Human Action: A Treatise on Economics

by Ludwig Von Mises

  The fact that not every technological improvement is instantly applied in the whole field is not more conspicuous than the fact that not everybody throws away his old car or his old clothes as soon as a better car is on the market or new patterns become fashionable. In all such things people are motivated by the scarcity of goods available.

  A new machine, more efficient than those used previously, is constructed. Whether or not the plants equipped with the old, less efficient machines will discard them in spite of the fact that they are still utilizable and replace them by the new model depends on the degree of the new machine's superiority. Only if this superiority is great enough to compensate for the additional expenditure required, is the scrapping of the old equipment economically sound. Let p be the price of the new machine, q the price that can be realized by selling the old machine as scrap iron, a the cost of producing one unit of product by the old machine, b the cost of producing one unit of product by the new machine without taking into account the costs required for its purchase. Let us further assume that the eminence of the new machine consists merely in a better utilization of raw material and labor employed and not in manufacturing a greater quantity of products and that thus the annual output 2 remains unchanged. Then the replacement of the old machine by the new one is advantageous if the yield z (a — b) is large enough to make good for the expenditure of p — q. We may disregard the writing off of depreciation in assuming that the annual quotas are not greater for the new machine than for the old one. The same considerations hold true also for the transfer of an already existing plant from a place in which conditions of production are less favorable to a location offering more favorable conditions.

  Technological backwardness and economic inferiority are two different things and must not be confused. It can happen that a production aggregate which from a merely technological point of view appears outclassed is in a position to compete successfully with aggregates better equipped or located at more favorable sites. The degree of the superiority provided by the technologically more efficient equipment or by the more propitious location as compared with the surplus expenditure required for the transformation decides the issue. This relation depends on the convertibility of the capital goods concerned.

  The distinction between technological perfection and economic expediency is not, as romantic engineers would have us believe, a feature of capitalism. It is true that only economic calculation as possible solely in a market economy gives the opportunity to establish all the computations required for the cognition of the relevant facts. A socialist management would not be in a position to ascertain the state of affairs by arithmetical methods. It would therefore not know whether or not what it plans and puts into operation is the most appropriate procedure to employ the means available for the satisfaction of what it considers to be the most urgent of the still unsatisfied wants of the people. But if it were in a position to calculate, it would not proceed in a way different from that of the calculating businessman. It would not squander scarce factors of production for the satisfaction of wants deemed less urgent if this would prevent the satisfaction of more urgent wants. It would not hurry to scrap still utilizable production facilities if the investment required would impair the expansion of the production of more urgently needed goods.

  If one takes the problem of convertibility into proper account, one can easily explode many widespread fallacies. Take, for instance, the infant industries argument advanced in favor of protection. Its supporters assert that temporary protection is needed in order to develop processing industries in places in which natural conditions for their operation are more favorable or, at least, no less favorable than in the areas in which the older established competitors are located. These older industries have acquired an advantage by their early start. They are now fostered by a merely historical, accidental, and manifestly “irrational” factor. This advantage prevents the establishment of competing plants in areas the conditions of which give promise of becoming able to produce more cheaply than, or at least as cheaply as, the old ones. It may be admitted that protection for infant industries is temporarily expensive. But the sacrifices made will be more than repaid by the gains to be reaped later.

  The truth is that the establishment of an infant industry is advantageous from the economic point of view only if the superiority of the new location is so momentous that it outweighs the disadvantages resulting from the abandonment of nonconvertible and nontransferable capital goods invested in the older established plants. If this is the case, the new plants will be able to compete successfully with the old ones without any aid given by the government. If it is not the case, the protection granted to them is wasteful, even if it is only temporary and enables the new industry to hold its own at a later period. The tariff amounts virtually to a subsidy which the consumers are forced to pay as a compensation for the employment of scarce factors of production for the replacement of still utilizable capital goods to be scrapped and the withholding of these scarce factors from other employments in which they could render services valued higher by the consumers. The consumers are deprived of the opportunity to satisfy certain wants because the capital goods required are directed toward the production of goods which were already available for them in the absence of tariffs.

  There prevails a universal tendency for all industries to move to those locations in which the potentialities for production are most propitious. In the unhampered market economy this tendency is slowed down as much as due consideration to the inconvertibility of scarce capital goods requires. This historical element does not give a permanent superiority to the old industries. It only prevents the waste originating from investments which bring about unused capacity of still utilizable production facilities on the one hand and a restriction of capital goods available for the satisfaction of unsatisfied wants on the other hand. In the absence of tariffs the migration of industries is postponed until the capital goods invested in the old plants are worn out or become obsolete by technological improvements which are so momentous as to necessitate their replacement by new equipment. The industrial history of the United States provides numerous examples of the shifting, within the boundaries of the country, of centers of industrial production which was not fostered by any protective measures on the part of the authorities. The infant industries argument is no less spurious than all the other arguments advanced in favor of protection.

  Another popular fallacy refers to the alleged suppression of useful patents. A patent is a legal monopoly granted for a limited number of years to the inventor of a new contrivance. At this point we are not concerned with the question whether or not it is a good policy to grant such exclusive privileges to inventors.14 We have to deal only with the assertion that “big business” misuses the patent system to withhold from the public benefits it could derive from technological improvement.

  In granting a patent to an inventor the authorities do not investigate the invention's economic significance. They are concerned merely with the priority of the idea and limit their examination to technological problems. They deal with the same impartial scrupulousness with an invention which revolutionizes a whole industry and with some trifling gadget, the uselessness of which is obvious. Thus patent protection is provided to a vast number of quite worthless inventions. Their authors are ready to overrate the importance of their contribution to the progress of technological knowledge and build exaggerated hopes upon the material gain it could bring them. Disappointed, they grumble about the absurdity of an economic system that deprives the people of the benefit of technological progress.

  The conditions under which it is economical to substitute new improved equipment for still utilizable older tools have been pointed out above. If these conditions are absent, it does not pay, either for private enterprise in a market economy or for the socialist management of a totalitarian system, to adopt the new technological process immediately. The new machinery to be produced for new plants, the expansion of already existing plants a
nd the replacement of old equipment torn out will be effected according to the new design. But the still utilizable equipment will not be scrapped. The new process will be adopted only step by step. The plants equipped with the old devices are for some time still in a position to stand the competition of those equipped with the new ones. Those questioning the correctness of this statement should ask themselves whether they always throw away their vacuum cleaners or radio sets as soon as better models are offered for sale.

  It does not make any difference in this regard whether the new invention is or is not protected by a patent. A firm that has acquired a license has already expended money for the new invention. If it nonetheless does not adopt the new method, the reason is that its adoption does not pay. It is of no avail that the government-created monopoly which the patent provides prevents competitors from applying it. What counts alone is the degree of superiority secured by the new invention as against old methods. Superiority means reduction in the cost of production per unit or such an improvement in the quality of the product that buyers are ready to pay adequately higher prices. The absence of a sufficient degree of superiority to make the cost of transformation profitable is proof of the fact that consumers are more intent upon acquiring other goods than upon enjoying the benefits of the new invention. It is the consumers with whom the ultimate decision rests.

  Superficial observers sometimes fail to see these facts because they are deluded by the practice of many big enterprises of acquiring the rights granted by a patent in their field regardless of its usefulness. This practice stems from various considerations:

  The economic significance of the innovation is not yet recognizable.

  The innovation is obviously useless. But the firm believes that it could develop it in such a way as to make it useful.

  The immediate application of the innovation does not pay. But the firm intends to apply it later when replacing its worn-out equipment.

  The firm wants to encourage the inventor to continue his research in spite of the fact that up to now his endeavors have not resulted in a practically utilizable innovation.

  The firm wants to placate litigious inventors in order to spare the money, time, and nervous strain which frivolous infringement suits bring about.

  The firm resorts to hardly disguised bribery or yields to veiled blackmail when paying for quite useless patents to officers, engineers, or other influential personnel of firms or institutions which are its customers or potential customers.

  If an invention is so superior to the old processes that it makes the old equipment obsolete and peremptorily demands its immediate replacement by new machines, the transformation will be effected no matter whether the privilege conferred by the patent is in the hands of the owners of the old equipment or of an independent firm. The assertions to the contrary are based on the assumption that not only the inventor and his attorneys but also all people already active in the field of production concerned or prepared to enter into it if an opportunity is offered to them fail entirely to grasp the importance of the invention. The inventor sells his rights to the old firm for a trifle because no one else wants to acquire them. And this old firm is also too dull to see the advantages that it could derive from the application of the invention.

  Now, it is true that a technological improvement cannot be adopted if people are blind to its usefulness. Under a socialist management the incompetence or stubborness of the officers in charge of the department concerned would be enough to prevent the adoption of a more economical method of production. The same is the case with regard to inventions in fields dominated by the government. The most conspicuous examples are provided by the failure of eminent military experts to comprehend the significance of new devices. The great Napoleon did not recognize the help which steamboats could give to his plans to invade Great Britain; both Foch and the German general staff underestimated on the eve of the first World War the importance of aviation, and later the eminent pioneer of air power, General Billy Mitchell, had very unpleasant experiences. But things are entirely different in the orbit in which the market economy is not hampered by bureaucratic narrow-mindedness. There a tendency to overrate rather than to underestimate the potentialities of an innovation prevails. The history of modern capitalism shows innumerable instances of abortive attempts to push innovations which proved futile. Many promoters have paid heavily for unfounded optimism. It would be more realistic to blame capitalism for its propensity to over-value useless innovations than for its alleged suppression of useful innovations. It is a fact that large sums have been wasted for the purchase of quite useless patent rights and for fruitless ventures to apply them in practice.

  It is absurd to speak of an alleged bias of modern big business against technological improvement. The great corporations spend huge sums in the search for new processes and new devices.

  Those lamenting an alleged suppression of inventions on the part of free enterprise must not think that they have proved their case by referring to the fact that many patents are either never utilized at all or only used after a long delay. It is manifest that numerous patents, perhaps the far greater number of them, are quite useless. Those alleging suppression of useful innovations do not cite a single instance of such an innovation's being unused in the countries protecting it by a patent while it is used by the Soviets—no respecters of patent privileges.

  The limited convertibility of capital goods plays an important role in human geography. The present distribution of human abodes and industrial centers over the earth's surface is to a certain degree determined by historical factors. The fact that definite sites were chosen in a distant past is still operative. There prevails, it is true, a universal tendency for people to move to those areas which offer the most propitious potentialities for production. However, this tendency is restrained not only by institutional factors, such as migration barriers. A historical factor also plays a momentous role. Capital goods of limited convertibility have been invested in areas which, from the point of view of our present knowledge, offer less favorable opportunities. Their immobilization counteracts the tendency to locate plants, farms, and dwelling places according to the state of our contemporary information about geography, geology, plant and animal physiology, climatology, and other branches of science. Against the advantages of moving toward sites offering better physical opportunities one must weigh the disadvantages of leaving unused capital goods of limited convertibility and transferability.

  Thus the degree of convertibility of the supply of capital goods available affects all decisions concerning production and consumption. The smaller the degree of convertibility, the more realization of technological improvement is delayed. Yet it would be absurd to refer to this retarding effect as irrational and antiprogressive. To consider, in planning action, all the advantages and disadvantages expected and to weigh them against one another is a manifestation of rationality. Not the soberly calculating businessman, but the romantic technocrat is to blame for a delusive incomprehension of reality. What slows down technological improvement is not the imperfect convertibility of capital goods, but their scarcity. We are not rich enough to renounce the services which still utilizable capital goods could provide. The fact that a supply of capital goods is available does not check progress; it is, on the contrary, the indispensable condition of any improvement and progress. The heritage of the past embodied in our supply of capital goods is our wealth and the foremost means of further advancement in well-being. It is true, we would be still better off if our ancestors and we ourselves in our past actions had succeeded in better anticipating the conditions under which we must act today. The cognizance of this fact explains many phenomena of our time. But it does not cast any blame upon the past nor does it show any imperfection inherent in the market economy.

  7. Accumulation, Maintenance and Consumption of Capital

  Capital goods are intermediary products which in the further course of production activities are transformed into consumers' goods. All ca
pital goods, including those not called perishable, perish either in wearing out their serviceableness in the performance of production processes or in losing their serviceableness, even before this happens, through a change in the market data. There is no question of keeping a stock of capital goods intact. They are transient.

  The notion of wealth constancy is an outgrowth of deliberate planning and acting. It refers to the concept of capital as applied in capital accounting, not to the capital goods as such. The idea of capital has no counterpart in the physical universe of tangible things. It is nowhere but in the minds of planning men. It is an element in economic calculation. Capital accounting serves one purpose only. It is designed to make us know how our arrangement of production and consumption acts upon our power to satisfy future wants. The question it answers is whether a certain course of conduct increases or decreases the productivity of our future exertion.

  The intention of preserving the available supply of capital goods in full power or of increasing it could also direct the actions of men who did not have the mental tool of economic calculation. Primitive fishermen and hunters were certainly aware of the difference between maintaining their tools and devices in good shape and serviceableness and wearing them out without providing for adequate replacements. An old-fashioned peasant, committed to traditional routine and ignorant of accountancy, knows very well the significance of maintaining intact his live and dead stock. Under the simple conditions of a stationary or slowly progressing economy it is feasible to operate successfully even in the absence of capital accounting. There the maintenance of a by and large unchanged supply of capital goods can be effected either by current production of pieces destined to replace those worn out or by the accumulation of a fund of consumers' goods which makes it possible to devote effort at a later time toward the replacement of such capital goods without being forced to restrict consumption temporarily. But a changing industrial economy cannot do without economic calculation and its fundamental concepts of capital and income.