A Reevaluation of the Subsistence Fund

JW Rich
13 min readMay 2, 2023


While storied to some, and archaic to others, no one can deny the long history of the subsistence fund in the lineage of economic thought. It was utilized by nearly all the classical economists including Adam Smith, David Ricardo, and John Stuart Mill. As the years have progressed, however, the concept has somewhat fallen by the wayside. There are some who believe that this abandonment is unjustified, and wish to see it reincorporated into a macroeconomic framework. Likewise, there are some that wish to see it left in the dustbin of economic history. Can the concept of the subsistence fund be rejuvenated and reinserted into macroeconomic analysis, and if so, how?

First, as always, terms must be defined. What exactly is the “subsistence fund”? The concept originated out of the classical economists describing the wages paid out by entrepreneurs to the workers they employ (thus, the term that they used to describe it, “wages fund”). These entrepreneurs don’t get this money out of thin air, it must be saved and accumulated before it can be paid out. Thus, the entrepreneurs must first save in order to pay wages in the hope of receiving income in the future when they sell their goods or services. The classical economists — much to their detriment — did not possess any substantial theory of capital, and it was not until the work of Eugen von Bohm-Bawerk that the “wages fund” could be properly expanded upon. Bohm-Bawerk saw the “wages fund” more fundamentally as being the means of subsistence that allow for production and investment to take place — thus, the term “subsistence fund”.

This can be seen more clearly in the model of a one-person economy (or Crusoean economy). An individual may realize that he would be much more productive if he had tools, such as a shovel or ax, to use to gather materials. However, for him to work on creating these tools, that restricts the time he could spend on gathering today’s food and other necessary supplies for consumption. Therefore, in order to ensure that he can successfully complete the investment process in these tools, he must first gather together enough food and other necessities to sustain him through that process. While our modern economy is much more complex than just one person, the point stands: in order to be able to invest successfully, we have to ensure we have adequate sustenance to provide for our needs during the investment process.

Ludwig von Mises would pick up from where Bohm-Bawerk had left off, incorporating the idea of the subsistence fund into his theory of the business cycle in his “Theory of Money and Credit”. Mises writes that the period of production “must be of such a length that exactly the whole available subsistence fund is necessary on the one hand and sufficient on the other for paying the wages of the labourers throughout the duration of the productive process” (pg. 360). In other words, for a production process to be successfully carried out, there is a required subsistence fund to carry the process out. If, for some reason, entrepreneurs were deluded into thinking that the subsistence fund was larger than was actually the case, then they would undergo production processes — particularly lengthy investment decisions — that would not be able to be completed before the subsistence fund is exhausted. It is precisely this situation that describes the bust of the business cycle in Mises view. The reason why this initial deception about the size of the subsistence fund occurs is because of an artificially low interest rate, which signals to entrepreneurs that more present goods exist than actually do.

However, in later writings — most notably his magnum opus “Human Action” — Mises largely omits any reference to the subsistence fund, preferring instead to focus solely on interest rate manipulations. As a result, the subsistence fund has been generally eschewed by many other later writers as well, such as Hayek and Rothbard. This absence has been extrapolated further into the present day, where the subsistence fund is relegated to a pedagogical tool for introductory students, if it is used at all.

In their paper, “The Rise and Fall of the Subsistence Fund as a Resource Constraint in Austrian Business Cycle Theory”, David Howden and Eduard Braun advocate for a reimplementation of the subsistence fund into Austrian macroeconomics, specifically in the area of business cycle theory. Howden and Braun argue that including the subsistence fund in one’s analysis of capital and production theory helps to understand both the resource constraints underlying any production process, as well as why the bust the business cycle occurs exactly when it does. Without the subsistence fund, both of these questions are left more or less unanswered.

With all of this in mind, I do believe that there is a place for the subsistence fund to be incorporated in a larger macroeconomic framework. However, doing so requires several layers of clarifications to be made concerning the concept of the subsistence fund in the first place. While the single-actor, Crusoe model of an economy is useful for understanding economic fundamentals, in the case of the subsistence fund, it can be profoundly confusing to apply this concept wholesale to a complex exchange economy, especially in the case of business cycles. Once these clarifications and refinement of the subsistence fund concept are made, its place within macroeconomics as a whole can be ascertained.

The first point of clarification is that in an exchange economy, investment and consumption happen simultaneously. People are consuming goods at the same time that those goods are being produced. Even in the Crusoe model, it is possible for Crusoe to be picking berries while also eating these berries at the same time. However, it is generally assumed that Crusoe has the choice between either relying on his subsistence fund during an investment process, or working to enlarge that subsistence fund through production. In a modern economy, however, there isn’t a binary choice between either working towards investments or working towards consumption. All throughout the economy, there are constantly investment processes, production processes for consumer goods, and consumption happening simultaneously. Even in the case of the individual, they set aside a portion of their income for consumption and a portion for savings (as Keynes was so eager to point out). Thus, instead of a subsistence fund being a stock variable, it is a flow variable. Put in mathematical terms, it might be described as such:

SF1 = SF0 + P — C

SF1 = Subsistence Fund in Period 1

SF0 = Subsistence Fund in Period 0

P = Production of Consumers Goods

C = Consumption of Consumers Goods

Or put in more simple terms, the subsistence fund in any period is the sum of the subsistence fund in the previous period, plus the produced consumer goods, minus the goods consumed.

To be clear, I am not saying that the time involved in these investment processes does not matter. Investment still takes time to come to fruition, and this remains relevant for economic realities. What this does mean, however, is that the economy is not in a binary choice between investment and consumption. Both are constantly occurring at the same time.

The second point of clarification is that in an exchange economy, the entire economy is not engaging as a whole in capital-lengthening investments. In the Crusoe model of the subsistence fund, his decision to invest — and thereby abstain from producing goods for consumption — effectively translates to the entire economy shifting from production of consumer goods to investment. He is the only actor on his island, so every economic activity he takes comprises all economic activity on the island. If he decides to invest, 100% of the island’s economy is now enamored in that investment process. Outside of this simplistic model, however, these economic functions are no longer binary. Some actors in an economy might be using a portion of their resources for investment, while other actors are instead consuming those resources instead.

In other words, just as investment and consumption are not binary choices, the entire economy as a whole does not enter into “investment mode” or “consumption mode”. We can even identify the economic role of those who engage in this investment: it is the capitalists. They are the ones who take present resources (either their own savings or borrowed savings of another) and invest them into capital goods, thus extending the structure of production.

The last point of clarification concerning the subsistence fund is that our focus is not with the exhaustion of subsistence, but the economization of subsistence. For Robinson Crusoe, he has access to only a very limited supply of resources. Thus, his main concern when faced with an investment process is whether or not he can engage in that process — i.e. if his subsistence fund is large enough to support such an endeavor. In a modern economy, however, we are not faced with the same resource constraints. In any given investment project, it is almost certain that the total subsistence fund of society at large could sustain us through that project if need be. In other words, the relevant point of interest is no longer if we can engage in this investment process, but whether or not we should. The method by which the suitability of any decisions are judged on markets is through economic calculation — through the comparison on revenues and costs. Thus, we are no longer concerned about exhausting the subsistence fund, so much as economizing the subsistence fund. Now, the question of exhaustion does become relevant when the subsistence fund is misused, as we will see later on.

Of course, this does not mean that the subsistence funds that entrepreneurs hold can never run out. This happens all the time whenever firms go bankrupt, for instance. However, entrepreneurs do not think it terms of the possibilities of their subsistence fund at hand, but the most optimal ways in which it can be used — particularly if this fund will be supporting several production processes at once.

It is this last point of clarification that applies most directly to Howden and Braun. In their entire paper detailing the concept and utilization of the subsistence fund, nowhere (by my reading, at least) do they mention economic calculation. For scholars working the Misesian tradition, I was mortified by this omission. After all, entrepreneurs do not make decisions just by looking at the subsistence fund at their disposal. Rather, they engage in economic calculation through forecasting future revenues as compared to costs. It is only with the eyes of the economist can we recognize the subsistence fund in the entrepreneur’s economic projections. Thus, any analysis of the subsistence fund — just as with all other market phenomena — must make use of economic calculation if it is to be of any relevance for market-based decisions.

To review, here are the three clarifications of the subsistence fund we have mentioned:

  • The subsistence fund is not a fund, but a flow with inputs and outputs
  • Investment and consumption happen simultaneous, not as a binary choice
  • Subsistence funds are limited not by exhaustion, but economization.

Equipped with these conceptual clarifications, how exactly might we be able to implement the subsistence fund within a macroeconomic framework? Our main focus in this pursuit will be the all-important question of the business cycle — the same area of analysis emphasized by Holden and Braun. This is because business cycle theory (as Hayek so astutely pointed out) can demonstrate how the economy — and by extension, the business cycle — can go wrong. When everything functions smoothly in a market economy, it can be difficult to ascertain the function of each of its various contiguous parts. The failure of these parts, however, can reveal their purpose and importance in the context of the greater whole.

The traditional Austrian Business Cycle Theory story goes something like the following: through the deceptions of a central bank, the interest rate is artificially lowered. This lowered interest rate then induces entrepreneurs to engage in more lengthy investment processes, as the profitability of these investments has now increased. These artificially lowered rates cannot last forever, though, and when they are inevitably raised, these longer investment processes are revealed to actually be unprofitable. These investments are then liquidated, which results in the bust of the business cycle.

Holden and Braun specifically advocate in their paper for the subsistence fund to be incorporated as a real resource constraint. Given the subsistence fund’s role in determining the feasibility of any investment opportunities, this is a sensible role for it to play. In ABCT, what is the constraint which determines the feasibility of investments? The interest rate. As the interest rate increases, so do the investments in durable capital goods. What, then, determines the interest rate? On the unhampered market, the interest rate is the premium placed on present goods as compared to future goods. While this interest return is represented in the return on capital, it can be more easily seen in the time market, where the interest rate is the product of the supply of present funds and the demand for borrowing these funds in exchange for future funds. It is not the demand for these present goods that serves as the constraint, as demand can always be increased or decreased according to individual desires. It is instead the supply of present goods that is the real resource constraint on the interest rate. This constraint can be tightened or loosened depending on the supply of present goods at any given time, which correlates then to the investments undertaken with those present goods by entrepreneurs.

Therefore, when we speak of a “decrease in the interest rate”, this is analogous to an increase in the available subsistence fund (or either a decrease in the demand for present goods, which amounts to the same effect as the supply of present goods available has increased). But in the event of a falsified interest rate that does not reflect the true present resources this is equivalent to a falsified subsistence fund. Therefore, when entrepreneurs embark on their new investments, the resources at their disposal are not as large as the interest rate has signaled.

It is important to note, however, that the interest rate does not just mislead the entrepreneurs about the size of the subsistence fund, but also the future revenue these investments will yield. This is because the future revenues from any prospective investment are discounted by the interest rate and summed to calculate a net present value. Whenever the interest rate decreases, the value of these future revenues goes up, increasing the profitability of these investments. Whenever the interest rate goes down, the inverse occurs. Therefore, the interest rate affects both elements of calculation — costs and revenues- for the entrepreneur’s investment opportunity.

Whenever the interest rate is artificially decreased, this provides a false price signal with regard to the availability of present resources. It is when this price signal is corrected by bringing the interest rate in line with the natural rate that these investments are revealed to be unprofitable. This decrease in profitability comes from both a decrease in the value of future revenues — because of the increased interest rate — as well as an increase in the costs of borrowing to procure present goods to invest. It is at this point — when the unprofitability of these investments is realized — that the bust occurs. Up to this point, even if the costs of these investments were mounting, interest rates are still low, and more funds could conceivably be borrowed to continue these investment processes. In other words, even under increased costs, it could still be profitable according to the entrepreneur’s economic calculation. It is only when interest rates are increased that the unprofitability of these investments is decisively revealed.

Nevertheless, there is a finer point in the realization of the bust that relates back to our clarifications. Whenever the entrepreneur realizes the infeasibility of continuing his investment processes, he is forced to suspend those processes. This is not, however, because the resources for continuing these investments do not exist. If he wanted to, he could borrow money (at now-heightened interest rates) to procure the means necessary to sustain these investments until their completion. The reason why he does not do so, however, is because these resources are more highly valued elsewhere. Thus, there are not enough resources to both continue on these investment processes and other production processes as well. In other words, the subsistence fund cannot support both at the same time. Doing so would cause a drain on the subsistence fund — more present resources flowing out than flowing in — which would drain the subsistence fund completely. The tool of economic calculation prevents this from happening by translating the usage of resources into costs and forecasting those costs into the future. The entrepreneurs can then see for themselves the infeasibility of their present course, and liquidate their unprofitable investments before they can be completed.

To summarize: the subsistence fund as a resource constraint can be seen as embodied in the costs necessary to undertake any investment process. The way in which these costs are transmitted to the entrepreneur is through the interest rate. When this interest rate is manipulated, the actual size of the subsistence fund available is misrepresented.

The subsistence fund can be integrated into a theory of the business cycle, and by extension, a larger macroeconomic framework; but how much value does it have as a concept? In other words, how much deeper is our understanding of economic mechanics by integrating the subsistence fund into our analysis? I contend that while the subsistence fund can be helpful and useful in its own right, it is by no means a necessary element of economic understanding. It is not without its faults, however. To even transform the concept into something usable for application to an interpersonal, exchange economy, we had to make several necessary clarifications and refinements. It is only once these had been made that we could even think about how it may be applied. It is my suspicion that this is the reason why more modern writers have failed to include it as part of their analyses on capital theory — the concept itself is tricky and can be misleading if not first smoothed out. I suspect another reason why the subsistence fund has been largely replaced can be found in one of our clarifications: economization rather than exhaustion. In order for the entrepreneur to know the limits of the subsistence fund at his disposal, he makes use of economic calculation. However, once economic calculation comes into the picture, the subsistence fund concept itself can be easily dropped out. One can instead just view them as the costs of production. While I don’t necessarily advocate for this, as I believe the subsistence fund helps us to further clarify the nature of these costs, the subsistence fund concept is not crucial to understanding capital dynamics. I believe it is for this reason that Mises did not include the subsistence fund in his capital analysis in Human Action when he did so in Theory of Money and Credit — the former uses economic calculation as a focal point whereas it is not emphasized in the latter.

Has the absence of the subsistence fund in modern capital been a mistake? Even though it is largely a tertiary point of capital theory, its exclusion has been a missed opportunity to deepen analysis of capital, especially in the area of business cycles. Even in its absence, however, the subsistence fund has not been forgotten, as demonstrated by Howden and Braun’s efforts to revive it. This represents one of the greatest strengths of the Austrian school — that ideas that were left in the past are not just forgotten, but picked back up and re-evaluated. Whenever value is still found in those ideas, they can then be placed back into the wider corpus of economic theory, increasing our knowledge, appreciation, and understanding of the economic science.