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Austrian Capital Theory A Prelude to Capital-Based Macroeconomics Two Views: The Knightian Stock-Flow Model The Hayekian Stages-of-Production Model The Keynesian “Animal Spirits” Model July 22, 2013 “Bank Capital”: The Many Assets minus Liabilities, i.e., Net Worth. Meanings of “Capital” The Measuring of “Capital” Capital is heterogeneous. Capital is radically heterogeneous. Capital is dimensionally heterogeneous. The Measuring of “Capital” (units) Not all ____________ of labor are alike. worker-hours acres (units) Not all ____________ of land are alike. chunks doses (units) hunks Not all ____________ of capital are alike. hunk chunk units dose Clark and Bohm-Bawerk Butted Heads about Capital Knight and Hayek Butted Heads about Capital John FrankBates H. Knight Clark 1885 — 1938 1847 1972 Eugen Friedrich von Bohm A. Hayek Bawerk 1851 1899 — — 1914 1992 Black-Box Capital Theory (Clark and Knight) A flight recorder on an aircraft. Any complex piece of equipment, typically a “plug-and-play” unit in an electronic system, with contents about which the user has “no need to know.” THE CAPITAL STOCK DO NOT OPEN Black-Box Capital Theory (Clark and Knight) A STEADY-STATE ECONOMY A flight recorder on an aircraft. Any complex piece of equipment, typically a “plug-and-play” unit in an electronic system, with contents about which the user has “no need to know.” THE CAPITAL STOCK DO NOT OPEN MAINTENANCE OF CAPITAL FLOW OF CONSUMPTION Black-Box Capital Theory (Clark and Knight) A STEADY-STATE ECONOMY The Capital Stock in this theory includes maintenance as a technical detail. Hence, the Capital Stock is “permanent.” The Capital Stock is permanent, in asato so it sense. were. speak. THE CAPITAL STOCK MAINTENANCE OF CAPITAL DO NOT OPEN And accordingly: The “permanent” Capital Stock yields a “perpetual” income. QUALIFICATIONS: “in a sense,” “as it were,” “so to speak,”…. Black-Box Capital Theory (Clark and Knight) The economy is a system of “capital” “sources”yielding yielding“consumable “services.” output.” There is only one factor of production. It’s “capital” ---in the broad sense of “sources.” Land, labor,* and capital are all “capital” in the broad sense. THE CAPITAL SOURCES STOCK DO NOT OPEN MAINTENANCE OF SOURCES CAPITAL FLOW SERVICES OF CONSUMPTION Black-Box Capital Theory (Clark and Knight) THE CAPITAL STOCK DO NOT OPEN Black-Box Capital Theory (Clark and Knight) AN EXPANDING ECONOMY THE CAPITAL THE STOCK CAPITAL STOCK DO NOT OPEN Black-Box Capital Theory (Clark and Knight) A CONTRACTING ECONOMY THE CAPITAL STOCK What about production time in a Clark-Knight vision? George Stigler defends Clark and dismisses Bohm-Bawerk on YEAR 1 2 the basis of the 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 is simply no point in saying it.” George Stigler, Production and Distribution Theories, 1941 Once a Steady State is reached, production time is irrelevant. The trees have a linear maturity structure (log-linear, actually). Each period, a sapling is set out, and a mature tree is harvested. The next period presents us with the same maturity profile. It is the setting out that “enables” the harvesting. Setting out the sapling (now) “produces” the harvestable tree (now). Production and consumption are “simultaneous.” QUALIFICATIONS: “in a sense,” “as it were,” “so to speak,”…. Knight and Hayek Butted Heads about Capital Maintenance is a technical detail. Maintenance is a matter of choice. Capital is permanent. Capital is ever changing. Capital is the only factor. Capital is unique and heterogeneous. Production time is irrelevant. Production time is a key variable. It’s all about sources and services. It’s all about temporal capital structure. It’s about steady-state equilibrium. It’s about dynamic market processes. Frank H. Knight 1885 — 1972 Friedrich A. Hayek 1899 — 1992 Bohm-Bawerk’s Maturity Classes MENGER’S LAW The value of higher order goods derives from the value of the respective consumer goods. HIGHER ORDER GOODS Value Imputation goes from Bottom to Top Production Proceeds Top to Bottom GOODS OF THE SEVENTH ORDER GOODS OF THE SIXTH ORDER RICH COUNTRY GOODS OF THE FIFTH ORDER GOODS OF THE FOURTH ORDER GOODS OF THE THIRD ORDER GOODS OF THE SECOND ORDER POOR COUNTRY GOODS CONSUMPTION OF THE GOODS FIRST ORDER S T AOGRE DS E O R FS PORF OG DO UO CD T ISO N GOODS OF THE SEVENTH ORDER GOODS OF THE SIXTH ORDER GOODS OF THE FIFTH ORDER GOODS OF THE FOURTH ORDER GOODS OF THE THIRD ORDER GOODS OF THE SECOND ORDER GOODS OF THE FIRST ORDER The Hayekian Triangle PRODUCTION TIME (A SEQUENCE OF STAGES) ---from F. A. Hayek’s The Pure Theory of Capital, 1941 CONSUMPTION The Structure of Production STAGES OF PRODUCTION Capital-based macroeconomics disaggregates capital intertemporally. Consumable output is produced by a sequence of stages of production, the output of one stage feeding in as input to the next. Early-stage investment activity Late-stage is exemplified investment by The temporally defined stagesdevelopment. are arrayed graphically from left to right, by product activity is exemplified the output of the final stage constituting consumable output.management. inventory PRODUCT DEVELOPMENT INVENTORY MANAGEMENT WE ARE HERE YOU ARE HERE The directory at the front gate includes the conventional YOU ARE HERE sign but no Hayekian WE ARE HERE sign. CONSUMPTION The Structure of Production STAGES OF PRODUCTION For pedagogical convenience, the initial capital structure is shown as having five stages. With growth, the number of stages will increase. Although all five of these stages are in operation during each time period, resources can be tracked through the structure of production over time. Watch the resources, or “goods in process,” move through the stages. CONSUMPTION The Structure of Production STAGES OF PRODUCTION For pedagogical convenience, the initial capital structure is shown as having five stages. With growth, the number of stages will increase. Although all five of these stages are in operation during each time period, resources can be tracked through the structure of production over time. Watch the resources, or “goods in process,” move through the stages. NOTE: Hayek introduced his triangle in 1931, when Henry Ford was still producing the Model A. If only Hayek had had PowerPoint, he could have shown how the abstract triangle aligns with real world output. CONSUMPTION STAGES OF PRODUCTION Together, the sequence of stages form a Hayekian triangle, a summary depiction of the economy’s intertemporal structure of production. In an economy experiencing secular growth, the triangle increases in size but not in shape. CONSUMPTION STAGES OF PRODUCTION Together, the sequence of stages form a Hayekian triangle, a summary depiction of the economy’s intertemporal structure of production. In an economy experiencing secular growth, the triangle increases in size but not in shape. Watch the Structure of Production expand. CONSUMPTION STAGES OF PRODUCTION When people choose to save more, the change in their preferred temporal pattern of consumption is registered by the market, first and foremost by a reduction in interest rates. Reduced current consumption frees up resources in the late stages ---which can then be employed in the early stages. Lower interest rates favor more time-consuming production processes. CONSUMPTION Watch the structure of production respond to an increase in saving. Note the emergence of a sixth stage of production. STAGES OF PRODUCTION When people choose to save more, the change in their preferred temporal pattern of consumption is registered by the market, first and foremost by a reduction in interest rates. Reduced current consumption frees up resources in the late stages ---which can then be employed in the early stages. Lower interest rates favor more time-consuming production processes. CONSUMPTION THE CAPITAL STOCK DO NOT OPEN STAGES OF PRODUCTION In the Hayekian construction, increased saving results in a reallocation of resources among the stages of production. Here, the differential interest-rate sensitivities are at work. In the Knightian construction, increased saving (i.e., saving beyond the technical requirement of maintaining capital) results in a an increase in the capital stock (and a decrease in the flow of consumables) with no implications about capital’s temporal structure. CONSUMPTION THE CAPITAL STOCK DO NOT OPEN STAGES OF PRODUCTION The increased output of consumer goods emerges over time as the early and intermediate products move through the more timeconsuming structure of production. This is the construction that allows us to depict both economic growth and the boom-bust cycle. In the Knightian construction, increased saving (i.e., saving beyond the technical requirement of maintaining capital) results in a an increase in the capital stock (and a decrease in the flow of consumables) with no implications about capital’s temporal structure. CONSUMPTION THE CAPITAL STOCK LET’S DO OPEN STAGES OF PRODUCTION We can clearly see the critical difference between Knight and Hayek. If we burn through the casing of the Knightian Black Box, we see the Hayekian temporal structure of capital that allows for differential interest-rate sensitivity and hence reveals the market mechanism that tailors production plans to intertemporal preferences. If interest rates are telling the truth about people’s willingness to save, we get genuine, sustainable growth. If interest rates are being held down by the central bank we get an artificial boom followed by a bust. Knight and Hayek Butted Heads about Capital Frank H. Knight 1885 — 1972 Friedrich A. Hayek 1899 — 1992 Austrian Capital Theory A Prelude to Capital-Based Macroeconomics Two Views: The Knightian Stock-Flow Model The Hayekian Stages-of-Production Model July 22, 2013