Comparative Economic Organization and the Re-Evaluation of Economic Theory
Convinced by Weber that competitive price theory provided only an archetype of actual competition, Knight began to synthesize neoclassical theory and Weberian comparative history over the 1930s and 1940s.
The final form of his synthesis is summarized for a general audience in the third and fourth chapters of Knight (1960), but pieces of it appear earlier in Knight (Knight 1951; Knight and Merriam 1945). The purpose of the synthesis was to accomplish two tasks simultaneously: (1) distinguish between those aspects of economic analysis which treat conditions as given, and those which provide an analysis under conditions of progress; and (2) use an analysis of individual organization of activity as the context for identifying the fundamental principles of economic rationality and key aspects of competitive theory, while allowing a concurrent examination of the states of social economic organization. The analysis of individual action under given conditions produced a sole individual allocating resources among competing wants according to the equimarginal principle, and drawing upon a Crusonia plant for the replacement of all those aspects of the production process that deteriorated and needed replacement. Savings from current resource use and investment into future resource use not only determined the rate of interest, but also created the conditions for social economic organization to move from exchange of basic necessities among largely self-sufficient units to expand into the organized production of modern economic life. However, it was the “entrepreneur function” that Knight had first identified in Risk, Uncertainty, and Profit that provided the opposite of Crusoe’s life alone on an island with given resources. By investing in new products and re-organizing existing production, entrepreneurs created new conditions for human activity, thereby facilitating the progress of economy and society.The theory of capital and the interest rate embedded in Knight’s theory of economic organization had emerged originally in the context of his debate with Austrian economists. During the 1930s, Knight wrote a sequence of almost a dozen articles on capital theory, specifically targeting Austrian theory. After the initial broadside (Knight 1933), the articles are written in the context of exchanges with Fritz Machlup (Machlup 1935; Knight 1935b), Kenneth Boulding (Knight 1935d), F.A. Hayek (Hayek 1934, 1935; Knight 1935c), and Nicholas Kaldor (Kaldor 1937; Knight 1938). At the end, he wrote a two part article summarizing his view (Knight 1999a: 290-344). At the heart of his argument is the effort to show how the “period of production” concept of Austrian theory is incompatible with pure equilibrium analysis because it changes, in real historical time, the conditions of production while maintaining that all given conditions remain the same - everything remains the same; yet capital has changed.
In cost theory, as in capital theory, Knight set out to reformulate neoclassical theory by stripping away elements of change that had slipped into static equilibrium contexts. Cost became measured in terms of alternative or displaced product (Knight 1928, 1935a), with no mention of the classical theory of abstinence or sacrifice (Knight 1999a: 237-89). Knight’s formulation of cost has become the standard version of opportunity cost theory in economics today (see Buchanan 1969).
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