Austrian Capital Theory | Roger W. Garrison

okay y'all quiet down at three o'clock it works fine this lecture is on Austrian capital theory and that that's essential to learning about the business cycle of the Austrian school and I'll do a lecture on that and another day or so but I'm going to lead up to it so that you can so see just how crucial it is to get the capital Theory straight and to recognize that other schools of economics just don't see it they don't they don't see it at all and especially Milton Friedman and so I showed you two views here one is a Hayekian stages of production model you know what that is and the other one is the freeing Banyon and actually it's naughty and it comes from Frank Knight when both knight and freedmen were at the University of Chicago and I would claim that freedmen got just a little too much night to understand how the business cycle works we're going to neglect changes animal spirits okay we'll just leave that leave that aside now start out that one of the reasons that people get confused about capital in Austrian theory or any other theory is that the word capital is used in so many contexts and so I'll show you a few and then we'll zoom in on the couple that are at at issue this afternoon we can talk about bank capital as assets minus liabilities or net worth you know we know about that liquid capital how liquid is it well that's cash held by producers for future investment so it's that's the you know dollar Capital hears fixed capital you know what that is plant and equipment fixed implies durable working capital that's goods in process raw materials and semi-finished good capitalized value that's present value of net future receipts so the word is used to mean a lot of different things and human capital present value of a skilled workers future earnings rothbard didn't like the use of the word human capital and I'm not sure just why I think I know and that's because business firms have to hire people and the capital that those people have are their capital not not the producers capital but nonetheless that's still another use of the word capital now we're going to get serious because I'm underlining things okay and one of them is Frank Knight his concept of capital was as a capital stock so it's a stock of productive factors that yield a flow of consumption good so you'll hear a lot this time about stock inflows and then you could guess the other one is capital structure that's the Austrian school the temporal pattern of heterogeneous producers capital okay and it's a pattern that can change and can change by changes in the interest rate and the changes based on the interest rates do one thing if the rates come down because people start saving more and it does another thing if it's a central bank that pulls them down one gets you increasing growth the other one gives you boom and bust so that's what you want to look for in this lecture so trawl the rest of them out and those are the ideas of capital that we're going to work with now there's a problem of major in capital and sometimes it's hard to get a handle on this what's what's the problem okay and one way of saying it is capital as heterogenous doesn't get very far a lot of things are heterogeneous okay so that can't be it exclusively another one the C but aren't labor and land heterogeneous - well yeah yeah so what's so strange about capitals let's go on capital is radically heterogeneous now that sounds like something Ludwig Lachman would say okay and that's fine but we need to see what it means okay so just how radical is capital heterogeneity so capital is dimensionally capable there are every genius it's dimensionally heterogeneous all right now let's look at our labor land and capital and I've put in some units here for you to figure out what they are not all units of labor are alike well of course not all units of land are alike and not all units of capital airline well so what's so good and what's so strange about capital and I'll show you what and you'll be able to see just what let's start with was labor worker hours that's that's the working unit now okay we could talk about unskilled labor semi skilled labor or skilled labor okay but there's still heterogeneous but at least we have an idea of what the units are and then you could guess what it is in land we'd call it acres if you're talking farmland and of course it can be different grades of fertility it can be terrain it could be location and so on but we can talk about acres if it's residential then of course look with the other way if it's residential then you know that's another way of looking at it now I'll ask you what what are the units of capital what are those units and you kind of hard-pressed to say something and I've scoured through a number of well say intermediate level macro books to see what they say about it right so and so here are a few of them they just put units on it's they have their parentheses there are units of capital yeah what are they well let's look at even some worse intermediate macro what you get doses are counted it's not gonna work okay chunks and honks I'm not a differential no I'm you know I went to the computer and just looked up and see what these things are and and if that can work okay so you know there you got gallons and you got pounds and said no that's not gonna work there's a dose of capital okay there's a chunk is it a standard chunk could be in a home that's human capital beef broth barrage against that - okay now what our focus is on is the Austrians and Frank Knight and later Friedman right so you can see what the the divisions are temporal pattern that's that's the Austrians and it's not just Hayek it's minger Mises shoe Pater bomba burger all right it's all about the temporal pattern you have to have a time element in there and it it can change with the interest rate and it's important what about what it is that changed the interest rate as I've already indicated and then stock and flow has a pretty antiseptic look it doesn't it doesn't have any pattern at all just a stock of it and the flow from it right now it turns out that that same clash came much earlier with of course now bomba Varick looking at the temporal pattern and John Bates Clark was stock and flow okay and I don't I don't see much of stock and flow that he had as opposed to some of the others and Friedman for instance although I have to say I have good feelings with Clark but that's only because he looks just like my grandfather well-spotted mad so what about production time in the Clark night vision and it goes like this you see a bunch of trees that have been set out and some of them are growing because they've been there more time than others and Clark would argue and so would night and so would freedom them okay that once the steady state is reached and I underline that then production time is irrelevant to relevance and right now clue you in that you may not have read enough night but night puts quotation marks around verbs that make you wonder why to do and to me it seems like it when he puts quotation marks you just sort of crossing his finger like hope you'll go for that you know so we'll see more of them I'll let you look for the quotation marks point them out if you don't see him okay so trees have a linear maturity structure actually log glean here you can see the curve a little bit okay each period of sampling is set out and a mature tree is harvested well okay look they're over on the Left we'll start now with year one these already got set it out okay and so there we've got another one okay and then look over at the right and you can harvest that true okay and so you've got a new tree and yet you've got left what you had to start with all right because it's a steady state as long as you maintain this steady state there's no time element involved at all according to Knight and Freeman in that sense maybe so the next period presents us with the same maturity profile all right let's see yeah see there grows it grows again so that's that's what you had before and you don't have to worry about time at all okay so here's a look at look at the quotation marks okay it's the setting out that enables the harvesting really is that what enables the harvesting and what that means of course is that somehow if you're just dead set on having a steady-state economy with no increase or no decrease if you just have to have that then this is what you do okay now this this one just got Hayek he couldn't stand it setting out the sapling now producers looking close the harvestable free now okay and of course Hayek says that's just an absurd use of words that's all there is to it it can't be true and there you go so production and consumption are simultaneous so don't why kayak why you're worried about the time element it's the same every every time so this is what what night and then Friedman are thinking about okay now here's George Stigler and stickler courses most of you know was at Chicago at the time that Friedman was and night was so George Stigler defends Clark and dismisses bomba Varick on the basis of the simultaneous simultaneity of production and consumption we can say that any one row of trees takes fifty years to mature but since there is a constant output of timber forever there's simply no point in saying and then a strange thing that's George Stigler and this price is in production no that's not it it's production production and distribution theories in 1941 and that's stigler's dissertation under guess who Frank not that's the story and we'll get one more thing about about stings we look at this I wrote my dissertation in the history of economic thought under Frank ty he was so strong minded and so critical a student of the literature that it was a good many years before I could read economic classics through my own eyes instead of his I have never brought myself to read through my doctoral dissertation and that's production and distribution theories again because I knew I would be embarrassed by both the knighting excesses and its immaturity that's a stickler who said it at a at a talk in the 1984 that and that's it all right now we got when I call it black box capital fear watch but black box capital Theory is it it's like a flight recorder on airline that's the black box is it really black you know it's orange okay it's a joint but the blackness is that you don't get to see inside that's it you don't just don't look at it okay don't open it up so it's any complex piece of equipment typically a plug-and-play unit in an electronic system the specific context about which the user has no need to know all right now this is a complete analog to the capital stock all we need do now though so that's the idea that you don't mess what's in the box that's that's the capital in there see what we can do with it yeah so you have maintenance of capital it sort of maintains itself as you can see and a flow of consumption so oh oh I want to leave the maintenance of capital there because that is just a technicality because what that's what you're looking at with the capital stock the capital stock includes maintenance as a there it is technically detail well of course this it's not a technical detail I mean some people would do more maintenance than others you might do it once a week or once every ten days once every five days whatever you choose to do okay and worries about this if it goes wrong maybe you should do a little more maintenance all right so it it's if not a technical detail at all so hence the capital stock is permanent it it maintains itself it's permanent and they say you know I'm saying he puts quotation marks every time you turn around and that that's actually not always because he has another way of saying it capitals the Gerald O'Driscoll put me onto this years ago and I keep underlining it in my book on night here it is the capital stock is permanent well it is safer and then a page or two later now capital stock is permanent as it were what else with a cold capital stock is permanent so to speak what can you do it's not permanent we're sorry okay so the permanent capital stock yields a perpetual flow and you think about what the quality shion's are in a sense as the work so to speak okay so if you go for night and that's that's what you've got to get into so here we are the capital stock we've got maintenance of capital we've got flow of consumption okay so we have a system of capital yielding consumable output all right and then he says but really there's only one factor of production you thought there were three there were only one it is capital okay so human capital everything everything becomes capital land becomes capital and so on in the broad sense of sources so now we've gone to the idea of sources okay good sources much more inclusive than just capital as you thought it was before you realize there really there's only one factor of production and sources now look at her maintenance of capital well land labor and capital are all capital in the broader sense right so maintain main maintenance of sources is what we look at and look at the flow of consumption it's the flow of services because Knight doesn't want to mess with people who aren't producers that nonetheless have things like houses that yield a return over time okay he wants it he wants it all be services so you have to think that everybody's a renter or something everybody has a service book cause they own a home all right now don't try to read this what what I read this it just wasn't wouldn't work let's put the sources up and the maintenance of sources and the services so that's what we got and I'm gonna try to read it for you I may not make it but to help me and maybe you are color coded so you know where the services are and you know where the sources are now before I go through this just a wild girl is all that's given so this is this one is Freeman it goes over to the next slide and I'll show you where it comes from Freedman so this is Freeman and so he's locked into tonight on on capital theory okay well I have one blue thing up there just to let you know what it's about the key feature that's Freeman and then I write of the process in which interest rates have been lowered and has put it that way because what they're talking about has been lowered by the central bank but there's nothing just not that she decided that to change her saving habits okay it's been lowered okay so and so the key feature is that it tends to raise the prices of sources okay that this student Hornstein of both producer and consumer services and those consumer services I have to do with houses that are rented okay relative to the prices of services themselves there really are services like the maid or something like that if therefore encourages the production of such sources and at the same time the everything happens here at the same time so you don't have any any problems during a bust right because the whole happens at the same time the direct acquisition of the services rather than of the sources but these reactions in their turn tend to raise the price of services relative to the prices of sources that is to undo the initial effects of the interest rate okay so nothing really has happened because though time has been allowed for anything to happen and it goes on it's pretty busy okay the final result may be arise in expenditures all directions without any change in interest rates at all interest rates and asset prices may simply be the conduct through which the effect of the monetary change is transmitted to expenditures without being altered at all so everything just happens at once essentially and this is there's no time for a depression or a downturn and this comes from Friedman's optimum quantity of money and other essays you could look it up that's the strange thing so essentially he could have said he could have said okay so much for that Mises you know so it's for that Hayek because nothing actually happens all right now despite the fact that they're talking talking about steady state do you realize that things can go awry and you can actually grow or you can actually train right and so that they show how this works do let's see if we can do it okay there's a capital stock doesn't get much output but everything comes back to the capital stock it's gone alright now this let's just look at night and hayek and modulus a Friedman and Hayek alright it goes like this maintenance is a technical detail Oh hiya Quinn degree maintenance is a matter of choice capital is permanent no capital depreciates but is aldeman able capital is the only factor capital is heterogeneous and multi specific production time is irrelevant in production time is a key variable in boy is that true in Austrian economics its key variable it's all about sources and services it's all about temporal capital structure it's about stocks and flow according to night and it's about dynamic market processes according to hi hi you can't think of two economists that would be that far apart on these basic issues but there they are and to me it's I don't get it with Friedman I don't get it the Friedman would pick up on that and the only thing I can think of is that he was there with Frank Knight and you heard what always said what Stiegler said about how how he just couldn't read it on his own had to read it through 9 as reported in March thousand in his vienna and chicago very webern and early 1950s PhD candidate at the University of Chicago reports that Austrian capital theory was one of those subjects were potent verboten in Chicago right he says one of those what were some of the others I all right now let's look at minger and so what's going on here he uses two term goods of different quarters goods of the seventh order goods of the first order the goods of the first order are consumption goods so we'll change that to consumption good and you have higher-order goods and that always struck me as strange higher what makes up higher and all I can think of it's up there at the top of the screen you know that's higher you call that higher order good put the highest order Goods near the top of the screen and Hayek followed suit as you'll see shortly so there's a higher word goods now what we see here is production proceeds top to bottom well how could it not you can't start at the bottom and go to the top all right but value imputation goes from bottom to top okay some of those parallels what dr. Salerno talked about this morning you can see what I've done is just superimposed high-hat structural production that's page 56 or whatever in the structure of production orders of goods and this this thing hood of strange took me a long time to wonderful what does that mean birthing in another Hayek hangers strange and what strange is is that you have time coming down the horizontal axis well okay but there's nowhere else in this world of economics where time goes downward always goes upward but they've got it goes down with you you might think that it crashes at the origin or something and at the bottom you have consumer goods that are flushed out okay and that's that's sort of on to clean it up a little bit that's that's just higher now okay yep I work on this to sort of fix it because I didn't like this time coming down in that and I worked on it quite a while Walter block told me I did a good job okay so let's see how it works [Laughter] okay so though the time goes left to ride as you would think and the consumption comes out of right as you would guess okay you know there's a more stylized trying well it does not a styler that's the triangle so we talk about the - triangle it's just really the blue part there or purple whatever whatever that is hi I think triangle yeah production time is the sequence of stages we get that right now you might all be thinking if we're dealing with a capital structure isn't that really a simple thing thing is simple to way looking at G's but at least you have the time element there and if you really think that's just too simple for you to play with then go to pure theory of capital instead of prices in production and here's what you'll find so you'll be better off with with the purple triangle okay okay here we go the structure production I think they've got time capital base macroeconomics disaggregates capital to enter temporally consumable output is produced by sequence of stages of production the output of one stage feeding in to the input of the next the temporal temporally defined stages or array graphically from left to right the output of the final stage constituting consumable output so there's the triangle in stages at least we put the stages back in and there's somebody at the early stage it looks like he's on the ball goes what he's doing late stage now that guy's kind of loafing and entering customers but show up yeah late stage investment activities is simple exemplified by inventory management now I put this and this is a factory it says main gate down here and you see the main gate over there and you'll see a sign that says you are here if you've ever gone to look at you you are here now what's missing is that one that says we are here and the point the point is that that almost any factory would be producing things that some go one stage and some go another and you're not quite sure because you haven't read prices and production you don't know what is where alright so they wouldn't be able to tell you where it goes it might be ball bearings that are that go to that go to mining mining equipment and also go to stage board is that early stage your late stage so it's really you can't sort it out at the industry level for pedagogical convenience the initial capital structure is shown as having five stages with growth the number of stages will increase well okay so while all five of these stages are in operation during each period resources can be tracked to the structure of production over time let's see this what what's that what's the goods in process there is oh this is a note here Henry I see I can reduce the triangle in 1931 when Henry Ford was still producing a Model A if only Hayek had had PowerPoint he could have shown how the abstract triangle aligns with real-world output we can do that here and that's just to show you that the output doesn't fall out of the bottom okay you comes to the right together the sequence of stages format hijacking triangle of summary depiction of the economies intertemporal structure of production in an economy experiencing secular growth the triangle increases in size but not or not necessarily in shape and that is an increase in size if people are saving right you know it'll change in shape if they decide to save more or save less that's what a man watch to the watch the structure of production to expand here you can see it expands as people must be saving but it's the same general shape as to triangle when people choose to save more the change in their preferred temporal pattern of consumption is registered by the market the first and foremost by reduction in interest rates and this see reduced current consumption frees up resources in the late stages which then can be employed in the early stages I should say which some can become employed in the early stages so it looks like it looks different let's see so what's the structure production respond to an increase in save so sure enough see when cane so they he didn't have a triangle so when he saw that people saved that means they're not consuming well if they're not consuming why would we be producing and Hayek says realizes that notes if they're saving that changes the interest rate and it makes it makes production better more profitable so in Hayek in theory increase saving results in a reallocation of resources towards the early stages of production there the differential interest rates that sensitivities or the xix theory in nineteen theory increasing saving beyond capital mainland maintenance requires a requirements result in an increase in the capital stock but with no implications about capital's temporal structure that's that's what's lame about this you can get a big capital stock but it's not spread out just right an increase in output of consumer goods emerges over time as their as the early and intermediate products move through the more time-consuming structure of production so now now that you have saving you can increase faster we can see clearly the critical difference between night and high if you burn through the casing of the high of the night in black box we see the hayek Hayekian temporal structure of capital that allows for differential interest rate sensitivities and hence reveals the market mechanism that tailors production plans to the inner temporal preferences if the interest rates are telling you the truth about people's willingness to save it gets genuine sign a sustainable growth if interest rates are being held down by the central bank's we get an artificial boom followed by a bust so that's the end of this one in the start of boom bust cycle when I do another you okay they're there they are thank you [Applause] you

Channel: misesmedia

Views: 2,857

Rating: 4.9560437 out of 5

Keywords: Garrison, Austrian School, Economics, Theory, Capital, Mises

Id: I7N_Zz1dERs

Length: 43min 21sec (2601 seconds)

Published: Wed Jul 18 2018