macroeconomics were introduced by Frisch himself ), and to dynamic economics, particularly but not exclusively with regard to business cycle problems, and to methodological issues relating to the problems of interpretation of empirical work and statistical methodology, in his attempt to make theoretical economics quantitative: his econometric program of research consists in the unification of these different lines of interest. Ragnar Frisch coined the term econometrics in 1926: in Frisch (1926) he wrote: “Intermediate between mathematics, statistics, and economics, we find a new discipline which for lack of a better name, may be called econometrics”: Econometrics has as its aim to subject abstract laws of theoretical political economy or “pure” economics to experimental and numerical verification, and thus to turn pure economics, as far as possible, into a science in the strict sense of the word. (Frisch 1926, p. 3)

Without empirical verification, and this is the point Frisch emphasized, economics could not be a science in the full sense of the word. It is necessary to give empirical meaning to concepts through operational definitions so that they can be measured, and to formulate economic relationships so that they can be tested against observations. In this neopositivistic program of research, the work of the mathematical school, in Pareto’s perspective in particular, had to be continued from the theoretical and statistical standpoint. Four years later, Frisch made an essential contribution to founding the Econometric Society and then became editor of the associated journal Econometrica whose aim was: to promote studies that aim at a unification of the theoretical-quantitative and the empirical-quantitative approach to economic problems and that are penetrated by constructive and rigorous thinking similar to that which has come to dominate in the natural sciences. (Frisch 1933b)

From this perspective, the natural sciences’ “rigorous thinking” is thus an ideal for economics to emulate. In his 1931 inaugural lecture at

5 Economics in the Rest of Europe

231

the University of Oslo, entitled “New Orientation of Economic Theory. Economics as an Experimental Natural Science” (Frisch 1995 [1931]), Frisch maintained that the weak point of neoclassical economics had been that its theories were not suitable for statistical verification, thus permitting the emergence of the schools he considered anti-theoretical— German historicism and American institutionalism. As a consequence, according to Frisch, the necessary transformation of economics into an experimental science had been delayed, but it was time, he stressed, to enter a new phase. In 1933, after the foundation of the Econometric Society, Frisch was invited by the Poincaré Institute in Paris to give a series of lectures on Problèmes et Méthodes de l’Econométrie [The problems and methods of econometrics] (Frisch 2009 [1933]). Here, again, quantification was at the center of Frisch’s program: in his introductory words in Paris he states: The attempt at quantification in econometrics comprises two aspects of equal importance. First, we have the axiomatic aspect, i.e., an abstract approach which consists of establishing as far as possible logical and quantitative definitions and constructing from the definitions a quantitative theory of economic relations. Then we have the statistical aspect, where we use empirical data. We try to fill the boxes of abstract quantitative relationships with real numerical data. We try hard to show how the theoretical laws manifest themselves at present in this or that industry or for this or that consumption category, etc. The true unification of these quantitative elements is the foundation for econometrics. (Frisch 2009 [1933], Lecture 1)

A new methodology for connecting theoretical and empiricalquantitative analysis: this is econometrics for Frisch.

Frisch and the Establishment of the Econometric Society and Econometrica Frisch deserves more credit than anyone else for the creation of an econometric association and founding its journal. In 1926, he tried to involve other economists in the effort (on this story see Louçã 2007). The first

232

R. Marchionatti

colleagues involved were Europeans: Ladislau von Bortkiewicz, Arthur Bowley, Eugen Slutsky and François Divisia (on Divisia see Chap. 5.4). The next step was in 1927, when Frisch arrived in the United States and met Irving Fisher, Joseph Schumpeter (at that time at Harvard) and the mathematician Charles Roos (on Roos see Chap. 6.4). He and Roos co-authored a memorandum which promoted rigorous quantification in economics. They wrote: Two important features in the modern economic development are the application of mathematics to abstract economic reasoning … and the attempt at placing economics on a numerical and experimental basis by an intensive study of economic statistics. Both these developments have a common characteristic: they emphasize the quantitative character of economics. This quantitative movement in our estimation is one of the most promising developments in modern economics.

The memorandum sparked curiosity and sympathy but, as Louçã (2007, p. 28) writes, received “only tentative support”. It was not until Schumpeter and Fisher adhered to the movement that “it became a force” (ibid.). Back in Europe, Frisch involved many other economists. Returning to the United States at the beginning of 1930 as a Visiting Professor at Yale, Frisch worked together with Fisher and Roos to organize the foundational meeting of the Econometric Society, which took place on December 1930 in Cleveland, Ohio—Cleveland was chosen as the meeting’s venue, as the American Economic Association, the American Statistical Association and the American Mathematical Society were holding their annual meeting there. The meeting was held under the presidency of Schumpeter. Sixteen men, including Frisch, Roos, Harold Hotelling, Frederick Mills, Henry Schultz and Karl Menger, decided upon the foundation of the Econometric Society. The conference elected ten men to the first council of the Econometric Society: Fisher, Roos and Wilson, from the United States; and Frisch, Schumpeter, Amoroso, Bortkiewicz, Bowley, Divisia and Zawadzki from Europe. Fisher, who was not present at the meeting, was elected president of the Society and Divisia vice-president. According to its constitution, the Econometric Society was “an international society for the advancement of economic

5 Economics in the Rest of Europe

233

theory in its relation to statistics and mathematics”. Its main object was, as said before, “to promote studies that aim at a unification of the theoretical-quantitative and the empirical-quantitative approach to economic problems and that are penetrated by constructive and rigorous thinking similar to that which has come to dominate in the natural sciences”. In the following years, the Society organized regular conferences and meetings in Europe and in the United States, and, from 1933, published the journal Econometrica. The first meeting was held in Lausanne September 1931 and was conceived of as an evocation of Walras. Frisch organized the program, and also gave three of the nineteen papers, plus the opening address and the closing address. The speakers included Pasquale Boninsegni, Jacob Marschak, Jan Tinbergen and other European economists. The US econometricians met at Washington and New Orleans later the same year. The following European conference was organized in Paris in 1932. Two of the subsequent conferences were particularly noteworthy. First, the conference held in Leiden in 1933, organized by Tinbergen and dealing with business cycle analysis: there Frisch presented his “Propagation Problems and Impulse Problems in Dynamic Economics”—discussed by Machlup, Koopmans, Kalecki, Divisia and Schultz—and Kalecki presented the first outline of his cycle model. Second, the conference held in Oxford in 1936, described by Frisch as being “the best so far”, where Meade, Hicks and Harrod presented their models based on Keynes’s General Theory. It was harder to create the journal, since it required financing. This problem was solved in 1933, when, thanks to the financial support of the American businessman Alfred Cowles it was possible to launch the new journal, Econometrica. The idea of a journal had been first put forward by Frisch in a letter to Divisia in 1926, in which he tried to enlist his support for a new organization and a journal. In the letter, Frisch noted that journals like the Economic Journal and Revue d’Economie Politique occasionally accepted mathematical papers, but authors were required to refrain as much as possible from mathematical language and reasoning. Econometrica’s first issue appeared in January 1933. Frisch took over

234

R. Marchionatti

editorial duties from 1933 until 1955. In 1942, when the war interrupted communications with Europe, Oskar Lange was appointed acting editor and Frisch resumed his position in 1946. As Louçã writes At least for the first decade of the journal’s existence, Frisch was the sole driving force behind its publication: he set the agenda, corresponded with the authors, asked for articles, was the referee in most cases, discussed the papers and made suggestions, and, finally, decided on publication, changed the notation for coherence and even corrected the galley proofs. (Louçã 2007, p. 37)

In fact, for the first decade of its existence, Frisch’s activity is indistinguishable from the journal’s development. Econometrica became one of the leading journals in the profession and fully accomplished its role as a pillar for the development of the econometric movement. At the same time, another initiative in the field of econometrics was also under consideration: the creation of a research center at Colorado Springs, the Cowles Commission for Economic Research. Indeed, the key to the success of the econometric movement was this virtuous combination between the various workings of the Society, namely its conferences, the publication of the journal and the creation of the Cowles Commission as a permanent research facility (see Chap. 6.4).

Jan Tinbergen According to the Nobel Prize winner in economics James Tobin, Jan Tinbergen may be considered “the twentieth century’s economist par excellence” (Tobin 1997, p. 514): Jan Tinbergen’s life and work spanned the twentieth century. He was this century’s own economist, probably the most substantial contributor to the remarkable advances in economic science that occurred in these years … His scientific training led him to think of markets and economies as systems of algebraic equations linking economic variables to each other,

5 Economics in the Rest of Europe

235

and to estimate statistically the parameters of these equations. This pathbreaking methodology is what became known as econometrics. (ibid., pp. 511–512)

Lars Peter Hansen, in an appraisal of Tinbergen’s contributions to economics on the occasion of the Nobel prize, called Tinbergen “a truly Schumpeterian figure in economics” (Hansen 1969, p. 336) who was able to develop economics in many different directions: he was a pioneer of econometrics and contributed decisively both to founding empirical macroeconomics and to creating the modern techniques of economic forecasting, as well as the theory of economic policy. “It remains only to be said”, Hansen writes, that the humanitarian idealism which Nobel wanted to reward has no representative in our profession so fine and noble as Jan Tinbergen. As much as he is respected in the privileged world, he is beloved by the underprivileged, the underdogs. Always at their service, always on their side, always working on improving their conditions, Tinbergen would be an equally worthy candidate for the Nobel Peace Prize. (ibid.)

Biographical Note Jan Tinbergen was born on April 12, 1903, in the Hague, Netherlands. He was the oldest son in an intellectually gifted family: his father, Dirk Tinbergen, was a high school teacher and a linguist, his brother Nikolaas was a famous ethologist who won the Nobel Prize for physiology in 1973 and his youngest brother Luuk was a well-known ornithologist. From 1921 to 1926, Tinbergen studied mathematics and physics at the University of Leiden, the oldest Dutch university, which in the 1920s had gained an international standing, especially in physics. Tinbergen’s education in that highly stimulating environment—with physicists like Paul Ehrenfest, Albert Einstein and Niels Bohr—was of great importance in his approach to theoretical and practical economic problems when he left physics for economics during the great depression, deeply upset by the social problems exacerbated by the crisis—in fact, Tinbergen had strong political interests, and in 1923 had become a member of

236

R. Marchionatti

the Dutch Labor Party. After completing his undergraduate degree, Tinbergen continued to study at Leiden for his doctorate under Ehrenfest’s supervision. In the meantime, he was called up for military service, but because of his political views, he did government service instead as a conscientious objector: he was assigned first to an administrative position at Rotterdam State prison, and then transferred to the Dutch government’s Central Bureau of Statistics in The Hague. When he completed his service in 1928, the head of the Bureau offered him a permanent position. Tinbergen accepted but before entering the Bureau he completed work on his doctoral dissertation in mathematical economics entitled “Minimumproblemen in de natuurkunde en de economie” (Minimization Problems in Physics and Economics). It had two appendices, the first describing applications of mathematics to physics, the second giving applications to economics—here he developed his idea of mathematical modeling. Tinbergen received his doctorate in 1929, and then joined the Dutch Central Bureau of Statistics where he served as a statistician for ten years, developing a strong interest in policy planning. He was put in charge of the unit for business cycle research. Jolink (1992) writes that Tinbergen was influenced at that time by the German business cycle research institutes and gradually developed an empirical approach to dynamic problems in economics, at the same time surrounding himself with young engineers, mathematicians and physicists, who shared the need for a rigorous approach to the issue. In 1933, he was appointed adjunct Professor (then full professor) of Mathematics and Statistics at the Netherlands School of Economics (later Erasmus University) in Rotterdam, where he stayed until his retirement in 1973. In 1936, he completed his first econometric work, a model of the Dutch economy. In the period 1936–1938, he served as consultant at the League of Nations in Geneva—he was given two years leave of absence from the Central Bureau of Statistics—to test empirically the cycle theories reviewed by Gottfried Haberler at the request of the League in his Prosperity and Depression (1937). By 1938, Tinbergen and his team had completed a macro-econometric model of the United States economy from 1919 to 1932. Under the supervision of Alexander Loveday, director of the Financial and Economic Intelligence Service of the League of Nations at Geneva, the results of the research were published in two volumes

5 Economics in the Rest of Europe

237

under the title Statistical Testing of Business Cycle Theories, Tinbergen’s most important work in the 1930s. In decade between 1945 and 1955, Tinbergen contributed to founding the modern theory of economic policy as the Director of the Central Planning Bureau. From the midFifties, Tinbergen devoted himself almost exclusively to the methods and practice of planning for long-term development, in particular of underdeveloped countries, and international economic cooperation. His final academic appointment, in 1973, was as Professor of International Cooperation at the University of Leiden. He died in June 9, 1994, in the Hague.

Tinbergen’s Contributions to Business Cycle Analysis The explanation of cyclical movements was the core of Tinbergen’s work in the 1930s (see Van Der Linden 1988), starting from his 1927 paper “Over de Mathematies-Statistiese Methoden voor Konjunktuuronderzoek” (On Mathematical-Statistical Methods of Business Cycle Research) (Tinbergen 1927), where he criticized the business research by the Harvard Committee on Economic Research and the Berlin Institut für Konjunkturforschung, which was based on the construction of socalled barometers to forecast business cycles, for not being based on any kind of theory of causation. Tinbergen outlined a “quantitative business cycle theory” (see Tinbergen 1935) to explain the generation of the movements of economic variables, or the system of relations existing between the variables—the structure of the economic system. At least one of these relations, Tinbergen emphasized, must be dynamic— i.e., a relation between variables that relates to different moments of time—obtained by introducing lag terms, or other dynamic relations, containing differentials and integrals, which generate endogenous fluctuations. The mathematical form suggested possible movement schemes, or possible business cycle mechanisms, to be statistically verified. Tinbergen’s first empirical contribution was the construction, in 1936, of a 24-equation model for the Dutch economy as a whole, the prototype for the later models of the Dutch Central Planning Bureau. Undoubtedly, Tinbergen’s great contribution was his empirical macroeconomic

238

R. Marchionatti

model—in fact we can say that empirical macroeconomics was founded by this work—and statistical theory testing of business-cycle research, commissioned by the League of Nations and published in 1939 under the title Statistical Testing of Business-Cycle Theories. The work resulted in the two volumes, A Method and Its Application to Investment Activity, and Business Cycles in the United States of America, 1919–1932. The first volume of the report contained an explanation of the method of econometric testing and a demonstration of what could be achieved in three case studies. In Chap. 1, Tinbergen distinguished the role of the statistician from that of the economist. The latter hands over the theories to the statistician for examination. This means that the “responsibility” for the theories lies with the economist. As a consequence, “the sense in which the statistician can provide ‘verification’ of a theory is a limited one” (Tinbergen 1939a, p. 12). On the other hand, the role of the statistician is not confined to “verification”, Tinbergen writes, but extends to the discovery of what causes are operative and how strongly each of them operates. This is the problem of “measurement”. Second, Tinbergen defined the form in which an economic theory must be expressed in order to be verified. This form must be quantitative form, which restricts the inquiry to the examination of measurable phenomena. Moreover, in order to inquire about the business cycle, it must be a dynamic theory. It must be one which “deals with the short-term reactions of one variate upon others but without neglecting the lapse of time between cause and effect” (ibid., p. 13). The equation in which it is expressed relates to nonsimultaneous events: the form taken is described as “sequence analysis”. To the extent that the additions to static theory are the result of statistical research, we can say that “the statistician may supply theoretical suggestions to the economist” (ibid., p. 14). In Chap. 2, Tinbergen outlined the technical method of multiple correlation analysis by applying it to an economic business cycle theory translated into a parametrized mathematical-economic model. He then tested for the plausibility of the parameter estimates. Lastly, he checked the outcomes generated by the system as a whole to see whether a theory provides a business cycle mechanism or not. Tinbergen was interested in testing the economic importance of results. Specifically, he investigated whether particular effects have a plausible sign and are quantitatively important. If so,

5 Economics in the Rest of Europe

239

significance tests were used to assess the statistical accuracy of estimates. In Chap. 3, Tinbergen discussed the results obtained in applying the method to the relation and indicated the proximate objective causes of changes in investment activity “looked at from the side of entrepreneurs and public authority” (ibid., p. 34). The analysis presented three case studies—on general investment, investment in residential building and in railway rolling stock. In the second volume, Tinbergen sets up a complete macro model for the United States economy in the form of a system of 48 difference equations and definitional relations. The book was considered an important innovation in business cycle theory, as well as an innovative contribution from the point of view of testing procedures (Morgan 1990). As Hansen (1969, p. 328) emphasized, the model “represented a decisive break with the past” in some respects: first, Tinbergen considered the cycle “a unified, single phenomenon to be explained by the properties of a complete dynamic model”, and second, he demonstrated that it was possible to describe an economy in quantitative terms “in such a way that not only may developments of the past be better understood, but also that forecasts of future developments may be made and policies calculated which modify future developments in a desired direction” (ibid.). Tinbergen’s work had a significant impact in the economists’ debate on econometrics, above all the first volume on the methodology “proved highly controversial” (Morgan 1990, p. 121). In particular, the volume drew serious criticism from Keynes, with whom Tinbergen had an extremely important methodological controversy about the applicability of regression analysis to economic material on the pages of the Economic Journal (see Chap. 7.3).

5.4

Economics in France, Italy and the USSR

Economics in France The French situation between the two world wars is characterized on the one hand by the slackening of the previous period’s strong opposition between the liberal school, represented by the group around the Journal

240

R. Marchionatti

des economists, and the heterodox group around the Revue d’èconomie politique—the latter becoming more open to liberals “in accordance with the principle of methodological and ideological eclecticism” (Le VanLemesle 1998, p. 88)—and on the other hand by the development and increasing international significance of the group of engineer-economists of the Grandes Écoles, in particular the students of Clément Colson (see Vol. I, Chap. 6.3) at the École Nationale des Ponts et Chaussées, François Divisia and René Roy.5 François Divisia (1889–1964) was Colson’s student and then collaborator (on Divisia see Roy 1965). He succeeded him as Professor of Political and Social Economics at the École Nationale des Ponts et Chaussées in 1926 and at the École Politechnique in 1929. After publishing an important contribution in the field of monetary economics in the Revue d’économie politique in 1925 and 1926, where he introduced the “Divisia Index” to measure monetary aggregates, in 1928, Divisia published L’économie rationelle, a book which had considerable success in France and argued that rigorous economic analysis is the result of applying mathematics in combination with experimental verification. This made him a promoter of the econometric approach in France: he was associated from 1926 with Irving Fisher’s and Ragnar Frisch’s project to create an econometric society, becoming the Society’s vice-president in 1933, president in 1935, and a member of the editorial committee of Econometrica in 1933. In fact, the spread of the econometric approach in France increased during the Depression, as is also shown by the role of X-Crise, a society founded in 1931 by graduates of the École Politecnique—the most famous being Robert Gibrat (1904–1980) (on Gibrat see Armatte 1998, 2018)—which applied mathematical methods to current economic problems (see Fischman and Lendjel 2000) and by the attempt by Divisia to organize an econometrics laboratory at the CNRS (see Le Van-Lemesle 1998). Last but not least, we should mention René François Joseph Roy (1894–1977), who played an important role in spreading econometrics in France (see Allais 1988). After 5 We should also mention Maurice Allais (1911–2010). He undoubtedly was one of the most outstanding economists of his generation, but, although he began to publish economic studies in the early 1940s, it is from 1945 onwards that he had a decisive influence on the development of economic research in France and abroad.

5 Economics in the Rest of Europe

241

his studies at the École Polytechnique and then at the École Nationale des Ponts et Chaussées, he was appointed in 1931 to the Chair of Econometrics at the Institut de Statistiques de l’Université de Paris (Paris Institute of Statistics), a graduate school founded in 1922 by the mathematician Émile Borel (1871–1956). Starting in 1947, he led a famous econometrics seminar at the Centre National de la Recherche Scientifique for many years until his retirement in the 1960s.

Economics in Italy By 1914, economic science in Italy had achieved a high level due principally to the work in pure economics by Pantaleoni, Pareto, Barone and the Paretian school, and secondly to efforts in applied economics, of which the work of Luigi Einaudi and his Turin school was a remarkable example (see Vol. I, Chap. 6.3). The period after the war was in general a period of consolidation of the discipline. In addition to the two centers in Turin and Rome, programs were launched in other public universities as well as the two private schools in Milan, Bocconi University and the Catholic University, while several new journals joined the two major ones in the field, Giornale degli Economisti and Riforma Sociale. At the same time, the death of the three leaders, Pareto, Pantaleoni and Barone, who left behind several worthy successors in their great tradition, but no one of the same theoretical mettle, weakened Italian economics on the whole—Faucci (2000) aptly defined this period as the “silver age” of Italian economic science, as opposed to the previous “golden age”. Italian economics between the two world wars was essentially a bulwark of traditional orthodoxy, with a generally negative attitude to new ideas, Keynes’s in particular, and determined to develop economic theory along the neoclassical mainstream established in the pre-war years. In this context where, as Schumpeter wrote, scientific economics continued to move at a high level until the war, we have important contributions by many economists who were already active in the previous period. Marco Fanno (1878–1965), Costantino Bresciani-Turroni (1882–1963) and Attilio Cabiati (1872–1950) did valuable work in international

242

R. Marchionatti

monetary economics (see Meacci 1998), while Luigi Einaudi (1874– 1961) (see Forte and Marchionatti 2010) made contributions in public finance and in developing a methodological view of economics as a historical-theoretical science, an approach in which economic theory was considered the result of the fruitful interlacing of pure theory and historical and applied analysis, in a neoclassical perspective—a synthesis of the thought of the major economists of the previous period reinforced by the contributions of the new exponents of the old Cambridge school, of the neo-Austrian school and German neoliberalism. In the field of pure economics, the most interesting contributions came from the Paretian School. Its main line of research, pursued chiefly during the 1930s, concerned dynamic equilibrium (see Pomini 2009; see also Pomini 2012), a subject which Pareto, while emphasizing its importance, did not develop, except for the theory of economic crisis. His Italian disciples’ main objective centered on the dynamization of general economic equilibrium. Here, the most important proponent was Luigi Amoroso.6 Luigi Amoroso (1886–1965) (see Keppler 1994), a mathematician by training, became interested at an early stage of his academic career in mathematical economics, where he was influenced by Pantaleoni’s lectures and by reading Pareto’s work. He became Professor of Political Economy at the University of Rome in 1926. His contributions—the most important being Lezioni di meccanica economica (Lectures on Economic Mechanics) (Amoroso 1921)—like those of the Italian Paretian School, built on the epistemological and theoretical foundations of mathematical economics in the Paretian era (see Vol. I, Chap. 4), where the essential reference was rational mechanics and the main question was going beyond the limits of static equilibrium and dealing with the issue of dynamic equilibrium. As Pomini (2009, p. 68) writes, his “epistemological project found its more complete expression in the energetic interpretation of the productive process, as expounded in Meccanica Economica (Economic Mechanics) (1942)”. Notwithstanding the undeniable developments on the mathematical side—in particular in the use of variational calculus to construct a formal dynamic model—this approach was far removed 6 Two other minor economists who contributed to this theoretical construction were Giulio La Volpe (1909–1996) and Giuseppe Palomba (1908–1986).

5 Economics in the Rest of Europe

243

from Frisch and Tinbergen’s new conceptions of economic dynamics and alien to the mathematical developments originating in Vienna. Focusing chiefly on essentially formal issues, with only limited interest in the problems connected with the relationship between mathematical expression and experimental reality, it had little impact abroad and was gradually marginalized in Italy as well. As regards international relationships, however, it should be emphasized that the Italian Paretians were involved in the creation of the econometric movement. Amoroso—with Gustavo Del Vecchio (1883–1972), Alfonso De Pietri Tonelli (1883–1952) and Corrado Gini (1884–1965)—was among the invitees to the foundational meeting of the Econometric Society in 1930, was elected to its first council, and became a fellow of the society in 1933.7 In the second part of the 1930s, the freedom of economic research and academic teaching was restricted. Many economists were removed from the university and some emigrated, in particular when the racial laws were promulgated in 1938: this is the case of Gustavo Del Vecchio, Riccardo Bachi (1875–1951) and Einaudi’s pupil Renzo Fubini (1904– 1944), later killed at Auschwitz. As early as the 1920s, two other economists chose to emigrate: Umberto Ricci (1879–1946), dismissed in 1928 from his teaching position, and the young Piero Sraffa who moved to Cambridge where he had a major role in the criticism of Marshallian theory and in the construction of the new Cambridge School (see Chap. 2).

Economics in the Soviet Union Schumpeter (1954, p. 1123) writes that in the Soviet Union (which he still calls Russia) between 1917 and 1927 “scientific research itself, not only discussion of policies, was regimented in a manner unheard of in Germany or Italy [the other “totalitarian countries]”. This was due, according to Schumpeter, not only to the nature and methods of the Bolshevist administration but also to ideological and political reasons. 7 Several other Italians were elected fellows of the Society in the 1930s, including Pasquale Boninsegni, Pareto’s successor at Lausanne (see Vol. I, Chap. 4), Gustavo Del Vecchio, Corrado Gini, Umberto Ricci and Costantino Bresciani-Turroni.

244

R. Marchionatti

Nevertheless, he writes, “the break was not complete” (ibid.). First of all, Schumpeter recognizes that the work of Marxists like Nikolai Ivanovich Bukharin (1888–1938), of Austro-Marxian formation, and Yevgeni Alekseyevich Preobrazhensky (1886–1937), was “genuinely analytic work” (ibid., p. 1124). The mere existence of the Marx-Engels Institute, Schumpeter writes, testified that there was “genuinely scholarly work” (ibid.). The Institute was set up by the Marxist David Riazanov (1870– 1938) in 1921 and had in Isaak Il’ich Rubin (1886–1937), a student of Tugan-Baranowsky and later Professor at the University of Moscow, its most important researcher. Rubin worked on the first collected works of Marx and Engels in German and Russian translation—the so-called Marx-Engles-Gesamtausgabe (MEGA)—and wrote influential essays on Marx’s theory of value. Indeed, the 1920s were years in which the debate, although “constrained” in the Marxist language, was quite free and original (see, e.g., Spulber 1964): according to Barnett (2005, p. 113), the period was “the heterodox decade par excellence in the USSR with respect to the range of different currents that were represented”. This theoretical work developed in the many new research institutes— for statistical research, research in agricultural economics and for business cycles analysis. In 1918, the Central Statistical Bureau was created: it hosted economists and statisticians like Pavel Illich Popov (1872–1950) and Lev Nikolaevich Litoshenko (1886–1943), pioneers in the construction of material balances of the national economy (essentially primitive input–output tables), on which the first attempts at planning were based using an analysis framework drawing on Quesnay’s Tableau Economique and Marx’s reproduction schemes. A simple input–output model for agriculture was developed by Alexander Vasil’ievich Chayanov (1888–1937), agrarian economist and professor at the Moscow Agrarian Academy, who for more than ten years led an agricultural economics seminar, later renamed the Research Institute of Agricultural Economics. In 1925 he published a book entitled Organizatsiya krest’yanskogo khozyaistva (translated in English in 1966 as The Theory of Peasant Economy), a major contribution to peasant studies and development economics. But the most famous economist in this period was probably Nikolai Kondratieff (1892–1938). Schumpeter writes that “Kondratieff ’s work … caused a

5 Economics in the Rest of Europe

245

great stir and constitutes, so far as I can make out, the peak performance of the work produced by a considerable number of competent economists” (ibid.).8 A student of Tugan-Baranowsky at the University of St Petersburg, Minister of Supply in the last Kerensky government in 1917, which only lasted for a few days, Kondratieff was appointed in 1919 to a teaching post at the Agricultural Academy of Peter the Great, and in October 1920 he founded and directed the Conjuncture Institute of Moscow. The institute had links with several foreign research centers, such as the Harvard Economic Service and the National Bureau of Economic Research (NBER) in the USA, and several other sister institutes throughout Europe. Kondratieff formulated his theory of the business cycle on the basis of detailed empirical studies, which applied modern statistical technique to the analysis of time series, and argued, à la Marx, that crises are “organically” part of capitalism (see Barnett 1998). In particular, Kondratieff suggested the existence of a long cycle of about fifty years—the “Kondratieff cycle” as Schumpeter called it. The results of his studies were published in Russian and German journals and in books mainly between 1922—in his 1922 book Kondratieff formulated for the first time the basic tenets of the theory of long cycles (Kondratieff 1992 [1922])—and 1928 and had an immediate international impact.9 Kondratieff was among the first to be invited to the Econometric Society and in 1933 was elected a fellow. Another of the first scholars invited to join the Econometric Society was Evgeny Slutsky (see Vol. I, Chap. 4.3), who had been at the Conjuncture Institute under Kondratieff since 1926. In 1927, he published an important paper (in Russian) where he suggested that the cycles were a consequence of a sequence of disturbances, the cumulative effect of random elements. The paper remained largely unknown for a decade, until Frisch made it internationally available by publishing it in Econometrica in 1937 (Slutsky 1937 [1927]). 8 Schumpeter cites three of them: Sergei Alekseevich Pervushin (1888–1966), Professor at Moscow State University, Dmitriy I. Oparin (1891–1978) and Grigori Yakovlevich Sokolnikov (1888–1939) (see Owen 2009; Oppenheim 1989). 9 They were partially translated and published in German in Archiv fur Sozialwissenschaft und Sozialpolitik and in English in the Quarterly Journal of Economics and in The Review of Economics and Statistics. A large selection of Kondratieff ’s works in English is published in Makasheva et al. (1998).

246

R. Marchionatti

As Schumpeter writes, “serious economics survived until the rigors of the Stalinist regime fully asserted themselves. Then the break occurred after all” (p. 1124). Actually, few among the above mentioned economists survived Stalin’s purges—the exceptions being Slutsky and Popov who died from natural causes, respectively, in 1948 and in 1950— and their destiny was as tragic as that of a great number of Russian intellectuals of this period. From 1930 onwards, they were arrested and imprisoned for their unorthodox theoretical and political views and, like many of their colleagues in different institutes and organizations, were eventually killed. Chayanov and Rubin were executed in 1937, Riazanov and Kondratiev in 1938, Bukharin and Preobrazhensky, both important members of the Communist Party, were executed, respectively, in 1937 and 1938, while Litoshenko died in a labor camp in 1943.

References Allais, Maurice. 1988. La théorie des choix dans l’œuvre de René Roy une analyse critique. Revue d’économie politique 98 (3): 315–357. Amoroso, Luigi. 1921. Lezioni di economia matematica. Bologna: Zanichelli. ———. 1942. Meccanica economica: lezioni tenute nell’anno accademico 1940– 41. Città di Castello: Unione Arti Grafiche. Armatte, Michel. 1998. Robert Gibrat and the Law of Proportional Effect. In European Economists of the Early 20th Century, ed. Warren J. Samuels, vol. I, 94–111. Northampton: Edward Elgar. ———. 2018. Que représentait Robert Gibrat (1904–1980) au Congrès international de philosophie scientifique de 1935? Philosophia Scientiæ 22 (3): 135–157. Arrow, Kenneth J. 1960. The Work of Ragnar Frisch, Econometrician. Econometrica 28 (2): 175–192. Barber, William J. 2008. Gunnar Myrdal: An Intellectual Biography. London: Macmillan. Barnett, Vincent. 1998. Kondratiev and the Dynamics of Economic Development. London: Palgrave MacMillan. ———. 2005. A History of Russian Economic Thought. London: Routledge.

5 Economics in the Rest of Europe

247

Baumol, William J. 1990. Erik Lundberg, 1907–1987. The Scandinavian Journal of Economics 92 (1): 1–9. Bjerkholt, Olav. 1994. Ragnar Frisch 1895–1995. Statistics Norway Research Department. ———. 1995. Ragnar Frisch, Editor of Econometrica 1933–1954. Econometrica 63 (4): 755–765. ———. 1998. Ragnar Frisch and the Foundation of the Econometric Society and Econometrica. In Econometrics and Economic Theory in the 20th Century: The Ragnar Frisch Centennial Symposium, ed. Steiner Strøm, 26–57. New York: Cambridge University Press. ———. 2007. Ragnar Frisch’s Business Cycle Approach: The Genesis of the Propagation and Impulse Model. The European Journal of the History of Economic Thought 14: 449–486. Boianovsky, Mauro, and Hans-Michael. Trautwein. 2006. Price Expectations, Capital Accumulation and Employment: Lindahl’s Macroeconomics from the 1920s to the 1950s. Cambridge Journal of Economics 30: 881–900. Brems, Hans. 1978. What Was New in Ohlin’s 1933–34 Macroeconomics? History of Political Economy 10 (3): 398–412. Carlson, Benny, and Mats Lundahl. 2017. Ingvar Svennilson on Economic Planning in War and Peace. History of Economic Ideas 25 (2): 115–138. Caves, Richard E. 1978. Bertil Ohlin’s Contribution to Economics. The Scandinavian Journal of Economics 80 (1): 86–99. Chayanov, Alexander V. 1925. Organizatsiya krest’yanskogo khozyaistva. Moscow; translated in English in 1966 as The Theory of Peasant Economy, ed. Daniel Thorner, Basile Kerblay, and R.E.F. Smith. Homewood, IL. Chipman, John S. 1966. A Survey of the Theory of International Trade: Part 3, The Modern Theory. Econometrica 34 (1): 18–76. Dekker, Erwin. 2019. Entangled Economists: Ragnar Frisch and Jan Tinbergen. Erasmus Journal for Philosophy and Economics 12 (2): 65–85. Divisia, François. 1928. L’économie rationnelle. Paris: Gaston Doin et Cie. Dostaler, Gilles. 1990. An Assessment of Gunnar Myrdal’s Early Work in Economics. Journal of the History of Economic Thought 12: 197–221. Faucci, Riccardo. 2000. L’economia politica in Italia. Torino: UTET Libreria. Findlay, Ronald, Lars Jonung, and Mats Lundahl, eds. 2002. Bertil Ohlin: A Centennial Celebration, 1899–1999. Cambridge: MIT Press. Fischman, Marianne, and Emeric Lendjel. 2000. La contribution d’X-crise à l’émergence de l’économétrie en France dans les années trente. Revue Européenne Des Sciences Sociales 38 (118): 115–134.

248

R. Marchionatti

Forte, Francesco, and Roberto Marchionatti. 2010. Luigi Einaudi’s Economics of Liberalism. The European Journal of the History of Economic Thought 19 (4): 587–624. Frisch, Ragnar. 1926. Sur un Problème d’Economie Pure. Norsk Matematisk Forenings Skrifter, Series 1 (16): 1–40. ———. 1932. New Methods of Measuring Marginal Utility. Tübingen: Verlag von J. Siebeck. ———. 1933a. Propagation Problems and Impulse Problems in Dynamic Economics. In Economic Essays in Honour of Gustav Cassel , 171–205. London: Frank Cass. ———. 1933b. Editorial. Econometrica 1 (1): 1–4. ———. 1970a. From Utopian Theory to Practical Applications: The Case of Econometrics. Réimpression de Les Prix Nobel en 1969, 213–243. ———. 1970b. Econometrics in the World Today. In Induction, Growth and Trade: Essays in Honour of Sir Roy Harrod , ed. Walter A. Eltis, Maurice FitzGerald Scott, and J.N. Wolfe, 152–166. Oxford: Clarendon Press. ———. 1995 [1931]. New Orientation of Economic Theory: Economics as an Experimental Science (Inaugural Lecture, University of Oslo). In Foundations of Modern Econometrics: The Selected Essays of Ragnar Frisch, ed. Olav Bjerkholt, vol. II, 481–495. Aldershot, UK: Elgar. ———. 2009 [1933]. The Philosophical Foundations of Econometrics. The Axiomatic Method. Utility as Quantity. In Problems and Methods of Econometrics: The Poincaré Lectures of Ragnar Frisch, 1933, ed. Olav Bjerkholt and Ariane Dupont-Kieffer. London: Routledge. Hansen, Bent. 1969. Jan Tinbergen: An Appraisal of His Contributions to Economics. The Swedish Journal of Economics 71 (4): 325–336. Hansson, Björn. 1982. The Stockholm School and the Development of Dynamic Method . London: Croom Helm. Heckscher, Ely F. 1919. Utrikshandelns verkan pa inkomstfoerdelningen. Ekonomist Tradskrift 2: 1–32. English translation: The Effect of Foreign Trade on the Distribution of Income. In Readings in the Theory of International Trade, ed. Howard S. Ellis and Lloyd A. Metzler, 272–300. Philadelphia: Blakiston, 1949. Hicks, John R. 1934. Review of Beiträge zur Geldtheorie by F. A. von Hayek. Economica 1 (4): 479–486. Jolink, Albert. 1992. “No Man Is an Island” the Case of Jan Tinbergen, Editing Economists and Economists as Editors. Revue européenne des sciences sociales 30 (92): 261–277.

5 Economics in the Rest of Europe

249

Keppler, Jan Horst. 1994. Luigi Amoroso (1886–1965): Mathematical Economist, Italian Corporatist. History of Political Economy 26 (4): 589– 611. Keynes, John Maynard. 1973. The General Theory and After: Part II, Defence and Development, vol. 14 of The Collected Writings of John Maynard Keynes. London: Macmillan. Kondratieff, Nikolai. 1992 [1922]. The World Economy and Its Conjunctures During and After the War. Vologda: Regional Branch of the State Publishing House. Le Van-Lemesle, Lucette. 1998. François Divisia, a Pioneer Responsible for the Integration of Mathematical Method into French Economics. In European Economists of the Early 20th Century, ed. Warren J. Samuels. Cheltenham: Edward Elgar. Lindahl, Erik. 1939. Studies in the Theory of Money and Capital . London: Allen & Unwin. Louçã, Francisco. 2007. The Years of High Econometrics: A Short History of the Generation That Reinvented Economics. London: Routledge. Lundberg, Erik F. 1937. Studies in the Theory of Economic Expansion. London: P. S. King and Son. Reprints of Economic Classics. New York: A. M. Kelly, 1955. ———. 1972. Ingvar Svennilson: A Note on His Scientific Achievements and a Bibliography of His Contributions to Economics. The Swedish Journal of Economics 74: 313–328. ———. 1996. The Development of Swedish and Keynesian Macroeconomic Theory and Its Impact on Economic Policy. Raffaele Mattioli Lectures. Cambridge: Cambridge University Press. Makasheva, Natalia, Samuels, Warren J., and Vincent Barnett, eds. 1998. The Works of Nikolai D. Kondratiev. 4 vols. London: Routledge. Meacci, Ferdinando, ed. 1998. Italian Economists of the 20th Century. Cheltenham: Edward Elgar. Morgan, Mary. 1990. The History of Econometric Ideas. Cambridge: Cambridge University Press. Myrdal, Gunnar. 1927. Prisbildningen och föränderligheten. Uppsala: Almqvist & Wiksell. ———. 1930. Vetenskap och politik i nationalekonomien. Stockholm: P.A. Norstedt. English translation: The Political Element in the Development of Economic Theory. London: Routledge & Kegan Paul, 1953. ———. 1931–1939. Om penningteoretisk jämvikt. En studie över den “normala räntan” i Wicksellspenninglära. Ekonomisk Tidskrift 33 (5 and 6)

250

R. Marchionatti

(1931): 191–302. German translation: Der Gleichgewichtsbegriffals Instrument der geldtheoretischen Analyse. In Beiträge zur Geldtheorie, ed. F.A. von Hayek. Vienna: Julius Springer, 1933. English translation: Monetary Equilibrium. London: William Hodge, 1939. ———. 1957. Economic Theory and Under-Developed Regions. London: Gerald Duckworth. ———. 1968. Asian Drama: An Inquiry into the Poverty of Nations. New York: Twentieth Century Fund. Ohlin, Bertil. 1933. Interregional and International Trade. Harvard: Harvard Economic Studies. ———. 1937a. Some Notes on the Stockholm Theory of Savings and Investments-I. The Economic Journal 47: 53–69. ———. 1937b. Some Notes on the Stockholm Theory of Savings and Investments-II. The Economic Journal 47: 221–240. Oppenheim, Samuel A. 1989. Between Right and Left: G. Ya. Sokolnikov and the Development of the Soviet State, 1921–1929. Slavic Review 48 (4): 592–613. Owen, Thomas C. 2009. The Death of a Soviet Science: Sergei Pervushin and Economic Cycles in Russia, 1850–1930. The Russian Review 68 (2): 221– 239. Patinkin, Don. 1982. Anticipations of the General Theory and Other Essays on Keynes. Chicago: University of Chicago Press. Pomini, Mario. 2009. The Paretian Tradition of Dynamic General Equilibrium in Italy’s Interwar Period. History of Economic Ideas 17 (1): 57–83. Pomini, Mario. 2012. From Steady State to Dynamic Equilibrium: The Perspective in the Interwar Period. History of Economic Ideas 20 (2): 17–41. Roy, René. 1965. François Divisia, 1889–1964. Econometrica 33 (3): 635–640. Stolper, Wolfgang F., and Paul A. Samuelson. 1941. Protection and Real Wages. The Review of Economic Studies 9 (1): 58–73. Schumpeter, Joseph A. 1954. A History of Economic Analysis. London: Allen & Unwin. Shackle, G.L.S. 1967. The Years of High Theory: Invention and Tradition in Economic Thought 1926–1939. Cambridge: Cambridge University Press. Slutsky, Eugen. 1937 [1927]. The Summation of Random Causes as a Source of Cyclic Processes. Econometrica 5: 105–146. Spulber, Nicolas. 1964. Soviet Strategy for Economic Growth. Bloomington, IN: Indiana University Press. Svennilson, Ingvar. 1954. Growth and Stagnation in the European Economy. United Nations Economic Commission for Europe, Geneva.

5 Economics in the Rest of Europe

251

Tinbergen, Jan. 1927. Over de Mathematies-Statistiese Methoden voor Konjunktuuronderzoek. De Economist 76 (1): 711–723. ———. 1935. Quantitative Fragen Der Konjunkturpolitik. Weltwirtschaftliches Archiv 42: 366–399. ———. 1939a. Statistical Testing of Business-Cycle Theories I: A Method and Its Application to Investment Activity. Geneva: League of Nations. ———. 1939b. Statistical Testing of Business-Cycle Theories II: Business Cycles in the United States of America, 1919–1932. Geneva: League of Nations. Tobin, James. 1997. Jan Tinbergen (12 April 1903–9 June 1994). Proceedings of the American Philosophical Society 141 (4): 510–514. Trautwein, Hans-Michael. 2016. Stockholm (Swedish) School. In Handbook on the History of Economic Analysis Volume II: Schools of Thought in Economics, ed. Gilbert Faccarello and Heinz D. Kurz, 358–366. Cheltenham: Edward Elgar. Van Der Linden, J.T.J.M. 1988. Economic Thought in the Netherlands: The Contribution of Professor Jan Tinbergen. Review of Social Economy 46 (3): 270–282.

6 Economics in the United States: New York, Harvard, Chicago and Princeton

6.1

Prologue

Between the two world wars, the United States’ rise to economic and financial world leadership went hand in hand with the increasing consolidation of its centers of economic studies. In the 1920s, the process of growth in economics which had taken place in the country before World War I took firmer form. This gradual process of development saw a sudden surge in the 1930s: these were the years when theoretical thinking laid the foundations for what was to become the postwar mainstream, redefining microeconomics and macroeconomics. At the same time, there were major advances in institutional economics, which perhaps reached its peak in this period. These achievements by American economics were largely due to, or at least accelerated by, the influx of scholars from Europe. In fact, the rise of European Fascism and Nazism in the 1920s and 1930s, and, to a lesser extent, the Russian situation, caused significant numbers of intellectuals to migrate to the United States (see Craver 1986; Craver and Leijonhufvud 1987; Vaughn

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 R. Marchionatti, Economic Theory in the Twentieth Century, An Intellectual History—Volume II, https://doi.org/10.1007/978-3-030-80987-4_6

253

254

R. Marchionatti

1998, Scherer 2000, Hagemann 2005, Mongiovi 2005). Their intellectual contribution helped American universities and research centers build high-quality teaching programs and substantially increase the quality of their theoretical production.1 As Samuelson (1988, p. 319) wrote, “the triumphant rise of American economics after 1940 was enormously accelerated by importation of scholars from Hitlerian Europe”. The most important centers of economic studies in the United States were Columbia, Harvard and Chicago, which already excelled by the end of the 1890s, together with Fisher’s Yale. In New York, Columbia University became the main center of American institutionalism between the two world wars under the leadership of Wesley Mitchell, and together with the recently founded New School of Social Research and the National Bureau of Economic Research (NBER) was a hub for non-neoclassical scholars. The Harvard Department of Economics became a great intellectual community, thanks to such eminent economists as Joseph A. Schumpeter and Wassily Leontief who had arrived from Europe in the early 1930s, and the innovative work of Harvard-trained scholars like Edward Chamberlin and Edward Mason, as well as Alvin Hansen’s contribution to the development of Keynesian economics. In the other great center, the University of Chicago, the situation was quite different. Here, economics was a mix of different groups, including advocates of different conceptions of economics: alongside the precursors (in part) of the future Chicago school, like Frank Knight, Jacob Viner and Henry Simons, there were the small group of the institutionalists and the group of quantitative economists, such as the émigré economist Oskar Lange, close to the Cowles Commission for Economic Research, which moved to Chicago in the late 1930s and was a major force in the econometric revolution. Alongside these leading centers, we must add Princeton— both the university and the Institute of Advanced Studies—where two

1

The Rockefeller Foundation played an important role in these scholars’ absorption, providing financial assistance to help many émigrés resettle. Similar initiatives were fielded in England, though to a lesser extent. William Beveridge of the London School of Economics organized an Academic Assistance Council to support refugee economists financially and help them find new employment. The Oxford Institute of Statistics, with the support of the Rockefeller Foundation, was also a source of temporary employment for émigrés to Great Britain.

6 Economics in the United States: New York, Harvard …

255

other European émigrés, John von Neumann and Oskar Morgenstern, created the new field of game theory.

6.2

Economics in New York: Columbia and the New School for Social Research, and the Leadership of Wesley Mitchell (1874–1948)

Following World War I, New York consolidated its preeminence in the country’s economic and financial sectors—by the 1920s, New York had surpassed London as a world banking center—but also became a culturally international city. The age of economic prosperity ended abruptly with the Wall Street crash in 1929, but the cultural ferment continued unabated. Many factors contributed to this phenomenon, but the main movements which most characterized the process which made New York a culturally international city were the so-called Harlem Renaissance—the complex, primarily literary and musical, movement centered in Harlem and growing out of the migration of African Americans from the south of the country—and the arrival of intellectual and artistic European refugees in the 1930s. In this dynamic setting, universities and research institutions flourished. Columbia University was the most important of these institutions, and its department of economics was the main center of teaching and research in the field, while the New School for Social Research and The National Bureau of Economic Research (NBER), founded in 1919 and 1920 respectively, were also important research institutions in economics and in the social sciences more generally.

Economics at Columbia, the Main Center of Institutionalism in United States At the end of the 1890s, the Department of Economics had been a center of marginalism and neoclassicism under the leadership of John B. Clark. Clark retired in the early 1920s, but his academic production had been

256

R. Marchionatti

in decline for some years. By the end of World War I, the hard core of the old department consisted of Edwin R. A. Seligman (1861–1939), the chairman of the department, and Henry L. Moore (1869–1958), while Henry Rogers Seager (1870–1930) played a somewhat lesser part. Seligman, at Columbia since 1885, had had an important position in the American economics profession since the early 1900s, when he was also president of the American Economic Association. In the first two decades of the century he had a significant influence in the fields of taxation and public finance—“pioneer in public finance”, as Joseph Dorfman (1959) called him—as well as in economic history, areas in which he published extensively, above all contributing to making public finance a subject of theoretical and practical importance. Henry Ludwell Moore, theoretically speaking the most important of the trio, at Columbia since 1902, was a mathematical economist. Disciple of Walras and Pareto, he was particularly interested in the statistical examination of neoclassical economics. Particularly important was his attempt to connect business cycles and general economic equilibrium theory in a number of papers and his last important book Synthetic Economics (Moore 1929). His proto-econometric research program—“Moore is responsible for the introduction of the method of statistical analysis, not mere statistical description, into economic usage” (Ezekiel 1930, p. 663)—influenced several younger economists, in particular his students Paul Douglas and Henry Schultz, though they pursued that program at the University of Chicago. At the end of the 1920s, the center of gravity of the Economics Department at Columbia shifted radically. Moore retired in 1928 (for health reasons), as did Seligman in 1930 after suffering a mild heart attack. Seager died in the same year while on a visit to Eastern Europe. The department’s most representative economists became two institutionalists, Wesley Mitchell, already at Columbia before the war and now back at Columbia after a short stint at the New School for Social Research, and John Maurice Clark, the son of J. B. Clark, who had taught at the University of Chicago after his Ph.D. at Columbia, and then returned to Columbia in 1926 to assume the chair vacated by his father.

6 Economics in the United States: New York, Harvard …

257

Columbia was in fact the main center of institutionalism in the United States between the two world wars,2 the other being Wisconsin where John R. Commons (1962–1945), the author of The Legal Foundations of Capitalism (1924) and Institutional Economics (1934), taught until he retired in 1933.3 Mitchell, who had studied in Chicago where he was deeply influenced by Veblen (see Vol. I, Chap. 7.5), was the leader of an institutional school that advanced empirically based theoretical research in the field of business cycles principally developed at the National Bureau of Economic Research in New York, directed by Mitchell himself for a quarter of a century.4 The National Bureau of Economic Research (NBER) was founded with the help of a group of business and labor leaders, as well as university-based economists, who were committed to addressing the information gap in data on the American economy and improving data measurement in order to deal more effectively with many economic policy issues. At the outset, the NBER received essential support from the Carnegie Foundation and the Laura Spellman Rockefeller Foundation, and funding from several corporations. The founders recruited Wesley Mitchell to direct the bureau. Mitchell assembled a small group of researchers who developed statistical methods for investigating income distribution and, later in the 1920s, business-cycle fluctuations. The NBER under Mitchell began by investigating the size and distribution of national income, work later assigned to Simon Kuznets who went on to develop the system of national income accounting for the US government. From 1922 onward, however, the major focus of Mitchell’s and the NBER’s work was on business cycles, a project designed to update and expand on Mitchell’s 1913 book. The NBER business cycle 2 Rutherford (2001) notes that Columbia’s Economics Department was small, but part of a larger School of Political Science. In fact, Columbia University became the academic home of a large concentration of economists of institutionalist leanings scattered across many schools and departments in the university, particularly Business, Law, Sociology and Philosophy in addition to Economics. 3 Commons became a recognized member of the Institutionalist movement only after the publication of his 1924 book (see Rutherford 2000), as he had previously been considered a labor economist. On Commons’s contribution, see Dorfman (1959) and Hodgson (2001). 4 His manifesto may be considered his presidential address as President of the American Economics Association in 1924, entitled “Quantitative Analysis in Economic Theory” (Mitchell 1925).

258

R. Marchionatti

project produced a vast collection of data series, many empirical studies of cyclical behavior in specific economic variables, industries, or sectors, and developed business cycle indicators. It also pioneered methods of dealing with an array of measurement issues relating to timing, amplitude and rates of change across successive cycles which resulted in what became known as the “NBER method” of specific and reference cycles (Morgan 1990, pp. 44–56). The NBER research staff published 23 books during the organization’s first decade. John Maurice Clark (1884–1963) was the other eminent institutionalist at Columbia, an important contributor to the development of institutional economics. He was the author of a “constructive synthesis” (Dorfman 1959) of tradition and “new dynamics”, or, as he himself said, “a social-institutional-dynamic economic theory”,5 developed in publications before and during his stay at Columbia, like Studies in the Economics of Overhead Costs (1923), Social Control of Business (1926), Strategic Factors in Business Cycles (1935) and several articles. Examples include his 1917 paper, where he introduced—“in a literary and intuitive way” (Samuelson 1948)—the acceleration principle from his study of Mitchell’s Business Cycles, and his notable 1940 paper on workable competition. These were works which addressed questions that the traditional neoclassical model of competition was unable to explain, and which arose as part of the wider reflection on imperfect and monopolistic competition then taking place in the United States and United Kingdom. In addition to Mitchell and Clark, other scholars and graduate students were part of the institutionalist community at Columbia—including some of Mitchell’s pupils like Frederick Cecil Mills (1892–1964), the Russian-born future Nobel laureate in economics

5 It should not be forgotten that at the 1918 session of the American Economic Association conference in which Walton Hamilton introduced the term “institutional economics” Clark contributed with an article entitled “Economic Theory in an Era of Social Readjustment” (Clark 1919) which, as Rutherford (2001) writes, complemented Hamilton’s in calling for an economics “relevant to the issues of its time” and based on a more properly scientific method.

6 Economics in the United States: New York, Harvard …

259

Simon Kuznets (1901–1985)6 and the Polish-born Arthur Burns (1904– 1987), all members of the research staff of NBER (and Burns became its director in 1944 after Mitchell’s retirement), as well as other Columbia economists such as Rexford Tugwell (1891–1979), who was one of the Columbia professors associated with Roosevelt’s brain trust, James Cummings Bonbright (1891–1985), professor of finance at Columbia Business School, Eveline Richardson Burns (1900–1985), Arthur Burns’s wife and professor of Social Work at Columbia since 1946, and the Russian-born Joseph Dorfman (1904–1987), biographer of Veblen and important historian of American economic thought. Other noteworthy members of this intellectual circle include Gardiner Means (1896–1988) (on Means see Samuels and Medema 1990; Lee and Samuels 1992), a Harvard-trained economist, and Adolf A. Berle Jr. (1895–1971) of the Columbia University school of law. In 1927 Berle invited Means to assist in statistical research on the modern corporation. Their work resulted in the coauthored The Modern Corporation and Private Property (1932), a well-known book which analyzed the implications of the separation between ownership and control of the corporation that occurred with the development of the joint stock company, and profoundly changed the understanding of business enterprises in modern society.7 In the 1930s the non-institutionalist side at Columbia was covered by two eminent mathematical economists and statisticians: Harold Hotelling (1895–1973), appointed in 1931 to replace Henry L. Moore (see Arrow and Lehmann 2005), and Abraham Wald, who arrived from the Cowles Commission in 1939 (on Wald see also Chap. 4.8). Already 6 In 1927 Simon Kuznets was recruited by Mitchell to join the NBER staff. Kuznets quickly became an expert on economic measurement. In the early 1930s, in response to a request from the US Department of Commerce for support in developing measures of aggregate economic activity, he led an NBER research project that became the foundation of the US national income accounts. This was one of the contributions for which Kuznets would be awarded the Nobel Prize in Economic Sciences in 1971. In 1936, Kuznets launched the Conference on Research on Income and Wealth, a group of researchers and economic statisticians devoted to improving measurement. The rapporteur for the first meeting was Milton Friedman, one of Kuznets’ students and a research assistant at the NBER. 7 Another product of the research project at Columbia Law School was published in 1932: The Holding Company: Its Public Significance and Regulation, which Means coauthored with James C. Bonbright. A further important book on these issues was A. R. Burns’s The Decline of Competition: A Study of the Evolution of American Industry (1936).

260

R. Marchionatti

well known for his work on spatial competition (Hotelling 1929), where he showed that differences in the location of the enterprises in an industry are representative of differentiation of products, Hotelling devoted much of his work during the 15 years at Columbia to developing “the first program in the modern (Fisherian) theory of statistics” (Arrow and Lehmann 2005, p. 3). Hotelling and Wald were members (and Hotelling director) of the Statistical Research Group (SRG), founded in 1942 and based at Columbia during World War II (see Wallis 1980). Other young members were scholars who would later become famous: Milton Friedman, Leonard Savage and George Stigler. The group was supported by the Applied Mathematics Panel of the National Defense Research Committee, which tasked it with studying statistical methods for war objectives. The most seminal statistical idea originating at SRG, largely as a result of Wald’s efforts (see Wald 1945), was sequential analysis.

Economics at the New School for Social Research and the “University in Exile” The New School for Social Research (NSSR) was founded in 1918 by a group of prominent Columbia scholars—the philosopher John Dewey (1859–1952), the historians James Harvey Robinson (1863–1936) and Charles A. Beard (1874–1948) and the economist Wesley C. Mitchell among others—who were dissatisfied with the state of academic freedom and education in the United States and looking to create an American equivalent of the LSE. Thorstein Veblen (see Vol. I, Chap. 7.5), who had in part inspired these scholars, joined soon after and was accompanied by two more economists, the labor statistician Leo Wolman (1890– 1961) and Alvin Saunders Johnson (1874–1971). Johnson guided the New School as its director from 1922 to 1945. He was well known at the beginning of the 1920s. Trained under E. R. A. Seligman and John Bates Clark at Columbia, where he acquired his doctorate in 1901, he had taught in various American universities (Columbia, Nebraska, Texas, Chicago, Stanford and Cornell, where he was Frank Knight’s teacher), worked as editor of the New Republic and served on the wartime

6 Economics in the United States: New York, Harvard …

261

Council of National Defense in Washington, DC. In its early years, under Johnson’s direction, the New School emphasized progressive adult education as well as independent social science research. In the 1920s, Johnson worked with E. R. A. Seligman on editing the massive Encyclopaedia of the Social Scienc es which allowed them to establish many international links, in particular with European scholars. In the 1930s and 1940s, as Fascism and Nazism conquered a large part of Europe, Johnson saved numerous Central European scholars, some of whom contributed to the Encyclopaedia, from persecution. In 1933, working closely with Emil Lederer, Johnson helped found the “University in Exile”, an especially-created division of the New School, to accommodate exiled German scholars. The University in Exile, which was later to become the Graduate Faculty for Political and Social Science of the New School, consolidated scholarly research at the NSSR. The New School virtually transplanted the entire Kiel Institute of World Economics (see Chap. 4.2) to New York—its two directors Adolph Löwe and Gerhard Colm, Jacob Marschak and Hans Neisser as well as Emil Lederer.8 The Kiel Institute was recast under the New School as the “Institute of World Affairs” in 1942. The University earned a reputation as a center of innovative research in the social sciences. It adopted an approach which was methodologically eclectic, largely interdisciplinary. Two interdisciplinary seminars taught by the entire faculty were organized which contributed to the creation of an intellectual community among the faculty: a general seminar was devoted to themes like economic democracy and the Europe-America relationship, while a more specific seminar dealt with the methodology of social sciences. This seminar’s work was published in Social Research, a journal of social and political science founded by Johnson in 1934.9 As the exiled scholars carried forward 8

The young Italian economist Franco Modigliani (1918–2003), a future Nobel Prize winner, was a member of the Graduate Faculty and received his doctorate from the New School in 1944 with a thesis on the Keynesian system under Marschak and Lowe. 9 In the foreword to the first issue, Johnson writes: “On rare occasions in literary history a new publication appears, not as a result of long, conscious planning, not a product of particularistic ambitions, but a spontaneous generation within a dominant circle of circumstances. Social Research is such a spontaneous growth. Political revolution on the European continent had expelled from their usual orbits of activity scores and hundreds of the ablest scholars, to whom the scientific world had turned for light upon the problems that harass the whole of mankind.

262

R. Marchionatti

the research programs they had been developing in Germany, issues relating to economic dynamics and structural theories of cyclical fluctuations were addressed. During the war they investigated the economics of war. In 1938, with the support of the Rockefeller Foundation, the Faculty initiated a Peace Research Project which studied the institutional conditions for stable postwar peace. Their model, as Krohn noted (1993, pp. 144–145), “was a kind of global New Deal” that anticipated the postwar agreements.

Wesley Clair Mitchell’s Institutional Economics Wesley Mitchell was one of the major figures of the institutionalist movement in American economics. His contributions to economics lie in his work on business cycles—as Schumpeter (1954, p. 1090) wrote, it was “a most important part of the cycle analysis of our own time”—and in his promotion of empirical work in economics—he led the National Bureau of Economic Research (NBER), of which he was “the moving spirit” (ibid.). Mitchell is generally considered primarily as an empirical scientist—actually, emphasis on empirical research distanced Mitchell from his master Veblen—rather than a theorist. This is correct, with the caveat that, as Friedman (1952, p. 237) wrote, Wesley Mitchell’s empirical work is itself a contribution to economic theory—and a contribution of the first magnitude. His work on prices and on business cycles provides an invaluable body of tested knowledge about these phenomena for the formulation of new theories and the testing of old theories; his work on the construction of index numbers and on statistical techniques for analyzing data on business cycles furthers the accumulation of additional tested knowledge.

These scholars, representing collectively an important fraction of the world’s thinking power, had been divorced from their customary avenues of expression. Magazines published in their countries of origin, if not formally closed to them, were practically closed. Nothing could be more natural than the emergence of a new organ of publication at the New School, where the largest organic grouping of continental scholars abroad has been established as a Graduate Faculty of Political and Social Science”.

6 Economics in the United States: New York, Harvard …

263

Mitchell’s 1924 Presidential Address to the American Economic Association (AEA) expressed his belief in the combination of institutional and quantitative analysis. For Mitchell, quantitative analysis complements the institutional approach to economics, as institutions standardize behavior and create those patterns of behavior that quantitative work observes. Quantitative work thus provides the basis for a constructive criticism of the institutions of the money economy, capable of guiding efforts to make the economic system better fitted to serve human needs (Mitchell 1925).

Biographical Note Wesley C. Mitchell was born in Rushville, Illinois, on August 5, 1874, the second of seven children. His father was a physician. He was educated at the University of Chicago, where he studied economics and philosophy under the influence of Laurence Laughlin, Thorstein Veblen and the philosopher of pragmatism John Dewey. He obtained his Ph.D. in economics in 1899 under Laughlin’s supervision on the Greenback issues of the Civil War.10 In his dissertation Mitchell tried to assess the validity of Irving Fisher’s quantity theory of money: using empirical data, he concluded that the 1879 legalization of American Civil War Greenbacks had no perceptible effect on the American price level, thus criticizing Fisher’s statement. His work was published in 1903 under the title History of the Greenbacks (Mitchell 1903). Mitchell worked for a year in the Census Office and for two years at the University of Chicago as an instructor, and was then recruited by Berkeley in 1903. In the meantime he continued to work on the issues of his Ph.D. thesis, exploring the evolution and functioning of the “money economy”, and in particular inquiring into the causes of price fluctuations. His findings were published in 1913 in Business Cycles (Mitchell 1913). Thenceforth business cycles remained his main field of interest: in 1927 he published 10

As Homan (1952, p. 158) writes, “it is plain that Dewey and Veblen, particularly the latter, had a decisive influence upon Mitchell’s attitude toward systematic economic theory”. Homan also notes that “It was … as an offset to the philosophical influence of Veblen and Dewey that Laughlin had suggested to Mitchell the very concrete and realistic subject of greenbacks for his doctor’s thesis” (ibid.).

264

R. Marchionatti

an entirely re-written version of the 1913 book, Business Cycles: The Problem and Its Setting, and in 1946 (with Arthur F. Burns) the monumental Measuring Business Cycles which revised and refined the method for empirical study outlined in the previous books—the 1927 book in particular—completed by research work at the National Bureau of Economic Research. In 1913 Mitchell moved to New York where he was appointed to a position at Columbia University. During World War I he was Chief of the Prices Section of the War Industries Board. In 1919 he became involved with the founding of the New School for Social Research11 and left his Columbia professorship to become a lecturer there. However, three years later he returned to Columbia, where he taught until his retirement in 1944. In 1920 he was prominent in the founding of the National Bureau of Economic Research, and acted as its Director of Research from 1920 until 1945, when he was succeeded by his student, Arthur F. Burns. Although he gave up this office in 1945, he continued as an active member of the research staff until his death. He was co-author of the first National Bureau publication, Income in the United States, in 1921, and of several other Bureau volumes, as well as the already cited Measuring Business Cycles (1946). He contributed to the Bureau’s Bulletin and Occasional Papers, wrote introductions to many Bureau monographs, and a long series of Annual Reports which stimulated economic thinking and research. Another of Mitchell’s important research interests was the history of economic thought: at Columbia University he gave a course on “Formative Types of Economic Thought”, which his students recorded, and after he died one of his pupils and colleagues, Joseph Dorfman, edited the lectures. In them, and in his collection The Backward Art of Spending Money (Mitchell 1937), he elaborated on his conception of institutional economics as the study of historical context serving as the basis for and background to the interpretation of economic phenomena. Wesley Mitchell died on October 29, 1948.

11 This experience showed Mitchell’s reforming attitude: in fact, as Burns (1952, p. 29) writes, “at heart Wesley Mitchell was a reformer”, who in New York actively participated in social causes involving workers, women’s suffrage, adult education, etc.

6 Economics in the United States: New York, Harvard …

265

Mitchell’s Contributions on Business Cycles Business Cycles (Mitchell 1913), as Mitchell writes in the preface, offers an empirically based “analytic description of the complicated processes by which seasons [or phases] of business prosperity, crisis, depression, and revival come about in the modern world” (Mitchell 1913, p. vii). The materials used in this description consist chiefly of market reports and statistics concerning the business cycles since 1890 in the United States, England, Germany and France. Mitchell notes that “many diverse theories about the causes of crises seem plausible when considered in the light of common knowledge” (ibid.) and discusses these theories’ consistency with the empirical evidence at the beginning of the book. To determine which of these explanations are really valid, however, “it is necessary to find out the regularity with which each alleged stress recurs, the scope which each attains, the elements which enter into each, and the consequences with which each is associated” (ibid.). To make progress toward the solution of these problems “requires the collection and analysis of elaborate records of business experience in quantitative form” (ibid.). The book is organized in three parts: Part I “The Problem and its Setting”, Part II “Statistical Data Concerning the Business Cycles of 1890–1911 in the United States, England, France, and Germany” and Part III “The Rhythm of Business Activity”. Summarizing the contents of Part I, Mitchell criticizes economic theory for “the artificiality” of its assumptions of a “static” or “normal” condition in economic affairs. In fact, he writes, “despite all efforts to give technical meanings to these ambiguous terms, they suggest the idea of an unchanging order, or of an order which economic principles are always tending to re-establish after every aberration” (ibid., p. 86). However, Mitchell emphasizes, a review of business annals never discloses the existence of a “static” or a “normal” state in either of these senses. On the contrary, in the real world of business, affairs are always undergoing a cumulative change, always passing through some phase of a business cycle into some other phase. Prosperity is relapsing into depression, or becoming more intense, or breeding a crisis; a crisis is degenerating into a panic, or subsiding into depression; depression is becoming deeper, or merging into a revival

266

R. Marchionatti

of prosperity. In fact, if not in theory, a state of change in business conditions is the only “normal” state. (ibid.)

The next step in the investigation “is to examine in detail the various business phenomena which have characterized the periods of prosperity, crisis, and depression sketched in the present chapter” (ibid., p. 87): this is the task of the long (350-page) Part II, “Statistical Data Concerning the Business Cycles of 1890–1911 in the United States, England, France, and Germany” devoted to the statistical study of the phenomena of business cycles since 1890. Mitchell finds that the cycles grow out of the existence of the “money (or business) economy” in the form of the interaction of business decisions based on profit expectations, the behavior of the banking system, and the leads and lags in the movement of wages and prices. In other words, the analysis shows a close connection between the “business economy” and recurrent cycles of prosperity and depression. In this analysis, Mitchell writes, profit making is the central process in the confused mix that constitutes the activities of a business economy. Every chapter of this part, Mitchell stresses, bears upon “the crucial problem of business profits”, doing so “either by dealing with factors which determine profits, like prices and the volume of trade; or by dealing with necessary conditions for the successful quest of profits, like the currency, banking, and investment; or by offering direct gauges of business success and failure, like the statistics of profits themselves and of bankruptcies” (ibid., p. 92). The problem discussed in Part III, “The Rhythm of Business Activity”, is based on the suggestions and materials provided by the two preceding parts. The problem is “to account for the rhythmical alternations of prosperity, crisis, and depression which occur in the modern business world” (ibid., p. 449). The recurrent phases presented by economic activity, Mitchell notes, “grow out of and grow into each other” (ibid.). Mitchell thus maintains that a theory of business cycles “must … be a descriptive analysis of the cumulative changes by which one set of business conditions transforms itself into another set” (ibid.). In framing such a theory, “the deepest-seated difficulty”, he writes, “arises from the fact that while business cycles recur decade after decade each new cycle presents points of

6 Economics in the United States: New York, Harvard …

267

novelty” (ibid.). In fact, “[b]usiness history repeats itself, but always with a difference”. In other words, we are dealing here with “a process of cumulative change” (ibid.), a sequence of revival, prosperity, crisis or depression, each sequence being at the same time the outgrowth of the preceding series of events and a unique series of events. From 1923 onward Mitchell, with the help of the NBER researchers, set out to update and expand on the 1913 book. The result was Business Cycles: The Problem and Its Setting, published in 1927. The general plan of the book is substantially the same as that of the 1913 book, as is its conception of the business cycle. As Mitchell writes in his preface to the new book, his new work confirmed his impression that business cycles consist of exceedingly complex interactions among a considerable number of economic processes, that to gain insight into these interactions one must combine historical studies with quantitative and qualitative analysis, that the phenomena are peculiar to a certain form of economic organization, and that understanding of this scheme of institutions is prerequisite to an understanding of cyclical fluctuations. (Mitchell 1927, p. x)

The book provides a new review of theories of the business cycle, a historical section linking the phenomenon of business cycles to the rise of the money economy’s institutions, a discussion of business cycles in relation to business decision-making, the system of prices, and the monetary mechanism, as well as a survey of data sources. A fundamental point discussed is the criticism of the concept of equilibrium. Mitchell writes that “the conception that business cycles consist in rhythmical ruptures and restorations of balance in some fundamental process is explicitly presented by several of the theories reviewed, and may be read into others” (ibid., p. 186), and asks: “Can we make use of this idea?”. He notes that “[d]oubtless it was a mechanical analogy which gave its vogue to the notion of economic equilibria”, but he thinks that “[t]he usefulness of the analogy in question was greatest and its dangers least when economists were treating what they called ‘static’ problems” (ibid.): such problems, he continues, “can be given a quasi-mechanical character, for they are not taken from life, but made in an inquirer’s head to suit his

268

R. Marchionatti

purposes, and mechanical analogies are appropriate to mechanical problems”. Nevertheless, he maintains, “the problems of business cycles are the opposite of ‘static’” (ibid.). The concept of business cycles developed in the book suggests, as Mitchell writes at the end of the analysis, “that the leading question … be put in the form ‘How do business cycles run their course?’ rather than in the form ‘What causes business cycles?’ What we are seeking to understand is a complex of recurrent fluctuations in numerous interrelated processes” (ibid., p. 470). In conclusion, Mitchell offers what he calls “a working concept of business cycles”: To find out what business cycles are, we have looked at them through the eyes of economic theorists, through the eyes of economic statisticians, and through the eyes of business reporters. Each group of workers helps us to appreciate features of the common object which the other groups take for granted, or fail to see. It is by combining the three sets of observations that we can form the mental picture of business cycles most useful in the constructive work which lies before us. (ibid., p. 455)

The book concludes with a new plan for gaining a clearer understanding of the complicated processes that bring about financial crises and industrial depressions with the purpose, as Mitchell stated (Mitchell 1940, pp. 23–24), of creating a knowledge which must be “prerequisite to intelligent efforts to prevent, or even to mitigate appreciably, these recurring disasters”. The outcome of much of this new work was published as Measuring Business Cycles in 1946 (Burns and Mitchell 1946). As the statistical findings accumulated, Mitchell and his collaborators refined chronologies and modified the terminology—the words “prosperity” and “depression” were replaced by “expansion” and “contraction”. For six years this developmental work was carried forward by Simon Kuznets and several assistants, and when Kuznets became absorbed in estimating national income and its components, Arthur F. Burns took over. With the help of research workers at the NBER, Burns revised and refined Mitchell’s statistical methods so that, as Mitchell writes in the preface, “the present volume is mainly his work”: “Though the basic features of my original design have been retained, Dr. Burns has made our technique

6 Economics in the United States: New York, Harvard …

269

of measuring cyclical behavior a much better kit of tools than it was when put into his hands” (ibid., p. viii). Measuring Business Cycles was attacked by Tjalling Koopmans of the Cowles Commission as “measurement without theory” (Koopmans 1947), while Rutledge Vining, research assistant at NBER in 1948–1949, defended the NBER approach (Vining 1949).

6.3

Economics at Harvard: Development of a Great Intellectual Community

The Department of Economics in the 1920s: Old Guard and New Entries On the threshold of World War I, the Department of Economics at Harvard had become a leading center of economic thought in the United States under Taussig’s leadership (see Vol. I, Chap. 7.4). During the war many members of the faculty, Taussig among them, left for Washington. The consequent weakening of the department created a situation that continued into the years immediately after the war. At the beginning of the 1920s, two new important scholars entered the department: Allyn A. Young from Cornell, and John H. Williams. Allyn Young (1876–1929)—“[o]ne of the most neglected persons in the annals of modern economic thought” (Blitch 1983, p. 1)—was born in Kenton, Ohio, on September 18, 1876, in a middle-class family “of sturdy English stock” (ibid., p. 2). He studied at Hiram College and then at the University of Wisconsin under Richard Ely (see Vol. I, Chap. 7) where he received his Ph.D. in economics in 1902. He came to Harvard after teaching in a number of American universities (from 1902 he taught at the universities of Wisconsin, Stanford, Cornell and others, coming to be called “the Peripatetic Economist” [Blitch 1995]). He also served in several federal organizations: in 1918 and 1919 he was chief of the Division of Economics and Statistics in the American delegation at the Paris Peace Conference, while in the 1920s he was adviser to the governor of the New York Federal Reserve Bank. In his Harvard years—from 1920 to 1927—he was one of the major American economists and “the

270

R. Marchionatti

most highly respected economics professor at Harvard” (Carlson 1968, p. 106). The presidency of the American Economic Association, and earlier of the American Statistical Association, testify to the fame he enjoyed, despite a relatively small number of publications. According to Schumpeter: He was first and last a creative teacher, and it was through his teaching rather than his writing that he influenced creative thought. Most of his work is irretrievably lost or lives on in the work of others to an extent which it is impossible to estimate. Rarely, if ever, has fame comparable to his been acquired on the basis of so little published work. What there is consists of mere fragments written in response to chance occasions. (Schumpeter 1937, pp. 514–515)

Schumpeter’s appraisal is somewhat exaggerated, according to Mason (1982, p. 411): He had contributed extensively to the theory of index numbers, was one of the authors of the leading textbook in economics [he supervised some of the revisions of the Outlines of Economics, the famous textbook coauthored with Ely and other members of the Ely team (author’s note)], and had written a number of path-breaking articles in the fields of value theory and taxation before coming to Harvard.

Many of these articles were later collected in a volume, Economic Problems New and Old (Young 1927) (see also Mehrling and Sandilands 1999). His most famous contribution is probably “Increasing Returns and Economic Progress” originally given as a presidential address to Section 7 of the British Association in 1928 (see Chap. 7.1), an article which developed Marshall’s thought in extremely fruitful directions.12 Growth was certainly one of Young’s grand themes, the other being monetary economics, but his contributions in the latter field have been neglected, and their importance has only recently been recognized (Laidler 1993, 1998; Mehrling 1997). As Laidler (1993) wrote, 12

“As regards this great article, Schumpeter (1954, p. 875) writes: Ex ungue leonem, that is to say, the reader may form some idea of that lion from a single claw, namely, his paper “Increasing Returns and Economic Progress”.

6 Economics in the United States: New York, Harvard …

271

the work in monetary economics done at Harvard until the mid-1930s was due to Young and his assistant Lauchlin Currie (1902–1993)—then in Roosevelt’s brain trust and a leading figure of the New Deal—and was heavily influenced by Hawtrey’s thought (on monetary economics at Harvard see Alacevich et al. 2015). In any case, his major influence, according to Mason (1982), was achieved through the works and careers of his students: first of all Frank Knight and Edward Chamberlin—the latter wrote his dissertation on monopolistic competition at Harvard under Young—but also Lauchlin Currie (1902–1993), Arthur Marget (1899–1962), as well as Nicholas Kaldor, his student at LSE. In fact in 1927, Young had accepted the offer of the chair vacated by Cannan at the LSE. When he moved to the United Kingdom, he had intended to return to Harvard at some stage—in 1928 he also refused the University of Chicago’s offer to became the chairman of the Department of Economics—but he died, quite suddenly, in 1929 at the age of 52. John H. Williams (1887–1980) came to Harvard in 1921 to lecture on money, banking and international trade, and remained there until his retirement in 1957. In 1947 he became the dean of the Harvard Business School. He had born in Wales, and his parents emigrated to the United States when he was an infant. He studied at Brown University and then at Harvard where he obtained his Ph.D. in 1919 under Frank Taussig who directed him toward the field of monetary and international economics and banking with an approach based on Taussig’s restatement of English classical theory and strongly oriented toward quantitative analysis. His major early work, stemming from his Ph.D. dissertation, was Argentine International Trade Under Inconvertible Paper Money (Williams 1920). He was an important economic adviser to the American government and the New York Federal Reserve Bank (he was its vice president from 1936 to 1947). In particular, he contributed to postwar monetary arrangements and is regarded as the main supporter of the key-currency principle, which stressed the role of the dollar in the international monetary system (on Williams see Asso and Fiorito 2009; Alacevich et al. 2015). During the 1920s an important research program—the largest departmental research initiative according to Mason (1982)—was constituted by The Harvard Committee on Economic Research, loosely connected

272

R. Marchionatti

with the Department, but absorbing the time and energy of a number of faculty members. It was created in 1917 by C. J. Bullock (1869–1941), Richard Ely’s pupil at the University of Wisconsin, at Harvard from 1903, together with Warren Persons (1878–1937), a Harvard statistician. From the beginning, the Committee on Economic Research attempted to promote scientific research on economic trends and fluctuations and at the same time to provide business with a short-term forecasting service: the Harvard Economic Service developed barometric indicators of the business cycle. A key element of the Service was the founding of the Review of Economic Statistics, a quarterly academic publication now known as the Review of Economics and Statistics. The forecasting service exercised considerable influence at that time and its methods and techniques were copied by the London and Cambridge Economic Service, the Institut für Konjunkturforschung in Berlin, Morgenstern’s Institute in Vienna, and other European centers (in Turin, for example, by Einaudi’s group).

The Golden Era of the Department in the 1930s Young and Williams flanked the old guard members during the 1920s, while new young scholars, often Harvard Ph.D.s, gained experience. The change of the guard took place in the early 1930s. It was, as Mason (1982, p. 419) writes, “not so drastic as what occurred at the beginning of the century, but sufficiently sweeping to remove all the senior faculty who had made the Department outstanding in the years before the first world war”. Thomas Carver retired in 1932, William Ripley resigned in 1932 (he had already suffered a nervous breakdown in 1927 which made him unable to teach for more than two years), Bullock retired in 1933, and Taussig, the “grand old man of economics at Harvard”, in 1935, at the age of seventy-five. The positions of the economists who had made the Department important before World War I were filled by an outstanding group of economists: first of all, several economists from Europe: Joseph A. Schumpeter, Gottfried Haberler and Wassily Leontief; then, Alvin H. Hansen, who joined the faculty in 1937; lastly, among the new Harvard Ph.D.s who entered the faculty, Edward Chamberlin

6 Economics in the United States: New York, Harvard …

273

and Edward Mason. These new appointments had, by the end of the decade, again brought the Department of Economics to a position of eminence. An important new intellectual community grew, but, at least in appearance, with working habits and relationships that were quite loose compared with other intellectual communities13 : for example, as Mason (1982) maintains, in the development of such important books as Chamberlin’s Monopolistic Competition and Leontief ’s Structure of the American Economy, there was “very little consultation with colleagues” (Mason 1982, p. 424) and no significant influence in their production. Certainly, the working habits prevailing at Harvard were different from those at Cambridge, England, where interactions between the community members appeared to be relatively stronger. However, there was a group around Schumpeter and, later, a group whose center was Alvin Hansen and his seminar (the importance of the practice of the research seminars in the 1930s must be stressed), and Chamberlin’s influence among the new generation was significant.14 We can thus say that there was a specific intellectual community at Harvard, which gave rise to what we might call the new Harvard School of economics. In the 1930s and 1940s, the intellectual leadership of this community, which in the tradition of Taussig’s department continued to be strong in both theoretical and applied fields, should probably be assigned to Schumpeter, a sort of primus inter pares. Close to Schumpeter was Gottfried Haberler, who had been one of the most important young members of the Mises group in Vienna (see Chap. 4.4). In 1936, he moved to Harvard—where he had already been a visiting lecturer in 1931–1932—from Geneva, where he had 13 The department’s weak direction probably played a role in keeping its intellectual relationships relatively loose: the chairman was Harold Burbank (1887–1951), generally considered a mediocre figure, remembered above all for his decision in 1940 to deny a post to Paul Samuelson, the department’s star student, a decision that angered Schumpeter. Regarding this episode, Robert Solow said of the Harvard economics department at the time: “You could be disqualified for a job if you were either smart or Jewish or Keynesian. So what chance did this smart, Jewish, Keynesian [i.e., Samuelson] have?” 14 We should also mention the so-called Harvard Pareto circle founded by the physiologist, biochemist and sociologist Lawrence Henderson and attended by Schumpeter and the structural-functionalist sociologist Talcott Parsons, where Pareto’s Sociologia was discussed (see Heyl 1968; Cot 2011; on Pareto’s Sociologia and its reception in the English-speaking world, see Marchionatti and Mornati 2021).

274

R. Marchionatti

gone in 1934 to work at the League of Nations. It was at Harvard that he published Prosperity and Depression: A Theoretical Analysis of Cyclical Movements (1937), the result of his research in Geneva. Haberler remained at Harvard until 1971, when he joined the American Enterprise Institute for Public Policy Research, a Washington-based conservative think tank, as a resident scholar, becoming a strong supporter of neo-liberal policies. The third European economist at Harvard in the 1930s was Wassily Leontief. It was Schumpeter, who greatly admired his young colleague, “who coaxed Harvard to steal Leontief from the New York National Bureau of Economic Research” (Samuelson, 2015, pp. 31–36). It was at Harvard during the 1930s that Leontief began developing his input– output model for the US economy. In subsequent decades, he refined and expanded this model, and used it to examine many economic problems. In 1941 he published his basic monograph, The Structure of American Economy, 1919–1929 (Leontief 1941). Leontief ’s Structure of the American Economy, like Monopolistic Competition, was largely the product of his own work with, as we said before, very little consultation with colleagues. Edward Chamberlin was undoubtedly one of the Department’s leading international figures in the 1930s and 1940s. His Theory of Monopolistic Competition published in 1933, together with Joan Robinson’s The Theory of Imperfect Competition, also published in 1933, were acknowledged as the two path-breaking contributions which paved the way to the imperfect and monopolistic competition revolution.15 Chamberlinian analysis, departing from the old stereotypes of monopoly and competition, took account of product differentiation, mutual interdependence and other variables. It was strongly criticized by Chicago’s economists, but, as Samuelson wrote, “Chicago economists can continue to shout until they are blue in the face that there is no elegant alternative to the theory of perfect competition. … ‘So much the worse for elegance’…” (Samuelson 1967, pp. 108–109). In fact, Chamberlin’s book profoundly influenced market theories and studies of the structure 15

We should add Berle and Means’s The Modern Corporation and Private Property (1932): this latter book contributed to setting the stage for many writings in the 1930s and 1940s on the theory of the firm and the structure and functioning of markets.

6 Economics in the United States: New York, Harvard …

275

and functioning of markets: it was a prelude to the development of the new field of industrial organization. Chamberlin’s theoretical contributions were developed by his Harvard colleagues Robert Triffin and Edward Mason. The Belgian-born Robert Triffin (1911–1993)16 had moved to Harvard with a scholarship after graduating from the University of Louvain in 1935. In 1938 he obtained his doctorate under Chamberlin with a dissertation on “General Equilibrium Theory and Monopolist Competition” which was then published in 1940 (Triffin 1940). In this book he tried to restate monopolistic and imperfect competition theories, which had evolved along the lines of Alfred Marshall’s theoretical tradition, in terms of the Walrasian general equilibrium system of economic theory. This was a step forward in the theory of value: the main result of the analysis was to emphasize the theoretical importance of the concept of the firm against that of industry. Triffin taught at Harvard until 1942, when, with the United States entry into the war, he applied for American naturalization and worked with the Administration by joining the Federal Reserve System from 1942 to 1946, when he was transferred to the International Monetary Fund. In 1948, he was sent to Europe as the IMF’s representative, and in 1949 he served the administration of the Marshall Plan (ECA). In 1951 he became a professor in the Department of Economics at Yale University where he stayed until 1977, when he returned to Belgium to work at the University of Louvain-la-Neuve. While Triffin’s (1940) book was important in clarifying the imperfect competition theories’ theoretical consequences on the traditional theory of value, the more fruitful line of inquiry introduced by Chamberlin’s book and which was destined to prevail as a new field of analysis was that of industrial organization. Its pioneer was Edward Mason (1899– 1992). Mason, who had received his Ph.D. at Harvard in 1925 under Taussig, worked on market classification in order to analyze the relationships between the structure of markets and the behavior of the firm. An important group of younger colleagues and graduate students worked with him, of whom Donald Wallace and Joe Bain deserve particular 16

For an intellectual biography of Triffin, see Maes (2021).

276

R. Marchionatti

mention. Donald Holmes Wallace (1903–1953), Ph.D. in 1931, then associate professor in economics at Harvard, was the author of an important monograph published in 1937, Market Control in the Aluminum Industry, a revised version of his dissertation on the aluminum monopoly in the United States. During the war he served in government departments on programs of price control and stabilization, and after the war went to Princeton University as professor of economics and Director of the Graduate Program of the Woodrow Wilson School of Public and International Affairs. Joe S. Bain (1912–1991) studied at Harvard, where he was also an instructor in Economics from 1936 to 1939. He obtained his Ph.D. in 1940 under the direction of Schumpeter, Chamberlin and Mason. Published in the Quarterly Journal of Economics in 1942, his “Market Classifications in Modern Price Theory”, a product of Mason’s research group, offered an operational classification of market structures that—as was the hope—would be useful in explaining the behavior of firms and also in providing normative standards of performance of use to antitrust policy. In 1939 Bain went to the University of California, Berkeley, where he served until his retirement in 1975. After World War II he laid out the structure, conduct and performance paradigm of Industrial Organization with his fundamental Barriers to New Competition (1956) and Industrial Organization (1959). In 1936, Harvard established the Graduate School of Public Administration. One of the School’s new recruits was Alvin H. Hansen (1887–1975), who joined the faculty from Minnesota in 1937 and occupied a new chair in economics. At the University of Minnesota he had published Business Cycle Theory (1927) and Economic Stabilization in an Unbalanced World (1932). He reviewed Keynes’s General Theory and was quite skeptical of Keynes’s ideas, but by the end of 1938 became convinced of the need for government intervention in periods of economic recession and embraced Keynesianism. In 1938 he published Full Recovery or Stagnation? where he expounded his thesis of secular or long-term stagnation due to the maturity of the American economy. Examining its recent history, he suggested that stagnation might have long-term structural causes: the decline of population growth, the changing nature of technical progress and the structural incapacity of investment demand to absorb saving. The implication was

6 Economics in the United States: New York, Harvard …

277

that government deficits might be necessary to ensure growth and prosperity. In Fiscal Policy and Business Cycles, published in 1941, Hansen argued for a deficit spending policy. Hansen became the chief popularizer and interpreter of Keynesian economics in the United States—he was called “the American Keynes” (see Samuelson 1976; Haberler 1976; Musgrave 1976; Barber 1987; Cord 2013)—with his books of the late 1940s and early 1950s (Hansen 1949, 1953). Soon after his arrival at Harvard in 1937, Hansen’s graduate seminar on fiscal policy (held with John H. Williams) (see Salant 1976)—perhaps the most famous of the research seminars at the Harvard department of economics—was the “vehicle” (Haberler 1976) for the spread of Keynesian ideas in the United States (Cord 2013, p. 56) and for the training of many graduate students such as Paul Samuelson (1915–2009) and James Tobin (1918–2002) who later developed Keynesian economics and economic policy. More generally, a sizable number of Ph.D. students, some of whom were appointed faculty instructors, were attracted to Harvard in the second half of the 1930s, including John Kenneth Galbraith (1908– 2006), Alan Sweezy (1907–1994), his younger brother Paul M. Sweezy (1910–2004), Robert Triffin, Gardiner Means and Donald Wallace, to mention just a few. Galbraith and Paul Sweezy were to become important heterodox economists in the postwar era, but they had already distinguished themselves for some important publications in the second half of the 1930s. In 1938 Galbraith published Modern Competition and Business Policy, a book in the new field of industrial organization written together with the Boston businessman Henry S. Dennison and largely based on the works of Chamberlin and Robinson on market structure and of Berle and Means on the corporation. Paul Sweezy—Schumpeter’s assistant lecturer—was extremely active: he contributed in 1933 to founding the LSE journal The Review of Economic Studies with Abba Lerner and Ursula Hicks, and published articles including “Demand Under Conditions of Oligopoly” in The Journal of Political Economy, which was one of the two works which introduced the kinked-demand curve theory in the economic literature in 1939, the other being Hall’s and Hitch’s “Price Theory and Business Behaviour” (see Chap. 2.5). In 1942 Sweezy published The Theory of Capitalist Development, a contribution in the neo-Marxist economics, a field in which he became an important figure.

278

R. Marchionatti

Joseph A. Schumpeter (1883–1950), the Harvard Years In 1932 Schumpeter left Germany for Harvard University (where he had already lectured in 1927–1928 and 1930), remaining there until his death.17 Smithies (1950, p. 632) writes that “he moved permanently to Harvard in a mood of resignation rather than enthusiasm … motivated by a desire to leave the sinking ship of Europe”. In his Harvard years he contributed to strengthening the education provided by the department and promoted mathematical economics—he himself taught the course in the subject, which then passed to Leontief and to the mathematician Edwin Bidwell Wilson (1879–1964), at that time professor of statistics at the Harvard School of Public Health, who gave a course of mathematics for graduate students. The Harvard years were the second period of Schumpeter’s great intellectual productivity: His main purpose was to build on the foundation he had laid before the war, to test his earlier conclusions and to modify them where necessary in the light of his historical and statistical research. And his last years, through his History [of Economic Analysis], were devoted to a supreme effort to hasten the progress of economics towards scientific maturity. (Smithies 1950, p. 632)

During the first years at Harvard, Schumpeter’s main interest was in business cycles. In 1939 he published Business Cycles: A Theoretical, Historical, and Statistical Analysis of the Capitalist Process (1939)—a massive work in two volumes, a monument of encyclopedic erudition and essentially an effort to fill his 1912 book (see Vol. I, Chap. 5.3) with historical and statistical facts. On the whole, it is an attempt to deal with the complex phenomenon of modern capitalism’s secular development with a combination of tools: his theoretical model of economic change plus historical and statistical empirics. The analysis introduces a crucial aspect of the development process, namely the simultaneous presence of many cycles. Schumpeter utilized a scheme with three cycles, short, long and very long 17

In 1940 Schumpeter was offered a position at Yale University, but ultimately decided to stay at Harvard, persuaded by the young Samuelson (see Samuelson 2015).

6 Economics in the United States: New York, Harvard …

279

run—respectively named the Kitchin, Juglar and Kondratieff cycles after the scholars who had first identified and analyzed them18 —the fifty-year or Kondratieff cycle having to do with “epoch-making innovations” that affect the whole of the productive system. The years of the war were, as Haberler (1950, p. 357) writes, “among the most somber and depressing of his life”, and he “buried himself in his scientific work, unhappily watching the decline of much that he considered valuable in the Western world” (ibid.). The result was Capitalism, Socialism and Democracy (1942), considered one of the greatest works of social science written in the twentieth century. A projected book on the theory of money, on which Schumpeter had worked for a lengthy period of time, never materialized. During his last years he worked on his great History of Economic Analysis, published, unfinished, after his death (he died at the beginning of January, 1950) by his wife Elizabeth Boody Schumpeter.

Schumpeter’s Economics: Capitalism, Socialism and Democracy, 1942 Capitalism, Socialism and Democracy “is one of the great classics in twentieth century social science” (Swedberg 2003, p. ix). It was written between 1938 and 1942 and published in the fall of that year (and republished in 1947 and 1950). In the preface to the first edition, Schumpeter says that his book was the result of “an effort to weld into a readable form the bulk of almost forty years’ thought, observation and research on the subject of socialism”. From the methodological standpoint, it is an interdisciplinary work in an institutionalist perspective where Schumpeter ranges from economics, to history, sociology and political science. It has its analytical roots in the Historical School and Viennese Marxism, from Schmoller, Weber and Sombart to Hilferding. Undoubtedly, the tragedies of the first part of the century—wars, economic and social 18

Clément Juglar (1819–1905) was a nineteenth-century French statistician, author of Des Crises commerciales et leur retour periodique en France, en Angleterre et aux Etats-Unis (1862). Joseph Kitchin (1861–1932) was a British statistician. Nikolai Dmitriyevich Kondratieff (1892 –1938) was a Russian economist and socialist, director of the Institute of Conjuncture in Moscow (see Chap. 5.4).

280

R. Marchionatti

crises, the rise of totalitarianism—influenced Schumpeter’s vision and analysis. The book is divided into five loosely connected parts.19 As Schumpeter writes in the preface, it consists of “heterogeneous material” which “reflected the views and experiences of an individual … at various stages of his life”, grouped around five central themes: “[l]inks and bridges between them have been provided … and something like systematic unity of presentation has … been achieved”, he writes, and adds: “but in essence they are—though not independent—almost self-contained pieces of analysis”. Part I, “The Marxian Doctrine”, is devoted to Karl Marx’s thought. In the first chapter, “Marx the Prophet”, Schumpeter identifies “Scientific Socialism” as a set of beliefs that must be embraced by its followers— much like the system of organized religion. In the two following chapters he introduces the separation between Marx as sociologist and economist. He admired Marx’s sociology, but was critical of his economics, along the lines of the European (above all German and Austrian) debate on Marx of the previous decades. He criticizes Marx’s economic arguments, such as the labor theory of value and Marx’s inability to distinguish between capitalists and entrepreneurs: in fact, innovation is the factor which best describes the capitalist process and, moreover, overturns many of Marx’s gloomy predictions of the future. However, he credited Marx very highly for having tried to introduce a dynamic element into economic analysis. In Chap. IV (“Marx the Teacher”) Schumpeter maintains that Marx’s theories lack explanatory power for many events of the past, and casts doubt on Marx’s ability to explain the future. However, he thinks that Marx was correct in believing that socialism would replace capitalism. Part II of the book deals with the crucial question: “Can Capitalism Survive?” And the answer he gives is: “No. I do not think it can” (Schumpeter 1942, p. 61). He writes: The thesis I shall endeavor to establish is that the actual and prospective performance of the capitalist system is such as to negative the idea of its breaking down under the weight of economic failure, but that 19

We will not analyze Part IV, which is a political analysis of socialism and democracy.

6 Economics in the United States: New York, Harvard …

281

its very success undermines the social institutions which protect it, and “inevitably” creates conditions in which it will not be able to live and which strongly point to socialism as the heir apparent. My final conclusion therefore does not differ, however much my argument may, from that of most socialist writers and in particular from that of all Marxists.

The first chapters of this part are devoted to an analysis of the way contemporary capitalism works. Chapter VII, “The process of creative destruction”, begins with the statement that “the essential point to grasp is that in dealing with capitalism we are dealing with an evolutionary process” (Schumpeter 1942, p. 82), a fact emphasized by Marx but neglected by mainstream economics. “Capitalism—Schumpeter writes— … is by nature a form or method of economic change and not only never is but never can be stationary” (ibid.). This is not merely due “to the fact that economic life goes on in a social and natural environment which changes and by its change alters the data of economic action” (ibid.) or “to a quasi-automatic increase in population and capital” (ibid.), but: The fundamental impulse that sets and keeps the capitalist engine in motion comes from the new consumers’ goods, the new methods of production or transportation, the new markets, the new forms of industrial organization that capitalist enterprise creates. (ibid., pp. 82–83)

It is a process of “industrial mutation” (Schumpeter uses a biological term) “that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism” (ibid., p. 83). The traditional conception of the modus operandi of competition—price competition—neglects this essential and typically capitalist element—“the competition from the new commodity, the new technology, the new source of supply, the new type of organization”—that is, “competition which commands a decisive cost or quality advantage and which strikes not at the margins of the profits and the outputs of the existing firms but at their foundations and their very lives” (ibid., p. 84). So, the traditional theoretical construction, Schumpeter maintains, “is like Hamlet without the Danish prince” (ibid., p. 86).

282

R. Marchionatti

In the “perennial gale of creative destruction”, “restrictive” or “monopolistic practices” (Chap. VIII), i.e., practices that aim, through restricting output, at conserving established positions, “acquire a new significance … a significance which they would not have in a stationary state or in a state of slow and balanced growth” (ibid., p. 87): “in the process of creative destruction, restrictive practices may do much to steady the ship and to alleviate temporary difficulties” (ibid.). Not only, the large-scale establishment must not be accepted “as a necessary evil inseparable from the economic progress” (p. 106), but a “powerful engine” of “the longrun expansion of total output not only in spite of, but to a considerable extent through, this strategy which looks so restrictive when viewed in the individual case and from the individual point of time” (ibid.). In this respect, perfect competition, Schumpeter maintains, “is not only impossible but inferior, and has no title to being set up as a model of ideal efficiency” (ibid.). At this point, Schumpeter writes, we are faced with the question: “to what extent it is legitimate to assume that the capitalist engine will—or would if allowed to do so—work on in the near future … about as successfully as it did in the past” (ibid., p. 110)? “The nature of this problem can be most tellingly displayed against the background of contemporaneous discussion”, Schumpeter writes. In fact “[t]he present generation of economists has witnessed not only a worldwide depression of unusual severity and duration but also a subsequent period of halting and unsatisfactory recovery” (ibid., p. 111). According to many economists, Schumpeter says, “we have been witnessing not merely a depression and a bad recovery, accentuated perhaps by anticapitalist policies, but the symptoms of a permanent loss of vitality which must be expected to go on and to supply the dominating theme for the remaining movements of the capitalist symphony” (ibid.). This is the theory of “vanishing investment opportunity” (ibid., p. 112). However, according Schumpeter, purely economic considerations cannot confirm this theory. It is necessary to turn “to the cultural complement of the capitalist economy—to its sociopsychological superstructure, if we wish to speak the Marxian language—and to the mentality that is characteristic of capitalist society and in particular of the bourgeois class” (ibid., p. 121). The last chapters of Part II are devoted to a discussion of why Schumpeter believes capitalism cannot survive. Chapter XII,

6 Economics in the United States: New York, Harvard …

283

dramatically entitled “Crumbling Walls”, identifies three factors: “The Obsolescence of the Entrepreneurial Function”, “The Destruction of the Protecting Strata” and “The Destruction of the Institutional Framework of Capitalist Society”. As regards the entrepreneurial function, Schumpeter argues that this social function is already losing importance and is bound to lose it at an accelerating rate in the future even if the economic process itself of which entrepreneurship was the prime mover went on unabated. For, on the one hand, it is much easier now than it has been in the past to do things that lie outside familiar routine—innovation itself is being reduced to routine. Technological progress is increasingly becoming the business of teams of trained specialists who turn out what is required and make it work in predictable ways. The romance of earlier commercial adventure is rapidly wearing away, because so many more things can be strictly calculated that had of old to be visualized in a flash of genius. On the other hand, personality and will power must count for less in environments which have become accustomed to economic change— best instanced by an incessant stream of new consumers’ and producers’ goods—and which, instead of resisting, accept it as a matter of course. The resistance which comes from interests threatened by an innovation in the productive process is not likely to die out as long as the capitalist order persists. It is, for instance, the great obstacle on the road toward mass production of cheap housing which presupposes radical mechanization and wholesale elimination of inefficient methods of work on the plot. But every other kind of resistance—the resistance, in particular, of consumers and producers to a new kind of thing because it is new— has well-nigh vanished already. Thus, economic progress tends to become depersonalized and automatized. Bureau and committee work tends to replace individual action. (ibid., pp. 132–133)

And adds: if capitalist evolution—“progress”—either ceases or becomes completely automatic, the economic basis of the industrial bourgeoisie will be reduced eventually to wages such as are paid for current administrative work excepting remnants of quasi-rents and monopoloid gains that may be expected to linger on for some time. Since capitalist enterprise, by

284

R. Marchionatti

its very achievements, tends to automatize progress, we conclude that it tends to make itself superfluous—to break to pieces under the pressure of its own success. The perfectly bureaucratized giant industrial unit not only ousts the small or medium-sized firm and “expropriates” its owners, but in the end it also ousts the entrepreneur and expropriates the bourgeoisie as a class which in the process stands to lose not only its income but also what is infinitely more important, its function. The true pacemakers of socialism were not the intellectuals or agitators who preached it but the Vanderbilts, Carnegies and Rockefellers. (ibid., p. 134)

The second factor that explains capitalism’s incapacity to survive is “The Destruction of the Protecting Strata”. By this, Schumpeter means the fact that “[i]n breaking down the pre-capitalist framework of society, capitalism thus broke not only barriers that impeded its progress but also flying buttresses that prevented its collapse” (ibid., p. 139). That process, which Schumpeter calls “impressive in its relentless necessity”, “was not merely a matter of removing institutional deadwood, but of removing partners of the capitalist stratum, symbiosis with whom was an essential element of the capitalist schema” (ibid.). In fact, Schumpeter maintains, “the bourgeois class is ill equipped to face the problems, both domestic and international, that have normally to be faced by a country of any importance” (ibid., p. 138); in other words, the function of classe dirigente was played by other social strata, in particular by the aristocracy that, in the majority of cases, “continued to rule the roost right to the end of the period of intact and vital capitalism” (ibid., p. 136). The third factor is the destruction of the institutional framework of capitalist society. The capitalist process “pushes into the background” all the institutions “that expressed the needs and ways of the truly ‘private’ economic activity” (ibid., p. 141), in particular the institutions of property and free contracting. Moreover, the capitalist process changes contents or meanings of legal forms of business. Schumpeter writes: The capitalist process, by substituting a mere parcel of shares for the walls of and the machines in a factory, takes the life out of the idea of property. It loosens the grip that once was so strong—the grip in the sense of the legal right and the actual ability to do as one pleases with one’s own; the grip also in the sense that the holder of the title loses the will to

6 Economics in the United States: New York, Harvard …

285

fight, economically, physically, politically, for “his” factory and his control over it, to die if necessary on its steps. And this evaporation of what we may term the material substance of property—its visible and touchable reality—affects not only the attitude of holders but also that of the workmen and of the public in general. Dematerialized, defunctionalized and absentee ownership does not impress and call forth moral allegiance as the vital form of property did. Eventually there will be nobody left who really cares to stand for it—nobody within and nobody without the precincts of the big concerns. (ibid., p. 143)

Given all these phenomena, it is not difficult to understand “how the capitalist process produced that atmosphere of almost universal hostility to its own social order” (ibid.). In addition, Schumpeter identifies other factors which erode the basis of capitalism, for example the family, which brings anti-saving theories indicative of a short-run philosophy of business. By undermining the motivation to save, capitalism destroys its own foundation—the capital needed for future growth. This tendency to decomposition of capitalist society, Schumpeter writes, is accompanied by a tendency toward another civilization: socialism. Part III of the book is devoted to the question: “Can Socialism Work?”, where by socialist society he means an institutional pattern in which the control over means of production and over production itself is vested with a central authority. “Of course it can”, Schumpeter answers. In Chap. XVI, “The Socialist Blueprint”, Schumpeter begins by asking if “there is anything wrong with the pure logic of a socialist economy” and answers that there is nothing wrong, thus dealing with the debate on socialist calculation (see Chap. 7.2) and, first of all, Mises’s criticism (see Chap. 4.5). Schumpeter thinks that “the economist who settled the question in a manner that left little to do …, was Enrico Barone” (ibid., p. 173), and mentions, among those who further pursued Barone’s reasoning, Fred Taylor and especially Oskar Lange and Abba Lerner (see Chap. 7.2). This literature, Schumpeter writes, has clarified that socialist planning is not only logically well-defined and consistent, but also possible in practice. In Chap. XVII, “Comparison of Blueprints”, Schumpeter argues that socialism may be superior to capitalism in some respects. “As a matter of blueprint logic” it is undeniable, he writes, “that

286

R. Marchionatti

the socialist blueprint is drawn at a higher level of rationality” (ibid., p. 196). In fact: Whatever the economic goals desired by whoever is in the position to give effect to his desires, socialist management could attain them with less disturbance and loss without necessarily incurring the disadvantages that would attend attempts at planning progress within the framework of capitalist institutions. (ibid., p. 195)

Wassily Leontief (1905–1999), the American Years Leontief moved to the United States in 1931, after a period of research at the University of Kiel. He worked first as a research associate at the National Bureau of Economic Research in New York, then went to Harvard University where he remained for many years developing his input–output model for the US economy. This work began in the 1930s, and in subsequent decades, he refined and expanded this model, using it to examine many economic problems. In 1941 he published his basic monograph, The Structure of American Economy, 1919–1929 (Leontief 1941). In 1944–1946, he published many path-breaking papers exemplifying the use of input–output analysis for estimating the effects of variations in final demands on output, employment, wages and prices in individual sectors. He established the Harvard Economic Research Project in 1948, and headed it for the next 25 years. Among other activities, he was consultant to the US Bureau of Labor Statistics for constructing its 400-sector table for projecting postwar employment by major industries. His analyses of the capital and labor content of US exports led him to enunciate the so-called Leontief Paradox (Leontief 1953), which seemed to undermine the validity of the Heckscher-Ohlin international trade theory of comparative advantages in determining trade patterns. Leontief left Harvard in 1975—after being awarded the Nobel Prize for Economics for his work in developing input–output analysis—to assume a position at the Institute of Economic Research at New York University, where he directed a UN-sponsored study of the

6 Economics in the United States: New York, Harvard …

287

evolution of the world economy until the year 2000, based on a multiregional input–output model of the world. In all his work, as Dorfman (1995, p. 308) wrote, Leontief was motivated and guided by a dominating motif: the conviction that economics is not an exercise in pure science, but an eminently practical applied science. Thus we [sic] was never satisfied with mathematical theorems, no matter how elegant. The payoff of economic research always had to be numbers—operational, verifiable numbers. It was this conviction that led him to regard Walrasian general equilibrium as only a starting point; statistically estimated, numerical input-output tables were the usable results that made Walras’ theory operational. From the beginning of his career until today, Leontief ’s unceasing quest has been for numbers and for verifiable relationships among them.

Leontief ’s Economics: The Structure of American Economy, 1941, or Leontief ’s “Tableau Économique” Leontief ’s American contributions to input–output economics begin with the two 1936 and 1937 articles in the Review of Economic Statistics and bore their first fruit with his 1941 monograph The Structure of American Economy, 1919–29, which presented the principles of the input–output model in its “closed” version, i.e., “closed with respect to final demand”, where final demand is treated as residual quantity. A second edition of the book was published in 1948, containing an additional Part IV and four further chapters that had appeared first as journal articles and present the “open” version of the model. In characterizing his approach to empirical general equilibrium, Leontief (1948, p. 407) writes that on the one hand, “in its theoretical orientation [it] has greater kinship with classical Walrasian than with the aggregative Keynesian type of approach” while on the other hand, “for determination of the actual magnitudes of the relevant empirical constants it relies on direct observation rather than on indirect methods of probabilistic inference”, such as those of econometric research à la the Cowles Commission. In his introduction to the 1941 edition, Leontief presents his work as follows:

288

R. Marchionatti

This modest volume describes an attempt to apply the economic theory of general equilibrium—or better, general interdependence—to an empirical study of interrelations among the different parts of a national economy as revealed through covariations of prices, outputs, investments, and income … This present inquiry … carries the marks of a compromise between unrestricted generalities of purely theoretical reasoning and the practical limitations of empirical fact finding. (Leontief 1941, pp. 3–4)

Part I (“Quantitative Input and Output Relations in the Economic System of the United States in 1919 and 1929”) presents a statistical description of the structure of the American economy. Leontief writes that his statistical study can be defined as “an attempt to construct, on the basis of available statistical materials, a Tableau Économique of the United States for 1919 and 1929” (ibid., p. 9). Statistical information is sourced from government publications and the work of the National Bureau of Economic Research on national income. The country’s economic activity is visualized as if covered by one huge accounting system presenting the system of costs and outputs of forty-one industrial groups. A statistical input–output table describing the interrelationship between all the various branches of production, transportation, distribution and consumption constitutes the factual basis of analytical procedures. The basic tables show the actual flow of commodities and services from one industry to another, from industry to households and from households to industries. Each industry is treated as a single accounting entity with sales entered on one side of its trading account and purchases on the other. The sales of one industry are the purchases of another. “Entering the sales and purchase accounts of all the separate industries in one large table we get a comprehensive view of the structure of the national economy as a whole” (ibid., p. 4). Part II (“The Theoretical Scheme”) gives a concise formulation of the economic theory of general interdependence. Leontief follows the general equilibrium theory approach, well aware of the fact that the theory in its present state cannot cope with the complexities of actual economic process, but must be refined and its base of actual information fortified. Leontief ’s theoretical model consists of three systems of equations. The first system, the accounting equations, shows the disposal of the total output of each industry among its consumers.

6 Economics in the United States: New York, Harvard …

289

Leontief writes: “The fundamental theoretical setup is described first under the assumption of stationary equilibrium—a hypothetical state of simple reproduction which knows neither saving nor investment” (ibid., p. 35). The equations describe the fact that the total output of each industry (measured in physical terms) equals the sum total of the amounts of its product consumed by all other industries: (I) −X 1 + x21 + x31 + . . . + xi1 + . . . + xn1 = 0 x12 − X 2 + x32 + . . . + xi2 + . . . + xn1 = 0 x13 + x23 − X 3 + . . . + xi1 + . . . + xn1 = 0 ... x1n + x2n + x3n + . . . + xin + . . . − X n = 0 The second system, the pricing equations, states that under conditions of stationary equilibrium the value (i.e., price x quantity) of the product of each industry is equal to the value of all goods and services absorbed by it. (II) −X 1 P1 + x12 P2 + x13 P3 + . . . + x1i Pi + . . . + x1n Pn = 0 x21 P1 + X 2 P2 + x23 P3 + . . . + x2i Pi + . . . + x2n Pn = 0 x31 P1 + x32 P2 − X 3 P3 + . . . + x3i Pi + . . . + x3n Pn = 0 ... xn1 P1 + xn2 P2 + xn3 P3 + . . . + xni Pi + . . . − X n Pn = 0 The third system is formed by the equations of production. It describes the technical relation between the physical output of an industry and the input of all the different cost elements absorbed in production: in other words, it describes the production function, under the assumption that the amount of each cost element is strictly proportional to the quantity of output—“the type of relation originally used by Walras in his first formulation of the general equilibrium theory” (ibid., p. 37). Leontief uses the Walrasian term “coefficients of production”, and the assumption of fixed coefficients of production (ai1 , ai2 , . . . , ain , . . .): “the amount

290

R. Marchionatti

of each cost element is assumed to be strictly proportional to the quantity of output … We describe the technical setup of each industry by a series of as many homogeneous linear equations as there are separate cost factors involved” (ibid.), i.e.: xi1 = ai1 X i , xi2 = ai2 X i , . . . , xin = ain X i . Then Leontief introduces the phenomenon of saving and investment. It requires the modification of all the cost equations of the second set: the value product of any industry or household, instead of being simply equal to its aggregate outlays, can be either larger or smaller. In other words, total costs must be equated to the total revenue divided by a certain saving coefficient. Moreover, it requires an adjustment in the form of the production functions, and an investment coefficient must be inserted. In Part III (“Data and Variables in the American Economic System, 1919–1929”), the analytical tools developed in the theoretical inquiry are put to work, in an attempt at empirical verification of the theoretical model. The difficulty of handling very large numbers of simultaneous equations was overcome through the use of computers. Using the data presented in Part I, Leontief shows: how the outputs of various industries and the prices of their products would have reacted to different types of primary changes, i.e., changes in the technical productivity of one or another industry, variations in the willingness to invest capital …, or shifts in the willingness to save. (ibid., p. 5)

In Sections 7 and 8 Leontief deals with the question: “If price and quantity changes can be predicted from primary structural shifts, it is not possible to compute these latter from the known combined price and quantity variations?” (ibid., p. 6). To this end, Leontief determines a series of indices showing the structural changes which marked the development of the American economic system in the decade of 1919–1929. He then uses these indices for an indirect roundabout computation of the corresponding price and output indices for the purposes of a final

6 Economics in the United States: New York, Harvard …

291

cross check: “A comparison of the resulting figures with the actual price and output statistics … reveals a satisfactory agreement” (ibid.). According to many economists, the input–output analysis is a filiation of Walrasian general economic equilibrium theory, and Leontief himself confirmed this connection in some of his writings (e.g., Leontief 1954). However, setting aside the formal similarities, the differences cannot be ignored. Recent research has drawn attention to some aspects of the two approaches that appear difficult to reconcile. First, Leontief, unlike Walras, considered economics as an empirical science. Moreover, as Kurz and Salvadori (2000, 2006; see also Marchionatti 2019) have emphasized, Leontief preserved the classical concept of circular flow introduced in his 1928 habilitation, rejecting (explicitly in the second 1951 edition of his book) the view of production as a one-way avenue from the services of the factors of production to final goods. The thesis of Leontief ’s return to the classics has been underestimated by William Baumol (2000, 2009 with Raa) who, without denying the classical roots of Leontief ’s analysis, preferred to emphasize how his analysis had advanced over that of his predecessors: the creation of a flexible model with widely varied applications that permits direct empirical evaluation. In fact, Leontief seems to retain that complementary view of the relationship between the classics and Walras expressed in the tradition of Bortkievicz’s and Dimitriev’s German-Russian mathematical school (see Vol. I, Chap. 5.4; and Marchionatti 2019).

Edward Hastings Chamberlin (1899–1967) Biographical Note Chamberlin, one of the main representatives of the Harvard intellectual community in the 1930s and 1940s, was a man of one idea, monopolistic competition, which he presented in The Theory of Monopolistic Competition, published in 1933, and continued to develop and defend against its critics (Chicago economists in particular) for the rest of his life. Schumpeter considered The Theory of Monopolistic Competition “one of the most successful books in theoretical economics that the period since 1918

292

R. Marchionatti

has produced”, in importance ranking “next to Keynes’s General Theory and with Hicks’s Value and Capital and Hayek’s contribution” (Schumpeter 1954, p. 116 note). As Mason (1982, p. 423) writes, “as a scholar Chamberlin was a ‘lone wolf ’ whose work owed remarkably little to the extensive literature of the 1920s on increasing returns”, although it must be emphasized that his work was in the Marshallian tradition. He was not much interested in developments in areas of economics other than his own—macroeconomics in particular left him cold. But “his influence on the study of the structure and functioning of markets and on the theory of the firm was profound” (ibid.). Edward Chamberlin was born on May 18, 1899, in La Conner, Washington, and studied first at the University of Iowa and then at the University of Michigan. He then moved to Harvard as a Ph.D. student in the mid-1920s, and he devoted the years 1924–1926 to writing his Ph.D. dissertation on imperfect competition under the guidance of Allyn Young.20 He received his Ph.D. in 1927 and published his revised dissertation as a book entitled The Theory of Monopolistic Competition in 1933. For most of his career Chamberlin taught economics at Harvard, from 1937, when he became professor, to his retirement in 1967. He also served as editor of the Quarterly Journal of Economics from 1948 to 1958. In 1957 he published Towards a More General Theory of Value, a collection of sixteen papers devoted to restating, extending and defending his work on monopolistic competition. He died on July 16, 1967, in Cambridge, Massachusetts.

Chamberlin’s Economics: The Theory of Monopolistic Competition, 1933 Chamberlin’s interest in value theory, in general, and on the relationship between perfect competition and monopoly, in particular, dates back to 1921 when he was at the University of Michigan. The book took shape between 1925 and 1927 in his Ph.D. thesis at Harvard University. After rewriting it, it was published at the beginning of 1933 under the title

20

On Young’s influence on Chamberlin see Reinwald (1977, 1985) and Blitch (1985).

6 Economics in the United States: New York, Harvard …

293

The Theory of Monopolistic Competition. A Re-orientation of the Theory of Value. On the originality of this contribution Schumpeter (1954) writes: The thesis does not differ in any essential from the 1st ed. of the book and, since it was in the stage of final revision for several months before, does not owe anything to Sraffa’s article (“The Laws of Returns under Competitive Conditions”), which appeared in the Economic Journal , December 1926. The author proposed the subject for a Ph.D. thesis as early as 1921, when he was a student at the University of Michigan … In spite of subconscious influences that may have come from early Marshallian training, we therefore have here a striking instance of subjective and objective originality—and of originality of the purely theoretical type that owed nothing to “the collection of direct empirical evidence,” though a “guiding principle” certainly was to create a theory that would fit facts better than what Chamberlin conceived to be the theory of competition current at that time. (pp. 1116–1117, note)

Chamberlin writes in the introduction that the thesis of the book, which deals “with the whole of value theory”, is that “both monopolistic and competitive forces combine in the determination of most prices”, and therefore that “a hybrid theory affords a more illuminating approach to the study of price system than does a theory of perfect competition, supplemented by a theory of monopoly” (Chamberlin 1933, p. xi). Economic literature—he writes—has assumed that “all the phenomena to be explained are either competitive or monopolistic” and therefore that “the expedient of two purified and extreme types of theory is adequate” (ibid., p. 3). Actual competition, he continues “is supposedly explained by the theory of pure competition” (ibid.) but, he maintains, this association of the theory of competition with facts which it does not fit has not only led to false conclusions about the facts, it has obscured the theory as well. This is the more serious because the mixture of the two forces is a chemical process and not merely a matter of addition. (ibid.)

The ubiquity of monopoly elements has been recognized by many economists, Chamberlin admits, but “with the exception of the theory of duopoly, the middle ground between competition and monopoly

294

R. Marchionatti

remains virtually unexplored” (ibid., p. 5). This “middle ground” is the main subject of the book. The book is organized in eight chapters. The first chapters are devoted to a discussion of pure competition, duopoly and oligopoly. Beginning with Chap. IV, the book deals with “monopolistic competition”: it appears when there is product differentiation, where “each seller has an absolute monopoly of his own product, but is subject to the competition of more or less imperfect substitutes” (ibid., p. 9): “[s]ince each is a monopolist and yet has competitors, we may speak of them as ‘competing monopolists’ and … of the forces at work as those of ‘monopolistic competition’” (ibid.) Monopolistic competition, Chamberlin emphasizes, is a different thing from either pure monopoly or pure competition. The starting point of the theory of monopolistic competition is the theory of monopoly, which is, however, inadequate, because it deals with the isolated monopolist, the demand curve for whose product is given. In general, Chamberlin writes, “the competitive interrelationships of groups of sellers preclude taking the demand schedule for the product of any one of them as given” (ibid., p. 68). It depends, he continues, upon “the nature and prices of the substitutes with which it is in close competition” (ibid.). Monopolistic competition “concerns itself not only with the problem of an individual equilibrium …, but also with that of a group equilibrium … within a group of competing monopolists …: in this it differs both from the theory of competition and from the theory of monopoly” (p. 69). In this perspective the market, in which each seller is in some measure isolated, is “a network of related markets, one for each seller” (ibid.) and the theory brings into the foreground “the monopoly elements arising from ubiquitous partial independence” (ibid.). These elements, the author stresses, are not to be considered “imperfections”, as the theory of competition does, thus eliminating them from the theoretical point of view. On the contrary, Chamberlin writes, “it is now proposed to give due weight to whatever degree of isolation exists by focusing attention on the market of individual seller” (ibid., pp. 69–70). A study of competition from this standpoint gives results which are “out of harmony with accepted competitive theory” (ibid.). Chapter V, “Product Differentiation and the Theory of Value”, develops the theory of monopolistic competition. Under monopolistic competition, Chamberlin writes, the sales of the

6 Economics in the United States: New York, Harvard …

295

individual seller are limited and defined by three factors: “1) his price, 2) the nature of his product, and 3) his advertising outlays” (ibid., p. 71). The price problem arises because the demand curve for the product of the seller is negatively sloped, as in the case of monopoly. The nature of the product—i.e., the manner in which it differs from that of the competitors—influences the volumes of sales. Thirdly, the seller may influence the volume of his sales by making expenditures, advertising in particular: it is a peculiarity of monopolistic competition. Chamberlin stresses the fact that “the position and elasticity of the demand curve for the product of any one seller depend in large part upon the availability of competing products and the prices which are asked for them” (ibid., pp. 73–74). The equilibrium problem of the individual firm is dealt with by assuming, as a rough approximation, that the conditions with respect to the competitors are held constant, while the firm’s own equilibrium is considered “in isolation” (ibid., p. 74). This case can be regarded merely “as an extension of theory of monopoly” (ibid.). Chamberlin then turns to what he calls the “group equilibrium” (ibid., p. 81)—note that the concept of industry is not applicable in a context of product differentiation—where a number of producers exist “whose goods are close substitutes for each other” (ibid): “each producer within the group is a monopolist, yet his market is interwoven with those of his competitors, as he is no longer to be isolated from them” (ibid.). In order to facilitate the analysis, Chamberlin assumes that “both demand curves and cost curves for all the products are uniform throughout the group” (ibid., p. 82). He introduces the curve DD’ , “a fractional part of the demand curve for the general class of product” (ibid., p. 90)—which is the demand curve facing the group—and “shows the demand for the product of any one seller at various prices on the assumption that his competitors’ prices are always identical with his” (ibid.), and the curve dd’—i.e., the individual firm’s demand curve—which shows the buyers’ preferences for the product of one seller over that of another, and shows “the increased sales which any producer may enjoy by lowering his price, provided the others hold theirs fast” (ibid., pp. 90–91). Chamberlin argues that a firm may increase its profit by cutting its price, without fear “of ultimately reducing his gains through forcing others to follow him because his competitors are so numerous that the market of each of

296

R. Marchionatti

them is inappreciably affected by his move” (ibid., p. 91). Thus, since all firms within the group are assumed to have the same demand and cost conditions and the same belief concerning their rivals’ reaction, all firms have an incentive to, and actually will, cut their prices. As a consequence, in the graphical representation (see Figure 14 of the book), firm i’s demand curve will shift downward until it becomes tangent to the average (U-shaped) cost curve. At this tangency point the price cutting policy ceases to be profitable and the equilibrium price is determined. The analysis of this case shows that: (a) competition reduces profits to the competitive level, but leaves prices higher, because “the demand curve is never tangent to the cost curve at its lowest point” (p. 88) and (b) “the price is inevitably higher and the scale of production inevitably smaller under monopolistic competition than under pure competition” (ibid.). Chamberlin then passes to the small-group case where “the sellers are relatively few in number” and “each enjoys a market which is to a degree protected from those of the others” (ibid., p. 100): the result, he writes, “is a composite of the results of the two types of monopoly elements in isolation” (ibid.). Chamberlin emphasizes the uncertainty of the outcome: Each seller may be in doubt as to his rival’s policy, and therefore as to his own, because he does not know (a) whether, if his rival’s present policy continues, it will continue with respect to his price or with respect to his output, (b) how intelligent and farseeing his rival is, and (c ) how large would be the incursions made upon him by his own price cut. This last factor is augmented by a new unknown—the extent of the buyers’ preferences for his own product over others, expressed by the shape of the demand curves for individual products. (ibid., p. 101)

As a consequence, there are as many solutions as there are behavioral assumptions to be made. However, Chamberlin draws particular attention to the case of “mutual dependence recognized”, which he considers the most probable solution, supported by tacit or formal agreement as regards prices, and no-price competition. The fifth edition of the book, in 1946, added a chapter on the difference between monopolistic and imperfect competition, a revision of a

6 Economics in the United States: New York, Harvard …

297

paper published in 1937 in the Quarterly Journal of Economics (Chamberlin 1937).21 In essence, Chamberlin recognizes that his concept of monopolistic competition is similar in its technical apparatus to Robinson’s imperfect competition but emphasized that it differed from the latter in being “a challenge to the traditional viewpoint of economics that competition and monopoly are alternatives”: By contrast, it is held that most economic situations are composites of both competition and monopoly, and that … a false view is given by neglecting either one of the two forces and regarding the situation as made up entirely (even though “imperfectly”) of the other. (ibid., p. 204)

The Impact of the Chamberlinian Revolution: Edward Mason (1899–1992) and the Emergence of Industrial Organization “The label, ‘Industrial Organization’, and the initial form and impetus came out of Harvard” (Grether 1970, p. 83). In fact, the publication of Chamberlin’s book strongly influenced the work of some economists around Harvard, which gave rise to the field of industrial organization. According to Joe Bain, one of the most important representatives of industrial organization in the post-World War II era, the field’s development and general design was suggested by Chamberlin’s Theory of Monopolistic Competition. Bain (1964) writes: it was this work which simultaneously did two very important things. It advanced expressly—really for the first time—the major and crucial theoretical construct in which an economy of enterprises was viewed as being made up of industries having a variety of distinctly different market structures, with market conduct and performance tending to differ significantly with differences in structure. And it implemented this construct by developing an uncomplicated but actually quite sophisticated classification of market structures. This classification reflected a remarkable insight into what in the world of markets was empirically relevant to price theory, was the 21

For a discussion of the many analytical differences between the two books, see Shackle 1967 and O’Brien 1983.

298

R. Marchionatti

evident parent of substantially all more elaborate market classifications which have been subsequently suggested, and provided the basic skeleton for all of them which have had appreciable merit. Suddenly, therefore, economists were presented with a sophisticated theory of markets in lieu of a theory of perfect competition with dangling appendages concerning monopoly and economic warfare. (Bain 1964, p. 29, emphasis added)

In framing price theory in the context of the new field, Bain considers Chamberlin’s theory of small groups, or oligopoly, to be particularly important: “In reformulating price theory, the basic novel things that Chamberlin did were to introduce the notion that groups of rivalrous firms often sell differentiated products and explore its implications, to resurrect and reformulate a long-lost theory of duopoly, and to expand it into a major novelty, a theory of oligopoly” (ibid.). It would fill “a gaping hole in pre-existing price theory” (ibid.): “In the twelve pages which comprise his three sections of ‘mutual dependence recognized’, ‘the effect of uncertainty’, and ‘the small group: oligopoly plus product differentiation’, Chamberlin revised modern price theory drastically and permanently” (ibid.). By providing the main outlines of a theory of oligopoly, Chamberlin, Bain maintains, identified a crucial area and direction for further theorizing and for empirical research, supplied the crucial construct and its basic pattern of implementation and identified dimensions of market performance in addition to those involving price, production cost and output—i.e., selling cost and product quality and variety—which suggested an expanded range of matters deserving empirical study within the sort of theoretical framework he had established. Further yet, he suggested several fruitful hypotheses concerning market conduct in imperfectly collusive oligopolies. The subsequent development of the field of industrial organization which grasped the implications of the Chamberlin construct and advanced empirical research was the result of Edward Mason’s work, supported by a stream of graduate students, in the 1930s. Mason created the paradigm of the industry study, exploring the relationship between industry structure, the conduct of enterprises and the resulting economic performance. Edward Sagendorph Mason (1899–1992) was born on February 22, 1899, in Clinton, Iowa. He graduated from the University of Kansas and

6 Economics in the United States: New York, Harvard …

299

then entered Harvard University, where he earned a Ph.D. in economics in 1925 under Taussig’s supervision with a dissertation on dumping in international trade. In those years he began his teaching career, becoming a professor in 1936. He remained at Harvard for his entire career. By the mid-1930s he was teaching courses on “The Corporation and its Regulation” and on “Industrial Organization and Control”. In 1947 he became dean of the Graduate School of Public Administration, since renamed the John F. Kennedy School of Government. In his courses he focused on market structures, corporate organization and issues of price policy and corporate governance, as well as on regulation and anti-trust policies. He also worked with the National Bureau of Economic Research in New York and the Bureau of Labor Statistics. With the advent of World War II, Mason became chief economist in the Office of Strategic Services, commencing a decade or more of active involvement in wartime and postwar advising and participation in international economic policymaking. In 1945 he was appointed Deputy to the Assistant Secretary of State for Economic Affairs and in 1947 a member of the President’s Committee on the Marshall Plan. He died on February 29, 1992 in California. Mason’s article “Price and Production Policies of Large-Scale Enterprises”, presented at the meeting of the American Economic Association and then published in The American Economic Review in 1939, immediately became a fundamental text for the emerging field of industrial organization. In the paper, Mason presents the concept of “price policy” as crucial in defining the new area of research: The … emphasis on price policy, as against price, as a proper object of study represents recent economic reflection on the significance of expectations, uncertainties, market control, and the position of price as one among many selling terms. Policy implies some degree of control over the course of events and, at the same time, the use of judgment as to the probable consequences of alternative lines of action. In perfect markets, whether monopolistic or competitive, price is hardly a matter of judgment and where there is no judgment there is no policy. The area of price policy, then, embraces the deliberative action of buyers and sellers able to influence price; that is to say, it covers practically the whole field of industrial price. (Mason 1939, p. 61)

300

R. Marchionatti

Mason distinguished between two paths in Industrial Organization. First, “the analytical method”, which implicitly refers to Chamberlin himself and to Triffin, and focuses “on rival’s reactions as considerations in the determination of price or production policies and on the importance of non-price forms of competition” (ibid., p. 63). This type of analysis provides “a pattern of thought useful in separating data which are relevant from those which are irrelevant to the explanation of price and production policies” (ibid., p. 64). Second, the “statistical approach” which starts with the empirical investigation of price policies implemented by enterprises and then attempts “to correlate” these variations to those of other economic variables (ibid., p. 65). This second direction of analysis is, of course, that more specifically definable as Industrial Organization. An adequate analysis of price and production policies requires, Mason writes, consideration of the influence of the organization of a firm on the character of the firm’s reaction to given market situations, and of elements of market structure which include many more things than numbers and product differentiation. It goes without saying, he adds, that “a realistic treatment of these questions necessitates the use of analytical tools which are amenable to empirical application”: The problem, as I see it, is to reduce the voluminous data concerning industrial organization to some sort of order through a classification of market structures. Differences in market structure are ultimately explicable in terms of technological factors. The economic problem, however, is to explain, through an examination of the structure of markets and the organization of firms, differences in competitive practices including price, production, and investment policies. (ibid., p. 66)

This classification, as we have said, was exhaustively developed by Mason’s pupil, Joe Bain in a work of 1942 stemming from his participation in the Harvard seminar on “Industrial Organization and Price Policy”. This market classification aims to give empirical content to the broad category of oligopoly in order to shed light on patterns of price policies and gain a better understanding of strategic interaction. Bain’s classification hinges on six variables: the number of sellers, the durability of the product, the differentiation of the product, the variation of the

6 Economics in the United States: New York, Harvard …

301

product, the number of buyers and the nature of buyers. Each of these criteria is twofold, so he obtains a classification with 64 cases. From this classification, which is presented as a hypothesis that should be submitted to empirical verification, he proposes a shorter one reduced to 14 cases (Bain 1942, pp. 566–569, 573).

6.4

Economics in Chicago: A “Mixed Bag”

Introduction Economically and socially, Chicago was one of the places showing the greatest intellectual ferment in the country between the two world wars. In the 1920s and 1930s, the economic expansion that had begun in the mid-1800s picked up speed, transforming Chicago into a bustling metropolis of over two million inhabitants, the nation’s second largest city and second largest manufacturing area after New York City. In this period, the University of Chicago, Department of Economics grew significantly. Between 1892 and World War I, the Department had been organized around the dominant figure of James L. Laughlin and a few other scholars (Thorstein Veblen, Leon C. Marshall, Walton Hale Hamilton, Robert Hoxie), the most prominent of whom was the founder of American Institutionalism, Veblen (see Vol. I, Chap. 7.5). Laughlin retired in 1916, leaving the department in Marshall’s hands. Veblen had left some years earlier, Hamilton left in 1915, Hoxie died in 1916. These departures were coupled with new arrivals, and as a consequence, the department changed considerably. On the threshold of the war, two institutionalists appeared on the Chicago scene: John Maurice Clark (1884–1963), who arrived in 1915 and took over the theory courses after Laughlin’s retirement, and Harold Moulton (1893– 1965), giving a new institutional turn to the department. However, they left Chicago after some years, Moulton in 1922 to join the recently founded Brookings Institution, Clark in 1926 to return to Columbia. New counter-institutionalist leaders emerged and assumed partial leadership of the department, first of all Jacob Viner (1892–1970)—who had arrived in 1916 but in 1917 had followed his old Harvard master Taussig

302

R. Marchionatti

to Washington, returning to Chicago in 1919 where he remained until 1946—and Clark’s successor Frank H. Knight (1885–1972), at Chicago since 1928. At the beginning of the 1930s, the University of Chicago Department of Economics was a remarkable concentration of first-rate economists, but not a school. As Reder (1982, p. 3) writes, “Chicago economics was a mixed bag”, consisting of essentially three groups: the precursors of the future Chicago school, sometimes referred to as the first Chicago School of economics, the institutionalists, and the quantitative economists. The first group, in addition to Knight and Viner, was made up of the monetary economists Henry Calvert Simons (1889– 1946) and Lloyd Winn Mints (1888–1989) as well as the Russian-born Aaron Director (1901–2004, from 1927 at Chicago), who was to have a central role in the development of the field of law and economics and in the foundation of the Journal of Law and Economics in the Fifties. The most important of these figures was undoubtedly Henry Simons. He had studied with Knight at the University of Iowa and followed him to Chicago in 1927. Here he published extensively on banking and monetary policy. In 1934 he published his best-known book, A Positive Program for Laissez-Faire: Some Proposals for a Liberal Economic Policy (Simons 1934), which dealt with the problems created by the Great Depression. An opponent of the New Deal policies, he investigated— from a perspective not dissimilar to that of Eucken’s ordoliberal Freiburg School in Germany and Einaudi’s Turin liberal school of economics in Italy22 —the conditions for a system of classical liberalism and the policy proposals to move toward it, believing that government action was necessary in setting the framework for a free market economy. Simons proposed to eliminate private monopoly, establish definite rules of the game with money by abolishing private deposit banking based on fractional reserves and replacing it with a 100% reserve requirement on deposits, creating a system whereby the federal monetary authority has responsibility for controlling the quantity of effective money under definite rules, and establishing a tax system aimed at reducing inequality. The program of monetary reform was reflected by the so-called Chicago 22

Ekkehard Köhler and Stefan Kolev (2011) suggest the hypothesis of a “Simons-Eucken-Hayek triangle of academic interaction”, but the reference to Hayek does not seem entirely convincing.

6 Economics in the United States: New York, Harvard …

303

Plan, which is generally traced back to Irving Fisher (1935), whose goal was to “prevent inflation and deflation” and to “cure or prevent depressions”. The 100% reserve plan is considered a Chicagoan Plan essentially because, as Fisher (1935) recognized in the preface to his book, several Chicago economists contributed to it, including Knight, Mints, Director and, above all, Simons. The strong institutional element that marked Chicago in the 1920s was still quite well established in the early 1930s (see Rutherford 2000), and then gradually vanished. The most important representative was undoubtedly John Maurice Clark (1884–1963), but he left Chicago for Columbia in 1923. The remaining group of institutionalists was made up of minor figures like the economic historians Chester Wright (1879–1966), a Harvard Ph.D. with Taussig, at Chicago from 1906, and John Ulric Nef Jr. (1899–1988), a Harvard graduate at Chicago from 1929 who in 1941 was one of the co-founders, with Knight, of the interdisciplinary “Committee on Social Thought”, and the economists Harry A. Millis (1873–1948) and Simeon Leland (1897–1972) (on the Committee see Emmett 2009). The third group was represented by the mathematical and quantitative economists Paul Douglas, Henry Schultz and Oscar Lange. Paul Howard Douglas (1892–1976), a student of J. B. Clark and Henry L. Moore at Columbia, where he received his Ph.D. in economics, came to Chicago in 1920 and remained there until 1942. He was well known for his writings in labor economics, in particular his Theory of Wages (Douglas 1934). Moreover, in a famous 1928 article in the American Economic Review, he and the mathematician Charles W. Cobb formulated the Cobb–Douglas production function in testing the marginal productivity theory of distribution, where the production process is described by a linear homogeneous function with an elasticity of substitution of one between factors. The Polish-born Henry Schultz (1893–1938), at Chicago from 1926 until his death, was a statistician and pioneer of econometrics. He received his Ph.D. at Columbia where he was deeply influenced by Henry L. Moore, under whom he developed his econometric study of demand. His program of research, whose theoretical framework was Paretian, was essentially the measure of demand and supply functions, perfecting statistical methods (see Yntema 1939;

304

R. Marchionatti

Hotelling 1939). The product of this statistical research was The Theory and Measurement of Demand (Schultz 1938). His sudden death in an automobile accident in 1938 made the Polish-born Oskar Lange, recently arrived in the United States, the senior mathematical economist in the department (see Reder 1982). Oskar Lange (1904–1965) had emigrated in 1934 from Poland, first to the United Kingdom and then, in 1937, to the United States. He had acquired a considerable reputation as a mathematical economist, highly regarded for his 1936 and 1937 articles on the socialist calculation debate (see Chap. 7.2). He was appointed to a professorship at Chicago where he stayed until 1945, when he and his wife decided to return to Poland. During these years he published several papers and books which brought him renown: the book On the Economic Theory of Socialism (Lange and Taylor 1938), a collection of his earlier articles on socialism, and Price Flexibility and Employment (Lange 1944). The latter was an important landmark in the debate that followed the publication of Keynes’s General Theory, which, influenced by Hicks’s work, linked General Theory and Walras’ general equilibrium theory, in the sense that the foundations of Keynes’s theory were to be found in the general economic equilibrium theory (see Rubin 2011, 2016), and presented, as Lange writes, “a systematic investigation of the effect of price flexibility, particularly flexibility of prices of factors of production, upon employment and economic stability” (Lange 1944, p. 1). According to traditional economic doctrine, unemployment is entirely due to rigidity of factor prices, Lange writes, and thus flexibility of these prices is regarded as desirable and is advocated as a norm of an economic policy which aims at full employment and proper allocation of resources. However, he continues, Keynes holds that under certain conditions, “changes in money wage rates have no effect upon employment but influences only the level of product prices” (ibid.). Not surprisingly, the book was published as a Cowles Commission Monograph, as evidence of the strict relationship between Lange and the Cowles Commission for Research in Economics, which had arrived at Chicago in 1939 (to stay there until 1955), and was directed in the years between the two world wars by two Chicago professors, Theodore Yntema and the Russian-born Jacob Marschak (at Chicago since 1943). Many years later Lawrence Klein (1991) wrote that this arrival created two worlds of economics at

6 Economics in the United States: New York, Harvard …

305

Chicago, the Cowles group on the one hand and the Knight and Simons groups on the other: they were divided not only by methodological and theoretical questions but also by political issues, as the Cowles Commission members were sympathizers of Roosevelt’s New Deal and the others were fiercely opposed. Thus, as we noted, Chicago was “a mixed bag”, not a school. The diversity of thinking and interests was what impressed the young scholars who attended the University (see, e.g., Bloomfield 1992), though it should be emphasized that this took place in a setting where Knight and Viner were widely considered, as Samuelson wrote, “the giants of the present” (Samuelson 1972, p. 5). However, if we exclude Lange and the Cowles Commission—the latter technically separate from the department—there was a common ideological substratum among Chicago economists, who were joined by their rejection and criticism of the Keynesian revolution, or in other words by a diffuse anti-Keynesianism and more generally an anti-new-Cambridge school attitude which favored neoclassical theory (but was not totally hostile to institutionalism) and political and philosophical liberalism. It was only in the 1950s that we can say there was a new Chicago School, after the upheavals of the 1940s with the tragic death of Schultz, a string of departures— Viner, who left for Princeton, Lange, who left for Poland and Douglas who became a US Senator—and the emergence of new leaders, in primis Milton Friedman (who came to Chicago in 1946) and George Stigler, who were to become the leaders of the Chicago School in the postwar era.

Precursors of the Chicago School, I: Frank Knight (1885–1972) Frank Knight, as Stigler (1987) wrote, was “the dominant intellectual influence” in the University of Chicago Economics Department during the interwar period. He joined the department in 1929, coming from the University of Iowa. His most influential work in economics was Risk, Uncertainty and Profit (1921), a crucial contribution to modern postMarshall microeconomics. In the 1930s his interests changed, shifting

306

R. Marchionatti

chiefly to social philosophy and in particular the issue of liberalism and the criticism of the market system from the ethical point of view— “radical conservatism” is the term coined for defining his vision (Burgin 2009)—as well as interdisciplinary issues.

Biographical Note Frank Hyneman Knight (1885–1972) was born on a farm in Illinois on November 7, 1885, the oldest of eleven children. He attended high school in Illinois, and then studied at the University of Tennessee. Starting in 1913, he pursued doctoral studies in philosophy and economics at Cornell University, where he studied with Alvin Johnson (one of the founders of the New School in New York in 1918) and Allyn A. Young. He completed his Ph.D. in economics in 1916, under Young’s supervision. Knight’s doctoral dissertation—entitled Cost, Value and Profit—was devoted to the theory of profit in conditions of uncertainty. It was published in 1921 under the title Risk, Uncertainty and Profit (Knight 1921). After a year as an instructor at Cornell, Knight moved to the same post at the University of Chicago, where he stayed from 1917 to 1919. As Chicago had no permanent position to offer, he accepted a job at the University of Iowa where he stayed for nine years, until 1928, becoming professor in 1922. He returned to the University of Chicago in 1928. In the 1920s he contributed with a series of important articles to the pre-Sraffian phase of the controversy on costs (see Chap. 7.1) which refined the perfect competition theory. In the 1930s his interest in economics shifted to capital theory—debating against the neo-Austrians. In the meantime, in the mid-1920s, Knight began reading intensively in the literature of the German Historical School, and translated Max Weber’s General Economic History, the first of Weber’s works to be put into English (Weber 1923). In these years Knight’s work took new directions, attempting to develop an approach to economics which combined economics, history and institutionalist issues, and his interests shifted to social philosophy. His main contributions in this field were published in The Ethics of Competition and Other Essays (1935) and in Freedom and Reform (1947), where his “radical conservatism”

6 Economics in the United States: New York, Harvard …

307

clearly emerges. From the institutional standpoint, his interdisciplinary interest took concrete shape though his participation in the foundation of the university’s “Committee on Social Thought” and in the change in his teaching: in 1942 he became professor of the social sciences and in 1945 professor of philosophy. However, he continued to participate in economics at his university, serving with Jacob Viner from 1929 to 1946 as coeditor of the Journal of Political Economy. Knight officially retired from the University of Chicago in 1952, although he continued to teach and write until his death. He died in Chicago on April 15, 1972.

Knight’s Economics: Risk, Uncertainty and Profit, 1921 Risk, Uncertainty and Profit , a revision of Knight’s doctoral dissertation on “The Theory of Business Profit”, was published in 1921, the same year Keynes published his Treatise on Probability. Schumpeter (1954, p. 894n) considers it a text that lights up “an important line of analytic advance”: it contains “a very useful emphasis upon the distinction between insurable risk and non-insurable uncertainty” (ibid., p. 894) and “a profit theory that linked this non-insurable uncertainty on the one hand to rapid economic change—which … is the main source of this uncertainty—and on the other to differences in business ability” (ibid.).23 From the end of the 1920s—when Robbins at the LSE adopted it as a key text for the students of his course on the principles of economic analysis (see Emmett 2021)—the book was greeted by much of the international community of economists as an outstanding contribution to economic theory, and was considered a classic. In his preface Knight writes: There is little that is fundamentally new in this book. It represents an attempt to state the essential principles of the conventional economic doctrine more accurately, and to show their implications more clearly, than has previously been done. That is, its object is refinement, not reconstruction; it is a study in “pure theory”. (Knight 1921, p. vii) 23

Schumpeter (1954) also notes that a similar theory of entrepreneurship was developed some years later by Maurice Dobb in Capitalist Enterprise and Social Progress (Dobb 1925).

308

R. Marchionatti

Knight examined two main issues in the book: the definition of perfect competition and the treatment of risk and uncertainty. The latter is traditionally considered Knight’s most important contribution to economic theory. However, the discussion of perfect competition in Part II of the book, together with the articles published in 1921–1925 (see Chap. 7.2), was also important in defining modern microeconomics (see Marchionatti 2003). The book is divided into three parts: the methodological and historical introduction, Part II on “Perfect Competition”, and Part III, “Imperfect Competition through Risk and Uncertainty”. The book begins with a series of methodological statements: (1) a body of pure theory in economics (an abstract deductive system) is a “very fundamental”, although small, “section” of economic science; it is a prerequisite for economics as theoretical mechanics is for physics; (2) the method of economics is the scientific method, i.e., “the [Paretian] method of successive approximations” (Knight 1921, p. 8); (3) the first approximation is the competitive system—the “particular form of organization of human want-satisfying activity which has become prevalent in Western nations” (ibid., p. 9)—a perfectly competitive system “in which the multitudinous degrees and kinds of divergences are eliminated by abstraction” (ibid.): it presents the “general principles” of the competitive system (ibid.). Knight maintains that economists had always followed the methodology implicit in these three statements, although not “in a sufficiently self-conscious, critical, and explicit way” (ibid., p. 10). Rather, they had employed a “loose use of assumptions and looser application of conclusions” (ibid., p. 14). Knight acknowledges that “notable progress in the right direction has recently been made” (ibid.), the direction being one “toward a sharper separation of the theoretical portion of economics from the empirical portion, and toward the clearer formulation of premises” (ibid.). He attributes this progress mainly to the work of two economists, Vilfredo Pareto and Philip Wicksteed, who built “a considerable and fairly satisfactory body of consciously and rigidly ‘theoretical’ (i.e., general and approximate) doctrine” (ibid.). Nevertheless, he adds, Unfortunately it has not achieved the recognition and been accorded the fundamental place in the general program of the science which we think it

6 Economics in the United States: New York, Harvard …

309

should have … In the great mass of economic literature there is certainly still wanting the evidence of a comprehensive grasp of general principles and even more of the meaning and importance of general principles in a scientific program. There is still a need for thoroughgoing and critical comparison and contrast of theoretical assumptions with the conditions of real life and of theoretical conclusions with concrete facts. (ibid.)

On this subject, Knight writes that “[i]ndication of progress in this field is furnished especially by the discussion centering around the concept of normality in the work of Marshall in England and the related notion of the static state espoused in particular in this country by J. B. Clark” (ibid., p. 15). In a note, he adds that “[t]he static state idea is further developed along rigidly theoretical lines by Professor Schumpeter in Austria” (ibid.)—the reference being to Schumpeter’s two books of 1908 and 1912. Knight takes Schumpeter’s critical view of Marshall, arguing that Marshall adopted a “cautious, almost anti-theoretical attitude toward fundamentals”: [Marshall] refuses to lay down and follow rigidly defined hypotheses, but insists on sticking as closely as possible to concrete reality and discussing “representative” conditions as opposed to limiting tendencies. The gain in concreteness and realism is in our opinion much more than offset by the obscurity, vagueness, and unsystematic character of the discussion, the inevitable consequence of burying fundamentals in an overwhelming mass of qualification and detail. (ibid.)

On the contrary, Knight thinks that it was necessary to adopt the sharp separation mentioned above. He thus saw static method and equilibrium as the two key concepts of pure theoretical analysis. He stresses that the static method in economics is necessary from a scientific standpoint as the only nonarbitrary assumption, writing: The opposition to pure theory in general is based on a failure to understand it, and especially common is the misconception as to the meaning of static or normal hypotheses. It is not recognized that their use is inherent in the methodology of science, is in fact the very essence of scientific procedure … Static method and reasoning are … coextensive.

310

R. Marchionatti

We have no way of discussing a force or change except to describe its effects or results under given conditions … The “static” method in economics does merely this. It inquires what conditions exist and studies the results which recognizable forces at work … tend to produce under those conditions. (ibid., p. 16)

The other key concept, that of equilibrium, Knight says, is closely related to the concept of static method and, likewise, is methodologically necessary: It is the nature of every change in the universe known to science to have “final” results under any given conditions, and the description of the change is incomplete if it stops short of the statement of these ultimate tendencies. Every movement in the world is and can be clearly seen to be a progress toward an equilibrium. Water seeks its level , air moves toward an equality of pressure, electricity toward a uniform potential , radiation toward a uniform temperature, etc. Every change is an equalization of the forces which produce that change, and tends to bring about a condition in which the change will no longer take place. The water continues to flow, the wind to blow, etc., only because the sun’s heat—itself a similar but more long-drawn-out redistribution of energy—constantly restores the inequalities which these movements themselves constantly destroy. So also in economic phenomena. (ibid., p. 17)

The primary attribute of competition, Knight writes, is “the ‘tendency’ to eliminate profit or loss, and bring the value of economic goods to equality with their cost” (ibid., p. 18). But in actual society, Knight continues, “cost and value only ‘tend’ to equality” and “they are usually separated by a margin of ‘profit’, positive or negative” (ibid., p. 19): “Hence the problem of profit is one way of looking at the problem of the contrast between perfect competition and actual competition” (ibid.). The explanation of profit must bring into relief this distinction, Knight writes, and the connected examination of the concept of uncertainty. Here Knight introduces the difference between risk and uncertainty: Uncertainty must be taken in a sense radically distinct from the familiar notion of Risk, from which it has never been properly separated. The

6 Economics in the United States: New York, Harvard …

311

term “risk,” as loosely used in everyday speech and in economic discussion, really covers two things which, functionally at least, in their causal relations to the phenomena of economic organization, are categorically different. (ibid.)

Risk proper, Knight maintains, is a “measurable uncertainty”, while uncertainty is unmeasurable: We shall accordingly restrict the term “uncertainty” to cases of nonquantitative type. It is this “true” uncertainty, and not risk, as has been argued, which forms the basis of a valid theory of profit and accounts for the divergence between actual and theoretical competition. (ibid., p. 20)

The concepts of risk and uncertainty are taken up in Part III of the book. As a preliminary to discussing the theory of profit, Knight moved to the study of perfect competition in Part II of the book (Chaps. 3–6). He began in Chap. 3 (“The Theory of Choice and of Exchange”) by noting that “the historic body of economic theory rests upon the assumption of perfect competition” (ibid., p. 51). However, “the precise character of this assumption has been partially implicit and never adequately formulated” (ibid.). Consequently, “the assumptions actually made and their implications need to be brought to the surface and emphasized” (ibid.). Knight considered this the basis needed to advance and explain the problem of profit. Knight continued: “In order to study first the most essential features of exchange relations, it will be necessary to simplify the situation as far as possible by a process of ‘heroic’ abstraction” (ibid., p. 76), the crucial assumptions being those of perfect rationality, costless intercommunication between individuals and perfect knowledge, in a world where all given factors and conditions remain unchanged.24 In Part III (“Imperfect Competition through Risk and Uncertainty”), Knight begins by specifying that the drastic assumptions made in his construction of a perfectly competitive economy “were necessary to show the operation of the forces at work free from all disturbing influences” 24

On this basis, Knight approached the problem of the form of the supply curve in the long run, which involves him in the controversy on costs of the 1920s (see Chap. 7.2) and Marchionatti (2003).

312

R. Marchionatti

(ibid., p. 197). The “chief ” of these simplifications was “the assumption of practical omniscience on the part of every member of the competitive system” (ibid.), i.e., the hypothesis of perfect knowledge and information. From here, he moved on to examine the imperfection of knowledge and the relation between knowledge and behavior. In fact If all changes were to take place in accordance with invariable and universally known laws, they could be foreseen for an indefinite period in advance of their occurrence, and would not upset the perfect apportionment of product values among the contributing agencies, and profit (or loss) would not arise. Hence it is our imperfect knowledge of the future, a consequence of change, not change as such, which is crucial for the understanding of our problem. (ibid.)

The real world is, Knight writes, “a world of change” and “a world of uncertainty”: here “[t]he essence of the situation is action according to opinion, of greater or less foundation and value, neither entire ignorance nor complete and perfect information, but partial knowledge” (ibid., p. 199). It is the existence of uncertainty which gives the “form of ‘enterprise’ to economic organization as a whole and accounts for the peculiar income of the entrepreneur” (ibid., p. 232). Agents’ rational conduct seeks to reduce uncertainty to a minimum through assurance but, Knight maintains, the business risks that the process of decision involves are too uncertain to be insurable. The process of organizational decision explains the existence of entrepreneurial profit. Knight summarizes his discussion of the meaning of the profit in a few statements: Organization involves the concentration of responsibility, placing resources belonging to a large number of individuals under centralized control. Examination shows that the human functions in production involve making decisions, exercising control, but that this control is not final unless combined with assumption of the results of the decisions. The responsible decision relates to men rather than things; the ultimate manager is he who plans the organization, lays out functions, selects men for functions and appraises their value to the organization as a whole, in competition with all other bidders in the market. For this ultimate management there is but one possible remuneration, the

6 Economics in the United States: New York, Harvard …

313

residuum of product remaining after payment is made at rates established in competition with all comers for all services of men or things for which competition exists. This residuum is profit; it is the remainder out of the value realized from the sale of product after deduction of the values of all factors in production which can be valued, or after all the product has been imputed to productive elements which can be imputed by the competitive mechanism. Profit is unimputable income, as distinguished from the total income of the owner of the business. (ibid., p. 308)

Precursors of the Chicago School, II: Jacob Viner (1892–1970) “There has never been a greater neoclassical economist than Jacob Viner”, wrote Paul Samuelson (1972, p. 9), and Lionel Robbins (1970, p. 2) defined him as “the outstanding all-rounder of his time in our profession” (see Bloomfield 1992). Indeed, Viner was concerned with the whole field of economics, and his writings ranged from international economics, probably his main field of interest, to price theory, macroeconomics, money and banking, public finance, economic development, and economic and financial history, as well as the history of economic thought. His intellectual interests were even broader, including philosophy, theology, literature and social science in general.

Biographical Note Jacob Viner was born in Montreal, Canada, on May 3, 1892. He was educated at McGill University. In the fall of 1914 he went to Harvard to begin his graduate studies. There he fell under the influence of Frank Taussig. From Taussig he derived his life-long interest in international economics and his classical and neoclassical attachments. Viner received his MA in 1915 and his Ph.D. in 1922, under Taussig’s supervision. Viner joined the faculty of the University of Chicago as an instructor in the fall of 1916. He left at the end of the academic year to move to Washington to work at the US Tariff Commission under Taussig in 1917–1919. He returned to Chicago in 1919. He remained in the faculty of Chicago’s economics department for about 30 years, becoming full

314

R. Marchionatti

professor in 1925. In 1946 he resigned his professorship in Chicago and joined the faculty of Princeton University, where he served from 1950 until his retirement in 1960. He continued his research and writing, in part as a member of the Institute for Advanced Study, and remained active in the Princeton community until his death on September 12, 1970 (on his years in Princeton see Baumol (1972). He served as special assistant at the US Treasury and as consulting expert to Secretary Henry J. Morgenthau in 1934–1939, and then again for part of 1942. In the mid-1940s he served as consultant to the Department of State and the Federal Reserve Board. The Chicago years were a highly productive period of Viner’s life. In addition to many articles, he published several books, the most important between the two world wars being Dumping: A Problem in International Trade (1923) and his most famous book, Studies in the Theory of International Trade (1937). After the war he continued to publish extensively in the field of international economics, where his work included The Customs Union Issue (1950), International Trade and Economic Development (1952) and The Long View and the Short (1958). He was coeditor (with Frank Knight) of the Journal of Political Economy for most of the period.

Viner’s Economics: “Cost Curves and Supply Curves” (1931), a Classic in Neoclassical Microeconomics “Cost Curves and Supply Curves”, published in 1931 in Zeitschrift für Nationalökonomie, the Viennese journal directed by Oskar Morgenstern, systematized the debate on Marshall of the 1920s in order to build a rigorously static theory of perfect competition on the formal bases laid by Marshall but totally abstracting from Marshall’s concern with realism and dynamic considerations. The paper was destined to become a classic in modern post-Marshallian microeconomics. In this sense, as (Bloomfield 1992, p. 2072) writes, “[Viner’s] analysis, the tools and ideas he introduced, and the graphical techniques he employed had a major impact on the profession and entered into the mainstream of economic thought”. Viner says that the primary purpose of his article is:

6 Economics in the United States: New York, Harvard …

315

to develop a graphical exposition of the manner in which supply curves are dependent upon the different possible types of technological and pecuniary cost situations, under the usual assumptions of atomistic competition and of rational economic behavior on the part of the producers. Ibid. (Viner 1931, p. 23)

In this exposition “[n]o attempt is made … at realistic description of the actual types of relationship between costs and supply” (ibid.). In other words the “modest” purpose of the article is to present “the formal types of relationship which can be conceived to exist under certain simplifying assumptions” (ibid., p. 23). Viner’s partial equilibrium analysis, presented in some graphs, distinguished between a number of different cost situations, for the firm and for industry, in the short run and the long run, identifying the supply curves in each case. Viner begins by considering the short-run equilibrium of the firm. He describes the “fundamental graph”, where the curves representing the firm costs as functions of quantity produced are U-shaped (average costs) or upward sloping (marginal cost). Average cost and marginal cost intersect at the lowest point of the average cost curve. The short-run supply curve for the industry as a whole is the sum of the abscissae of the individual short-run marginal cost (= individual supply) curves. In the long-run, in which each producer can change the scale of his plant the equilibrium of the firm requires equivalence between price, average cost and marginal cost. As the relations of costs in the long-run will depend on the technological conditions under which output can be most economically varied, Viner moves on to analyze the different types of technological conditions. First he analyzes the case of “Ricardian” increasing costs, i.e., a “special case” where the output of the industry as a whole can be increased only by “the more intensive utilization of the absolutely limited factor” (ibid., p. 30). This appears to be the case, Viner writes, “usually designated in the textbooks as the case of increasing costs. I have labelled it as ‘Ricardian increasing costs’ to indicate its close relationship to the Ricardian rent theory” (ibid., p. 32). Viner then considers the case of constant costs. Inconceivable in the short-run if there are increasing marginal costs, constant costs are theoretically conceivable in the long-run (ibid., p. 33).

316

R. Marchionatti

The most interesting case, Viner explains, is when “each producer can vary his scale of production without affecting his long-run average costs” (ibid.). “This case presents certain difficulties when perfect competition prevails” (ibid., p. 33), introducing indeterminacy for the firm. If each individual firm experienced constant returns, marginal and average costs would be constant and the firm’s supply curve horizontal. With identical costs among the firms, each producer could produce any amount at the equilibrium price (the minimum of the long-run average-cost curve), nothing below it, and unlimited quantities above it. In this case, the industry supply curve would not be definable: “it is impossible to indicate graphically the relationship between the long-run supply curves of the individual concern and the industry as a whole” (ibid.): If the costs of different producers are uniform, the supply curve of the industry would be indefinite, and in the long-run there would be a constant tendency toward overproduction, with consequent losses and a reaction toward underproduction. Actual long-run price and output would be unstable, but would oscillate above and below stable points of equilibrium price and equilibrium output. (ibid., p. 34)

Viner then considers the case where Marshall’s “net internal economies of large-scale production” exist (ibid.). The peculiarity of this case is that the long-run marginal cost curve is negatively inclined. The chart illustrates, Viner maintains, “[t]he familiar proposition that net internal economies of large-scale production and long-run stable equilibrium are inconsistent under competitive conditions” (ibid., p. 37) at the firm level, monopoly being the resulting situation. Lastly, Viner considers the cases of net external economies and diseconomies. External economies (technological or pecuniary), Viner writes, are “those which accrue to particular concerns as the result of the expansion of output by their industry as a whole, and which are independent of their own individual outputs” (ibid., p. 38). If an industry which enjoys net external economies of large production increases its output—presumably through increase in number of plants—“the average costs of the member concerns of that industry will fall even though each concern maintains a constant scale of plant and a constant output” (ibid.).

6 Economics in the United States: New York, Harvard …

317

Viner’s Contributions to International Economics Starting from his doctoral dissertation, Viner made many contributions of great importance to the theory of international economics. Drawing upon the work of his master, Taussig, he refined the classical-neoclassical (à la Marshall) approach to international trade theory. Here we will consider two of his writings from the interwar period: his book on dumping, Dumping: A Problem in International Trade (Viner 1923), and his Studies in the Theory of International Trade (1937) on the evolution of the theory of international trade. Dumping (1923) is a substantial contribution to the theory and practice of dumping, a subject already investigated by Taussig. It stands as the classic theoretical treatment of dumping in the literature which for many years “remained the standard work in the field” (Bloomfield 1992, p. 2064). Viner defined dumping as price discrimination between national markets, most commonly involving sales of a product at a lower price abroad than at home, and analyzed the kinds, motives and effects of dumping. In addition, he presented a detailed examination of its historical, legal and administrative aspects and measures taken to prevent it.25 Viner’s Studies in the Theory of International Trade (1937) is considered “the definitive statement of the classical and neoclassical position on trade” (Bloomfield 1992, p. 2059) before the Heckscher-OhlinSamuelson model. The book is dedicated to Taussig: My heaviest intellectual indebtedness is to Professor F. W. Taussig, who first aroused my interest in the field of international trade as long ago as I914, who has done much by his writings and oral discussion to sustain it since and to set the mold for my thinking, and to whose teachings I have remained faithful in my imperfect fashion. As a gesture of gratitude in 25

An analysis of dumping as price discrimination, i.e., its theoretical analysis in the context of imperfect competition, had been developed before Viner by the Italian economist Pasquale Jannaccone (see Vol. I, Chap. 6.3) in a 1914 article presented at a symposium on dumping in Riforma Sociale. Actually, Jannaccone’s article was quoted by Viner in the part of his volume where empirical facts are discussed, but it came to the attention of economists only more than twenty years afterward, when it was reprinted in Jannaccone’s book Prezzi e mercati (1936) and reviewed in several leading international journals (for a reconstruction of Jannaccone’s contribution see Cantono and Marchionatti 2012).

318

R. Marchionatti

this connection, I have taken the liberty of dedicating the book to him. (Viner 1937, p. xiv)

In this book, Viner endeavored to trace the evolution of the modern “orthodox” theory of international trade—this was a remarkable survey of some of the history of economic thought—and then proceeded to a detailed examination of current controversies in the literature “centering about important propositions of the classical and neo-classical economists relating to the theory of the mechanism of international trade and the theory of gains from trade” (ibid., p. xiii). His aim was to “resurrect forgotten or overlooked material worthy of resurrection, to trace the origin and development of the doctrines which were later to become familiar, and to examine the claims to acceptance of familiar doctrine” (ibid.). These aims are pursued in nine chapters. The first part of the book—the first five chapters—is devoted to English thought from the seventeenth to the mid-nineteenth century, i.e., from the development of mercantilist theory to Adam Smith, the bullionist controversies and the English currency controversies of 1825–1865. The second half of Viner’s book is more specifically devoted to international trade: the history and the “present status of the theory of the mechanism of adjustment of international balances”, under a simple specie currency and in relation to modern banking processes, and the theories of the gains from international trade. Viner used the so-called real-costs approach to the theory of comparative advantage. Rejecting the other two competing approaches—Gottried Haberler’s (1937) “opportunity-costs” approach, based on the Austrian theory of value, and Ohlin’s (1933) “factorendowments” approach, which, as Bloomfield noted (1992, p. 2059) “quickly won out over the first and, with important extensions by Samuelson, emerged in the form of the Heckscher-Ohlin-Samuelson model”—Viner considered, and continued to consider, the classical doctrine of comparative costs the sole systematic analytical tool for attacking the problem of the gains from trade (in the real-costs approach to comparative costs, gains from trade were assumed to consist of minimizing through trade the aggregate real costs at which a given amount of real income could be obtained), as well as the problem of the mechanism of trade.

6 Economics in the United States: New York, Harvard …

319

The Cowles Commission at Chicago and Haavelmo’s “Econometric Revolution” Introduction In 1939, the Cowles Commission for Research in Economics moved to the University of Chicago, remaining there for the next 15 years. The Commission had been founded in Colorado Springs, Colorado, in 1932 by the businessman Alfred Cowles (1891–1984), a stockbroker who wanted to find a scientific method of explaining the causes of the 1929 Stock Market Crash and the Great Depression of the 1930s. In this endeavor, Cowles acted on a proposal by Irving Fisher, president of the fledgling Econometric Society which had been founded in 1930. In 1933 the Society, thanks to Cowles’s financial help, launched the journal Econometrica, with Ragnar Frisch as its editor (see Chap. 5.3). The Econometric Society and Cowles agreed that the Econometric Society would sponsor the new Cowles Commission for Research in Economics, the Cowles Commission would be guided by an Advisory Council appointed by and from the Econometric Society, and Cowles would underwrite the cost of publishing the journal. The first research director of the Cowles Commission was the mathematician Charles F. Roos (1901–1958), at the time professor of econometrics at Colorado College (on Roos see Davis 1958). His main colleagues were the Austrian émigré economists and mathematicians Gerhard Tintner and Abraham Wald—two of the young scholars to whom Morgenstern was able to provide opportunities to study and work abroad, in this case with Cowles’s sponsorship—as research fellows, and the American mathematician Harold T. Davis as research associate. The Commission’s main activities in this period were the annual summer seminars which attracted economists, mathematicians and statisticians from Europe and United States. During its first two years, the Commission’s focus was essentially on Cowles’s interest in stock market analysis. Roos left the Commission in 1937 when he abandoned academic research and went to New York to found the Institute for Applied Econometrics, a company which offered forecasting services to business.

320

R. Marchionatti

The Commission moved to Chicago in 1939, initially under the direction of Theodore O. Yntema (1900–1985)—a student of Henry Schultz and professor of statistics at Chicago where he obtained his Ph.D. in 1929—who in 1940 became director of the National Bureau of Economic Research. In 1943 Jacob Marschak became its new research director. Marschak had arrived in the United States with a fellowship from the Rockefeller Foundation at the end of 1938. In 1939 he was appointed Professor at the New School for Social Research, succeeding Gerhard Colm who had joined the Roosevelt administration. In January 1943 Marschak became professor at the University of Chicago and director of the Cowles Commission. He was then elected Vice President (1944–1945) and President (1946–1947) of the Econometric Society. As Christ (1994, p. 31) writes, “it was he who assembled the staff that created the econometric revolution”. In those years the research staff consisted of scholars such as the senior members Oskar Lange and Theodore Yntema, and, among the younger, the Dutch-born Tjalling Koopmans (1910–1985), who had moved to the United States in 1940, Frisch’s pupil the Norwegian Trygve Haavelmo (1911–1999), Schultz’s assistant the Chicago Ph.D. Jacob Mosak (1913–2013), the Polish statistician Leonid Hurwicz (1917–2008), who had been a refugee in the United States since 1939 and the American Lawrence Klein (1920– 2013), the youngest of the group. Some of the group (Koopmans, Haavelmo, Klein and Hurwicz) would go on to become Nobel laureates in economics. In addition to these researchers, others who had frequent contacts with the Commission included Abraham Wald, at that time at Columbia, and, of course, many members of the Econometric Society. In the following years, scholars such as Kenneth Arrow and Herbert Simon, who would become among the most important economists of the postwar period, were also associated with the Commission. Thanks to the team Marschak was able to attract, he could reorient the research program, spurring the Cowles econometric revolution at Chicago. For Marschak, the pillars of this revolution were the works of Trygve Haavelmo and Abraham Wald (see Haavelmo 1943, 1944; Mann and Wald 1943). As Epstein (1987, p. 61) writes, Marschak “planned to devote all the resources of the Commission to develop the work of Tinbergen in the light of the works of Haavelmo and of Mann and

6 Economics in the United States: New York, Harvard …

321

Wald”. In fact, the aim was to construct and estimate a system of simultaneous equations that could describe the working of the economy in order to learn how economic policy could improve the economy’s performance. As Christ (1994, p. 31) writes, “The two main components of the Cowles econometric revolution at Chicago were: an explicit probabilistic framework and the concept of a simultaneous equation model”. “Probabilistic framework” or “probability approach” means that inference from a sample of observations must proceed within, and be judged with respect to, a stochastic model representing the phenomenon under study and the generation of the data. This principle was introduced by Koopmans (1937) but it was Haavelmo in several papers and then in “The Probability Approach in Econometrics” (1944) who earned scholars’ attention with his arguments about the inference required to solve statistical problems in a simultaneous equation model (going beyond Tinbergen’s statistical tools, a necessity already emphasized by Frisch), i.e., through the development of methods to solve the so-called identification problem and new methods of estimation.

Trygve Haavelmo (1911–1999) In 1989 Trygve Haavelmo was awarded the Nobel Prize “for his clarification of the probability theory foundations of econometrics and his analyses of simultaneous economic structures”. He made two revolutionary contributions to econometrics. The first is a 1943 article that shows some of the statistical implications of simultaneous equations. The second, more fundamental from a historical perspective, is a 1944 paper that bases econometrics more firmly on probability theory. Both were written in the United States. As Schumpeter (1954, p. 1163) noted, Haavelmo, “during his brief sojourn in the United States, without holding a teaching position, exerted an influence that would do credit to the lifetime work of a professor”.

322

R. Marchionatti

Biographical Note Trygve Haavelmo was born in Skedsmo, near Oslo, Norway, on December 13, 1911. In 1930 he entered the University of Oslo where he studied under Ragnar Frisch and obtained a degree in economics in 1933. After graduation he worked as Frisch’s assistant at the Institute of Economics. Between 1936 and the middle of 1939 he studied in many European research centers: at the University College London Department of Statistics with the statisticians Jerzy Neyman and Egon Pearson, at Geneva with Jan Tinbergen and at Oxford with Jacob Marschak. In the 1938–1939 academic year Haavelmo became a lecturer in statistics at the University of Aarhus, Denmark. In June 1939 Haavelmo left for the United States, where he had a Rockefeller Fellowship. In 1942– 1944 Haavelmo worked as a statistician at Nortraship’s office in New York, and in 1944–1946 as Commercial Secretary at the Norwegian Embassy in Washington, DC. In 1943–1944 Haavelmo also completed and published his dissertation, “The Probability Approach in Econometrics”, where he introduced a probabilistic foundation for analyzing economic relations. He then worked at the Cowles Commission until his return to Norway in March 1947. In Norway Haavelmo worked as head of a division under the Ministry of Finance. He was appointed professor of economics and statistics in March 1948 and remained so until retirement in 1979. He died in July 1999 in Oslo.

Haavelmo’s Probabilistic Approach to Econometrics (1944) Haavelmo provided the basis for much of the Cowles Commission’s methodology. In his Nobel Prize lecture (Haavelmo 1989), he describes the context in which his approach took shape: [I]t all began in the late nineteen-twenties and early nineteen-thirties …The status of general economics was more or less as follows. There were lots of deep thoughts, but a lack of quantitative results. Even in simple cases where it can be said that some economic magnitude is influenced by only one causal factor, the question of how strong is the influence still remains. It is usually not of very great practical or even scientific interest

6 Economics in the United States: New York, Harvard …

323

to know whether the influence is positive or negative, if one does not know anything about the strength. But much worse is the situation when an economic magnitude to be studied is determined by many different factors at the same time, some factors working in one direction, others in the opposite directions. One could write long papers about so-called tendencies explaining how this factor might work, how that factor might work and so on. But what is the answer to the question of the total net effect of all the factors? This question cannot be answered without measures of the strength with which the various factors work in their directions. The fathers of modern econometrics, led by the giant brains of Ragnar Frisch and Jan Tinbergen, had the vision that it would be possible to get out of this situation for the science of economics. Their program was to use available statistical material in order to extract information about how an economy works … The work of quantifying economic interrelations was taken up with great enthusiasm and the volume of quantitative results grew very rapidly. … There were many scholars, first of all Ragnar Frisch, who began to see dangerous pitfalls in the attempts to draw information about economic interrelationships from observed data. The most formidable among these difficulties were connected with the old-time enemy of statisticians; the phenomenon of so-called spurious correlation. This expression refers to the danger of drawing hasty conclusions about cause and effect from observed connections between two or more economic variables. … But the phenomenon of spurious correlation has a more intricate form which is often much harder to discover. If we have what we think is a good and reasonably well-founded theory of some interrelation within a group of economic variables, and the observed facts do not seem to contradict such a theory, we may still be misled, because the same apparent interrelation may often be produced by many different models of economic structures … During the nineteen-forties I had the good fortune of being invited to the Cowles Foundation at the University of Chicago to work with an eminent staff of econometricians, statisticians and mathematicians. We worked hard on the task of trying to find more powerful and acceptable methods of doing econometrics, and to find some more general principles. In particular, we faced two groups of problems. The one type of problems, seemingly paradoxical, grew out of a rather intricate consequence of successful economic theory. Strangely enough, the fact is that if an economic theory, an economic relation, is a good theory, true to reality, it may not be possible to quantify it by using data

324

R. Marchionatti

from the economy of which that relation is a part. This is the so-called “problem of identification”. Tjalling Koopmans devoted himself to this very difficult subject and organized extensive research to try to clarify the issues involved. The other group of problems to be attacked was how to find satisfactory methods of actually measuring those economic relations which it could be meaningful to confront with facts (after the question of identification had been cleared up). The staff of the Cowles Commission set out on extensive work also on this group of problems, assisted by some of the world’s most eminent capacities in mathematical statistics.

In the preface to “The Probabilistic Approach to Econometrics”, Haavelmo begins by presenting his main objective: to provide the theoretical foundation for econometric modeling “based upon modern theory of probability and statistical inference”. He justifies such a study as follows (Haavelmo 1944, p. 3): The method of econometric research aims, essentially, at a conjunction of economic theory and actual measurements, using the theory and technique of statistical inference as a bridge pier. But the bridge itself was never completely built. So far, the common procedure has been, first to construct an economic theory involving exact functional relationships, then to compare this theory with some actual measurements, and, finally, “to judge” whether the correspondence is “good” or “bad.” Tools of statistical inference have been introduced, in some degree, to support such judgments, e.g., the calculation of a few standard errors and multiple-correlation coefficients. The application of such simple “statistics” has been considered legitimate, while, at the same time, the adoption of definite probability models has been deemed a crime in economic research, a violation of the very nature of economic data. That is to say, it has been considered legitimate to use some of the tools developed in statistical theory without accepting the very foundation upon which statistical theory is built. For no tool developed in the theory of statistics has any meaning—except, perhaps, for descriptive purposes—without being referred to some stochastic scheme.

Economists, he writes, are reluctant to accept probability models as a basis for economic research, but this reluctance is based upon a narrow concept of probability:

6 Economics in the United States: New York, Harvard …

325

Probability schemes, it is held, apply only to such phenomena as lottery drawings, or, at best, to those series of observations where each observation may be considered as an independent drawing from one and the same “population”. From this point of view it has been argued, e.g., that most economic time series do not conform well to any probability model, “because the successive observations are not independent”. But it is not necessary that the observations should be independent and that they should all follow the same one-dimensional probability law. It is sufficient to assume that the whole set of, say n, observations may be considered as one observation of n variables (or a “sample point”) following an ndimensional joint probability law, the “existence” of which may be purely hypothetical. Then, one can test hypotheses regarding this joint probability law, and draw inference as to its possible form, by means of one sample point (in n dimensions). (ibid.)

The probabilistic approach allows economic theory to be rigorously tested: First, if we want to apply statistical inference to testing the hypotheses of economic theory, it implies such a formulation of economic theories that they represent statistical hypotheses, i.e., statements—perhaps very broad ones—regarding certain probability distributions. The belief that we can make use of statistical inference without this link can only be based upon lack of precision in formulating the problems. (ibid., p. iv)

The work consists of six chapters. Chapter I (“Abstract Models and Reality”) contains a general discussion of the connection between abstract models and economic reality: it introduces the methodological discussion on the nature, structure and function of theory. Haavelmo defines the intended scope of theory as purporting to provide idealized descriptions of real phenomena of interest. In addition, he views theoretical models as human constructs and not hidden truths: it is not to be forgotten that they are all our own artificial inventions in a search for an understanding of real life; they are not hidden truths to be “discovered”. According to Haavelmo, a theoretical model gains empirical meaning

326

R. Marchionatti

only when accompanied by some form of “actual” or “designed” experiment stating the circumstances under which the theoretical relationships are measurable: when we set up a system of theoretical relationships and use economic names for the otherwise purely theoretical variables involved, we have in mind some actual experiment, or some design of an experiment, which we could at least imagine arranging, in order to measure those quantities in real economic life that we think might obey the laws imposed on their theoretical namesakes. (ibid., p. 6)

Haavelmo then sets out the main problems in quantitative research: the construction of models, the testing of theories, the problem of estimation and the problem of prediction. Haavelmo maintains that to compare theory and data a theoretical model must be defined as a combination of hypotheses and a design of experiments: The model thereby becomes an a priori hypothesis about real phenomena, stating that every system of values that we might observe of the “true” variables will be one that belongs to the set of value-systems that is admissible within the model. The idea behind this is, one could say, that Nature has a way of selecting joint value-systems of the “true” variables such that these systems are as if the selection had been made by the rule defining our theoretical model. Hypotheses in the above sense are thus the joint implications—and the only testable implications, as far as observations are concerned—of a theory and a design of experiments. (ibid., p. 9)

Chapter II (“The Degree of Permanence of Economic Law”) deals with the question of establishing “constant relationships” in the field of economics, and with the degree of invariance of economic relations with respect to certain changes in structure. Haavelmo introduces a simple demand equation as a linear function of price and income, both variables expressed relative to the cost of living, and considers the question of whether it can be approximated by a function that is linear in the three variables. He shows that this may cause some unexpected problems.

6 Economics in the United States: New York, Harvard …

327

Chapter III discusses the nature of stochastic models and their applicability to economic data. It contains discussions of the problem of aggregation of the behavior of different individuals. What we want are theories that, without involving us in direct logical contradictions, state that the observations will as a rule cluster in a limited subset of the set of all conceivable observations, while it is still consistent with the theory that an observation falls outside this subset “now and then”.’ As far as is known, the scheme of probability and random variables is, at least for the time being, the only scheme suitable for formulating such theories. (ibid., p. 40)

Chapter IV contains an exposition of the Neyman–Pearson theory of testing of hypotheses. It is shown that a hypothetical system of economic relations may be transferred into a statement about the joint probability law of the economic variables involved, and that, therefore, such a system can be regarded as a statistical hypothesis in the Neyman–Pearson sense. A brief exposé of the Neyman–Pearson theory of testing statistical hypotheses and estimation is given at the beginning of this chapter. Chapter V, under the heading of “the problem of confluent relations” or the “problem of arbitrary coefficients”, discusses what Koopmans later called the “identification problem”. It deals, essentially, with the following problem of estimation: given a system of stochastical equations, involving a certain number of parameters, such that the system is actually satisfied by economic data when a certain set of values of the parameters is chosen, is then the system also satisfied for other values of the parameters? If that be the case, no unique estimate of the parameters can be obtained from the data. This is, in the case of linear relations, the now well-known problem of multicollinearity. Mathematical rules for investigating such situations are given. Lastly, Chapter VI contains a short outline of the problems of predictions.

328

6.5

R. Marchionatti

Economics at Princeton: John von Neumann, Oscar Morgenstern and the Birth of Game Theory

Von Neumann and Morgenstern at Princeton Between the two world wars Princeton, one of the oldest institutions of higher education in the United States, considerably increased its importance in graduate education and research: alongside the university, in 1930 the Institute for Advanced Study was founded as an independent center for theoretical research and intellectual history consisting of three prestigious schools: the School of Mathematics, with its unrivaled faculty, the School of Humanistic Studies and the School of Economics and Politics. It was the academic home of internationally eminent scholars, many of whom had migrated to the United States after the rise of Fascism and Nazism in Europe, including scientists like Albert Einstein, Hermann Weyl, Kurt Gödel and John von Neumann. Neumann, who had been invited to Princeton as visiting professor in 1929, became a lifetime professor at the Institute in 1933. Morgenstern arrived in the United States in 1938 and, due to the political events in Austria, remained there, at the university of Princeton, where he became an associate professor in 1941 and full professor in 1944. It was at Princeton that his collaboration with von Neumann on game theory began. According to Morgenstern, he first discussed this subject with von Neumann at the beginning of 1939 in conversations at the famous Nassau Club.26 Their relationship intensified in the two subsequent years and become the collaboration which led to a book completed at the end of 1942 but published 26

Morgenstern (1976, pp. 807–808) writes: “I gave an after-luncheon talk on the 1st of February 1939 on business cycles at the Nassau Club, and he [von Neumann] was there with Niels Bohr, Osvald Veblen, and others. Both he and Bohr invited me that afternoon for tea at Fine Hall, and we sat several hours talking about games and experiments. This was the first time that we had a talk on games, and the occasion was heightened by Bohr’s presence. … These talks were taken up again with both at Weyl’s house … This circle still widened when I encountered Einstein for the first time at dinner with Bohr at von Neumann’s house, and I recall vividly Einstein’s discussion of the priority of theory over experiment, the preeminence of conceptualization, and the deep puzzle of intuition. In many later meetings he would often return to these and related issues”.

6 Economics in the United States: New York, Harvard …

329

only in 1944, Theory of Games and Economic Behavior (Neumann and Morgenstern 1944), a work which introduced game-theoretic thinking in economics and other social sciences.27

The Theory of Games and Economic Behavior, 1944 The Theory of Games and Economic Behavior marks the emergence of game theory as a distinct field of research in the social sciences. Although economics was a central concern for the authors, the scope of the book, thanks to the generality of the approach, extended far beyond economics to include political science and sociology. In his important review of the book, Abraham Wald writes that it develops “a fundamentally new and rigorous theory of economic behavior” (Wald 1947, p. 47). An essential feature of this theory, he writes, is that the problem of rational behavior is not treated as a simple maximum problem, but is considered to be of the type that arises in the theory of games of strategy. Although a participant in a social economy may be assumed to wish to maximize his gain or profit, the problem he is confronted with is, in general, fundamentally different from an ordinary maximum problem for the following reasons: His gain depends on the values of a number of economic variables but he usually controls only some of these variables, while the remaining variables are determined by the actions of the other participants of the economic system. (ibid.)

The situation is precisely of the type that arises in the theory of games of strategy—in fact, as Simon (1945) noted, the Theory of Games is a rigorous mathematical development of a theory of games of strategy. The gain of each player depends not only on his own moves but also on those made by the others during the course of the play. Each of the players tries to maximize his gain, but the interests of all the players do 27

In the interwar years many works on strategic games were published (in particular by the French mathematician Émile Borel [1871–1956]) but, as Dimand and Dimand (1996, p. 142) notes, “these were known only to a small community of Continental European mathematicians”. (For the history of game theory before von Neumann and Morgenstern see Dimand and Dimand [1996].) It was Theory of Games that drew the attention of economists and social scientists to these issues.

330

R. Marchionatti

not run parallel, since the gain of one player usually implies a loss for some of the other players. The problem of rational economic behavior is of the same nature as that of choosing a proper strategy for playing a game. For dealing with this type of situation, the mathematics developed for the physical sciences is not sufficient: a new kind is needed which makes it possible to go beyond the representation of economic problems using physical analogies. In this sense, game theory is ambitiously considered the basis for a new foundation of economics. The analytical starting point is the theory of games which von Neumann originated as early as I928, which moved in an entirely different direction from the traditional attempts at mathematization in the social sciences (i.e., the tools of the calculus and differential equations) and employed the mathematics of point-set theory and of topology. Von Neumann’s mathematical work can thus be said to have dominated in the Theory of Games, while Morgenstern’s analytical contribution was comparatively marginal, but important from the methodologically standpoint. As Ingrao (2013, p. 645) notes, “[Morgenstern] took to their common work a lucid sense of the problems of method and content that economics had come up against, enhanced through his contacts with the Austrian economists and the Vienna circle”.28 The book is divided into 12 chapters. The first, principally written by Morgenstern, formulates the economic problem, presenting the objectives of the system used, the notion of utility and a description of the structure of the authors’ theory. The second chapter is a general formal description of games of strategy, and the following chapters deal with the different types of game. Chapter I is devoted to the formulation of the economic problem. The authors write that the purpose of the book is to analyze some basic problems arising from the study of economic behavior which have their 28

Undoubtedly, as Ingrao (2013, pp. 646–647) maintains, it is far from simple to reconcile the results of the collaboration between the two scholars with the young Morgenstern’s critique of economic theory (see Chap. 4.5): “applying the criteria of consistency and relevance dealt with in his earlier articles, the Theory of Games and Economic Behavior passed the test for axiomatic rigor but was found wanting in terms of dynamics and, indeed, empirical verification”. Actually, Morgenstern considered the theory of games a first theoretical stage, a logical skeleton of rational behavior, to adopt in analyzing economic phenomena as an alternative approach to the general economic equilibrium theory. See also Leonard (2010).

6 Economics in the United States: New York, Harvard …

331

origin in the attempts to find an exact description of the endeavor of the individual to obtain a maximum of utility, or a maximum of profit. The mathematical methods usually applied by older or contemporary mathematical economists are inadequate for such problems, which can only be solved by very different techniques, viz., through the application of the mathematical theory of “games of strategy” developed by von Neumann in several successive stages in 1928 and 1940–1941. In analyzing the behavior of individuals, the main assumption is traditionally that the consumer desires to obtain a maximum of utility or satisfaction and the entrepreneur a maximum of profit, and the individual who attempts to obtain these respective maxima is said to act “rationally”. But, the authors say, there is at present no satisfactory treatment of the question of rational behavior. Rejecting the Robinson Crusoe model of the economy (i.e., assuming from the outset that a social exchange economy exists) and the general economic equilibrium approach, and at the same time assuming that utility can be treated as a numerically measurable quantity, the problem is investigated from the perspective of a game of strategy, which according to Morgenstern and von Neumann makes it possible to define the general characteristics of rational behavior. The axiomatization of the utility function, in fact, is considered one of book’s most important contributions. Using Bernoulli’s analysis as their starting point, the authors established a system of axioms for a numerical utility and put forth the “von Neumann-Morgenstern utility function”. When a rational consumer is faced with a choice of items or outcomes subject to various levels of chance, the optimal decision will be the one that maximizes the expected value of the utility (i.e., satisfaction) derived from the choice made. Expected value is the sum of the products of the various utilities and their associated probabilities. The consumer is expected to be able to rank the items or outcomes in terms of preference, but the expected value will be conditioned by their probability of occurrence. While in Chap. I the primary interest lay in economics, from Chap. II games become the main issue. The first step is to construct a mathematical description of a game, based essentially on von Neumann’s I928 publication. A game is defined by the decision-makers, called players; the decisions they must make and their information; how their decisions determine the outcome; and their preferences over outcomes, represented

332

R. Marchionatti

by utility or payoff functions. A player’s decisions are summarized by a strategy, i.e., a complete plan which specifies what choices he should make in every possible situation. The problem of rational economic behavior is of the same nature as that of choosing a strategy for playing a game. In this schema, the consequences of the behavior of each member of the system are explicitly dependent on the behaviors of the other members. Within this system, the concepts of competition and cooperation can be defined unambiguously and analyzed. The following chapters are concerned with a systematic development of the theory of games. The simplest type of game is the zero-sum two-person game, analyzed in Chaps. II and III. This is played by two players, and the sum of the outcomes for the two players is zero, i.e., one player’s gain is always equal to the other’s loss. Such a game is solved by the so-called minimax solution, or in other words is the minimization of the worstcase potential loss: a player considers all his opponent’s best responses to his strategies and selects the strategy such that the other player’s best strategy gives the largest possible payoff. Chapter V deals with zerosum three-person games and Chap. VI with zero-sum n-person games. A section of the book is devoted to the case of cooperative games, and considers the possibility of binding agreements between groups of players. The book raised high hopes among economists, even if some were skeptical about game theory’s usefulness for economists, Viner being perhaps the most famous opponent in those years. Mathematical economists welcomed it as path-breaking (see Simon 1945; Hurwicz 1945; Marschak 1946; Wald 1947). However, as Leonard (2010, p. 264) notes, games theory “made its entry into the world” during World War II, when operations research developed and a part of game theory was applied to the analysis of military engagements. In that context its ambitious theoretical aims were forgotten, at least for some time.

6 Economics in the United States: New York, Harvard …

333

References Alacevich, Michele, Pier Francesco Asso, and Sebastiano Nerozzi. 2015. Harvard Meets the Crisis: The Monetary Theory and Policy of Lauchlin B. Currie, Jacob Viner, John H. Williams, and Harry D. White. Journal of the History of Economic Thought 37 (3): 387–410. Asso, Pier Francesco, and Luca Fiorito. 2009. A Scholar in Action in Interwar America: John H. Williams on Trade Theory and Bretton Woods. In American Power and Policy, ed. Robert Leeson, 180–242. London: Palgrave Macmillan. Arrow, Kenneth J., and Erich L. Lehmann 2005. Harold Hotelling 1895–1973: A Biographical Memoir. Washington, DC: The National Academies Press. Bain, Joe S. 1942. Market Classifications in Modern Price Theory. Quarterly Journal of Economics 56 (4): 560–574. ———. 1956. Barriers to New Competition. Cambridge, MA: Harvard University Press. ———. 1959. Industrial Organization. New York: Wiley. ———. 1964. The Impact on Industrial Organization. The American Economic Review 54 (3): 28–32. Barber, William J. 1987. The Career of Alvin H. Hansen in the 1920s and 1930s: A Study in Intellectual Transformation. History of Political Economy 19 (2): 191–205. Baumol, William J. 1972. Jacob Viner at Princeton. Journal of Political Economy 80 (1): 12–15. ———. 2000. Leontief ’s Great Leap Forward: Beyond Quesnay, Marx and von Bortkiewicz. Economic Systems Research 12 (2): 141–151. Baumol, William J., and Thijs Raa. 2009. Wassily Leontief: In Appreciation. European Journal of the History of Economic Thought 16 (3): 511–522. Berle, Adolf, and Gardiner C. Means. 1932. The Modern Corporation and Private Property. New York: Macmillan. Blitch, Charles P. 1983. Allyn A. Young: A Curious Case of Professional Neglect. History of Political Economy 15 (1): 1–24. ———. 1985. Allyn Young. The Peripatetic Economist. London: Palgrave Macmillan. ———. 1995. Allyn Young: The Peripatetic Economist. London: Palgrave Macmillan.

334

R. Marchionatti

Bloomfield, Arthur. 1992. On the Centenary of Jacob Viner’s Birth: A Retrospective View of the Man and His Work. Journal of Economic Literature 30 (4): 2052–2085. Bonbright, James C., and Gardiner C. Means. 1932. The Holding Company: Its Public Significance and Regulation. New York: McGraw-Hill. Burgin, Angus. 2009. The Radical Conservatism of Frank H. Knight. Modern Intellectual History 6 (3): 513–538. Burns, Arthur F., ed. 1952. Wesley Clair Mitchell: The Economic Scientist. New York: National Bureau of Economic Research. Burns, Arthur F., and Wesley C. Mitchell. 1946. Measuring Business Cycles. New York: National Bureau of Economic Research. Burns, Robert. 1936. The Decline of Competition: A Study of the Evolution of American Industry. New York: McGraw-Hill. Cantono, Simona, and Roberto Marchionatti. 2012. Dumping as Price Discrimination: Jannaccone’s Classic Theory Before Viner. Journal of the History of Economic Thought 34 (2): 193–218. Carlson, Valdemar. 1968. The Education of an Economist Before the Great Depression. American Journal of Economics and Sociology 27 (1): 101–112. Chamberlin, Edward H. 1933. The Theory of Monopolistic Competition. Cambridge, MA: Harvard University Press. ———. 1937. Monopolistic or Imperfect Competition? Quarterly Journal of Economics 51 (4): 557–580. Clark, John Maurice. 1919. Economic Theory in an Era of Social Readjustment. American Economic Review 9 (Suppl.): 280–290. ———. 1923. Studies in the Economics of Overhead Costs. Chicago: University of Chicago Press. ———. 1926. Social Control of Business. Chicago: University of Chicago Press. ———. 1935. Strategic Factors in Business Cycles. New York: National Bureau of Economic Research. Cobb, Charles W., and Paul H. Douglas. 1928. A Theory of Production. American Economic Review 18 (1): 139–165. Commons, John R. 1924. The Legal Foundations of Capitalism. New York: Macmillan. ———. 1934. Institutional Economics: Its Place in Political Economy. New Brunswick and London: Transaction Publishers. Cord, Robert. 2013. Reinterpreting the Keynesian Revolution. New York: Routledge. Cot, Annie. 2011. A 1930 North American Creative Community: The Harvard “Pareto Circle.” History of Political Economy 43 (1): 131–159.

6 Economics in the United States: New York, Harvard …

335

Craver, Earline. 1986. The Emigration of Austrian Economists. History of Political Economy 18 (1): 1–32. Craver, Earline, and Axel Leijonhufvud. 1987. Economics in America: The Continental Influence. History of Political Economy 19 (2): 173–182. Christ, Carl F. 1994. The Cowles Commission’s Contributions to Econometrics at Chicago, 1939–1955. Journal of Economic Literature 32 (1): 30–59. Davis, Harold T. 1958. Charles Frederick Roos. Econometrica 26 (4): 580–589. Dimand, Mary Ann, and Robert W. Dimand. 1996. A History of Game Theory, Volume 1: From the Beginnings to 1945. London and New York: Routledge. Dobb, Maurice. 1925. Capitalist Enterprise and Social Progress. London: Routledge. Dorfman, Joseph. 1959. The Economic Mind in American Civilization. 5 vols. New York: Viking Press. Dorfman, Joseph. 1995. In Appreciation of Wassily Leontief. Structural Change and Economic Dynamics 6: 305–308. Douglas, Paul Howard. 1934. Theory of Wages. New York: Macmillan. Emmett, Ross B. 2009. Specializing in Interdisciplinarity: The Committee on Social Thought as the University of Chicago’s Antidote to Compartmentalization in the Social Sciences. Available at SSRN: https://ssrn.com/abstract= 1410761. ———. 2021. The Writing and Reception of Risk, Uncertainty and Profit, Cambridge Journal of Economics. Special Issue on Frank Knight’s Risk, Uncertainty and Profit & J. M. Keynes’ Treatise on Probability, forthcoming. Epstein, Roy J. 1987. A History of Econometrics. Amsterdam: Elsevier. Ezekiel, Mordecai. 1930. Moore’s Synthetic Economics. The Quarterly Journal of Economics 44 (4): 663–679. Fisher, Irving. 1935. 100% Money. New York: Adelphi Company. Friedman, Milton. 1952. The Economic Theorist. In Wesley Clair Mitchell: The Economic Scientist, ed. Arthur F. Burns, 237–282. New York: National Bureau of Economic Research. Grether, Ewald T. 1970. Industrial Organization: Past History and Future Problems. The American Economic Review 60 (2): 83–89. Haavelmo, Trygve. 1943. The Statistical Implications of a System of Simultaneous Equations. Econometrica 11: 1–12. ———. 1944. The Probability Approach in Econometrics. Supplement to Econometrica 12: iii–118. ———. 1989. Econometrics and the Welfare State. Nobel Prize in Economics Document 1989-1, Nobel Prize Committee.

336

R. Marchionatti

Haberler, Gottfried. 1937. Prosperity and Depression: A Theoretical Analysis of Cyclical Movements. Geneva: League of Nations. ———. 1950. J.A. Schumpeter, 1883–1950. Quarterly Journal of economics 64 (3): 333–372. ———. 1976. Alvin H. Hansen: Some Reminiscences. Quarterly Journal of Economics 90 (1): 9–13. Hagemann, Harald. 2005. Dismissal, Expulsion, and Emigration of GermanSpeaking Economists After 1933. Journal of the History of Economic Thought 27 (4): 405–420. Hansen, Alvin H. 1927. Business Cycle Theory: Its Development and Present Status. Boston: Ginn and Co. ———. 1932. Economic Stabilization in an Unbalanced World . New York: Harcourt, Brace and Co. ———. 1938. Full Recovery or Stagnation? London: Adam and Charles Black. ———. 1941. Fiscal Policy and Business Cycle. London: Allen & Unwin. ———. 1949. Monetary Theory and Fiscal Policy. New York: McGraw-Hill. ———. 1953. A Guide to Keynes. New York: McGraw-Hill. Heyl, Barbara S. 1968. The Harvard “Pareto circle.” Journal of the History of the Behavioral Sciences 4 (4): 316–334. Hodgson, Geoffrey M. 2001. How Economics Forgot History: The Problem of Historical Specificity in Social Science. London: Routledge. Homan, Paul T. 1952. Place in Contemporary Economic Thought. Wesley Clair Mitchell: The Economic Scientist, ed. Arthur F. Burns, 153–192. New York: National Bureau of Economic Research. Hotelling, Harold. 1929. Stability in Competition. The Economic Journal 39: 41–57. ———. 1939. The Work of Henry Schultz. Econometrica 7 (2): 97–103. Hurwicz, Leonid. 1945. The Theory of Economic Behavior. The American Economic Review 35 (5): 909–925. Jannaccone, Pasquale. 1936. Prezzi e mercati. Torino: Einaudi. Ingrao, Bruna. 2013. Portraits of European Economists. Rome: Aracne Editrice. Klausinger, Hansjörg. 2006a. “In the Wilderness”: Emigration and the Decline of the Austrian School. History of Political Economy 38 (4): 617–664. ———. 2006b. From Mises to Morgenstern: Austrian Economics During the Ständestaat. The Quarterly Journal of Austrian Economics 9 (3): 25–43. Klein, Lawrence R. 1991. Econometric Contributions of the Cowles Commission, 1944–47: A Retrospective View. Banca Nazionale del Lavoro Quarterly Review 44: 107–117.

6 Economics in the United States: New York, Harvard …

337

Knight, Frank H. 1921. Risk, Uncertainty and Profit. Boston and New York: Houghton Mifflin. ———. 1935. The Ethics of Competition and Other Essays. London: Allen & Unwin. ———. 1947. Freedom and Reform. New York: Harper & Brothers. Köhler, Ekkehard, and Stefan Kolev. 2011. The Conjoint Quest for a Liberal Positive Program: “Old Chicago”, Freiburg and Hayek. HWWI Research Paper, No. 109. Koopmans, Tjalling C. 1937. Linear Regression Analysis of Economic Time Series. Haarlem: De Erven F. Bohn N.V. ———. 1947. Measurement Without Theory. Review of Economic Statistics 29: 161–172. Krohn, Claus-Dieter. 1993. Intellectuals in Exile: Refugee Scholars and the New School for Social Research. Amherst, MA: University of Massachusetts Press. Kurz, Heinz D., and Neri Salvadori. 2000. ‘Classical’ Roots of Input-Output Analysis: A Short Account of Its Long Prehistory. Economic Systems Research 12 (2): 153–179. ———. 2006. Input-Output Analysis from a Wider Perspective: A Comparison of the Early Works of Leontief and Sraffa. Economic Systems Research 18 (4): 373–390. Laidler, David. 1993. Hawtrey, Harvard, and the Origins of the Chicago Tradition. Journal of Political Economy 101 (6): 1068–1103. ———. 1998. More on Hawtrey, Harvard and Chicago. Journal of Economic Studies 25 (1): 4–24. Lange, Oskar (with Fred Taylor). 1938. On the Economic Theory of Socialism. University of Minnesota Press. ———. 1944. Price Flexibility and Employment. Cowles Commission Monograph No. 8. Bloomington, IN: Principia Press. Lee, Fredric S., and Warren J. Samuels, eds. 1992. The Heterodox Economics of Gardiner C. Means. Armonk: M. E. Sharpe. Leontief, Wassily. 1941. The Structure of American Economy, 1919–29: An Empirical Application of Equilibrium Analysis. Cambridge, MA: Harvard University Press, 2nd ed., enlarged 1948. New York: Oxford University Press. ———. 1953. Domestic Production and Foreign Trade; The American Capital Position Re-examined. Proceedings of the American Philosophical Society 97 (4): 332–349.

338

R. Marchionatti

———. 1954. Input-Output Analysis and General Equilibrium. In The Structural Interdependence of the Economy: Proceedings of an International Conference on Input-Output Analysis, ed. Tibor Barna. New York: Wiley. Leonard, Robert. 2010. Von Neumann, Morgenstern and the Creation of Game Theory, From Chess to Social Science, 1900–1960. Cambridge: Cambridge University Press. Maes, Ivo. 2021. Robert Triffin: A Life. Oxford: Oxford University Press. Mann, Henry B., and Abraham Wald. 1943. On the Statistical Treatment of Linear Stochastic Difference Equations. Econometrica 11 (3–4): 173–220. Marchionatti, Roberto. 2003. On the Methodological Foundations of Modern Microeconomics: Frank Knight and the ‘Cost Controversy’ in the 1920. History of Political Economy 35 (1): 49–75. ———. 2019. Between Berlin and Cambridge: Classical Conceptions of the General Economic Equilibrium in the late 1920s. Cambridge Journal of Economics 43 (5): 1377–1395. Marchionatti, Roberto, and Fiorenzo Mornati. 2021. Pareto’s Trattato di Sociologia Generale: A Behaviourist ante litteram Approach. Cambridge Journal of Economics 45 (2): 353–369. Marschak, Jacob. 1946. Neumann’s and Morgenstern’s New Approach to Static Economics. Journal of Political Economy 54 (2): 97–115. Mason, Edward S. 1939. Price and Production Policies of Large-Scale Enterprises. The American Economic Review 29 (1): 61–74. ———. 1982. The Harvard Department of Economics from the Beginning to World War II. Quarterly Journal of Economics 97 (3): 425–428. Mehrling, Perry G. 1997. The Money Interest and the Public Interest: American Monetary Thought, 1920–70. Cambridge, MA: Harvard University Press. Mehrling, Perry G., and Roger J. Sandilands, eds. 1999. Money and Growth: Selected Papers of Allyn Abbott Young. London: Routledge. Mitchell, Wesley C. 1903. A History of the Greenbacks, with Special Reference to the Economic Consequences of Their Issue, 1862–65. Chicago, IL: University of Chicago Press. ———. 1913. Business Cycles. Berkeley, CA: University of California Press. ———. 1925. Quantitative Analysis in Economic Theory. American Economic Review 15 (1): 1–12. ———. 1927. Business Cycles: The Problem and Its Setting. New York: National Bureau of Economic Research. ———. 1937. The Backward Art of Spending Money. New York: McGraw-Hill. ———. 1940. Report of the Director of Research. In The National Bureau’s Social Function, Twentieth Annual Report of the Director of Research, A Record

6 Economics in the United States: New York, Harvard …

339

of 1939 and Plans for 1940, 5–29. New York: National Bureau of Economic Research. Moore, Henry Ludwell. 1929. Synthetic Economics. London: Macmillan. Morgenstern, Oskar. 1976. The Collaboration Between Oskar Morgenstern and John von Neumann on the Theory of Games. Journal of Economic Literature 14 (3): 806–816. Morgan, Mary S. 1990. The History of Econometric Ideas. Cambridge: Cambridge University Press. Mongiovi, Gary. 2005. Emigré Economists and American Neoclassical Economics, 1933–1945. Journal of the History of Economic Thought 27 (4): 427–437. Musgrave, Richard A. 1976. Alvin Hansen: Caring for Real Problems. Quarterly Journal of Economics 90 (1): 1–7. Neumann, John von, and Oskar Morgenstern. 1944. Theory of Games and Economic Behavior. Princeton: Princeton University Press. O’Brien, Denis P. 1983. Research Programmes in Competitive Structure. Journal of Economic Studies 10 (4): 29–51. Ohlin, Bertil. 1933. Interregional and International Trade. Cambridge, MA: Harvard University Press. Reder, Melvin W. 1982. Chicago Economics: Permanence and Change. Journal of Economic Literature 20 (1): 1–38. Reinwald, Thomas. 1977. The Genesis of Chamberlinian Monopolistic Competition Theory. History of Political Economy 9 (4): 522–534. ———. 1985. The Genesis of Chamberlinian Monopolistic Competition Theory: Addendum—A Comment. History of Political Economy 17 (3): 400–402. Robbins, Lionel. 1970. Jacob Viner: A Tribute. Princeton: Princeton University Press. Rubin, Goulven. 2011. Oskar Lange and the Influence of Walrasian Theory During the Keynesian Revolution. HAL Working Papers. ———. 2016. Oskar Lange and the Walrasian Interpretation of IS-LM. Journal of the History of Economic Thought 38 (3): 285–309. Rutherford, Malcolm. 2000. Institutionalism Between the Wars. Journal of Economic Issues 34 (2): 291–303. ———. 2001. Institutional Economics at Columbia University. Department Discussion Papers 0103, Department of Economics, University of Victoria. Salant, Walter S. 1976. Alvin Hansen and the Fiscal Policy Seminar. Quarterly Journal of Economics 90 (1): 14–23.

340

R. Marchionatti

Samuels, Warren J., and Steven G. Medema. 1990. Gardiner C. Means: Institutionalist and Post Keynesian. Armonk: M. E. Sharpe. Samuelson, Paul A. 1948. Dynamic Process Analysis. In A Survey of Contemporary Economics, ed. H. S. Ellis, vol. 1, 352–378. Homewood, IL: Richard D. Irwin. ———. 1967. The Monopolistic Competition Revolution. In Monopolistic Competition Theory: Studies in Impact. Essays in Honor of Edward H. Chamberlin, ed. Robert E. Kuenne. New York: Wiley. ———. 1972. Jacob Viner, 1892–1970. Journal of Political Economy 80 (1): 5–11. ———. 1976. Alvin Hansen as a Creative Economic Theorist. Quarterly Journal of Economics 90 (1): 24–31. ———. 1988. The Passing of the Guard in Economics. Eastern Economic Journal 14 (4): 319–329. ———. 2015. The Harvard-Circle. Journal of Evolutionary Economics 25 (1): 31–36. Scherer, Frederic M. 2000. The Emigration of German-Speaking Economists After 1933. Journal of Economic Literature 38 (3): 614–626. Schultz, Henry. 1938. The Theory and Measurement of Demand . Chicago: University of Chicago Press. Schumpeter, Joseph A. 1937. Allyn Abbott Young. In Encyclopaedia of the Social Sciences, ed. Edwin R.A. Seligman and Alvin Johnson, vol. XV, 514–515. New York: Macmillan. ———. 1939. Business Cycles: A Theoretical, Historical, and Statistical Analysis of the Capitalist Process. New York: McGraw-Hill. ———. 1942. Capitalism, Socialism and Democracy. New York: Harper & Brothers. ———. 1954. History of Economic Analysis. New York: Oxford University Press. Shackle, George L. S. 1967. The Years of High Theory: Innovation and Tradition in Economic Thought, 1926–39. Cambridge: Cambridge University Press. Simon, Herbert A. 1945. Review of Theory of Games and Economic Behavior. American Journal of Sociology 50 (6): 558–560. Simons, Henry C. 1934. A Positive Program for Laissez-Faire: Some Proposals for a Liberal Economic Policy. Chicago: Chicago University Press. Smithies, Arthur. 1950. Memorial: Joseph Alois Schumpeter 1883–1950. The American Economic Review 40 (4): 628–648.

6 Economics in the United States: New York, Harvard …

341

Stigler, George J. 1987. Frank Hyneman Knight. In The New Palgrave: A Dictionary of Economics, ed. John Eatwell, Murray Milgate, and Peter Newman, vol. 3, 55–59. New York: Stockton Press. Swedberg, Richard. 2003 [1942]. Introduction. In Capitalism, Socialism and Democracy, ed. Joseph A. Schumpeter. London: Routledge. Sweezy, Paul. 1939. Demand Under Conditions of Oligopoly. The Journal of Political Economy 47 (4): 568–573. ———. 1942. The Theory of Capitalist Development. New York: Oxford University Press. Triffin, Robert. 1940. Monopolistic Competition and General Equilibrium Theory. Cambridge, MA: Harvard University Press. Vaughn, Karen. 1998. Austrian Economics in America: The Migration of a Tradition. Cambridge: Cambridge University Press. Viner, Jacob. 1923. Dumping: A Problem in International Trade. Chicago: University of Chicago Press. ———. 1931. Cost Curves and Supply Curves. Zeitschrift für Nationalökonomie 3 (1): 23–46. ———. 1937, Studies in the Theory of International Trade. London: Allen & Unwin. ———. 1950. The Customs Union Issue. New York: Carnegie Endowment for International Peace. ———. 1952. International Trade and Economic Development. Glencoe: The Free Press. ———. 1958. The Long View and the Short: Studies in Economic Theory and Practice. Glencoe: The Free Press. Vining, R. 1949. Koopmans on the Choice of Variables to Be Studied and on Methods of Measurement. Review of Economics and Statistics 31 (2): 77–86. Wald, Abraham. 1945. Sequential Tests of Statistical Hypotheses. The Annals of Mathematical Statistics 16 (2): 117–186. ———. 1947. Review of Theory of Games and Economic Behavior by John V. Neumann and Oskar Morgenstern. The Review of Economics and Statistics 29 (1): 47–52. Wallace, Donald H. 1937. Market Control in the Aluminum Industry. Cambridge, MA: Harvard University Press. Wallis, W. Allen. 1980. The Statistical Research Group, 1942–1945. Journal of the American Statistical Association 75 (370): 320–330. Weber, Max. 1923. Wirtschftsgeschichte: Abriss der universalen Sozial- und Wirtschaftsgenschichte. Munchen: Duncker & Humblot. English Translation: General Economic History. London: Allen & Unwin, 1927.

342

R. Marchionatti

Williams, John H. 1920. Argentine International Trade Under Inconvertible Paper Money 1880–1900. Cambridge, MA: Harvard University Press. Yntema, Theodore O. 1939. Henry Schultz: His Contributions to Economics and Statistics. Journal of Political Economy 47 (2): 153–162. Young, Allyn. 1927. Economic Problems New and Old . Boston: Houghton Mifflin Company.

7 Great Controversies

7.1

The Controversy on Marshall and the Marshallian Orthodoxy in England and the United States in the 1920s1

Prologue In the 1920s, the main theoretical issue in economics was the Marshallian theory of value and competition. Many economists were involved in the so-called controversy on costs dealing with a crucial aspect of what Schumpeter considered a theoretical exposition “that seemed to leave many loose ends … and certainly left plenty of problems for his successors” (Schumpeter 1954, p. 1045): the question of increasing returns and competitive equilibrium, the main issue of the controversy. Edgeworth (1925), in his review of the new 1924 edition of Pigou’s Economics 1

This chapter is partially based on Marchionatti (2001). For a survey of the Marshallian debate, see also Marchionatti (2006) and Hart (2012).

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 R. Marchionatti, Economic Theory in the Twentieth Century, An Intellectual History—Volume II, https://doi.org/10.1007/978-3-030-80987-4_7

343

344

R. Marchionatti

of Welfare, wrote that “the action of increasing returns in a competitive regime has proved a stumbling-block even to expert economists” (Edgeworth 1925, p. 30) and continued: “It is justly considered by Mr. Keynes”—the reference was to Keynes’s 1924 essay on Marshall (Keynes 1924)—that “this is the quarter in which Marshall’s analysis is least complete and satisfactory, and where there remains most to do” (ibid.). The issue of “increasing returns and competition” did not cease to absorb economists’ minds after the publication of the Principles, but it was at the beginning of the 1920s that, first in the United States and then in the United Kingdom, a strong dissatisfaction with the state of the competition theory as left by Marshall and his followers clearly came to light. The static structure and the dynamic superstructure of Marshall’s theoretical proposal were perceived to be inconsistent, and there was a call for logical rigor. Between 1921 and 1930, the Americans Allyn Young and Frank Knight, the Englishmen J. H. Clapham, Arthur C. Pigou, Dennis Robertson, Lionel Robbins and Gerald Shove, the Italian Piero Sraffa and the Austrian Joseph Schumpeter all made important contributions to the debate. While the debate went through several phases, its premises were laid down at the end of the previous era, in the review of Pigou’s Wealth and Welfare by the American economist Allyn Young (1913). In Wealth and Welfare, Pigou (1912) had also contributed to the formal definition of competition and in that context faced the question of trying to reconcile Marshall’s falling long-run supply curve with the price-taking aspect of perfect competition using the concept of external economies as treated by Edgeworth (1905). According to Pigou, increasing returns and competition could be considered compatible by using the device of the external economies generated internally to an industry “without reference to the time element”: in this way, the industrial supply curve could be decreasing while the firm’s supply curve was increasing. By doing so, Pigou necessarily gave up the inter-industrial characteristic of external economies and their irreversibility, and thus ruled out considering the dimension of time. We may say that this exclusion is the most evident difference between Marshall’s treatment of the problem and Pigou’s— actually, a real methodological break. But this formal solution was immediately criticized for its lack of realism, first of all by Young. Young

7 Great Controversies

345

hinted that increasing returns are not of the same character as diminishing returns and are not subject to analysis of the partial-equilibrium type. He wrote that cases of increasing returns interpreted as “diminishing aggregate expenses per unit of product as production increases”, “must be rare, if not altogether lacking, in competitive industry, unless an increase in the size of the representative establishment be taken into account as a natural concomitant of increased production in the industry in question” (Young 1913, p. 678). On the other hand, Young rejected Pigou’s concept that external economies are adequate to solve the Cournot dilemma: The economies of large scale production affect industry at large (if competitive) only by reducing the expense per unit in individual establishments. It is scarcely logical to treat these economies in the same general manner as the increasing expense of agricultural production, which arises from causes external to the individual undertaking. …. I cannot imagine [Professor Pigou’s] “external economies” adequate to bring about this result. (ibid.)

The 1921–1925 Phase: Knight’s Criticism, 1921–1925, and the Controversy About “Empty Economic Boxes”, 1922–1924 The issue raised by Young was reconsidered at the beginning of the 1920s, when a new protagonist of the debate, in truth one of Young’s pupils, appeared on the scene. This was Frank Knight (see Chap. 6.4), whose contributions can be considered the starting point of the controversy in the 1920s. In his Risk, Uncertainty and Profit (1921), the result of his doctoral dissertation under Allyn Young, and in a series of articles written between 1921 and 1925 in the Journal of Political Economy, Knight offered what at that time was perceived as the most complete reformulation of the perfect competition theory in rigorous terms, and argued for a sharp separation between the “static” and the “dynamic” problems along Schumpeter’s (1908, 1912) lines. Knight regarded the Marshallian concept of external economies and increasing returns as falling within the dynamic area. Thus, he concluded, it was

346

R. Marchionatti

logically inconsistent to use it, as Marshall had, in the static price theory. Knight agreed with Schumpeter’s judgment that Marshall’s theory is oldfashioned, eclectic and unable to recognize the fundamental difference between statics and dynamics. Knight maintained that Marshall’s attitude toward fundamentals was anti-theoretical with his insistence on sticking as closely as possible to concrete reality and discussing “representative” conditions as opposed to limiting tendencies. However, Knight wrote, “the gain in concreteness and realism is … much more than offset by the obscurity, vagueness, and unsystematic character of the discussion”, with the consequence “of burying fundamentals in an overwhelming mass of qualification and detail” (Knight 1921b, p. 15). Consequently, Knight thought it was necessary to adopt the tendency toward “a sharper separation of the theoretical portion of economics from the empirical portion, and toward the clearer formulation of premises” (ibid., p. 14). He stressed the necessary role of the static method in economics, maintaining that: “The ‘static’ method in economics … inquires what conditions exist and studies the results which recognizable forces at work … tend to produce under those conditions” (ibid., p. 17). From these methodological premises, Knight presented the assumptions needed for perfect competition: complete “rationality”; “perfect mobility in all economic adjustments, no cost involved in movements or changes; “perfect, continuous, costless intercommunication between all individual members of the society”, and free and independent individuals. Under these conditions, he concluded, the long-term supply curve must have an increasing shape. Decreasing cost as a long-run tendency is impossible under a natural competitive adjustment of industryand incompatible with long-run competitive conditions: Decreasing cost (or increasing returns) is alleged to result in several ways. … The most important is the technological economy of largescale production. When the output of a commodity is increased, the cost of the productive services used to produce it will be higher; but this increase in their cost per unit may, it is held, be more than offset by economies in utilization, made possible by larger-scale operations, which increase the amount of product obtained from given quantities of materials and resources consumed … If competition is effective, the size of the

7 Great Controversies

347

productive unit will tend to grow until either no further economies are obtainable, or there is only one establishment left and the industry is a monopoly. When all establishments have been brought to the most efficient size, variation in total output is a matter of changing their number, in which no technical economies are involved. (Knight 1924, p. 598)

Knight dismissed the Pigouvian idea of external economies: The rejoinder to the above argument is the doctrine of “external economies”, which surely rests upon a misconception. Economies may be “external” to a particular establishment or technical production unit, but they are not external to the industry if they affect its efficiency ... External economies in one business unit are internal economies in some other, within the industry.Any branch or stage in the creation of a product which offers continuously a chance for technical economies with increase in the scale of operations must eventuate either in monopoly or in leaving the tendency behind and establishing the normal relation of increasing cost with increasing size. (Knight 1924, p. 598)

Echoing Young (1913), he wrote: In spite of the weight of authority which may be cited for such [external] economies, I have never succeeded in picturing them in my mind, or finding any convincing reason to believe they exist. I can imagine conditions in which the production of a good may be tied up with a monopolistic industry like transportation, operating below capacity, in such a way as to produce some tendency in the direction argued. But I cannot believe such conditions general enough to justify a special law in economic theory. (Knight 1925, p. 322)

Knight (1924) held that “until a plausible example is brought forward, the category of decreasing cost under stable competition remains an empty economic box ” (p. 333): this expression echoed the debate in England raised in the pages of the Economic Journal in those same years, a controversy inside the Marshallian school which timidly but explicitly embarked on a criticism of Pigou. In a paper entitled “Of Empty Economic Boxes” (Clapham 1922), J. C. Clapham, Marshall’s student in the 1880s who became Professor of Economic History at Cambridge in

348

R. Marchionatti

1928, expressed the economic historians’ dissatisfaction with the available analytical tools by describing the difficulties that an economist, well-educated in the dominant British school, would have in actually putting real industries into the boxes on the shelves of his mind labeled with the categories of increasing, decreasing or constant returns. This economist tries The Economic of Welfare “to find that, in nearly a thousand pages, there is not even one illustration of what industries are in which boxes”, even though “many an argument begins—‘when conditions of diminishing returns prevail’ or ‘when conditions of increasing returns prevail’, as if everyone knew when that was” (Clapham 1922, p. 305). Clapham’s paper maintained that there were difficulties in the conception of a rate of returns in industry, and particularly of a rate of increasing returns, and that there were difficulties in deciding which particular industries are at the present time being conducted under conditions of increasing or conditions of diminishing returns—difficulties which kept these economic boxes empty. Pigou (1922) recognized that there were difficulties but maintained that the problem was not whether these concepts can be of any direct help in the practical conduct of affairs but whether the concepts of increasing and diminishing returns are instruments that are of service in constructing a realistic economic science. He wrote: These boxes … are not merely boxes; they are also elements in the intellectual machinery by which the main part of modern economic thought functions. If then it be granted that this thought, as a whole is able to render any practical service ... these particular elements in that machinery cannot be singled out from the rest and condemned as useless; they are an organic and inseparable part of that machinery. But there is a further consideration of a more direct kind. Even regarded as boxes, and empty ones at that, the categories of increasing and diminishing returns are not mere ornaments ... [they enable] us to discover ... what assumptions are implicit in the statement about economic causation (upon which action is often based) that politicians and other such persons are accustomed to make for the guidance of the public. (Pigou 1922, p. 462)

7 Great Controversies

349

Hence the solution of the problem, according to Pigou, was not to renounce the theory but rather to enrich the empirical portion of economics. The controversy between Pigou and Clapham cast a sharp light on the problem of the realism of the analytical tools that emerged from Pigou’s theoretical “departure” from Marshall’s more concrete approach in favor of a more formal analysis. Two years later, Dennis H. Robertson, echoing “certain criticisms which have been wafted across the Atlantic on the analytical mechanism elaborated by Pigou in his Economics of Welfare for dealing with these conceptions of diminishing and increasing return” (Robertson 1924, p. 16), voiced the criticism that in Pigou, “all the improvements in organisation from which ‘decreasing cost’ arises are of the nature of external economies.. the familiar ‘internal economies’.. having vanished into thin air” (ibid., p. 23). Referring positively to Young’s (1913) criticism, Robertson wrote: So determined is the Professor to banish these old friends that, disturbed by the apparent theoretical incompatibility of pure competition with the prevalence of decreasing cost at all, he seems to hold .. that each firm is (? or would be if it were isolated) working under conditions of increasing cost while the industry as a whole is working under conditions of decreasing cost. I would prefer to offend the mathematical theory of competition than to follow him through this logical hole in his own logical net. (ibid., note, our italics)

These controversies in Cambridge prepared the ground for the most radical criticisms of the period, those of Piero Sraffa and Lionel Robbins.

350

R. Marchionatti

Sraffa’s Criticism of the Supply Schedule, 1926, and Robbins’s Criticism of the Representative Firm, 1928 Sraffa’s “The Laws on Returns Under Competitive Conditions”, 1926 Sraffa’s paper “The Laws on Returns under Competitive Conditions” published in The Economic Journal (Sraffa 1926)—and preceded by a paper in Italian written in 1925 (Sraffa 1925) of which the English article was in part a summary—displayed as much critical rigor in analyzing the concept of competition as Knight had shown, but his “brilliantly original performance”, as Schumpeter wrote, brought the criticism to a different level: it no longer stopped at questioning the rigorous refinement of Marshallian pure economics, but critiqued the entire theory radically. Sraffa’s purpose was to demonstrate that the supply schedule with variable costs is not a general conception. At the time, his criticism appeared to be devastating, particularly in the Cambridge environment.2 First, Sraffa dealt with the difficulties of classifying industries according to whether they belong in the categories of increasing, decreasing or constant returns, as Clapham (1922) had described. These difficulties did not depend, Sraffa maintained, on insufficient data or scholarly incompetence, as Pigou (1924) had said, but rather on the nature itself of the criterion of classification: they depend on the heterogeneousness of the two laws of increasing and decreasing returns. These laws’ profoundly diverse nature springs from the fact that they: (a) originate from different parts of the classical theoretical apparatus, and (b) the law of decreasing returns is connected to changes in factor proportions, whereas the law of increasing returns is connected to changes in the scale of production. Co-ordinating the two laws in a single law of variable 2

In fact, the 1926 article had a “tremendous impact”, as Kahn (1984) wrote, on the Marshallian Cambridge environment, much more than the earlier 1925 Italian article had had on Italian academic circles. In fact, Sraffa came from a country where Marshall’s doctrine was well-known and enjoyed considerable circulation, but not dominant—“Marshall was not Economics” in Italy, where it was subject to criticisms and the limits of partial equilibrium analysis were widely recognized.

7 Great Controversies

351

costs in order to explain the value of competition—which emphasized the functional connection between cost and quantity produced—was a neo-classical operation, Sraffa writes. But, he notes, in order to reach this result, “It was found necessary to introduce certain modifications into the form of the two laws”. As regards the law of diminishing returns, the case of land was generalized to every case in which there existed a factor of production of which only a constant quantity was available. The law of increasing returns was subjected to “a much more radical transformation”: “consideration of that greater internal division of labour, which is rendered possible by an increase in the dimensions of an individual firm, was entirely abandoned”, because “it was seen to be incompatible with competitive conditions”. On the other hand, the importance of “external economies” was more and more emphasized (Sraffa 1926, pp. 537–538). The following, crucial, step of Sraffa’s criticism was to deal with the analytical difficulties of Marshallian theory, which, he writes, make their appearance “when it is considered to what extent the supply curves based on the laws of returns satisfy the conditions necessary to enable them to be employed in the study of the equilibrium value of single commodities produced under competitive conditions” (ibid., p. 538). The Marshallian point of view, Sraffa wrote, “assumes that the conditions of production and the demand for a commodity can be considered, in respect to small variations, as being practically independent, both in regard to each other and in relation to the supply and demand of all other commodities” (ibid.). This assumption, Sraffa writes, is legitimate if a variation in the quantity produced by the industry under consideration has no collateral effects or slight ones. Unfortunately, however, Sraffa continued, it so happens that in the great majority of cases the applications of the laws of returns fall in the case in which the collateral effects are such to upset the conditions of the particular equilibrium which it was intended to isolate. As regards the punctum dolens of the decreasing supply curve, Sraffa notes that the cases in which productivity increases with the increase of firm size cannot be treated in the theory of price under competitive conditions because if a firm can decrease its costs by endlessly increasing its production, it will continue to reduce the price until it has conquered the whole market, thereby violating the assumption of perfect competition. Actually, Sraffa continues, there was a way of escaping from this

352

R. Marchionatti

difficulty and constructing an industry decreasing supply curve which is correct from the formal point of view: to explain increasing returns by external economies, external to the individual firm but internal to the industry, but, Sraffa writes, following Young’s and Knight’s criticism of Pigouvian external economies: Those economies which are external from the point of view of the individual firm, but internal as regards the industry in its aggregate, constitute precisely the class which is most seldom to be met with … In any case, in so far as external economies of the kind in question exist, they are not likely to be called forth by small increases in production. (ibid., p. 540)

Sraffa did not limit his criticism to the decreasing cost supply curve, as he more generally criticized the supply curve based on variable costs under competitive conditions. He emphasized the artificial conditions of constructing an increasing supply curve and noted that “the imposing structure of diminishing returns is available only for the study of that minute class of commodities in the production of which the whole of a factor of production is employed” (1926, p. 539).3 Sraffa concluded that the conditions which a supply curve must satisfy in partial equilibrium and under competitive condition make the laws of variable costs applicable in a very limited way: Reduced within such restricted limits, the supply schedule with variable costs cannot claim to be a general conception applicable to normal industries; it can prove a useful instrument only in regard to such exceptional industries as can reasonably satisfy its conditions. (1926, p. 540)

Hence Sraffa’s conclusion that the supply schedule with variable costs is not a general conception. A more general first approximation, Sraffa continues, seems to be the Ricardian constant cost hypothesis, which holds that the cost of production of commodities produced competitively “must be regarded as constant in respect of small variations in 3 Sraffa’s criticism here was not new: as Sraffa himself wrote in the 1925 article, he accepted Enrico Barone’s conclusions (Barone 1894) on the inadmissibility of the increasing supply curve of a commodity for the production of which factors are used which are also employed in other productions.

7 Great Controversies

353

the quantity produced” (ibid., p. 541). This is the outcome of the logical difficulties met by variable costs. According to Sraffa, two theoretical routes could be taken to find a way out of the impasse: (a) the simultaneous equilibrium of all industries (“Pareto’s point of view”), (b) abandoning the assumption of perfect competition (“Cournot’s route”). As Sraffa considered the Paretian conception unfruitful because of its “complexity” (a judgment shared with many Italian economists, Pantaleoni for example), Cournot’s route seemed to be the only viable research direction4 : it was a further approximation, which makes it possible to consider the case of increasing returns. In the second part of his paper, Sraffa investigates “the intermediate zone” between monopoly and perfect competition to which neoclassical economics thinks the conclusions proper to competition may be applied “even if the market in which the goods are exchanged is not absolutely perfect, for its imperfections are in general constituted by frictions which may simply retard or slightly modify the effects of the active forces of competition, but which the latter ultimately succeed in substantially overcoming” (ibid., p. 542). However, Sraffa maintains,

4 Sraffa’s proposal to follow Cournot’s approach had been undervalued by economists in the past decades, though not totally neglected: in one of his Economic Essays (1906) on Cournot, Dmitriev (see Vol. I, Chap. 5.4) had maintained that the French economist was the only author capable of constructing a complete theory of competition. More recently, in Italy, the Paretian Luigi Amoroso (Amoroso 1921) had favorably reassessed the analysis Cournot conducted in his Recherches. Sraffa’s positive suggestions had been partly anticipated by Knight, who wrote in his 1921 book that the competitive theory may be a good analytical device, a first approximation, but it does not exist in the real world, and must thus be supplemented to make it more applicable. Similarly, in his 1921 article, Knight wrote: “One of the most serious oversights in the discussion of decreasing cost is the neglect of the mixture of competition and monopoly which is a general characteristic of the type of business supposed to exhibit this type of cost function … The correct approach to the explanation of price in the case of partial monopoly would seem to be to apply the theory of monopoly, not that of competition” (Knight 1921, p. 332). On the other hand, these ideas were not completely new in the United States at that time. First, Moore had noted that “actual industry … to a large extent, is in a state intermediate between perfect monopoly and perfect competition” (Moore 1906, p. 215). Then, Viner (1921) anticipated some of the essential ideas underlying the theory of imperfect competition and J. M. Clark (1923) emphasized that in the contemporary American economic world the majority of markets lay in the intermediate zone between theoretical competition and theoretical monopoly. Some years later, in 1927, Chamberlin laid the foundation of The Theory of Monopolistic Competition in his dissertation at Harvard (under Young’s supervision).

354

R. Marchionatti

this view appears to be fundamentally inadmissible. Many of the obstacles which break up that unity of the market which is the essential condition of competition are not of the nature of “frictions,” but are themselves active forces which produce permanent and even cumulative effects. They are frequently, moreover, endowed with sufficient stability to enable them to be made the subject of analysis based on statical assumptions.

Sraffa emphasizes the importance of two of these effects, which are closely interconnected, and which “are to be found with great frequency in industries in which competitive conditions appear to prevail” (ibid.): first, as firms work under conditions of individual diminishing costs, producers “would consider absurd the assertion that the limit to their production is to be found in the internal conditions of production in their firm, which do not permit of the production of a greater quantity without an increase in cost” (ibid., p. 543); second, “The chief obstacle against which they have to contend when they want gradually to increase their production does not lie in the cost of production—which, indeed, generally favours them in that direction—but in the difficulty of selling the larger quantity of goods without reducing the price, or without having to face increased marketing expenses”. The demand curve of a good of a determined producer is therefore descending. These aspects of “everyday experience” deny two points of the traditional theory: “first, the idea that the competing producer cannot deliberately affect the market prices, and that he may therefore regard it as constant whatever the quantity of goods which he individually may throw on the market; second, the idea that each competing producer necessarily produces normally in circumstances of individual increasing costs” (ibid., p. 542). Sraffa’s approach makes it possible “to ascribe the correct measure of importance to the chief obstacle which hinders the free play of competition, even where this appears to predominate, and which at the same time renders a stable equilibrium possible even when the supply curve for the products of each individual firm is descending—that is, the absence of indifference on the part of the buyers of goods as between the different producers” (ibid., p. 545) due to causes of diverse nature (custom, personal acquaintance, confidence in the quality of the product, proximity, knowledge of particular requirements and the possibility of

7 Great Controversies

355

obtaining credit, reputation of a trade-mark, etc.). What these and the many other possible reasons for preference have in common is that they are expressed in a willingness on the part of the group of buyers who constitute a firm’s clientele “to pay, if necessary, something extra in order to obtain the goods from a particular firm rather than from any other” (ibid.). When each of the firms producing a commodity is in such a position the general market for the commodity is subdivided into “a series of distinct markets”: “within its own market and under the protection of its own barrier each [firm] enjoys a privileged position whereby it obtains advantages which—if not in extent, at least in their nature—are equal to those enjoyed by the ordinary monopolist” (ibid.).

Robbins’ Criticism of the Representative Firm, 1928 A new attack on the Marshallian tradition was mounted in the September 1928 issue of the Economic Journal by Lionel Robbins of the London School of Economics. It centered on a fundamental concept of Marshall’s theoretical construction, that of the representative firm. Robbins opened his article by stating that “the Marshallian conception of a Representative Firm has always been a somewhat unsubstantial notion” (Robbins 1928, p. 387), a type of criticism that had already been made some years before, in 1924, in the United States, by the Harvard economist Norman J. Silberling (1892–1942) who maintained that the concept of representative firm was “misleading and superfluous” (Silberling 1924, p. 438). Robbins’ article, although its interpretation of Marshall’s notion was superficial, was important from a historical point of view in the breakdown of Marshallianism. Robbins examined the places in which Marshall used the concept and concluded that it was “essentially a long-period conception” (ibid.) without statistical significance or practical usefulness. Theoretically it was not a necessary tool—“There is no more need for us to assume a representative firm or representative producer, than there is for us to assume a representative piece of land, a representative machine, or a representative worker”— maintaining that “all that is necessary for equilibrium to prevail is that each factor shall get at least as much in one line of production as it could

356

R. Marchionatti

get in any other” (ibid., p. 393). He also considered the concept not necessary to solve the problem of diminishing costs under competitive conditions: in this case Robbins referred to the criticisms of Young and Knight and questioned the existence of external economies. Lastly, he regarded the representative firm as a very poor tool for examining the problems of change and development. Referring to the contemporary research program of Allyn Young, at that time at the London School of Economics, Robbins wrote that: In a world in which growth in the economic system proceeds just as much by way of differentiation and subdivision as by the expansion and development of particular economic units, the idea of a representative unit which preserves its essential identity while undergoing progressive expansion is apt to be very misleading … In such a case to continue to speak of the representative firm of the industry ... is to suggest a state of affairs having no counterpart in reality … It is no accident, I suggest, that in Industry and Trade where problems of this sort are dealt with, the use made of the Representative Firm is even more nebulous and half-hearted than in the Principles. (ibid., p. 402–403, note)

The Marshallian Reaction: Pigou’s Line of Defense, 1927–1928, and Robertson’s and Shove’s Contributions at the 1930 “Symposium” of the Economic Journal Pigou’s Defense and Definite Statement of the Theory of Competitive Supply, 1927–1928 A few months after the publication of Sraffa’s article, Pigou responded in the June 1927 issue of the Economic Journal to what he considered a “very interesting paper”. He discussed “analytically” the relation between the quantity of output and the costs of production of particular commodities in the long period, that is, in Marshall’s language, he was concerned with the normal relation between output and cost and “exclusively with variations in aggregate cost associated with and due to variations in the scale of output” (Pigou 1927, p. 189) of the particular

7 Great Controversies

357

commodity. Moreover, he assumed that the relative value of the factors of production remains constant, with the consequence that he was forced to confine his study “to commodities which individually employ so small a proportion of each of the several factors of production that no practicable changes in the scale of their output could sensibly affect the relative values of these factors” (ibid.). His study concluded that with the class of commodity under review “it is impossible for production anywhere to take place under conditions of increasing costs”. “In this matter my conclusion—Pigou said—agrees with that by Professor Sraffa in his recent article” (ibid., p. 193). By contrast, Pigou maintained that production could take place under conditions of increasing costs, in opposition to Sraffa’s judgment that it was impossible or extremely unlikely. He accepted that under competitive conditions internal economies cannot be considered, but he asked “whether he [Sraffa] is right in denying that external economies special to particular industries may be looked for in a measure adequate to establish conditions of decreasing costs” (ibid., p. 195). According to Sraffa it was highly improbable that a small increase in the scale of output of a single industry would lead to a growth of external economies sufficient appreciably to affect costs in that industry. This is apparently true, Pigou said, but really illusory. In fact: Nobody, of course, imagines that a small addition to the scale of output will lead to more than a small increase of external economies. What signifies, however, is not the absolute size of this increase. It is the ratio between this increase, expressed as a proportion of previously existing costs, and the increase of output, expressed as a proportion of previously existing output; and there is no reason why the ratio between two quantities which are both of the second order should not itself be of the first order. (ibid., p. 195)

So Pigou rejected Sraffa’s criticism of external economies from the analytical standpoint, but, he said, “to determine the actual content of any part of the cost function for any commodity would necessitate a very difficult combination of statistical research and intelligent guess-work” (ibid., p. 196).

358

R. Marchionatti

The definitive statement of Pigou’s theory of competitive supply came one year later in his June 1928 article in the Economic Journal , substantially incorporated in the third edition of the Economics of Welfare. In the paper Pigou concluded his study of the relation “between variations in normal supply price and variations in quantity of output” (Pigou 1928, p. 238) under “other things being equal” and competitive conditions— i.e., the outputs of the individual firms are small relatively to the output of the whole industry, and there is free entry—in a rigorous and highly abstract manner in order to give precise form to Marshall’s discussion of internal and external economies. To do so, he considered it necessary to reject Marshall’s representative firm and its complexity: Most industries are made up of a number of firms, of which at any moment some are expanding, while others are declining. Marshall ... likens them to trees in a forest. Thus, even when the conditions of demand are constant and the output of an industry as a whole is correspondingly constant, the output of many individual firms will not be constant. The industry as a whole will be in a state of equilibrium; the tendencies to expand and contract on the part of the individual firms will cancel out; but it is certain that many individual firms will not themselves be in equilibrium and possible that none will be ... This is evidently a state of things the direct study of which would be highly complicated. Fortunately, however, there is a way round. (ibid., p. 239)

The device introduced in order to reduce the analytical complexity is the concept of the “equilibrium firm”: There can exist some one firm, which, whenever the industry as a whole is in equilibrium, in the sense that it is producing a regular output y in response to a normal supply price p, will itself also individually be in equilibrium with a regular output x r . (ibid., pp. 239–240)

The equilibrium firm cannot have unexhausted internal economies, and the possibility that supply price might fall as industry output increases can be attributed only to external economies which lower the average cost curve of the equilibrium firm as industry output increases. In this paper, Pigou used the concept of external-internal economies—so defined by

7 Great Controversies

359

Robertson (1930)—whose nature is such that they emerge as a result of those increases in the size of the individual firm which are directly caused by increases in the size of the industry as a whole, a device for reconciling the contradiction between increasing returns and competition. The increased specialisation of its component firms made possible by an enlargement in an industry as a whole often involves a large reduction in costs ... an increase in the scale to which an industry is producing frequently alters—in general diminishes—the average and (marginal) costs of the equilibrium firm contained in it, whether or not it also alters its size. There is then no difficulty in seeing that the law of decreasing supply price, as conceived when correction has been made for transfer elements in rates of price change, is not merely formally possible, but is likely to be followed in practice by many manufacturing industries. (ibid., p. 252)

Robertson (1930) acknowledged that Pigou’s concept of external-internal economies was ingenious, but argued “that it is not the line of approach which springs most naturally either out of Marshall’s suggestions or out of the observed facts” (Robertson 1930, pp. 86–87) because, although “it is doubtless true, as Marshall and Pigou observe, that the growth of an industry and the growth of its constituent firms frequently proceed more or less pari passu” (ibid. p. 87), the bulk of the observed internal economies of large-scale production cannot have “the derivative nature” that Pigou asks us to suppose. The reconciliation between increasing returns and competition (by endowing each firm with a rising marginal cost curve while allowing firms’ marginal and average cost curves to shift as industry output changed) was a view which became normally accepted after the Viner’s classical argument (Viner 1931).5 However, a crucial implication of the Pigou-Viner approach, which Viner (but not Pigou) recognized clearly, is the absence of realism and empirical relevance of their analysis. From Sraffa’s point of view, of course, this defense was 5 Pigou (1928) holds that the firm’s expansion is offset by an exactly equal contraction on the part of the other firms in the industry, whereas for Viner (1931) expansion in the industry takes place as a result of an increase in the number of firms. As Chipman (1970) demonstrated, these are artificial assumptions which need not be introduced.

360

R. Marchionatti

worthless, as it did nothing to close the gap between theory and its practical relevance.

Robertson’s Defense of the Representative Firm and Sraffa’s “Destructive” Criticism, 1930 Robertson (1930) tried another defense he hoped could preserve the “nature” of Marshall’s approach. In a symposium organized by Keynes in 1930 and published in the Economic Journal , Robertson countered Robbins by maintaining the representative firm is “a fruitful and indeed an indispensable instrument in the construction of a theory of value”. The question is whether the “the scramble by individual firms, regardless of the actions of their neighbours, to reap the direct advantages of large-scale organisation and plant” (Robertson 1930, p. 87) in the process toward equilibrium, “can or cannot be played upon by the mind with any success without abandoning the theory of competition” (ibid.). Robertson thought that Marshall “while not rejecting Professor Pigou’s external economies and Mr. Sraffa’s monopoly theory as auxiliary weapons, held that it could” (ibid.). Marshall’s metaphor of the trees of the forest, Robertson continued, was meant “to assist the reader in making a more violent effort of the imagination than most of those who have quoted it have realised” (ibid.). The “not easy” task of showing that “[competitive] equilibrium might be legitimately conceived with the representative firm working under conditions of decreasing cost, with price equal to the average costs of that firm, and with the industry as a whole obeying the law of increasing returns” (ibid., p. 88) is pursued by introducing the metaphor of Messrs. Smith and Robinson’s firm: it is a representative firm at a certain moment—with all the properties belonging to the Representative Firm but not the “quality of being able to expand output indefinitely at a lower cost per unit” (ibid.), a quality which belongs “to no firm whose name is to be found in the directory” (ibid.). As a consequence “the fact that ‘the Representative Firm’ is to be conceived of as working under conditions of decreasing cost proves not incompatible with the fact that Messrs. Smith and Robinson will never obtain a monopoly of the whole trade” (ibid., p. 89). Robertson

7 Great Controversies

361

also used another metaphor, comparing Messrs. Smith and Robinson to “a collection of water-drops at this moment forming part of a wave, and sharing all the obvious physical properties of the wave … but not its continuity of existence with the wave of five minutes later” (ibid., p. 88). This position—Robertson acknowledged this point—“cannot be cleared up mathematically” (ibid., p. 89), but he considered it the best way at that time available to throw light “on the turmoil of what happens in real life” (ibid.). Sraffa’s “criticism” of Robertson’s paper at the symposium was, according to Keynes (1930) and most other commentators, destructive. First, Sraffa commented that “if there is no equilibrium, it is not denied that internal economies may be the main force in operation …; it is only denied that in a state of equilibrium they can be” (Sraffa 1930, p. 90). And he continues: “Now, if Mr. Robertson thinks that internal economies are ‘the main factor’ in the ‘progress towards equilibrium’, how can he at the same time hold that they go on acting undisturbed beyond that point?” (ibid.). Second, as regards the metaphors used by Robertson, Sraffa maintained that they cannot “reconcile the contradiction” (ibid., p. 91). And he concluded: We seem to agree that the theory [i.e., Marshall’s] cannot be interpreted in a way which makes it logically self-consistent and, at the same time, reconciles it with the facts it sets out to explain. Mr. Robertson’s remedy is to discard mathematics, and he suggests that my remedy is to discard the facts; perhaps I ought to have explained that, in the circumstances, I think it is Marshall’s theory that should be discarded. (ibid., p. 93)

Shove’s Contribution, 1930 In his paper presented at the symposium of the Economic Journal , Gerald F. Shove tried to draft a theory of competitive equilibrium that could take in account the demands raised by Robertson without using the notion of the representative firm. He wrote that: Equilibrium for the industry as a whole does not imply that all (or indeed any) of the individual firms are in equilibrium: every one may be either

362

R. Marchionatti

expanding or contracting, provided that the rates at which the output of the growing firms is expanding and that of the declining firms contracting are such as to leave the aggregate output unchanged … What is necessary for equilibrium is that a general expansion or contraction in the scale of the business unit should not be profitable. (Shove 1930, p. 96)

He considered first the question: how can the existence of internal economies be reconciled with competitive equilibrium? The internal economies here in question must obviously be internal economies of individual expansion, i.e. improvements in its internal organisation which a firm would obtain if it had a larger share in a constant aggregate output … The answer which most readily occurs to the mind is that these internal economies of individual expansion are offset by equivalent diseconomies … The obstacles which check the growth of a firm’s share in a trade ... are the increases in the cost of transport and of marketing …, which a firm is liable to encounter as it advances further into its competitors’ territory or markets. (ibid., p. 105)

“This simple reflection—Shove continues—at once enables us to reconcile competitive equilibrium with ‘increasing returns’ or ‘diminishing supply price’ arising from internal economies alone ”, without referring to external economies, a “secondary line of escape” (ibid., p. 107). This solution, Shove recognized, may encounter two objections from Sraffa and Robertson: a. “Sraffa will say, perhaps, that the equilibrium reached under these conditions is not competitive but monopolistic” (ibid., pp. 108–109) b. “Robertson may complain that … I am evading his real difficulty—which only arises when the economies of individual expansion predominate over its diseconomies” (ibid., p. 109). Shove answered Sraffa’s objection by saying that, although there may be a real issue behind it—viz. the question whether in the given situation value approximates to cost of production or departs from it widely—“we are not concerned with that problem here” (ibid.); on the contrary, “we have simply to enquire whether, and if so why, substantial economies of

7 Great Controversies

363

mass-production are consistent with the survival of a large number of competing firms” (ibid.). To answer Robertson’s question, he maintains that “the solution of this problem turns, as Marshall saw, on the element of time” (ibid.): If a firm could enlarge its output to any required size... instantaneously ... then indeed the predominance of internal economies would, on our present hypothesis, be incompatible with competitive equilibrium; but since it cannot, the two conditions can be reconciled. (ibid., p. 110)

In other words, Shove stressed the fact that the firm’s costs are not a function of only two variables (the firm’s output and the industry’s output), as in Pigou (1928), but a function of three variables (the firm’s output, the industry’s output and time): it is the Marshallian life cycle of the firms which contributes in an essential way to explain to coexistence of a large number of firms. What Shove proposed was an analysis of dynamic equilibrium, in a Marshallian mood, but discarding the representative firm. As Newman (1960) wrote, Shove saw very clearly “that equilibrium of the Marshallian type implied that the size distribution of output among firms should be constant and, further, that increases in the industry’s output might lead to ‘quite a different distribution of business between the size-groups’” (Newman 1960, p. 598).6

Young’s, 1928, and Schumpeter’s, 1928, Contributions, or the Return to the Classic Dynamics Allyn A. Young may be considered the economist who started the criticism of Marshallian theory, with his critical review of Pigou’s Wealth and Welfare. Moreover, he was a sort of critical conscience behind some 6 Shove’s suggestions were ignored at that time. His statement was made again 25 years later by J. N. Wolfe (1954): in his article, inspired by Robertson’s and Shove’s contributions, the American economist suggested that the representative firm should be treated as an “abbreviated notation” for the distribution of firms by size, thus making the result a process of chance. This concept of equilibrium can be represented mathematically, by employing, as Newman and Wolfe (1961) do, the technique of non-homogeneous Markov chains. The rehabilitation of Marshall’s life cycle theory by Negishi (1989) can be also considered a variation of the theme sounded by Newman and Wolfe.

364

R. Marchionatti

of the major theoretical works of that time, from Knight to Chamberlin. Young had developed an increasing disaffection and skepticism regarding the model of static equilibrium and its capability for description and prediction in the years he spent teaching at Harvard University between 1920 and 1927 (see Blitch 1983a, b). Young felt that the solution of the problem of increasing returns and competition was not the theory of monopoly, but a revision of the external economies concept after abandoning the static method. He expressed his position in his speech at the University of Glasgow as the President of Section F of the British Association in September 1928, three months after it was published in the Economic Journal under the title “Increasing Returns and Economic Progress” (Young 1928). Young considered external economies to be the prime source of increasing returns and economic progress. The question of increasing returns is considered as a part of a theory of industrial growth, from the perspective of Book IV of the Principles. The paper starts with the statement that the partial equilibrium apparatus which economists have built up for dealing with the range of questions raised by the phenomena of increasing returns does not give a clear view of all that it involves. Certain aspects of those processes are obscured in the partial analysis: in fact, Young writes, if, as with traditional apparatus, we assume a condition of comparative stability looking at the internal economies of a particular firm, we see changes in its operations but fail to see changes of another order which are occurring in the external field, viz. the appearance of new products and new industries, and the assumption of new tasks by the firms. This change is not only quantitative but also qualitative. He writes: No analysis of the forces making for economic equilibrium, forces which we might say are tangential at any moment of time, will serve to illuminate this field, for movements away from equilibrium, departures from previous trends, are characteristic of it. (Young 1928, p. 528)

Another view, “simpler and more inclusive”, must be assumed: “such as some of the older economists took when they contrasted the increasing returns which they thought were characteristic of the manufacturing industry taken as a whole with the diminishing returns which they

7 Great Controversies

365

thought were dominant in agriculture” (ibid.); specifically, Adam Smith’s so-called theorem that the division of labor depends upon the extent of the market as formulated in the Wealth of Nations. Young’s paper dealt with two related aspects of the division of labor: the growth of indirect methods of production and the division of labor among industries, which he discussed by developing ideas that were present in Book IV of the Principles. Young stressed that the size of the market is the most important single factor in determining the industry’s effectiveness and defines, classically, the market as “an aggregate of productive activities, tied together by trade” (ibid., p. 533) between which there “must be some sort of balance”. Moreover, Young emphasized that the counter forces which are continually defeating the forces which make for economic equilibrium are more pervasive and more deeply rooted in the constitution of the modern economic system than we commonly realise … Every important advance in the organisation of production ... alters the conditions of industrial activity and initiates responses elsewhere in the industrial structure which in turn have a further unsettling effect. Thus change becomes progressive and propagates itself in a cumulative way. (ibid., p. 533)

Young’s analysis7 had strong analogies with an article published by Schumpeter the same year in the pages of the Economic Journal (Schumpeter 1928). In his paper Schumpeter, after defining the traditional view of industrial progress inside an essentially static structure as “inadequate, or even misleading”, maintains that change is the fundamental characteristic of capitalist economic progress. Consequently, expansion cannot adequately be dealt with by static analysis at all: “Expansion … is itself the result of a more fundamental ‘economic force’, which accounts both for expansion and the string of consequences emanating from it” (p. 376). As we know (see Vol. I, Chap. 5.3), for Schumpeter, that fundamental force is innovation, a specific function of the entrepreneur.

7

Young’s view was to be theoretically fertile: its influence can be seen in Stigler (1951), Downie (1958), Richardson (1975), and Kaldor (1981) among others, and to some extent in Romer (1986, 1987).

366

R. Marchionatti

Concluding Remarks In Book IV of the Principles, Marshall offered a dynamic view of the competitive process and the growth of the firm that was strictly connected with the classical view (see Vol. I, Chap. 3.1). Using the Smithian concept of the division of labor as a starting point of his analysis, Marshall presented a model in which the division of labor produces increasing returns and tends to increase the scale of production and the opportunities for further division of labor. Though the exploitation of internal economies makes it possible for a firm to increase its size, this tendency does not transform the competitive system into a monopolistic one because the possibility of exploiting increasing returns is limited by opposing tendencies: the life cycle of the firm and the difficulties of marketing, while external economies facilitate the general diffusion of the economies of production. Marshall’s model is one of dynamic monopolistic competition—i.e., the monopoly positions of firms can be only temporary because the dynamic nature of the capitalistic system does not allow the process to reach an end point. In this context, in order to consider Cournot’s dilemma, he created the concept of the representative firm. The analytical result, however, was not only unsatisfying but was also inadequate for solving the problem of the theory’s “realism”. The shaky foundations of Marshall’s theory were soon recognized, and criticism mounted steadily, especially in the Twenties. Sraffa emphasized two types of limit in Marshall’s theory of value: of analysis and of relevance. Regarding the first type, Sraffa leveled his charges against the supply curve based upon the laws of increasing and diminishing returns: under conditions of stable partial equilibrium, he noted, the shape of the supply curve cannot be decreasing, unless it is introduced by the hypothesis of external economies in a precise sense— external to the firm, but internal to the industry—in order to guarantee the ceteris paribus condition. Under those conditions of partial equilibrium, moreover, the shape of the supply curve can be increasing only if the totality of the factor of production is used in order to produce the commodity under examination. Lastly but far from unimportantly, some writers deny the theoretical validity of the long-period descending

7 Great Controversies

367

curve, holding that such a curve can only represent an irreversible, historical process, and it is thus a descriptive curve. As for the second type of limit—the relevance of Marshall’s construction—it was pointed out that the representative firm was not a necessary tool for the determination of equilibrium and, above all, was a poor tool for examining the problem of change and development. In fact in conditions of stationary state and partial equilibrium, the broad forces of increasing returns— by their nature inter-industrial—have a very limited action, and there is also the major limitation to the un-exhausted growth of the firm, the mortality of entrepreneurial ability, because under those assumptions the available resources do not change. Lastly, the representative firm describes the characteristic of the equilibrium situation, but not the path to equilibrium and whether the process converges toward equilibrium. As Schumpeter—and Knight somewhat later—saw, overcoming the difficulties Marshall faced and clarifying their theoretical aspects seemed to call for separating statics from dynamics. But this solution was unacceptable for the Marshallians, as is clear from Pigou’s work in reconstructing and defending the tradition. Pigou, from the years of Wealth and Welfare to the end of the Twenties, tried to remedy the breaches opened in Marshall’s theory. He met the critics on their own ground, i.e., he assumed the autonomy of abstract reasoning and the need for absolute rigor in the theory of value—implicitly abandoning Marshall’s epistemology—and thus attempted to defend Marshall’s construction without referring to the element of time, as he himself wrote. Though the solution he offered was, undoubtedly, logically consistent solution in the framework of marginal analysis, it was weak because: (a) he claimed to preserve, at least in part, some of Marshall’s realism, (b) at the same time, he made assumptions, that though necessary from an analytical standpoint, were unrealistic. Pigou’s work oscillated between the requirements of rigor and realism, unsuccessfully seeking a bridge between them. From Schumpeter’s and Knight’s perspective, which separates statics and dynamics, the non-realism of the hypothesis is not a serious limit. From that standpoint, unrealistic assumptions are seen as a necessity dictated by the requirement for rigor and statics has its specific task: “There is nothing unduly abstract in considering the phenomena incident to the running of economic life under given conditions taken by

368

R. Marchionatti

themselves—Schumpeter writes in his 1928 article—. On the contrary it means giving this class of problems the treatment they require” (Schumpeter 1928, p. 368). It may be also a simple pedagogical instrument, as Viner (1931) reduced the theory of the firm and industry. According to these authors, changes and instability must be considered in the field of dynamics: “they cannot be adequately dealt with by static analysis at all”, Schumpeter said, and similar statements were made by Young, Knight and Robbins. In this sense, Schumpeter and Young, the authors who followed the research path of dynamics, acknowledged the practical irrelevance of the theory of value as inevitable. Moreover, they considered it wrong to examine discontinuous change in a static framework, because this entails considering economic life in itself as essentially passive, while they believe it is essentially dynamic and unstable. This “degrading” of static and stationary analysis, which makes the theory of value more or less a pedagogical instrument, was an undesired result from Pigou’s perspective, unacceptable in the Marshall-Pigou research program—a dead-end situation for the Marshallians, who had no way out except Shove’s constructive but neglected paper in 1930.

7.2

The Socialist Calculation Debate, 1919–1940

Before the Debate: Pareto, Barone and the Origin of the Marginalist Theory of the Socialist Economy Marx and Engels envisaged the need for planned management of the economy following the socialist revolution, but they did not deal with it at a theoretical level, nor did later Marxist thinkers until a few years before World War I. In fact, the socialist calculation debate was first theoretically discussed by Vilfredo Pareto—who according to Schumpeter (1954, p. 987) had “more claim than any other individual to being considered as the originator of the modern pure theory of the socialist

7 Great Controversies

369

economy”8 —and above all by Enrico Barone in his 1908 Italian article (see Vol. I, pp. 117–118), where he presented the set of equations for the collectivist state as a modified free competition system with a ministry of production that acts as the Walrasian auctioneer, showing that the conditions required for maximum economic welfare under socialism are the same as the conditions required under free competition. As Schumpeter wrote, Barone’s work showed that “so far as … pure logic is concerned the socialist plan makes sense” (ibid.).9

The Austrian Phase of the Debate, 1919–1925 With the end of World War I and the collapse of the Central Empires, when socialist parties came into power in most of the Central European states, the discussion entered a new phase. In Germany, there was an extensive debate on the development of plans for socialization, with important contributions by Emil Lederer (1882–1939), Eduard Heimann (1889–1967)—who both emigrated later to the United States—and by the industrialist, thinker and influential politician Walther Rathenau (1867–1922).10 In Austria, on a more theoretical level, the sociologist and economist Otto Neurath, one of the leading 8 We should also mention Friedrich von Wieser, who in Der Natürliche Werth (1889) maintained that the method of value calculation is essentially the same under communism and under capitalism. 9 Hutchison (1953) cites the criticism of socialist economics by the German liberal-socialreformist Albert Schäffle (1831–1903). He notes that Schäffle in some works—principally Die Quintessenz des Sozialismus (1874) and Bau und Leben des sozialen Körpers (1881)—on the one hand emphasized the dangers to freedom of choice in goods and jobs in a collectivist economy (a judgment also stressed by the member of the historical school Lujo Brentano) and on the other hand “tentatively sketched out a scheme for a liberal-socialist economy with a centralized authority, plentifully supplied with statistical intelligence, and manipulating a system of taxes and subsidies, which would retain the freedom and stimuli of the competitive market. Schaeffle’s idea was essentially that later developed by Barone, Lange, and others, but without the precise mathematical formulation and the background of Walrasian and Paretian analysis” (p. 294). 10 Eminent figure of German society in the tragic years between the war and the early postwar period, Walther Rathenau, industrialist, writer and politician, was one of the main organizers of the German economy during the war, and after the war was minister of reconstruction and then foreign minister of the Weimar republic. He was assassinated in 1922 by members of a right-wing movement.

370

R. Marchionatti

figures of the Wiener Kries (see Chap. 4.7), in a book entitled Durch die Kriegswirtschaft zur Naturalwirtschaft (War Economy and Natural Economy, Neurath 1919), outlined a calculation theory based upon the example given by war economy. He asserted that the central planning that occurred during war, when government assumes responsibility for planning material distribution and suppresses the market price system, should continue during peace time, with the government acting as a central enterprise, with the aim of avoiding recurrent periods of overproduction and unemployment and of working to achieve maximum productive capacity. Moreover, he maintained that there was no need for money, as all calculation regarding the appropriate levels of inputs and output could be handled in “natural” physical terms, and the price system would be replaced by “planned” prices resulting from a national plan drawn up by a Central Economic Office in which the general needs of the population determine the allocation of means. The leader of new Austrian school, Ludwig von Mises, replied with his famous paper (Mises 1920) in the 1920 issue of Archiv für Sozialwissenschaft und Sozialpolitik, the journal whose first editors included Werner Sombart and Max Weber—and then in 1922 with his book Die Gemeinwirtschaft: Untersuchungen über den Sozialismus [Socialism: An Economic and Sociological Analysis]—(see Chap. 4.4) where he asserted that rational economic calculation requires a market price system, and it is impossible under socialism, where a market price system does not exist. In a market system, Mises writes, prices, which are expressed in monetary form, represent a system of scarcity indexes, and the value of goods can thus be calculated rationally. But in a planned economy, where the means of production are controlled by the state, production goods are not an object of exchange and their (monetary) value cannot be determined, so rational calculation becomes impossible. Mises maintained that it was useless to substitute monetary calculation with calculation in natura, or “an economy in kind” in Neurath’s terminology. Socialism, he concluded, is the abolition of rational economy.11 11

Hayek (1935) claimed that Max Weber had also arrived independently at the same conclusion in the second chapter of Wirtschaft und Gesellschaft, which was published posthumously in 1921: “Like Professor Mises, [Max Weber] insisted that the in natura calculations proposed by the leading advocates of a planned economy could not provide a rational solution” (Hayek 1935,

7 Great Controversies

371

Mises’s paper kicked off a debate among economists that was to continue with a series of replies and rejoinders over the course of twenty years. The first phase of this debate took place in Vienna (see Chaloupek 1990; Becchio 2007), in the pages of the Archiv für Sozialwissenschaft und Sozialpolitik, since 1921 edited by Emil Lederer, where Mises’s 1920 article had been published, and involved Lederer’s young student Jacob Marschak (on Marschak see Chaps. 4.3 and 6.4), Mises himself, Otto Neurath, and Karl Polanyi (1886–1964), at that time editor of the economic and political magazine Der Österreichische Volkswirt (The Austrian Economist). In 1922 Karl Polanyi replied to Mises (Polanyi 1922). Mises’s reply followed in 1923 (Mises 1923), while 1924 saw a new contribution from Polanyi (Polanyi 1924) and Marschak’s paper (1924). Neurath’s reply to Mises was published in 1925 (Neurath 2004 [1925]), only to confirm his reasoning that “calculation in kind in the economic plan must be the moneyless basis of the socialist calculation of economic efficiency” (Neurath 2004 [1925], p. 430). Polanyi (1922) was critical of Neurath’s moneyless economy, agreeing with Mises that a rational solution to the problem of socialist computation in an administrative economy was impossible. At the same time, he argued against Mises’s “dogmatic” position, maintaining that efficiency in production and equality in distribution could only be achieved in a socialist society. In fact, for Polanyi the contrast between socialism and capitalism could no longer reduced to that between an economy without exchange and an economy of exchange (a point also emphasized in Polanyi 1924), because capitalism was very far from having created a free market, and an economy on a large scale was impossible without a mechanism of exchange. Polanyi proposes a “functionalist” system of socialism, i.e., a system organized like English guild socialism, based on a market socialism model where the economy was planned, but not centrally. Costs can be correctly computed jointly by the political authority (the Kommune, which owns the means of production), and the producers’ p. 33). In fact, as Hutchison (1953) writes, Weber advanced an analysis similar to Mises at some points, “but quite different”: “Weber agrees that ‘monetary calculations’ ensure, and are necessary for, a certain purely formal rationality in economic activity, but points out that this formal rationality may, and usually will, conflict with a substantive rationality in the direction of economic activity” (Hutchison 1953, p. 301).

372

R. Marchionatti

and consumers’ associations have the right to use them. This system, Polanyi maintained, is able to guarantee efficiency and equality through a correct computation of costs, avoiding the inefficiencies of capitalist society (essentially cyclical crises and monopolies, with underutilization of resources). To support Polanyi’s line of reasoning, Marschak (1924) objected to Mises’s contention that the requirements of price formation on free markets are not fulfilled in capitalist economies with cartels and trusts, and presented an interesting criticism of mixing up theoretical and practical questions (for a discussion of Marschak’s article see Hagemann 2019). Mises replied to Polanyi’s article (Mises 1923), claiming that any third form of society between socialism and liberalism could not exist and that the presence of the productive associations was merely a ruse to mask the fact that there was an administrative economy.

The Debate’s Sequel in the English-Speaking World, 1928–1934 At the end of the 1920s the debate moved to the English-speaking world12 where it involved the American Fred Manville Taylor (1929), and in the early 1930s H. D. Dickinson (1933), Maurice Dobb (1933) and Abba Lerner (1934). The American marginalist economist Fred Manville Taylor (1855– 1932) was Professor of Economics at the University of Michigan. Upon his election as president of the American Economic Association in 1928, 12 Two important contributions also appeared in Germany in these years: Carl Landauer’s Planwirtschaft und Verkehrswirtschaft (Planned Economy and Exchange Economy) (1931) and Cläre Tisch’s doctoral dissertation Wirtschaftsrechnung und Verteilung im zentralistisch organisierten sozialistischen Gemeinwesen (Economic calculation and distribution in the centrally organized socialist community (1932), discussed at the university of Bonn with Schumpeter as tutor). Carl Landauer (1891–1983) was born in Munich and received his doctorate at Heidelberg. Member of the Social Democratic Party from 1912, he was Professor at the Commercial University in Berlin up to 1933. He then left Germany and joined the Department of Economics at Berkeley. Cläre Tisch (1907–1941) studied economics in Bonn and Berlin and became Spiethoff ’s assistant, but she was forced to leave university under Nazism and in 1941 was deported to the Minsk ghetto where she was murdered. Landauer and Tisch’s works were contributions to the theory of market socialism. As regards Tisch’s dissertation in particular, Hagemann (2019) considers it an important contribution, as it dealt with the socialist calculation problem in terms of the Walrasian general equilibrium system in Gustav Cassel’s simplified version.

7 Great Controversies

373

he delivered an address which was then published in 1929 by the American Economic Review under the title “The Guidance of Production in a Socialist State” (Taylor 1929) in which, taking the tack anticipated by Barone, he outlined a socialist model of economy, and showed that a socialist economy could be as efficient as a private enterprise economy, with the further benefit that in a collective system, by contrast with a market economy, initial income distribution would be an additional variable controlled by the government. In Taylor’s model, the state distributes monetary income to the members of the community, and equalizes the expense of the total income of the population with the sum of prices of consumer goods on the market. In equilibrium the price of products equals their production cost. This cost is the total value of productive resources. Taylor then considers the value of the primary factors, which he calls the “imputation problem”. To determine the value of each use of the primary factors he uses “the so-called method of trialand-error, that is the method which consists in trying out a series of hypothetical solutions till one is found which proves a success” (Taylor 1929, p. 6). The planning office assigns each primary factor a provisional valuation based on a careful analysis as well as on experience; it lets the economy operate with these values. It is then necessary to detect and correct imbalances. The English economist Henry Douglas Dickinson (1899–1969) trained at Cambridge, where he was mostly influenced by Pigou, and at the LSE under Cannan. He entered the debate in 1933 (at that time he was at the University of Leeds) with an article entitled “Price formation in a socialist community” published in the Economic Journal (Dickinson 1933), which is considered a notable contribution to the problem of rational calculation (together with his 1939 book Economics of Socialism), and probably the best one in this period. Dickinson refuted Mises’s thesis on the impossibility of socialist calculation—in particular Mises’s charge that “where the State is the sole owner of instrumental goods there can be no price formation for such goods, hence no rational reckoning of cost and hence no rational economy” (Dickinson 1933, p. 237)—and tried to show “that a rational pricing of instrumental goods is at least theoretically possible in a socialistic economy” (ibid., p. 238). More generally, his aim is to demonstrate the theoretical possibility of “an economic

374

R. Marchionatti

system based upon the collective ownership of land and capital, directed towards the realisation of equality of income, and in which there would be room for free choice both of occupation by workers and of gratifications by consumers” (ibid., p. 250). He believed that under such a system it would be possible “to establish an economic equilibrium between cost and utility and to allocate resources to the satisfaction of competing needs at least as well as, if not better than, under capitalism” (ibid.). He postulates a monetary economy in which private property is recognized in goods used for personal consumption, natural resources and instrumental goods are owned by the community, and all production is undertaken by the community, there being two sectors of the economy, the sector of individualized consumption and the sector of socialized consumption. Within the “glass walls” of the socialist economy, complete information is assumed. The problem is how prices would be determined for consumption goods and for production goods. In the consumption goods sector, Dickinson assumes the existence of stocks of goods in the hands of the selling agencies, which “sell on the basis of what the market will bear, raising price when stocks fall short and lowering it when they accumulate” (ibid., p. 239), thus determining equilibrium prices. As regards the pricing of production goods, the process for obtaining equilibrium is presented as follows. “On the basis of the orders sent back by selling agencies the manufacturing organisations will be able to draw up demand schedules for their products” (ibid., p. 240), and they will offer a price for the goods used in the process of manufacture. Thus demand schedules can be established for the goods of higher order and for the ultimate factors of production. The available quantities of these factors being known, their market price is determined at the level that ensures full employment. The prices of primary factors being fixed, the cost of producing every goods can be calculated. On this basis, the supply of production goods can be defined by slowing down or stopping the production of those whose demand price does not cover the cost, and increasing the production of those whose demand price is higher than the cost. Moreover, Dickinson adds, “the various productive agencies will find it possible, on the basis of possible alternatives in methods of production, to substitute one factor for another, thus modifying their demand for such factors” (ibid., p. 241). Ultimately, “by a process of

7 Great Controversies

375

successive approximation”, a price for each factor will be established. Having described the process of reaching equilibrium, Dickinson writes that “It would be possible to deal with the problems mathematically [with a set of simultaneous equations], on the basis of the full statistical information” (ibid., p. 242). The final part of the paper is devoted to discussing two more things which are necessary to a complete costing system: “these are an allowance for time spent in production (interest or discount) and an allowance for risk (in the form of a surcharge above the normal rate of interest)” (ibid., p. 243). He describes how to calculate those which are considered “mere accounting terms” (ibid., p. 247) and emphasizes that “instead of inuring directly to individuals as personal income, they would be paid into a general fund [called the Social Fund] that would be at the disposal of the community” (ibid.) and used to finance investments and to produce social goods. Dickinson concludes, against Mises, that: there is, in theory, no ground for the assertion that a socialist community, lacking a free market for intermediate goods, would be unable to regulate production in accordance with the principles of scarcity and utility. In fact we may go so far as to say that only in a socialist community, where production can be carried on in the full light of statistical measurement and publicity, is it possible to realise the true principles of economic valuation. Capitalist society, with its deviations from equilibrium due to inequalities in individual income, to competition, to monopoly, and to the mutual ignorance of entrepreneurs concerning other entrepreneurs’ activities, is a very imperfect approximation to the economic ideal. (ibid.)

In the same year, 1933, the December issue of the same prestigious journal carried an article by the Cambridge socialist Maurice Dobb, entitled “Economic Theory and the Problems of a Socialist Economy”. Rather general in character, the paper sharply criticizes not only Mises but also those solutions, like Dickinson’s, which criticize Mises by maintaining that socialism and the price system can be combined and assumes free choice of goods and employment. The fact is that both Mises and Dickinson assume that the economic theory is as applicable in the socialist, as in the capitalist, society—i.e., they assume its universal applicability. In this regard Dobb mentions Robbins’s Essay where economic

376

R. Marchionatti

theory is defined in purely formalistic terms (see Chap. 3.2). According to Dobb, this is the logical conclusion of the abandonment of the old hedonistic basis of the theory of value. What is the implication of this? That no criterion of judgment at all exists, he answers. He writes: The more formal … that Economics is made, the more universal become its propositions; which might seem to imply that the equations of Cassel would have more application to a socialist economy than the more homely precepts of Adam Smith. But, in becoming more formal, such propositions have at the same time quite changed their significance. The theory of value, conceived simply as a theory of equilibrium, can postulate that, in a given set of circumstances, prices will conform to a certain pattern; in a different set of circumstances to a different pattern. It can say this, and it can say no more. It may define a “maximum” as consisting in one particular “pattern”; but the definition will be entirely arbitrary. It is powerless to pass judgment upon any particular arrangement of resources in the real world, and declare one arrangement to be preferable or more “economic” than another, for the reason that it has specifically excluded any assumption about the ends in view. It is powerless to prescribe a maximum for us. A reviewer in this Journal [he refers to Kaldor] recently complained that in a socialist economy the problem would be not that the planning authority “(would) not be able to reach a position of equilibrium, but that it (could) reach too many such positions—precisely an infinite number—and (have) no means of choice between them.” But this is precisely the dilemma of any pure equilibrium theory: it can give no means at all for preferring the “unique” equilibrium of an individualist economy to any of the n possible alternative equilibria that a planned economy might choose. Economic theory reduced to these dimensions provides absolutely no criterion of judgment at all. (Dobb 1933, p. 591)

However, in truth, Dobb continues, when it comes to such judgments, the equilibrium theorist tacitly appeals to a norm: Despite his trumpetings against the welfare-economists, he in fact secretly imports an assumption which at once places him precisely on the same ground as the Hedonist whom he has pretended to disown. And in this assumption the whole apparatus of Utility and Welfare, which it was his pride to dispense with, is implied. But the manœuvre has not been for

7 Great Controversies

377

nothing: it has enabled the scientific dignity of an ethical neutrality to be combined with an undiminished capacity to deliver judgments on practical affairs. The crucial assumption is as simple as it is questionable: it amounts to the sacredness of consumers’ preferences. (ibid., pp. 590–591)

However, Dobb continues, this “sacredness” is attacked by advertisers and the magnates of the Press: in the economic market, he maintains, there are no equal voting rights, but plural voting. In his view, the central dilemma is the following: Precisely because consumers are also producers, both “costs” and “needs” are precluded from receiving simultaneous expression in the same system of market valuations. Precisely to the extent that market valuations are rendered adequate in one direction they lose their significance in the other. Mr. Dickinson cannot have it both ways. (ibid., p. 592)

But, Dobb continues, “this is not the only reason why a price-system under socialism might still be far from constituting a ‘perfect’ ‘automatic’ regulator of economic affairs” (ibid.). In fact, If consumers’ choice under capitalism was so malleable by convention and seducible by the advertising agent, what right have we to assume that under socialism it will be supremely wise? If it was so corruptible then, why is it suddenly reliable now? (ibid.)

In conclusion, Dobb maintains that “economists and their analyses are likely to shed more obscurity than enlightenment” (ibid., p. 598): the problem raised by Mises, and consequently by market socialism economists, is not relevant in a planned economy, because planned economy and laissez-faire economy have different economic laws and different calculation systems. In subsequent papers—in particular those collected in On Economic Theory and Socialism (1955) as well as in Political Economy and Capitalism (1937)—Dobb will go beyond the mainly negative analysis of the 1933 paper and specifies his standpoint: the problem raised by Mises—this is essentially Dobb’s argument—concerns the efficient allocation of given resources, while planning, considered as

378

R. Marchionatti

a substitute for the market, is a powerful tool to increase resources, i.e., it is relevant for the issue of accumulation. Dobb’s thesis was strongly criticized by Abba Lerner in his paper “Economic Theory and Socialist Economy” published in the Review of Economic Studies in 1934. In support of Dickinson’s approach, Lerner draws an analogy with Marxist dialectic: Mises is thesis, Dobb is antithesis and Dickinson is synthesis. He maintains that “without the pricing system that Mr. Dickinson … [was] seeking to develop, it is impossible for an economic system of any complexity to function with any reasonable degree of efficiency” (Lerner 1934, p. 55). He considers Dobb’s arguments and illustrations to the contrary “erroneous or irrelevant” and emphasizes that “while starting out with the argument that pricing is not necessary”, Dobb “finds himself in the company of ‘Mises’ in dogmatic assertions of its impossibility” (ibid.). Moreover Lerner, in his argument in favor of market socialism, stresses the democratic character of the price system: Just as the bureaucracy tries to free itself from the direct democratic control of the masses whom it comes to despise, so it is anxious to be above and beyond the external control of a still more democratic pricing machine to which it would in certain respects be subservient. (ibid., p. 58)

In turn, Dobb briefly replied in 1935 in a paper entitled “Economic Theory and Socialist Economy”, in Review of Economic Studies, noting the “strangeness” of Lerner’s view that it makes no difference to the theory whether the consumer himself makes his choice or someone else does it for him, and comments that it will make no difference in a formal analysis, but that, in his view, it puts things on the “plane of abstraction” where all discussion becomes meaningless. In “A Rejoinder” in the Review of Economic Studies (Lerner 1935, p. 152), Lerner explains his disagreement with Dobb by emphasizing the issue of values, his point being that individuals ought to have maximum freedom in the conduct of their lives and this, he believes, can only be approached if there is a free market in consumers’ goods.

7 Great Controversies

379

The Climax of the Debate: Hayek Versus Lange and Lerner, 1935–1940 In the following years, the debate moved into a new fundamental phase, with the entry of Friedrich von Hayek and Oskar Lange, the latter supported by Abba Lerner, his classmate at the LSE at the end of 1920s. Thus began the most important part of the controversy.

Hayek’s New Austrian Attack Against Collectivist Economic Planning, 193513 In 1935 Hayek edited Collectivist Economic Planning (Hayek 1935), a book which—as Dobb (1935) recognized in his review in The Economic Journal—“constitute[s] a formidable counter-attack by laissez-faire on all forms of planning, and in particular on Socialism” (Dobb 1935, p. 532). The book included a forgotten 1902 paper by the Dutch economist Nicolaas Gerard Pierson (1839–1909), written in order to criticize the Marxist Karl Kautsky, and a paper by the German economist Georg Nikolaus Halm (1901–1984) summarizing the contemporary state of the debate in Germany. A translation of Barone’s (1908) “The Ministry of Production in the Collectivist State” and Mises’s (1920) article are printed in an appendix. But the book’s most significant contribution was Hayek’s introduction and above all his conclusion, entitled “The Present State of the Debate”, where he replies to socialists.14 In his introduction on “The Nature and History of the Problem”, Hayek offers a reconstruction of the debate until then. He notes that Pierson’s 1902 paper, which had remained practically unknown outside Holland, was the first important contribution to the modern discussion of the economic aspects of socialism, as it at last presented a general statement concerning the impracticability of socialism. Hayek also states that

13

See Caldwell (1997) for a survey of Hayek’s life-long contributions on socialism. It is worth mentioning that Lionel Robbins had anticipated many of Hayek’s comments one year before in Chapter seven of his The Great Depression (Robbins 1934), criticizing the American New Deal. This reveals that the place where these new Austrian positions developed was, not surprisingly, the LSE (see Chap. 3).

14

380

R. Marchionatti

Barone’s (1908) article on “The Ministry of Production in the Collectivist State” is of “considerable interest as an example of how it was thought that the tools of mathematical analysis of economic problems might be utilized to solve the tasks of the central planning authority” (Hayek 1935, p. 29). When with the end of the Great War socialist parties came into power in most of the states of Central and Eastern Europe, the discussion necessarily entered a new and decisive phase, Hayek writes, in which “the socialist literature of the years immediately following the War was for the first time largely concerned with the practical question how to organize production on socialist lines” (ibid.). Here, the most interesting, and representative, socialist contribution to the discussion was Neurath’s 1919 book which sparked Mises’s (1920) criticism. Hayek writes: The distinction of having first formulated the central problem of socialist economics in such a form as to make it impossible that it should ever again disappear from the discussion belongs to the Austrian economist Professor Ludwig von Mises. In an article on Economic Calculation in a Socialist Community, which appeared in the spring of 1920, he demonstrated that the possibility of rational calculation in our present economic system was based on the fact that prices expressed in money provided the essential condition which made such reckoning possible. The essential point where Professor Mises went far beyond anything done by his predecessors was the detailed demonstration that an economic use of the available resources was only possible if this pricing was applied not only to the final product but also to all the intermediate products and factors of production, and that no other process was conceivable which would take in the same way account of all the relevant facts as did the pricing process of the competitive market. A translation of this article is contained in the present volume … Professor Mises’ writings contain beyond doubt the most complete and successful exposition of what from then onwards became the central problem, and while they had by far the greatest influence on all further discussions. (ibid., pp. 32–33)

Hayek goes on to say that about the same time as Mises’s article two other authors arrived independently at very similar conclusions. The first was Max Weber (see note 4 in this chapter), while the second was

7 Great Controversies

381

the emigré Russian agricultural economist Boris Brutzkus (1874–1938), mainly known for his studies of agricultural problems in Russia. In a series of lectures which appeared under the title “The Problems of Social Economy under Socialism” in a Russian journal, Brutzkus’s main conclusion showed a “remarkable resemblance to the doctrine of Mises and Weber”, as his criticism centered round the impossibility of a rational calculation in a centrally directed economy, although he could not have known of the similar efforts of the Austrian and German scholars. But “it was the more complete and systematic exposition of Professor Mises … which has mainly influenced the trend of further discussion on the Continent” (Hayek 1935, p. 36). According to Hayek, in the subsequent discussion it became more and more clear that in so far as a strictly centrally directed planned system of the type originally proposed by most socialists was concerned, his central thesis [that socialism made rational calculation impossible] could not be refuted. (ibid.)

The reactions were, Hayek writes, of two types: on the one hand, from those who thought that the loss of efficiency, due to the absence of a means of rational calculation, would not be too high a price for the realization of a more just distribution of wealth, and, on the other hand, from those who considered Mises’s criticism “as valid only as regards the particular form of socialism against which it was mainly directed, and [tried] to construct other schemes that would be immune against that criticism” (ibid., p. 38). They are discussed in the last section of the book where Hayek examines the recent English literature on the subject and attempts “to evaluate the recent proposals which have been devised to overcome the difficulties which have now been recognized” (ibid., p. 203). Hayek admits that the analyses by Taylor and Dickinson15 show that a planned economy is possible, but adds that to argue that a determination of prices by such a procedure being logically conceivable in any way invalidates the contention that it is not a possible 15 Hayek also cites W. Crosby Roper Jr’s The Problem of Pricing in a Socialist State (1931), but this book is simply a summary of the debate until then.

382

R. Marchionatti

solution, only proves that the real nature of the problem has not been perceived. (ibid., pp. 207–208)

In fact, he continues, it is only necessary to attempt to visualize what the application of this method would imply in practice in order to rule it out as humanly impracticable and impossible. It is clear that any such solution would have to be based on the solution of some such system of equations as that developed in Barone’s article ... But what is practically relevant here is not the formal structure of this system, but the nature and amount of concrete information required if a numerical solution is to be attempted and the magnitude of the task which this numerical solution must involve in any modern community. (ibid., p. 208)

It is obvious, Hayek adds, that the mere statistical task of enumeration “exceeds anything of this sort hitherto undertaken” (ibid., pp. 209–210). But there is a problem of greater importance, Hayek writes: The usual theoretical abstractions used in the explanation of equilibrium in a competitive system include the assumption that a certain range of technical knowledge is “given”. This, of course, does not mean that all the best technical knowledge is concentrated anywhere in a single head, but that people with all kinds of knowledge will be available and that among those competing in a particular job, speaking broadly, those that make the most appropriate use of the technical knowledge will succeed. In a centrally planned society this selection of the most appropriate among the known technical methods will only be possible if all this knowledge can be used in the calculations of the central authority. This means in practice that this knowledge will have to be concentrated in the heads of one or at best a very few people who actually formulate the equations to be worked out. It is hardly necessary to emphasize that this is an absurd idea even in so far as that knowledge is concerned which can properly be said to “exist” at any moment of time. But much of the knowledge that is actually utilized is by no means “in existence” in this ready-made form. Most of it consists in a technique of thought which enables the individual engineer to find new solutions rapidly as soon as he is confronted with new constellations of circumstances. To assume the practicability of these

7 Great Controversies

383

mathematical solutions, we should have to assume that the concentration of knowledge at the central authority would also include a capacity to discover any improvement of detail of this sort. (ibid., pp. 210–211)

Then there is, Hayek adds, another set of data which would have to be available, relative to importance of the different kinds of consumers’ goods. It is probably evident, Hayek comments, that “the mere assembly of these data is a task beyond human capacity” (ibid., p. 211), but “if the centrally run society were to work as efficiently as the competitive society, which as it were decentralizes the task of collecting them, they would have to be present” (ibid.). However, Hayek continues, let us assume for the moment that this “statistical” difficulty is overcome. This would be only the first step in the solution. The second step consists of working out the decisions which this task implies. This is an operation whose magnitude depends on the number of unknowns to be determined. The number of simultaneous differential equations needed for the solution poses a task, Hayek maintains, “which, with any of the means known at present, could not be carried out in a lifetime” (ibid., p. 212). These difficulties have induced many socialists, like Dickinson, to seek for a solution introducing competition in a socialist state. Hayek considers these plans “interesting”, noting that they confine planning “to the provision of a permanent framework within which concrete action would be left to individual initiative” (ibid., pp. 218–219), the direction of economic activity being left to competition. Summarizing this proposal, he writes: The common fundamental idea is that there should be markets and competition between independent entrepreneurs or managers of individual firms, and that in consequence there should be money prices, as in the present society, for all goods, … but that these entrepreneurs should not be owners of the means of production used by them but simply salaried officials of the State, acting under State instructions and producing, not for profit, but so as to be able to sell at prices which will just cover costs. (ibid., p. 218)

The main question “is … whether decisions and responsibility can be successfully left to competing individuals who are not owners” (ibid.,

384

R. Marchionatti

p. 219), or, in other words, whether real competition under socialism is possible. First, Hayek maintains that in this system “the need for some central economic authority will not greatly diminish” (ibid., p. 232). In fact, if the community is the owner of the resources of production, “somebody will have to exercise this right for it, at least in so far as the distribution and the control of the use of these resources is concerned” (ibid.) So the question becomes: “on what principles will it act?” (ibid., p. 233). According to Hayek: It will at best be a system of quasi-competition where the person really responsible will not be the entrepreneur but the official who approves his decisions and where in consequence all the difficulties will arise in connection with freedom of initiative and the assessment of responsibility which are usually associated with bureaucracy. (ibid., p. 237)

Thus, Hayek claims that he has shown that a successful administration presents obstacles and difficulties “which must be surmounted before we can believe that its results will even approach those of competition which is based on private property of the means of production” (ibid.). In their present state, Hayek thinks that “these proposals seem rather more than less impracticable than the older socialist proposals of a centrally planned economic system” (ibid., p. 238). The absence of private property, Hayek continues, necessarily involves a restriction of the competition and that some decisions have to be left to the arbitrary decision of a central authority, with a loss of efficiency: “what are the advantages which will remain to compensate for the loss of efficiency”? (ibid.). He concludes: One thing … seems to emerge from the discussions of the last years with incontrovertible force: that to-day we are not intellectually equipped to improve the working of our economic system by “planning” or to solve the problem of socialist production in any other way without very considerably impairing productivity. What is lacking is not “experience” but intellectual mastery of a problem which so far we have only learnt to formulate but not to answer. (ibid., pp. 241–242)

7 Great Controversies

385

Lange’s Counter-Attack in Defense of Collectivist Economic Planning, 1936–1937 In 1938, the Austrian Mises-Hayek position was attacked by the Polish (and later naturalized American) socialist economist Oskar Lange, who reformulated Barone’s argument in a paper entitled “On the Economic Theory of Socialism”, published in two parts in the Review of Economic Studies in 1936–1937, and then as a book entitled Economic Theory of Socialism (1938). This paper is rightly considered “the most coherent and articulate case for market socialism” (Shleifer and Vishny 1994, p. 165).16 Lange recognizes that Mises formulated the problem of socialist calculation clearly, but, he maintains, his “contention that a socialist economy cannot solve the problem of rational allocation of its resources is based on a confusion concerning the nature of prices” (Lange 1936a, p. 54). Referring to Wicksteed’s Common Sense, Lange notes that the term price has two meanings: the exchange ratio of two commodities on a market, and the terms on which alternatives are offered. It is in this second “generalized” meaning that prices “are indispensable to solve the problem of allocation of resources” (ibid.). The economic problem, Lange emphasizes, is a problem of allocation of resources, a problem solved when three data are given: preferences, knowledge of the terms on which alternatives are offered, and knowledge of the amount of resources available. While we can consider preferences and knowledge of resources available as given, the question remains whether the data relating to knowledge of the terms on which alternatives are offered are available to the administrators of a socialist economy. Lange answers in the affirmative: they “are determined … by the production functions” (ibid., p. 55). Thus “Professor Mises’s denial of the possibility of economic calculation in a socialist system must be rejected” (ibid.). As regards Hayek’s and Robbins’s “more 16

As Schumpeter notes, in the formulation of his theory of the socialist market, Lange (together with Lerner) is the representative of a phenomenon that had developed since the 1920s, viz. that “the scientifically trained socialist is no longer a Marxist except in matters of economic sociology” (Schumpeter 1954, p. 884). He adds that Lange made the position in question very clear in his paper on “Marxian Economics and Modern Economic Theory” published in the Review of Economic Studies (Lange 1935).

386

R. Marchionatti

refined” argument—“a significant step forward in the discussion of the problem” (ibid., p. 56)—which does not deny the theoretical possibility of a rational allocation of resources in a socialist economy, Lange maintains that in this “second line of defence” (ibid., p. 56) the problem is whether a solution is possible in practice. In this connection, Lange writes, “already Barone has pointed to the fact that the equations of economic equilibrium must be solved also in a socialist society by trial and error” (ibid.), but he “failed to indicate how it would be done” (ibid.) in a socialist society. Taylor (1929) had already indicated the solution, but the importance of Hayek’s and Robbins’s argument “necessitates a more detailed investigation”, which is the purpose of Lange’s paper. Lange first deals with the determination of equilibrium on a competitive market along Walrasian lines: the problem is solved by trial and error with the equilibrium value of prices determined by a series of successive trials, or tâtonnements in Walras’s terminology. Lange himself recognizes that this is a “textbook exposition” of the theory of general economic equilibrium, but considers it necessary. He then applies this trial and error procedure in a socialist economy. Lange assumes that there is a free market for both consumer goods and labor, and public ownership of the means of production. The determination of equilibrium consists of two parts: (a) the decisions made by consumers, workers and managers (assumed to be public officials) on the basis of given indices of alternatives (market prices in the case of consumers’ goods and of the labor services and accounting prices), i.e., “the subjective … equilibrium conditions” (ibid., p. 61), and (b) the condition of the equality of the quantities demanded and supplied of each commodity, i.e., “the objective equilibrium conditions” (ibid.). As regards the subjective equilibrium conditions, Lange notes that “the subjective equilibrium conditions of a competitive market apply also to the market of consumers’ goods in a socialist economy” (ibid., p. 62), and “the decisions of the managers of production are no longer guided by the aim to maximise profit” (ibid.), but “there are certain rules [minimization of the average cost of production and equalization of price and average cost of production] imposed on them by the Central Planning Board which aim at satisfying consumers’ preferences in the best way possible” (ibid.). The subjective equilibrium conditions required given

7 Great Controversies

387

prices determined by a Central Planning Board. They can be determined objectively, Lange writes, “if the parametric function of prices is retained” (ibid., p. 63): On a competitive market the parametric function of prices results from the number of competing individuals … In a socialist economy … the managers certainly can and do influence prices by their decisions. Therefore, the parametric function of prices must be imposed on them by the Central Planning Board as an accounting rule … Once the parametric function of prices is adopted as an accounting rule, the price structure is established by the objective equilibrium conditions … The technique of attaining this end is very simple: the Central Planning Board has to fix prices and see to it that all managers of plants, industries, and resources do their accounting on the basis of the prices fixed by the Central Planning Board, and not tolerate any use of other accounting. Once the parametric function of prices is adopted as an accounting rule, the price structure is established by the objective equilibrium conditions. For each set of prices and consumers’ incomes a definite amount of each commodity is supplied and demanded … Any price different from the equilibrium price would show at the end of the accounting period a surplus or a shortage of the commodity in question. Thus the accounting prices in a socialist economy, far from being arbitrary, have quite the same objective character as the market prices in a regime of competition”. (ibid.)

Lange comments that his study of the determination of equilibrium prices in a socialist economy has shown that the process of price determination is quite analogous to that in a competitive market: The Central Planning Board performs the functions of the market. It establishes the rules for combining factors of production and choosing the scale of output of a plant, for determining the output of an industry, for the allocation of resources, and for the parametric use of prices in accounting. Finally, it fixes the prices so as to balance the quantity supplied and demanded of each commodity. It follows that a substitution of planning for the functions of the market is quite possible and workable. (ibid., p. 64)

388

R. Marchionatti

After establishing the equivalence between market and socialist resource allocation, in Part II of the paper, published in 1937, Lange went on to present several reasons why market socialism is superior to the market system. First, there is a more equitable income distribution. Second, since the state controls all firms, it can solve the problem of externalities. Third, since the state sets prices and determines entry, it can avoid monopolies, which present more disadvantages: excessive and rigid prices, economic rents and low rate of innovation.

Lerner’s Contribution in Support of Lange and Dickinson, 1936–1938 Lange was joined in the debate on socialist calculation by Abba Lerner, who contributed with several papers on the allocative efficiency of socialism (Lerner 1936, 1937, 1938). In this work, as Scitovsky writes, he “confined himself to reviewing and criticizing the contributions of others, correcting their mistakes, amending their proposals, and standing up for consumers’ freedom of choice” (Scitovsky 1984, p. 1551). However, he drove home several important points, the most important being to clarify that the necessary condition of perfect competition—to be considered not an end, Lerner (1936) emphasizes, but the means to reach the end of efficient resources allocation—is price = marginal cost. While pursuing the same purpose as Dickinson and Lange, Lerner thinks that they looked at the problem from the wrong end of the stick. In his article “Statics and dynamics in socialist economics” (Lerner 1937) he begins: This article is in the main a protest against the developing tradition, in approaching the problems of socialist economics, of starting from the consideration of general equilibrium, instead of going direct to the more fundamental principle of marginal opportunity cost. (Lerner 1937, p. 253)

“We shall have completely achieved the ideal that the economic calculus of a socialist state sets before itself ” (ibid.), Lerner writes, “If we so order the economic activity of the society that no commodity is produced

7 Great Controversies

389

unless its importance is greater than that of the alternative that is sacrificed” (ibid.). How can this be achieved? In a long-run equilibrium of perfect competition, he stresses, price (or average revenue), marginal revenue, average total cost and marginal cost all tend to equal one another, but of the equalities between those variables price = marginal cost is the necessary and sufficient condition of optimal resource allocation, the other being merely the consequences of everybody’s behavior being optimal. As he writes, “there is no second general principle. Price must be made equal to marginal cost. This is the contribution that pure economic theory has to make to the building up of a socialist economy” (1937, p. 270). Lerner’s contributions to the subject were restated and expanded in his 1944 book, The Economics of Control. Principles of Welfare Economics (see Chap. 3.5).

Answering Lange and Dickinson: Hayek’s Criticism of the Competitive Solution, 1940 Hayek replied to Lange in an article entitled “Socialist Calculation: The Competitive Solution” published in 1940 in the LSE journal Economica. It was a review of two books, the first containing a reprint of Lange’s paper originally published in I936 and I937, together with Taylor’s paper published in 1928, the second being a book on the economics of socialism by Dickinson, substantially an enlarged re-proposal of his 1933 paper. Hayek specifies that when he edited his 1935 book there was “no systematic exposition of the theoretical bases of competitive socialism … available” (Hayek 1940, p. 128), but “this gap has now been filled by the two books” (ibid.). Hayek discusses the planning procedures proposed by the two economists, i.e., the simulation of the functioning of the market in an economy controlled by a central planning board using the Walrasian tâtonnement process. Apart from the usual objection that such a procedure raises problems of calculation capacity, Hayek raises another objection, viz. that the Lange-Dickinson proposal “has been born out of an excessive pre-occupation with problems of the pure theory of stationary equilibrium” (ibid., p. 132). The point is that:

390

R. Marchionatti

If in the real world we had to deal with approximately constant data, that is, if the problem were, to find a price system which then could be left more or less unchanged for long periods, then the proposal under consideration would not be so entirely unreasonable. With given and constant data such a state of equilibrium could indeed be approached by the method of trial and error. (ibid.)

But, Hayek adds, “this is far from being the situation in the real world, where constant change is the rule” (ibid.). “The practical problem”, Hajek continues, “is not whether a particular method would eventually lead to a hypothetical equilibrium, but which method will secure the more rapid and complete adjustment to the daily changing conditions in different places and different industries” (ibid., pp.131–132). According to him, it is difficult to believe that “the method where the prices are decreed from above” can be considered superior to the market price system. The flexibility the market affords in the process of adaptation to new conditions represents a clear advantage of competition over central planning, Hayek maintains, while the cost minimization issue is another case of market superiority: The force which in a competitive society brings about the reduction of price to the lowest cost at which the quantity saleable at that cost can be produced is the opportunity for anybody who knows a cheaper method to come in at his own risk and to attract customers by underbidding the other producers. But, if prices are fixed by the authority this method is excluded. (ibid., p. 139)

Then Hayek refers to his seminal piece “Economics and Knowledge” (1937) which has obvious implications for the calculation debate: As I have tried to show on another occasion, it is the main merit of real competition that through it use is made of knowledge divided between many persons which, if it were to be used in a centrally directed economy, would have all to enter the single plan. To assume that all this knowledge would be automatically in the possession of the planning authority seems to me to be to miss the main point. (ibid., p. 144)

7 Great Controversies

391

In conclusion, Hayek’s main point was that Lange’s solutions to the socialist calculation critique presupposed that knowledge was available to the socialist manager that could be discovered only in the marketplace.

After the Debate After Hayek’s intervention, the controversy, as such, came to an end. Some of the participants brought up the same issues in the following decades, but without carrying the debate into a new phase. Hayek dealt with it in his new construction of how the market works (see in particular his Princeton lecture “The meaning of competition” [Hayek 1946]). Mises reaffirmed his position in his Human Action (Mises 1949), his American work. As for Lange, we should mention an article of many years later, “The Computer and the Market” (Lange 1967), where he came back to his reply to Hayek and the other critics in a way that may seem effective but in fact is a bit rough and inconclusive: Were I to rewrite my essay today my task would be much simpler. My answer to Hayek and Robbins would be: so what’s the trouble? Let us put the simultaneous equations on an electronic computer and we shall obtain the solution in less than a second. The market process with its cumbersome tâtonnements appears old-fashioned. (Lange 1967, p.158).

7.3

The Keynes–Tinbergen Controversy on Econometric Method17

Prologue Tinbergen’s report for the League of Nations, Statistical Testing of Business-Cycle Theories (Tinbergen 1939a) made a fundamental contribution to contemporary statistical and econometric research on the business

17 The chapter is partly based on Garrone and Marchionatti (2007) and Garrone and Marchionatti (2009).

392

R. Marchionatti

cycle in the context of the radical change in the theoretical and methodological approach to economics in the 1930s. The work was expected both to provide general economic forecasts and to guide government policies for controlling business cycles (Epstein 1987; Hallett 1989; Morgan 1990; on Tinbergen’s contribution see Chap. 5.3 of this book). The first volume of the report contained an explanation of the method of econometric testing. Tinbergen presented it as a synthesis of statistical business cycle research and quantitative economic theory, in the spirit of Econometrica’s program. Tinbergen outlined the technical method of multiple correlation analysis by applying it to an economic business cycle theory translated into a parametrized mathematical-economic model. He then tested for the plausibility of the parameter estimates. Lastly, he checked the outcomes generated by the system as a whole to see whether or not the theory provides a business cycle mechanism. The first volume was followed by a second, entitled Business Cycles in the United States of America, 1919–1932 (Tinbergen 1939b), where Tinbergen applied his method to annual data for the United States and endeavored to construct an economic model of the economic system taking into account all the important factors influencing US business cycles after World War I. Tinbergen’s work immediately raised a lively debate, known as “the Tinbergen debate”, which involved Keynes, Frisch and others (see Leeson 1998; Louçã 1999).18 Keynes was one of the economists who expressed 18

Keynes’s critique of Tinbergen’s first League of Nations study is considered to have sparked the debate about the role of econometrics (Hendry and Morgan 1995). Keynes’s criticism remains controversial, but the long-prevailing view is that Keynes was an a priori anti-econometrician. Samuelson (1946) maintained that he was technically incompetent. Klein (1951, p. 450) called his review “one of his sorriest professional performances”. Stone (1978) maintained that Keynes had little or no awareness of the econometric literature. He wrote that his review was “a model of testiness and perverseness” (Stone 1978, p. 61), largely because of his temperament.Since the end of the 1970s, the relevance of Keynes’s criticism has been acknowledged. It was Patinkin (1976) who first found it “somewhat depressing to see how many of [Keynes’s criticisms of the use of correlation analysis to estimate equations] are, in practice, still of relevance today” (Patinkin 1976, p. 1095). Hendry (1980, p. 396) wrote that “[Keynes’s] objections make an excellent list of what might be called problems of the linear regression model”. Pesaran and Smith (1985) and Rowley (1988) went beyond the simple consideration of technical issues. The former scholars recognized that Keynes was right on both the technical and logical arguments: on the technical level, “the problems that Keynes raised were real, despite his occasional technical confusion” (Pesaran and Smith 1985, p. 144). At a logical level, “econometric inference … is insupportable” (ibid., p. 147). Rowley (1988, p. 25) maintained that “Keynes’ criticisms have been diluted, forgotten or mis-stated rather than absorbed into the prevalent

7 Great Controversies

393

doubts and objected to this new approach. In the years 1939–1941, Keynes was at the center of a harsh debate on method with Jan Tinbergen and other leading figures of the emerging field of econometrics which illustrates how Keynes and the “new economists” differed in their views of the nature and methods of economics. The Keynes-Tinbergen debate went through two different phases. The first took place in the short period between August and September 1938.19 It was semi-private in character, and took the form of an exchange of letters between Keynes, Tinbergen and other economists and League of Nations officers, where Keynes expressed the critical feeling that the work was methodologically weak. The second phase took place between September 1939 and March 1940 and was marked by Keynes’s review of the first volume of Tinbergen’s book, which was “limited to an explanation of the statistical method which it is proposed to employ” (Keynes 1973c [1939], p. 306), published in the September issue of the Economic Journal , and by Tinbergen’s reply. Tinbergen dealt at length with Keynes’s “serious” questions in the March 1940 issue of the Economic Journal .20 In his “Comment” (Keynes 1973c [1939]) Keynes judged Tinbergen’s reply to be “very valuable’” but not adequate to answer his questions persuasively. Nevertheless, he declared (no doubt a bit ironically) that he was in favor of the continuation of Tinbergen’s type of research: “Newton, Boyle and Locke all played with alchemy. So let him continue” (ibid. p. 320). orthodoxy”. He regretted that “we have waited too long for econometric methodology to come of age and address its logical bases” (ibid., p. 30). Actually, it is in this wider context that Keynes has been considered in the 1990s. McAleer (1994, p. 332) writes that some of Keynes’s criticisms of Tinbergen’s econometric methodology “remain relevant to this day” and that his implicit research program “subsequently led to the development of numerous econometric techniques that are now widely used in applied econometrics” (ibid., p. 334) (see also Dharmapala and McAleer 1996). Similarly, Keuzenkamp (2000) maintains that Keynes’s skeptical attitude remains substantially justified. Summing up, it is now recognized that Keynes’s criticism of Tinbergen was sound in many points. However, it is considered overly harsh and Keynes is blamed for throwing the baby out with the bath water. 19 Keynes received a proof copy of Tinbergen’s book from the American economist and diplomat Royall Tyler (1884–1953), expert in the Economic and Financial Section of the League of Nations in Geneva, in order that he might comment on it. 20 In the same year, at the invitation of the editors of the Review of Economic Studies, Tinbergen also wrote a paper “to go into some more detail concerning the method” of analysis (Tinbergen 1940b). It offers a restatement of the method and integrates Tinbergen’s reply to Keynes. In particular, Tinbergen emphasizes his method’s flexibility.

394

R. Marchionatti

Keynes’s Criticism Keynes began by stating the central question: the “question of methodology” in general—that is, as he wrote in a letter of August 1938 to Royall Tyler, “the logic of applying the method of multiple correlation to unanalysed economic material, which we know to be non–homogeneous through time” (Keynes 1973c, p. 285). The logical condition for using the method of multiple correlation, Keynes wrote, is the existence of “numerically measurable, independent forces, adequately analysed”— that is, “independent atomic factors and between them completely comprehensive, acting with fluctuating relative strength on material constant and homogeneous through time”. However, Keynes continued, “we know that every one of these conditions is far from being satisfied by the economic material under investigation”. Hence “how far does this impair the validity of the method? That seems to me to deserve a most careful preliminary enquiry” (ibid.). Unfortunately, Keynes writes, in his review, Tinbergen’s discussion appeared “grievously disappointing” because “it leaves unanswered many questions which the economist is bound to ask before he can feel comfortable as to the conditions which the economic material has to satisfy, if the proposed method is to be properly applicable” (Keynes 1973c, p. 306). Keynes then raised a set of detailed questions about the conditions of validity of Tinbergen’s procedures.21 , 22 The first condition Keynes enunciated was the completeness of significant causes. Keynes asked: “is it assumed that the factors investigated are comprehensive and that they are not merely a partial selection out of all the factors at work?” (ibid., pp. 286–287). If they are not all included, the estimated coefficients suffer from what today we call omitted variable bias. Only if they are included, and if “the economist has correctly analysed beforehand the qualitative character of the causal relations” (ibid., p. 307), can he then examine their quantitative importance, 21

On some points Keynes’s critique shows his limited knowledge of the developments of the econometric literature in the previous two decades (despite the fact that Keynes had been on the editorial board of Econometrica since 1933) and a few misunderstandings of technical issues. This fact is well known and widely emphasized (see, e.g., Hendry and Morgan 1995). 22 Keynes also cites the inadequacy of statistics—an “obvious” difficulty: “These many doubts are superimposed on the frightful inadequacy of most of the statistics employed, a difficulty so obvious and so inevitable that it is scarcely worthwhile to dwell on it” (Keynes 1973c, p. 317).

7 Great Controversies

395

i.e., how strongly each of them operates. For Keynes this is the primary role of econometrics. It is quite different from affirming, as Tinbergen did, that the statistical test can prove a theory to be incorrect, or incomplete—that is, can falsify a theory—by showing that it does not cover a particular set of facts.23 In addition, Keynes raised the related problem of testing theories when different econometric specifications can be derived from a theory. The second condition is that all the significant factors be measurable. Keynes wondered what place was left for expectations, for the state of confidence relating to the future and for non-numerical factors, such as inventions, politics, labor troubles, wars and financial crises, and suspected that the choice of factors is influenced by the availability of statistics. The third issue was the independence of factors. First, Keynes raised the problem of spurious correlation: “If we are using factors which are not wholly independent, we lay ourselves open to the … complications of ‘spurious’ correlation”—a term introduced by the statistician Karl Pearson in a discussion of correlation between indices. Then he drew attention to the problem of simultaneity: What happens if the phenomenon under investigation itself reacts on the factors by which we are explaining it? … When he investigates the fluctuations of investment, Professor Tinbergen makes them depend on the fluctuations of profit. But what happens if the fluctuations of profit partly depend (as, indeed, they clearly do) on the fluctuations of investments? Professor Tinbergen mentions the difficulty in a general way in a footnote … where he says ... that “one has to be careful”. But is he? ,.. In practice Professor Tinbergen seems to be entirely indifferent whether or not his basic factors are independent of one another’ (ibid., pp. 309–310).

Then Keynes raised two questions of technical importance concerning the functional forms, the time lags and trends. First, Keynes maintained the implausibility of the widespread assumption of linearity and called for the examination of alternative functional forms. Regarding the 23 The question of whether testing can prove a theory to be correct is not controversial. Both Keynes and Tinbergen agree that testing cannot prove the correctness of a theory, whatsoever amount of empirical evidence is available. As noted in Keuzenkamp (1995), the idea that scientists cannot prove a theory but may be able to falsify it was “a common sense notion in the statistical literature since (at least) the turn of this century” (Keuzenkamp 1995, p. 240).

396

R. Marchionatti

general problem of dynamic specification, Keynes accused Tinbergen of scarce rigor in treating time lags and trends in an ad hoc manner by choosing them by trial and error: Professor Tinbergen ... invents them [time lags] for himself. This he seems to do by some sort of trial-and-error method. That is to say, he fidgets about until he finds a time lag which does not fit in too badly with the theory he is testing and with the general presuppositions of his method …The introduction of a trend factor is even more tricky and even less discussed ... In the case of fluctuations in investment, “trends”, Professor Tinbergen explains, “have been calculated as nine-year moving averages for pre-war periods … and as rectilinear trends for post-war periods. (ibid., p. 315)

This seemed to Keynes inaccurate and arbitrary. In other words, Keynes questioned the manipulation of data to “make [it] possible to fit any explanation to any facts” (ibid., p. 311). In conclusion, Keynes went back to what he considered the critical condition, viz. that the likely structural instability calls the constancy of the parameters into question24 : “the coefficients arrived at are apparently assumed to be constant for 10 years or for a larger period. Yet, surely we know that they are not constant” (ibid., p.286). This issue is directly connected with the problem of inductive generalization, i.e., the inductive and predictive value of the estimates, or the relevance of the estimated model to the future. Referring to his Treatise on Probability (Keynes 1973a [1921]), Keynes recalled that “thirty years ago I used to be occupied in examining the slippery problem of passing from statistical

24

Pesaran and Smith (1985) re-estimated some of Tinbergen’s relations by the OLS method using the original undetrended series. (Their purpose was to examine the effect of de-trending on Tinbergen’s results.) They found that “the un-detrended OLS results suffer from a significant degree of residual autocorrelation which sheds considerable doubt on the size and the statistical significance of the estimated regression coefficients … The method of de-trending employed by Tinbergen can, and often does, deal with the problem of residual autocorrelation. But … its application can also introduce erroneous dynamics into the relation and its residuals” (Pesaran and Smith 1985, pp. 141–142). The presence of residual autocorrelation can be due to the factors stressed by Keynes: omitted variables, functional form misspecification, structural change and a host of other factors “all of which are highlighted in Keynes’s review” (p. 143).

7 Great Controversies

397

description to inductive generalisation in the case of simple correlation”, and felt that there had been little improvement since then. Keynes asks: How far are these curves and equations meant to be no more than a piece of historical curve-fitting and description, and how far do they make inductive claims with reference to the future as well as the past? ... Put broadly, the most important condition is that the environment in all relevant respects ... should be uniform and homogeneous over a period of time. We cannot be sure that such conditions will persist in the future, even if we find them in the past. But if we find them in the past, we have at any rate some basis for an inductive argument. (Keynes 1973c, pp. 315–316)

Keynes maintained that Tinbergen made “the least possible preparation for the inductive transition” (ibid., p. 316). The period under examination should have been broken up into a series of sub-periods, “with a view to discovering whether the results of applying our method to the various sub-periods taken separately are reasonably uniform” (ibid.). If this is the case, then “we have some ground for projecting our results into the future” (ibid.). Tinbergen failed to follow this procedure: For his pre-war investigations he takes a period of about forty years and makes no attempt to break it up into sub-periods. If he had done so, would his regression coefficients, calculated for each decade taken separately, differ somewhat widely from those calculated as the best fit for the whole period? This is worth examination. For the main prima facie objection to the application of the method of multiple correlation to complex economic problems lies in the apparent lack of any adequate degree of uniformity in the environment. (ibid., pp. 316–317)

The chief dilemma Tinbergen was facing was, Keynes mantained, “that the method requires not too short a series, whereas it is only in a short series, in most cases, that there is a reasonable expectation that the coefficients will be fairly constant” (Keynes 1973b, p. 294): this is, and will be, the leitmotif of Keynes’s criticism. Actually:

398

R. Marchionatti

the broad problem of the credit cycle is just about the worst case to select to which to apply the method, owing to its complexity, its variability, and the fact [that] there are such important influences which cannot be reduced to statistical form. (ibid., pp. 294–295, emphasis added)

This does not mean, Keynes added, that “there may not be problems within the general field of the trade cycle which would provide suitable material” (ibid.). However, “surely there is no general presumption that any enquiry one might fix on will be suitable. The presumption is to the contrary” (ibid.). According to Keynes, “the method will prove valuable” when applied to more elementary cases “where adequate statistics exist” (ibid.). Keynes’s conclusion was that Tinbergen needed to demonstrate that his method was applicable, rather than simply applying it. For, when applied inappropriately, the method could result in “a false precision”, beyond “what either the method or the statistics actually available can support” (Keynes 1973c, p. 289).

Tinbergen’s Reply The core of Keynes’s discussion was the issue of the logical conditions for applying the method of multiple correlation—that is, a problem that precedes its application, and to which the technical questions were subordinate. By contrast, Tinbergen’s reply avoided as much as possible the logical question and the “slippery problem of passing from statistical description to inductive generalisation”, and stressed—with many illustrations of his approach in business cycle research—the flexibility of his empirical method, leaving Keynes’s central objection substantially unanswered. Tinbergen was truly astonished at Keynes’s reaction and politely rejected it. However, he did not offer any systematic technical methodology for dealing with the problems under discussion, although he seemed to anticipate some contemporary advances (see Dharmapala and McAleer 1996; McAleer 1994). Regarding the need for a complete list of the relevant factors—i.e., for a correct specification—Tinbergen assumed that “the factors included are comprehensive as far as the more important are concerned ” (Tinbergen 1940a, p. 142, emphasis added). He added that “it does not matter if

7 Great Controversies

399

non-relevant factors have been forgotten”, because “what factors are relevant and what are not will not always be clear beforehand. It must then be tried out” (ibid.). In other words, he maintained that a correct specification is subject to statistical testing. What is important, according to Tinbergen, is that some conditions (drastic restrictions, as a matter of fact) be met: (a) that the explanatory variables chosen are the relevant ones; (b) that the non-relevant explanatory variables can be treated as random residuals, not systematically correlated with the other explanatory variables (“this may be tested afterwards—e.g. by calculating the serial correlation for the residuals and the bunch maps”); and (c) that “the mathematical form of the relation is given” (ibid., p. 141). As regards expectations and the state of confidence, Tinbergen thought expectations are “products of the human mind which are based on past experience, even though they relate to future moments” (ibid., p. 147). They are “hidden” in some systematic variables such as profits. He did not deny that “external events” may also influence expectations. However, he thought that “these external events will be, as a rule, of an unsystematic character, and may thus be part of unexplained residuals” (ibid.). As for the question of whether the explanatory variables should be independent of each other, Tinbergen distinguished between the statistical and the economic meaning of the word independent, arguing that, for statistical purposes, explanatory factors needed to be uncorrelated rather than independent in an economic sense. Regarding the constancy of the coefficients, he explained that it was assumed as a first approximation. As to lags and trends, he admitted that “they are sometimes assumed by common-sense guessing” and that “in principle both [lags and regression coefficients] have been determined so as to make the correlation the highest possible and by only admitting such values as seemed to have economic sense” (ibid. p. 150, emphasis in the original). As regards Keynes’s observation that it was arbitrary to use nine-year moving averages as trends in pre-war periods and straight lines in postwar years, and that a manipulation makes it possible to fit any explanation to any facts, Tinbergen answered with arguments in favor of examining linear models:

400

R. Marchionatti

for short periods there is not much difference between a straight trend and a moving average. For long periods there is, and then the moving average is decidedly better ... The advantage of straight-line trends is that no observations are lost in the extremes. This is why they have been preferred for the (short) post war-period. (ibid., p. 251)

Lastly, regarding the crucial question of inductive generalization, Tinbergen maintained that “If there is no reason to suppose that the laws that have governed the reactions of individuals and firms in the past will have changed in the near future”, it seems possible, Tinbergen writes, “to reach conclusions for the near future by measuring as exactly as possible those same reactions in the past” (ibid. p. 152). Of course, he added, “this is only true if no structural changes take place” (ibid.). However, he concluded, “even if [structural changes] take place, it will, in many cases, be possible to ‘localise’ their influence—i.e., to indicate which of the elementary or direct causal relations they affect” (ibid., emphasis in the original). On the whole, Tinbergen rejected Keynes’s pessimistic view not because he considered his criticism irrelevant, but because in his opinion “the method under discussion promises—and actually yields— much more than Mr. Keynes thinks”. Mainly interested in getting on with the job, he concluded: “The proof of the pudding is in the eating” (ibid, p. 154).

An Appendix to the Debate: Rothbarth’s Review of Tinbergen’s Second Volume A review of the second volume of Statistical Testing of Business-Cycle Theories, published in the June–September 1941 issue of the Economic Journal , sheds further light on Keynes’s real attitude toward statisticaleconometric work. Kalecki called the review “a model of careful econometric analysis” (Kalecki 1944–1945, p. 121). The author was Erwin Rothbarth (see Chap. 2.4), who had already reviewed Tinbergen’s An Econometric Approach to Business Cycle Problems (Rothbarth 1938). His highly competent discussion of Tinbergen’s analysis of the Dutch economy was preceded by the acknowledgment of the “unassailable” case for the econometric method, “forced on the economist” by the fact that

7 Great Controversies

401

“the system as a whole acquires a certain measure of stability by the interactions of a fairly large number of not very stable relationships” and by the need “to be able to exclude some possibilities at least on empirical grounds”. However, Rothbarth expressed caution as regards how far the econometric approach could go: “the advance of this branch of economics seems to be bound up with the advance realised in the theory of time series” (Rothbarth 1938, p. 489). Rothbarth considered Volume two of Tinbergen’s study a “brilliant pioneering effort” (Rothbarth 1941, p. 293). Again, before discussing Tinbergen’s results, Rothbarth emphasized the relevance of his attempt to demonstrate that it is possible to construct a mathematical model of the trade cycle which is sufficiently simple to be tested statistically and a sufficiently good approximation to reality to be useful. Such relevance, Rothbarth wrote, is “independent of the question whether Professor Tinbergen succeeds in explaining the trade cycle in the U.S.A. In my view he fails, but his failure is almost insignificant beside the great merit of the attempt” (ibid., p. 294). In fact, Rothbarth analyzed Tinbergen’s findings with painstaking accuracy, questioning in a few cases Tinbergen’s reading of his own results. For instance, he pointed out that the econometric findings in themselves do not allow us to decide between two alternative interpretations of the influence of profits on consumption (either through speculative gains or through the increase of demand for durables and semi-durables—the acceleration principle). He regarded other results, such as the negligible role of short-term interest rate in determining investment in stocks, as ultimately inconclusive in light of the poor statistics available and behaviors that might not be constant in time. As regards the treatment of long-term interest rates, he noted, in a Keynesian line of reasoning, the potential importance of immeasurable factors. Lastly, he also raised the issue of collinearity and the problem of the degrees of freedom, which Tinbergen “seems entirely to neglect” (ibid., p. 297). Rothbarth concluded by recommending smaller models to Tinbergen—which is consistent with Keynes’s methodological suggestions. In fact, constructing smaller models entails putting greater responsibility on the economist before he passes the material to be analyzed on to the statistician, or in other words, giving more weight to economic theory and to investigating the economic material before

402

R. Marchionatti

data is manipulated. The very last paragraph brings us back once again to one of Keynes’s main perplexities, the issue of non-homogeneity over time: [With a smaller model, Tinbergen] would have needed a separate model for the 1919–22 cycle; but I cannot help feeling that this would have been an additional advantage rather than the reverse. It would have focussed the reader’s and Professor Tinbergen’s attention on the strong differences existing between this cycle and both the 1929 and 1937 cycles. (ibid.)

The Reception of Keynes’s Criticism by the Econometricians, 1939–1943: From Reconciliation to Rejection. A Note The econometricians’ first reactions to the debate consisted in careful considerations of the issues raised by Keynes. The reviews of Tinbergen’s League of Nations study often mentioned Keynes’s criticism. Allen (1940) considered Keynes’s questions “pertinent”. Tintner (1941) agreed with Keynes that the expectations “are not introduced explicitly enough” in the study (p. 622). J.E.W. (the reviewer for the Journal of the Royal Statistical Society) (1940) raised some of Keynes’s methodological questions (without quoting him) on factor measurability, the constancy of coefficients, linearity, etc. Bartlett (1940) noted that Keynes “set out with gusto the host of statistical difficulties that still remain [in Tinbergentype investigations]—the validity of the data, the measurability of all relevant variables, the linearity of the relations, the absence of specified time-lags, the stability of the series” (p. 18). Keynes’s attack also prompted some attempts by eminent econometricians to reconcile his criticism with statistical-econometric work (among them Oskar Lange, Jacob Marschak and Tjalling Koopmans).25 The attempts at reconciliation ended with Trygve Haavelmo (1943, 1944), who introduced full probability reasoning in econometrics. With the establishment of Haavelmo’s approach through the work of the Cowles Commission, 25

For an analysis of the early reception of Keynes’s criticism by the econometricians, see Garrone and Marchionatti (2009).

7 Great Controversies

403

Keynes-type discussions are increasingly ignored and, as Leamer (1985, p. 255) writes, “the slippery issues of causal inference” were to be “kept in the econometric closet for over thirty years”.

Concluding Remarks Keynes was not a critic and an opponent of econometric work per se. What he opposed were the attempts at statistical inference without any prior effort to ascertain whether the economic material was suitable for making such inferences. The question of methodology lies at the core of Keynes’s criticism of Tinbergen’s work. He doubted the legitimacy of inductive methods in the form of correlation analysis applied to economic matters. He argued that there was no reason to expect the system to be stable over the long run, and so there was no reason to infer stable correlations. Keynes raised a question that prima facie seemed to him to have a positive answer: whether “the slippery problem” of passing from statistical description to inductive generalization (which he showed to be relevant in the case of simple correlation in his Treatise on Probability) also arose for the method of multiple correlation. Keynes focused on the inductive aspects of Tinbergen’s analysis and examined the legitimacy of its implicit “fundamental assumptions”—uniformity and homogeneity of the environment over a period of time, completeness of the list of the significant causes, measurability of all the significant factors and independence of the different factors from one another. According to Keynes “every one of these conditions is far from being satisfied” (Keynes 1973c, p. 286) in business cycle research: “The successful application of this method to so enormously complex a problem as the business cycle does strike me as singularly unpromising project in the present state of our knowledge” (ibid., p. 317, emphasis added). It is the general opinion that Keynes’s criticism was overly harsh in the context of contemporary econometrics of 1939–1940. Why was it so harsh? This did not depend on Keynes’s temperament, as Stone (1978) suggested. Rather, Keynes was harsh because from the mid-1930s on he began to notice that a new conception of the nature, method and style of economics, opposed to what he considered correct, was meeting

404

R. Marchionatti

with increasing success. For Keynes, statistics also has an instrumental role in economics: it is of fundamental importance in order “to eliminate impressionism”, i.e., to increase the accuracy of the theories. In the General Theory he called for a statistical examination of such key concepts as the propensity to consumption and the multiplier. Prediction, though, was not the main object of the statistician. His conception of the nature and method of economics (see Chap. 2.3) made Keynes seriously worried about the emerging tendency to use statistical and mathematical methods to formalize economic analysis. Many such methods “assume strict independence between the factors involved and lose all their cogency and authority if this hypothesis is disallowed”, he wrote in the General Theory (Keynes 1973b [1936], p. 297). On this basis, his judgment was strongly negative: Too large a proportion of recent “mathematical” economics are merely concoctions, as imprecise as the initial assumptions they rest on, which allow the author to lose sight of the complexities and interdependencies of the real world in a maze of pretentious and unhelpful symbols. (ibid., p. 296)

By “recent mathematical economics”, Keynes was referring to those economists who agreed to the Econometric Society program. This can be asserted on the basis of the little explicit evidence available—his correspondence with Harrod and with Ragnar Frisch in the 1930s.26 As can be seen from his exchange with Frisch, Keynes’s mistrust of “recent mathematical economics” stemmed from: (a) the imprecision of assumptions, often “special”, but covered by a maze of symbolism; e.g., the assumption of strict independence between the factors (common in mathematical works) rules out considering complexity; (b) the unclear application of conclusions. Keynes’s concern about this “recent mathematical economics” was reinforced by the fact that his own ideas—from A Treatise on Money to the General Theory—had had a significant

26 The correspondence with Roy Harrod is published in Keynes’s Collected Writings; the (unpublished) correspondence with Ragnar Frisch, concentrated in the period 1932–1936, is kept at the National Library of Norway, Oslo Division. A discussion of the latter is in Louçã (1999).

7 Great Controversies

405

impact on young econometricians.27 Many of them, such as Frisch and Tinbergen, thought that an important goal of economics was to create a basis for practical measures to be implemented in order to fight economic crises and unemployment. Keynes’s theoretical analysis in the General Theory and his emphasis on monetary and fiscal policies made his work extremely valuable as a theoretical structure that could underlie quantitative analysis of those problems. According to econometricians, Keynes’s theory, originally expressed in literary form, needed to be translated into a system of equations to emphasize the basic hypotheses in a simpler, formal framework. Immediately after its publication, Keynes’s theory was discussed in Econometrica’s circle. The first version of Hicks’s paper (Hicks 1937), which contained the IS-LM model of Keynes’s theory, had been presented at the sixth European meeting of the Econometric Society at Oxford in September 1936 and published in Econometrica in April 1937 (see Chap. 3.4), just after Harrod’s and Meade’s papers on the same subject. This simultaneous equation interpretation of the General Theory—i.e., a simplified version offering a mathematical framing in the form of a specified model—became its dominant interpretation even though this was at odds with Keynes’s original formulation. The tendency to accept only a part of his work while rejecting the rest had already worried Keynes, when he was discussing various issues of the General Theory with Harrod: I am frightfully afraid of the tendency, of which I see signs in you [Harrod], to appear to accept my constructive part and to find some accommodation between this and deeply cherished views which would in fact be only possible if my constructive part had been partially misunderstood. (Keynes to Harrod, August 27, 1935, in Keynes 1973d, p. 548)

In the mid-1930s, Keynes became aware that what we can call the early “neoclassical synthesis” interpretation of the General Theory and the 27 Tinbergen himself, reviewing the recent business cycle theories in 1935 (Tinbergen 1935), devoted great attention to the parts of Keynes’s Treatise of Money “which give very pertinent remarks on the business cycle problem” (p. 266). Tinbergen classifies Keynes’s theory as a semi-mathematical one and argues for its mathematical treatment.

406

R. Marchionatti

interpretation given by the econometricians were starting to converge. Keynes’s virulence against Tinbergen can be explained by the fact that the latter epitomized this tendency at its best. On the one hand Tinbergen reintroduced a conception of economics and its method that Keynes, as Marshall before him, had rejected, while on the other he proposed a use of statistical inference that Keynes had criticized.

References Allen, Roy G. D. 1940. Review of Statistical Testing of Business-Cycle Theories, Vol. I: A Method and Its Application to Investment Activity: Statistical Testing of Business-Cycle Theories. Vol. II: Business Cycles in the United States of America, 1919–32. Economica 7: 335–339. Amoroso, Luigi. 1921. Lezioni di economia matematica. Bologna: Zanichelli. Barone, Enrico. 1894. Sul trattamento di questioni dinamiche. Giornale Degli Economisti 9: 407–435. ———. 1935 [1908]. Il Ministro della Produzione nello Stato Collettivista. Giornale degli Economisti 2: 267–293, 392–414. English translation: The Ministry of Production in the Collectivist State. In Collectivist Economic Planning, ed. Friedrich Hayek, 245–290. London: Routledge, 1935. Bartlett, Maurice S. 1940. The Present Position of Mathematical Statistics. Journal of the Royal Statistical Society 103 (1): 1–29. Becchio, Giandomenica. 2007. The Early Debate on Economic Calculation in Vienna (1919–1925): The Heterodox Point of View: Neurath, Mises and Polanyi. Storia del pensiero economico 2: 133–144. Blitch, Charles P. 1983a. Allyn Young on Increasing Returns. Journal of Post Keynesian Economics 5 (3): 359–372. ———. 1983b. Allyn A. Young: A Curious Case of Professional Neglect. History of Political Economy 15: 1–24. Caldwell, Bruce. 1997. Hayek and Socialism. Journal of Economic Literature 35: 1856–1890. Chaloupek, Günther. 1990. The Austrian Debate on Economic Calculation in a Socialist Economy. History of Political Economy 22 (4): 659–675. Chipman, John S. 1970. External Economies of Scale and Competitive Equilibrium. The Quarterly Journal of Economics 3: 347–385.

7 Great Controversies

407

Clapham, John H. 1922. Of Empty Economic Boxes. The Economic Journal 32: 305–314. Clark, John Maurice. 1923. Studies in the Economics of Overhead Costs. Chicago: University of Chicago Press. Crosby Roper, W. 1931. The Problem of Pricing in a Socialist State. Cambridge, MA: Harvard University Press. Dharmapala, Dhammika, and Michael McAleer. 1996. Econometric Methodology and the Philosophy of Science. Journal of Statistical Planning and Inference 49: 9–37. Dickinson, Henry D. 1933. Price Formation in a Socialist Community. The Economic Journal 43: 237–250. ———. 1939. Economics of Socialism. London: Oxford University Press. Dickinson, Z. Clark. 1960. Fred M. Taylor’s Views on Socialism. Economica 27: 42–52. Dobb, Maurice H. 1933. Economic Theory and the Problems of a Socialist Economy. The Economic Journal 43: 588–598. ———. 1935. Economic Theory and Socialist Economy: A Reply. Review of Economic Studies 2 (2): 144–151. ———. 1937. Political Economy and Capitalism: Some Essays in Economic Tradition. London: Routledge. ———. 1955. On Economic Theory and Socialism: Collected Papers. London: Routledge. Downie, Jack. 1958. The Competitive Process. London: Duckworth. Edgeworth, Francis Y. 1905. Review of A Geometrical Political Economy by H. Cunynghame. The Economic Journal 15: 62–71. ———. 1925. Review of Pigou’s Economics of Welfare. The Economic Journal 35: 30–39. Epstein, Roy. 1987. A History of Econometric Ideas. Amsterdam: NorthHolland. Garrone, Giovanna, and Roberto Marchionatti. 2007. The Appropriate Style of Economic Discourse: Keynes on Economics and Econometrics. Working Paper of the Department of Economics ‘Cognetti de Martiis’, University of Torino, No. 2. ———. 2009. The Role of Econometric Method in Economic Analysis: A Reassessment of the Keynes-Tinbergen Debate 1938–1943. In Open Economics: Economics in Relation to Other Disciplines, ed. Richard Arena, Sheila Dow and Matthias Klaes, 148–172. London: Routledge. Hagemann, Harald. 2019. On the (Im)Possibility of Socialist Calculation: Marschak Versus Mises. In The First Socialization Debate (1918) and Early

408

R. Marchionatti

Efforts Towards Socialization, ed. Jürgen Backhaus, Günther Chaloupek and Hans Frambach. Berlin: Springer. Hart, Neil. 2012. Equilibrium and Evolution: Alfred Marshall and the Marshallians. London: Palgrave Macmillan. Haavelmo, Trygve. 1943. Statistical Testing of Business Cycle Theories. Review of Economics and Statistics 25: 13–18. ———. 1944. The Probability Approach in Econometrics. Econometrica 12 (Suppl.): 1–115. Hallett, A. J. Hughes. 1989. Econometrics and the Theory of Economic Policy: The Tinbergen-Theil Contributions 40 Years On. Oxford Economic Papers 41: 189–214. Hayek, Friedrich A. von. 1935. “The Nature and History of the Problem” and “The State of the Debate”. In Collectivist Economic Planning, ed. Friedrich A. von Hayek. London: Routledge. ———. 1937. Economics and Knowledge. Economica 4: 33–54. ———. 1940. Socialist Calculation: The Competitive ‘Solution’. Economica 7: 125–149. ———. 1946. The Meaning of Competition. In Individualism and Economic Order, ed. Friedrich A. von Hayek, 92–106. Chicago: University of Chicago Press, 1948. Hendry, David F. 1980. Econometrics—Alchemy or Science? Economica 47: 387–406. Hendry, David F., and Mary S. Morgan, eds. 1995. The Foundations of Econometric Analysis. Cambridge: Cambridge University Press. Hicks, John R. 1937. Mr. Keynes and the ‘Classics’: A Suggested Interpretation. Econometrica 5: 147–159. Hutchison, Terence W. 1953. A Review of Economic Doctrines 1870–1929. Oxford: The Clarendon Press. J.E.W. 1940. Review of Statistical Testing of Business—Cycle Theories, Vol. I: A Method and Its Application to Investment Activity: Statistical Testing of Business-Cycle Theories. Vol. II: Business Cycles in the United States of America, 1919–32. Journal of the Royal Statistical Society 103: 259–261. Kaldor, Nicholas. 1981. The role of increasing returns, technical progress and cumulative causation in the theory of international trade and economic growth. Economie Appliquée 34 (4): 593–617. Kalecki, Michal. 1944–1945. The Work of Erwin Rothbarth. The Review of Economic Studies 12 (2): 121–122. Kahn, Richard. 1984. The Making of Keynes’s General Theory. Raffaele Mattioli Lectures. Cambridge: Cambridge University Press.

7 Great Controversies

409

Keuzenkamp, Hugo A. 1995. The Econometrics of the Holy Grail—A Review of Econometrics: Alchemy or Science? Essays in Econometric Methodology. Journal of Economic Surveys 9: 233–248. ———. 2000. Probability, Econometrics and Truth: The Methodology of Econometrics. Cambridge: Cambridge University Press. Keynes, J.M. 1924. Alfred Marshall, 1842–1924. The Economic Journal , September 1924, now in Essays in Biography, vol. X of the Collected Writings of J.M. Keynes, 161–231. London: Macmillan and Cambridge University Press. ———. 1930. Note by the Editor: Increasing Returns and the Representative Firm. The Economic Journal 40: 79. ———. 1973a [1921]. The Treatise on Probability. Reprinted in The Collected Writings of J.M. Keynes, vol. VIII. London: Macmillan for the Royal Economic Society. ———. 1973b [1936]. The General Theory of Employment, Interest and Money. London: Macmillan Press. Reprinted in The Collected Writings of J.M. Keynes, vol. VII. London: Macmillan for the Royal Economic Society. ———. 1973c [1939]. Professor Tinbergen’s Method. The Economic Journal 49: 558–568, and On a Method of Statistical Business-Cycle Research. A Comment. The Economic Journal 50: 154–156. Reprinted in The Collected Writings of J.M. Keynes, vol. XIV, The General Theory and After. Part II. Defence and Development. London: Macmillan for the Royal Economic Society. ———. 1973d. The Collected Writings of J.M. Keynes, vol. XIII, The General Theory and After. Part I. Preparation. London: Macmillan for the Royal Economic Society. Knight, Frank H. 1921a. Risk, Uncertainty and Profit. Boston and New York: Houghton Mifflin Company. ———. 1921b. Cost of Production and Price Over Long and Short Periods. Journal of Political Economy 29: 304–335. ———. 1924. Some Fallacies in the Interpretation of Social Cost. Quarterly Journal of Economics 38: 582–604. ———. 1925. On Decreasing Cost and Comparative Cost: A Rejoinder. Quarterly Journal of Economics 34: 331–333. Klein, Lawrence. 1951. The Life of J. M. Keynes. Journal of Political Economy 59: 443–451. Landauer, Carl. 1931. Planwirtschaft und Verkehrswirtschaft. Munchen und Leipzig: Duncker & Humblodt,

410

R. Marchionatti

Lange, Oskar. 1935. Marxian Economics and Modern Economic Theory. The Review of Economic Studies 2 (3): 189–201. ———. 1936a. On the Economic Theory of Socialism: Part One. The Review of Economic Studies 4 (1): 53–71. ———.1936b [1973]. Mr Lerner’s Note on Socialist Economics. In Readings in Welfare Economics, ed. M.J. Farrell. London: Macmillan. ———. 1937. On the Economic Theory of Socialism: Part Two. The Review of Economic Studies 4 (2): 123–142. ———. 1967. The Computer and the Market. In Socialism, Capitalism and Economic Growth: Essays Presented to Maurice Dobb, ed. C. Feinstein. Cambridge: Cambridge University Press. Lange, Oskar, and Fred M. Taylor, 1938. On the Economic Theory of Socialism, ed. B. Lippincott. New York: McGraw-Hill. Leamer, Edward E. 1985. Vector autoregressions for causal inference? In Understanding Monetary Regimes, ed. K. Brunner and A.H. Meltzer, 255–305. Amsterdam: North-Holland. Leeson, Robert. 1998. The Ghosts I Called I Can’t Get Rid of Now: The Keynes-Tinbergen-Friedman-Phillips Critique of Keynesian Macroeconometrics. History of Political Economy 30 (1): 51–94. Lerner, Abba P. 1934. Economic Theory and Socialist Economy. Review of Economic Studies 2 (1): 51–61. ———. 1935. Economic Theory and Socialist Economy: A Rejoinder. Review of Economic Studies 2 (2): 152–154. ———. 1936. A Note on Socialist Economics. Review of Economic Studies 4 (1): 72–76. ———. 1937. Statics and Dynamics in Socialist Economics. The Economic Journal 47: 253–270. ———. 1938. Theory and Practice in Socialist Economics. Review of Economic Studies 6 (1): 71–75. ———. 1944. The Economics of Control: Principles of Welfare Economics. New York: Macmillan. Louçã, Francisco. 1999. The Econometric Challenge to Keynes: Arguments and Contradictions in the Early Debate About a Late Issue. The European Journal of the History of Economic Thought 6: 404–438. Marchionatti, Roberto. 2001. Sraffa and the Criticism of Marshall in the 1920s. In Piero Sraffa’s Political Economy: A Centenary Estimate, ed. Terenzio Cozzi and Roberto Marchionatti, 43–80. London: Routledge. ———. 2006. The ‘Increasing Returns and Competition’ Dilemma: From Marshall to Pigou. In The Elgar Companion to Alfred Marshall , ed. Tiziano

7 Great Controversies

411

Raffaelli, Giacomo Becattini and Marco Dardi, 617–624. Cheltenham: Edward Elgar. Marschak, Jacob. 1924. Wirtschaftsrechnung und Gemeinwirtschaft. Zur Mises’schen These von der Unmöglichkeit sozialistischer Wirtschaftsrechnung. Archiv für Sozialwissenschaft und Sozialpolitik 51: 501–520. McAleer, Michael. 1994. Sherlock Holmes and the Search for Truth: A Diagnostic Tale. Journal of Economic Survey 8: 317–370. Mises, Ludwig von. 1920. Die Wirtschaftsrechnung im sozialistischen Gemeinwesen. Archiv für Sozialwissenschaft und Sozialpoliti k 47: 86–121. English translation as Economic Calculation in the Socialist Commonwealth. In Collectivist Economic Planning, ed. Friedrich A. von Hayek, 87–130. London: George Routledge, 1935. ———. 1922. Die Gemeinwirtschaft: Untersuchungen uber den Sozialismus. Jena: Gustav Fischer. English Translation: Socialism: An Economic and Sociological Analysis. London: Jonathan Cape, 1936. ———. 1923. Neue Beiträge zum Problem der sozialistischen Wirtschaftsrechnung. Archiv für Sozialwissenschaft und Sozialpolitik 51 (2): 488–500. ———. 1949. Human Action: A Treatise on Economics. New Haven: Yale University Press. Moore, Henry Ludwell. 1906. Paradoxes of Competition. The Quarterly Journal of Economics 20: 211–230. Morgan, Mary. 1990. The History of Econometric Ideas. Cambridge: Cambridge University Press. Negishi, Takashi. 1989. History of Economic Theory. Amsterdam: North Holland. Newman, Peter. 1960. The Erosion of Marshall’s Theory of Value. The Quarterly Journal of Economics 74: 587–601. Neurath, Otto. 1919. Wesen und Weg der Sozialisierung. In Durch die Kriegswirtschaft zur Naturalwirtschaft, 209–222. Munich: Callwey: English translation: Character and Course of Socialisation. In Otto Neurath, Empiricism and Sociology, ed. M. Neurath and R.S. Cohen, 135–150. Dordrecht: Reidel, 1973. ———. 2004 [1925]. Wirtschaftsplan und Naturalrechnung. Berlin: Laub; English translation: Economic Plan and Calculation in Kind. In Otto Neurath, Economic Writings: Selections 1904–1945, ed. T.E. Uebel and R.S. Cohen, 405–465. Dordrecht: Kluwer. Newman, Peter, and J.N. Wolfe. 1961. A Model for the Long-Run Theory of Value. The Review of Economic Studies 29 (1): 51–61.

412

R. Marchionatti

Pareto, Vilfredo. 1896–1897. Cours d’économie politique. 2 vols. Geneva: Librairie Droz. Patinkin, Don. 1976. Keynes and Econometrics: On the Interaction Between the Macroeconomics Revolutions in the Interwar Period. Econometrica 44: 1091–1123. Pesaran, Hashem, and Ron Smith. 1985. Keynes on Econometrics. In Keynes’ Economics: Methodological Issues, ed. Tony Lawson and Hashem Pesaran. London: Croom Helm. Pigou, Arthur C. 1912. Wealth and Welfare. London: Macmillan. ———. 1920. The Economics of Welfare. London: Macmillan, 2nd ed., 1924. ———. 1922. Empty Economic Boxes: A Reply. The Economic Journal 32: 458–465. ———. 1927. The Law of Diminishing Returns and Increasing Cost. The Economic Journal 37: 188–197. ———. 1928. An Analysis of Supply. The Economic Journal 38: 238–257. Polanyi, Karl. 1922. Sozialistische Rechnungslegung. Archiv für Sozialwissenschaft und Sozialpolitik 49 (2): 377–420. ———. 1924. Die funktionelle Theorie der Gesellschaft und das Problem der sozialistischen Rechnungslegung (Eine Erwiderung an Prof. Mises und Dr. Felix Weil). Archiv für Sozialwissenschaft und Sozialpolitik 52: 218–228. Richardson, George B. 1975. Adam Smith on Competition and Increasing Returns. In Essays on Adam Smith, ed. Andrew S. Skinner and Thomas Wilson, 350–360. London: Oxford University Press. Robbins, Lionel. 1928. The Representative Firm. The Economic Journal 38: 387–404. ———. 1934. The Great Depression. London: Macmillan. Robertson, Dennis. 1924. Those Economic Boxes. The Economic Journal 34: 16–31. ———. 1930. The Trees of the Forest. The Economic Journal 40: 80–89. Romer, Paul M. 1986. Increasing Returns, Specialization and External Economies: Growth as Described by Allyn Young. Working Paper No. 64, Rochester, NY. ———. 1987. Growth Based on Increasing Returns due to Specialization. American Economic Review 77 (2): 56–62. Rothbarth, Erwin. 1938. An Econometric Approach to Business Cycle Problems. Economica 5 (20): 488–491. ———. 1941. Review of Statistical Testing of Business-Cycle Theories: II. Business Cycle in the United States of America, 1919–32. Economic Journal 51: 293–297.

7 Great Controversies

413

Rowley, Robin. 1988. The Keynes-Tinbergen Exchange in Retrospect. In Keynes and Public Policy after Fifty Years, ed. Omar F. Hamouda and John N. Smithin, 2 vols., vol. 2, 23–31 Cheltenham: Edward Elgar. Samuelson, Paul. 1946. Lord Keynes and the General Theory. Econometrica 14: 187–200. Schumpeter, Joseph A. 1908. Das Wesen und der Haupttinhalt der theoretischen Nationalokonomie. Munchen and Leipzig: Duncker & Humblot. ———. 1912. Theorie der wirtschaflichen Entwicklung. Berlin: Duncker & Humblot. ———. 1928. The Instability of Capitalism. The Economic Journal 38: 361– 386. ———. 1954. History of Economic Analysis. New York: Oxford University Press. Scitovsky, Tibor. 1984. Lerner’s Contribution to Economics. Journal of Economic Literature 22 (4): 1547–1571. Schäffle, Albert. 1874. Die Quintessenz des Sozialismus. Gotha: Perthes. ———. 1881. Bau und Leben des sozialen Körpe. Tübingen: Laupp. Shleifer, Andrei, and Robert W. Vishny. 1994. The Politics of Market Socialism. Journal of Economic Perspectives 8 (2): 165–217. Shove, Gerald F. 1930. The Representative Firm and Increasing Returns. The Economic Journal 40: 94–116. Silberling, Norman J. 1924. Graphical Illustrations of the Law of Price. American Economic Review 14: 417–442. Sraffa, Piero. 1925. Sulle relazioni tra costo e quantità prodotta. Annali di Economia 2: 277–328. ———. 1926. The Laws of Returns Under Competitive Conditions. The Economic Journal 36: 535–550. ———. 1930. A Criticism. The Economic Journal 40: 89–93. Stigler, George J. 1951. The Division of Labour Is Limited by the Extent of the Market. Journal of Political Economy 59 (3): 185–193. Stone, Richard. 1978. Keynes, Political Arithmetic and Econometrics. Proceedings of the British Academy, vol. 64. Oxford: Oxford University Press. Taylor, Fred M. 1929. The Guidance of Production in a Socialist State. American Economic Review 19 (1): 1–6. Tinbergen, Jan. 1935. Annual Survey: Suggestions on Quantitative Business Cycle Theory. Econometrica 3: 241–308. ———. 1939a. Statistical Testing of Business-Cycle Theories, vol. I: A Method and Its Application in Investment Activity. Geneva: League of Nations.

414

R. Marchionatti

———. 1939b. Statistical Testing of Business-Cycle Theories, vol. II: Business Cycles in the USA. 1919–1932. Geneva: League of Nations. ———. 1940a. On a Method of Statistical Business Research: A Reply. Economic Journal 50: 141–154. ———. 1940b. Econometric Business Cycle Research. The Review of Economic Studies 7: 73–90. Tintner, Gerhard. 1941. Review of Business Cycles in the United States of America, 1919–1932. Journal of Political Economy 4: 618–622. Tisch, Cläre. 1932. Wirtschaftsrechnung und Verteilung im zentralistisch organisierten sozialistischen Gemeinwesen. University of Bonn. Viner, Jacob. 1921. Price Policies. The Determination of Market Price. In Business Administration, ed. L.C. Marshall. Chicago: University of Chicago Press. ———. 1931. Cost Curves and Supply Curves. Zeitschrift fur Nationalokonomie 3: 23–46. Young, Allyn 1913. A. Pigou’s Wealth and Welfare. The Quarterly Journal of Economics 27 (4): 672–686. ———. 1928. Increasing Returns and Economic Progress. The Economic Journal 38: 527–542. Weber, Max. 1921. Wirtschaft und Gesellschaft: Grundriß der Verstehenden Soziologie. Tübingen: Mohr. Wieser, Friedrich von. 1889. Der Natürliche Werth. Wien: A. Holder. Wolfe, J.N. 1954. The Representative Firm. The Economic Journal 64: 337– 349.

8 Between the Two World Wars: The Years of High Theory?

The years between the two world wars are often called “the years of high theory”, from the title of G. L. S. Shackle’s important book (Shackle 1967). Shackle maintained that there began in the mid-1920s an immense creative spasm, lasting for fourteen years until the Second World War, and yielding six or seven major innovations of theory which together have completely altered the orientation and character of economics. (Shackle 1967, p. 5)

This was the result of the work of a generation of scholars—Shackle lists Piero Sraffa, Joan Robinson, Edward Chamberlin, John Hicks, Gunnar Myrdal, John Maynard Keynes, Roy Harrod, Wassily Leontief—who, “freed in some degree from old pre-conceptions” (ibid.), responded to the demand for new tools to deal with the ruins of European organization to which the traditional approach—the so-called, stereotypical, “Great Theory”, i.e., “the theory of general, perfectly competitive, fullemployment stationary (or better, timeless) equilibrium” (ibid., pp. 4–5) which dominated in the years when men believed “in a self-regulating, © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 R. Marchionatti, Economic Theory in the Twentieth Century, An Intellectual History—Volume II, https://doi.org/10.1007/978-3-030-80987-4_8

415

416

R. Marchionatti

inherently and naturally self-optimizing, stable and coherent economic system” (ibid., p. 5)—had been unable “to bring back the old order of things” (ibid.). Shackle defines the period he considers—which covers the years between 1926 and 1939—as “marvellous”: in it, he maintains, “perhaps, more invention was crammed than into the whole generation from 1870 to 1900 ” (ibid., p. 12, our italics). Little wonder, then, that he called the period the “years of High Theory”. A quite different perspective had been offered by Schumpeter in the last part of his History (Schumpeter 1954), devoted to “a sketch of modern developments” from 1920 to 1945. According to Schumpeter this period saw the emergence of a new “Political Economy”—Schumpeter uses the term to mean the sum total of views about practical questions and “the schema of social values that underlies these views” (Schumpeter 1954, p. 1106)—with “a complete change in the economic policies of all nations which has persisted ever since” (ibid.). From the point of view of economic theory, the period was particularly characterized by an increase of statistical information which was so great as to open up quite new possibilities for scientific research. In step with this increase of statistical material , there has been an equally important development of statistical methods. (ibid.)

However, the theoretical basis of this work was—Schumpeter emphasizes—the system of economic theory consolidated between 1890 and 1914, slowly transformed, through the work started in the early 1920s and developed in the 1930s, into a new system. “It is impossible to foresee what future generations will think of the work in economic theory from 1920 to 1945”, Schumpeter writes (ibid., p. 1109), but [t]he one thing that can be confidently asserted about the work of the period … is that the theory of 1945 is greatly superior to the theory of 1900 as regards technique. Results are more reliable, proofs are more rigorous. This in itself also means more results and more specialized results that fit better the endless variety of the configurations of economic reality. (our italics)

8 Between the Two World Wars: The Years …

417

At the same time, Schumpeter continues, “it must be admitted that fundamentally new ideas have been almost wholly absent ” (ibid., our italics). In fact, he comments, “[w]e make much more of the ideas which we have inherited from the preceding period and often present them in a new light, but we have added little to them” (ibid.): “the new tendencies—he maintains—were discernible before 1914” (p. 1111). In his sketched evaluation, Schumpeter puts more emphasis on the continuity with tradition than on change, while recognizing that in two decades the traditional system was slowly transformed. But he rejects the clear opposition between invention and tradition stressed by Shackle. We are dealing here with two quite different interpretations, which capture different aspects of the story, with different estimations of the elements of tradition and innovation and their connections. Our interpretation, in a perspective closer to Schumpeter than to Shackle, recognizes the presence of often interconnected elements of tradition and innovation, in a framework in which criticism of the tradition and recognition of its internal problems and its inadequacy for dealing with the problems of the real world gives rise to a process of theoretical innovation which is connected in complex ways with a tradition which in some ways feeds innovation. Our narrative of the transformation of economic theory in the turbulent period between the two world wars shows a process of change which involves the intellectual communities of economists emphasizing their nature as dynamic evolving interacting entities. The picture that emerges from this narrative may be summarized as follows. The starting point of the process of deconstruction and reconstruction of economic theory in the period is the discussion and criticism of the classical situation represented by Marshall’s (and Marshallian) theory, the most widespread version of neoclassicism and the main pillar of the old mainstream. What is at the center of the debate is not only Marshall’s analytical framework but also, albeit less evidently, his conception of economics and methodological approach. Though several routes were followed in the attempt to answer the issues discussed in the debate, among the emerging research programs two were most important. The first was Keynes’s macroeconomic revolution, with its emphasis on answering new issues posed in the real world first theoretically and then practically. Revolutionary as

418

R. Marchionatti

it was, however, Keynes’s approached returned to Marshall’s tradition from the methodological standpoint—the question of the nature and method of economics was at the core of Keynes’s thinking in the early 1930s—which clearly stated the fundamental problem of how to deal with complexity without simplifying: “comment envisager la complexité de facon non-simplifiante?”, as the philosopher Edgar Morin (2005 [1990], p. 9) put it, is the methodological question which Keynes tried to answer. The second route was the program of research, destined to became mainstream, followed by most economists of the new generations, often partially unaware of the complexities of the thought of the great economists of the recent past, who considered the key question to be that of achieving formal rigor in economic theory, which they saw as a science that follows the method of natural science and primarily adopts the language of mathematics. According to them, economic theory needed—in the language of Wiener Kreis’s Manifesto—to be purified of metaphysical residuals. However, their analytical innovations were substantially a revival of Walras’s and Pareto’s theoretical framework— i.e., they returned to a tradition and advanced it from a technical point of view—from a predominately neo-positivist perspective. This neo-positivist approach was the backbone of the making of a new mainstream, and econometrics—as a program of connection between economic theory, statistics and mathematics—can be considered the most complete expression of this line of thought, becoming the core conception of economics in the new mainstream. It introduced an idea of economics and its method and style that Keynes, like Marshall before him, had rejected—and in respect to which Pareto in his Sociologia had expressed substantial reservations—which Keynes believed came at a cost: that of losing sight of “the complexities and interdependencies of the real world”. In other words, the cost of constructing the new mainstream was for Keynes its reductionist methodology. As Keynes never stopped emphasizing, and as his controversy with Tinbergen clearly expresses, he felt that this methodology oversimplified the complexity of the real world. At the end of the golden age of capitalism, neoclassical economics appeared to most as an imperfect science which presented problems at the analytical and methodological level—as had already been stressed in

8 Between the Two World Wars: The Years …

419

the works of Marshall and Pareto as well as in the radical criticism of Veblen and other non-orthodox thinkers—and was thus unable to deal with the problems of those hard times. The challenge of constructing a new economics was accepted by many scholars, in our narrative essentially along two main paths, Keynes’s complexity approach (to which we could add Hayek’s neo-Austrian program of research) and the neo-positivist approach of the budding mainstream, which developed a mathematical-statistical framework to give “scientific rigor” to theory, of course with the aim of promoting intelligibility, and rejecting Keynes’s complexity approach while accepting the analytical structure of his aggregate model, or in other words incorporating it in its framework. Undoubtedly, much important and exiting thinking crystallized around the line of research we have labeled neo-positivist in the years between the two world wars. They were indeed years of theoretical ferment, but if we look at the outcome of the process of theoretical transformation in the period, we can hardly agree with Shackle that they were “the years of high theory”. Along with this process of deconstruction and reconstruction of economic theory, the geographic map of economics was also redrawn. The most relevant phenomenon was the strengthening of the American centers, above all in the 1930s, largely as a result of the European intellectual immigration to the United States. However, these scholars’ exodus was disastrous for economics in Europe, especially in Austria and Germany. At the end of the 1930s, economic theory still showed a diversified map, but with a clear concentration of importance in a few American centers. At the same time, a new war was coming. In September 1939, the world plunged back again into the tremendous tragedy of world war. Beginning with Germany’s invasion of Poland, it soon became a global conflict that lasted until 1945 and involved most of the world’s countries, essentially divided in two opposing military alliances: the Allies (initially France, the United Kingdom and the British Commonwealth, and Poland, joined later by other European countries, the Soviet Union and finally by the United States after the Japanese attack on Pearl Harbor in December 1941), and the Axis (Germany, Italy and Japan). It concluded with the unconditional surrender of Germany in May

420

R. Marchionatti

1945 and of Japan in August 1945—Italy had signed the armistice in September 1943. World War II was the deadliest conflict in human history, marked by 70 to 85 million fatalities, and included tragic events like genocides (in primis the Holocaust) and the use of nuclear weapons. At the end of the war, Europe was again exhausted and devastated, as it had been at the end of World War I. But the lines of the new order under the increasing hegemony of the United States had already been laid down. For economics it began a new era, the American era, with the main centers and the new mainstream located in the United States.

References Morin, Edgar. 2005 [1990]. Introduction à la pensée complexe. Paris: Editions du Seuil. Schumpeter, Joseph A. 1954. A History of Economic Analysis. London: Allen & Unwin. Shackle, G.L.S. 1967. The Years of High Theory: Invention and Tradition in Economic Thought 1926–1939. Cambridge: Cambridge University Press.

Author Index

A

Allais, Maurice (1911–2010) 240 Allen, Roy G.D. (1906–1983) 13, 102, 132, 134, 135 Amoroso, Luigi (1886–1965) 167, 242 Andrews, P.W.S. (1914–1971) 87

B

Bachi, Riccardo (1875–1951) 243 Bain, Joe S. (1912–1991) 276, 297, 300 Barone, Enrico (1859–1924) 241, 285, 352, 369, 373, 379, 382, 385, 386 Beard, Charles A. (1874–1948) 260 Berle, Adolf A. Jr. (1895–1971) 259 Beveridge, William (1879–1963) 99, 102, 103, 106, 254

Böhm-Bawerk, Eugen (1851–1914) 10, 119, 177, 199 Böhm, Franz (1895–1977) 17, 161, 162, 174–176 Bonbright, James C. (1891–1985) 259 Boninsegni, Pasquale (1869–1939) 16, 233, 243 Borel, Émile (1871–1956) 241, 329 Bortkiewicz, Ladislaus von (1868– 1931) 17, 160, 163, 165, 166, 173, 205, 232 Bowley, Arthur (1869–1957) 232 Bresciani-Turroni, Costantino (1882–1963) 241, 243 Brutzkus, Boris (1874–1938) 381 Bukharin, Nikolai Ivanovich (1888–1938) 244, 246 Bullock, C.J. (1869–1941) 272 Burbank, Harold (1887–1951) 273

© The Editor(s) (if applicable) and The Author(s) 2021 R. Marchionatti, Economic Theory in the Twentieth Century, An Intellectual History—Volume II, https://doi.org/10.1007/978-3-030-80987-4

421

422

Author Index

Burchardt, Fritz (1902–1958) 174 Burns, Arthur F. (1904–1987) 259, 264, 268

Cowles, Alfred (1891–1984) 14, 15, 19, 163, 181, 200, 233, 234, 254, 259, 269, 287, 304, 305, 319, 320, 322–324 Currie, Lauchlin B. (1902–1993) 271

C

Cabiati, Attilio (1872–1950) 64, 241 Cannan, Edwin (1865–1935) 100, 106, 271, 373 Carnap, Rudolf (1891–1970) 113, 196, 197 Carver, Thomas (1865–1961) 272 Cassel, Gustav (1866–1945) 39, 199, 216, 218, 372 Chamberlin, Edward H. (1899– 1967) 11, 19, 103, 168, 254, 271, 272, 274–277, 291–298, 300, 353, 415 Chapman, Sydney (1871–1951) 24 Chayanov, Alexander Vasil’ievich (1888–1937) 244, 246 Clapham, John Harold (1873–1946) 21, 24, 344, 347, 350 Clark, Colin (1905–1989) 64 Clark, John Bates (1847–1938) 260 Clark, John Maurice (1884–1963) 256, 258, 301, 303 Coase, Ronald H. (1910–2013) 101, 102, 104 Cobb, Charles W. (1875–1949) 303 Colm, Gerhard (1897–1968) 172, 174, 261, 320 Colson, Clément (1853–1939) 240 Commons, John R. (1962–1945) 257 Cournot, Antoine A. (1801–1877) 73, 168, 169, 345, 353, 366

D

Dalton, Hugh (1887–1961) 100, 106, 132 Davis, Harold T. (1892–1974) 319 Del Vecchio, Gustavo (1883–1972) 243 De Pietri Tonelli, Alfonso (1883–1952) 243 Dewey, John (1859–1952) 260, 263 Dickinson, Henry D. (1899–1969) 372, 373 Director, Aaron (1901–2004) 302 Divisia, François (1889–1964) 18, 232, 240 Dmitriev, Vladimir K. (1868–1913) 353 Dobb, Maurice (1900–1976) 25, 64, 66, 68, 307 Dorfman, Joseph (1904–1987) 256, 258, 259, 264 Douglas, Paul H. (1892–1976) 256, 303, 305

E

Edelberg, Victor Gregory (1909–2005) 102, 104, 105 Edgeworth, Francis Y. (1845–1926) 22, 36, 65, 344

Author Index

Einaudi, Luigi (1874–1961) 64, 241–243 Ely, Richard T. (1854–1943) 269, 270, 272 Espinas, Alfred (1844–1922) 186 Eucken, Walter (1891–1950) 17, 161, 162, 167, 174–176, 302

F

Fanno, Marco (1878–1965) 241 Fisher, Irving (1867–1947) 10, 14, 228, 232, 240, 254, 263, 303, 319 Florence, Philip Sargant (1890–1982) 24, 70 Friedman, Milton (1912–2006) 146, 260, 262, 305 Frisch, Ragnar (1895–1973) 14, 18, 67, 226–234, 240, 319, 322, 323, 404 Fubini, Renzo (1904–1944) 243 Fürth, Herbert (1899–1955) 118, 178

G

Galbraith, John K. (1908–2006) 277 Gibrat, Robert (1904–1980) 240 Gini, Corrado (1884–1965) 243 Granger, Clive W. (1934–2009) 190 Gregory, Theodore (1890–1970) 100, 106 Großmann-Doerth, Hans (1894–1944) 174–176 Guillebaud, Claude W. (1890–1971) 25

423

H

Haavelmo, Trygve (1911–1999) 15, 19, 228, 320–322, 324–326, 402 Haberler, Gottfried (1900–1995) 17, 148, 161, 162, 178, 179, 236, 272, 273, 277, 279, 318 Hahn, Hans (1879–1934) 163, 197, 198 Hall, Robert (1901–1988) 87 Halm, Georg Nikolaus (1901–1984) 379 Hammarskjöld, Dag (1905–1961) 220, 221 Hansen, Alvin H. (1887–1975) 19, 254, 272, 273, 276 Harms, Bernhard (1876–1939) 160, 170 Harrod, Henry Roy Forbes (1900– 1978) 17, 22, 50, 61, 64, 68, 74, 84–87, 415 Hawtrey, Ralph (1879–1975) 44, 271 Hayek, Friedrich A.(1899–1992) 12–14, 17, 18, 44, 101, 103, 105, 107, 117–122, 124–130, 137, 161, 162, 173, 178–180, 182, 187, 188, 218, 219, 379–386, 389–391, 419 Heimann, Eduard (1889–1967) 369 Henderson, Hubert (1890–1952) 25, 33, 87 Henderson, Lawrence (1878–1942) 273 Hicks, John R. (1904–1989) 12, 18, 78, 102, 131, 133–138, 140–142, 144, 147, 169, 217, 221, 223, 405, 415

424

Author Index

Hitch, Charles J. (1910–1995) 87–89, 277 Holland, Marjorie (1895–1977) 25 Hotelling, Harold (1895–1973) 232, 259, 304 Hurwicz, Leonid (1917–2008) 320, 332 Hutchison, Terence W. (1912–2007) 109, 112–116

J

Jannaccone, Pasquale (1872–1959) 317 Jenks, Jeremiah (1856–1929) 118 Johnson, Alvin S. (1874–1971) 260, 261, 306

K

Kahn, Richard F. (1905–1989) 16, 22, 23, 25, 44, 53, 61–64, 68, 72, 73, 76 Kaldor, Nicholas (1908–1986) 16, 61, 101, 103, 105, 271, 376 Kalecki, Michał (1899–1970) 17, 61, 63, 64, 66–68, 79–83, 181, 233, 400 Kaufmann, Felix (1895–1949) 178 Keynes, John Maynard (1883–1946) 1, 2, 4, 10, 12, 14–16, 21–89, 102–105, 107–109, 117, 131, 133, 140–142, 144–147, 151, 173, 217, 222, 223, 225, 233, 239, 241, 276, 277, 292, 304, 305, 307, 344, 360, 391–406, 415, 417–419 Keynes, John Neville (1852–1949) 30

Klein, Lawrence (1920–2013) 304, 320 Knight, Frank H. (1885–1972) 11, 19, 120, 191, 195, 254, 260, 271, 302, 305–312, 314, 344–347, 352, 364, 367 Kondratieff, Nikolai (1892–1938) 18, 244, 245, 279 Koopmans, Tjalling C. (1910–1985) 19, 228, 233, 269, 320, 321, 324, 327, 402 Kuznets, Simon (1901–1985) 257, 259, 268

L

Landauer, Carl (1891–1983) 372 Lange, Oskar (1904–1965) 13, 19, 145, 148, 234, 254, 285, 303–305, 320, 379, 385–388, 402 Laski, Harold (1893–1950) 99 La Volpe, Giulio (1909–1996) 242 Lederer, Emil (1882–1939) 160, 161, 173, 261, 369, 371 Leland, Simeon (1897–1972) 303 Leontief, Wassily (1905–1999) 14, 17, 19, 148, 160, 162–164, 166, 172, 173, 254, 272, 274, 278, 286–291, 415 Lerner, Abba P. (1903–1982) 13, 18, 100, 102, 105, 145, 146, 148–152, 277, 285, 372, 378, 379, 388 Lindhal, Erik (1891–1960) 222 Litoshenko, Lev Nikolaevich (1886–1943) 166, 244, 246 Löwe, Adolph (1893–1895) 170–173, 261

Author Index

Lundberg, Erik Filip (1907–1987) 216, 220–222 Luxemburg, Rosa (1871–1919) 67, 159

M

Macgregor, David H. (1877–1953) 24 Machlup, Fritz (1902–1983) 161, 162, 178–180, 233 Malinowski, Bronislaw (1884–1942) 99 Marget, Arthur (1899–1962) 271 Marschak, Jacob (1898–1977) 19, 172–174, 233, 261, 304, 320, 322, 332, 371, 372, 402 Marshall, Alfred (1842–1924) 10, 25, 30, 275 Mason, Edward S. (1899–1992) 19, 254, 270–273, 275, 276, 292, 298–300 Mayer, Hans (1879–1955) 161, 177, 180, 188, 190 Meade, James (1907–1995) 22, 44, 87, 140, 152, 220, 233, 405 Means, Gardiner C. (1896–1988) 259, 277 Menger, Carl (1840–1921) 161, 194, 198 Menger, Karl (1902–1985) 161, 163, 198, 200, 232 Millis, Harry A. (1873–1948) 303 Mills, Frederick C. (1892–1964) 232, 258 Mints, Lloyd W. (1888–1989) 302, 303

425

Mises, Ludwig von (1881–1973) 10, 17, 118, 161, 178, 181–187, 370, 380 Mitchell, Wesley C. (1874–1948) 15, 19, 118, 254, 256–258, 260, 262–268 Modigliani, Franco (1918–2003) 261 Moore, George Edward (1873–1958) 30 Moore, Henry L. (1869–1958) 256, 259, 303 Morgenstern, Oskar (1902–1977) 15, 17, 19, 119, 127, 139, 161, 163, 178, 179, 181, 187–194, 199, 202, 255, 314, 328, 330, 331 Mosak, Jacob (1913–2013) 320 Müller-Armack, Alfred (1901–1978) 174 Myrdal, Gunnar (1898–1987) 18, 120, 133, 217–225, 415

N

Nef, John Ulric Jr. (1899–1988) 120, 303 Neisser, Hans Philipp (1895–1975) 172, 173, 200, 261 Neumann, John von (1903–1957) 13, 15, 17, 19, 139, 166, 189, 199, 201, 204, 205, 255, 328, 330, 331 Neurath, Otto (1882–1945) 163, 182, 196, 197, 369, 371, 380 Neyman, Jerzy (1894–1981) 322

426

Author Index

O

Ohlin, Bertil (1899–1979) 18, 217, 219–221, 286, 318 Oparin, Dmitriy I. (1891–1978) 245 Opie, Redvers (1900–1984) 87 Oulès, Firmin (1904–1992) 16

P

Palomba, Giuseppe (1908–1986) 242 Pareto, Vilfredo (1848–1923) 10, 13, 196, 308, 368 Pearson, Egon (1895–1980) 322 Pearson, Warren (1878–1937) 272 Pervushin, Sergei Alekseevich (1888–1966) 245 Phelps Brown, Henry (1906–1994) 68, 87 Pierson, Nicolaas G. (1839–1909) 379 Pigou, Arthur C. (1877–1959) 23, 27, 33, 38, 44, 74, 76, 77, 107, 132, 140, 142, 343, 344, 347–350, 356–360, 363, 367, 373 Plant, Arnold (1898–1978) 102, 104, 105 Polanyi, Karl (1886–1964) 194, 195, 371, 372 Popov, Pavel Illich (1872–1950) 244, 246 Preobrazhensky, Alekseyevich (1886–1937) 244, 246

R

Ramsey, Frank P. (1903–1930) 36

Rathenau, Walther (1867–1922) 369 Reichenbach, Hans (1891–1953) 13 Reimer, Alva (1902–1986) 218 Remak, Robert E. (1888–1942) 17, 160, 162–166, 205 Riazanov, David (1870–1938) 244, 246 Ricci, Umberto (1879–1946) 243 Richardson Burns, Eveline (1900–1985) 259 Ripley, William (1867–1941) 272 Robbins, Lionel C. (1898–1984) 7, 18, 33, 99, 100, 106–112, 119, 187, 313, 344, 349, 355, 379 Robertson, Dennis H. (1890–1963) 21, 25, 27, 44, 61, 132, 344, 349, 356, 358–363 Robinson, Edward Austin G. (1897–1993) 61 Robinson, James Harvey (1863–1936) 260 Robinson, Joan V.(1903–1983) 11, 16, 21, 22, 26, 28, 44, 61–64, 66–68, 73–76, 78, 103, 105, 113, 274, 415 Roos, Charles F. (1901–1958) 232, 319 Röpke, Wilhelm (1899–1906) 162, 174 Rosenstein-Rodan, Paul (1902–1985) 178 Rothbarth, Erwin (1913–1944) 400, 401 Roy, René (1894–1977) 240 Rubin, Isaak Il’ich (1886–1937) 244, 246 Russell, Bertrand (1872–1970) 29–31, 34, 36, 38, 196

Author Index

Rüstow, Alexander (1885–1963) 174

S

Samuelson, Paul A. (1915–2009) 15, 138, 145, 148, 254, 258, 274, 277, 305, 313 Savage, Leonard J. (1917–1971) 37, 260 Schäffle, Albert (1831–1903) 369 Schlesinger, Karl (1889–1938) 199, 200, 203 Schlick, Moritz (1882–1936) 161, 163 Schultz, Henry (1893–1938) 232, 256, 303, 320 Schumacher, Hermann (1868–1952) 175, 198 Schumpeter, Joseph A. (1883–1950) 10, 14, 19, 29, 32, 73, 77, 78, 113, 168, 170, 171, 177, 202, 216, 232, 241, 243–245, 254, 262, 270, 272–274, 276–282, 284, 285, 291–293, 307, 309, 321, 343–345, 350, 363, 365, 367, 368, 385, 416, 417 Schutz, Alfred (1899–1959) 178 Seager, Henry R. (1870–1930) 256 Seligman, Edwin R.A. (1861–1939) 256, 260, 261 Shackle, George L.S. (1903–1992) 11, 74, 102, 415 Shove, Gerald F. (1887–1947) 21, 25, 28, 61, 62, 74, 77, 344, 361–363 Silberling, Norman J. (1892–1942) 355 Simons, Henry C. (1889–1946) 19, 254, 302, 303, 305

427

Slutsky, Eugen (Evgeny) (1880– 1948) 18, 135, 136, 229, 232, 245, 246 Sokolnikov, Grigori Yakovlevich (1888–1939) 245 Sombart, Werner (1863–1941) 160, 162, 163, 279, 370 Spann, Othmar (1878–1950) 161, 180 Spiethoff, Arthur (1873–1957) 160, 162 Sraffa, Piero (1898–1983) 11, 16, 21, 22, 44, 61, 64, 66, 68, 74, 243, 344, 349, 350–355, 415 Stackelberg, Heinrich von (1905– 1946) 75, 160, 162, 167–169, 200 Stamp, Josiah C. (1880–1941) 44, 107 Steindl, Josef (1912–1993) 67, 68, 181 Stigler, George J. (1911–1991) 260, 305 Stone, Richard (1913–1991) 403 Svennilson, Ingvar (1908–1972) 220, 221 Sweezy, Alan (1907–1994) 277 Sweezy, Paul M. (1910–2004) 88, 100, 277

T

Taussig, Frank W. (1859–1940) 219, 220, 269, 271–273, 299, 301, 303, 313, 317 Taylor, Fred M. (1855–1932) 285, 304, 372, 373, 386, 389 Tinbergen, Jan (1903–1994) 13, 15, 18, 58, 226–228, 233–239,

428

Author Index

243, 322, 323, 393, 395–398, 400, 401, 418 Tintner, Gerhard (1907–1983) 181, 199, 319, 402 Tisch, Cläre (1907–1941) 372 Tobin, James (1918–2002) 226, 234, 277 Triffin, Robert (1911–1993) 275, 277, 300 Tugwell, Rexford (1891–1979) 259 Tyler, Royall (1884–1953) 393, 394

V

Veblen, Thorstein (1857–1929) 260, 263, 301 Viner, Jacob (1892–1970) 19, 181, 219, 254, 301, 305, 307, 313–318, 332, 359, 368 Vining, Rutledge (1908–1999) 269

W

Wagemann, Ernst (1884–1956) 17, 160, 170, 189 Wald, Abraham (1902–1950) 13, 17, 139, 163, 181, 198–205, 259, 260, 319, 320, 329, 332 Wallace, Donald H. (1903–1953) 276, 277

Webb, Ursula K. (1896–1985) 100, 102, 132, 133 Weber, Alfred (1868–1958) 160, 162 Weber, Max (1864–1920) 17, 160, 178, 306, 370, 380 Wicksell, Knut (1851–1926) 10, 44, 121, 133, 135, 215–217, 220, 222–225, 229 Wieser, Friedrich von (1851–1926) 10, 116, 118, 177, 180 Williams, John H. (1887–1980) 44, 269, 271, 272, 277 Wilson, Edwin B. (1879–1964) 278 Wolman, Leo (1890–1961) 260 Wright, Chester (1879–1966) 303

Y

Yntema, Theodore O. (1900–1985) 75, 303, 304, 320 Young, Allyn A.(1876–1929) 100, 107, 269, 292, 306, 344, 345, 356, 363

Z

Zawadzki, Władysław M.(1885–1939) 232 Zeuthen, Frederik (1888–1959) 200