Whenever Mises speaks about the ERE (evenly rotating economy) he mentions the fact that there can be no profit in such a state of affairs. This is, of course, correct. The ERE is characterized by a set of certain unrealizable conditions such as perfect information, instantaneous price adjustments, etc, which makes the realization of supernormal profit (based on the correct anticipation of future economic changes) impossible. But I always assumed that, even in the ERE, that there was a “normalized” rate of return on capital known as interest, or “normal profit.” The Austrians call this originary interest, natural interest, and/or surplus value, the inevitable result of time preferences (as opposed to the “normalized” or “average rate of exploitation” and/or the marginal productivity of capital).
But then this passage, in Human Action, has confused me:
Italics are mine.
It seems like he’s conflating two very different phenomena, namely interest (normal profit), on the one hand, and entrepreneurial (or supernormal profit), on the other. Again, just to be clear, does Mises believe that there is an average rate of return on capital, brought about by arbitrage and time preference, in the ERE?
It seems that he’s implying that within an ERE profits wouldn’t exist due to that it’s already in a state of rest, or in equilibrium, compared to an economy that’s constantly striving towards equilibrium with unknown conditions.
In an ERE, or in some examples I have seen, there literally would be a “cycle” that would end where it has begun. If this is the type of ERE Mises is referring to there seemed to be now actual growth, only rotation.
Yet, I would be interested in seeing an example of an ERE where there is economic growth.
You know a lot more on this subject than I do, but I always thought interest and entrepreneurial profit were the same, or at least connected to the same phenomenon. Interest collection is not an automatic thing. A lender only manages to collect interest and make a profit if the funds are used in a productive way. This applies whether this is an example of a direct loaning of funds, or an indirect example of an extension of capital. Thus, profit always ultimately has to derive from a satisfaction of consumer’s wants.
The remuneration to all of the various factors of production are ultimately the result of satisfying consumer desires. This doesn’t tell us much. A laborer will cease to earn a wage once his firm goes out of business because it was unable to serve the needs of the consumer at all, or as efficiently as its competitors. But interest and entrepreneurial profits are two different things; the origin of the former is debated while the origin of the latter is almost universally accepted, namely the ability to forecast future market conditions and respond accordingly.
You would know better than I, but I thought Mises only considered the proceeds gained by entrepreneurial action as profit. By definition, these proceeds are the result of unanticipated (necessarily abnormal) circumstances. Here Mises explains what he considers profit and all those proceeds that are not profit. I think Mises allows for there to be interest in the ERE, but it is known to all and accounted for by all actors, and so is not profit.
According to Mises’ terminology, “entrepreneurial profit” is pleonastic; all profit is entrepreneurial. And according to his terminology, interest is not any kind of profit. So, for Mises, saying “normal profit” is as nonsensical as saying “normal entrepreneurial profit” would be for you.
And I’m pretty sure there is no arbitrage in the ERE.
From what I understand, if psychic considerations of economic actors were all neutral, then in the ERE the price spread (the interest rate) would be equal among all stages of production. This equalization comes from arbitrage, i.e, if a rate of return was higher in one production process compared to another (9% to 5%), then capitalists would move into this stage because of the higher return. They would bid up factor prices and increase supply of the product in one stage (thereby reducing the return) while hiring less factors in the other stage and decreasing the supply of the product (increasing the return). This process would continue until the rates are equal. Arbitrage does not occur in the ERE, since all information is known and all P.P receive the interest return (neutral psychic), but it plays a crucial element in the transition to the ERE.
Profit in the Austrian framework only arrives when the return is greater than the interest rate. It results from uncertainty and comes from when entrepreneurs estimate that factors’ DMVP’s are underpriced relative to their potential DMVP. If an entrepreneur estimates correctly, by shifting resources from lower to higher DMVP he earns a profit because his return is greater than the interest rate (he could also short sell if he expects factors to be “overpriced”, but its the same fundamental mechanism-correct estimation of the future and its relation to consumer satisfaction). If the return was equal to the interest rate, then that means the factors’ DMVP were correctly capitalized. If the return was less than the interest rate, then the factors’ DMVPs were overcapitalized in relation to their potential DMVP (or overpriced in relation to this particular production process). The same process that transitions the economy to the ERE is the same process that removes profit and loss. Industries with profits will be met with greater competition and entry while those with losses will suffer quick removal.The statement that profits result from uncertainty and a correct estimation that factor prices are underpriced is essentially the same thing, because factors DMVPs are unknown because of uncertainty.
Profit is considered ephemeral because of what was stated above. Holding everything else constant, a single change in the economy that resulted in profits would be quickly met by an increased demand for those requisite factors and an increased supply of the product, which removes the profit return. Problem is the world is constantly changing and so are the opportunities for profit. Thinking of it in the opposite way, it would be absurd to think of a normal rate of loss (unless its government we are talking about ).
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