Critique of Austrian Capital Theory (Wikipedia)

[Esuric]

Many claim that the Austrian’s faith in their capital theory is tragic because it is the most theoretically untenable aspect of Austrian economics in general. Now, I’ve never fully understood most of the arguments raised against Austrian capital theory, namely those put forth by Cambridge (Sraffa, Khaldor, etc), but there is one claim that I continuously hear, and it shows up on Wiki (when you search “roundaboutness”). It shows a complete misunderstanding of Austrian capital theory, as I understand it.

It says,

This makes it unnecessary to postulate exploitation in order to understand the return on capital, although how the length of the production process in and of itself produces value remains unclear, as if Böhm-Bawerk’s idea were correct, the more inefficient a capitalist manufacturer, the longer their production process and the more profit they would accrue. When in fact the additional costs they incur through their inefficient production process would prevent them from selling their output at the market price. Rather than accruing higher profits therefore, they would accrue none at all.

Again, as I understand it, roundaboutness is not a microeconomic concept and profit (interest) is not the result of roundaboutness at all. Profit is the result of time preference (an entirely independent economic phenomenon) which determines the degree of roundaboutness (relatively mediate/immediate methods of production) employed during capitalistic production, i.e., the capital structure (again, a macroeconomic concept). Austrian capital theory specifically says that a high time preference yields more direct methods of production and a higher rate of interest (profit). In other words, they seem to be confusing causality.

Additionally, a higher stock of capital, brought about by a lower time preference (lower rate of interest), will reduce profit rates, but in the aggregate, since production/total output are not constant, you may have a higher amount of total profit (real goods distributed to capital). In fact, such a condition should be expected, but is not guaranteed. This can be easily demonstrated with the simple neoclassical Cobb-Douglass production function (which is theoretically problematic in many ways but still useful for general demonstrative purposes).

Thus, if we understand (a) the fact that time preference is an entirely independent phenomenon, (b) the causal relationship (time preference → interest → roundaboutness), and (c) that the price of capital are the actual market prices of heterogeneous capital goods and not the rate of interest, then all of the arguments raised by Cambridge, Samuelson, etc, seem to fall apart.

And finally, there is one other argument raised by Cambridge that I simply cannot understand/resolve. They claim that lower rates of interest stimulate the use of certain capital goods relative to other capital goods, but that even lower rates of interest induce the exact opposite effect (reswitching). Now it seems like this problem arises solely because they’re trying to quantify extremely complex economic relationships and are probably ignoring or abstracting from extremely relevant variables. But I’ve also heard that low rates of interest will, at first, increase capital intensity (higher ratio of capital relative to labor), but then even lower rates of interest will actually decrease capital intensity (during normal economic times). This makes absolutely no sense; it has to be wrong.

Has anyone heard this claim before?

[Azure]

Again, as I understand it, roundaboutness is not a microeconomic concept and profit (interest) is not the result of roundaboutness at all.

This sounds like a misunderstanding I had when I first started reading about Austrian theory. After all, a furniture mover who hires a bunch of men to pass off each piece down a huge chain across the country is certainly using more (human) capital than someone who just buys a truck.

But this ignores the production process involved in making the truck! The length of the production process isn’t something you can pick apart from a single industry and analyze, it has to be considered over the whole of society. Perhaps they are making the same mistake.

[Esuric]

Well their argument seems to be this: Bohm-Bawerk claimed that profit is the result of roundaboutness, or increasing the length of production (inefficiency). Thus, if profit stems from inefficiency, than as a firm becomes more inefficient, it should accrue higher rates of profit (clearly incorrect). I recently debated a Marxian that made this very same argument, and it shows a complete misunderstanding of Austrian capital theory, as I understand it.

[Giant_Joe]

Well their argument seems to be this: Bohm-Bawerk claimed that profit is the result of roundaboutness, or increasing the length of production (inefficiency). Thus, if profit stems from inefficiency, than as a firm becomes more inefficient, it should accrue higher rates of profit (clearly incorrect). I recently debated a Marxian that made this very same argument, and it shows a complete misunderstanding of Austrian capital theory, as I understand it.

You are correct. I like the Example Dr. Murphy gave in the business cycle course:

You have a hut in the middle of the jungle, and you have no water. You have a few options to obtain water.

1. You have to go to the stream, cup your hands in the stream, and then have a drink. Or bring it back to your hut. Or do whatever you want with it.

2. You go out of your way to crack open a coconut and use the shell to hold water. You go to the stream with this and collect water that way. It involves another step, but you end up being more effective at collecting and transporting water.

3. You divert the stream to get closer to your hut. You no longer have to travel as far, and you can get a lot more water much more quickly as a result, but it takes a lot of time and effort to divert the stream to come closer.

Profit is still revenues - costs. I don’t see how in the above example, the person is using increasingly inefficient methods to get more water. The efficiency can only be measured by money. But you can now see how an example like this could work in an economy.

Increasing the length of the production process does not necessitate increased inefficiency.

The quoted critique of capital theory misunderstands capital theory. I think a simple real-life example would be manufacturing with an assembly line vs. manufacturing without one.

As for that last paragraph with the switching and whatever, I never heard that critique and I don’t really follow.

This makes it unnecessary to postulate exploitation in order to understand the return on capital, although how the length of the production process in and of itself produces value remains unclear, as if Böhm-Bawerk’s idea were correct, the more inefficient a capitalist manufacturer, the longer their production process and the more profit they would accrue. When in fact the additional costs they incur through their inefficient production process would prevent them from selling their output at the market price. Rather than accruing higher profits therefore, they would accrue none at all.

The production process doesn’t create value, and doesn’t have value outside of subjective valuations. Someone will consider it valuable if it better achieves their intended ends. Of course the whole of Austrian capital theory doesn’t make sense if you throw away the premises it rests on.

[nirgrahamUK]

Mises Daily | Mises Institute

[DD5]

@Esuric

profit (interest) is not the result of roundaboutness at all. Profit is the result of time preference

You shouldn’t do that - conflate interest with profit. Profit and interest are two separate independent components. Interest is the result of time preference and profit is the result entrepreneurial foresight.

[Think_Blue]

Ah yes, the Cambridge Capital controversy:

http://en.wikipedia.org/wiki/Cambridge_capital_controversy