Does Austrian Business Cycle Theory Depend Upon a Lengthening of the Structure of Production?
No, it does not:
"But now the drop in interest rates falsifies the businessman's calculation. Although the amount of capital goods available did not increase, the calculation employs figures which would be utilizable only if such an increase had taken place. The result of such calculations is therefore misleading. They make some projects appear profitable and realizable which a correct calculation, based on an interest rate not manipulated by credit expansion, would have shown as unrealizable. Entrepreneurs embark upon the execution of such projects. Business activities are stimulated. A boom begins.
"The entrepreneurs embark either upon lateral expansion of production (viz., the expansion of production without lengthening the period of production in the individual industry) or upon longitudinal expansion (viz., the lengthening of the period of production). In either case, the additional plants require the investment of additional factors of production." -- Mises, Human Action, p. 550-553
The evidence above is decisive: "in either case," whether the structure of production does or doesn't lengthen, the same process sets in.
"But now the drop in interest rates falsifies the businessman's calculation. Although the amount of capital goods available did not increase, the calculation employs figures which would be utilizable only if such an increase had taken place. The result of such calculations is therefore misleading. They make some projects appear profitable and realizable which a correct calculation, based on an interest rate not manipulated by credit expansion, would have shown as unrealizable. Entrepreneurs embark upon the execution of such projects. Business activities are stimulated. A boom begins.
"The entrepreneurs embark either upon lateral expansion of production (viz., the expansion of production without lengthening the period of production in the individual industry) or upon longitudinal expansion (viz., the lengthening of the period of production). In either case, the additional plants require the investment of additional factors of production." -- Mises, Human Action, p. 550-553
The evidence above is decisive: "in either case," whether the structure of production does or doesn't lengthen, the same process sets in.
Garrison shows that an artificially lower interest rate *both* lengthens and shortens the structure of production; creating what Garrison calls "dueling triangles".
ReplyDeleteDo you see this as conflicting with the Misesian version?
Well, Garrison *claims* that it does. Whether he *shows* this is what I am questioning.
DeleteWhat I am saying is that these triangles could just be dropped with no loss to the theory.
To quote Garrison
Delete"The Austrian theory is a malinvestment – rather than an over-investment – theory of the business cycle. It is certainly true that policy-induced malinvestment is the unique aspect of the theory. We now see, however, that while malinvestment – the misallocation of resources in the direction of stages remote from consumption – is rightly taken to be the unique and defining aspect of Austrian theory, over-investment is a critical enabling aspect of the theory. Without the over-investment, the malinvestment would be as short-lived as Hicks's critical remarks suggest."
I still contend that ABCT without lengthening is Hamlet without the prince, and Garrison seems to agree.
The triangles I think were meant as a simplified way of showing a complex theoretical structure. Not all people will get what is being said in the theoretical context, so the triangles often help in understanding what is happening. Unfortunately, they miss much of what is most crucial.
DeleteI personally have no problem with dropping the triangles altogether because not only am I better at understanding things theoretically rather than through other methods, I also think that the theoretical understanding is far more important. I will admit, however, that Garrison's changes to the standard Hayekian triangle do elaborate the theoretical content better than other versions that I've seen.
I do agree with Mises that the boom doesn't require a lengthening of the SOP, and I also think that more often than not the lateral expansion of production is that which is most seen during a boom initiated by the lowering of the rate of interest.
Though it is interesting to note that Mises in Human Action indeed does not emphasis the lengthening aspect.
ReplyDeleteIs Hayek perhaps more explicit about this in Prices and Production ?
In P&P Hayek accepts the following as a correct statement of his views:
ReplyDelete" A lengthening of the process of production caused by forced saving (the money supply not having been held neutral) cannot possibly be permanently maintained, but must necessarily be followed by a shortening in the process of production. An increase in money supply (bank credit) made available to entrepreneurs would cause an increase in the demand for producers' goods in relation to consumers' goods, and this would raise the prices of goods of the higher order in relation to those of the lower order. The consequent elongation of the process of production could not, however, be maintained, because a reversal in the price relationship of higher and lower order goods would appear as soon as the money supply ceased to increase owing to the fact that spending and saving habits had not changed. Thus, a shrinkage in the artificially elongated process of production would inevitably occur."
Rothbard certainly emphasizes the lengthening aspect of ABCT
"Now what happens when banks print new money (whether as bank notes or bank deposits) and lend it to business?[6] The new money pours forth on the loan market and lowers the loan rate of interest. It looks as if the supply of saved funds for investment has increased, for the effect is the same: the supply of funds for investment apparently increases, and the interest rate is lowered. Businessmen, in short, are misled by the bank inflation into believing that the supply of saved funds is greater than it really is. Now, when saved funds increase, businessmen invest in "longer processes of production," i.e., the capital structure is lengthened, especially in the "higher orders" most remote from the consumer. Businessmen take their newly acquired funds and bid up the prices of capital and other producers' goods, and this stimulates a shift of investment from the "lower" (near the consumer) to the "higher" orders of production (furthest from the consumer) — from consumer goods to capital goods industries.[7]
If this were the effect of a genuine fall in time preferences and an increase in saving, all would be well and good, and the new lengthened structure of production could be indefinitely sustained. But this shift is the product of bank credit expansion"
(From America's great depression)
I also found this intriguing quote from Joe Salerno
'One of Rothbard’s greatest contributions to economics was his integration of the Wicksell-Hayek structure-of-production analysis with the Fetter-Mises time preference theory of interest. Mises never employed the structure of production in his capital and interest theory, perhaps because of its vague association with Böhm-Bawerk’s erroneous backward-looking formulation of the “average period of production.” In any event, Hayekian capital theory is at the very core of Rothbard’s reconstruction of Austrian production theory that extends for more than 300 pages in Man, Economy, and State.'
Seems like Haye and Rothbard (and Garrison) all take a different view to Mises on this subject.
Gene, I don't really care too much about it, but I can tell you what the orthodox response would be. You are overlooking a key phrase:
ReplyDelete"The entrepreneurs embark either upon lateral expansion of production (viz., the expansion of production without lengthening the period of production in the individual industry)
If consumers started saving more by spending less on going out to dinner, and the freed-up resources were channeled into duplicating existing factories that made tractors, this wouldn't show up as a new stage of production, further removed from consumption than was the case for the original tractor factory (last year). But the period of production for the economy as a whole would be lengthened. Bohm-Bawerk talks about this, and I think Salerno emphasized the point in one of his articles.
No, I am not overlooking this. I understood it was a point of dispute right away: I was merely setting it aside, since the discussion is getting very subtle at this point.
DeleteThe *typical* interpretation of a "lengthening of the structure of production" is that means longer-term processes, and thus empirical studies of ABCT often look at things like "Do industries that produce products that won't ultimately reach the consumer until time X + 1 expand more than those whose products will reach the consumer at time X?"
THAT is what the Hayekian triangle seems to be pointing at, and what I am claiming is that what I will call the Mises-Garrison cycle theory is more plausible and more in line with the data than the typical interpretation of the triangle theory.
I DO recognize that someone could classify Mises's theory as "lengthening the period of production" as well, but only under the subtler meaning you offer, which would not show up under the typical tests.
Its also worth noting that Hayek emphasizes that the new money in his model comes in via the credit markets and will therefore increase the demand for capital goods over consumers goods.
ReplyDeleteI think he sees banks as increasing lending by reducing reserves (which will indeed cause the new money to enter the economy via the credit market and be centered on capital goods) rather than what happens today - the CB increases the monetary base by buying assets and only some of this new money ends up being lent out - the effects here will be much more evenly split between consumer and capital goods spending.