Austrian School Claims About The Period Of Production And Capital

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Robert Vienneau
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Economists of the Austrian school generally retain some concept that lower interest rates incentivize capitalists or entrepreneurs to adopt more lengthy production processes, in some sense, while still rejecting aggregate physical measures of roundaboutness or capital intensity. This post collects some quotations of economists of the Austrian school or Austrian-adjacent saying such or saying something confused about the Cambridge Capital Controversy. I want to recall this post.

Hayek's 1936 paper is, I think, often cited by Austrian economists. I can agree with the following:

"The basic mistake – if the substitution of a meaningless statement for the solution of a problem can be called a mistake – is the idea of capital as a fund which maintains itself automatically, and that, in consequence, once an amount of capital has been brought into existence the necessity of reproducing it presents no economic problem. According to Professor Knight, 'all capital is normally conceptually, perpetual,' 'its replacement has to be taken for granted as a technological detail,' and in consequence 'there is no production process of determinate length, other than zero' or 'all history,' but 'in the only sense of timing in terms of which economic analysis is possible, production and consumption are simultaneous.'" Hayek 1936: 201-202.

I think Bohm-Bawerk has a metaphor of capital as like a lake, with a stream flowing in and another one out. The streams may have the same volume of water flowing at the same rate, but the depth of the lake still matters.

Here is a less well-posed objection Hayek has to Knight:

"it is asserted that 'making an item of wealth more durable' or 'using a longer period of construction,' i.e. lengthening the time-dimension of investment in either of the two possible ways, is only one among an 'accurately speaking, infinite number' of possible ways of investing more capital, which are later even described as 'really an infinite number of infinities.'" Hayek 1936: 202

And here Hayek clearly makes a mistake:

"An increase of capital will always mean an extension of the time dimension of investment, that capital will be required to bring about an increase of output only in so far as the time dimension of investment is increased." Hayek 1936, p. 204

Hayek is considering the analysis of the choice of technique in a given state of technical knowledge:

"It should be quite clear that the technical changes involved, when changes in the time structure of production are contemplated, are not changes in technical knowledge." Hayek 1936: 205

And here Hayek rejects Böhm Bawerk's measure of the period of production:

"It is not proposed, and is in fact inadmissible, to reduce the description of the range of periods for which the different factors are invested to an expression of a single time dimension such as the average period of production." Hayek 1936: 206

I skip ahead to this century. Here is a deeply confused quotation:

"growth in voluntary saving always causes, in prospective terms, a ‘lengthening’ of the productive structure, irrespective of whether techniques which were only profitable at higher interest rates are readopted in certain new investment processes - all initial factors (land, labor, and existing capital goods) are subjectively deemed to be 'original means of production' which merely determine the starting point of the production process. It is therefore irrelevant whether or not the new investment process incorporates techniques which, considered individually, may have been profitable at higher rates of interest." de Soto (2006)

Considering which techniques are cost minimizing at different rates of interest is an analysis conducted in a comparision of long period positions. It is questionable if it even makes sense to talk about an interest rate on money in an intertemporal equilibrium, that being the model in which initial quantities of capital goods are given. Some fans of Austrian economics have recently injected confusion into the entry on the Cambridge Capital Controversy. De Soto is certainly a 'reliable source', though, in Wikipedia terms.

Leland Yeager was, at least, sympathetic to the Austrian school. He re-introduced something like a period or production, where that period depends on prices:

"The paradoxes dissolve when we recognize that the amount of that factor required in a physically specified production process does indeed depend on its own price." (Yeager 1976)

I do not think his definition is clear. He calls this measure 'waiting':

"We have to recognize waiting as a factor of production—the tying-up of value over time." (Yeager 1976)

And he is clear about how it is dependent on prices:

"the amount of waiting required in accomplishing a physically specified purpose does depend on its own price." (Yeager 1976)

In their response to comments on their retrospective, Cohen and Harcourt say, as I recall, that Yeager misunderstood the issues. Traditional marginalist theory is about the allocation of given resources. Those given resources are land, labor, and capital. What does it mean to talk about a given quantity of capital in the theory? Yeager's waiting does not help answer this question.

At any rate, Yeager recognizes consumption-reversal remains a challenge:

"One paradox not cleared up to my full satisfaction concerns consumption... It seems inadequate to reply that labor is not the only factor of production and that the higher output per man in [a] technique ... does not, at all interest rates, mean higher output in relation to labor and waiting together." (Yeager 1976)

Yeager claims that not fully specifying a traverse limits the CCC:

"Standard theory need not be embarrassed by stories that do not even say how the interest rate is determined and changed, why one economy might be in a steady state employing one technique and an otherwise similar economy in a steady state employing another, or how an economy might make a transition between such states." (Yeager 1976)

I conclude with one more quotation:

"the concept of an aggregate of physical capital is inherently fuzzy. Some capital goods are always being worn out and scrapped, and new ones are always being constructed. Whether the aggregate is growing or shrinking or staying unchanged may be hard to say, especially since unforeseen changes in technology and tastes are always occurring and raising or lowering the market values and the genuine usefulness of particular capital goods." (Yeager 1976)

Cachanosky and Lewin champion an old measure of the period or production:

"It is the (present-) value-weighted amount of time involved in the investment. As such, it is a money-value of time measure. It can be easily show that it is also the elasticity of the NPV with respect to the discount factor f. Therefore, Duration (D) can be interpreted as a measure of 'roundaboutness' and also of the sensitivity of the value of the investment to changes in the interest rate." (Lewin and Cachanosky 2019b)

I know this measure from Hicks' Value and Capital. They also cite Macaulay, a researcher in finance about contemporary with Hicks' work. Duration depends on prices. Fratini recalls that this measure requires a division of zero in an equilibrium. I have noticed a lack of appreciation of the wage-rate of profits frontier in some literature from Austrian school economists.

Anyways, they present Duration in the context of Austrian business cycle theory:

"In its most generic form, the ABCT posits a scenario in which, because of an unsustainably low discount rate, many investors mistakenly invest in unsustainable (ultimately unprofitable) ventures. A surge of investments characterized by higher Durations as a result of the lower rate of discount, is followed eventually by a surge of business failures reversing this trend, bouncing back to lower Duration, safer, investments. Regardless of whether the Duration of some investments rise more or less than others, thus changing the ranking of ventures in terms of their Durations, investors are in general choosing higher duration investments." (Lewin and Cachanosky 2019b)

I am not sure quite what is being claimed in that last sentence, especially with the phrase, "in general".

Anyways, they resist explicitly equating Duration to a measure of the quantity of capital, although I thought that was the point:

"our definition of capital does not suggest that more capital and less labor is implied by an increase in Duration. These are the very aggregate concepts that are rejected by our approach." (Lewin and Cachanosky 2019b)

Consumption reversal might still be an issue for Cachanosky and Lewin.

I do not know how much more literature I want to look at. Above, I have nothing to say about Hayek's triangles or Hayek (1941). I skip over Roger Garrison's more recent book, too, and much more. Apparently, Cachanosky and Lewin have an even more recent book where they might have a response to Fratini.

• Cachanosky, N and P. Lewin. (2018). The role of capital structure in Austrian business cycle theory. Journal of Private Enterprise, 8(2): 268–280.
• de Soto, J. H. (2006). Money, Bank Credit, and Economic Cycles, 1st English ed. (trans. by M. A. Stroup) Auburn: Ludwig von Mises Institute.
• Fratini, S.M. (2019a) A note on re-switching, the average period of production and the Austrian business-cycle theory. Review of Austrian Economics. 32 (4): 363-374
• Fratini, S.M. (2019b) Re-switching and the Austrian business-cycle theory: A rejoinder. Review of Austrian Economics. 32 (4): 368-389.
• Hayek, Friedrich A. (1936). The mythology of capital. Quarterly Journal of Economics 50: 199-228.
• Hayek, Friedrich A. (1941). The Pure Theory of Capital. Chicago: University of Chicago Press.
• Lewin, P. and Cachanosky, N. (2019a) Austrian capital theory: A modern survey of the essentials. Cambridge: Cambridge University Press.
• Lewin, P. and Cachanosky, N. (2019b) Re-switching, the average period of production and the Austrian business-cycle theory: A comment on Fratini. Review of Austrian Economics. 32 (4):375-382.
• Yeager, Leland B. (1976). Capital paradoxes and the concept of waiting. In Time, Uncertainty, and Disequilibrium: Exploration of Austrian Themes (Ed. by Mario Rizzo). Lexington: D. C. Heath.