Abstract
The time is right for a reexamination of Austrian capital-theory. We attempt to capture the essence of Carl Menger’s approach to capital, highlighting the important distinction between goods and the valuable services they yield (implying that goods are valuable only because they yield valuable services) and highlighting also the importance of money in facilitating exchange and production and in providing the means to value them. We look at the capital-theory of Böhm-Bawerk and suggest that, in many respects, this was a wrong turn, although it did set in motion valuable efforts to clarify the importance of the heterogeneity of productive-resources and their growing complexity over time. We examine the production-function, micro and macro, and show that it is logically untenable and useless as an instrument for empirical investigation, and that this has been known for decades. Of the Austrians after Menger, only Mises followed Irving Fisher in focusing on valuation. He did so in the context of explaining the importance of calculation. Mises’s approach to capital has been insufficiently understood and appreciated. By way of conclusion we draw from our considerations to provide a research agenda in Austrian capital theory.
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Notes
Menger realized that the price represented the “marginal value” to each trading partner. It represents a value at least as high as the best alternative the buyer could have purchased with the money-price, and to the seller the money-price represents the value of something he can purchase that is at least as great what he has given up.
“Menger, … severely condemned Böhm-Bawerk’s theory from the first. In his somewhat grandiloquent style he told me once: ‘The time will come when people will realize that Böhm-Bawerk’s theory is one of the greatest errors ever committed’. He [Menger] deleted those hints in his 2nd edition.(Schumpeter 1954, p. 847, note 8)”. See de Bornier 2016.
A significant proportion of the contemporary empirical work on the ABCT rests on Garrison’s (2001) model, which is an adapted and expanded version of the Hayek triangle. Garrison shows that when the monetary authority reduces the interest rates (below its equilibrium level) earlier and later stages of production grow relative to the middle stages of production. Empirical work following Garrison’s approach looks at industry level statistics and locates different economic activities in different stages of Hayek’s triangle. Then, the correlation between the behavior of each stage of production and interest rates is observed. For a sample of this literature see Lester and Wolff (2013), Luther and Cohen (2014), Mulligan (2002), Powell (2002), and Young (2005).
Our ability to adapt to and facilitate change is also greatly enhanced by the encapsulation of knowledge in physical production-goods. Production-goods may be said to “know how” to do certain things. They are embodied knowledge put there by their creators. They are modules of knowledge that can be used in multi-specific ways. “Modularity” is a key aspect of our ability to enhance and adapt to change. See Lewin and Baetjer 2011.
More accurately, it is the services of capital and labor that are the inputs into production. K and L are stocks that when employed yield a flow of services per period of time.
Successful aggregation would mean that the aggregate production function that resulted, behaved as the neoclassical theory says it should, with the input categories, like K and L, providing unambiguous information about the variation of the components of these categories. K and L will behave like quantities of identifiable factors of production contributing marginal products (in terms of variations in the aggregate output) and for which there are the expected downward sloping demand curves. Realizing this, it is perhaps not surprising that aggregate production functions are never likely to be found in the real-world.
It is well known that the IRR criterion is inferior to using the magnitude of NPV (net present-value) when deciding among exclusive investment projects and that there are instances when the two criteria give different rankings. Among available investments that cover the (the opportunity) cost of capital the investor should choose the one with the highest NPV at that cost. This does not affect our discussion.
For a more detailed treatment on risk and uncertainty in this financial context see the discussion in Cachanosky and Lewin (2016a, 2016b)and Cachanosky (forthcoming).
See Cachanosky and Lewin (2014) for a fuller discussion.
We omit here discussion of difficulties in the practical use of D for immunization purposes owing to the inaccuracies produced by second and higher order effects that result from real-world discrete changes (when measuring CV sensitivity to discount-rate changes), and also from consideration of the connection between the discount-rate used by the investor and the structure of market interest rates. These complications have been extensively considered in the literature. Our purpose here is to highlight the conceptual cogency of D as a measure of time involved in any investment.
See Cachanosky (forthcoming) and Cachanosky and Lewin (2014, 2016a, 2016b)
We can tie our discussion back to the conceptual discussion of capital at the beginning of our paper. Equation 9 explicitly shows that if K does not exist (a different situation than being zero), then the computation of the present value (the market price of the firm) is undefined. This means that the market process cannot do without a financial concept of capital, a point of view that is lost when focusing solely on heterogeneous capital-goods. Since equation 9 is an algebraic transformation of equation 6, this is equally true in the case of the FCF method. However, in the FCF framework financial K is an implicit variable. In this approach FCF = NOPAT − NI where NI is the net investment. Since NI = ΔK, if financial K is undefined, so is NI and so is FCF. This problem, however, it is not as evident in the FCF methodology as it is in the EVA® framework.
Capital-value, CV = CV(i, p, w, n, τ) is a multi-variate function, and so is D = D(i, p, w, n, τ), where i is the discount-rate, p is the price of the product, w is the wage (rental)-rate for productive resources employed, n is the number of periods, and τ is a technological parameter. These variables are better interpreted as vectors. When i changes, what else changes?
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Lewin, P., Cachanosky, N. Value and capital: Austrian capital theory, retrospect and Prospect. Rev Austrian Econ 31, 1–26 (2018). https://doi.org/10.1007/s11138-016-0374-8
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DOI: https://doi.org/10.1007/s11138-016-0374-8