Carl Menger (1840-1921)

Menger (1871) insisted that economic analysis must start from the single needy indi­vidual; he took Robinson Crusoe (before the latter’s encounter with “Friday”) in Daniel Defoe’s famous novel as the paradigmatic case in point.

The realm of “goods”, that is, things capable of satisfying human needs and wants, may be subdivided in the following way: goods of the first order comprise goods that are directly capable of satisfying human needs and wants, or consumption goods, whereas goods of a higher order are only capable of doing this indirectly: goods of the second order are goods used in the production of goods of the first order, goods of the third order are goods used in the production of goods of the second order, and so on. Goods of higher orders comprise not only intermediate products, or capital goods, but also dif­ferent kinds of labour and the services of nature (land, mineral deposits and so on).

Since, according to Menger’s point of view, the value estimation of individuals deter­mines the prices of goods of the first order, he advocates a recursive structure of the problem of price determination. With the prices of consumption goods taken as already fixed, how are the prices of goods of higher order, including wage rates, rent rates, profits and interest, ascertained? This leads to the (in)famous imputation problem. Menger tried to solve it with reference to the “principle of loss” (which foreshadows the principle of opportunity cost): imagine a certain quantity of a good of higher order would be taken away.

Menger’s solution cannot be sustained. First, think of a bus and take away one of its wheels then it can no longer carry the tourists to the beach and the value of the wheel ought to be equal to the value of the entire transportation and nothing is left to pay the bus driver. The same argument applies also to the other three wheels and we are con­fronted with multiple counting. Second, what about when the number of goods of first order (n) is not equal to the number of all goods of higher order (m), n ≠ m? In the case of n < m the problem would be underdetermined, in the case of n > m it would be overde­termined. Clearly, there is no presumption that n = m. Third, in the case of circular pro­duction, in which commodities are produced by means of commodities (corn by means of corn or steel by means of steel, and so on), which is the normal case in industrialised economies, the hierarchy of goods invoked by Menger loses much of its appeal, because in the extreme one and the same type of good may be contained in each and every order. Fourth, dealing with competitive conditions, costs of production at each and every stage must be discounted forward at the prevailing rate of interest, but how is it determined and how to deal with compound interest? Fifth, is it generally true that consumption goods (goods of the first order) are produced more capital intensively than capital goods (goods of higher order), because they obtain at a later stage of the time-phased process of production? The contention that this is indeed the case was one of the propositions that assumed almost the status of an “iron law” in marginalist or neoclassical theory and gave rise to the view that in the case of a choice of technique the higher is the interest-wage ratio (rlw) the lower will be the capital-labour ratio or capital intensity (KIL), that is:

∂(KIL)I∂(rIw) < 0 (1)

This is supposed to hold with regard to single firms, industries and the economy as a whole.

As regards the determination of the rate of interest (or profit), Menger distinguished between the capital good proper, on the one hand, and its utilisation, on the other. He argued that while the price of the capital good refers only to the capital good proper, interest is a separate price paid for its utilisation.

Already during Menger’s lifetime his theory was criticised harshly by other Austrians. Wieser drew attention to the fact that the proposed solution of the imputation problem was a failure and insisted that the problem cannot be tackled in the successivist manner in which Menger had attempted to solve it, starting from given prices of consumption goods which then had to be split up and divided among the various input factors collabo­rating in its production. In a circular framework, which is characteristic of developed economies in which products are produced by means of products, the problem rather had to be approached in terms of simultaneous equations. This ran counter to some Austrian economists’ opposition to the use of mathematics. Bohm-Bawerk and, later, Schumpeter discarded Menger’s explanation of interest on the ground that it amounted to double counting, because the price of the capital good includes interest and is in fact equal to the sum of the discounted stream of future net profits obtained by utilising the capital good until the end of its economic life. There was no room for a payment in addi­tion to that.