The Spatial Market Process: Volume 16

In “An Austrian Theory of Spatial Land,” Fred E. Foldvary addresses the disregard of spatial issues in basic Austrian economic theory as formulated by Carl Menger (1871) and elaborated upon by Ludwig von Mises (1940). Foldvary shows that Johann Heinrich von Thünen (1826) and Henry George (1879/1884), in particular, serve to fill these gaps in the classical Austrian theory of the market process. Moreover, a theory that incorporates spatial land leads to the conclusion that Austrian business cycle theory is incomplete: The “malspeculation” that accompanies urbanization whenever capital and labor rather than land are the main sources of tax revenue will have to be added to the malinvestment that is caused by expansionary monetary policies.

Classical economics recognizes three categories of inputs into production: land, labor, and capital goods. The three factors are also germane to Austrian economics.

Besides subjectivism (in terms of value and cost) and the market process approach (as opposed to mainstream economics’ equilibrium analysis), methodological individualism is a foundational methodological principle of Austrian economics. While being (arguably) more consistently and consciously practiced within Austrian economics, methodological individualism is far from unique to this tradition and is a well-recognized principle of inquiry in the social sciences (Watkins, 1952a, 1952b). Needless to say though, methodological individualism remains controversial and discussions of its true meaning and adequateness periodically resurface in the philosophy of science literature (Hodgson, 2007; Udehn, 2002).

The first Austrian school was preoccupied with the nature of capital, its time dimension, and the necessity of interest. The second school also focused on economic dynamics, but with an orientation toward issues related to entrepreneurial activity as well as the use of information and knowledge in economic evolution. The third Austrian school, which was organized around Karl Menger's mathematical colloquium in Vienna, clarified the necessary and sufficient conditions for static and dynamic economic equilibriums. In addition, it created the foundations of economic game and negotiation theories.

In a society with dispersed knowledge, entrepreneurs have to identify opportunities, recognize them as relevant, and match them with (demand) preferences, technological feasibilities, and their own skills. According to Austrian theory, this is done on a subjective basis: different people not only have different preferences but also different perceptions, interpretations, and understandings of values and feasibilities, which they adapt in mutual interaction and communication in specific contexts over their unique life courses (Nooteboom, 2000). Different minds think different things (Lachmann, 1978), and the entrepreneurial opportunities people perceive very much depend on their prior knowledge (Shane, 2000).

According to Ludwig Von Mises (1949/1963), economics studies the causes and consequences of goal-directed action. Each of us seeks to improve our situations as we see it. But just how each of us perceives our situation, and what alternative ends and means we believe are available to us, depends crucially on the context.² Action is never without context but is instead undertaken by someone for something at a certain time and a certain place (Hayek, 1945).

The types of innovation considered to be Schumpeterian can be very broad. What is an innovation? According to The Advanced Learner's Dictionary (Hornby, Gatenby, & Wakefield, 1973, p. 545), an innovation is “something new that is introduced.” This covers both inventions and their introduction. Thus, introducing methods to a new market can certainly be a form of Schumpeterian innovation. Schumpeter, however, distinguished innovations (innovators) from inventions (inventors) (Swedberg, 1991, p. 173). He considered innovations as the prime movers in the capitalist process. Johannessen, Olsen, and Lumpkin (2001) dwell on six measures of the “newness” of an innovation based on his interpretation of Schumpeter and others, but glossed over the distinction between innovations and inventions. What, then, was Schumpeter's original formulation?

“Unplanned city” (and its relation “unchecked growth”) is the way many people describe cities of which they disapprove. They usually mean too little top-down planning, assuming that this is the only planning possible. But Stephen Davies, describing urbanization in England, shows that this was not always so. He notes that,[t]he years between 1740 and 1850 therefore saw an unprecedented amount of urban growth. Cities and towns of all kinds and sizes grew more rapidly and on a greater scale than ever before in history. The rapidly increasing population was drawn into the towns in ever larger numbers with the rise of industry, creating an enormous demand for housing and the urban fabric in general. This was the kind of situation that, when its like happens today, is regularly described in terms of “crisis” or even “catastrophe”. And yet the challenge was largely met. Housing and other facilities were built and provided. The towns of Britain grew to meet the new demands of a growing population and a transformed economy. There were no great shantytowns around growing cities such as Manchester and Birmingham. Instead a tidal wave of brick and stone swept over fields, turning them into new urban areas. Moreover, the period also saw the creation of great architectural achievements of lasting value in both the great cities and the new towns …. The elegance of Bath and Cheltenham, the West End of London and Bloomsbury, the New Town in Edinburgh, and the centers of Glasgow and Newcastle-upon-Tyne – all were built in this period. As this was the first instance of such wide-spread urbanization our understanding of its nature is crucial for our thinking about the process of urbanization in general, whether historically or today. In particular this instance raises the question of how urbanization can happen in the absence of an apparatus of planning and controls, by voluntary means, and what the results of this may be. (Davies, 2002, p. 19)

One aspect of agglomeration economies is economies of scale. When automobile production centered in Detroit in the early part of the twentieth century, this allowed more efficient production methods, which lowered the per-unit cost of output. Arrow (2000) emphasizes the tension between increasing returns to scale and equilibrium models, and as Young (1928) noted, increasing returns to scale is at the foundation of economic progress. Kaldor (1972), building on Young's insights, noted that static neoclassical economic models did not do a good job of depicting the economic progress that results from increasing returns to scale in production. This insight goes at least as far back as Adam Smith (1776), however, who noted the increased productivity that comes with an increased division of labor. Smith's example of the pin factory, where individuals specializing in one small part of a larger manufacturing operation increase productivity by, perhaps, hundreds of times, shows the benefits of agglomeration economies. The division of labor is limited by the extent of the market, Smith argued, so enlarging the extent of the market allows for a greater division of labor, which increases productivity and generates prosperity. By concentrating automobile production in Detroit rather than having automobiles locally built, the extent of the market is increased from one locality to an entire nation, and in some cases an entire world. The resulting agglomeration economies increase productivity and produce prosperity.

The market is not the only spontaneous order. Hayek himself drew attention to language and English common law as other examples, noting that they had first been identified as such by Scottish Enlightenment philosophers such as Adam Smith and Adam Ferguson. Hence, such orders “are made with equal blindness to the future; and nations stumble upon establishments, which are indeed the results of human action, but not the execution of any human design” (Ferguson, 1782, sec. II). In the 20th century, Michael Polanyi used the term spontaneous order for the polycentric feedback system that explains the growth of scientific knowledge (Polanyi, 1962).

What I will call the generic theory basically affirms that there often exists a disparity between the intentions of the actors and the outcome of their actions that gives rise to side-effects that are neither expected nor predictable.⁴ Unintended consequences are “incongruent” consequences, because what is in place in this case is a disparity between an action's original purpose and its results (Ermolaeva & Ross, 2011). This occurs because whenever we carry out our intentions in a complex world, there will be countless side-effects that could only partly be foreseen; most of the outcome depends on a series of combined reactions of a largely random nature. In other words, the interplay of forces and circumstances are so numerous and complex that it is impossible to consider all possible outcomes in advance. We can therefore say that any action has immediate effects – to some extent intentional and predictable – along with remote side-effects that are not necessarily intended or predictable. By acting we (intentionally) bring about certain things, while (unintentionally) provoking other things.

An NBM is a market form in that it is made of institutions and business models. It arises in a particular context where abundant novelty issuing from the producer side meets substantial search costs and evaluation difficulties on the consumer side. In a NBM consumers don’t necessarily know what they are searching for. These difficulties on the demand side are specifically caused by the fact that novel goods, which are experience goods, often require new “rules for choice” as new suites of evaluative criteria.

The level of financial development is a key factor influencing long-term economic growth. A high level of financial development allows for the effective diversification of risk and allocation of capital, which, in the long run, improves the growth prospects of an economy. Schumpeter (1911) was one of the first to highlight the importance of financial development as a determinant of economic growth. Recent empirical work supports this relationship (see Beck & Levine, 2002; Levine, 2004; Mishkin, 2007). For example, Levine (2004) summarizes the empirical evidence on financial development and economic growth and states that “the level of financial development is a good predictor of future rates of economic growth, capital accumulation and technological change” (Levine, 1997, p. 689).² Thus, stock and forward markets spread knowledge about market expectations of factors and changes that are important for economic development (Lachmann, 1978).

The neoclassical theory of investments, as formulated by Dale Jorgenson (1963, 1967), can be expressed in a fairly straightforward way.¹ Neoclassical formulations such as Jorgenson's were preceded by contributions by many influential economists. Both John Maynard Keynes and Irving Fisher, for example, argued that investments are made until the present value of expected future revenues, at the margin, equals the opportunity cost of capital. This means that investments are made until the net present value is equal to zero.