Roger Garrison argues in the opening chapters of Time and Money (2001) that a recovery of Austrian Business Cycle Theory (ABCT), and the capital theory that underlies it (ACT), is not so simple a matter as updating the old framework in light of modern developments in macroeconomics; that it is something sufficiently sui generis as to require advancement on its own terms. The most urgent and overdue task is to jettison the wage-fund framework passed down through Böhm-Bawerk, something that Garrison himself failed to do in that work.
The wage fund or subsistence fund (i.e. savings), out of which the expansion of production can be financed, is the kernel of the canonical account of ACT. With an appropriately sized fund, more productive processes can be embarked upon, which are somehow more productive for being longer.1 Laborers are then paid out of this subsistence fund, which must be sufficient to cover the period of waiting. This is the notion of roundabout production that underlies the most familiar tellings.
Initially, capital goods were conceived of as goods-in-progress (cf. Hirshleifer 1970, p. 159), and the notion of roundaboutness depended, implicitly or explicitly, on the reduction of capital into stored-up labor time. Samuelson (1966) notes that the Average Period of Production, Böhm-Bawerk’s measure of an economy’s roundaboutness, “was actually a primitive capital/output ratio, namely that one which would prevail if the interest rate were zero and all goods could be priced at their wage costs alone.” Hence, more roundabout production was said to involve more waiting from the point of the initial input to the final output. Capital is “tied up” in a roundabout process, eventually to be “released” as consumer goods to support further production.
Eventually, what Samuelson called “circulating capital” models were replaced with “durable capital” models, in which “capital goods” were understood as tools aiding in production rather than goods-in-progress. The notion of capital as stored-up labor, along with the apparatus of the subsistence fund, began to fade into the background. The idea of an average period of production was called by Mises an “empty concept”,2 and by Hayek a “meaningless abstraction” – and this was the consensus among those sympathetic to Böhm-Bawerk’s project. They recognized the necessity of a theory of capital valuation that looked forward to the prices of its products, rather than backward to the labor supposedly embodied in it. Roundaboutness was no longer equivalent with waiting, but it still required waiting. Thus, the notion of a time-structure of production, now unmoored from its original theoretical justification, lived on essentially unchanged, as synonymous with capital intensity.3
With the Cambridge Capital Controversy, and especially with the proof of “reswitching” (Sraffa 1960, ch. 12), it became clear that even the concept of capital intensity was not unambiguous. Between two different capital configurations, one cannot be clearly judged more or less capital intensive than the other except in the context of a prior interest rate. Paul Samuelson (1966) opens his salvo with characteristic bluntness:
The phenomenon of switching back at a very low interest rate to a set of techniques that had seemed viable only at a very high interest rate involves more than esoteric technicalities. It shows that the simple tale told by Jevons, Böhm-Bawerk, Wicksell, and other neoclassical writers – alleging that, as the interest rate falls in consequence of abstention from present consumption in favor of future, technology must become in some sense more “roundabout,” more “mechanized,” and “more productive” – cannot be universally valid.
Samuelson goes on to provide arithmetical examples of reswitching for both circulating and durable capital models. Even before Sraffa’s proof, Lachmann (1956, p. xiv) could claim that “most economists agree today that except under equilibrium conditions, a ‘quantity of capital’ is not a meaningful concept.” Though the main target of the reswitching debate was neoclassical capital theory, the notion of roundabout production was an important casualty,4 and no doubt this gave an air of obsolescence to ACT. With the cold reception of Hayek’s (by all accounts) convoluted attempt to jettison the wage-fund apparatus (1941) decades earlier, and the near-total abandonment of capital theory by neoclassical economists in the wake of the controversy, progress stalled. Even modern retellings, such as Garrison’s, find it easier to use the Hayekian Triangle, an essentially wage-fund construct, from Hayek’s earlier work on the topic (1931).
Given the origin of the Austrian school in the marginal revolution, the fixation on roundabout production is a surprising reversion to pre-marginalist thought. The progress of ACT in the first half of the twentieth century consisted in the progressing realization of how many concepts were tied up with this backward-looking, labor-theory-esque notion of roundaboutness for the structure of production (Fetter 1900). If we are to bring it into the twenty-first, the first step will be to jettison once and for all the concepts which depend, explicitly or implicitly, on this notion of capital intensity.
What this entails is nothing less than the elimination of the time-structure of production as an analytical device. Lewin (1999, p. 64) ably sums up the conceptual problems:
The formula is crucially dependent on being able to identify the stages of production. It is assumed that the process begins at stage 1 and ends at stage n. In this way any kind of “looping” (coal is used in the production of iron and vice versa), where the output of one stage becomes available as an input of an earlier stage, is ruled out. Second, if the output is a flow (as it usually is), then we must also have some way to connect inputs that occur at time periods n—t with precisely that output that arrives at time period n and separate them from those that need to be connected to outputs occurring at time periods n+j where j is an index of time periods occurring after n. In other words, if the production process is a flow input—flow output process, a set of inputs are used to produce jointly a set of outputs occurring over time and the measuring of T becomes more problematic. Similarly, we must be able to identify the amount of labor time l that is used. This obviously presumes that it is possible to reduce any labor heterogeneity to comparable terms, like efficiency units, and then to measure the number of such units supplied per period of time.
Yet, despite all this, the notion has its appeal, even for Lewin. He argues that Böhm-Bawerk’s conception of capitalistic production “is in no way dependent on being able to measure practically or conceptually the degree of roundaboutness by the average period of production or any other measure”, which is tantamount to denying roundaboutness any real-world referent.5 He is unwilling to abandon it because “even where we have a simultaneous and perfectly synchronized production process, considerations of the time structure and the decisions related to it must still enter” (p. 66). The vision of Böhm-Bawerk’s critics of “consumption and investment tak[ing] place at the same time”, he argues, “is valid only for an economy that has reached a state of stationary equilibrium.”
Thus, by his telling, we face a choice between a notion (roundaboutness) with no real-world referent and no possibility of being operationalized, and a methodology that assumes everything it wants to explain, namely the reconciliation of plans in a market economy.
Our options are, of course, not quite so dire. Rather than focusing on the time-structure of production as a stock of capital, an intelligible ACT must focus on the flow of investment – and without the pointless diversion to original factors of production. “Time is germane to [the problems of capital],” Lachmann (1956, p. 111) argues, not as the dimension of capital-intensity, but “as the dimension in which capital resources are turned from one mode of use to another.” When taking out a loan for a definite investment, a businessman can intelligibly speak of a period of investment: the time before his investment begins turning out consumable products. As these are the entrepreneurs whose expectations are frustrated in the course of investment, it is in these marginal investments that we must look for malinvestment and trace the story of boom turning to bust.
Focusing on investment in time rather than production in time not only gives us a framework to appreciate role of time in coordinating plans and expectations, as is the essence of the Austrian approach, but also allows us to appreciate the simultaneity of consumption and production once the investment period is complete, and to sidestep the complaints of incoherence from critics of the canonical approach. Time is relevant because the primary goal of investment is not capital maintenance (as in the steady state), but alteration of the capital structure.6
Hints of this paradigm can in fact be found in the canonical accounts. Mises’ telling (1966, p. 547), for example, is very close to it, if we take “embarking on projects” to mean adjustment of the capital structure rather than production of some particular object:
[The interest rate] shows [the entrepreneur] how far he can go in withholding factors of production from employment for want-satisfaction in nearer periods of the future and in dedicating them to want-satisfaction in remoter periods. It shows him what period of production conforms in every concrete case to the difference which the public makes in the ratio of valuation between present goods and future goods. It prevents him from embarking upon projects the execution of which would not agree with the limited amount of capital goods provided by the saving of the public.
However, vestiges of the capital stock perspective still creep in here and there – for example in arraying goods by their distance from final consumer goods (1966, p. 559) – and he fails to explicitly distinguish the two approaches. It appears many of his readers did not even realize he was advancing a different approach, nor is it clear that he intended to do so. Lachmann, likewise, made a great step forward in “contriv[ing] to tell the story of roundaboutness without mentioning time” (Capital And Its Structure, p. 84), but his explanation of the business cycle as resulting from inflexible prices is so general as to be of little practical use, and his description of the division of capital as an increase in the number of stages through which raw materials pass on their way to the consumer (p. 82) passes dangerously close to the old mode of thought.
It makes no sense to conceive of an investment as embarking on a more roundabout method of production. Investment will be required in order to change the composition of any stock of capital, and as noted before, it is not generally possible to say whether the resulting configuration is more or less capital intensive than the previous. As Lachmann noted (Ibid., p. 58), “the distinction between external capital change in the form of investment (formation of new capital combinations) and internal capital change (regrouping) is entirely unwarranted and one cannot take place without the other” (emphasis in original). This being the case, it should be obvious that the stock perspective is a distraction from the essential point: not that production takes time, but that investment takes time, regardless of its ultimate effect on the capital-intensity of the production process. Stages of production are irrelevant to the story except as an aspect of the general structure of complementarity within the capital stock that constrains the sorts of investments that can be made.
It is, for this reason, too simple to say that during a boom “higher order” industries expand at the expense of “lower order” industries. As an empirical statement it is essentially meaningless, as any sufficiently advanced division of labor will render it impossible to make a satisfactory distinction between consumer and producer goods, much less to array these goods by their order in some production process. It fares hardly better as an analytic statement, i.e. that the place in the structure of production is equivalent to how it fares during the boom and bust cycle. “Heavy industry” – i.e. the highest “order” of goods – which Mises identified as the primary beneficiary of credit expansion, has no definite catallactic meaning.7 The story of expectations disappointed by the failure of complementary capital goods to appear partway through the productive process only makes sense in the context of a highly stylized model of production – the sort of model Austrians tend to look askance at in other contexts.
This notion of a long investment period serves much the same analytical function as the original notion of roundabout production. In particular, both are positively correlated with productivity in the long run. In the traditional account of roundaboutness, processes whose length isn’t warranted by increased productivity die out, so the length of a productive process is evidence of its warrant. Long investment periods, likewise, are more likely to require stopgap measures to increase production until it can be filled in with the production of more suitable capital and labor.8 Rather than training designers to do engineering, for example, college-goers respond to prevailing wages and train as engineers to begin with. Those productive processes requiring a long investment period to alter their capital or labor structure will tend to be those with the most specific capital and labor, i.e. those which face the highest cost of incorporating substitutes. Because uses of specific factors of production which are not profitable enough to withstand periodic restructuring will tend to be competed out of business, the specificity of a firm’s capital and labor structure is likewise evidence of its warrant in terms of productivity.
An important difference, however, is that the investment period will vary inversely with productivity in the short run. The fact that these processes face high marginal costs of short-run expansion, and cannot expand permanently except after a long time, means that average productivity will fall – sometimes steeply – in the meantime. When there are abnormal short-run profits to be made, production must increase even in the face of high marginal costs.
Thus, while the relevance to business cycle theory of marginal investments rather than the entire capital stock does suggest the modifications presented here – namely a focus on bubbles as characteristic of a boom – the central explanandum of ABCT is preserved: the boom turning into bust. It also suggests areas for further theoretical and empirical progress. For example, the story herein has thus far been told without specifying the source of the demand shock. The canonical ABCT story pins the blame on central bank expansion, consistent with the Monetarist account of booms as an exogenous excess of money over expectations (e.g. Lucas 1972). Though a credit expansion can certainly generate a more sustained demand shock than a shift in tastes, the latter can in principle have the same effects. Critics looking for evidence of endogenous business cycles (e.g. Mueller & Niles 2014) may therefore more fruitfully look for endogenous bubbles than endogenous variations in output. Without clear examples of the former, the practical relevance of the latter loses plausibility.
The relevance of ACT to economics in the twenty-first century depends on its clear rejection of Böhm-Bawerk’s conception of capitalistic production. So long as the time structure of production is perceived as the central analytical feature of ACT, no progress can be made in its rehabilitation. Nevertheless, given the failure of mainstream business cycle theory to explain the connection between boom and bust, its rehabilitation remains the most promising way forward.
Suppose that 95 percent of enterprises are operating within their execution phases, leaving five percent of enterprises at nodal positions where they are either creating or revising plans. This kind of situation would generate observations that would fit with the reasonably predictive properties of models of static equilibrium. An established furniture manufacturer that also owned its forests would confront the world in pretty much simultaneous fashion. During any year, or other time span, it would be planting trees, harvesting trees, buying and repairing equipment, and making furniture, all of it appearing to be simultaneous. . . . The source of the motion [in an economy] . . . is the five percent of enterprises not in stasis at any particular instant that are eroding the static reposes of the other enterprises.