27: Knight: nemesis from the Chicago School

American Journal of Economics and Sociology, The, April, 2004 by Nicolaus Tideman, Florenz Plassmann

Frank Hyneman Knight (1885-1972) was one of the most influential economists of the twentieth century. He received his Ph.D. in economics from Cornell in 1916, under the guidance of Allyn A. Young. He taught at the University of Iowa, Cornell, and the University of Chicago, where he was Martin D. Hull Distinguished Service Professor and one of the founders of the "Chicago School" of economics. Among his students were such famous economists as James Buchanan, Milton Friedman, and George Stigler. During the 1930s, he was one of the editors of the Journal of Political Economy, and he became the president of the American Economic Association in 1950. In 1957, he was awarded the Francis Walker medal, which is awarded every five years to the "living American economist who has made the greatest contribution to economics."

Knight was a man of forceful disposition, with opinions strongly held, bluntly expressed, and tenaciously retained. One of these opinions was hostility to Georgism. This hostility, however, did not extend to personal relationships--as witnessed by his gratuitous offer to nominate a Georgist, Harry Gunnison Brown, to the presidency of the American Economic Association.

Knight's most famous contribution to economics, developed in his 1921 book Risk, Uncertainty and Profit, (1) concerns the difference between "risk" and "uncertainty." As he defined these terms, "risk" is concerned with known probabilities and can be dealt with through pooling and insurance, while "uncertainty" is concerned with unknown probabilities and is the source of true economic profit. (2)

Besides being a widely respected economist, Knight was also a social philosopher who strongly believed in individual freedom and opposed all forms of social engineering. In a famous 1924 article, (3) he responded to Arthur Pigou's claim that road congestion justifies taxes on roads users. Knight argued that such congestion is a result of the absence of property rights in roads. The assignment of property rights, Knight asserted, would induce owners of congested roads to demand tolls from travelers, yielding the same efficient allocation of road space as taxation. This insight laid the foundation for James Buchanan's and Ronald Coase's famous analyses of property rights.

Knight did not believe that unregulated markets had the ethical merit that some economists have claimed. In a 1923 article on the "Ethics of Competition," (4) he agreed that competitive markets allocate resources efficiently and that they reward every market participant according to the value of his marginal contribution to output. However, he argued, not only are real markets unlikely to meet the assumptions that are necessary for competition to yield the theoretically predicted outcome, but it is also impossible to conclude that any ethical implications are embedded in the theory of competition. (5) The only justification of competition is that "it is effective to get things done; but any candid answer to the question, 'what things,' compels the admission that they leave much to be desired." (6)

While rejecting an ethical defense of markets, Knight still defended laissez-faire because he considered it impossible to preserve individual freedom when governments have great power. In a public lecture at the University of Chicago in 1944, he said:

   Extensive positive action as a unit by a large group, defined by
   Residence in a contiguous area, means delegation of power to a
   limited number of officials, politicians and bureaucrats. If this
   is done on an extensive scale, as it is done by planners and
   "neo-liberals," the agent cannot be held responsible for the use of
   power, even to a technical majority of those for whom he acts. Such
   grants of power tend to become irrevocable and the power itself
   tends to grow beyond assignable bounds. (7)

This distrust of extensive government power may have been at the root of Knight's negative position on the single tax. It is possible that Knight regarded George's call for government action to rectify the ethical problem posed by the private appropriation of rent as just another utopian call for social planning. On at least one occasion, he characterized the single tax as "socialist" confiscation. (8) But Knight's main argument against the single tax was his claim that there is no conceptual difference between rent and interest, and that "pure land value" simply does not exist. A tax on land value, he believed, would lead to the same inefficiencies as a tax on capital.

Knight's View of Land as a Factor of Production

To understand Knight's argument, we must establish what he meant by "pure land value." This is not an easy task because of Knight's elliptical writing style. However, a reasonable inference can be developed from Knight's view of factors of production, which differed notably from the view of classical economists.

Classical economists divided the factors of production into land, labor, and capital. "Land" was defined as everything that had not been produced by human effort. Human beings were classified as "labor." "Capital" was defined as everything that had been produced by human effort, except human beings. This division implies that the supply of land is fixed (or "inelastic"), while the supplies of human labor and capital are variable (or "elastic"). Labor supply can be increased either by producing offspring or by working more or harder, and the supply of capital can be increased by investment.