9/04/2009

Capital Theory and some comments regarding the supremacy of the Austrian School of Economics.

Keynes "Paradox of Thrift" states that if saving increases, there is a decrease in consumption. This is correct. If there is a decrease in consumption, retailers have unsold inventories on their store shelves etc. This is also correct. As a result of these newly created excess inventories in light of a shift away from consumption and toward savings, the retailers will devote less resources to investment not more. Thus the paradox of thrift where saving destroys the economy by reducing consumption, which in turn leads to a reduction in production, and so on and so on until either the government prints enough money to stimulate consumer spending back up, or the economy dies. My paraphrasing of John Maynard Keynes from his "General Theory of Economics." (1936)

Represented in the formulaic aggregate Keynes created: GDP = C + I + G, (where "I" represents investment, C is consumer spending, and G is government spending) one can justifiably come to this conclusion of the paradox of thrift.


Austrians Attack!

So if the Austrians do not view investment as the unit, I, and plug it into a formula as one lump sum, how do they view it? They view it as a structure of production. Specifically a Hayekian Triangle. Where Investment is broken down into stages; early stage production might be research and development or operating an ocean mining rig for oil, end stage production could be the gasoline station that sells the converted oil as gasoline or the CVS that sells the drug created in research and development, and all the various stages of production in between make up the middle areas of the triangle.  So what does this mean regarding Keynes "paradox of thrift?" Well most of what he said is correct. But since he fails to view investment in stages, he is unable to realize that because investment in retail goods is constantly falling as a result of reduced consumption, this does not mean total investment is falling. In fact, as a result of this increased savings, the interest rate will fall. This will have the effect of increasing early stages of production in the investment triangle, namely stages of investment that are far away from the final project and take years to complete and are highly sensitive to the changes in the interest rate.

The Austrian or I should say, the correct view of capital and investment as a structure, not as a simple aggregate, allows us to understand why a reduction in consumption and an increase in savings does not result in catastrophic failure for the economy, but rather simply shifts investment from one end of the production process (late stage) to other areas (early and middle stages). In fact, this increase in the earlier stages of production will lead to an increasingly more efficient and sustainable growth in the economy than would have otherwise been possible, had the previous level of consumption to investment been maintained. 

I find it quite absurd that was seems so apparently obvious and simple to me and virtually everyone I've discussed this concept with, namely that capital exists in stages of production and is not one giant homogeneous blob, is apparently radical thinking when you compare it to the mainstream and Keynesian school of thought. It seems as if it has become so desperate to apply mathematics to the science of human action, their theory is littered with massive amounts of truly debilitating and fundamental errors such as their misunderstanding of the nature of capital theory, their position to claim with total certainty that it was impossible to have both high inflation and rising unemployment simultaneously (this "impossibility" occurred in the US during the 70's and is now known as stagflation), their backwards understanding of the nature of money, to support and advocate Nixon's severing the last ties of gold to the US dollar, while forecasting a drop in price of gold from 35 dollars an ounce to 6 dollars an ounce as they believed it was the dollar that gave gold its value, not the other way around...Their total inability to forecast the current crisis, and more so not than just failing to predict it, but to be so misinformed to have made comments to the effects that "the era of recessions are over" and the "US economy is stronger than ever" "housing growth is supported by solid fundamentals" and so on as recently as a few months before the recession hit.

And these are the top economists! The head of the FED, the US Treasury secretary, Nobel Prize winning economists, and they all fail and fail and fail and get reappointed to their positions of power anyway. I can assure you in the free market that those whom are so terrible at forecasting are not rewarded with continued employment and gain, but are swiftly removed from the marketplace altogether. Yet, this is the essence of Government in a nutshell. Deny the profit and loss system. Remove yourself from the restrictions of having to engage in voluntary and thus mutually beneficial exchange, and instead substitute it for force and government decree. The result, widespread incompetence to the point that it is no longer even recognized as such by the majority.

F.A. Hayek speaking on the government created monopoly of monetary policy and production said "that is a system in which we can never again hope to get good money." That was over 50 years ago, and the story remains the same. The Austrians got it right, go on being ignored and marginalized, mainstream economics produce failures of truly catastrophic measures and the very same people whom created the errors are now being turned to as our saviors.I don't see how such a system can ever again restore our nation to one of true prosperity and sustainable growth.

For a more thorough and in depth analysis of the importance of capital theory, from one of the great modern day Austrian Economists please check out Robert Murphy's fantastic article.

To view the PowerPoint slides I mentioned, which are extraordinarily illuminating and are a must viewing if one is interested in this material and is unfamiliar with what exactly a "Hayekian Triangle" is, click on the link titled "The Austrian Theory of the Trade Cycle" here.

No comments:

Post a Comment