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I agree with Steve on this point.

At UCLA, capital theory was third course in the 3-course microeconomics sequence in the first year of the Ph.D program. It was heavy on Fisher, and all about intertemporal plan coordination. It complemented Leijonhufvud's macro class very nicely.

The future impinges on the present in capital markets. Every action with a future impact is priced into assets today. (Try to think about fiscal stimulus in that model.)

We learned about Knight's Crusonia plant. Even then, I thought it was a crazy view of capital. Capital is embodied in specific goods.

Ludwig Lachmann and Israel Kirzner constantly emphasized capital heterogeneity. Capital is part of a plan and has (full) value only if the plan is realized.

Capital cannot be aggregated because plans are not mutually compatible. In Kirzner's example, a man builds a house and another man builds a bomb to blow up the house. Adding up the values of the two objects is a meaningless enterprise. One of the plans is bound to be frustrated and capital value overstated.

Unoccupied homes in Las Vegas were not additions to the capital stock, but failed intertemporal plan coordination. The individuals involved are poorer not richer. More physical "stuff" is not automatically more capital. (Ask the East Germans about their factories after the Berlin Wall fell.)

Agreed Steve. This was the theme of my HOPE paper with Karen Vaughn.


As you say, it is the foundation for the other two debates.

A very timely comment for my purposes, Steve, as I'm currently writing the editor's intro to the volume in Hayek's Collected Works that will contain the articles doing battle with Knight's capital theory.

I'd add Roger Garrison to the list of important contributors to the capital theory field from an Austrian perspective.

I had the same capital theory course, from Jack Hirshliefer. His 1970 book Interest, Investment, and Capital is an important resource for understanding the profound difference between Knight's Crusonia Plant and the Austrian (Bohm-Bawerk, Wicksell, Hayek) model of capital as a time-phased set of maturing goods.

Just last week Nick Rowe explained to me that capital is a stock, not a heterogeneous production goods coordination problem across time.

And this was part of his argument against (1) the validity of the Bohm-Bawerk / Hayek logic of choice problem, whereby no one will extend the length of a production process without the promise of a greater output; and against (2) the possible existence of a misinvestment discoordination across time.

If you look closely, the _key_ turning point in Hayek's case against neo-classical socialism is in the pricing and "allocation" of production resources. If you'd like the page numbers, I'll get them for you.

Similarly, the key turning point in Hayek's case against Keynes is in the pricing and "allocation" of inputs to production.

There wasn't one "debate" over capital theory, there were several

Even though this was hardly what I expected to read, it is something I definitely agree with. It all boils down to how we see the world, and this is captured in capital theory. (It just happens to be a very important basis in my own work :-) .)

Capital theory and methods have seemed to me, a trained neoclassical (financial) economist, the hallmarks of the Austrian school.

The current state of the art in capital budgeting theory is strategic real options. On the face of it, I can see Austrian capital theory accommodating real options very nicely. As circumstances change, so too does the value of the real options portfolio that a firm has.

If capital is stock, then real options is nonsense. But if capital is a set of plans, including human and physical capabilities, then real options analysis makes sense and fits in with the Austrian idea of capital.

On a personal note, I don't understand how anyone can think of capital as schmoo. A processing chip testing device can't be used to make shoes.

Most people don't know that Hayek's work inspired Harrod to develop the first version of neo-classical growth theory, i.e. the mathematics of the growth across time of "K" later developed and popularized by Solow. (see John Hicks on this.)

Ironic, to say the least.

And yes, Larry is quite right: I should have included Roger Garrison as well.

J Oxman,

Excellent comment.

Austrian capital theory coupled with a thorough-going subjectivist perspective is exactly why Austrian economics is directly relevant to analyzing how an economy really functions. It is not irrelevant, it is not insignificant, it is not radical, and it is not "idealistic." What, after all, could be so idealistic about a theory that takes into account the multifarious plans of the capital structure? It is the Austrians who seem to stress more often than others how messy and complex the world really is, yet, ironically, it is many of the Austrian critics who label the school as defunct. Regardless of whether Austrian economics has got it all right (I don't think they do), it is clear to me that economists--and thus the profession--could greatly benefit by taking heterogeneity seriously.

Lewan's book on capital theory is one of the most importanat books in Austrian economics in past 10-15 years.

Keynes (1936, 183) wrote, in the General Theory, in comments aimed at, but not directly mentioning, Hayek and his capital theory, “But at this point we are in deep water. ‘The wild duck has dived deep down to the bottom—as deep as she can get—and bitten fast hold of the weed and the tangle and all the rubbish that is down there, and it would need an extraordinary clever dog to dive after and fish her up again.’”

From a forthcoming paper on Hayek's relevance to 21st century business cycles:

"Hayek highlighted the complexities of the dynamics of capitalistic production embedded in a structure of production. Maintaining a structure of production, which takes place through time, requires constant replacement of used up, consumed, capital goods. While his development of capital theory was initially part of Hayek’s attempts to provide a better foundation for his cycle theory, the capital structure concepts provides the foundation for a better understanding the complexities of a modern economy that make stimulus, whether by a central bank or by fiscal authorities ineffective. Understanding capital structure is of extreme importance in better understanding the nature of economic development, growth and hence recovery. Perhaps the lesson from this current crisis is not that the duck should be left tangled in the weeds, but that the profession should have been more diligent in sending clever dogs down into the murky waters of capital theory and worked more diligently on its multiple implications for institutions and policy in a dynamic economy."

Following up on J. Oxman's point, I have been telling students for years to read Dixit's work on investment under uncertainty as a point of intellectual arbitrage between the traditions --- in particular, the work on irreversible investment. Only Pete Leeson did that, and eventually he, Chris and I published a paper on whether the market self-corrects beginning with that problem situation (as defined by Dixit and Bernanke).

Per -- why were you surprised? Horwitz and I in a variety of places have emphasized the centrality of capital theory to our respective work on monetary economics and comparative economic systems. It is why I developed my legos versus play-doh analogy. One of my former students from NYU --- Kyle Swan (did his MA under me and then his PhD under Loren Lomasky in Philosophy and now is a philosophy professor) did his thesis on capital theory at NYU. We are all into capital theory over here --- at least my generation of GMU trained economists. Lavoie and High made sure we were.


I agree it would be a great dissertation topic. But I also believe it is the way that you and I, and all our cohort, read O'Driscoll's Economics as a Coordination Problem. The unifying theme throughout Hayek's writings was coordination, and the problem situation was a capital-using economy --- with production for an uncertain future, and requiring the combination of heterogeneous and multiple-specific capital goods.

Jerry shows in that book both in the contestation of ideas with Keynes and with Lange-Lerner, that Hayek was consistent in his emphasis on the coordination of economic activity through time.

So first, lets get all the students to read O'Driscoll and understand what he is saying, and then go from that starting point. Reading O'Driscoll book and then Hayek's L, L, & L, when I was just starting grad school changed the way I thought about the technical issues in economics and the role of the price system. And it made me see Mises and Rothbard in a new light as well. Very powerful book in my opinion.

BTW, Garrison used to have this great line --- tell me your interest rate theory and I will tell you what sort of economist you are. Garrison was at the forefront of Austrian capital theory so should never be overlooked in these discussions.

Not just his book, and his classic article "time and money", but also a variety of papers. I was the discussant on his paper that came out in HOPE in the Menger issue, where Roger talks about capital theory and though I haven't looked at that paper in 20 years my memory of it is that it is an excellent paper.

Cochran, interesting comment from Keynes. I have noticed a similar attitude among many mainstream economists. They seem to prefer simplicity to accuracy, taking Ockham to ridiculous extremes.

Krugman’s baby-sitting analogy for the economy is one example. Sumner’s obsession with ngdp targeting is another. It seems that if the answer isn’t simple and intuitive then mainstream doesn’t want to have anything to do with it.

Of course, the need to turn capital into schmoo is absolutely necessary if you're going to turn economics into applied physics.

As Hayek wrote, the desire for precision is killing mainstream economics.

To get a good prospective on the importance of Capital in development one of Shenoy's last publications is an excellent start:

"Investment Change Through History or An Historian's Outlook of Development: Using Goods of ever Higher Orders"

IJEB Special Issue 2008

PDF available on request.

I earned a masters in neo-classical economics from the University of Oklahoma decades ago, but completely lost interest in economics because I found it useless.

Then I discovered Austrian capital theory and it was like the fog lifted.

Pete wrote:

"The unifying theme throughout Hayek's writings was coordination, and the problem situation was a capital-using economy --- with production for an uncertain future, and requiring the combination of heterogeneous and multiple-specific capital goods."

THIS. And this is why Mises is indispensable. It is HIS understanding of the role of monetary calculation that enables us to explain how we are ABLE to coordinate our plans in an economy comprised of those sorts of capital goods and where humans face an uncertain future. THAT is the Mises-Hayek research program, and it's what I tried to lay out in my SDAE presidential address a few years back, though in somewhat different terms.


Pete, I wasn't expecting this kind of post, that's all. In fact, I was expecting something along the lines of the other debates--capital theory has not to my knowledge been one of those high-profile discussions as the socialist calculation debate or the Keynes-Hayek monetary/fiscal/state debate. But I also wasn't expecting it since Pete Leeson wrote on this very blog that doing capital theory is one of the "vices" of Austrian economists (especially students)... Since nobody objected (as I recall), I thought the bloggers had similar views.

So both capital and labour are "nonfungible" or heterogenous and both have to be analysed in terms of processes that take time and do not have a certain or equilibrium endpoint. But there are universal laws that place limits (parameters if you like) on events and may be used to generate pattern predictions. The notion of pattern predictions take care of Knight's demand for prediction in the open (non-determinate) universe.

speaking of inter-war debates, does anyone know anything about this?

Nicholas Wapshott "Keynes Hayek: The Clash That Defined Modern Economics," forthcoming in October.

see http://www.washingtonpost.com/wp-srv/special/opinions/outlook/whats-in-a-name/keynes.html

There will be a symposium on the Hayek/Keynes debates in the autumn Journal of Private Enterprise.

Jim: I haven't read the book, but I have seen a review by an Austrian whose judgment I trust and the book appears to be a very pro-Keynes/anti-Hayek book, and one that does not treat Hayek very fairly or accurately.

Wapshott appears to be a Fleet Steet journalist .. with all which that implies.

He's still spreading the widely debunked myth of Hayek & Keynes doing air guard duty together during the blitz.

thanks Steve, saved me on buying the book for now.

I am not closed minded, but I do have a number of other books planned to be read over the coming months.

thanks Jerry, I will look out for the symposium on the Hayek/Keynes debates in the Journal of Private Enterprise

Professor Horwitz,

I assume you are refering to _Rivalry and Central Planning_, I still have to read this one. What is special about his method that should be used again in the context of capital theory?


What Don did in that book was to revisit the original texts of the SCD and offer a reinterpretation of the issues at stake that emphasized the deep "Austrianness" of what Mises and Hayek were arguing and how Lange et. al. simply did not understand it (nor did the rest of the profession). The whole Austrian notion of competition/rivalry/discovery that was taken as a given by M&H was not at all understood by the other side and their own equilibrium-bound conception of how markets work made their market socialist proposals unworkable.

This is all common currency in the Austrian world now, and much of the rest of the profession, but it was Don's book that made it so.

I think one could do a parallel thing for the debates over capital.

This post made me realize why I'm strangely obsessed with capital theory (an obsession which I admitted recently to Peter Lewin).

The key thing in these capital "debates" is the asymmetry.

Hayek was a master of both sides of the literature.

His debate rivals didn't know the opposing literature and demonstrably dodn't know the opposing explanatory and logical vision and arguments -- Keynes most obviously, but also Kaldor, Knight and even Lerner and Hicks.

Hayek lost interest in capital theory when folks ignored his Menger-like exploration of the foundations of hetereogeneous production coordination, and folks began to work of the math of the average period of production and the growth of "K" across time -- Hayek wasn't interest in the mathematics of constructs having nothing to do with production goods coordination across time in the real world.

He wasn't bothered by the math, Hayek did math.

He was not interested in essentially pointless math.

There is a big difference.

If someone worked on capital theory, who would publish it?

Who would hire you?

Don't economists pretent capital theory doesn't exist because it is hard and doesn't promise an easy and rewarding career path?

Nick Rowe says he abandoned a dissertation on the Cambridge Capital controversies because it took to much time and effort and promised so little reward.

If this stuff was easy and professionally rewarding, it woukd already have been done,

Steve Horwitz just wrote an article on capital forthcoming in a symposium on the Hayek/Keynes debates (in the Journal of Private Enterprise).

If Greg is right, maybe I should try to get into GMU and write the dissertation. I have a bad habit of doing projects that do nothing to advance my career: my humanities dissertation on the evolutionary origins of art and literature, my ongoing publications on Austrian economics, my articles on how overvalued higher education is, etc. If you want to go nowhere in the humanities, write on evolution and support free markets.

Are any of the modern day Austrians by any chance planning to write the sequel to The Pure Theory of Capital that Hayek never managed to? Surely that would help give a boost to those who view it (rightly) as a highly important topic.

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