It is expedient to substitute the notion of the convertibility of capital goods for the misleading distinction between fixed and free or circulating capital. The convertibility of capital goods is the opportunity offered to adjust their utilization to a change in the data of production. Convertibility is graduated. It is never perfect, i.e., present with regard to all possible changes in the data. In the case of absolutely specific factors it is entirely absent. As the conversion of capital goods from the employment originally planned to other employments becomes necessary through the emergence of unforeseen changes in the data, it is impossible to speak of convertibility in general without reference to changes in the data which have already occurred or are expected. A radical change in the data could make capital goods previously considered to be easily convertible either not convertible at all or convertible only with difficulty.
It is obvious that in practice the problem of convertibility plays a greater role with goods the serviceability of which consists in rendering a series of services over a period of time than with capital goods the serviceability of which is exhausted by rendering only one service in the process of production. The unused capacity of plants and transportation facilities and the scrapping of equipment which according to the plans underlying its production was designed for longer use are more momentous than the throwing away of fabrics and clothing out of fashion and of physically perishable goods. The problem of convertibility is peculiarly a problem of capital and capital goods only in so far as capital accounting makes it especially visible with regard to capital goods. Essentially it is a phenomenon present also in the case of consumers’ goods which an individual has acquired for his own use and consumption. If the conditions which resulted in their acquisition change, the problem of convertibility becomes actual with them too.
Capitalists and entrepreneurs in their capacity as owners of capital are never perfectly free; they are never on the eve of the first decision and action which will bind them. They are always already engaged in some way or other. Their funds are not outside the social process of production, but invested in definite lines. If they own cash, this is, according to the state of the market, either a sound or an unsound “investment”; but it is always an investment. They have either let slip the right moment for the purchase of concrete factors of production which they must buy sooner or later, or the right moment to buy has not yet come. In the first case their holding of cash is unsound; they have missed an opportunity. In the second case their choice was correct.
Capitalists and entrepreneurs in expending money for the purchase of concrete factors of production value the goods exclusively from the point of view of the anticipated future state of the market. They pay prices adjusted to future conditions as they themselves appraise them today. Errors committed in the past in the production of capital goods available today do not burden the buyer; their incidence falls entirely on the seller. In this sense the entrepreneur who proceeds to buy against money capital goods for future production crosses out the past. His entrepreneurial ventures are not affected by changes which in the past occurred in the valuation and the prices of the factors of production he acquires. In this sense alone one may say that the owner of ready cash owns liquid funds and is free.
6. The Influence of the Past Upon Action
The more the accumulation of capital goods proceeds, the greater becomes the problem of convertibility. The primitive methods of farmers and handicraftsmen of earlier ages could more easily be adjusted to new tasks than modern capitalist methods. But it is precisely modern capitalism that is faced with rapid changes in conditions. Changes in technological knowledge and in the demand of consumers as they occur daily in our time make obsolete many of the plans directing the course of production and raise the question whether or not one should pursue the path started on.
The spirit of sweeping innovation may get hold of men, may triumph over the inhibitions of sluggishness and indolence, may incite the slothful slaves of routine to a radical rescission of traditional valuations, and may peremptorily urge people to enter upon new paths leading to new goals. Doctrinaires may try to forget that we are in all our endeavors the heirs of our fathers, and that our civilization, the product of a long evolution, cannot be transformed at one stroke. But however strong the propensity for innovation may be, it is kept in bounds by a factor that forces men not to deviate too hastily from. the course chosen by their forebears. All material wealth is a residuum of past activities and is embodied in concrete capital goods of limited convertibility. The capital goods accumulated direct the actions of the living into lines which they would not have chosen if their discretion had not been restricted by binding action accomplished in the past. The choice of ends and of the means for the attainment of those ends is influenced by the past. Capital goods are a conservative element. They force us to adjust our actions to conditions brought about by our own conduct in earlier days and by the thinking, choosing and acting of bygone generations.
We may picture to ourselves the image of how things would be if, equipped with our present knowledge of natural resources, geography, technology, and hygienics, we had arranged all processes of production and manufactured all capital goods accordingly. We would have located the centers of production in other places. We would have populated the earth’s surface in a different way. Some areas which are today densely inhabited and full of plants and farms would be less occupied. We would have assembled more people and more shops and farms in other areas. All establishments would be equipped with the most efficient machines and tools. Each of them would be of the size required for the most economical utilization of its capacity of production. In the world of our perfect planning there would be no technological backwardness, no unused capacity to produce, and no avoidable shipping of men or of goods. The productivity of human exertion would far surpass that prevailing in our actual, imperfect state.
The writings of the socialists are full of such utopian fancies. Whether they call themselves Marxian or non-Marxian socialists, technocrats, or simply planners, they are all eager to show us how foolishly things are arranged in reality and how happily men could live if they were to invest the reformers with dictatorial powers. It is only the inadequacy of the capitalist mode of production that prevents mankind from enjoying all the amenities which could be produced under the contemporary state of technological knowledge.
The fundamental error involved in this rationalistic romanticism is the misconception of the character of the capital goods available and of their scarcity. The intermediary products available today were manufactured in the past by our ancestors and by ourselves. The plans which guided their production were an outgrowth of the then prevailing ideas concerning ends and technological procedures. If we consider aiming at different ends and choosing different methods of production, we are faced with an alternative. We must either leave unused a great part of the capital goods available and start afresh producing modern equipment, or we must adjust our production processes as far as possible to the specific character of the capital goods available. The choice rests, as it always does in the market economy, with the consumers. Their conduct in buying or not buying settles the issue. In choosing between old tenements and new ones equipped with all the gadgets of comfort, between railroad and motorcar, between gas and electric light, between cotton and rayon goods, between silk and nylon hosiery, they implicitly choose between a continued employment of previously accumulated capital goods and their scrapping. When an old building which could still be inhabited for years is not prematurely demolished and replaced by a modern house because the tenants are not prepared to pay higher rents and prefer to satisfy other wants instead of living in more comfortable homes, it is obvious how present consumption is influenced by conditions of the past.
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 marke
t 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 and 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 f
or 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.
Human Action: A Treatise on Economics Page 73