Structure, (Human) Capital, and Coordination

Over at Coordination Problem, Steve Horwitz nicely explains why the U.S. economy might well today be suffering from structural maladjustments in the labor market.

Steve’s superb brief post supplies the occasion for me to offer below the full text of the late Sudha R. Shenoy’s “A Note on Austrian Capital Theory” that appears on pages xv-xvi of Hayek’s 1979 monograph Unemployment and Monetary Policy.  (I searched for a version of Sudha’s “Note” already on-line, but found none.)  Here’s Sudha (original emphasis):

Austrian capital theory views capital not as a homogeneous stock but as a network of interrelated goods: a diversified structure of complementary elements, rather than as a uniform lump.  The process of production is seen as occurring in a series of “stages,” extending from final consumption to stages successively further removed.  To take a simple example: A steel mill by itself cannot produce final consumption goods, like cars or washing machines.  In order to produce such consumer goods, a whole intervening chain of complementary investments is required: in factories, machinery, stocks of raw materials, etc.  The steel mill’s output passes into the next stage of production as an input, together with other inputs (raw materials, etc.), and is used in the factories in this stage to produce various intermediate goods.  These goods in turn serve as inputs for the next stage of production, until final consumption is reached.

Thus, investments in wholesale and retail distribution, in this view, are complementary to investments in previous stages of production; they are an integral part of the capital structure as a whole necessary to bring goods to the final consumption stage.  Particular capital goods may be specific to one stage of production, or they may be adaptable to several stages.

In other words, a miscellaneous jumble of nonconsumption goods will not necessarily raise final output.  Individual capital investments (whether in plant, machinery, raw materials or semi-finsished goods) must fit into an integrated capital structure, completed to the final consumption stage.  Investments that do not form such an integrated structure are (or become) mal-investments yielding capital and operating losses.

The “filigree” (i.e., composition) of capital goods forming a coordinated capital structure changes with circumstances.  Thus a factory, once profitable, becomes unprofitable as the circumstances in which it was originally built are themselves altered.  Equally, new investment opportunities open up with changing circumstances; investments once useless may become profitable again.  In short, capital is not automatically maintained intact; neither is any investment automatically profitable in all circumstances.

The essential role of prices (and of rates of return on individual goods) emerges from this brief outline.  Only if there exists markets in which prices reflect (changing) relative scarcities of the different sorts of capital goods involved can the capital structure as a whole be integrated, and mal-investments be revealed.

Quotation of the Day…

… is from page 279 of The State Is Rolling Back, which is volume 2 in the 2004 Liberty Fund series The Collected Works of Arthur Seldon; specifically, it’s from Seldon’s 1988 essay “Policies: The Difficult and the ‘Impossible’”:

Keynes’ prescription has been shown to be not only defective in economic analysis.  The public choice analysis of Professors J. M. Buchanan and Richard Wagner has also shown it to be politically unrealistic.  Politicians have to deal with the public not only in the market process, as buyers or sellers of products or services, but also in the political process, as voters and electors.  If it was politically naive to assume that workers would accept reductions in real wages in the short term it was no less politically unrealistic to assume that politicians would faithfully operate budget surpluses in the long term to remove inflation once budget deficits had created them.

Despite some careless grammar, Seldon here summarizes one very important reason why Keynesian economics is far less scientific than its adherents think it to be.  Keynesians unscientifically assume one of the conclusions that they mistakenly believe themselves to have established through rigorous analysis, namely, that empowering government to ‘manage’ aggregate demand is the most feasible means of achieving, over the long-run, appropriate levels of aggregate demand.