Unmixing the Metaphors of Austrian Capital Theory
Journal Article2

Unmixing the Metaphors of Austrian Capital Theory

Review of Austrian Economics, 35: 163-176.

Abstract. A complement of metaphors inherited from the classical era has held back progress in Austrian capital theory (ACT). In particular, the attachment to circulating capital as the paradigmatic capital good, largely motivated by the business cycle theory, has locked ACT into a nonoperational point-output model of production. This paper draws out a distinct flow-output approach from work by Lachmann, Lewin, and Cachanosky, contrasts its associated metaphors and paradigms with those of the canonical Hayek-Garrison model, and argues that the former has the potential to bolster both the analytical coherence and the empirical relevance of ACT that it has so far found elusive. By focusing on the investment project rather than the capital good as the object of planmaking, the flow-output approach affirms the core appeal of ACT – a heterogeneous capital structure and a market process approach – by declaring independence from the business cycle 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. Severe conceptual problems have been masked by a sense that the pure axiomatic theory of capital is essentially complete, and that its conclusions are invariant the particular metaphors and paradigms used for capital. In fact much of ACT is not pure theory, and important conclusions hinge on precisely on the simplifying metaphors used to make it operationalizable. In particular, the capital metaphor typically used commits authors to a point-output model of production that cannot account for important features of actual industrial processes. Though some authors in the Austrian tradition have 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 conservative, preferring to leave the edifice intact despite significant revisions to the foundation.

This paper argues that further progress will consist in developing a flow-output model of capital, where the goal of an investment plan is the establishment of a production process rather than the production of a consumption good. This approach is implicit in work by Lachmann, Lewin, and Cachanosky, particularly in the latter’s papers on financial duration. Nevertheless, for the most part they still lack a self-consciousness about their distinctiveness from the Hayek-Garrison point-output model, which remains standard in Austrian pedagogy. The attempt to maintain backward compatibility with the constructs used in point-output models, while understandable, retards further progress, and a decisive pedagogical break is needed.

The following section surveys some conceptual problems that have arisen with ACT over the past century, along with attempts to deal with these problems along the way. Most of them arise from the point-output model of capital necessary to maintain backward compatibility with classical Ricardian analysis. Next, a constructive alternative is offered. Finally, the paper argues that if we are to preserve the analytical distinctives of ACT in light of these conceptual problems, it will be necessary to separate it from the concerns motivated by Austrian Business Cycle Theory (ABCT), to which ACT has been largely subservient.

A Brief History and Critique of the Canonical Austrian Theory

Classical Ricardian analysis is a cost-of-production theory of value, plus a grouping of factors of production into quasi-homogenous aggregates (land, labor, and capital), the ownership of which defines social classes, and quantities of which determine the incomes of those classes. Though the value theory was superseded in the marginal revolution, Ricardian metaphors have continued to profoundly shape the way problems of economic analysis are framed, particularly in capital theory, and even more so in Austrian capital theory.1 The latter’s development through Böhm-Bawerk and Hayek reflects growing awareness of tensions and inconsistencies in these metaphors. In the postwar decades, the leading lights of Austrian capital theory – Mises (1966), Lachmann (1956), and Kirzner (1966) – have sought solutions in the more rigorous application of the subjective method, that is, by attempting to expunge metaphorical elements in favor of axiomatically valid pure theory. Of these three however, as we will see, only Lachmann has managed to break free from a point-output model, and therefore from the complement of classical metaphors.

Capital in its pure theory sense refers to the productive aspect of any property claim; that portion of its value that reflects its usefulness for future consumption as opposed to immediate consumption (Lachmann 1956: xv). It is distinct from the concept of the capital good, which refers to a good whose value is derived entirely (or at least predominantly) from capital value. Provided we remain at this level of abstraction, anything we say about capital will be valid for any form of capital, whether a durable good, a good-in-progress, land, human capital, financial capital, or anything else.2

In practice however, the capital value and the consumption value of a good are not disentaglable. To tell a relevant and operationalizable causal story requires a mid-level theory shaped by the choice of a paradigmatic capital good. This is the type of concrete good we have in mind when telling a causal story, and to which the capital aspect of all other goods can (in principle) be assimilated by analogy. Such a theory, though necessary to refer the results of capital theory to the real world, will not be axiomatically valid, and the attempted retreat to pure theory will not suffice to solve problems inherent in the application of mid-level metaphors.

To see the importance of these metaphors, it will be useful to start from the Crusoe economy used by both Mises (1966) and Kirzner (1966), following Böhm-Bawerk ([1891] 1930), to introduce the explananda of capital theory. In the hands of Austrian writers, this device focuses the analysis on the pure logic of choice; to show to what extent the problems of economic interrelation can be reduced to problems inherent in single acts of choice. In the case of capital theory, the argument runs something like this: Crusoe faces a choice between a hand-to-mouth existence gathering berries, or devoting some time up front to tilling a plot of land and cultivating crops. In order to pursue the latter course, however, he must determine how much time he is able to spare from direct production without starving.

Already in this stylized example we can see the main elements of classical capital theory: the increased productivity of indirect (roundabout) production, the necessity of foregoing current consumption (saving) in order to increase future consumption (investing), the fact that Crusoe must still eat while waiting for his crops to grow (the subsistence fund), and the goal of his plan as the production of a specific good (a point-output model).

Though Austrian writers have largely been aware of particular problems with generalizing these elements to an exchange economy where any particular plan covers only a small portion of a production process, there has been a nearly universal faith that generalizing in this manner is possible with the scrupulous application of the subjective method. In fact, whatever problems the subjective method did solve, it could not touch other fundamental problems in the metaphors entailed by setting up Crusoe’s problem this way.

Roundaboutness and the Circulating Capital Metaphor

Kirzner (1966) argues that consistent subjectivism requires that we define capital and investment in terms of the plans of the investor to provide for future consumption. The Crusoe construct is intended to isolate the relevant plan, but it does not do so uniquely. Compare the following two framings of Crusoe’s capital problem:

  1. Crusoe desires to produce a meal. He can produce it directly by gathering, or spend some time on a longer production process in order to get a bigger or better meal.
  2. Crusoe desires a stream of food. He can secure one stream of food by gathering, or spend some time up front in order to secure a larger or better stream over time.

Kirzner’s analysis builds up exclusively from (a), but both of these are consistently subjectivist. The crucial question, rather, is what we consider to be the goal of the plan: the production of a particular good, with each new meal constituting a new plan, or the establishment of a production process, a routine that results in a stream of food over time, all of which is considered a result of the same plan? This is the distinction between a point output (a) and a flow output (b) model of capital.

Though there are some cases where either interpretation will do, it is not quite an arbitrary choice. If we imagine a production process to be composed of (1) up-front costs, (2) maintenance costs over time, and (3) a flow of output over time, a point-output model is a sensible depiction of a process where maintenance costs are primary and up-front costs are negligible. Each repetition of the process can be considered as a plan in isolation. A flow-output model, on the other hand, is necessary where up-front costs dominate maintenance costs, especially where maintenance costs can be regarded as routine, and therefore part of the initial plan. With an up-front investment in something like a durable tool, each repetition of the productive process cannot be considered in isolation, and can only intelligibly be considered as a continuation of the overarching plan for which the initial investment was made.

These two models are each associated with a different paradigmatic capital good. In a point-output model, Crusoe’s capital (remembering that capital is defined as the potential for future consumption) consists in partly-finished goods. This was the basis for Böhm-Bawerk’s ([1891] 1930) capital theory, with growing trees or aging wine as the paradigmatic capital good. After a certain amount of waiting, capital goods mature into consumption goods of varying quality. In this model there is no up-front investment (or it is ignored); production is a succession of (possibly overlapping) input→waiting→output sequences. Hayek’s (1931) model added some sophistication to Böhm-Bawerk’s by accounting for a flow input, allowing for more complicated production processes where capital goods pass through multiple ‘stages of production’. Nevertheless, for Hayek, as for Böhm-Bawerk, a capital good was still fundamentally understood as an unfinished consumption good.

In a flow output model, on the other hand, the paradigmatic capital good is a tool, or a durable capital good,  something distinct from the consumption good, whose planned use cannot be separated from the entire flow of output it is intended to generate, net of maintenance costs.

Laying it out this way makes it clear that circulating capital can be assimilated relatively easily to flow-output models, provided the production process is repeated, but durable capital cannot generally be assimilated to a point-output model. Nevertheless, most authors have taken it quite for granted that anything said in terms of one can be said equally well in terms of the other. Bruno et al. (1966) argued that “there is no essential difference between the circulating-capital and [durable]-capital models.” Hayek in numerous places (1929; 1931: Preface; 1932b: §XII) insisted that the issues in circulating and durable capital models were, aside from some expository differences, identical in all essential economic respects, and even endeavored to “abstract from the existence of durable goods” (1931: ch. 2). In order to integrate with Ricardian static theory, therefore, which dealt in stocks rather than flows, early expositors of capital theory chose to assimilate durable capital processes to a circulating capital model. Subsequent authors have largely maintained this choice,3 even while recognizing the insufficiency in particular respects of the Ricardian apparatus that motivated it in the first place.

In order to assimilate durable capital into a circulating capital model, capital would have to be regarded as in some sense an unfinished consumption good rather than a good in its own right. For Ricardo, and continuing well into the Marginalist era, this was done by considering capital to represent embodied labor time – or, more generally, “labor, nature, and time stored up” (Mises 1966: 493). Durable capital, therefore, was to be thought of as the indirect application of original factors over an increased number of stages. Any increases in real income would redound up the supply chain and accrue only to the owners of those original factors applied at each stage of production (Mises 1966: 493; Hayek 1931). This is the crucial simplifying assumption behind Ricardian capital theory (see Harwick 2019b), necessary to homogenize (and therefore to be able to compare) inputs and outputs,4 and the reason it sits so uncomfortably beside the Marginalist elements grafted on by Böhm-Bawerk and later Austrians.

The decision to take circulating capital rather than durable capital as the paradigmatic capital good, or (what is the same thing) the decision to employ a point-output model rather than a flow-output model, has resulted in numerous dead ends since the time of Böhm-Bawerk. The most significant was the ‘average period of production’ concept, intended to measure the average period of time original factors were ‘tied up’ in circulating capital goods before being ‘released’ in the form of consumption goods. More capitalistic production embodied more of the original factors, and thus more cumulative waiting between the start of a production process and the end.

Among Austrian writers, this collapsing and homogenization coexisted for a long time with an explicit emphasis on the heterogeneity of capital, with the latter serving to obscure the former. As Lachmann (1956: 73) argued,

On the one hand, no other economist saw more clearly than [Böhm-Bawerk] the essential heterogeneity of all capital… On the other hand, his theory is essentially an attempt to reduce this ‘complex’ to a common denominator and to measure all changes in it in the single dimension of time… [H]e failed when he tried to introduce the incongruous element of single-dimension measurement into a theory conceived in terms of heterogeneous products.

Later Austrian writers did become aware of particular difficulties in Böhm-Bawerk’s exposition. The average period of production, 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.

Nevertheless, despite the wide acknowledgement of Böhm-Bawerk’s error in this narrow respect, it was not until Hayek (1941: vi) that a major Austrian capital theorist acknowledged that the conceptual problems ran much deeper, and even there they were not solved. The basic issue was that the decision problem in a point-output model requires attributing units of output to particular units of input – a straightforward step in principle for circulating capital goods, but one that can only be done for durable capital goods with a backward-looking cost theory of value that treats it as stored up labor time (or factor-time more generally). This point was noted as early as Fetter (1902) and wrestled with at length in Hayek (1941), but was not widely 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, most obviously the average period of production but also more abstract concepts tied to a point-output model of production like ‘roundaboutness’, could not, in the end, be generalized.

Monetary versus Physical Units on Capital

If limitations of point-output models rendered the roundaboutness concept nonoperational, 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, as Hayek tried;5 a more fundamental reconceptualization would be necessary.

Sraffa (1960, ch. 12) showed that capital intensity could not be understood as a one-dimensional scalar. In particular, if the flow of inputs into the production of a good was not constant over time as Hayek (1931) assumed, the optimal technique might vary in unpredictable ways with the interest rate. If two production techniques could not be unambiguously ordered as to capital intensity, the simple Ricardian story, where saving and investment work through the quantity of capital to determine long run income, could not be applied to actual industrial processes. Samuelson (1966) summarizes the issue:

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, however, 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 – which relied even more heavily on the roundaboutness and capital intensity metaphors – acquired an air of obsolescence in its wake.

The issue, again, is one of 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 neoclassical analysis, however – which formalized the Ricardian factors as the Cobb-Douglas production function – 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 or intensity of capital was a function of the interest rate, and not vice versa, and therefore to abandon the Ricardian project of income determination by social class.6

Toward a Coherent Austrian Capital Theory

Even if no particular reconstruction of the Austrian theory has yet superseded 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 its original claims. Though the former would be a book-length task, this section takes some steps toward the latter by delineating a distinct Lachmann-Lewin-Cachanosky model from the standard Hayek-Garrison model.

The Duration Concept

One important corrective has been developed in Lewin & Cachanosky (2015, 2018) and Cachanosky & Lewin (2016, 2018), who build on Hicks (1939; 1973) to provide a replacement for the average period of production and its long succession of abortive successors: namely, financial 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, whether measured in time or labor time, but capital value. As Lewin and Cachanosky (2018) point out, by making “capital intensity” a function of the interest rate rather than vice versa, the Ricardian project of determining the incomes of various classes of owners is rendered defunct, precisely the break necessary to put ACT on firmer footing.

Lewin and Cachanosky trace through several implications of the duration concept for ACT. In the first place, the time structure of production as a series of stages is an untenable holdover of the circulating capital metaphor. Contra Mises’ (1966: 333) attempt, Lewin (1999: 64) sums up the conceptual problems with arranging capital goods by order:

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 … 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 conservative, preferring to repair the foundation without modifying the edifice. They argue that financial 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. Lewin (1999), after the above quote, is unwilling to abandon the roundaboutness metaphor 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.”

In a pure theory sense, duration does capture much of the intuition behind the roundaboutness metaphor and the average period of production intended to quantify it. Nevertheless, because the term ‘roundaboutness’ suggests a plan terminating in a consumption good – a point-output model with a paradigmatic circulating capital good – duration is not simply a drop-in replacement. Though it is possible to attach the meaning of duration to the term ‘roundaboutness’, the constellation of nonoperational metaphors surrounding the latter, and their pedagogical persistence, suggest the desirability of replacement rather than rehabilitation. Lewin and Cachanosky’s (2018, §V) “financial reformulation” of ABCT, for example, in addition to swapping out financial duration for the average period of production, employs a flow-output durable capital paradigm that departs fundamentally from the circulating capital metaphors used in the Hayek-Garrison model. Lachmann, in his corpus, largely does the same, though without an explicit duration concept. Both tell flow-output stories unselfconsciously; indeed, it is not clear that any of these authors have fully appreciated the ramifications of the different paradigm. Most commentators, both friends (e.g. Ebeling 2015) and critics (e.g. Vienneau 2008), have accordingly overlooked this essential difference:7 it is not that we have simply replaced a problematic measure with a workable one; it is that we have replaced the entire set of metaphors used to build up ACT.

Duration and Durable Capital

The flow-input-flow-output (FIFO) paradigm suggested by Lewin above entails substantially 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 commits to a paradigmatic durable capital good receiving inputs and delivering outputs synchronously. Only this way can we adequately capture the place of durable capital in production plans without the futile attempt to reduce capital to “embodied” factors.

The important step is not simply to elevate durable capital to a first-class citizen in capital theory. So long as we regard durable capital as stored up labor time, another detour taken by original factors of production in the process of their transformation into consumption goods, “there is no essential difference between the circulating-capital and [durable]-capital models” (Bruno et al. 1966). It is not circulating capital as such that poses so many intractable problems; rather, it is the habit of thinking of productive processes in point-output terms. A durable paradigmatic capital good will be necessary, but not sufficient, for a productive reorientation.

What would such a reorientation look like? Most importantly, the unit of analysis in capital theory will not be the capital good, but rather the investment project. Rather than resulting in a final consumption good as in point-output models, the goal of investment plans in a flow-output model is understood to be a production process (or changes to an existing one) that itself generates a flow of goods. Rather than focusing on the time-structure of production as intermediate goods flow through it, a flow-output capital theory would focus on changes to production processes, thereby obviating the diversion to “original” factors of production. As Knight (1934, §12) pointed out, though somewhat obscurely, the original factors to which the income from a capital project is imputed are not those gifts of nature present at the beginning of time, but rather those present at the initiation of that project. That these factors were themselves produced with the aid of land and labor is irrelevant except to the extent that they were produced with the income from this project in view, in which case the plan’s boundaries would include them too.

This argument distinguishes Lachmann (1956) from Kirzner (1966), both of whom share the subjectivist emphasis on the plan as the unit of analysis. To take the project instead as our paradigmatic plan orients the subjective method in the context of a flow-output model that was implicit in Lachmann’s work. Once a capital structure is in place, production itself, along with capital maintenance, can be seen as routine, in the sense of being foreseen as part of the original plan.8 This allows us take seriously both the insurmountable problems with the circulating capital metaphor, without giving up on the distinctives of the Austrian process approach. To develop this line further is fundamentally Hayekian in spirit,9 even if it does not follow Hayek’s own analysis in many particulars.

A flow-output model with durable capital at the center is the more natural setting for the duration concept. It is hardly sensical to speak of the duration of a piece of circulating capital, except in a highly stylized arithmetical example. From the perspective of an entrepreneur, the financial duration (which is to say, the time pattern of costs and revenues) relevant to his investment decisions is not that of an individual durable capital good itself except under circumstances of peculiarly non-joint production, but rather that of the project of which it is a part.10 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 stationary equilibrium; it does not require prices to equal costs, nor does it require plans to be pre-reconciled. It requires only that we regard particular investments as starting from a given baseline capital structure, the result of previous investments.11

To call the financial duration of an investment project “roundaboutness” is to strain the metaphor to the breaking point. Roundaboutness, in its straightforward meaning, pertains to and suggests a circulating capital metaphor, goods in progress taking detours through a longer production process, 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. The essential relevance of time to capital theory, therefore, is not that production takes time, but that investment takes time. By reorienting toward a flow-output model this way, we can do justice to the essential Austrian insights without relying on defunct concepts like capital-intensity or stages of production.

Implications for Business Cycle Theory

In the 20th century, investment in Austrian capital theory has been driven mainly by its complementarity with Austrian Business Cycle Theory. While a thorough critique of ABCT is outside the scope of this paper, it will be useful to indicate some of the ways that this complementarity has ‘locked in’ particular problematic concepts and thus prevented their timely liquidation. There are three related supports for ABCT that a properly amended ACT will now fail to offer: (1) the structure of production concept, (2) the nature of the interest rate, and (3) the empirical prevalence of interest-rate-induced malinvestments.

Among Austrian writers, the inadequacy of the structure of production concept has gathered the most assent of these three issues. It has been increasingly acknowledged in recent decades that “higher order” industries – i.e. those further up the supply chain in a circulating capital model – may be the wrong place to look for a boom.12 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. The prices most affected by low interest rates will not in general be pieces of circulating capital further up the supply chain, but investment projects of long duration, whose income streams lie furthest in the future.

The other two, however, cut closer to the core claims of ABCT, and cast doubt in particular on the relevance of the Austrian story as a primary explanation for business cycles. In a pure theory sense, the interest rate is the ratio between the prices of future consumption and present consumption. This is the basic intertemporal model at the core of all the major modern traditions in macroeconomics. The differences among them – whether the interest rate is thought to reflect the productivity of capital, time preferences, liquidity preferences, or some combination of the three – hinge on how consumers are imagined to lay claim to future consumption; or in other words, on the paradigmatic capital good. Because traditional ACT operationalizes future consumption as claims to goods-in-progress, the interest rate can be understood as a ratio between the values of inputs to and outputs of a productive process, a more definite assumption than was even made by the kindred neoclassical production function. This inference is central to the mechanics of ABCT. Nevertheless, from the foregoing it will be apparent that it follows not as a deduction from pure theory, but from the choice of capital metaphor.

Finally, though the specificity of capital goods in certain lines of production is emphasized as a source of losses when consumer preferences reassert themselves, the malinvestment part of the story depends on techniques of production being relatively responsive to the money rate of interest. This responsiveness is easy to imagine in a world where production processes consist simply in the application of original factors to circulating capital goods over time as they pass through a supply chain. The diversion of these capital goods to alternate lines of production may be costly, but it does not itself take time.

The responsiveness of production processes to changes in the money rate of interest is rather less plausible in a durable capital good paradigm. Ironically, the crux of this implausibility is the much-emphasized specificity and immobility of capital goods. If we take ‘investment’ to refer not merely to the purchase of claims future consumption goods, but to the time-consuming establishment or alteration of a production process, then techniques of production will necessarily be much less responsive to short-term movements in interest rates. Because durable capital goods will generally be more specific and less mobile than circulating capital goods, reinterpreting the ‘lengthening’ of processes of production as an increase in the financial duration of investment projects implies a very different story than that told by Hayek and Mises. In particular, investments with a financial duration unjustified by the pattern of consumer demand will be embarked upon not merely if interest rates are too low, but if interest rates are spuriously expected to remain low for the duration of the project. Furthermore, once the process is established, a rise in interest rates will not affect the ratios of input prices to output prices in a way that bears any relation to the duration of the already-completed project (recall here that it is investment projects, and not productive processes, that have a financial duration). Any rise in interest rates will only liquidate those investment projects (1) currently in progress, (2) which were only marginally viable at the lower interest rate, and (3) which need to refinance in the interim, implying a failure to hedge against a rise in interest rates over a long period of time. While the classical ABCT story would indeed intelligibly apply to these investments, it is difficult to imagine circumstances where they would not be an exceedingly small proportion.13 For the rest, immobility simply prevents malinvestment from occurring in the first place.


If the aspects of Austrian capital theory most in need of amendment were those most complementary to the Austrian business cycle story, the amendments suggested in this paper have the potential to raise its complementarity with alternative business cycle theories,14 or other areas of economics entirely. In particular, industrial organization and the theory of the firm are obvious places where a robust theory of capital could be profitably employed.

By using Lewin and Cachanosky’s duration concept to build a flow-output model centered on durable capital as the paradigmatic good, we have given 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 left behind once and for all the vestiges of Ricardian analysis that have retarded progress for over a century. With this more tractable approach to the problems of capital theory, without being stymied by the variety of paradoxes that beset the capital theorists of earlier generations, the difficulties of applied capital theory have the potential to become much more soluble.


  1. See especially Hayek (1941: 47), where he argues that continuity with Ricardo and Mill is a point in favor of Austrian capital theory and against contemporary Anglo-American capital theory. Hayek (1931; 1933) also express debt to Ricardo’s conceptualization of monetary and capital problems. Gordon (1973) argues that the Ricardo-Mill wage fund construct was essentially dead by the end of the 19th century until Böhm-Bawerk ([1891] 1930) revived it in a modified ‘subsistence fund’ form and moved it to the realm of capital theory rather than wage analysis. That very division, of course, is a Ricardian legacy as well.
  2. Other uses in economics, such as ‘social capital’, are more analogies than proper instances of capital, as they do not generally have a rental or sale value.
  3. Hayek (1941) is most notable in this respect for attempting to assimilate in this direction in full view of the difficulties of doing so.
  4. Hayek (1936) at various points both asserts that capital can only be sensibly measured in value terms and not physical, and criticizes Knight’s use of value units to homogenize capital into a fund. Yeager (1976) retains the “attractive quasi-homogeneity” of capital by retreating to pure theory and defining it quasi-tautologically as the thing (whatever that may be) which embodies waiting as a factor of production. It is not clear that this is more operationalizable than the standard Ricardian setup, or even that it suggests a paradigmatic capital good, though Yeager does seem attached to the circulating capital metaphor.
  5. The translator of Hayek (1929) 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).
  6. The Cambridge (UK) antagonists to the debate, on the other hand, saw the basic incompatibility between marginalism and the Ricardian income-determination project more clearly, but preferred to preserve the latter by rejecting the former. See Cohen & Harcourt (2003).
  7. 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). Ebeling (2015), similarly, even states that Lachmann “remain[ed] true to the Böhm-Bawerkian emphasis on capital goods as intermediate goods within time-structures of production”, despite the fact that the lack of this emphasis is precisely what separates Lachmann from preceding Austrian capital theorists.
  8. Hayek (1936) in arguing against Knight’s conception of capital as intrinsically perpetual emphasizes that capital maintenance is not routine; that capital equipment is not necessarily replaced with identical items, and that active decisions are involved at each step. This seems like an overstatement. For our purposes, we can say that planned replacement with an identical item is a routine extension of the original plan, and replacement with different equipment would be a relevant time-consuming change to the capital structure in our sense.
  9. Interestingly, Hayek (1936, fn. 33) suggests avoiding the use of the term ‘capital’ altogether.
  10. Analytically, jointness in production poses the same capital-theoretic problems as the durability of capital. The effect of both is to make it impossible to attribute particular units of output to units of input.
  11. Wagner’s (2010) process-focused and non-equilibrium ‘neo-Mengerian’ approach to economics, for example, appears quite comfortable with this sort of simultaneity:

    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.

  12. 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.
  13. Even such a small set of failures could, in principle, trigger a recession if these failures snowball by 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. This transmission mechanism is significantly different than the standard ABCT story, however: it would place the primary emphasis on what Hayek (1933) and later writers have largely dismissed as “secondary” deflation (though Horwitz [2000] does place somewhat more importance on it). Very different practical conclusions for stabilization policy follow.
  14. Given the role of real business cycle theory in reviving the neoclassical production function following the Cambridge capital controversies (Cohen & Harcourt 2003), a richer capital-theoretic approach has the potential to elucidate the plausibility of its causal claims, as opposed to its statistical fit.


CapitalMacroeconomicsEugen Von Böhm-BawerkF.A. HayekFrank FetterFrank KnightIsrael KirznerLudwig LachmannLudwig Von MisesPaul SamuelsonPeter LewinRoger Garrison


Facebook Twitter Reddit Threads


  • 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.

Leave a Reply

More Content