This looks interest, I’ll read through it and respond once I get the time.
No, Austrians speak of “capital ceilings” (industry specific) where too much of one form of capital is created, thus taking resources away from other, more profitable investment ventures; hence, malinvestments. The problem occurs because certain investment activities, during an inflationary period (when the market rate is suppressed below the natural rate), either cannot be completed at all, on time, or at the expense of more justified activities. So no, no Austrian ever considers capital to be a homogeneous structure. Austrians look at the structure of production realizing that capital is heterogeneous and complementary (not just supplementary, as Keynes has it).
Again, this is confusing to an Austrian. Austrians speak of the “original means of production” (labor and land), and the “factors of production” (which includes land, labor, and producer’s goods as well as intermediary goods, which are semi-finished or unfinished products). During the boom higher stages bid capital away from the lower stages, as well as labor, thus increasing factor prices. Essentially, “inputs” are not homogeneous, there are specific capital goods, and non specific capital goods; the former being drawn away from the lower stages towards the higher stages, and vice versa (increased capital intensity, and a longer structure of production). It seems that many people don’t understand the term “structure of production.” You should read Prices and Production (more than once) if you wish to understand the nature of boom-bust in greater detail.
Was this directed at me? If it is, I don’t need to be lectured on the ABCT. I agreed the OP’s point was valid, which you didn’t refute, but qualified that it is quantitatively insignificant.
This is the point that Tullock takes issue with, and that I still haven’t seen a viable response to. These capital goods aren’t created for industries with zero pre-existing demand; the demand for them during the boom phase is just overstated. After the maliinvestment is discovered, these capital goods can still be used for the purposes they were made for, but since the supply of them has increased, their price will go down. This might cause businesses that invested in them to go bankrupt, but the goods themselves would not be squandered. This doesn’t deny the effect of the credit, only that it wouldn’t lead to a recession.
I would be interested to hear a response to that point.
@liberty student
hehe, yeah! Kind of adding an Indian flavor to this forum[:P]
…And the demand for consumption goods is also overstated during the boom phase of the BC, during which (without a prior accumulation of capital sufficient to meet the new ‘excessive’ demand) a portion of the capital stock is depleted. At some point, the boom is revealed as a boom, when it goes bust. The capital depletion is what’s left. Many businesses have worn their capital to unsalvageable levels (A) trying to ride out the boom, others have ‘invested’ in capital (B) that could have satisfied some future consumption demand, except the demand is not in the future, it’s now.
During the boom and in the context of time preferences, too much of some goods have been produced, and not enough of other things have been produced.
It was poor writing on my part. I didn’t mean “Austrian critiques” but “critiques of Austrians”. Sorry.
I believe Austrians view the economy as dynamic.
Jake, I think the key to the Austrian response lies in emphasizing not the objective, physical capital goods (which Tullock seems to do) but the subjective “methaphorical structure of production”, to use Salerno’s phrase. The point is not that buildings, factories, cranes etc. can’t be built in time (because, well, they can) but that because of the lack of savings and the falsified interest rate the lengthened structure of production can’t be completed due to the fact that increase prices of complementary goods will make such investments unprofitable.
Now, you seem to have a better understanding of Austrian theory and the ABCT than almost everybody else here does, so I won’t lecture you. But some Austrians have emphasized the importance of the notions of complementarity in regards to the ABCT. In order for goods of one stage to provide goods for the next stage all of the complentary factors of production of required. Now, because the interest rate has been falsified entrepreneurs have incorrect notions of the urgency of various wants. They believe that consumers are more willing to sacrified present consumption than they are and that accordingly, they have will have access to labour and other complementary goods. But as you know, in the Austrian story, this just isn’t so. They don’t have the access to goods that they believe they do. This makes long term investments unprofitable as the price of labour is bid up. The fact that consumers do want present satisfaction more than entrepreneurs believe they do means that employing labour in the stages of production closest to consumption will be more profitable than employing it in the production of capital goods will be.
On a similar note. The notion of imperfect substitutability comes in when we discuss the boom. If capital were homogenous and perfectly substitutable then the boom would be over very quickly, in fact, almost instantly. But it isn’t, capital must be refitted for it’s new task, and labour must wait for the necessary capital and be retrained accordingly. Various price rigidities will only make this worse, especially in a deflationary environment.
As I said, I’ll get to this post in more detail later.
I think the main problem arises from trying to apply the ABCT to an event that did not follow the course outlined in it. The traditional ABCT has validity, but it does not explain the recent real estate / consumer goods boom and the subsequent bust: I explained this at http://www.economicsjunkie.com/the-austrian-business-cycle-theory-insufficient-at-explaining-the-current-financial-crisis/
The biggest flaw is that it’s a model. Yet, it still “works”.
I think your scope was to narrow… The capital formation (or rather misformation) was done in other parts of the world.
Also, you could notice oversupply of steel with mines closing recently, overinvestment in shipyards etc…
I never said that capital formation did not happen in other parts of the workd. In fact, it is rather obvious that a big part of US consumption goods was produced abroad in China. So those export countries, too, bacame part of the consumption business cycle and are now hurting due to the fact that their consumer goods are no longer as demanded as they used to be. Hence, my theory of the consumption business cycle beautifully integrates with all that happened recently. I pointed this out in the ensuing discussion comments under that post so I assume you must have missed that.
Well, which is it?
In a capital goods boom and bust (classic ABCT theory), goods higher up in the production process fall in price much more. Did copper fall in price more than corn? How about the price of all of the capital goods in the tens of thousands of factories going out of business here in Southern China, vs the price of food at the supermarkets here (which is steadily going up, btw)
Jesus Huerta de Soto makes it clear that it is this price movement, during the inevitable bust, which is the characteristic of a classical ABCT bubble (in Money, Bank Credit, and Economic Cycles). In a true consumer goods driven bubble, the prices of consumer goods would fall relative to the price of everything else. That’s not happening (with the only possible exception of housing, and only if you define the house as a consumer good instead of the rent / live in value it produces every month).
When you have China financing so much of the US’s consumption (in exchange for promises of future goods), you have to take into account their capital goods industries as well, or consider both markets as one large one.
It’s not about prices!!! Prices may go up or down or not change at all, but they are always merely a symptom of underlying developments. If anything you would have to look at the number of goods sold multiplied by prices, and put the two into relation.
As you can see in my chart (http://www.economicsjunkie.com/wp-content/uploads/2009/06/us-true-consumption-as-percentage-of-gdp-1929-2008.png), during the boom, production and sales of consumer goods went up relative to capital goods. Now, during the correction, production of capital goods is going up against consumer goods. This is precisely contrary to the events outlined in the classic ABCT.
Let me just ask you in very simple terms, set aside all your bias in trying to apply the ABCT to what happened:
Do you think the crisis in the US primarily came about due to an overhang in the production of industrial robots, unfinished production facilities, an excessive number of energy plants, oil rigs, and the like? Is this what you see when you walk through the streets, look at the news, read the papers?
Isn’t it rather obvious that we are primarily faced with a massive overhang in consumer goods, such as houses, cars, strip malls, Starbucks branches, nail salons, beauty salons, energy drinks, shampoos, fast food stores, kitchen appliances, flat screen TVs, etc. ?
When I talk about a shift from producing capital goods to consumer goods, I mean that, as a tendency, and within a certain period, the entire structure of production moves closer toward turning out immediate consumption goods rather than goods that are half finished or that aide in the production process. I do NOT mean that suddenly all capital goods disappear and all we have is consumer goods. This is simply not possible since the consumer goods also need to be produced by utilizing capital goods.
Cars, flat screen TV’s, kitchen appliancies etc. are consumer durables, not consumer goods. There are in essence capital goods to a consumer. There also must exist capital to support overproduction of those goods.
Nail salons, starbucks coffe shops, shoping malls, casinos, hotels, airplanes are all capital goods. There were investments in capital goods that yielded no value to consumer.
There is massive surplus in transport capacity (trucks, ships), shipyards, steel mines and all the industries related to production of such goods. There is also surplus in construction machinery, cement factories etc.
azazel: TVs, cars, nail treatments, movies, shiny stovetops, etc. are consumer goods, by every criterion one could possibly apply. That one would list those as capital goods simply baffles me. That you have to bend and twist youself and call them “in essence capital goods to a consumer” (which one is it now??) indicates that you are not very comfortable with your thesis yourself. Seriously? You consider a TV, a kitchen faucet, or a Porsche Boxter a factor of production?? Come on now! 
But let me ask you, just for the sake of your argument: What DOES pass your test as consumer good if not a TV??
I will now repeat what I already said and what I assume you may have overlooked:
"Yes a Starbucks location is a factor of production, a capital good. But it is one that immediately turns out cups of coffee, consumer goods. It is thus much closer to the consumption stage, than, say, a store that sells industrial robots, or a factory that produces metal parts, or an oil rig that drills for crude oil.
When I talk about a shift from producing capital goods to consumer goods, I mean that, as a tendency, and within a certain period, the entire structure of production moves closer toward turning out immediate consumption goods rather than goods that are half finished or that aide in the production process. I do NOT mean that suddenly all capital goods disappear and all we have is consumer goods. This is simply not possible since the consumer goods also need to be produced by utilizing capital goods."
Then why bother responding at all? The guy asked an intelligent question, politely, and giving every impression of wanting to learn something. I count two posts among all the replies that actually attempted to respond, and everyone else is basically just saying “don’t question Holy Writ!” (except for McCloskey, who’s off on some silly tangent, again).
Duckinstein: you appear to think the “factors” at the lowest (closest to the consumer) level under consideration are things like hamburgers – but, of course, McDonalds’ hamburgers are made daily: once they start losing sales, they’ll cut back on their burger production, and thus on their meat and bread orders, etc., and the baker who bakes the buns will cut back on his orders for flour, eggs, etc.; ultimately, the factors being saved are mostly fairly highly “retargetable”, coming from more distant lines of production (the methods of production that get extended due to saving or malinvesting are not necessarily the same ones that existed prior)
No, it is all about prices. During the boom the interest rate, the price of money, is lower than it would be without an artificial expansion of the money supply and given the current state of savings. Because of this, entrepreneurs or management think there is enough savings to fund long term investments (or in the case of some management know there isn’t but proceed to act as if there were, knowing that they will make a lot of money through stock options before the real owners wise up), and as they bid on them the price of capital goods rises relative to consumer goods. Hence the price of the factors of good farthest from consumption go up the most (including titles to these factors, aka stocks)
When the bust comes, the price of consumer goods rises relative to capital goods (depending on what’s happening to the money supply, both could be falling or rising though).
That’s classic ABCT theory. If you say it isn’t, you are strawmanning the theory and should read more of Mises and/or Jesus Huerta de Soto, who is a little more clear on the issue.
Again, to be clear, in an ABCT boom, the prices of capital goods rise relative to consumer goods and then this reverses when the bust sets in. This is undeniably true if you accept the idea that interest rates are lower than what they would have been otherwise thanks to an expansion of the money supply and what follows from that.
You can’t really analyze this boom & bust clearly without taking into account other countries that lent us vast sums of consumer goods in exchange for future promises of something tangible (right now they are still mostly paper promises sitting on the books of central banks around the world).
You quoted my entire comment and at the same time ignored everything I said in there except for the first sentence.
“That’s classic ABCT theory. If you say it isn’t, you are strawmanning the theory and should read more of Mises and/or Jesus Huerta de Soto, who is a little more clear on the issue.”
Where did I say that it isn’t? I outlined precisely that process myself in what I call the production business cycle (http://www.economicsjunkie.com/the-business-cycle-revisited/#production). I fully agree with Mises’ ABCT. I never said anything to the contrary.
I don’t mean to get picky, and I assume you chose your words out of convenience, but just to be clear on what you said: “During the boom the interest rate, the price of money, is lower than it would be…” - the interest rate is NOT the price for money, it is the price for credit. But other than that, yes, you’ve done a fine student’s job reciting Mises’ brilliant ABCT … what is unclear to me is what your comment has to do with the thesis I am proposing.
So, what are you saying is that the development of consumer credit changes the model?
@Caley McKibbin:
I thought about what you said for a while and I believe we are on the same page. I just want to clarify that I do NOT propose to change the model of the ABCT itself, the theory that explains the events that ensue upon the expansion of business credit.
I am merely saying that this existing model does NOT cover the events that ensue upon the expansion of consumer credit. This is, in fact, what Rothbard himself admitted.
As I pointed out on http://www.economicsjunkie.com/the-business-cycle-revisited/:
Rothbard and Mises hold that a credit expansion that aims at expanding consumer credit will not cause a business cycle:
Mises did not deal with the relatively new post-World War II phenomenon of large-scale bank loans to consumers, but these too cannot be said to generate a business cycle. Inflationary bank loans to consumers will artificially deflect social resources to consumption rather than investment, as compared to the unhampered desires and preferences of the consumers.
But they will not generate a boom-bust cycle, because they will not result in “over” investment, which must be liquidated in a recession. Not enough investments will be made, but at least there will be no flood of investments which will later have to be liquidated. Hence, the effects of diverting consumption investment proportions away from consumer time preferences will be asymmetrical, with the overinvestment-business cycle effects only resulting from inflationary bank loans to business.
Indeed, the reason why bank financing of government deficits may be called simple rather than cyclical inflation is because government demands are “consumption” uses as decided by the preferences of the ruling government officials.
… you see?
Rothbard himself says with 100% clarity that an expansion of consumer credit does NOT create “the business cycle”. But by “the business cycle” he can’t be referring to anything else but the ABCT.
He calls the events that ensue upon consumer credit expansion “simple inflation”. OK, very well, let’s call it that. But then he still needs to clarify what exactly he means by that.
He also leaves open why the structure of production shouldn’t change upon such a consumer credit expansion. Why should it be impossible for the structure of production to be aligned toward an excessive production of consumer goods, while it IS possible for it to be aligned toward an excessive production of capital goods? - There is absolutely no reason.
He clearly leaves a void right there that needs to be filled. That is all I am suggesting, that we fill that void.