Fritz Machlup on Schneider’s Introduction to Economic Theory (1949)

Fritz Machlup’s review assesses the first volume of Erich Schneider’s projected three-volume introduction to economic theory, published in 1947 and devoted to the circular flow of the economy. Its central concern is the relationship between aggregate accounting and economic explanation. Machlup welcomes Schneider’s systematic presentation of national-income relationships and his account of the connection between individual decisions and aggregate analysis. His principal objection is that accounting identities, despite explicit warnings about their limits, are repeatedly presented in language that invites causal interpretations and unwarranted policy conclusions.

The review first situates Schneider’s undertaking within the recent integration of price theory, monetary theory, business-cycle analysis, public finance, and business economics. The projected second volume concerns the economic plans of households and firms; the third addresses general equilibrium, money, and employment. Schneider insists that observable economic conduct must be understood through the individual plans behind it, yet postpones the analysis of those plans until the second volume. Machlup identifies this decision to begin with aggregation as following contemporary English and American textbook practice. It establishes the methodological tension running through his review: aggregates are useful, but their explanatory foundations lie in individual conduct.

Machlup then outlines the first volume’s progression. Schneider distinguishes production from consumption plans and individual planning from central planning to sketch four pure economic systems, before concentrating on the free-exchange economy. A second chapter consolidates the financial statements of households, firms, banks, and governments into a national-wealth account. The next three chapters examine, respectively, a closed economy without government, an open economy without government, and a closed economy with government. Their organizing relationships equate saving with investment, with domestic investment plus the export surplus, and with private investment plus the budget deficit. Machlup regards these as Keynesian themes developed with originality and coordinated with subsidiary arguments.

The strongest pedagogical feature is Schneider’s attempt to derive macroeconomic equations from the accounts of individual economic units. Beginning with a firm, he follows payments, purchases, costs, production, sales, and receipts before moving toward consolidated national-income accounts. Machlup praises the potential of this procedure:

This is an excellent procedure because, among other things, it can clarify, in one pedagogic sweep, as it were, a number of different concepts: gross income, gross investment, depreciation, net income, net investment, value added by manufacture, personal incomes, etc.

The qualification concerns execution rather than the method itself. Schneider’s explanation of accounting techniques is insufficiently lucid for students without prior training. The conceptual bridge from firm accounts to national accounts therefore risks becoming difficult to follow precisely where it should clarify distinctions among income, investment, depreciation, and value added.

Machlup’s more consequential criticism separates retrospective accounting relationships from explanations of economic change. Schneider acknowledges both that his equations concern goods and services rather than monetary payments and that the quantities are measured after the event:

He also mentions repeatedly (pp. 47, 49, 52, etc.) that the quantities involved are ex post and that the equations therefore do not represent statements of causal relationships.

Yet the exposition undermines these cautions. An identity relating entrepreneurial income to investment, non-entrepreneurial saving, and entrepreneurial consumption is described as especially important and interpreted through assertions about higher or lower income. Machlup asks whether students will consequently suppose that changing a right-hand term must cause the corresponding change in entrepreneurial income. His objection is not to the identity’s validity, but to the passage from an accounting equality to an apparent account of determination.

The fiscal-policy discussion makes this problem sharper. Schneider includes taxes in entrepreneurial income, making it income before taxes, and then concludes that direct taxes are irrelevant to its total. Machlup treats this conclusion as dependent on the definition, not as an independently established policy result. A related statement presents an increased budget deficit as automatically raising entrepreneurial income by the same amount, other things equal. The review challenges the practical effect of such language:

How many students will remember that statements of this sort are supposedly without causal significance and, hence, should not be directly applied to questions of economic policy?

The final section turns from these misleading formulations to what Machlup considers the book’s best passage. He supplies his own free English translation of Schneider’s explanation of microeconomics and macroeconomics. Individual decisions determine the economic process, but tracing millions of decisions and their interactions is impractical for policy. Aggregation reduces the number of quantities and relationships by grouping economic units according to the problem under investigation. Its usefulness comes at a cost:

The significance of the results of a macro-economic theory and its quantitative reliability will be smaller the larger the size and the smaller the actual homogeneity of the groups with which the analysis operates.

Machlup thus closes on a qualified endorsement of aggregation, not a rejection of it. Macroeconomic analysis is indispensable because policy cannot readily reach individual households and firms, while detailed analysis remains necessary to understand the decisions underlying aggregate movements. The review’s enduring conceptual distinction is between simplifying economic relationships for practical use and mistaking that simplification for causal knowledge. Schneider’s methodological statement recognizes this distinction; Machlup’s criticism is that his treatment of accounting equations does not consistently preserve it.