Unmixing the Metaphors of Austrian Capital Theory
Money & Macro2

Unmixing the Metaphors of Austrian Capital Theory

The distinctiveness of Austrian capital theory (ACT) against competing theories of capital lies in (1) its process approach over time as opposed to a comparative statics approach, (2) its emphasis on relative prices as opposed to the general level of prices, and (3) its recognition of the importance of the heterogeneity of physical capital. On the strength of these analytical convictions, ACT has persisted into the 21st century as a robust, though marginal, perspective in macroeconomics.

Unfortunately, progress in the decades since its divergence from neoclassical capital theory has been sporadic at best, even in the face of severe conceptual problems. Though some authors in the Austrian tradition have addressed these problems and made important advances since Hayek (1931), no subsequent work gained widespread consensus as a canonical statement until Garrison (2001), essentially a formalization of Hayek (1931). Even those authors making progress in the intervening period have been on the whole essentially conservative, preferring to leave the edifice intact even while replacing the foundation.

This paper argues that further progress will consist in developing Lachmann’s (1956) suggestion that the plan rather than the capital good is the appropriate unit of analysis in capital theory. Though a number of authors have criticized Lachmann for being more cautionary than constructive, there have been strands of more recent work – particularly in Lewin and Cachanosky’s series of papers on duration – that point the way toward an operational plan-centric Austrian capital theory. These developments, however, still lack a self-consciousness about their distinctiveness from the Ricardian Hayek model, which still unfortunately remains standard in Austrian pedagogy.

The following section surveys the conceptual problems that have arisen with ACT, and especially the Austrian business cycle theory (ABCT) that largely motivates it, in the decades since Hayek (1931), along with the various attempts to deal with these problems along the way. Most of these problems arise from capital theory’s pre-marginalist Ricardian heritage. The paper then argues that dealing with these problems has major implications for the conclusions of ABCT. In particular, if we are to preserve the analytical distinctives of ACT in light of these conceptual problems, it will be necessary to discard many of the important conclusions of ABCT, particularly the relevance of malinvestments as an explanation for business cycles and the necessary connection between boom and bust.

A Brief History and Critique of the Canonical Austrian Theory

As with the term ‘saving’ (Harwick 2019b), many of the difficulties with ‘capital’ stem from its shifting use over the history of the discipline of economics. There are two such shifts relevant to capital theory: (1) the shift from a circulating to a durable capital concept, and (2) the shift from a physical to a monetary capital concept. Both of these shifts can be thought of as efforts to replace the Ricardian metaphor for capital, which collapses these distinctions, with metaphors that take these distinctions more seriously.

The Ricardian “Subsistence Fund” Model

The earliest macroeconomic model of capital, which in some respects is still the foundational metaphor of ACT, is the wage fund or subsistence fund, first developed in Mill (1848) and building on the Ricardian model of capital.1

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 sufficient stock of accumulated goods to pay wages and support consumption during this period. If it does, then these investments will lead to an increased equilibrium flow of consumption, though requiring a longer period of time to produce any single good. As the subsistence fund grows, longer – and therefore more productive – investments 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.

The subsistence fund is a powerful metaphor. Just as the classical English economists insisted against the mercantilists that it was goods rather than money as such that made an economy wealthy, so they insisted that all clear-eyed economic analysis be done in terms of goods rather than money. Money was understood as a “veil” that coordinated (and was isomorphic to) the more fundamental movement of goods, and could thus be ignored provided it does not get “out of order” (Mill 1848: 488). The loan market, therefore, was understood to be in its essentials a market where idle resources (the subsistence fund) could be rented out. Even if any particular person could borrow beyond his means, this always required someone with idle resources willing to lend.

In its original form, the subsistence fund was intended as an explanation for economic growth and the distribution of incomes, hence Mill’s caveat. ABCT uses it to explain features of business cycles: artificially low interest rates induce entrepreneurs as a whole to undertake investments for which the subsistence fund is insufficient. There remain, however, a number of issues that call into question whether the subsistence fund is a coherent metaphor for an economy in any respect. First, does it make sense to think of an economy as possessing an accumulated subsistence fund? And second, does it make sense to think of a production process in terms of waiting?

Both questions, in fact, can only be answered in the affirmative by homogenizing capital. If capital is not intrinsically homogenous, as in a corn economy model, it can at least be thought of as embodying homogenous labor time. This is the crucial simplifying assumption behind the Ricardian model, and the reason it sits so uncomfortably beside the Marginalist elements grafted on by Böhm-Bawerk and later Austrians.

Over the first several decades of the twentieth century, these issues came up repeatedly in attempts to advance formulations of ACT and ABCT. In particular, these issues drove (1) the transition from Böhm-Bawerk’s point-input-point-output model to Hayek’s flow-input-point-output model in the 1920s and 1930s, (2) the transition from circulating capital models to durable capital models in the 1930s and 1940s, and (3) the transition from physical-unit to monetary-unit models of capital following the Cambridge Controversy in the 1960s and 1970s. We take these transitions in turn.

Roundaboutness and the Circulating Capital Metaphor

Roundaboutness has always been an opaque concept with a variety of metaphors. Why, after all, should a more roundabout process be more productive?

The answer to the question is bound up with the metaphor or paradigmatic good used to stand in for capital. Predominantly through the 1930s, and continuing in some expositions as late as the mid-20th century, capital was identified with goods in progress – unfinished goods in the process of being completed (e.g. Hirshleifer 1970: 159) – what Samuelson (1966) called “circulating capital” models – rather than, as is more common today, goods used in the production of other goods, or “durable capital” models.

One influential paradigmatic good-in-progress comes from Böhm-Bawerk ([1891] 1930), namely, growing trees or aging wine, which suggests that waiting itself is a basis for roundabout processes being more productive. This metaphor was the core of Böhm-Bawerk’s basic point-input-point-output (PIPO) model: one invests a certain amount of value at an initial point (say, planting a tree), which accumulates value over time but at a diminishing rate. The choice problem, then, is to find the optimal harvest time, when the marginal benefit of waiting just begins to outweigh its marginal cost. The trees in the process of growing were understood to be capital, which become consumption goods when harvested.

Trees, however, were never a particularly intuitive metaphor for industrial processes. As Lachmann (1956: 84) points out, “there are [also] many examples of goods (fruit, flowers) which are spoiled by the lapse of time.” The paradigmatic capital good had to be broadened to account for goods-in-progress for which labor over time, rather than time as such, accounted for increasing value.

The Ricardian device allowed just this. Capital goods could be collapsed into homogenous units of labor-time, resulting in an “average period of production” across an economy. More capitalistic production embodied more labor time, and thus more cumulative waiting between the start of a production process and the end. For this reason, Strigl ([1934] 2000) could argue that roundaboutness is nothing more than the division of labor: specialization entails more labor units being employed on capital goods rather than directly on consumption goods, and can thus be understood as increased total waiting.2

Nevertheless, it soon became clear that thinking of capital as embodying labor-time was incompatible with developments in marginal theory. The average period of production construct, though used uncritically in Hayek (1929), was later called a “meaningless abstraction” in Hayek (1936) and an “empty concept” in Mises (1966: 489) – and this was the consensus among those sympathetic to Böhm-Bawerk’s project. If the Ricardian device for collapsing durable capital into waiting time was invalid, a new capital metaphor would be necessary.

This was the impetus for the development of Hayek’s flow-input-point-output (FIPO) model, carried through in Garrison (2001) and still the prevailing metaphor for capital in expositions of ABCT. In this model, a good passes through various “stages of production” with its value increasing in each stage, hence the flow input.

Hayek’s FIPO model provided a more directly applicable metaphor for capital than Böhm-Bawerk’s PIPO model. Rather than being equivalent with waiting, capitalistic production now simply required some amount of waiting as a capital good moved through the stages of production, which together constituted a time-structure of production. The grounds of the higher productivity of roundabout production also became clearer: the connection between productivity and roundaboutness holds only at the possibilities frontier. Though there is no intrinsic link between the two, processes requiring additional waiting will only survive if the increase in productivity is sufficient to justify it.

In spite of these advances, however, Hayek’s model was basically conservative. Economists had begun by this point to prefer a durable capital metaphor, where the paradigmatic capital good was a good used in the production of other goods rather than a good in progress. Nevertheless, Hayek (1929; 1931: Preface) insisted that the issues in circulating and durable capital models were, aside from some expository differences in the application of the metaphor, identical in all essential economic respects.3 To produce a durable capital good is understood as an additional stage in the production of the good in which the capital good aids. Roundaboutness, now unmoored from its original Ricardian grounds, lived on in an essentially unchanged model, as synonymous with capital intensity.4

The basic problem, however, was that the circulating capital metaphor, passing from Ricardo through Böhm-Bawerk and Hayek, depended implicitly on the labor theory of value to reduce capital to a single scalar value, whether understood as a unit of time, labor time, or capital more generically – a point noted as early as Fetter (1902), but never fully internalized until Sraffa (1960), when the roundaboutness metaphor lost currency among non-Austrians for other reasons. The tools developed with the circulating capital metaphor in mind, particularly the average period of production but also more abstract concepts like ‘roundaboutness’, could not, in the end, be rescued. Conservatism in the development of capital theory led ultimately to a dead end. If the Ricardian edifice – which Hayek (1933) took to be synonymous with “economic theory” – was to be rescued, capital could not be reduced to time or labor units. The roundaboutness metaphor, therefore, was nonoperational.

Unfortunately, with the cold reception of Hayek’s (by most accounts) convoluted attempt to jettison the wage-fund apparatus (1941), and the near-total abandonment of capital theory by neoclassical economists in the wake of the controversy, progress on ABCT stalled. Even modern retellings, such as Garrison (2001), find it easier to use these older and essentially Ricardian constructs from Hayek’s earlier work on the topic (1931).

Monetary versus Physical Units on Capital

If problems with the circulating capital metaphor vitiated the roundaboutness concept, issues raised during the Cambridge Capital Controversy made it clear that capital intensity, even divorced from a notion of roundaboutness, was not conceptually viable. Capital theory could not, therefore, simply replace roundaboutness with capital intensity; a more fundamental reconceptualization would be necessary.

Sraffa (1960, ch. 12) showed that capital intensity was not, after all, a one-dimensional scalar. In particular, if the flow of inputs into the production of a good was not constant, the optimal technique might vary in unpredictable ways as the interest rate fell. If two production techniques could not be unambiguously ordered as to capital intensity, the simple Ricardian story, where saving and investment work through capital to determine long run income, could not be applied to actual industrial processes. 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: 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 Austrian theory – now bereft of both the roundaboutness metaphor and the capital intensity concept – was an important casualty,5 and no doubt this gave an air of obsolescence to ACT.

The issue, again, is one of homogenization and aggregation. Following the classical economists, capital theory was one of the last holdouts in continuing to insist on analysis in physical terms. In this case, the purpose of the insistence was that aggregating capital in value terms makes the capital stock a function of the interest rate. In the Ricardian edifice, however – formalized as the Cobb-Douglas production function of neoclassical theory – diminishing returns to capital in physical terms pin down the interest rate at the productivity of the marginal piece. To abandon physical aggregation of capital was to admit that the quantity of capital was a function of the interest rate, and not vice versa. Though conservatism had carried Ricardo through the middle of the century, if capital could only be meaningfully aggregated in value terms, the edifice would have to – at last – be abandoned totally.

Unfortunately, the Ricardian edifice continues to be used pedagogically and in actual theory. Neoclassical growth theory – in an unbroken line from Solow (1956) to Acemoglu (2009) – continues to model the interest rate as the marginal productivity of (physical) capital. Austrian capital theory – in an unbroken line from Böhm-Bawerk ([1891] 1930) to Garrison (2001) – continues to draw on the roundaboutness metaphor. If ACT is to be made conceptually viable, it will have to dismantle the remaining vestiges of the Ricardian edifice.

Progress since Prices and Production: The Duration Concept

Even if no particular reconstruction of the Austrian theory has yet surpassed the Hayek-Garrison exposition, a number of authors have made important steps toward a more analytically satisfactory ACT, even if we still lack both a full statement of the amended theory and a reevaluation of the original claims of the theory. Though the former would be a book-length task, some steps toward the latter will be offered in the following section.

With the exception of Hayek (1941), most expositions of ACT and ABCT in the decades following Prices and Production attempted to avoid the problems raised with that book by saying less. The lengthy discussion of business cycles in Mises (1966), for example, draws very little from Hayek. Though still making explicit use of the wage fund metaphor at points, Mises mostly avoids committing to a particular operationalization of time in his theory. No doubt he was aware that this point constituted the bulk of the criticism of Hayek’s theory, and wished to avoid what he perceived as secondary empirical issues in favor of building a logically valid pure theory of business cycles – a validity which depended, nonetheless, on a capital metaphor which could not be straightforwardly applied in practice.

Lachmann, on the other hand – the preeminent post-Hayek capital theorist in the Austrian tradition – was an active participant in the Cambridge capital controversy (Lachmann 1958; 1966; 1973), and fully aware of the foregoing problems. It is significant, therefore, that though he wrote at length about capital theory throughout his career, he hardly raised the question of business cycles at all after 1941.

The reception of Lachmann’s innovations within the Austrian tradition has been mixed. Especially in his later years and under the influence of Shackle, many Austrians took his “radical subjectivism” to be tantamount to epistemic nihilism (see Lewis [2011] for a summary), and there remains an impression of Lachmann’s work as one that raises problems more than it offers solutions.

Nevertheless, Lachmann’s approach is pregnant with avenues for development, many of which have been taken up and operationalized by subsequent authors.6 Lewin & Cachanosky (2015, 2018) and Cachanosky & Lewin (2016, 2018), for example, build on developments in Hicks (1973) to provide an alternative and conceptually valid concept to replace the average period of production concept, namely, duration.

Duration, in its modified or Macaulay form, represents the semi-elasticity of the capitalized value of a stream of income with respect to the interest rate (see Cachanosky and Lewin 2016 for a derivation). In this respect it captures much of what the ‘average period of production’ concept was meant to: industries with a longer duration will be more sensitive to changes in interest rates, and therefore more prone to malinvestment under the guidance of misleading intertemporal price signals. The important difference is that the quantity responding to changes in the interest rate is not a (physical) quantity or aggregate of capital, but capital value. Here, finally, is the decisive departure of Austrian capital theory from classical capital theory.

To what extent this matters for the conclusions of ABCT is not obvious. Like Hayek in the 1930s, Lewin and Cachanosky are essentially conservative, repairing the foundation without modifying the edifice. In what follows, I argue that duration is not simply a drop-in replacement for the average period of production, that ‘roundaboutness’ as a sensical metaphor depends crucially on a conception of capital as circulating rather than durable, and that the duration concept implies rather different substantiative conclusions than the standard ABCT story.

Duration and Durable Capital

Lewin and Cachanosky do trace through several implications of the duration concept. In the first place, the time structure of production as a series of stages is an untenable holdover of the circulating capital metaphor. Lewin (1999: 64), for example, 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.

Even so, the main thrust of Lewin and Cachanosky is to argue that duration “captures what it was that the Austrians struggled to express” (2018) and that, besides some infelicitous metaphors like the time structure of production, and some misidentification of where malinvestments would arise (2016), the basic logic of ABCT is sound. Subsequent work takes ‘roundaboutness’ to be an apt metaphor which is adequately measured by duration. Lewin (1999), after the above quote, 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.”

Nevertheless, the flow-input-flow-output (FIFO) paradigm suggested by Lewin above does suggest entirely different metaphors for capital than either Hayek’s flow-input-point-output (FIPO) or Böhm-Bawerk’s point-input-point-output (PIPO) models. If the paradigmatic capital good in a PIPO model is trees, and the paradigmatic capital good in a FIPO model is a good-in-progress (say, a brick, to which is added successively larger structures), only a FIFO model entirely rejects the circulating capital metaphor and commits to a paradigmatic durable capital good both receiving inputs and delivering outputs synchronously.

Fortunately, we can capture the synchronous quality of production with durable capital without resorting to a full Knightian capital model that assumes everything it wants to explain, namely the reconciliation of plans in a market economy. Specifically, the unit of analysis in capital theory cannot be the capital good, but rather the investment project.

This builds on Lachmann (1956), who sets out to analyze capital theory with the plan as the basic unit of analysis. To take the project instead as the basic unit is to give this suggestion more specific content in the context of a FIFO model that was only implicit in most of Lachmann’s work, and to clarify that it is something qualitatively different than the point-output models that took circulating capital as the paradigmatic goods. It also allows us take seriously both the insurmountable problems with circulating capital metaphors, without giving up on the distinctives of the Austrian process approach. Indeed, Lachmann (1956: 14) specifically identifies analysis based on plans as identical with an Austrian process approach. To develop this line further is fundamentally Hayekian in spirit, even if it does not follow Hayek’s own analysis in many particulars.

How would a process-based FIFO capital theory differ from a process-based FIPO capital theory? Rather than focusing on the time-structure of production as a stock of capital, an it would focus on the flow of investment – and without the diversion to original factors of production. It is hardly sensical to speak of the duration of a piece of circulating capital, except in a highly stylized arithmetical example. In real-world usage, it is not the durable capital itself that has a duration, but rather investment in durable capital; a capital project. In other words, it is not the stock of capital to which the Austrian malinvestment story applies, but marginal changes to the capital structure. To imagine a factory receiving inputs and producing outputs synchronously, as Knight did, does not require the economy as a whole to be in equilibrium, nor does it require plans to be pre-reconciled. It requires only that that particular investment have been completed at some point in the past.

To call the duration of an investment “roundaboutness” is to strain the metaphor to the breaking point. Roundaboutness, in its straightforward meaning, pertains to and suggests a circulating capital metaphor, and is therefore misleading in the context of a durable capital FIFO model. “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.” 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 (or roundabout) than the previous. This being the case, it should be obvious that the stock perspective is a distraction from the essential relevance of time to capital theory: 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.

This change in perspective 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, which addresses Knight’s concerns without abandoning the distinctiveness of the Austrian process 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.7

Hints of this paradigm can in fact be found in canonical accounts, even without being clearly distinguished from earlier circulating capital metaphors. Mises’ scrupulousness in the praxeological approach (1966: 547), for example, approaches very close to it if we take “embarking on projects” to mean adjustment of the capital structure rather than production of some particular object, although the reference to “the saving of the public” hearkens back to the subsistence fund metaphor:

[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 (p. 559). It appears many of his readers did not 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” (1956: 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 an increase in the stages of production through which raw materials pass (p. 82) is an unfortunate atavism.

Implications for Business Cycle Theory

One point which has been suggested by various authors on various grounds is that, in light of difficulties with the structure of production concept, a boom proceeding in “higher order” industries – i.e. those further up the supply chain – may be the wrong place to look for verification of ABCT.8 The story of expectations disappointed by the failure of complementary circulating 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.

More importantly, however, is the implication that the Austrian business cycle story – however valid its causal chains – is not necessarily a business cycle story at all once we correct the theoretical shortcomings.

If we were to restate the ABCT story in light of the necessary modifications to ACT, it would be something like: rises in interest rates can cause previously viable investments-in-progress to become nonviable, if they should need to refinance. But aside from the pervasiveness of the interest rate as a price in the economy, it is unclear why this should be of more theoretical import than any other speculative failure to anticipate future price movements. The perception of interest rates being (in the short run) under the control of the central bank, and its connection (in the short run) with the volume of circulation, appears to have led Austrian writers to assign these particular failures far more importance than is warranted.

This latter connection does, however, warrant a more thorough discussion. The canonical Austrian story, drawing on Wicksell, is rather more specific in its discussion of the trigger. The central bank (or private banks with an elastic currency issue) holds interest rates below the ‘natural rate’, i.e. the rate that equilibrates saving and investment, which leads to a mispricing of time. An investment boom results, which – being inconsistent with consumer preferences – eventually forces interest rates higher, and liquidating these investments.

Notice how much of this story – as compared to the skeletal story in the prior paragraph – depends on nonviable concepts above. In the first place, the ‘natural rate’ concept depends crucially on analysis in physical terms (see the discussion in Hayek 1931; 1932 and Sraffa 1932), in a way that does not – in light of the difficulties above – translate readily into a monetary economy. Second, the concept of saving underlying the natural rate concept is a Ricardian economy where saving is accumulated in physical terms, with the interest rate a declining function of the subsistence fund (=saving) (Harwick 2019b). An unsustainable investment boom is one where entrepreneurs are induced to deplete the subsistence fund. However, if the Ricardian metaphor is nonoperational in a monetary economy, the natural rate of interest is also nonoperational, and whether an investment boom is unsustainable or not cannot be referred to it.

A second potential connection is between currency issue and interest rates in the short run. Quite apart from interest rate movements, a monetary expansion can generate a boom if it causes real money balances to rise before prices do. If this is not perceived as a temporary boom, the increase in general profitability can be imputed to capital goods, inducing overinvestment in those capital goods which will turn out to be unwarranted by the pattern of consumer demand once prices do begin to rise and choke off demand. Though that monetary expansion is accompanied by temporarily lower interest rates due to a liquidity effect, it is the spending as such, rather than the interest rate, driving the overinvestment.

Whether or not rational entrepreneurs will be misled this way has been the subject of a great deal of debate. But more importantly, even supposing that there is such a “cluster of errors”, there is no reason to think that the liquidation of these investments at the end of a boom will necessarily lead to a recession. There is certainly some opportunity cost for reassigning specific capital, and real income will be to some degree lower than if the boom had not happened. But where in this story is a sudden crash? It is hard to imagine that the failure of the marginal investments induced by a monetary expansion would diminish real income to the extent necessary to constitute the main explanation for recessions.

A third potential connection might answer the previous challenge by bringing in financial markets. A series of realized bad investments can ramify through financial markets, forcing financial firms to contract their issues of broad monies and financial assets (see Harwick 2019a). This can cause a decline in real money balances, slow spending until prices fall, and a rise in interest rates due to a scarcity of liquidity. In principle the liquidation of marginal investments following a boom could snowball in this way, reminiscent of an Austrian business cycle, though to my knowledge no recession has been demonstrated to have been triggered by a previous overinvestment in exactly this manner.

Even supposing such a story, however, the causal chain differs in important ways from the classical Austrian story. Most importantly, the snowball effect is critical. It is not the malinvestments being liquidated that constitutes a recession; rather, the recession forces the liquidation of more investments than would be warranted by the end of a boom. In this sense, a central bank could fruitfully prevent those further liquidations through monetary expansion at the beginning of a recession without propping up the previous nonviable investments, as both Mises and Hayek feared. The object of monetary policy, therefore, is not to set an interest rate matching saving to investment – indeed, it is not clear what that would mean outside of a Ricardian model – but to supply a quantity of money matching money demand so as to avoid the general pressure on prices that leads either to overspending or underspending.


For much of its life, and especially since Mises, Austrian capital theory has been subservient to the needs of the business cycle theory. The business cycle theory, however, is crucially reliant on just those parts of the capital theory that could not survive a more rigorous specification. By using Lewin and Cachanosky’s duration concept to build a durable capital flow-input-flow-output model, we can give flesh to Lachmann’s fruitful suggestion to use the investment project, rather than the capital good, as the appropriate unit of analysis in capital theory, without abandoning the distinctive process orientation of the Austrian approach, and leaving behind once and for all the vestiges of Ricardian analysis that have retarded progress for over a century now.

Nevertheless, it remains for future work to evaluate the relative importance of ABCT-adjacent causal processes such as those suggested in the previous section. With a more theoretically satisfactory approach to the problems of capital theory, without being stymied by the variety of paradoxes that beset the capital theorists of previous generations, the difficulties inherent to applied capital theory have the potential to become much more soluble.


  1. Böhm-Bawerk ([1891] 1930: 419) distinguishes his own subsistence fund concept from the earlier and cruder wage fund concept of the English economists. While granting his specific criticisms of Mill and Ricardo regarding wage dynamics, for our purposes the essential metaphor is the same between them.
  2. Critics who took the higher productivity of roundabout production as equivalent with technical progress asked 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).
  3. Bruno et al. (1966) was more explicit: “There is no essential difference between the circulating-capital and fixed-capital models as far as the important capital-theoretic issues are concerned.”
  4. The translator of Hayek’s (1929) “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: 17] thought this rendering “somewhat too literal”) as “roundaboutness” (Ibid.: 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).
  5. Besides their common wage-fund heritage, the affinity between Austrian and Neoclassical capital theory as antagonists to the reswitching debate can be 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.
  6. Ironically, O’Driscoll & Rizzo (1985), the most influential book explicitly advancing Lachmann’s research agenda, contains in its chapter on business cycles (ch. 8) a markedly Hayekian and pre-Lachmannite exposition of ABCT which would later be developed into Garrison (2001).
  7. This also fits well with Wagner’s (2010) demarcation of what he calls a neo-Mengerian approach, which is distinct 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.

  8. Cachanosky & Lewin (2016) argue that investments of long duration “do not correlate coherently” with what were understood by previous Austrian authors as higher-order stages of production. Salter & Luther (2016) argue that, in the context of a rational expectations model, whether the boom occurs in higher-order industries or somewhere else has little relevance to the Austrian story. Luther & Cohen (2014; 2016) discuss some of the difficulties in operationalizing the stages of production concept in the context of empirical work.


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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