Knight, Frank H.

WORKS BY KNIGHT

Frank Hyneman Knight was born on a farm in McLean County, Illinois, in 1885. He received a motley education; his higher degrees commenced with a B.A. from Milligan College (Tennessee) in 1911, followed by two degrees (B.A. and M.A.) from the University of Tennessee in 1913, and a PH.D. from Cornell University in 1916. His major subjects ranged from chemistry, through German literature, to economics and philosophy. At Cornell he studied under Allyn Young, who was perhaps the only man to have exerted an important direct influence on Knight’s economic ideas. His academic career included appointments at Cornell, Chicago, and Iowa before he finally returned in 1928 to the University of Chicago. Knight served as president of the American Economic Association in 1950, and in 1957 he was awarded the association’s Francis Walker medal.

Knight has always lived primarily in the world of ideas, and he has not compromised his commitment by becoming involved in governmental service or in quasi journalism. He has never been much concerned with defending his own works, once completed, and in these works one senses the struggle of a man who seeks first of all to set his own thinking straight rather than to preach the gospel or to enhance his own professional stature. Frank Knight, the scholar–critic, the self-made intellectual, is a product of the American Midwest, and it is difficult to imagine that he could have emerged from the more sophisticated culture of the eastern seaboard.

“Risk, Uncertainty and Profit.” Knight’s first major work, Risk, Uncertainty and Profit (1921), was written as a doctoral dissertation at Cornell in 1916. It won second prize in the Hart, Schaffner and Marx essay competition in 1917 and after rewriting was published as a book.

The motivation for this work, as with so much of Knight’s writing, was the desire for clarification. Ambiguities remained in the formal neoclassical theory of economic organization, notably in relation to the role and meaning of pure profit and its connection with predictive knowledge. Critical of the lack of precision that seemed to be present in the Marshallian treatment, Knight made explicit the distinction between rent, which is a distributive share in the ordinary sense, and profit, which results from imperfect knowledge. In order to do this he was forced to spell out, in considerable detail, the features of a system in which competition is perfect, and his treatment represents, in a sense, the apogee of neoclassical theorizing. He fully recognized and stated quite explicitly that the model of perfect competition is an idealization of reality, not a description.

Lesser theorists who followed Knight overlooked this essential point and erroneously expected real world institutions to match up descriptively with the idealized model. Their overly simplistic comparisons of theoretical perfection and observed reality have permitted the critics of a competitive economic order to undermine effectively much of its general social support, especially when comparisons failed to consider the flaws of alternative arrangements. Since the rigorous formulation of the idealized competitive model, by Knight and others, did lend itself to this misinterpretation, it is appropriate to ask whether the relevant theory could have been so formulated as to prevent these results. The answer is, of course, that rigorous construction of the model was essential to the development of economic science as it exists.

To construct this model of the perfectly competitive economy, Knight explained profit as the result of uncertainty, which he distinguished sharply from risk. This step involved the differentiation, in degree, between those possible events which can be insured against, to which an objective probability calculus can be applied, and those possible events to which such a calculus cannot be applied. This important distinction between risk and uncertainty found its way quickly into the general structure of theory, and it represents one of Knight’s more specific contributions to the standard body of doctrine.

Developments since 1921 in the theory of prob-ability have tended to reduce somewhat the sharpness of the differentiation between risk and uncertainty, at least in any formal sense. The fact remains, nonetheless, that there exist certain uninsurable uncertainties in the institutional environment of modern business operation. Moreover, the distinction retains its formal validity, despite modern notions of probability, when it is recognized that insurance against the possibility of making wrong decisions removes all content from decision itself. To this extent, therefore, genuine Knightian uncertainty must exist in a world where decisions must be made and where decisions may be erroneous. As Knight quite explicitly stated in this early work, where there is no genuine uncertainty, there are no decisions [seeDecision MAKING, article onECONOMIC ASPECTS; Economic Expectations].

Theory of economic organization. Several generations of students at the University of Chicago obtained their “vision” of the whole economic process only after encountering Henry Simons’ syllabus (for Economics 201, his course in introductory economic theory) and Frank Knight’s monograph, Economic Organization (1933). The latter was first prepared in the early 1920s at Iowa, and it was later duplicated at Chicago. It was intended solely for student use, and it is in no sense an ordinary textbook, yet it contains the elements of theory that helped to establish for Chicago its eminence in neoclassical economics. There is little in the monograph that is wholly original; its value is in its critical emphasis on key points, its clarification of ambiguous concepts and notions, and, finally, its integrated approach to the economy as a social organization.

In this monograph Knight used his now-familiar double dichotomy of the whole subject field, the sharp distinction between statics and dynamics on the one hand, and between the individual and the social economy on the other. He spelled out in some detail the five functions of an economic system, an approach that has since found its way into many introductory textbooks. He also used the image of the wheel of wealth or income, another standard textbook feature. He emphasized the central position of the economic principle—equalization of returns at the margin. Further, he stated the law of variable proportions, classifying the first, second, and third stages of the production function, and distinguished between the meanings of the law of diminishing returns. Finally, he stressed opportunity cost, a characteristic feature of his economic theory.

Many of the points made in this small mono-graph had been discussed, earlier and more thoroughly, in Risk, Uncertainty and Profit and in journal articles. But for Chicago graduate students, Economic Organization was the first encounter with Knight’s basic thought. The monograph was not widely circulated beyond Chicago, and Knight’s early theoretical contributions became known primarily through his first book and a series of important papers in the 1920s. His influence was notable at the London School of Economics, where, largely at the urging of Lionel Robbins, Knight’s work became a necessary part of reading for an economics degree.

Theory of capital. In his early theoretical writings Knight accepted without much question the Austrian theory of capital, which utilizes the time period of production as the common denominator for abstract capital. Later he emphatically rejected this theory, and in the 1930s he published a series of important papers designed to show the fallacies inherent in the Austrian view.

Knight held that the Austrian theory is based more or less directly on the classical Ricardian model of an agricultural economy in which capital stock is conceived of as the subsistence for labor over the year until a new crop is harvested. This model of an economy, along with the classical tendency to “explain” all payments as rewards for “pain,” produced the notion that the return to capital is a payment for waiting and that capital itself is nothing more than labor embodied in storable product. It is the capital theory that emerges from this model, which attempts to measure the quantity of abstract capital in terms of the time period between input and output, namely roundaboutness in production, that Knight flatly rejected. Capital, he asserted, is not embodied labor; there is no measurable time period of production, and an increase in the quantity of abstract capital need not amount to a lengthening of the production process. While Knight’s criticism does not entirely apply to the more sophisticated versions of the Austrian theory, it did much to under-mine the more elementary versions of the period-of-production approach.

Knight’s own theory of capital is based on a consistent application of the theory of opportunity cost. The rate of return is determined by the real yield on capital investment at the margin, and the economy in equilibrium is adjusted so that the return is equalized in all uses. The long-run demand for investment is extremely elastic at ruling rates of return. There is little need for the tortuous reasoning involved in the Austrian theory, since the rate of return can be explained more straightforwardly.

This theory of capital has been somewhat neglected by other economists. This is largely due to the fact that attention has shifted away from abstract capital theory since the 1930s, so much so that it is now difficult to say just what pure theory of capital the majority of economists do accept. It is to be expected that when the attention of economists does return to this theory, Knight’s contribution will be critically re-examined [seeCapital].

The methodology of economics. Knight is the economist as philosopher, not the economist as scientist. Economic theory is for him an idealized construction, a logical system, not an explanatory science. His work represents the search for logical contradictions rather than for conceptually refutable hypotheses, although these two approaches can lead to quite similar results, as evidenced best by Knight’s work on realism and its relevance for the theory of demand.

His conception of economic theory as relevant to idealized rather than actual behavior enables Knight to be both an abstract theorist and a severe critic of the “economic” explanation of human behavior. Theory allows prediction to the extent that men do, in fact, act in terms of economic motives and to the extent that they do not make errors. But since, in fact, these motives do not exclusively, or perhaps even primarily, determine behavior, and since there is no way of observing the extent to which they do, theory cannot be operational in the modern methodological sense. Theory can help in the understanding and explanation of behavior, but not in the scientific prediction of behavior.

Limitations of economics as a science. Although he has written several books, Knight is essentially an essayist, and much of his work has taken the form of essays in “criticism of established dogma.” It has been suggested that he is the ideal book reviewer, and in a real sense his whole work can be interpreted as a continuing review of the books that are written or read uncritically by so many others. Nowhere is this quality of Knight’s work more evident than in The Ethics of Competition (1921–1935), a collection of essays (most of which had been previously published) edited by a group of his students.

The pervasive concern here is with the limits that must be placed on the economic way of looking at behavior, on the limitations of economics as a science. Knight’s avowed skepticism of any extended application of theory places him alongside the American institutionalists. This question-ridden, almost answerless, set of essays shows that he is that rare theorist who is also an institutionalist, an institutionalist who is not a data collector.

In a classic discussion, he denied the givenness of human wants, emphasizing the continual emergence of wants in creative interplay with the environment. Central to Knight’s conception of economic order are the game elements in economic behavior, the deliberate setting of goals designed to make the process of achieving them interesting in itself. This conception, in turn, leads to considerations and more questions regarding the establishment of rules for economic and social behavior, the formation of the social constitution.

Social philosophy. Knight’s concern with the larger issues of social philosophy is clear in his 1935 essay “Economic Theory and Nationalism” (in 1921–1935). Although written in the mid-1930's, the essay has remained relevant. Basically Knight is a pessimist, and his interpretation of the historical process is a tragic one. Liberalism, as a system of order, failed to realize what it might have become, partly because of its own excesses; socialism emerged as its replacement. While regretting the failure of what might have been, Knight nonetheless conveys perceptively the values inherent in systems alternative to liberalism, and he especially stresses the human desire to be part of a larger organic whole, suggesting the modern necessity of a “social” religion. This essay distills features of national socialism that transcend the disastrous experiments of the 1930s and 1940s, and its predictions continue to be relevant.

Knight’s concern with the larger issues of social philosophy is also evident in a second volume of essays, Freedom and Reform (1929–1946), which, like its predecessor, was published by students. His shift toward philosophical issues, toward ethics, morals, and values, arises out of his developing conviction that these are the important issues for modern society. The economic problem, as such, is one of Western man’s lesser worries; its removal will leave the problem of social order largely unchanged. The difficulties that twentieth-century man confronts are not centrally intellectual; scientific progress offers no panacea.

One of Knight’s many crusades has been against the view, which he associates with John Dewey, that science in some instrumental sense can be used to solve social problems in a community of free men. Knight believes that science applied instrumentally implies control, whereas the social problem is one of attaining consensus, of securing mutual agreement. The “social engineer,” so preva-lent in the background of modern economic models, has no place in Knight’s approach to social problems.

Modern man’s central problem, according to Knight, is a moral one. Historical liberalism has destroyed conventional religion and has provided no effective substitute for it; as a consequence, men have turned all too quickly to nihilism or to the deification of the state. What men need, therefore, is a common morality founded on truth, honesty, mutual respect, and “good sportsmanship,” the ethics that liberalism should have produced but somehow failed to.

It is noteworthy that Knight believes the prospects for a society embodying the liberal ethics improved, if only slightly, in the years after World War II. In his most recent book, Intelligence and Democratic Action (1960), he assesses somewhat more optimistically the possibility of a man’s applying critical intelligence to his relationships with other men in organized political society. He warns against romanticism in all its varieties, and he calls for an education of the will rather than of the intellect, an education that must, above all, inculcate the critical attitude that is based on a respect for truth. “The distinctive virtue for men in a free society, the essence of the whole liberal view of life, is truth-seeking.”

Surveying the history of Western civilization since the Enlightenment, Knight sees no clear indication that man can rise to the challenge presented by the liberation of his own mind. But in his later writings especially, one senses his increased willingness to leave this question open.

Knight’s attitude toward organized religion is directly related to his commitment to truth-seeking. As he sees it, the very exercise of critical intelligence requires a willingness to examine all things objectively, to hold nothing sacrosanct. Religion is designed to “fence off” certain areas of inquiry and to ask that the individual accept certain precepts on faith. This represents the antithesis of the critical attitude, which Knight deems so essential. He insists that religious dogma is not different from other dogma and that it should be subject to the same critical scrutiny.

Knight’s revulsion from religious dogma resulted from his overexposure in early life to the hell-fire and brimstone of prairie evangelism. His reaction against religious orthodoxy was, perhaps, an essential ingredient in his intellectual development: having rejected it, the less rigid dogma encountered in the world of scholarship became easy prey to the Midwestern skeptic.

Assessment In his critical attitude and outlook, in his abhorrence of nonsense even in its most sophisticated forms, Frank Knight has much in common with David Hume, although Hume does not appear to have directly influenced Knight’s thought. These two critics share a determination to cut through the metaphysical—linguistic fuzziness that enshrouds the human mind.

Knight is no social reformer in the ordinary sense of this term. He believes that reform, improvement, in social order can corne only through man’s acquisition of an ability, and a willingness, to use his own mind. Knight’s emphasis is always on changing man’s way of thinking about social problems rather than on changing social institutions in order to solve problems.

Knight has no “disciples” as such, and those who have been most influenced by his work are as likely to criticize him as others are. This is because as a teacher he has been almost uniquely willing to look for merit in all questions and because he has refused to accept any final answers. His attitude has always been that all principles have their limits, that most of them are both right and wrong, that they hold more or less, and that judgment can never be dispensed with. This is the central point in his 1950 presidential address to the American Economic Association (1951).

Scorning both the relativist and the absolutist, Knight finally insists on the relevance of the “relatively absolute absolutes,” a position that makes him refuse to interpret matters in terms of black or white, yet, at the same time, allows him to hold steadfastly that man can, and must, use his own good judgment in making distinctions among the various shades of gray.

James M. Buchanan

WORKS BY KNIGHT

(1921) 1957 Risk, Uncertainty and Profit. London School of Economics and Political Science, Series of Reprints of Scarce Tracts in Economic and Political Science, No. 16. New York: Kelley. → A paperback edition was published in 1965 by Harper.

(1921–1935) 1951 The Ethics of Competition, and Other Essays. New York: Kelley.

(1928–1951) 1956 On the History and Method of Economics: Selected Essays. Univ. of Chicago Press.

(1929–1946) 1947 Freedom and Reform: Essays in Economics and Social Philosophy. New York and London: Harper.

1932 Interest. Volume 8, pages 131–144 in Encyclopaedia of the Social Sciences. New York: Macmillan.

(1933) 1951 The Economic Organization. With an article, “Notes on Cost and Utility.” New York: Kelley. → A paperback edition was published in 1966 by Harper.

1934 Profit. Volume 12, pages 480–486 in Encyclopaedia of the Social Sciences. New York: Macmillan.

1943a The Ideal of Freedom: Conditions for Its Realization. Pages 87–118 in Charner M. Perry (editor), The Philosophy of American Democracy. Univ. of Chicago Press.

1943b The Meaning of Freedom. Pages 59–86 in Charner M. Perry (editor), The Philosophy of American Democracy. Univ. of Chicago Press.

(1945) 1948 Knight, Frank H.; and Merriam, Thornton W. The Economic Order and Religion. London: Routledge.

1951 The Rôle of Principles in Economics and Politics. American Economic Review ,41:1–29. 1960 Intelligence and Democratic Action. Cambridge, Mass.: Harvard Univ. Press.