What Would a Truly Marginalist Austrian Capital Theory Look Like?
Money & Macro2

What Would a Truly Marginalist Austrian Capital Theory Look Like?

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.

A Brief History of Time and Capital

The concept of “capital” has undergone substantial shifts over the course of the past 150 years. Nevertheless, even as problems with older meanings and models force successive shifts, kernels persist in new understandings, much to the detriment of their coherence. It will therefore be necessary to briefly trace the development of capital theory, beginning with the first marginalists, through the divergence of Austrian capital theory with the mainstream in the 1930s, and ending shortly after the Cambridge Capital Controversy in the 1970s.

The earliest macroeconomic model of capital, which in some respects still forms the kernel of the canonical account of ACT, is the wage fund or subsistence fund, first developed in Mill (1848). The subsistence fund is a theoretical aggregate of deferred consumption in an economy, usually identified with savings, which is necessary to keep an economy above subsistence while investments are being made. Because investment locks up resources for a period of time, the theory goes, an economy must have a sufficiently large stock of saved goods to pay wages and support consumption during this period. If it does, then these investments will be increasingly productive, though requiring a longer period of time to produce a single good. As the subsistence fund grows, longer – and therefore more productive1 – processes can be undertaken. If the fund is not sufficient to maintain subsistence consumption during this period, the investment must be liquidated and return to the previous production processes.

In the one-good “corn economy” model of the wage fund doctrine, there is no distinction between a good-in-progress and a good used in the production of other goods. Capital goods, therefore, were commonly identified with goods in progress (e.g. Hirshleifer 1970: 159) rather than, as is more common today, goods used in the production of other goods. These goods-in-progress could then be represented as a simple function of stored up effective labor time, with more “roundabout” processes involving more labor time over the course of a good’s production. 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 the labor necessary for 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:

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).

A Marginalist Reconstruction

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: 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.

Replacing Roundaboutness

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.


  1. Accounts differ as to what exactly it is about longer (or more “roundabout”) production processes that makes them more productive. Strigl ([1934] 2000) seems at times to argue as if roundaboutness is nothing more than the division of labor, though it is unclear whether this interpretation is sufficient to carry the rest of his argument. That waiting itself can be productive is suggested by Böhm-Bawerk’s ([1891] 1930) metaphor of growing trees or aging wine. Nevertheless, as Lachmann (1956: 84) points out, “there are [also] many examples of goods (fruit, flowers) which are spoiled by the lapse of time,” and it is questionable whether trees are a better metaphor for industrial processes than flowers. Some critics have understood the higher productivity of roundabout production as equivalent with technological progress, though it is not clear why such progress should be interpreted as lengthening rather than shortening waiting – i.e. allowing for a more favorable tradeoff between time and output. For this reason Strigl emphasizes that roundaboutness is more productive for a given level of technology (pp. 86ff, esp. fn. 49). The most satisfactory account is one of selection: productive processes requiring waiting will only survive if the increase in productivity is sufficient to justify the wait. The tradeoff between productivity and time holds therefore only at the possibilities frontier.
  2. However, in ch. 15, § 2, he seems to characterize saving by an increase in the APP: “saving [is] the provisionment of products that makes it possible to prolong the average period of time elapsing between the beginning of the production process and its turning out of a product ready for use and consumption.”
  3. The translator of Hayek’s 1929 article “The ‘Paradox’ of Saving” from its original German brings attention to his rendering of Kapitalintensität (an obvious cognate to “capital intensity” in English, though Hayek (1939, p. 17) thought this rendering “somewhat too literal”) as “roundaboutness” (Ibid., p. 234). This does not match Böhm-Bawerk’s ([1891] 1930) terminology, for whom “roundabout production” was translated from Productionsumwegen (“detours in production”). Hayek did, however, use “roundabout processes” in his English work (e.g. 1931).
  4. Besides their common wage-fund heritage, the affinity between Austrian and Neoclassical capital theory as antagonists to the reswitching debate can be readily seen in Schibuola (2014), where Garrison’s account of ABCT is reprised using the Solow growth model in place of the Hayekian triangle, with largely the same results.
  5. In fact, he directs the criticisms above only at the concept of the average period of production, apparently believing that the concept of roundaboutness which it is supposed to quantify is sound, even if it cannot even in principle be said whether one capital configuration is more or less roundabout than another.
  6. This also fits well with Wagner’s (2010) demarcation of what he calls a neo-Mengerian approach, separate from the steady state logic Lewin criticizes.

    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.

  7. It should be noted, however, that “higher order goods” has a different meaning in this context than in Mises’ economic calculation argument. In the latter, “higher order goods” is a category of action, similar to indirect exchange, in which one purchases a good not to consume or resell it, but to produce a different good for sale; the rational allocation of such goods requires a private property regime. This definite meaning does not carry over into an analysis of business cycle dynamics, where the meaning is, as noted above, something closer to “heavy industry”.
  8. ACT is also traditionally hobbled by its nearly exclusive focus on the complementarity structure of capital, neglecting the equally significant complementarity structure of labor, which displays similar cyclical consequences (i.e. malinvestment in human capital followed by widespread unemployment) – though Lachhmann (1956, p. 87) justifies this by the importance of capital gains and losses due to the fact that capital (unlike labor) can be owned. The term “human capital”, in fact, results from modern neoclassical usage in which K and L refer not to capital and labor, respectively, but to complementary specific and nonspecific factors of production. Any specific aspects of L are therefore reckoned into K, hence the term “human capital”. I suspect the Austrian vocabulary for talking about heterogeneous capital could also capture the heterogeneity of labor in a less tortuous way, but that’s a reconstruction for another paper.


CapitalEugen Von Böhm-BawerkF.A. HayekFrank FetterLudwig LachmannLudwig Von MisesPaul SamuelsonPeter LewinRichard Von StriglRoger Garrison


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  • 1

    Raymond Niles

    Oct 16, 2014 at 3:20 | Reply

    Im thinking about this. It is interesting.

    I agree with your general point that the focus must be on investment. How hard — i.e., how much investment does it require — to reconfigure production? If the change in demand is large and it requires significant amounts of investment to alter a production process, a huge price change will happen in that industry (either a bubble or a collapse).

    So, I think you are right that it is the time for investment (to alter a production process), not the time for producing goods, that matters.

    Does this mean that “roundaboutness” or a time-structure of production is no longer valid? It may be that this concept is confusing when trying to understand the role of capital in the business cycle. For conceptual clarity, one may want to jettison the Bohm-Bawerkian framework, or most of it, as you suggest. (I am still not sure about this.)

    However, it is still true that time is a valid concept when thinking about these things. For example, investment comes from savings, the size of which is a function of time. The more time there is to save, the larger the amount that can be invested. Thus, a large investment is also a more “time-consuming” process.

    From your earlier post, it is clear that bubbles form when large changes in demand confront an industry that requires a large investment to change output (e.g., housing). Such large investment is time-consuming.

    So, we may be able to rescue the concept of roundaboutness, not by applying it to capital stocks, but by applying it to the levels of investment required to alter an industry.

    However, an industry that takes a lot of investment to alter is also one with a large embedded capital structure. Consider the stock of housing, as an example. Then we are back to roundaboutness. It applies to both the stock of capital and to the quantity of investment required to alter output in that industry.

    Does this mean that Bohm-Bawerk is rehabilitated? Probably not. I think that your focus on investment as opposed to capital stock is important and may represent an improvement to ABCT.

  • 2

    Jim Caton

    Oct 16, 2014 at 22:13 | Reply

    This all fits very well with Lachmann and sits well with me, at least mostly. Time structure of production is not so significant to coordination in equilibrium. It does matter out of equilibrium where market actors must form new expectations concerning the profitability of particular ventures and must wait to see if they correctly judged market conditions and interpreted prices. Once in equilibrium, the time element is only important in that the processes are constantly rolling over in a sustainable manner. That’s boring anyhow.

    What is significant is that the structure of production must change to meet certain needs. The time element is important in that it effects profit margins of producers, but this is taken care of well enough with a run-of-the-mill financial framework. Austrian theory is special because of its emphasis on capital structure. Changes to it take time both to plan and integrate. The idea of stages of production is partly a hangover from equilibrium theorizing – otherwise profit margins make nonsense… – and as you aptly point out, Ricardo.

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