(Great Thinkers in Economics) David Cowan (Auth.) - Frank H. Knight - Prophet of Freedom-Palgrave Macmillan UK (2016)

GREAT THINKERS IN ECONOMICS
Series Editor: A.P. Thirlwall
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.
More information about this series at

http://www.springer.com/series/15026
David Cowan
Frank H. Knight
Prophet of Freedom
David Cowan
Boston College
MA, USA
Great Thinkers in Economics

ISBN 978-1-137-46210-7 ISBN 978-1-137-46211-4 (eBook)
DOI 10.1057/978-1-137-46211-4
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To my son David, with love and admiration!
Preface
Frank Knight is an interesting thinker to have spent a portion of one’s life

life in writing a book such as this. Perhaps it is my own roots in Scotland
that has led me to have some warmth for his curmudgeonly persona,
but that aside, it is his realism and insight into the limitations of the
human person that truly holds some fascination for me. My PhD at the
University of St Andrews, jointly undertaken in the School of Divinity
and the School of International Relations, was on the Religious Right in
America in dialogue with Reinhold Niebuhr, a theologian and contem-
porary of Knight, though they had little to do with each other. I found
more than a few parallels between the endeavours of the two thinkers, as
Niebuhr tried to find a better liberalism and, I suggest, Knight tried to
find a better conservatism.
There are two aspects to Knight’s work that make him such an appeal-
ing figure to a broader audience today. First, his interest in linking eco-
nomics to behaviour, in ways that are quite different from later Chicago
economists such as Gary Becker, and others who want to look at behav-
iour through economics. Knight’s vision was quite the reverse, as he
wanted to look at economics through the lens of behaviour. I have long
been intrigued by the ethics and behaviour of economic life, and it was
a revelation for me to find Knight, and to explore his reflections on the
same areas of interest as my own. Knight was a very philosophical thinker,
and he used this approach to offer some prophetic insights that can help
vii
viii Preface
us to look into the humanity of the economic challenges, and sometimes

travesties, that have befallen modern history.
The second reason builds on the first, and his status of being a conser-
vative economist. When I studied as an undergraduate in the early 1980s,
it was in the heyday of monetarism, and Ronald Reagan’s embrace of
Friedman and Margaret Thatcher’s embrace of Hayek put the Austrian
school at the heart of economic orthodoxy. There was thus a tendency to
make the conservative economic approach strangely progressive and con-
trary to human nature, rather than the more cautious approach tradition-
ally taken by conservative thinkers. In this, the Austrians, from Knight’s
point of view, held much in common with their socialist adversaries. I
believe he was a conservative economist, for reasons set out in the final
chapter of this volume, but I stress in this particular respect he deserves to
be listened to by conservative constituencies in his native America today,
as they search for an economic approach for the future.
It is the sheer breadth of his interests that may have alienated him at times
within the economics profession, but it does make Knight an ideal dialogue
partner for many disciplines. As a prophetic figure, and with his reputation
for being something of a theologian amongst economists, he is a natural figure
for me to present in this wonderful series of great economic thinkers. Knight
deserves to be studied among these thinkers, and he also deserves a broader
audience, and I hope the inclusion of this book in this important series pre-
sented by Palgrave Macmillan, will bring him a new audience of readers within
economics and among those more broadly interested in economic ideas.
I would like to thank Tony Thirlwall for being such an inspired edi-
tor. At Palgrave Macmillan, I have been graced with a team of dedicated
individuals during the course of bringing this book to publication: Taiba
Batool, Ania Wronski, Laura Pacey, Grace Jackson, Aimee Dibbens, and
Alexandra Morton. I offer my thanks to all for their patience and sup-
port. Ross B. Emmett has been a wonderful pioneer of Knight’s work,
and Knightian study would never be where it is without his enthusiasm
and dedication. I am grateful for his ground-breaking body of work, but
also to Ross personally for reviewing the final manuscript and discussing
with me the finer points of Knight’s thought – any errors remain mine!
As in all such endeavours, I owe much in personal debt, chiefly to my
wife Hanny, and our children Yasmin and David, and it is to David, an
emerging writer himself, I have dedicated this book.
Contents
1 A Prophet and a Pioneer 1
2 Knightian Uncertainty 27
3 The Grand Crusade 75
4 Knight contra mundum 99
5 The Economic Organization 129
6 Understanding the Ethics of Competition 153
7 Welfare Economics 181
8 Freedom and Reform 207
9 The Economic Order and Religion 225
ix
x Contents
10 Why Knight Was (Not) a Conservative Prophet 247
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.
© The Editor(s) (if applicable) and The Author(s) 2016 1

D. Cowan, Frank H. Knight, DOI 10.1057/978-1-137-46211-4_1
2 Frank H. Knight
Knight was a co-founder of the “Chicago School”, but he was

a teacher more than a theorist or producer of books. His work is
scattered across a host of economic journals in essay form stand-
ing on the base of his first and major work Risk, Uncertainty and
Profit published in 1921. Within the economic world, he is chiefly
noted for the notion of Knightian uncertainty. He established his
reputation in the pantheon of economic thinkers largely because
of Risk, Uncertainty and Profit, which was based on his PhD thesis.
The remainder of his writings comprised essays, lectures and book
reviews, the most notable being collected in the single volumes of The
Economic Organization (1933a), The Ethics of Competition and other
Essays (1935a), The Economic Order and Religion, with T.W. Merriam
(1945), Freedom and Reform (1947), On the History and Method of
Economics (1956), and Intelligence and Democratic Action (1960). As
one of his former students, James M. Buchanan, who became a long-
time friend and Nobel prize-winner, notes in the foreword to the
1982 edition of Freedom and Reform, Frank Knight was a critic, and
apart from Risk, Uncertainty and Profit his work “can be interpreted
as a series of long book reviews.” His “social function” was that of
“exposing fallacies, nonsense and absurdities in what was passed off
as sophisticated scientific discourse” (Knight 1947, 1982 edn. p. xi).
Because Knight was essentially a teacher and a critic, he did not pen
the major volumes for which one might have hoped. His relevance as
a great economic thinker for us today, apart from Knightian uncer-
tainty and his status as a founding father of the Chicago School, was
threefold. First, he is arguably one of the most interdisciplinary of
economists, and thus provides a basis on which thinkers can discuss
economic issues from their own disciplines. Second, he raised issues
that are prevalent in the latest stages of capitalism, being issues we
currently face and will continue to face in the future. Lastly, he was
an economic realist who knew the weaknesses and strengths of capi-
talism, so while remaining a supporter of capitalism as the best avail-
able system he also addressed the limitations and difficulties thrown
up by this imperfect way of organizing our economic affairs without
overthrowing what he saw as an ultimately workable system.
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.
from philosophy to economics at Cornell; with various versions of the

switch portraying that he was, depending on which reports you read,
either invited to look elsewhere or kicked out of the philosophy faculty.
Knight joined the Chicago faculty after his dissertation, taking up an
appointment as instructor in economics from 1917 to 1919, but was then
offered a tenured associate professorship at the State University of Iowa, a
community of some 15,000 faculty and students, which he held from 1919
to 1922. It is easy to skip the Iowa years in Knight, but that would miss
the significance of this period in his career. Knight did his core and lasting
work at Iowa including the publication of Risk, Uncertainty and Profit.
The other important work at Iowa was his article “Cost of Production and
Price over Long and Short Periods”, published April 1921 in the Journal of
Political Economy, the same year as Risk, Uncertainty and Profit. He wrote
this article as a didactic tool from the standpoint of the student, whom
Knight believed was baffled by many contemporary expositions of price
theory He wrote much of the work collected by his Chicago students and
published in the later volume The Ethics of Competition, while in Iowa.
Knight certainly enjoyed his time in Iowa. He lived close to campus
and was heavily involved in the social and intellectual life of the univer-
sity. He participated in many of the university academic and technical
clubs, the latter being the name applied to those clubs specific to a disci-
pline. His primary activities were with the Political Science Club and the
Philosophical Club, and he gave numerous talks at these and other clubs.
Despite a growing reputation, research by Norquist and Emmett reveals
that Knight only had two doctoral students at Iowa, one of whom was
Henry C. Simons, who would join him in Chicago in 1927 but never
defended his dissertation at Iowa (Emmett 2011 p. xxii.). This low rate of
supervision continued at Chicago, where again Knight only supervised
two completed dissertations, one of whom was George J. Stigler who
would go on to be a major figure in Chicago and win a Nobel Prize. The
other was William D. Grampp, who remains an emeritus professor at the
University of Illinois at Chicago.
The other major activity for Knight in Iowa was his involvement with the
Unitarian Church, which he decided to join despite his well-documented
opposition to organized religion. In a letter Knight explained, “I am
committed to casting my fortunes with the local Unitarian association.
6 Frank H. Knight
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).
a proclamation by Massachusetts Governor Michael Dukakis in 1977

that Sacco and Vanzetti had not received a fair trial, and, confirmation
in 1983 that the revolver taken from Sacco was used in the killings. The
case grew in notoriety against the backdrop of communist fears in 1920s
America, and the two men played on this to gain support from the left
wing with claims that the prosecution was politically motivated, result-
ing in millions of dollars raised for their defense by radical left supporters
around the world. The Harvard connection came though A. Lawrence
Lowell, president of Harvard University, who was asked to head a com-
mittee to consider calls for clemency. The calls were rejected by the com-
mittee and the two men were executed, and as a result Harvard became
stigmatized and Knight remained distasteful of the whole affair.
Whatever the reason, Knight was not lured away to Harvard. He left
Iowa for the University of Chicago in the fall of 1927, with a brief return
to the State University of Iowa for a term in 1928, before taking up the
permanent post in Chicago later that year, replacing John Maurice Clark
who had moved on to Columbia University. In September 1929, he then
married his second wife Ethel Verry, who had been one of his students
in Iowa. The following year they took a six-month sojourn to Europe on
a Guggenheim Foundation fellowship, with Knight giving a lecture in
Vienna on the possibility of a value-free economic science, and spending
time with Ludwig von Mises and his circle.
Knight was essentially a teacher, and so his career focused on teaching
rather than writing books or finding fame or fortune outside of academia.
He stayed at Chicago for the remainder of his career, retiring in 1952 but
remaining active in the Chicago community until his death in 1972. He
stayed active on the Chicago faculty, and as a co-founder of the Chicago
School, Knight continued to embody the Chicago spirit. He was a man
who had little respect for orthodoxy and offered a radical challenge to the
accepted norms. In a personal recollection, Buchanan classified Knight
as “Chicago’s critical spirit,” and a pessimist at base who observed the
behaviours of fools (Shils 1991, p. 251). This attitude of Knight certainly
comes across in his writing, and alongside his writing style may have been
the reason he attracted barbed criticism back. His writing style is chal-
lenging, and has been a constant source of criticism for opponents and
supporters alike. Buchanan, writing an essay in a volume of memoirs,
8 Frank H. Knight
Remembering the University of Chicago, edited by Chicago professor

Edward Shils, offers us some insight when he notes that Knight would
never read what he had written, always starting with a tabula rasa, and
this explains the many repetitions, restatements and redundancies in his
writings (Shils 1991, p. 251).
3 Founding of the Chicago School

Paul Samuelson described the topography of the Chicago economics
department as being like Gaul:
The University of Chicago economics department, like Gaul, was divided

into parts. Knight and Viner were the theorist patriarchs and rivals. Paul
Douglas was the more-than-token liberal. Henry Schultz represented the
wave of the future in econometrics and mathematical economics. Henry
Simons, critic of the regulated state and advocate of redistributive income
taxation, was in Knight’s camp. Although Aaron Director began in the
Douglas workshop, his heart was with Knight. (Samuelson 2011, p. 590)
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
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.
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 The Intellectual Milieu

The debate over economics as a science is central to understanding
Knight, and it was this debate that raged in the 1930s and 1940s. In
these interwar years, dominated by the Great Depression, the debate is
one commonly characterized as the Neoclassical versus Institutionalist
viewpoints, but to focus on these two is to miss the diversity and vibrancy
of debate in these years. These two schools of thought argued about the
very fundamentals of economics, the niceties of theory and the demands
of policy in the face of depression and the business cycle. At the same
time, Knight and others were doing important work at Chicago, but
this was also the time of the advent of Keynesianism and the continuing
challenge of socialism and Marxism. Much time will be spent later in

this book on two of the 20th- century giants Knight engaged with, John
Maynard Keynes and F.A. Hayek. It suffices now to sketch out the broad-
est of points of debate. It was an exciting time for the dismal science!
Neoclassical economics put homo economicus, then translated as eco-
nomic man and now best put as the economic person, at the centre of
the action and characterized the economic person as a rational utility-
maximizer. The fundamental assumptions of the neoclassicals were three-
fold. First, people have rational preferences among outcomes. Second,
individuals maximize utility and firms maximize profits. Lastly, people
act independently based on full and relevant information. Neoclassical
economics was a term first attributed to Thorstein Veblen, and its theo-
rists set out to establish a science of economics. Like institutionalism, in
many respects Knight had common ground with the neoclassical view.
However, his view of human nature and its relationship to economic
considerations led him to put severe limits on how helpful this scientific
approach was in reality. As he noted, it was necessary to have “an adequate
appreciation of the meaning and the limitations, of this body of accurate
premises and rigorously established conclusions” (Knight 1924a, p. 28).
Knight believed neoclassical economics to be limited as a social science,
which he set out to demonstrate by use of the analogy of the hard sciences
of mechanics and physics. Knight was not alone in resisting the tide of
neoclassical economics.
In the late 1950s and early 1960s the battle resurfaced and became
known as the “Two Cambridge’s Controversy,” which was named by
G.C. Harcourt (1969)4 because the protagonists were mainly based at
Cambridge University and Harvard in Cambridge, Massachusetts, when
British economist Joan Robinson, along with her colleagues and students
at Cambridge University, set out to discredit neoclassical economics.
Robinson kicked off the controversy on the topic of capital theory, and
the debate raged from the middle of the 1950s through to the mid-1970s.
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 Cambridge controversies, if remembered at all, are usually portrayed

today as a tempest in a teapot over anomalies involving the measurement
of capital in aggregate production function models, having as little signifi-
cance for the neoclassical marginal productivity theory of distribution as
do Giffen good anomalies for the law of demand. When theories of endog-
enous growth and real business cycles took off in the 1980s using aggregate
production functions, contributors usually wrote as if the controversies had
never occurred and the Cambridge, England contributors had never
existed. (Robinson and Sraffa obliged by dying in 1983.) Since neoclassical
theory has survived and the challengers have largely disappeared, the usual
conclusion is that the “English” Cantabrigians were clearly wrong or
wrong-headed. (Cohen and Harcourt 2003, p. 200)
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
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
used over a definable period, evaluating the quantity of capital in relation

to the average time between investment of the primary factor and con-
sumption of the final product. However, this caused Knight to contest
the point with his different meaning of the period of production, and
to challenge the Austrian desire to relate quantity of capital to a period
of production. As with his other points of conflict, Knight sought to
test the argument against reality. Knight argued that such a theory “can
be defended as true only under assumed conditions so divergent from
the basic facts of modern economic life that there is a strong presump-
tion against employing it fruitfully as a tool of analysis” (Knight 1933a,
p. 32). While respecting Knight’s contribution to the discipline, Hayek’s
riposte was that Knight’s argument rested on “fatal confusions.” This was
indeed to be a feisty debate!
5 Economist, Historian, Theologian or

Philosopher?
Knight’s early career is typically seen as the more narrowly “economic”
of his years, and by the time the postwar years came along he was more
or less fully dedicated to social philosophy. In the economic field spe-
cifically, he was teaching and writing his first major works in an era of
institutionalism, the school of economics that flourished in the United
States during the 1920s and 1930s. Knight arrived in Chicago expecting
that institutionalism would be his main field of work, but Jacob Viner
went to Geneva for 2 years and left Knight to teach the main course
in economic theory. The institutionalists viewed the evolution of eco-
nomic institutions as part of the broader process of cultural develop-
ment, with the foundational thought set down by Thorstein Veblen, who
argued that people are continually affected by changing customs and
institutions, rather than affected by people making economic decisions.
John R. Commons (1934) emphasized the collective action of various
groups in the economy, viewed within a system of continually evolving
institutions and laws. Institutionalists emphasized the importance of non-
market factors and social institutions in influencing economic behaviour.
This analysis subordinated economic notions in favour of sociological
factors, history, and institutional development. However, while Knight

had points in common with the institutionalists, he was also opposed to
them and has been described as “the dean of the opposition to institu-
tionalism” (Yonay 1998, p. 144).
As noted, however, this is to misread his approach. Knight, in his
early career, does set out his core economic ideas in detail, but as his
career developed he continually expanded to link them to broader social,
ethical, historical, and philosophical concerns. He also sought restlessly
to dig more deeply into the foundations of his thought, revisiting and
elaborating the underpinning ideas of his economic approach. As Knight
worked at his teaching and refined his ideas through many essays and
book reviews, the post-war years in the broader economic community
was dominated by Keynesianism, and the teaching of economics in the
American schools was based on Paul Samuelson’s textbook Economics, first
published in 1948, with competition for classroom orthodoxy coming
from a succession of Chicago economists, many of them Nobel winners.
Paul Samuelson had been another student of Knight’s at Chicago, and
he was quick to see the broader social and philosophical approach of
Knight, but came to be critical of his teacher. Gerald L. Nordquist in
conversation with Knight’s widow, Mrs. Ethel Verry Knight, told her one
of the only two items to be found in Knight’s file in the University of
Iowa’s archive was a tribute to Knight written by Samuelson, published in
Newsweek and the New York Times. Mrs. Knight responded:
“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)
As noted, generations of economists in America studied the set text of

Economics by Samuelson, which since its publication in 1948 has seen 19
editions so far. While Samuelson had changed his view of his old teacher
over the years, he had started out with an infatuation for Knight in his
teenage years until reaching the age of 21, saying Knight was the pied
piper. However, explaining his important influences Samuelson noted
these influences only came “after my infantile infatuation with Frank
18 Frank H. Knight
Knight simmered down to measured respect for a brilliant but erratic

economist and theologian.” (Samuelson 1998, p. 1381)
Samuelson’s comment is representative of the great difficulty that
economists have with Knight, which includes his propensity to delve into
philosophy or religion at just about every turn. Knight’s approach was
not overly mathematical, and for some he did not strictly adhere to the
discipline of economics, leaving less economic “bones” or facts to pick
over for those who like their economics with numbers. However, there is
in fact much hard economics in Knight’s work, and in his teaching, but
on occasion, there seems much more for the philosopher, theologian,
moralist, or political scientist to mull over. In our age of academic special-
ism, Knight seems a little out of place, yet it is his desire to connect ideas
to economics that makes his work so compelling. If Chicago is the home
of behavioural economics then Knight is the philosophical wellspring
and spiritual guide, offering insights and lines of inquiry into the connec-
tion between economics and behaviour. We do not find in Knight ideals
and plans for the future, nor do we find a host of policy options, and we
certainly do not find a working economist or a Keynes working in gov-
ernment and high politics to shape the economy and its institutions. If
economics is the dismal or gloomy science, then Knight is the archetype
of this science. If any passage sums up Knight’s philosophical pessimism
or realism, depending on your tastes, it is from his essay on freedom and
ethics where he wrote:
There is no reason to believe that if all properly economic problems were

solved once [and] for all through a fairy gift to every individual of the
power to work physical miracles, the social struggle and strife would either
be reduced in amount or intensity, or essentially changed in form, to say
nothing of improvement – in the absence of some moral revelation which
could by no means be assumed to follow in consequence of the change
itself. (Knight 1939, p. 408)
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
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:
On its polemical side, it is or involves an emphatic rejection of the simple

“positivism” (i.e. exclusive devotion to “science” conceived as work con-
forming in all fields to the standards set by the natural modern natural
sciences) which is widely prevalent today among economists and all social
20 Frank H. Knight
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)
The reviewer concluded that Knight was attempting to revive in a

modern way a “moral sciences” conception of the human-social inquiries
including economics. As Emmett astutely observed, unsurprisingly given
his pioneering work in the study of Knight, he was a dissenter, not merely
someone who disagreed or was reactionary. He had a particular mind
about method, as Emmett explains it:
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:
History as a whole is against the possibility of a free society; it looks like a

strange accident under a very peculiar concourse of circumstances…The
supreme fact here is that the free society is a society with social problems...a
democratic society is a society which, as a society, faces problems that have to
be solved by its members acting collectively as a unit…the problem of social
action is to control the future course of history. (Knight 1960, pp. 38–9)
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:
In fact, the two central methodological principles of Chicago economics –

Friedman’s principle of positive economics, and the Stigler/Becker de gusti-
bus principle – combine to deny the pluralism Knight advocated for social
science in a liberal democracy. (Emmett 2009, p. 155)
The ascendency of these new Chicago approaches, along with

Keynesian economics, saw these views gain traction, and so Knight’s star
fell. His influence on Chicago specifically, and on economic thinking
generally, waned. Knight was too much of a social scientist, not scientific
enough for an economics profession in a victorious capitalist world. He
was also too much of a prophet, but it is this last point which points us
to his legacy.
Knight lived and worked during an era of scientific confidence and
grand political movements, not just communism but also fascism. It was
a time when alternatives to capitalism were, being put into action in the
Soviet Union and elsewhere. For his entire life, capitalism competed with
communism in a world where these two economic models dominated the
global economy and the political system. He died before the fall of the
Berlin Wall in 1989 and a new economic order emerged where capital-
ism was considered victorious. What would Knight have said of this if he
were alive to observe capitalism as the sole economic form of organiza-
tion? The key word here is organization, and the competing systems he
observed were both defective in this respect, and capitalism is preferred
given that he saw it as the best system in an imperfect world. Knight was
a sceptic of any grand human scheme, and was concerned that the “isms,”
especially communism, would create absolute authority and ignore free-

dom by laying claim to scientific truth and access to the ultimate truth
of things.
Yet, these modern scientific authoritarian movements he understood
to be drawing on a religious inheritance, going so far as to state com-
munism was one of the modern totalitarian movements that had its own
priesthood. He believed that progressive political and economic ideas
were founded on a rationality of human nature. Behaviour failed the
test, because human behaviour is essentially unpredictable and human
nature irrational. He thought that what he saw as a fetish of scientific
method to rationalize behaviour was as false a promise as the promises
of the salvation peddled by the medieval Christian church. His realism,
and scepticism of science, marks him out as a conservative and arguably
alienating to many readers, but his prophetic questioning should help us
to probe many of our contemporary problems, and we should not dis-
miss him lightly. Knight was the kind of conservative or classical liberal,
who wanted intellectual debate and doubted the claims to truth made by
anyone in a debate, regardless of where they lay on the spectrum of views.
Knight has left us a legacy beyond his famous location of Knightian
uncertainty and the success of founding the Chicago school. The
Chicago tradition has continued down the ensuing decades, and Knight’s
contribution is part of this success, even if some of the major figures
produced by Chicago would find many areas of disagreement with him.
However, his legacy is enhanced with his work on uncertainty. While
Knightian uncertainty is something he wrote about in Risk, Uncertainty
and Profit and became accepted thought, it also remained at the core of
his whole career. In today’s economic environment, we can find some
inspiration for his focus on how economic agents operate under the con-
straints of both ontological and economic uncertainty, which can lead us
to appreciate his spirit of questioning and his professional iconoclasm,
indeed his prophecy. I hope to introduce the reader to a Frank Knight
who is not a pessimist, but in fact a realist, who in our fanciful age is a
useful dialogue partner for serious questions on the role of capitalism and
economics in our lives today, where we are troubled economic souls in
need of just such a prophet.
24 Frank H. Knight
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University Press.
2
Knightian Uncertainty
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

28 Frank H. Knight
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 Nothing Fundamentally New

For the main part Risk, Uncertainty and Profit is a robust restatement, or
what Knight presents as a refinement, of the theory of perfect competi-
tion and sits in the tradition as a classic statement in neoclassical econom-
ics; even Knight himself starts by boldly stating in his Preface to the First
Edition, “There is little that is fundamentally new in this book” (Knight
1921, p. vii). As Ross B Emmett explains, Risk, Uncertainty and Profit is:
…a classic statement of the theoretical core of neoclassical economics and

a precursor to several of the most important twentieth-century develop-
ments in economics (including decision theory, the theory of imperfect
competition, and market-failure-based theories of the firm). Beyond that,
interpretations diverge significantly. (Emmett 2009, p. 48)
While Risk, Uncertainty and Profit is a text worthy of revisiting today,

and also a precursor to some major developments in the field, including
the theory of imperfect competition and decision theory, it continues
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).
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:
…is the study of a particular form of organization of human want-satisfying

activity which has become prevalent in Western nations and spread over
the greater part of the field of conduct. It is called the free enterprise or
competitive system. (Knight 1921, p. 9)
Knight added to this that economics, precisely theoretical economics,

is the only social science aspiring to be an exact science, but it doesn’t
match the discipline of science when compared to disciplines such as the
science of physics. However, he explained that in this work:
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)
In later times, Knight put it more bluntly when he wrote, “I have

repeatedly said that the way to sounder economic thought and action
calls less for “research” or discovery than for more common sense instead
of nonsense” (Knight 1967, p. 782). This quest remains at the heart of
critical studies of Risk, Uncertainty and Profit, as well as other Knightian
30 Frank H. Knight
study, as it goes against the strict quest of scientific discipline in economics.

Knight argued that economics is in truth a science of successive approxi-
mations (Knight 1921, p. 8); as Knight discussed in his Preface to the
second edition, he wants to focus on the divergence between theory and
reality (Knight 1921, p. xiii).
Because critics find Knight’s approach troubling, it is worth noting
the observation made by Richard N. Langlois and Metin M. Cosgel that
successive writers on Knight have committed “a variant of the sin sup-
posedly characteristic of eighteenth-century Whig historians: they have
interpreted the ancient text in the narrow light of their own generation’s
favored theories and received categories of analysis” (Langlois and Cosgel
1993, p. 456). In Knight’s case, we ought to bear in mind that this was
his first major work, and suffers from the blemishes of many a first work,
though rather less than most first works. Second, as noted, it originated
in a PhD thesis, which often suffers from the constraints of that ori-
gin, not always compensated for by rewrites for publication. Thirdly, and
most key in the Whig sense, we need to remember that many of the
things Knight was writing about we may take for granted today.
Risk, Uncertainty and Profit was based on Knight’s Cornell 1916 doc-
toral dissertation, “A Theory of Business Profit,” supervised by Allyn
Young who wrote to Knight that this was the best thesis that had ever
passed through his hands.2 It was at Cornell that Knight had switched
from philosophy to economics; as noted earlier it appears he was in fact
“kicked out” of philosophy. Whatever the reason, philosophy remained
fundamental to his approach to economics, and this is clearly seen in
this his first and major work. In addressing the difficulty of reading Risk,
Uncertainty and Profit, Stephen F. LeRoy and Larry D. Singell Jr. state
“the major culprit is Knight’s writing,” and they write of the “overripe
fruit” and “cloudy nature” of Knight’s prose. They also express sympathy
with readers who might skip his “extended Austrian-style disquisitions,”
pointing out that he “frequently enlarges at tedious length on such obvi-
ous points”. Yet, in correspondence LeRoy & Singell themselves were
informed by George Stigler that in fact they were being “too generous”
2
Knight Papers, box 62, folder 24, Special Collections Research Center, University of Chicago
Library.
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)
The exception he noted was J.B. Clark’s theory, which is further

discussed below. To prepare for his analysis of uncertainty, Knight
believed he had to clear some ground. In particular, he thought that
the influence of economic practice and loose terms hampered clarity
in terminology, and the concept of profit was bound up in a certain
type of organization of industry that was constantly evolving. Hence,
the English classical writers of the later eighteenth and early nineteenth
century were writing at a time when they did not see corporations as
overly important, and a time when English industries were new and
expanding, competition was not highly developed, and the possession
of capital appeared to be the dominant factor in the economy. Under
these conditions, Knight continues, it was natural to connect directly
the income of the business manager with the ownership of capital, and
in the classical writings profit is used in this sense. Knight explained it
was only in recent times that the accumulation of capital, the creation
of new financial institutions, and the growth of competition that the
focus shifted to a broader understanding, including the understand-
ing that it was possible to secure capital when not in possession of it
through direct ownership.
Another confusion Knight highlighted was one between natural and
market price, and he stated it was not until the analysis of long-term
normal price by Alfred Marshall and the “static state” by J.B. Clark and
Joseph Schumpeter that economists grasped what entailed natural or
normal conditions in the economy. To the classical writers there were
a number of distinctions which were obscured and so they arrived at a
simpler understanding of “normal profit.” In his Principles of Economics,
Marshall explained: “when “normal” prices are contrasted with tempo-
rary or market prices, the term refers to the dominance in the long run
of certain tendencies under given conditions” (Marshall 1890, p. 30).
In a discussion of the differences between land and other capital goods

important in economic dynamics, J.B. Clark, in his Essentials of Economic
Theory, argued:
In studying the law which would govern economic society if no essential

economic changes were taking place, – in reducing society, as it were, to a
static state, – we find that there is a certain set of characteristics which land
shares with those capital goods which are the products of human industry.
(J.B. Clark 1907, p. 37)
Knight perhaps assumed Schumpeter was building on the founda-

tions of J.B. Clark, someone who as Andersen points out Schumpeter
“quickly came to admire” (Andersen 2011, p. 37). This view was also
held by Lionel Robbins, who argued that Schumpeter shared JB Clark’s
view that the supply of capital is held rigid (Robbins 1930, pp. 213–14),
but this view is disputed by Doreen Warriner, who argued the reverse,
that Schumpeter deduced the constancy of capital from the static state
(Warriner 1931, p. 14). Either way, Schumpeter argued that the econ-
omy always has a static equilibrium state (Schumpeter 1910, p. 16), and
he set out six theses starting with the first that economic processes fall
into two distinguishable categories: static and dynamic (Schumpeter
1910, p. 50).
The lack of understanding by the English classical writers concerning
the productivity of capital was another barrier to a clear statement of
the relationship between interest and profit, Knight explained. However,
he also highlighted the presence of some of the basics in nascent eco-
nomic thinking. Adam Smith had already explained that profits normally
contain elements other than interest on capital, and he had even ref-
erenced risk, though this was in the sense of the risk of losing capital.
Knight added that J.S. Mill was “groping” his way towards the notion
that management wages were determined differently from other wages
to include an element of risk (Knight 1921, p. 24). The French writ-
ers took a different view, starting with Jean Baptiste Say, who insisted
on a separation of profit from interest and defining profit explicitly as a
wage. However, in the fourth edition of his Traité d’économie politique
(1821), Say included in profit the reward for risk-taking. Jean-Gustave
34 Frank H. Knight
Courcelle-Seneuill, who had translated J.S. Mill’s Principles of Political

Economy (1848) into French, also insisted that profit was not a wage, but
due to the assumption of risk.3
Turning to the German writers, Knight said they veered at different
times towards either the English or French views he had set out. He
singles out Albert Schäffle, who followed the English view of classify-
ing profit as essentially a return to capital, and, Wilhelm Roscher, who
took the French view, which treated profit as a form of wages. Knight
then went on to present another and more important group of thinkers,
who treated profit as a unique form of income, which is not reduced to
remuneration for either capital or labour. Of this group, Knight stated
Hans Karl Emil von Mangoldt offered “a most careful and exhaustive
analysis of profit,” dividing the income of an enterprise into three parts:
a premium on risk, the entrepreneur’s interest and wages, and, the entre-
preneur’s rents (Knight 1921, p. 27). Knight gave a special place in his
study to the German socialist school, including Karl Marx and Friedrich
Engels. Knight mounted a typical Knightian assault when he wrote:
These writers take the English classical treatment of profit in a narrowly

literal (one must say wholly uncritical and superficial) sense as including all
income accruing to capital, to which they add land. Combining this with
an equally blind reading of the labour theory of value which was the
starting-point of Smith and Ricardo, they derive a simple classification of
income in which all that is not wages is a profit which represents exploita-
tion of the working classes. (Knight 1921, p. 27)
The German socialist writers then went on to explicate capital as power

over others due to the ownership of the implements of labour. In addi-
tion to this specific rejection of German Socialist writings as simplistic
versions of the English treatment, Knight was very dismissive of Socialism
generally and Marxism specifically, stating “Marxist economics is a tissue
of absurdity” (Knight 1967, p. 784).
Knight then turned his attention to the American writers, stat-
ing the first notable contribution to profit theory was that offered by
3
Jean-Gustave Courcelle-Seneuill, Profit, Dictonnaire de l’economie politique, eds. Charles Coquelin
& Guillaumins, (Librairie de Guillaumin et Cie, Paris 1852).
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:
No a priori argument is necessary to prove that with general foreknowledge

of progressive changes no losses and no chance to make profits will arise
out of them. This is the first principle of speculation…The effect of any
change which can be foreseen will be adequately discounted in advance.
(Knight 1921, p. 36)
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,
argued a dynamic residual theory of profit, but rather than uncertainty

and unpredictable change determining profit, he proposed innovation
and development as its drivers. Knight does not discuss Schumpeter
in Risk, Uncertainty and Profit, nor did he did he engage deeply with
Schumpeter later on this topic, despite Schumpeter being a major voice
during this period in the evolving understanding of the role of the entre-
preneur. Knight’s most significant critical treatment of Schumpeter was
his understanding of economic history.
In his earlier 1908 text, The Nature and Essence of Theoretical Economics
(1908), Schumpeter had explained the entrepreneur is not utilitarian,
and challenged the utilitarians to explain the motivational forces behind
entrepreneurial activities. Schumpeter did not see being pecuniary as
necessarily the same as being profit motivated, as the personality of the
entrepreneur does not translate into an individual necessarily possessing
the traits of hedonism or utilitarianism. Schumpeter had a vision for the
role, as Andersen highlights, of the entrepreneur as a “disruptive force”
(Andersen 2011, p. 4), and he revised his description of the entrepreneur
between editions of The Theory of Economic Development because “his
readers also tended to become distracted by the rich discussion of the
personality of the innovative personality of the entrepreneur” (Andersen
2011, p. 9). Schumpeter saw the entrepreneur as a sociologically distinct
individual, and as a creative innovator. He stated that wherever there is
innovation an entrepreneur was present in the process of innovation, and
the entrepreneur as the innovator is the one responsible for “the doing of
new things or the doing of things that are already being done in a new
way” (Schumpeter 1947, p. 151). In The Theory of Economic Development
(1912), Schumpeter stated that because the entrepreneur is pecuniary,
(Schumpeter 1912, p. 36), from a neoclassical perspective this descrip-
tion has most often been translated into the entrepreneur having the char-
acteristic of being a capitalist and profit motivated, which Schumpeter
explained led to a situation where writers before him had “continued to
confound the two functions of capitalist and entrepreneur” (Schumpeter
1954, p. 105). However, Schumpeter did not see the entrepreneur as
risk-bearer, it was the capitalist and the one giving the loan that bears
the risk, and is the one who comes to grief if a venture goes wrong. For
Schumpeter, the entrepreneur leads the capitalist to the gates of creative
38 Frank H. Knight
destruction on a road paved with innovation and obsolescence, while

for Knight the entrepreneur is a necessary part of the very success of
capitalism. For Knight, the entrepreneur plays a central role in the eco-
nomic order, having defined the economic order by breaking the notion
of economic actors into three, namely the capitalist, the labourer, and the
entrepreneur. The capitalist and the labourer are essentially on the same
level in his order of things, since both are purchased by the entrepreneur.
The next viewpoint to which Knight turned his attention was
F.B. Hawley,4 who upheld the doctrine that profit is to be explained
exclusively in terms of risk, and risk-taking is the essential function
of the entrepreneur and thus the basis of their income. Knight spent
rather less time than he did on J.B. Clark in dismissing Hawley’s view.
Hawley saw the business enterprise as the only really productive factor,
and relegated land, labour, and capital to being the means of produc-
tion. Like J.B. Clark, Hawley defined profit as residual income, but he
insists residual income is interchangeable with the concept of uncertain
income. He also argued that such income is wages, not profit, and he
does not make J.B. Clark’s distinction between static and dynamic con-
ditions. What is central for Hawley is the idea that profit should be a
reward for the entrepreneur, an activity that is restricted when insuring
against risk, and he drew a fundamental distinction between reward for
a known risk and that for assuming an unknown risk. However, Knight
interjected that a known risk does not result in any reward or special
payment. He stated that Hawley came closer to the crux of the matter
when he argued that responsibility and risk are essential to entrepre-
neurship and that the entrepreneur makes decisions and accepts the
consequences of decision. Hawley and his followers, in Knight’s view,
failed to appreciate the fundamental difference between an uncertainty
or risk that we can determine, and, one that cannot be determined or
measured. If risk can be a known chance or mathematically probable
then risk-taking would have no reward, and risk would not influence
distribution of income in any way. A known risk can be uncertain,
but this can be effectively converted into a certainty as such risks are
predictable according to laws of chance, and the margin of error moves
4
Knight primarily draws on essays by F.B. Hawley in the Quarterly Journal of Economics.
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).
3 Perfect Competition and the Real World

Knight accepted the economic model of the classical economists, but
he wanted to test the assumptions involved, and so he took three chap-
ters to examine the conditions and workings of a perfectly competitive
society, with the crucial condition being the possession by all competi-
tors of accurate and certain knowledge of the economy as a whole. The
historic body of economic theory rests upon the assumption of perfect
competition, but because this was always partially implicit and never ade-
quately formulated, Knight contended that the assumptions and impli-
cations needed to be brought to the surface. Hence, he embarked on
a task of defining and analyzing perfect competition in what, as noted
40 Frank H. Knight
above, he acknowledged is essentially a condensed summary of classical

economic theory, but with the aim of bringing the core assumptions and
implications to the surface with a view ultimately of assessing their prac-
tical worth.
In the second part of Risk, Uncertainty and Profit, Knight assessed per-
fect competition by setting out the three “grand divisions” of theoretical
economics. The first problem he addressed is the theory of choice and
exchange, which is a problem of the use of given goods in the satisfaction
of wants. The second is joint production and capitalization, a problem
of the use of given productive resources in the production of goods to
be used in the satisfaction of given wants, known as the “static state”
problem comprising two phases of the value of productive services, and
of particular consumption goods, incorporating productive services or
their cost. The third division is change and progress, with uncertainty
absent, which is a problem related to value and distribution phenomena,
what Marshall called “secular changes in normal price” (Marshall 1890,
p. 315) and the tendency toward equilibrium.
Knight understood economic theory as the social science of a system of
organization. In modern history, even more so since Knight was writing,
human society has seen many progressive changes in economic organiza-
tion over time. Knight presented a view of how the task of technical orga-
nization could be understood in three stages. First, as an organized entity,
society needs to determine different lines of consumption as a basis for
guiding production, and this requires an understanding of the theory of
market price. Second, society must organize production, which is sub-
divided into short-time distribution theory and long-time value theory.
Third, while society needs resources to satisfy wants, it must also set aside
resources and ensure better methods of production, a problem solved
in the market by competition between present goods and the fruits of
investment. This allows for society to decide how much is to be diverted
to present consumption, and how much used for social progress, a prob-
lem solved by competition for savings between different opportunities for
their use. Knight does not see these stages, especially the first and last, as
done either ideally or at best by free exchange, and the approach is open
to criticism, but there nothing better is available and our task is to study
how the system works in relation to the task of organization.
In this context, Knight explained that organization is near synonymous

with the division of labour, with the fundamental problems being the
assignment of tasks and the apportionment of rewards, which the mod-
ern economy does through free and voluntary exchange by individu-
als. All of which is simplified by economic analysis as the only form of
human relation, which he wants to study in terms of the complexity of
human behaviour and to posit a theory of conduct. Since Knight was
arguing that economics is a human science with foundations based on
principles of human behaviour, he naturally thought it right to draw out
some observations on the psychology of human conduct which controls
economic activity, and to define a psychology of economic life. Knight
explored both the psychological dimension of the homo economicus,
another direction that some find uncomfortable. He also attempted to
map out a philosophy and a psychology of knowledge, aimed at reaching
the mundane level of thinking that comprises every day knowing, think-
ing and doing, which brings economic science down to earth and into
the realm of the business person. This is part of the appeal for Knight,
because the existing economy solves these two fundamental problems of
individual conduct and the social dimension, as one, for it is individualis-
tic whereby interrelationships are determined by the self-seeking of each.
At base, economic behaviour is about conduct and ends, usually directed
at what is expressed as “the satisfaction of wants.” Want-satisfaction is a
problem of proportions or relative rates, and it is for Knight a funda-
mental fact that there is a conflict of wants, which seems essential to the
very nature of conscious desire. The power of things to satisfy conscious
wants, or the quality of what is being wanted, is utility in the economic
sense, which is equivalent to “power over conduct.” As want is a corre-
late of conflict, utility is a correlate of limitation, with intensity of want
and means of satisfaction varying inversely. The intermittence of wants
tends to give a false notion of diminishing utility, giving an impression
that there is a difference in the different portions of supply. Diminishing
utility is the scientific designation, meaning if any want is satisfied rela-
tive to others then it diminishes in intensity. However, every valuation
is a comparison, so there is not absolute utility. In a conflict of utilities,
the crucial alternative is that of enjoying utilities at the expense of effort,
versus sacrificing the utility for the sake of freedom from exertion. Hence,
42 Frank H. Knight
labour is really a sacrifice of some desirable alternative to the use of one’s

time and strength. If there is no alternative there is no sacrifice, and so
Knight concluded there was no problem to resolve.
This understanding of wants underscores the limitation of economics
as a science, since our behaviour is impulsive and capricious, a limitation
which Knight suggested is more sweeping in scope and importance than
is usually imagined, and raises a question about how far we can subject
human behaviour to scientific treatment; in this respect, Knight referred
to himself as an “irrationalist.” Knight explained that the basis of a science
of conduct must be fixed principles of action, with enduring and stable
motives. However, what motivates people is the want of interesting expe-
riences, which often lacks fixed principles or stable motives. Economics,
Knight noted, is the science of a particular form of organizing human
activities and conduct, and so economic theory tries to reflect economic
behaviour and human conduct. Organized conduct in an economy is
naturally forward-looking, which forms part of the anticipation of wants
problem in economics. Hence conduct, especially organized conduct, is
an anticipation of the wants of the consumer over a long period of produc-
tion, which implies stability in the wants themselves. On closer inspec-
tion, Knight thought our motives assimilate to the game spirit, by which
he meant we set ourselves objectives or goals. We set ourselves objectives
more or less at random, and once we set ourselves a goal it becomes for us
an absolute value. Meanwhile, our social context furnishes us with much
of the driving power to move forward. In managing our conduct, it is self-
evident that the importance of anything is the effort or sacrifice necessary
to get it.
The whole theory of conduct Knight stated may be summed up in a
comprehensive “Law of Choice”:
When we are confronted with alternatives, quantitatively variable lines of

action or experience, we tend to combine them in such proportions that
the physically correlated amounts or degrees of each are of equal utility to
the person choosing. (Knight 1921, p. 64)
Knight also restated the fundamental law of conduct, arguing that the
principle is a true statement of the goal of rational planning:
In the utilization of limited resources in competing fields of employment,

which is the form of all rational activity in conduct, we tend to apportion our
resources among the alternative uses that are open in such a way that equal
amounts of resource yield equivalent returns in all fields. (Knight 1921, p. 65)
Knight provides a lengthy discussion of the fundamentals of valuation

of psychology to provide a way of understanding the principles manifested
in exchange relations. To understand the psychology of valuation, two
equally important aspects are (1) logically, choice is a matter of comparing
alternatives and combining them, and (2) there is nonetheless a practical
difference between the two kinds of alternatives in an ordinary situation.
The difference lies in the quantitative character of the alternatives, thus
in Marshall’s famous example, in his Principles of Economics, of the boy
picking blackberries it is the amount of exertion connected to a specific
quantity of a measurable commodity (Marshall 1890, p. 276). We can see
how Knight further explores the economics and the psychology together in
his exploration of Marshall’s example, that the “boy not only does not ask
how much sacrifice is how many berries worth, but merely, are these berries
worth the sacrifice; he does not even ask, “by how much” are these berries
worth “the” sacrifice” (Knight 1921, p. 68f). Only the commodity is mea-
sured or measurable, not the psychic quantity involved. Knight explained:
It is not the province of economics to determine the value of life in “hedonic

units” but to work out the general principles of conduct and the funda-
mental facts of the social situation, the laws which determine the prices of
commodities and the direction of the social economic process. (Knight
1921, p. 71)
In a footnote to this quote, Knight explained that the doctrine of sur-

plus is one of the few areas where he disputes Marshall on a matter of
doctrine, which he saw as a dispute about scope and method rather than
fact or logic:
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
drawing of wholly irrelevant conclusions from economic reasoning. Moreover,

an appeal to “unsophisticated common sense” seems to fail utterly to substanti-
ate the existence of the phenomenon. A man might pay, say, a thousand dollars
for the “first” loaf of bread (whichever that one is) rather than do without it,
but it does not follow and is not true that when he gets it for a dime he gets
$999.90 worth of free satisfaction. Various thinkers have perceived the mythi-
cal character of these alleged surpluses. (Knight 1921, p. 71, fn.2)
To test economic theory further, Knight moves from his extended

psychological valuation to set out his own scenario of Crusoe’s island
economy, a commonplace straw man in economic discussion. Karl Marx
made use of Robinson Crusoe in Das Kapital (1867) offering him as a
favourable example of the pre-capitalist man producing goods because
they are useful and producing only as much as is useful to him and not
seeking a profit. Marx also refers to Crusoe in Grundrisse (1858), where
he explained Crusoe is not “a reaction against over sophistication and
a return to a misunderstood nature life” but “rather the anticipation of
‘civil society,’” and that “The individual and isolated hunter and fisher-
man, with whom Smith and Ricardo begin, belongs among the unimagi-
native conceits of the eighteenth-century Robinsonades …” (Marx 1858,
p. 83) At the risk of being a 19th Century Robinsonade, in his use of
Crusoe, Knight set out the characteristics of the imaginary island:
1. Normal human beings

2. A society acting with complete “rationality”
3. Formally free to act
4. Complete absence of physical obstacles
5. Perfect competition and perfect, continuous, costless
intercommunication
6. Each person acting individually and independently
7. Excludes all predatory behaviour
8. Motives for division of labour and exchange must be present and
operative
9. All given factors and conditions remain absolutely unchanged
10. No productive property in the ordinary sense
11. Production is organized through the exchange of finished products
only
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:
The whole argument is merely an elaboration of the Law of Choice (the

correct form of the principle of utility), that preference ratios between alter-
natives will by combining the alternatives in the requisite proportions be
46 Frank H. Knight
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)
Knight turns to another problem of economics in the real world, that

of joint production, and the organization of several productive agents in
the making of a single commodity. Knight said he was introducing more
reality into the idealized economic system he had outlined hitherto, as he
set out to discover what is necessary for perfect competition. Even though
he can drop some of the Robinsonade assumptions without destroying
the conditions necessary to a perfect equilibrium, where costs and values
are entirely identical, Knight argued that the core assumption remains
that “men know exactly what they are doing” (Knight 1921, p. 94). He
developed an imaginary social structure by analyzing the nature and bear-
ings of organized production, moving from primary to secondary labour
division, which creates two new problems. Firstly organization by means
of a free contract mechanism, and secondly, the division of joint product
among individuals making different contributions to production. This
means coming to terms with the general principles of social organization
under free exchange, where given resources are used in producing goods
to satisfy given wants through technical organization. It is the problem
Knight said of the static state, and we need to simplify matters so no
other changes need to be made in his study of the problem. He also
assumed absolutely continuous production, exchange and consumption,
and an absence of other free or superabundant agents.
Knight regards it as axiomatic that this is a process of production
undertaken by groups of individuals performing different types of work
through free agreements by individuals, and is as fundamental as the
principle of choice or diminishing utility, and similarly stated:
It is the principle of the variation of proportions in the factors of produc-

tion, already long famous under the name of “diminishing returns,” though
its clear and approximately accurate formulation in general terms is a rela-
tively recent achievement…Like the other great axioms of economics, it is
purely a principle of relativity, dealing with proportions only. In this respect

the current statements of the principle are generally less misleading than in
the case of diminishing utility, there being less temptation to give it an
absolutistic interpretation. It does seems strange, however, that it took
economists so long (nearly a century) to recognize the inherent reversibility
of a change in proportions and to draw the obvious inferences from the
fact. (Knight 1921, p. 96)
Knight continued to discuss what he called the two fundamental prin-

ciples of proportionality: the psychological law of diminishing utility, and,
the technological one of diminishing returns, both of which presuppose
the continuous divisibility of the variable element. Knight explained that
the variability in the proportions of agencies in the productive organiza-
tion, and in the yields relative to different agencies based on diminish-
ing returns, make the economic organization through free contract both
possible and renders meaningless any notion that they could be absent.
Economists cannot argue over whether we can separate contributions to a
joint product; business does this and it is the job of economists to explain
by which mechanism it is done. Furthermore, Knight contended, it is not
difficult to see the actual mechanism of the organization and the role of
free competition.
The next step for Knight was to look at the contemporary objec-
tions to the productivity theory of distribution. These contemporaries
included Friedrich von Wieser, one of the principal members of the
Austrian School of Economics, R.S. Padan, the already-mentioned
J.M. Clark, H.J. Davenport, W.M. Adriance, of Chicago and Princeton
respectively, and lastly the English economist J.A. Hobson, whose under
consumption theory was recognized by Keynes as an important forerun-
ner of The General Theory of Employment, Interest, and Money (1936).
Knight remarked that most of the objections raised to the productiv-
ity theory related to the meaning of production and of product, boiling
down to a debate over the propriety of using the word rather than any
deep disagreement over how the distributive mechanism actually works.
Knight then provided an analysis of the static organization. In terms of
price and supply and demand, it raises valuation problems of consump-
tion goods and productive services. The equilibrium price under static
48 Frank H. Knight
conditions is the productivity of the given supply of the agency, and in

the equilibrium condition the value of each service is equal to the value
of its contribution to the total product, and the contributions of like
agencies are thus equal throughout the system. Hence, the equilibrium
conditions or long-run tendency toward the static state can be under-
stood in three ways. First, in terms of distribution, every agency must
give the greatest value to social income and be valued by its contribu-
tion. Second, in respect to consumption goods, prices must be a result
of rates of production and consumption being equal, or costs and selling
prices per unit being uniform everywhere. It is then, thirdly, self-evident
that costs of goods are identical in aggregate with distributive shares, and
both are identical with prices of goods. Knight explained that these three
points together are in fact different names for the total income of society,
and offers what he understood to be a clearer formulation of these points
drawn together:
Consumption goods and productive services must be so priced that equal

price amounts of the second make equal price contributions of the first
which have equal utilities to all persons in the system. It is really self-
evident that this condition alone can be stable, that any other sets forces to
work to bring it about. (Knight 1921, p. 123)
This formulation reinforces in truth the difficulty critics had with

Knight, as the convoluted explanation he offered seems to obfuscate
rather than clarify.
Further exploration was required of the categories of land, labour and
capital, all terms needing correct definition and classification, in Knight’s
view. His overarching interest is, however, to repudiate such a tripartite
classification, which is central to his thesis. He agrees that all three are
not at all homogenous, indeed they are quite diverse. They may, however,
be equivalent and interchangeable in respect to the results they achieve.
The example he offered was that of a human being or a machine dig-
ging a ditch. The respective results may be a matter of proportion, the
machine can dig faster and deeper than the worker, but it allows for the
possibility of substitution, albeit within severe limits. In turn, this allows
for competition between agencies and separate evaluation of the agencies
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)
However, with the role of time in economic conduct as he understood

it, Knight returned to property relations in the sense of productive agen-
cies separated from the person as owner and subject to lease and sale,
by which he meant land. A piece of land essentially represents future
value income distributed uniformly over time, and as such land will be
in demand by those persons wanting to store up wealth for future use.
Knight’s last point here is that “the capital loan for productive purposes
is a device for separating the ownership of value equities in production
goods from the direct ownership of the goods themselves. It is mainly the
presence of the risk or uncertainty factor which makes such a separation
desirable” (Knight 1921, p. 140).
Knight turned to look at how in the society he had described, with

both uncertainty and progress absent, “there would be no motive for
lending or borrowing value funds for the purchase of productive agen-
cies” (Knight 1921, p. 140). This change, which as we have seen he had
called the third grand division of theoretical economics, involves first the
use of given goods in the satisfaction of given wants, second the use of
given productive resources in the production of goods to be used in satis-
fying these wants, and lastly the phenomena of value and distribution. To
understand uncertainty Knight tackled the problem of progress and the
general conditions of demand and supply, and the difficulty of predicting
the actual changes involved. To understand this, as we have seen, Knight
assessed the problems of the use of given goods and the satisfaction of
wants, in respect to the static society or “static state.” In his explanation,
Knight closely followed Marshall in addressing distribution and the ten-
dency toward equilibrium, and argued that the theory of progress lies in
predicting the change taking place.
He set out to offer a clear view of the mechanism of competitive valu-
ation and distribution as they would be if uncertainty and its correlative
profit were entirely absent, examining the conditions and workings of a
perfectly competitive society. In these conditions, he noted the posses-
sion of accurate and certain knowledge of the whole economic situation
by all the competitors is crucial. The place Knight wanted to take us to
in this general inquiry is uncertainty, the presence or absence of which is
the important difference between what is assumed theoretically and what
exists in practice.
The conditions in the supply of productive services, changes in sup-
ply of services and the goals or equilibrium they tend toward, all raised
questions in his mind because he said it was in terms of these ultimate
equilibrium levels that the classical theory of distribution was largely
worked out. John Stuart Mill and classical theorists had worked out
equilibrium changes, but Knight characterized these conditions as mis-
conceived and overestimated. He characterized equilibrium as indefinite
and very much in the future, and thus is not to be anticipated in a par-
ticular case. However, it is part of the process of taking into account all
the tendencies at work in a situation, and understanding their relative
importance, whilst giving a wide berth to unpredictable fluctuations.
52 Frank H. Knight
However, this involves so many variables as to make accurate and definite

predictions about some distant future out of the question. The variables
he considered in change and progress are fourfold. First, he looked at
population, including wage levels and standards to living. Second, psy-
chological factors, which involves the dispositions and tastes of people.
This gives rise to developing, creating and directing consumptive wants,
which he defined as an uncertain and risky undertaking. Third, Knight
looked at the amount of productive resources in existence, and examined
supply, the investment of resources in creating new productive capacities,
the role of demand, and offered a brief statement of the eclectic theory of
interest. Knight stated that:
… the most serious criticism to be made of the eclectic theory as it is cur-

rently presented (e.g., in Marshall) is its failure to recognize the true mean-
ing of the equilibrium and its assumption that actual conditions at a given
time approach that state. The contrary is true… (Knight 1921, p. 166)
While the conditions of equilibrium can be formulated, Knight stated

the actual course of events that bring about those conditions or the length
of time they will occupy are matters of speculation, which he dismissed
as unfruitful. The fourth item in his list is the distribution of owner-
ship of productive services, where labour and property are affected in the
same way in equilibrium conditions, with the facts dependent entirely
on social institutions. We have become accustomed to think in terms
of rights to income from either inherited property or inherited ability,
to which Knight added “That we should separate the two categories in
our thinking, taking property rights for granted in the case of inherited
personal powers and stigmatizing the yield of inherited material goods
as “unearned income” seems to be quite inexplicable” (Knight 1921,
p. 170). In respect to society, he noted that society has been progressively
limiting ownership, both in control and income, by means including
restrictions on the use of property, changes to working conditions, and
more taxation for social purposes. A last point is one of geographical
distribution, which he said raised interesting issues of population con-
centration and more transient populations, which he did not have time
to explore, but they are still major questions for us even today.
Knight concluded his study of change stating:
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)
Knight concluded Part II of his study with some minor prerequisites

for perfect competition. Only one theoretical simplification is studied in
detail, and that is the assumption of perfect knowledge. He concluded
that he has provided an analytical construction of a perfectly competi-
tive society to show the precise nature of private property, free exchange,
organization of society, and the conditions necessary to realize these eco-
nomic tendencies. The next step is to contrast this ideal, perfect com-
petition with the facts of real life in order to see the limitations of the
general principles which have been developed and how these need to be
supplemented.
For Knight, the key to understanding risk and uncertainty, and the
role of the entrepreneur, is judgment.5 Langlois and Cosgel (1993)
suggest in their insightful essay Frank Knight on Risk, Uncertainty, and
the Firm: a new interpretation, that the role of judgment in economic
life is the key to understanding Knight, a view supported if we stand
back from Risk, Uncertainty and Profit and look at the whole corpus of
Knight’s work. Underpinning Knight’s approach is his desire to define a
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
theory of knowledge, which then in economic terms, or in the life of the

business person, finds impact in the decisions taken and estimates made
that draw on many economic factors, while not necessarily all factors are
accounted for in the decisions taken. In other words, judgment is used,
along with “common sense,” “intuition”, and “inference.” Most real deci-
sions are based on reasoning that is of this type, which makes it tenuous
and uncertain in character. We can classify the basis of our judgments in
terms of a priori probability, statistical probability or estimates, which
Knight discusses in some detail, and this may be one of the discussions
his critics would describe as an Austrian-style disquisition.
Knight, in his discussion, wanted to take us to an important place,
namely the identification of “true uncertainty.” This is a type of prob-
ability judgment, which Knight argued is neglected in economic theory.
If an uncertainty can, in the ways of reasoning Knight has discussed, be
reduced to an objective state or determined quantitatively then it can in
effect be reduced to a complete certainty by comparing it to like instances.
There is thus, he believed, a higher uncertainty which is not susceptible to
measurement. This is what he called is true uncertainty, and it is this that
characterizes the economic organization of “enterprise” and the “peculiar
income of the entrepreneur.”
A later approach to explain such unique investment decisions under-
taken in conditions of uncertainty, without the help of probability theory,
was first offered by G. L. S. Shackle, in his book Expectation in Economics,
published in 1949. In this and later work, Shackle presented an analy-
sis of the changes in the expectations a person can logically expect, and
from it drew some conclusions concerning the rate of investment. He
then considered in turn the speculative purchase of assets, the effects
of taxation on investment and bilateral monopoly, concluding with his
attack on the orthodox analysis of uncertainty. Shackle was critical of the
orthodox views of probability in most theoretical discussions. As Earl and
Littleboy point out, Shackle supported Knight’s distinction between risk
and uncertainty (Earl and Littleboy 2014, p. 107), but was not impressed
by his work on uncertainty as unquantifiable risk (Earl and Littleboy
2014, p. 13). Like Knight, Shackle approached economics in terms of
subjective analysis and the ethical issues raised. His interpretation of
uncertainty is similar to Knight, but his terminology is different. He
proposed that it is difficult to know the full range of possible outcomes,

and a probability distribution can only be estimated when the list of
possible outcomes is complete and specific, with each possible outcome
having a probability calculated. If the list is not complete, then there is
“a lack of a residual hypothesis” (Shackle 1961, p. 49). For some events
in the future, it is difficult to define probability distributions, and what
is needed is a specific list of possible outcomes, and as a result a residual
hypothesis and uncertainty is present. The likelihood of certain outcomes
may be defined, but this presents infinite possibilities. This results in the
event becoming a non-divisible case, and as each possibility is unique and
the outcome in each case can only occur once, there is no sound basis on
which to allocate probabilities.
Shackle advanced his case by offering three analytical concepts. The
first concept is focus-values, by which he means a person will assess the
attractiveness of a course of action by reference to two hypotheses con-
cerning the outcome, namely the focus-gain and the focus-loss, or in
other words, what will be gained or lost by committing to a particular
course of action. Second is the potential surprise. He substitutes the idea
of probability with that of potential surprise, when considering events
that are essentially unique. The potential surprise a person attaches to
a particular outcome of an event, with any intensity such as shock or
surprise represented for Shackle a step towards a truly subjective theory
of confidence. Third is the degree of belief involved, which depends on
the degree of potential surprise associated with the hypothesis in ques-
tion, and on the degree associated with a contradictory hypothesis. In
this way, Shackle tried to make the required distinction between the
certainty of focus-values and the true uncertainty involved in potential
surprise. In the matter of risk, Shackle explained Knight’s risk as an actu-
arial frequency distribution, obtained from the observation of a large
number of instances, showing definite numerical probabilities, which as
Shackle argued needed a complete list, whereas Knight was happy to
accept a more general basis for deciding outcomes. Uncertainty remains,
and Shackle’s view dismissed the subjective probability distribution of
Knight’s uncertainty, on the basis of what he called a “sham” frequency
distribution, based not on observation of a large homogeneous set of
instances, but rather an estimation and hunches (Shackle 1949, p. 137).
56 Frank H. Knight
Despite these differences, both Knight and Shackle emphasize

uncertainty as a profoundly important reality of day-to-day life, which
needs to be acknowledged as a factor affecting business decision-making,
and this draws out ethical considerations for both thinkers. In some ways,
Shackle interpreted uncertainty similarly to Knight, but he emphasized
the difficulty in knowing the full range of possible outcomes in the pro-
cess of defining uncertainty, whereas Knight derived from such calcula-
tions the notion of true uncertainty. Also, like Knight, Shackle linked
the existence of uncertainty to the importance of ethical guidelines. The
problems of accurate prediction caused by uncertainty led Shackle, in
an interview with Richard Ebeling, to warn economists not to provide
“advice, except on the most hesitant, the broadest grounds” (Shackle
1983, p. 4). There should be “an ethical element” (Shackle 1983, p. 4),
and where the “argument is not an economic argument; it’s an argument
with one’s conscience” (Shackle 1983, p. 4).
Shackle characterized the thought- process of a decision maker in fac-
ing uncertainty:
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
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.
4 An Analysis of Risk and Uncertainty

Part III of Risk, Uncertainty and Profit is where Knight gets to the heart
of the matter, and provides an analysis of the concepts of risk and uncer-
tainty that discuss the meaning and consequences of uncertainty. Critics
argue Knight does not give an adequate definition of risk, and indeed
Knight waits until over half way through his thesis to define risk, which
he does in relation to uncertainty, when he explained that to preserve
the distinction between the measurable uncertainty and an unmeasur-
able one, we may use the term “risk” to designate the former and the
term “uncertainty” for the latter. This, he argued, rids us of the ambiguity
present in other economic writings. In practical terms, this is a distinc-
tion between risk as known by looking at a group of instances, and uncer-
tainty as not being able to form a group of instances because the instances
are to a high degree unique. The best example of this uncertainty is judg-
ment or opinion-forming about the future, which guides most conduct.
Adam Smith noted that people will risk a small amount for a big win
with the odds against them winning, while they will not incur a small
chance of losing a larger amount even when the odds are favorable. To
this observation, Knight adds the inveterate belief of individuals in their
own “luck.” Cases of economic uncertainty are ones of choice between
anticipation of a smaller reward more confidently and a larger one less
confidently. The basis of the uncertainty problem in economics is the
forward-looking character of the economic process itself. Goods are pro-
duced to satisfy wants, and the production of goods requires time and
the introduction of two types of uncertainty, namely, an estimation of
58 Frank H. Knight
production outcomes in terms of quantity and quality of goods, and the

prediction of wants, again in terms of quantity and quality. This requires
the producer to estimate future demand and to understand the outcome
of his operation in satisfying that demand. Rational conduct strives to
reduce to a minimum the uncertainties in adapting means to ends, and
Knight pondered whether the impossibility of reaching the end point is
why we are interested in striving for it. The striving to reduce uncertainty
depends on two factors. First, uncertainties are less present in groups
than in single instances. Second, there is a difference in human attitudes
toward uncertainty. Knight explored the various methods for meeting
uncertainty, focusing especially on insurance, specialization, and specula-
tion as a means of reducing uncertainty.
Uncertainty, he stated, is one of the fundamental facts of life, but we
can try to reduce it by increasing our knowledge of the future, clubbing
uncertainties through large-scale organizations, by increasing our control
over the future, or by slowing up the march of progress. All these options
have various costs associated them, and so Knight pondered what “the
essential evil of uncertainty” (Knight 1921, p. 347) is and how much
we are prepared to pay, in terms of cost and other factors, in order to
reduce it. Critics may have differed over the exact definition of uncer-
tainty in Knight, and how it affects the enterprise economy, but this may
be because Knight had developed his notion of uncertainty by explain-
ing it is effectively converted into certainty. Knight explained “in a con-
siderable number of cases the results become predictable in accordance
with the laws of chance, and the error in such prediction approaches zero
as the number of cases is increased,” and hence business organizations
develop their technique to allow for a degree of uncertainty to be borne
by groups so as to make it negligible and to promote certainty (Knight
1921, p. 46).
In approaching uncertainty, Knight wanted to build on his exposition
of the limitations of traditional theory, looking at the limitations on the
decision-maker and those imposed by the environment, challenging “the
assumption of practical omniscience on the part of every member of the
competitive system” (Knight 1921, p. 197). Economic analysis focused
on the satisfaction of wants, which Knight argued is only a small part of
economic behaviour. If, as he argues, human behaviour is unpredictable,
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
Risk, he argued, can be measured and expressed in terms of probabilities,

such as the odds of a horse in a race where we cannot predict with cer-
tainty which horse will win, but we can state the probability of any one
of the horses winning. Knight also distinguishes between insurable and
uninsurable risks. Insurable risk cannot produce profits because of the
very fact they are insurable, which is because they are rationally assessed
and costed out. Runde in his study of Knightian uncertainty, referenc-
ing a number of sources, explains that the convention of using the term
‘risk’ to describe decision-situations in which ‘probabilities are available
to guide choice,’ and ‘uncertainty’ to describe decision-situations in
which ‘information is too imprecise to be summarized by probabilities,’
is deeply ingrained in both economic theory and decision theory (Runde
1998, p. 539).
In introducing the distinction between risk and uncertainty, Knight
was accounting for the importance of organization in economic activity,
and he set out how specialization and risk management gave rise to free
enterprise and the modern corporation. As noted, it was not until the
1920s that risk was connected to the social dimension of human organi-
zation. In Risk, Uncertainty and Profit, Knight’s major contribution to the
discipline was to articulate risk more specifically in the context of political
economy and the modern entrepreneurial organization. Knight sensed
that neoclassical theory was rather too static, and he wanted to introduce
a more dynamic dimension to the otherwise static notion of market equi-
librium. This dynamism is what gives rise to profit and the entrepreneur-
ial enterprise, and Knight argued it was a result of the entrepreneur’s skill
and effort, and the taking-on of risk, that the entrepreneur was rewarded
by profit.
Moving on to considering enterprise and profit further, and with it the
economic organization, Knight devoted a large part of the third section
of Risk, Uncertainty and Profit to covering the rationale for the business
firm, though as Langlois and Cosgel (1993) suggest in their essay, his
analysis of the firm is often misunderstood or ignored. The business firm
is founded on private ownership of productive resources, for Knight a
synonym for individual freedom, and the essence of ownership is the
union of agency of control and right of disposition. Knight continues his
study of enterprise and profit by looking at the specific role of the salaried
manager. As the typical form of business unit is the corporation, it is

important to understand that it is a combination of diffused ownership
with concentrated control. There can be many layers of hierarchy and
function within the corporation, and Knight believes it is essential to see
“control” as the activity of choosing someone else to do the “controlling,”
which brings judgment to the forefront of business. We know what the
business activity is, and that it exists to make money. The fundamental
principle underlying this activity is thus the reduction of uncertainty,
through judgment both at the individual and group level. Making deci-
sions and assuming responsibility for their correctness is one and the same
thing. What in fact happens is that uncertainty and responsibility net-off,
with a partial transfer to a higher level of the organization. Likewise, there
is a responsibility for those whom one manages, and Knight argued that
the paradox of the hired manager, which confused the analysis of profit,
is that in organized activity the crucial decision is the selection of persons
to make decisions, all other decisions being routine in nature. If we try
to separate out control and uncertainty-bearing then we end up confus-
ing routine activities with real control. In the case of the entrepreneur,
the entrepreneur is self-selecting, and takes control and responsibility for
uncertainty. However, entrepreneurship cannot be completely specialized
or pure in form.
However, Chicago economist Ronald Coase argued, in The Nature of
the Firm (1937) that Knight had left himself open to criticism on sev-
eral grounds, and these are important to note. Coase explained Knight’s
theory:
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
or knowledge, and every business buys the services of a host of advisers

and consultants. It is possible to get a reward from better knowledge or
judgment by not actively taking part in production, and instead forg-
ing contracts with agents in production. Coase explained that Knight
said “with human nature as we know it, it would be impracticable or
very unusual for one man to guarantee to another a definite result of
the latter’s actions without being given power to direct his work” (Coase
1937, p. 401); this is surely, Coase argues, wrong. Many jobs are done
based on contract, whereby the contractor is guaranteed a certain sum
providing he performs certain acts, which is the basis of contract law,
and much of Coases’s writing on the firm relates to choice of contract
issues. However, Coase pointed out, this does not necessarily involve any
direct involvement with the work being done or the production process.
Finally, Coase explained, it seemed important to notice that even in the
case of an economic system where there is no uncertainty, Knight con-
sidered that there would be coordinators, though they would perform
only a routine function. And Knight immediately added that they would
be “without responsibility of any sort” (Coase 1937, p. 401). Coase said
this raised the question of who pays them and why? He suggested that
Knight did not give us give a reason why the price mechanism should be
superseded in this case.
Coase’s paper The Nature of the Firm in 1937 was one of two papers
that essentially earned him the Nobel Prize, the other being The Problem
of Social Cost, published in 1960. Coase himself discussed the nature of
the firm within the context of the institutional structure of production,
and challenged the neoclassical notion of frictionless markets. There are
many reasons given for the creation of the firm as a means of organiza-
tion, including division of labour, risk, and the coordination of produc-
tion activities, but Coase did not accept them. The primary reason he
believed was transaction costs. He argued that the main reason “why it is
profitable to establish a firm would seem to be that there is a cost of using
the price mechanism. The most obvious cost of ‘organizing’ production
through the price mechanism is trying to find out the relevant prices”
(Coase 1937, p. 390). It is more efficient to organize an activity within
the institution of the firm, by avoiding the market transactions involv-
ing products or commodities, and utilizing the operating costs of the
firm as factors of production. A business organization will bring a part of

the process of production within the firm, rather than forging contracts
with other producers, where the costs of coordinating the firm’s inputs
by market transactions exceed the costs of coordinating them vertically.
The growth of a firm can be viewed as the replacement of a product
market by a factor market, which results in a saving in transaction costs.
In respect of the use of labour as a factor of production, Coase explained
employment contracts that entitle the employer to direct the employee’s
work differs from external supplier contracts in respect to outputs based
on price, quality, quantity, date of delivery, and performance, where the
control over inputs is then left to the supplier.
Knight briefly touched on the case of labour, which he also says, is dif-
ferent, and he typified the labouring class somewhat unsympathetically
as reckless in matters of life, limb and income, upon whom some of the
business loss falls as brute fact. Knight then ran through further issues of
remuneration, specifically relations between profit and contractual shares,
interest on investment, property and profit. The point he wanted to reach,
in looking at managers, entrepreneurs and labour was their relationship to
risk and uncertainty, arguing that the “true uncertainty in organized life is
the uncertainty in an estimate of human capacity, which is always a capac-
ity to meet uncertainty” (Knight 1921, p. 309). Just as profit and wages
need to be distinguished, it is essential to contrast profit from payment for
risk-taking. How profit arises from uncertainty, Knight explained thus:
The only “risk” which leads to a profit is a unique uncertainty resulting

from an exercise of ultimate responsibility which in its very nature cannot
be insured nor capitalized nor salaried. Profit arises out of the inherent,
absolute unpredictability of things, out of the sheer brute fact that the
results of human activity cannot be anticipated and then only in so far as
even a probability calculation in regards to them is impossible and mean-
ingless. The receipt of profit in a particular case may be argued to be the
result of superior judgment. But it is judgment of judgment, especially
one’s own judgment, and in an individual case there is no way of telling
good judgment from good luck, and a succession of cases sufficient to eval-
uate the judgment or determine its probable value transforms the profit
into a wage. (Knight 1921, p. 311)
64 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.
5 Keynes and Knight on Risk

and Uncertainty
It is one of the great coincidences of economic history that Knight and
Keynes should both have their respective books published in the same
year, 1921. Both books looked at uncertainty and how it impacts eco-
nomic decision-making. They shared concerns about capitalism, and
they both highlighted uncertainty as a topic at the heart of addressing
the short-comings of capitalism, but they both arrived at quite differ-
ent conclusions. Knight’s argument identified uncertainty as a source of
profit (Knight 1921, p. 20), while Keynes held that uncertainty leads eco-
nomic agents to seek liquidity as a money balance, which is held as secu-
rity against a future that is unknown and unpredictable (Keynes 1936,
p. 168). Keynes understood time and uncertainty to be related, with time
necessarily entailing uncertainty. The future can be predicted by means of
probability-analysis, in the long- run, but as Keynes quipped, in the long-
run we are all dead. Keynes’s system makes time an essential element, and
when investment is volatile, due to uncertainty, there is no single level of
output or employment. To this extent, uncertainty can be called a dis-
equilibrium phenomenon, and Keynes was dealing with disequilibrium
problems. Any adjustments to an equilibrium level of employment are
meaningless in a world of uncertainty, for there might be no equilibrium
in the sense of a maintained state of the system.
Paul Davidson, in his book Post-Keynesian Macroeconomic Theory
(1994), makes the argument that the specific notion of uncertainty and
the future was one of the most fundamental elements of the Keynesian
revolution. For Keynes, probability is rationally assessed on the basis of
knowledge, and is interpreted in part subjectively. Keynes took as his start-
ing point probability in relation to knowledge, which can be understood
subjectively to the extent that people make judgements based on posses-
sion of different levels and quality of information. However, probability
is not subjective; rather it is ruled by known facts. Keynes explained:
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
in these circumstances has been fixed objectively, and is independent of our

opinion. The Theory of Probability is logical, therefore, because it is con-
cerned with the degree of belief which it is rational to entertain in given
conditions, and not merely with the actual beliefs of particular individuals,
which may or may not be rational. (Keynes 1921, p. 3)
Keynes then elaborated:
Between two sets of propositions, therefore, there exists a relation, in virtue

of which, if we know the first, we can attach to the latter some degree of
rational belief. The relation is the subject-matter of the logic of probability.
A great deal of confusion and error has arisen out of a failure to take due
account of this relational aspect of probability. (Keynes 1921, pp. 5–6)
There is no external reality that we discover. And he related probability

not to the balance between favorable and unfavorable evidence, but to
the balance:
between the absolute amounts of relevant knowledge and of relevant igno-

rance respectively…an accession of new evidence increases the weight of an
argument. New evidence will sometimes decrease the probability of an
argument, but it will always increase its ‘weight.’ (Keynes 1921, p. 78)
A high probability, he argued, does not entail more certainty than a

low one. Traditional theory dealt with uncertainty using probability to
handle risk, with the assumption that it is possible to maximize expected
payoffs, even though expected values could not necessarily be calculated
with great confidence. Keynes said the problem was that individuals must
act today, yet the effects of their choices will only be known in the future,
whilst economic activity must be undertaken in the meantime. Thus,
he said, the economic agent must base decisions on something, and he
suggested this “something” is the recent past and what others are doing.
His Treatise on Probability had its origins in his fellowship dissertation at
King’s College, Cambridge, and was the result of a further 15 years work
on the theory. There is some debate about whether the path from the
1921 work and The General Theory of Employment, Interest, and Money
in 1936 was a distinct change, evolution or development. R.F. Harrod
provided the background to this time lapse:
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)
Keynes turned again to discussion of risk and uncertainty in The

General Theory of Employment, Interest, and Money, and he engineered
another innovation in economics, which was to connect the relationship
of uncertainty to investment. He also offered an assessment of the role of
the entrepreneur, so central to Knight’s discussion in Risk, Uncertainty and
Profit. Keynes discussed the entrepreneur in respect to being an employer
and as aggregated, leaving out any deep discussion of innovation, though
he does refer to techniques, and elsewhere he references invention and
new techniques. In The General Theory, Keynes explained extensively, in
the opening section of Chap. 3:
In a given state of technique, resources and costs, the employment of a

given volume of labour by an entrepreneur involves him in two kinds of
expense: first of all, the amounts which he pays out to the factors of
production (exclusive of other entrepreneurs) for their current services,
which we shall call the factor cost of the employment in question; and sec-
ond, the amounts which he pays out to other entrepreneurs for what he has
to purchase from them together with the sacrifice which he incurs by
employing the equipment instead of leaving it idle, which we shall call the
user cost of the employment in question The excess of the value of the
resulting output over the sum of its factor cost and its user cost is the profit
or, as we shall call it, the income of the entrepreneur. The factor cost is, of
course, the same thing, looked at from the point of view of the entrepre-
neur, as what the factors of production regard as their income. Thus the
factor cost and the entrepreneur’s profit make up, between them, what we
shall define as the total income resulting from the employment given by the
entrepreneur. The entrepreneur’s profit thus defined is, as it should be, the
quantity which he endeavours to maximize when he is deciding what
amount, of employment to offer. It is sometimes convenient, when we are
looking at it from the entrepreneur’s standpoint, to call the aggregate
income (i.e. factor cost plus profit) resulting from a given amount of
employment the proceeds of that employment. On the other hand, the
aggregate supply price of the output of a given amount of employment is
68 Frank H. Knight
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:
The entrepreneur when he decides to invest has to be satisfied on two

points: firstly, that he can obtain sufficient short-term finance during the
period of producing the investment; and secondly, that he can eventually
fund his short-term obligations by a long-term issue on satisfactory condi-
tions. Occasionally he may be in a position to use his own resources or to
make his long-term issue at once; but this makes no difference to the
amount of “finance” which has to be found by the market as a whole, but
only to the channel through which it reaches the entrepreneur and to the
probability that some part of it may be found by the release of cash on the
part of himself or the rest of the public. Thus it is convenient to regard the
twofold process as the characteristic one. (Keynes 1937, p. 664)
In respect to the principle of uncertainty, the entrepreneur Keynes

stated acts instinctively. Keynes does not offer us a sociologically distinct
character, as Schumpeter did, but he did link the entrepreneur to a type

of behaviour and judgment, as Knight did. In Keynes’s theory the capi-
talist entrepreneurs and financiers, in making investment decisions, face
uncertainty, as discussed by Knight, and by Keynes himself in his Treatise
on Probability. Keynes expressed the actions of the capitalist or entrepre-
neur as ones based on what might be called “gut instinct.” As Keynes
explained uncertainty and action:
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)
Keynes elaborated on this instinct, as a process of tapping into what he

famously called the “animal spirits” as the perseverance shown by enter-
prise and entrepreneurs:
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 theme of uncertainty is related to the central argument of the

General Theory, because employment depended on the level of output,
and this depends on the level of investment. Keynes explained in an arti-
cle for the Quarterly Journal of Economics:
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
amount of investment…. [Although several other factors can affect output]

it is those which determine the rate of investment which are most unreli-
able, since it is they which are influenced by our views of the future about
which we know so little. (Keynes 1937, p. 221)
The effect of uncertainty on the investment decision is thus involuntary

unemployment, where negative speculations about the future lead to less
investment, and this in turn impacts output and employment. Business
means taking action today which can foreseeably lead to unemployment
tomorrow, quite unlike a perfect world of full employment. Underpinning
these arguments was a view held by Keynes of the general character of
business, which was not a flattering one. As Skidelsky explained, Keynes:
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)
Knight held arguably a more nuanced view of the decision-making

process, and certainly held a more positive view of the decision-maker in
business than Keynes. Knight stated that rational economic agents make
intelligent decisions based on knowledge of the numerical probability of
outcomes. Assessment of probability can be done: a priori, as in games
of chance; statistically, based on possible outcomes which are empiri-
cally identifiable but not necessarily known; and lastly, as an estimate,
where all possible outcomes are identified or calculated according to how
likely they are to occur. Business decisions are typically made as estima-
tions, where knowledge, or the lack of it, will determine what decision
is made. Knight concluded his study by stating that uncertainty is one
of the fundamental facts of life, and he explored some ways in which we
can consider the social aspects of uncertainty. This leads us to consider
Knight’s view of social economics, and we will consider this aspect of his
work more holistically when we consider his work on welfare econom-
ics in Chap. 7. Suffice it to say we can highlight at this stage a few areas
he discussed in his last chapter, being more of an overview of various
thoughts rather than a concluding argument.
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
proposal to tackle uncertainty means making decisions, as noted earlier,

about the extent of the “essential evil of uncertainty” and the cost or sac-
rifice of reducing it. Enterprise concentrates responsibility into the two
aspects of decision-making and taking the consequences of such decision,
though Knight qualified this in respect to levels of management and their
stake in the Risk, Uncertainty and Profit. Large-scale organizations have
a drive toward efficiency, and the concentration of control in the hands
of executives, though this does not necessarily entail a concentration of
responsibility. Responsibility is transferred and dispersed amongst man-
agers to the extent, in Knight’s view, that lower grades take no risks and
have no control. Yet, it is essential to Knight, that uncertainty-bearing
and responsible control are inseparable.
After highlighting the necessity of ownership and freedom of contract,
in relation to the state, Knight observed:
Viewing society, then, as a want-satisfying machine and applying the single

test of efficiency, free enterprise must be justified if at all on the ground that
men make decisions, exercise control, more effectively if they are made
responsible for the correctness, or the opposite, of those decisions. If prop-
erty were socialized we should still have to concentrate the function of the
actual making of decisions, but it would be in a far greater degree than now
a routine task, with the remuneration independent of the results. (Knight
1921, p. 358)
The outcome of socialization of a business would be the transfer to

public enterprises managed by hired functionaries, which is clear enough,
but in the case of a corporation currently controlled by a hired manager
there would be superficially little change, as the decision-maker remains
with the same control. However, this is just that, a superficial argument
exaggerating the claims of socialists and capitalists alike. The shareholder
is not so much a stakeholder as a creditor, leaving the great companies run
by people who know each other, their motives and policies. Participants
in this business structure are more motivated when they feel their work is
their own and they align their personalities with it, which is seen less with
the social functionary in a government structure. The desire of business
leaders is not the conventional economic argument; they are driven by
the desire to excel and win the game.
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3
The Grand Crusade
Austrian economist Friedrich Hayek opened his 1936 essay “The

Mythology of Capital,” referring to “Professor Knight’s crusade against
the concept of the period of investment” (Hayek 1936, p. 199). What
Knight was crusading about has been named in different ways, in terms
of length of the production process, roundaboutness, period of waiting,
period of investment, period of maturing, and others. It may be overstat-
ing the case to say this was a crusade, though it fits with the theological
terminology so often applied to Knight, but it was certainly true that in
the 1930s one of Knight’s core interests was capital theory and his writings
on capital and interest theory were to span two decades. Like so much of
his thinking, during this period Knight never offered a systematic theory;
rather he developed his views through a series of journal articles, essays
and book reviews, starting in 1916, with the bulk published from 1931
onwards. It was, as Emmett so neatly states, “a string of conversations
with other theorists” (Emmett 2009, p. 78). As a result, trying to explain
his theory is a process of picking one’s way through a series of essays
and opponents’ responses to present a unified view, rather than explain-
ing a coherent theory presented by Knight himself. This picking one’s
way means encountering repetition and restatement of ideas in different
ways, a fraught exercise that can easily give rise to debate with the other

76 Frank H. Knight
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:
…I recall the observation in your letter, that systematic exposition rather

than the meeting of specific questions is the way to “advance knowledge.”
I am strongly convinced of the opposite.1
1 Hayek and Knight: A Protracted Debate

Both Hayek (1931) and Knight (1932a,b) had set out their basic posi-
tions before engaging with each other, with the direct criticisms and
defence coming a year later for Knight in 1933 and ending with Hayek’s
1936 The Mythology of Capital. Despite the protracted debate, much of
the difficulty between Knight and Hayek was left unresolved, with each
stating and restating their respective positions on capital theory. In the
next chapter we will look in more detail at Knight’s debate with Hayek,
and his battle with the Austrians, but it was out of this work in the early
1930s that the conflict arose. By his own admission, Knight had not
intended to get into a debate on economic theory upon his return to
Chicago, but the departure of Jacob Viner to Geneva forced him to teach
a class on economic theory, using material from various sources, some of
which were auxiliary to his other classes. In a letter to his colleague Paul
Douglas in 1936, Knight wrote that the controversy:
…grew especially out of my growing realization that the treatment of capi-

tal and productive factors generally in this material and in all my previous
teaching is simply “wrong.” A year ago I started seriously to re-work this
material, but found myself wrestling with unresolved problems over virtu-
ally the whole field of traditional theory.2
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.
Knight started his argument by assessing what is intended by the

period of production and asking why the quantity of capital must be
related to a specified period of production. The consummate teacher,
Knight sketches out the traditional theory, as he sees it, that produc-
tion is conducted by labour, supported by capital and applied to land.
Knight, “To explain the origin of the three-factor theory, we should go
back to the historical conditions in which our economic conceptions were
formed… “Capital” is the ideal “factor of production” and is “theoreti-
cally” (meaning in a society completely economic) all-inclusive” (Knight
1935a, p. 185). Hence, classical economics had always assumed a trinity
of land, labour and capital, which socialist economics also assumed when
arguing a dichotomy of labour against capital and land ownership. Land
and labour are also called primary or original factors as they precede the
production of capital or capital goods.
Renouncing this orthodoxy, Knight argued that in reality capital is
the only factor of production, because essentially land and labour are
identical to, and classified as, capital. His approach to the issue was nega-
tive, in that he explained over the course of his writing the many reasons
why land, labour and capital could not be made distinct, rather than
presenting a systematic case as to why they are essentially the same. The
argument he had to contend with principally is that land and labour
differ from capital in their means of production and how they increase
in quantity. Knight discusses modern labour theory on the basis that
slavery no longer exists, which means that people are not built and sold,
which in turn means they are not produced under economic conditions.
Human capital is not capitalized as property; people sell a service. Land
is fixed in supply, while the labour supply, being the human population,
varies or fluctuates over time. Hence, land and labour are a given in an
economic sense, since they just are, while capital is produced under eco-
nomic conditions specifically for economic purposes. Economic reason-
ing has necessarily to keep these separate for this reason. For Knight the
difference is only one of degree, in that all are factors produced under
economic conditions but in varying degrees of concreteness. That capital
is the only factor of production is the most prevalent point Knight makes
which remains core to modern theory, specifically in the discussion of
“human capital.” Knight’s argument finds expression today in how we
78 Frank H. Knight
understand labour as “human capital,” a point on which M. Northrup

Buechner notes that “certainly Knight had had an impact” though to
what extent “is difficult to say” (Buechner 1976, p. 598). However,
Buechner also concluded that Knight failed to obliterate successfully the
differences between land, labour, and capital (Buechner 1976, p. 612).
The classical theory of capital informs us on how interest rates are
determined, by households investing for future consumption and giv-
ing up current consumption and accumulating funds over time. In his
landmark study The Theory of Interest (1930), Irving Fisher stated that
the interaction of our impatience to consume now and the investment
opportunities that yield higher returns, will determine the quantity of
funds available and the rate of return. At the time Fisher was writing his
book, Knight was undertaking preliminary research for an encyclopedia
entry on interest rate theory. Knight entered the debate on capital theory
through an exchange with Fisher, who had asked Knight to offer pre-
publication comments on his manuscript. Knight offered his thoughts
in a letter to Fisher, dated 13 March 1929.3 The letter sets out a num-
ber of comments and questions challenging Fisher’s theory. A response
from Fisher didn’t come until over a year later on 25 July 1930, in which
he offered a number of points on which he thought they might both
agree, but then challenged Knight’s contention that productive condi-
tions alone determine the interest rate. Fisher stated he was not certain
whether Knight wanted to challenge equilibrium theorizing as a whole,
or was merely making an argument in favour of a vertical supply curve
for capital. Knight’s response to this came in a short letter of 9 October
1930, in which he explained the points of disagreement between them.
He offered the suggestion that the difference was over the elasticities of
demand and supply. He wanted Fisher to accept that short-term supply
of capital is inelastic as it gives rise to an interdependence between the
short-term and long-term, although this somewhat undermined Fisher’s
“time preference” theory of interest. Knight wrote of the whole dispute,
“Differences in view[s] of this kind do bother me, after all. Is there some
ultimate difference in mental make-up which prevents different people
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.
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)
As in the earlier correspondence, Knight presented points of disagree-

ment between the two of them, but then sought to move the debate along
by providing a comprehensive definition of the interest rate. However,
Avi J. Cohen (2006) suggests that when all is said and done in the essay
on Fisher, Knight still concluded with a theory of interest based on a
conventional supply and demand diagram. He sees many Fisherian simi-
larities and influences on Knight, which of course both thinkers alluded
to in preparation of stating their differences. Cohen traces Knight’s view
of capital through a variety of works stretching from 1916 to 1946, with
the caveat that Knight never in fact articulated a clear theory and indeed
contradicted himself and, as in much else according to critics, is difficult
to follow. After the Fisher exchange, Knight engaged in another bout
of exchanges about capital, this time with the Austrians, which we will
return to in the next chapter. As we frequently see in Knight’s work, he
wasn’t simply interested in theory and demarcation disputes with other
thinkers, he wanted to test theory against reality, and capital theory is no
different. In this instance, as Emmett explains, Knight:
80 Frank H. Knight
insisted that capital decisions were historical events. Explaining those

events required understanding static equilibrium theory (which would illu-
minate the essential characteristics of choice), and understanding the his-
torical and cultural evolution of the values, resources, and technology (the
economic givens of economic theory) that decision-makers have available
at the moment of choice. (Emmett 2009, p. 67)
Perfect competition is a particular equilibrium or state of affairs, where

information and knowledge meet with market participants and other ele-
ments to ensure that potential buyers have full view of perfectly elastic
demand, or supply curves. Hence, the buyer can see the equilibrium level
and can exchange at an agreeable market price. Knight, along with other
thinkers such as Hayek, Böhm-Bawerk, and Veblen, expressed concerns
about equilibrium. For example, Hayek, in The Pure Theory of Capital
discussed equilibrium in relation to the concept of dynamics in econom-
ics, which he stated:
…has indeed two altogether different meanings according as (sic) it is used

in contrast to the concept of a stationary state or in contrast to the wider
concept of equilibrium. When it is used in contrast to equilibrium analysis
in general, it refers to an explanation of the economic process as it proceeds
in time, an explanation in terms of causation which must necessarily be
treated as a chain of historical sequences. What we find here is not mutual
interdependence between all phenomena but a unilateral dependence of
the succeeding event on the preceding one. (Hayek 1941, p. 17)
2 Establishing a Capital Interest Theory

Knight’s more extended discussion first came in his 1933 paper
“Capitalistic Production, Time and the Rate of Return” (1933b), an essay
included in a collection of essays in honour of the Swedish economist
Gustav Cassel.4 However, we can see the building blocks explained in
4
Originally published in Economic Essays in Honour of Gustav Cassel (London: George Allen &
Unwin 1933), pp. 327–42.
The Economic Organization (1933a), published in the same year. In The

Economic Organization, he explained the meaning of production as a
stream of services, time and value, and other themes. However, in The
Economic Organization he had explained them in the context of explor-
ing price theory and the organization, but he soon found himself delving
more deeply to extract the theoretical themes that became part of his
“crusade.” What Knight does in his 1933 paper is to set out the primary
definitions in order to think about a capital interest theory, which helps
us to understand what such a theory is discussing. Knight argued, as
Buechner helpfully points out, that four propositions are at the heart of
any valid capital theory:
1. Capital is the only factor of production

2. Capital is a fund of value
3. Production and consumption are simultaneous, and
4. Capital is permanent. (Buechner 1976, p. 598)
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
thus unproductive. Allied to this theory, Knight explained, is the wage-

fund doctrine, a theory of the distribution of wealth widely-accepted by
early American economists, which in its simplest form assumed that the
entire income-less-rent of society is paid out each year to labour, making
capital, annual income and the wages fund virtually identical.
The theory that capital reflects time of production is not evident in
Jevons, Knight points out, “but is clear in the Böhm-Bawerk defence
against being a wage-fund theorist” (Knight 1933b, p. 328). Böhm-
Bawerk combined the idea of the wages fund with that of roundabout
production, and Knight explained:
What Jevons and Böhm-Bawerk do to the Ricardo-Mill theory of distribu-

tion and of capital is essentially to drop the assumption of a natural annual
cycle of production and the corresponding fixity of proportions between
labour and capital, and to make the quantity of capital (for a given quantity
of labour and land) a linear function of a variable production period.
(Knight 1933b, p. 328)
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
mechanical view of the economy treats as the cause, is want-satisfaction,

which is a change of state in the economic subject, produced and main-
tained over some period of time by some direct economic agency, which is
either a person or a thing. This direct agency is called consumption, from
a process viewpoint, and a service in respect of the object of the service,
or what is consumed. To understand what we mean by wealth, value and
income, Knight states that both consumption and service have a time
dimension, and a rate. The spending choices of each consumer reduces
different kinds of service to a common denominator in harmony with
the price at any point in time, and comparisons of such choices made by
the individual consumer become measured objectively through buying
and selling taking place in the market as events at a specific point of time.
Knight argued such exchange is not part of a flow; rather it is an absolute
quantity or value of a right to some stream of service of some magnitude
over some time period giving rise to a conception of wealth, the distinctive
attribute of which is value. Knight explained:
The primary economic reality is consumption income; but since wealth is

what is generally measured, we must have a name for the stream of service
defined in terms of wealth, by reinversion, as it were. The resulting concep-
tion is consumption-income, a stream of exchange value, which must
therefore be defined dimensionally as wealth divided by time, or, accu-
rately, the derivative of a wealth magnitude with respect to time. (Knight
1933b, p. 329)
The analogy Knight used to explain basic economic magnitude was

electric current or light, which exists in a specific moment of time such
as when we switch a light on; unlike water which exists whether it flows
or not. Likewise in economics, wealth has the two dimensions of income
and time. It is essential, in Knight’s view, that what he called the “real
relationship” should be understood, based on wealth as “income-times-
time, or an integral of income over time” (Knight 1933b, p. 330). This
relationship is further complicated by time entering in a relative way, and
only future income having value at any time, depending on the distance
in time between this future time and the time separated as a moment in
the income-stream being valued. This process is subsumed in the process
of discounting or capitalization.
84 Frank H. Knight
3 The Problem of Production

and Immortality
All this said, Knight held that the core conceptual confusion in eco-
nomic terminology is the notion of production, rooted in the difficulty
of distinguishing the stationary economy and historical growth, which
is essentially confusion between the rendering of consumption services,
and the creation of agencies for the rendering of such services. The classi-
cal notion of production, inherited from J.S. Mill, began by considering
production as the result of labour producing the utility of objects, per-
sons and services, creating an increase in wealth. Knight argues against a
consistent relation between production and consumption, but more fun-
damentally he wrote there is confusion among what he called the three
bases of distinction between kinds of production: what is produced, the
agency producing it, and the process itself:
The “tripartite” classification of “factors” results from separating human

beings from other agencies and then dividing non-human agencies into
two classes, those given by nature and those artificially created. Kinds of
entity are here confused with elements of properties. (Knight 1933b,
p. 332)
This is to confuse kinds of entity with elements or properties. However,

the fundamental confusion is between production as a rendering of con-
sumption service (at some rate) and the creation or quantity of new capac-
ity to render such a service. To avoid such error, Knight recommended
keeping to the concept of consumption, as the enjoyment of services, and
production as the rendering of consumption service or income. It is also
necessary to have such a concept covering the creation of new wealth,
because wealth is discounted future consumption services. The act of cre-
ating wealth and yielding income is often done by different people who
coordinated through pecuniary relations. These need to be accounted for
separately, since an increase in wealth is income during a period of time,
even though no final value has been realized.
Knight defined capital as identical with wealth in relation to the
consumption stream of which it is the capitalized value, and simply a
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
existence at the start may be said to be primary and applied to produc-

tion of secondary instruments which yield an income stream, but when
the process is finished the new capital is indistinguishable and so the
distinction drawn between primary and secondary becomes meaningless.
In the second view, productive capacity over a hypothetical growth inter-
val may be seen as an intermediate product of earlier economic activity
and expanded over time, but this becomes an infinite process. Knight
concluded:
…it is impossible to impute any unit of product, in the shape of consump-

tion in a particular time interval, to any time-segment of productive activ-
ity if between the production and the consumption in question the creation
of any intermediary agency intervenes. All that can be imputed to an incre-
ment of productive activity is an increment of perpetual income stream;
and conversely, an increment of consumption bounded in time can be
imputed only to an endless stream of past activity, if the creation of the
capacity to produce is included in the production process. (Knight 1933b,
p. 340)
Investment is converted into another inherently perpetual income, the

human cost of which is “abstinence” rather than “waiting,” and results
from a certain rate of non-consumption over a certain period of historical
or chronological time, and then added to an infinite past or taken from
an infinite future. Knight concluded his study by stating that he does not
offer a physical proof of the theoretical conclusions he has reached, nor
did he seek to correct the cycle theory which is based on false doctrine,
though he did spell out what he saw as sources of confusion.
4 Seeking Clarity in Capital Interest Theory

Knight’s clearest, or certainly the most clearly written, statement of a
theory of interest came in his 1934 essay Capital, Time and the Interest
Rate (1934). He wrote a sixteen point essay, starting with the reiteration
of the theme that economic thought and behaviour are divergent, and
stressed the point that notions of a definite relation between quantity of
capital and time or length of production need to be eliminated, save for

the basics of expenditure at a uniform rate for a given period.
There are three empirical facts Knight sees as the basis of a sound the-
ory of capital. First, is the “technological” fact, that the volume (time
rate) of production can be increased after any interval by using part of
the existing productive resources instead of current consumption income
to produce. Instruments or agencies, when produced can become pro-
ductive or additional income. This, Knight summarized, describes the
process of investment. Second, the investment process takes place with
large volumes on a competitive basis in the economic societies, to which
ordinary price theory is applied. The third fact is an “institutional” one,
there is a general market in which productive resources or income sources
are freely bought and sold.
It is under these conditions that capital accounting inevitably arises,
and Knight explained:
The operation of capital accounting converts ever saleable productive

resource into a pure quantity of “capital.” The theory of capital accounting
under the conditions named is virtually the sum and substance of the the-
ory of “interest” as a rate of return on capital. (Knight 1934, p. 258)
There is, he suggests, no necessary error in the theory developed

by Jevons and his followers, but we need to understand the notion of
ascending and utilization phases discussed in his 1933 essay Capitalistic
Production, Time and the Rate of Return, which he again sets out in
Capital, Time, and the Interest Rate.
Knight took as his starting point the isosceles diagram, which
W. Stenley Jevons discussed in The Theory of Political Economy (1871).
Jevons stated:
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
or gradually invested and suddenly withdrawn; or gradually invested and

gradually withdrawn; the amount of investment will be in every case the
greatest amount of capital multiplied by half the time elapsing from the
beginning to the end of the investment. (Jevons 1871, p. 231)
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:
…the second phase of the diagram is a horizontal straight line parallel to

the base (which is a time axis) and extending from the maximum point of
the ascending phase onward to infinity. Where using up, wearing out,
depletion, or decline in rentability from any cause is involved, it may rep-
resent a virtually infinite variety of changes in the income source itself or
outside of it, and the entire curve of capital-quantity (value) for a given
identical agency may have an infinite variety of shapes, even rising and fall-
ing, and any horizontal length, before falling to “zero” (see below).5
Moreover, all using up is a technical detail; all capital is normally conceptu-
ally, perpetual, as will be shown later.6 (Knight 1934, p. 259)
Knight strongly emphasized “that there must be a utilization part of

the diagram, either finite or infinite; its base cannot be zero” (Knight
1934, p. 259). By which he means any item that has saleable value must
yield some return over some period of time. Value, in his view, cannot
be instantaneous or lack a time dimension, and the utilization of an item
created by economic production must be the result of planned activity,
and thus Knight concluded:
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”.
it is clearly impossible to value by anticipation an instantaneous experience

not thought of as leaving a more or less enduring change of state, either in
the subject or in his environment. This is true even if we assume that it is
possible to imagine an instantaneous experience as such, which it rather
clearly is not. (Knight 1934, p. 259)
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
essay to refine definitions and clear up confusions. He explains that in a

property system the increased cost of the capital instrument representing
the carrying charge cannot be attributed to productive agents; it accrues
to the owner of the new instrument, and is functionally separate from the
owners of the productive agencies, and in a progressive society one takes
together the total quantity of investment or capital of an individual or
enterprise. Capital is inherently perpetual and once produced becomes an
indistinguishable fraction of the total capital of the economic system, and
Knight goes on to discuss the theory in algebraic terms and focuses on
the notion of durability of capital. He then draws a distinction between
capital and income as logically absolute, being the foundation of a prop-
erty system, and when new capital is created a new source of income
appears on the books, which shows that there is a fundamental difference
between the use of productive capacity to create more productive capac-
ity and its use to create consumption income. As Knight asserts “The
choice between two uses is absolute. The new, “future” income, when it
comes to be created by the new capacity, can in no wise be imputed to
the old capacity which created the new capacity; it has to be imputed to
the new capacity!” (Knight 1934, p. 274)
There are several distinctions to be drawn regarding the length of
the production process as an independent problem. Knight explained
“Viewed in economic terms, production, means the rendering of services,
and it is self-evident that a service can only be produced when it is ren-
dered, and only enjoyed or consumed at the same instant” (Knight1934,
p. 276), and he argued that consumption and production are instantly
simultaneous, and Knight added:
The connection in which the notion of a lapse of time between production

and consumption has practical meaning has been indicated in general
terms. It does require time to change the direction of production or the
mode of use of productive instruments, or the capital they represent, to
meet unanticipated changes in conditions. (Only capital instruments and
capital are in question in the present discussion; the problems of the mobil-
ity of labour are quite as important, and indeed closely connected; but they
have to be treated separately.) It is commonly true that changes in the char-
acter of productive activity become reflected in changes in the physical form
of consumable output only after a considerable lag. (Knight 1934, p. 276)
As regards the relation between quantity of investment and the time

required for production, Knight addressed what he saw as certain confu-
sions, before finally summing up that the theory of capital as time com-
prises three fallacies. First, that capital is produced by labour or “primary
factors,” which he says cannot be because there is no homogeneity and
they are overlapping. However one classifies productive agencies, it is evi-
dent to Knight that they are continuously produced and reproduced by
the cooperation of all. Second, it is absurd to think that reproduction of
any kind of instrument can be considered as economic production. Third
is the idea that the product of a capital instrument can be treated as the
product of the economic activity itself, it being obvious to Knight that
an instrument cannot be counted as both product of the instrument and
also product of the activity creating it.
Fritz Machlup, writing in his 1935 essay Professor Knight and the
“Period of Production” (1935) offered an assessment of Knight’s position.
This position is contained in what he called “a series of ingenious arti-
cles” and he presented how Knight “has proposed to discard as worthless
some tools of economic analysis which I consider indispensable for suc-
cessful handling of certain problems” (Machlup 1935, p. 578). If such
concepts as Knight attacked are to be rehabilitated, Machlup states the
criticisms he makes must indeed be addressed, though he was also, as
Emmett explains , indirectly calling on Knight “to stop asking questions
and systematically set out his own theoretical position for comparison
and criticism” (Emmett 2009, p. 78). As we’ve already discovered, this
was never going to happen, due to Knight’s habit of offering criticism
without a replacement system.
5 The Knight and Machlup Exchange

In challenging Knight, Machlup started by stating that the usefulness or
necessity of a “stationary” or static economy cannot be seriously ques-
tioned; such is its centrality to the application of the method of variation
in economics. Additionally, Knight indulged in tautology, for instance in
his treatment of “the fact of perpetuity,” where Machlup (1935, p. 580)
suggested that Knight was essentially stating that “unless society acts
92 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”
(Machlup 1935, p. 591, 592). Machlup concluded in fact that Böhm-

Bawerk and Knight were not in conflict, because he said that the “aver-
age durability of goods” (Knight) and “the average construction period
for such goods” (Böhm-Bawerk), need not be increased if total invest-
ment increases (Machlup 1935, p. 593). The relationship between aver-
age durability and capital supply is much closer than Knight allows, and
Machlup highlighted that, Knight in his criticism of the production
period, focuses his attention on the increased durability of goods, and
so the crux of his argument, based on his interpretation of the Austrian
theory, is the idea that making goods “more durable” is a lengthening
of the investment period, while making more “durable goods” need not
be. In a static economy, the past or historical production period and the
future, or anticipated production period, may be equal, but in the real
world we are presented with a dilemma over how we understand their
relationship. We have to make a distinction Machlup argued between the
economic problem, which is the problem of choice and distribution, and
the data given for its solution, including the total equipment available,
which is the result of history.
A key term used by Machlup is “consumption distance.” He argued that
we can look at successive time periods, stages of production or distribu-
tion of productive services as consumption distances. Hence, a change in
the investment function, people saving or investing, is a switch of services
from the lower to higher consumption distances. Likewise, productive
services are distributed among uses of different consumption distance.
Different stages of production can be identified in terms of technical
process, locational units, vocational units, financial units, and time units,
the last being different consumption distances. A last application offered
by Machlup is disinvestment, which becomes the failure to reinvest in
work of great consumption distance. In October of the same year, Knight
wrote a terse response to Machlup, noting that to take point–by- point
the argument made, would be “in part to rehash the content of my papers
which he quotes and in part to deal with extraneous issues” (Knight
1935c, p. 625). Knight explains he had sought to tackle the interpreta-
tion of capital as a time period of any sort, and Machlup’s response added
up to the substitution of one phrase for another, namely “consumption
distance” for “production period.” In an echo of Machlup’s assessment of
94 Frank H. Knight
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).
6 The Hicks Solution to the Austrian

and Knightian Problem
John Hicks, who had just received a Nobel Prize in Economics in 1972,
offered a fresh insight into the Austrian theory in Capital and Time: a Neo
Austrian Theory, first published in 1973. In a review of the book, Robert
Solow suggested that Hicks was taking a flyer on Austrian capital theory,
and explained the Austrian approach in the review:
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)
The Austrian and Knightian approach had been largely abandoned

because it was deemed incapable of dealing with fixed capital. Hicks
sought to overcome the problem by allowing for a sequence of outputs.
Hicks had been dealing with these topics over a number of decades, start-
ing with The Theory of Uncertainty and Profit (1936) and Value and Capital
(1939) where he critically considered Böhm-Bawerk’s average period of
production, then in Capital and Growth (1965) he elaborated on growth
theory, and finally in a series of contributions in the 1970s, including
Capital and Time: a Neo Austrian Theory, where he focused on time as a
topic in economics and revived an interest in the Austrian theory of capi-
tal. Hicks called his new approach to capital a Neo-Austrian approach.
Hicks distinguished different kinds of capital from the different kinds

of capital processes in which they are found, and he said there are differ-
ent theories of capital because there are varieties of capital. He argued
that fixed capital goods “are “durable-use goods” with the essential char-
acteristic that they contribute, not just to one unit of output, at one date,
but to a sequence of units of output, at a sequence of dates” (Hicks 1973,
p. 8). Hence, the real capital of any economy extends entirely from very
durable instruments through to goods that are in the pipeline, meaning
goods in the process of production (Hicks 1973, p. 97). The old Austrian
theory he argued was based on a ‘goods in the pipeline approach,’ and
the production function approach is based on ‘a quasi-land fixed capital’.
A theory of capital should be able to capture both approaches. Hicks
explained, Böhm-Bawerk had attempted to use Menger’s flow-input-
point-output approach, and Wicksell had extended this to a point-input-
point-output approach, like the aging of wine. Both are models of time,
which characterizes the production process in terms of time.
What Hicks wanted to do was to provide a theory of capital that is
within time, using a theory as flow-output, and he explained:
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
In this way, Hicks stated, we can abandon the ‘period of production’

approach, and agree there is no measure of roundaboutness. However, we
cannot abandon the insights of Böhm-Bawerk and Menger, rather we can
keep the strong points of the Austrian approach. Hicks explained:
Production is a process in time…the characteristic form of production is a

sequence, in which inputs are followed by outputs. Capital is an expression
of sequential production. Production has a time structure so capital has a
time structure (Hicks 1973, p. 100).
Hence, we can define a production process as a stream of inputs, which

give a stream of outputs. Hicks then asked, “what, in general, are the con-
ditions that must be satisfied in order that the process should be viable?”
(Hicks 1973, p. 100). He answered, that every process or project has a
capital value which is the discounted-flow of the sum of the net values
yielded by the project over its life. It is a necessary condition for the
viability of any process as a whole that its capital value should be positive,
or at very least neutral, at every stage in its life (Hicks 1973, p. 100).
Time in his theory of capital has far reaching implications in terms of
changes in the value of the capital stock. Hicks explained:
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.
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.
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.
1: 257–286.
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.
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.
Press.
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
There is an element in Knight’s career that gives the impression he was

against the world. He founded the Chicago school, but they subsequently
took somewhat different paths. He had close affinities with the Austrian
School, but had some serious points of difference. He shared some of the
social concerns of Keynes, and yet despite even sharing some fundamental
assumptions, Knight ended up diametrically opposed to his conclusions.
While he had great interest in socialism and Marxism, going back to his
early study visit to Germany, he was greatly opposed to such schools of
thought. It seemed that it was indeed Knight the prophet contra mundum,
or at least at odds with the world of intellectual economic endeavour. This
chapter will look at these oppositions, except for Chicago which was exam-
ined briefly in the opening chapter, but let us first consider the Austrians.
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:

100 Frank H. Knight
…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 )
Knight, along with Aaron Director, introduced The Road to Serfdom

to the University of Chicago Press (Hartwell 1995, p. 23). The previous
decade Knight had been in open conflict with Hayek in his rejection
of the Austrian theory of capital, as we have seen in the “conversation”
raised in the last chapter. In the 1930s, Knight got deeply embroiled in
a debate with the Austrians, not just through the exchange with Hayek,
but also a protracted exchange with Nicholas Kaldor, as well as Ludwig
von Mises, and a host of colleagues from the Mont Pelerin Society. In his
review of Mises’ 1940 work Nationalökonomie,1 in which Mises had set
out his complete theory of interest, Knight noted the work was “highly
controversial in substance and in tone, though the argument is directed
toward positions, with very little debate or Auseinandersetzung with
named authors”(Knight 1941, p. 409). Like Knight and Hayek, Mises
drew the distinction between the human social science and natural sci-
ences. Again like Knight, Mises was critical of the positivists and their
refusal to recognize the interests and motives present in economic reality.
However, Knight over and above his strong objections to the Austrians,
and the Austrian elements in Böhm-Bawerk’s argument, saw in Mises an
attempt to take these elements in an even more Austrian direction that he
found to be quite unpalatable.
This was part of an ongoing debate on capital, which had its roots in
the theory of capital controversy of the early 1900s, in the clash between
JB Clark and Böhm-Bawerk. It was a technically thorny and theoreti-
cal problem of trying to define the quantity of capital outside a one-
commodity world, and a problem of supply and demand explanation
of profit which had been grappled with since the days of the marginal
‘revolution’ towards the end of the 19th century. This was what Böhm-
Bawerk, Clark, Fisher, Hayek, and Knight were all seeking to answer,
1
This title would later become Ludwig von Mises, Human Action (1949).
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:
... the production function has been a powerful instrument of miseduca-

tion. The student of economic theory is taught to write Q = f (L, K) where
L is a quantity of labor, K a quantity of capital and Q a rate of output of
commodities. He is instructed to assume all workers alike, and to measure
L in man-hours of labour; he is told something about the index-number
problem in choosing a unit of output; and then he is hurried on to the next
question, in the hope that he will forget to ask in what units K is measured.
Before he ever does ask, he has become a professor, and so sloppy habits of
thought are handed on from one generation to the next. (Robinson 1953–
1954, p. 81)
Or, as Samuelson wrote in one essay, “Voltaire, Horace Walpole, and

Napoleon concurred that history is a fable agreed upon. Alas, doctrinal
history in economics seems to be a variety of fables not agreed upon”
(Samuelson 1991, p. 570).
We can trace the genealogy of the debate in more detail here than in
the last chapter. The initial conflict was sparked by papers published in
the early 1930s, but we can trace the roots a little further back. At the
tail end of the 1920s, Hayek had published two papers, On the Problem
of the Theory of Interest (1927) and Intertemporal Price Equilibrium and
Movements in the Value of Money (1928). Hayek was following Eugen von
Böhm-Bawerk, who had emphasized heterogeneous capital goods and
the period of production. Later, in The Pure Theory of Capital (1941),
Hayek likewise focused on heterogeneous and specific capital goods, but
replaced Böhm-Bawerk’s subsistence fund determination of the interest
rate with an inter-temporal price system that determined multiple own-
rates of interest, which Hayek argued would tend towards a uniform rate
(Hayek 1941, pp. 146–7, 265, 266). In a prelude to the debate, in 1931
102 Frank H. Knight
Knight wrote Professor Fisher’s Interest Theory: A Case in Point, part of an

exchange with Irving Fisher, who had asked for comments on his work
for an encyclopedia. At the same time, Hayek was publishing his key
exposition in Prices and Production (1931). There were other voices who
joined in the conversation, most notably Burchardt (1931), Edelberg
(1933), Hill (1933), Gifford (1933), and Marschak (1934), but it was
Knight’s attack on what he called the Jevons/Böhm-Bawerk/Wicksell/
Hayek theory that truly kicked off the controversy. Knight’s case was
developed, and continually restated (as was his habit) in a series of essays.
His opening salvo, Capitalistic Production, Time, and the Rate of Return
(1933) sought to demonstrate what he saw as a number of fatal confu-
sions in the theory of capital. This was followed by Capital, Time, and
the Interest Rate (1934), in which Knight stated that it was essential to
eliminate the doctrine of a definite relation between the quantity of capi-
tal and the length of the production process or time. This was followed in
the mid-1930s by a direct assault entitled Professor Hayek and the Theory
of Investment (1935d), then his The Ricardian Theory of Production and
Distribution (1935b), leading finally to a two-part essay The Quantity of
Capital and the Rate of Interest (1936).
For his part, Hayek also developed his thinking in the heat of debate,
with his own series of essays covering On the Relationship between
Investment and Output (1934), The Maintenance of Capital (1935),
The Mythology of Capital (1936a), Utility Analysis and Interest (1936b),
Economics and Knowledge (1937), and Profits, Interest, and Investment
(1939). In the midst of this came Hayek’s book Prices and Production
(1931); while Hayek put his thoughts together into a book, Knight kept
to the essay format. Additionally there was a protracted exchange of let-
ters between the two antagonists, starting with a letter from Hayek to
Knight on 16 July 1935, with further correspondence over the course
of a year or so,2 ending with a letter from Knight to Hayek on 2 July
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,
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:
In general, I’m in a perfectly low ‘depression’ over the state of economics,

and the Hayek-Sraffa altercation with which my essay is remotely con-
nected is a case in point. I should like to see some headway which I do not
see towards establishing terms and concepts in which economists could
talk to each other and when they argue, argue issues rather than disputing
about the meaning of each other’s assertions. (Wood 1995, p. 209)
Knight repeated in parenthesis from his earlier letter, “I haven’t seen

anyone who could tell what Sraffa and Hayek were arguing about”
(Wood 1995, p. 209). Throughout his argument, Knight claimed and
restated the theory that the quantity of capital corresponds to the length
of time over which “primary” factors of production are employed to cre-
ate “secondary” capital goods. His argument was chiefly threefold. First,
there is no distinction between primary and secondary factors. Second,
there is no productive cycle, or length of production period, which has
determinate length or meaning. Lastly, the theory of capital is not involved
in business cycle theory. Knight also continued to restate his views on the
determination of the interest rate, the permanence of capital, and the
both sides of the correspondence have been preserved. The Hayek papers do not contain any of the
correspondence.” (p. 470).
104 Frank H. Knight
simultaneity of production and consumption in a stationary state, which

eliminates any interval for a production period.
Knight set out the following year, in Capital, Time, and the Interest
Rate, what he saw as the five main essentials of the theory of capital and
interest. First, the amount of capital in any item is determined mathe-
matically as a “present worth” by discounting its future yield back in time
to the moment of valuation, at a uniform rate. When capital first reaches
its maximum value then it is at the end of its “construction period.”
Second, the amount of capital represented by any item is also determined
mathematically by its “construction cost,” which always comprises the
two elements of the sum paid to previous productive agencies and the
accumulated “carrying charge.” Third, every increment of cost must yield
a return at the same rate over the whole investment period, and so the
carrying charge is accumulated at the same rate as any discount on incre-
mental income to determine its present worth. Fourth, Knight combined
these first three points, to state that the construction cost is equal to
the present value of the anticipated yield, when the rate of carrying cost
of direct outlay items accumulates at the same rate as the future direct
yield is discounted. Lastly, any investment is made under the condition
that the rate that Knight had defined in the previous points is the maxi-
mum possible in the technical circumstances of the economic situation
in which it is made. By this, Knight means an economic society where
there is freedom of choice in investment opportunities and a free- market
for the buying and selling of capital items for cash. Knight undertook
a process of clarifying the various terms he uses to explain this theory,
including the observation that he believed it should be clear why the
length of production process has nothing to do with the matter in hand,
and in fact holds no real meaning.
In concluding his 1934 essay, Knight proposed three fallacies he
understood to be at the base of the theory of capital and time. First, it
is absurd that capital is produced by labour or “primary factors” in any
sense, since labour or capital instruments lack homogeneity and over-
lap, and however such productive agencies are categorized it is evident
that each is produced and continuously produced by the cooperation of
all. The second fallacy is the equally absurd point that the reproduction
of instruments of any kind can be considered as economic production.
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
1935b, p. 79). The realization of how he saw the theory fundamentally

wrong came to him as he worked on the wage-fund theory in relation to
Böhm-Bawerk, as set out in his major work The Positive Theory of Capital.
The theory is based on the classical theory of capital, which in turn was
based on the notion that the production process is discontinuous and
time-consuming, which if correct means that the real wages received for
the work performed today must have been produced yesterday, and in
turn what workers produce today reaches the form of finished goods at
a future date.
The notorious, as Böhm-Bawerk characterized it, wage-fund the-
ory was a powerful one, for it had been prevalent in England after the
Napoleonic wars, had been accepted by the classical economists, and had
subsequently passed into American economics. The theory stated there
is at any one time a fixed capital fund available for wage payments, and
increases in wage rates to any groups will only redistribute wage pay-
ments and do not increase the aggregate of wages paid. The doctrine
asserts that in any shorter period of time than the length of the total
production process, the aggregate amount of wages-goods is a fixed fund
which cannot be increased during the period in question. The fund
divided by the number of workers provides the average wage rate. A rapid
growth of capital will increase the wage rate, with aggregate wages lim-
ited by the amount of wages-goods transferred by capitalists to labourers
in the period of production. The wage bargain affects distribution only
indirectly, through profits and investment; in other words, as future and
not present income, because future wages depend very much on present
profits. The theory made the capitalist employer the residual claimant of
the product of industry, after rent and wages had been deducted, leaving
profit composed of interest on the capital employed and the capitalists’
remuneration. The primary policy implication of the wages fund doc-
trine was that labour unions, factory legislation and such other means
of raising wages simply reduced aggregate profits and investment, with
only net additions to the capital stock able to increase real income for the
working classes, thus making life arguably more difficult for organized
labour.
The theory connects the means of subsistence very closely to the con-
cept of capital, leading Böhm-Bawerk to propose a Subsistence Fund,
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
amount; it cannot provide any secure point of support to determine wage

levels. Böhm-Bawerk:
“The amount of capital destined by capitalists to pay wages” is neither

equivalent to the total national capital, nor to the total “circulating capi-
tal;” nor yet to any one fixed quota of the national capital. It represents a
variable portion of the community’s wealth, and a portion the extent of
which varies directly, among other things, with the height of wages: it is
greater when and because wages have risen, smaller when and because
wages have fallen. In explaining, then, the rate of wages by an amount
which itself is conditioned by the rate of wages, the Wage Fund theory
describes a circle. My Subsistence Fund, on the other hand, starts with a
fixed given amount – the stock of wealth accumulated in a community. Of
course that amount of goods which specially serves as subsistence for
labourers, and which I might call the “Wage Fund,” forms a part of the
total subsistence fund. But the amount of this portion does not hang in the
air, as it does in the English theory: in exactly analyzing what parties share
in the total subsistence fund, and according to what laws, my “wage fund”
becomes – at least relatively – fixed and definite. (Böhm-Bawerk, 1891,
pp. 419–20)
Most importantly, he explained, the English theory that the rate of

wages is simply got by dividing the wage fund by the number of existing
workers is “entirely wrong.” The labourers get the wage fund wholly and
entirely as wage, but it is not stated whether the wage is for one year, two
years, three years, or even more. Böhm-Bawerk’s theory made the rate of
wages depend chiefly on the proportion between the number of labour-
ers and the amount of the wage fund, meaning the amount of capital
destined for the support and payment of the labourers, and was an idea
that helped to connect the means of subsistence still more closely with
the conception of capital.
Böhm-Bawerk concluded:
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
accompanies successive extensions of production) that it leads to a curtailment

of the capitalist’s share, and to a proportionate rise in the wages of labour; the
rise too being in a much weaker ratio than the increase of the subsistence fund.
The English Wage Fund theory has thus a core of truth, but it is wrapped up in
a quite overpowering mass of error. (Böhm-Bawerk 1891, p. 420)
Recalling Samuelson’s comment about economic fables, the whole

wage fund debate certainly involved a variety of arguments not agreed
upon, and many reflections on this period take a dim view. Looking back
over this intellectual history, Robert Solow suggested that “when a theo-
retical question remains debatable after 80 years there is a presumption
that the question is badly posed – or very deep indeed” (Solow 1963,
p. 10). James Bonar observed, “The wages fund theory is the crown-
ing instance of an untrue abstraction… and it has probably done more
injury to the reputation of economic theory than any other generaliza-
tion ever received into economics textbooks and then expunged from
them” (Bonar 1911, p. 75). Paul Samuelson was struck by the “falseness
and emptiness of the wage fund doctrine,” which for him “constitutes
one of the most sterile chapters in that dreary gap between the classical
age and the revolutionary neoclassical discoveries of the last third of the
nineteenth century” (Samuelson 1951, p. 316).
Sterile or not, the larger debate in which Knight and Hayek engaged
sustained some lively argument based on their respective understand-
ing of capital being very much at odds with each other, and with each
following different influences. Knight, following JB Clark, proposed a
fund of value which is homogeneous, malleable, and permanent with an
emphasis on capital as a permanent fund of value. He believed interest
was determined entirely by the technical marginal productivity of capital,
without reference to either the measurement of capital or time prefer-
ence. Knight portrayed the classical conception of production, and the
role of capital within it, as a schema of production carried out by labour,
which is supported by capital and applied to land. A fixed amount of cap-
ital supports a fixed amount of labour, and each year labour produced in
the previous year will reproduce it for the following year, and labour that
does not reproduce the capital it consumes is “unproductive.” Knight
believed this theory:
110 Frank H. Knight
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)
This, Knight said, is a “false view of the nature of the co-operation

between labour and capital” (Knight 1933b, p. 328). It is also false, he
said, in the two ways that he extracts from other essays. First, the relation
in production between capital and labour is strictly mutual, with neither
factor being primary as the wage fund and Böhm-Bawerk’s subsistence
theory suggest. Second, there is no productive cycle or length of produc-
tion period with determinate length or meaning.
Hayek criticized Knight’s argument. Hayek sympathized with anyone
who saw the concept of a single or average period of production as a
meaningless abstraction detached from the real world, but he suggested
Knight misdirected his attack by not attacking the wrong-headed tradi-
tional theory and instead trying to put “a more appropriate treatment of
time in its place” (Hayek 1936, p. 200). After praising Knight, Hayek
writes that his “basic mistake – if the substitution of a meaningless state-
ment for the solution of a problem can be called a mistake – is of the idea
of capital as a fund which maintains itself automatically, and that, in con-
sequence, once an amount of capital has been brought into existence, the
necessity of reproducing it presents no economic problem” (Hayek 1936,
pp. 201–2). For Hayek problems do arise, because part of the productive
equipment is non-permanent and has to be deliberately replaced on eco-
nomic grounds, and an increase of capital will always mean an extension
of the time dimension of investment.
In the Austrian view, capital is presented as “equivalent to a “fund” out
of which incomes, and particularly wages, are paid in the period before
their contribution to the production process can be sold” (Hayek 1941,
p. 325). The use of labour to produce capital, and together to produce
consumption goods, is in the Austrian schema described in terms of an
indirect, or ‘roundabout’, method of production. The concept of “round-
aboutness” involves forgoing consumption today for capital invest-
ment for consumption at some time in the future. A longer period of
production is subject to diminishing returns, and savers gain by being

rewarded for waiting and the longer investment period. Equilibrium of
interest is based on the relationship between the saving supply curve and
the capital demand curve, based on marginal productivity of increased
roundaboutness. Hayek argued productivity increases with its “round-
aboutness,” or capital intensity, and that decreases in the interest rate
prompt more roundabout, capital-intensive production, though he could
not prove this in heterogeneous goods models. Hayek freely acknowl-
edged: “All attempts to reduce the complex structure of waiting peri-
ods...are bound to fail, because the different waiting periods cannot be
reduced to a common denominator in purely technical terms” (Hayek
1941, pp. 141–2).
Knight argued the Austrian roundaboutness made connections that
simply were not there. He stated that changes in the durability of goods
or in their construction period do not exert an identifiable effect on a
definable “period of production” in society as a whole. Such changes are
not connected with the quantity of investment, nor are they connected
with any production period. Knight explained “Correspondences in this
field are limited and accidental, without theoretical significance for the
nature and role of capital. It is extremely difficult to give any intelligible
meaning to a “period of production, “and it certainly has no meaning of
the sort assumed in the Böhm-Bawerk–Hayek theory of capital” (Knight
1935a, p. 88). Hayek dismissed the objections, arguing that in his paper
Knight’s permanent, homogeneous fund of capital, J. B. Clark’s true capi-
tal, and:
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
conceived as a separate actor of determinate magnitude which is to be

treated on the same footing with “land” and “labour“ belongs to the same
category. (Hayek 1936, pp. 221–2)
Ultimately, Hayek argued, it is even worse to attempt, as Knight did,

to eliminate time entirely from the analysis of the capitalist process of
production, thus preventing him from answering how the limitation of
capital limits the possible size of the product, and to explain why and
how capital is maintained. Hayek went on to argue on this basis that
Knight made further errors about the function of interest.
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.”
(Knight 1967, p. 783) Again, in a somewhat scathing assessment of

Werner Sombart’s work, Knight stated:
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)
Socialism argues history is determined by economic or materialistic

considerations which raise questions of interpretation, believing that the
course of history is thus a matter of human behaviour. While economic
and other motives are to be distinguished, economic motives are consid-
ered to be more fundamental because they arise out of necessities. In the
same essay where he attacked Sombart, Knight singled out Max Weber,
whose General Economic History (1927) Knight had translated, for tow-
ering over all the other writers discussed in the essay, because Weber
stated the origins of capitalism in negative form: Why did capitalism not
emerge at another time or place? Especially, why did it not develop in the
classical or ancient civilizations? The writers who were critical of capital-
ism, in Knight’s view, failed to understand the topics of property and
labour within the system. People are freed from servitude and can form
contracts, which is a great liberation. The spirit of capitalism, Knight
believed, is one of being part of a constructive system, which replaced the
previous acquisitive forms of economic organization, and which thrives
because modern business is productive. Capitalism is also the triumph of
human invention and conquest over nature. The historical uniqueness of
capitalist Europe is that it took technical advances of other civilizations
and used them to lift each nation’s status from medieval to modern and
eliminated slavery and servitude in the process.
Socialism was a proposal to replace the organization of economic life
based on markets and the economic enterprise, but Knight believed
114 Frank H. Knight
the solutions offered by socialism were a form of romanticism, offering

proposals that could not adequately tackle humans’ behaviour and
change. The two forms of romanticism in socialism he highlighted in
particular were the belief in the unlimited possibility of changing human
nature through laws or political constitution, and the facility of blaming
the wrongs of the world on others by finding an enemy and offering the
simple cure of liquidating somebody, by which he means class warfare.
One problem of socialism for Knight was the simple fact that it is dif-
ficult to define it “with any degree of definiteness or concreteness with
internal consistency. The concept lies both in the realm of prophecy, as
well as in that space where vague ideals or wishes can be designated as
“cloud-cuckoo land”” (Knight 1940, p. 79).
Knight argued that it was easy to imagine or believe, as many intel-
ligent people do, he hastened to add, that the evils in the world or in a
particular society are: Economic in basis, consequences of the form of
economic organization, and can be corrected by replacing the economic
organization with control by politicians. This he said is the essential con-
tent of socialism, which Knight argued somewhat acidly is a belief in a
benevolent god-like state that could act without incurring its own evils,
so that most of us would “live happily ever after.” Yet, Knight stated there
is more in common between capitalism and socialism than some critics of
socialism might accept. Both, in essence, are individualistic in their ends,
and they treat individual and social problems as essentially economic
ones. However, despite his condemnations, Knight was not interested in
dismissing the charges made by socialism, again as some critics are wont
to do. He is more interested in a discussion of some of the legitimate
issues raised by socialism, rather than its basic philosophic outlook or
policy options. He explained that economic theory does not disprove nor
reject socialism. His objections were based on the grounds of practicality.
Apart from doubting the benevolent godlike state, he doubted whether
people holding other non-economic views and values would appreciate
the onset of socialism. The first is a problem of politics, the second a
problem of conflicting values.
Knight raised the questions of whether economic socialism itself is fea-
sible, and would a state which socialized economic production be indi-
vidualistic or free in economic and other aspects of life? He suggested
socialism had gone farther than liberalism in treating individual and

social life as economic. The economic problem was, in his view, rela-
tively unimportant and superficial, since if all economic wants were to
be satisfied, it seemed to him probable that the conflicts that cause strife
and unhappiness among people, and give rise to social policy problems,
would be intensified rather than improved. The deeper motives in play
are the desire for freedom and power for their own sake.
In challenging the feasibility of socialism, Knight argued that ulti-
mately a socialist economy would operate on the basis of profit-making,
just as the economy does in private capitalism. The only real difference is
the treatment of monopoly, which is the problem socialism, puts high up
in its list of points against capitalism. However, Knight argued there is a
misconception of the “evil” of monopoly, and the problem itself would
not be solved under socialism, as it would face the same issues of monop-
oly discussed in the previous chapter. Two further problems concerning
feasibility need to be discussed. First is the internal organization of pro-
duction, in other words management. Management is largely a matter
of prediction, but socialism would put management into the hands of
government appointees, thus essentially prohibiting the specialization of
risk-taking, and this in turn would restrict individual freedom. In capi-
talism, the enterprise owner or owners are free to choose the form of
organization, which includes creating the producer cooperatives favoured
by socialists. The second question is one of how profits are to be disposed
of, since even in socialism there will be profit and loss, but in socialism
the government must arrange matters so that managers are compelled to
manage conservatively and cover losses, using profits for that purpose.
Knight also attacked the labour theory of value, which is a major pillar
of traditional Marxian economics, though it was not unique to Marxism.
The theory had long been debated by the classical economists, despite
being clearly false. Knight described the theory as the most important
source of corruption in economic thinking through most of its history,
and comprised a mixture of fallacious causal analysis and false ethics. The
theory stated the value of a commodity can be objectively measured by
the average number of labour hours required to produce that commodity,
so that if a pair of shoes takes twice as long to produce as a pair of trou-
sers, then the shoes are twice as valuable as the trousers. As a result, the
116 Frank H. Knight
competitive price of shoes will be double that of the trousers, regardless

of the value of the physical inputs. Marx tried to turn the theory against
capitalism, arguing the theory could explain the value of all commodi-
ties, including the commodity that workers sell to capitalists in return for
a wage, that he called “labour power.” Marx then argued that capitalists
enjoy their profits due to their privileged and powerful position as own-
ers of the means of production, and ruthlessly exploit workers by taking
the “surplus value” created by the workers for themselves. Knight argued
that there is no close correspondence between the size of income and the
character of the source. In rejecting the labour theory of value, Knight
and orthodox economists argued that capitalists do not earn profits by
exploiting workers. What happens is that entrepreneurial capitalists earn
profits by forgoing current consumption, taking risks, and organizing
production.
One last concern to highlight in Knight’s critique is how socialism
responds to the problem of business cycles, the “boom and bust.” The
notion that some form of collectivism, as a response to the tendency in
capitalism toward cyclical business, is not a solution at all in Knight’s
view, for two very good reasons. First, the business cycle does not
advantage any one group or interest in a capitalist society, and indeed
all suffer, and the business cycle does not involve a conflict of these
interests. Second, to preserve the traditional economic liberties of the
individual, any collectivist government will still have to operate on the
basis of money and market transactions, with prices, productivity, and
competition still operating akin to the enterprise system. For people
to choose their wants, socialism has to be pecuniary like capitalism,
and thus price and supply have to be adjusted, which means the final
distribution of products must be identical with capitalism. In other
words, the two types of society will both have the same character of an
individualistic or free-enterprise system, and with this comes the same
tendency to oscillation and problems of control. Certain types of reme-
dial action may be easier in a collectivist state, but then again, Knight
said, such actions would be rooted in arbitrary power, and “there is no
problem of unemployment in a penitentiary.” As a result, a collectivist
society and central authority poses greater difficulties than feature in
the capitalist economy.
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:
The controversy revolves around three questions: Is capital a distinct factor

of production? Is capital quantifiable in a theoretically consistent manner?
Do we need process stories around convergence to, or changes in, equilib-
rium interest rates? To all questions, Kaldor essentially answers “yes” to
Knight’s “no.” (Cohen 2006, p. 142)
In the opening essay on the topic, Kaldor started first by tackling

the notion of distinguishing between permanent and nonpermanent
resources. Knight distinguishes between the services of the resources and
the resources themselves. Services are a rate of flow in time which can-
not be held in stock or transferred to another time period; hence one
day’s hours of labour cannot be held over to the next, rather it’s a case
of use them or lose them. In respect to the resources used, such as land,
machines, and the labourers themselves, there is no difference between
permanent or non-permanent resources since permanent resources do
not exist. There are no resources existing without the need for mainte-
nance, contradicting the stationary-state analysis. This is wholly true of
labour, since the labourer needs maintaining. Knight explained capital-
ism was different to the slave state, where investment in human labour
is akin to investment in machines, but concluded that even in the mar-
ket state there is a minimum cost of maintaining the labourer. Even if
this was not the case, there would still need to be a distinction drawn
between “original” and “produced.” Importantly, Kaldor agreed that if
“produced” resources always require the cooperation of the services of
“non-produced” resources in further production, then Böhm-Bawerk’s
concept of a “period of production” is destroyed. However, Kaldor in his
rejoinder to Knight argued that despite agreeing with many of his con-
cerns, he had yet to be convinced by the conclusions drawn by Knight.
Kaldor then tackled the notion of maintenance versus replacement,
which Knight had explained was irrelevant, especially since in many
cases it is difficult to determine precisely the difference between mainte-
nance and replacement. This point Kaldor believed was the most open to
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
understanding of the average period of production. Another difficulty

he shared with Knight was the application of the period of production
to more than one productive factor, or more than one good. However,
Kaldor fundamentally disagreed with Knight on his conclusion, and had
argued two years earlier:
So long as the quantity of annual labour service remains constant with

variations in the quantity of capital, and so long as the quantity of no other
type of services remains constant, there will be a unique correlation between
the rate of interest and the amount of labour input per unit of final out-
put – or, if you like the rate of interest and the average investment period
of the services of labour. (Kaldor 1937, p. 228)
Two decades later, having converted to Keynesianism, Kaldor would

say he no longer believed in such a unique correlation, and that labour
productivity and the capital/labour ratio had nothing to say about the
rate of return on capital, since this is only deduced once it is known what
is the rate of growth in labour productivity and the propensity of profit
and wage-earners to consume.3
Cohen, who offers a useful and detailed study of the Knight/Kaldor
exchange, believes the controversy is historically important on three
grounds:
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.
Kaldor turned to Keynesianism for his future direction, and it is to

Keynes and Knight’s opposition to him that we now turn.
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
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
confirms the soundness of the Marshallian tradition as to the uselessness

of the Böhm-Bawerkian analysis, the theory of interest is given precisely
in the traditional, classical mould.”
Like other critics, Knight homed in on the process Keynes had
adopted, contending that he had caricatured classical doctrines, and
refashioned old fallacies. Keynes later admitted, on a number of occa-
sions, that he should have concentrated more on his own theory and less
on classical theory. Writing much later in 1950, in an essay on the role of
principles in economics and politics based on his presidential address to
the American Economics Association, Knight was forthright in his opin-
ion of Keynes’s legacy that his “new economics” was “fallacious doctrine”
with “pernicious consequences” putting economic thinking “well back to
the dark age,” but he observed the wave of Keynesianism was “happily
passing” (Knight 1951, p. 2).
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
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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5
The Economic Organization
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

130 Frank H. Knight
mid-career works. The two themes are, first, Knight’s understanding of

economic organization, and second, the ethical basis of competition. The
work undertaken here also provided a Knightian critique of the quest for
an alternative, a Knightian view of the overarching concerns that critics
of capitalism have entertained since the dawn of capitalism.
1 The Economic Organization

Although published in 1951, The Economic Organization in a mimeograph
was a required text for undergraduates in Social Sciences in the College
of the University of Chicago in the 1930s. It is considerably more clearly
written and set out than Risk, Uncertainty and Profit. The book gives us
a good sense of Knight’s approach to teaching, as he switches between
reflections on the philosophical underpinnings of economic ideas and
standard treatments of the building blocks of economics, highlighting
the areas where he contests orthodox theory, such as the role of labour in
production. In The Economic Organization, Knight is not writing about
the organization in terms of the individual firm, but the way in which we
all are organized economically as participants in the economy, whether it
is as workers, consumers, businesses or government. As ever with Knight,
he reflects his interest in the social dimension of economics, and starts The
Economic Organization with a study of the social economic organization,
because as Knight writes with greater clarity in The Ethics of Competition:
Economics deals with the social organization of economic activity. In prac-

tice its scope is much narrower still; there are many ways in which eco-
nomic activity may be socially organized, but the predominant method in
modern nations is the price system, or free enterprise. (Knight 1935a, p. 6)
For Knight, economics is more closely defined as a discussion of the

structure and working of the free enterprise system, in other words the
economic organization in the broadest sense of the term. He could then
define the problems of organization, which arise because different things
are done for a common end, and are undertaken in definite relations or
coordination with each other, whilst many of the underlying elements,
such as consumer desire or the competitive spirit, are not adequately

understood or are simply stated as fact rather than explained. In The
Economic Organization, it is essential to note the description Knight
gives to the term “economic progress.” As with many terms, still widely
employed today, he offered a different and challenging perspective.
Knight explained, “There is no moral connotation in the term progress;
it refers to any persistent cumulative change, whether regarded as good or
bad.” (Knight 1933a, p. 12).
To understand the economic system fully, Knight outlined its five
main functions. The first function is to fix standards and to drive effi-
ciency, which involves addressing the different uses of productive power
and the problems of distribution, which he says are interlaced as ques-
tions over whose wants, and which wants, are to be given preference,
and in what measure. The practical objective of economics is the social
organization and increasing economic efficiency, the correct definition
of which is between useful output and total output or input; otherwise
the terms are meaningless. The second function is the organization of
production. This is the putting to use of productive power according to
a scale of values, which is a process of assigning or allocating productive
forces and materials, and effectively coordinating the various means of
production to produce the greatest result, which is a technological rather
than an economic task. The third function is distribution, a process
whereby different individuals contribute in different ways to production.
If everyone is to make a living out of the economic system, then some
social mechanism of distribution is required. There is a close relationship
between distribution and the control of production, and what to produce
is tied up with whom production is to benefit. It is at this point in the
analysis that Knight makes the Smithian point:
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)
The fourth function is to ensure maintenance and progress. As Knight

stated bluntly, there is no moral connotation to his use of the term of
132 Frank H. Knight
progress. He took this simply to infer any persistent cumulative change,

and thus he took economic progress principally to include three major
changes. The first change is the growth of population, and any cumula-
tive change in its composition or education affecting productive powers
or wants. The second change is the accumulation of material aids to pro-
duction or “capital” of all kinds, ranging from newly discovered natural
resources to works of art. The third change is improvements in technical
processes or in the form of business organization. Returning to the fourth
function, it cuts across the previous three functions, and is a matter of
standards or values determining how much progress society can afford,
or what sacrifices of present value society will make. Productive organiza-
tion uses the share of productive power to bring about progress, while the
problem of distribution is one of apportioning the burdens and benefits
of progress.
The fifth function he defined is the adjustment of consumption to
production within very short periods. He stated this was rarely distin-
guished from a stationary economy point of view, where the problem is
to adjust production to consumption under the given conditions. Knight
made the point that there is sensitivity to past and current consumption
in practice, in contrast to the stationary economy point of view, because
in practice production cannot be adjusted quickly and yet at the same
time demand conditions do rapidly change. Often changes cannot be
made to meet a short-term demand without great expense, though in
recent decades Just-in-Time production and other inventory methods
have sought to address this problem.
Being organized economically has advantages and disadvantages, the
biggest gain coming from specialization and the utilization of natural
aptitudes and leadership; though Knight noted “undoubtedly the largest
single source of the increased efficiency through organization results from
having work planned and directed by the exceptionally capable individu-
als, while the mass of the people follow instructions” (Knight 1933a,
p. 17). Organization also develops the skill and knowledge base of indi-
viduals, while on the other hand he explained “specialization in itself is
an evil, measured by generally accepted human ideals” (Knight 1933a,
p. 21). It narrows the personality, and the “specialization of leadership
means that the masses of the people work under conditions which tend
to suppress initiative and independence, to develop servility as well as

narrowness and in general to dehumanize” (Knight 1933a, p. 21). This
seems to be an echo of the Marxian view that workers are alienated. It
is intriguing that Knight argues this way, since it can be argued that it
is consistent with his realism that the workplace is not the place where
workers are humanized, it is the place where they earn the money that
allows them to be humanized in their life outside the workplace. There
are many people who find fulfilment at work, often at the cost of enjoy-
ment outside the workplace, especially when they are “on call” or have to
travel. This intrusion of work would not be welcomed by those for whom
the workplace is simply a means to an end, where they walk outside the
factory gates or drive out of the car park and leave all work cares and wor-
ries behind them.
While specialization brings technical advantages to assembly and dis-
tribution, as Adam Smith had argued, it also brings another disadvantage
in Knight’s mind, that of interdependence of persons and groups. This
is seen most dramatically in times of strikes or accidental stoppages, but
most critically Knight elaborated, in the “ebb and flow of prosperity, par-
ticularly the recurrence of business crises bringing widespread distress”
(Knight 1933a, p. 22). To further his analysis, Knight categorized the
types of social organization we find in economics and politics. The first
category is formed according to status and tradition, or caste. The sec-
ond type, which is a step up in freedom, is autocratic or militaristic. The
third type is anarchism, which is a swing to the other extreme of the
first type, where there is absolute freedom or purely voluntary associa-
tion; but Knight defines this as a possible type rather than actual. The
fourth type is democratic socialism, which is a compromise between the
authoritarian and anarchistic regimes already discussed. The fifth and
last type is the system under discussion, which is the exchange system.
This is characteristic of western nations, and is organized and controlled
through an impersonal competitive market. The most interesting aspect
of exchange system, Knight suggested, is that it is automatic and uncon-
scious, as no-one plans it out or assigns people to their role within the
system. He further subdivides the exchange system into handicraft and
free enterprise, noting the study of economics is mainly the study of free
enterprise.
134 Frank H. Knight
In his appraisal of the Classical writers on the economic system as a

whole, Knight contended they suffered from “at least seven” aberrations
in classical thinking on value and price, which he discussed in his 1935
essay, Ricardian Theory of Production and Distribution (Knight 1935b,
p. 3). Firstly, he asserted they held an unfortunate concept of value, where
cost was interpreted as pain instead of being positive, and the result of the
necessity of making choices among alternatives. Beyond this general phil-
osophical assertion, he does not expand on which writers he has in mind.
Theoretically, making a choice among alternatives should be equally
painful or pleasurable, he stated, but the basis of value in human life is
the necessity of making choices among relative alternatives. The cost of
any value is the alternative value given up in the act of choosing, which is
a limitation of resources of some sort, and they are economized in allocat-
ing among the choices on offer. The economic problem he argued, where
there is one, is one of what he defined as diminishing value-effectiveness.
Second, he argued they had a false view of production and the nature
of wealth or capital. Production was defined as wealth, when in fact he
argued in terms of what he called primary production as the rendering
of services, where wealth is an agency by which services are rendered, not
a product in the primary sense. Wealth axiomatically is “produced” to
replace an item or what he discussed as maintenance, used up in render-
ing the service or adding to the total stock of service-rendering agencies.
Looking at the productive organization and distribution, Knight is con-
cerned with the meaning of product, and especially with the confusion
involved in treating production as production of wealth. What is con-
sumed in the economy is exclusively services, he said, and thus produc-
tion is the rendering of services. A service is a matter of intensity and time.
Knight uses the analogy of a stream of water, which can be measured
independent of time, and switching on a light, which cannot; an analogy
discussed earlier. Knight explained “A quantity of services, or of light, is
derivative from flow, and is obtained by aggregating a “rate” of flow over
some time interval” (Knight 1935a, p. 9). However, we don’t think of
the quantity of the service, rather we think of the value in exchange of a
specified service over a period of time, future or past. The value is affected
by discounting, if paid for in advance, or interest accumulation, if paid
for after. In an economic sense we think of a service as rendered by some
agency, but the value depends on the “utility” to a consumer.
The wrong is further compounded, in his view, by the third aberra-

tion of thinking labour produces all wealth, by which he says we actually
mean want-satisfaction. Here there is a failure to distinguish sharply the
two branches of study, the first being the economic theory of progress or
growth in the total means of want-satisfaction, and the second, the activi-
ties which minister to current satisfaction, and those leading to growth,
which interact in complicated ways. The fourth aberration was a defi-
ciency in methodology, as Knight argued that the classical writers had no
clear conception of causality, manifested in their failure to apply the law
of diminishing utility, which is essential to value analysis. As he explained
in his study of the Ricardian theory, in understanding the law of dimin-
ishing utility and scarcity, scarcity is always a result of competition from
other uses. Knight elaborated:
…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)
Ignorance of the principles of analysis was the fifth aberration, which

he related to the lack of mathematical or logical understanding which he
saw as underpinning the previous aberration, and this led to a sixth aber-
ration of the classical writers, in Knight’s view, that they lacked a clear or
definite concept of the meaning of economy “as a process of maximizing
a value return from given limited resources of whatever kind” (Knight
1935a, p. 6).
The seventh and final aberration, Knight believed, was the problem of
distribution, the sharing of a joint product among an indefinite number
of agencies co-operating in its creation. Knight argued that this was not
seen as a problem of imputation; indeed, he said it was not approached as a
problem of valuation at all. The reason this aberration seemed mysterious
to Knight was because of what he saw as the inescapable fact that the
shares in social income are received by individuals as money payments for
services rendered, and second, because classical writers, most especially
Adam Smith, were “on the very threshold of a correct general conception
136 Frank H. Knight
of the organization of production and distribution in society as a whole

through price competition” (Knight 1935a, p. 7). Knight added that the
classical writers had no concept of the nature of the economic organiza-
tion in which a pecuniary distribution arises, as in the enterprise econ-
omy, where the individual gets a livelihood by selling productive services
to enterprises for money and using money to buy from the enterprise the
products they consume. The organization as a whole works, he explained,
through two interacting systems of markets and prices, one for products
where individuals are buyers and enterprises are sellers, and the other for
productive services, where the roles are reversed. Knight concluded:
The classical economists give no picture of a system of prices, and practi-

cally no hint of a system of economic organization worked out and directed
by price forces. As noted under the first two aberrations, they failed to see
the relativity of all values and costs; still less did they grasp the identity of
costs with distributive payments and the functional roles of the two inter-
acting sets of prices. (Knight 1935a, p. 7)
Economic theory needs, Knight said, to show how in a price economy

the price system works out in terms of: Assigning productive capacity
in society to different uses or industries; the technical organization of
productive agents within each industry; and finally, the sharing of the
joint product among the cooperating individual owners of productive
capacity. Distribution theory he believed concerns itself with the pricing
of productive services, and such pricing is significant for the division of
the product, but more fundamentally is concerned with apportioning
productive capacity. Arthur H. Leigh explained how Knight shifted his
focus from the normal discussion of distribution, as the distribution of
income between wages, profits and rent, to re-evaluate how we should
understand it, presenting it in the form of:
a clarification of the relationships among cost, utility, value, and price

within a general interdependent system. It directs attention to the choice
problem central to efficient resource allocation and away from moralistic
justification of the prices paid for productive services in terms of subjective
sacrifice. In a market economy, income distribution is a matter of the pric-
ing of productive services and the ownership of productive capacity.
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)
It is competition between producers in the same industry that provides

pressure to increase technical efficiency, as well as keep prices down to
the level of costs. Knight concluded that the price system comes down to
these two sets of prices, consumption goods and productive services, and
their interaction.
2 The Price System

Knight typifies our modern economic organization as an “automatic” sys-
tem, which excludes conscious design or control, and one where there is a
great diversity in labour in which each individual finds their place in the
system, and the innumerable conflicts of interest in society are constantly
resolved. The way this system is built up and controlled is through the
impersonal forces of price; though he noted the presence of handicrafts
and cooperatives. Producers are competitive in pricing, interpreting the
consumer wants, and rewarding labour; all the time maintaining their
productive power. Hence, “the distribution of income is worked out on
the principle of paying each individual in accord with his contribution to
the total social product, as measured by the amount consumers are will-
ing to pay” (Knight 1933a, p. 35). He noted consumers also compete,
with those who pay the most being assured the product, while there are
also rich rewards for those who can make improvements in the produc-
tive process and those who can bring new resources into use. Such an
“airplane” view, as he called it, can show a simple and beneficial sys-
tem, but once clothed in everyday reality we can quickly see the sys-
tem is far from ideal, and does not produce universal happiness or even
match expectations. Indeed, he explains that the explanation he offers
brings forth fundamental weaknesses in the very nature of the system.
Explaining the system is not the same as justifying it, though critics and
138 Frank H. Knight
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:
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
However brief his flirtation with such cases, Knight observed it is a

trite statement to make that price is determined by demand and sup-
ply. He explained what the market is in fact, and the role price plays in
the relative utility of a commodity compared to other things one might
buy. This requires us to draw more careful distinctions. Knight examined
the social function of price in the short- run, having already highlighted
that the general function of coordinating production and consumption
commonly take on opposite aspects in the long-run and short-run views,
making it both a long-run and short-run problem. In the long-run there
is the challenge of conforming production to consumption, while deal-
ing with the short-run problem of distributing the existing supply. In a
system of free enterprise or “price system,” price performs both functions.
Admitting this is not an ideal way, especially in respect to the distribution
among consumers, Knight stated:
It is obvious without extended explanation that the price, the costliness of

goods to consumers, prevents their wasting goods…and bringing on desti-
tution or scarcity later. It also operates to keep any particular consumer or
group from using the supply and depriving others of their share. (Knight
1933a, p. 76)
The tendency of competition is to maintain a uniform price through-

out the time period, with an allowance for storage of unused supply. If
the income of the consumers is uniform over the same period, this should
lead to the correct distribution of consumption. In respect to distribu-
tion among consumers he noted a different outcome in the result, since
competition likewise sets a uniform price for all purchasers, which means
a limited supply of a commodity will be divided among them in propor-
tion to their demand, based on desire and purchasing power. With the
inequality in the distribution of purchasing power, and the burden of
scarcity of an important commodity thus falling on the poor, Knight
suggested “the results of unregulated competition become indefensible.
When an abnormal scarcity occurs, the government is forced to intervene
and establish some limitations on the consumption of the well-to-do”
(Knight 1933a, p. 77), and this was the case in World War Two, where
sugar and fats were so controlled.
As Knight asserted, the tendency of free competition is to maintain

uniform pricing during a period of limited supply, and this he said was
the function of the “much-abused” institution of speculation. The abuse
derives from being misunderstood, and not always working according to
the theory. The speculator plays a valuable role in maintaining uniform
prices, and the popular notion that speculators fix prices, in Knight’s
view, is arbitrarily false, as they do not have that much more influence
than the producer or consumer. To make money out of price changes, the
speculator needs to get accurate information about supply and demand,
so they can forecast future prices. The buying and selling activities of the
speculator move the price up or down accordingly. What is misunder-
stood is that speculators can only make money if they do what the pro-
ducers and consumers need them to do. Also, not all speculators judge
correctly, or there would be no money to be made beyond the price they
get for their trouble, which statistically he stated is exactly what specula-
tors as a class get. The “real evils” of speculation are due to manipulation
through misrepresentation and fraudulent reports, as well as the igno-
rance of those who gamble on the market. Such speculation, and the
perception of gambling, was as important in the aftermath of the 1929
financial Crash as it is for today’s market economy critics. Knight would
still want to draw the same distinctions today as he did with his students
back in the 1930s.
Knight returned to his point on the social function of the economy,
explaining that price is not the correct measure of the social importance of
goods, for two reasons. First, people’s preferences, reflected in price offers,
do not always represent what is “best” for them, and second, the vast dif-
ferences in spending power do not indicate differences in the importance
to society of the individuals themselves or those dependent upon them.
Added to which, the purchase and consumption of commodities impacts
others who are not doing the buying or consuming; for good and ill.
Knight maintained the overriding point that there is a generality about
the way in which economic laws operate, to direct productive power
into the most socially useful channels, which also means understanding
why there are exceptions to this tendency. He studied the dynamic of
inequality further in relation to distribution of purchasing power. Knight
explained there is only a tendency towards price adjustment, which is
142 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
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.
3 Distribution Theory and Interest

Prices tend to equal costs of production, meaning also that the money
value of productive power tends to be equal to the money value of its
product. This observation, Knight explained, is the starting point of the
theory of distribution. The total income of society is apportioned among
those who comprise the total productive power, and Knight explained
how the mechanism of apportionment works. We have to be able to
unpack the units of productive power and value them separately, no easy
task. Taking the example of a biscuit, Knight said it is hard to break it
into its productive parts of the cook who prepares it, how many goes into
which oven, etc. yet this is precisely what the competitive system does
and it is the job of the economist to explain how it is done.
In order to discuss distribution theory, we need to understand what
we mean by production itself, especially what we mean by the product
and how we understand the agencies that create the product. Knight
explained, “the classical writers viewed production as the creation of
“wealth” by “labour”; other agencies (capital, stock, and land) were recog-
nized, but their role was auxiliary, not co-ordinate” (Knight 1935a, p. 8).
Thus, labour which did not produce capital was called “unproductive.”
144 Frank H. Knight
What we consume in economic life is exclusively services, and in Knight’s

schema the primary meaning of production is the rendering of service,
which is a magnitude of the nature of intensity.
The demand, supply and price of a productive service is of the same
pattern as for any consumption good, and the relation between quan-
tity and price for any single purchaser is the inverse of what it is for the
market as a whole, meaning price determines the quantity bought, and
competition ensures sellers set a price that will clear the market. Such
reasoning, Knight explained, requires more consideration to satisfactorily
explain the pricing of productive services, since the purchaser has to con-
sider the total of productive services to buy and apportion expenditure
accordingly. In reflection, the producers fix the apportionment of pro-
ductive power among commodities and enterprises in each industry. The
entrepreneur will thus use the various factors depending on their relative
prices, and each productive service will tend to be used up to the point
where marginal productivity is maximized, though this is complicated by
the marginal contribution to the product being made by a unit of that
productive service.
Such reasoning depends on the operation of a principle of diminishing
marginal productivity and governs the entrepreneur’s purchase of pro-
ductive services and the consumer’s purchases of commodities. Knight
established two principles of diminishing productivity:
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)
The problem of distribution is one of price related to productive ser-

vices, or the use of productive agencies, and not the sale price of the pro-
ductive agencies themselves. The most important agency is the human
being, and in our society human beings cannot legally be bought and
sold, but only their services. Supply of productive services is not neces-
sarily fixed or independent of the price of the service, when the supply
of the agent rendering the service is fixed; though supply is in practical
terms fixed over considerable periods of time. However, the amount of

service from a given supply of labour or productive property may vary
considerably as the price varies, and two principles may be applied here.
First, variation in supply is inversely related to a permanent change in
remuneration, so price increases lead to supply decreases and vice versa.
In the case of labour, a wage increase will cause the same workers to work
less and have more leisure if their wants remain the same. Rationally the
worker will seek a compromise between work done for more money or
less work to maintain the same level of income. Theoretically, Knight
suggested, this conclusion also holds for factors other than labour. The
long-run question is whether price affects the supply of a service by
affecting the supply of the factor rendering it, in which case we have to
distinguish three types of factor, and the related long-run forces. First
are labourers, which is a matter of wages and population growth. Second
is capital, which is the relation between interest rate and the saving and
investment of capital. Last are the natural agents, meaning the relation
between the “rent” of such agents and the discovery and development of
natural resources, including the rate of exhaustion.
However, for Knight, the most complex branch of distribution theory
is the theory of interest, with the chief source of confusion arising because
of a failure to recognize the fact of interest as a mode of receiving income
rather than a distinct share from a distinct source, meaning that interest
is a special way of paying and receiving income earned by any factor of
production, and not income earned or produced by a special productive
factor. He suggested this is certainly true of property, but it may also
be said of wages. Interest is not found, he said, but made in the general
competition of borrowers and lenders in connection to loans as a class,
and not on a particular loan. The value of productive property is not
determined by capitalization but by its cost of production, and Knight
explained the interest rate is a datum, “it “determines” the value of the
productive power necessary to construct a piece of productive property
and the anticipated value of its product after it is made” (Knight 1933a,
p. 112). As with any other price, the competition of borrowers attracts
the “loanable” free productive power, or liquid capital, into the most pro-
ductive forms of investment. What is really loaned is command over free
productive power, and so capital is capital goods and the source of capital
146 Frank H. Knight
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.
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
institutionalist also influenced by Veblen, explained Chamberlin’s theory

was an attempt to make neoclassical economics more relevant than was
managed by the theory of pure competition. J.M. Clark explained, “This
is perhaps the culminating challenge which this latest industrial revolu-
tion has presented to economic theory, to bring itself into closer touch
with economic processes and problems in ways that involve enlarging its
scheme of variables. It is this challenge that Chamberlin undertook to
meet in his study of the theory of monopolistic competition” (J.M. Clark
1961, p. 39), and he believed Chamberlin was attempting to infuse pro-
cess into the theory of the firm.
Chamberlin did not accept a clear dichotomy of pure competition and
pure monopoly as market structures, which was the orthodox understand-
ing of American capitalism; instead he saw monopolistic competition as
an attack on pure competition. He presented an imperfectly competitive
market comprising a number of smaller markets, each characterized by
a seller’s monopoly imperfectly isolated from the others. In his theory of
monopoly, chamberlain presented what he called the marginal revenue
curve, which shows the relation between the marginal revenue received
by a firm for selling its output, and the quantity of output sold. The firm
maximizes profits by producing the quantity of output found where it
intersects the marginal revenue curve and marginal cost curve. The mar-
ginal revenue curve reflects the degree of market control held by a firm,
so the curve for a firm with no market control is horizontal while for a
firm with market control it is negatively sloped and lies below the average
revenue curve. Chamberlin also distinguished monopolistic competition
from static equilibrium concepts. In Towards a More General Theory of
Value he explained, “The point can be made that the fundamental ques-
tion is the nature of the economy. If its structure is one of monopolistic
competition, this must be true whether it is being studied as a system
of static equilibrium or as one of dynamic movement, or perhaps of
‘development.’ Whether segments of it are being studied in isolation or
whether the whole of it is being studied as a single system; whether the
focus is upon the parts or upon their aggregates” (Chamberlin 1957,
p. 9). Monopolistic competition included the entire range of market
organizations, from pure monopoly to pure competition. Even oligopoly
was merely a “small group” case of monopolistic competition, and to this
extent he essentially reinvented the term oligopoly by emphasizing the

product differentiation.
Like other institutionalists, Chamberlin tried to build on orthodox
theory rather than to replace it altogether, and he considered his the-
ory to be evolutionary and a process-based explanation of how a mar-
ket develops. Chicago was a major source of criticism, led by Stigler,
who argued that Chamberlin’s innovation was not revolutionary, but
simply another forward step in the world of economics. Rather than
talking about market equilibria, Chamberlin discussed group equilib-
ria, by which he meant the group was a collection of firms producing
non-identical but closely related products that have high elasticities of
substitution. This elasticity is a relative matter, and Chamberlin him-
self accepted all goods are substitutes for one another, varying only
in degree. Stigler criticized Chamberlin’s theory on grounds that the
group concept does not allow technically for any type of equilibrium
to be attained, stating “it will be observed that the theory of monopo-
listic competition now contains no conditions of equilibrium, only a
definition of equilibrium” (Stigler 1949, p. 18). He also argued that
Chamberlin developed a reformulated theory of value based merely
upon the alleged unrealism of neoclassical assumptions, noting “The
sole test of the usefulness of an economic theory is the concordance
between its predictions and the observable course of events…One
can but show that a theory is unrealistic in essentials by demonstrat-
ing that its predictions are wrong” (Stigler 1949, p. 24). Chamberlin
explained the short run equilibrium of a monopolistically competi-
tive firm potentially results in economic profit, but with free entry the
long- run equilibrium produces a tangency of the firm‘s demand curve
with the downward-sloping portion of its long- run average cost curve.
This tangency results in only normal profit and in excess capacity. Gary
Becker explained Chamberlin’s tangency solution as only a minor part
of a section on imperfect competition, and he remarked that there are
technical flaws in its application, and stated “although the concept of
monopolistic competition captures relevant dimensions of the compe-
tition prevailing in many industries, the tangency solution has serious
defects” (Becker 1971, p. 96).
150 Frank H. Knight
Stigler, in his memoirs, recalled a meeting with Chamberlin:
when I was a professor at Columbia University, I attended a meeting of the

American Economic Association in Washington D.C. and on the flight
back to New York to my surprise I found myself sitting next to Edward
Chamberlin. He opened the conversation, “You and Professor Knight are
the two most mistaken economists I know on the subject of monopolistic
competition.” Thank heaven it was a short trip.” (Stigler 1988, p. 58)
Chamberlin wrote directly of Knight that:
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)
In his recollections as a student of Knight, Patinkin recalled Knight’s

view of Chamberlin:
Knight was critical of Chamberlin’s concepts of imperfect competition,

and denied that the possibility that an “…enterprise can have diminishing
(i.e., negatively sloped) demand curve but still no monopoly profits … cor-
responded to fact.” (Patinkin 1973, p. 794)
In concluding his look at economic organization, Knight explained

that much of the risk that gives rise to profit is connected with progres-
sive social change, since changes in demand and the finding of new natu-
ral resources are fraught with such difficulties. The possibility of profit
from change induces investment in business and changes in every field,
and can often lead to improvements and real social progress. However,
he is not so convinced by the promotion of changes in human desires,
which can be against social improvement. Knight suggested “where dis-
tinctively human values are involved, the working of the profit motive is
likely to give very unsatisfactory results” (Knight 1933a, p. 120). Where
producers can prevent others from using productive resources to make
equivalent goods they will act to gain by restricting output, unlike the
individual rendering a unique service, such as an artist or professional
with a reputation whose monopoly is distinctive and secure. Knight con-

cluded in The Economic Organization that uniqueness is the very essence
of monopoly, which is why consumer advertizing is used “to establish
what may be called a “psychological” uniqueness, in particular products,
and thus to secure a degree of monopoly power” (Knight 1933a, p. 121).
Bibliography
1951.
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
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.
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
1 Knight’s Classical Greek Roots

The roots of economic thinking, and political issues related to economy,
lie in moral thinking, going back to the Greek classics. Frank Knight
noted that there was no justification of competition as a motive to be
found in the Aristotelian conception of the good as that which is intrinsi-
cally worthy of the human as human, or what Plato called the archetypi-
cal goodness. Knight explained:
The outstanding characteristic of Greek ethical thought was the conception

of the good as objective, and of moral judgment as a cognition. A thing
should be done because it is the thing to do, not because it is or is not being
done by others. Virtue is knowledge, and the good is intellectually con-
ceived, but the meaning of these statements contrasts as widely as possible
with the modern reduction of virtue to prudence and of choice to a calcula-
tion of advantage. The intellectual equality in Greek ethics is the capacity
of discrimination between true and false values, which is a wholly different
thing from the ability to foresee changes and adapt means to ends. The one
runs in terms of appreciation as the other runs in terms of power. (Knight
1935a, p. 64)

154 Frank H. Knight
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
of wisdom, justice, moderation and courage. Poverty and wealth were

perceived as causes of evil, because the poor did evil out of necessity and
the rich did so out of arrogance or hubris. The greater of the two evils
by far was wealth, because wealth gives greater opportunity to choose
between right and wrong. As a result, the elite of society tried to be mor-
ally deferential towards their wealth for fear of the stigma of hubris, and
pragmatically due to the threat of being sued for large sums.
The modern science of economics Knight was examining did not
entertain such debates, differing vastly from the ancient Greeks in every
way, as philosopher Scott Meikle notes:
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.
2 The Ethics of Competition Foundational

Essays
His core essays on ethics were collected in the volume The Ethics of
Competition, originally published in 1935, in particular the first two
essays of the volume entitled Ethics and the Economic Interpretation, and
The Ethics of Competition. In these first two essays, Knight presented his
156 Frank H. Knight
views on social organization and its outcomes. He picked up on some of

the technical aspects of the economic organization of society, but painted
these on a broader canvas than we see in The Economic Organization. The
idea for The Ethics of Competition started out as a discussion at a dinner in
1934, on the occasion of Knight’s 49th birthday, to showcase his major
essays, and resulted in a publication the next year of this collection cho-
sen by his students: Milton Friedman, Homer Jones, George Stigler, and
Allen Wallis. These first two essays were based on lectures he delivered
by invitation of the Department of Economics at Harvard, in which he
looked at the role of values in the competitive system and explained that
the market, even the perfect market, presents us with ethical challenges
and is open to criticism. For all this, Knight does not posit his own ethi-
cal solution to answer the criticism he had of the market economy; in
keeping with the definition of prophet defined in the opening of this
book. Indeed he struggled with the question until his death, leaving us
with a final unfinished volume entitled Intelligence and Democratic Action
(1960). In his lecture The Ethics of Liberalism, published in Intelligence
and Democratic Action, Knight admitted that he was guilty of “being bet-
ter at criticizing other people’s asking and answering than at doing either
myself, and more addicted to the former role” (Knight 1960, p. 121).
As with all his work, but most especially in the examination of eth-
ics, Knight moved beyond economics and typically drew insights from
a range of disciplines, including philosophy, psychology and sociology,
whilst all the time returning to the economic and ethical arguments he
wanted to establish about human society and the economic individual.
The notion of Homo Economicus as a modern scientific person maximiz-
ing ends is an incomplete story for Knight, since the human being seeks
much more. In seeking to analyze what the human being seeks, Knight
did not want to separate out the ethical from the economic pursuit as if
they were two completely different ends. We will return to this argument,
and how Knight thought about a better society, in the next chapter when
we look at welfare economics, but here we can lay down some of Knight’s
ethical groundwork. Knight contended that in the economy we all seek
happiness. Plato when he pondered the meaning of happiness in Gorgias,
had Socrates mocking Callicles, “Isn’t your idea of eudaimonia scratching
your itchy place forever?” Knight was scratching this itch as well, looking
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:
… when it comes to saying in what happiness consists, opinions differ, and

the account given by the generality of mankind is not at all like that of the
wise. The former take it to be something obvious and familiar, like pleasure
or money or eminence, and there are various other views; and often the
same person actually changes his opinion: when he falls ill he says it is
health, and when he is hard up that it is money. Conscious of their own
ignorance, most people are impressed by anyone who pontificates and says
something that is over their heads. (Aristotle, Ethics, Book I, p. iv)
Knight’s starting point is that economics and ethics, in their different

ways, both deal with the problem of value. He distinguished modern
values from Greek values (and again Christian values, as we will see in
Chap. 9). The Greek view was that ethical judgements were based not on
efficiency or quantity, but the character of results or the motive that led
to an action, and Knight stated, “The Greek view fixes attention upon
the character of the result, and gives an essentially aesthetic conception
of ethical value…” (Knight 1935a, p. 65). Because the Greek identified
virtue with knowledge, Knight explained, it is inconceivable that one
would recognize true values and not act in accordance. Comparing this
to our modern approach, Knight stated:
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
As a result we search in vain for an ethical basis of approval for

competition as a basis for the ideal type of human relations or as a motive
for our actions. Competition is only good at getting things done, but
then it fails in terms of what those things are. Hence, he concluded, com-
petition does not measure up to ideal standards, and does not have a basis
on which to compare with other systems. Yet, according to orthodox
theory, the standards underlying competition are the desires of individual
members of society, and on this basis we try to organize society in the
best way.
This leads, in the case of economics, to confusion by writers over
whether it is concerned with facts and cause-and-effect, or “welfare.”
Knight asked whether human motives in general, including wants and
desires, can be treated as facts in the scientific sense, or whether they are
“values” or “oughts” not amenable to such a treatment. A science must
have a static subject-matter, and economics has always treated desires or
motives as facts, and are sufficiently stable for the period under study
to view life as a process of satisfying desires. If this approach is true,
then life is a matter of economics. Institutionalist economists, especially
the noted J.M. Clark,1 observed that wants which impel economic activ-
ity and directed towards want-satisfaction are the products of the eco-
nomic process itself, and in this respect Knight agrees with them. Wants
may be unstable, but it is in their nature to change and grow. Wants
are also preferences, and thus the scientific student gravitates toward a
criticism of standards, which is quite different from the comparison of
given magnitudes. However, life is not, Knight said echoing the Greeks,
fundamentally a striving for ends and satisfaction, but a desire to achieve
refinement and an elevation of the plane of desire, a cultivation of taste.
The reality, however, is that human society is in conflict, and in his
essay The Sickness of Liberal Society (1946), Knight examined the ideal
and spiritual foundations of modern civilization, which he referred to
as liberalism and individualism. Liberalism suggested to him the ethical
ideal of freedom, and freedom is the fundamental moral exulted in the
modern world, both in terms of society and the individual. Freedom is
ambiguous, and Knight argued freedom is an intrinsic value, but does
1
J.M. Clark, Economics and modern psychology, Journal of Political Economy, Jan/Feb, 1918, p. 8.
not mean unregulated behaviour; rather it is action directed by rational

ideals and conforms to rational laws. Freedom also includes the freedom
to change, which means making progress, and Knight said liberalism
“conceives of progress in terms of cultural values, intellectual and aes-
thetic as well as moral, all based on material advance” (Knight 1946,
p. 81). He also suggested liberalism might be called secular rationalism,
in contrast to religious and metaphysical idealism.
Economics has always been important to liberal theory, with the chal-
lenge being the tension between the use of means to achieve better ends
and the scarcity of means to achieve them. Even the wealthiest econo-
mies, Knight suggested, do not have the means required to give everyone
a decent standard of living. The basic ethical principle of liberalism,
which entails freedom and democracy, means an equal right to better-
ment, but this requires an increase in the total means available and equi-
table distribution. Knight argued there is hypocrisy in exalting poverty
as an ideal, since poverty was an ideal for others and not for the elite
preachers of such a doctrine. Liberal theory also promotes the notion
that everyone is free to choose their own ends, yet access to means is
directly dependent upon one’s social situation. This presents us with a
social problem, and liberal society came under attack on the basis of a
contradiction of its fundamental values, and specifically in respect to its
economic organization, with its failure to realize these ideals for a major
section of society.
In The Tanner Lectures on Human Values, delivered at Harvard
University in 1980, Stigler set out four charges made by Knight against
the claims of the competitive system to be just:
1. An economic system molds the tastes of its members, so the system

cannot be defended on the ground that it satisfies demands
efficiently.
2. The economic system is not perfectly efficient: There are indivisibili-
ties, imperfect knowledge, monopoly, externalities, etc.
3. The paramount defect of the competitive system is that it distributes
income largely on the basis of inheritance and luck (with some minor
influence of effort). The inequality of income increases cumulatively
under competition.
160 Frank H. Knight
4. Viewed (alternatively) as a game, competition is poorly fashioned to

meet acceptable standards of fairness, such as giving everyone an even
start and allowing a diversity of types of rivalries (Stigler 1981, p. 166).
Then, commenting on Knight’s essay The Ethics of Competition, Stigler

went on to note:
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.
The economic organization is core to the economy, and the balance

between the organization of individuals and of society is problematic.
Knight highlighted two major mechanical weaknesses in the free market
system, a term he preferred over “capitalism,” which had been coined
by Karl Marx. The first is the role of monopoly, which he believed to
be much exaggerated and misconceived, but problematic all the same,
as discussed in the previous chapter. The second, also previously men-
tioned, is the tendency toward “boom and bust,” or cycles of prosper-
ity and depressions. Knight stated such problems lead to the belief in
“two common assumptions that depressions are inherent in the nature
of capitalism, and that the problem would be avoided under any other
system of organization, or at least any which allowed individual freedom
of purchase and sale” (Knight 1946, p. 85). The twentieth century was
dominated by the contest between two major approaches to economic
organization, namely the free market and socialism. Knight in his advo-
cacy of the former, in light of the concerns the free market system raises,
took seriously the critique of socialism and communism, but ultimately
was dismissive of it. We shall return to socialism and communism when
we consider welfare economics in the next chapter, but having rejected
the overthrow of the system or the possibility of a socialistic alternative
model, Knight believed we have to engage with the inherent problems
of capitalism, and this brings us to consider first those he was closer to,
namely the Austrians and the Chicago school he started.
3 Chicago and Austrian Morality

Part of the Knight legacy is the role of ethics in economic thought, and
his students at Chicago took a keen interest in the ethical questions they
heard from their teacher, and explored how ethics relates to understand-
ing behaviour, which, Knight argued, is what makes economics such an
ethical concern. Chicago economist Gary Becker helpfully suggests:
I believe that what most distinguishes economics as a discipline from other

disciplines in the social sciences is not its subject matter but its approach…
I contend that the economic approach is uniquely powerful because it can
162 Frank H. Knight
integrate a wide range of human behaviour. Everyone recognizes that the

economic approach assumes maximizing behaviour more explicitly and
extensively than other approaches do, be it the utility or wealth function of
the household, firm, union, or government bureau that is maximized.
Moreover, the economic approach assumes the existence of markets that
with varying degrees of efficiency coordinate the actions of different par-
ticipants – individuals, firms, even nations – so that their behaviour
becomes mutually consistent. (Becker 1976, p. 5)
Becker states that as economic persons our preferences or wants

are assumed to be stable. Thus, he argues that maximizing behaviour,
market equilibrium and stable preferences form the heart of the eco-
nomic approach, and thus all forms of behaviour can be assessed in
economic terms. Becker approvingly quotes George Bernard Shaw’s
dictum that “economy is the art of making the most of life.” The
economic problem is the same as the political one, namely how are
we to manage to coexist in society? This means we need to consider
what economic philosophy and approach is required in our market
economy, and from that we can arrive at a moral resolution. At the
heart of Becker’s argument:
…is that human behaviour is not compartmentalized, sometimes based on

maximizing, sometimes not, sometimes motivated by stable preferences,
sometimes by volatile ones, sometimes resulting in an optimal accumula-
tion of information, sometimes not. Rather, all human behaviour can be
viewed as involving participants who maximize their utility from a stable
set of preferences and accumulate an optimal amount of information and
other inputs in a variety of markets. If this argument is correct, the eco-
nomic approach provides a unified framework for understanding behav-
iour that has long been sought by and eluded Bentham, Comte, Marx, and
others. (Becker 1976, p. 14)
This poses the question as to what extent we use rules, self-regulation

and government to ensure that we all play the economic game fairly. In
Capitalism and Freedom (1982), Milton Friedman contended that mar-
kets, being free, does not mean anarchy, it means the minimal rules of the
game being respected. The failure of communism was that the state could
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:
Economic arrangements play a dual role in the promotion of a free society.

On the one hand, freedom in economic arrangements is itself a component
of freedom broadly understood, so economic freedom is an end in itself. In
the second place, economic freedom is also an indispensable means toward
the achievement of political freedom. (Friedman 1982, p. 8)
For Friedman, the process of government and law is akin to a game

with rules, where the basic roles of government in a free society are:
… to provide a means whereby we can modify the rules, to mediate

differences among us on the meaning of the rules, and to enforce compli-
164 Frank H. Knight
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)
At heart, economics means free commerce, which arises out of, as

Anne Robert Jacques Turgot stated back in 1770, “the debate between
every buyer and every seller [which] is a sort of tâtonnement which
makes everything known to everyone, with certainty, the true price of
everything.”2 It is the behaviour of individuals that determines eco-
nomic activity, and collectively what happens in the market is a mea-
surement of that activity. A person’s place in the economy reflects their
status and power relations within the economy, and their wealth or lack
of it is a numerical value of their status and power. When people act
economically, they are doing so in the same way they approach activ-
ity in any other sphere of their life, and their moral motives will play a
part in their expression of preferences. Hence, as Becker puts it human
behaviour is not compartmentalized, and the economy can measure the
many things people do. This is not the same as saying that there is an
economic morality.
2
Turgot, A.R.J. (I770) (L). Lettres sur le commerce des bles. In Oeuvres de Turgot, vol. III,
pp. 265–354.
In addition to direct curbs put in place by society through government,

businesses are also subject to the economic rules ensuring that right is
rewarded by success and that we act in voluntary association as persons
and organizations. However, one issue for freedom is that individual or
organizational freedoms conflict with those of others, and so they must
be limited in order to preserve the freedom of others. Friedman sees the
economy as a neutral mechanism ensuring the correct role of freedom
and power:
A liberal is fundamentally fearful of concentrated power. His objective is to

preserve the maximum degree of freedom for each individual separately
that is compatible with one man’s freedom not interfering with other men’s
freedom. He believes that this objective requires that power be dispersed.
He is suspicious of assigning to government any functions that can be per-
formed through the market, both because this substitutes coercion for vol-
untary co-operation in the area in question and because, by giving
government an increased role, it threatens freedom in other areas. (Friedman
1982, p. 39)
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
4 The Ethics of Knight and Keynes

In the last essay of The Ethics of Competition, Knight looked at the alter-
native approaches to the market system he had meticulously explored
hitherto, and the two major voices were socialism and Keynesianism.
Certainly in examining both these views, we see Knight’s scepticism about
government and politicians. As Stephen G. Medema points out, Knight
had a particular liking for Adam Smith’s reference to “that insidious and
crafty animal, vulgarly called a statesman or politician,” (Medema 2009,
p. 21) and he was largely dismissive of socialism, as discussed earlier, but
at this stage it is useful to return to Knight and Keynes and compare their
ethical outlooks, given that they shared certain presumptions, if not their
conclusions. Both Knight and Keynes were liberals who saw the faults
of capitalism, and yet ended up with very different conclusions from
each other. The intention here is not to get into an extensive compari-
son of Knight and Keynes, albeit a fascinating discussion, and one well
pursued by William B. Greer in Ethics and Uncertainty: The Economics
of John M. Keynes and Frank H. Knight (2000). Greer presents Knight’s
views primarily as a dialogue between the Knight in Risk, Uncertainty and
Profit and the Knight in Intelligence and Democratic Action, the former a
narrower economic work and the latter a primarily philosophical work.
What is interesting is to look at how the two different worldviews of
Knight and Keynes squared up to each other, with the poignant knowl-
edge that Keynes would be the more dominant of the two economists in
the 20th century, leaving Knight somewhat on the side-lines. However,
Knight is one who can speak for our economic conditions today, just as
much as Keynes has experienced a revival of interest.
A major economic concern, and certainly one pushed by critics of
capitalism, is the twin presence of unemployment and the recurrence
of economic depression, or “boom and bust.” Critics have, with some
justification, argued that economic theory has failed to recognize the
reality, or adequately inquired into the causality, of the business cycle.
Knight pointed out that depression is the correlate of “boom” conditions,
a natural part of the oscillation and fluctuation of the rhythmical or cycli-
cal character of the economy due to market competition. He explained,
however, this is not a repudiation of the deductive-theoretical method
of attacking economic problems; rather it is the case that pure abstract

reasoning “should long ago have led students to expect cyclical changes
as a matter of course.” Knight saw the problem in terms of methodology,
and if we mount the defence of the free market as an “automatic” mecha-
nism of voluntary exchange then it suffices to explain how the workings
of any mechanical governance follows a rhythm. There is always a lag in
the working of the mechanism, which we can understand by way of the
simple analogy of the thermostat to control room temperature. From this
analogy, Knight stated that we can see the inevitability of oscillations in
its operation, and from this we can spot the obvious unreality of the idea
of establishing a stationary equilibrium.
As this example illustrates, Knight took his concern in a different
direction from the one that Keynes discussed in his work, despite both
thinkers being critical of classical economic theory, and their willingness
to challenge many of the underlying assumptions. They shared a philo-
sophical interest in their subject, but also a strong sense of the ethical
import of their overall work. They both understood economics as a way
to increase social welfare, but where Knight was a pessimist, Keynes was
an optimist. Where Knight saw primacy of the market and laissez-faire,
Keynes saw a role for government. As we saw in Chap. 2, both thinkers
also started their publishing career in 1921 with a major work on uncer-
tainty. Again they differed in their treatment, so where Knight saw free
markets as the way to resolve the problem, Keynes saw the need for state
involvement and direction.
Richard Boyd, in his introduction to a 1997 edition of The Ethics of
Competition, offered a helpful outline of the Knightian schema, which sits
in opposition to what Knight called “apologetic economics” of his day.
His opposition made Knight, Boyd suggests, a “reluctant liberal” (Knight
1935a, p. xiii). Boyd explains that Knight’s liberalism is “restrained and
qualified,” based as it is on three tenets. First, he argued for the funda-
mental incommensurability of freedom and justice. Second, the pursuit
of economic equality is not simply a matter of individualism without
unintended social consequences, and the economic interpretation of
human affairs or homo economicus lead to an over-simplification and falls
short of resolving the “social problem.” Lastly, Knight recognized there
are competing perspectives on what is the good or just in society, and
168 Frank H. Knight
ultimately they are in conflict. This brings us to a consideration of con-

flicting values, which is what Knight believed brought economics and
ethics into close proximation.
In his comparison of Knight and Keynes, Greer is at pains to point out
how different the religious and ethical upbringing of the two men was,
yet both were pioneering ethical thinkers in economics. Keynes was from
a well-to-do Cambridge academic household at a time when religion was
being deeply questioned, while Knight was attending religious educa-
tional institutions in an America where religion, primarily Christianity,
was at the heart of the national way of thinking. As Skidelsky explained,
“Keynes was born and bred for success. He was the product of two
Nonconformist stocks, distinguished by brains, religious and didactic
vocation and practical ability” (Skidelsky 1992, p. xvi). Knight was quite
different, and Greer is perhaps correct to identify Knight as “a self-made
intellectual” (Greer 2000, p. 27), he certainly came from humbler aca-
demic stock than Keynes, developing his work in sciences, languages
and arts at conservative Christian colleges, before heading to the grander
Cornell and philosophy. However, as Stigler noted, Knight’s academic
development was a “strange educational career dictated by the family’s
poverty” (Stigler 1988, p. 181). He grew up on the farm, leaving school
to work the land before putting himself through college and university.
This was a far cry from the leafy avenues of Cambridge.
Skidelsky offers a keen insight, one which bridges Marshall, Keynes
and today’s world, but also one that shows what both Keynes and Knight
were concerned about, and it is worth a lengthy statement here:
For Keynes’s teacher Alfred Marshall, the connections between economics

and culture, wealth and welfare, were still relatively unproblematic.
Material prosperity, Marshall believed, was the necessary condition of
moral growth: a ‘gentleman’ needed £500 a year. And business life was, for
Marshall, itself a form of moral and moralising activity: sacrificing present
enjoyment to make things which people needed to make them good. By
the twentieth century this reciprocal connection between commerce, cul-
ture and morals, too readily assumed by the Victorians, could not be taken
for granted, decreasingly so as the century unfolded. Today the main object
of business activity is to make a quick profit, the quicker the better. The
main object of contemporary statecraft is to make societies even richer. To

what end, and with what effect on individual and social virtue, we no lon-
ger ask, and scarcely dare think about. Keynes was the last great economist
to hold economics in some sort of relation to the ‘good life.’ But already the
language available to him to talk about relationship sounded threadbare.
What, in fact, was the connection between being rich and being good?
(Skidelsky 1992, p. xxiii)
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:
Keynes tried to improve on Moore by detaching the question of what we

ought to do from conventional morality, and linking it instead to different
courses of action. Thus he tried to close the circle of reason. The theme of
his Treatise on Probability, at which he worked for eight years prior to 1914,
is that probability can be, and should be, the ‘guide of life.’ But Keynes’s
judgment of probability, no less than Moore’s ethical judgements, rest on
intuition. This attempt to ground moral reasoning in the judgement of
rational individuals breaks down when it becomes apparent that people’s
intuitions of goodness and right conduct differ, and there is no appeal out-
side the individual intuition by reference to which those differences might
be resolved. The result is moral disorder. (Skidelsky 1992, p. 517)
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
5 Knight’s Common Sense Philosophy

In the lecture mentioned at the beginning of this chapter, Stigler chal-
lenged his old teacher:
Knight kept referring to the objections to competitive results under any

“acceptable ethical system” but never told us what such a system contained
in the way of ethical content. His own specific judgments do not seem
compelling, as when he asserted that “no one contends that a bottle of old
wine is ethically worth as much as a barrel of flour.” Dear Professor Knight,
please forgive your renegade student, but I do so contend, if it was a splen-
did year for claret. (Stigler 2011, p. 166–7)
Knight would doubtless respond that this is not an ethical judgment

but a matter of taste. However, Stigler does raise the interesting question
of what in fact Knight proposed in terms of a solution. We have already
seen that Knight didn’t seek to offer a solution, essentially pre-empting
Stigler’s point. Rather than attempting a solution, Knight wanted to out-
line a “common sense” approach that would lead to dialogue about what
solutions there might be. He advocated what he believed to be a more
common sense approach to the problem, which is that people regard the
economic side of their life in what may be summed up by the phrase
“making a living.” Another common sense notion is that economics
involves making and spending money, or creating and using things which
have a money value. Knight also considered that people, unless in dire
need, do not think in terms of ultimate physical needs as ends. Arguing
more closely to the Greek ideal, he stated people live in order to act, and
seek to achieve what they consider to be worthwhile. In respect to class,
the life of the individual is logically prior to that of the group or class
they belong to. People when faced with a “real need” at the same time as
a sentimental consideration, will go for the latter rather than the former,
a reversal of a materialist reading. However, in examining this common
sense approach we see the departure Knight takes from his Chicago stu-
dents and the Austrian School.
He proposed that our reasons for wanting things, or to achieve eco-
nomic or social ends, however we might define these, come down largely
both to a desire to be like other people and the desire to be different,

however contradictory this may appear. Knight pointed out that, “The
higher one is in the economic scale, the more successful in doing what all
are trying to do, the larger is the proportion of his consumption which
tends to make him less, and not more, comfortable” (Knight 1935a,
p. 23). Though it can be argued that economically the richer one is the
less one consumes as a proportion of income, such a view he stated can
be tempered by the practical argument that some of the rich will expand
their consumption in line with income, whilst others will save more.
Knight’s point is more to do with the burden of wealth, and the sense
that the richer one is, the more “stuff” one has, the more there is to
worry about, hence making the rich feel less comfortable. Since the earli-
est thinkers, it has been posited that it is more satisfactory and economi-
cal to repress desire than to attempt to satisfy it. The test, however, is not
happiness. This is not what people want. Knight suggested people do not
want to live in a world where things run smoothly and carefree, and so
when things do get too comfortable we look for challenges, conflicts or
problems to solve. What people want, in, Knight’s view, is to strive for
life. He concluded that the notion of distinguishing between economic
and other wants must therefore be abandoned.
To define economics in this way, we should start from the ordinary
meaning of the verb to economize, which is to use resources wisely in
the achievement of given ends. This meaning meets with the traditions
of economic literature, is familiar to the economic person or the homo
economicus, and, underlies all economic behaviour. The homo economicus
is the individual, he said, who obeys some laws of conduct, and acts ratio-
nally to order conduct intelligently to achieve wants. The objections
raised to the notion of homo economicus are also sound in their own way,
in Knight’s view. He stated that such objections are reduced to a funda-
mental proposition that there is no such being as homo economicus, which
he said is literally true. People are not always rational, or necessarily even
know what they want, which are among the limitations that frustrate
the work of defining rational behaviour in the economy. Knight argued
the definition of economics must be revised to state that it deals with
conduct “in so far as conduct is amenable to scientific treatment, in so
far as it is controlled by definable conditions and can be reduced to law”
172 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
of game it is. Lastly, economic life is part of a bigger picture, and as an

impact on character we can see this only superficially, and in competi-
tion emulation and rivalry seem to be only a part of the issue. Hence, for
Knight, economic activity is at once a means of want-satisfaction, a field
of creative self-expression and a competitive sport.
Knight turned to his interest in individualism and laissez-faire, given
poignancy by our system of liberty and the “disappointing character” of
its practical outcomes. Knight accepted as sound Adam Smith’s notions
of a freely competitive organization of society as producing a social divi-
dend that rewards every participant. However, he is concerned this is not
a statement of a sound social ideal. The contest between individualism
and socialization centres on questions about the tendencies of competi-
tion, rather than the ethical significances if true. Knight argued that the
individualism assumed in the theory of competition is at odds with the
conditions of life, and “there are in the conditions of actual life no ethi-
cal implications of the kind commonly taken for granted as involved in
individualism in so far as it is possible of realization” (Knight 1935a,
p. 40). This is a matter for the economic theorist rather than the ethicist,
and for this reason it is essential to understand the assumptions of perfect
competition theory, which is the premise of pure economics.
Knight outlined a dozen presuppositions of the competitive system
(Knight 1935a, pp. 41–50), grounded in the postulates of theoretical
individualism, which discredits a policy of practical laissez-faire. First,
an individualistic competitive system must be made up of freely con-
tracting individuals, which is really “familism” as the family in Knight’s
view is the basic unit in production and consumption. Second, the fre-
est individual is in no real sense an ultimate unit or social datum, but
a product of the economic system and the cultural environment that
has formed their desires and needs, made them marketable, and controls
their opportunities. Free contract implies rationality but human activity
is largely impulsive, and Knight noted “there is truth in the allegation
that unregulated competition places a premium on deceit and corrup-
tion…and it must be conceded that the lines along which a competitive
economic order tends to form character are often far from being ethically
ideal” (Knight 1935a, p. 42). Third, effective competition calls for fluid-
ity and mobility of all goods and services entering into exchange. Fourth,
174 Frank H. Knight
a crucial prerequisite to perfect competition is complete knowledge on

the part of competing individuals in exchange for opportunities, yet the
market for most consumptive goods is very crude. Fifth, buyers know
the properties and powers of purchased goods and services to satisfy their
wants. Sixth, the results of intelligent action are the purposes to which it
is directed, and will be ethically ideal only if these ends are true values.
Seventh, free competition is limited by the fact there is not free access
to imperfect markets as they exist, and there is an egregious confusion
between freedom and free competition. More money can always be made
in combination, and under freedom only human nature stands in the
way of monopoly and has need of social recourse. “Competition edu-
cates” many groups “progressively for monopoly”, not just capitalists but
labour and other groups. The eighth point is that the wants and means
of satisfaction are individual. We want things because others have them
or cannot have them. Ninth, an exchange system cannot work based on
theory without a scientific unit to measure values. Tenth, the economic
organization of society must use productive power to provide for current
needs and future growth. Penultimately, all human planning and execu-
tion involve uncertainty, and social action could only be achieved if all
had a rational attitude toward risk and chance, but “the general human
proverbial attitude is irrational” (Knight 1935a, p. 46). Lastly, there is a
list of reasons under the heading of ethics of distribution which explain
why individualism cannot bring about a social ideal use of resources,
since “productive contribution can have little or no ethical significance
from the standpoint of absolute ethics” (Knight 1935a, p. 46) and there
is a tendency to confuse the standard of distribution they accept and the
outcome they disapprove, which includes the fact that the ownership of
productive capacity comes down to a complex mix of inheritance, luck
and effort.
Ultimately, the competitive system, as a want-satisfying mecha-
nism falls short of our highest ideals, and the market value, as price of
goods, diverges widely from ethical values. If we had a purely competi-
tive system, or even reduced the current scope of the social controls we
already have in society, then Knight believed we would be left with an
even more divergent state of affairs; as Knight said, giving people what
they want means corrupting popular taste. Having criticized both the
individualistic and socialistic approach, Knight concluded the problem

is finding the right balance between the individual and social interests,
and to use our findings wisely. Attention has already been drawn to the
notion of economic organization as a game, and Knight does explore this,
suggesting the desire for wealth takes on aspects of a game which makes it
an ethical consideration. He pondered what sort of game it is, noting that
it becomes akin to the existence of class levels in society, since the “ill-
paid masses” see it as an unfair game depriving them of a higher standard
of living, while the higher social class resents having to play the game,
since they are compelled to play it and they revolt against being judged
as a success or failure in these terms. To keep driving economic life we
need to keep the game interesting, and in this competitive game we find
three ethical ideals in conflict, namely: Distribution based on effort, giv-
ing the best player the best hand, and, fairness in the game. There is also a
conflict between liberty and equality, and, efficiency. Who wins becomes
a matter of three factors: Those with the ability to play, effort and luck.
However, Knight concluded:
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)
Knight concluded by questioning the moral value of competition,

especially in its game-playing form. We can ask, he suggests, whether
emulation is ethically good or not, and if success in contest is a noble
objective. In a game the greater virtue is to win, the lesser is to go out and
die gracefully after defeat. Given that economic production is a fascinat-
ing sport for leaders, and drudgery for the rest, Knight asked if competi-
tion is a matter of being goaded rather than lured. If the end of life is
about getting things done then the case for competition is strong, but
then we can ponder what things are to be done, leaving competition to be
selective but not in an exalted sense, just in terms of what works.
If we interpret life in terms of power then we can see how competitive
economics is justified. That is, if we are to accept an ethics of power as
the basis of our world view. There is here, Knight observed, a partial truth
176 Frank H. Knight
in the “economic interpretation” view he had attacked, insofar as the

system tends “to mould men’s minds in the channels which will justify
the system itself ” (Knight 1935a, p. 61). However, we are taught that the
connection between morality and power is not admirable, but perhaps
we should put away such “childish” things, such feeble-mindedness, in
our tough scientific age; and, logically Knight suggested, referring to the
advocates of economic interpretation, “they are inevitably right!” (Knight
1935a, p. 61). To close this discussion, Knight looked at historic ethical
theories used to address the problem of evaluating competition. He has
in mind here the ancient Greeks and Christianity. As we have seen, the
former is a happiness philosophy, with an ethical principal of the objec-
tive good. The latter, which he accepted may have many variations, has
a conception of good that is the antithesis of competition. Our modern
times, however, have separated the spiritual good, Greek and Christian,
from the drive toward efficiency, with spirituality being driven into a
smaller fraction of our daily reality. We will look at the religious dimen-
sion in Knight’s work in Chap. 10, so what remains to be looked at in his
discussion of ethics, is Knight’s underlying view of the human condition,
which also overlaps with his thinking on religion.
6 Knight and Original Sin

In practical terms, Knight would have accepted his former pupil’s assess-
ment of history, when Friedman contended:
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:
To understand our civilization, one must appreciate that the extended

order resulted not from human design or intention but spontaneously: it
arose from unintentionally conforming to certain traditional and largely

moral practices, many of which men tend to dislike, whose significance
they usually fail to understand, whose validity they cannot prove, and
which have nonetheless fairly rapidly spread by means of an evolutionary
selection – the comparative increase of population and wealth – of those
groups that happened to follow them. The unwitting, reluctant, even pain-
ful adoption of these practices kept these groups together, increased their
access to valuable information of all sorts, and enabled them to be ‘fruitful,
and multiply, and replenish the earth, and subdue it’ (Genesis 1:28). This
process is perhaps the least appreciated facet of human evolution. (Hayek
1988, p. 6)
This process appears to be Hayek’s employment of Smith’s “invisible

hand” at first glance, but in fact what he is saying is “economy happens.”
In other words, economic situations evolve in a process we cannot fully
control, the outcome of which we cannot fully predict.
Hayek’s notion of conceit may have been inspired by Adam Smith,
who wrote in the Theory of Moral Sentiments:
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
An unfortunate truth it may be, but the human condition, as

understood by Smith, Friedman Hayek and Knight, supports a prag-
matic economics, and free markets are the most effective because they
are based on what we are like, rather than based on what we think we
would like to be. It is for Knight a part of the human condition. He
may have echoed the idealism of the Greeks, but Knight also inherited a
negative Christian view of the human condition, as Robert H. Nelson,
writes:
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)
This points us to the Genesis biblical narrative, and suggests there is

an economic effect of original sin. As noted, his ethics and religious ideas
overlap, and we will return to Nelson’s argument in Chap. 10. In such
a view, the human condition is what stops us from having the planner’s
Garden of Eden, and instead banishes homo economicus to the harsh reali-
ties of the economic pursuit of gain. Thus we live in a brutish Hobbesian
state, and we need some curbs on how we organize ourselves economi-
cally. However, as Knight argued in his Laissez-faire essay, he is not an
anarchist, rather the question that he pondered was what limits on free-
dom should exist in society.
As Nelson explains:
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
behaviour in the world corresponds closely to the biblical understanding of
the consequences of original sin. (Nelson 2001, p. 14)
Perhaps at his most prophetic, Knight suggested the spirit of life in

the “Christian” nations, and the spirit of Christianity itself, are a case
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)
A key problem for critics of capitalism is the ethical basis of competi-

tion. Knight agreed that we cannot find a truly ethical basis for competi-
tion, which is its fundamental weakness in respect to ideal standards, an
argument that allows for comparison with any other possible system. In
orthodox economics what underlies the competitive system are the actual
desires of individual members of society, and competition is supposed
to effect, or tend towards, a comparison of these desires, to organize the
resources of society to satisfy them to the greatest possible magnitude. In
this exploration, Knight had sought to set limits on this tendency, and
we can explore this approach more fully by looking at how Knight under-
stood the problem of welfare.
Bibliography
Knight, Frank Hyneman. 1946. The sickness of liberal society. Ethics 56: 79–95.
Secondary Sources
Becker, Gary S. 1976. The economic approach to human behavior. Chicago:
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.
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.
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:
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

182 Frank H. Knight
allocation of resources. However, reality is not so ideal and free enterprise

does not in truth imply an ideal social order.
In America at the time, there had been two major movements that
Knight reacted to, namely progressivism and positivism. Progressivism,
which emerged in the late 1800s and lasted until America entered the
First World War, was a social movement that pushed for a number of
reforms, including antitrust laws, state and national income taxes,
increased business regulation, minimum wage law, direct election of U.S.
senators, the creation of the Federal Reserve System, and perhaps less
welcome, the prohibition laws on alcohol. Positivism was a philosophical
movement that drew sharp distinctions between scientific facts and val-
ues, and found its way into economics in the 1930s. Both the progressive
and positivist thinking of his era, and the confidence in science applied
to human social life, were not palatable to Knight, just as he did not wel-
come the notion of unfettered laissez-faire.
1 Knight’s Dissent on Welfare

Ross B. Emmett, in his essay Frank Knight’s Dissent from Progressive Social
Science (1998b) sets out what he sees as Knight’s twofold strategy, sug-
gesting “On the one side, he tried to isolate economic theory from criti-
cism by describing it as scientific. On the other side, he wanted social
discourse to be an open discussion in which members of society explored
together what the true, the good, and the beautiful could mean in the
modern world” (Emmett 1998a, b, p. 71). However, this was frustrated
in Emmett’s view because Knight was not optimistic that the language
of social control could be resisted, and he despaired of a post-liberal
society dominated by the tyranny of expertise. Following the interwar
period and subsequent events, Emmett concludes that Knight’s dissent
was “soured by his cynicism.” This is a fascinating appraisal of Knight,
and does reach deep into Knight’s psyche, and perhaps it is here on this
welfare issue that we can really come to terms with Knight’s approach to
economic and social thinking. There are, however, in looking at his views
more ways to typify his dissent beyond a souring by cynicism. To draw
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:
An act to provide for the general welfare by establishing a system of Federal

old-age benefits, and by enabling the several States to make more adequate
provision for aged persons, blind persons, dependent and crippled chil-
dren, maternal and child welfare, public health, and the administration of
their unemployment compensation laws; to establish a Social Security
Board; to raise revenue; and for other purposes.2
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
Administration and the Civilian Conservation Corps. The American

optimism of a new liberal internationalism in the era of Democratic
President Woodrow Wilson, had passed into the era of pragmatic and
domestic liberal reform of Democratic President Roosevelt, who won the
1932 election.3 In the midst of this change, the Great Depression and the
First World War had created an atmosphere of realism in some political
and intellectual circles.
There was a debate similar to the economic one to be found in the
field of political theory and international relations, and there are some
areas of political debate that deeply resonated with Knight’s economic
and political thinking, chiefly in what is called the school of classical
realism. Realism still dominates the thought and theory of international
relations, and is predicated upon an Augustinian predicament of human
society. The Augustinian view was one based on the impact of original
sin on humanity, and was part of the realist approach pioneered by Hans
Morganthau and others in the 1930s in the emergent field of interna-
tional relations, and its development ran in parallel with the time when
Knight was teaching and writing. Although a school of the 20th century,
realism is a way of thinking about international relations that draws deep
from history, going as far back as the ancient Greeks, in particular the
realist writings on power by Thucydides (c.460–400). Thucydides drew
attention to the natural existence of unequal power between political
states, and the need to act realistically and prudently in order to survive
by recognizing these limitations. The realist school is very diverse, but
all realist theories share roots in ideas about human nature and power,
in an approach similar to that of Knight. They all agree that power, and
nations competing for power, lie at the heart of understanding inter-
national relations within this anarchic system4 of nations. Critics sug-
gest there is a pessimism and cynicism to the classical realists; illustrated
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.
by the term “Machiavellian” as defining a cynical and manipulative use

of power. Indeed Machiavelli is a member of the realist hall of fame,
alongside an historical range of thinkers: Thucydides, Thomas Hobbes,
Martin Luther, Max Weber, and E.H Carr. Realists would respond that
it is just being realistic about people and organizations, ‘telling it like it
is.’ In other words, realists would argue that they deal with the world as
it is rather than as they would like it to be, just as Knight was doing in
economics.
Realists share Knight’s somewhat pessimistic assumption about the
limitations of human nature, often portrayed, as stated, in an Augustinian
view of humanity that shares a pessimistic view of what humanity is truly
capable of achieving. Lest one should think realists are here taking a
step in the direction of moralism or endorsing a theological view, given
their Augustinian view of human nature, it is important to note that this
sense of the negativity of human nature plays out in a non-theological
sense. In other words, the realists have their own form of “original sin.”
Kenneth Waltz (1979, p. 186) sums up this view rather neatly when he
writes, “The web of social and political life is spun out of inclinations and
incentives, deterrent threats and punishments. Eliminate the latter two,
and the ordering of society depends entirely on the former – a utopian
thought impractical this side of Eden.” We are social beings paradoxi-
cally acting in our self-interest, which in politics results in the assertion
of power. The ontological assumption is that we are at heart egoists, and
this trumps altruism. The sense of being this side of Eden and the secular
sense of original sin, find great resonance in Knight’s work.
One key figure in realism, and a contemporaneous figure that more
closely parallels Knight’s position, is the theologian Reinhold Niebuhr;
Knight’s life spanned 1885 to 1972. Dubbed “the Cold War theolo-
gian,” Niebuhr spoke to American power and called for a curb on its
power. Politically, Niebuhr was a contrast to Knight, since he was a
liberal whose politics were always left of centre, firstly becoming rad-
ically left and Marxist before swinging back to settle left of centre.
His politics, and his belief in political action, were forged in his time
working as a pastor in Detroit, especially engaging with car workers at
the Henry T. Ford factory, from 1915 to 1928; a period described in
186 Frank H. Knight
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)
Both thinkers had ethical concerns with respect to capitalism, but

the anvil on which Niebuhr hammered out his criticisms of liberal
illusions was quite different to Knight. Niebuhr’s assault led him to be
critical of the optimism in liberalism, and the progressive view of his-
tory, offering what Robert Song calls a “chastened progressivism” (Song
1997, p. 4). Song’s “chastened progressivism” is a term that could also
be applied to Knight, but perhaps adapted to refer to his “chastened
liberalism.”
2 Welfare and Social Limits

In his essay Laissez-faire: Pro and Con, Knight studied Hayek and
explained that laissez-faire simply meant economic freedom or “freedom
of economic conduct from dictation by government,” and the relationship
between laissez-faire and government control, cannot arise outside of an
economic and political order operating under market conditions. Knight
argued it is absurd to draw strict battle lines between laissez-faire and
“planning.” He explained that humans are social animals, and social life
sets many limits to freedom, and this includes social and welfare issues. In
advancing his thinking about welfare, Knight attacked what he saw as the
“literary field” of laissez-faire, singling out Hayek’s Constitution of Liberty
and Henry Hazlitt’s Foundations of Morality, giving more attention to the
former, and for the purposes here we shall only look at Knight’s view of
Hayek. Welfare became another area where we see some acute differences
in approach between Hayek and Knight, perhaps another crusade for
Hayek to flag. Hayek was deeply concerned by collectivism, and attacked
the collectivism of Auguste Comte, which he put under the same head-
ing of scientism as the historism of Gustav von Schmoller, in his two-part
Essay, Scientism and the Study of Society (1942, 1943). Hayek pointed
out the subjectivism of social science compared to physical sciences, and
questioned the assumption of treating as a whole both society and capi-
talism as though they were pre-existent matter, instead of the basis for
choosing and constituting a model of “wholes,” which social scientists
attempt to construct from familiar elements. These “wholes” are likewise
the basis of the mythical concepts utilized by the historical school to
derive theories of how social “wholes” such as “capitalism” or “imperial-
ism” are bound together in stages or events.
Recognizing Hayek’s “imposing work of historical scholarship,” Knight
criticized him for focusing too narrowly on the rule of law, ignoring the
crucial events that led to or constituted the liberal revolution, establish-
ing a free society and democracy. Hayek also ignores church power, the
reformation and religious toleration, which Knight concluded demon-
strates that Hayek was “scornful of politically organized freedom.” Also
absurd, in Knight’s view, is Hayek’s treatment of equality, which relies on
188 Frank H. Knight
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).
3 The Challenge of the New Welfare

Economics
The standard work of reference on welfare in the interwar years was
Pigou’s The Economics of Welfare (1920), which is usually associated with
the 1930s controversy5 over the interpersonal comparisons of utility as a
general approach to welfare. Pigou offered two criteria to show improve-
ment in social welfare: First, an increase in the national dividend without
any increase in the supply of factors, and second, a transfer of wealth from
the rich to the poor. The 1930s welfare debate started by Lionel Robbins
with his essay An Essay on the Nature and Significance of Economic Science
(1932), building on the subjective-value foundation laid by von Mises,6
where Robbins contended there was no scientific basis for welfare, and
rejected the idea of making social welfare judgments on the basis of inter-
personal comparisons of utility. Robbins admitted such interpersonal
comparisons were in the popular mind, but it is not the business of the
economist to argue this way. Robbins explained:
Economics is not concerned with ends as such. It assumes that human

beings have ends in the same sense that they have tendencies to conduct
which can be defined and understood, and it asks how their progress
towards their objectives is conditioned by the scarcity of means…The ends
may be noble or they may be base. Economics takes all ends for granted.
(Robbins 1932, pp. 23–24)
Robbins advanced the “new welfare economics,” along with Oscar

Lange, and some of Robbins’s younger colleagues at the London School of
Economics, including J.R. Hicks and Nicholas Kaldor.7 This new welfare
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
approach used the concept of “Pareto efficiency” or “Pareto optimality,” a

term coined by Ian Little8 meaning it is not possible to make one person
better off without making someone else worse off, to explain the condi-
tions to be met if the Pareto conditions9 were to be satisfied. Schumpeter
had referred to Pareto as “the patron saint of the New Welfare Economics”
(Schumpeter 1949, p. 163). Pareto’s views on compensation were basically
stated in just two paragraphs of a 1894 article,10 where he argued, it is pos-
sible, by means of lump sum intra-household transfers to make all house-
holds better off, thus providing a scheme of lump sum compensation
which brings about a Pareto improvement. Kaldor and Hicks took this
a step further with what they called a “compensation test,” which meant
that if the gainers could potentially compensate the losers while remaining
better off then there would be a social benefit, and there would be a Pareto
improvement, and hence the Pareto Rule can be used to judge movements
toward the satisfaction of the optimal conditions. Kaldor explained:
In all cases, therefore, where a certain policy leads to an increase in physical

productivity, and thus of aggregate real income, the economist’s case for the
policy is quite unaffected by the question of the comparability of individ-
ual satisfactions; since in all such cases it is possible to make everybody
better off than before, or at any rate to make some people better off with-
out making anybody worse off. There is no need for the economist to
prove – as indeed he never could prove – that as a result of the adoption of
a certain measure nobody in the community is going to suffer. In order to
establish his case, it is quite sufficient for him to show that even if all those
who suffer as a result are fully compensated for their loss, the rest of the
community will still be better off than before. (Kaldor 1939, p. 551)
While J.R. Hicks explained in Value and Capital:
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.
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)
The Kaldor-Hicks argument was seen as a way of separating issues

of efficient use of resources from those of income distribution. Kaldor
argued:
it is quite impossible to decide on economic grounds what particular pat-

tern of income-distribution maximizes social welfare. If the postulate of
equal capacity for satisfaction is employed as a criterion, the conclusion
inescapably follows that welfare is necessarily greatest when there is com-
plete equality; yet one certainly cannot exclude the possibility of everybody
being happier when there is some degree of inequality than under a regime
of necessary and complete equality. (Kaldor 1939, p. 551)
However, in 1941, Tibor Scitovsky (1941) exposed the Kaldor-Hicks

compensation as a fallacy. He demonstrated that there are easy examples
where compensation tests would be satisfied in both directions, and thus
the test gives contradictory results. Essentially, he argued, the compensa-
tion tests did not in practice provide any better answer than the Pareto
principle.
Building on Bergson (1938), Paul Samuelson (1947) advanced the
new welfare economics approach in the 1940s, and looked at how real
192 Frank H. Knight
national income can be connected to the welfare of society, but challenged

egalitarian approaches. He argued that the old welfare economists’ appe-
tite for income equality was “a fetish or shibboleth, albeit a useful one,
in that the means becomes the end, and the letter of the law takes prece-
dence over the spirit.” Such welfare views fail because “it is easy to show
that the rule of equality of income... Applied to individuals of different
tastes... Is actually inconsistent with any determinate, definite [social wel-
fare] function” (Samuelson 1947, p. 225). Samuelson went on to explain
that he did not accept “the bourgeois penchant for laissez-faire…the only
case on record where a substantial number of individuals have made idols
of partial derivatives, i.e., imputed marginal productivities” (Samuelson
1947, p. 225). He opposed “the belief that the individual should right-
fully receive his imputed productivities,” which is “not consistent with a
[social welfare] function having properties” (Samuelson 1947, p. 225).
Bergson and Samuelson introduced an external ethical norm in the form
of a social welfare function. Bergson explained how the different forms
of ethical premises could be implemented through the concept of social
welfare functions, and how these different norms could be reflected in
economic outcomes. Samuelson then posited a social welfare function
which is dependent upon the welfare each individual obtains from the
amounts of all goods and services they receive. He then asserted that
such a social welfare function is “only ordinally determinable” but can
be subject to all mathematical operations (e.g., aggregation of individual
utilities and differentiation) by assigning arbitrary cardinal numbers to
each ordinal rank (Samuelson 1947, pp. 228–29).
The new welfare thinkers viewed the old welfarists as ethicists who
were advancing their own, mainly egalitarian, ethical views rather than
being value-free economists, and years later, Samuelson reflecting on the
debate in an interview, suggested that the new welfarists did not advance
the argument very far:
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
“new” welfare economics of the compensationist school is not really that

new. In the second place, there is a great ambiguity as to whether the fact
that gainers would be capable of compensating the losers, yet do not actu-
ally pay compensations, has any significance. (Suzumura 2005, p. 8)
4 Welfare, Choice and Freedom

What the new welfare economists didn’t do was to say much about imple-
menting a social plan after one has been selected, and this brings in the
question of public choice central to Knight’s concerns, since the practical
outcome of bringing social choice and policy implementation together
raises questions of what is socially optimal and how to deal in practice
with conflicting values. Knight’s understanding of welfare, as he stated in
his review of Myint’s Theories of Welfare Economics (1948) is that welfare
is about freedom, positively in terms of its promotion and protection or
negatively in its limitation in favour of other values. We can find a more
recent advocate of the relationship between freedom and welfare in the
Nobel-winning economist Amartya Sen, who offered the following view
of the market that, would strike a chord with Knight:
To be generically against markets would be as odd as being generically

against conversations between people (even though some conversations are
clearly foul and cause problems for others – or even for the conversational-
ists themselves.) The freedom to exchange words, goods or gifts doesn’t
need defensive justification in terms of their favorable but distant effects;
they are a part of the way human beings in society live and interact with
each other (unless stopped by regulation or fiat). (Sen 1999, p. 6)
Where Knight explored the relationship of freedom generally, Sen

focuses primarily on freedom in the context of global development eco-
nomics, an area Knight did not focus on, in part because poverty in
places far away from Chicago, and in the West generally at the time, was
not on the agenda. Sen sees freedom as the end and means of advancing
development, because like Knight he sees the advance of freedom as the
194 Frank H. Knight
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:
The assumption of the materialistic, or economic, or biological interpreta-

tion of conduct is that when men must choose between some “real need”
and a sentimental consideration they will take the former. The truth is that
when the issue is drawn they typically take the former. For any practical
social purpose, beauty, play, conventionality, and the gratification of all
sorts of “vanities” are more “necessary” than food and shelter. (Knight
1933a, p. 20)
However, Myint saw a problem with Knight’s analysis, despite acknowl-

edging that Knight had undertaken the important task of pointing out
the limitations of the conventional assumption of given wants. Myint
suggested Knight, and J.M. Clark, have erred in the other direction: “If
wants are not sufficiently stable to be treated as data in some sense by the
economist, then they will not be stable enough to be treated as data by
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
an abstract term covering everything which men do actually (provisionally)

want. The only other important economic law of conduct, the law of
diminishing utility, is almost as abstract; its objective is covered by the
statement that men strive to distribute income in some way most satisfac-
tory to the person at the time among an indefinite number of wants and
means of satisfaction rather than to concentrate upon one or few. (Knight
1933a, p. 28)
Again, this has nothing to do with content. To understand concrete

content one must, Knight urged, study biology, social psychology, and
especially cultural history, not economic theory. This poses the question
of ethics and welfare, since economic science is abstract conduct, and
concrete conduct takes place in history.
In Knight’s critical book review of Myint’s Theories of Welfare Economics,
he also asserted the role of freedom as core to any discussion of welfare,
and the extent to which a mechanically perfect system of markets is a
social ideal in an ethical sense. Knight points out that consumption is
a form or field of associative life, whereby an attempt is made to mea-
sure personal relationships by a number, measured in terms of money or
wealth. Related to this are our “play” interests in which concrete ends are
pursued instrumentally, to which Knight added “The assumption that
production is merely a means to consumption is correct for theoreti-
cal economics but needs drastic qualification and supplementing for any
inclusive account of conduct and especially of its human values or “wel-
fare.” This notion of play is related to freedom, a fact presupposed in the
idea of economy, and free activity involves “wanting wants” and using
productive capacity to cultivate tastes and appreciations, as well as want-
ing capacities in all forms of power” (Knight 1933a, p. 222).
Knight continued, “Modern economics grew up in a society accept-
ing – with important restrictions – the ideal of individual freedom
and – with important limitations – constituted on that pattern” (Knight
1933a, p. 223). Modern economics assumes as scientific postulates the
economic behaviour of individuals, in truth families, and a mechanically
perfect system of markets, the latter being a social ideal in an ethical sense.
Hence, Knight said “Any discussion of welfare must begin by raising the
question as to how far and in what sense it is such an ideal” (Knight
1933a, p. 224), which is done by contrasting with other (“realistically

conceivable” or “possible”) systems of social order, thereby raising great
difficulties, in part because the alternative to the open-market system is a
regime based on central authority, meaning at best a majority tyranny to
some degree. Knight concluded:
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
demand for luxury and secondary goods, where consumer demand is

very unstable. Myint urged:
While discussing the instability of demand for luxury products, however,

we should not forget that even in this so-called age of plenty there still
remains the larger section of the world population who have not even satis-
fied their wants for bare necessities, and in a balanced view of human
nature the wants of these people must command our foremost attention.
There is thus still a very large scope for a welfare economics based on the
assumption of given wants. (Myint 1948, p. 213)
What we need to avoid is the move towards value judgments, but

this is central to welfare economics, because of the values assumed as
Myint explained them. It is difficult to get to the level of ethical neutrality
Knight sought by confining himself to human wants, and not the con-
crete content of these wants. Myint argued that Knight offered “a broader
welfare economics” (Myint 1948, p. 10), not based on a narrow view
of uncertainty but on methodological difficulties, which Stephen John
Nash (1998) captures as the starting point for something new, which is a
broader understanding of social welfare. Citing Myint, Nash claims that
Knight’s major contribution to economic theory was “the establishment
of an alternative theory of welfare economics” (Nash 1998, p. 2). Nash
argues Knight understood the social welfare function as “an aggregate
measure of national, or social, well-being” (Nash 1998, p. 2).
Ronald Coase (1960), along with Knight, argued that problems of
welfare economics ultimately dissolve into a study of aesthetics and
morals. We see this most clearly in Knight’s case in his Intelligence and
Democratic Action, but perhaps this was unrecognized because his think-
ing fell under the rubric of social philosophy, and this work is the most
philosophical of all his output. In these lectures, Knight arguably has
a larger philosophical point to make about welfare in society, but rule-
making or centralized control is not the way to improve welfare, sug-
gesting the welfare state is not the answer for a society that takes welfare
seriously. His approach, however, may appear too high level for some,
since he doesn’t bring it down to the policy level, except perhaps to advo-
cate the broad principle that a social contract entails a balance between
rules and rules applied responsibly by government administrators. The

economy is a system of free relations, and is free largely because it is
impersonal; while government is infinitely less free, because people must
agree on laws but do not do so completely. At best, he suggested, govern-
ment is a matter of the majority dictating to the minority, and Knight
summed up his scepticism about the high ideals of government when he
stated, there is “much moonshine in the talk about democracy” (Knight
1960, p. 115). He challenged the romance of government by laws, stating
government is by people according to laws, which are made by people for
people. A weakness he saw in the freedom of individuals is that we are all
born into a family line and into a state, neither of which we choose, we
are members by compulsion, which is something he said once applied to
the church and still applied to some other organizations, most notably
trade unions. To which he added, in parenthesis as he frames it, there is
the matter of distinguishing between being free and feeling free. He cast
doubt on Thomas Jefferson’s statement that we are all born equal, saying
it simply has no meaning, since in fact we are largely a product of social
processes and culture.
6 The Knightian Pyramid

To relate Knight’s understanding of social contract to the question of
welfare, it may be helpful to look at what Nash (1998) presents as the
‘Knightian pyramid.’ Nash argues that Knight conceives of a ‘social wel-
fare function’ comprised of three components, namely economic free-
dom, the balance of economic power, and economic efficiency. These
three components Nash states are held in tension with each other, and
“well-meaning attempts to increase welfare, eventually cause unintended
reductions in welfare” (Nash 1998, p. 43). An imbalance of economic
power impacts the other two components and ultimately such conflict
may break the free market system. Indeed, this would be Knight’s riposte
to Myint, that the welfare economist does not take seriously enough the
nature of conflict. Finally, Nash suggests the last feature of this Knightian
pyramid is the way it helps us to sharpen our perceptions of the overall
200 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)
Hence the inequality of which Knight writes in the above passage is

passed on to the next generation, in a major part by inheritance of prop-
erty. Inequality means an unequal start in life, which he states is “palpably
unfair.”
It is easy to get lost in the weeds of when Knight is being an economist
and when he is being a social philosopher, and a more unified view of his
thought is required. Nash and other critics attempt to do this by getting
to the economic thinking of Knight and keeping it linked to his social
thought, seeing them as parts of a whole, and their contribution is an
important one. We can trace Knight’s public discourse to his first publi-
cation Risk, Uncertainty and Profit, where he set out economic theory in
its relation to scientific thought, and introduced uncertainty and human
action to the heart of why scientific progress applied to human prob-
lems cannot solve the social problem, as he later framed the question. He
refused to separate theory from reality, the former having its value only in
relation to the latter. Hence socialism, as a scientific theory, had limited
value for Knight. Human beings are not wholly predictable or reliable,
and so human society cannot be run as if they are. The other key aspect
for Knight is that human life is ultimately about seeking values, and
on this point various individuals and groups will disagree on what it is
they value most. As human beings we live in tension between our needs,
desires and values, and the needs, desires and values of others. This makes
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
the balance of economic power, and economic efficiency” (Nash 1998,

p. 161). Nash adds,
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)
Nash interestingly uses this opportunity to challenge the separation of

Knight the economist from Knight the philosopher, and to offer a more
integrated perspective of his view. If we focus on one dimension, we lose
the import of the other dimension of his thought. In this, he disagrees
with Emmett’s analysis of Knight as offering a running commentary on
the changing ideological context. Nash raises an important debate, but
it is not clear that there is that much of a disagreement with Emmett in
fact. Emmett (2005) offers a more nuanced viewed than that assessed by
Nash, in the context of Knight’s engagement with Weber. Here Emmett
refers to a view of Knight that gradually percolated through his many
writings, suggesting that we need to understand the pluralist context
in which Knight was working, and also to focus on understanding how
Knight used resources at his disposal to address specific debates. In this
way we can see how Knight’s engagement in these various debates altered
his viewpoint. Emmett makes a very important summary point about
Knight’s work when he argues that Knight was primarily concerned
with articulating a social science, and with understanding how scientific
knowledge could be used to better the human lot in a world of uncer-
tainty where people are free and creative, while at the same time sci-
ence and culture can constrain us and determine much of what we do.
Max Weber offered Knight a way of escaping “the intellectual morass of
American social thought” (Emmett 2009, p. 103) Emmett suggests. In
this analysis, Emmett does seem to tie the strands together and offers a
more comprehensive picture of Knight than suggested by the earlier criti-
cism of Nash.
Knight refused to separate the intellectual from the moral pursuit of

understanding society, nor could he accept there was a way of having
widespread agreement on the goals of social policy. He does not agree
with the idea that social and economic thinking can achieve the best ends
for society. The problem we face in social policy-making is one of values,
not of facts, he argued, and social problems arise through conflict caused
by the mere assertion of opposite claims. In a market society, a price
theory amounts to a value theory because price is the means by which we
arrive at agreement between individuals in exchange. Yet, we have higher
wants and goals of conduct with which to test our values, rather than
simply having a system that accepts and satisfies wants. Again, we see in
this analysis how Knight uses his “economics” and “social philosophy”
combined to help us understand the human predicament. If we simply
look at the competitive system as a wants-satisfying system, then we will
see into a mirror that reflects back who we are rather than what are our
highest ideals. Knight argued that the social order we have may gratify
us, but it also shapes our wants, and hence our system must be judged
ethically by the type of character it encourages and forges in the people
within this social order, since giving the public what it wants “usually
means corrupting popular tastes” (Knight 1935a, p. 49). The problem
emerges, however, that price is the measure of efficiency and reflects what
the people really want, through their free choice in the market, yet it
also means corrupting public taste. Who is to say what is in good taste?
Is this not simply liberal elitism? Emmett, following Buchanan, doubts
that Knight really gets to the heart of the tension of values in liberalism,
but he does make the useful point that “The tension between the two
concepts of value theory within Knight’s work may frustrate the reader’s
desire for a coherent account of economics and its relation to ethics, but
it also entices the reader to think more deeply about the problems of
economic organization” (Emmett 2009, p. 102).
Emmett, Nash, and others are not the first to make the connection,
though there is ingenuity in the way they have established the link.
Nelson also draws deeply on the moral undercurrent of Knight’s thought
and as Thomas R. DeGregori (1987) succinctly sums up Knight, in his
useful essay comparing Knight’s views to those of contemporary Clarence
E. Ayres: “Knight seeks to have people be moral and change themselves
204 Frank H. Knight
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.
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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

208 Frank H. Knight
free markets, because the mechanisms of democratic political activity

allowed for the coordination of individual interests in collective decisions
in a manner similar to the coordination of individual choices by the mar-
ket. Given the centrality of the tension between the two sides of value
theory in his exploration of the market system, it is not surprising that the
same tension emerged as a dominant theme in his exploration of liberal
democracy. (Emmett 2009, p. 105)
Put plainly, for Knight economics is about freedom. Knight’s essays in

Freedom and Reform were collected and published in 1947, essentially as
a sequel to the 1935 The Ethics of Competition, and again on the initiative
of some of his former students. The major theme of the work, as the title
implies, is freedom, but the reference to reform makes this very much a
Knightian expedition, as he sought to mount an attack on any superficial
grasp of freedom, and root it in some deep economic and philosophical
soil. He supports the market, whilst accepting the significant challenges
faced by capitalism in respect to morality and equality. Many aspects of
inequality in the Knightian view have been dealt with in the previous
chapter in relation to welfare, but we do not get the full picture until we
fully consider Knight’s view of freedom. For Knight, inequality is an inev-
itable outcome of freedom, even if at times it leads to unfortunate out-
comes for some people. The past is very much a foreign land in Knight’s
view, making freedom an “historical anomaly. A few generations ago the
opposite was the case; conformity and obedience were moral norms of
social life” (Knight 1960, p. 112). Complaints about inequalities, big
business and monopolies are for Knight borne out of a romanticism, and
he argued this is not the way to face up to the real economic problems we
face, though he is by no means denies the seriousness of the problems that
exist. What is essential for Knight is that such romantics need to see free-
dom as the core sentiment, if we are fully to understand economic society.
1 Freedom and Social Power

Freedom has become a core value in the modern world, but it is also
somewhat in the eye of the beholder, for which reason Knight, whilst
trying to avoid dogmatism, felt it was essential to give it more definition.
He also wanted to link freedom clearly to power, which in turn is a limi-

tation on freedom. The dynamics of economic power that Knight out-
lines can lead, in his view, to a problematic concentration of economic
power. Knight stated, “Freedom, particularly economic freedom, has to
be restricted by rules, made and enforced as law by social agencies acting
on behalf of the general interest” (Knight 1960, p. 113). The alternative
is collusion, which limits freedom and creates monopoly. While freedom
has become a core notion of modern capitalism and the free market econ-
omy, Knight offered a very different view from that offered by his former
pupil Friedman in his classic libertarian work Capitalism and Freedom
(1962). Especially in access to the means of economic power, Knight
pondered how many of us are in fact truly free. It is an idealization rather
than a daily reality for the vast majority of economic people, as Knight
wrote:
Where incomes range from nothing up to tens of millions of dollars per

year, it is idle to prate of equality, and the concentration of pecuniary
power amounts in fact to the disinheritance and disenfranchisement of the
great masses of people.1
The answer to the conundrum, however, is not government control of

the economy. To the extent that the economy in reality works according
to theory, Knight argued it is a system of free relations, and it is largely
free because it is impersonal in nature, while as we have seen Knight
believed:
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 )
Here we see Knight sitting between a Chicago suspicion of govern-

ment and a Keynesian support of government. Knight had recognized
a dimension of limitation that is at odds with the views of the Chicago
school and libertarianism, though he is far from the Keynesian view
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
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:
…the tendency of freedom to eventuate in monopoly rather than competi-

tion, the fact that bargains between individuals usually have effects, good
or bad, for persons other than the immediate parties, the further fact that
many wants like culture and a beautiful environment must practically be
provided for on a local group basis of all, etc. (Knight 1947, p. 7)
Knight accepted that notions of economic efficiency, which incorpo-

rate ideals of perfect competition, often merely serve to reinforce social
injustice. In a free social-economic system there is ironically more of a
presumption that it will move away, rather than toward, fundamental
human equality. To grasp this, what needs to be understood philosophi-
cally is the problem of what we mean by free activity. First, with respect
to the individual in the private sphere, and second, to social behaviour
and its relation to free mutual consent.
To delve deeper, it is helpful to follow a very useful of Knight’s view of
economic freedom offered by an American economist Richard A. Gonce,
which he says comprises fourteen parts (Gonce 1992, p. 819f ). The first
set of points made by Gonce draw on Knight’s philosophical understand-
ing of the subject of freedom, namely the individual, who seeks self-real-
ization. Hence, economic freedom is predicated on a subject, defined in
philosophical rather than economic terms, and this freedom the indi-
vidual pursues is limited by “internal” or “metaphysical” freedom. The
individual is a self who has a degree of rationality, and acts directed by
rational ideas and in conformance to rational laws. In society, the indi-
vidual may have external or social freedom, but this is not according to
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
being confused. He distinguished “freedom to” and “freedom from,” not-

ing that freedom is something possessed, and it must have content if it is
to be effective.
However, in Knight’s discussion of freedom, including his reference
to total freedom, he did not answer the question of economic inequality
as an aggregate. Instead, he kept mainly to individual economic rela-
tionships and the freedom from coercion between individuals in soci-
ety. How this all works out in an aggregated economy, as Gonce rightly
highlights, is not a problem Knight attempted to resolve. The last prob-
lem Gonce poses is whether “effective” economic freedom has an empiri-
cal and measurable point of reference. He cites a possible answer from
Knight’s Intelligence and Democratic Action, where Knight offered what
Gonce called a “crude surrogate” when he wrote “The practical issue is
the alternatives open, the conditions under which one chooses.” Gonce
concluded, “All told, Knight’s definition of economic freedom is a vari-
ant of the positive conception of freedom. He begins with a spiritual,
personal self with some autonomy and rationality in the quest for self-
realization. To this subject he predicates internal freedom and external or
social freedom under juristic law” (Gonce 1972, p. 145).
Because freedom is ultimately a matter of power, it may be that not
being able to get something is not necessarily a matter of a deprivation of
freedom, but a deprivation of power. Knight argued:
The “wrongs” on grounds of which social organization or policy is to be

criticized undoubtedly have the character of inequitable distribution of
power rather than unethical coercion or interference with the use of power.
But for neither sorts of wrongs is the notion of freedom a criterion by
which definition or identification is possible. (Knight 1947, p. 15)
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
purview of the statesman or politician. In the second place Knight pro-

posed, “the representative common-man is a better final authority on
issues involving the weighing of basic values, than any individual whom
there is a feasible way of selecting” (Knight 1960, p. 122).
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:
For most present-day economists, the primary purpose of their study is to

increase our knowledge of the workings of the enterprise and other eco-
nomic systems. For Knight, the primary role of economic theory is rather
216 Frank H. Knight
different: it is to contribute to the understanding of how by consensus

based upon rational discussion we can fashion [a] liberal society in which
individual freedom is preserved and a satisfactory economic performance
achieved. This vast social undertaking allows only a small role for the econ-
omist, and that role requires only a correct understanding of the central
core of value theory. (Stigler 1987, p. 58)
As Stigler makes clear, value was central to how Knight understood

human social organization, and thus freedom. However, Knight also
thought the term ‘value’ attracts a host of interpretations, and is often used
in a way that confounds us. Life is not simply about means, but also how
we value our wants and how we seek a higher sense of what we value.
Knight believed we strive for a higher goal of conduct that tests and tries
our values, which are more simply stated as interests, in a way that seeks to
define and improve them, rather than being wants or needs that are “satis-
fied.” It is these values that tie us to an ethical understanding, and Knight
firmly believed that the ultimate object of economic theorizing is to cri-
tique in ethical and human terms how the economic system works, which
thus makes a theory of value and price indispensable. This means that ulti-
mately in a market-based society, price theory is value theory, since price
is fundamental to the coordination of human activity and interests, which
means our wants and values. Knight believed the price system was the most
effective mechanism at our disposal to negotiate different interests, needs
and wants. The individual strives not just to satisfy wants, but strives after
more and better wants in a market system that falls short of our ideals.
In coming to the market individuals are not uniform, and the market
imperfections allow for the coercive power of the stronger party to be
exerted over the weaker party. Hence, the liberal principle of free mutual
relations needs to be reconsidered. Bargaining power is a core concept
here. Knight notes that market dealings leave many interests unprotected
on the one hand, and fail to give effective expression to other interests, a
fact which he says calls for a need to have a compulsory coordination of
activities through inclusive group organization. As a further note of cau-
tion, Knight wrote in the conclusion of his essay Laissez-faire: pros and
cons, while we are made to be free, this should not be made “the” truth.
More nuance is needed, according to Knight:
Exchange is free by definition, but unlimited market freedom would have

“intolerable” consequence, as is shown both by general reasoning and by
historical experience. Ideal enterprise and democracy both imply co-
operation, but with human nature and conditions as they are, not at all
necessarily fair co-operation or to the general advantage, individual or
social. The major fact omitted in individualistic analysis is simply “compe-
tition.” Rivalry has no place in the general theory of either economics or
politics, but is in fact a major motive in both fields because it is a major fact
of human nature. Man is a contentious being, antisocial as well as social….
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…. The most one can say for freedom is that there is a presumption
in its favor unless there is sufficient ground for believing that coercive
action will yield a better result in a particular situation. But the antisocial
side of human nature must be taken into account in any serious and intel-
ligent discussion of economic policy. (Knight 1967, p. 795)
Again, Knight sought to demonstrate how economic principles are

limited by reality and the human condition. In economic terms, the eco-
nomic individual is a composite of three factors, namely wants, physical
capacities useable in satisfying wants, and knowledge of the processes in
which want-satisfying services, or production, are rendered. Hence, the
economic problem is not primarily one of means, but one of value, as
the individual seeks to know and realize what “better wants” consists of.
Equally, a naïve faith in the power and benevolence of non-political and
non-legal social forces, which is presupposed in laissez-faire individual-
ism, has to be questioned in connection to the three basic economic fac-
tors (land, labour and capital), specifically in respect to the individual,
especially in terms of the productive capacity divided into the individ-
ual physical and mental endowment, and, earning power as vested in
property.
If we look more deeply into property, Knight defined this as the power
to render saleable service in a form that is itself saleable or exchangeable.
It is partly for this reason he argues that socialism would not substantially
change anything. The socialist ends and means argument he responds to
in part by highlighting that the means of enjoyment is not about a stock
of goods, but a stream of total production and its division into streams
218 Frank H. Knight
flowing to the consumers individually, which is worked out through

money income secured through the continuous offer in exchange of
productive services. Productive resources are not a matter of quantity in
terms of amounts but of kinds, so that one can only think of it quanti-
tatively through the pricing process. The fixing of price, with different
producers in the stream, is a matter of demand and supply or reciprocal
supply, and hence scarcity. Individual income is determined by being in
a position to render services for which consumers can and will pay large
amounts, and services of a type no others are prepared to offer. How
far the principle of freedom goes in justifying differences in incomes is
answered by how far people are truly free to render a larger amount of
a given service, a service more in demand, or scarcer services as a matter
of voluntary choice. His answer is that it does not take us very far, as it
is a matter of difference in power, whereby the social-total of income is
a matter of market forces and not of right, and inequalities in income
overwhelmingly reduce rather than increase total satisfaction.
Existing capacities to render a service, which includes ownership and
wealth, are a result of how the economic process has worked in the past,
and economic power not only produces satisfaction-yielding goods, but
also reproduces itself, which in turn means there is a powerful tendency,
argued Knight, for inequality to increase cumulatively and compound
at an enormous rate. This means that economic power is therefore also
a matter of inheritance and uncertainty. The former is a mere brute fact,
which is hard to associate ethically with any sense of equal freedom or
any personal merit. The latter is harder to reduce to formal principles,
but is based on being unpredictable, and as such the maintenance or
increase of productive capacity is to a fair extent a matter of luck, as
well as the success or failure of choices made. Thus Knight takes the
step of suggesting, in ethical terms at least, that the three productive fac-
tors usually organized in the three classes of land, labour and capital can
be more significantly analyzed in terms of effort, inheritance and luck,
and as Knight quipped “the greatest of these is luck!” (Knight 1982,
p. 13). The matter of exchange is thereby a matter of what one brings to
the exchange, which is ultimately for him a question of fact, and not of
ethics.
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)
Freedom is the freedom to act to change events, in other words the

freedom to use power towards this end. This lies at the heart of how
Knight connected the question of freedom to ethics, which he traced
back to how utilitarianism as an ethical approach was dominated by
economists. Freedom is not the old metaphysical matter of free will, nor
can one speak of coercion, since no human being can “force” another
to do something per se, and Knight noted it is interesting that when an
offer is made to improve one’s condition, instead of worsening it, we do
not call this force or duress. In short, Knight believed “freedom is itself
an ethical category and cannot possibly furnish an objective criterion for
moral judgments of legislative policy” (Knight 1947, p. 17). His consid-
eration of freedom leads, he concluded, to two propositions. Firstly, that
the notion of economy, in terms of efficiency and satisfaction of desire,
is not objective in the scientific sense. Second, equally repugnant but,
inescapable he observed, is that no discussion of policy can be done apart
from a moral judgment, and any discussion appealing to a standard of
maximum freedom is fallacious, resulting in a dogmatic acceptance of an
existing distribution of power, which is itself an ethical proposition and
a value judgment.
The question we really face, Knight posited, is a question of what
power ought to be exercised. He explained that “the good” or pleasure is
a purely individual matter, whereby the individual is the ultimate judge
of what comprises the good, and shall pursue or attain what they want.
220 Frank H. Knight
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 fatal defect in the utilitarian doctrine of maximum freedom as a goal

of social policy is its confusion of freedom and power. Its advocates over-
look the fact that freedom to perform an act is meaningless unless the
subject is in possession of the requisite means of action, and that the practi-
cal question is one of power rather than of formal freedom. (Knight 1982,
p. 7)
The notion of voluntary exchange in the economy is one test of equal-

ity of freedom. We are all free to exchange in equal turn, but this is ques-
tionable since it is a question of the maximum the other party will pay,
and this is a standard of market forces, Knight argued, as it “sanctifies the
status quo…Its ethic is in the first place the right to keep what one has…
it also sets up the right to use what one has to get more, without limit!”
(Knight 1982, p. 9).
5 Knight’s Dissent on Freedom

Though often portrayed as a conservative, Knight was a dissenter. The
three areas of dissent at the core of his approach are freedom, value and
power, all of which takes us back to the social question. The first eco-
nomic thinkers, in the classical tradition, were utilitarian, and Knight was
critical of the utilitarian understanding of freedom. In understanding the
individual and the state, Knight rejected the traditional liberal and classi-
cal view offered by the early economists, suggesting that while it was the
pattern in the nineteenth century to think of social problems of conflict
and struggle between individuals or private groups and the state, as well
as between states, primarily in economic terms, such a view cannot be
fruitfully maintained. Instead, Knight explained every form of human
association gives rise to power relations, and conflicts of interest within
these various parts of human life, which ultimately become violent con-
flict because of our human nature and the absence of law in controlling
a given conflict. If all economic problems were resolved, through a “fairy

gift,” it is highly unlikely in his analysis that social strife would be reduced
or nullified. It would need a moral transformation as well, and even then
there is no evidence that a moral revolution would emerge from any eco-
nomic change. In an economic analysis there are other aspects left to sort
themselves out, and equally what is viewed in an economic way is in real-
ity rooted in other interests, which would remain fractious even after an
economic revolution. This said, Knight argued that economic freedom
is still basic to other forms of freedom, so there is a relationship, but he
doubted the extent to which the nineteenth century thinkers saw this
relationship clearly.
Turning to the value question, there are the two sides of the value
question alluded to earlier, which we need to address (Emmett 2009,
p. 348). First, the way in which our ethical ideals form a part of our
interests, playing a similar role in our collective decision-making as our
economic interests do in individual decision-making. On the second side
of the question, values exist as interests both subjectively, and are also
expressed supra-individually in our understanding of the common good.
Thus, social institutions are both mechanisms for the coordination of
our varying interests, and are also the embodiment of our values, and in
this way together we strive for higher ethical ideals. The reason we need
discussion is that we can never realize these higher goals in any other way.
Those who do have access to means, as well as the freedom to act, will
increase their economic power. This means that, in terms of social policy,
there are many who will be excluded by virtue of having no access to the
means that will give expression to their economic freedom. Given the
constraint that human beings have of conflicting and common interests,
Knight feared that this would lead reformers to call for wrong-headed
kinds of reform, and this is a threat to the free market and creates the
social problem of which Knight speaks. What he feared was that reform-
ers would challenge the existing system and this would lead to more gov-
ernmental control, and this he saw as equally problematic, as we have
discussed, and also ultimately a limitation of freedom in contradiction to
the ideals of reform.
For this reason, Knight dissented from social science by challenging the
science, but also differing on the social question. He suspected that social
222 Frank H. Knight
scientists were among the interest groups that become self-interested

agents of social groups, and thus went on to undermine the discussion
needed in society to address the negotiation of competing wants. Rather
than taking sides, he wanted to promote an impersonal sense of the mar-
ket as a place where people could discuss, and co-operate economically,
without having to agree on their wants and values. As Knight explained
early in his career, discussion is “a co-operative quest of an impersonally,
‘objectively’ right (or best) solution of an impersonal problem. It cannot
be an attempt to ‘sell’ a solution already reached, or it is not a discussion”
(Knight 1933a, p. xxxiii). In other words, there needs to be a neutral
space for dialogue and a true attempt to have a meeting of minds.
Liberalism, he argued, mistakenly takes the individual as a given,
and thinks of the social problem as one of right relations between such
given individuals. The reason Knight gave is that the individual is largely
formed in the social process, and thus is affected by any social action.
Revolutionary liberals were, he said, excessively rationalistic, and ignored
the tension between freedom of transactions and political freedom, on
the one side, and freedom of association in the broader institutional con-
text of family and primary-community life, on the other side. In reality,
Knight suggested liberalism is more “familism” than a literal sense of
individualism. The family, rather than a naïve belief in the individual, is
what Knight believed to be truly at the heart of the economy, and it is in
his view the effective social unit in consumption. Knight writes:
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 –
than which nothing could be more antagonistic to the accepted teachings

of Christianity. (Knight 1939, p. 404)
It is to his views of religion and Christianity that we now turn, given

that Knight wrote a great deal on the subject and with which he had a
very complicated relationship.
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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
Having made many references to Knight’s religious attitude and dis-

cussed his ethics, it is time to delve more deeply into the religious aspects
of Knight’s prophetic work. It has already been noted how his students
viewed this role, but we gain a little more insight from Paul Samuelson
who assigned biblical names to the key figures of his era. Samuelson
explained that Knight, as the founder of the Chicago School, was
Abraham, the tragic figure Henry Simon was Isaac, and Milton Friedman
was Jacob (Nelson 2001, p. 114). In spite of all this religious talk, how-
ever, Knight was not writing as an avid follower of religion. At an early
age he had given up his conservative religious traditions, but retained
active religious worship in the Unitarian tradition. He certainly saw the
church and organized religion as being a stumbling block to economic
progress. At a meeting of the Mont Pelerin Society in 1947, religion was a
debate raised by Hayek, inspired by the Christian opposition to Hitler in
Germany. He posed the question of whether there was an opportunity to
bridge the gap between Christians and liberals, to which Knight retorted
“the question is whether Christians will allow us to be liberals” and “we
do not discuss public issues in terms of whether they are Christian or
not” (Hartwell 1995, p. 38). However, despite many comments which
may give us a picture of Knight as someone who had rational contempt

226 Frank H. Knight
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.
1 A New Religious Plea

Knight’s engagement with religion took place against a religious background
in America of fundamentalism and the social gospel movement on the one
hand, and the secular idealism of Marxism and progressive liberalism, on
the other. The backdrop of this was his upbringing at home and university
in a conservative Christian milieu. The major religious political argument
at the time was the Scopes Monkey Trial, a case centered on the teaching of
evolutionary theory in schools, which was decided at a Dayton, Tennessee,
court in 1925. The trial caused Christian conservatives, who won the case
and the right to prevent evolutionary theory from being taught in schools,
but lost the cultural war, to retreat from public political debate and live in
a state of quietism, until the 1970s and their re-emergence in the form of
the “silent majority” identified by President Richard Nixon, and the not so
quiet “moral majority” of the 1980s in the era of President Ronald Reagan.
This left the social gospel movement, with its socialistic and Marxian eco-
nomic ideology, as the more vocal religious voice on economic matters in
the early 20th century. Knight argued, “The Christian admiration of pov-
erty, weakness and submissiveness is a pose, not to say a hypocritical pre-
tence, conscious or unconscious. It is usually enjoined upon others but not
practiced by those who preach it” (Knight and Merriam 1945, p. 35). He
said such people want power, just as much as any other person or group,
including the faith, as he described it, of Marxism, but “Marxists are more
candid in this regard” (Knight and Merriam 1945, p. 35).
At the end of the previous decade, Knight had warned that:
The tendency of Christianity to join hands with revolutionary Marxism is

one of the conspicuous trends of the times, in countries where all social
movements and public discussion of social problems have not been suppressed
by a dictatorship, either of the (self-appointed spokesmen for the) exploited
proletariat, or of the (self-appointed leaders of the) advocates of preserving
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)
Although the faith of Marxism was essentially atheistic, the libertar-

ian and Chicago school of faith has always been less hostile, but Robert
H. Nelson suggests it still raises similar implications for a Christian read-
ing of the economy:
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:
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)
Keynes may have delighted in the freedom from the constraints of

English religion, but, as Skidelsky pointed out, he was less sure in his later
life, telling Virginia Woolf in 1934, “We destroyed Christianity yet it had
its benefits” (Skidelsky 1986, p. xx).
For Knight, there was a need to find a middle ground in the reli-
gious life of America, which 1920s fundamentalism had provoked in his
mind. Just as he thought conservative churches were seeking to enforce
their religious dogma, he saw there was a challenge for the mainstream
churches of America, which he thought were moving in the direction of
capitulating so much to liberal thought that it risked getting away from
religion altogether. As he stated in an address to the Unitarian regional
association in October 1923, he was making “a plea for “fundamental-
ism,” in a sense, for the view that there are things which cannot be given
up without ceasing to be religious; it is a plea for Spirituality.”2
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
He stated they insisted on the restoration of the ideals of righteous-

ness and brotherhood against the corruption of urban life and politics;
there was also, he noted, an emphasis in Jewish religion on the social
dimension rather than the individualistic emphasis he saw in American
Christianity. Christianity was a new prophetic movement, which ulti-
mately spawned a church he saw as opposed to every view of progress
held by his generation. The modern economic order in particular has
been viewed as good by those Christians who support it and bad by
those who oppose it; in the latter case certainly since the inception
of social economic planning. Knight said he did not seek to criticize
Christianity or the church, since, perhaps similarly to the later Keynes,
he understood it to have a good moral intent in many respects. His
attack is more specifically against what he saw as a broader principle
of “moralism.” He stated, and restated, that Jesus sought to establish,
in an imminent sense, the kingdom of God in this world, which is a
notion that has had different interpretations throughout the history
of the Christian church. On this topic, his view had some resonance
with the liberal Christian biblical hermeneutic school prevalent in
European universities at the time, which discussed imminence in this
way. However, there is a view of imminence held by many conservative
Christian groups, including those of Knight’s upbringing, which led
them to expect Jesus to come back within their lifetime.
Robert H. Nelson, in his stimulating study of the Chicago school,
Economics as Religion: From Samuelson to Chicago and Beyond (2001)
deserves much praise for delving deep into Knight’s religious views.
Nelson summarizes Knight’s “theology,” stating that:
Knight was expressing a classic Christian view of fallen human beings,

beset by original sin. 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 pres-
ence 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 either).
In the current world infected by sin, it is simply that private property and
the pursuit of profit are the best ways to maintain a semblance of order in
society. (Nelson 2001, p. 121)
In such a fallen world, all economic actors face a future of uncertainty,

which makes it both an economic and theological problem. As Nelson
notes, even a priesthood of economists could not escape the human con-
dition. The earlier reference to the notion of predestination is a strongly
Calvinist one, and attempts have been made to link Knight’s economics
to a deeper theological understanding, albeit that Knight had rejected his
conservative theological origins in favour of a less dogmatically stringent
Unitarian faith. Emmett helpfully asks about Knight and religion “what
if the Chicago story about Knight’s religion is wrong?” (Emmett 2007,
p. 6). In other words, Emmett wanted to trace Knight’s religion from his
upbringing forward, rather than reading backward from his anti-religious
rhetoric of the 1940s. He traces his early religious influences and their
expression whilst he was in Iowa, from 1919 to 1928, where Knight was
an active member of the Iowa City Unitarian congregation. Unitarian
principles can be set out briefly as follows:
1. The inherent worth and dignity of every person.

2. Justice, equity and compassion in human relations.
3. Acceptance of one another and encouragement to spiritual growth in
their congregations.
4. A free and responsible search for truth and meaning.
5. The right of conscience and the use of the democratic process within
their congregations and in society at large.
6. The goal of world community with peace, liberty, and justice for all.
7. Respect for the interdependent web of all existence of which we are
a part.
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.
3 A Calvinist Economic Vision

As noted, a pioneer of the argument that Knight was offering a Calvinist
economic vision is Robert H. Nelson (2001). Knight was reluctant to
accept both the confidence of science, and scientific management of the
economy. He saw the problem of economic self-interest, marked by the
human condition of original sin, as all-pervasive, infecting both private sec-
tor activity or laissez-faire, and government or public control of the econ-
omy. This, Nelson traces to Knight’s Calvinist roots (mistakenly so, see
below), a view that sees sin as all-pervasive in the world, infecting all that we
say and do. This, Nelson sees in contrast to Roman Catholics, and he notes
Knight’s opposition to the natural law favoured by Roman Catholicism,
which Nelson ventures has the virtue of greater faith in human reason and
improvement in the human condition. Human nature being what it is,
irrespective of the theological category of sin, stands between us and prog-
ress, and prevents us from realizing our plans fully. The problem is not
primarily economic; it is social, as we have seen in Knight’s reflections on
welfare economics, ethics and freedom. As we also saw in these previous
reflections, the context in which we act and pursue our goals is power.
Christianity itself is one of the threats to freedom perceived by Knight,
a lesson he saw as coming from history, and the example of Christianity
as a theocratic medieval state. However, he did recognize that Christianity
was not necessarily true to its roots or the intentions of Jesus, but he
didn’t see contemporary Christianity as a particular threat either. He saw
communism as a greater threat, a secular religion that attacked more the

roots of the economy and the freedom he so cherished. Like Christianity,
it made its own truth claims in respect to ultimate reality and human well-
being. It had the advantage of having more in common with the profession
of economics than did the faith of Christianity, since both believed in the
scientific basis of society and the economy, even if they argued for different
outcomes. They talked the same language and shared the same confidence,
something that a good theology casts doubt upon. Nelson explains:
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:
Knight marks the beginning of a fundamental break of the Chicago school

with the progressives of Samuelson’s ilk, a new assumption that self-interest
will be expressed not only in the marketplace but also in the actions of
government and indeed perhaps in every area of society. It is a secular form
of an old view, characteristic of Calvin and other Protestant Reformers,
that sin has fundamentally invaded every aspect of human existence. While
Roman Catholic theologians also recognized the centrality of sin in the
world, they tended to show considerably greater faith in human reason and
in possibilities for rational striving toward improvement in the human con-
dition. (Nelson 2001, p. 121)
234 Frank H. Knight
Nelson suggests that despite his negative view of Christianity, Knight’s

own theology “follows surprisingly closely in the Calvinist understand-
ing of Christian faith.” His view of human nature as a stumbling block
to achieving the goals dreamt of in economic theory is close to the
corrupted nature view of original sin found in Calvinism. Given such
resonance, Nelson sees Knight’s antagonism to Christianity as only a
surface- level antipathy. Likewise, James Buchanan also saw Knight’s
thought as rooted in his evangelical Christian upbringing, explaining
Knight was “a product of middle America, of the agricultural economy
of Illinois, of the late nineteenth century, of evangelical Christianity”
(Buchanan 1991, p. 246). Nelson goes further though by suggesting
Knight’s was a secularized Calvinist-Puritan ethic, or Calvinism without
God, and this resulted in a critical attitude towards authority and com-
peting claims to truth. This, however, seems to make him a moralist, the
very thing he condemned in his ethical reflections. Nelson also presents
Knight as a Calvinist, which was not part of his upbringing; he came
from a more broadly evangelical conservative background. The church
he was raised in rejected Calvinism for being a system derived from the
Bible rather than a biblical system, and they objected to the tendency of
Calvinism to emphasize divine sovereignty at the expense of human free-
dom. Indeed, in Knight we find something of a high doctrine of human
freedom, and his view of human nature was more broadly Augustinian
than dogmatically Calvinist; a view he shared with Reinhold Niebuhr, as
we shall see later in this chapter.
Emmett (2009), in a fascinating trilogy of essays Frank Knight:
Economics versus Religion; Is Economics a Religion? and The idea of a
Secular Society Revisited explores in some detail the religious aspects
of Knight, and his attempt to grapple with the question of values in
economics. He makes use of an interesting dialogue between Arthur
J. Vidich and Stanford M. Lyman, both sociologists and anthropolo-
gists, in their book American Sociology: Worldly Rejections of Religion
and Their Directions (1985), in which they suggest that at the heart
of American social science lie concerns that “emanate from the dilem-
mas and contradictions in the relationship between God, the state,
and civil society” (Vidich and Lyman 1985, p. 281). Emmett sees this
statement as a key to understanding Knight’s economic thinking, and
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.
4 Religion and Liberal Society

Knight was writing at a time when American attitudes toward religion were
changing, and these new attitudes were being reflected in economics in a
thinking process that was happening within other fields, including theol-
ogy. His work does find resonance, as already noted, with Reinhold Niebuhr
and the realist understanding of international relations. Knight saw a con-
tradiction, as the remark at the Mont Pelerin Society indicated, between
Christianity and liberalism. Since human conduct bedevils the progress of
humanity, he cannot see how faith contributes to progress, and hence social
Christianity or the social gospel are inherently problematic for the economy.
In making much of Knight’s Calvinist and conservative religious upbringing,
writers arguably underplay the fact that his concern is primarily with the social
gospel and other liberal expressions of religion which would seek to impose
their beliefs on the economy. We can see the theological and the economic
problem in Knights’ thinking, as Emmett notes “To put it in theological
terms: Knight’s work expresses the tension between the need to get on with
the work of making sense of a world in which God is absent, while remain-
ing acutely aware of what we have lost because God is no longer present”
(Emmett 2009, p. 161). Yet, as we have seen, for Knight the economic chal-
lenge of humanity is joined at the hip with modern liberal democracy, and
“Ultimately, economics is not susceptible to theological reflection because
modern social relations are not open to theological speculation” (Emmett
2009, p. 161). However, the problem we face in the economy is ultimately
for Knight an ethical one with an horizon that lies beyond economics.
As Emmett explained more fully:
In a society which has no recourse to the providential nature of a God who

is present in human history, the provision of a justification for the way
society works is a “theological” undertaking. Despite the fact that modern
economists often forget it, their investigations of the universal problem of
236 Frank H. Knight
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)
Traditionally, as Emmett helpfully outlines, the view of Knight was that

the Christian gospel was one of love which speaks to personal relations,
whereas the economic problem is a social one, and as such the gospel does
not address the collective aspect of society, whatever proponents of social
Christianity or the social gospel might argue. This is especially true in such
a large and pluralistic society as America was becoming, and even more
so in today’s complicated globalized world. At this juncture, it is useful
to point out that whilst much is made of his Calvinism, Knight in many
respects is more in tune with Luther, who is the one theologian alongside
Augustine who is in the pantheon of political thought and the realist school
of international relations, since he wrote much more directly on theology
in relation to political power and economic matters; although it was Calvin
who ultimately provided a theological trapdoor to end the ban on usury.
Emmett suggests that if we look beyond the “vituperative rhetoric of
Knight’s responses to Catholicism” (Emmett 2009, p. 2), his two main
concerns are with a personal ethic that puts a value on our individual
actions in a world of impersonal association, and the substitution of a
moral authority structure for personal decision-making. The impersonal
emphasis is an important one, which Emmett suggests come from the
emphasis in the Christian, and other religious, traditions of a personal
ethic that is at odds with the modern impersonal world of economic and
political organization. If this is correct, it is because Knight is engag-

ing more with a personal protestant tradition, which is at odds with a
social Roman Catholic tradition. However, critics of Knight’s religious
stance are perhaps taking things rather at face value, and that may well be
because Knight takes things at face value.
The social dimension of the Christian tradition is far more impor-
tant than many critics seem to appreciate in the Christian tradition,
or perhaps it is a lack of precision in what they mean by the social
dimension of religion. The Augustinian and Lutheran tradition is the
theological model that draws out the difference most starkly, that the
world is to be seen through two realms, the political or human king-
dom, and the divine kingdom. This is often explained as the right and
left hand of God, whereby faith rules in God’s kingdom, while natural
law is put in place in the left-handed human kingdom to curtail the
excesses of human sin. As Paul wrote in one of his letters, the law is not
laid down for the just but for the lawless and disobedient (Timothy
1:9). Paul is not saying that there is a complete separation of powers,
because God ultimately rules over all, and it is God’s law that forms
the base of natural law.
This two kingdoms approach played out in the political realities of the
reformation period, as Knight explained in his exchange with Merriam,
in that Luther’s initial intention was one of reform:
but he soon found that if his movement was to escape extermination as a

heresy, he had to get political power behind it. Consequently, he adopted
the principle of cuius region, eius religio; which means two things, the con-
trol of the state over religion and that of the prince over the state. (Knight
and Merriam 1945, p. 16)
The standard set by the gospel is ultimately destructive of the social

basis of life, as all is under God and the salvation of individual souls is
the goal of human life, rather than the building of a Christian or theo-
cratic society. Knight contrasts this pursuit of power with a focus on the
relation between the love ethic and the use of power, whereby love fails
to recognize the use of power. A love ethic also has unintended conse-
quences, because it cannot truly stand up to power; as the saying goes,
the road to hell is paved with good intentions.
238 Frank H. Knight
5 Knight and Niebuhr: Fellow Travellers

Given such a Knightian view, it is surprising that Knight did not engage
more with his contemporary Niebuhr, as both firmly rooted their work in
Augustinian ground and surveyed similar territory. In his work, Knight
did not engage directly with Niebuhr’s work on the ethic of love and
power, but had they had the opportunity to discuss such themes together
the result would have been fascinating. In conversation with the author,
Emmett explained that while they had tangential connections, Niebuhr
seemed to dismiss Knight’s approaches to engage more deeply and also
seemed to lack any real grasp of Knight’s economic concerns.3 We can
only put this down to one of those wonderful “if only” moments that
bedevil history. The secular understanding of original sin, which we find
in political thought and international relations, is theologically rooted in
Augustine, author of the classic City of God (426 AD) which looks at the
two kingdoms of the heavenly realm of God and the political realm of
humanity. As Niebuhr explored, for Augustine, love and not self-love is
the law of humanity’s existence. Augustine takes into account the power
and persistence of egotism in seeking to set the problem within the con-
text of human sin. It is in understanding the tension between love which
has God as its object, and self-love which has egotism as its object that we
come to see Augustine’s political realism as a powerful guide. Niebuhr’s
highlighted love may not be as realistic as notions of justice, and hence
he argued Augustine suffers from “several grave errors” (Niebuhr 1954,
p. 123). One of which, he argued, is that Augustine does not take into
account the conflict between love and self-love in every soul, as Luther’s
phrase puts it simul justus et peccator, which means that one is both justi-
fied or saved, and a sinner at the same time. His view is also, Niebuhr
suggested, more classical than biblical, meaning it was more indebted to
the Roman thinker Plotinus than to New Testament notions of love or
agape. Despite such errors, however, Niebuhr commended Augustine to
the modern realist as far superior to others, in part because he relied on
biblical notions of selfhood, negotiating his way through biblical norms
and human values. While arguing that we need to take into account some
3
Ross B. Emmett, in conversation with the author, 25 November, 2015.
of their condemnation of human nature, Niebuhr was critical of Luther

and Hobbes for stating a purely pessimistic view of human nature, and for
believing that the human character is devoid of inner checks upon selfish
desires, and for not recognizing that people can exercise self-discipline
over such desires.
Despite this objection to pessimism, like Knight, Niebuhr had high-
lighted that democratic theorists are overly optimistic about human nature.
Knight’s thinking could have gone in Niebuhr’s direction, which is well
explained in The Children of Light and The Children of Darkness (1945a),
where Niebuhr suggested the individual and the community are related
to each other on many levels. The highest individual consciousness and
awareness, rooted in social experience, finds ultimate meaning in relation
to the community. The individual, as a product of the whole socio-histor-
ical process, may yet reach a level of uniqueness apparently transcending
this social history completely, but individual decisions and achievements
grow into, and out of, the community, finding final meaning in the com-
munity. Perhaps anticipating an era of globalization, Niebuhr concluded:
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
his work on liberal democracy. Niebuhr was skeptical about political

arrangements under liberal democracy just as much as Knight, but he
saw God as active in history all the same, and tempered rather than
deserted his socialistic understanding of the economy. Emmett, writing
in The Oxford Handbook of Christianity and Economics, notes Niebuhr’s
regular contributions to the Christian Century:
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)
As Emmet highlights, theologians have tended in their economic

views to veer toward an economic understanding rooted in socialism or
Marxism, and it is hard to find many positive statements on economic
matters prior to the fall of the Berlin Wall by major theologians; although
there is no such shortage among the “prosperity preachers,” with their
“God will make you rich message,” in America. The fall of communism
forced theologians to engage in a more balanced way, and so one finds
a handful of voices with a more balanced view of economic matters,
such as the British theologians Ronald H. Preston and John Atherton.
However, there still remains a seemingly natural animus toward business
and economic realities that leads the church bodies and theologians to
rally behind todays anti-capitalistic polices and movements. Knight had
no time for such things, and explained:
The direct effects of “preaching” about economic relations and obligations

are in general bad; and the kind of legislation which results from the
clamour of idealistic preachers – and from the public attitude which such
preaching at once expresses and tends to generate or aggravate – is espe-
cially bad. All this is the natural consequence of exhortation without
knowledge and understanding – of well-meaning people attempting to
meddle with the workings of extremely complicated and sensitive machin-
ery which they do not understand. (Knight 1939, p. 418)
242 Frank H. Knight
Emmett discusses how Knight and Niebuhr seemed to make similar

offers to their respective disciplines:
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)
However, Knight had a prophetic stance as well, because his scientific

approach was to deny the status of a science fully to his profession, which
is what made room for his prophecy. In Nelson’s conclusion on Knight,
he explains:
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:
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)
The difficulty is that liberal society is based on the impersonal mecha-

nisms of political order or democracy and the market. In democracy we
can discuss finding ways of being together, while in the markets we can
do business together regardless of beliefs, and through the impersonal
mechanism of price. Knight’s credo was that we must be free to discuss,
and free to trade. We cannot rule liberal society or the world by social
action, or to paraphrase Luther, you can try and rule the world with the
gospel, but you better fill it with real Christians first, which he ultimately
believed to be impossible. This is an admission that it is the base human
244 Frank H. Knight
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
Knight, Frank Hyneman. 1923. Business management: Science or art? Journal
of Business, State University of Iowa 4: 5–8, 24.
1–29, 296–321, 398–422.
W. Merriam. New York: Harper & Bros.
Press, 1956.
Secondary Sources
Buchanan, James M. 1991. Frank H. Knight. In Remembering the University of
Chicago: Teachers, scientists, and scholars, ed. Shils Edward. Chicago: University
of Chicago Press.
Emmett, Ross B. 1994. Frank Knight: Economics vs. religion. In Economics and
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.
Emmett, Ross B. 2014. Economics and theology after the separation. In The
Oxford handbook of Christianity and economics, ed. Paul Oslington. Oxford:
Fund.
Macmillan.
Niebuhr, Reinhold. 1945a. The Children of Light and The Children of Darkness
New York: Charles Scribner’s Sons.
Niebuhr, Reinhold. 1945b. Unfinished debate – The economic order and reli-
gion, by Frank H. Knight, Thornton W. Merriam, The Nation March 10,
1945.
Niebuhr, Reinhold. 1954. Christian realism and political problems. London:
Faber & Faber.
University Press.
Vidich, Arthur J., and Stanford M. Lyman. 1985. American sociology: Worldly
rejections of religion and their directions. New Haven: Yale University Press.
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)
Knight’s benediction on the passing of Keynesianism was some-

what premature, as the 1950s and 1960s were to be the heydays of
Keynesianism. It was the 1970s that saw the passing of Keynesianism,
until its recent resurgence. Knight’s own thinking and the Chicago tra-
dition he pioneered, on the other hand, had long since passed, swept
away by the post-World War II Chicago of his students, which became
the economic fashion of the 1970s and 1980s. While Keynesian insights

248 Frank H. Knight
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:
… cannot offer an alternative to the direction in which we are moving. It

may succeed by its resistance to current tendencies in slowing down unde-
sirable developments, but, since it does not indicate another direction, it
cannot prevent their continuance. It has, for this reason, invariably been the
fate of conservatism to be dragged along a path not of its own choosing. The
tug of war between conservatives and progressives can only affect the speed,
not the direction, of contemporary developments. (Hayek 1960, p. 520)
In Knight’s case, it wasn’t so much that he sought to slow down con-

temporary developments, rather he called for caution in how we apply
economic theory and policies to real life, based on the notion that the
problem that stalls progress is to do with people and power, not sys-
tems. The outcome of his critique may, however, be the same as Hayek’s
critique, since there is a sense in Knight’s oeuvre of a conservatism that
highlights the problems we face in the economy, but never offers us the
solution. Yet, if we return to Chap. 1 and apply Carroll’s definition of a
contingent language that “is not directly predictive but is threatening or
warning. It is not designed to forecast the future but to create responses,”1
then we will have captured Knight’s voice very accurately. He warns us
of the threats of capitalism, and the predicament we are in with respect
to our social and spiritual problems. He warns of the uncertainty of our
1
See Chap. 1.
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.
1 American Liberalism and Conservatism

The labels of liberalism and conservatism were contested terms in Knight’s
America, and this remains the case today. Knight’s thought somewhat
confounds the popular division of liberal and conservative, terms which
today need much qualification. Classically understood, liberalism is the
dominant political ideology of modernity shared by “conservatives” and
“liberals” alike. This liberalism divides broadly into laissez-faire and social
welfare liberalism. The former is a conservative reading, while the latter
is what today’s American conservatives are referring to when they use the
term “liberal.” The “liberals” tagged in debates by “conservatives” range
from being anyone who disagrees with them, through to those advocates
of progressive change or specific polices which contradict conservative
policies, whether it is abortion or the intractable issue of welfare reform.
While there are many ‘liberalisms’ they are often conflated, hence though
there is a trend in contemporary political liberalism towards social welfare,
there remain distinctions between this liberalism and notions of progres-
sivism. We can also note in respect to Knight’s religious upbringing, and
perhaps to confuse matters a little further, that theological liberalism is
something different to this debate; with its own “liberals” versus “conser-
vatives” in an ongoing theological and doctrinal battle, differing in their
treatment of scripture and interpretation of revelation. Many conservatives
in America today, from backgrounds similar to Knight, tend to equate
250 Frank H. Knight
their conservative faith with the conservative politics of the Republican

Party. Likewise, in Knight’s childhood household there was a Republican
bias, and Knight as an adult seemed to retain Republican sympathies, as
Angus Burgin points out, “despite his distaste for political parties, many
surviving letters reveal Knight’s support for Republican candidates, and
none align him with specific alternatives” (Burgin 2009, p. 356).
Knight can also be said to be a liberal, in a sense that is consonant
with a classical liberalism that champions freedom, negatively free from
authority and positively free in the assertion of rights, underpinned by a
third concern for democratic participation to extend and to protect these
rights and freedoms. He stood very much in the classical tradition of lib-
eralism, and in America that also meant standing in the tradition of the
often-acknowledged father of American political liberalism John Locke,
who provided material common to conservative and liberal thought. One
way of distinguishing the two strands of political thought is the view
each takes of what is normative, with conservatives claiming normative
and operative principles, in dogmatic terms, for all time, and liberalism
holding more contingent views. As the philosopher Bertrand Russell sug-
gested, “The essence of the Liberal outlook lies not in what opinions are
held, but in how they are held; instead of being held dogmatically, they
are held tentatively, and with a consciousness that new evidence may at
any moment lead to their abandonment” (Russell 1947, p. 22). Or, as
Keynes is often quoted to have put the point more succinctly, “When the
facts change, I change my mind. What do you do, sir?”2 The reference to
dogma is often used as an insult, but in this proper form it is a helpful
descriptor, because it refers to a conservative belief in what is normative
rather than simply being bigoted, the latter word used in the cut and
thrust of political debate as a synonym for dogmatism. In recent decades
the challenge to classical enlightenment liberalism from the rise of a
somewhat more contingent and tentative way of thinking in the form
of postmodernism, is a well-worn seam of cultural, philosophical and
political debate. Notions of authority, rights and freedom have always
been at the heart of the liberal debate, whether one is discussing them
from a conservative and secular view, such as Friedrich Hayek, Ludwig
2
Where referenced is a matter of some debate.
von Mises, Robert Nozick, and Milton Friedman, or liberal secularists

such as John Dewey, Isaiah Berlin, John Rawls, and Noam Chomsky;
or indeed from Knight’s conservatism, if conservative is what he is was.
However, I would venture they are all members of the same club arguing
over the club rules of social contract.
As a member of the same club, it can be said that Knight’s dissent was
not so much soured by cynicism, as tempered by realism. His teaching
style, writings and demeanour may have found refuge in the language of
cynicism, but such approaches are often a disguise for disillusionment,
and like his contemporary Reinhold Niebuhr arguably Knight was more
simply a thwarted lover of liberalism. Knight certainly sounded like
Niebuhr when he told the American Economic Association in his 1950
presidential address:
I mistrust reformers. When a man or group asks for power to do good, my

impulse is to say, “oh yeah, who ever wanted power for any other reason?
And what have they done when they got it?” So, I instinctively want to
cancel the last three words, leaving it simply “I want power;” that is easy to
believe. (Knight 1951, p. 29)
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:
In the face of a real problem, idealism tends to advocate the “ traditional

”solution in so far as one can be found; first, in the literal sense of follow-
ing tradition on the concrete issue; and second, when tradition gives no
direct answer, it tends to emphasize the traditional distribution of author-
ity in the group. Thus the whole bias and tendency of idealism is conser-
vative, in both the natural meanings of the term, adherence to any
252 Frank H. Knight
established practice, and leaving all matters of social action or change to

the decision of the parties actually established in positions of authority.
(Knight 1939, p. 304)
2 Knight the Prophetic Conservative?

Given the nature of his dissent within the profession, and on specific top-
ics such as welfare and freedom, we can ponder whether Knight is indeed
a conservative. In terms of contemporary American conservatism, he is
not such a conservative as popularly and polemically understood today
and outlined above. Nor did he take the conservative line followed by
Hayek or Friedman. As noted, Knight was very much a classical liberal.
In the nineteenth century, liberalism was an economic and political doc-
trine associated with free trade and limited government, which is echoed
by Knight, and like many of the early classical writers he was forward-
looking. Emmett writes that Knight was:
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
However, Angus Burgin puts the matter in more starkly conservative

terms, when he explains Knight’s outlook was one of “radical conserva-
tism,” which Burgin sets in historical context:
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.
manifest limitations and sins, or to observe those limitations and sins

without enumerating the formidable difficulties inherent in any attempt to
overcome them. He articulated a complex social philosophy that affirmed
the critical content of radicalism without yielding to its positive demands.
The fact that he has been eulogized as one of his generation’s most emphatic
champions of free markets illuminates the essential discontinuity between
the defence of market-centered modes of social organization in the 1930s
and the conservative economic rhetoric that has become familiar in more
recent years. Knight’s deep ambivalence about the attributes of capitalist
societies demonstrates the extent to which laissez faire was discredited dur-
ing the Great Depression even among those who were perceived to be its
least compromising advocates. To be a conservative economist at the height
of Knight’s career was not to champion free markets, but rather to disagree
with the particular manipulations that the government at the time was
pursuing. (Burgin 2009, p. 515).
If Burgin’s argument stands, we can see that Knight stood firmly in a

prophetic tradition. He offered insights and warnings to any progressives,
and those who act with hubris, in their pursuit and desire to change society,
while warning conservatives and others against the complacency of those
who benefit from the organization of economic life without a thought for
those who lose out. This would have made him very uncomfortable with
the confidence in the economy that thrived in the 1980s and the heyday
of Friedman and the monetarists. Knight would have seen one form of
confidence simply exchanged for another and one dogmatism traded for
another. His prophetic voice was one that drew attention to the state of
dissonance we experience in the economy, and the inevitability of inequali-
ties and uncertainties that could only be addressed by dialogue and action.
There certainly is a conservative voice in Knight’s work, which was not
that of today’s libertarians or certain sections of the conservative spec-
trum. He offered an explanation of an emphasis, or what he called an
onus probandi, in favour of conservatism. Knight clearly pointed out:
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)
To answer the question of Knight’s conservatism definitively, how-

ever, we need to be clear on what we mean by conservatism. There are
three useful approaches to classifying conservatism, supplied by Edmund
Burke (1790), Russell Kirk (1953) and Samuel Huntingdon (1957).
Turning first to Burke, the political thinker writing in the eighteenth
century, his thought is one that is central to understanding the tradition
of American conservatism. Burke spelled out some core elements, or six
“canons,” of conservative thought:
1. People are basically religious, and religion is the foundation of civil

society. A divine sanction infuses the legitimate, existing, social
order.
2. Society is the natural, organic product of slow historical growth,
with institutions drawing on the wisdom of previous generations.
3. People are creatures of instinct and emotion as well as reason.
Prudence, prejudice, experience, and habit are better guides than
reason, logic, abstractions, and metaphysics. Truth exists not in uni-
versal propositions but in concrete experiences.
4. The community is superior to the individual. Rights derive from
duties. Evil is rooted in human nature, not in any particular social
institutions.
5. Apart from an ultimate moral sense, people are unequal. Social orga-
nization is a complex of classes, orders, and groups. Hence, differen-
tiation, hierarchy and leadership are the inevitable characteristics of
any civil society.
6. A presumption exists “in favor of any settled scheme of government
against any untried project. Man’s hopes are high, but his vision is
short.” Thus, efforts to remedy existing evils usually result in even
greater ones.4
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.
With a significant qualification of the first point, the remaining points

all feature in Knight’s philosophy. Knight personally found a degree of
faith helpful in living life, and his Unitarianism was not at odds with this
first canon, but he would want to qualify heavily the extent to which
this point should be taken in a doctrinal Christian way as it is in varying
degrees by Burke, American conservatives and others.
We find echoes of these Burkean elements in the second set of descrip-
tors. In his influential 1953 essay The Conservative Mind, the American
political theorist Russell Kirk offered what he called “six canons of con-
servative thought.” Like Burke, the divine plays a foundational role:
1. Belief that a divine intent rules society as well as conscience.

2. Affection for the proliferating variety and mystery of traditional life.
3. Conviction that civilized society requires orders and classes.
4. Persuasion that property and freedom are inseparably connected,
and that economic leveling is not economic progress.
5. Faith in prescription and distrust of “sophisters and calculators”.
6. Recognition that change and reform are not identical.
Perhaps it is in keeping with the traditions of Scottish Enlightenment in

American conservative thought that Kirk wrote much of The Conservative
Mind in Scotland, as it was his doctoral thesis at the University of St
Andrews.5 In this definition, with a significant qualification of the first
two points, we find Knight’s philosophy contains such canons of conser-
vative thought.
A third set of descriptors comes in the form of a liberal assault on the
conservatism of the 1950s launched by Samuel Huntingdon in his essay
Conservatism as an Ideology. In his 1957 defense of liberalism against the
conservatism of Russell Kirk, and what he called the “New Conservatives”
of the 1950s, Huntington6 suggested there are at least three deficiencies in
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
century classical liberalism Classical Liberalism and International Economic

Order: Studies in Theory and Intellectual History (1998), offers a useful study
of Knight as a political thinker, suggesting he had less in common with many
of the Chicago School than his reputation as a co-founder might suggest,
since he had less truck with its positivist methods and the assumptions of
homo economicus. Sally also suggests Knight was more conservative than he is
usually described, because he sought to understand the changing moral and
cultural foundations of classical liberalism, and he had an economic method
based on realist assumptions about human motivation. This is in keeping
with what has been discussed in these chapters in respect to Knight as a dis-
senter, but far from being a dissenter, the traditional assumption made by
many critics is simply that he was a conservative.
Emmett strikes the right balance when he notes that it is Knight’s stop-
ping short of resolving these social conflicts that draws the frustration
of his critics and social reformers, and as Emmett contends this leads to
an incorrect view that dismisses Knight as a conservative unwilling to
change the status quo. In truth, Emmett says his conservatism is borne:
out of an almost paralyzing tension created by a strong belief in the need

for social progress and an equally strong belief in the essential tragicness of
human existence. Here was a man who desperately desired a better world,
but whose study of economics and society had brought him face-to-face
with the terrible constraints that scarcity places upon us, and the fact that
even our best-intentioned efforts fail to draw us closer to a better world.
(Emmett 2009, p. 107)
It is in keeping with the portrayal of his prophetic role that Knight

should express such dissonance in how he understood and spoke to the
world and the human condition.
3 Ontology and the Problem of Progress

In broad terms, Knight believed that modern liberals tended toward
hedonism in their understanding of good as pleasure, and that they
often confused ethical and psychological hedonism. He described this
258 Frank H. Knight
psychological hedonism, embedded in utilitarianism, as “the economic

philosophy of life” (Knight 1935a, p. 22). Knight outlined the ideals of
liberalism, in the sense he understood the terms, in his 1946 essay The
Sickness of Liberal Society. He explained:
These ideals will be referred to as liberalism or individualism. The former

term directly suggests the ethical ideal of freedom; and freedom is the funda-
mental moral value exalted in the modern view of life, individual and social,
in thinking and in practice… The main point for emphasis is that freedom is
an ethical principle. Its acceptance does not involve a repudiation of morality
or idealism, but rather it does involve an inversion of the ethical principle
which has ruled in all civilizations prior to liberalism. All these earlier systems
of social order have been rooted in tradition and authority, and it is by oppo-
sition to these that liberal freedom is to be defined. (Knight 1946, p. 80)
However, Knight added that freedom “does not mean unregulated

impulse or “licence,” but action directed by rational ideals and conform-
ing to rational laws” (Knight 1946, p. 81).
In his psychological realism, what Knight did was to explore the dis-
sonance between what the market can do for us and the limitations of
human nature in cooperating to achieve better things in society, which
was also to repudiate the seemingly benign sense of the market that so
enraptured his libertarian students. As Burgin explains:
Throughout his career, he refused either to extol the virtues of markets

without drawing attention to their manifest limitations and sins, or to
observe those limitations and sins without enumerating the formidable dif-
ficulties inherent in any attempt to overcome them. He articulated a com-
plex social philosophy that affirmed the critical content of radicalism
without yielding to its positive demands (Burgin 2009, p. 515).
Knight went on to say that the most important defect of liberalism is

that it takes the individual as a given, when in reality the individual is in
part shaped by social traditions, institutions, and cultural norms.
In economic terms, liberalism promoted freedom in exchange of
goods and services as the objective of freedom, with a view to ultimately
increase efficiency, as a synonym for economy. In terms of ends, the
economy is not an end in itself but instrumental to achieving whatever

ends one had in mind, since the end of action is not a concrete position,
rather an end is whatever someone wishes or strives for free from coer-
cion. In such utilitarian ethics that which is good is an entirely individ-
ual matter, or as Knight explained it “what is good is that the individual
shall get what he wants” (Knight 1929, pp. 3–4). This is based on the
notion that the individual is the best judge of their own ends, and more
impartial than government in such matters. In regards to efficiency, the
individual is free to pursue ideals such as poverty, charity or love, and
free to join in association with others, even to the extent that they can
organize their economic life not to establish markets or exchange, but to
practice other forms of cooperation. This all said, Knight did not believe
in the notion that one can “pull oneself up by the bootstraps,” and so
this individual freedom does not exist for all and there are great inequali-
ties in the economy by necessity.
Hence, while Knight rehearsed some of the traditional arguments for
laissez-faire, which was understood to be instrumental and to increase
efficiency, and also meant the individual could act according to ability
and tastes, he saw the inherent difficulties of capitalism. The weakness
in the system, Knight explained, exists because freedom is freedom to
use power, which an individual may both lack and yet be equally free.
Freedom may also be seen as an end or value in itself, not simply for
its own sake but for deeper ethical reasons in the sense that individuals
ought to be free for reasons of dignity and responsibility, which Knight
says is in keeping with Puritan religious ethics. Knight also believed a
reason for supporting laissez-faire is that the capacity of the State to act is
limited, since freedom also means “freedom of economic conduct from
dictation by government” (Knight 1967, p. 782).
Ultimately, however, our human problem is an ontological one in
which the modern person looks at the question of freedom in physi-
cal terms. Knight argues this point that “We have to face the fact that
our craving for a simple, monistic, mechanical explanation of experi-
ence is intrinsically doomed to frustration” (Knight 1947, p. 22), yet
it is this physical state that we seek to change. In the individualistic
analysis of our situation, Knight says competition is omitted, because
such rivalry:
260 Frank H. Knight
…has no place in the general theory of economics or politics, but is in fact

a major motive in both fields because it is a major fact of human nature.
Man is a contentious being, antisocial as well as social. When most people
are free they play, usually in a contest of some kind, in which individual
end is victory, not the production of a useful result. Here, what one gains,
the other must lose – the opposite of intelligent exchange, though com-
monly asserted of market relations (as by many great writers in the past).
(Knight 1967, p. 795)
Hence, we are most disposed, in his view, to co-operate in organiza-

tions for effective competition, especially but sadly most true in matters
of war and thus any serious consideration of the human condition must
take into account the antisocial nature of humanity. The further Knight
presses his exploration of freedom, the more he looks to the spiritual and
religious state of humanity. Historically he says democracy arose out of
the struggle for freedom and individual liberty, specifically economic and
religious, and they are in his view interrelated.
A useful intersection we can see here is with Reinhold Niebuhr, who
was discussed earlier in respect to his realism and religious approach. It
is the picture of liberalism that Niebuhr held which provides an interest-
ing counterpoint to Knight. Niebuhr argued liberals were too optimistic
about common humanity, because they ignored the reality that humanity
is riddled with sin. Meanwhile conservatives were too stoically trusting of
authority as a means of controlling sinful humanity, believing everyone
has to be accountable. In the liberal case humanity needs to recognize
God’s love, not human love. In the conservative case, humanity is capable
of transcending sinful nature by reaching out for God. Perhaps for this
reason, it has been easy for different voices, liberal and conservative alike,
to claim Niebuhr for their own. Whereas conservatives criticize both the
institutions and theories of liberalism, Niebuhr was critical of elements
of liberal theory but endorsed its institutions. He denounced all theories
that do not situate the problem of human misery in sin or shift the prob-
lem of sin from the self to social or institutional processes. He understood
democracy to be the result of the bourgeois revolution and as such an ide-
ology of particular class interest, believing there is a bourgeois optimism
of democratic life which Niebuhr argued “represents the typical illusion
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.
4 Knight’s View of Limited Government

Knight did not oppose government per se, instead he mounted an attack
on bureaucracy, the excesses of government ideologies evident in the rise
of communism and Nazism, and, lastly what he saw as the new deal
authoritarianism of the FDR era. As Burgin explains to be “a conserva-
tive economist at the height of Knight’s career was not to champion free
markets, but rather to disagree with the particular manipulations that the
government at the time was pursuing.” (Burgin 2009, p. 515) He wor-
ried about the government curtailment of freedom, but if the heart of
capitalism is freedom, what then is the role of government? The problem
for the followers of the Chicago school and libertarians, if they are right,
is how to strike any kind of balance between the individual and the com-
munity. For, where socialism is condemned for championing society at
the cost of the individual, libertarianism is criticized for doing the exact
opposite. This concern was taken up by Robert Nozick, who asked in his
book Anarchy, State and Utopia, “if the state did not exist would it be
necessary to invent it?” (Nozick 1974, p. 3). The outcome of any such
debate is always likely to be affirmative, but there would be widely diver-
gent views as to what should constitute the necessary state, as opposed to
the state we have or the state many or the government of the day would
like it to be. This is evident in the discussion over what the economic
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:
To be GOVERNED is to be watched, inspected, spied upon, directed, law-

driven, numbered, regulated, enrolled, indoctrinated, preached at, con-
trolled, checked, estimated, valued, censured, commanded, by creatures
who have neither the right nor the wisdom nor the virtue to do so. To be
GOVERNED is to be at every operation, at every transaction noted, regis-
tered, counted, taxed, stamped, measured, numbered, assessed, licensed,
authorized, admonished, prevented, forbidden, reformed, corrected, pun-
ished. It is under pretext of public utility, and in the name of general inter-
est, to be placed under contribution, drilled , fleeced, exploited, monopolized,
extorted from, squeezed, hoaxed, robbed; then, at the slightest resistance,
the first word of complaint, to be repressed, fined, vilified, harassed, hunted
down, abused, clubbed, disarmed, bound, choked, imprisoned, judged,
condemned, shot, deported, sacrificed, sold, betrayed; and to crown it all,
mocked, ridiculed, derided, outraged, dishonoured; That is government;
that is its justice; that is its morality. (Proudhon 1923, p. 293)
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
Knight it is indeed questionable that the state apparatus is sensitive to the

needs and choices of the people it portends to serve. Such state bodies
can demonstrate great versatility in their arguments for planning; only
to find public dissatisfaction with their grand designs, because interests
conflict. Yet, on the other hand, the libertarian view that the marketplace
can achieve better results without such a belief in design, preferring to
leave the mutual interests of market participants to achieve the desired
end, was not entirely shared by Knight either.
5 Knight’s Commonsense Philosophy

Revisited
At various times in his writings and career, Knight would frequently make
reference to what was common sense, to the point of stating his views, or
prejudices, as if they were self-evident truths. It may well be that he made
these references in a commonplace or hyperbolic manner, but his refer-
ences do provoke the possibility that his work as a whole stands in the
tradition of commonsense philosophy. In Chap. 6, I explored Knight’s
commonsense philosophy, with its roots in the Scottish Enlightenment.
To conclude this study of Knight, this is the place I suggest we ought to
end up in order to understand Knight both then and now. As discussed,
the traditional understanding of the intellectual roots of America is that
John Locke, often portrayed as a “prophet” of the American Revolution,
influenced Jefferson and thus the Declaration of Independence and
American public discourse. The most influential theories of state legiti-
macy are John Locke’s Two Treatises of Government, published around
1690, which was rooted in his empiricism and that of Hume, but also the
commonsense philosophy of Thomas Reid and Thomas Paine.
When the first Europeans landed on American soil they brought with
them a dichotomy of ideas. While it is commonplace to talk about this
dichotomy being one of enlightenment and Calvinism, both impact-
ing political and religious life in America, and then to see Knight as an
economic Calvin as Nelson does, there is a more poignant dichotomy
pertinent to Knight. This is the dichotomy within English and Scottish
enlightenment, and within this the Scottish enlightenment itself, which

is between the empiricist ideas of David Hume and the commonsense
philosophy of Thomas Reid. Knight was ultimately a secularist, and so
rather than being Calvinist he gravitated more to the secular ideas of
Hume and Reid. The Scottish enlightenment certainly influenced the
founding fathers of America, which in turn remained highly influential
in American political and economic thinking. Hume’s ideas influenced
James Madison, leading to a tradition of accommodation of enlighten-
ment ideas in American intellectual life, or the so-called “American mind.”
While of influence, Montesquieu’s Spirit of the Laws (1748) was rejected
by Madison who preferred Hume’s The Idea of a Perfect Commonwealth
(1754). Madison’s notes on the confederacy in the 10th Federalist Paper,
were metaphorically, if not essentially, “written” by Hume, dripping in
the skepticism of human motive. Hume and Adam Smith likewise were
direct sources of influence on Knight, but the tenor of his approach and
thought resonates deeply with the Scottish commonsense philosophy,
as explained by Reid and Adam Ferguson. Reid’s ideas would influence
another founding father James Wilson and others in America. Reid’s
commonsense philosophy speaks to a democratic ideal and, I suggest,
finds expression in Knight, as well as the continued populism of modern
American conservative thought.7
The commonsense approach means not allowing theory to overrule
experience and convention lightly. There are aspects of this in Hume’s
work as well, since it was the spirit of thinking in Scottish enlighten-
ment as a whole. Knight’s view of economics was that it was unable to
encompass the whole of humanity, and could not treat human behaviour
in a mechanical sense or escape from the need of empirically verifiable
general laws. As Thomas Reid similarly expressed the point:
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
One reviewer of Knight’s On the History and Method of Economics

stated that unlike St. Augustine, “Knight escapes the dilemma between
predictability and freedom of action by imposing limitations on the pre-
dictability of human action.”8 This limitation applied philosophically
to the capabilities of the human individual, and extended to collective
action by human beings. Knight wanted to curb excessive government
influence and let freedom prevail in the market, because the individual
knew best, but he also understood there is a role for government in the
form of democratic discussion, as individuals have different motivations
and ultimately pursue power in such situations. Unfortunately, he was
never too clear on how this would work in practice, in part because he
sensed failure in such ventures. It is this that ultimately gives his work a
conservative disposition, and puts him at odds with the collectivist and
progressive visions of the thinkers and movements in later decades of his
life. Whether portraying himself as an ex-liberal or highlighting, as he
did in a 1946 essay, the “sickness of liberal society,” Knight did not offer
a way out beyond seeing economy and government in a process of co-
operation, albeit dysfunctional. He did not see this necessarily as a case
of moral degeneracy or arrested intellectual development. In considering
alternatives, Knight wrote:
The alternative to dictatorship is simply democracy in general as we have

known it, struggling to solve its problems along lines already familiar. It
means co-operation in thinking and acting to promote progress, moral,
intellectual, and aesthetic, with material and technical progress as the basis
of all, and all under the limitation of gradualism and “seasoned” with
humor and play. The combination is the meaning of liberalism. (Knight
1946, p. 95)
In his view, the progressives and modern liberals needed to be realis-

tic, economically and psychologically, about human behaviour, as Knight
explained:
8
Review by: Emile Grunberg, The Journal of Economic History, Vol. 17, No. 2 (Jun., 1957),
pp. 276–9
The ‘economic man’…underlies all economic speculation. The economic

man is the individual who obeys economic laws, which is merely to say that
he obeys some laws of conduct, it being the task of science to find out what
the laws are. He is the rational man, the man who knows what he wants
and orders his conduct intelligently with a view to getting it. In no other
sense can there be laws of conduct or a science of conduct; the only possi-
ble science of conduct is that which treats the behaviour of the economic
man, i.e., economics in the very broad sense in which we have used the
term. (Knight 1922, p. 474)
It is this open-endedness, and the lack of specific alternatives or poli-

cies, that ultimately makes Knight frustrating, or even irrelevant, to some
critics.
6 A Concluding Note
In typical self-effacing manner, Knight in The Role of Principles in
Economics and Politics, noted:
I have been increasingly moved to wonder whether my job is a job or a

racket, whether economists, and particularly economic theorists, may not
be in the position that Cicero, citing Cato, ascribed to the augurs of
Rome – that they should cover their faces or burst into laughter when they
met on the street. (Knight 1951, p. 2)
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
This dissonant view of hope in liberalism, tempered with a deep

sense of the limitations of humanity, may serve us well in contem-
porary political and economic debates as conservatism in America
and Britain seeks to move on from the economic debate of the 1980s
and leave behind the Chicago of Friedman and monetarism, with-
out wanting to embrace Keynesianism or progressive and collectiv-
ist approaches. A more productive dialogue partner for conservatives
today is to head back to the Chicago of Knight and his prophetic
exploration of economic life and human behaviour, and to seek a more
productive dialogue between conservatives and liberals about what it
means to be human in the economy.
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Index
A Burgin, Angus, 250, 252–253,

American Economic Association, 258, 261–262, 267
124, 150, 228, 251 Burke, Edmund, 254–255
Aristotle, 154, 157
Augustine, 236, 238, 266
Austrian economics, viii, 15–16, 47, C
50, 75–80, 93–96, 99–112, Calvinism, 227, 231–236, 242–243,
117–124, 161–165, 170, 197 264–265
Cambridge Capital Controversy,
The, 13–14, 13n4, 101
B Cantillon, Richard, 36, 53n
Becker, Gary, vii, 9–10, 12, 22, 149, Capital, 14–16, 32–35, 38, 48–49,
161–162, 164 71, 84–91, 121, 123, 132,
Bergson, Abram, 191–192 134, 143, 145–146, 215,
Berlin, Isaiah, 251 217–218
Böhm-Bawerk, Eugen von, 80–82, Austrian theory of capital, 16,
92–96, 100–102, 106–111, 100–112
117–118, 124 capital theory, 13, 13n
Boyd, Richard, 167 Hicks theory of capital, 50, 64,
Buchanan, James, 2, 7–8, 203, 234 94–96

D. Cowan, Frank H. Knight, DOI 10.1057/978-1-137-46211-4
282 Index
Capital (cont.) Communism, 22–23, 112, 129,

Kaldor and capital theory, 160–163, 207, 222, 233, 241,
117–121 261–262
theory of capital, 74–80 Competition, 17, 28, 31–32, 35,
tripartite distinction of land, 112–113, 116, 130, 135–138,
labour and capital, 138–139 140–142, 144–145, 147–151,
Carr, E.H., 185 153–179, 188, 201–202, 208,
Carroll, Robert P., 1, 248 212–213, 217, 259–260
Chamberlin, Edward, 142, 147–150 imperfect competition, 28, 31,
Chicago School, vii, 2–3, 18, 99, 148–150, 201–202
149, 161, 165, 170, 209, 225, perfect competition, 15, 31, 39–64
227, 230–231, 233, 244, 247, Comte, Auguste, 162, 187
257, 261–262, 268 Conduct, law of, 42, 171, 187–188,
Founding of the Chicago School, 195–196, 267
8–12 Conservatism, 248–257, 268, vii
Chicago Tribune, 3 Consumption, 15, 40, 46–50, 71,
Chicago, University of, 5, 7, 16–17, 78, 81, 83–87, 90, 92–93,
76, 121, 130 104, 110, 116–117, 123, 132,
Choice, 10, 40, 59–60, 66, 80, 83, 137–141, 144, 146, 171, 173,
89, 93, 134, 136, 153, 172, 195–196, 222
181, 193, 203, 208, 210, Cornell University, 4, 30, 168
218, 264 Crash, 1929 financial, 10, 141
Law of Choice, 42–43, 45–46
Chomsky, Noam, 251
The Christian Century magazine, 186, D
240–241 DeGregori, Thomas, 203, 256
Christianity, 168, 176, 178, 223, Depression, 122, 161, 166
226, 229–245 Great Depression, 4, 12,
Clark, John Bates, 15, 32–38, 100, 183–184, 253
109, 111, 117 Dewey, John, 186, 251
Clark, John Maurice, 7, 15, 47, Disciples of Christ, denomination,
147–148, 158, 194, 197 3, 231
Coase, Ronald, 61–63, 198 Distribution and Distribution
Cohen, Avi J., 14, 79, 102n, theory, 11, 14, 40, 47–49,
118, 120 51–55, 59, 82, 93, 106, 113,
Cohen, Leonard, 183 116, 131–132, 134–137,
Commonsense philosophy, 264–267 139–141, 143–147, 154, 159,
Commons, John R., 16, 28 174–175, 191, 201
Index 283
E Friedman, Milton, viii, 9–12,

Economic cycles, 14, 71, 112, 116, 161 21–22, 27, 125, 156, 162–
Economic freedom, 41, 60, 71, 89, 165, 176, 178, 209, 215, 225,
104, 115, 124, 133, 158–159, 251–253, 268
162–165, 167, 174, 176,
187–188, 193–197, 199–200,
204, 232–234, 250, 255–256, G
258–262, 266 Gifford, C.H.P, 102
Emmett, Ross B, viii, 5–6, 11, 17, Glasgow, University of, 155
20, 22, 28, 75, 79–80, 91, Gonce, Richard A., 212–214,
182, 202–203, 207–208, 215, 219, 256
221, 231–232, 234–238, Grampp, William D., 5
241–242, 252, 257 Greeks, classical, 153–158, 170, 176,
Employment, 43, 53, 65, 67–70, 178, 184, 195
107, 122–123
Enterprise, the firm and the
economic organization, 13, H
27–29, 31, 34, 38, 46–47, 54, Harcourt, G.C., 13–14
58–64, 69, 72, 90, Harvard University, 6–7, 13, 124,
113, 115–116, 130–137, 139, 147, 156, 159
148, 150–151, 160–162 Hawley, F.B., 15, 35, 38
Entrepreneur, entrepreneurship, 15, Hayek, Friedrich von, viii, 13,
27, 34–39, 53–54, 59–61, 63, 15–16, 28, 75–76, 80–81, 96,
67–71, 105, 116, 144, 215 99–105, 109–112, 119,
Equilibrium, 33, 40, 45–48, 51–52, 124–125, 164, 176–178,
60, 65, 78–80, 111, 123, 187–188, 225, 248–250, 252
148–149, 162, 167, 181f Hazlitt, Henry, 187
Ethics, vii, 11, 19, 115, 129, 186, Hicks, John R., 50, 64, 94–96,
188, 194, 196, 213, 218, 228, 189–192
242, 259 Hitchinson, Terence, 215
ethics and freedom, 219–220 Hobbes, Thomas, 178, 185, 239
ethics and welfare, 201–204 Homo economicus, 13, 19, 41, 147,
156, 167, 171, 178, 195, 201,
249. 256–257
F Human conduct, 11, 29, 41–44, 58,
Family, familism, 173, 199, 210, 172, 189, 194–196, 203, 235
213, 222–223 Hume, David, 264–265
Fisher, Irving, 78–79, 100, 102 Huntingdon, Samuel, 254–256
284 Index
I Keynes and ethics, 166–169

Individual, the, 10, 13, 20, 37, 41–49, Keynes and Knight, 121–124
57, 60–61, 63–64, 66–69, 100, Keynes at University of
114–116, 131, 135–137, 139, Cambridge, 22, 66, 168
141, 150f, 156, 158, 161, Keynes on risk and uncertainty,
164–165, 167, 169–175, 179, 65–70
191–192, 194, 196–197, Kirk, Russell, 254–255
199–200, 203, 208, 210–223, Knight, Frank H.
227, 236, 239, 253–254, early life, 2–3
258–260, 262, 266–267 The Economic Organization, 2, 81,
Institutionalism, 13, 16 129–131, 156
Interest The Ethics of Competition and other
Austrian theory of interest, Essays, 2, 5, 129–130, 156–
94–95, 100 157, 160, 166–167, 188, 208
Investment, 16, 36, 40, 52, 54, 65, On the History and Method of
67–70, 75, 78, 85–93, 96, Economics, 2, 19, 266
104–106, 110–111, 118–120, Intelligence and Democratic Action,
122–123, 145, 150 2, 20, 125, 156, 166, 181,
Invisible hand, the, 177 198, 214
Iowa and State University of Iowa, Knight and Machlup discussion
4–7, 11, 17, 147, 231 of capital, 92–94
Knight’s capital interest theory,
80–83
J Knight’s Chicago School legacy,
Jevons, William Stanley, 81–82, 21–23
87–89, 102 Knight’s distinction of risk, 27
Justice, 137, 155, 167, 197, 200, Knight’s liberalism, 6, 20, 23,
231, 238, 263 166–167, 169, 183, 185,
207–208, 210, 220, 252–253,
266–268
K Knight’s theology, 4, 204,
Kaldor, Nicholas, 14, 100–101, 229–232, 234, 242–243
117–121, 189–193 Risk, Uncertainty and Profit, 2,
Keynesianism, 12, 17, 22, 117, 4–5, 15, 23, 27–31, 37,
120–121, 125, 209, 247, 268 39–40, 56–57, 59–60, 64, 67,
Keynes, John Maynard, 3, 8, 13, 18, 72, 105, 117, 129–130, 138,
22, 27–28, 47, 59, 64, 99, 142, 166, 200
125, 210, 228–230, 247, 250 Knightian pyramid, 199–201
Index 285
L Marshall, Alfred, 32, 35, 40, 43,

Labour, 11, 14, 34, 38, 41–42, 44, 51–52, 168
46, 48, 52, 62–64, 77–78, Marshallian, 10, 124
81–82, 85, 90–91, 101, Marxism, 13–15, 34, 99, 112–113,
104–110, 112–113, 130, 135, 115–116, 121, 133, 185–186,
137–138, 143, 145, 174, 226–227, 241
217–218, 244 Marx, Karl, 14, 34, 44,
Kaldor on labour, 117–119 161–162, 186
Keynes on labour, 67, 121–123 Medema, Stephen G, 10–11, 166
The Marx labour theory of value, Merriam, Thornton W., 2, 226,
14–15, 34, 115–116 229, 237
Laissez-faire, 167, 172–173, 178, Milligan College, 4, 231
182, 187, 192, 216–217, 232, Mill, John Stuart, 33–34, 51, 82,
249, 259 84, 192
Liberalism, vii, 115, 158–159, Mises, Ludwig von, 7, 96. 100,
165, 184, 186, 203, 213, 100n, 189, 251
219, 222, 226, 228–229, Modigliani, Franco, 14
255–257, 260 Monopoly, 54, 113, 115,
American liberalism, 249–252 142–143, 159–161, 174,
liberalism and Christianity, 209, 212
225–226, 230, 235–237, and profit, 147–151
240–241 Montesquieu, Charles-Louis de
liberalism and progress, Secondat, 279
257–258, 261 Mont Pelerin Society, 12, 96, 100,
liberal society, 22, 124, 182, 187, 225, 235
200, 211, 216, 243–244 Moore, G.E., 169
Libertarian, 209, 219, 227, 244, Myint, Hla, 188, 193–199
253, 258, 261–262, 264
Limited government, 252, 259,
262–264 N
Locke, John, 250, 264 Nelson, Robert H., 178, 203, 227,
Luther, Martin, 185, 233, 230–234, 242–243
236–239, 243 New deal, the, 183–184
Niebuhr, Reinhold, vii, 185–186,
234–235, 238–242, 251,
M 260–261
Machlup, Fritz, 91–94 Norquist, Gerald L., 5–6
Marschak, Jacob, 102 Nozick, Robert, 251, 262
286 Index
O 115–116, 120, 136, 142–143,

Ontology, 23, 185, 257–262 146, 160, 163, 168, 178, 201,
Original sin, 176–179, 184–185, 230
230, 232–234, 238, 242–243 and monopoly, 147–151
Progressivism, 182, 186, 252
Prophecy, 23, 114, 125, 242
P Proudhon, Pierre-Joseph, 263
Pareto, 190–191
Patinkin, Don, 150, 228
Perfect competition, 39–57 R
Pigou, Arthur C., 189 Rawls, John, 251
Plato, 153–154, 156, 222 Realism, vii, 18, 23, 133, 238, 248,
Positivism, 19, 182, 215, 236 251, 258, 260
Price, 32, 35, 40, 45, 47–48, 62–63, classical realism, 184–188
80, 83, 87, 101, 107, 116, Recession of 2008, 28, 125, 247
119, 122–123, 130, 134, Reform, 182, 184, 208, 221, 249,
136–137, 143–147, 160, 164, 251, 255
174, 218, 243 Reid, Thomas, 264–265
Chicago price theory, 9–11 Ricardo, David, 14, 34–35, 44,
the price system, 137–143 82, 139
price theory, 5, 79, 81, 216 Risk, 3, 15, 28, 31, 50, 53, 57,
Probability, 27, 54–55, 59–60, 63 59–60, 62–63, 115–116, 142,
Keynes on probability, 65–70, 169 146, 150, 163, 174
Production, 84–88, 134, 140, 145 classical writers on risk, 33–34
Bohm-Bawerk on production Hicks on risk, 64
period, 106–109 insurable & uninsurable risks, 15
Hayek on production period, Keynes on risk, 65–70
109–111 modern writers on risk, 34–39
Hicks on production period, probability, 27
94–96 Shackle on risk, 54–56
Kaldor on production period, Robbins, Lionel, 33, 189
117–121 Robinsonades, 44
Machlup on production period, Robinson, Joan, 13–14, 101, 142, 147n
91–94 Roosevelt, Franklin D., 183–184
period of production, 16, 42, 77, Roundaboutness, 75, 96, 102n, 111,
82, 91, 101, 103–104, 132 119–120
Profit, 13–15, 27, 31–39, 44, 51, Runde, Jochen, 27, 60
59–61, 63–65, 67, 100, 106, Russell, Bertrand, 264
Index 287
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

(Great Thinkers in Economics) David Cowan (Auth.) - Frank H. Knight - Prophet of Freedom-Palgrave Macmillan UK (2016)

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GREAT THINKERS IN ECONOMICS

Series Editor: A.P. Thirlwall

More information about this series at

Great Thinkers in Economics

Library of Congress Control Number: 2016936771

© The Editor(s) (if applicable) and The Author(s) 2016

Printed on acid-free paper

This Palgrave Macmillan imprint is published by Springer Nature

Frank Knight is an interesting thinker to have spent a portion of one’s life

us to look into the humanity of the economic challenges, and sometimes

3 The Grand Crusade 75

4 Knight contra mundum 99

5 The Economic Organization 129

6 Understanding the Ethics of Competition 153

7 Welfare Economics 181

8 Freedom and Reform 207

9 The Economic Order and Religion 225

10 Why Knight Was (Not) a Conservative Prophet 247

© The Editor(s) (if applicable) and The Author(s) 2016 1

Knight was a co-founder of the “Chicago School”, but he was

from philosophy to economics at Cornell; with various versions of the

a proclamation by Massachusetts Governor Michael Dukakis in 1977

Remembering the University of Chicago, edited by Chicago professor

3 Founding of the Chicago School

The University of Chicago economics department, like Gaul, was divided

4 The Intellectual Milieu

challenge of socialism and Marxism. Much time will be spent later in

The Cambridge controversies, if remembered at all, are usually portrayed

used over a definable period, evaluating the quantity of capital in relation

5 Economist, Historian, Theologian or

factors, history, and institutional development. However, while Knight

As noted, generations of economists in America studied the set text of

Knight simmered down to measured respect for a brilliant but erratic

There is no reason to believe that if all properly economic problems were

On its polemical side, it is or involves an emphatic rejection of the simple

The reviewer concluded that Knight was attempting to revive in a

History as a whole is against the possibility of a free society; it looks like a

In fact, the two central methodological principles of Chicago economics –

The ascendency of these new Chicago approaches, along with

especially communism, would create absolute authority and ignore free-

Emmett, Ross B. 2011. The passage from classical to neo-liberalism: Frank

© The Editor(s) (if applicable) and The Author(s) 2016 27

1 Nothing Fundamentally New

…a classic statement of the theoretical core of neoclassical economics and

While Risk, Uncertainty and Proﬁt is a text worthy of revisiting today,

…is the study of a particular form of organization of human want-satisfying

Knight added to this that economics, precisely theoretical economics,

In later times, Knight put it more bluntly when he wrote, “I have

study, as it goes against the strict quest of scientific discipline in economics.

The exception he noted was J.B. Clark’s theory, which is further

In a discussion of the differences between land and other capital goods

In studying the law which would govern economic society if no essential

Knight perhaps assumed Schumpeter was building on the founda-

Courcelle-Seneuill, who had translated J.S. Mill’s Principles of Political

These writers take the English classical treatment of profit in a narrowly

The German socialist writers then went on to explicate capital as power

No a priori argument is necessary to prove that with general foreknowledge

argued a dynamic residual theory of profit, but rather than uncertainty

destruction on a road paved with innovation and obsolescence, while

3 Perfect Competition and the Real World

above, he acknowledged is essentially a condensed summary of classical

In this context, Knight explained that organization is near synonymous

labour is really a sacrifice of some desirable alternative to the use of one’s