Machlup’s many publications include The Stock Market, Credit and Capital Formation (see also his interview in the Austrian Economics Newsletter and How to Think About Losses). On the basis of his business experience and Austrian School training, Machlup was well placed to shed light upon something – the consumption of capital – that helped to destroy Austria between the two World Wars. A good example is an address he delivered to the American Statistical Society in 1934 and published under the title The Consumption of Capital in Austria. In that article, which acknowledged that Ludwig von Mises was the first to identify the phenomenon, Machlup examined factors that might induce entrepreneurs to consume the funds that would normally be allocated to the replacement or expansion of inventory, plant and equipment. His “discussion of capital consumption and economic decline was provoked by the course of events observed in Austria during the [First World] War, the post-war inflation and the years of social reform.” Alas, it is so relevant that it might have been written yesterday. 
  
Miscalculation Due to a Rising Price Level 
  
          Attention stock market and real estate speculators: “profits due to an increasing price level are only fictitious profits. If they are consumed, capital is consumed.” Machlup showed that inflation (in the proper sense of the term) in Austria induced entrepreneurs to calculate replacement reserves incorrectly and thereby to consume fixed capital. He also showed how inflation and consumption depletes working capital. As an example, consider a commodity speculator who buys 1,000 kilos of copper. As its price rises he sells it at a considerable nominal profit. He consumes half of the proceeds and uses the rest to buy (say) 800 kilos of copper. Prices continue to rise, the dealer continues to sell at a large nominal profit, spends half the proceeds and reinvests the remainder in progressively fewer kilos of copper. It is likely, given the inflation, that in nominal terms the speculator’s money capital will eventually grow to a multiple of his initial outlay; in real terms, however (as measured by the decreasing purchasing power of his money, either for copper or consumer goods), he has progressively consumed his capital. 
  
Overtaxation of Incomes 
  
          To tax incomes at higher and higher rates, as has been the habit of Western governments since the 1930s (today’s “conservative” coalition government at Canberra, for example, is the highest taxing and spending in Australian history), is to encourage the owners of capital to consume capital. Austrian governments between 1913 and 1930 set a woeful example. In response, “if a capitalist’s income is too heavily taxed, he does not always cut down his expenditures accordingly but rather nibbles on his capital. High income taxes are seldom a transfer of consumers’ purchasing power from the rich to the public, but more often a conversion into consumption of funds which otherwise would be saved [or reinvested], and which are therefore disinvested capital.” 
  
Overtaxation of Production 
  
          Machlup notes that “while income tax snatches profits after they have come into existence, other kinds of taxation increase costs of production and, therefore, may prevent profits from coming into existence.” Higher taxes increase costs; and to increase costs is to discourage employment and production (see, for example, The Welfare State and Income Redistribution in Democracy). During the period Machlup analysed, decreased employment triggered higher expenditures by the state. These expenditures, in turn, were financed by more taxes and credit created out of thin air by the central bank. Both policies ultimately discouraged production and employment. Machlup summarised this dreary process: “the numerous friends of public expenditure … reiterate every day the high productivity of these expenditures and public works. I doubt by which indexes one should measure this productivity: by the increase in unemployment; by the decrease in profits; or by the steady decline in the capital stock.” 
  
“Social Justice” and Industrial Zombies 
  
          Austria, Machlup said in 1935, “has always been the most progressive country in the world. There is compulsory illness insurance, accident insurance, unemployment insurance, unemployment benefits and old-age pensions. There is obligatory bonus for overtime and a bonus for Sunday work. Children’s labour is forbidden and women’s night labour [is also] forbidden. Safety and sanitation in plants are strictly controlled. Every worker is entitled to be paid yearly vacations, and the first days of illness have to be paid for by the employer. Clerks are dismissed only after one to 12 months’ notice and receive, moreover, a dismissal fee in the amount of 1-12 months’ salary.” 
  
          Adam Smith and the classical economists called it mercantilism. Our grandparents knew it (and some experienced it) as fascism. As Friedrich Hayek observed during the Second World War (The Road to Serfdom, 1944, 1972, The University of Chicago Press), “at least some of the forces which have destroyed freedom in Germany are also at work [in Britain]. The character and the source of this danger are, if possible, even less understood than they were in Germany … Few are ready to recognise that the rise of Fascism and Nazism was not a reaction against the socialist trends of the preceding period but a necessary outcome of those tendencies." 
 

“Adam Smith and the classical economists called it mercantilism. Our grandparents knew it (and some experienced it) as fascism. Nowadays people call it 'social justice.'”

 
          Nowadays people call it “social justice.” To question it – to say nothing of revealing its fascist pedigree and thus opposing it on the grounds that it creates and exacerbates problems far worse than the ones it allegedly addresses – is to be indignantly ejected from polite middle class conversation. But these sensitivities do not change the fact that social justice is a fair-sounding phrase that distracts attention from incessant and worsening assaults upon the property rights of owners and employers of capital (see in particular Alexander Shand, The Capitalist Alternative: An Introduction to Neo-Austrian Economics, New York University Press, 1984). The trouble with social justice is not just that it encourages capitalists to erode their capital: for that and other reasons it also harms people of modest means (see Eric Schansberg, Poor Policy: How Government Harms the Poor, Westview Press, 1996). 
  
          As ineluctably as the sun rises in the morning, to increase remuneration above market-clearing levels is to manufacture unemployment (An Austrian Critique of Neo-Classical Monopsony Theory provides a good overview). But why does social justice inevitably consume capital? Because the same politicians who foist uneconomic wages, medical obligations and the like upon businesses also encourage them, whether with carrots or sticks, to undertake operations where entrepreneurs in a free market would not – and to continue operations long after unfettered capitalists would have ceased them. To impart a mercantilist privilege, in other words, is to issue a license which invites its holder – with impunity and temporary immunity – to transform politicians’ allegedly good intentions (their determination to favour mates is more like it) into widespread economic damage. As a result, not only individual favoured businesses but entire protected industries produce at a huge loss. They consume capital and use ever more arcane methods to obscure their tracks and flatulent communications to justify their privileged existence. 
  
          Examples of zombie industries abound. The world’s airlines, despite decade after decade of massive subsidy, have in aggregate never earned a penny of profit. Nor have “biotech” companies. What do you get when you combine incomprehensible boffins and silver-tongued promoters (these categories, by the way, are not mutually exclusive)? According to The Wall Street Journal (20 May), “since the first biotechnology company went public a quarter-century ago stock-market investors have put somewhere close to $100 billion into the industry. The results so far: more than a hundred new drugs and vaccines, several hundred million people helped by biotech medicines – and cumulative net losses of more than $40 billion for the industry’s public companies.” Biotechnology can cure deadly diseases, “but it’s hard to argue that it’s a good investment. Not only has the biotech industry yielded negative financial returns for decades: it generally digs its hole deeper every year. This often gets lost during periodic bursts of enthusiasm for biotech, one of which is under way right now.” 
  
          Net of their many and various subsidies, vast tracts of American and European agriculture – and Australia’s sugar, textile and automotive industries – also seem to be zombies; and not for years has America’s motor industry (which one wag has dubbed “a giant finance house with a garage out back”) turned a profit from the manufacture of vehicles. Perhaps most ominously, Fanny Mae (sometimes known as the Federal National Mortgage Association) and the Federal Home Loan Mortgage Corporation (Freddie Mac) seem to be voracious consumers of capital. According to the Cato Institute, they “receive government subsidies estimated to be worth $6 billion a year. Of that total, an estimated $2 billion goes directly as income to shareholders and employees of Fannie Mae and Freddie Mac. By design, the remainder of the subsidy largely diverts investment into the middle- and upper-income housing sector and away from capital sectors of the economy.” 
  
          Like other white elephants, Fannie Mae and Freddie Mac “preserve their privileged status through a multi-million-dollar lobbying effort that includes massive ‘soft money’ campaign contributions and the payment of exorbitant salaries to politically connected executives and lobbyists. [They] also protect their government-sponsored empire through millions of dollars of charitable donations to Washington advocacy groups. Because of their quasi-governmental status, there is a market perception that Fannie Mae and Freddie Mac mortgage-backed securities and debt carry an implicit federal guarantee against default. Hence, [they] expose the federal taxpayer to an ever-increasing potential contingent liability that could ultimately cost tens of billions of dollars to rectify.” 
  
          An analysis by Barron’s (17 May) “of Fannie’s accounting methods finds that, while legal, they obfuscate rather than illuminate Fannie’s true financial condition, allowing billions of dollars of derivative-related losses not to be reflected on its income statement. As a result, Fannie’s capital strength is less robust than the company’s many fans on Wall Street and Capitol Hill would contend.” Traditionally, Fannie packaged the home loans it purchased from banks into mortgage-backed securities. It guaranteed these securities’ interest and principal and sold them to major institutional investors. More recently it has concentrated upon the more profitable – and risky – business of buying and hedging mortgage-related securities for its own portfolio. It presently guarantees or owns outright approximately half of America’s $7.8 trillion colossus of outstanding residential mortgages – and “potentially threatens the financial safety of the U.S. and, indeed, the global financial system” (according to the FAQ section of Fannie Mae’s web site, “could a small mistake at Fannie Mae ever cause a big problem in the economy? No. To the contrary, Fannie Mae is capitalised to protect against enormous, devastating problems that would fell most other financial institutions.”) 
  
Distributing Unearned Dividends 
  
          Between 1913 and 1930, Austrian enterprises “paid dividends although they had zero or negative profits.” Their motive was not altruistic. Quite the contrary: it had everything to do with “the interest of hired business managers in maintaining their jobs and their salaries.” Plus ça change: Sean Corrigan noted in early 2003 that “double taxation or no, U.S. non-financial corporations have shelled out 118% of after-tax profits in the past seven quarters, amounting to a $116 billion diversion of their depreciation allowances to more consumptive ends. Why, in such difficult times, are they dissipating their resources in this manner? To keep Wall Street happy, of course, as well as to maintain the existing boards of directors and cliques of executives in the Lear Jet luxury to which they have become accustomed." 
  
Bloated Consumers’ Demand 
  
          These five factors, Machlup contended, are sufficient causes of the consumption of capital. A sixth accompanies – indeed, subsumes – them. The erosion of Austria’s capital stock coincided with a marked per capita increase in the consumption of consumer goods. High and rising taxes, “social justice” and corporate largesse and shenanigans, in other words, were symptoms of an underlying disease: the determination of rich and poor alike to live beyond their means. But neither then nor now does the diversion of resources from producers and towards consumers extract ore out of the ground. Nor does it pour metal from the mould or assemble parts into motor cars. In no country and at no point in time, then, is this diversion a recipe for durable prosperity. 
  
          So never mind what contemporary mainstream macroeconomists insist (and ignore Alan Wood, who mangled and confused it dreadfully in The Weekend Australian of 15-16 May): Say’s Law is valid in the form that Say originally stated it. One must produce, in other words, before one can consume; and the diversion of resources from production to consumption forecloses the fructification of capital such that over time it cannot generate a steady and rising stream of income. The consumption of capital implies a big (and undoubtedly enjoyable while it lasts) party. But human nature and big shindigs being what they are, the consumption of capital today implies a hangover tomorrow. 
  
          Sadly, since Machlup delivered his address the causes of the consumption of capital have not been contained – indeed, albeit at different rates in different places, several have been liberated from their nineteenth century constitutional moorings. As a result, since the 1930s entrepreneurs have had to struggle – fortunately, largely successfully – to create wealth more rapidly than politicians and central bankers stunt, deform and destroy it. Machlup spoke directly to today’s Anglo-Saxons when he observed that the “[importation] of capital does not increase the productive capacity of the country but only compensates for the internal capital consumption. This was obviously the case in Austria. Money, borrowed from abroad, was lent (mostly through banks) to corporations [in order to] … finance investments which were in reality replacements of outworn or obsolete equipment.” 
  
          Further, “in the absence of new saving, mere shifts in demand involve economic decline; in other words, an economy which is stationary in respect to the supply of savings is declining in respect to its capital base. Or, to put it another way, quick change in the objects of consumption without the emergence of new savings is itself a form of consuming capital.” Machlup identified an extreme consequence of this phenomenon. “Austria,” he concluded, “was successful in pushing through policies which are popular all over the world. Austria has most impressive records in five lines: she increased public expenditures; she increased wages; she increased social benefits; she increased bank credits; and she increased consumption.” This is clearly not capitalism. Call it what you will – mercantilism, fascism or social justice – it means interventionism, privilege, corruption, violence, economic superstition and financial voodoo. Its fruits are bitter and inedible: “after all these achievements [Austria] was on the verge of ruin.”