[ed. As my first post back, in the new year, I thought I would make it a good one. This post was an essay I turned in for my class on history of economic thought, and I hope it makes up for the dearth of material from me lately.]

Eugen von Bohm-Bawerk was an economist, lawyer, finance minister, teacher, and a founding figure of the Austrian School of economics. Born in 1851 in the city of Brno in the Austria-Hungary Empire, Bohm-Bawerk was initially trained as a lawyer at the University of Vienna. During his education, he first read Menger’s Principles of Economics and it immediately transformed him into an economist. Although he never studied economics under Menger directly, he quickly became an adherent of his work. He also became friends with Friedrich von Wieser, another founding figure of the Austrian School, at the University of Vienna. Wieser would later become Bohm-Bawerk’s brother-in-law.

In the early 1870s, Bohm-Bawerk gained employment at the Austrian ministry of finance, where he held various positions within the ministry. Though his current occupation would prove short-lived and uneventful, Bohm-Bawerk would return later to the ministry of finance with a much stronger influence in economic matters.

Bohm-Bawerk’s teaching career began in 1880 when he qualified as a privatdozent – or, private lecturer – of political economy at the University of Vienna. The following year he transferred to the University of Innsbruck. In 1884, he was promoted to professor, which earned him a steady, salaried position until 1889 when he became councilor in the ministry of finance of Vienna. It was this time as a professor that Bohm-Bawerk had the most time to dedicate to intellectual pursuits, and it was during his academic tenure where he wrote the first two volumes of his magnum opus, Capital and Interest.

As councilor, however, he was busier with more political matters. One of his chief accomplishments was his reform work on the Austrian tax code, which happened to burden production particularly. As councilor, he proposed a modern version of an income tax to replace the existing structure of taxes. His proposal passed, and it soon met with a great deal of success. In 1895, Bohm-Bawerk was promoted to minister of finance. [1] He held this position on and off again until third term where he stayed from 1900 to 1904. In the interim, Bohm-Bawerk was an ambassador to the German court in 1897, and in 1899 was promoted to the House of Peers – an upper level government body. The period between ministry appointments also saw the publication of Bohm-Bawerk’s fiery annihilation of Marxist economics, when his work Karl Marx and the Close of His System was finished in 1896.

As minister of finance, Bohm-Bawerk fought for strict adherence to the nation’s gold standard and consistently tried to balance the Austrian budget. In 1902, he successfully repealed a powerful sugar subsidy that had been in place for centuries. In 1904, Bohm-Bawerk resigned and returned to his teaching position with a chair at the University of Vienna. In 1907, he became the vice-president of the Academy of Science, with a promotion to president in 1911. Bohm-Bawerk died shortly thereafter in 1914, in Kramsach – a small town in Austria.[2]

During his interrupted teaching career, he taught many students including Joseph Schumpeter and Ludwig von Mises.[3] While Schumpeter did not incorporate Bohm-Bawerk’s teachings into his work, Ludwig von Mises did. Despite the unfair charge that “whatever the Austrians got correct, it was already incorporated in Marshall’s Principles,” it was certainly the case that von Mises expanded, elaborated, and refined the advancements made by Bohm-Bawerk, just as Bohm-Bawerk had made similar expansions, elaborations, and refinements from the work of Carl Menger.

Methodologically, Bohm-Bawerk kept in line with his predecessor, Menger. He approached the study of economics as the study of individual action. Methodological individualism is a principle of methodology that looks at the specific actor to determine cause, rather than the whole or in large aggregates. It is mostly an Austrian principle, and it was Menger who popularized its use in economics. While Menger achieved great success in using this principle to describe the origins of money and other economic phenomena, it was left to Bohm-Bawerk to push it further. His classic “parrot example” is an illustration of how marginal utility is determined on the basis of the actions of a single isolated person:

A pioneer farmer had five sacks of grain, with no way of selling them or buying more. He had five possible uses—as basic feed for himself, food to build strength, food for his chickens for dietary variation, an ingredient for making whisky and feed for his parrots to amuse him. Then the farmer lost one sack of grain. Instead of reducing every activity by a fifth, the farmer simply starved the parrots as they were of less utility than the other four uses, in other words they were on the margin. And it is on the margin, and not with a view to the big picture, that we make economic decisions.[4]

In addition to his adherence to the individualism principle, Bohm-Bawerk was also not an empiricist. The preferred method of understanding logical relations between actors and between economic phenomena was not by pouring over statistical tables and divining correlations, but it was by constructing hypothetical constructions – mental abstractions – and trying to isolate certain qualitative variables. While nowhere near as advanced as Mises in so-called “praxeology,” Bohm-Bawerk nevertheless tried to develop theory on the basis of logic, and not experience. He argued that the interest rate is essentially the price of time, not because investors happen to trade money for time, but because it is the interest rate that guides roundabout production and roundabout production can only be undertaken when people choose to wait longer for their consumption. It was a necessary logical relation, rather than a happenstance. It could be said that Bohm-Bawerk held a similar view of methodology as Friedrich Hayek. While not strictly opposed to using available data to argue or explain theory, the necessity of constructing and developing logical arguments to explain the interrelationships of economic phenomena was paramount. Hayek’s work on the rate of interest and price spreads between stages of production is an elaboration of Bohm-Bawerk’s description of roundaboutness – and it is done with sharp logical precision.[5]

As a direct forerunner of the marginal revolution, Bohm-Bawerk was strategically placed to shatter the fallacies of the classical, mercantilist, and Marxist economics that came before him. His greatest contributions included a time-preference theory of interest, the inclusion of time in the development of the capital structure, the refutation of Marxist exploitation theories, and how marginal utility determines prices. In developing his theory of interest, Bohm-Bawerk necessarily had to refute all other possible explanations – including use theories, productivity theories, and exploitation theories. Mises is known to have lamented that Bohm-Bawerk, his teacher, did not take his own theories to their full logical conclusions, and accuses Bohm-Bawerk of adopting a quasi-productivity theory himself and falling into the trap Bohm-Bawerk sets for his contemporaries. [6]

In the discussion of capital, Bohm-Bawerk begins by arguing that all men psychologically prefer goods sooner rather than later, ceteris paribus. Thus, the only reason why men would elect to construct lengthier production processes – that deliver their final output further removed from the actor – is because the process yields a high enough return to justify the waiting. Essentially, Bohm-Bawerk argues that the existence of any production process longer than the absolute minimum illustrates that they must be more physically productive, otherwise no actor would bother waiting. Roundabout production processes, then – when the capitalists are not in error – are therefore more productive processes, and they must be so to make up for the disutility consumers must experience by waiting.[7] The inclusion of the time element in production processes was entirely new, and was at the heart of his debates with J.B. Clark (this debate would resurface between Hayek and Frank Knight in the following decades). Modern macroeconomics, when it bothers to say much at all about capital theory, almost never discusses the fact that capital formation and transformation must take place through time, and it is this time element that brings interest rate theory and capital theory into harmony.

A further contribution of Bohm-Bawerk was the utter devastation he laid to Marx and the Marxists. Prior to Bohm-Bawerk, no economist had bothered to refute Marx’s labor theory of value – but it stood to Bohm-Bawerk to show that even Marx’s own volumes were inconsistent on it. Value, explained Bohm-Bawerk and the marginalists, did not result from any addition of labor or resources, but simply how people subjectively appraised goods. Menger’s early work on subjective theory of value gave Bohm-Bawerk adequate ammunition to rip Marx’s “simple average labor hours” theory to shreds. He furthermore destroyed Marx’s exploitation theories by explaining how “Capitalists do not exploit workers; they accommodate workers-by providing them with income well in advance of the revenue from the output they helped to produce.”[8] [9] Bohm-Bawerk’s work in refuting Marxist economic errors culminated in Mises’ success decades later of refuting socialist economic errors, using more refined theory.[10]

His final major contribution was in showing that it was marginal utility that determined prices, and not the cost of production as so many classical economists had argued. While cost of production may be an upper bound for prices, Bohm-Bawerk concedes, it cannot describe the fluctuations in prices at different places and times. In fact, the only thing that can explain such variations in prices are changes in marginal utilities of the buyers of goods (demanders) and the reservation demand of the current holders of goods (suppliers). Marginal utility determines the demand schedule of both actors in an exchange. [11]

George Reisman, a student of Mises, is famous for his attempts to bridge Austrian economics and Classical/Ricardian economics together.[12] He attempts to justify a “cost of production” theory of prices by referring to Bohm-Bawerk’s parrot example arguing that the marginal utility of grain for the farmer is dependent on how easy or how difficult it is for the farmer to raise grain. If it were difficult to grow, and he could only grow three bags of grain, the marginal utility of grain would be high. On the other hand, if the soil was plentiful and yielding, and the farmer could easily grow nine sacks of grain, the marginal utility would fall. It was this cost of production, Reisman argued, that had an effect on marginal utility. What Reisman misses, and what the British classical economists missed, was that virtually no producer consumes his own product. While it might be true that the value of grain to an isolated farmer is partly determined by the ease of growing the grain, prices on a competitive market or exchange ratios in bargaining are determined by the demand of both the buyer and seller. The price of bread in a grocery store is not any more determined by the cost of grain as the price of fan belts is determined by the cost of leather; both are the price they are because of valuations of other market participants. Prices are not a mirror of value, though they are derived from value. Prices are rather an exchange ratio between goods, and it is this concept of opportunity cost – the subjective valuation of other uses for goods – rather than concrete “costs of production” that determine the prices consumers pay for goods. Bohm-Bawerk, and later Rothbard, illustrates this principle.

While Bohm-Bawerk certainly did not close the book on any topic, his most brilliant and enduring contribution to the Austrian School, and economics in general, must be his work on the relationship between time and the capital structure. The economics profession has unfortunately taken the position of Frank Knight on capital theory and has devoted precious little time in describing its relationship to the rest of the economics profession. Just as money and monetary theory were not properly integrated into the corpus of economic science until 1912[13], so has capital theory been left aside to be treated by specialists in sundry journals, seemingly unrelated to the more general economic picture. The strongest champions of Bohm-Bawerk’s capital theory have been Hayek, Mises, and Rothbard. Combining Bohm-Bawerk’s theories on the physical productivity of roundabout production processes, and Wicksell’s work on the rate of interest, these Austrians have managed to give capital theory the rich integration it needed. Bohm-Bawerk’s work on capital virtually led to the Mises-Hayek theory of the business cycle, as Mises explained how increases in fiduciary media in lending channels leads to unsustainable booms in higher order capital industries, and as Hayek explained how changes in the rate of interest affects price spreads and profit margins of entrepreneurs in more lengthy industries. Mises integrates money and interest theory, Hayek integrates capital and entrepreneurship theory, and the synthesis is one of the most brilliant achievements of economic science. Bohm-Bawerk’s work on the time structure of production was absolutely essential for this discovery (as was Wicksell’s interest theory, Mises’ monetary theory, and Hayek’s theories on entrepreneurship and competition). These four components were intelligently combined by Mises into a coherent and rigorous explanation for trade cycles.[14]

The work done by Bohm-Bawerk in Capital and Interest and Karl Marx and the Close of His System built upon the Mengerian subjectivist foundation with new insights and refinements, rather than rehashed theories and dry mathematics. While certainly not without his methodological or theoretical faults, Bohm-Bawerk was nevertheless a genius who pushed the frontiers of economic science beyond Menger and certainly beyond the Classical economists. As his student, Mises clearly inherited his capacity for penetrating logic and clarity. Roger Garrison writes:

[Mises] indicated that no one could claim to be an economist unless he was perfectly familiar with the ideas advanced in [Capital and Interest], and he even went so far as to suggest–as only Mises could–that no citizen who takes his civic duties seriously should exercise his right to vote until he has read Böhm-Bawerk![15]