~700 words, ~4 min reading time
One of the primary contributions of the Austrian school was moving from thinking of goods and people in terms of “classes” to think of them in individual units and as individual people. This emphasis on the individual provided three main insights.
(1) The Law of Diminishing Marginal Utility – while classical economics was stuck on the paradox of value (best seen in the diamond-water paradox, which points out that water is essential for life but cheap while diamonds are mere decoration but are expensive) and had to propose that there was a disconnect between use value and exchange value, Carl Menger pointed out that this paradox is resolved if we think about the usefulness of an additional (that is to say, marginal) unit of the good. While water, as a class, may be very important, the reality is that we have so much of it available in most places that humans live that ADDITIONAL water isn’t really very useful. As a result, water is cheap – we’re not willing to pay much to get more than we already have. Diamonds, however, are very rare. So, we are willing to pay a lot to get an additional one. By thinking in terms of exchanging individual units of the good, Austrians could discover this law of diminishing marginal utility – which connects exchange value with (marginal) use value.
(2) Time Preference – where does interest come from? With their faulty value theory, classical economists were stuck going one of two directions. One group – which led to the Marxian view – suggested that interest was a kind of “surplus value”. The labor embodied in the good was what gave it value, so if the exchange value was greater than that intrinsic value, then the difference was a “surplus” of value. Another group suggested that capital is productive. So, the reason that capitalists earn interest or profit is because they own productive resources. However, both of these views are incorrect. Austrian economist Eugen von Bohm-Bawerk builds on Menger’s individualist view of value to show that what distinguishes capital is not its exploitative nature (which competition between employers would diminish) nor its productivity (which should be fully embodied in the price of the capital good when it is purchased). Rather, it is time. When an individual acts, they demonstrate a preference for sooner want-fulfillment to later want-fulfillment. What a capitalist does, then, is pay for the production of a good up front – knowing that they won’t get the revenue until later. They would only do this if they expect the revenue to be enough greater than the cost that it is worthwhile to delay gratification. That is: if they receive interest. Meanwhile, workers are willing to work at a “discount” below the value of the product precisely because they do not have to wait for the final product to be sold before they receive their pay. They are willing to sacrifice some money in order to get their pay sooner rather than later.
(3) The law of diminishing marginal productivity – finally, thinking in terms of individual units allows for the Austrians to explain, for example, wages (and other factor prices). Factors are paid according to their marginal productivity – that is what an additional unit of the factor would add to production. We can’t arbitrarily divide production of goods from distribution of income. Rather the two are intimately connected. Distribution of income is not arbitrary – rather it comes about as a result of marginal productivity. This thinking also changes the question of class dynamics. Laborers and capitalists should not fight over how to distribute goods between them – the two are partners, as labor and capital are typically complements. (That is, most of the time, having more capital makes labor more productive – raising wages, while having more laborers makes capital more productive as well!) Rather, the conflict should be between members of the SAME class. Rothbard’s example: a new discovery of copper doesn’t hurt workers (who will now have additional jobs available) or consumers (who will find that copper goods are cheaper). It hurts those who ALREADY PRODUCE copper, as they see the price of their product decline. So, then, the Marxian approach suggesting there is some fundamental conflict between labor and capital is incorrect. Rather, conflict exists WITHIN each of these classes – labor v labor and capital v capital.