L.A. Liberty

Austrian Capital Theory (and Why It Matters) →

The Austrians emphasize that production takes time: The more indirect it is, the more “time” it takes. Production today is much more “roundabout” (Böhm-Bawerk’s term) than older, more rudimentary production processes. Rather than picking fruit in our backyard and eating it, most of us today get it from fruit farms that use complex picking, sorting, and packing machinery to process carefully engineered fruits. Consider the amount of “time” (for example in “people-hours”) involved in setting up and assembling all the pieces of this complex production process from scratch—from before the manufacture of the machines and so on. This gives us some idea of what is meant by production methods that are “roundabout.” …

Through countless self-interested individual production decisions, we have adopted more roundabout methods of production because they are more productive—they add more value—than less roundabout methods. Were this not the case, they would not be deemed worth the sacrifice and effort of the “time” involved—and would be abandoned in favor of more direct production methods. What are at work here are the benefits of specialization—the division of labor to which Adam Smith referred. Modern economies comprise complex, specialized processes in which the many steps necessary to produce any product are connected in a sequentially specific network—some things have to be done before others. There is a time structure to the capital structure.

This intricate time structure is partially organized, partially spontaneous (organic). Every production process is the result of some multiperiod plan. Entrepreneurs envision the possibility of providing (new, improved, cheaper) products to consumers whose expenditure on them will be more than sufficient to cover the cost of producing them. In pursuit of this vision the entrepreneur plans to assemble the necessary capital items in a synergistic combination. These capital combinations are structurally composed modules that are the ingredients of the industry-wide or economy-wide capital structure. The latter is the result then of the dynamic interaction of multiple entrepreneurial plans in the marketplace; it is what constitutes the market process. Some plans will prove more successful than others, some will have to be modified to some degree, some will fail. What emerges is a structure that is not planned by anyone in its totality but is the result of many individual actions in the pursuit of profit. It is an unplanned structure that has a logic, a coherence, to it. It was not designed, and could not have been designed, by any human mind or committee of minds. Thinking that it is possible to design such a structure or even to micromanage it with macroeconomic policy is a fatal conceit.

The division of labor reflected by the capital structure is based on a division of knowledge. Within and across firms specialized tasks are accomplished by those who know best how to accomplish them. Such localized, often unconscious, knowledge could not be communicated to or collected by centralized decision-makers. The market process is responsible not only for discovering who should do what and how, but also how to organize it so that those best able to make decisions are motivated to do so. In other words, incentives and knowledge considerations tend to get balanced spontaneously in a way that could not be planned on a grand scale. The boundaries of firms expand and contract, and new forms of organization evolve. This too is part of the capital structure broadly understood.

In addition, the heterogeneous capital goods that make up the cellular capital combinations also reflect the division of knowledge. Capital goods (like specialized machines) are employed because they “know” how to do certain important things; they embody the knowledge of their designers about how to perform the tasks for which they were designed. The entire production structure is thus based on an incredibly intricate extended division of knowledge, such knowledge being spread across its multiple physical and human capital components. Modern production management is more than ever knowledge management, whether involving human beings or machines—the key difference being that the latter can be owned and require no incentives to motivate their production, while the former depend on “relationships” but possess initiative and judgment in a way that machines do not. …

For Austrians the whole macroeconomic approach is problematic, involving, as it does, the use of gross aggregrates as targets for policy manipulation—aggregates like the economy’s “capital stock.” For Austrians there is no “capital stock.” Any attempt to aggregate the multitude of diverse capital items involved in production into a single number is bound to result in a meaningless outcome: a number devoid of significance. Similarly the total of investment spending does not reflect in any accurate way the addition to value that can be produced by this “capital stock.” The values of capital goods and of capital combinations, or of the businesses in which they are employed, are determined only as the market process unfolds over time. They are based on the expectations of the entrepreneurs who hire them, and these expectations are diverse and often inconsistent. Not all of them will prove correct—indeed most will be, at least to some degree, proven false. Basing macroeconomic policy on an aggregate of values for assembled capital items as recorded or estimated at one point in time would seem to be a fool’s errand. What do the policymakers know that the entrepreneurs involved in the micro aspects of production do not?

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