January 21, 1999
A Note on the Treatment of Davenport's
Loan Fund Theory of Capital by Austrian Economists
Herbert Davenport's name is absent from the most popular history of thought textbooks. So it is little wonder that his loan fund theory of capital has gone unrecognized in mainstream economics. However, since his work is so close to the subjectivism of the Austrian economists, one might expect a more extensive treatment there. However, I have been able to locate only three references relating to capital or interest. Two of them are incorrect and the third is sketchy. The reason for Davenport's neglect appears to be the respect that the Austrians have had for Frank Fetter combined with Fetter's blistering review of Davenport's 1914 book (Fetter 1914). Apparently, no Austrian has read Davenport's book thoroughly enough to see its importance as a genuine contribution to subjectivist economics.
The first reference is in Israel Kirzner's 1975 book (Kirzner 1975: 102-103) . Kirzner links Davenport to Vilfredo Pareto and others as being among a group that was concerned only with the consequences of human behavior -- prices. Since the beginning point of Davenport's analysis of loan fund capital was the reservation demand of individuals for their money-evaluated wealth, just the opposite seems to be true. Judging from Kirzner's citations, he apparently made the error of relying on Fetter's review.(1)
A more accurate reference is provided by O'Driscoll (1980, 542), who says that Davenport was a member of an American School of economists consisting also of J. B. Clark, Fetter, and Fisher, each of whom contributed to the advance of the new marginal utility theory. O'Driscoll presumably does not mean marginal utility theory, however, but the subjective theory of value, since Davenport was a critic of marginal utility theory as such.(2) Moreover, since Fetter's review viciously criticized Davenport's 1914 book, it would seem misleading to put the two in the same club. O'Driscoll (352-3) also cites Davenport as one of many contemporaries who "deferred" to Clark, Fetter and Fisher regarding capital and interest. He quotes a comment by Davenport (1908) that it would be difficult to separate Fetter's ideas from his own. However, O'Driscoll seems to have overgeneralized. Davenport's comment was about the similarity between Fetter's and his own criticism of Bohm Bawerk's roundaboutness doctrine, not about the concepts of capital and interest in general. Other of Davenport's references to Fetter in the 1908 book are less complementary.(3)
Another brief mention of Davenport is in Joseph Salerno's 1994 paper. After pointing out that Davenport accounted for what he calls the "inelasticity of the exchange demand for money [i.e., the transactions demand], Salerno goes on to say that Davenport "provides a surprisingly modern account of the reservation demand for money, as a short-run, speculative phenomenon, but ultimately fails to integrate the two components [the other component being the transactions demand] into a satisfactory overall theory of the demand for money"(Salerno 1994: 83n). It is difficult to understand Salerno's purpose for writing the second part of this remark, since Davenport explained the trade cycle by referring to the desire, on account of time preference, for individuals to hold money for speculation and precaution, instead of for transactions.(4) Salerno does not specify exactly what else would be necessary to construct a satisfactory overall theory of the demand for money. His point appears to be that Davenport's speculative demand did not account for the real balance effect or, more correctly, for the step-by-step reactions of money demanders to falling individual prices that occur during a monetary contraction. Salerno is concerned with the issue that the real balance effect, as usually described, disregards changes in relative prices and the sequence of changes that occur between the initial change and a later equilibrium. However, since Davenport rejected social concepts like the Pigou-Keynes real balance effect (Salerno 1994: 82), he had no need to mention the Misesian step-by-step process (ibid.: 84). It was sufficient to attribute the changing demand for money during a contraction to changing time preference. Indeed, one might argue that Davenport's formulation is superior since it is more fundamental.
Notes
1. Apparently, this error was contagious. The other famous first generation American neo-Austrian, Murray Rothbard, cites the same article as an example of Frank Fetter's "brilliant dissections of various forms of the 'productivity' theory of interest..."(Rothbard, 1962, p. 457n) I argue in Gunning 1998b that Fetter misinterpreted Davenport's discussion of the "productivity" theory.
2. See Gunning 1998a: 112-113. Indeed, the later Fetter (1915) also rejected the idea of utility in favor of an elementary form of praxeology.
3. Davenport wrote a long footnote on Fisher, which concludes that Irving Fisher's view of capital, as well as Frank Fetter's, differs from his view (1908 154n). He criticized Fetter for holding a social view of capital that "can scarcely be regarded as of theoretical adequacy or of practical service when carried over into the field of existing facts"(ibid.: 155). He went on to criticize the contradiction between (a) Fisher's view of capital as a stock and income as a flow and (2) Fisher's inclusion of legal rights in the capital concept. Also in a footnote he criticizes Fetter for occasionally slipping into a materialist definition of capital.(ibid.: 147) Also see p. 213. Contrast this with Murray Rothbard's remark about Fetter's brilliant criticisms of the various forms of the productivity theory of interest (Rothbard 1962: 457n).
4. The problem is that "[f]oreseen future needs are outranking in the present estimate the actual present needs...Falling prices necessarily result"(Davenport 1914: 302-3) Falling prices don't change matters, since the problem is the "current psychological attitude"(ibid.: 303). When will the money emerge from its hiding? Only when expectations change-- when "this retired purchasing power will some day come to realize that prices must finally turn toward rise"(ibid.) Why won't investment solve the problem? There is "no occasion to build more factories or to borrow for more equipment." Thus "savings will not capitalize into forms of intermediate social wealth..." The problem is caused by the "restriction of the disposition to consume."(ibid.: 305)
References
Davenport, H. (1908). Value and Distribution. Chicago: University of Chicago Press.
Davenport, H. (1914). Economics of Enterprise. New York: Macmillan.
Fetter, Frank A., "Davenport's Competitive Economics," Journal of Political Economy, June, 1914.
Fetter, Frank, Economic Principles, Vol. 1, New York: Century Co., 1915.
Gunning, J. Patrick (1998a). "Herbert J. Davenport's Transformation of the Austrian Theory of Value and Cost." in Malcolm Rutherford (ed.). The Economic Mind in America: Essays in the History of American Economics. London: Routledge.
Gunning, J. Patrick (1998b). "H. J. Davenport's Loan Fund Theory of Capital" Journal of the History of Economic Thought. 20: 3 (349-369)
Kirzner, Israel, The Economic Point of View: An Essay in the History of Economic Thought, Kansas City: Sheed and Ward, 1975.
O'Driscoll, Gerald P. "Frank A. Fetter and 'Austrian' Business Cycle Theory," History of Political Economy, Winter, 1980.
Rothbard, Murray N., Man, Economy, and State, Menlo Park, California: Institute for Human Studies, 1962.
Salerno, Joseph T., "Ludwig von Mises's Monetary Theory in Light of Modern Monetary
Thought," The Review of Austrian Economics, Vol. 8, No. 1, 1994.
Copyright © 2000 by James Patrick Gunning
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