The Production Structure, Interest, and Payment

Economics Economics Questions
1

Okay so I’ve been reading the description of the production structure in De Soto’s treatise in an attempt to better understand some things that I was confused about in Hayek’s and Rothbard’s work surrounding the same subject. While I thought that up to this point everything which De Soto wrote was extremely elegant and made a lot of sense to me, as soon as I hit page 303 in the book (354 in the pdf search) I found myself being bamboozled by the same fact that Hayek and Rothbard were confusing me with. I thought that I might have come to a suitable conclusion when three pages later another table reinforced everything I was confused about. This compounded with De Soto’s words on the surrounding pages just bashing more on the things which I’m confused about. I’m absolutely lost here so some of the questions I ask may be really stupid because I can’t make heads or tails of this, I’m in an absolute brain f***

So here we go with questions:

  1. How is it possible for more money to be accumulated within the costs of production than are paid out in consumer services?

In De Soto’s table he says that there’s a total demand of 270 in the production of a certain good whereas consumer demand is only. How is it that this cannot be paid back by the spending of the consumer when consumer demand is only 100? There are two possibilities here: either that the 270 figure is just figurative (that’s total demand but it’s then paid back by the next capitalist) or that it’s real, in which case I don’t understand how it is that it could ever be paid back because in each consecutive period another 270 would be charged with only an extra 100 in consumer demand. This would eventually lead to the entire monetary unit being used in paying for production processes and there would be no consumption at all.

I have reason to believe that it is the second based upon his remarks concerning Smith.

There is also a possibility which is not directly indicated that some of the stages produce durable capital goods which last longer than the period which we are looking at here. For instance if I acquire a capital good from this transaction and it lasts me for a long period of time then a capitalist of a lower order will receive income from that over time and he won’t have to pay as much next time around.

  1. Where does De Soto get his interest rate?

On page 296 book (347 pdf entry) De Soto gives data which would appear to be attempting to clarify this entire situation but he says that the interest rate is 11 percent. Fine, but he seems do determine this by saying that 10/90= .11 repeating… Where does the 10 come from?

But furthermore it would appear that he isn’t even applying his interest rate properly because all of the interest numbers are reflected off of an interest rate of 10. For instance in the final stage of production we see 10 percent interest gained off of a transaction of 100, not 11 percent. Is this just rounding?

I’ll probably have more questions for whatever saint can answer all the questions that I’ve poised thusfar.

Thanks a lot.

2

11% is easy - take capitalist 5 as example. He invests 18 mu in labor, and gets back 20 mu in a year from sales to capitalist 4. (20-18)/18=2/18=1/9=11.(1)%

Capitalist 4 - invests 16 in labor, 20 in capital goods from capitalist 5, gets 40 from capitalist 3 in a year. (40-16-20)/(16+20)=4/36=1/9

Etc.

ON EDIT: in other words, while the profit is 10% of the sales, it is 11.11% of the investment.

3

On the main question, I am confused, too.

The following does not make sense to me:

At the right-hand side, we find the corresponding
demand for present goods experienced by the providers
of future goods, mainly owners of the original means of production
(labor and natural resources) and the capitalists of
earlier stages.

While I agree that labor is consuming present goods in return for future goods, I do not see can this can be said about “the capitalists of earlier stages”. My understanding is, capitalist 5 sells present units of the 5th order goods to capitalist 4 for present money. I will try to make a simulation to better understand this :slight_smile:

4

270 is the sum of amounts received by labor (70) and capitalists for capital goods (200).

It only makes sense to add them together if we assume that all the payments are simultaneous, so that we need that much money in the economy in order to transact (I guess this is the meaning of the term “gross saving” in this context). The sum of all transactions is 370: 200 spent on capital goods, 70 on labor, and 100 on consumption goods. Of them, only the last 100 are spent on immediate consumption, thus the rest were in some sense saved.

I am still sceptical about this accounting, though. Any amount of money will do, as long as we allow for sequences of transactions, instead of a single simultaneous exchange.

Imagine the end of one year and the beginning of the next one. Capitalist 1 has stock of 100 mu-worth consumption goods, capitalist 2 has 80 mu-worth of capital good 2, etc. Capitalist 1 may pay 1 mu to labor, labor will pay 1 mu back to capitalist 1 to buy consumption good, capitalist 1 will pay 1 mu to labor, etc., until all transactions are settled. Money is just the medium of exchange here, so any amount of money is enough (ignoring transactional costs, of course). We can actually drop mu completely, using the consumption good for accounting. What happens at the end, is capitalist 1 giving 70 units of the consumption good to labor and 20 units of the consumption good to other capitalists at the beginning of the year so that labor works and capitalists move their capital along the supply chain. There is 300 mu-worth goods accumulated (200 capital and 100 consumption), so if anything, the saving ratio should be 200/100=2, not 2.7. And it makes much more sense to call it investment, not saving, as saving is usually defined as income less consumption (which is 0 in this equilibrium economy). Granted, my setup is different from the original, which I guess assumes simultaneous transactions - I just do not see how the original one is useful.

Just my opinion, anyway.

5

Sorry to hijack this thread, but… :slight_smile:

I suggest reducing the problem, and making it more specific at the same time, so it is more tractable without resorting to pencil and paper.

The simplest economy has just one consumption good, and no capital goods. Let’s call this good a bun. We have labor L and a capitalist C. Each New Year, C gives to L 18 buns, while at the end of the year L gives to C 20 buns. This is usury, plain and simple :slight_smile: Why does L agree to this? Because he needs buns throughout the year, while the new 20 buns will be available only at the end of the year. C happens to have these 18 buns (plus some for personal consumption). C has saved the buns before. Now, he enjoys the fruits of his previous frugality. If L is good at saving, he may be able to reduce his consumption, and save at least one bun by the end of the year. This is one bun less to borrow for the next year - making it even easier to save the next bun. Eventually, L will have enough buns to last him through the year without borrowing from C. C will have to work himself :slight_smile:

But let’s say, the situation is fully static - the same situation repeats year after year. Is there any saving going on? It really depends what we mean by that. C receives 20 buns, and withholds 18 of them from consupmtion. Let’s say for simplicity that he consumes the remaining 2 buns. Is he saving 18 buns? L consumes 18 buns and produces 20 buns. Thus, our tiny economy produced 20 buns and consumed 20 buns. Are they saving 0 buns? Is the difference between 18 and 0 the difference between gross saving and net saving?

6

Re: the first question

At first, there seems to be double counting involved when we say that more than 100 is needed to maintain the capital structure. Because surely the payment for “the next years capital goods” comes from “next years consumer expenditure”. However, this is false. The payment for capital goods comes from saving.

Let’s take the producer of consumer goods. How does he pay for the capital and land/labor bought to make the consumer goods? Is it from the revenue of consumer goods sold? NO. He must pay land/labor and the second stage capitalist NOW if he wishes to sell consumer goods next year. Therefore, he must have saved that money. What about the second stage producer? How does he pay for the capital and labour bought to make his capital good that he sells to the first order producer? Is it from the revenue of the sold good? NO. He must pay land/labor and the third stage capitalist NOW if he wishes to sell the capital good next year. Thefore, he too, must have saved that money at some point.

So you see, the capitalist in each stage must every year save the discounted value of his expected revenue if we want to have enough capital goods to work with next year as well. There is no automation in this and also no assumption of “self-maintenance” as in mainstream economics. Perhaps the capitalist in stage 3 is getting really old and doesn’t wish to save any more. He takes the revenue he made from the sale last year and buys presents for his children and grandchildren. Interestingly we would be able to produce the same amount of consumer goods for another two years since the necessary capital goods in stage 2 and 1 are already present. It is also this “lag” that explains how “100” can repay 270 worth of investments. Namely, it is the revenue of consumer goods sold in the future that is expected to repay the investments made today.

7

Okay I believe that I have a better understanding now.

So 70 is the amount paid to the original factors while 200 is the total value of capital goods purchased and the 100 consumption goods. But by this tolken couldn’t one individual just save throughout the whole period? This would mean that he would only have to save 70 and retain ownership of the capital goods at each stage. In this way that much would not need to be saved to retain the capital structure.

Also, how do we account for the fact that in the real world the money supply is much smaller than GDP in any specific period? Wouldn’t this require that the real money supply is much larger than GDP with most of it going into investment?

8

I keep meaning to post on here that I’ve really come to better understand the answers and reality of the entire issue.

What I was confused on was the issue of how more money could be “involved” in production than is paid back. The answer is, of course, that savings are paid back at interest. A large amount of savings is used to keep a long-period project “afloat”, yet very little of the total money used is actually added to the costs, only the interest rate, the “opportunity cost” of money.

Therefore one could look at capitalists at each stage in the production structure as doing two things: they are paying for the costs of “additional production” on the project in the production of the next capital good, and they are keeping the project “afloat” by “buying the project” and temporarily remove the need for final payment. All of their costs are then paid to them by the next capitalist who then does the same until the last capitalist is paid back in full by the consumer.

The capitalist in the first stage doesn’t have the role of keeping the project afloat because he is the one who makes the project. If there were a stage where the project just had to “ferment”, where no additional work had to be done and the project had to be left alone for a year (for whatever reason), then only the role of keeping the project alive would be needed, the capitalist would by the project, keep it safe for a year, and charge up by the rate of interest on what he purchased. Therefore to justify a project the final total revenue on the project must be high enough to pay off all the “raw costs” of the project, the land and labor used to construct it, in addition to the rate of interest.

With this in mind it should become obvious exactly how time-oriented Austrian theory really is as well as how important the interest rate is because different interest rates dramatically increase or decrease the cost of doing business over time. For instance, if we say that the first stage of a five year project is 100 dollars then an increase from an interest rate of 5 to 10 percent will mean that total payment JUST on the first stage of production will go up from 162 dollars to a whopping 259 dollars. That’s a 60 percent increase in a long term project if it were just left to sit. If it were a more realistic project and more costs were added along the way then the total percentage markup would be far higher, although the increase, regardless of how much is added in that stage (you can calculate this easily), would decrease the higher the stage of production. Meanwhile stages which only took a single year would only be 5% higher than before the increase in the interest rate. This shifts us away from longer term projects towards more immediate projects because they are now comparatively much cheaper.

That’s what I have to say about that.

Edit

Also, justto clarify on my answer to my own OP question; there could well be 270 dollars overall in much “cheaper” project is involved with the entire production structure, that is how much money “moves” through the system, but only a certain portion of that is added in through interest payment. If I take two years to complete a 100 dollar project at a 10 percent rate of interest then (purely for the sake of argument we’ll say that the second year is pure fermentation) then even though the final project only need 121 dollars in final payment to justify, a total of 210 dollars flow through the system, 100 for the first year plus 110 the next year to pay back the principle plus interest payment.

This money could also come from the same capitalist, and indeed in many cases this is much more likely, in which case only 121 dollars would be spent on “each” project, yet if projects are continually self replicating, if as a project moves from the first to the second stage the first stage starts up again producing another iteration of the same type of project, then 270 in the first example, or 210 in my example will need to be present. If the project is a “one shot”, then you could get by with a single capitalist with the 110, or some number less than 270 above.

I would be interested in an Austrian assesment of “one shot” industries, or a production-structure analysis outside of the ERE. It might add something to Austrian unemployment and business cycle theory, although I don’t think it would change fundamental principles dramatically.