Previously in this series: Blogging Menger, a preface to this series of posts.
The great Austrian Economist Friedrich August von Hayek wrote the introduction to the 1976 edition of Menger's Principles. Hayek lays out the intellectual background of Menger's 1871 magnum opus, and it's not a pretty scene. The Classical School of economics which had been dominant in Britain and France since John Stuart Mill's Principles of Political Economy (1848) was "born in sin", based as it was on David Ricardo's fallacious theory of value. Theories of value had always been beset by an obnoxious paradox. Why is a good's use value often so different from its exchange value? Why are such fripperies as diamonds priced so much higher than something as important as water? Ricardo tried to solve this paradox by separating exchange value from utility altogether. Instead, he tied exchange value to labor:
The value of a commodity, or the quantity of any other commodity for which it will exchange, depends on the relative quantity of labour which is necessary for its production.1
According to Ricardo's theory then, diamonds command a higher price than does water, because it requires more labor to dig up diamonds than it does to scoop up water. This, as Menger would prove, is pure fallacy.
Having made that blind turn, mainstream economics had been stumbling around in the bushes ever since. Instead of adopting such a poor economic theory, the German-language economists had largely abandoned theory altogether. Economic theory up to that point had tended toward laissez-faire conclusions, which were highly inconvenient for the German-speaking intellectual class, beholden as it was to the state. The German-speaking intelligentsia therefore developed the Historical School of economics which eschewed the very notion of economic laws which apply to all societies at all times. Since every society was a special case, the Historical schoolmen were free to construct conveniently statist economic prescriptions custom-fitted for their own situation.
So economic theory in the 1850s and '60s was in a sorry state: bad theory in the west and anti-theory in the east. But running through this confused fabric was a single fragile thread of clear thinking; there was, throughout the classical era, a succession of German economists who did not give up on reconciling exchange value with utility. Menger, an avid bibliophile, read them all, and integrated their insights with his own contributions to form a undeniably powerful synthesis which blew away both the Classical and Historical Schools. Thus did Menger, through his Principles of Economics, sire the Marginal Revolution. Unfortunately, he was not its only parent: there were two other co-creators who replaced faulty theory with faulty methodology. What ought to have been a solid new foundation for economics was fissured by new cracks of fallacy which would eventually bring the whole edifice crashing down.
More on that in my next post.
1 David Ricardo, On the Principles of Political Economy and Taxation
Next in this series: The Mathematical Marginalists