(Great Thinkers in Economics) David Cowan (Auth.) - Frank H. Knight - Prophet of Freedom-Palgrave Macmillan UK (2016)
(Great Thinkers in Economics) David Cowan (Auth.) - Frank H. Knight - Prophet of Freedom-Palgrave Macmillan UK (2016)
(Great Thinkers in Economics) David Cowan (Auth.) - Frank H. Knight - Prophet of Freedom-Palgrave Macmillan UK (2016)
FRANK H. KNIGHT
Prophet of Freedom
David Cowan
Great Thinkers in Economics
Series Editor
A.P. Thirlwall
School of Economics
University of Kent
Canterbury, United Kingdom
The famous historian, E.H. Carr once said that in order to understand
history it is necessary to understand the historian writing it. The same
could be said of economics. Famous economists often remark that specific
episodes in their lives, or particular events that took place in their forma-
tive years attracted them to economics. This new series Great Thinkers
in Economics is designed to illuminate the economics of some of the
great historical and contemporary economists by exploring the interac-
tion between their lives and work, and the events surrounding them.
Frank H. Knight
Prophet of Freedom
David Cowan
Boston College
MA, USA
Cover illustration: © Courtesy of the Special Collections Research Center, University of Chicago Library
1 A Prophet and a Pioneer 1
2 Knightian Uncertainty 27
ix
x Contents
Bibliography 271
Index 281
1
A Prophet and a Pioneer
1 God’s Prophet
The subtitle for this book on Frank Hyneman Knight (1885–1972) is in
part inspired by what his students said of him, which is “There is no God,
but Frank Knight is his prophet.” However, the main reason for the title
is that it is one that describes the voice that Knight had in the economics
profession in his time, namely that of prophet in the deep sense in which
theologians talk about prophecy. The popular conception of a prophet
is of someone who warns believers of the future. The more refined view
is that a prophet is someone who reveals laws, speaks to the nature of
persons as they are and warns them of the path they should tread and the
outcome of their errors. Biblical prophets were not particularly popular
people, because they had a habit of telling people what they did not want
to hear. Knight, whose curmudgeonly persona was not out of place with
a Jeremiah or Isaiah, was similarly direct and sought to reveal economic
truths, warning us, cajoling us in the hope of eliciting a realistic response.
As one of my old teachers wrote of prophetic speech, “Contingent lan-
guage is not directly predictive but is threatening or warning. It is not
designed to forecast the future but to create responses” (Carroll 1979,
p. 67). Knight certainly tried to create responses.
2 An Observer of Fools
Frank Knight was born on 7 November in 1885, making 2015 the 130th
anniversary of his birth. He was born 2 years after John Maynard Keynes,
and died in 1972, surviving Keynes who died in 1946, by a quarter of
a century. However, Keynes rose to pre-eminence in economics, while
Knight is best remembered for bringing to light the true economic signif-
icance of risk, and being the cofounder of the highly influential Chicago
School of Economics. Perhaps it was fitting that Knight, a teacher by
instinct and temperament, should find his real influence through a School
rather than in his own name. Reading his articles and book reviews in
particular, one is struck by the number of times Knight takes a negative
turn rather than setting out first to prove a positive point or going on to
offer a solution. His methodology was one of razing to the ground the
views or arguments of his target and then, seeing what had withstood the
attack, he sought to build our understanding in the way he wanted us to
understand, so that we could join him as economic realists.
Born into humble origins, Knight was the first of eleven children of
Winton Cyrus Knight and Julia Ann Hyneman Knight, born in White
Oak Township, the smallest town in Mclean County, Illinois, with a
population that today is still below 1000. The town’s most historic site is
a marker that notes Abraham Lincoln rode through the township before
becoming president. Knight’s grandfather, Moses H Knight, was a church
pastor who had settled in the county in 1850 and been ordained in 1858,
serving the church in Lower and Upper White Oak. A history of the
county records that Moses “In his preaching trips he traveled horseback
or walked. Much of his service was without financial compensation. He
was a pure, true and efficient servant of God and men.” (Haynes 1915,
p. 553) One of his sons, James W. Knight, entered the ministry as well,
and it seemed that the church was very much a family business, alongside
farming. Knight was raised on a farm in a household that followed the
Disciples of Christ, his brothers Bruce and Melvin, also went on to teach
economics at Dartmouth and Berkeley denomination. Although his fam-
ily was religious and adorned with pastors, religion for Knight was always
a source for skepticism, as the May 28th 1972 edition of the Chicago
4 Frank H. Knight
Tribune noted on his death, “His skepticism, one of the trademarks of his
brilliance in economic analysis, also carried over into other fields. Former
students recall that his two great whipping boys were medical doctors
and the clergy. He considered the clergy a form of quackery as bad as he
regarded doctors. Both of them, Knight considered, pretended to know
things that couldn’t be known.”
He may have rejected organized religion, but he did his first aca-
demic work at Christian universities in East Tennessee, and he retained
a keen interest in theology for the rest of his life. Because of the farm
work, Knight did not complete high school, but he was able to enter the
American Temperance University, a theologically conservative college in
an alcohol-free town of Harriman 40 miles west of Knoxville at the age
of 20, but the university failed financially and closed in 1908. Knight
had studied a range of subjects there, including chemistry, mathematics
and German. Such was the financial modesty of the college resources he
also acted as administrator and tutor. Knight moved to Milligan College,
100 miles east of Knoxville, where he graduated 3 years later. At Milligan,
Knight met his first wife Minerva Olena Shelbourne, who started at the
college in 1908 and graduated in 1911 as the top student in her class,
above Knight. They married just before the graduation ceremony, and
spent the next 16 years together, with Minerva balancing family life with
ongoing studies in philosophy, eventually gaining a PhD in the 1930s.
Their divorce came on the eve of the “great depression,” but Knight con-
tinued to provide a generous alimony and child support, as she contin-
ued to work at the University of Iowa for the rest of her professional
career. In the meantime, Knight entered the University of Tennessee in
Knoxville, graduating in 1913, before taking his doctorate at Cornell in
1916, where he also started his teaching career. Knight’s doctoral disserta-
tion was entitled “A Theory of Business Profits”, which was supervised by
Allyn Young who wrote to Knight saying this was the best thesis that had
ever passed through his hands.1 Knight regarded Young as the greatest
influence on his intellectual formation. The thesis was awarded the Hart,
Schaffner and Marx economic essay prize in 1917, and was reworked to
become his classic work Risk, Uncertainty and Profit. Knight switched
1
Knight Papers, box 62, folder 24, Special Collections Research Center, University of Chicago
Library.
1 A Prophet and a Pioneer 5
I want some sort of religious connection, and while these people are really
about as dogmatic and opinionated as any…at least they stand theoreti-
cally for a truth seeking attitude.”2 He was very active in various groups,
including the Men’s Group, teaching the Sunday school, and leading
discussion in other study groups. His wife Minerva was also involved
in teaching the Sunday school and the woman’s group, which she con-
tinued to do after Knight’s departure to Chicago and their divorce. The
Unitarians are cut from a different cloth than the conservative evangelical
church of Knight’s upbringing, and whilst rooted in the Jewish-Christian
tradition, they deny the Christian doctrine of the Trinity of the Godhead
and the divinity of Jesus. This liberal and rationalist form of faith was
new to Knight the sceptic, and he joined because he wanted to keep some
religious connection without doctrine being too evident.
Life in Iowa and Chicago was not all about economics and religion,
he was a great lover of books, poetry and other cultural pursuits. He
also enjoyed the company of close friends. His second wife Ethel Verry
Knight in conversation with Norquist told him about the bonfire talks he
would have with friends, explaining Knight:
…had a lot of gusto, a lot of enjoyment in life. In Iowa, I know one of the
things he liked…they used to go out [out into the country] and build a big
bonfire – they drank, I guess, it was prohibition time. Anyway, they had
awful things to drink, and they just had one whee of a good time. (Emmett
2011, p. 12)
He was then promoted to full professor, which may have been to pre-
vent him from accepting an appointment at Harvard University, though
his widow in the Norqist interview explained, “he wouldn’t go because
he said he wouldn’t shake hands with people that were involved in the
Sacco-Vanzetti case” (Emmett 2011, p. 6). The case, extending over
the 7 years 1920–27, involved Nicola Sacco and Bartolomeo Vanzetti,
who were anarchist immigrants from Italy. These men were tried and
executed in 1927 for armed robbery and murder. Another man fled to
Italy. The case remained controversial, with a fresh investigation in 1961,
2
Quoted in Ebenstein, Lanny, Chicagonomics (St. Martin’s Press, NY. 2015).
1 A Prophet and a Pioneer 7
Since the founding of the Nobel Prize for economics in 1968 there have
been 26 Chicago Nobel laureate economists, a testimony to the place of
the School in the economics firmament. Too late for such a prize, Frank
Knight never made this list, though he is one of four Chicago econo-
mists to have been awarded the American Economic Association Walker
Medal, the closest to a Nobel Prize for an American scholar at the time.
Aside from Knightian uncertainty, Knight’s legacy in economics has been
as a founder of the Chicago school, a status he shares with Jacob Viner,
and as the teacher of some of the Chicago alumni on the prestigious list
of Nobel winners. Perhaps a reason why Knight has not been lauded in
the way some of his colleagues and students have, is because of his com-
mitment to teaching, along with his desire to explore the philosophical
underpinning of economics, thus excluding him from such accolades. It
may also be because he never moved in the political and consulting circles,
as Keynes did successfully for a period, and hence did not inspire or have
an impact on economic policy. Another explanation may be that Knight
1 A Prophet and a Pioneer 9
was never a theorist; rather he sought to ask questions and sharpen the
definition of key terms in economics, as he explained in a letter to Viner
in 1925, where he himself stated he had little skill as a theorist.3 To say
Knight was a co-founder is not to say he consciously set about creating
such a School, rather it is to read backwards into the origins of the move-
ment and miss his legacy of teaching price theory in Chicago. Viner him-
self wrote later that it was not until 1946 that he began to hear “rumours”
about such a “Chicago School” (Patinkin 1981, p. 266).
The Chicago School really became famous after World War II, with
the first mention in print of “The Chicago School” appearing in 1971
(Overtveldt 2007, p. 6). It was to become especially famous in its 1980s
heyday, though even disregarding those controversial years the school con-
sistently remained home to Nobel economists and exerted corresponding
influence. Arguably, and because of the 1980s, the most famous among
them was Milton Friedman, who entered the Chicago graduate school
in the fall of 1932, arriving from Rutgers University. His tutors included
Knight, Viner and George Stigler, and Friedman noted that Knight’s
approach was one of “debunking” (Van Horn et al. 2011, p. xxx). He
and his wife Rose met there, sitting alphabetically in Viner’s class, and
they note in their co-authored memoirs that he was now part of “what
even then was known as the Chicago view“(Friedman and Friedman
1998, p. 32). Whether it was also a “school” at that time is uncertain, but
clearly, there was a Chicago attitude.
The Chicago School has long been famous for its microeconomics, or
price theory, and it remains a core part of Chicago teaching and research
today, with the most notable names in recent years being Gary Becker,
George Stigler, and Milton Friedman. The Chicago mantra has always
been theory, empiricism and the market. For Knight this means theory
has its limitations, and “isms” are to be completely avoided. He believed
that everything should be tested against experience, and the market is the
best mechanism for a conflicted world, though it should not be unfettered.
Chicago price theory formed the very basis of their methodology, and
3
Knight to Viner, 9 September 1925, JVi, The Jacob Viner Papers at Princeton University, Seeley
G. Mudd Manuscript Library, Department of Rare Books and Special Collections, Princeton
University Libraries. Correspondence is used by permission of the Princeton University Libraries.
10 Frank H. Knight
they use this approach to view the world, including human behavior and
social outcomes. Price theory was taught in Economics 301. From the
1920s, when Knight joined the faculty, until the 1990s, twenty years after
his death, the course was primarily taught by a string of great theorists:
Knight and Viner, then Freidman, Al Harberger, and Becker. Hence, the
roots of price theory are found in Knight and Viner, who were the teach-
ers of these later generations. Teaching at a time when the tide had turned
away from markets towards regulation, in the wake of the 1929 economic
and financial crash, Knight was advocating a positive view of markets as
a means of coordinating diverse behaviours. Alongside him, Viner taught
Marshallian ideas of supply and demand, and advanced the argument
that price theory is the key to understanding everyday economic prob-
lems. Both teachers explained that people generally buy less when prices
increase, and their actions correlate behavior with price. However, whereas
the Chicago tradition puts price theory at the heart of everything, Knight
believed its significance lay in the ways in which price theory informs our
understanding, and this falls short of the comprehensive role assigned to
it by the Chicago tradition and its evolution.
Steven G. Medema outlines the case for an evolution in price theory
from the early generation of Knight and Viner to the later generations of
Stigler and Becker. He starts by noting both Knight and Viner empha-
sized a deductive approach to economics, rather than the inductive
approach in favour at the time. Medema explains:
Early Chicago price theory was grounded in demand theory and the analysis
of markets; There was an underlying idea of utility maximization, but only in
an “as if” sense. With Stigler and Becker, we see a move toward the analysis of
individual behavior as the foundation of price theory, with the theory placed
on a rational choice footing: individuals are deemed to be rational maximiz-
ers, not necessarily of utility, but of whatever their chosen ends may be.
Demand theory was sufficient to explain prices; a more refined behavioural
grounding was necessary to explain choices. This move to a rational choice
approach to modeling agent behaviour was bound up in the axiomatic turn
in the profession during the 1950s and 1960s. (Medema 2009, p. 162)
Medema also notes that this shift was to economics as the analysis of
choice instead of the study of economic organization, a category shift
from subject matter to an analytical subject.
1 A Prophet and a Pioneer 11
In this evolutionary tale, Emmett in his essay “Did the Chicago School
reject Frank Knight?” (2009), suggests that Knight went through the fol-
lowing trajectory at Chicago: Knight initiated the teaching of Econ 301
and the Chicago approach to price theory, but in time his approach to
price theory was different from subsequent strands of the tradition, in
ways that suggests the Chicago tradition stepped away from Knight’s
emphasis on the role of ethics and politics in human conduct and the for-
mation of public policy. While a founder of the school, in later years, his
influence waned, and Knight was not at the heart of the research infra-
structure of the postwar Chicago school. The focus of Chicago research
was in a different direction on price theory than Knight, and addressed
critical appraisals of the theory, but not the ethical points that Knight saw
as paramount, and central to his criticism of capitalism. In the 1940s,
Chicago offered only seminars to graduates in the core areas of economic
theory (which were led by Knight), economic history, and labour. The
use of seminars in Chicago was a new approach taken from the German
system, but was by no means unique among elite universities in America.
One of the other traditions which evolved at Chicago, was the study
of a nexus between economics and law. A pioneer of this approach was
Henry Simons, who Knight brought to Chicago from Iowa. However,
Simons was soon embroiled in disputes over the quality of his teach-
ing, and his limited scholarly output. The matter was resolved by mov-
ing Simons from the economics department into the Law Faculty, where
he offered a course on “Economic Analysis of Public Policy” (Medema
2009, p. 165). Another leading faculty member at Chicago was Aaron
Director, who undertook his graduate studies at Chicago from 1927, and
then tutored there until 1934, when he left to join the U.S. Treasury
Department. Director was highly influenced by Knight and Viner, chiefly
through attending the course on price theory. (Medema 2009, p. 166) It
was Director who took over Simons’ course in 1946, after Simon’s tragic
death by an overdose.
Among the student cohort, apart from Friedman, were Paul Samuelson
and George Stigler. There are a few reminiscences from these students
about Knight, but the one perhaps closest to him was Stigler, who enroled
in the PhD program in 1933, and Knight became his thesis supervisor.
Stigler’s research was a study of production and distribution in the history
of economic thought. When he joined, Stigler (1988, p. 148) later stated,
12 Frank H. Knight
at that time there was no “Chicago school,” since that really emerged
later out of the context of meetings of the Mont Pelerin Society. In the
1980s, the School came to prominence, and the high priest of the age was
Friedman, who had rapidly become apostate from the Knightian enclave
and had not followed Knight’s line, but had listened selectively to his for-
mer teacher (Van Horn et al. 2011, p. 342). While Friedman remained in
agreement with some points of Knight, Thomas A. Stapleford explains,
“Knight’s perspective on the nature of economic knowledge and its polit-
ical function was fundamentally opposed to that of Friedman. Ironically,
in fact, the grounds for Knight’s critique of institutional economics could
have applied equally well to Friedman and the postwar Chicago School”
(Van Horn et al. 2011, p. 24). Knight’s skepticism would have equally
applied to the 1980s, and he would have been concerned by what he
would doubtless have seen as the apparent omniscience of the monetarist
school. As W.S. Kern writes, “His views on the limitations of the “eco-
nomic point of view” puts him at odds with the recent developments in
economics, known as economic imperialism, pioneered by his Chicago
School descendants such as Gary Becker who have sought to extend
the domain of economic analysis beyond the realm of market relations.
Economic imperialists, such as Becker and Gordon Tullock, see all forms
of social interaction as a result of the economizing behavior stemming
from the existence of scarcity” (Kern 1997, p. 319–30).
4
Harcourt, G. C. 1969. Some Cambridge Controversies in the Theory of Capital, Journal of
Economic Literature. 7:2, pp. 369–405. Harcourt was joined by Mark Blaug in tracing out the his-
tory of the controversy, see Blaug, Mark, The Cambridge Revolution: Success or Failure? A Critical
Analysis of Cambridge Theories of Value and Distribution, (Revised Edition. London: Institute of
Economic Affairs. 1975).
14 Frank H. Knight
The economists Robinson drew into the argument involved many of the
major economic thinkers of the day, including Pierangelo Garegnani,
Nicholas Kaldor, Luigi Pasinetti, Richard Kahn, and Piero Sraffa (all on
her “side”) pitted against Christopher Bliss, Frank Hahn, Paul Samuelson,
Franco Modigliani, and Robert Solow. They battled it out principally in
the major economic journals, such as the Quarterly Journal of Economics,
the Review of Economic Studies and the Economic Journal.
The controversy will be taken up again in Chap. 4; suffice to say, Avi
J. Cohen and G. C. Harcourt succinctly summarize the contemporary
view of this piece of economic history:
The chief Marxist contribution that interested Knight was the labour
theory of value, which states that the value of a commodity can be objec-
tively measured by the average number of labour hours required to pro-
duce that commodity, irrespective of other capital and physical inputs.
Hence, if it takes twice as long to produce a pair of shoes than a pair of
trousers then shoes are double the value of trousers. Adam Smith played
with the idea in An Inquiry into the Nature and Causes of the Wealth of
Nations (1776) but it was first systematized by David Ricardo in The
Principles of Political Economy and Taxation (1817). Karl Marx took the
theory further to explain the value of all commodities, including labour
as the commodity that workers sell to capitalists for a wage, or what Marx
called “labour power.” Marx then went on to pose the question that if
labour power is the value of commodities, from where does the capitalist
1 A Prophet and a Pioneer 15
get profit? His answer was that there is a surplus value that the capital-
ist draws from the worker, through exploitation of the worker and the
wages paid for his labour. This exploration of profit turned out to prove
both Marx and the classical writers were wrong, and Knight was one of
the pioneers of the orthodox view today that profits come from entrepre-
neurial activity where profit is earned by forgoing current consumption,
by taking risks, and by organizing production.
In the first part of Risk, Uncertainty and Profit, Knight explored theo-
retical economics, which builds on the theory of perfect competition in
an attempt to exercise control over the economic society. Once he had
taken the reader through this process, Knight sought to knock down
the construction and challenge the core notion of perfect competition,
explaining that limitations to knowledge make perfect competition
unachievable, leaving us merely with partial knowledge. This paved the
way for a core role played by the entrepreneur in creating profit. Risk,
Uncertainty and Profit was Knight’s unique contribution to the theory
of entrepreneurship, explaining how profit is linked to the behaviour of
entrepreneurs, or what he called the “organizers of uncertainties.” Knight
drew the distinction between insurable risks and uninsurable uncertain-
ties, and offered a theory of profit linking this distinction to entrepre-
neurial activity. He wanted to take us to a higher level of uncertainty
or what he termed “true uncertainty.” True uncertainties, rather than
those that can be insured against which become a fixed cost, are what
the entrepreneur profits from, and this uncertainty is a necessary condi-
tion for entrepreneurship, and thus the generation of profits. It is not
change, something he explored in theoretical terms in dialogue with the
theories of John Bates Clark (1900, 1907), the father of J.M. Clark, and
F.B. Hawley (1907), which is the cause of profits, rather profit is a return
to the entrepreneur for their skill, ability or talent. The concept of profit
is bound up in a certain type of organization of industry, and this is con-
stantly in the process of change.
Knight’s battle with the Austrians was at its heart a battle between
himself and Friedrich Hayek, with the main cause of disagreement
being that they held fundamentally different conceptions of capital. The
Austrian theory argued capital corresponds to time and primary factors
of production, which are then applied to their ultimate use in final goods
16 Frank H. Knight
“Yes, I have a copy of that. It always made me mad because he called him a
“cracker barrel philosopher,” and I considered it was sort of a smart-alecky
thing to say. He meant to be praising, but he was so kind of superior that I
was very angry with him.” (Emmett 2011, p. 2)
The religious irony in Knight is clear here, in that economists and those
who would manipulate economics to achieve their own power goals offer,
in his view, the miracles and fairies. It was not the case, however, that
Knight was working in an either/or paradigm. His intention was to delve
1 A Prophet and a Pioneer 19
deeper into the human roots of economics, the soul of homo economicus,
and provide economists and non-economists alike with a new under-
standing of our economic environment. In linking economics to behav-
iour Knight was carving out a role for ethics in the economic landscape.
Another area of Knight’s thought was his sense of history. It is per-
haps ironic that Knight features very little in all the major histories of
economics. Apart from Knightian uncertainty, writers tend to leave him
alone, except perhaps for the occasional footnote. It is ironic because he
himself wrote some important economic history. His most notable work
in the field of economic history is his translation from the German of
Max Weber’s 1927 work General Economic History, introducing Weber to
a broader English-speaking audience. The book is based on Weber’s lecture
notes and was compiled shortly after his death, and it had a significant
influence on Knight. Weber proposed an institutional theory of the rise of
capitalism in the west. He places the state at the centre of things, and pos-
ited laws that can demonstrate in calculable ways how economic actors can
predict exchange for gain. Weber’s institutional theory of capitalism was
rediscovered in the early 1980s. Encountering Weber early in his under-
graduate years, the sociologist remained a key influence on Knight’s work,
though one needs to exercise care in making too much of this influence.
Knight wrote his own, albeit sketched, ideas on history as well. The
collection of essays under the title On the History and Method of Economics
(1956) gathers Knight’s thoughts on problems in pure analysis, intellectual
history, and the philosophy and methodology of economics and social sci-
ence. The volume, which was compiled with his consent, but not partici-
pation, was published to mark Knight’s seventieth birthday, with the essays
collected by W.J. Letwin and A.J. Morin who were friends and disciples. In
the opening essay, which was based on his entry in the 1951 Encyclopedia
Britannica, Knight, sketched out the history of economics. One contem-
porary book reviewer, O.H. Taylor, offered a useful insight in trying to
assess the volume, when he suggested there is an overall thesis which:
scientists. And on its affirmative side, this central tenet of Knight’s philoso-
phy is a contention that the social sciences, instead of being only “positive”
or “natural-sciencelike” sciences, must be also and chiefly humanistic disci-
plines, involving central or basic ethical concerns and postulates, and lead-
ing to (practical, applied or applicable) “solutions” of human-social
problems understood as in essence or ethical or moral problems. (Taylor
1957, p. 343)
For Knight, social inquiry was not a science, but an art involving the appli-
cation of critical judgment. He confronted an ideology giving unique
authority to science and appointing social scientists as the guardians of
public discourse about social problems. In dissenting from this ideology,
Knight challenged the authority of science within social inquiry and the
public role of the social scientist. (Emmett 2009, p. 64)
Arguably, Knight’s most holistic thought came later in his life, and was
published in Intelligence and Democratic Action (1960), his last volume
of published work, which was in the form of a collection of lectures and
essays. In Intelligence and Democratic Action, Knight suggested, “History
makes men, much more than men make history” (Knight 1960, p. 36).
Knight engaged with the historical background of liberalism, taking the
popular liberal view that we can learn from history, and identified that
individuals and society have a history. We can learn about history, and
learn from history, but one point Knight highlighted was that:
Knight did not develop this last point. This is consistent with his oper-
ating principle of being incisive with the challenges of his study but then
avoiding the provision of a solution, thus continuing to frustrate his critics
until the end. Wearying of the “angry young men” what he does is to spell
out that action is aimed at building a higher civilization, which he supposed
to be a balance of fundamental values that form what might constitute the
“good life”. What this exactly means, and how we understand balance and
values, remains somewhat of a mystery to him, which suggested to him
that no one else has quite managed to grasp these points either. There is
thus an intractable problem of defining what comprises progress.
6 Knight’s Legacy
Beyond the Chicago label, it is not especially straightforward to catego-
rize Knight. Part of the difficulty, as noted, is that he drew on a much
broader range of sources than economic thinkers and theory, and pur-
sued arguments and an interest in advancing social scientific thought
more broadly. He addressed economic theory, but in applying himself to
the real world and the problems of the human in society, he sought his
answers in a range of social sciences. Hence, we see that a major influence
on his work was the sociologist Max Weber, whom Knight held in such
high regard that he said that Weber was one of the few thinkers he had
read who he still respected after reading him.
Aside from straying beyond the disciplinary boundaries of economics,
perhaps the principle reason why Knight did not lead the Chicago School
in the postwar years is that he was more of a teacher than a researcher. He
was too much of a prophet, for the needs of a school that needed to earn
its way in the world and play a part in public policy. Friedman, Wesley
Clair Mitchell, and the positivists at Chicago, had the ability and interest
to prescribe policy. The weakness of Knight, as often resonated in this
book, is his prophetic voice, which was good at castigating humanity and
showing the need for ethical direction, but without providing answers
that many would find satisfactory. It seems his main conclusion was that
as a society, we require an open democratic discussion about the problems
we face, but this appears to be a self-defeating proposition, as it seems
the society Knight discussed was not capable of achieving consensus.
22 Frank H. Knight
His conclusions were also certainly not the kind of proposition that paves
the way to power, or even one might add to a successful economics PhD
thesis. What the world wanted was not a prophetic voice like Knight,
but a purveyor of policy like Keynes, or an evangelist of economic liberty
like Milton Friedman. In the post-Knight era, it was Friedman and like
voices that would get a hearing, while in more recent times we have seen a
resurgence of Keynesian approaches to our modern economic dilemmas.
Knight was a great teacher, and as such Emmett enigmatically suggests
“Ironically, then, the Chicago School can be said to owe everything, and
nothing, to Knight.” Emmett concludes:
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(1982).
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tics. Presidential address to the American Economic Association, December
28, 1950. The American Economic Review 41(1): 1–29. Reprinted in On the
history and method of economics, 251–281. Chicago: University of Chicago
Press, 1956.
Knight, Frank Hyneman. 1956. On the history and methods of economics: Selected
essays. Chicago: University of Chicago Press.
Knight, Frank Hyneman. 1960. Intelligence and democratic action. Cambridge:
Harvard University Press.
Secondary Sources
Carroll, Robert P. 1979. When prophecy failed. Reactions and responses to failure
in the Old Testament prophetic traditions. London: SCM Press.
Clark, John Bates. 1900. The distribution of wealth, a theory of wages, interest and
profits. New York: The Macmillan Company.
Clark, John Bates. 1907. Essentials of economic theory: As applied to modern prob-
lems of industry and public policy. New York: The Macmillan Company.
Cohen, Avi J., and G.C. Harcourt. 2003. Whatever happened to the Cambridge
capital theory controversies? Journal of Economic Perspectives 17(1): 199–214.
Commons, John R. 1934. Institutional economics. New York: Macmillan.
Emmett, Ross B. 2009. Frank Knight and the Chicago School in American eco-
nomics. London: Routledge.
1 A Prophet and a Pioneer 25
If Frank Knight is arguably the most famous economist few have heard
of, it is because of Knightian uncertainty which established a major idea
and reputation in the discipline of economics, but was not the beginning
of other pioneering work, as he turned to teaching and essay-writing as a
critic of other ideas and thinkers that were to remain more famous than
himself. Knight put forward his ideas on uncertainty in his doctoral the-
sis and then turned it into his classic book Risk, Uncertainty and Profit
(1921). As Jochen Runde quips “It is safe to say that Frank Knight is
more widely quoted than read on his eponymous distinction between risk
and uncertainty” (Runde 1998, p. 539). Knight is credited with drawing
out the distinction between risk, as known chance, and uncertainty, as
unmeasurable probability. The distinction is important to Knight because
while risks can be calculated and insured against, it is uncertainty that
paves the way for opportunities to create profit and the entrepreneurial
enterprise. Risk, Uncertainty and Profit was to establish Knight in the
pantheon of economists, but he never became a household name like his
contemporary John Maynard Keynes or pupil Milton Friedman. Many
have attempted to assess Knight in modern terms, either to make use of
his work for today or to offer a modern-day insight into what he said at
the time. Knight, as one author has said, is one “itch economists need to
scratch” (Emmett 2009, p. 49). Knight’s thesis rewards study today, even
scratching that itch, for economic reasons given the rise of an entire risk
management industry in recent decades and the recessionary times that
erupted in 2008, as well as for social reasons given the ever-increasing
tendency to be risk-averse in our modern society; all of this in the context
of globalization and protest over these past decades.1
As with any significant thinker, Knight’s work sits within an intel-
lectual milieu. In the 1920s, this meant his work overlapped with John
Maynard Keynes, whose book A Treatise on Probability (1921) appeared
in the same year, Friedriech A. Hayek and John R. Commons, amongst
others.
1
In the context of globalization, Charlie Dannreuther and Robin Lekhi offer a useful assessment of
how different views of risk underpin different narratives of globalization and how actors make sense
of the uncertainty they face. Charlie Dannreuther & Robin Lekhi, Globalization and the Political
Economy of Risk, Review of International Political Economy, 7:4, 574–594 (2000).
2 Knightian Uncertainty 29
to befuddle as much as it has done since the day it was first published.
Critics and supporters of Knight alike admit the difficulty of reading the
text, in large part because of his own critical stance with its philosophi-
cal and anti-positivist approach, as well as the challenge of how Knight
understood science and economics as a science. Knight did something
in Risk, Uncertainty and Profit that was to become a hallmark of his sub-
sequent work, and is the source of much misunderstanding of his oeu-
vre, whilst being the key to understanding his corpus as a whole. He
consciously linked economics to human behaviour and always saw what
economists do in very practical terms. It was this challenge to economics
as a science, and his insistence on the need to root our understanding of
economic ideas and activities in human nature, that causes much of the
confusion around his work.
Knight started off by stating what economics is, framing it as a justifi-
ably separate study which:
We shall endeavor to search out and placard the unrealities of the postu-
lates of theoretical economics, not for the purpose of discrediting the doc-
trine, but with a view to making clear its theoretical limitations. (Knight
1921, p. 11)
2
Knight Papers, box 62, folder 24, Special Collections Research Center, University of Chicago
Library.
2 Knightian Uncertainty 31
to Knight! (LeRoy and Singell 1987, p. 402) If one gets past the writing,
part of the challenge for Knight, and for his reader, lies with the disci-
pline of economics itself, in terms of its status as a scientific discipline,
and the relationship between economics and human behaviour.
Knight breaks Risk, Uncertainty and Profit into three parts. In Part One,
he offers an overview of the history of the previous proposed theories of
profit, including the classical theories, and recent controversies in relation
to the explanation of profit in terms of risk. In Part Two, Knight takes up
the study of a theoretical, perfectly competitive society. In exploring this
study, Knight believed it becomes quite evident that the absence of uncer-
tainty explains the gap between what perfect competition would achieve
and what actual competition achieves, in what Knight calls a “tendency”
of actual competition toward perfect competition (Knight 1921, p. 20).
The third part is a detailed analysis of imperfect competition in relation
to risk and uncertainty. He looks at the effects of risk and uncertainty,
especially on the economic organization and upon economic theory, and
the contrast he saw between risk as a known chance and true uncertainty.
2 An Historical Enquiry
The connection between uncertainty and profit is seen in the difference
between theory and reality. Even in today’s debates, especially in the
more public arena, profit, and those who benefit from profit, makes
the word an emotionally charged one. Knight was surprised in his own
time that no-one had, in his view, tackled it more head-on and assessed
the failure of ideal competition in practice. Profit is tied to the type of
organization and organizational theory and management. In his assess-
ment of the static state of classical theoretical economics, he concluded
it left no room for profit. Knight sought to rectify this in his thesis with
an inquiry into the cause of the failure of ideal competition to be fully
realized in practice, and set out to understand the existence of profits
under conditions of perfect competition. In providing an overview of
classical and contemporary theories of profit, Knight explained his con-
cern that consideration of profit was a latecomer to serious theoretical
analysis, stating:
32 Frank H. Knight
…the theory of profit has remained one of the most unsatisfactory and
controversial divisions of economic doctrine. Considering, however, the
universal recognition of the “tendency” of competition to eliminate profit,
it is perhaps somewhat remarkable that the problem of profit itself has not,
with one important exception, been attacked from the direct point of view
adopted in this essay, of an inquiry into the causes of the failure of ideal
competition to be fully realized in fact. (Knight 1921, p. 23)
Francis A Walker in his Political Economy (1887), which was the chief
economics textbook in America prior to Alfred Marshall’s Principles of
Economics. Walker emphasized the role of the entrepreneur or “captain
of industry.” However, the focus quickly shifted to two other opposed
views of “dynamic theory” and “risk theory,” chiefly propounded by
J.B. Clark and F.B. Hawley respectively. Both theories dealt with many
ideas in common, but Knight saw them as worthy of exploration for
their presentation of a principle for explaining the peculiar income of
the entrepreneur. It is on the anvil of these two American views that
Knight truly forged his own argument, and they merit an extended
discussion.
The dynamic theory is a correlate of J.B. Clark’s theory of distribu-
tion in the profitless static state, which is the state of “natural adjust-
ments” of Ricardo and the earlier classical writers. To realize such a
static state one would have to eliminate five kinds of change, namely
population increase, capital increase, improving methods of produc-
tion, increasingly efficient forms of industrial establishments, and
multiplying consumer wants. In such a static state each factor secures
what it produces, and since cost and selling price are always equal
there can be no profits beyond wages for routine supervised work.
Profits are the result exclusively of dynamic change, meaning inven-
tion. As J.B. Clark explained it, profit eludes the entrepreneur’s grasp
and “slips through their fingers and bestows itself on members of soci-
ety…As a result we have…the standard of wages moving continuously
upward and actual wages steadily pursuing the standard rate in its
upward movement, but always remaining by a certain interval behind
it” (J.B. Clark 1900, p. 404, 405). This makes profit also dependent
on what J.B. Clark defined as a friction between actual wages and
the static standard, which in turn is the source of the entrepreneur’s
reward; otherwise he suggested competition without such friction
“would be annihilated as fast as it could be created.” (J.B. Clark 1900,
p. 410). Knight contested this view, stating it was fallacious, “since the
profits of change come largely in the form of readjustments of capital
values,” adding in true Knightian fashion this view could only apply if
friction were so broadly defined that:
36 Frank H. Knight
“perfect mobility” means the absence of all resistance to the human will.
But in a world where a breath could transform a brick factory into a railway
yard or an ocean greyhound there would be no need for economic activity
or economic science. (Knight 1921, p. 34, fn4)
Knight believed the fatal flaw in the dynamic theory was that it over-
looked the fundamental question of the difference between a foreseen
change within a reasonable time, and an unforeseen change. Knight
argued:
Change occurs because of human activity, and profit can arise without
J.B. Clark’s dynamic change taking place, which Knight believed simply
creates a peculiar form of income in the sense they are unpredictable
changes. Knight argued that this change is not the cause of profit, and
that the connection between change and profit is uncertain and always
indirect. That said, change may cause a situation giving rise to profit,
but only if it also creates ignorance about the future. It is this point that
change is a necessary condition of our being ignorant of the future that is
the cause of the erroneous conclusion that change is the cause of profit.
Knight explained that entrepreneurs undertake “uncertain investment,”
and the personality trait of an entrepreneur is one of being a successful
uncertainty-bearer and a judgmental decision-maker. The first work to
give the entrepreneur a central economic role, and to coin the term, was
Essai sur la nature du commerce en general (1755), by the Irish/French
banker Richard Cantillon, published 21 years after his death in 1755.
He introduced the notion of risk-taking into the theory of the entrepre-
neur. One of the major voices to delve deeper into the role, motives and
personality of the entrepreneur was Schumpeter, who like Knight was
influenced by J.B. Clark, and like Clark regarded profit as surplus. In
The Theory of Economic Development (1934), Schumpeter, like Knight,
2 Knightian Uncertainty 37
4
Knight primarily draws on essays by F.B. Hawley in the Quarterly Journal of Economics.
2 Knightian Uncertainty 39
towards zero the greater number of cases involved: this is what happens
in the case of insurance.
Knight’s analysis aimed to show the inadequacy of opposing argu-
ments, and to take us in the right direction to solve the problem of profit.
Knight believed he had demonstrated:
…first, that change as such cannot upset the competitive adjustment if the
law of change is known; and now, secondly, that an unpredictable change
will be similarly ineffective if the chance of its occurrence can be measured
in any way. (Knight 1921, p. 47)
Thus, if business people know either what actual changes are pending
and the risks they run, the effect is in the long run the same. The only
result of such changes will be the redistribution of productive energy,
taking place continuously and without any disturbance of perfect com-
petition conditions. That said, Knight concluded that there is an element
of truth in both theories and to posit a true theory entailed his reconcili-
ation of those two views, because profit is bound up in economic change
and is clearly the result of risk. In part one of Risk, Uncertainty and Profit,
what Knight had undertaken was a clearing of the theoretical ground for
what he called “the real work of construction” in part two (Knight 1921,
p. 51).
Knight also restated the fundamental law of conduct, arguing that the
principle is a true statement of the goal of rational planning:
2 Knightian Uncertainty 43
I simply cannot see any use for the notion in understanding human conduct or
explaining economic phenomena, and am convinced that the confusion of
viewpoint which underlies putting it to the fore has led to serious error and the
44 Frank H. Knight
Knight explained that these assumptions, especially the first eight, are
idealizations or purifications of tendencies which hold good in reality,
and they are the conditions necessary for perfect competition, the ninth
point is a control assumption. It is points 10 and 11 which are purely
analytic assumptions. Having isolated these factors, Knight was able to
give a picture of such a society and discover the conditions of equilibrium
or forces at work.
The next task Knight undertook was to create a picture of economic
society in action, which allowed us to discover equilibrium conditions or
the natural forces at work. If we start by imagining a population start-
ing out fresh in the business of satisfying wants, each person would start
producing some commodity with a view to exchanging with others in
order to satisfy their varied wants. After a brief time interval, they will
have accumulated a small stock of a particular good, and will exchange
these on a central market. Skipping over the process of how exchange
is fixed in practice, the outcome will be a single homogenous fund of
exchange equivalence or value. If intercommunication is perfect then
exchanges can only be done at one price. However, each individual has a
good which has exchange power, possible uses to choose from, and can
purchase equivalent uses or wants. This leads us to consider the theory of
market price, the element skipped over earlier. In a perfect market each
commodity commands a fixed price, which is the highest uniform price
at which the stock can be sold entirely. Knight examined, in what he
called a dogmatic treatment, the contemporary price theory discussion,
and concluded that price theories are little more than corollaries from the
single fundamental law of choice, and had little sympathy for some of the
controversy of the time, especially the question of a causal relationship
between cost and value.
Knight contended that cost is the value of the resources embodied in a
thing, or more precisely the value of some use for a thing, which may be
economic or not. If a thing is not wanted there will not be an exchange,
and therefore not a use. Knight concluded his examination by stating:
made equal to the externally given physical equivalence ratios, first in the
market and then in production. That “goods” are largely alternative to each
other in production (involving the use of the same ultimate resources) is the
condition of how having economic order, an organization of want-satisfying
activities based on free production and exchange. (Knight 1921, p. 93)
in bidding for a job. Knight argued on this basis that classification has
no meaning for the distribution problem, and these factors form one vast
homogenous fund. This said, Knight stated in a footnote that he still uses
this tripartite classification for expository purposes and because the terms
“have social and ethical significance if none of a strictly economic sort”
(Knight 1921, p. 125, fn.2). This discussion also raises the question of
the meaning of capital, which we will discuss below. It also raises some
moral problems as to how we measure the value of work to the individual
and society, but we will consider his views on this in Chap. 7 on welfare
economics.
A last clarification identified by Knight is the relation of time to the
production and consumption of goods. He only presented a brief survey
at this point, but it was for him a controversial and complicated question.
He questioned the common assumption that human nature has a general
preference for present over future products, an assumption further com-
plicated by a false conception of the nature of the problem. The presence
of interest in society is taken as evidence that people discount the future,
Knight said, but there is an error in choosing a zero point from which to
measure time preference. The correct basis is not everything today and
nothing in the future. Knight suggested it is more sensible to ask: “if a
man were given his entire income for a year in a lump-sum payment
on January first, how would he distribute its expenditure through the
year?” (Knight 1921, p. 13) The answer would not be the sum being
spent all in one go. Knight answered a zero time preference means a uni-
form distribution in time, and any emphasis on early spending or leaving
major spending to later would be a discounting of the present or future.
Given human nature, there will be varied forms of distribution, with
most spending in waves rather than uniformly, with irregularity being the
behavioural norm of the spirited individual. Knight argued time prefer-
ence in consumption is at best unimportant to understand saving, since
spending is more influenced by other motives and social standards. On
an individual level, these different views of time may give grounds for a
mutually advantageous exchange between parties. On a society level, if
there is a tendency favouring the present then no great net accumula-
tion of goods will take place, and vice versa if there is a view toward the
50 Frank H. Knight
future then production will exceed consumption and there will be a net
accumulation for society.
The role of time was reassessed later by John Hicks, in Capital and
Time: a Neo Austrian Theory (1973) and in his essay Some Questions of
Time in Economics (1976). Hicks believed in the importance of the “irre-
versibility of time” (Hicks 1976, p. 135). Time, he said, was not strictly
analogous to space, a realization he explained he had not always been
faithful to, “but when I have departed from it I have found myself com-
ing back to it”, adding that we cannot escape the fact that the future is
not determined in the same way as the past, and it is very easy “to forget,
when we contemplate the past, that much of what is now past was then
future” (Hicks 1976, p. 263). This he said has profound implications for
how we might break down time in processes. Hicks argued:
Action is always directed towards the future; but past actions when we
contemplate them in their places in the stream of past events, lose their
orientation toward the future which they undoubtedly possessed at the
time when they were taken. We arrange past data in time-series, but our
time series are not fully in time. The relation of year 9 to year 10 looks like
its relation to year 8; but in year 9 year10 was future while year 8 was past.
The actions of year 9 were based, or could be based, upon knowledge of
year 8; but not on knowledge of year 10, only on guesses about year 10. For
in year 9 the knowledge that we have about year 10 did not yet exist.
(Hicks 1976, p. 264)
This completes the list of progressive changes. In every case the necessary
and sufficient condition of a perfect, remainderless distribution of the
product of industry among the agencies causally concerned in creating it,
in addition to perfect competition itself, is that the change can be antici-
pated over the period of time to which producers’ calculations relate.
Where the results of the employment of resources can be foreseen, compe-
tition will force every user of any productive resource to pay all that he can
afford to pay, which is its net specific contribution to the total product of
industry. No sort of change interferes with the no-profit adjustment if the
law of the change is known. (Knight 1921, p. 173)
5
Fontaine (1999) argues the case that Knight’s thought parallels Jean-Baptiste Say, who ventured
that judgment is “a moral quality, whose diffusion across society has to be encouraged.” Fontaine
may be accused of a Whiggish turn by analyzing Say’s position on risk and uncertainty, though they
defined this in a footnote, stating that they were well aware that Knight’s RUP is generally consid-
ered the first work here this distinction is drawn in detail, and in relation to Say they explain he
sheds light on the definition of risk and uncertainty in economics, as Richard Cantillon had done
a century earlier in his Essay on the Nature of Trade in General (1755).
54 Frank H. Knight
For any course of action he will have in mind many different hypothetical
outcomes, and out of these there will be a large number of any one of
which would cause him some degree of surprise if it were to turn out to be
the actual one without there having been, in the meantime, any change in
the knowledge on which he is now basing his expectations. The degree of
this potential surprise will differ between different hypotheses. Some will
seem to involve assumptions which conflict with elements in the present
situation, and therefore to involve the further assumption that special
factors will arise, of which there is no evidence at present, capable of can-
celling these adverse elements. (Shackle 1949, p. 14)
Risk, Uncertainty and Profit was unique in its dealings with decision-
making and uncertainty. As he explained it in his introduction, Knight
was writing about, as Stigler frames it, “the crucial importance of uncer-
tainty, and its inevitable consequence, ignorance, in transforming an eco-
nomic system from a beehive into a conscious social process with error,
conflict, innovation, and endless spans and varieties of change” (Stigler
1971, p. x). Knight turned the table on the rational economist and took
2 Knightian Uncertainty 57
away the key assumption of perfect knowledge that played a central role
in his explication of perfect competition. Knight explained that he had in
part two of Risk, Uncertainty and Profit presented a picture of the compet-
itive industrial society under conditions of perfect competition, free from
“all disturbing influences,” by allowing a significant simplification which
is the assumption of “practical omniscience” on the part of the econo-
mist. Drawing on a theory of knowledge, he wanted to show how eco-
nomic phenomena are connected with the imperfection of knowledge.
this means economic predictions and laws are limited in scope by this
brute fact and for such reasons uncertainty cannot be measured. The
advent and future of new products cannot be predicted nor their demand.
We can see how fickle consumers can be, as we see the dramatic flop of
a blockbuster movie at the box office. The outcome of this uncertainty,
Knight argues, is that it gives opportunities for profit that do not exist in
situations where risks can be calculated, and uncertainty converted into
certainty.
Risk and uncertainty are challenges that humanity has always faced,
and in recent decades, since Risk, Uncertainty and Profit was written, risk
has evolved as a major element on the contemporary economic land-
scape. Our modern notions of risk are rooted in 17th century probability
theorems, developed by mathematicians including Pascal and de Fermet,
enabling calculations to be made about the future based on past obser-
vations. This became the foundation of early insurance, and remains so
today. However, the application of risk in a broader social context gen-
erally and the economy had to wait until the 1920s, and the work of
economists including Knight and Keynes, who refined the use further by
examining risk in relation to the modern entrepreneurial organization.
Knight argued that risk is subject to rational choice in a way that
uncertainty is not. He explained that the introduction of uncertainty into
perfect competition or an “Eden-like situation” demonstrates “the fact of
ignorance and necessity of acting upon opinion rather than knowledge”
(Knight 1921, p. 268). Hence, he believed, uncertainty is ignored in
much of the economic literature or treated wrongly as if it were risk.
He defined risk as distinct from uncertainty with the practical difference
between the two categories being that in the former the distribution of
the outcome in a group of instances is known (either through calculation
a priori or from statistics of past experience), while in the case of uncer-
tainty this is not true, the most common reason being that it is impossi-
ble to form a group of instances, because the situation dealt with is highly
unusual. His distinction relies on two conditions of the identification of
an homogenous group and the ability to calculate distributions. He dis-
tinguished situations where chance can be known, and those where they
are not known, suggesting the difference implies a distinction in making
decisions where chance and a closed set (or not) of factors are involved.
60 Frank H. Knight
The fact of uncertainty means that people have to forecast future wants.
Therefore, you get a special class springing up who directs the activities of
others to whom it gives a guaranteed wage. It acts because good judgment
is generally associated with confidence in one’s judgment. (Coase 1937,
p. 400)
Coase sets out three objections to Knight. First of all, as Knight him-
self pointed out, the fact that certain people have better judgment or
better knowledge does not mean that they can only get an income from
it by themselves taking part in production. They can sell their advice
62 Frank H. Knight
In 1930, John R. Hicks gave his first course on risk and based it
on Knight’s Risk, Uncertainty and Profit, alongside Charles O. Hardy’s
Readings in Risk and Risk Bearing (1924). Hicks took his theory about
risk and uncertainty, and the role of profit, from Knight, which formed
the basis of his 1931 article “The Theory of Uncertainty and Profit”, pub-
lished in Economica. He had previously submitted the article to the
more prestigious publication the Economic Journal, edited by Keynes,
but he rejected it and called it “a little crude.” Hicks thought that while
Knight was strong on the economic phenomenon which explains profit,
Knight lacked a satisfactory explanation of exactly what profit is, and
the causes that determine its magnitude. Hicks credits Knight with plac-
ing the theory of profit on a firm foundation, namely the dependence
of profit on uncertainty, but argues that a satisfactory theory of profit
can be developed without Knight’s concept of true “uncertainty” or non-
measurable risk. Hicks also had less time for Knight’s metaphysics and
psychology, preferring instead a purer economic analysis of theory of
profit. Hicks believed Knight gave disproportionate weight to “unquan-
tifiable risks” and to “genuine uncertainties,” and Hicks also wanted to
limit risks, rather than eliminate them as Knight did. He explained that
in an organized society, risk could be addressed in three different ways.
First, as a result of economic organization, it would be possible to reduce
the inherent risks in some processes in particular. Second, actual risks
may be borne by certain individuals or institutions in return for a lump
sum payment. Lastly, actual risks could be supported by a payment, the
amount of which will vary depending on the amount obtained from the
operation at hand. Hicks was also critical of Knight’s theory of capital. He
argued the demand by a company for any factor of production depends
on the company’s expected success as a whole, and they depend on these
factors being available. This division differs from the typical one of the
three factors of production, land, labour, and capital. Hicks explained
one cannot conclude that work receives wages, and capital receives prof-
its. The capital receives rent and interest, but profit is not correlated to
this income. As a result, there is uncertainty that the profit will be the
total income generated less costs in the form of wages, interests, and rents
which are contractually fixed.
2 Knightian Uncertainty 65
A proposition is not probable because we think it so. When once the facts
are given which determine our knowledge, what is probable or improbable
66 Frank H. Knight
Between 1906 and 1911 Keynes was devoting all his spare time to the
theory of Probability…. In 1912 other work supervened, and his treatise
had to be left on one side until 1920, when he polished it up before its
appearance in 1921. Thus it was his main work from the age of twenty-
three to twenty-nine. (Harrod 1966, p. 133)
the expectation of proceeds which will just make it worth the while of the
entrepreneurs to give that employment. It follows that in a given situation
of technique, resources and factor cost per unit of employment, the amount
of employment, both in each individual firm and industry and in the
aggregate, depends on the amount of the proceeds which the entrepreneurs
expect to receive from the corresponding output. For entrepreneurs will
endeavour to fix the amount of employment at the level which they expect
to maximize the excess of the proceeds over the factor cost. (Keynes 1936,
pp. 23–4)
Turning to risk Keynes defined three types of risk, the first two of
which affect the volume of investment. The first is the entrepreneur’s
or borrower’s risk, which he wrote was in a sense a real social cost. The
second is the lender’s risk, a pure addition he argued to the cost of invest-
ment. Lastly, there is a possible adverse change in the value of the mon-
etary standard, which could make a money-loan riskier than a real asset,
though this should be absorbed in the price of durable real assets. (Keynes
1936, pp. 144–45) Keynes had shifted the ground from the relationship
between uncertainty and investment to the relationship between interest
rates and investment.
Keynes explained how the entrepreneur invests in a twofold process in
his essay, The “Ex-Ante” Theory of the Rate of Interest, Keynes explained:
Even apart from the instability due to speculation, there is the instability
due to the characteristic of human nature that a large proportion of our
positive activities depend on spontaneous optimism rather than on a math-
ematical expectation, whether moral or hedonistic or economic. Most,
probably, of our decisions to do something positive, the full consequences
of which will be drawn out over many days to come, can only be taken as
a result of animal spirits – of a spontaneous urge to action rather than inac-
tion, and not as the outcome of a weighted average of quantitative benefits
multiplied by quantitative probabilities. (Keynes 1936, p. 161)
It is safe to say that enterprise which depends on hopes stretching into the
future benefits the community as a whole. But individual initiative will
only be adequate when reasonable calculation is supplemented and sup-
ported by animal spirits, so that the thought of ultimate loss which often
overtakes pioneers, as experience undoubtedly tells us and them, is put
aside as a healthy man puts aside the expectation of death. (Keynes 1936,
p. 162)
The theory can be summed up by saying that, given the psychology of the
public, the level of output and employment as a whole depends on the
70 Frank H. Knight
had little respect for the business vocation…Keynes ranked business life so
low partly because he considered that the material goods produced by
entrepreneurs had less ethical value than the intellectual and aesthetic
goods produced by dons and artists, partly because he despised the ‘love of
money’ as a motive for action. (Skidelsky 1992, p. 259)
6 A Social Conclusion
Knight turned his attention to the dynamics of the economic process,
and the uncertainty connected to them. He started by stating that change
is part of life in a world of contradiction and paradox. To deal with this
world we analyze the world in terms of what is unchanging or chang-
ing in certain ways, excepting those things which change according to a
known law that do not cause uncertainty. There is both natural change
and human change, the latter distinguished by deliberate intent or as
an indirect result of action directed toward some other end. The main
uncertainty affecting the entrepreneur in this process relates to the sale
of a product, in particular the judgment about what to supply. It is, he
said, common to think of the economic process as producing goods and
satisfying wants, but Knight argued that this view is deficient because the
economic process produces wants, as well as goods to satisfy these wants,
and it is not directed to ultimate satisfaction of wants. Gaining wealth
is an end in itself, and we work to gain wealth not just for the reason
of consumption. Knight discussed this progress in a range of categories:
Accumulation of capital, rate of interest, and money and savings, noting
that money is simply a medium of exchange and not the object of our
pursuit. It is the surplus of wealth we pursue. More broadly, Knight sug-
gested social progress is motivated by the desire to possess wealth. The
uncertainty Knight discussed at this later stage in this thesis is solely that
of conversion of free capital (surplus) into new productive equipment.
Creation of free capital is itself subject to uncertainty, in terms of interest
rate changes, and business conditions and cycles, with growth coming in
waves. The last progress factor he considered was “invention,” explain-
ing business uncertainty is greatly affected by technological improvement
and the creation of new knowledge, points which certainly resonates with
our modern economy.
As much as he asserts a theory of knowledge that gives rise to con-
cerns about what we do not or cannot know, he does admit that we do
improve our knowledge of the future. To address uncertainty involves
cost; including cost associated with organizational solutions, which in
turn can lead to a loss of individual freedoms. We can, also at a cost,
try and slow the march of progress. However, Knight concluded, any
72 Frank H. Knight
Bibliography
Knight, Frank Hyneman. 1921. Risk, uncertainty, and profit. Boston: Houghton
and Mifflin.
Knight, Frank Hyneman. 1934. Capital, time, and the interest rate. Economica
1: 257–286.
Knight, Frank Hyneman. 1967. Laissez-faire: Pro and con. Journal of Political
Economy 75: 782–795.
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Andersen, Esben Sloth. 2011. Joseph A. Schumpeter: A Theory of Social and
Economic Evolution. London: Palgrave Macmillan.
Clark, John Bates. 1900. The distribution of wealth, a theory of wages, interest and
profits. New York: The Macmillan Company.
Clark, John Bates. 1907. Essentials of economic theory: As applied to modern prob-
lems of industry and public policy. New York: The Macmillan Company.
Coase, R.H. 1937. The nature of the firm. Economica, new series 4(16): 386–405.
Coase, R.H. 1960. The problem of social cost. Journal of Law and Economics 3:
1–44.
Davidson, Paul. 1994. Post-Keynesian macroeconomic theory. Vermont/Aldershot:
Edward Elgar.
Earl, Peter, and Bruce Littleboy. 2014. G.L.S. Shackle. London: Palgrave Macmillan.
Emmett, Ross B. 2009. Frank Knight and the Chicago School in American eco-
nomics. London: Routledge.
Hardy, Charles O. 1924. Readings in risk and risk-bearing. Chicago: The
University of Chicago Press.
Harrod, R.F. 1966. The life of John Maynard Keynes, 133. New York: Macmillan.
Hicks, John R. 1931. The theory of uncertainty and profit. Economica 11:
170–189.
Hicks, John R. 1973. Capital and time. A neo-Austrian theory. Oxford: Clarendon
Press.
Hicks, John R. 1976. Some questions of time in economics. In Evolution, wel-
fare and time in economics, Festschrift in honor of Nicholas Georgescu-Roegen,
ed. A.M. Tang et al. Lexington: Lexington Books.
Keynes, J.M. 1921. Treatise on probability. London: Macmillan.
Keynes, J.M. 1936. General theory of employment, interest and money. London:
Macmillan.
Keynes, J.M. 1937. The "ex-ante" theory of the rate of interest. The Economic
Journal 47(188): 663–669.
74 Frank H. Knight
Langlois, R.N., and M.M. Cosgel. 1993. Frank Knight on risk, uncertainty, and
the firm: A new interpretation. Economic Inquiry 31(3): 456–465.
LeRoy, Stephen F., and Jr. Larry D. Singell. 1987. Knight on risk and uncer-
tainty. Journal of Political Economy 95: 394–406.
Marshall, Alfred. 1890. Principles of economics. London: Macmillan.
Marx, Karl. 1858 [English, 1973]. Grundrisse: Foundations of the Critique of
Political Economy (Rough Draft). London: Penguin.
Mill, John Stuart. 1848. Principles of political economy with some of their applica-
tions to social philosophy. London: Longmans, Green and Co.
Robbins, Lionel. 1930. On a certain ambiguity in the conception of stationary
equilibrium. Economic Journal 40: 213–214.
Runde, Jochen. 1998. Clarifying Frank Knight's discussion of the meaning of
risk and uncertainty. Cambridge Journal of Economics 22(5): 539–546.
Schumpeter, J.A. 1908. Das Wesen und der Hauptinhalt der theoretischen
Nationalo¨konomie. Trans: The nature and essence of theoretical economics.
Leipzig: Duncker & Humblot.
Schumpeter, J.A. 1910. On the nature of economic crises. In Business cycle the-
ory: Selected texts 1860–1939, vol. 5, ed. M Boianovsky, 5–50. London:
Pickering & Chatto, 2005.
Schumpeter, J.A. 1912. Theorie der wirtschaftlichen Entwicklung. Leipzig:
Duncker & Humblot. Trans: The theory of economic development. Cambridge:
Harvard University Press, 1934.
Schumpeter, J.A. 1947. The Creative Response in Economic History. The
Journal of Economic History 7(2): 149–159.
Schumpeter, J.A. 1954. History of economic analysis. New York: Oxford University
Press.
Shackle, G.L.S. 1949. Expectations in economics. Cambridge: Cambridge
University Press.
Shackle, G.L.S. 1961. Decision, order and time in human affairs. Cambridge:
Cambridge University Press.
Shackle, G.L.S. 1983. Interview by Richard Ebeling. Austrian Economics
Newsletter (Center for Libertarian Studies) 4(1): 1 & 5–7.
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London: Allen Lane.
Stigler, George J. 1971. Foreword in Knight, Frank H. Risk, uncertainty, and
profit, with an introduction by George J. Stigler. Phoenix Books. Chicago:
University of Chicago Press.
Walker, Francis. 1887. A political economy. New York: Holt.
Warriner, Doreen. 1931. Schumpeter and static equilibrium. Economic Journal 14
41(161): 38–50.
3
The Grand Crusade
attempts to piece together his theory. If this is a problem for his critics,
it certainly wasn’t for Knight, who was fully aware of the criticism, as he
noted in a letter to Hayek:
1
Frank H. Knight Papers, Box 60, Folder 10, Special Collections Research Center, University of
Chicago Library.
2
Talcott Parsons Papers, Harvard University Archives, HUG(FP) 42.8.2, Box 2, Pusey Library.
3 The Grand Crusade 77
3
All letters with Fisher referred to in this section are held in the Frank. H. Knight Papers Box 59
File21, Special Collections Research Center, University of Chicago Library.
3 The Grand Crusade 79
seeing the same things in the same way? (As two technically competent
painters endeavoring to paint the same subject faithfully produce quite
different pictures?).”
Bothered or not, a second onslaught came in the form of a paper where
Knight said he was ‘provoked’ by Professor Fisher’s restatement of his
interest theory, also warning the paper was:
a“rethreshing of the old straw” not only of interest theory in general, but
worse, of price theory in general… Two contentions are to be argued: first,
that the prices of ordinary, typical commodities are practically “deter-
mined” by objective factors, cost or productive conditions, subjective (util-
ity) factors typically exerting a large influence on supply but an insignificant
one on price; and, second, that the interest rate is an extreme example of
this principle, regarding which it is especially true and demonstrable that
the subjective factors (“impatience,” “time-preference”) are in a peculiar
degree purely passive. Thus the argument is directed primarily against the
generally accepted “eclectic” or “equilibrium” statement of general price
theory, according to which demand and supply are “like the two blades of
a pair of scissors.” (Knight 1931, p. 176)
4
Originally published in Economic Essays in Honour of Gustav Cassel (London: George Allen &
Unwin 1933), pp. 327–42.
3 The Grand Crusade 81
In tandem with this objective he tries to delve into the most funda-
mental meanings that can form the bases of any theory, whilst also attack-
ing the confusions he sees arising out of the classical position. Knight
argued the existing theory had “fatal confusions” and can only be best
defended on the basis of assumptions divorced from economic reality.
The theory that capital corresponds to the time until primary factors of
production are applied to their ultimate use, by being employed to create
capital instruments as “secondary” factors, is a theory Knight explains was
first stated by William Stanley Jevons (1871), then popularized by Eugen
von Böhm-Bawerk (1891) and finally refined by the Swedish economist
Knut Wicksell (1901). Knight traced the genealogy from its roots in
the classical conception of production and the role of capital in produc-
tion, and noted this widely held theory was also the basis of the business
cycle theory put forward by Hayek. The theory, which he summarized as
“production is carried out by labour, which is supported by capital and
applied to land,” explains how a fixed capital supports fixed labour, and
labour uses up capital produced the previous year and reproduces it for
the following year while capital is food and raw materials originating in
agriculture. Labour that does not reproduce the capital it consumed is
82 Frank H. Knight
This, Knight was quite adamant, is a false view of the nature of the
cooperation between labour and capital, since firstly labour does not
produce capital and secondly it is not a technological principle that the
longer the production cycle the larger the yield. Hence, any such theory
of capital and its return is equally fallacious. The thesis Knight proposed
was twofold: First, the relationship between capital and labour in pro-
duction is mutual, coordinate and simultaneous; there is no primary fac-
tor. Second, there is no productive cycle or length of production period
which has a determinate length.
He approached the problem by offering explicit definitions of the key
terms for the main stages of the economic process, and these terms are
italicized in what follows, as they were by Knight. He started by explain-
ing that the conception of economic behaviour includes two phases:
The maximum utilization of a given environment, and activity which
improves that environment. Maximum utilization indicates a station-
ary economy, and the latter activity includes broadly economic acts
that maximize return from given resources through correct allocation
among competing alternatives. The end of all economic activity, which a
3 The Grand Crusade 83
quantity of exchange value. Knight sets out three principles, all of which
assume competitive conditions. The first principle of capitalization is that
of a uniform rate of income, through time, for every wealth item, under
competitive conditions. The second principle is the open opportunity to
invest money and productive services, and consumption income of some
magnitude over some period of time sacrificed where wealth is obtained
instead. The third principle is that under such conditions, any time seg-
ment of money income at any future interval is equivalent to a uniform
and perpetual income from the moment the decision is taken to convert
from one to the other, from which we can derive the rate of return or rate
of interest.
Knight goes on to make the bold claim that in a growing society all
capital is, as he stated it, inherently “immortal,” meaning that the pro-
duction period has no beginning and no end, unless the date of the end
of the world was known, and the entire social-economy was able to pre-
pare for this end. The wealth contained in an object is the capitaliza-
tion of a perpetual income, which is the remainder of ordinary imputed
income after provision and replacement in perpetuity. If a capital item
is more durable, the depreciation charge will be less, but as that is only
one dimension in capital quantity alone it tells us nothing. Any assess-
ment of the time of production has to be set in this context, according to
Knight, and he presented two facts which he argued prevent calculation
of the length of production process. First, new equipment goods made
especially for the job are made in co-operation with a great part of the
capital wealth and labour power, which already existed when the enter-
prise started. Second, the liquidation of the equipment after the project
ends, will involve turning a large fraction of all the wealth value back into
the production stream of society as a whole, and the more accurately the
liquidation date is known the greater this fraction will be.
The contrast between the stationary economy and economic growth
was made clear by Knight. In the former, there is no interval between
production and consumption, the rendering of the service and its enjoy-
ment are simultaneous and equal. When growth by investment occurs,
there are two ways of conceiving the time relation as productive capacity
used over a certain period of time to create additional capacity, instead
of current consumption. In the first view, some part of the capacity in
86 Frank H. Knight
In the 37th proposition of the first book of Euclid it is proved that all tri-
angles upon the same base and between the same parallels are equal in area.
Hence we may draw the conclusion that, provided capital be invested and
uninvested continuously and in simple proportion to the time, we need
only regard the greatest amount invested and the greatest time of invest-
ment. Whether it be all invested suddenly, and then gradually withdrawn;
88 Frank H. Knight
Knight explained that the history of every new capital item involves
an ascending phase of construction, and a period of utilization, but we
should see that the utilization of an item may or may not represent a
descending phase of being used up. If it is not so used up, then Knight
explained:
5
Knight (1934, pp. 262–3) went on to argue that “It is exceptional, if ever, that the capital account
with a particular instrument really ends at the zero point. In all ordinary cases there will be an
appreciable, and often a large, residual or salvage value to be carried over into an account with some
other instrument, or into the general capital account of the owner.
6
Discussing this further in pages 264–66, Knight noted (1934, p. 266) “the realistic way…is that
of viewing capital once invested as perpetual, even when the instrument in which it is first invested
happens to have limited life”.
3 The Grand Crusade 89
Knight restated his theory of value and explained “The only primary
value magnitude possible for economic thought is consumptive income, a
pure service, a pure intangible, a flow, at some intensity, for some inter-
val” (Knight 1934, p. 259). Knight then set out the essentials of capital
theory, which he did by stating five propositions. The first proposition is
that theoretical sale value is determined mathematically as present value
by discounting future yields back to the moment of valuation, at a uni-
form rate. Capital reaches its maximum value at the end of its construc-
tion period. Second, an amount of capital is mathematically determined
by its construction cost, which always includes the sum of payments
made by existing productive agents, and an accumulated carrying charge.
Third, each cost increment incurred must yield a return at the same rate
over the whole period the increment is invested, and the carrying charge
accumulates at the same rate as used in discounting any increment of
income in order to arrive at present value. These first three points Knight
explained show that the construction cost is equal to the present value of
the anticipated yield, when the rate of carrying the cost of direct outlay
accumulates at the same rate as future direct yield is discounted. Finally,
any investment is made under the condition of seeking the maximum
rate under the economic circumstances, comprising freedom of choice
and a free market. Yield here means the imputed yield, which is the sale
value of some service rendered, less payments to other agents and upkeep
cost. This service can be a contribution to another item, a current mon-
etary return, current satisfaction or an increase of value in the item itself.
On the cost side, the ascending phase, direct outlays will always include
payments for pre-existing capital items, including rent and interest.
The form of capital is immaterial to the theory of capital and inter-
est, indeed the theory fits the original “wage fund” conception with the
modification given by of Jevons et al, discussed in the 1933 Capitalistic
Production, Time, and the Rate of Return essay. Knight continues in the
90 Frank H. Knight
differently it acts in the asserted way.” Another example was his handling
of individual disinvestment and social disinvestment, where Machlup
suggested Knight was essentially stating a tautology when he wrote “in a
stationary or growing society disinvestment by an individual owner in no
wise involves actual reconversion of ‘capital’ into income” (Knight 1934,
p. 273), it is Machlup retorted “just the relation of the total amounts
of capital individually disinvested to the total amounts of capital indi-
vidually invested at any moment of time which makes society stationary,
growing or retrograde” (Machlup 1935, p. 580). He also challenged the
point Knight asserts, and reasserts, that production and consumption are
simultaneous. The statement by Knight that all capital is always main-
tained, and therefore perpetual, was made to support the notion that
a period of time between production and consumption is meaningless,
but Machlup responded that surely the notion that capital is not always
maintained ought to support the contrary argument, that this period has
meaning and significance. A final point Machlup makes relates to capi-
talization of perpetual or of time-limited income, which he says Knight
stated with the utmost clarity.
Machlup then turned to the length of the production period itself,
starting with the concept and its name, which he said was confused by
Böhm-Bawerk when he added the “length of the production process” and
the “period of production” to the concept of the “degree of roundabout-
ness of production.” If we try and add up the durations of time of direct
and indirect production, and services, we will arrive at an infinite period.
Thus production, as Knight explained, is continuous, and Machlup
agreed, using Knight’s analogy that it is not possible to say when the
production of a certain glass of milk began or ended. To address this
Böhm-Bawerk considered the notion of an average time of production,
and likewise for the investment period. These, along with the confusion
caused by the careless use of the word “time”, to measure the point of
productive input to the dependent final output rightly needed to be dis-
closed and blocked Machlup argued. The misconceptions of construction
and utilization periods were recognized as a concern by Böhm-Bawerk,
and to answer this Machlup said Knight applied a “novel method of
arriving at erroneous averages” and “it is inexplicable to me how Professor
Knight could arrive at such a narrow definition of the production period”
3 The Grand Crusade 93
him, Knight states that Machlup asserts or assumes “over and over” that
distance corresponds and explains capital quantity, without in his view
showing what the connection is in practice. Knight concluded, “Professor
Machlup’s entire argument seems to assume that capital is consumed in
some definite period, in spite of his observation that the contrary is a tru-
ism” (Knight 1935c, p. 626).
What distinguishes the Austrian way of doing capital theory from other
ways is its longitudinal approach. A production process is merely a time –
sequence of inputs and a time-sequence of outputs. That is all one sees;
whether the intermediate stages are pink or blue, still or bubbly, animal,
vegetable or mineral, is unimportant. From the Austrian point of view, an
oil refinery is just a pile of unripe gasoline. There is obviously something to
be said for this approach; it will call attention to things that might other-
wise be missed. It has disadvantages, too… (Solow 1974, p. 189)
While the old Austrian theory was “point output” (its elementary process
having a single dated output), we shall use an elementary process that con-
verts a sequence (or stream) of inputs into a sequence of outputs. Our
conception of capital-using production is thereby made much more gen-
eral. (Hicks 1973, p. 8)
In this theory, goods that are produced by the use of fixed capital are
jointly supplied, and it is the same capital good that are the source of
the whole stream of outputs, which are outputs at different dates (Hicks
1976, p. 98). Hicks explained that if it were not for joint supply, we could
work very well with a cost of production theory of value. Likewise here, if
it were not for the joint supply that is implied in the use of fixed capital,
we could work very well with the Böhm-Bawerk model, where every unit
of final output is part of a sequence of previous inputs that have led to that
output. This means the cost of the final output can be translated into a
sum of the costs of the associated inputs, which are accumulated for each
input by interest for the appropriate length of time. In an economy which
uses fixed capital, such imputation is not possible (Hicks 1976, p. 99).
96 Frank H. Knight
The value that is set upon the opening stock depends in part upon the
value which is expected, at the beginning of the year, for the closing stock;
but that was then the future, while at the end of the year it is already pres-
ent (or past). There may be things which were included in the opening
stock because, in the light of information then available, they seemed to be
valuable; but at the end of the year it is clear that they are not valuable, so
they have to be excluded. This may well mean that the net investment of
year 1, calculated at the end of year 1, was over-valued – at least it seems to
be over-valued from the standpoint of year 2 (Hicks 1976, p. 265).
What Hayek called Knight’s crusade against the concept of the period
of investment was just a beginning, and arguably it was ultimately the
neo-Austrian Hicks in the 1970s who mounted the most robust chal-
lenge to Knight, but it was also part of a much larger debate against
the Austrian school, that would include Hayek, von Mises, and Knight’s
friends and colleagues at Mont Pelerin, to which we now turn.
3 The Grand Crusade 97
Bibliography
Knight, Frank Hyneman. 1931. Professor Fisher’s interest theory: A case in
point. Journal of Political Economy 39: 176.
Knight, Frank Hyneman. 1932a. Interest. In Encyclopedia of the social sciences,
vol. 8. New York: Macmillan. Reprinted in The ethics of competition (1935).
Knight, Frank Hyneman. 1932b. The case for communism: From the stand-
point of an ex-liberal. In Research in the history of economic thought and meth-
odology, ed. Warren J. Samuels. Archival supplement 2(1991): 57–108. JAI
Press: Stamford, Conn USA.
Knight, Frank Hyneman. 1933a. The economic organization. Chicago: University
of Chicago. Published as The economic organization. New York: A.M. Kelley,
1951.
Knight, Frank Hyneman. 1933b. Capitalistic production, time and the rate of
return. In Essays in honor of Gustav Cassel, 327–342. London: George Allen
& Unwin.
Knight, Frank Hyneman. 1934. Capital, time, and the interest rate. Economica
1: 257–286.
Knight, Frank Hyneman. 1935a. The ethics of competition and other essays.
New York: Harper & Bros. The ethics of competition. Originally published
in Quarterly Journal of Economics 37(August, 1923): 579–624.
Knight, Frank Hyneman. 1935c. Comment (on Professor Knight and the
period of production, by F. Machlup). Journal of Political Economy 43:
625–627.
Secondary Sources
Bohm-Bawerk, Eugen von. 1891. The positive theory of capital. London:
Macmillan.
Buechner, M.N. 1976. Frank Knight on capital as the only factor of production.
Journal of Economic Issues 10(3): 598–617.
Cohen, Avi J. 2006 The Kaldor/Knight Controversy: Is Capital A Distinct and
Quantifiable Factor of Production? European Journal of the History of Economic
Thought 13(1): 141–161.
Emmett, Ross B. 2009. Frank Knight and the Chicago School in American eco-
nomics. London: Routledge.
Hayek, F.A. 1931. Prices and production. London: Routledge & Sons.
98 Frank H. Knight
Hayek, F.A. 1936a. The mythology of capital. Quarterly Journal of Economics 50:
199–228.
Hayek, F.A. 1941. The pure theory of capital. London: Routledge & Kegan Paul.
Hicks, John R. 1939. Value and capital. Oxford: Clarendon Press.
Hicks, John R. 1965. Capital and growth. Oxford: Clarendon Press.
Hicks, John R. 1973. Capital and time. A neo-Austrian theory. Oxford: Clarendon
Press.
Hicks, John R. 1976. Some questions of time in economics. In Evolution, wel-
fare and time in economics, Festschrift in honor of Nicholas Georgescu-Roegen,
ed. A.M. Tang et al. Lexington: Lexington Books.
Jevons, William Stanley. 1871. Theory of political economy. London: Palgrave
MacMillan.
Machlup, Fritz. 1935. Professor Knight and the “period of production”. Journal
of Political Economy 43(5): 577–624.
Solow, Robert M. 1974. Review. The Economic Journal 84(333): 189–192.
Wicksell, Knut. 1901. Lectures on political economy, vol. 1. Trans. E. Classen.
London: Routledge and Kegan Paul.
4
Knight contra mundum
1 Knight and the Austrians
In Friedrich Hayek’s famous 1944 work The Road to Serfdom, Hayek
approvingly quotes Knight on power and the duties of those in authority
in the collectivist state:
…they would have to do these things whether they wanted to or not; and
the probability of the people in power being individuals who would dislike
the possession and exercise of power is on a level, with the probability that
an extremely tender-hearted person would get the job of whipping-master
in a slave plantation. (Hayek 1944, p. 112f )
1
This title would later become Ludwig von Mises, Human Action (1949).
4 Knight contra mundum 101
each of them believing they had identified the problem and offering an
answer. What erupted in the 1930s would erupt once more thirty years
later in the 1950s, and last into the mid-1970s – which may be why this
1930s battle still retains some broader interest – in the battle of the two
Cambridges, discussed in Chapter 1. Notably, Kaldor took different sides
in the 1930s and 1950s. In launching the controversy, Joan Robinson
wrote, in an almost Knightian way, that:
2
Knight to Hayek, Letter of 15 August 1935; Hayek to Knight, Letter of 21 June, 1935; and
Knight to Hayek, Letter of 7 October 1935 Frank Knight Papers, University of Chicago, B60, F10.
This correspondence is examined by Avi J. Cohen, “The Hayek/Knight Capital Controversy: The
Irrelevance of Roundaboutness, or Purging Processes in Time?” History of Political Economy (2003),
Vol. 35:3, in which notes “All correspondence is located in the Knight papers at the University of
Chicago. Because Knight had the fortunate habit of keeping carbon copies of his letters to others,
4 Knight contra mundum 103
1936. The debate ended in the 1940s, when in 1941 Hayek published
The Pure Theory of Capital with the stated objective of making capital
theory, which he believed had previously been devoted almost entirely to
the explanation of interest rates, “useful for the analysis of the monetary
phenomena of the real world.” Knight’s last word in this particular debate
came in his 1944 essay Diminishing Returns from Investment (1944).
Hayek’s interest did not start with Knight, because he had already
started a debate with Piero Sraffa about capital theory, and it has been
suggested that this may have stimulated Knight’s own venture into the
debate, though such a conclusion is arguable since this was clearly a
subject “in the air” and one that Knight would have naturally explored.
Knight had written a letter to Oskar von Morganstern on December 19,
1932, where he had complained about the lack of sense he could make
of the disagreement between Hayek and Sraffa. He wrote again on May
4, 1935:
both sides of the correspondence have been preserved. The Hayek papers do not contain any of the
correspondence.” (p. 470).
104 Frank H. Knight
The third fallacy is the idea that the product of a capital instrument is
the product of economic activity creating or reproducing the instrument
itself, as net yield cannot be treated both as the product of the instrument
and the product of the activity that created it.
A year later in an essay aimed directly at Hayek, Knight, referring to
Hayek’s essay The Relationship between Investment and Output (1935),
explained “he asserts or assumes, on the average of at least once a page,
that he has proved, or is proving, or that it is self-evident and requires no
proof, that a change in the amount of capital in society is identical with
a change in the “investment structure”, an increase corresponding to a
lengthening, and a decrease to a shortening of that structure.” (Knight
1935b, p. 77) Hayek then went on to identify this investment structure
with the interval between the time when labour is performed and the
time when the product is consumed. If there is any argument in favour
of this theory, or reason to believe it, from Hayek’s argument, Knight
noted “I have not been able to locate the passage in question” (Knight
1935b, p. 77). Again, Knight asserted “there is no production process
of determinate length, other than zero, or “all history”” (Knight 1935b,
p. 78). Hayek offered a footnote in his essay that though he was making
little attempt to deal directly with objections raised against the Austrian
approach to the theory of capital, much of what is in the essay was an
implicit reply to some of the most important recent contributions to the
subject, including Knight’s Capitalistic Production, Time, and the Rate of
Return.
On the question of time, Knight admitted it was reasonable to believe
that the use of more capital equates with the use of more time, because
it had been taught as doctrine for so long, and it does indeed take time
to construct capital goods. What he found harder to fathom was the
doctrine of labour producing capital, though it was generally accepted
by economists. He started by noting that he himself had completely
accepted the doctrine, and had taught and expounded it for years, “and of
course it was never questioned by the “innocents” who were my victims”
(Knight 1935b, p. 79). He also noted at this point, in a footnote, that
the theory of profit in Risk, Uncertainty and Profit, referencing the view of
the entrepreneur or business unit buying productive services in the pres-
ent for selling future products, also had to be entirely reworked (Knight
106 Frank H. Knight
which bore a superficial resemblance to the wage fund theory, but what
he intended by “means of subsistence” was more than food or the com-
mon comfort and necessities. He included everything that maintains the
workers, regardless of their various levels of comfort. He argued it is not
a fixed wage fund given by capitalist employers for the “subsistence” of
the working classes; rather it is the entire wealth of the community that
is available for the maintenance of all classes of workers. His definition
states the true relation of wealth to labour is that existing wealth is to pro-
vide subsistence to the workers during the interval from the beginning to
the end of the social production period. However, because the wage is not
a fixed amount, the value of labour to the employer depends upon future
product which itself depends on productivity, and this in turn depends
on the length of the production process. Hence, there is no fixed start-
ing point. To get to a fixed point, Böhm-Bawerk suggested a necessary
exchange, whereby the available quantity of present sale goods would
purchase the total available labour, since labourers need to hire themselves
out and the capitalist needs to hire out their wealth. Unemployment is
thus a case of bad organization because when the proportions of wealth
and of labourers changes, all that is required is to contract or extend the
production period. At any given point labour buys up the available “wage
fund,” and the rate of interest is determined by the formation of price.
The time period will be extended until the marginal employment of the
unit of capital is reached; meaning the extra product gained by lengthen-
ing the process is outweighed by the diminishing productiveness of the
process.
Where wage fund theorists thought of a given and fixed amount,
Böhm-Bawerk argued it was a fluctuating indefinite amount. The amount
of capital destined by capitalists to pay wages is neither equivalent to the
total national capital, nor to the total “circulating capital,” rather it repre-
sents a variable portion of the community’s wealth. As with the wage fund
theory, Böhm-Bawerk maintains the existence of a certain subsistence
fund, from which the wages of labour in any country are defrayed, and
it has an important influence on the reciprocal level of wage and inter-
est. However, he argued the resemblance ends at this point; from there
he finds great divergence. The wage fund is really a fluctuating indefinite
108 Frank H. Knight
The increase of the subsistence fund is, in the first instance and principally, used
up in lengthening the production period; and it is only in so far as the length-
ening of the production period leads, at the same time, to a decrease of the
surplus returns (according to the diminishing scale of surplus returns which
4 Knight contra mundum 109
carried with it the wage-fund doctrine, which in its simplest form assumed
that the entire income-less-rent of society is paid out each year to labour,
thus making capital, annual income (apart from rent) and the wages-fund
virtually identical, capital’s share in income being regarded as negligible.
(Knight 1933b, p. 327)
All the other attempts to state the assumptions as regards the supply of
capital in terms of a definite fund and without any reference to the time
structure, whether this is attempted by postulating given quantities of
“waiting,” or “capital disposal,” or a “subsistence fund,” or “true capital,” or
“carrying powers,” are just so many evasions of the real problem of
explaining how the existence of a given stock of capital limits the possibil-
ity of current investment. Without such an analysis they are just so many
empty words, harmful as the basis of that noxious mythology of capital
which by creating the fiction of a non-existing entity leads to statements
which refer to nothing in the real world. And the concept of capital
112 Frank H. Knight
2 Knight and Socialism
The opposite view to the free market system is what Knight termed
“economic interpretation,” which he associated with socialism. Knight
looks at socialism here simply as a theory of conduct, and he is much
more interested in socialism than is perhaps usually the case with critics
of socialism. By the time Paul Samuelson’s 15th edition of his textbook
was published, the Berlin Wall had fallen in 1989, leading as Samuelson
wrote to a rediscovery of the market. The impact of this in his textbook
was that the regular sections in earlier editions on Marxian economics,
along with farming and labour unions, was replaced by sections about
environmental economics, rising healthcare costs, growth of the corpora-
tion, and real business cycles (Samuelson 1995, p. xxxiii). Knight was
writing long before this transformation, but his thoughts on socialism
and communism remain useful. Certainly, Knight would have embraced
the implosion of the Soviet Union and the fall of communism, but not
in any triumphal sense of capitalism’s victory. He would have seen it as a
victory for common sense, and a warning against the fanciful thinking of
an alternative economic system.
He may have been interested in socialism, but towards the end of
his life, in his 1967 essay Laissez-faire: Pro and Con, Knight argued that
socialism, specifically Marxism, misunderstood the nature of the mar-
ket and competition, stating “In control are not capitalists but entrepre-
neurs and finally, consumers. Marxist economics is a tissue of absurdity.”
4 Knight contra mundum 113
In the popular mind, and of course especially in the Marxian and most
other socialistic literature, it is viewed as an axiom that the owner of “capi-
tal,” or “the means of labour,” has the worker in his power. But the proposi-
tion is false or meaningless if employers are in competition with each other
and act in accordance with economic motives. The distribution of eco-
nomic power in a competitive society is simply the relative market values
of the property or labor services offered to production by different indi-
viduals. And if monopoly is assumed, each group will be equally in the
power of the other. (Knight 1928, p. 122)
3 Knight and Kaldor
Another major exchange was that between Knight and the British
economist Nicholas Kaldor (1908–1986), who was a major force in
British economics and a thinker who transitioned from the Austrian
School to Keynesianism. Kaldor lectured at the LSE on Knight’s theory
of capital set out in the first part of Risk, Uncertainty and Profit, and it
was in his Austrian days that he had a protracted exchange with Knight,
when in 1937, he defended the Austrian position. Samuelson, writing to
his widow, Clarissa, on the occasion of Kaldor’s death eulogized “Nicky
showed himself to be brilliant on the theory of capital. Until he left this
stage behind, Kaldor was the best neo-classicist of us all, and we grew
up on his great articles in the Review of Economic Studies, Economica,
Economic Journal and Econometrica” (Targetti and Thirlwall 1989, p. 7).
It was in the pages of Econometrica that Kaldor took up his pen to engage
Knight, in an essay entitled Annual Survey of Economic Theory: The Recent
Controversy on the Theory of Capital (1937). Kaldor’s work was also impor-
tant in discussing the notion of a ‘capitalist-slave’ economy, in which all
goods produced are capital goods, while wages and consumption are zero.
The core of the debate with Knight, takes us back to the notion of “aver-
age period of production” put forward by Knight as a useful concept for
analyzing industrial fluctuations. Knight, as we have seen, treated capital
as indistinguishable from the factors of labour and land, and he opposed
any distinctions between factors of production, insisting capital cannot
be treated as an homogeneous factor of production equal to labour.
Kaldor sought to systematize what Knight had scattered across a num-
ber of essays and journals, admitting this was more of an interpretation
than a summary, as he had to “fill in the gaps” in Knight’s treatment.
Kaldor noted that the Austrians had not fully grasped or effectively
answered Knight’s chief points, a state of affairs for which Knight himself
was partly responsible due to his repetition and tendency to restate the
same ideas in many different ways. Knight, in Kaldor’s words, “launched
an offence” that brought the subject into a lively debate, which was in
part a re-opening of the controversy in the opening years of the century
between J.B. Clark and Böhm-Bawerk. He notes that the focus of the era
118 Frank H. Knight
was on the criteria for policy that mitigates economic instability, and how
far the period of production is relevant in the analysis of business fluctua-
tions. Avi J. Cohen summarizes the debate thus:
criticism, but also the least important of the three points. Knight argued
that maintenance expenditure cannot be distinguished from expenditure
on replacing worn-out capital goods. He also outlined the irrelevancy of
distinguishing between expenditures incurred in maintaining resources
and those incurred in replacing them, and as such they should be lumped
together and not be treated separately. The third point Kaldor addressed
concerned the optimal length of the investment period. Knight had
argued that there is no necessary correlation between the “period of pro-
duction” and the quantity of capital. This point, Kaldor suggested, was
the most important, but also the least adequately explained by Knight.
The first two points Kaldor tackled did not affect the assumption made
by the Austrian school, that of the law of roundaboutness. In this last line
of argument, Kaldor explained that Knight sought to prove the Austrian
law is irrelevant as far as capital theory is concerned, because it cannot be
demonstrated that an increase in the quantity of capital in a community
will necessarily lead to a “roundabout” process.
Kaldor argued Knight’s views did not explain how the rate of return,
on different investments, is kept at a level of equality, nor did it explain
why an increase in capital should lead to a fall in interest, and lastly it
did not contribute much to the explanation of how a distributive share
is determined. Kaldor offered an argument to demonstrate that Knight’s
view of the irrelevance of the law of roundaboutness ignored the effect of
a change in the quantity of capital on price relationships. There is another
way of looking at the Austrian theory that survives most of the criticisms,
and the law of roundaboutness was a derivation from the general law of
nonproportional returns. The real objections against the Austrian capital
theory, Kaldor believed were related to the measurability of the invest-
ment period, rather than Knight’s argument on the grounds of relevance.
In his essay Capital and Intensity and the Trade Cycle (1939), Kaldor
agreed with Knight against Hayek that capital intensity in a boom period
moves in the opposite direction to that posed by Hayek. Kaldor also
agreed that the inverse, monotonic relation between capital intensity and
the interest rate is not sustained in heterogeneous commodity models.
However, they disagreed about which of their respective one-commodity
models provided better insights. He also saw the same difficulty as Knight
of measuring capital as a productive factor, and of applying the Austrian
120 Frank H. Knight
First, it shifts the framing of issues in the three major recurring clusters of
20th century capital theory controversy from periods of production to pro-
duction functions, and from roundaboutness to diminishing returns.
Second, the exchanges between Kaldor and Knight explicitly reveal Knight’s
position on the role of increasing knowledge in offsetting diminishing
returns over time, making Knight an unacknowledged “precursor” of this
idea in new growth theory. Third, the controversy with Knight is a turning
point for Kaldor’s attachment to Austrian theory. He enters this contro-
versy sympathetic to Austrian theory, but afterwards moves away from the
Austrian position. In a letter4 to Knight, Kaldor explains frankly his change
in views and concerns for the future. (Cohen 2006, p. 142)
3
Nicholas Kaldor, Collected Papers I (1st edition), p. 7.
4
Letter to F.H. Knight (draft), 10 September 1937, in Nicholas Kaldor Papers, Kings College,
University of Cambridge, 3/30/130/59–67.
4 Knight contra mundum 121
4 Knight and Keynes
If any duopoly in economic society existed, in Knight’s view, it was not
the Marxian division between labour and capital. The divide he saw was
essentially one between the prevailing view that government drives the
economy, and the alternative view that markets do the job best. What
Knight did was to back the markets by pointing out the weaknesses and
challenges the markets present us with, which while opening the door to
a defined role for government does not go so far as the Marxian, Socialist,
or Keynesian schools of thought. It was his evaluation of the role of gov-
ernment and the market, along with his interpretation of how one under-
stands factors of production and labour, that brought Knight into conflict
with Keynes, and to act as a counter to the Keynesian Revolution. In
his 1937 essay Unemployment: And Mr. Keynes’s Revolution in Economic
Theory, Knight started by admitting that Keynes’s General Theory of
Employment, Interest and Money effected a revolution, though the evalua-
tion was not what Keynes or his supporters would agree. Given the status
of Keynes and his General Theory it might surprise the layman that the
first reviews in the United States were hostile, and Knight was amongst
those leading the charge. While the significance of the work was appre-
ciated, it caused much angst. Knight and Jacob Viner at Chicago were
among the major reviewers of the work, with Knight’s review appearing
in the Canadian Journal of Economics, in February 1937. Keynes never
responded to Knight’s arguments specifically. He chose to play the man
rather than the ball, as Skidelsky records, in private Keynes wrote acidly
“with Professor Knight’s two main conclusions, namely, that my book
had caused him intense irritation, and that he had great difficulty in
understanding it, I am in agreement.” (Skidelsky 1992, p. 577)
In offering solutions to the problems of the business cycle, Knight
argued that monetary change does not have any direct or permanent
effect on the interest rate; because he says there is no functional relation
between the price-level and any rate of interest. It is far better, in Knight’s
122 Frank H. Knight
view, to move past economic theory and see what Keynes has offered as
a contribution to the theory of business oscillations, which he admit-
ted requires great effort and “laborious interpretation” on the part of the
reader. His overall impression is one of great disappointment, with its
chief value being the hard labour of reading the book and grappling with
the problems it raises. Simply put, Knight thought Keynes was wrong,
and had fallen into a methodological fallacy of confusing the power to
“disturb” a value of magnitude with a real functional connection to cau-
sality. He explained that Keynes based his monetary theory of interest
on the fact that open- market operations can be effective, yet the rate of
interest as a rate of return on investment is the ratio between two value
magnitudes, namely income and wealth.
As discussed earlier, Keynes argued that employment depended on the
level of output, which in turn depended on the level of investment. Knight
noted that Keynes entitled his major work “The Theory of Employment”
rather than “The Theory of Unemployment,” a manoeuvre he believed is
suggestive of the general character of the argument. He contends at the
outset that the work is “quite unsubstantiated” and is at variance with the
“economic society in which we live.” Keynes offered two principles, the
first that “wage is equal to the marginal product of labour” and “the util-
ity of the wage when a given volume of labour is employed is equal to the
marginal disutility of that amount of employment” (Keynes 1936, p. 5)
Knight accepted the first point, but rejected the second on the grounds
that wages are not revised downward in case of involuntary unemploy-
ment. Keynes, contrasting his views with those of the classical theorists,
stated, repeatedly said Knight, a large amount of involuntary and non-
frictional unemployment is a fact of common observation, yet there is no
reference to depression conditions. Knight suggested that Keynes’s belief
is simply a deduction from the principles of his system, the very crime of
which Keynes accused the classical writers. Knight argued this is a funda-
mental position that needs to be kept in mind as one makes the journey
through Keynes’s great work.
Knight spelt out the assumptions Keynes was making, namely, those
of unemployment, the price situation, and, a mode of price mechanism,
leading to a blockage in the growth of employment. He found it extremely
difficult to fathom the meaning of Keynes’s approach, especially since in
4 Knight contra mundum 123
general matters he said Keynes does not mean what he says. This is not
just true in the title of the General Theory, but also in the way he made
his specific arguments. For instance, the subject of the book, Knight said,
is really the monetary demand for labour, with the thesis that unemploy-
ment is due to the failure of effective demand, and unemployment is to
be remedied by an increase in the effective, or monetary, demand for
labour. He suggested it would be much clearer to the reader if Keynes
stated the supply price is fixed and adjustment is made on the demand
side, rather than giving the impression that the supply-price function is a
real function in the sense understood ordinarily.
Having divided monetary demand for labour into consumption and
investment demand, Knight suggested the logical next step would have
been to follow the money in these two channels, to the point of either
where employment results, or the failure to do so becomes clear. Instead,
Keynes took a different route and inserted a group of what Knight called
“four general chapters” to explain the meaning of investment. In Book II,
this amounts to making the point that saving and investment are defined
as necessarily and continuously equal, and then in Book III “finally” arriv-
ing at the point where Keynes can develop his view of the forces deter-
mining the division of individual money income between consumption
and saving. The investment demand for labour, a pivotal one for Keynes,
Knight explained, is the discussion of Book IV, which occupies eight
chapters and over a third of the entire work. The assumptions in this
section relate to the decision to save money, and the decision to invest
money in the creation of real capital. In a typically acerbic remark, Knight
suggested “Mr. Keynes’s theory of interest is even more original than his
theory of wages, but runs along somewhat the same lines” (Knight 1937,
p. 310), noting it was not mentioned in the opening chapter. Interest for
Keynes is, Knight explained, purely a monetary phenomenon. For his
part, Keynes made a solitary reference to Knight, in a footnote, where he
quoted Knight’s explanation of equilibrium in respect to capital produc-
tion, which is “a rate of interest that savings flow into the market at pre-
cisely the same time-rate or speed as they flow into investment producing
the same net rate of return as that which is paid savers for their use”
(Knight 1934, p. 282). Keynes noted that Knight’s discussion “contains
many interesting and profound observations on the nature of capital, and
124 Frank H. Knight
5 Conclusion
This chapter has covered some of the core topics in the opposition
Knight mounted against other contemporary thinkers. Knight also con-
tested Hayek and the Austrians in other ways outside the economic top-
ics focused on here, and especially contested Hayek’s understanding of
law, addressing towards the end of his career in particular, the arguments
Hayek put forward in Constitution of Liberty (1960), which Knight
regarded as “an imposing work of historical scholarship” (Knight 1967,
p. 788). That said, his first line of criticism was historical, with the con-
tention that in Hayek’s look at rule of law, and its historical development,
he failed to “mention the crucial events that led to or constituted the
Liberal Revolution” (Knight 1967, p. 789). The establishment of free
society and democracy in a broader sense is missing, along with references
to church power, the Reformation and of religious toleration leading to
freedom of thought. Knight concluded from this that Hayek was scornful
of politically organized freedom. These concerns over freedom, democ-
racy and economy exercised Knight throughout his career, but became
most fully formulated in his last work, his Harvard lectures published in
4 Knight contra mundum 125
the same year as Hayek’s Constitution of Liberty under the title Intelligence
and Democratic Action (1960), matters we will consider in later chapters.
As Knight noted in his AEA presidential address, Keynesianism did
indeed recede, and later it was the school that Knight co-founded which
would come to the fore in the closing stages of the 20th century, in par-
ticular the Monetarism of Milton Friedman. Skidelsky suggested “In
Knight’s ‘passionate, expiring cries’ there is the feeling, common to many
of the older economists, that Keynes had committed a trahison des clercs”
(Skidelsky 1992:576–8). However, in a new century and millennium,
and in the wake of the recession that started in 2008, Keynes made a
comeback and the social concerns that mattered to both Keynes and
Knight resurfaced and with it the need for prophecy and no doubt, from
a Knightian perspective, some of the old heresy. The last chapter will
look briefly at this recent development, but the next chapter considers
Knight’s thoughts on the organization of economic life.
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4 Knight contra mundum 127
Given issues today, ranging from the continued anti-market view of the
world to concerns about a growing rich/poor divide, Knight is a criti-
cal dialogue partner in this current climate, because he takes a realistic
view whilst recognizing the imperfections, and hence the contradictions,
inherent in our economic organization of human beings. After Risk,
Uncertainty and Profit, Knight’s core writings were essays and collections
of essays, rather than any systematic works or impressive individual vol-
umes. Two of his early and most important collected volumes were The
Economic Organization (1933a), published as a volume in 1951 but dat-
ing back to 1933 as course material for his students, and The Ethics of
Competition (1935a), published in between the course material and the
published volume. In these works, Knight explored the market system
and its weaknesses, and engaged with socialism and communism as alter-
natives to capitalism. He was also developing his thought on the role of
science in economics and economics itself as a science, along with his
interest in ethics, psychology and behaviour. Knight was coming at his
economic interest from a variety of angles, and much of what is discussed
in this period has its roots in Risk, Uncertainty and Profit, often drill-
ing more deeply into this or that aspect. In this, and the next, chapter
we will look chiefly at two major themes which emerged in his early to
The strongest argument in such a system as ours is the contention that this
direct, selfish motive is the only dependable method, or at least the best
method, for guaranteeing that productive forces will be organized and
worked efficiently. (Knight 1933a, p. 12)
…from the economic standpoint, this scarcity is always a result of the com-
petition of some other use, or uses, for the agency or agencies; otherwise,
no “economic” problem arises, though a technical, or “technological”,
problem may. In “free” society economic agencies, or “resources”, include
human beings and external things “owned” by human beings. (Knight
1935a, p. 9)
Distributive justice, with which Knight was deeply concerned, was to him
a matter of free market competition and (more important as problems
unsolved) inequality in inherited capacities and wealth, and in the oppor-
tunity to acquire, develop, and market valuable productive services. (Leigh
1974, p. 584)
supporters alike often take it this way, which may explain why Knight is
held up as such a staunch defender of Capitalism.
There are hidden assumptions to challenge, such as the notion that
producers and consumers are in competition, with the existence of
monopolies. Likewise, the controlling force of pecuniary demand can be
manufactured by fraud or corruption of tastes, and people may not want
what is best for them, nor may it necessarily represent a perfect index of
real value. In using economic power, society seeks to satisfy current wants
and provide for maintenance and progress, which Knight sets out in
detail. In his teaching, he took his class through consumption and want-
satisfaction, the “static” society, stages of production of goods for direct
and indirect consumption, and the aspects of capitalization and wealth,
all the while challenging assumptions and sharpening their understand-
ing of the workings of the market economy.
A major contention put forward by Knight, which he had explored
earlier in Risk, Uncertainty and Profit, was his challenge to the tripar-
tite distinction of land, labour and capital as the three primary produc-
tive factors. These may well be roughly distinct groups, but Knight sees
serious defects in this classification which need to be addressed, and he
examined arguments for and against the tripartite classification. The argu-
ment against starts with the notion that none of these factors are really
ultimate, they are largely “produced” as a matter of historical fact, and
they are different from raw nature since things have been done to bring
them into use. Human beings are essentially products as well, they have
been developed and a human being without training is of little value.
Finally, none of the groups considered as factors are homogeneous, and
there are many different natural agents, different types of capital goods,
and different kinds of workers. In favour of the tripartite classification,
he cited arguments that there are good reasons in society for making
a distinction between human beings and material productive agencies,
because humans are not saleable and cannot be properly considered as
“produced,” as their development does not conform to the economic
principles governing the production of property. Knight’s conclusion is
that any useful classification should look forward and not backwards, and
any historical questions of origin have little practical significance, though
they may possibly raise ethical issues. We need, Knight explained, to see
the complexity of the problem and understand that:
5 The Economic Organization 139
Land and capital should be thought of, not as groups of concrete things,
but as names for elements of qualities in things. The ultimate elements or
sources of productive power are nature, man and time, or waiting. (Knight
1933a, p. 59)
In true Knightian style, and with his hallmark impatience with theory,
he typifies the teaching set out in this section as “tedious” and “necessary”
being a prelude to understanding economic organization as a system of
price relations.
The exchange of productive power for consumption goods is mediated
between individuals and business units by the circulation of money, as
shown by what is called the “wheel of wealth.” The wheel shows, Knight
explained, “Two sets of exchange relations into which each person enters
with business in the large, the “sale” of productive power and “purchase”
of products. In the final result, it is a single exchange, of productive
services for products, with money as an intermediary” (Knight 1933a,
p. 60). The study of the price system comes down to these two aspects,
which are the prices of consumption goods and productive services, and
together they control the process of production and distribution under
free enterprise. The four main tasks of organized activity are to set stan-
dards to determine what things get produced and their quantity, the allo-
cation of resources to the branches of production and their coordination,
the distribution of the product, and lastly the provision for maintenance
and future progress, understood in terms of resources, technology and
wants. Samuelson, writing on Piero Sraffa, believes Knight, along with
others, offered a one-legged case:
Competitive prices, everyone now knows, must stand squarely on the two
legs of (1) tastes, desires, needs and distribution of endowments (in short,
on consumer-demand factors), and (2) technology and production costs.
At one time or another, Adam Smith (very briefly), David Ricardo, and
Frank Knight (briefly), have tried to concentrate on subcases of reality
where competitive prices (price ratios, and goods prices relative to factor
prices) can be determined autonomously in terms of technology and costs
alone: the one-leg case. What is consistent throughout the lifeline of Piero
Sraffa – in 1925, 1926, between 1926 and 1930 in 1951 and 1960 – is the
attempt to emphasise the singular cases in which the theory of value hap-
pens to be dependent only on technology and costs independently of the
composition of demand. (Samuelson 1991, p. 570)
140 Frank H. Knight
to say demand cannot be known in the present, and there is a long lead
time from preparation to getting the product to market, during which
time one producer does not know what other producers are doing. All of
which, and this is the point Knight wanted to get to, creates risk for pro-
ducers. Manager and speculator alike are trying to forecast the future, and
the one who gets it right makes money, and is the one acting in harmony
with the social interest in respect of pecuniary demand. Knight exclaimed
that if all participants forecasted correctly there would be no profits, his
point underpinned by his arguments in Risk, Uncertainty and Profit.
Markets can fall short of perfect competition, and monopoly is a
major example of this, which Knight tackled. In turning to the subject
of monopoly, Knight explained that the common situation is to have a
degree of monopoly with competition through substitution, i.e. monop-
olistic competition, a theory which Joan Robinson and the American
economist Edward Chamberlin are usually credited for simultaneously
and for their independent development. The producer has monopoly
over the product, and the crux of the whole matter between monopoly
and competition, he said, is the degree or distinction between the goods
of one producer and another. In products such as wheat, there is no dis-
tinction to be made and hence no monopoly, there is only competition.
The seller of branded goods has a small element of monopoly. In com-
petition all commodities compete for the consumer’s money, even food
competes with cars in the same use, in the sense that each is purchased
to maintain social position or display. Knight underlined that there can
hardly be such a thing as absolute monopoly, where production is freed
entirely from some form of competition. Competition is more commonly
called substitution, and perfect substitution or interchangeability is per-
fect competition. The confusion often arises because of what we think is
necessary; so while food and clothing are necessary, a particular food or
item of clothing is not. The ability to fix price is the measure of monop-
oly power, in other words elasticity of demand is the test and measure.
As the degree of product uniqueness increases, or product substitution
decreases, the elasticity of demand falls, so that decreased responsiveness
of sales to price change leads to increased monopoly power.
The outstanding evil of monopoly is the burden for the consumer of
paying a higher price than necessary, but less conspicuous is the reduction
5 The Economic Organization 143
in the use of good. Monopolists often try to address the latter evil, though
not to address its moral quality, by using what he defined as a class price,
that is by charging different classes of consumers different prices based on
their ability to pay rather than do without the good. Knight concluded
by looking at the theory of monopoly price, noting that while a profitable
industry will expand until profits cease, for the monopolist it is always
profitable to stop production more or less short of the point where profit
is eliminated. This is true when demand is most elastic, and more so
when the demand is less elastic. The monopolist will strive to control
price by limiting supply. His last point is that tax may or may not cause
output to be restricted or prices to rise, but the result is the tax is passed
on to the consumer and thus shifts an additional burden on to them ,
though the monopolist will under some conditions have to bear some of
the burden.
the physical law that successive equal applications of one factor to given
amounts of other factors make decreasing additions to physical product,
and the value law that the value of the additions made to product falls off
still more rapidly. The two principles work together in determining the
apportionment of factors among industries. (Knight 1933a, p. 104)
is saving, which is the production of more than one consumes. The saver
directs productive power into creating productive wealth, and instead of
the satisfaction of consuming gains ownership of new capital goods, the
significance of which is to create more consumption goods before they
wear out, and in a quantity greater than the consumption goods sacri-
ficed in constructing the capital good.
An increase in the supply of capital can flow into all industries and take
many forms, which also makes it subject to a law of diminishing produc-
tivity, although in a special sense, since it is subject to diminishing returns
to a lesser degree than any one productive factor in all industries, because
capital represents all the infinitely various productive factors which can
be made by using it. As a result, society can absorb a great deal of capital
with a relatively small reduction in productivity and its demand price;
the demand for capital is extremely elastic. The supply of capital comes
from saving, and the relationship between the interest rate and saving is
uncertain. There is also a presumption that the interest rate does not make
a great difference in the total rate of saving. Knight makes the twin points
that the demand for capital is extremely elastic, and the supply of capital is
extremely inelastic. Underlying motives for saving are complex and uncer-
tain, but he said obviously “the great bulk of the social supply of capital
must come from saving by persons who do not consume or expect to con-
sume” (Knight 1933a, p. 116). Knight pointed out aside from the effects
of wars, the rate of interest is surprisingly steady and constant over the
course of history, but discussion of “the” interest rate requires interpreta-
tion. All discussion about “the” interest rate, Knight explained, is neces-
sarily abstract, and depends on the kind of loan, as well as well as being
related to a particular place or time. The main factors causing diverging
rates on different loans are the uncertainty of repayment, or risk, and the
trouble involved in making and renewing small loans over the shorter-
term. Adding to this, Knight reiterated points garnered from his theory
of risk and uncertainty, as many risks can be insured against, the cost of
which is converted into a constant element of expense, and thus ceases to
be a cause of profit or loss. Uncertainties persist because they are uninsur-
able as there is no objective measure, which is very much the case with the
prediction of demand.
5 The Economic Organization 147
4 Profit and Monopoly
Knight also explored the theory of profit as a form of income and monop-
oly gain, again reflecting his approach of looking at what works and what
creates problems for homo economicus. The normal price in relation to the
cost of production raises some issues to consider, including the distribu-
tion process and evaluation of productive services not being perfectly
accurate, for the reason that demand is difficult to forecast, especially for
those reliant upon natural forces such as the weather; for example agricul-
ture. Knight is especially concerned about errors in estimating conditions
and adjusting to them, stating that conditions other than competitive
ones imply monopoly gain.
The concept of monopolistic competition was explored by one of
Knight’s former students Edward Chamberlin, who had been an under-
graduate student of Knight’s at the University of Iowa, and was later
supervised by Allyn Young for his doctorate at Harvard; Knight’s own
doctoral supervisor. His work, Theory of Monopolistic Competition, was
published in 1933,1 earned Chamberlin his reputation, which despite
Schumpeter calling it one of the most successful books in theoreti-
cal economics since 1918, and reviewer Morris A. Copeland saying it
deserved “to rank as one of the major contributions to the theory of value
and distribution in recent years” (Copeland 1934, p. 531), led to many
economists simply regarding him as a “man of one idea.” There has been
discussion by critics concerning the influence of Thorstein Veblen on
Chamberlin’s Theory, in particular his Theory of Business Enterprise (1904),
and Chamberlin himself claimed he advanced Veblen’s theory. In respect
to both Veblen and Knight, Chamberlin said their influence on him and
how he developed his theory was to the extent that “such fragmentary
recognition, of the problem is not hard to find. Yet, with the exception
of the theory of duopoly, the middle ground between competition and
monopoly remains virtually unexplored and the possibilities of applying
such a theory relatively little appreciated” (1933a, p. 5). J.M. Clark, an
1
He published his work at the same time as Joan Robinson discussed the same approach in her
Economics of Imperfect Competition (1933). Chamberlin’s theory was more far-reaching and sought
to reconstruct the theory of value.
148 Frank H. Knight
Monopoly, then, and its cousins, are descriptive of reality, but not a part of
“economic theory.” It is now clear why “theory” is to Professor Knight virtu-
ally a finished subject – any new development (and monopolistic competition
is only one example) which is not a part of the theory of a perfectly competi-
tive market simply is not a part of the subject!” (Chamberlin 1946, p. 142)
Bibliography
Knight, Frank Hyneman. 1933a. The economic organization. Chicago: University
of Chicago. Published as The economic organization. New York: A.M. Kelley,
1951.
Knight, Frank Hyneman. 1935a. The ethics of competition and other essays.
New York: Harper & Bros. The ethics of competition. Originally published
in Quarterly Journal of Economics 37(August, 1923): 579–624.
Knight, Frank Hyneman. 1935b. The Ricardian theory of production and distri-
bution. Canadian Journal of Economics and Political Science I: 3–25, 171–196.
Secondary Sources
Becker, Gary S. 1971. Economic theory. New York: Alfred A. Knopf.
Chamberlin, Edward. 1946. Discussion of Knight. American Economic Review:
Papers and Proceedings 36(2): 139–142.
Chamberlin, Edward H. 1957. Towards a more general theory of value. New York:
Oxford University Press.
Clark, J.M. 1961. Competition as a dynamic process. Washington, DC: Brookings
Institution.
Copeland, Morris A. 1934. The Theory of Monopolistic Competition. Journal
of Political Economy 42(4): 531–536.
Leigh, Arthur H. 1974. Frank H. Knight as economic theorist. Journal of
Political Economy 82(3): 578–586.
Patinkin, Don. 1973. Knight as teacher. The American Economic Review 63(5):
787–810.
Samuelson Paul A. 1991. Sraffa's other leg. The Economic Journal 101(406):
570–574.
Stigler, George J. 1949. Monopolistic competition in retrospect. In Five lectures
on economic problems. New York: Macmillan.
Stigler, George J. 1988. Memoirs of the unregulated economist. New York: Basic Books.
6
Understanding the Ethics
of Competition
The Greeks had an admiration for competition and glory, but the ideal,
Knight noted, was the achievement of perfection, and for the Greeks, peo-
ple should be educated to recognize superior merit and not simply to win at
all costs. The winning of power was not the good the Greeks had in mind.
Commentators on the Greeks generally start with Aristotle (384–322
BC) and the passages where he addressed economic matters, contained
in three books: Ethics, Politics and Metaphysics; though some commen-
tators only refer to the first two writings. There are some earlier eco-
nomic discussions in the works of two of his predecessors, Xenophon
(c.430–354 BC) and Plato (427–347 BC), but they are not seen as sys-
tematic and analytical in their work as Aristotle. It was in Xenophon that
we first find the word economy discussed, a derivation from the Greek
words oikos (household) and nomos (custom, law), in his book entitled
Oikonomikos, which was a work essentially on land estate management.
Just how sophisticated the Greek economy was is a subject of continuing
academic debate. What is certain is that the market of Greek times had
little in common with the contemporary markets Knight was discuss-
ing, and the distribution of wealth occurred through the outcomes of
wars, dishonesty and gifts; some might jest that not much has changed
in the intervening years! The Greek poet Homer (c.800 BC to c.701 BC)
was dismissive of trading, preferring war as the means of achieving great
wealth, as heroes were rewarded for their efforts by way of gift. Gifts were
part of the spoils of war, with a strict code of reciprocal giving governed
according to the status of the giver and receiver. At the heart of this econ-
omy was the household, agriculture and landed estates.
Knight wanted to bridge modern economics and the ancient under-
standing of economy, but as Knight pointed out, the Greek understand-
ing was quite unlike the modern economy, with our focus on utility and
pleasure. The Greek philosophers assumed the principle that character
is a higher good than action, and what is good is different from plea-
sure. Hence, ancient ethics looked to the person rather than action and
consequences, which is valued in modern ethics. This is why education
in Greece was so critical, as it groomed the person toward the gods and
toward the good. The Greek notion of Eudaimonia, or happiness, covered
the life of the whole person, which cannot be known in totality until
the end of the person’s life. To know happiness is to reflect the virtues
6 Understanding the Ethics of Competition 155
If the Greeks thought only in terms of ethics, or politike and ethike, then they
had only ethics as a source of reasons for public decision-making. In modern
society based on market economy, swathes of the most important kinds of
decisions have been removed from the field of ethics altogether, and transferred
into the province of economics. The relation between economics and ethics is
a contested matter, but opinion has swung decisively, certainly among econo-
mists in this century, towards the view that the relation is minimal or non-
existent, and that economics is an independent science. (Meikle 1995, p. 5)
The journey from the Greeks to Adam Smith, whose chair at the
University of Glasgow was in Moral Philosophy, is one of economics and
morals joined at the hip. It is with the advent of economics as a science in
the Enlightenment that the two became separated, as economists started
to take the view that their work was both scientific and morally neutral.
Knight questioned, as we have seen, the status of economics as a science,
and also wanted to bring ethics back to the foreground of economic think-
ing. Indeed, ethics lies at the heart of understanding Knight’s body of work.
to the classical roots of economic thinking for his foundation, and like
Aristotle and his fellow Greek thinkers, he was essentially asking what is
“the Good”? Aristotle approached the question of the good, in the open-
ing of Ethics, as the object of every art and investigation, every action and
pursuit. The end of economic science is wealth, but this means asking
how it relates to living the good life and how happiness is achieved. The
end we all seek is happiness, which means living well or doing well, but
Aristotle wrote:
The striking fact in modern life is the virtually complete separation between
the spiritual ethics which constitutes its accepted theory of conduct and
the unethical, uncriticized notion of efficiency which forms its substitute
for a practical working ideal, its effective values being accepted uncon-
sciously from tradition or the manipulations of commercial sales managers,
with a very slight admixture of aesthetic principles. (Knight 1935a, p. 65)
158 Frank H. Knight
1
J.M. Clark, Economics and modern psychology, Journal of Political Economy, Jan/Feb, 1918, p. 8.
6 Understanding the Ethics of Competition 159
When I first read this essay a vast number of years ago, as a student writing
his dissertation under Professor Knight’s supervision, you should not be
surprised to hear that I thought his was a conclusive refutation of “produc-
tivity ethics.” When I reread it a year or so ago, I was shocked by the argu-
mentation. Knight made a series of the most sweeping and confident
empirical judgments (such as those underlying the first and third charges)
for which he could not have even a cupful of supporting evidence. (Stigler
1981, pp. 166–7)
Knight may not have set out the full argument in the one essay,
but throughout his work there is collectively a less sweeping judge-
ment raised by Knight, and he raised these points because of his con-
cern for society and his opposition to socialistic answers to the flaws of
capitalism.
With the fall of the Berlin Wall in 1989 and the implosion of
Communism, today there is only one economic system broadly speak-
ing, with many different economic arrangements in respect to the bal-
ance between private and public roles in the economy, with different
ideas remaining about how best to organize society economically. Knight
would observe this was inevitable, since there was only ever one eco-
nomic system in the first place, albeit a flawed system. Socialism and
communism appealed in part because they spoke to the idealism of those
who looked at the cold, harsh realities of capitalism and looked for some-
thing else. Knight prefers to live with the dissonance of a system that
works with the inherent problems it has for the human being and society,
as exampled by the question of monopoly. His study of value, profit,
price and the economic organization cleared the way for him to address
the higher arguments he wanted to pursue and the ethical direction he
wanted to take.
6 Understanding the Ethics of Competition 161
not manage the economy, while the risk of the free market is that rules get
broken and mistakes are made. Freedom in the market economy is based
on the need for competition, which many moralists regard as wholly
impersonal in its character and ultimately problematic. There is a sense in
many moral studies that competitive businesses cannot exercise any social
responsibility because of the competitive drive that causes businesses to
maximize profits and the utility of their own resources. Knight and his
students would dispute this, as Friedman stated, in a free economy:
…there is one and only one social responsibility of business – to use its
resources and engage in activities designed to increase its profits so long as
it stays within the rules of the game, which is to say, engages in open and
free competition, without deception or fraud. (Friedman 1982, p. 133)
It is not realistic, or even desirable, in his view, for businesses to seek such
responsibility. The outcomes of business are such things as profits and wealth,
jobs and opportunities, and research, and if a business does these things well
then they will succeed, and it is ultimately of benefit to society that they do
so. Friedman recognized that people may try to circumvent the rules, but
this is to the detriment of society, and hence governance is needed to ensure a
judicial framework so that all play within the rules. This places a curb on the
freedom of businesses to win at all costs, because illegal means are outlawed.
As we have seen, Knight believed freedom is central to our understanding
of ethics. Friedman argued that economic freedom is the precondition for
political freedom, which is what we have in the Western world:
ance with the rules on the part of those few who would otherwise not play
the game. The need for government in these respects arises because abso-
lute freedom is impossible. (Friedman 1982, p. 25)
The modern market order is one that is too dispersed and unmalleable,
a point Knight argued, and one which was taken up by Hayek, who
stated that:
Modern economics explains how such an extended order can come into
being, and how it itself constitutes an information-gathering process, able
to call up, and put to use, widely dispersed information that no central
planning agency, let alone any individual, could know as a whole, possess
or control. Man’s knowledge, as Smith knew, is dispersed…. Information-
gathering institutions such as the market enable us to use such dispersed
and unsurveyable knowledge to form super-individual patterns. (Hayek
1988, pp. 14–15)
Knight, Chicago and the Austrians were united against socialistic and
welfarist arguments that to point to the failures in the market and advo-
cate that the state has a higher moral purpose than individual market
participants. Those who advance the argument for such a role for gov-
ernment propose policy options on the basis of redistribution of wealth.
Knight accepted, as we shall explore in the next chapter, that even the
minimal state must accept a certain welfare role in its function. If we
reduce the state to a protective functionary, taking care of national secu-
rity, policing the market, and so on, this implies that a cost in helping out
others is acceptable. The question becomes one of deciding how far such
a rationale should be extended to the economic sphere, on the basis that
the state can help in redistribution of the economic resources of society to
help others. The question is then merely one of defining not whether the
state should be involved in economic redistribution, but to what extent
the state role should be necessary.
166 Frank H. Knight
This moral concern about welfare and economic society was common
to both Keynes and Knight. Like Knight, Keynes was greatly interested
in ethics, influenced principally by G.E. Moore, and his influential work
Principia Ethica. Skidelsky refers to Keynes as “an unreconstructed fol-
lower of G.E. Moore” (Skidelsky 1992, p. 104). Skidelsky frames the eth-
ical interest with the question of uncertainty, the point at which Keynes
and Knight had embarked in 1921:
Both Keynes and Knight had their roots in the liberal ideals of the
enlightenment, but where Keynes drank from the more modern well of
G.E. Moore, Knight I suggest was more inclined to remain with classical
thought generally, and Scottish enlightenment thinking specifically in
the form of Scottish scepticism and common sense philosophy. In the
final chapter, we will delve more deeply into these roots as we consider his
economic and philosophical approach as a whole, but at this point I will
offer a portrayal of its specific outcome in the form of Knight’s ethical
thinking.
170 Frank H. Knight
(Knight 1935a, p. 27). This doesn’t take us very far. All of which makes
a science of conduct difficult to achieve, indeed only achievable in the
abstract. Economics can deal with the form of conduct, but not the sub-
stance or content. For example, we can say a person wants more wealth,
but not the concrete meaning of this wealth, only the wants in an abstract
and provisional sense. If ethics is merely “glorified” economics, Knight
pondered, then what of virtue? For there is a difference between virtue
and prudence, or what one “really wants,” and what one “ought” to do. If
there is to be a real ethics then it cannot be a science, and Knight took the
view that scientific data breaks down at this point, and that the contrary
view that rational economic criticism of values gives “results repugnant
to common sense…The economic man is the selfish, ruthless object of
moral condemnation” (Knight 1935a, p. 30).
The main argument for a transcendental ethics, Knight explained,
arises from the limitations of scientific explanation. There are “value-
standards” where the higher goal of conduct is to test these values and
improve them, rather than accepting or satisfying them. Knight’s objec-
tive is to repudiate what he understood as the view of ethics commonly
accepted by economists, and the view that sets out from the assumption
that human wants are objective and measurable magnitudes with want
satisfaction as the basis of value, reducing ethics as he says to a “glorified
economics.” What Knight wanted to do was argue a need for a defen-
sible criterion of values to approach policy, and explore the value implicit
in laissez-faire or individualistic social philosophy. Any notion of “social
efficiency” cannot be understood without some general measure of value.
The error of those who criticize the economic order, and here he specifi-
cally mentioned Thorstein Veblen, is the fallacy that society has a choice
between producing more goods and producing more value, and that wis-
dom prefers the former. Knight argued that the problem of social man-
agement is one of value, and it is meaningless to talk of mechanical or
technical efficiency in this respect. The question of policy is a purely rela-
tive consideration of alternatives, but what concerns him is the question
of ideals. Examining the competitive order or organization, led Knight
to argue three parts to the problem. First, wants are not ultimate data
or identified with values, but real and important all the same. Second,
industry and trade is a competitive game, and we have to ask what kind
6 Understanding the Ethics of Competition 173
Everyone is compelled to play the economic game and be judged by his suc-
cess in playing it, whatever his field of activity or type of interest, and has to
squeeze in as a side line any other competition, or non-competitive activity,
which may have for him a greater intrinsic appeal. (Knight 1935a, p. 58)
Because we live in a largely free society, we tend to forget how limited is the
span of time and the part of the globe for which there has ever been any-
thing like political freedom: the typical state of mankind is tyranny, servi-
tude, and misery. (Friedman 1982, p. 9)
How this came about is described by Hayek, in his work The Fatal
Conceit, suggesting a dynamic for our new economic civilization:
The man of system, on the contrary, is apt to be very wise in his own
conceit; and is often so enamoured with the supposed beauty of his
own ideal plan of government, that he cannot suffer the smallest devia-
tion from any part of it. He goes on to establish it completely and in all
its parts, without any regard either to the great interests, or to the
strong prejudices which may oppose it. He seems to imagine that he
can arrange the different members of a great society with as much ease
as the hand arranges the different pieces upon a chess-board. He does
not consider that the pieces upon the chess-board have no other prin-
ciple of motion besides that which the hand impresses upon them; but
that, in the great chess-board of human society, every single piece has a
principle of motion of its own, altogether different from that which the
legislature might choose to impress upon it. If those two principles
coincide and act in the same direction, the game of human society will
go on easily and harmoniously, and is very likely to be happy and suc-
cessful. If they are opposite or different, the game will go on miserably,
and the society must be at all times in the highest degree of disorder.
(Smith, Part.VI.ii.2.17)
178 Frank H. Knight
In a long-standing Christian tradition (if not the only such tradition), the
existence of private property and the marketplace has been seen as an
unfortunate but necessary concession to the pervasive presence of evil in
the world. In the past in the Garden of Eden and in the future in heaven,
there will be no private property (or government). In the current world
infected by sin, private property and the pursuit of profit are the best means
of maintaining a semblance of order in society. (Nelson 2001, p. 8)
study in the contrast between theory and practice. While there remained
a genuine spiritual hunger among the population, people:
… have got away from the spiritual attitude toward life, and do not know
how to get back. Science is too strong for old beliefs, and competitive com-
mercialism too strong for old ideals of simplicity, humility, and reverence.
(Knight 1935a, p. 66)
Bibliography
Knight, Frank Hyneman. 1935a. The ethics of competition and other essays.
New York: Harper & Bros. The ethics of competition. Originally published
in Quarterly Journal of Economics 37(August, 1923): 579–624.
Knight, Frank Hyneman. 1946. The sickness of liberal society. Ethics 56: 79–95.
Knight, Frank Hyneman. 1960. Intelligence and democratic action. Cambridge:
Harvard University Press.
Secondary Sources
Becker, Gary S. 1976. The economic approach to human behavior. Chicago:
University of Chicago Press.
Friedman, Milton. 1982. Capitalism and freedom. Chicago: University of
Chicago Press. Reissue, orig. 1962.
180 Frank H. Knight
Greer, William. 2000. Ethics and uncertainty: The economics of John M. Keynes
and Frank H. Knight. Cheltenham/Northampton: Edward Elgar.
Hayek, F.A. 1988. Fatal conceit. London: Routledge.
Medema, Steven G. 2009. The hesitant hand: Taming self-interest in the history of
economic ideas. Princeton: Princeton University Press.
Meikle, Scott. 1995. Aristotle’s Economic Thought. Oxford: Oxford University
Press.
Nelson, Robert H. 2001. Economics as religion: From Samuelson to Chicago and
beyond. University Park: Pennsylvania State University Press.
Skidelsky, R. 1992. John Maynard Keynes: The economist as saviour, 1920–1937.
London: Allen Lane.
Stigler, George J. 1981. Economics or ethics in the Tanner lectures on human val-
ues, vol. 2. Salt Lake City: University of Utah Press.
Stigler, George J. 1988. Memoirs of the unregulated economist. New York: Basic
Books.
Stigler, George J. 2011. The Tanner Lectures on Human Values. Cambridge:
Cambridge University Press.
7
Welfare Economics
In his last major work, Intelligence and Democratic Action (1960), Knight
recalled reading Ruskin who described Adam Smith as a half-bred, half-
witted Scotsman who founded the dismal science of economics and
encouraged the blasphemy of people hating God and despising God’s
commandments whilst coveting their neighbour’s goods. Knight noted
“This is a somewhat florid statement of what the world at large seems
to think about us political economists” (Knight 1960, p. 96). Nowhere,
perhaps, is the negative view of economists more clearly seen than in the
area of welfare, and its connection to ethical considerations of economic
life. Welfare in Knight’s work is approached somewhat differently from
the way the subject is normally discussed today. Knight contended that
there are two sets of policy problems in considering welfare, those aris-
ing because the system doesn’t work according to theoretical principles,
and problems arising for just the opposite reason that they do work.
Economic theory describes, he suggested, what superficially appears to be
an ideal social order of “perfect cooperation” based on mutual advantage,
achieving maximum possible efficiency in the use of available resources
and rational choice, and so on and so forth. The classical economists
had taught that free market equilibrium would create the most efficient
a musical parallel, Frank Knight was perhaps the Leonard Cohen1 of the
economics profession, torn between despair and hope. One of Cohen’s
famous lyrical lines is “There is a crack in everything, that’s how the light
gets in,” and it seems Knight had a similar view of the human being and
the human predicament in economic society. Knight had the romantic
and hopeful disposition of seeing a liberal view of a society where things
could be discussed, where people co-operate and find their way towards
a reasonably well-run society. However, given the reality and history of
human society, one can see the sources of Knight’s disillusionment.
Naturally, Knight was not operating in an intellectual and historical
vacuum, and it is important to understand some of the economic and
political thinking that was dominant in this period. There were great
changes happening in the economic and political landscape of America,
chief among these were the historic events of the Great Depression of
the 1930s, which brought economic questions to the fore. This was a
time when the economy was under severe pressure, and there was tre-
mendous political will to get America out of the Great Depression and
put Americans back to work. President Franklin D. Roosevelt signed the
Social Security Act of 1935 into law, with the political intent of reliev-
ing human suffering, helping business and industry to recover, and to
alleviate the consequences of the economic events seen in the Great
Depression. The stated aim of the Act itself was:
The Act was also a part of Roosevelt’s “New Deal” plan, which included
other programs, including the establishment of the Works Progress
1
The Canadian singer-songwriter and poet, who has frequently been called the “bedsit bard”.
2
The Social Security Act (Act of August 14, 1935) [H. R. 7260].
184 Frank H. Knight
3
Wilson held office from 1913 to 1921 and was followed by three Republican presidents, Harding
(1921–23), Coolidge (1923–29) and Hoover (1929–33), who had been seen ultimately to lead the
country into economic disaster.
4
To clarify, in the discipline of International Relations this means something somewhat different
from the popular conception of anarchy. In IR it refers to the absence of authorities above the state,
because the nation state is considered to be the primary actor in international relations.
7 Welfare Economics 185
his book Leaves from the Notebook of a Tamed Cynic (1929). His clas-
sic work Moral Man and Immoral Society was written in the summer
of 1932, and has remained in print ever since, though it owes rather
more to Karl Marx than to theology, as the New York Times review at
the time headlined it “Doctrine of Christ and Marxism Linked.” His
politics remained Socialist, belonging to the Socialist third party in
New York until the 1940s and then aligning himself with the Socialist
wing of the Democratic Party, founding the Union for Democratic
Action in 1941.
There is scant evidence that Knight and Niebuhr had much to do
with each other, which given their kindred concerns is a little surpris-
ing. Knight did contribute an article in 1933 to the Christian Century,
a magazine Niebuhr contributed to regularly, entitled Can We Vote
Ourselves Out of the Fix We are In? Sidney Hook, the New York University
philosopher, who followed John Dewey and focused on the pragmatic
theory of knowledge and ethical naturalism, wrote a letter to Knight in
1938 criticizing his ethical approach, and linking Knight to Niebuhr.
Hook wrote:
I cannot understand how anyone who has read Dewey, as I presume you
have, can write about ethics as you do. There is some justification for my
good friend Niebuhr because his ethics, like that of most sky pilots, is just
poetry. It’s not supposed to be applied. Where he deals with material which
is empirically relevant to ethics, i.e. human psychology, his basic assump-
tion is that man’s nature is unalterable and unalterably bad. As I get him he
believes that since man is by nature “sinful,” he ought to live in the best
possible society in order to discover that fact. (Hook 1995, p. 65)
equality of the general rules of law and conduct, but such a view is one
of “extremism” and “absolutism,” and Knight explained that even before
the law equality is impossible where people are economically unequal.
However, the “supreme absurdity” is Hayek’s discussion of opportunity,
especially equality of opportunity. Hayek, argued Knight, ignores power
in relation to freedom, explaining “The social problem of freedom centres
in power and its use in relations among persons and between them and
society or its agents” (Knight 1967, p. 790). Knight went as far as saying
that Hayek reaches the “peak of fallacy” when dealing with questions of
equality and inequality.
His assault on Hayek leaves little room for putting forward a construc-
tive proposal, but Knight did outline a few concerns. He argued that
while exchange is free by definition, unlimited market freedom would
have “intolerable” consequences. Although a keen advocate of freedom
and democratic ideals, Knight explained that while ideal enterprise and
democracy both imply cooperation, human nature is such that not all
collaboration is necessarily fair cooperation. He also admits that an indi-
vidualistic analysis omits “competition,” yet we have to understand that
rivalry is a major fact of human nature. Knight explained “Men are most
disposed to co-operate in organizations for more effective competition –
most of all, sad to say, in war – where they are most social-minded”
(Knight 1967, p. 795). If we are to take freedom, the subject of the next
chapter, seriously in economic policy then we must consider the antiso-
cial side of human nature.
Knight believed there is a trade-off between a free society and an ethi-
cally just society. It is possible to pursue one or the other, but it is not
possible to have both. He is very much in the realist mode, but refused to
let that take him in the direction of ignoring what he frequently refers to
as “the social problem.” As discussed in the last chapter, in The Ethics of
Competition, Knight tackled what he saw as the ethical basis of the wel-
fare question, and linked economics directly to ethics. Knight was part of
a significant debate in the interwar years, on what Hla Myint termed the
methodological controversies surrounding the development of modern
welfare economics, flagging the term welfare as a “highly suggestive term”
with “its ethical overtones, adding fuel to the fire” of the controversy
(Myint 1948, p. 199).
7 Welfare Economics 189
5
A very useful study of the controversies can be found in E. J. Mishan, A Survey of Welfare
Economics, 1939–59, The Economic Journal [Vol. 70, No. 278 (Jun., 1960)], pp. 197–265.
6
Robbins thanks von Mises in his essay (Robbins, 1935, p. xvi), suggesting it was written under his
influence.
7
See, Lange, O. (1945) The scope and method of economics, Review of Economic Studies, 13, 19–32;
Hicks, J.R. (1939), Value and Capital, Oxford: Clarendon; Kaldor, N. (1939) Welfare Propositions
of Economics and Interpersonal Comparisons of Utility, Economic Journal, 49: 549–552. The inter-
relationship between the Robbins essay and these authors, and the welfare debate as a whole, is
comprehensively discussed in the conference proceedings of the 75th anniversary of the essay, avail-
able at the LSE http://darp.lse.ac.uk/papersdb/LionelRobbinsConferenceProveedingsVolume.pdf.
190 Frank H. Knight
For society as a whole, the only obstacles to satisfaction are the limited
quantity of physical resources, and the limited quantities of products which
8
Little, I.M.D. (1957) A Critique of Welfare Economics. Oxford: Clarendon Press, p. 87.
9
An excellent discussion on Pareto and the welfare debate can be found in Jeffrey M. Herbener, The
Pareto Rule and Welfare Economics, Review of Austrian Economics 10, no. 1 (1997): 79–106.
10
Vilfredo Pareto (1894) II massimo di utilità dato dalla libera concorrenza. Giornale degli Economisti
9(2): 48–66.
7 Welfare Economics 191
can be got from those resources. For the individual, however, the wants of
other people have to be reckoned among the obstacles which limit the
satisfaction of his wants. There are usually some ways in which he can
improve his position without damaging the satisfactions of other people;
there are other ways in which an improvement in his position (an upward
movement on his scale of preferences) involves a downward movement for
other people on their scales. Now these latter movements, which make
some people better off and some people worse off, cannot be reckoned as
involving an increase in “social satisfaction” unless we have some means of
reducing the satisfactions of different individuals to a common measure-
and no unambiguous means for such reduction seems to exist. But the
former movements, which benefit some people without damaging others,
stand in another category. From any point of view, they do represent an
increase in economic welfare or better, an increase in the efficiency of the
system as a means of satisfying wants, that is to say, in the efficiency of the
system tout court. (Hicks 1939, pp. 700–1)
I think on the whole the “new” welfare economics of Kaldor, Hicks, Lerner
and Scitovsky was overrated. In the first place, you know already you can
find it in John Stuart Mill who discusses something like free trade. He in
effect says that free trade may help some people, and hurt some other peo-
ple, but the gainers would be able to compensate the losers. Thus, the
7 Welfare Economics 193
litmus test of human progress, and that achieving the goals of develop-
ment is dependent upon the free agency of people. There is a positive role
for the market, and Sen opposes regulations that impede the freedom of
people in respect to where they work, how they produce, and what they
consume. He calls this a ‘capability approach’, by which he means ‘our
capability to lead the kind of lives we have reason to value’, rather than
the usual concentration on rising GDP, technical progress, or industrial-
ization (Sen 1999, p. 285), and he ‘inescapably focuses on the agency and
judgment of individuals’ (Sen 1999, p. 288), including their capability,
responsibility, and opportunity. In this way people improve and influ-
ence social change and economic production. Thus, like Knight, Sen ties
together freedom, welfare and value.
For Knight, the discussion of welfare is a place where we see economics
and ethics connected by the problem of value, and leading on from this
debates over conflict in the desires and wants of humanity. Our wants
are unstable and have an essential nature of changing and growing. The
opposite view of wants, as explicated by Knight, is that of the “economic
interpretation” or “scientific” socialism. As a theory of conduct, scien-
tific socialism argues an Hegelian dialectic where the course of history is
predetermined by economic or materialistic considerations. However, as
discussed earlier on his ethics, Knight argued:
business men” (Myint 1948, p. 212). Yet business does make use of data
in decision-making and in making predictions about consumer demand
and other factors.
Knight set out some of the behaviours of people that impact how we
might understand the homo economicus construct in reality, and we need
to revisit his understanding of homo economicus in order to understand
specifically his approach to welfare economics. He argued that our wants
are products of our culture to be judged by the canons of our culture,
understood and controlled through the categories of our culture. As dis-
cussed in the previous chapter, Knight suggested our wants come down
largely to the seemingly contradictory desire to be like other people, and
the desire to be different. Furthermore, the better off we are economi-
cally, the larger is the proportion of our consumption, but this does not
make us more “comfortable,” quite the reverse. Knight does not justify
this assertion; it is one of the many assertions he makes and expects us
to accept it as correct. He does, however, draw upon the ancient Greek
philosophers, who he stated believed more does not mean happier, and
happiness is not the economic test in fact. In Knight’s mind, economics
it is not the measure of what people want, since what we want to do is
to strive for more interesting challenges, some of which may well be eco-
nomic in whole or part but many are non-economic, such as winning at
sport, falling in love or embracing spirituality. Hence, Knight explained
the concept of homo economicus underlies all economic behaviour, but is
both used and abused.
As we also saw in the previous chapter, Knight argued the definition of
economics must be revised to state that economics deals with conduct in
so far as conduct is amenable to scientific treatment, and in so far as it is
controlled by definable conditions and can be reduced to law. However,
he expanded on why this does not take us very far in understanding
human society or welfare. It is because, in part, conduct is provisional,
and Knight explained:
Economics deals with the form of conduct rather than its substance or
conduct. We can say that a man will in general prefer a larger quantity of
wealth to a smaller (the principal trait of the economic man) because in the
statement the term “wealth” has no definite concrete meaning; it is merely
196 Frank H. Knight
Group action is really free only so far as there is virtual unanimity on objec-
tives and procedures, in which case there is no problem; and this depends
on the capacity of men to reach agreement on normative values through
intellectual discussion. Values that guide action attach to rules which at
some point are enforced by law; hence the primary issue in any discussion
of welfare is freedom – its promotion and protection or its limitation in
favor of other values. (Knight 1933a, p. 224)
5 Welfare and Justice
The perfect market in achieving efficient use of resources also achieves
“commutative justice,” the exchange of equal values whereby one takes
out what one has put in. However, this justice, if that is what it is, comes
about as a result of the economic capacity of the individual; in other
words the skills and property brought to the market, and hence are not
given but created by the system. The market is in reality an agency of
cooperation between “given units, it is no agency for improving tastes”
and it “will not redistribute capacity, and hence product, to accord with
any norm of justice” (Knight 1933a, p. 224).
However, this is not a justice that critics like Myint wanted to see.
Myint divided his own study into three historical epochs which relate
to the British classical schools, the subjective-value or Austrian school
and the “eclectic” or neoclassical, before tackling the contemporary era
centered on two American economists, namely J.M. Clark and Knight
himself. In respect to Knight, Myint argued against Knight that wants are
relatively stable enough to make predictions and use as the possible base
of welfare analysis, and make a useful contribution to human welfare.
Knight and Clark, he argued, get it half right when applied to consumer
198 Frank H. Knight
social ideal, and economists are often left to provide policy solutions for
the whole of society whereas they are only part of society.
The social order depends on moral forces and on understanding the
progress of a liberal society, and Knight saw a need for agreement on the
meaning of economic justice, writing:
The issue of justice is acute especially because the natural tendency of indi-
vidualistic economic behavior is in the direction of increasing inequality,
through the use of economic means; those who at any time have more are
in a better position to get still more. But under realistic conditions very
much inequality in this respect undermines the justice of exchange of equal
market value contributions to output – and extreme inequality renders
freedom of no effect. (Knight 1960, p. 119)
homo economicus a very different being from the scientific view, and as
Knight posed the question, “Is life all economics or does this view require
supplementing by an ethical view of value?” (Knight 1922, p. 471).
Nash argues that Knight has not been regarded as making an impor-
tant contribution to economic policy, especially welfare economics,
because his theoretical analysis is not well understood, and because of
the common view that Knight establishes profit as a reward for bearing
uncertainty (Nash 1998, p. 146). This he argues is an incorrect assess-
ment. He proposes that Knight’s theory is “centered on the competitive
struggle to reduce uncertainty-control costs” and this results in two policy
options. First, a distribution problem, and second an efficiency problem,
creating a trade-off between the two objectives of equity (or distribution)
and efficiency. It is, in the Nash view, uncertainty that theoretically con-
nects imperfect competition and economic welfare in Knight’s analysis.
Variations in profit margins exist within the imperfect market, and are
inconsistent with the maximization of the social welfare function, and
hence Knight seeks to offer a new conception of the “social welfare func-
tion” (Nash 1998, p. 159) but this has been largely ignored by econo-
mists because it falls within the realm of social philosophy. Nash seeks to
rehabilitate the argument offered by Knight.
7 Welfare and Ethics
The presentation by Nash of Knight is that he offered a conclusion that
the outcomes of imperfect competition reflect the relative power imbal-
ances in an industry, and these outcomes are fundamentally unfair. We
can extrapolate from this the general conclusion for all markets that
unconstrained self-interest will not always lead to fair outcomes, or out-
comes beneficial for society as a whole. This is a challenge to the “invis-
ible hand” of Smithian economic thinking, and provides an alternative
notion of perfect competition to orthodox economics, critical to which is
Knight’s conception of economic welfare. Nash concludes that at the core
of Knight’s notion of economic welfare “is the premise that economic
welfare must not be identified with aggregate (i.e. allocative) economic
efficiency. Rather, welfare must be seen as the sum of economic freedom,
202 Frank H. Knight
Knight’s contribution has not yet received the attention it deserves. While
enriching our understanding of the ‘economic,’ Knight opens the window
into a subject which economic analysis remains silent: the vital links
between the ‘economic’ and ‘moral’ domains of our social existence…
Knight’s analysis of imperfect competition shows us that unrestrained self-
interest cannot maximize the value of the aggregate ‘social welfare func-
tion.’ (Nash 1998, p. 165)
and then by mutual understanding change the world.” This is a very theo-
logical approach to the problem, found in conservative and Augustinian
schools of theology, and we will return to them in Chap. 10. Knight
contested the normal analysis of economic efficiency, and proposed a dif-
ferent conception of the social welfare function, and as Nash explains
“such a function requires a rigorous examination of the relationship
between economic efficiency, economic freedom, and economic power”
(Nash 1998, p. 30), which brings us to consider the last major theme in
Knight’s work, that of freedom.
Bibliography
Knight, Frank Hyneman. 1922. Ethics and the economic interpretation.
Quarterly Journal of Economics 36: 454–481.
Knight, Frank Hyneman. 1933a. The economic organization. Chicago: University
of Chicago. Published as The economic organization. New York: A.M. Kelley,
1951.
Knight, Frank Hyneman. 1935a. The ethics of competition and other essays.
New York: Harper & Bros. The ethics of competition. Originally published
in Quarterly Journal of Economics 37(August, 1923): 579–624.
Knight, Frank Hyneman. 1960. Intelligence and democratic action. Cambridge:
Harvard University Press.
Knight, Frank Hyneman. 1967. Laissez-faire: Pro and con. Journal of Political
Economy 75: 782–795.
Secondary Sources
Bergson (Burk), A. 1938. A reformulation of certain aspects of welfare econom-
ics. Quarterly Journal of Economics 52: 310–34.
Coase, R.H. 1960. The problem of social cost. Journal of Law and Economics 3:
1–44.
De Gregori, Thomas R. 1987. Resources are not; they become: An institutional
theory. Journal of Economic Issues 21(3): 1241–1263.
Emmett, Ross B. 1998a. Frank H. Knight. In The handbook of economic method-
ology, ed. John B. Davis, D. Wade Hands, and Uskali Mäki, 267–269.
Cheltenham: Edward Elgar.
7 Welfare Economics 205
Emmett, Ross B. 1998b. Frank Knight’s dissent from progressive social science.
In Economics and its discontents: Twentieth century dissenting economists, ed.
S. Pressman and R. Holt, 153–164. Cheltenham: Edward Elgar.
Emmett, Ross B. 2005. Frank Knight, Max Weber, Chicago economics and
institutionalism (April 2005) James Madison College, Michigan State
University, Working Paper No. 0405-02.
Emmett, Ross B. 2009. Frank Knight and the Chicago School in American eco-
nomics. London: Routledge.
Hayek, F.A. Scientism and the study of society. Part I: Economica N.S. 9 (1942).
Part II: Economica 10 (1943). Part III: Economica 11 (1944).
Hicks, John R. 1939. Value and capital. Oxford: Clarendon Press.
Hook, Sidney. 1995. Letters of Sidney Hook Edward S. Shapiro (Ed). New York:
M.E. Sharpe.
Kaldor, Nicholas. 1939. Capital intensity and the trade cycle. Economica, new
series, 6(21): 40–66.
Myint, Hla. 1948. Theories of welfare economics. Cambridge, MA: Harvard
University Press, for the London School of Economics and Political Science.
Nash, Stephen John. 1998. Cost, uncertainty and welfare, Frank Knight's theory of
imperfect competition: Frank Knight's theory of imperfect competition. Farnham:
Ashgate.
Niebuhr, Reinhold. 1929. Leaves from the notebook of a tamed cynic. Chicago:
Willett, Clark & Colby.
Pigou, Arthur C. 1920. The economics of welfare. London: Macmillan and Co.
Robbins, Lionel. 1932. An essay on the nature and significance of economic science.
London: Macmillan and Co.
Samuelson, Paul. 1947. Foundations of economic analysis. Cambridge: Harvard
University Press.
Scitovsky, Tibor. 1941. A Note on Welfare Propositions in Economics. Review of
Economic Studies 9: 77–88.
Sen, Amartya. 1999. Development as freedom. New York: Alfred A. Knopf.
Schumpeter, J.A. 1949. Vilfredo Pareto (1848–1923). Quarterly Journal of
Economics 63: 147–173.
Song, Robert. 1997. Christianity and liberal society. Oxford: Oxford University
Press.
Suzumura, Kotaru 2005. An interview with Paul Samuelson: Welfare econom-
ics, “old” and “new”, and social choice theory. Social Choice and Welfare
25(2): 327–356· January 2005.
Waltz, Kenneth. 1979. Theory of International Politics. New York: McGraw
Hill.
8
Freedom and Reform
Much has been said about the centrality of freedom in Knight’s thought,
and having looked at the moral and welfare limitations on freedom, it is
time to look at his understanding of freedom in more detail. In the latter
part of the 20th century and ever since, the question of economic equal-
ity has been at the forefront of public economic discussion. The inequali-
ties of capitalism became clearer with the fall of the Berlin Wall and the
end of communism in 1989. For much of the 20th century there was a
foil for capitalism in communism, so that supporters could point to the
failures of communism, and opponents could imagine at least there was
an alternative, even if that alternative was not fully defensible; and for the
early part of the 20th century there were many in the West who thought
it to be fully defensible. To understand Knight’s view of freedom, we have
to understand that for him capitalism and western-style democracy go
hand in hand. Ross B. Emmett offers great insight into the connection
between Knight’s view of the democratic process and the free market,
both of which are integral to freedom:
Like most social philosophers who follow in the tradition of classical liber-
alism, Knight saw democracy as the most compatible political partner for
Government is indefinitely less free because men must agree on the laws
but do not agree at all completely through free discussion…At most,
government is a matter of the dictation of a majority over minorities in
whatever political unit we are considering. (Knight 1960, p. 114f )
1
Frank H. Knight Papers, Box 31, Folders 6–7, Chicago, IL: Special Collections Research Center,
University of Chicago Library.
210 Frank H. Knight
discussed in the next chapter. Knight’s argument was that for liberalism
to triumph it was essential for individuals to use reason, critical judg-
ment and common sense to associate freely. In this way, we can discuss
the needs and objectives of society and how to achieve these objectives.
In other words, what he called government by discussion. However, he
had less confidence in the Keynesian or progressive views of govern-
ment, and as we have already discovered he thought any such views were
romantic nonsense. He believed it was a pretense that it is governments
rather than people that make laws, for laws he believed were made by
people for people. Any groups of people have their power acted out
by individual agents, supposedly on their behalf, and inevitably such
agents have a great deal of arbitrary power. However, the alternative to
such agency is not unfettered freedom, because we have to accept we are
part of certain groups without choice, whereas complete or unfettered
freedom would suggest we are free to join social groups by voluntary
means. Like being the member of a family, we do not have much choice
in choosing what State we belong to, and not much more choice in
whether we remain a member if we don’t like it. We are members of the
State by compulsion, a privilege he noted once enjoyed by the church,
when for some centuries the church wielded political power.
The object of his study of freedom and society is ultimately law, sug-
gesting that law and order are virtually synonymous. We live by nature in
conflict, which includes conflict of interests and needs. This conflict cre-
ates a difference of opinion on social issues, and it is this difference that
government reflects by acting though agents of government, and these
agents in turn operate on the basis of discretionary power. The outcome
of this, Knight argued, is that:
Further, the more the society stresses freedom, mobility, change and vari-
ety, the more the functions of government are multiplied and elaborated,
and the more it inevitably becomes in details a government by men and not
of law…Much discretionary power is inevitable everywhere, and especially
in political life – and perhaps even more in economic relations. (Knight
1960, p. 127)
This means that in terms of our economic life, concrete individual free-
doms with limitations operate chiefly through economic cooperation, the
8 Freedom and Reform 211
free exchange of goods and services in a free market and innumerable other
voluntary associations. Knight quickly moved beyond consideration of
the individual to look at the social dimension of freedom and economic
life. The economic implications of voluntary association he believed are
often ignored because we look economically and narrowly at groups, yet
social, cultural, religious and other groupings of human activity reflect
freedom of association just as much as any business cooperation. Knight
drew attention to religion here, because he argued that in a prescriptive
society religion is dominant. However, a free society is inevitably a secular
society, whereby religion is just another free association of people, which
requires people to be tolerant of those holding to other religions or beliefs,
in order that peace, order and freedom prevail. In society, freedom as a
simple ideal might suggest no controls and a minimum of laws needing
to be enforced, but society is not simply a question of freedom and order.
Society also encompasses other concerns, such as equality of opportunity,
efficiency, security and progress. Hence, Knight’s concern was not with
the groups or organizations in society, but with the way they might deny
free association, or create barriers to the necessary discussion that is at the
heart of a liberal democracy.
2 An Anatomy of Freedom
Knight believed that the liberal revolution, with the industrial revolu-
tion being a major factor, has inverted ethical values and the place of the
individual in relation to society. Social action became a new factor, but
Knight clarified that truly social action is democratic action, by which he
means action not just for society but by society. Freedom also changed,
and along with the term liberalism has been inverted to signify state
paternalism rather than individual action. His other concern was that
freedom has been fashioned to include the power to do what one wants
to do, whereas in social life this right is subject to various limitations.
This means we should respect the same freedom in others. In summary,
he defined freedom in society as essentially the free voluntary associa-
tion on agreed terms, rather than by dictate, prescription or authority.
Knight argued that such an associative life must be regulated by law,
which means law made through a free discussion leading to agreement.
212 Frank H. Knight
Earlier, Knight had talked of romantic nonsense and here he risks being
guilty of the same charge himself. However, he referred to human nature
being what it is as reason to understand that such discussion does not in
fact lead to complete agreement, and thus the nearest a society can get
to the ideal is by majority rule. This explains why in practical terms a
society, by which he means government, never acts on the basis of major-
ity opinion, because power is usurped by agency, as people hand over
decision-making powers to agents of government.
There are other implications of freedom which are problematic for
Knight, such as:
any natural law, but rather law made by persons that enshrines religious,
intellectual, political and economic freedom. This economic freedom he
viewed as an absence of coercion, which is a matter of ethics rather than
facts. Such coercion excludes two economic phenomena, namely market
forces in terms of perfect competition, and contractual offers of increased
benefits or decreased costs, preventing the individual from satisfying their
wants, and as such these are not coercive factors. However, if one were
able to exclude coercion, absolute economic freedom would not neces-
sarily or naturally occur, since there are limitations such as a moral duty
not to interfere with the freedom of another, and the fact that certain
customs are necessary for social order. Other limits are political, with
Knight positing three cases. (Knight 1956, p. 278) First, there is a rejec-
tion of natural law, in favour of the state enforcing man-made laws to
repress anti-social behaviour and ensuring civil order. Second, political
action imposing sweeping limits is necessary “to equip the individual and
family for social life”. Third, in a democratic state, with individuals vot-
ing for laws of self-protection against injury resulting from lack of perfect
rationality and knowledge, then such laws are not coercive, and perhaps
oddly in Knight’s view not to be seen as paternalistic.
This view of economic freedom as negative and free of coercion, Gonce
suggests meets with Knight’s understanding of early liberalism, and as
such omits the idea of power, which Knight saw as problematic and hence
he labeled it as “formal” economic freedom (Knight 1947, p. 7). Power
resides in the educated faculties of the individual, but it also resides in
property held in ownership and the intelligence required for its effective
and intended use. There are two kinds of power to consider, in Knight’s
view. First, there is the productive power to make things effective, which
increase opportunities for all. Second, there is arbitrary power, which is
used to exert power on others without equal compensation for others, in
other words power that promotes economic freedom at the expense of
others. However, for effective economic freedom a degree of equality in
the distribution of power is required, as inequality can emerge to destroy
freedom. In the exercise of freedom individuals will use their power to
increase their own power as well, though to differing degrees. This said,
Knight also believed that freedom proper is the absence of coercion, and
freedom needs to be understood in relation to power without the two
214 Frank H. Knight
In the end, Knight does not alas, offer us much of an answer to the
conundrum of freedom and power, a fact he himself draws attention to
in Intelligence and Democratic Action. It is here we see most clearly his self-
understanding as a prophet of freedom, within the definition given at the
outset of this book. In the first place, he argued that the role of the intel-
lectual leader is to clarify issues, with their risks and benefits explained,
but not necessarily to provide solutions. Answers he suggests are in the
8 Freedom and Reform 215
3 Economics and Values
In the context of a debate between Knight and the British economist
Terence Hutchison on positivism, Emmett compares Friedman and
Knight, explaining:
Friedman assumes that the process of Knightian social discussion will gen-
erate the convergence of values among individuals in society, because the
alternative is for groups to become entrenched in their values and have no
alternative but to fight. Once we assume the values converge, he argues,
then the social question is not Knight’s determination of the correct scale
of value, but rather, given our agreement on values, how do we best accom-
plish our goal? A positive question, for which economics provides the best
answer. (Emmett 2009, p. 348)
If the questions and problems of freedom and power Knight raises can
best be answered in the sphere of economic relations, Knight tempered
this with the argument that economists have often failed to grasp the
distinction between economic freedom and economic power. This he sees
as the fatal defect of the utilitarian doctrine of maximum freedom as the
goal of social policy, since it overlooks the fact that being free to act is
meaningless if one does not have the means to act. In simple economic
terms, Knight would say that an individual may be free to create a busi-
ness, to be entrepreneurial, but this has no meaning for them if they do
not have the capital to do the work or the cash flow to run a business.
Stigler explains Knight’s approach:
4 Freedom as Ethics
Knight believed that over the years he had become increasingly hesitant
to speak very positively or definitely on the relationship between ethics
and economics. Gonce summed up Knight’s liberal approach to ethics:
His own ethics are grounded in rationalism and libertarianism and are
those of liberalism. The individual ought to be self-reliant, rational, and at
liberty. By ‘liberty’ he means the ability to rationally choose among known
alternatives; it presupposes power or control means, for he states that lib-
erty without power is empty. (Gonce 1972, p. 549)
Thus the goal of political action is the negative ideal of freedom, with
the greatest good worked out through maximizing freedom. However, as
discussed earlier, Knight explained:
The family relation is also the best illustration of the undoubted fact that
we are under a moral obligation to treat in different ways persons who
stand in different social relations to ourselves. We seem even to be bound
to feel differently toward them, though an obligation to have a feeling also
appears dubious under critical scrutiny. Passing over the whole question of
the ideal of emotional relations between husband and wife, we consider
only the relation of parents to children. The command to love one’s neigh-
bour as one’s self may seem like a “ hard saying” ; but it is “ nothing” in
comparison with the obligation to love other people’s children as one’s
own, as would be required by universal and undifferentiated or impartial
love. This is not conceivably possible without destroying the private family
and going over to some Platonic communism as the basis of social order –
8 Freedom and Reform 223
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of Chicago. Published as The economic organization. New York: A.M. Kelley,
1951.
Knight, Frank Hyneman. 1939. Ethics and economic reform. Economica 6:
1–29, 296–321, 398–422.
Knight, Frank Hyneman. 1947. Freedom and reform: Essays in economics and
social philosophy. New York: Harper & Bros. Reprint edition: Liberty Fund
(1982).
Knight, Frank Hyneman. 1956. On the history and methods of economics: Selected
essays. Chicago: University of Chicago Press.
Knight, Frank Hyneman. 1960. Intelligence and democratic action. Cambridge:
Harvard University Press.
Knight, Frank Hyneman. 1967. Laissez-faire: Pro and con. Journal of Political
Economy 75: 782–795.
Secondary Sources
Emmett, Ross B. 2009. Frank Knight and the Chicago School in American eco-
nomics. London: Routledge.
Gonce, R.A. 1972. Frank H. Knight on social control and the scope and method
of economics. Southern Economic Journal 38(4): 547–558.
Gonce, R.A. 1992. F. H. Knight on capitalism and freedom. Journal of Economic
Issues 26(3): 813–844.
Stigler, George J. 1987. Frank Hyneman Knight. In The New Palgrave: A diction-
ary of economics, vol. 3, ed. John Eatwell, Murray Milgate, and Peter Newman,
55–59. New York: Stockton Press.
9
The Economic Order and Religion
for religion, such a picture would not be fully accurate. Just as he was a
jilted lover of liberalism, there is a case to be made that he was likewise a
jilted lover of Christianity.
civilization – as the case may be. And in any event, as we have emphasized,
the approach to problems of economic inequality and unfreedom (or what
appears to be such) in terms of “moralistic” judgments of personal rights and
duties, in the absence of careful economic and politico-legal analysis, is virtu-
ally certain to have consequences utterly different from the intentions of the
reformers, and predominantly evil. (Knight 1939, p. 422)
Chicago has taken us past the revelations of the Bible by showing how the
one and only god in the universe actually operates exclusively through eco-
nomic forces. The Chicago project in this perspective may not have tran-
scended God per se – the Chicago religion need not be a form of
atheism – but rather the Chicago project has perhaps found a new divinely
inspired tablet. God may have sent Jesus to earth two thousand years ago
but perhaps he has now thought it desirable after so many years to update
his message. (Nelson 2001, p. 186)
Nelson offers the thesis of how this religious thought transformed into
a secular libertarianism:
Gradually, later members of the Chicago school would recast the Calvinist
elements in Knight’s economic thought in a more clearly libertarian direc-
tion. As one authority on Puritan thought comments, “the preponderance
of modern libertarian theory – from French Huguenots, the Netherlands,
Scotland and England – came from Calvinists.”1 Libertarianism may not
have all the answers – libertarians also experience a tension in resolving the
claims of individualism and the demands of community – but in clearly
and explicitly rejecting the orthodoxies of the American Progressive gospel
and its prescription for the scientific management of society, contemporary
libertarian thought opens the way to discussion of whole new governing
philosophies. (Nelson 2001, p. 22)
1
Nelson footnotes Conkin, Paul K. Puritans and Pragmatists: Eight Eminent American Thinkers
(Bloomington: Indiana University Press, 1976) p. 18.
228 Frank H. Knight
Knight was also engaging with the secular background of his profession,
and what he saw was a need for ethical reflection, and this often took him
into more overtly theological territory and language. He went so far as
to call his presidential address to the American Economic Association in
1950, a “sermon” to the profession (Knight 1951). Recalling attendance
at his economics courses, Patinkin remembered that Knight had a habit of
engaging in “long digressions on the nature of man and society – and God”
(Patinkin 1981, 46). The core social and economic problem in Knight’s
view was one of “discovery and definition of values – a moral, not to say a
religious, problem,” which stood in great contrast to progressive aspirations
of the “value-free” scientific management of society (Knight 1936, 52).
As we have seen, Knight and Keynes were at an interesting intersec-
tion in respect to ethics, and the same might be observed to an extent in
respect to religion. Knight offered great insight into the social and spiri-
tual context of economics, which contrasted with the liberalism and
social thought of Keynes, who became the dominant force in Knight’s
time. The prophet was outshone by the public intellectual. Skidelsky
explained that Keynes was raised in the England of the late 19th cen-
tury, which was “the critical moment at which Christian dogma fell
away from the serious philosophical world of England, or at any rate
of Cambridge” (Skidelsky 1992, p. 168). The real point of departure
between Keynes and Knight is their understanding of human nature,
the prophetic role taking centre- stage here. Keynes believed that bring-
ing about the better society was not about changing human nature,
and he argued “transmuting human nature must not be confused with
the task of managing it.” (Keynes 1936, p. 374) He argued we need to
examine the “dangerous human proclivities” which can be channelled
into capitalistic activities, rather than outlets of cruelty, personal power
and other forms of self-aggrandizement. As Keynes wrote “It is better
that a man tyrannise over his bank balance than over his fellow-citi-
zens” (Keynes 1936, p. 374). In Knight’s view of the human condition
this approach does not work, and he thought the more likely, if not
inevitable, outcome would be that such a man would use his bank bal-
ance precisely to tyrannize over his fellow-citizens.
William B. Greer in Ethics and Uncertainty: The Economics of John
M. Keynes and Frank H. Knight compares the world-views of Keynes and
Knight in the following, and one might add theological, terms:
9 The Economic Order and Religion 229
Knight adopts the view that mankind is at the mercy of a predetermined, and
ultimately predictable, natural order. Economic actors are relatively power-
less to take actions that will improve their long-term state of being, since to
do so impedes the working of the free forces of the market. Keynes, on the
other hand, is of the opinion that it is perhaps not in man’s best interest sim-
ply to allow the economic world to spin undisturbed. It is, rather, in them to
take action on their own to correct for the economic system’s imperfections.
The question of Keynes’ and Knight’s economics becomes a question of free
will against predestination, of one’s ability to determine one’s own future
against inevitable and unchangeable results. (Greer 2000, p. 48)
2 Knight’s Theology
In 1945, a unique exchange was published under the title of The
Economic Order and Religion, which was a sharing of views on the eco-
nomic order and religion between Knight and Thornton W. Merriam,
at the time Director of USO Training at the National Council of the
YMCA, who was active in religious practice and policy. It is in this vol-
ume that Knight explained his understanding of the biblical prophets.
2
Knight states this in The Concept of Spirituality. Frank H. Knight Papers, Box 4, Folder 23.
Chicago, IL: Special Collections Research Center, University of Chicago Library.
230 Frank H. Knight
This is quite different from principles that would be set out by Christian
denominations, which usually start from doctrinal statements about Jesus,
the Trinity and discipleship made by the churches of Knight’s upbring-
ing. Though Knight would have been most interested in the fourth point,
the sixth point listed is one that probably would have troubled him.
Knight had essentially deserted the Christian church when he left
Milligan College in 1913, and though he only attended occasionally
the Disciples’ University Church in Chicago, in Iowa he had been very
active, as Emmett explains: “he attended the men’s group, taught Sunday
232 Frank H. Knight
School, led discussions for the young adults, participated in the Unitarian
Laymen’s League, and served as a delegate for the local congregation at the
regional association” (Emmett 2007, p. 8). The men’s group was a venue
for progressive and academically-minded individuals and community
leaders to meet, and Knight eventually served as president of the group.
What appealed to him about the Unitarians is explained by Knight in
the 1922 letter quoted in Chap. 1, where he explained he wanted some
sort of religious connection, and while he saw the Unitarians about as
dogmatic and opinionated as any, he thought they at least theoretically
had a truth-seeking attitude.
Many centuries earlier, Martin Luther had similarly complained that the
Roman Catholic Church had diminished its followers and endangered
human freedom by encouraging the faithful to believe that life – even in such
fundamental matters as the attainment of salvation in the hereafter – could
follow mechanical rules as set by the church hierarchy. (Nelson 2001, p. 126)
Economists and planners suffered the same delusion, and Knight was
being Luther to them by saying this could not be justified, and said to
the profession “Here I stand!” Life is a more open-ended affair, with the
human condition and the environment of humanity testing the best of
human intentions and plans to their limit. As Nelson points out, this was
the Protestant emphasis on original sin undermining any human efforts
to order the world rationally. Luther said “a good man does good works,
good works do not make a good man,” to which Knight would probably
equivocate that a good person may do some good things, but a good eco-
nomic arrangement of human affairs will not make such good persons.
For this reason, as Nelson explains:
like other writers draws attention to the fact that Knight wrote more
than most economists on the subject of religion, in spite of his antago-
nism towards it.
scarcity and its consequences for human behavior and social organization
is [sic] a form of theological inquiry: in a world where there is no God,
scarcity replaces moral evil as the central problem of theodicy, and the
process of assigning value becomes the central problem of morality. Knight’s
(implicit) recognition of the theological nature of economic inquiry in this
regard is one of the reasons for his rejection of positivism in economics and
his insistence on the fundamentally normative and apologetic character of
economics. In some sense, therefore, it is appropriate to say that Knight
understood that his role in a society which did not or could not recognize
the presence of God was similar to the role of a theologian in a society
which explicitly acknowledged God’s presence. As a student of society, he
was obliged to contribute to society’s discussion of the appropriate mecha-
nisms for the coordination of individuals’ actions, and to remind the mem-
bers of society that their discussion could never be divorced from
consideration of the type of society they wanted to create and the kind of
people they wanted to become. (Emmett 1994, 118–19)
The world community, toward which all historical forces seem to be driv-
ing us, is mankind’s final possibility and impossibility. The task of achiev-
ing it must be interpreted from the standpoint of faith which understands
the fragmentary and broken character of all historic achievements and yet
has confidence in their meaning, because it knows their completion to be
in the hands of a Divine Power, whose resources are greater than those of
men, and whose suffering love can overcome the corruptions of man’s
achievements without negating the significance of our striving. (Niebuhr
1945a,b, p. 128)
Politics, as the art of the possible, is the horizon of here and now, while
the divine horizon, the not yet, is the test of this present horizon. Niebuhr
argued we can transcend politics by appeal to the far divine horizon of
love, and he sought to reconcile our understanding of the human condi-
tion with the divine potential, but given that we live in tension and with
dissonance between the two, Niebuhr had offered a potentially successful
answer to understanding human relations in democracy, and it is surpris-
ing that this was never a line of enquiry pursued by Knight.
240 Frank H. Knight
Niebuhr’s appeal to liberals in his time was that he gave them an ethic
without God, in part because the theological assumptions were so deeply
implied that he never embarrassed his audience with too much doctrine,
and so they could take the moralism with the political reality without hav-
ing to bow before his god. This could have appealed to Knight, but again
he did not engage with Niebuhr, and it is doubtful he would have walked
too far by his side. To impose any Christian ethic on society would be
destructive in Knight’s view, yet the liberal model of society he thought
was sadly lacking a soul, left as it was to the combination of free markets
and democratic government to guide individuals in their pursuit of free-
dom. Knight argued that the classical liberal approach was over-confident
in its assessment of markets and government, and had excluded much-
needed ethical norms. Knight and Niebuhr did cross paths at one point,
through the pages of The Christian Century magazine, which Niebuhr
wrote for on a regular basis, and Knight made a rare appearance from
the ranks of economists as a contributor to its pages. In the 1st February
1933 edition of The Christian Century, Knight wrote an article entitled
Can we Vote Ourselves Out of the Fix We Are In?, where he argued the the-
sis that the political and social problems of the day would not be resolved
by economics or even social sciences, because there are decisive issues to
be understood through social psychology and religious sentiment.
If we look at Knight’s concerns about liberal democracy, he was not
helped in his expedition by the high degree of naiveté and disciplin-
ary ignorance of economic matters among theologians and churchmen
discussed earlier. Indeed, prior to the fall of the Berlin Wall it is hard
to find any significant theological figure with a nuanced view of eco-
nomic matters, and what views were expressed in the theological acad-
emies or the policy committees of churches were nearly always hostile
to capitalism. Knight would have found this exasperating, as one who
took a realist view of the economy as the best possible option within a
fallen realm. Hence while he does seem to have a lot in common with
Niebuhr, one finds there is a distance between them, because although
Niebuhr deserted the social gospel, he did not leave the political left,
and his view of economics would have been less than Knight would
have desired from him. For this reason, in all likelihood, Knight ignored
Niebuhr, though Niebuhr was also commonly called prophetic in
9 The Economic Order and Religion 241
While the magazine often discusses issues such as banking, trade, and
labor, it does so in language that echoes the debates of the nineteenth
century – most often caricaturing “economic man” in favor of a quasi-
Marxist interpretation of economic life. Niebuhr was typical of the theo-
logians of the time, although his moral theology was in the process of
moving away from the Social Gospel toward a more orthodox position.
(Emmett 2014, p. 144)
Just as Niebuhr’s prophetic stance led theologians away from the search for
the society which perfectly reflected God’s will on earth, Knight’s scientific
stance led economists away from the search for the perfect policy prescrip-
tions…In many ways, the stance between these two stances represents what
the separation of theology and economics brought us to in the twentieth
century. (Emmett 2014, p. 144)
His Calvinistic vision of fallen humanity in the iron grip of sin may be too
pessimistic for the basic American temperament. Yet the very fact of
Knight’s having made the effort – to find a new governing model that
rejects the redemptive hopes for science and progress as a starting point,
but yet sophisticated in its economic understanding – is a significant devel-
opment in itself. In the future other economists may have to look more to
Knight’s work for inspiration as they seek to reconcile science, economics,
and religion. (Nelson 2001, p. 328)
6 Knight the Iconoclast
Knight was a great admirer of Tolstoy, who had shown in War and Peace
how plans are highly contingent, and can only be made in the broadest of
senses, and in Knight’s view, had managed to get to the heart of Christian
ethics (Knight 1923). Tolstoy was also a protester and iconoclast, which
no doubt appealed to Knight. However, having highlighted the problem
of human nature, and recognized the severe limitations of social, political
and economic organization, Knight did not offer an alternative solution.
As Nelson explains this lack, linking it back to Knight’s own doctrine of
original sin:
9 The Economic Order and Religion 243
A great iconoclast (in the spirit of Luther and Calvin, we might say
“protester”), Knight seemingly rejected all of these explanations for the
existence of evil, which were grounded in a particular view of human
nature, yet he did not offer any explicit alternative of his own. One must
read behind the lines to find Knight’s views of the human condition.
Indeed, despite all his outward hostility to Christianity, his own theology –
mainly expressed in an implicit fashion – followed surprisingly closely in
the Calvinist understanding of Christian faith. Although any notion of an
actual fall in the Garden of Eden might be a myth, human beings in
Knight’s view are corrupt creatures whose actual behavior in the world cor-
responds closely to the biblical understanding of the consequences of origi-
nal sin. (Nelson 2001, p.)
In his essay Ethics and Economic Reform, Knight argued that the social
sciences need an impersonal approach, whilst the Christian approach is
emotional and personal, suggesting “evil rather than good is likely to
result from any appeal to Christian religious or moral teaching in connec-
tions with problems of social action” (Knight 1939, p. 47). Knight’s real
problem arguably is with how religion is practiced rather than religion
per se, consistent with his Unitarian commitment. In a statement that
many a theologian and church advocate has made to the slackers in their
congregation, Knight stated:
In large part, religion seems merely to sublimate any moral urge which
people have, giving it expression and release in more or less esthetic ritual,
and leaving them entirely free, except for an hour or so in the week, to
pursue worldly objectives by worldly methods. (Knight 1939, p. 421)
nature and plurality of beliefs that create human conflict, and where there
is conflict there is power. Knight is, in fact, making a similar judgment.
We need to agree on what is a better configuration for ruling the world,
but rather than it coming about by all being good Christians, he means
we first all need to be good liberals, and able to discuss the difficulties we
face, which is about as close as we can get to a solution in Knight’s view.
Knight lacks the optimism of progress found in his fellow Chicagoans
and the libertarians among them, but then again he did liken the pursuit
of economic satisfaction to the labour of Sisyphus. If social action is not
effective, and discussion is to be more than a talking platform, we may
liken Knight’s position to a labour of Sisyphus as well, and this drives
toward the conclusion, and considers whether Knight was a pessimistic
conservative iconoclast or simply a realistic classical liberal.
Bibliography
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of Business, State University of Iowa 4: 5–8, 24.
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1–29, 296–321, 398–422.
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W. Merriam. New York: Harper & Bros.
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tics. Presidential address to the American Economic Association, December
28, 1950. The American Economic Review 41(1): 1–29. Reprinted in On the
history and method of economics, 251–281. Chicago: University of Chicago
Press, 1956.
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religion, Recent economic thought, ed. H.G. Brennan and A.M.C. Waterman,
103–120. Boston: Kluwer Academic Press.
Emmett, Ross B. 2007. The Religion of a Skeptic: Frank H. Knight on Ethics,
Spirituality and Religion during His Iowa Years http://ssrn.com/
abstract=979221 Last accessed 1 May 2016.
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nomics. London: Routledge.
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Oxford handbook of Christianity and economics, ed. Paul Oslington. Oxford:
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Greer, William. 2000. Ethics and uncertainty: The economics of John M. Keynes
and Frank H. Knight. Cheltenham/Northampton: Edward Elgar.
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Fund.
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Macmillan.
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beyond. University Park: Pennsylvania State University Press.
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gion, by Frank H. Knight, Thornton W. Merriam, The Nation March 10,
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10
Why Knight Was (Not) a Conservative
Prophet
The recession of 2008 was not just the bursting of an economic bubble; it
was the bursting of the bubble of optimism, dating back to the 1980s, for
what the economy can do for human society. It also brought Keynes and
his policy ideas back into favour, an evolution Knight would no doubt
question were he alive today, as noted in an earlier chapter, Knight had
said of Keynes in 1950:
The latest “new economics” and in my opinion rather the worst, for falla-
cious doctrine and pernicious consequences, is that launched by the late
John Maynard (Lord) Keynes, who for a decade succeeded in carrying eco-
nomic thinking well back to the dark age, but of late this wave of the future
has happily been passing. (Knight 1951, p. 2)
may have offered a renewed way to think about policy today, Knight also
deserves reconsideration, and his insights can offer a view into the soul of
the modern economy. Knight was a critical supporter of capitalism, and
his ultimate concerns focused with a deep sense of realism on the spiri-
tual and behavioural state of society and the economy. It is easy to see his
approach as a conservative one, but to appreciate truly Knight’s insights
into our contemporary situation, and the ongoing relevance of his work,
we need to dig a little deeper.
His approach was indeed in many ways conservative, but we have to be
careful not to pigeonhole him too simply or too readily. Another thinker,
much beloved by conservatives, was Hayek, yet Hayek offered the view in
his essay Why I am not a Conservative that conservatism by its very nature:
1
See Chap. 1.
10 Why Knight Was (Not) a Conservative Prophet 249
human activity and economic arrangements, and that we should not take
too much comfort from our theoretical approaches, and he doubts the
predictability of outcomes. This is the nature of his “conservatism,” a
practical and realist view of our economic and political arrangements,
and a suspicion of government and schemes that would seek to guide
us to a better life. Hayek had assumed conservatism equated with status
quo, but this is not necessarily the case for all conservative views, as we
will see below. Knight certainly did not accept the status quo, but he was
cautious of progressive change, and he based his thought on the notion of
a fallen nature of humanity and the very concrete existence of such fallen
people, rather than drawing on any abstract notion of homo economicus.
2
Where referenced is a matter of some debate.
10 Why Knight Was (Not) a Conservative Prophet 251
This could be said to be at odds slightly with his desire for discussion;
for who else can discuss but people, and to what extent should we really
worry about their motives or impute necessarily negative motives to the
desire to lead or to lead a discussion?
In respect to economics, Knight believed reformers and welfare advo-
cates did not understand economics, and they were ignorant of their own
ethical ideals, the relationship between economics and law, and, the cul-
tural process. He fired a special salvo at the preachers of idealism when
he argued:
a liberal of a certain age: an age which had already rejected the certainties
of both classical liberalism and its Victorian moral critics; an age which had
been enamored of Progressivism but understood its fundamental flaws; an
age which could not be enticed by promises of a world to come, but was
cognizant of what the loss of certainty meant; an age which could be skep-
tical and sometimes even cynical, yet also sometimes share the hopefulness
of the new generation.3
Frank Knight’s writings have never neatly aligned with his imputed role as
a dedicated advocate of free enterprise. Throughout his career, he refused
either to extol the virtues of markets without drawing attention to their
3
Emmett, Ross B, The Passage from Classical to Neo-Liberalism: Frank H. Knight’s Role Reconsidered
(March 6, 2011). Available at SSRN: http://ssrn.com/abstract=1779102.
10 Why Knight Was (Not) a Conservative Prophet 253
Primitive society was wise in its conservatism, for it knew at least that the
group had previously lived somehow, both as individuals and as a group.
And liberal society, it now seems, has acted frivolously in switching over
quite suddenly to an extreme opposite set of assumptions, that the new is
254 Frank H. Knight
better than the old, that the good consists in change, or at least in free-
dom of the individual to make changes, rather than in stability. (Knight
1947, p. 90)
4
Reflections on the Revolution in France. A Critical Edition (Stanford: Stanford University Press,
2001), J. C. D. Clark (ed.), to which I am indebted in this précis of Burke’s thought.
10 Why Knight Was (Not) a Conservative Prophet 255
5
Essay published in The Conservative Mind: From Burke to Eliot, 7th edition, Russell Kirk, ed.
(Washington, DC: Regnery, 2001). Patrick Allitt, in The Conservatives: Ideas & Personalities
Throughout American History (New Haven: Yale University Press, 2009), highlights the point,
p. 168.
6
Conservatism as an Ideology, Samuel P. Huntington, The American Political Science Review, Vol. 51,
No. 2 (Jun., 1957, pp. 454–73.
256 Frank H. Knight
this conservative movement, which still remain at the heart of the liberal
criticism of conservatism today. First, he argued many new conservatives
appear uncertain as to what it is they wish to defend. Second, many new
conservatives are astonishingly vague as to the nature and source of the
threat to what they wish to conserve. A third deficiency of this new con-
servatism is the effort to uncover a conservative intellectual tradition in
America, which Huntingdon stated is a liberal nation. When we measure
Knight against Huntingdon’s criteria, on the first points he has certainly
been accused of not stating exactly what he “stood for.” On the second
point, while some critics may feel he was not entirely clear on what threat
he believed we faced, he certainly posited the threat that is within our
human nature and our inability to build the “good society.” On the last
point, Knight would have argued that he was advocating a classical lib-
eral philosophy in keeping with the liberal tradition of America of which
Huntingdon speaks. In many of his writings, particularly on welfare and
freedom, Knight highlighted social conflict and the difficulty of human
life in the economy, not as homo economicus, but in terms of what it means
to be human in the economy and in a world of scarcity. Having done this,
he does stop short of offering any concrete solutions of a plan, but this
is because he did not see planning as the solution. His solution, and his
critics will question whether it is a solution at all, is for discussion and a
pragmatic process of trying to get along. This certainly would not appeal
to those who believe in engineering change, and falls far short of the ide-
alism that many would bring to the discussion he wanted to see happen.
As Thomas R. DeGregori critiques Knight’s thought, his approach “is a
theory of status quo and not of social change. In fact, in Knight there is
no way historically to explain how we arrived at the position we are in,
let alone how we move to another” (DeGregori 1977, p. 46).
Knight reacted against what he saw as a “new” liberalism or “neoliberal-
ism,” which he said was a twentieth century development that “simply con-
fuses freedom with power and with other goods and right,” and he called its
exponents “new or fair dealers, welfare-statists” (Knight 1953, p. 875). Gonce
suggests he went further than this, “In this class, however, he probably placed
institutionalists who favored the New Deal. Knight’s sympathies and antipa-
thies soon became manifest: he favoured the view of modern liberalism and
criticized all rivals” (Gonce 1992, p. 815). Razeen Sally, in his study of 20th
10 Why Knight Was (Not) a Conservative Prophet 257
of an advancing class which mistook its own progress for the progress of
the world” (Niebuhr 1922, p. 4).
Such analysis of the Niebuhrian position finds resonance in Knight,
and the mistake of such progress is one Knight draws attention to in sug-
gesting there are inequities we must come to terms with in capitalism. In
this sense we find Knight, like Niebuhr, being less easy to categorize and
locate according to a liberal or conservative camp. Niebuhr, like many
intellectuals of his and Knight’s era, flirted with communism. There is
some discussion among friends and critics alike as to whether Knight was
writing in jest, but it was thought at one point that perhaps Knight had
gone towards communism with his extended essay written in 1932, enti-
tled The Case for Communism: From the Standpoint of an Ex-Liberal. The
essay, based on a presentation given on the eve of the 1932 presidential
election, is a feisty assault by Knight on capitalism, where he offered the
view that “those who want a change and wish to vote intelligently should
vote Communist (Knight 1991, p. 57). Like many of both Niebuhr’s
and Knight’s academic milieu, there was tendency to flirt with far left
views, which resulted in many Trotskyites of the 1930s becoming the
Neoconservatives of the 1960s onwards. In this respect, Burgin suggests
Knight’s lectures were credited, despite their notoriously diffuse presen-
tation, with transforming incoming socialists into nascent libertarians,
in an act of political alchemy often cited as the origin of the Chicago
School” (Burgin 2009, p. 514).
It is highly unlikely that Knight was overly serious about commu-
nism; rather he used it as a foil for his assault on the excessive optimism
of modern or progressive economic liberalism, reiterating the notion of
him being a thwarted lover of liberalism. What trumps any plan for life
in Knight’s mind, whether it is the economic planning of communism
or the excessive libertarian confidence in the market to foster the best
conditions, is the limitation of the human being. These limitations exist,
he said, because people like to violate laws, and the human person is a
“contrary critter” (Knight 1956, p. 262), whose behaviour “is. .. satu-
rated with varied make-believe and deception not clearly separable from
realities” (Knight 1956, p. 258). Yet, he also says, that “man is a roman-
tic animal” (Knight 1956, p. 276), which explains why communists,
libertarians and others yearn for something more solid than the life of
262 Frank H. Knight
dissonance that forms the basis of Knight’s position. For these reasons
collectively, we should understand he said that “Surely no one thinks
that from any conceivable knowledge of the physical world it would be
possible to predict what interests intelligent beings living in it would
have, even if all conceivable knowledge of human psychology is thrown
in” (Knight 1956, p. 162). If then human action cannot be predicted
then Knight argued economic science cannot be merely explanatory,
because through freedom we act in a way that makes economic events
quite unpredictable. This means the economist needs to be concerned
equally with the basic principles of human behaviour, and the most fun-
damental principle involved is freedom and it was as a prophet of free-
dom that Knight worked.
role of the state should be, and to what extent should government move
towards attempting to manage the economy rather than leaving things to
the market. When we see the extent to which governments legislate our
economic activities, often under the guise of public interest, conserva-
tive opponents are inclined to identify with the “inconveniences” of the
state outlined in Pierre-Joseph Proudhon’s What is Government?, where
Proudhon wrote:
Would Knight have gone as far as Proudhon to define this as the moral-
ity of government? Most likely not, but he would have had some sympa-
thy with this invective against state influence over us in the sense that the
state is not necessarily the focus of all hope, and other mechanisms such
as the market can also deliver hope. Though where Proudhon had anar-
chy in mind, Knight worried about the stultifying effect of bureaucracy.
The problem with government, both Knight and Proudhon believed, is
that the apparatus of government is bedeviled by red-tape, bureaucracy
and stupidity, and this creates a sheer indifference to those whom the
government managers are put in place to serve. Like a company going
out of business, these bureaucratic servants can treat their “customers”
with the superior disdain of knowing that they are working for the state,
in the full knowledge that unlike a business they don’t go under. For
264 Frank H. Knight
In this unequal contest betwixt Common Sense and Philosophy, the latter
will always come off both with dishonour and loss. But, on the other hand,
Philosophy has no other root but the principles of Common Sense; it grows
out of them, and draws its nourishment from them. (Reid 1764, p. 7)
7
An argument I put forward in a feature article The Tea Party’s roots are in Aberdeen, not Boston,
David Cowan, The Scotsman (30/9/2010)
266 Frank H. Knight
8
Review by: Emile Grunberg, The Journal of Economic History, Vol. 17, No. 2 (Jun., 1957),
pp. 276–9
10 Why Knight Was (Not) a Conservative Prophet 267
6 A Concluding Note
In typical self-effacing manner, Knight in The Role of Principles in
Economics and Politics, noted:
He could have added to this picture the example of the prophets, who
likewise have been scorned on the street or viewed as parlaying a racket.
His was ultimately such a prophetic role, perhaps even priestly as Burgin
explains:
The viability of liberalism had passed with the nineteenth century, and
Knight had assumed the role of the doubt-ridden priest of a superseded
religion. He expressed his love for the principles of liberalism alongside
his belief that an enduring liberal society could never be. (Burgin 2009,
p. 523)
268 Frank H. Knight
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S U
Sally, Razeen, 256–257 Uncertainty, 2, 8, 15, 19, 23, 27,
Samuelson, Paul, 8, 11, 14, 17–18, 31–32, 36–38, 40, 50, 53,
101, 109, 112, 117, 139, 53n, 71–72, 146, 169, 174,
191–192, 225, 233 198, 200,–201, 218,
Say, John Baptiste, 33, 53n 231, 248f
Schmoller, Gustav von, 187 absence of uncertainty, 51
Schumpeter, Joseph, 32–33, 36–37, Keynes on uncertainty, 65–70
69, 147, 190 ‘true’ uncertainty, 54–57
Scitovsky, Tibor, 7, 192 uncertainty and risk, 57–64
Scottish Enlightenment, 169, 255, Unemployment, 107, 116, 122–123,
264–265 166, 183
Sen, Amartya, 193 Unitarian Church, 5–6, 225, 229,
Shackle, G.L.S, 54–57 231–232, 243, 255
Smith, Adam, 14, 33–34, 44, 57,
133, 135, 139, 155, 164, 166,
173, 177–178, 181, 201, 265
V
Socialism, 13, 34, 99, 112–116, 129,
Veblen, Thornstein, 13, 16, 80,
133, 160–161, 166, 194, 200,
147–148, 172
217, 241, 262
Viner, Jacob, 8–11, 16, 76, 121
Song, Robert, 186
Sraffa, Piero, 14, 103, 139
St. Andrews, University of, vii, 255
Stigler, George, 9–10 W
Surplus, 15, 36, 44, 71, 108–109, 116 Wage-fund, 82, 89, 106–110
Wages, 38, 61, 122, 136
Walker, Francis A., 35
T Waltz, Kenneth, 185
Theory of value, 14–15, 34, 40, 45, Wants, economic discussion of, 42,
89, 95–96, 109, 115–116, 45, 52, 58, 61, 115–116,
134–135, 139, 143, 145, 149, 131–132, 138–139, 145, 158,
203, 208 162, 171–172, 174, 194–198,
values as ethics, 157–159, 174, 212, 222, 259, 267
194, 200–201 consumer wants, 35, 42, 137
values, economics and, 215–218 satisfaction of, 40–41, 46, 51,
Thucydides, 184–185 57–58, 71, 191, 203, 213,
Tolstoy, Leo, 242 216–217
Turgot, Anne Robert Jacques, 164 Warriner, Doreen, 33
288 Index
Wealth, 50, 71, 82–85, 107–108, Wicksell, Knut, 81, 95, 102
122, 134–135, 137–138, 143, Wilson, Woodrow, 184
146, 154–155, 157. 159, 163. Woolf, Virginia, 229
164–165, 168, 171–172, 175,
177, 189, 195–196, 218
wheel of wealth, 139 Y
Weber, Max, 19, 21, 113, 185, 202 Young, Allyn, 30, 147
Welfare, 158, 165, 167–169, 179,
249, 251–252, 256