I’ve a question concerning the Austrian theory of capital structure. As far as I understand it, when people’s time preference decreases, and they buy less consumer goods, this somehow helps the capital goods industry.
But suppose people buy fewer cars, why then should there be more investments in R&D, production plants, etc. ? Since all companies produce for the consumer market, won’t then all companies in all stages of production adjust their production to the demand for consumption goods?
I can help the capital goods industry if they decide to invest. As a matter of simple logic if savings increase the price of money or interest tends to decrease. Of course the sticking point is anyone who doesn’t immediatly dissipate their income on consumer goods is technically saving. For how long and to what end are also factors. All of society could be saving, but if all everyone does is buy a six month CD and keep the rest in cash you’re not going to see a whole lot of long term loans.
Assuming people buy fewer cars because they want to save for the long term, put their money away in longer term timed savings products, then that’s what makes more money available for R&D, production, etc.
The company that makes the dies to form sheet metal for car doors is producing for the consumer market? Maybe in some odd way they are, but not really. They’re producing for the producer market, so instead of hammering a piece of metal into a mold they can press a button and produce more doors than they could manually.
Think about it, as always to simplify, in Crusoe terms. If you’re on an island and you’re catching just enough fish a day to live and sleep but want more, the first thing you’re going to have to do is stop eating as much fish. You’ll either save some time not for fishing but for making a net or trap or something, or save some fish so you can support yourself while doing the same. Either way you cut back on present consumption and then make a decision to devote those resources to the future. Say you’re fishing 16 hours a day and sleeping 8. Maybe instead you fish for 12 hours a day, build a net for 3 hours, bum around for 1 hour, sleep for eight. It’s not your whole curtailment of present consumption that’s devoted to the future, only three quarters. However that extra hour still sort of effects the ‘price’ of investing doesn’t it, because it’s no longer spent fishing but just jerking around, so it has a different value now. Say that extra hour is cash, you’re hanging on to it for uncertainty. The less uncertain things are, the more likely you’d be willing to knock it down to a half hour and put more time toward the net. Things get more uncertain, you’ll want more cash, maybe keep two hours each day in reserve, only two hours to the net, twelve for fishing and eight for sleeping.
See the relationship? While total savings necessarily affects the overall interest rate simply because all the money is being diverted from consumption, it’s not necessarily all just automatically available to investors. People have to make the decision to do that kind of thing.
I’m not sure how your question relates to time preference. If people buy fewer cars, they will have more savings available to sell investments with. This in turn will drive the prices of investments down and result in more and longer investments overall.
But let’s say we are a car company, obviously it is no good that people are buying fewer cars as this implies that our own savings will be impacted due to lower profits. The car company will not have any savings to invest in R&D. However, this does not impact the global market for savings-investment, other than removing one possible investment choice due to it having become unprofitable.
But if, for example, people are saving little and spend all their money on cars. Then car companies will invest that money in R&D, they will expand production plants, they will invest in machinery, tools, employee education, etc.
The companies producing the tools, auto parts and machinery for the car company will also invest more until finally, also the mining companies will expand production to service the additional demand.
Therefore, consumption and investment should also move up and down together, not against each other.
How do you know they will do that? Why should they do anything other than putting aside money to account for depreciation of plant and equipment? And what are their margins? Do they have enough after materials, payroll, dividends, depreciation, etc., to even afford to invest?
Your assuming an ultimately closed system it sounds like, at least to me. There’s no reason why they can’t go up together, but one still has to preceed the other at any given moment. The point being that for any given moment in time the supply of everything is fixed and what portion given over now to say three year time deposits influences what’s avaliable just after now for three year loans. You are approaching the subject, whether you know it or not, from the point of view of an equation that is in eternal balance, always equalling out to some constant. That’s understandable since that’s the view of the economy many economists push, but it isn’t reflective of reality. Savings and the decision to invest has to preceed investment and curtails consumption at that moment, but the chunk of income given over to investment is just that, momentary, and doesn’t mean the long term supply of income has been forever reduced by that amount until the investments pay off. People go out and earn more. And spend and invest more. The supply of money is momentarily fixed and allocated at opportunity cost, but not fixed for all time.
I just assume, that a company that sells many goods will earn a higher profit. I may oversimplify a little, but it is not unrealistic, that a company that earns a higher profit will expand its business activity.
The point of my question was, assume people cut back on consumption in order to buy IOUs. Why should company use that money for expansion, when people just buy less? In that case, the Keynesian argumentation of more consumption->more investment → more consumption, etc. sounds much more logical to me than the Austrian less consumtion ->more investment.
I don’t think that’s really keynesian. It’s obvious that ‘popular’ industries invest more. Technological development is triggered both by ‘demand’ - people wanting to buy (and buying), say, microprocessors, and research and investments done by manufacturers. But that’s a separate issue from funding.
The common sense point made by Austrians is that in order to fund RD, savings are needed. You need to save before you can make any investment - almost a truism. Of course, keynesians believe you can bypass the small problem of savings by basically printing money.
The Keynesian claim is that the link between (desired) saving and investment can break down, such as in the case of the paradox of thrift. If that link is not broken (say because prices adjust fast enough to falls in aggregate demand) then there is no problem. There really is no Austrian theory of investment. Everyone accepts that increased saving leads to increased investment if nothing goes wrong.
It’s not unrealistic, but it’s also not realistic. They may, they may not. No one operates in a vacuum.
Because eventually they will be buying more. Unless of course the money will be permanently invested somehow, never to return to the investor in any exchangable form. Investing is a conscious decision to buy in the future as opposed to now. Say everyone does buy IOUs, what’s the company then to do? It owes everyone the money. Should it just sit on the money, or swim in it like Scrooge McDuck? Eventually the money will go back to the lenders, and they’ll spend. And if all the company CEO did was temporarily fill his pool with it, the interest the lenders got ain’t going to his company’s bottom line, but to someone else’s. Just because people curtail consumption to a degree doesn’t mean they stop wanting stuff. It just means they’re willing to wait a bit, and, in so doing, they essentially increase the amount of time and resources available to produce more stuff for them to buy.
But if we go by your reasoning, apply it to the Crusoe example. Why should he make the net if he just decided to eat less fish? The question ignores the whole point in that the reason he stopped eating so many fish is because he deliberately and purposefully decided to engage in a project which would end up getting him a whole lot more fish in the future. It’s kind of like you’re asking why would someone go bowling after they’ve made a conscious decision to go bowling. Why should the business expand? Because the well of human want has not run dry simply because people aren’t spending every single cent on consumer goods right this second. Those people saved and invested purposefully because they wanted more money to spend in the future. Which ain’t going to do this or any other company any good unless they’re producing more in the future, which they won’t be able to do unless they take that resource which is temporarily on loan and use it productively to expand…
The car company can only invest if it has saved money to do so from its profits. If it instead decides to consume its profits by buying mansions there will not be any sales of tools and machinery.
The lower phases of production have declining revenues and must cut costs (they may produce less intermediary goods or lay off workers, or both).
Increased savings causes a shift to the right in the supply of loans, thus l**owering the rate of interest.
Investing is cheaper, now ventures with lower rates of return become profitable.
Investors always want to produce products with the highest prices in order to maximize revenue.
The price of consumption goods has fallen (either relatively or absolutely), thus they begin producing more producer’s goods or intermediary goods (unfinished or semi-finished products).
They get capital and labor for production. Fortunately, there is a pool of cheaper labor.
There are more phases of production and more capital in the economy. Increased capital per worker increases real wages and leads to a higher degree of production efficiency (Increasing your output with a given number of inputs at lower costs). The production process becomes more roundabout.
Increased efficiency lowers costs, and every individual stage of production requires a lower number of laborers (but the economy doesn’t). Marginal costs fall faster than revenues (increasing profit).
Key things to remember: There is a structure of production, a multi-tier process where inputs and intermediary goods become final goods or consumption goods. No firm produces any product from start to finish. More capital means increased efficiency and lower production costs, as well as increased wages (due to the increase in productivity). As real wages and the purchasing power of the monetary unit increases, people have more money to both spend and save, thus consumption can increase without changing the ratio between consumption and savings. The structure of production is solely determined by this ratio, namely between consumption and savings.
The problem arises when the tradeoff between consumption and savings is temporarily removed due to inflation. You have increased activity at all levels of production without enough capital or labor to actually complete the malinvestments and other ventures. This causes a sharper increase in prices relative to revenues. Producers require perpetual, ever increasing doses of inflation in order to remain profitable; when this stops, the recession occurs. The recession may also occur if the ratio between consumption and savings changes too much in favor of the former without a sharp enough increase in inflation (in the form of credit) for the producers (they continue to lengthen the structure of production).
An easy way to think of this is one firm becoming two.
There’s a lot I forgot/didn’t mention. Hopefully this helps.