Congruences and Clashes: Comparing the Views of Irving Fisher and Thorstein Veblen

Introduction

In the early twentieth century,  American Economists Thorstein Veblen and Irving Fisher provided significant contributions to economic theory. While their views on neoclassical capital theory were sharply contrasting, there was a “close intellectual affinity” (Dimand, 2004) between Veblen’s Theory of Business Enterprise and Fisher’s Debt- Deflation Theory of Great Depressions. The purpose of this paper is to compare the congruity and contradictions between Veblen’s and Fisher’s economic thought. It is organized as follows: the first section discusses the contrasting methodologies adopted by the two scholars, despite being doctoral students under the same mentor at Yale. The second section describes how their approaches collided between 1906 and 1909 in Veblen’s review of Fisher’s articles on capitalist theory. The third section illustrates the striking parallels between their views on crises and depressions, and attention is paid to how this connection is not very well known in mainstream economics. The fourth section is dedicated to concluding remarks and sheds light on why American economics ultimately followed Fisher’s path as opposed to Veblen’s legacy.

Differences in Methodology and the Sumner Connection

Although Veblen and Fisher were both doctoral students under William Graham Sumner at Yale, they offered contrasting methodological alternatives to classical political economy (Dimand, 1998). In 1883, Sumner explained his ideas surrounding Social Darwinism in his book titled  “What Social Classes Owe Each Other.” Veblen was fascinated by his mentor’s ideas and described Sumner as “the first major theorist of the evolutionary origin, nature, function, and persistence of group habits, belief systems, and institutions” (Samuels, 1987). In this light, Veblen took an anthropological view of society and rejected the neoclassical view that reduced the rich, institutional, and cultural diversity of economics to mathematical models. As the founder of institutional economics, Veblen stressed how the evolution of institutions, biology, social, and cultural norms affected economic behaviour.  Dorfman (1972) writes that Veblen was deeply influenced by Sumner, considering him the only man worthy of his “deep and unqualified admiration.”

Ten years younger than Veblen, Irving Fisher entered Yale as an undergraduate student the year Veblen left and was inspired by Sumner in very different ways. Like Veblen, he was interested in economics and philosophy. However, he preferred to study these topics from a mathematical perspective. His dissertation “Mathematical Investigations in the Theory of Value and Prices,” was inspired not only by Sumner but also by the physicist Josiah Gibb (Dimand, 1998). Fisher writes that Sumner was his guiding force and suggested to him, “Why don’t you write on mathematical economics?” (Fisher, 1956). Overall, his use of mechanical models and analogies to physics led Fisher to introduce general equilibrium analysis into  American economics and develop a hydraulic model to describe price discrimination. Overall, Fisher and Veblen followed different aspects of Sumner’s social Darwinism.

While Veblen adopted an evolutionary approach to economic theory, Fisher pursued equilibrium analysis through a mathematical perspective and the use of econometrics. Dimand (1998) writes that Sumner’s two brilliant students, the evolutionary thinker and the mathematician, “divided Sumner’s legacy between them, drawing inspiration from two strikingly different facets of that extraordinary figure.” These differences in methodology are crucial to understanding why the two scholars’ ideas were compatible at times and contradictory at others.

The Clash: Veblen and Fisher’s Contrasting Views on   Neoclassical Capital Theory

Fisher is best known for his two books titled “The Nature of Capital and Income” and “The Rate of Interest.” Between 1906 and 1909, Thorstein Veblen wrote two review articles critiquing Fisher’s ideas in these books demonstrating his antipathy towards Fisher’s mainstream works. This Veblen-Fisher controversy was unique because of “shared clashes of fundamentally different visions of economic life” (Cohen, 2014). In The Nature of Capital and Income (1906), Fisher argues that his book “may supply a link, long missing” between the ideas underlying business transactions and abstract economics (Fisher, 1906). In response, Veblen criticized Fisher for failing to supply such a link. He argued that ideas and usages underlying business activity evolve over time, highlighting his evolutionary approach to economics. He further contended that it is necessary to view capital from a sociological perspective rather than from its deduced definition (Dimand, 1998). Veblen said that although Fisher’s work is “thoughtful, painstaking, and sagacious,” it “lacks the breath of life.” (Veblen, 1908) In his second article, Veblen rejected Fisher’s book “The Rate of Interest” as an “incoherent mix of two incompatible theories” (Dimand, 1998). He argued that interest rates must be viewed from an institutional perspective as opposed to the lens of hedonistic calculus. Veblen attacked Fisher for drawing utility concepts like time preference and psychic income in his analysis, rather than focusing on the monetary aspects of business. Fisher responded to Veblen’s criticisms by arguing that although the historical development of business institutions is important, it does not form an essential part of the field of his book which deals primarily with mathematical analysis (Fisher, 1909).

This controversy depicted the “gulf separating their approaches to economics.'' (Dimand, 1998) While Veblen gave the social dimensions of capital paramount importance, Fisher emphasized the importance of mathematical models and hedonistic calculus to describe business transactions and capital (Cohen, 2014). This Cambridge controversy, between the social and mathematical positions on the measurement of capital goods, clearly underscores how differences in methodology and approach led Veblen and Fisher to develop sharply contrasting visions of the discipline of economics.

The Congruence: the Close Affinity Between Veblen’s Theory of Business Enterprise and Fisher’s Debt Deflation Theory of Great Depressions

In 1933, Wesley Mitchell drew Fisher’s attention to chapter VII of Veblen’s Theory of Business Enterprise. Mitchell, a student of Veblen’s and founder of the National Bureau of Economic Research,  noted that it “probably comes nearest to the debt-deflation theory.” (Fisher, 1933) Furthermore, Dimand (2004) argues that Mitchell was right to argue for the “existence of an intellectual affinity between the two theories.” While most economists fail to link these two theories together given the contrasting approaches of Veblen and Fisher, it is incredibly meritorious to analyze this connection and understand the similarities between their works on crises and depressions.

Veblen’s Theory of Business Enterprise (1909)

The dominating vision of Veblen’s theory, which strongly diverges from neoclassical thinking, is the contrast between business enterprise, seen as profit-making, and the machine process which controls production (Arrow, 1975). In Chapter VII titled “The Theory of Modern Welfare,” Veblen discusses crises, prosperity, and depressions, which closely mirrors Fisher’s work on debt deflation. He discusses how a boom in the economy is characterized by an unstable process in which debt is accumulating as business capital is expanding. If lenders begin to infer that there is over-capitalization, loans will be called, leading to growing uncertainty amongst investors. This leads to a recession and the possibility of a depression should there be unemployment. Veblen notes that the depressed state of return on capital discourages investment, and the “shrinkage incident to a crisis is chiefly pecuniary, not a material, shrinkage” (Veblen, 1904). He states that “depression is primarily a malady of the affections of the businessman” (Veblen, 1904). His argument is psychological, which ties back into his anthropological and institutional vision of economics.

Fisher’s Debt-Deflation Theory of Great Depressions (1933)

At the onset of the Wall Street Crash of 1929, Irving Fisher’s reputation took a hit after he  claimed that the stock market had reached a “permanently high plateau” (Fisher, 1929). His claim was disproven just eight days later when the Dow Jones fell by 13%. To explain the Great Depression of the 1930s that followed, Fisher wrote the Debt-Deflation Theory of the Great Depressions to understand the financial factors behind a recession. He aimed to link together two fundamental elements that characterize financial distress — “over-indebtedness to start with a deflation following soon after” (Fisher, 1933). He proposed a nine-link mechanism to explain the sequence of disturbances which lead to a depression. In his view, debt liquidation leads to distress selling to pay off bank loans, which contracts the money supply and slows down the velocity of circulation. This results in a fall in the price level, swelling of the dollar, bankruptcies in businesses, lower profits, and a reduction in output, trade, and employment. Overall, there is pessimism in the economy, leading to further money hoarding and reduced circulation. All these disturbances complicate the interest rate with a fall in nominal rates and a rise in real rates (Di Martino, 1999; I. Fisher, 1933).

Fisher’s Debt-Deflation Theory had a slight initial impact and was met with decades of neglect by neoclassical economists, including Keynes. However, the theory was Fisher’s most “disquieting contribution” (Dimand, 2004), as it closely parallels modern economics and has been re-discovered in the last twenty years (Di Martino, 1999; Dimand & Geanakoplos, 2005). The theory has shaped how modern macroeconomists think about financial crises leading to recessions. In addition to this, interest in the theory has been renewed with the works of Hyman Minsky and Ben Bernanke who have used it to analyze the 2008 recession and the 2020 pandemic. The theory bears a strong affinity to Veblen’s analysis of crises and depressions, a scholar who was also a “dissenter and fount of disquieting thoughts” (Dimand, 2004).

The Congruity and “close intellectual affinity” Between the Two Theories

When Irving Fisher wrote Booms and Depressions (1932), he did not draw direct inspiration from Veblen’s Theory of Business Enterprise. It was only when Wesley Mitchell pointed out the crucial relationship between their analyses that Fisher acknowledged Veblen in the appendix of his book. This congruity between Veblen and Fisher was also recognized by Dimand (2004), who noted a “close intellectual affinity” between their theories. Veblen argued that stock prices fluctuate, sometimes very slowly, but always compensate for long-period fluctuations of discount rates in the money market. Therefore, the purchase price fluctuates to equate with the capitalized value of its “putative earning capacity”, which is computed at current discount rates and allows for risk (Veblen, 1904). Similarly, Fisher’s theory treated the expected stream of income, referred to in Veblen’s work as the putative earning capacity, as the fundamental concept and stated that the stock of capital derived from it is the present discounted value of expected net earnings (Fisher, 1933). Both of these theories hypothesized that the tangibility of assets is irrelevant and that expected earning capacity was of utmost importance (Dimand, 2004). Mitchell and Dimand point out that Veblen shared the stress on the changing real value of outstanding nominal debt with Fisher’s Debt-Deflation theory. Although most economists fail to draw associations between these two theories, it is tremendously important to analyze the strong connection between these two visions, even though they hold clashing views on the capitalist theory and different methodologies.

Conclusion

Even with exceedingly different methodologies, highlighted by strong clashes during the Cambridge controversy, Irving Fisher and Thorstein Veblen have a surprising affinity in their views on financial crises and have made a significant mark on the discipline of American economics.

Although Veblen was forced to resign from Stanford due to personal affairs in 1909 and Fisher’s disastrous misprediction of stock prices shattered his reputation and personal finances, both thinkers command strong legacies. Veblen was very popular in the eyes of non-economists studying social thought in the twentieth century. His broader cultural and institutional approach to economics is “attributable from a methodological standpoint” (Coats, 1954), and his “ideas pervaded the intellectual culture” (Arrow, 1975) and undermined neoclassical thought. Fisher was described as the “greatest economist the US has ever produced” (Schumpeter, 1997) and the world's most-cited economist in the early twentieth century (Dimand & Geanakoplos, 2005). Despite the previous neglect of his debt-deflation theory,  Fisher’s ideas on quantification, the quantity theory of money, and general equilibrium have been embraced by mainstream economists. His debt-deflation theory has been taken up by heterodox economists like Hyman Minsky and Ben Bernanke and has proven very relevant in the COVID-19 pandemic.

Overall, American economics ultimately followed Fisher’s path and not Veblen’s. While Fisher’s use of mathematical models and physics could be remoulded, Veblen’s use of institutionalism and evolutionary economics were intractable for research and reform. Veblen’s legacy only offered a sarcastic skepticism and intuitive critique rather than an alternative body of theory and practice, whereas  Fisher had a more narrow, technical, and efficiency-oriented approach. However, it is important to note that economic historians run the risk of accepting too narrow a vision of the debt-deflation approach and using a large and broad definition of the theory, as done by Veblen, can be successful as well (Di Martino, 1999).

In conclusion, the congruency and collision between Veblen and Fisher’s economic visions are exceptionally important to the understanding of early twentieth-century economic thought and the ways in which their legacies have shaped mainstream and heterodox economics today. “Fisher and Veblen, both influenced by Sumner, symbolize two contrasting paths for American economics” (Dimand, 1998) while also demonstrating harmony in their opinions on financial crises and depressions.

By Saisha Vasudeva for ECON460: History of Thought I

Edited by Ava Liang, Mary-Michelle Brown, & Romain Perusat

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