“The year 1871 . . . is now generally and with justice regarded as the beginning of the modern period in the development of economics.”
The pages of history are filled with the stirring tragedies of great intellects who were ignored by their contemporaries, destined to be rediscovered long after their earthly demise. But this was not the situation with respect to the life and work of Carl Menger.
Indeed, the tale might well be told in reverse of Menger. As the founder of the renowned Austrian School of Economics, as the learned theorist of "subjective value," and as the supreme advocate of the "individualistic methodology," Menger achieved enormous influence in the last four decades of his lifetime. Now, after more than half a century, it is proper to recall the scope and contribution of one of history’s outstanding economists.
Carl Menger was born February 28, 1840, in New-Sandec, Galicia, currently under the dominion of Poland. He was educated in law at the Universities of Prague and Vienna, and received his doctorate from the University of Cracow in 1867. That was a landmark year in the academic history of Austria, for the liberals finally succeeded in getting the Emperor to enact their constitution promoting civil liberties, legal equality, representative government and free trade. It provided the impetus for the intellectual liberation of the barren Austrian universities. As the late Ludwig von Mises, in his interesting study, The Historical Setting of the Austrian School of Economics, comments:
From the middle of the sixteenth to the end of the eighteenth century Austria was foreign to the intellectual effort of Europe . . . . With the exception of Bolzano, no Austrian before the second part of the nineteenth century contributed anything of importance to the philosophical or the historical sciences.
As the backwardness of Austrian academia might indicate, Menger was shown almost nothing in the way of formal economics in his education. It was only by pursuing an intensive course of independent study that he came to familiarize himself with the ideas of Adam Smith, Ricardo, Mill, and the leading French, German and Italian economic thinkers. Menger’s interest in economics had been piqued while working as a commodities analyst and reporter for the official newspaper, Wiener Zeitung. He saw that the conventional value and price theories did little to explain actual changes in the prices of goods. After considerable reading, he began to see that the whole of classical economics had driven itself to a dead end but was refusing to back up and turn around. Indeed, it appeared as if the classical economists had completed their en-tire thesis and saw few new fields to conquer. It remained for Carl Menger to attempt to set the record straight.
Principles of Economics
Menger’s momentous achievement, Grundsätze der Volkswirthschaftslehre (translated as Principles of Economics), was published in 1871. In that same year appeared William Stanley Jevons’ Theory of Political Economy thus marking, as Hayek has concluded above, the beginning of the modern age of economic theory. The Grundsätze was powerful exposition, an economic blockbuster if ever there were one. By force of logic and insight, Menger made it literally inconceivable that classical economics should try to evade the shortcomings of its analysis any longer. The Swedish economist, Knut Wicksell, was led to say fifty years later: "No book since Ricardo’s Principles has had such an influence on the development of economics as Menger’s Grundsätze."
Menger’s treatise began with a thorough rejection of the classical doctrine of cost-value. The classicists (including Marx) had labored diligently to construct a rationale for determining a product’s value by the mechanical task of adding up all the factors that went into its production. The determination of how much should be afforded to each input was awkwardly handled; Adam Smith spoke of distribution between the social classes and set the stage for similar arguments by his successors.
Such a viewpoint was untenable in the mind of Menger. He clearly saw that value was derived only to the extent that a product satisfied a human want. Moreover, the "objective" approach of adding up the various costs produced a discouraging series of vagaries and contradictions. How could costs ever be truly established if every input were merely the result of other, more basic, costs? Why was a diamond found accidentally worth the same as one which was the product of "a thousand days of labor"? Why the eagerness of sellers to offer some goods (clothes out of season or style, for example) at less than "cost"? Why the obvious failure of the cost-value theories to provide for a consistent explanation of the prices of goods, services, land, raw materials, capital and labor of varying efficiencies?
An Undeveloped Area
In spite of such shortcomings, there was little opposition to the conventional thesis in 1871. The Germans, while criticizing the British, had nothing to suggest as an alternative. The British seemed quite content with their formulations; as eminent an economist as John Stuart Mill observed that all that need be said of value had already been covered. Indeed the works of Gossen, Dupuit, and Cournot—earlier experimenters with subjective value ideas—had been buried beneath an avalanche of apathy.
Working in all but a vacuum, then, Menger’s theory took shape in the period from 1868 to 1871. It was meticulously constructed around the essential concept outlined above that goods exist only to serve human satisfactions. Starting with this idea of subjective value, Menger had half his theory. The other half was to be found in the objective relationship in the economy between how much of a good could totally be utilized to satisfy all needs, and how much of the good was in existence.
An economic good was distinguished by the fact that there was a total demand for the good greater than the existing supply; whereas a non-economic good (air, for instance) exists in greater supply than the amount in demand. An economic good would thereby lead men to the function of economizing—making the best use of available but scarce resources. Here Menger inserted his postulation of decreasing want-satisfaction being supplied by each additional increment of a commodity. Later identified as "diminishing marginal utility" by his student Wieser, this concept enabled Menger to create a systematic correlation between the subjective side of value—how much a good meant to individuals, and the objective side of value—the physical comparison between how much was demanded (in total) and how much was in supply.
Value Is Subjective
Carl Menger’s theory of value, then, rests upon both the subjective and objective factors influencing supply and demand. Subjectively the good is qualitatively demanded by the members of society to a certain degree, with the first units valued most highly, the last units valued least highly. Objectively there is a precise quantity of this good in existence. In the case of economic goods the available supply will fall short of satisfying all needs and a certain portion of such needs will go unprovided for. As these unfulfilled wants increase, so does the per-unit value of the needed goods (because of the concept of diminishing marginal utility—in reverse). As the "shortage" becomes larger—as the gap between total wants and total supply grows—the value of a commodity rises. Such was the qualitative-quantitative determination of value and price in the Menger system.
Menger triumphed over classical theory because his alternative was superior from two perspectives. In the first place, his model more correctly identified prices as the result of both subjective and objective criteria, springing from the demands of individuals and the real physical supplies of corresponding goods. The classicists stumbled here because, to the extent that market competition exists, prices tend to be bid down to a point where costs and profits are roughly equal throughout the economy. The illusion is that costs set prices. Disruptions such as unusually good (or bad) harvests, foreign embargoes, or sudden shifts in demand dramatize the shortcomings of such a cost-value theory, yet the classical economists found it difficult to overthrow the mirage that costs set market prices.
A Constant Formula
As Menger produced a more fundamental thesis, the obvious byproduct was also a more universal theorem. Where the classical school needed various manipulations and sociological judgments, Menger needed his single formula. Menger avoided the clumsy tradition of creating several makeshift models for several different factors. He was led to specifically attack separate theories for land ("Land occupies no exceptional place among goods . ."), and labor ("Labor services . . . do not have value as a matter of necessity.") Menger succeeded in including non-material goods in his price theory, dealing with the value of such things as entrepreneurship, money-lending, and a monopoly position in the market place. In short, Menger’s theory made the values of all goods and services explicable in terms of how much human satisfaction would be missed in their absence. The logical superiority of a system with such consistency was the reason for its ultimate predominance.
It is fortunate that Carl Menger lived fifty years past the publication of the Grundsätze because its acceptance did not come instantaneously. Outside the German-speaking countries there existed a language barrier; and within the German influence there was a sweeping sterility in regards to economic theory as a science. The pre-occupation of the German Historicists with data and history was extreme: they went so far as to exclude theoretical economics from the academy altogether. Consequently, Menger was ignored in Germany for many years after the Grundsätze. As Hayek puts it: "Menger’s work was neglected not because the German economists thought he was wrong but because they considered the kind of analysis he attempted was useless."
A Study of Methods
Out of the frustration of neglect came Menger’s second great and lasting work, Investigations Into the Methods of Sociology and Economics. Menger once more unveiled his gift of logical, meticulous reason and structured a broad treatise on the methodological justifications of the science of theoretical economics. While Investigations came to be known as the opening round in the "Methodenstreit" (the vicious German-Austrian debate over methods), the issue was not between competing methodologies. In reality, Menger was only fighting for his philosophical life—for simple existence.
Menger had profited greatly from his German influences and he was the very first to admit it: he had dedicated the Grundsätze "with respectful esteem" to Wilhelm Roscher, godfather of the German Historical School. But historical sentiment had dangerously overdosed in its quest to escape from the confines of British classicism and in creating an intellectual excuse for the rising nationalism of Bismark’s militaristic welfare state.
The primary concern of the Investigations, then, was to espouse the legitimacy of economics as a theoretical science. Menger granted the co-existence of the different approaches to economics as appropriate to complementary disciplines: ". . in the field of economy we encounter individual and general knowledge, and correspondingly sciences of the individual aspect of phenomena and of the general aspect. To the former belong history and the statistics of economy, to the latter theoretical economics."
Menger felt that the Historical School was not at all in error by claiming that every given situation had a different historical setting and that such diversities should be recognized. Menger readily agreed and declared that for economic policy and practical finance it was absolutely necessary to account for historical divergences. In fact, Menger went a step further than. the Germans in calling to their attention all differences in the society. It made no sense to spend tremendous effort to determine the precise historical stage of a nation or community and then to exclude the other relative influences. In allowing for the consideration of historical knowledge in a nation’s economic policy, Menger warns:
“But if at the same time it failed to take into consideration the diverse economic, geographic, and ethnographic conditions of nations at the same stage of development, it could not be acquitted, as scarcely needs to be remarked, of the charge of "absolutism of solutions."
Menger’s perception was quite keen— it saw through the contrived suppositions of the Historical School; in the Investigations it becomes evident that Menger is capable of being a much better historicist than the Historicists. But Menger understood the deeper implications of radical empiricism: the logical conclusion of the historical approach—the idea that everything is relative—was the negation of the social sciences at large. If every situation was unique to the extent that no generalizations could be made, what purpose remained for economics? What could be said in regards to prediction, control, improvement or change? While the stupendous worth of general concepts—of economic "laws"—is nearly evident prima facie to contemporary students, it was under severe attack in the nineteenth-century Deutschland. Carl Menger launched a brilliant one-man counterattack.
A Vicious Reaction
Despite Menger’s wholly academic treatment of the subject and his inclusion of competing perspectives in the realm of respectable pursuits, the German reaction was vehement. Gustav Schmoller, Roscher’s heir to the Historical throne, personally reviewed the Investigations and in inflammatory, offensive language attacked both Menger and his work. Schmoller took delight in immediately imposing a blanket discrimination excluding any Menger follower from gaining a teaching post anywhere in the Reich.
The vicious reaction of the Germans revealed a rancorous sentiment not just toward Menger’s theories, but toward his entire mode of analysis. The clear, precise logic of the subjective theory of value compelled agreement; and the proof of its correctness may be argued by its unanimous acceptance by modern scholars from Chicago to
Moscow a century later. Yet it was the very way in which Menger concocted the premises from which his conclusions inevitably flowed that set the critics into hysterics.
Menger’s framework dealt with an intensive study of individual economic units and the observation of how they do, in fact, behave. Subjective valuation could be derived simply from an analysis incorporating natural human behavior; the theory looked not at the social phenomena that are an outgrowth of individual action, but zeroed in on the individual action itself. It described what the social scientist actually observed.
The economist, Joseph Schumpeter, explained the essence of Menger’s discovery this way:
The critics of Menger’s theory have always maintained that no one could ever have been unaware of the fact of subjective valuation, and that nothing could be more unfair than to put forward such a triviality as an objection to the Classics. But the answer is very simple: it can be demonstrated that almost every one of the classical economists tried to start with this recognition and then threw it away because he could make no progress with it. . . . What matters, therefore, is not the discovery that people buy, sell, or produce goods because and in so far as they value them from the point of view of satisfaction of needs, but a discovery of quite a different kind: the discovery that this simple fact and its sources in the laws of human needs are wholly sufficient to explain the basic facts about all the complex phenomena of the modern exchange economy, and that in spite of striking appearances to the contrary, human needs are the driving force of the economic mechanism.
The machinations of the German Historicists reflect the helplessness certain social scientists feel upon being disarmed. Forced by the weight of Menger’s arguments to see the essential individualism that pervades economic analysis, they astutely (if cowardly) shuddered and turned. They realized that their complicity with the socialist state required an entirely different view of society, and they thereby waged a high-pitched war against Menger and his followers.
The Debate Continues
It is instructive to peek at this century-old intellectual battle and to compare the parallel conflict that still simmers. While statistical and mathematical analysis have nearly displaced general theory in some universities, it must be clearly stated that there are pronounced limits upon such analysis. While numbers can tell us the end results of economic activity, they can never state the explicit reasons why such behavior took place, under what circumstances it will take place again, or how such results may be altered. It remains for general theory, and specifically for Menger’s individualistic methodology, to examine the tiny interrelationships and motivations that, multiplied by millions, give us our economic statistics.
Murray Rothbard has said that books written by the Austrian School look different, feel different and even smell different from books written by other economists. There is no doubt that this is true. And it is precisely because the mode of analysis is so fundamental and individualistic and explicit that such is the case. This is, without question, the underlying reason for the brilliant success of the Austrian School in developing a clean, thorough, consistent and realistic theoretical basis for understanding economic activity.
An Outstanding Contribution
By the 1890′s, Menger, along with his famous pupils Wieser and Böhm-Bawerk, had demolished the German Historicists in academic circles throughout the Western world. The Austrian School arose as a respected and influential center of economic thought, and Menger’s theories of subjective value and individualistic methodology were widely heralded. Above all else, however, there is much to admire about someone who, operating in a barren wasteland of intellectual enterprise, is able to construct his own oasis. As Dr. W.E. Kuhn remarks:
The Austrian [Menger] occupies a place of honor in the history of economic thought not only for his superior performance and moral victory in the Methodenstreit, but also because he evinced a degree of consistency and strict adherence to the requirements of a comprehensive system which was probably unrivaled in the economic writings of the nineteenth century.
The way in which Menger looked upon his mission in life is most refreshing. He thought of himself, not as an actor, but as an ivory tower observer, a critic of the academic performance. Even though the political arena enthusiastically encouraged his involvement, Menger had little desire to participate in the affairs of state. He went so far as to resign his honorary lifetime membership in the Austrian Parliament at a relatively young age. He shunned the bright lights, so to speak, for the burning oil. He was, above all else, an intellectual; a man who lived for ideas.
As Hayek tells us:
"The man who is able to say, as it is reported he [Menger] once said, that if he had seven sons, they should all study economics, must have been extraordinarily happy in his work. That he had the gift to inspire a similar enthusiasm is witnessed by the host of distinguished economists who were proud to call him their master."
Menger’s founding of the Austrian School may well be claimed as the genesis of what we know today as micro-economics. In times dominated by "macro-aggregates" it is easy to side-step the individual transactions that are, per se, the life-blood of economics. As the contemporary predicaments of excess demand and unemployment grow side by side there is apt to be a second look at the "other" economics. How resources are valued and allocated within a society is definitely a question for microtheory and for the individualistic methodology of Carl Menger. There is much to be learned from the Austrian professor.