Return to Title Page for Economics as a Coordination Problem: The Contributions of Friedrich A. Hayek
The Online Library of Liberty
A project of Liberty Fund, Inc.
Search this Title:
Gerald P. O’Driscoll, Economics as a Coordination Problem: The Contributions of Friedrich A. Hayek 
Economics as a Coordination Problem: The Contributions of Friedrich A. Hayek, Foreword by F.A. Hayek (Kansas City: Sheed Andrews and McMeel, 1977).
About Liberty Fund:
Liberty Fund, Inc. is a private, educational foundation established to encourage the study of the ideal of a society of free and responsible individuals.
This work is copyrighted by the Institute for Humane Studies, George Mason University, Fairfax, Virginia, and is put online with their permission.
Fair use statement:
This material is put online to further the educational goals of Liberty Fund, Inc. Unless otherwise stated in the Copyright Information section above, this material may be used freely for educational and academic purposes. It may not be used in any way for profit.
Table of Contents
Studies in Economic Theory
Laurence S. Moss, Editor
America's Great Depression, Murray N. Rothbard (1975)
The Economic Point of View, Israel M. Kirzner (1976)
The Economics of Ludwig von Mises: Toward a Critical Reappraisal, ed. Laurence S. Moss (1976)
The Foundations of Modern Austrian Economics, ed. Edwin G. Dolan (1976)
Capital, Interest, and Rent: Essays in the Theory of Distribution, by Frank A. Fetter, ed. Murray N. Rothbard (1977)
Capital, Expectations, and the Market Process: Essays on the Theory of the Market Economy by Ludwig M. Lachmann, ed. Walter E. Grinder (1977)
Economics as a Coordination Problem: The Contributions of Friedrich A. Hayek, Gerald P. O'Driscoll, Jr. (1977)
|2 yrs.||1 yr.||½ yr.||¼ yr.||1/12 yr.|
|Percent return on each turnover:||12||6||3||1½||½|
|For an annual rate of return of:||6||6||6||6||6|
|Percent return after a rise in the price of the consumption good:||14||8||5||3½||2½|
|For an annual rate of return of:||7||8||10||14||30|
Hayek used this table as a pedagogic device to illustrate market tendencies that would be realized to the extent his assumptions adequately reflected reality.25 Certain adjustments are implied:
A rise in the price of the product (or a fall in real wages) will lead to the use of relatively less machinery and other capital and of relatively more direct labour in the production of any given quantity of output. In what follows we shall refer to this tendency as the “Ricardo Effect.”26
A change in the price of the product relative to the money wage rate is a change in the “real wage.” The analysis is a somewhat roundabout way of referring to the effects of an increase in the value of the marginal product relative to the wage rate in some areas of labor employment and a decrease in others.27 By “real wages” Hayek did not mean the nominal wage rate divided by the cost of living. He was concerned with the ratio of the nominal wage rate to the price of the specific product being produced rather than consumed by the worker. The Ricardo effect is thus a basic microeconomic proposition.28
Real wages may fluctuate irrespective of their measurement in terms of a unit of general purchasing power. Statisticians have often been confused about what constitutes the relevant real wage in economic analysis of the business cycle. The wage as measured in units of industrial output is what is important for labor demand, whereas the wage as measured in units of consumables is relevant to labor supply.29
THE RICARDO EFFECT AND CYCLICAL FLUCTUATIONS
The Ricardo effect had the same importance in Hayek's 1939 formulation as changes in price margins had in Prices and Production.30 A rise (decline) in real wages corresponded to a narrowing (widening) of the price margins. In the earlier work, a change in the interest rate altered the allocation of resources only by way of a change in price margins. Microeconomists often contend that the interest rate is a ratio of prices.31 But in practice macroeconomists often ignore this relationship.32 A change in the interest rate leads to systematic changes in the relation of consumer goods prices to capital goods prices and of the prices of various kinds of capital goods to one other. Changes in the relative prices of (heterogeneous) capital goods are at least as significant as the change in the price of “consumption” relative to “capital” enunciated in the so-called sophisticated macromodels. However, this former type of change is generally ignored. Nor do changes in the prices of capital goods depend entirely on durability. Other things being equal, the more durable an asset, the greater will be the sensitivity of its present value to changes in the interest rate. But, as Hayek emphasized, one must not overlook how that capital good is used in the structure of production.33
Once full employment is reached in industries producing consumer goods, the Ricardo effect begins to operate. Any further increase in the demand for consumer goods leads to the kind of factor substitution described previously. Most important, with capital specificity the demand is always for particular capital goods rather than for “capital.”34
Hayek's analysis does not depend on the assumption of full employment of all factors. In the model presented in “Profits, Interest, and Investment,” availability of additional factors of a given type in the capital goods industries does nothing to alleviate an excess demand for those factors in the consumer goods industries; the elimination of excess demand is excluded by the assumption of factor immobility in the short-run formulation of that model. But this stringent assumption, which has been criticized, obscures the operation of the Ricardo effect in the more general case. If factors are generally mobile and used in combination (that is, are complementary), and if some factors are used in both capital and consumer goods industries, then a rise in demand for one or more of these general nonspecific factors in consumer goods industries will produce characteristic effects. In other words, once one nonspecific (complementary) factor becomes fully employed and is bid away from firms producing capital goods, the Ricardo effect will operate. Many other factors may be in excess supply, but if none is perfectly substitutable in the short run for the factor in question, the cyclical expansion of capital goods industries must be choked off.
In the process that Hayek described, increasing incomes of factor owners leads to an increasing demand for goods in relatively short supply, namely, consumer goods. Resources have been attracted into the production of capital goods at the expense of consumption output.35 These capital goods would have been profitable to produce, ex post, only at higher rates of planned saving. Increasing consumption in the current period implies that the prices of consumer goods and of capital goods specific to the stages nearest to final output will rise relative to the current wage rate. The value of the marginal product of labor in these stages will rise relative to the current wage. Thus, real wage rates will fall. This basic story is not very different from that in Prices and Production.36
If labor were completely immobile in the short run, then, as the demand for consumer goods increased, the rates of return would rise in some industries and fall (even become negative) in others. As long as the factor immobility assumption is strictly adhered to, there will be unemployment in some industries, and the demand for labor will be high in others.37 But Hayek never envisioned this type of underemployment equilibrium. For Hayek the process does not end at this point.
A single firm, faced with different rates of return on different investments, would attempt to equalize them at the margin (net of risk differences). The firm would borrow at the going rate of interest and invest in capital goods until the marginal rate of return on all investments is equal to the rate of interest. Kaldor assumed that this model applied to the economy as a whole.38
Hayek responded that it is a non sequitur to apply the model of a single firm to the model of the entire economy. In so doing, the resource constraint is violated. An interest rate below the equilibrium rate will lead to a progressive rise in incomes. The process will continue until the rise in the rates of return in the consumer goods industries dominates the effects of the low money rate of interest.39 As long as the market rate of interest is below the equilibrium level, the marginal propensity to spend (that is, the marginal propensity to consume plus the marginal propensity to invest) will be greater than one. And if relative prices continue to be “wrong,” there should be some mechanism (other than a change in the market rate of interest) that will lead to a correction.
Entrepreneurs will not be successful in attempts to drive the various rates of return down to the (below equilibrium) rate of interest. For what is being supplied is an infinite quantity of credit, not an infinite quantity of labor and other factor services. Entrepreneurs' borrowing at the depressed rates of interest in order to maintain or extend the existing pattern of investments will promote a further rise in incomes and consumption demand. There will be no tendency for rates of return to become equalized. The reason is that factor scarcity necessitates the curtailment of some production (namely, consumer goods) to expand the production of other goods (namely, capital goods for capital deepening). The assumption is that planned saving out of increments to income will be less than planned investment. Consumption demand will be greater, ex post, than was anticipated by entrepreneurs in general.
In The Pure Theory of Capital Hayek put this more succinctly:
In long-run equilibrium, the rate of profit and interest will depend on how much of their resources people want to use to satisfy their current needs, and how much they are willing to save and invest. But in the comparatively short run, the quantities and kinds of consumers' goods and capital goods in existence must be regarded as fixed, and the rate of profit will depend not so much on the absolute quantity of real capital (however measured) in existence, or on the absolute height of the rate of saving, as on the relation between the proportion of the incomes spent on consumers' goods and the proportion of the resources available in the form of consumers' goods. For this reason it is quite possible that, after a period of great accumulation of capital and a high rate of saving, the rate of profit and the rate of interest may be higher than they were before—if the rate of saving is insufficient compared with the amount of capital which entrepreneurs have attempted to form, or if the demand for consumers' goods is too high compared with the supply. And for the same reason the rate of interest and profit may be higher in a rich community with much capital and a high rate of saving than in an otherwise similar community with little capital and a low rate of saving.40
Lured by rising prices of consumer goods, entrepreneurs may anticipate and plan for a greater rise in the future. But, insofar as they do, they will discover that prices of current period consumption output have risen faster than anticipated: “The faster entrepreneurs expected prices to rise, the more they would necessarily speed up this price rise beyond their expectations.” The reason is that “any increase of money expenditure on the one kind of good [that is, labor services] is found to cause an increase of money expenditure on the other kind of good [that is, consumer goods].”41
In presenting a theory of the inflationary process, Hayek provided a model in which it was meaningful to speak of the self-perpetuating characteristics of an inflation, or of rising prices fueled by inflationary expectations, or even of a “wage-price spiral.” Though not developed as theories, these characterizations are descriptive of particular phases of a Hayekian inflationary process. For example, as entrepreneurs bid up factor costs, an observer within the system may believe that rising prices result from rising incomes, which in turn are being generated by rising wage rates. This phenomenon might even be described as “wage-push inflation.” The superficial observation is that in the later stages of an inflationary process wages push prices up, or that inflationary expectations are keeping the inflation going. The economist, however, would know that at the root of the price inflation is the inflation of the monetary and credit media. Changed expectations alter the form of the inflationary process; they move the economy from one phase (say, an investment boom) to another phase (say, a relative expansion of consumer goods industries) in the expansionary part of the business cycle. But all these changes presuppose an expansion of the means of payment.42 It is by no means necessary that this expansion continue to occur in the money stock, narrowly defined. Whether this in fact is the case is entirely a question of institutions and each unique historical manifestation of the business cycle.
PRICE CHANGES AND EXPECTATIONS
Hicks observed that price expectations were not treated explicitly in Prices and Production because “their day had not yet come.”43 But even in the 1930s, Hayek was sensitive to the criticism that expectations played no role in his theory.44 Nonetheless he devoted less space in his work on cyclical fluctuations to an explicit consideration of expectations than did Lindahl, Myrdal, Shackle, Lachmann, or, for that matter, Keynes himself. Yet Hayek's theory is about the inconsistency of plans—about unfulfilled expectations. This point should have received wider recognition, especially after Hayek's work on the role of prices in communicating information for the coordination of economic activity. In fact, it was in a lecture delivered in 1933 on cyclical fluctuations that Hayek first presented the thesis of his later “Economics and Knowledge.”45 In Prices and Production and also in subsequent works, for example, “Profits, Interest, and Investment,” Hayek explained how entrepreneurs are induced to make investment decisions largely inconsistent with the saving decisions made by income recipients in general. But Hayek's formal work on the coordination problem has been grouped with his work on economic calculation under socialism. It is instructive, however, to read his work on economic coordination in conjunction with that on cyclical fluctuations because the two subjects are interconnected.
Hayek was explicit about the nature of investors' expectations: “Most investments are made in the expectation that the supply of capital will for some time continue at the present level.”46 The “supply of capital” is ambiguous and suggests that capital is a homogeneous fund—a concept hardly consistent with Hayek's own views on capital theory. The point is that entrepreneurs make investments not only on the expectation that funds will be available at the prevailing interest rate to complete that investment project, but also on the expectation that funds will be available to complete complementary investments in other stages, so that there will finally emerge a complete structure of production. “These further investments which are necessary if the present investments are going to be successful may be either investments by the same entrepreneurs who made the first investment, or—much more frequently—investments in the products produced by the first group by a second group of entrepreneurs.”47 As Hayek argued in “Economics and Knowledge,” an individual's plans are necessarily mutually consistent.48 But different entrepreneurs may be led into making inconsistent production plans by faulty price signals. The coordinating mechanism for these decisions can fail to operate in an equilibrating fashion. According to Hayek, the business crisis occurs when entrepreneurs can no longer attract the funds to complete or maintain a given structure of production.
Hayek acknowledged that entrepreneurs may react to a rise in the price of consumer goods and a fall in real wages in the consumer goods industries by anticipating an even larger price rise in the future. They may for a time have “elastic” expectations and react to a rise in the prices of consumer goods by increasing investment for the future production of consumer goods as opposed to increasing current output of consumer goods. Since when consumer prices rise, there is full employment in the industries producing consumer goods, these two increases cannot occur simultaneously. However, if entrepreneurs discover that they have continually underestimated the yield from increasing the output of consumer goods in the immediate future, they will revise their pattern of behavior, even if the loan rate of interest would otherwise prompt them to borrow and invest for the more distant future.49 Hayek's capitalists are not wont to entrust their funds to entrepreneurs who consistently pass up the more lucrative investment opportunities.
No discussion of Hayek's treatment of expectations would be complete without consideration of the role of entrepreneurship in his theory. Hayek himself contributed little to the theory of entrepreneurship. This failure is surely partly due to short shrift generally given to the entrepreneurial function in economics. This lacuna is ironic, given the theoretical importance assigned to the undertaker as far back as Cantillon and J. B. Say. But in classical British political economy it was the capitalistic function that occupied center stage. Moreover, Walras introduced the notion of timeless equilibrium, which renders unintelligible both the entrepreneurial and capitalistic functions. The roughly simultaneous attack by J. B. Clark—an attack renewed by Frank Knight—on the concept of an investment period obscured the need for theories of the entrepreneurial and capitalistic roles.
Joseph Schumpeter resurrected the entrepreneur in revitalizing Walras's system to explain economic development. The analysis of the entrepreneurial role became a possible research program once again. But the Schumpeterian example was not followed by neo-Walrasians, and there was little further development of the entrepreneurial concept outside the Austrian school.
It was to the twentieth-century Austrians that the task of developing entrepreneurial theory was left by default. Hayek only slowly developed and articulated his own conception of competition and the market as a process. As late as 1946 in his article “The Meaning of Competition,” Hayek's entrepreneur is a mere shadow in the wings, even though he is the moving force in the competitive process. I believe that the word entrepreneur does not even appear in that essay.
Mises had already developed his conception of the entrepreneur as a moving force in the market economy in the 1940 German edition of Human Action: A Treatise on Economics. The Misesian entrepreneur is not a refurbished version of Schumpeter's innovator-entrepreneur, but has the day-to-day responsibility of discovering discrepancies between prices and costs and of constantly reevaluating past methods of production. He is a discoverer of existing opportunities.50 The presence of the Misesian entrepreneur is needed to make Hayek's concept of the business cycle more plausible; for Hayek relied on the market system to produce the “right” expectations in the face of monetary disturbances that systematically distort expectations.
To repeat, entrepreneurs are misled by market signals that should indicate increased voluntary saving and react accordingly by changing their investment plans and adopting production processes consonant with a relatively high level of saving. That these expectations are erroneous is discovered as the real forces (the desired saving-consumption ratio) surface. That market forces dominate a purely monetary disturbance is plausible only in terms of a theory of entrepreneurship. The Austrian school (in this regard Schumpeter should perhaps be classified an Austrian) is the only one to emphasize the importance of entrepreneurship. But even Mises's ideas need elaboration to fit Hayek's analysis of the Ricardo effect. Two complex questions are involved: first, to what extent do actors, specifically entrepreneurs, learn from experience; and, second, upon what basis do entrepreneurs form expectations when important market signals, such as the interest rate, prove misleading. While these questions are superfluous to a perfectly coordinated economic model they are essential to a model of an imperfectly coordinated economy.
To the extent that Hayek's reasoning is sound, the Ricardo effect is operative even at a constant market rate of interest. As real wage rates fall in the consumer goods industries, labor is substituted for capital equipment, and less labor-saving capital is substituted for more labor-saving capital:
The effect of this rise in the rate of profit in the consumers' goods industries will be twofold. On the one hand it will cause a tendency to use more labour with the existing machinery, by working overtime and double shifts,...etc., etc. On the other hand, insofar as new machinery is being installed, either by way of replacement or in order to increase capacity, this, so long as real wages remain low compared with the marginal productivity of labour, will be of a less expensive, less labour-saving or less durable type.51
Changed profitability of different investments also increases uncertainty and makes entrepreneurs heavily discount future returns. This factor reinforces the tendency for entrepreneurs to capture short-run returns and pursue current opportunities that appear most profitable.52
One type of expectation formation does not affect Hayek's basic analysis, though a great deal of attention has been devoted to it in recent years. This is the effect of anticipated inflation of nominal interest rates. In Hayek's theory, where changes in the price level play no causal role, anticipations of such changes, whether correct or incorrect, also play no causal role.
Let us assume that n is the natural, or equilibrium, rate of interest; i is the nominal, or market, rate of interest; Pe is the expected rate of change in the price level per period Also assume that an expansionary monetary policy has depressed i below n, and a cumulative rise in incomes brings about a cumulative rise in prices.
Yet another rate of interest is needed—Fisher's realized, or real rate of interest, p, where p = i − P. If the per period rate of change in the price level is correctly extrapolated into the future, then i = p + Pe; and P = Pe. But the real rate will nonetheless be lower than it was prior to the inflationary disturbance. The so-called inflation premium is “added on” to a market rate that is lower than the equilibrium (natural) rate of interest, that is, (i + Pe) < (n + Pe). The fact that market participants may succeed in protecting themselves against the effects of a generally depreciating currency provides no basis for concluding either that inflation will be neutral in its effects on the allocation of resources or that capital malinvestment can be avoided.53
The entire Fisherian analysis is irrelevant to the present problem and is of little relevance in an ongoing inflation of any magnitude. The reasons are several, though interrelated and reenforcing. Each market participant is concerned with the market prices facing him and the expected costs he will incur. In each contract the creditor and debtor are concerned with different subsets of relative prices and weigh the importance of individual price changes differently. They form expectations about different prices, and they attach different degrees of importance to each particular price change. Moreover, the data each individual (creditor or debtor) considers are subjective, and each will interpret them differently.
Not only do market-day equilibria represent the temporary balancing of bullish and bearish expectations—the divergent views of those who expect higher and those who expect lower rates of inflation—but also these temporary equilibria are resultants of expectations about different events. What inflation premium could protect both parties to a debt contract? What indexation scheme could protect all or even most market participants? The questions are of course purely rhetorical.54
The whole notion of a balanced, anticipated inflation is a pure fiction resulting from a question-begging assumption and a methodological error. The question-begging assumption is that inflation is even-handed in its effects and is superimposed on a situation of long-run equilibrium. The existence of equilibrium in the form of anticipated inflation is deduced from the assumption of equilibrium. “The statement that, if people know everything, they are in equilibrium is true simply because that is how we define equilibrium. The assumption of a perfect market in this sense is just another way of saying that equilibrium exists but does not get us any nearer an explanation of when and how such a state will come about.”55
The methodological error involves the use of the Marshallian representative individual who buys the typical market basket and is confronted by prices increasing at the average rate. This construct leaves in doubt whether there are any atypical individuals, any gainers or losers in the process. The fact is that there are no representative individuals in an inflationary process.
In Hayek's theory, rising prices (particularly of consumer goods) result from a maladjustment in relative prices; the result is a planned output that is not synchronized with the planned demand for those goods. Even if transactors correctly anticipate the average rate of price increases—that is, if higgling and haggling in the securities market produce a consensus—then the stipulated rate of return for nominally dominated assets will increase once and for all. Assuming that in general transactors lower desired real money balances in an anticipated inflation, prices will increase on a once and for all basis.56 But relative prices remain out of line with desired saving, and it is the maladjustment of relative prices that constitutes the inflationary problem.
The very term anticipated inflation is misleading. What is anticipated in an anticipated inflation? For an inflation to have no effect on real activity (to be neutral), the precise sequence of price changes must be anticipated. If transactors could predict the exact sequence of price changes, they could predict every future price. To do so they must have direct access to future demand and supply conditions in each market. If such knowledge were possible, why would we use prices at all? Prices reflect the balancing of opinions as to future events. All the inefficiencies of a market system are tolerated because it is the least inefficient way of transmitting decentralized information. If the market could adapt perfectly to an inflation, then the power to choose the “correct” prices is being attributed to the market. In other words, in a fully anticipated inflation this power is attributed to every (representative) individual. If, however, the representative individual is privy to the information required to correctly anticipate prices in every period, society would be well served to pick out a representative individual at random and make him an economic dictator. Markets could be dispensed with and resources allocated by fiat. No one would have to worry about the future rate of inflation, since there would not be any prices, just allocation orders.
The conception is fanciful, as is the model of a perfectly anticipated inflation. But the conception does illustrate how seemingly unrelated arguments converge. The argument over economic allocation without prices is relevant to the theory of inflation. It is relevant because inflation threatens to destroy the mechanism for economic calculation upon which a complex economy depends for its continued existence. Inflation is not merely a technical issue, nor are its effects frictional (“imperfect adjustment”). Rather, the inflation problem threatens the very fabric of a developed society.
A typical Hayekian crisis is characterized by “a scarcity of capital.” The paradox that a decline in the production of capital goods occurs because capital is in short supply seemingly delighted Hayek. By this way of expressing his ideas he focused attention on the insights of some of the “common sense” observations of the British monetary tradition of which he was so fond.57
In Prices and Production, Hayek emphasized the responsiveness of wage rates to an excess demand for labor at relevant stages of production, and labor mobility between stages.58 In 1939, however, the emphasis was on the role of raw materials. Increasing consumption demand results in increasing demand for nonspecific (circulating) capital, particularly raw materials. Raw materials constitute the typical component of capital that is “turned over” rapidly. Users of highly labor-saving or durable machinery find themselves unable to compete for complementary factors, such as raw materials. The producers of such machinery find themselves in a similar situation as the demand for their products decreases. In short, the Ricardo effect induces businessmen to make more intensive use of labor and less durable machinery. Even where uses can be found for the relatively labor-saving machinery and durable capital goods in question, producers of these capital goods suffer. For while the stocks of capital goods can be used, they will not be maintained or replaced. Furthermore, this process occurs in the face of a changing pattern of demand for capital goods.
The capital goods in short supply consist mostly of raw materials. An excess demand for raw materials emerges because in the previous cyclical upswing capital was malinvested in fixed machinery as a consequence of forced saving.
It is not so much a matter of too much investment in money terms (or real terms, if this could be meaningfully measured), as of investment applied in the wrong areas. Without the availability of complementary circulating capital (for example, raw materials) at prices that permit a profit, the durable equipment (machinery) is eventually regarded as malinvested capital. In terms of Hayek's investment diagram, it is impossible to complete all stages on the way to a finished production structure. An unfinished production structure is incapable of producing consumption output. To the degree that investments have been made in incorrect anticipation of a finished production structure, capitalists incur losses. As capital goods are rearranged to fit a structure that can be finished, the value of the existing goods will generally be less than their earlier selling price; in some cases, the prices may fall to zero. In the language of classical analysis, too much revenue has been converted to fixed capital. The existing capital goods (machinery) is not all usable—at least not for the original purpose—because the raw materials (and, in the case of a mobile labor force, the labor services) are not available. In real terms, there is an undersupply of nonspecific capital relative to the amount of machinery and current consumption demand.
The crisis consists of a rise in the prices of raw materials, and labor services relative to the prices of fixed capital.59 Moreover, the same factor—rising consumption demand—that causes these price movements results in declining demand for capital goods specific to the earlier stages of production. A price “squeeze” in the capital goods industries results. Adjustment to these changes takes time, and in the process affects employment and output.
Hayek's emphasis on circulating capital and not on fixed machinery in Prices and Production is less of a lacuna than it might seem. In Hayek's later formulation, where fixed capital is worked into the model, circulating capital turns out to be the important link in the causal process.
A tradition in British political economy was concerned with the proportion between fixed and circulating capital. In Principles of Political Economy (especially the chapter “Of Circulating and Fixed Capital”), J. S. Mill examined the impact of a change in the proportion between fixed and circulating capital, the total quantity (in real terms) remaining constant.60 “All increase of fixed capital, when taking place at the expense of circulating, must be, at least temporarily, prejudicial to the interests of the labourers.”61 What interests us about Mill's analysis is his description of fixed capital created at the expense of circulating capital as a social loss, defined in terms of the workers displaced by this process. This misallocation of resources is not related to a discussion of prices and interest rates. The exposition is quintessentially macro in approach, indeed, a retrogression to mercantilist modes of thinking because processes are described without any consideration of what price incentives may have brought them about. Capitalists switch investments from circulating to fixed capital without specified changes in parameters. And the implications, except for labor employment, are not pursued. Nor does he make a connection with the role interest rates play in preventing the conversion of circulating into fixed capital. Furthermore, he fails to make the connection between the problem being discussed and the discussions of forced saving, which are common in British monetary theory and with which this problem is linked.62
The interrelation of the notion of forced saving and the capital structure was not perceived until certain aspects of classical capital theory were made coherent by Böhm-Bawerk, Wicksell, Mises, and finally Hayek.63 Nonetheless, the effects of an increase in fixed relative to circulating capital existed for all to see; it remained only for Hayek to give clearer expression to the problem that Mill had dimly seen.
THE DEPRESSION PROCESS AND REVIVAL
The assumption of labor immobility that Hayek employed in 1939 was a way of assuring that shifts in demand would have an impact on output and employment; for he wished to emphasize that employment in capital goods industries depends “at least as much on how the current output of consumers' goods is produced as on how much is produced.”64 At full employment, rising demand for consumer goods causes the demand for certain types of capital equipment to decline, especially that specific to methods of production that are only profitable at low rates of interest. Demand for labor increases at some stages of production (and in some industries) and declines in others. Wage rates rise in some stages (industries) because of increasing demand for labor there, while unemployment occurs elsewhere.65
In his later work, Hayek undertook a more extensive explanation of general unemployment in a depression. Generalized unemployment begins with unemployment in capital goods industries. As the incomes of factors previously employed fall, the demand for current output also decreases. Where many economists today would part company with Hayek is in his insistence that strong forces in the market process reverse a cyclical decline already under way.
As unemployment emerges in the capital goods industries, the rate of increase in consumer demand, and hence in the prices of consumer goods, slows. National income may even decline. In terms of the Ricardo effect, if consumption demand actually declines, prices of consumer goods fall relative to nominal wage rates, and real wage rates rise. At some point in this process, it would pay to substitute machinery for labor. Operating in reverse, the Ricardo effect restores full employment by making the production of capital goods once more profitable. Presumably, the stringent assumptions concerning structural rigidities could be relaxed, though Hayek did not pursue this possibility.
In this analysis, consumption demand need not decline in absolute terms. Whether a slowing down in consumption demand will lead to a rise in real wage rates depends on the level nominal wage rates have reached. This in turn depends on whether entrepreneurs anticipate a higher rate of growth in consumption demand than actually obtains.
It must be emphasized that Hayek did not envision a significant money wage deflation in the course of the depression; he accepted the proposition that money wage rates are “sticky.” In fact, he feared that real wage rates could rise so much that the cyclical revival would recur with malinvestment.66
There is more to a business cycle of course than changes in the allocation of resources between stages of production. Markets always produce changes in such aggregates as labor employment. Hayek insisted that changes in these aggregates cannot be analyzed in terms of the aggregates themselves. He admitted that there are macro variables but denied the possibility of macro-analysis; for Hayek and the Austrian school in general there is only microanalysis. To him, there are no fixed relationships between macro variables.67 Nonetheless, he considered the explanation of unemployment to be of an important goal of business cycle analysis.68
Is Hayek's analysis applicable to a deep depression, such as that of 1929–33? It was certainly a period in which deflation and unemployment were fairly general. Yet in an earlier work Hayek remarked: “There is no reason to assume...that the deflation itself is anything but a secondary phenomenon, a process induced by the maladjustments of industry left over from the boom.”69 Nonetheless, this “secondary phenomenon” became of utmost importance in the 1930s. While Hayek ranked it as of secondary importance, he did not fail to recognize the phonomenon.70
Robertson explicitly attempted to link Keynes's analysis with Hayek's.71 Others treated Keynes's Treatise on Money and Hayek's Prices and Production as similar in approach.72 According to Robertson, Hayek explained why a turning point occurs, that is, why a cyclical expansion, once begun, cannot continue. Keynes concentrated on the secondary deflation process, the existence of which depends on a crisis (as explained by Hayek's analysis). Robertson did not treat the analyses of Prices and Production and The General Theory as mutually exclusive. Rather, the two analyses refer to different aspects of one and the same process.73 The failure of either side in the Keynes-Hayek debates to make use of Robertson's attempted reconciliation is to be regretted.
Throughout the 1930s, Hayek opposed both monetary and fiscal measures designed to hasten a return to full employment. Reflation treats a symptom as a cause and ignores the maladjustments that are at the root of the depression. Indeed, if monetary policy succeeds in depressing the market rate below the equilibrium rate, it perpetuates the maladjustments.74 Hayek viewed fiscal policy as stimulating consumption, whereas maladjustments are caused by planned saving's falling short of planned investment. He had little faith in either monetary or fiscal remedies as a permanent solution to widespread unemployment.75
Hayek treated the general deflationary process of the Great Depression as a secondary phenomenon produced by previous maladjustments. Once this process has begun, however, little opposition can be offered to expansionary policy. If unemployment is truly general, little can be said against a policy that tends to increase employment. In this regard, however, he made an important point:
It may perhaps be pointed out here that it has, of course, never been denied that employment can be rapidly increased, and a position of “full employment” achieved in the shortest possible time by means of monetary expansion—least of all by those economists whose outlook has been influenced by the experience of a major inflation. All that has been contended is that the kind of full employment which can be created in this way is inherently unstable, and that to create employment by these means is to perpetuate fluctuations. There may be desperate situations in which it may indeed be necessary to increase employment at all costs, even if it be only for a short period.... But the economist should not conceal the fact that to aim at the maximum of employment which can be achieved in the short run by means of monetary policy is essentially the policy of the desperado who has nothing to lose and everything to gain from a short breathing space.76
By 1933 most Western countries were ruled by what Hayek termed “desperados.” If Hayek was accurate in his assessment of the consequences, it would be difficult to argue that the unemployment Western countries experienced after World War II justified “buying” a little employment. A rapid increase in employment, fueled by a monetary expansion, with market rates of interest depressed below the natural rate, leads to maladjustments. These maladjustments, in turn, lead to successive cyclical downturns. The cyclical process becomes self-perpetuating and proceeds to the “stop-go cycle,” a familiar phenomenon in Great Britain and one becoming familiar in the United States.
Hayek's business cycle corresponds more to a Juglar cycle than, say, to a National Bureau of Economic Research reference cycle. Though two minor recessions occurred in the 1920s, Hayek treated the period as one long expansion, particularly of capital accumulation; had the expansion ceased in 1927, he believed the depression would have been mild. For the Great Depression to be viewed correctly, the actions of the Federal Reserve System in 1927 would have to be treated as “unprecedented” in their attempts to halt a contraction process with an otherwise limited effect.77
The monetary shocks that occurred later were virtually unprecedented in their severity and could not have been foreseen. Hayek's purpose was to demonstrate how cyclical fluctuations may occur even in the absence of changes in the “general” price level. In his analysis of neutral money, Hayek concluded that the only way to prevent cyclical disturbances was to prevent investment booms. His policy conclusion was consistent with his earlier views and has a modern ring to it:
If we have to steer a car along a narrow road between two walls, we can either keep it in the middle of the road by fairly frequent but small movements of the steering wheel; or we can wait longer when the car deviates to one side and then bring it back by more or less violent jerks, probably overshooting the mark and risking collision with the other wall; or we can try to keep the steering wheel stiff and let the car bang alternately into either wall with a good chance of leading the car and ourselves to ultimate destruction.78
Hayek subsequently returned to this theme:
I find myself in an unpleasant situation. I had preached for forty years that the time to prevent the coming of a depression is the boom. During the boom nobody listened to me. Now people again turn to me and ask how the consequences of a policy of which I had constantly warned can be avoided.79
THE LENGTH OF THE LONG RUN
In Prices and Production Hayek did not take up the question of how long a cyclical expansion might last. He assumed that reserve losses or price inflation would eventually compel banks to raise the loan rate.80 He subsequently argued that even if banks maintained interest rates below the equilibrium level, the operation of the Ricardo effect would bring the expansion to an end. In his discussion of expectations, he was somewhat vague on timing matters, as is characteristic of most macroeconomic theories. In 1969 Hayek appeared less sanguine about whether the Ricardo effect would check an expansion in the absence of a rise in market interest rates. To him, it was “an open question” how long investment expenditures could be maintained in excess of planned saving. The actual check might only come when price inflation was so great that “money ceases to be an adequate accounting device.” “But this cannot be further discussed without raising the problem of the effect of such changes on expectations—a problem which I do not wish to discuss here.”81 The thorny problem remained.
Determining the importance of the Ricardo effect would have one tangible benefit that I have not seen discussed. The Ricardo effect offers an explanation of the Phillips curve phenomenon. The observed relationship between the rate of change of wages and unemployment occurs if workers suffer a short-run money illusion but in the long run react only to changes in real magnitudes. This approach to the Phillips curve has become quite popular. If the rate of increase in nominal wage offers is higher than expected, the worker will assume he is being offered a greater command over society's output; unemployment will decrease
as more workers accept employment at the going wage rate. When workers realize that the prices of consumer goods are increasing as fast as wage rates, unemployment will once again increase. There will then be “high” unemployment and “high” inflation. The Phillips curve will shift, as it were, from A to B.82
The Ricardo effect provides an alternative analysis. The initial decrease in unemployment rates is attributed to a characteristic investment boom fueled by monetary expansion. However, the decrease in the unemployment rate need not be associated with an increase in nominal wage offers as implied by the Phillips curve analysis offered above. Whether these two magnitudes are associated in this way depends on the short-run elasticity of the various labor supply functions. As an empirical matter the two magnitudes are associated in this way.
In later stages of the upswing, rising money wage offers may well be associated with declining (Ricardian) real wage rates. While real labor costs are not identical with real wage rates in the sense of purchasing power, declining real labor costs in the consumer goods industries imply a decline in the purchasing power of these wages. To the extent that real labor costs fall in the consumer goods industries, the purchasing power of wages paid in those industries will also decline. The fall in real labor costs provides a stimulus to increased employment in these industries. However, the operation of the Ricardo effect at this point in a business cycle involves declining employment in industries producing capital equipment. At some point total employment may fall, and the unemployment rate rise. But even if total employment does fall, we would see it accompanied by continually high rates of wage and consumer goods' price increases. High unemployment occurs despite (or more accurately because of) the “high” rate of inflation. The existence of an inflationary recession is explained as a natural consequence of the Mises-Hayek theory of economic fluctuations. Indeed, it might be argued that Mises and Hayek were talking about the Phillips curve phenomenon—interpreted in this way—long before that phenomenon in its statistical form had been named as such. Such an explanation proceeds without recourse to a money illusion, a stratagem that economists ordinarily shun.
Declining rates of increase in wages would, in the short run, be associated with rising unemployment rates as maladjustments are eliminated. In particular, rising unemployment is the mechanism that initially slows the growth of consumer demand and that triggers the reverse operation of the Ricardo effect, which leads to an increase in investment and recovery.
The point of this last section has been to breathe some life into a concept that is in danger of being consigned to the dusty volumes of the history of thought. If the Ricardo effect can be employed to develop an analysis that avoids the controversy over the worker-search hypothesis, the short-run money-wage-illusion hypothesis, the shifting Phillips curve, et hoc genus omne, it will have proved itself worthy of researchers' attention.
THE DYNAMIC QUALITY OF THE RICARDO EFFECT
The major contribution of Hayek's 1939 and 1942 publications is his emphasis on the details of the adjustment process. Indeed, as it evolved, the Hayek-Mises analysis became a theory of inflation in the tradition of Richard Cantillon; that is, Hayek offered a hypothesis as to the kind of sequential price adjustment that occurs between the time a new source of demand, in the form of newly issued money or freshly granted credit, enters the system and the long-run adjustment of the quantity theory takes place. His theory represented an alternative to the cash-balance approach of the neo-quantity theorists, in which imperfect anticipation of the price level is all that is emphasized.
Prices and Production was cast as if the market system were essentially stable and shocks were chiefly if not exclusively monetary. During the 1930s Hayek, in reconstructing ideas, returned to the Mengerian conception of the market as a metaphor for interdependent planning under uncertainty, where time is accorded a crucial theoretical position. In so doing, he attacked the static equilibrium concept of Walrasian and Paretian theory.83 Next he emphasized the problem of the acquisition and dissemination of knowledge.84 Not until 1946, in a lecture entitled “The Meaning of Competition,” did Hayek clarify his concepts of competition as a dynamic process and of markets existing in an environment of constant change.
By 1946 Hayek had abandoned monetary and capital theory and was on the verge of abandoning economic theory altogether. Thus his conception of constantly changing conditions as endemic to real world situations was never fully developed in his work on business cycle theory.85 There is, for instance, a definiteness to the sequence of price adjustment even in his 1942 article, “The Ricardo Effect,” that I do not think would have appeared in later work on the subject. Indeed, in subsequent work,86 there is a markedly different tone. To Hayek, the significant feature is the peculiarly discoordinating aspect of monetary disturbances. To the degree that his empirical hypothesis about the way money enters the economic system is correct, this hypothesis might be subject to statistical confirmation. But his theory of economic coordination is independent of this empirical hypothesis. The chief conclusion of his analysis is that monetary disturbances are inherently non-neutral in their effects. Moreover, these disturbances interfere with the coordinating and equilibrating forces of a market system.
It would be of great scientific interest if we could establish that monetary disturbances typically lead to malinvestment in “longer” or “more roundabout” structures of production. I suspect this may be true of nineteenth-and even twentieth-century business cycles. But our inability to demonstrate this empirically could scarcely count against the theoretical insights offered by Hayek's analysis of inflation. First, monetary disturbances have non-neutral effects and, hence, discoordinate economic activity. Second, the consequent malinvestments mean that there are disproportionalities in production, which in a world of stocks and flows, have to be “worked off.” Third, attempts to maintain the existing pattern of investments through monetary and fiscal policy only perpetuate—do not stabilize—economic fluctuations. Finally, theories that focus exclusively on price levels and aggregate output (and employment) overlook essential features of macroeconomic activity.
Particularly, as governments become relatively larger and more important borrowers and dispersers of loanable funds, it is increasingly difficult to argue that monetary inflation necessarily causes malinvestments of any special type. One could plausibly argue, for instance, that most of Great Britain's inflation in the 1970s is due to government deficits, and that most government expenditures in that country are unambiguously stimulating consumption. The changing and selective impact of the concomitant inflation means, however, that economic decision making is continuously being discoordinated. We know that the real value of pensions is being destroyed by the process of that inflation. Also we have strong theoretical reasons (quite aside from casual empiricism) to believe that production decisions are thoroughly discoordinated. The former we know from the quantity theory. The latter is a purely Hayekian insight.
THE HAYEK EFFECT?
Nicholas Kaldor argued that: “The proposition of Ricardo and that attributed to him by Professor Hayek are not the same—the assumptions are different, the mode of operation is different, and the conditions of validity are quite different.” C. E. Ferguson raised the same issue: “The so-called Ricardo Effect never appeared in the works of Ricardo. It was the invention of Hayek.”87
The question of whether Hayek invented the Ricardo effect is easy to adjudicate by examining the section in Ricardo's Principles to which Hayek referred.
In proportion to the durability of capital employed in any kind of production the relative prices of those commodities on which such durable capital is employed will vary inversely as wages; they will fall as wages rise, and rise as wages fall; and, on the contrary, those which are produced chiefly by labour with less fixed capital, or with fixed capital of a less durable character than the medium in which price is estimated will rise as wages rise, and fall as wages fall.88
Prices of goods produced with “machine-intensive” processes are less affected by changes in wage rates than those produced by a “labor-intensive” process. Substitution will occur toward or away from machines, depending on whether wage rates rise or fall.
Now according to Hayek (1939):
It is here that the “Ricardo Effect” comes into action and becomes of decisive importance. The rise in the prices of consumers' goods and the consequent fall in real wages means a rise in the rate of profit in the consumers' goods industries, but, as we have seen a very different rise in the time rates of profit that can now be earned on more direct labour and on the investment of additional capital in machinery. A much higher rate of profit will now be obtainable on money spent on labour than on money invested in machinery.
The effect of this rise in the rate of profit in the consumers' goods industries will be twofold. On the one hand it will cause a tendency to use more direct labour with the existing machinery, by working over time, and double shifts, by using outworn and obsolete machinery, etc., etc. On the other hand, insofar as new machinery is being installed, either by way of replacement or in order to increase capacity, this, so long as real wages remain low compared with the marginal productivity of labour, will be of less expensive, less labour-saving or less durable type.89
I can think of no more straightforward statement of Hayek's concept of the Ricardo effect, specifically of its operation in the latter part of a cyclical upswing. The effect comprises both a substitution of labor for machinery and of circulating for fixed capital in response to a fall in the real wage rate. Hayek used the effect exactly as Ricardo had, albeit in a different context. It is clearly out of place to call it the “Hayek effect.”90
TEXTBOOK TREATMENT OF THE RICARDO EFFECT
Mark Blaug's is undoubtedly the standard textbook treatment of the Ricardo effect. I do not believe, however, that Blaug correctly followed Hayek's argument at all points. According to Blaug, for instance, “Neither the wage rate, the rental per machine, nor the rate of interest have altered in the case Hayek analyzes.”91 Blaug also implied that Hayek assumed that a rising supply curve of loanable funds faces each firm!92 In fact, Hayek did not assume constancy of the money wage rate, the rental price of machinery, or the interest rate. The rental prices of the various heterogeneous machines change as the quasi-rents (and hence, the rental demand) change for the machines because of changing demand conditions.93 In his 1942 article, Hayek went through the analysis both for a rising supply curve of funds and of an infinitely elastic supply of funds.94 Blaug apparently used the assumptions of one case to criticize the conclusions of the other! Finally, Hayek analyzed the effects of a rise in the price of the product relative to the given wage rate. This does not mean that wage rates cannot rise, though in his 1939 paper he assumed that they at least cannot fall in the short run. Rather the analysis of the Ricardo effect must be conceived of as dynamic, demonstrating wage and price changes—and employment and output changes—that occur in the course of a process.
Blaug generally employed comparative static analysis to criticize Hayek's analysis of a dynamic process of adjustment. Blaug, moreover, employed aggregative concepts that Hayek specifically eschewed (as, for example, “‘the’ rental price per machine”). He apparently felt that, because Hayek borrowed a substitution effect from Ricardo, he also borrowed Ricardo's long-run comparative static analysis. Blaug's casting of Hayek's dynamic analysis into comparative static terms is his most egregious error. As a result, he entirely missed Hayek's argument about the discoordinating features of a disequilibrium rate of interest.95
Baumol also offered a textbook treatment of the Ricardo effect,96 as well as having written an earlier contribution on the subject.97 Though he was doubtful about the operation of the effect in his early article, his mathematical analysis in Economic Theory and Operations Research constitutes a defense of the effect for the simple point-input, point-output case.
THE DEMAND FOR COMMODITIES
The classical economists were able to identify important problems in capital theory but were often unable to handle them satisfactorily. We have already noted J. S. Mill's efforts to analyze the effects of converting circulating into fixed capital. On one issue, Mill anticipated Hayek completely: whether the demand for final output also constituted the demand for labor. His views are expressed in his famous “fourth fundamental proposition respecting capital”:
Demand for commodities is not demand for labour. The demand for commodities determines in what particular branch of production the labour and capital shall be employed; it determines the direction of labour; but not the more or less of the labour itself, or of the maintenance or payment of the labour. These depend on the amount of capital, or other funds directly devoted to the sustenance and remuneration of labour.98
This doctrine or theorem of Mill's is as controversial today as it was in his time. In an oft-quoted passage, Leslie Stephen remarked that “the doctrine [is] so rarely understood, that its complete apprehension is, perhaps, the best test of an economist.”99 Obviously, Hayek's theory accepted the fundamental thesis of J. S. Mill's proposition. Indeed, Hayek offered an even stronger statement of the theorem than did Mill.100
It is a matter of debate whether Hayek accurately restated Mill's proposition. Like Say's law, it has been restated so often that there is danger critics will lose sight of the author's words and debate an interpretation of it.101 Though Hayek's restatement obviously embodies Hayek's own views on what Mill said, it is, in my opinion, a restatement that is faithful to Mill's intention. First, Hayek understood “demand for commodities” to mean the “demand for consumers' goods.” Second, the question is whether an increase in demand for current consumption raises the demand for land and labor services.102 Hayek developed the argument in real terms (as did Mill):
An increase in the demand for consumers' goods in real terms can only mean an increase in terms of things other than consumers' goods; either more capital goods or more pure input or both must be offered in exchange for consumers' goods, and their price must consequently rise in terms of these other things; and similarly a change in the demand for labour (i.e., pure input) in real terms must mean a change of demand either in terms of consumers' goods or in terms of capital goods or both, and the price of labour expressed in these terms will rise. But since it is probably clear without further explanation that if the demand for capital goods in terms of consumers' goods falls, the demand for labour in terms of consumers' goods must also fall (and vice versa), and that if the demand for labour in terms of capital goods rises (or falls) it must also rise (or fall) in terms of consumers' goods, we can leave out the capital goods for our purpose and conclude that an increase in the real demand for consumers' goods can only mean a fall in the price of labour in terms of consumers' goods, or that, since an increase in the demand for consumers' goods in real terms must be an increase in terms of labour, it just means a decrease in the demand for labour in terms of consumers' goods.103
Combining the essential logic of Mill's fourth proposition regarding capital with Ricardo's analysis in the Principles, and adding to the classical analysis the inheritance of Austrian capital theory and Mises's monetary contributions, Hayek fashioned an original and still unappreciated theory of economic fluctuations.
Hayek concluded that an increase in demand for consumers' goods decreases the demand for units of labor, whereas for Mill the demand for labor is unaffected by this change; Hayek's formulation may thus appear to be an inaccurate restatement of Mill's proposition. But I see more agreement between the two theories than is at first apparent. Mill stated that “the more or less of the labour....depend on the amount of capital.” This statement embodies the classical wages-fund doctrine. In the case Hayek examined, an increase in the demand for consumers' goods takes place at the expense of capital in the form of the wages-fund. Thus, the demand for labor falls, using Mill's own analysis.
It is true that if all factors are available without limit at current prices (and these prices remain constant), any increase in demand (in both nominal and real terms) will meet with a corresponding increase in supply. But this is a very odd case indeed to set up as the general case. For in this situation, by assumption, changes in prices, wages, costs, and interest rates are simply inoperative. It is a situation that renders the whole price system purposeless. However, it is precisely changes in relative prices that insure that “demand for commodities is not demand for labour.”104 To invoke this case as a basis for criticizing either Mill's or Hayek's theory is to engage in a question-begging procedure.
It is certainly possible to accommodate modern teaching to Mill's and Hayek's views. Mill noted that if labor were under-employed (“supported, but not fully occupied”), then an increase in demand for commodities (that is, consumer goods) may serve to increase “wealth.” But this occurs only because the increased output is at a sacrifice of no other output, and no capital need be withdrawn from other occupations.105 Rather the increased demand for commodities becomes savings, out of which factors in excess supply are hired. But the recipients of the revenue must make a decision whether or not to engage in this saving. Mill was careful to note something that is easily forgotten in income-expenditure approaches to this problem.
The demand does not, even in this case, operate on labour any otherwise than through the medium of an existing capital, but it affords an inducement which causes that capital to set in motion a greater amount of labour than it did before.106
Hayek emphasized the same point:
Few competent economists can ever have doubted that, in positions of disequilibrium where unused reserves of resources of all kinds existed, the operation of this principle is temporarily suspended, although they may not always have said so. But while this neglect to state an important qualification is regrettable and may mislead some people, it involves surely less intellectual confusion than the present fashion of flatly denying the truth of the basic doctrine which after all is an essential and necessary part of that theory of equilibrium (or general theory of prices) which every economist uses if he tries to explain anything. The result of this fashion is that economists are becoming less and less aware of the special conditions on which their arguments are based, and that many now seem entirely unable to see what will happen when these conditions cease to exist, as sooner or later they inevitably must.107
Hayek's analysis of the operation of the Ricardo effect is, in essence, a refutation of the proposition that as a general rule demand for commodities is a source of an immediate demand for labor.
The reason Mill's fourth proposition appears fallacious to modern commentators has to do with two profound changes in economic thinking that occurred in the aftermath of the Keynesian revolution. First, there is the widespread adoption of the Walrasian general equilibrium approach, in which all activities occur simultaneously, and production is assumed to be timeless. As Robert Eagly showed, Walras's approach supplanted classical sequential analysis.108 But once we move out of a world of general equilibrium, we can neither ignore the time-consuming nature of production nor continue to avoid causal sequential analysis. First capital is accumulated or saved and then (and only then) is labor demanded.
The second change coincides with Keynes's use of saving ambiguously as both saving, narrowly defined, and hoarding. Non-spending is, by definition, not a source of demand. And generalized non-spending is countered by an increase in spending (on anything). This the classical economists certainly knew. But to confound the two concepts of saving and hoarding as Keynes did is to promote a loss of understanding about other issues. This is the explanation for the loss of interest in J. S. Mill's fourth proposition.
Finally, Keynesian tradition cannot accommodate a malinvestment theory such as Hayek's. A theory in which everything turns on factor scarcities and changing relative prices makes no sense in a theory in which relative prices are assumed (at least as a first approximation) to play no role and where, in sophisticated versions, bottlenecks are largely fortuitous events, unrelated theoretically to such basic factors as factor scarcity. Yet it is precisely out of such stern stuff as resource scarcity that Hayek constructed his theory.
NOTES[Back to Table of Contents]
Was the Marginal Revolution Aborted?
Economic Analysis, serving for two centuries to win an understanding of the Nature and Causes of the Wealth of Nations, has been fobbed off with another bride—A Theory of Value (Joan Robinson, The Accumulation of Capital [London: Macmillan and Co., 1956], p. v).
KEYNES AND HAYEK
When writing this book, I have attempted to develop Hayek's ideas in a logical fashion, which, as previously noted, means departing at times from a strict chronological presentation of Hayek's ideas. In this logical and historical development, I have noted the controversies in which Hayek was involved. I did so, not for the purpose of entering these controversies on one side of the debate, but to elucidate and explain his position in these debates, so as to contribute to the development of his ideas. One controversy above all, however, merits special attention—the long controversy between Hayek and Keynes, and later, the Keynesians. By examining Hayek's Gestalt-conception of economics, as applied to the issues raised in this debate, one can go a long way toward understanding Hayek's dissatisfaction with the development of twentieth-century economics. In so doing, I shall also be presenting in more detail some themes at which I have thus far only hinted.
Even for those previously unfamiliar with Hayek's monetary writings, it should be clear by now that he was generally quite critical of both Keynesian thought and the quantity-theory tradition. It has long perplexed scholars that Hayek never wrote a detailed and critical review of The General Theory. This is in sharp contrast to his treatment of Keynes's Treatise. The absence of such a review must certainly not be taken as a sign of acquiescence. If anything, one has good reason to suppose that Hayek had more sympathy with the earlier rather than the later work of Keynes. In the Treatise, Keynes was still explicitly writing as a monetary theorist; we know that the neo-Wicksellian overtones of that work were appealing to Hayek.1 We also know that Hayek found little that was appealing in The General Theory. For while he wrote no formal review of Keynes's new magnum opus, he did outline the sources of his dissatisfaction with that work in the final pages of The Pure Theory of Capital.2 He there paved the way for the never-completed second volume of that work on the dynamic aspects of capital theory, Hayek's real interest.3
One can say that Hayek's major technical criticism of The General Theory is the absence of theoretical capital discussions in that work. Hayek had earlier accused Keynes of postulating Wicksellian conclusions without accepting the Böhm-Bawerkian capital theory upon which these conclusions were based.4 Keynes surprisingly accepted this rather harsh judgment and promised to rectify matters in the future. Patinkin has told us that “of course [he] did [do this] in The General Theory.“5
“Of course” Keynes did no such thing. The microfoundations of Keynes's investment function were certainly controversial until comparatively recently.6 Economists are still by no means in agreement over this subject—forty years after the publication of that work. Yet this problem can be treated as symptomatic of a larger problem in The General Theory, namely, the lack of a coherent capital theory. Keynes virtually admitted that he knew little capital theory when he wrote the Treatise. There seems to be no evidence that he acquired expertise in this area in the five years leading up to the publication of The General Theory. In fact, there are bits and pieces of evidence that he continued to feel quite uncomfortable about the whole subject, despite the fact that he had strong prejudices on capital theory.7 There is amazingly little in the way of capital theory proper in The General Theory, though capital considerations are of crucial importance in that work. Keynes himself seemingly was acknowledging this lacuna implicitly by his titling of chapter 16, which bridged his analysis of “The Psychological and Business Incentives to Liquidity” and “The Essential Properties of Interest and Money.” He entitled this important link, “Sundry Observations on the Nature of Capital.”
Among economists there is now a general inclination to denigrate capital theory. This attitude is largely a legacy of the Keynesian revolution. Some would go so far as to forsake capital theory entirely for a theory of interest.8 At least the latter implicitly acknowledge that the theory of capital is not merely the theory of interest, a distinction commonly not made. Capital theory as it presently exists is largely a theory of capital as a homogeneous globule, a concept that obviates consideration of any important, dynamical and specifically capital-theoretic problem. In recent years, few outside of Ludwig Lachmann have been concerned with the choice of capital goods.9 The recent Cambridge (U.K.) attack on marginalism in capital theory represents a virtual attack on putty-putty-type models of capital, in which the choice of heterogeneous capital goods is suppressed, if not assumed away. Neoclassical economists, by adhering to these models, invite the inference that marginalism and homogeneous capital models are in fact logically linked.
Of course, Keynes's emphasis on the choice of consumption versus investment, first articulated in the Treatise, and present in less obvious form in The General Theory, is a step toward capital theory, conceived of as the choice of capital goods; but it surely is not itself a theory of capital, dependent though it may be on such a theory.
However important he felt the technical flaws of The General Theory were, Hayek had a far more fundamental disagreement with the argument of that book. He objected to the whole conception of Keynes's system, to the very idea that there can be a theory of output as a whole, or of aggregate demand, aggregate supply, etc. Here we are entering into the most general considerations concerning the nature of economic theory. To do so, we require a framework of analysis.
Whatever we now know of the many precursors of modern marginalist and subjectivist economics, of Bernoulli, Dupuit, Gossen, J. B. Say, and Senior; and, even earlier, of Lottini, Davanzati, Montanari, and Galiani,10 British political economy at the eve of the Marginalist Revolution was Ricardian in approach. Be this because of Ricardo's continued intellectual dominance, or the recrudescence of Ricardian thinking effected by the appearance of J. S. Mill's Principles, British economics especially was largely ignorant of these earlier insights. Ricardian classical political economy was macroeconomics by and large.11 What was lacking in Ricardian theory was precisely a theory of choice and demand, a non-materialist theory of costs, and a consistent marginalism and subjectivism in approach. In short, Ricardian microeconomics was a skeleton insofar as it existed. Suffice to say, Ricardian value theory was at the root of this.
The contention that Ricardian political economy was macroeconomic in nature must be carefully considered. I do not wish to argue that Ricardian economics was chiefly concerned with the determination of output as a whole, aggregate demand, etc. These were the least well worked out aspects of Ricardian macrotheory:
Classical economists were not primarily concerned with the adjustments of the economy to the growth process, but with how such a process could be generated and sustained.... Even the static Ricardian model was concerned...with the progress of the economy toward the stationary state, and with what this implied for the functional distribution of income.12
A macroeconomic theory of growth, the macro distribution of income among well-defined classes, and the economics of the stationary state—quintessentially Ricardian questions.
The Ricardians were concerned to some extent with the theory of the demand for output as a whole, despite their adamant stand on the general glut question. To deny that the demand for output as a whole could ever be insufficient is not to deny that there is an aggregate demand. Aggregate demand was constituted by aggregate supply for the Ricardians and worked its way through the medium of aggregate money turnover, MV. It might be true that a motto for Ricardians could have been, “we can safely neglect the aggregate demand function.”13 But the Ricardians certainly had the concept of a demand for output as a whole. Their approach was simply different from the modern one. And of course their approach was not all that well worked out, either; as a consequence, most modern “classical” macroeconomic paradigms are largely the construction of textbook authors.
The tripartite Marginal Revolution was a microeconomic revolution against Ricardian formalism. It was a revolution that took three distinctive forms: “the marginal utility revolution in England and America, the subjectivist revolution in Austria, and the general equilibrium revolution in Switzerland and Italy.”14 But these were all microeconomic upheavals.
Yet in the end, “neoclassical” economics in Britain developed as a horrible brew, in which marginal utility theory was merged with Ricardianism. Much of this development can be attributed to Alfred Marshall, who, in this view, launched an effective counter-revolution. He openly wished to save what he could of Ricardianism. The reasons for this are complex and devolve in part around Marshall's personality. But these are beside the point here.
It is not my main point that Marshall preserved almost intact the essential features of Ricardian long-run value theory, in his own long-run analysis. I am concerned more with the general Ricardian overlay that remained in British economics. Most generally, Marshallian economics is clearly not especially methodologically individualistic (compared to either the Lausanne or Austrian schools), and is almost anti-subjectivist in tone.
In Marshallian economics we have the genesis of the division between microeconomics and macroeconomics of modern economic theory, because it is here that Ricardian economics continued, albeit in modified form. (For instance: The Marshallian theory of costs is more Ricardian than not.) The microeconomic approach to monetary theory really postdated Marshall's tour de force. The Cantabrigian hostility to a Wicksellian microeconomic theory of capital, interest and business cycle theory, and to the Misesian theory of money is thus seen to be no accident. For a radically microeconomic approach to these questions was simply foreign to the Marshallian tradition.
The Marginalist Revolution, conceived of as a general microeconomic revolution, was never completed; and it was almost immediately met in Britain by a very effective counter-revolution. It consequently advanced least in Britain, and least of all in Cambridge. It is questionable to what extent Keynes was acquainted with non-Marshallian thinking. We have his own word that German economic writings were closed to him, if the writings were not on a subject about which he already knew.15 For Keynes to have broken out of the Marshallian framework, he would have had to read German more fluently, as did Lionel Robbins. Keynes knew of Jevons, of course; but while Jevons in spirit was against all manifestations of Ricardianism, he did not to my knowledge push the microeconomic approach to the frontiers of monetary theory. And he was surprisingly classical on cost theory.
Keynes returned to a classical, macroeconomic mode of thinking in The General Theory. Viewed by a radical microtheorist and subjectivist such as Hayek, Keynes's new work was not so much revolutionary as counter-revolutionary. Hayek was opposed to the macroeconomic formalism and nascent Ricardianism of The General Theory. His disagreement with Keynes was now more fundamental and methodological, rather than particular and technical. This state of affairs surely made a formal review of Keynes's new work most difficult, particularly since Hayek probably did not work out his own thoughts immediately upon publication of The General Theory.
Hayek's change of interests may also be thus explained. For he fairly abruptly ceased writing on monetary theory proper. He saw that his dissatisfaction with the New Economics (which to him was Very Old Economics) could only be brought out in work on the fundamentals of economics. Accordingly, he began a project on scientific methodology in the early 1940s, and he has moved further in this direction in his interests ever since. His Nobel Laureate lecture represents the culmination of this intellectual phase.16 Nowhere else has he more clearly spelled out his disagreement with macroeconomic thinking as fundamental and methodological.
Viewed historically, this Gestalt-conception, which, to repeat, I think is Hayek's, has great merit. We do not have a consistent microtheoretic discipline. We would have had if the Lausanne and Austrian schools had maintained a natural intellectual alliance. But ironically the very figure who brought Walrasian and Paretian economics to the attention of Anglo-American economists also provided us with an apparent synthesis of macroeconomic (i.e., Keynesian) and general equilibrium economics. This is no place to consider in detail Sir John Hicks's role in the evolution of modern economic thinking.17 But it is the place to pose a problem that is suggested by the previous historical analysis, an analysis, to repeat, that also aids in our understanding of Hayek's response to the publication of The General Theory.
The problem concerns the recent endeavors to provide microfoundations for macroeconomics. The results have been none too impressive so far, despite the otherwise impressive credentials of those engaged in this search. It may all be a matter of time; there is no denying the possibility. But if the historical view presented here is correct, then the recent macroeconomic research program is all a futile effort. In the view offered here, the microeconomic mode of analysis is radically opposed to the macroeconomic. A coherent economic theory could only be developed by the unqualified acceptance of one mode and the concomitant rejection of the other. The protagonists of Cambridge (U.K.) understand this fact, I believe. It is not clear that their counterparts among the neoclassicals do also. Friedrich A. Hayek and Piero Sraffa, who have perhaps never agreed on anything else before, may both be in error. But the possibility that they are correct certainly should give one pause.
This historical analysis should not be completely new to one who has read Prices and Production. For the analysis is presented there in a very summary form. Of course, the analysis presented in Prices and Production could make no reference to the Keynesian revolution and such later developments. But Hayek had said much of what I am now repeating here in dealing with the monetary theory then most representative of Ricardian thinking—the quantity theory, particularly the Fisherian version. Some of the relevant passages have been quoted earlier in this book in the course of developing Hayek's criticisms of the quantity theory. There I focused the technical aspects of his dissent. Here I wish to emphasize the methodological aspects.
Hayek argued that:
For so long as we use different methods for the explanation of values as they are supposed to exist irrespective of any influence of money, and for the explanation of that influence of money on prices, it can never be otherwise [that progress in monetary theory will be hindered]. Yet we are doing nothing less than this if we try to establish direct causal connections between the total quantity of money, the general level of all prices and, perhaps, also the total amount of production. For none of these magnitudes as such ever exerts an influence on the decisions of individuals; yet it is on the assumption of a knowledge of the decisions of individuals that the main propositions of non-monetary economic theory are based. It is to this “individualistic” method that we owe whatever understanding of economic phenomena we possess; that the modern “subjective” theory has advanced beyond the classical school in its consistent use is probably its main advantage over their teaching.
If, therefore, monetary theory still attempts to establish causal relations between aggregates or general averages, this means that monetary theory lags behind the development of economics in general. In fact, neither aggregates nor averages do act upon one another, and it will never be possible to establish necessary connections of cause and effect between them as we can between individual phenomena, individual prices, etc.18
Hayek need have altered little in the above in order for it to serve as his criticism of Keynesian economics. Indeed, the similarity between the quantity theory and Keynesian economics leads us to a related topic.
KEYNES AND THE CLASSICS: THE FALLACY OF THE NONEXHAUSTIVE DILEMMA
Several generations of economics students have been brought up on the “Keynes and the Classics” argument, as it is presented in virtually every macroeconomics textbook. The analysis of this chapter, indeed of the whole book, casts doubt on this two-fold division in monetary theory. The reasons for this doubt are likewise two-fold. First, as we have seen, there is a similarity between the Keynesian and quantity-theory traditions in their fundamentally classical and Ricardian bent. This similarity is being increasingly recognized in textbooks, as the propositions of one “theory” are being couched in terms of the other. Thus, while economists have for a long time emphasized that MV=Y and C+I+G=Y are tautologies, the textbook writers have only recently begun to draw the logical conclusions: any Keynesian proposition can be cast in quantity-theory language and vice versa.19
Second, Keynesianism and the quantity theory (or Keynes and the Classics) represents a non-exhaustive choice.20 As is always true of such fallacious choices, the arguer is thereby given great license with the facts. While Keynesian economic theory can be expressed in terms of the quantity theory and vice versa, the tradition represented by Hayek can be expressed in terms of neither theory. For the variables of neither theory encompass those of Hayek's theory; and the variables of these other theories do not even enter directly into Hayek's analysis. In fact, one could argue that the choice in monetary theory is between premarginalist Ricardian thinking and a consistent marginalist and subjectivist approach. This is not to deny that a good deal of marginalism and subjectivism is present in modern monetary theory; but so too is a good deal of Ricardian macro-formalism. For one who doubts this, I can only suggest reading Hayek's Monetary Theory and the Trade Cycle, or Monetary Nationalism and International Stability, and comparing it with almost any modern treatise on money. The best comparison here might even be between Mises's Theory of Money and Credit (the locus classicus in this tradition) and modern monetary thought.
I would emphasize once again that many of Ricardo's insights in capital theory and some even in monetary and value theory play an important role in Hayek's own analysis. Many have noted the Ricardian or classical roots of Austrian capital theory. What I have endeavored to juxtapose is Ricardian macro-formalism, or Ricardian methodology, and consistent methodological individualism and subjectivism. The Cambridge rediscovery of Ricardo has focused precisely on what are to economists in the Austrian tradition the most objectionable features of Ricardianism (for example, analysis by social classes rather than individuals and manipulation of aggregate variables rather than attention to the relevant micro signals). Insufficient attention is thereby paid to the interesting (to Austrian economists) Ricardian insights on capital (for example, the importance of the period of production) and value theory (for example, see chapter 5 on the Ricardo effect).
There are real points of disagreement in monetary analysis. But as Leijonhufvud has recently argued, these have more to do with questions of the existence of a self-regulating mechanism of a market economy21 ; and this truly fundamental difference has no logical connection with the presumed values of various elasticities that might lead one to be a Keynesian or a quantity theorist.
To discuss intelligently substantive disagreements, one must first recognize their nature. I have been arguing that differences among macrotheorists and monetary theorists are often misperceived and are consequently persistent. These differences are not narrowly technical in nature, though the debates are carried on in technical terms. Consequently, the issues are more easily muddled than solved. The differences are at root methodological, and broadly political-economic. This chapter has dealt with the former source of controversy. The latter would take us beyond the scope of this book, though I have touched on some of the issues in the second chapter. But then I did not set out to solve problems in this chapter, but only to identify them. I hope that I have done this.
NOTES[Back to Table of Contents]
An Alternative Research Program
In contrast to the majority of economists, [Austrian economists] talk and act like people who are doing extraordinary science. They produce relatively more books and contribute fewer articles to established journals. They do not write text books; their students learn directly from the masters. They are very much concerned with methodological and philosophical fundamentals and what makes the label extraordinary most applicable to their work is that they share a conviction that orthodox economics is at the point of breakdown, that it is unable to provide a coherent and intelligible analysis of the present-day economic world (Edwin G. Dolan, “Austrian Economics as Extraordinary Science,” in The Foundations of Modern Austrian Economics [Kansas City: Sheed & Ward, 1976]).
ECONOMICS IN CRISIS
The crises are being proclaimed everywhere by pundits and serious economists alike. When Sir John Hicks lends support to this chorus of woes in the very title of his recent book,The Crisis in Keynesian Economics, then truly something is amiss with economics. Moreover, a plethora of cures has been offered from various sources. But the patient must be excused if he hesitates before ingesting any of these elixirs. For many of these appear oddly familiar. In fact, some appear very similar to all-but-forgotten diseases from which our existing regimen was intended to protect us. Ricardian value theory, with its objective value theory and its absence of a theory of demand, scarcely represents an attractive alternative to general equilibrium theory. In many respects, of course, neo-Walrasian general equilibrium theory and Ricardian classical political economy share common faults; the tendency in both research programs to assume perfect foresight is one striking example.1 At least neoclassical economics, in its dominant neo-Walrasian variant, provides the basis for a satisfactory theory of demand. Ricardianism and its intellectual offshoots surely offer no such hope. One need only examine Mr. Sraffa's tour de force, Production of Commodities by Means of Commodities,2 which in many ways represents the logical culmination of Ricardian economics: general equilibrium theory without demand.3 This cannot represent an acceptable alternative to modern economic theory, however flawed the latter may be. It would truly be a cure worse than the disease.
Orthodox economists are justified, then, in their steadfast adherence to existing economic theory, given the visible alternatives. Nor does “radical economics” offer a very attractive substitute research program. Insofar as radical political economy is Marxist, and insofar as Marxist political economy is Ricardian, then it surely suffers many of the same faults as the other neo-Ricardian alternatives.4 In addition, the metaphysical underpinnings scarcely recommend the Marxist alternative. In a profound sense, then, all neo-Ricardian research programs, far from being “radical,” are reactionary intellectual developments.
None of the above is intended to deny that there is a general crisis situation in economic theory, of which various particular crises, such as that in Keynesian economics, are but manifestations of a more general intellectual malaise. Nor am I entirely out of sympathy with particular “radical” criticisms of orthodox models. I am simply arguing that the crisis has simply not been diagnosed, though its symptoms are now well known. They have been observed in numerous recent works, including Hicks's and in previous chapters of this book. But no satisfactory diagnosis having been made, it is no wonder that the putative cures are misconceived.
The analysis of the previous chapter provides the basis for a diagnosis. Ricardian economics is an unsatisfactory theory because of its inability to explain demand or short-run pricing. Even its long-run value is marred, dependent as it is on a materialist conception of costs. In the Ricardian analysis, costs depend on “the ultimate conditions on which nature yields her stores.”5 It was from this materialist conception of costs that subjectivist neoclassical economics was to emancipate us. This Ricardian conception is not entirely consistent with a thorough-going subjectivist cost theory, in which a cost is a forgone utility.6 Once again, the forgoing in no way subtracts from Ricardo's many valuable contributions, not the least of which is the concept of the margin.
Neoclassical economics represents a demonstrable improvement over Ricardian analysis, insofar as the former advanced our understanding of those phenomena least understandable in the Ricardian approach.7 The so-called Marginalist Revolution provided a basis for a solution to Ricardian lacunae. All three variants of neoclassicism, the Walrasian, Austrian, and Jevonian, focused on utility as an explanation of demand and made use of the older concept of the margin to explain pricing. The Austrians, particularly Wieser, developed the idea that costs are forgone opportunities, not coefficients of production dictated by physical laws of production. Their consistent methodological subjectivism enabled the later Austrians, particularly Mises and Hayek, to perceive that the only relevant forgone opportunities are those perceived by the individual decision maker. The pure logic of the economic short run and that of the long run were seen to be the same and to have no necessary connection with any laws of production that so occupied the Ricardians.
But Ricardian elements remained embedded in the emerging neoclassical synthesis, particularly its Marshallian variant. Though graduate school price theory today is basically Walrasian, intermediate textbooks abound with confusing Marshallian and Ricardian concepts intermingled with a neo-Walrasian analysis. The classical short run is superimposed on models that preclude imperfect and incomplete adjustment. The U-shaped cost curve—indeed, the whole cost curve apparatus—is a distracting Marshallian intrusion. No wonder undergraduates are confounded by all this!
Yet professional economists have learned their early intellectual gymnastics in this environment. Probably few discard entirely the more classical elements in orthodox economics. As a consequence, Ricardian analysis persists even in the “higher level” theoretical output of journals.
My suggestion, then, is that the emergent theoretical edifice in the twentieth century—which in the English-speaking world was predominantly Marshallian at first and later predominantly Walrasian—contained inner contradictions that had to be resolved before a satisfactory theoretical edifice could be constructed. It happened that the problems first became manifest in two distinct areas in the first decades of this century: monetary theory and the theory of costs, or supply.
Monetary theory occupied an unsatisfactory position so long as it remained separate and distinct from the general theory of value. Monetary theorists, who in this period were likely to be accomplished value theorists as well, discovered in effect that much of monetary theory was a holdover from Ricardian political economy. As was noted in chapter 3 of this book, Wicksell took the initial steps toward an integration of monetary and value theory. But Wicksell himself was incapable of solving the root theoretical conundrum: how can one apply the marginalist calculus to the demand for money? It was Ludwig von Mises who finally solved this problem, by recognizing the necessity of subjectivizing monetary theory in what surely remains one of the more neglected works of monetary theory.8 Curiously, though, he is accused of perpetuating the very problem that he solved.9
By building on the foundations laid by Mises, and indirectly by Wicksell, Hayek provided a microfoundation for monetary theory. He did so by showing that monetary theory could be viewed as an extension of the barter theory of price, rather than approached macroeconomically in the Ricardian tradition. For Hayek, the quaesitum of monetary theory is not the determination of the value of money, but the determination of the effects of monetary disturbances on (relative) prices and production. Moreover, Hayek's microfoundations and his general theoretical approach are independent of his specific empirical hypothesis about precisely how monetary disturbances typically operate. That is, the approach can be readily adopted to changing institutional arrangements (for example, the increasing role of government expenditures) and thus take account of changing consequences for the real sector of monetary disturbances.
Keynes was a comparatively late convert to these changes in monetary theory. Perhaps the reason was that he could never slough off entirely his Marshallian epidermis. Or, perhaps, as Mrs. Robinson now claims, Keynes did not at all times fully comprehend the point of his own revolution.10 In any case, he was never fully successful in articulating the centrality of relative prices in any monetary explanation of cyclical fluctuations.11
Hayek worked out the fundamentals of the problem in much more detail. This is most obvious in the case of the analysis of investment demand, but it is even more true in his analysis of prices as signaling devices and the role of changes in the array of relative prices on entrepreneurial expectations. In this regard, Hayek always treated changes in expectations as endogenous, whereas Keynes saw them more as an exogenous element in the market system.
The second area of concern was cost and supply theory. This area involved a number of problems, related by the common element of an ill-defined cost theory. The literature is too vast and diverse to cite here, but it covered such problems as the relation between costs and supply and the disappearing supply curve in monopoly. The aspect of this general problem that interests us here is the question whether opportunity costs are subjective or objective in nature. Hayek's interest in this issue can be seen as one with his interest in monetary questions. He wanted to develop a consistently methodological individualist and subjectivist theory of the coordination of economic activities. It would not do to leave cost theory hanging in the air, as it were, borrowed from Ricardian economics. The problems with inherited cost theory become apparent in the Socialist-calculation debate. Costs are not data for the individual, given to him as they are to the economist as ideal observer who constructs the models of decision making. Different transactors have different perceptions of the data and acquire different bits of knowledge about relevant opportunities. Moreover, even if all individuals, mirabile dictu, had the same experiences, they would interpret these differently. It is as if each of us saw part of some production function. Even if some central allocator costlessly and instantaneously collected all our perceptions as they occurred, he would discover that they did not make up one common production function. If perceived opportunities differ, the criterion of allocating according to costs—as though costs were a unique and measurable magnitude—is seen as non-operational, illusory, and, hence, irrelevant.12
All of these issues were actively discussed and debated in the thirties. Though surely no part of his intention, what Keynes did in The General Theory was to direct attention away from these central theoretical questions. Whatever The General Theory may have taught us, it answered none of these questions. Rather, the Keynesian revolution diverted attention away from these questions and effectively closed off paths of inquiry that at the time evidenced every sign of leading to a solution.
My argument, then, is that the various crises in economics are manifestations of inconsistencies in the neoclassical research program. These inconsistencies are present because of the curious admixture of Ricardianism and neoclassicism present in the modern research program. The inconsistencies were never resolved, though their resolution was in sight in the thirties when it was aborted by the Keynesian revolution. The current situation is the result of forty years of repressed debate over the very fundamental questions that occupied economists in the earlier period. We are now condemned to relive the debates unless we succeed in using the earlier discussion as starting points.
In particular, Mises and Hayek went a long way toward solving a theoretical problem that besets economists today—the integration of monetary and value theory. Whatever else can be said about Hayek's monetary economics, his work does consist of a monetary theory erected upon a consistent microfoundation. Whatever else can be said about almost any other monetary theory of economic fluctuations, it lacks that consistency. Since an avowed purpose of macro and monetary theory today is to provide a microfoundation for the analysis of economic fluctuations, this alone recommends a reconsideration of Hayek's work. It is true that an acceptance of his approach involves abandoning some of what is presently taken for granted (for example, monetary theory is the determination of the value of money). But once one accepts the fact that something is not quite right with the grand neoclassical synthesis, one is virtually committed to abandoning something substantial in the orthodox research program. The only question is what.
A HAYEKIAN RESEARCH PROGRAM
It would be to go far beyond the scope of this book to outline in detail a new Austrian or Hayekian research program. Such a program is really only in the first stage of development.13 This is partly because Hayek's attention turned elsewhere at a crucial moment, and because the Keynesian revolution swept aside many of the interesting questions that would surely be addressed in such a research program. In a very real sense, the program will be whatever those who choose to work in a Hayekian framework make it.
Above all else, Hayek emphasized a microeconomic approach to economic questions. Conventional macroeconomic models with constant functional relationships that can be mechanically manipulated are virtually ruled out of such a program.14 It is doubtful that there can ever be a Hayekian alternative to the Hicksian cross.15 This is true, not because Hayek's theory is needlessly complex, but because the world is too complex to picture it accurately in simplistic formulae. So long as economists are wedded to the contrary idea, so long will progress in the theory of economic fluctuations be stalled. In this, I should say, there is affinity between Hayek's views and those of Professor G. L. S. Shackle and the other Keynesians who agree with Shackle's radical interpretation of Keynes.16
Conversely, one area that seemingly cries out for attention is the sequence of effects in an inflationary expansion. Here one must distinguish carefully between Hayek's theory of economic fluctuations and his empirical hypotheses concerning the effects of an inflation of the money stock. His theory is in the Cantillon tradition, which, broadly speaking, emphasizes distribution effects. Hayek's hypothesis concerns where and how injections of money and credit enter the economy. He looked to private investment as the key variable. It would not be surprising if since 1931 there had been important changes in the paths taken in the inflation process. As an example, federal spending is a much more important part of the economy than it was in 1931. A substantial part of increases in the money stock, broadly or narrowly defined, is typically due to monetization of the debt. What is the net effect of government spending on the “consumption-investment” ratio? Does it stimulate investment or consumption relatively more? And particular kinds of private investment more than others? Do particular sectors, industries, or even firms usually gain first in such an inflation? These are the kinds of questions that will undoubtedly be addressed in a Hayekian research program in monetary theory.17
Finally, on the most general level a Hayekian research program must surely be concerned with the coordination of economic activities and the emergence of an undesigned (“spontaneous”) order.18
WHERE ARE THE AUSTRIANS NOW?
Hayek recently commented: “But though there is no longer a distinct Austrian School, I believe there is still a distinct Austrian tradition from which we may hope for many further contributions to the future development of economic theory.”19
There certainly are areas in which Hayek and his fellow economists have had an identifiable impact on current economic thought. One could scarcely call orthodox cost theory “Austrian,” but some versions contain strong Austrian elements. As James Buchanan has argued, there is really a separate and distinct approach to cost theory, in which the subjective element is strongly emphasized.20 Though never incorporated entirely into orthodox economic theory as such, this approach, heavily influenced by the twentieth-century Austrians, represents a lively alternative.
Elements of Austrian capital theory have been incorporated into many theoretical discussions about capital—especially in the period of investment approach. One could argue, of course, that other essential features of Austrian capital theory (for example, its emphasis on time preference and the subjective factors) are missing in these contemporary treatments. Yet Austrian capital theory, too, has been kept alive as an independent approach, though little has been done with it since World War II.21
A sort of modern version of the Austrian school is apparently emerging. In periods of intellectual convergence, such as we have had since the Keynesian research program was developed, there is comparatively little scope for distinct schools in a science. In periods of intellectual divergence, in which we now appear to be, there is comparatively more scope for fundamental disagreement and for distinct schools of thought.22 A number of new articles and books have been written in this emergent school.23 There is every indication that once again the intellectual climate exists in which the theoretical conundrums can be solved; and economists who consider themselves as part of the Austrian tradition will be addressing themselves to the pressing theoretical and practical problems of the day. Economics can only gain from this development, for in intellectual endeavors, too, increased competition is beneficial.
- Abramovitz, Moses, et al. The Allocation of Economic Resources. Stanford, Calif.: Stanford University Press, 1959.
- Alchian, Armen A., and Allen, William R. University Economics. 3d ed. Belmont, Calif.: Wadsworth Publishing Co., 1972.
- Allen, R. G. D. “A Reconsideration of the Theory of Value.” Part 2. Economica, n.s. 1 (May 1934):196–219.
- Baumol, William J. Economic Theory and Operations Research. 2d ed. Englewood Cliffs, N.J.: Prentice-Hall, 1965.
- Black, R. D. Collison; Coats, A. W.; and Goodwin, Craufurd D. W.,eds. The Marginal Revolution in Economics. Durham, N.C.: Duke University Press, 1973.
- Blaug, Mark. Economic Theory in Retrospect. Rev. ed. Homewood, Ill.: Richard D. Irwin, 1968.
- Blaug, Mark. “Kuhn Versus Lakatos, or Paradigms Versus Research Programmes in the History of Economics.” History of Political Economy 7 (Winter 1975):399–433.
- Böhm-Bawerk, Eugen von. Capital and Interest. Translated by George D. Huncke, and Hans F. Sennholz. South Holland, Ill.: Libertarian Press, 1959.
- Brozen, Yale M. “The Antitrust Task Force Deconcentration Recommendation.” Journal of Law & Economics 13 (October 1970):279–92.
- Buchanan, James M. Cost and Choice. Chicago: Markham Publishing Co., 1969.
- Buchanan, James M., and Thirlby, G. F., eds. L.S.E. Essays on Cost. London: Weidenfield Nicolsen, 1973.
- Buechner, M. Northrup. “Frank Knight on Capital as the Only Factor of Production.” Journal of Economic Issues 10 (September 1967):598–617.
- Campbell, Colin D., and Campbell, Rosemary G. An Introduction to Money and Banking. New York: Holt, Rinehart & Winston, 1972.
Cheung, Steven N. S. “Transactions Cost, Risk Aversion, and the Choice of Contractual Arrangements.” Journal of Law & Economics 12 (April 1969):23–42.
Cheung, Steven N. S. “The Structure of a Contract and the Theory of a Non-exclusive Resource.” Journal of Law & Economics 13 (April 1970):49–70.
Clower, R. W., ed. Monetary Theory. Baltimore: Penguin Books, 1970.
Clower, Robert W., and Due, John F. Microeconomics. 6th ed. Homewood, Ill.: Richard D. Irwin, 1972.
Davis, J. Ronnie. “Henry Simons, the Radical: Some Documentary Evidence.” History of Political Economy 1 (Fall 1969):388–94.
Davis, J. Ronnie. The New Economics and the Old Economists. Ames, Ia.: Iowa State University Press, 1971.
Dolan, Edwin G., ed. The Foundations of Modern Austrian Economics. Kansas City: Sheed & Ward, 1976.
Dunlap, J. T. “The Movement of Real and Money Wage Rates.” Economic Journal 48 (September 1938):413–34.
Eagly, Robert V. The Structure of Classical Economic Theory. New York: Oxford University Press, 1974.
Eisner, Robert. “On Growth Models and the Neo–Classical Resurgence.” Economic Journal 78 (December 1968):707–21.
Ferguson, C. E. “The Specialization Gap: Barton, Ricardo, and Hollander.” History of Political Economy 5 (Spring 1973):1–13.
Fetter, Frank W. “The Relation of Economic Thought to Economic History,” American Economic Review 55 (May 1965):136–42.
Fisher, Irving. “The Business Cycle Largely a ‘Dance of the Dollar’.” Journal of the American Statistical Association 18 (1922–23):1024–28.
Friedman, Milton. The Optimum Quantity of Money. Chicago: Aldine Publishing Co., 1969.
Friedman, Milton. “A Theoretical Framework for Monetary Analysis.” Journal of Political Economy 78 (March/April 1970):193–238.
Friedman, Milton. “A Monetary Theory of Nominal Income.” Journal of Political Economy 79 (March/April 1971):323–37.
Friedman, Milton. “Comments on the Critics.” Journal of Political Economy 80 (September/October 1972):906–50.
Friedman, Milton. ed. Studies in the Quantity Theory of Money. Chicago: Univeristy of Chicago Press, 1956.
Garrison, Roger. “Austrian Macroeconomics.” Menlo Park, Calif.: Photocopy, 1976.
Grossman, Hershel I. “Was Keynes a ‘Keynesian’?” Journal of Economic Literature 10 (March 1972):26–30.
Haberler, Gottfried. Prosperity and Depression. 3d ed. Lake Success, N.Y.: United Nations, 1946.
Hansen, Alvin, and Tout, Herbert. “Annual Survey of the Business Cycle Theory: Investment and Saving in Business Cycle Theory.” Econometrica 1 (April 1933):119–47.
Harrod, Roy. Money. London: St. Martin's Press, 1969.
Hawtrey, Ralph G. “The Trade Cycle and Capital Intensity.” Economica, n.s. 7 (February 1940):1–15.
Hawtrey, Ralph G. “Professor Hayek's Pure Theory of Capital.” Economic Journal 51 (June–September 1941):281–90.
Hawtrey, Ralph G. Capital and Employment. 2d ed. London: Longmans, Green & Co., 1952.
Hayek, Friedrich A. “Reflections on the Pure Theory of Money of Mr. J. M. Keynes.” Part 1. Economica 11 (August 1931):270–95.
Hayek, Friedrich A. “A Rejoinder.” Economica 11 (November 1931):398–403.
Hayek, Friedrich A. “Reflections on the Pure Theory of Money of Mr. J. M. Keynes.” Part 2. Economica 12 (February 1932):22–44.
Hayek, Friedrich A. “Money and Capital: A Reply.” Economic Journal 42 (June 1932):237–49.
Hayek, Friedrich A. “The Trend of Economic Thinking.” Economica 13 (1933):121–37.
Hayek, Friedrich A. Monetary Theory and the Trade Cycle. 1933 Reprint. Translated by N. Kaldor and H. M. Croome. New York: Augustus M. Kelley, 1966.
Hayek, Friedrich A. Prices and Production. 2d ed. London: Routledge & Kegan Paul, 1935.
Hayek, Friedrich A. Profits, Interest, and Investment. 1939 Reprint. New York: Augustus M. Kelley, 1970.
Hayek, Friedrich A. The Pure Theory of Capital. Chicago: Univeristy of Chicago Press, 1941.
Hayek, Friedrich A. “A Comment.” Economica, n.s. 9 (November 1942):383–85.
Hayek, Friedrich A. The Road to Serfdom. Chicago: University of Chicago Press, Phoenix Books, 1944.
Hayek, Friedrich A. “Time Preference and Productivity: A Reconsideration.” Economica, n.s. 12 (February 1945):22–25.
Hayek, Friedrich A. Individualism and Economic Order. Chicago: University of Chicago Press, 1948.
Hayek, Friedrich A. The Counter–Revolution of Science. New York: Free Press of Glencoe, 1955.
Hayek, Friedrich A. The Constitution of Liberty. Chicago: University of Chicago Press, 1960.
Hayek, Friedrich A. The Sensory Order. Chicago: University of Chicago Press, Phoenix Books, 1963.
Hayek, Friedrich A. Studies in Philosophy, Politics, and Economics. New York: Simon & Schuster, Clarion Books, 1969.
Hayek, Friedrich A. “Three Elucidations of the Ricardo Effect.” Journal of Political Economy 77 (March/April 1969):274–85.
Hayek, Friedrich A. Law, Legislation and Liberty, Vol. I: Rules and Order. Chicago: University of Chicago Press, 1973.
Hayek, Friedrich A. ed. Collectivist Economic Planning. London: George Routledge & Sons, 1935.
Hicks, John R. “A Reconsideration of the Theory of Value.” Part 1. Economica, n.s. 1 (February 1934):52–76.
Hicks, John R. Value and Capital. 2d ed. Oxford: Oxford University Press, Clarendon Press, 1946.
Hicks, John R. Critical Essays in Monetary Theory. Oxford: Oxford University Press, Clarendon Press, 1967.
Hicks, John R. Theory of Economic History. New York: Oxford University Press, Galaxy Books, 1969.
Hicks, John R. “A Neo–Austrian Growth Theory.” Economic Journal 80 (June 1970):257–81.
Hicks, John R. Capital and Time: A Neo–Austrian Theory. Oxford: Oxford University Press, Clarendon Press, 1973.
Hicks, J. R., and Weber, W., eds. Carl Menger and the Austrian School of Economics. Oxford: Oxford University Press, Clarendon Press, 1973.
Hirshleifer, J. Investment, Interest, and Capital. Englewood Cliffs, N.J.: Prentice–Hall, 1970.
Hirshleifer, J. “Where Are We Now in the Theory of Information?” American Economic Review 63 (May 1973):31–39.
Hirshleifer, J. “Exchange Theory: The Missing Chapter.” Western Economic Journal 11 (June 1973):129–46.
Hurwicz, Leonid. “The Design of Mechanisms for Resource Allocation.” American Economic Review 63 (May 1973):1–30.
Hutt, W. H. Keynesianism: Retrospect and Prospect. Chicago: Henry Regnery Co., 1963.
Hutt, W. H. A Rehabilitation of Say's Law. Athens, Ohio: Ohio University Press, 1974.
Jaffé, William. “Walras' Theory of Tâtonnement: A Critique of Recent Interpretations.” Journal of Political Economy 75 (February 1967):1–19.
Kaldor, Nicholas. “Capital Intensity and the Trade Cycle.” Economica, n.s. 6 (February 1939):40–66.
Kaldor, Nicholas. “The Trade Cycle and Capital Intensity: A Reply.” Economica, n.s. 7 (February 1940):16–22.
Kaldor, Nicholas. “Professor Hayek and the Concertina Effect.” Economica, n.s. 9 (November 1942):359–85.
Kauder, Emil. A History of Marginal Utility Theory. Princeton: Princeton University Press, 1965.
Keynes, J. M. “A Rejoinder.” Economic Journal 41 (September 1931):412–23.
Keynes, J. M. “A Reply to Dr. Hayek.” Economica 11 (November 1931):387–97.
Keynes, J. M. The General Theory of Employment, Interest, and Money. 1936 Reprint. New York: Harcourt, Brace & World, Harbinger Books, 1965.
Keynes, J. M. “Relative Movement of Real Wages and Output.” Economic Journal 49 (March 1939):34–52.
Keynes, Milo, ed. Essays on John Maynard Keynes. New York: Cambridge University Press, 1975.
Kirzner, Israel M. An Essay on Capital. New York: Augustus M. Kelley, 1966.
Kirzner, Israel M. Competition and Entrepreneurship. Chicago: University of Chicago Press, 1973.
Knight, Frank H. “Capital, Time, and the Interest Rate.” Economica, n.s. 1 (August 1934):257–86.
Knight, Frank H. “Comment.” Journal of Political Economy 43 (October 1935):625–27.
Kuhn, Thomas S. The Structure of Scientific Revolution. Chicago: University of Chicago Press, 1963.
Kuhn, W. E. The Evolution of Economic Thought. 2d ed. Cincinnati: South–Western Publishing Co., 1970.
Lachmann, Ludwig M. “A Reconsideration of the Austrian Theory of Industrial Fluctuations.” Economica, n.s. 7 (May 1940):179–96.
Lachmann, Ludwig M. “The Role of Expectations in Economics as a Social Science.” Economica, n.s. 10 (November 1943):12–23.
Lachmann, Ludwig M. Capital and Its Structure. London: G. Bell & Sons for the London School of Economics, 1956.
Lachmann, Ludwig M. Macro–economic Thinking and the Market Economy. Hobart Paper No. 56. London: Institute of Economic Affairs, 1973.
Lachmann, Ludwig M., and Snapper, F. “Commodity Stocks in the Trade Cycle.” Economica, n.s. 5 (November 1938):453–54.
Lakatos, Imre, and Musgrave, Alan, eds. Criticism and the Growth of Knowledge. Cambridge: Cambridge University Press, 1970.
Lange, Oskar; McIntyre, Francis; and Yntema, Theodore; eds. Studies in Mathematical Economics and Econometrics. Chicago: University of Chicago Press, 1942.
Leijonhufvud, Axel. On Keynesian Economics and the Economics of Keynes. New York: Oxford University Press, 1968.
Leijonhufvud, Axel. “Effective Demand Failures.” Swedish Journal of Economics 75 (1973): 27–48.
Lindahl, Eric, ed. Selected Papers on Economic Theory. London: George Allen & Unwin, 1958.
Lutz, Friedrich A., and Mints, Lloyd W., eds. Readings in Monetary Theory. Homewood, Ill.: Richard D. Irwin, 1951.
Machlup, Fritz. “Professor Knight and the ‘Period of Production.’” Journal of Political Economy 43 (October 1935):577–624.
Machlup, Fritz. “The Period of Production: A Further Word.” Journal of Political Economy 43 (October 1935):808.
Machlup, Fritz. “Friedrich von Hayek's Contributions to Economics.” Swedish Journal of Economics 76 (1974):498–531.
Makower, H., and Baumol, William J. “The Analogy Between Producer and Consumer Equilibrium Analysis.” Economica, n.s. 17 (February 1950):63–80.
Marget, Arthur W. “Review of Friedrich A. Hayek, Prices and Production; and Preise und Produktion.” Journal of Political Economy 40 (April 1932): 261–66.
McGee, John S. In Defense of Industrial Concentration. New York: Praeger Publishers, 1971.
Mill, John Stuart. Principles of Political Economy. Edited by Sir William Ashley. Clifton, N.J.: Augustus M. Kelley, 1973.
Mises, Ludwig von. The Theory of Money and Credit. N 2d ed. Translated by H. E. Batson. Irvington–on–Hudson, N.Y.: Foundation for Economic Education, 1971.
Mises, Ludwig von. “‘Elastic Expectations’ and the Austrian Theory of the Business Cycle.” Economica, n.s. 10 (August 1943):251–53.
Mises, Ludwig von. Human Action. New Haven: Yale University Press, 1949.
Mises, Ludwig von. Human Action. 3d ed. Chicago: Henry Regnery Co., 1966.
Moggridge, D. E., ed. The Collected Writings of John Maynard Keynes. Vols. 5 and 6. London: St. Martin's Press, 1971.
Myrdal, Gunnar. Monetary Equilibrium. London: William Hodge & Co., 1939.
Nuti, Dominico Mario. “On the Rates of Return on Investment.” Kyklos 27 (1974):345–69.
O'Driscoll, Gerald P., Jr. “The Specialization Gap and the Ricardo Effect: Comment on Ferguson.” History of Political Economy 7 (Summer 1975):261–69.
O'Driscoll, Gerald P., Jr. “Hayek and Keynes: A Retrospective Assessment.” Iowa State University Working Paper No. 20. Ames, Iowa: Photocopy, 1975.
O'Driscoll, Gerald P., Jr. “Spontaneous Order and the Coordination of Economic Activities.” Menlo Park, Calif.: Photocopy, 1976.
Patinkin, Don. Money, Interest and Prices. 2d ed. New York: Harper & Row, 1965.
Pesek, Boris P., and Saving, Thomas R. Money, Wealth and Economic Theory. New York: Macmillan Co., 1967.
Phillips, A. W. “The Relation Between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom, 1861–1957.” Economica, n.s. 25 (November 1958):283–99.
Phillips, C. A.; McManus, T. F.; and Nelson, R. W. Banking and the Business Cycle. New York: Macmillan Co., 1937.
Pirenne, Henri. Economic and Social History of Medieval Europe. New York: Harcourt, Brace & World, Harvest Books, 1970.
Ricardo, David. Principles of Political Economy. Edited by F. W. Kolthammer. New York: E. P. Dutton, 1948.
Ricardo, David. Works of David Ricardo. Vol. 3. Edited by Piero Sraffa. Cambridge: Cambridge University Press, 1951.
Richardson, J. Henry. “Real Wage Movements.” Economic Journal 49 (September 1939):425–41.
Robbins, Lionel. The Great Depression. London: Macmillan & Co., 1934.
Robbins, Lionel. An Essay on the Nature and Significance of Economic Science. 2d ed. London: Macmillan & Co., 1935.
Robbins, Lionel. Autobiography of an Economist. London: Macmillan & Co., 1971.
Robertson, D. H. “Mr. Keynes' Theory of Money.” Economic Journal 41 (September 1931):395–411.
Robertson, D. H. Essays in Monetary Theory. London: P. S. King & Son, 1971.
Rothbard, Murray N. Man, Economy and State. 2 Vols. Princeton: D. Van Nostrand Co., 1962.
Rothbard, Murray N. America's Great Depression. Princeton: D. Van Nostrand Co., 1963.
Rotwein, Eugene, ed. David Hume: Writings on Economics. Madison: University of Wisconsin Press, 1970.
Schumpeter, Joseph A.A History of Economic Analysis. New York: Oxford University Press, 1954.
Seligman, Ben B.Main Currents in Modern Economics. 3d ed. New York: The Free Press of Glencoe, 1963.
Shackle, G. L. S.The Years of High Theory. Cambridge: Cambridge University Press, 1967.
Shenoy, Sudha R., ed.A Tiger by the Tail. London: The Institute of Economic Affairs, 1972.
Smith, Adam.An Inquiry into the Nature and Causes of the Wealth of Nations. Edited by Edwin Cannan. New York: Modern Library, 1937.
Sowell, Thomas. Classical Economics Reconsidered. Princeton: Princeton University Press, 1974.
Sraffa, Piero. “Dr. Hayek on Money and Capital.” Economic Journal 42 (March 1932):42–53.
Stigler, George J. Production and Distribution Theories. New York: Macmillan Co., 1941.
Stigler, George J. The Theory of Price. 3d ed. New York: Macmillan Co., 1966.
Stigler, George J. The Organization of Industry. Homewood, Ill.: Richard D. Irwin, 1968.
Stigler, George J., and Boulding, Kenneth E., eds. Readings in Price Theory. Homewood, Ill.: Richard D. Irwin, 1952.
Streissler, Erich, et al., eds. Roads to Freedom. New York: Augustus M. Kelley, 1969.
Tarshis, Lorie. “Changes in Real and Money Wages.” Economic Journal 49 (March 1939):150–54.
Thompson, Earl. “The Theory of Money and Income Consistent with Orthodox Value Theory.” Los Angeles: Mimeographed, 1972.
Thompson, James H. “Mill's Fourth Fundamental Proposition: A Paradox Revisited.” History of Political Economy 7 (Summer 1975):174–92.
Thorn, Richard S., ed. Monetary Theory and Policy. New York: Random House, 1966.
Thornton, Henry.An Inquiry into the Nature and Effects of the Paper Credit of Great Britain. Edited by F. A. Hayek. London: George Allen & Unwin, 1939.
Tobin, James. “Friedman's Theoretical Framework.” Journal of Political Economy 80 (September/October 1972):852–63.
Tsiang, Sho-Chien. The Variations of Real Wages and Profit Margins in Relation to the Trade Cycle. London: Sir Isaac Pitman & Sons, 1947.
Tsiang, Sho-Chien. “Rehabilitation of Time Dimension of Investment in Macrodynamic Analysis.” Economica, n.s. 16 (1949):204–17.
- Walras, Léon.Elements of Pure Economics. Translated by William Jaffé. New York: Augustus M. Kelley, 1969.
- Wicksell, Knut. Lectures on Political Economy. 2 Vols. Edited by Lionel Robbins. London: George Routledge & Sons, 1935.
- Wicksell, Knut. Value, Capital, and Rent. Translated by S. H. Frowein. London: George Allen & Unwin, 1954.
- Wilson, Tom. “Capital Theory and the Trade Cycle.” Review of Economic Studies 7 (June 1940):169–79.
- Yeager, Leland. “The Keynesian Diversion.” Western Economic Journal 11 (June 1973):150–63.
- Yohe, William P., and Karnosky, Denis S. “Interest Rates and Price Level Changes, 1952–69.”Federal Reserve Bank of St. Louis Review 51 (December 1969):18–38.
The Studies in Economic Theory Series
Capital, Interest, and Rent: Essays in the Theory of Distribution by Frank A. Fetter,
edited with an introduction by Murray N. Rothbard.
ISBN: 0684–3 (cloth); 0685–1 (paper)
The Economic Point of View by Israel M. Kirzner
ISBN: 0656–8 (cloth); 0657–6 (paper)
America’s Great Depression by Murray Rothbard
ISBN: 0634–7 (cloth); 0647–9 (paper)
The Economics of Ludwig von Mises: Toward a Critical Reappraisal edited with an
introduction by Laurence S. Moss.
ISBN: 0650–9 (cloth); 0651–7 (paper)
The Foundations of Modern Austrian Economics edited with an introduction by
Edwin G. Dolan
ISBN: 0653–3 (cloth); 0647–9 (paper)
Capital, Expectations and the Market Process: Essays on the Theory of the Market
Economy by Ludwig M. Lachmann, edited by Walter E. Grinder
ISBN: 0684–3 (cloth); 0685–1 (paper)
If you are unable to obtain these books from your local bookseller, they may be
ordered direct from the publisher.
Sheed Andrews and McMeel, Inc.
6700 Squibb Road
Mission, Kansas 66202
Professor Gerald Patrick O’Driscoll, Jr, was born in 1947 and was graduated from Fordham University summa cum laude in 1969. He was awarded an M.A. in 1971 and a Ph.D. in economics in 1974 from the University of California at Los Angeles. His several areas of specialization include monetary theory, capital theory, law and economics, and the history of economic thought. His article “The American Express Case: Public Good or Monopoly?” appeared in thejournal of Law and Economics (1976). Recently his statement of “The Ricardian Nonequivalence Theorem” appeared in thejournal of Political Economy (1977), and his article on “The Specialization Gap and the Ricardo Effect: Comment on Ferguson” was published in History of Political Economy (1975). He is a frequent contributor to symposium volumes; an essay on stagflation coauthored with Sudha Shenoy was published Foundations of Modern Austrian Economics, one of the volumes in “Studies in Economic Theory.”
Currently O’Driscoll is editing a volume of essays on Adam Smith’s Wealth of Nations to be published by the Iowa State University Press in 1978. At present he is serving as Assistant Professor of Economics at Iowa State University. He formerly taught at UCLA and at the University of California at Santa Barbara.
[1.]Sir John Hicks, “The Hayek Story,” Critical Essays in Monetary Theory (Oxford: Oxford University Press, The Clarendon Press, 1967), p. 203. (Hereafter, Critical Essays.)
[2.]Compare Thomas S. Kuhn, The Structure of Scientific Revolution (Chicago: University of Chicago Press, 1963); see also Axel Leijonhufvud, On Keynesian Economics and the Economics of Keynes (New York: Oxford University Press, 1968), pp. 5–6. (Hereafter, Keynesian Economics.)
[3.]On Keynes—versus—the—classics debate, see, for example, W. H. Hutt, Keynesianism: Retrospect and Prospect (Chicago: Henry Regnery Co., 1963); Robert Lekachman, The Age of Keynes (New York: Random House, 1967); Hicks, Critical Essays; J. Ronnie Davis, The New Economics and the Old Economists (Ames, Iowa: Iowa State University Press, 1971) (hereafter, The New Economics). On Keynes and the Keynesians, Axel Leijonhufvud, Keynesian Economics; Hershel I. Grossman, “Was Keynes a ‘Keynesian’?” Journal of Economic Literature 10 (March 1972): 26–30; and G. L. S. Shackle, “Keynes and Today's Establishment in Economic Theory: A View,” Journal of Economic Literature 11 (June 1973): 516–19.
[4.]This shift occurred once economists were confident that they understood Keynes's message.
[5.]See Davis, The New Economics, passim. See also idem, “Henry Simons, the Radical: Some Documentary Evidence,” History of Political Economy 1 (Fall 1969): 388–94. Also relevant is the discussion in Leijonhufvud, Keynesian Economics, pp. 31–35.
[6.]Leijonhufvud, Keynesian Economics, pp. 24ff; 37–38; and passim. Yeager argued that Keynes cannot be easily credited with what Leijonhufvud claimed for him (cf. Leland Yeager, “The Keynesian Diversion,” Western Economic Journal 11 [June 1973]: 150–63).
[7.]Hayek to Milton Friedman, commenting on the latter's Henry Simons Lecture, wrote: “I believe you are wrong in suggesting the common element in the doctrine of Simons and Keynes was the influence of the Great Depression. We all held similar ideas in the 1920's. They had been more fully elaborated by R. G. Hawtrey who was all the time talking about the ‘inherent instability of credit,’ but he was by no means the only one.... It seems to me that all the elements of the theories which were applied to the Great Depression had been developed during the great enthusiasm for ‘business cycle theory’ which preceded it” (Milton Friedman, The Optimum Quantity of Money [Chicago: University of Chicago Press, 1969] p. 88n).
Not onlywas Hayek an active participant in these debates, but his consummate skill as a doctrine—historian and interpreter of economic theories is above dispute. For a compliment by a contemporary historian of the institutionalist school, whose section on Hayek can otherwise only be described as a series of misinterpretations and one-sided attacks, see Ben B. Seligman, Main Currents in Modern Economics, 3d ed. (New York: Free Press of Glencoe, 1963), pp. 342–43.
[8.]See Leijonhufvud for discussions of the continuity of Keynes's thought, for instance, the section on the relationship between the Treatise and the General Theory in Leijonhufvud, Keynesian Economics, pp. 15–31.
[9.]Erich Streissler et al., eds., Roads to Freedom (New York: Augustus M. Kelley, 1969); but see Ludwig M. Lachmann, “Methodological Individualism and the Market Economy,” ibid., pp. 89–103.
[10.]G. L. S. Shackle, The Years of High Theory (Cambridge: Cambridge University Press, 1967), pp. 4–5. “Money is the refuge from specialized commitment, the postponer of the need to take far—reaching decisions.” Yet in orthodox theory, money was but a “veil” (ibid., p. 6).
[11.]“Their ‘common denominator’...has with time become uninteresting and an obstacle to clear thought. The common denominator goes under the label of the ‘Marginalist Revolution’—portrayed as the simultaneous discovery of the first derivative of practically everything (followed, after decades of hard ‘neoclassical’ work, in due course by the discovery of the second derivative of absolutely everything). This is a conception of the work of the ‘neoclassical’ giants that irreparably trivializes their contributions in the eyes of a calculus—trained student generation” (Axel Leijonhufvud, “The Varieties of Price Theory: What Microfoundations for Macrotheory?” U.C.L.A. Discussion Paper no. 44 [Los Angeles: mimeographed 1974], 3); abbreviated, “Varieties of Price Theory.” See also William Jaffé, “Menger, Jevons, and Walras De—Homogenized,” Economic Inquiry 14 (December 1976): 511–24.
[12.]As an example, the paper by Leijonhufvud (see note 11), an outgrowth of his work on the microfoundations of macrotheory, demonstrated that there is “more than one ‘variety of price theory’.” This insight indicates why economists have been remiss in providing needed microfoundations for macrotheory and why they have often found Keynes's own efforts in this regard confusing.
Leijonhufvud's “grand conclusion” lends support to my own argument: “Let us be done with the term ‘neoclassical theory’” (Leijonhufvud, “Varieties of Price Theory,” pp. 2, 47).
Mark Blaug noted that the so-called marginal revolution was composed of three distinct revolutions—“the marginal utility revolution in England and America, the subjectivist revolution in Austria, and the general equilibrium revolution in Switzerland and Italy” (“Was There a Marginal Revolution?” in The Marginal Revolution in Economics, ed. R. D. Collison Black, A. W. Coats, and Craufurd D. W. Goodwin [Durham: Duke University Press, 1973], p. 14).
[13.]Knut Wicksell, “The New Edition of Menger's Grundsätze,” in Selected Papers on Economic Theory, ed. Erik Lindahl (London: George Allen & Unwin, 1958), p. 193.
[14.]It is true that Carl Menger and Eugen von Böhm—Bawerk were read to a limited extent in the United States. Jacob Viner for one was familiar with the general Austrian approach (“Cost Curves and Supply Curves,” in Readings in Price Theory, ed. George J. Stigler and Kenneth Boulding [Homewood, Ill.: Richard D. Irwin, 1952], pp. 198–226, esp. p. 200). Developments in the United States were less important at this time. The Austrians remained largely unknown in Great Britain, and to a great extent, despite the translation of Böhm—Bawerk's work and the best efforts of men like Viner, Irving Fisher, and J. B. Clark, in the United States as well. It must be remembered that the locus classicus of the Austrian school, Menger's Grundsätze, was not translated until 1950 (Carl Menger, Principles of Economics, trans. and ed. James Dingwall and Bert F. Hoselitz [Glencoe, Ill.: The Free Press, 1950]).
Credit belongs to Lord Robbins for breaking down British intellectual insularity in the 1930s and bringing Continental developments to the attention of British economists. Hayek's invitation to lecture at the London School was a by—product of these efforts.
[15.]Hicks discussed Austrian capital theory in Capital and Time (Oxford: Oxford University Press, Clarendon Press, 1973). On Menger, see John R. Hicks, Theory of Economic History (New York: Oxford University Press, 1969), p. 63; see also Boris P. Pesek and Thomas R. Saving, Money, Wealth, and Economic Theory (New York: Macmillan Co., 1967), pp. 47–48, for an appreciation that includes Ludwig von Mises.
[16.]James Buchanan, Cost and Choice (Chicago: Markham Publishing Co., 1969).
[17.]Ironically, the latter—day Austrians (that is, Ludwig von Mises and those who attended his seminar at the University of Vienna, including Hayek, Fritz Machlup, and Oskar Morgenstern among the younger generation) saw themselves as members of the same school in a geographical sense only. Otherwise, they considered themselves orthodox economists and applauded the demise of the Austrian school as a distinct intellectual entity. Clearly I do not accept the view that they then held; moreover, I think the course of history argues against their view.
[18.]On the subjective nature of economics, see Hayek, The Counter-Revolution of Science (New York: Free Press of Glencoe, 1955), pp. 25–35 and passim. See also Ludwig M. Lachmann, “Methodological Individualism and the Market Economy,” in Roads to Freedom, ed. Streissler et al., pp. 91–94.
[19.]Robert V. Eagly, The Structure of Classical Economic Theory (New York: Oxford University Press, 1974), pp. 126–38. Menger noted that: “The idea of causality...is inseparable from the idea of time. A process of change involves a beginning and a becoming, and these are only conceivable as processes in time. Hence it is certain that we can never fully understand the causal interconnections of the various occurrences in a process, or the process itself, unless we view it in time and apply the measure of time to it. Thus...time is an essential feature of our observations” (Principles of Economics p. 67). He concluded this section by discussing the significance of uncertainty in the process of man producing in time. In Menger the clash with the static/general equilibrium approach of Léon Walras is unequivocal. Erich Streissler argued that “Menger's Grundsätze was an attempt to sketch a theory of economic development” (“To What Extent Was the Austrian School Marginalist?” in Marginal Revolution, ed. Black et al., p. 164).
[20.]George J. Stigler, Production and Distribution Theories (New York: Macmillan Co., 1941), p. 181. For a strident attack on Stigler's position, see Murray N. Rothbard, Man, Economy, and State, 2 vols. (Princeton: D. Van Nostrand Co., 1962), 1: 279, 451n.
[21.]Lachmann, “Methodological Individualism,” pp. 89–91.
[22.]Gunnar Myrdal, Monetary Equilibrium (London: William Hodge & Co., 1939).
[23.]Shackle, The Years of High Theory, pp. 94–128. Shackle subsequently described Myrdal's achievement as providing a “language” that renders Keynes's fundamental equations (in the Treatise) intelligible (“The 1974 Nobel Prize for Economics,” Science 186 [Nov. 15, 1974]: 622).
[24.]An incorrect inference should not be drawn from the fact that Hayek edited a volume in which Myrdal's now—famous essay appeared. Hayek, wanting to make available in German those essays “which had not been available in one of the generally understood languages,” appealed to Lindahl. Lindahl was unable to supply Hayek with a new work, and instead had his student Myrdal submit an essay. In no sense then was Hayek influenced by Myrdal. And work that Hayek wrote subsequently can be understood, it will be argued, entirely in terms of his own earlier development. Hayek himself told me of the way in which Myrdal's piece came to be included in the volume in question; the information was conveyed in a letter dated 25 August 1974.
[25.]Friedrich A. Hayek, “Reflections on the Pure Theory of Money of Mr. J. M. Keynes,” part 1, Economica 11 (August 1931): 277–80; J. M. Keynes, “A Reply to Dr. Hayek,” ibid., 11 (November 1931): 394–95; Friedrich A. Hayek, “A Rejoinder,” ibid 11 (November 1931): 401–2; and idem, “Reflections,” part 2, ibid., 12 (February 1932): 25–26.
[26.]Many of the essays on the price system were reprinted in Individualism and Economic Order. A series of articles in Economica in the 1940s on his philosophy of the social sciences are incorporated into Counter-Revolution of Science. Generally overlooked, these articles are basic to Hayek's approach to economics. The Socialist calculation debate concerned the possibility of allocating resources by central authority, i.e., without the aid of a price system.
[27.]For the chronology of Hayek's work, see pp. 10–11.
[28.]Schumpeter spoke of a man's “vision.” He cited Keynes as the major example of the view that a man's work evolves from a basic insight (Joseph A. Schumpeter, History of Economic Analysis [New York: Oxford University Press, 1954], pp. 41–43).
[29.]The papers are “Economics and Knowledge” (1936), “The Use of Knowledge in Society” (1945), and “The Meaning of Competition” (1946); all are reprinted in Individualism and Economic Order.
[30.]“Profits, Interest, and Investment,” in Profits, Interest, and Investment (New York: Augustus M. Kelley, 1970). Reprint of 1939 edition.
[31.]“Twenty years ago I lost interest in monetary matters because of my disillusionment with Bretton Woods. I was wrong in my prediction that the arrangement would soon disappear” (Sudha R. Shenoy, ed., A Tiger by the Tail [London: The Institute of Economic Affairs, 1972], p. 112).
[1.]See Imre Lakatos, “Methodology of Scientific Research Programmes,” inCriticism and the Growth of Knowledge, ed. Imre Lakatos and Alan Musgrave (Cambridge: Cambridge University Press, 1970), pp. 174–75.
[2.]The term “Walrasianly” has been appropriated from J. R. Hicks, “A Neo—Austrian Growth Theory,” The Economic Journal 89(June 1970): 257–58.
[3.]“Modern attempts to erect a general theory of money and prices on Walrasian foundations have produced a model of economic phenomena that is surprisingly reminiscent of the classical theory of a barter economy” (R. W. Clower, “Foundations of Monetary Theory,” in Monetary Theory, ed. idem [Baltimore: Penguin Books, 1970], p.202). Clower specifically referred to the works of Oskar Lange, Don Patinkin, J. R. Hicks, and Paul Samuelson. I have adopted “neo—Walrasian” to avoid doctrine-history squabbles.
[4.]Axel Leijonhufvud, “Effective Demand Failures,”Swedish Journal of Economics 75 (1973):28. According to Leijonhufvud, the question has not been debatedexplicitly in this form. What he calls “the coordination problem” has always been the real issue.
[5.]Leijonhufvud, “Effective Demand Failures,” pp. 37–41.
[6.]The problem considered by Leijonhufvud, whether the form of a model differs according to the values for the variables, is not considered at this point (Leijonhufvud, “Effective Demand Failures,” p. 27).
[7.]See Shackle's remark on money in note 10 of the first chapter. Also see Murray N. Rothbard, “The Austrian Theory of Money,” in The Foundations of Modern Austrian Economics, ed. Edwin G. Dolan (Kansas City: Sheed & Ward, 1976) pp. 171–72. Earl Thompson has suggested that while there may be perfect information in equilibrium in a model, there may not be perfect information in disequilibrium. His basic approach seems consistent with my argument (Earl Thompson, “The Theory of Money and Income Consistent with Orthodox Value Theory” [Los Angeles: mimeographed, 1972], p. 6).
[8.]Leijonhufvud, “Effective Demand Failures,” p. 30.
[9.]Paul A. Samuelson, Economics, 6th ed. (New York: McGraw-Hill, 1964), pp. 360–61, 590.
[10.]“Despite the several alternative ways that we have developed to make the gulf between microtheory and macrotheory seem plausible to new generations of students, the micro—macro distinction remains basically that between models with ‘perfectly coordinated’ solutions and models where one or more markets reach such solutions only by chance. Both sets of exercises are referred to as ‘theories,’ but there could be no real—world economy for which both are true at once” (italics added) (Leijonhufvud, “Effective Demand Failures,” 30–31). The addition of inconsistent hypotheses to an existing theoretical edifice does not necessarily involve methodological error. Lakatos argued that progress in the “hard” sciences has resulted from this procedure (Criticism, pp. 141–43). At some juncture, however, one “programme” has to go, or theoretical progress is halted.
[11.]Robert Eisner, “On Growth Models and the Neo—Classical Resurgence,” Economic Journal 68 (December 1958): 707.
[12.]R. W. Clower, “The Keynesian Counter-Revolution: A Theoretical Appraisal,” in Monetary Theory, ed. idem, pp. 270–97. Clower dates the counterrevolution to Hicks's article (p. 270). Eisner, on the other hand, dates the “retreat” from the fifties (“On Growth Models,” p. 707).
[13.]On the milieu at Cambridge and at the London School of Economics, see Lord Robbins, Autobiography of an Economist (London: Macmillan & Co., 1971), pp. 105–6, 132–35. According to Hayek, Robbins played an important role in many of the developments that will be discussed.
[14.]Hicks noted that the concepts for Value and Capital were nurtured by what he termed a “sort of social process” at the London School in 1930–35. (John R. Hicks, Value and Capital [London: Oxford University Press, 1939], p. vi). Robbins discussed this social process in Autobiography of an Economist, pp. 129–32. Hicks and R. G. D. Allen referred to some of these concepts in “Reconsideration of the Theory of Value,” Economica, n.s. 1 (February 1934): 52–76. There is irony in this story in that it was on Hayek's suggestion that Hicks investigated Pareto's indifference curve approach to demand theory. Hayek believed that Pareto's approach was in many ways superior to Marshall's (personal communication).
One can speculate why Hayek preferred Paretian over Marshallian demand theory. Paretian—Walrasian demand theory is more explicitly “choice—theoretic” and, thus, closer in spirit to the Austrian approach. On the distinction between Walrasian and Marshallian demand theory, see Leijonhufvud, “The Varieties of Price Theory: What Microfoundations for Macrotheory?” U.C.L.A. Discussion Paper No. 44 (Los Angeles: mimeographed, 1974).
[15.]Walras referred to his introduction of tickets (bons) as a “fiction” (Léon Walras, Elements of Pure Economics, trans. William Jaffé [New York: Augustus M. Kelley, 1969] p. 37). The classic discussion of Walras's problems with his tâtonnement process is in William Jaffé, “Walras' Theory of Tâtonnement: A Critique of Recent Interpretations,” Journal of Political Economy 75(February 1967): 1–19.
[16.]Jaffé spoke of the “quasi—anecdotal” character of Walras's narrative about the Bourse (p. 4). Walras discussed the operation of the Bourse in the Elements, pp. 83–87. Walras's “faith” in markets is evident elsewhere (p. 106). Jaffé noted, specifically with reference to the tâtonnement process, that Walras had in mind “not a replica of the infinitely complex network of the heterogeneously organized markets of the real world, but a simplification of that network idealized in the sense that it was assumed to operate as a perfectly competitive mechanism” (pp. 11–12). Jaffé also suggested that Walras sought to lend “an air of empirical relevance to his abstract mathematical model of general equilibrium” (p. 2).
Clower and Due described Marshall's concept as “a more colorful and intuitively meaningful portrait of a market economy” than Walras's (Robert W. Clower and John F. Due, Microeconomics, 6th ed. [Homewood, Ill.: Richard D. Irwin, 1972], p. 24). At this point, Clower and Due were concerned with the treatment of money in the two paradigms.
There is some resemblance between Walras's tâtonnement process and auctions. An auction bid appears to be a crie au hazard. However, in actual auctions there are reservation prices of goods, and a given auction process depends on a past history of market prices and infor mation, which usually have been arrived at by a method other than that of auctioning. Standard price theory does not allow for differences in actual market clearing prices depending on the selling methods chosen (for example, auction or “ordinary” market). Little work has been done on the relative efficiencies of various market forms. Yet in a world where transaction costs exist, the method of contracting could be very important (that is, there could be differential transactions costs in various market situations). Markets in the boom that characterized Western Europe from the eleventh century on were in the form of great fairs held several times a year in various localities, where goods of all descriptions would be bought and sold. The market form gradually evolved, however, until by the fourteenth century the fairs were unimportant except as clearing house mechanisms. On the role of such fairs in the medieval economy, see Henri Pirenne, Economic and Social History of Medieval Europe (New York: Harcourt, Brace & World, Harvest Books, 1933), passim. Pirenne attributed their decline to the guilds; the fairs inhibited the cartellization of crafts (pp. 209–10).
Steven N. S. Cheung has done a major part of the work on the efficiency of different market forms (“Transactions Cost, Risk Aversion, and the Choice of Contractual Arrangements,” Journal of Law and Economics 12 [April 1969]: 23–42; idem, “The Structure of a Contract and the Theory of a Non-exclusive Resource,” Journal of Law and Economics 13 [April 1970]: 49–70).
George J. Stigler presents the orthodox case against the form of market organization affecting equilibrium. Stigler ignores any transaction cost problem (The Theory of Price, 3d ed. [New York: Macmillan Co., 1966] pp. 94–95).
[17.]17. Here one should remember that Hayek is the author of The Pure Theory of Capital (Chicago: University of Chicago Press, 1941).
[18.]On Walras's precise task, see Elements, pp. 170, 241–42. Jaffé's assessment is that Walras failed in his objective to prove that the market's operation will result in the vector of prices and quantities being identical with the solution of his simultaneous equations.
[19.]Friedrich A. Hayek, “The Use of Knowledge in Society,” in Individualism and Economic Order (Chicago: University of Chicago Press, 1948), pp. 89–91. (Hereafter, Individualism.)
[20.]Ibid., p. 35.
[21.]Hayek, “Socialist Calculation III: The Competitive Solution,” Individualism, p. 188.
[22.]Hayek, “The Use of Knowledge in Society,” p. 91. Walras seemed aware of the point Hayek made here (Elements, p. 106). See also J. M. Keynes, The General Theory of Employment, Interest, and Money (New York: Harcourt, Brace & World, 1936), pp. 272–79.
[23.]See, for example, K. J. Arrow, “Toward a Theory of Price Adjustment,” in The Allocation of Economic Resources, ed. Moses Abramovitz (Stanford: Stanford University Press, 1959), pp. 41–51; hereafter, “Toward a Theory.” See also Israel M. Kirzner, Competition and Entrepreneurship (Chicago: University of Chicago Press, 1973); hereafter: Competition. Kirzner's work has an explicitly Hayekian (Austrian) framework; Arrow's has a neo—Walrasian equilibrium framework.
[24.]Hayek, “The Meaning of Competition,” Individualism, p. 95. See also George J. Stigler, The Organization of Industry (Homewood, Ill.: Richard D. Irwin, 1968), pp. 5–16.
[25.]Hayek, “The Meaning of Competition,” p. 95.
[26.]Lionel Robbins, An Essay on the Nature and Significance of Economic Science, 2d ed. (London: Macmillan & Co., 1935). “The book [i.e., Robbins's] has been so influential that its once challenging thesis will seem almost platitudinous to today's students. For that very reason, it should be recognized as an important part of the story of how choice-theory became the predominant—indeed, all but exclusive—paradigm of modern theoretical economics” (Leijonhufvud, “Varieties of Price Theory”, 53n). Hayek convinced me that Robbins, in turn, was heavily influenced by the Austrian Richard von Strigl. Thus the earlier Austrians in part contributed to the development of a theoretical edifice they later came to reject.
[27.]The phrase “Robbinsian maximizing behavior” is Kirzner's (Competition, pp. 32–37).
[28.]Ibid., pp. 32–33.
[29.]Hayek, “Economics and Knowledge,” Individualism, p. 39. Modern work on the technical issues involved in alternative assumptions about the dispersal of knowledge among economic actors, although accomplished within a neo—Walrasian framework, is of interest to the theorist. See Leonid Hurwicz, “The Design of Mechanisms for Resource Allocation,” American Economic Review 63 (May 1973): 1–30.
[30.]Hayek, “The Use of Knowledge in Society,” p. 77.
[31.]Clower and Due, Microeconomics, p. 52 (emphasis in original).
[32.]This section is based substantially on Hayek, “Economics and Knowledge,” pp. 33–56, esp. pp. 35–45.
[33.]Ibid., p. 42.
[34.]It might be likely if the third assumption were true and we were dealing with an essentially stationary world. This possibility led Hayek to wonder whether the third assumption might imply the first.
[35.]Hayek, “Economics and Knowledge.” pp. 38–39.
[36.]Ibid., p. 42.
[37.]Ibid., p. 46.
[38.]Among his writings on cycles and monetary theory the one entitled “Price Expectations, Monetary Disturbances, and Malinvestments” most clearly makes use of this conception, in Profits, Interest, and Investment (New York: Augustus M. Kelley, 1970), pp. 135–56. Significantly, that essay antedates the three aforementioned essays on the price system.
[39.]Hayek, “The Use of Knowledge in Society,” p. 82.
[40.]This could be overdrawn, of course, but there are differences. Stigler's view is essentially different from Hayek's”: “These terms [‘stable’ and ‘equilibrium’] were obviously borrowed from physics—has the economist made sure that they really make sense in economics? The answer is, let us hope, yes. The stability of equilibrium is indeed the normal state of affairs in a tolerably stable world” (Theory of Price, p. 93). For further elaborations on the differences between the Austrian and the Schumpeterian conceptions of the entrepreneur, see Kirzner, Competition; Rothbard, Man, Economy, and State, 2 vols. (Princeton: D. Van Nostrand Co., 1962), 2: 493–94.
[41.]Hayek, “The Meaning of Competition,” p. 94.
[42.]Ibid., p. 96.
[43.]Much of Hayek's work on resource allocation was developed in the context of the Socialist calculation debates (Friedrich A. Hayek, ed., Collectivist Economic Planning [London: George Routledge & Sons, 1935]).
[44.]“Profits are a permanent income flowing from ever—changing sources, like the profits of a restaurant in which a different set of customers chooses a different set of dishes from the menu card every day” (Ludwig M. Lachmann, Macro-economic Thinking and the Market Economy, Hobart Paper No. 56 [London: Institute of Economic Affairs, 1973], p. 31). Buchanan most ably demonstrated that costs are an unrealized (and hence immeasurable) alternative (Cost and Choice [Chicago: Markham Publishing Co., 1969], pp. vii-x; and 38–50).
[45.]“To make a monopolist charge the price that would rule under competition, or a price that is equal to the necessary cost, is impossible, bacause the competitive or necessary cost cannot be known unless there is competition” (Hayek, “Socialist Calculation II:The State of the Debate (1935),” Individualism, p. 170).
[46.]One assumes that practitioners are not unaware of the theoretical problem and have a gestalt conception of markets significantly different from Hayek's. For sources on concentration and rates of return, see John S. McGee, In Defense of Industrial Concentration (New York: Praeger Publishers, 1971), p. 151n. For a criticism of the approach of many of these statistical studies, see Yale M. Brozen, “The Antitrust Task Force Deconcentration Recommendation,” Journal of Law and Economics 13(October 1970): 279–92.
[47.]Arrow pointed out that market adjustment behavior is often confused with long—run monopolistic power, a confusion that is elementary but widespread (“Toward a Theory,” pp. 45–47).
[48.]Hayek, “Economics and Knowledge,” pp. 35–37.
[49.]“It is only by this assertion that such a tendency [toward equilibrium] exists that economics ceases to be an exercise in pure logic and becomes an empirical science” (ibid., p. 44).
[50.]Ibid., p. 50.
[51.]Ibid., pp. 50–51.
[52.]Hayek, “The Use of Knowledge in Society,” p. 86.
[53.]Ibid., p. 87. His gestalt conception is evident in this passage; parameters change so often that, before the transactor can execute his plans, he is compelled to revise them.
[54.]Hirshleifer, while acknowledging the “pioneering” quality of “The Use of Knowledge in Society,” surely misinterprets the central message. The article is about the use and production of information (“Where Are We Now in the Theory of Information?” American Economic Review 63 [May 1973]: 34).
[55.]Hayek's mentor, Mises, was even more explicit on this point: “Action is always speculation.... In any real and living economy every actor is always an entrepreneur and speculator” (Ludwig von Mises, Human Action [New Haven: Yale University Press, 1949], p. 253).
[56.]The more finely developed the market for a commodity, the more accurately prices reflect anticipations and the better founded are anticipations. But the absence of an explicity time—dated market for a commodity is one with the absence of opera in central Iowa: the division of labor is limited by the scarcity of means.
[57.]Hayek, “Economics and Knowledge,” p. 34.
[58.]Austrian economists have been viewed as unremitting critics of the use of mathematics in economic theory. What in fact Hayek objected to about this tool in analyzing allocation questions was the assumption that a transactor's knowledge is necessarily consistent with the facts, and with each other's plans (Hayek, “The Use of Knowledge in Society,” pp. 89–91).
[1.]Harry Johnson, “Monetary Theory and Policy,” in Monetary Theory and Policy, ed. Richard S. Thorn (New York: Random House, 1969), p. 5 (hereafter, “Monetary Theory”).
[2.]Ibid., p. 5.
[3.]A strange agglomeration of questions, ancillary to general equilibrium theory, are taken up in monetary theory. Although the term—structure of interest rates is one of these, the determination of “the” interest rate is not. This division has proved less than salutory at times, see Leijonhufvud, On Keynesian Economics and the Economics of Keynes (New York: Oxford University Press, 1968), pp. 294–95.
[4.]For a lively discussion of these controversies, see Johnson, “Monetary Theory,” pp. 7–13. After the Johnson survey (1962), a great deal of interest developed in the argument developed by Boris P. Pesek and Thomas R. Saving in Money, Wealth, and Economic Theory, which may be viewed as a continuation of the Patinkin debate (New York: The Macmillan Co., 1967 [hereafter, Money]).
[5.]Milton Friedman, “The Quantity Theory of Money—A Restatement,” in Studies in the Quantity Theory of Money, ed. idem (Chicago: University of Chicago Press, 1956), pp. 3–21 (hereafter, “Quantity Theory”). On the importance of this paper, see Johnson, “Monetary Theory,” pp. 18–19.
[6.]It is of course largely because of Friedman that there was a revival of interest in the field, however narrowly defined.
[7.]Friedman, “Quantity Theory,” p. 4.
[8.]Ibid., p. 15.
[9.]Ibid., p. 15.
[10.]Milton Friedman, “A Theoretical Framework for Monetary Analysis,” Journal of Political Economy 78 (March/April 1970): 193–238 (hereafter, “Theoretical Framework”); and idem, “A Monetary Theory of Nominal Income,” Journal of Political Economy 79 (March/April 1971): 323–37.
[11.]“For monetary theory, the key question is the process of adjustment to a discrepancy between the nominal quantity of money demanded and the nominal quantity supplied” (Friedman, “Theoretical Framework,” p. 225).
The assumption that monetary theory is coextensive with the quantity theory is implicit, for the adjustment to an excess demand for money is the crux of the quantity theory.
[12.]Tobin juxtaposed “monetarists and neo—Keynesians” in a critique of Friedman. Tobin characterized himself as an “eclectic non—monetarist.” Non—monetarists appear reluctant to call themselves simply “monetary theorists.” “Keynesian” became almost synonymous with non—monetary explanation of cyclical fluctuations. Tobin characterized himself as “neo—Keynesian” or “Hicksian,” apparently because he believes “that both monetary and fiscal policies affect nominal income.” He pleaded: “One thing the non—monetarists should not be called is ‘fiscalists’” (James Tobin, “Friedman's Theoretical Framework,”Journal of Political Economy 80 (September/October 1972): p. 852).
[13.]“Monetary theory turns out to be simply value theory applied to a good that has the special technical characteristic of yielding real income the level of which is directly proportional to the price per unit” (Pesek and Saving, Money, pp. 135–36).
[14.]Hicks, Critical Essays in Monetary Theory (New York: Oxford University Press, The Clarendon Press, 1967), pp. 61–82.
[15.]Knut Wicksell, Lectures on Political Economy, ed. Lionel Robbins, 2 vols. (London: George Routledge & Sons, 1935), 2:141 (hereafter, Lectures).
[16.]Ibid., pp. 143–44.
[17.]“Consequently, the amount of goods and of transactions being the same, the value of money is inversely as its quantity multiplied by what is called the rapidity of circulation” (John Stuart Mill, Principles of Political Economy, ed. William Ashley [Clifton, N. J.: Augustus M. Kelley, 1973], pp. 494, 495). This is J. S. Mill's statement of the proportionality theorem, “other things being the same.” Mill then went on to analyze what occurs when these “other things” are not the same.
[18.]Schumpeter actually said that “velocity of circulation is an institutional datum that varies slowly or not at all, but in any case is independent of prices and volume of transactions.” The term institutional datum is potentially misleading and associates the theory too much with the version propounded by one man, Irving Fisher.
[19.]Joseph A. Schumpeter, History of Economic Analysis (New York: Oxford University Press, 1954), p. 703.
[20.]David Hume, who in other respects is treated as a major figure by Schumpeter, surely belongs on the list. Hume argued that “the prices of commodities are always proportioned to the plenty of money, and a crown in Harry VII's time served the same purpose as a pound does at present” (David Hume, “On Money,” in David Hume: Writings on Economics, ed. Eugene Rotwein [Madison: University of Wisconsin Press, 1970], p. 33). Hume's version might be considered the locus classicus (in English) for the quantity theory, as defined above. But the modernity of Hume's essay is also striking; we still apparently labor under his first formulation of the effects of money on prices and output. An incipient monetarism might be inferred in his prescription against increasing the paper credit of a nation “beyond its natural proportion to labour and commodities” (Hume, p. 36).
[21.]Mill, Principles, pp. 490–93.
[22.]Ibid., p. 491
[23.]Ibid., p. 492. Mill continued: “If the whole money in circulation was doubled, prices would be doubled. If it was only increased one—fourth, prices would rise one—fourth. There would be one fourth more money, all of which would be used to purchase goods of some description.”
[24.]Ibid., p. 495.
[25.]Ibid., p. 498.
[26.]Ibid., pp. 523–41. According to Sowell, “The idea that the price level is rigidly linked to the quantity of money by a velocity of circulation which remains constant through all transitional adjustment processes cannot be found in any classical, neoclassical or modern proponent of the quantity theory of money” (Thomas Sowell, Classical Economics Reconsidered [Princeton: Princeton University Press, 1974], pp. 59–60).
[27.]Schumpeter pointed out that after Mill considered the effects of credit, “there is hardly any difference left between Mill's version of the quantity theory and the views of its opponents, contemporaneous or later” (Schumpeter, History, p. 705). The reason is that Mill did not subscribe to the quantity theory as defined by Schumpeter.
[28.]Ricardo's position is clearly stated in The High Price of Bullion, reprinted in Piero Sraffa, ed., Works of David Ricardo, vol. 3 (Cambridge: Cambridge University Press, 1951) along with a chronology of Ricardo's contributions on this question. Schumpeter remarked that “Ricardo...introduced qualifications occasionally and that, here and there, he made statements that were logically incompatible with his strict quantity theory, exactly as he did in the matters of his labour—quantity law of value. In both cases, however, he mentioned them only in order to minimize their importance.... We are...justified in attributing to him the strict quantity theory, as an approximation” (History, pp. 703–4).
[29.]Adam Smith, The Wealth of Nations, ed. Edwin Cannan (New York: Modern Library, 1965), p. 58.
[30.]According to Smith, laborers could hope to raise their wages above “the lowest which is consistent with common humanity” if the “scarcity of hands occasions a competition among masters, who bid against one another, in order to get workmen.” Smith was explicit about the reason for such increased competition: “The demand for those who live by wages, therefore, necessarily increases with the increase of the revenue and stock of every country, and cannot possibly increase without it... It is not the actual greatness of national wealth, but its continual increase, which occasions a rise in the wages of labour” (Smith, Wealth of Nations, pp. 68–69 [emphasis added]).
[31.]Sowell, Classical Economics Reconsidered, pp. 33–34; see also Frank W. Fetter, “The Relation of Economic Thought to Economic History,” American Economic Review 55 (May 1965) :138–39.
[32.]“Ricardian comparative statics and concentration on long run equilibrium assumed away many transitional monetary phenomena, especially in Ricardo's Principles—though his polemical pamphlets and correspondence dealt with such problems, even if sometimes some what grudgingly” (Sowell, Classical Economics Reconsidered, p. 53). For a cost—of—production theorist, the ultimate effects of a change in the demand for a commodity money can only be analyzed by taking into account the effects on the cost of production (Mill, Principles, pp. 499–506.) But this was too long a run even for Mill and Ricardo. Both analyzed money in terms of demand and supply. Senior remained consistent, however, and insisted on analysis in terms of the cost of production of the metal (Schumpeter, History, p. 702).
[33.]The proportionality theorem does not follow from demand-and-supply analysis without further explanation (Schumpeter, History, p. 703; Wicksell, Lectures, 2: 141–44). On the nature of Ricardo's question, see Wicksell, Lectures, 2: 175–76.
[34.]Henry Thornton, An Inquiry into the Nature and Effects of the Paper Credit of Great Britain, ed. F. A. Hayek (London: George Allen & Unwin, 1939), p. 241 (hereafter, Paper Credit).
[35.]Richard Cantillon, quoted in Hayek, Prices and Production, 2d ed. (London: Routledge & Kegan Paul, 1935), p. 1.
[36.]J. S. Mill was concerned with analyzing the effects of monetary disturbances on the purchasing power of money and not on relative prices (Principles, pp. 491–93). He treated credit as a substitute for money with similar effects. These effects alter the demand for “goods” (ibid., p. 514). See the text below on forced saving.
[37.]Ibid., p. 492.
[38.]Thornton, Paper Credit, p. 253.
[39.]See pp. 40–41 above.
[40.]J. S. Mill should probably be called a “modified Ricardian” in that he paid more attention to the mechanism by which monetary disturbances are transmitted to real activity than did Ricardo (Mill, Principles, pp. 532–41).
[41.]Schumpeter, History, p. 704n. According to Sowell, “Thornton's careful separation of short-run transitional effects from long-run equilibrium contrasts sharply with Ricardo's repeated interpretation of others' doctrines in his own comparative statics terms” (Classical Economics Reconsidered, p. 58).
[42.]See p. 38 of text.
[43.]J. S. Mill recognized the possible distribution effects of an increase in the quantity of money. But he dismissed them as unimportant in the long run. If there were distribution effects, “then until production had accommodated itself to this change in the comparative demand for different things, there would be a real alteration in values.... These effects, however, would evidently proceed, not from the mere increase of money, but from accessory circumstances attending it. We are now only called upon to consider what would be the effect of an increase of money considered by itself.” That is, he considered the long run effects (Mill, Principles, p. 492).
[44.]See note 31 above.
[45.]On the tendency of classical economists to recognize but underestimate the short-run effects of a monetary disturbance, see Sowell, Classical Economics Reconsidered, pp. 52–66.
[46.]See note 32 above.
[47.]Friedman's theoretical framework consists of an analysis of the adjustment to a monetary disturbance and not of propositions about the long-run neutrality of money. “I believe the writings of earlier quantity theorists, from Ricardo and Thornton to Keynes, were not about [the long-run neutrality of money] either” (Milton Friedman, “Comments on the Critics,” Journal of Political Economy 80 [September/October 1972]: 945). I agree with Friedman on Henry Thornton, just as I disagree with him on Ricardo. Thornton and Ricardo were engaged in entirely different endeavors.
[48.]According to Anthony Lee, department of economics, University of California at Santa Barbara, no reference to Henry Thornton can be found in any of Wicksell's works (personal communication). If so, this would confirm my hypothesis that Wicksell was not acquainted with the work of the elder Thornton. Most historians of economic thought seem to agree.
[49.]Ricardo, Works, vol. II I, p. 91; Robbins, in Wicksell's Lectures, 1: xvi-xvii.
[50.]Axel Leijonhufvud has suggested that Wicksell never had access to a superior library.
[51.]Wicksell, Lectures, 2: 190.
[52.]The marginal product of investment is Wicksell's marginal productivity of capital, or Jevons's marginal yield of capital (Wicksell, Lectures, 1: 147–57; Ralph G. Hawtrey, Capital and Employment, 2d ed. [London: Longmans, Green & Co., 1952], p. 29; and Hayek, Pure Theory of Capital, p. 189). The term marginal product with reference to capital is a misnomer; what is usually meant is the rate of increase in output attributable to an increment to capital.
[53.]Wicksell, Lectures, 2: 192–93. According to Myrdal, Wicksell incorrectly stated the condition of monetary equilibrium as a result (Myrdal, Monetary Equilibrium, pp..126–31).
[54.]Mises's neglect by American economists is even more egregious than Hayek's. Thus, Mises never benefited from his idea of assisting German refugee intellectuals in finding positions, and he never held a regular academic position in the United States, doubtless because of political discrimination. Mises's place in economics is such that it deserves consideration in a separate work. On Mises's role in Beveridge's plan to help European refugee intellectuals, see Robbins, Autobiography of an Economist (London: Macmillan & Co., 1971), pp. 143–44.
[55.]Keynes is partly responsible for this neglect in Great Britain. Keynes admitted he understood in German what he already knew, yet he wrote an essentially negative review of Mises's monetary classic, though he later endorsed Mises's basic approach. As Hayek remarked, “He had reviewed L. von Mises’ Theory of Money for the Economic Journal (just as A. C. Pigou had a little earlier reviewed Wicksell) without in any way profiting from it” (Hayek, “Personal Recollections of Keynes and the ‘Keynesian Revolution,’” in A Tiger by the Tail, ed. Shenoy, p. 101). Keynes reviewed the Mises work in Economic Journal 24 (September 1914).
[56.]Lionel Robbins's Introduction to the Theory of Money and Credit (Irvington—on—Hudson, N. Y.: Foundation for Economic Education, 1971). This edition is a reprint of the revised English edition (1952); the first English edition (1934) was based on the second German edition (1924).
[57.]Mises, Theory of Money and Credit, pp. 339–66. The truly Misesian contribution commences on p. 349. If Prices and Production, a series of four lectures running over one hundred pages, was overly concise, pity the poor reader confronted with this theory explained in fewer than twenty (albeit lengthier) pages! On the “inner value of money,” see Friedrich A. Hayek, Monetary Theory and the Trade Cycle, trans. N. Kaldor and H. M. Croome (1933; reprint ed. New York: Augustus M. Kelley, 1966), p. 117 (hereafter, Monetary Theory); see also translator's note in Theory of Money and Credit, p. 124.
[58.]Mises, Theory of Money and Credit, p. 24.
[59.]Hayek, Monetary Theory and the Trade Cycle, p. 47; and Prices and Production, 2d ed. (London: Routledge & Kegan Paul, 1935), p. 26.
[60.]The period referred to antedated The General Theory, and Keynes's own criticism of the quantity-theory tradition.
[61.]Hayek, Prices and Production, p. 4.
[62.]Ibid., p. 2.
[63.]Ibid., p. 4.
[64.]Ibid., p. 7. By “prices” Hayek means relative prices. Footnote reference to Hawtrey omitted.
[65.]See p. 42 above.
[66.]Irving Fisher “The Business Cycle Largely a ‘Dance of the Dollar,’” Quarterly Publication of the American Statistical Association, December, 1923; cited in Hayek, Monetary Theory and the Trade Cycle, p. 236n.
[67.]Hayek, Prices and Production, p. 3. The “elementary propositions” would be the ceteris paribus, long-run connection between money and prices.
[68.]See p. 42 above.
[69.]See footnote 91 for the reference to Malthus's review of Ricardo's High Price of Bullion.
[70.]Hayek, Prices and Production, p. 4.
[71.]J. S. Mill, Principles, p. 488. “In considering Value, we were only concerned with causes which acted upon particular commodities apart from the rest. Causes which affect all commodities alike do not act upon values. But in considering the relation between goods and money, it is with causes that operate upon all goods whatever that we are specially concerned. We are comparing goods of all sorts on one side, with money on the other side, as things to be exchanged against each other” (ibid., p. 491).
[72.]Keynes, General Theory, p. 292.
[73.]Hayek, “Reflections on the Pure Theory of Money of Mr. J. M. Keynes,” part 1, Economica 11 (August 1931): 270. Hayek was here reviewing The Treatise.
[74.]See the text below pp. 95–96, for a discussion of whether Hayek's was a monetary explanation.
[75.]Hayek, Monetary Theory, p. 105.
[76.]Ibid., pp. 104–6; this work was written for a German audience.
[77.]See Hayek, Prices and Production, pp. 28–29.
[78.]Hayek, “Personal Recollections of Keynes and the ‘Keynesian Revolution,’” p. 102.
[79.]Ibid., p. 106.
[80.]Friedrich A. Hayek, “Three Elucidations of the Ricardo Effect,” Journal of Political Economy 77 (March/April 1969): 279–81.
[81.]See Hayek, “Economics and Knowledge,” in Individualism and Economic Order (Chicago: University of Chicago Press, 1948), p. 45.
[82.]Wicksell, Lectures, 2: 159 (emphasis in original).
[83.]Keynes, General Theory, p. 293 (emphasis in original).
[84.]Myrdal, Monetary Equilibrium, p. 45.
[85.]Shackle, Years of High Theory (Cambridge: Cambridge University Press, 1967), p. 6.
[86.]Piero Sraffa, “Dr. Hayek on Money and Capital,” Economic Journal 42 (March 1932): 43.
[87.]Hayek, “Money and Capital: A Reply,” Economic Journal 42 (June 1932): 238.
[88.]“[Keynes] was little concerned with relative prices” (Friedrich A. Lutz, “On Neutral Money,” in Roads to Freedom, eds. Erich Streissler, et al. [New York: Augustus M. Kelley, 1969], p. 112).
[89.]Ibid., pp. 112–14; Don Patinkin, Money, Interest, and Prices, 2d ed. (New York: Harper & Row, 1965), pp. 175–76.
[90.]The details of his analysis of the changes in real economic activity are considered in chapters 4 and 5 of this study.
[91.]Cited by Hayek, Prices and Production, pp. 19–20.
[92.]Hayek, “A Note on the Development of the Doctrine of ‘Forced Saving’,” Profits, Interest, and Investment (New York: Augustus M. Kelley, 1970), p. 190.
[93.]Which consumers would be expected to engage in the forced saving will be discussed in chapter 5.
[94.]Hayek, Prices and Production, pp. 87–88. Thus, forced saving is not a sum of money that consumers are forced to save. On this, see W. E. Kuhn, The Evolution of Economic Thought, 2d ed. (Cincinnati: South—Western Publishing Co., 1970), p. 386.
[95.]Strictly speaking, Hayek designated “forced saving” as the difference between consumption before the monetary disturbance and that after, or the difference between equilibrium saving and the higher level of investment, I1 (Hayek, Prices and Production, p. 57.) But in keeping with contemporary analysis, which focuses on planned magnitudes at current prices, I have defined forced saving somewhat differently in the text. The S function represents the supply of voluntary (i.e., planned) saving; it is not the standard “supply of loanable funds” curve. A chief purpose of this analysis is to distinguish between loanable funds composed of voluntary savings and those that are not.
[96.]“The case most frequently to be encountered in practice [is that] of an increase of money in the form of credits granted to producers” (Hayek, Prices and Production, p. 54).
[97.]Hayek, Monetary Theory, pp. 44–45.
[98.]See Lutz, “On Neutral Money,” pp. 105–9. The reader may detect a similarity between my analysis of the problem and that of Lutz. While I had considered these issues before reading Lutz and had arrived at a similar—though not identical—position, I was influenced by his analysis.
[99.]Patinkin, Money, Interest, and Prices, p. 75.
[100.]It is possible to conceive of money in this context as the numéraire of Walras's system: “Money in this latter sense is introduced, after the relative prices have been determined, in the shape of a money equation which sets the general price level while leaving relative prices unaffected” (Lutz, “On Neutral Money,” p. 107). But this concept of money would do violence to the work of Wicksell, Hayek, and others.
[101.]Ibid., p. 112.
[102.]Ibid., p. 116.
[103.]Keynes, General Theory, pp. 39, 59–60, 76, 79–80, 176, 183, 192–93, 214, 328–29.
[104.]Ibid., p. 80. Keynes continued: “This definition would make good sense, but a sense in which a forced excess of saving would be a very rare and a very unstable phenomenon, and a forced deficiency of saving the usual state of affairs” (General Theory, p. 80). It is the first two propositions (that is, that forced saving is “rare” and that it is “unstable”) that are at issue. The third proposition is one of which I can make no sense, unless Keynes wished to maintain that we suffer chronic unemployment. Such cryptic remarks led Hayek to conclude that Keynes believed that unemployment was chronic and to criticize Keynes's “economics of abundance” (Pure Theory of Capital, pp. 373–75).
[105.]Keynes here referred to Hayek's article “A Note on the Development of the Doctrine of ‘Forced Saving’,” reprinted in Profits, Interest, and Investment, pp. 183–97.
[106.]Keynes, General Theory, pp. 80–81. See the caveat in note 95 above. Keynes's treatment of forced saving is an instance of how his solecistic use of “classical” led him into error. He argued that “the usual classical assumption [is] that there is always full employment” (General Theory, p. 191). What is true is that Ricardians were virtually always concerned with the long run, in which ex hypothesi there is full employment. In Keynes's terminology, forced saving theorists were “classical.” Hence, the reasoning goes, they thought there was always full employment, etc. Keynes cited no reference on forced saving, except Hayek's note on the history of the concept. It is doubtful whether Keynes could have found any support for his argument.
[107.]Hayek, “Three Elucidations,” pp. 279–80.
Hayek, “Three Elucidations of the Ricardo Effect,” Journal of Political Economy 77 (March/April, 1969): 282. Lord Robbins gave a brief account of the favorable impact of these lectures (Autobiography ofan Economist [London: Macmillan & Co., 1971], p. 127). Hayek was almost immediately offered the long-vacant Tooke Chair at the London School of Economics.
The locus classicus for Hayek was Ludwig von Mises's Theorie des Geldes und der Umlaufsmittel (1912) (The Theory of Money and Credit, tr. H. E. Batson [Irvington-on-Hudson, N. Y.: Foundation for Economic Education, 1971]).
Hayek recognized the similarity of enterprise among these figures. In a letter to Milton Friedman he remarked: “We all had similar ideas in the 1920s. They had been most fully elaborated by R. G. Hawtrey who was all the time talking about the ‘inherent instability of credit’ but he was by no means the only one” (Friedman, Optimum Quantity of Money [Chicago: Aldine Publishing Co., 1969], p. 88n).
Irving Fisher does not fit this analysis as well as the others. His work on money is largely a restatement of the quantity theory, against which many of the other figures were reacting (Roy Harrod, Money [London: St. Martin's Press, 1969], p. 27).
Hayek, Monetary Theory and the Trade Cycle (New York: Augustus M. Kelly, 1966).
Hayek, Individualism and Economic Order (Chicago: University of Chicago Press, 1948), pp. 33–56. The other articles, all reprinted in this same volume, are “The Facts of the Social Sciences,” “The Use of Knowledge in Society,” and “The Meaning of Competition.”
Hayek, Profits, Interest, and Investment (New York: Augustus M. Kelley, 1970), pp. 6–7.
Hayek, Monetary Theory, p. 54 (emphasis original).
Gottfried Haberler, Prosperity and Depression, 3d ed. (Lake Success, N. Y.: United Nations, 1946), pp. 277–78. Haberler was particularly careful to note that each business cycle is a unique historical event, and that there are dissimilarities among cycles. He only argued that there are certain characteristic features of cycles. This is an historical question, and is treated as such by virtually all concerned (ibid., pp. 274–76).
Obviously Spiethoff influenced all Continental economists studying the business cycles at this time. Although both Mises and Hayek emphasized the monetary factors operating causally in the cycle, both mentioned Spiethoff in their works,though often to disagree with him. Also both contributed articles to Spiethoff's Festschrift (Schumpeter, History of Economic Analysis [New York: Oxford University Press, 1954], pp. 815–17, 1126–28).
It would be more precise to speak of changes in the rate of growth of credit, as these were the analytically important changes in Hayek's Misesian (or neo-Wicksellian) theory. Thus, while he was chiefly concerned with changes in bank deposits or credit money, he did not treat the amount of credit as rigidly determined by the stock of money, even though he viewed economic fluctuations as being initiated by monetary disturbances.
Hayek, Monetary Theory, pp. 103–6. On the attitude of the modern Austrian school toward price levels, see Schumpeter, History, pp. 701n, 1089, 1095.
See Hayek's own justification of this procedure in Prices and Production, 2d ed. (London: Routledge & Kegan Paul, 1935), pp. 32–36.
Hayek felt that Keynes, for one, was guilty of this error in The General Theory. Hayek at first appraised that work as providing theorists with “the economics of abundance.” Twenty-five years later, he argued that Keynes's analytical framework was one in which “the whole price system [was] redundant, undetermined and unintelligible” (Sudha R. Shenoy, ed.,A Tiger by the Tail [London: Institute of Economic Affairs, 1972], p. 103).
Haberler, Prosperity and Depression, p. 63n; and Fritz Machlup, “Friedrich von Hayek's Contributions to Economics,” Swedish Journal of Economics 76 (1974): 506.
One example is to J. S. Mill's exposition of the effects of a sudden conversion of circulating into fixed capital (Principles, pp. 93–97). Mill's analysis is reflected in Hayek's monetary explanations of the following century.
W. H. Hutt, The Theory of Idle Resources (London: Jonathan Cope, 1939), p. 15.
Hayek, Prices and Production, pp. 36–40. Throughout Hayek was concerned with the allocation of consumption over time; he did not consider the effects of a change in tastes for consumer goods to be consumed in a given time period. Thus, at times, “homogeneous consumption services” could be substituted for “consumers' goods.”
The durable-goods problem was of particular importance for the Austrian school. Wicksell was the first to point out that the durable-goods problem is identical with the Marshallian joint-supply problem (Wicksell, Lectures on Political Economy, ed. Lionel Robbins [London: Routledge & Kegan Paul, 1935], I:260). D. K. Benjamin and Roger Kormendi rediscovered this fact in “The Interrelationship between the Markets for New and Used Durables,” Journal of Law and Economics 18 (October 1974): 381–401. See also Hayek, The Pure Theory of Capital (Chicago: University of Chicago Press, 1941), pp. 66–67.
Hayek, Prices and Production, pp. x-xii; see also Hayek, Pure Theory of Capital, pp. 46–49.
Hayek, Prices and Production, p. 40n.
Ibid., pp. 40–41n.
Hayek, Pure Theory of Capital, p. 48.
Hayek, Prices and Production, pp. 38–42. Hayek said that Jacob Marshak suggested the term “Jevonian Investment Figure.” Jevons as well as Wicksell and Ackerman used similar figures (ibid., p. 38n). The similarity to Wicksell's approach is particularly striking (Wicksell, Lectures, 1: 151–54). See also W. Stanley Jevons, Theory of Political Economy, ed. R. D. C. Collison Black (Baltimore: Penguin Books, 1970), p. 231.
Hayek, Prices and Production, pp. 41–42.
Ibid., p. 42.
Hayek, Pure Theory of Capital, pp. 199–200.
Ibid., pp. 3–13, 93–94. Much of this reflects the still very strong influence of Böhm-Bawerk's thinking on Hayek.
Hayek, Prices and Production, p. 46.
Hayek, “Price Expectations, Monetary Disturbances, and Malinvestment,” Profits, Interest, and Investment, pp. 153–54 (hereafter, “Price Expectations”). In pointing out that his theory was “quite independent of any idea of absolute changes in the quantity of capital,” Hayek noted that his theory did not depend on being able to measure the capital stock or (to deal with the question that concerned him at this point) on giving any determinate meaning to the maintenance of capital.
Hayek was following his own dictum in “Economics and Knowledge” that “before we can explain why people commit mistakes, we must first explain why they should ever be right” (Individualism, p. 34).
The two methods involve hypothetical experiments: the increase in the propensity to save assumes a constant money supply, and the increase in the money supply assumes a given propensity to save. Hayek took into account the complexities introduced by an elastic supply of trade credit (Prices and Production, pp. 115–18).
Hayek, “Price Expectations,” pp. 152–154.
Ibid., p. 152.
Hayek placed no emphasis on the interest elasticity of saving. “The factors which affect an individual's willingness to save are the regularity and certainty of his income, the security of the investment opportunities available to him, and the possibility of investing in his own business... It seems that in the short run the willingness to save varies very little and that it is particularly not much affected in the aggregate by changes in the rate of interest” (Profits, Interest, and Investment, p. 169). The inclusion of this essay in Encyclopedia of the Social Sciences in 1935 suggests that it must have represented the consensus of the profession, for new theories are not usually introduced in such articles. The dependence of saving on income is referred to as “self-evident commonplace” (ibid., p. 53n).
To Wicksell, the adaptation of entrepreneurs to a changed propensity to consume is as a rule “of secondary importance in comparison with the main phenomenon,” changes in the struture of production. He did assume, however, an “adaptability and a degree of foresight in the reorganization of production which is far from existing in reality” (Lectures, 2: 193).
This analysis is from Hayek, Prices and Production, pp. 75–77. An application of resources to the early stages would allocate circulating capital to more productive operations. Production for consumption would take longer (measured from the first application of labor and land services). Fewer consumption goods would be available immediately and more would be available ultimately. This is precisely what consumers desire when they increase their propensity to save. If net value productivity is involved in extending the number of stages, the output of consumer goods will eventually increase (see note 39 below).
An investment period is “the interval between the application of a unit of input and the maturing of the quantity of output due to that input” (Hayek, The Pure Theory of Capital, p. 69). The concept is most applicable to what Frisch called a “point input-point output” model. For a continuous input-point output, or point input-continuous output model, Hayek used joint-demand analysis (for factors in the first case) and joint-supply analysis (for the services in the second case) (ibid., p. 67). Hayek did not give the Frisch citation there.
Hayek, Prices and Production, pp. 79–83. According to Hayek, the discounted value of the marginal product of nonspecific factors will increase for a second reason: the superiority of “roundabout,” or “capitalistic,” methods of production, which insures that total output of consumer goods will increase once the new process has been completed. This controversial and typically Austrian proposition is not essential for what follows, though one wonders why investment would ever become “more capitalistic” if this were not true.
“A change in the bank-rate is not calculated to have any effect (except, perhaps, remotely and of the second order of magnitude) on the prospective real yield of fixed capital” (J. M. Keynes, A Treatise on Money, 2 vols. [New York: Harcourt, Brace & Co., 1930], 1:202).
Hayek, “Reflections on the Pure Theory of Money of Mr. J. M. Keynes,” part 2, Economica 11 (February, 1932): 25; and Gerald P. O'Driscoll, Jr., “Hayek and Keynes: A Retrospective Assessment,” Iowa State University, Staff Paper no. 20, 1975), esp. pp. 24–26.
Hawtrey, Capital and Employment, 2d ed. (London: Longmans, Green & Co., 1952), p. 31; see also Hayek, Pure Theory of Capital, p. 286.
Hawtrey, Capital and Employment, p. 36. Wicksell spoke of the “breadth” and “height” of capital as capital accumulation occurs; he was apparently borrowing Âkerman's terminology (Lectures, 1:266).
Hayek, Pure Theory of Capital, pp. 286–87.
Ibid., p. 286.
It is questionable whether we want to measure market value when we try to measure capital. A number of writers (for example, Robert Dorfman and Abba Lerner) questioned this procedure, noting that we do not follow it with other factors, and that, if we did, some results would be paradoxical. For instance, were the demand for labor to be inelastic, an increase in supply would diminish the value of labor employed in production (Kirzner, Essay on Capital [New York: Augustus M. Kelley, 1966], p. 135).
Hayek, The Pure Theory of Capital, pp. 69–70, 76–78.
Ibid., pp. 69–70.
Ibid., p. 70.
Ibid., p. 76.
Hayek, Prices and Production, p. 53.
Hayek, Pure Theory of Capital, p. 31.
Two points are implicit here. First, in a barter world, there is no medium of exchange by definition. Thus one commodity will be demanded in equilibrium in a money economy, that will not be demanded in a barter economy. Second, no alternative mechanism for attaining equilibrium is specified in barter constructions (Pure Theory of Capital, p. 31). See Ludwig von Mises, Human Action, 3d ed. (Chicago: Henry Regnery Co., 1963), pp. 249, 398–99, 416–19.
“Monetary changes are...in a peculiar sense self-reversing and the position created by them is inherently unstable.For sooner or later any deviation from the equilibrium position—as determined by the real quantities—will cause a swing of the pendulum in the opposite direction” (Hayek, Pure Theory of Capital, p. 34).
He made the simplifying assumption that the entire increase in the money stock took the form of “credits granted to producers”; this was “the case most frequently to be encountered in practice” (Hayek, Prices and Production, p. 54). In fact Hayek's assumption is not unrealistic, even today. Most loans granted by commercial banks are for productive purposes. Consumer and personal loans are of growing importance in commercial bank portfolios (from approximately 18% in 1947 to approximately 25% in 1970). But even for this category of loans, shifts in consumer spending are induced by interest rate changes. For the portfolio statistics, see Colin D. Campbell and Rosemary G. Campbell, An Introduction to Money and Banking (New York: Holt, Rinehart & Winston, 1972), pp. 84, 89.
Wicksell demonstrated that the following analysis is no less valid if the changes in the money stock are induced by changes in the natural rate of interest, the money rate being constant (Lectures, 2:202–18). Hayek at one point chided Mises for emphasizing the autonomous nature of changes in the money stock (Monetary Theory, pp. 148–52). Machlup was too generous in crediting Hayek with an amendment to Wicksell in this issue. Machlup would have Hayek correcting Wicksell by pointing out that a cumulative process can be initiated by a rise in the natural rate of interest (Machlup, “Friedrich von Hayek's Contributions to Economics,” p. 501). Yet Wicksell treated this case as typical (Lectures, 2:205).
Hayek, “Price Expectations,” p. 143.
Ibid., p. 141. For a similar argument, see Ludwig von Mises, “‘Elastic Expectations’ and the Austrian Theory of the Trade Cycle,” Economica, n.s. 10 (August 1943): 252.
Hayek, “Price Expectations,” p. 141.
Shenoy, A Tiger by the Tail, p. 8.
Hayek, Prices and Production, p. 57.
Haberler called the class of theories of which Hayek's is an instance “Monetary Over-Investment Theories” (Prosperity and Depression, p. 33). Malinvestment is both illuminating and descriptively more accurate. The cyclical process in Hayek's work is generated when appropriate investments (given the equilibrium rate of interest) are made. Whether in some sense more capital is purchased with the increased investment expenditures is of secondary importance.
Hicks, “The Hayek Story,” in Critical Essays in Monetary Theory (New York: Oxford University Press, Clarendon Press, 1967), p. 208.
Hicks, “A Neo-Austrian Growth Theory,” Economic Journal 80 (June 1970): 277. Sir John is speaking here about Prices and Production. It must be pointed out that he amended his views in successive reassessments of Hayek and the Austrian school. But I believe that Hayek and Hicks still disagree about the role of Hayek's monetary considerations.
Hicks, “The Hayek Story,” p. 210. Hicks characterized this approach as downright “un-Hayekian.”
Ibid., p. 211. Streissler, in reinterpreting Hayek, follows a path similar to that taken by Hicks (Roads to Freedom [New York: Augustus M. Kelley, 1969], pp. 245–85).
Hicks, Critical Essays, p. 211.
Ibid., pp. 211–15. Hicks subsequently became intrigued with Ricardian analysis of the effects of excess investment in fixed capital, and his approach to capital theory must be seen as part of a general retrogression toward Ricardian macroanalysis. It is particularly unfortunate that Hicks subtitled his book “A Neo-Austrian Theory.” It could be more aptly described as “neo-Ricardian” (Capital and Time, pp. 97–99). On the radical dissimilarities between the neo-Ricardian macro approach and the Austrian micro approach to capital theory, see Ludwig M. Lachmann, Macro-economic Thinking and the Market Economy.
“Of course, if the expenditure of the additional money in investment were a single non-recurrent event, confined to a single month, the effects would be of transient character” (Hayek, “Three Elucidations,” p. 279).
Ibid., p. 280. Even if a given rate of increase in the money supply, and hence prices, came to be correctly anticipated, relative prices would not be at their equilibrium values. This situation would then not be one of equilibrium. More will be said on this in the next chapter.
Hicks, “The Hayek Story,” p. 206.
Hicks emphasized that prices in Prices and Production were “perfectly flexible, adjusting instantaneously, or as nearly as matters” (“The Hayek Story,” p. 206). This flexibility is not a necessary condition for Hayek's theory, and I do not think he assumed any such thing. Even if prices were perfectly flexible, his conclusions would not change. But Hicks did not appreciate the analogy Hayek employed (“Three Elucidations,” pp. 281–82).
Hayek and Hicks apparently parted company over their interpretations of Wicksell. Hicks interpreted Wicksell's system as being in neutral equilibrium (“The Hayek Story,” pp. 205–7). I believe that most students of Wicksell would have to disagree with Hicks's interpretation. In any case, the difference in interpretations may be reduced to disagreement over the importance of monetary analysis.
“Hayek is perhaps at his best as a historian of economic doctrine, but his impact on political philosophy has been much more powerful” (Kuhn, Evolution of Economic Thought, 2d ed. [Cincinnati: South-Western Publishing Co., 1970].
“Prices and Production was in English, but it was not English economics. It needed further translation before it could be properly assessed” (Hicks, “The Hayek Story,” in Critical Essays in Monetary Theory [New York: Oxford University Press, Clarendon Press, 1967] p. 204). However, some of the economics in Prices and Production was classically British; these parts seemed to engender an equal amount of controversy. Ironically, Hicks was later to make the very same point: “The ‘Austrians’ were not a peculiar sect, out of the main stream; they were in the main stream; it was the others who were out of it.” And: “The concept of production as a process in time...is not specifically ‘Austrian.’ It is just the same concept as underlies the work of the British classical economists, and it is indeed older still—older by far than Adam Smith” (Capital and Time [Oxford: Oxford University Press, Clarendon Press, 1973], p. 12).
Hayek, Prices and Production, 2d ed. (London: Routledge & Kegan Paul, 1935), pp. vii-ix.
Hayek was the editor of Collectivist Economic Planning (London: George Routledge & Sons, 1935).
Hayek, Profits, Interest, and Investment (New York: Augustus M. Kelley, 1970), p. vii. The first essay, from which the title was taken, was the new contribution. Reprints of articles on capital theory and business cycle theory were also included.
Leijonhufvud argued that misinterpretations of Keynes may be attributed in part to this same process (On Keynesian Economics and the Economics of Keynes [New York: Oxford University Press, 1968], pp. 15–24).
Nicholas Kaldor, “Professor Hayek and the Concertina Effect,” Economica, n.s. 9 (November 1942): 359 (hereafter, “Professor Hayek”).
Ludwig M. Lachmann, “A Reconsideration of the Austrian Theory of Industrial Fluctuations,” Economica, n.s. 7 (May 1940): 180.
Friedrich A. Hayek, “A Comment,” Economica, n.s. 9 (November 1942): 383–85.
Hayek, “Profits, Interest, and Investment,” p. 3.
Ibid., p. 3.
Ibid., p. 6.
Ibid., p. 5.
Hayek, Prices and Production, pp. 89–91. The rise in the interest rate was precipitated by the cessation in the expansion of bank credit.
Ibid., pp. 94–95, 106.
Leijonhufvud, Keynesian Economics, pp. 50–54.
See Hayek, Prices and Production, pp. 85–96.
Hayek dealt with the effects of changes in the rate of increase in the money stock, not just changes in the money stock. But since he started from a position of a zero rate of growth in Prices and Production, he at times talked of absolute changes (ibid., pp. 54–55, 149–50).
Hayek, Monetary Theory and the Trade Cycle (New York: Augustus M. Kelley, 1966), p. 41n. He also distinguished between underconsumption explanations and malinvestment theories. A reading of this work is essential for an understanding of Hayek's theory of economic fluctuations.
Machlup, “Friedrich von Hayek's Contributions to Economics,” Swedish Journal of Economics 76 (1974): 504.
In the 1939 work, Hayek employed the term time rate of profit to refer to the various rates of return on real capital. He subsequently dropped this terminology.
Wicksell, Lectures on Political Economy, ed. Lionel Robbins (London: Routledge & Kegan Paul, 1935), 1: 154 (emphasis in original).
Hayek, “Profits, Interest, and Investment,” p. 8. Footnote reference omitted.
Ibid., p. 8. There is a correction in the table as reproduced, along with minor changes in wording.
Ibid., p. 6.
Ibid., p. 10. Footnote reference omitted.
“We are here concerned with the relations between the costs of labor and the marginal product of that labor” (Hayek, “The Ricardo Effect,” in Individualism and Economic Order [Chicago: University of Chicago Press, 1948], p. 253).
Haberler's judgment is that capital and labor are usable only in fixed proportions in the short run (Prosperity and Depression, 3d ed. [Lake Success, N. Y.: United Nations, 1946], p.489).
After the General Theory appeared, numerous studies focused on whether changes in the nominal wage rate are correlated with changes in the purchasing power of these wages or move in opposite directions. Lorie Tarshis finally pointed out that employers are not interested in the purchasing power of the workers' wage, but in the impact of a given wage on a firm's rate of return (that is, the real cost of a given wage) (“Changes in Real and Money Wages,” Economic Journal 49 [March 1939]: 150–54).
Hayek, “A Comment,” p. 383; see also idem, Prices and Production, pp. 72–92.
For example, see J. Hirshleifer, Investment, Interest, and Capital (Englewood Cliffs, N.J.: Prentice-Hall, 1970), p. 35.
The assumption of one good with two uses (consumption and investment) means there are no relevant effects of a change in the interest rate. The pure substitution between consumption and investment that occurs in a schmoo model is more characteristic of a pure exchange economy than of a production economy.
See pp. 70–79.
Hayek usually referred to output specificity of capital. But the analysis in Prices and Production and subsequent work in capital theory draws attention to the fact that capital goods are used in specific combinations. This aspect of Austrian capital theory received special attention from Ludwig M. Lachmann in Capital and Its Structure.
In a situation of less than full employment, consumption output will undoubtedly expand. But it will expand too little, that is, there will be a “disproportionality” in production.
Hayek, Prices and Production, pp. 89ff. The implication is that the purchasing power of the wages of at least some labor would fall in this latter part of a cyclical expansion. Hayek did not pursue the matter since it was not important theoretically (“The Ricardo Effect,” p. 242n).
Of the changing demand for labor of different types, Hayek remarked: “Even if aggregate demand for labour at the existing wage level (if to express it as an aggregate has any meaning under the circumstances) continues to increase, it will be an increase in the demand for kinds of labour of which no more is available, while at the same time the demand for other kinds of labour will fall and total employment will consequently decrease” (“Profits, Interest, and Investment,” p. 26).
Nicholas Kaldor, “Capital Intensity and the Trade Cycle,” Economica 6 (February 1939): 40–66; see also Tom Wilson, “Capital Theory and the Trade Cycle,” Review of Economic Studies 7 (June 1940): 169–79.
The process will continue until “the rise in the rate of profit becomes strong enough to make the tendency to change to less durable and expensive types of machinery dominant over the tendency to provide capacity for a larger output” (Hayek, “Profits, Interest, and Investment,” p. 33).
Hayek, Pure Theory of Capital (Chicago: University of Chicago Press, 1941), p. 396.
Hayek, “The Ricardo Effect,” p. 240, 242.
More precisely, the product of the money supply and velocity (that is, M.V) must continue to expand at the same rate (or higher).
Hicks, “The Hayek Story,” p. 206.
Hayek, “Price Expectations, Monetary Disturbances, and Malinvestments,” Profits, Interest, and Investment, p. 155. Hayek responded here to an earlier criticism by Myrdal.
This lecture (“Price Expectations, Monetary Disturbances, and Malinvestments,”) was reproduced in Profits, Interest, and Investment. As far as I can ascertain, it was not available in English until 1939.
Hayek, “Price Expectations,” p. 142.
Ibid., pp. 142–43. Hayek assumed that capital goods can only be used in specific combinations (though not necessarily only one combination). This point was emphasized by Lachmann; see note 34 above.
“Actions of a person can be said to be in equilibrium insofar as they can be understood as part of one plan.” And “For a society, then, we can speak of a state of equilibrium at a point of time—but it means only that the different plans which the individuals composing it have made for action in time are mutually compatible” (Hayek, “Economics and Knowledge,” pp. 36, 41).
Hayek, “Profits, Interest, and Investment,” pp. 16–18.
Mises's theory of the entrepreneur has been amplified by Kirzner in Competition and Entrepreneurship.
Hayek, “Profits, Interest, and Investment,” p. 14.
“On the principle of ‘making hay while the sun shines,’ provision for the profits to be made in the near future will take the precedence” (Hayek, “The Ricardo Effect,” p. 250). Hayek was attempting to ascertain the relevant rate of discount—the market interest rate or the rate of return on real capital in different stages—when the market rate is not an equilibrium rate.
This analysis is similar to that of William P. Yohe and Denis S. Karnosky, “Interest Rates and Price Level Changes, 1952–69,” Federal Reserve Bank of St. Louis Review 51 (December 1969): 31–32. Indeed, in a neo-Wicksellian theory such as Hayek's, if i were not less than n there would be no inflation to anticipate!
Axel Leijonhufvud, “Costs and Consequences of Inflation,” mimeographed (Los Angeles, April 1975) pp. 10–19.
Hayek, “Economics and Knowledge,” p. 46.
It is dubious that transactors seek to dispose of one subset of nominal assets (that is, money) in an anticipated inflation, though it is perfectly plausible for the category “nominal assets” taken as a whole. Robert Clower criticized the argument to the contrary at a UCLA Money Workshop in the 1972–73 academic year. See also Leijonhufvud, “Costs and Consequences of Inflation,” pp. 43–46.
Hayek, “Profits, Interest, and Investment,” p. 33.
Hayek, Prices and Production, pp. 92–93.
This model must be amended to take into account capital heterogeneity and complementarity. Particular durable capital goods may be used in otherwise labor-intensive methods of production to meet current consumption demand. Nonetheless, either less durable reproductions or new less durable machines will be used for replacements of these capital goods. In either case the replacement demand will be for a different type of machine and will cause production and employment effects, which is the crucial point for Hayek.
Mill, Principles of Political Economy, ed. Sir William Ashley (Clifton, N. J.: Augustus M. Kelley, 1973), pp. 91–100; this chapter is the sixth chapter of book 1 and comes after Mill's fundamental propositions on capital. Of the three sections in this chapter, two (eight out of ten pages) deal with the proportion between fixed and circulating capital.
Ibid., p. 94.
Mill apparently discovered the forced-saving doctrines relatively late; he added a footnote in 1865 to the sixth edition of Principles (Principles, p. 512). See also Hayek, “A Note on the Development of the Doctrine of ȘForced Saving’,” Profits, Interest, and Investment, pp. 193–94.
Hayek, Prices and Production, pp. 22–23.
Hayek, “Profits, Interest, and Investment,” p. 24.
Ibid., pp. 25–26; see also note 37 above. Hayek was reluctant to aggregate the demand for labor, just as he was reluctant to aggregate the demand for investment. In an analysis of the process of adjustment in a cyclical expansion, the changing pattern of demand is important. The analysis would be impossible in terms of the “aggregate demand for labor” or the “aggregate demand for capital.”
Ibid., pp. 62–63.
Speaking of Keynes, Hayek remarked: “His final conceptions rest entirely on the belief that there exist relatively simple and constant functional relationships between such ‘measurable’ aggregates as total demand, investment, or output, and that empirically established values of these presumed ‘constants’ would enable us to make valid predictions. There seems to me, however, not only to exist no reason whatever to assume that these ‘functions’ will remain constant, but I believe that microtheory had demonstrated long before Keynes that they cannot be constant but will change over time not only in quantity but even in sign. What these relationships will be, which all macro-economics must treat as quasi-constant, depends indeed on the micro-economic structure, especially on the relations between different prices which macro-economics systematically disregards. They may change very rapidly as a result of changes in the micro-economic structure and conclusions based on the assumption that they are constant are bound to be very misleading” (“Personal Recollections of Keynes,” in Shenoy, A Tiger by the Tail (London: Institute of Economic Affairs, 1972), pp. 101–2).
“The existence of...unused resources is itself a fact which needs explanation. It is not explained by static analysis and, accordingly, we are not entitled to take it for granted” (Hayek, Prices and Production, p. 34).
“If, however, the deflation is not a cause but an effect of the unprofitableness of industry, then it is surely vain to hope that, by reversing the deflationary process, we can regain lasting prosperity” (Hayek, Monetary Theory, p. 19).
According to Ludwig M. Lachmann, Hayek observed as early as 1933 that while maladjustments bring on depressions, the disequilibrium process results in secondary deflationary processes. Hayek did not pursue this issue, though, if he had, it would have made communication easier (personal communication).
D. H. Robertson, “Industrial Fluctuations and the Natural Rate of Interest,” Essays in Monetary Theory (London: P. S. King & Son, 1940), pp. 83–91.
See C. A. Phillips, T. F. McManus, and R. W. Nelson, Banking and the Business Cycle (New York: Macmillan Co., 1937), pp. viii, 115–16. See also G. L. S. Shackle's Foreword to Knut Wicksell, Value, Capital, and Rent, trans. S. H. Frowein (London: George Allen & Unwin, 1954), pp. 7–8.
Both Keynes's and Hayek's analyses were Wicksellian in character and relied on inappropriate rates of interest. But in Hayek's analysis the boom is caused by a market rate below the natural rate. The crisis occurs when high consumer demand makes it unprofitable to maintain the current investment structure. In Keynes's analysis the crisis occurs when market rates lag behind a falling natural rate. Thus, at the turning point, market rates of interest may be too low in Hayek's analysis and too high in Keynes's. See also Robertson, Essays.
Robertson outlined a scenario in which the rate that in the short run equilibrates the supply of voluntary savings and the demand for investable funds falls below the natural rate of interest during the deflation process. An expansionary monetary policy at this point merely brings the market rate down to the short-run equilibrium rate. Clearly this short-run equilibrium rate is not the natural rate of interest (Robertson, Essays, pp. 83–91).
Any fiscal policy that directly stimulates consumption is the least desirable: “The scarcity of capital, which, of course, is nothing else but the relatively high price of consumers' goods, could only be enhanced by giving the consumers more money to spend on final products” (Hayek, Prices and Production, p. 154). See also Hayek, “Profits, Interest, and Investment,” pp. 62–63.
Hayek, “Profits, Interest, and Investment,” pp. 63n–64n.
Hayek, Prices and Production, pp. 161–62.
Hayek, “Profits, Interest, and Investment,” pp. 70–71. The “steering wheel” is the rate of interest on loans. He was not advocating “fine tuning” with monetary policy, but permitting (instead of impeding) the adjustment of market rates to natural rates of interest.
F. A. Hayek, “Inflation, the Misdirection of Labour and Unemployment,” Full Employment at Any Price? (London: Institute of Economic Affairs, 1975), p. 15.
Hayek, Prices and Production, pp. 89–90.
Hayek, “Three Elucidations of the Ricardo Effect,” Journal of Political Economy 77 (March/April, 1969): 282.
The relationship between changes in wages and unemployment was observed by A. W. Phillips in “The Relation between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom, 1861–1957,” Economica 25 (November 1958): 283–99.
Hayek, Profits, Interest, and Investment, pp. 135–56; and idem, “Economics and Knowledge,” pp. 33–56.
In “The Use of Knowledge in Society.”
The static quality of most of The Pure Theory of Capital has often been noted. What is generally ignored, however, is that this was to be the first of two volumes, the second being a volume on dynamic capital problems—Hayek's real interest. But when it came time to write it, his interests had turned elsewhere. It might be argued that Lachmann's Capital and Its Structure has served in its stead.
Full Employment at Any Price? which contains Hayek's Nobel Lecture, is one example.
Kaldor, “Professor Hayek,” p. 364; and C. E. Ferguson, “The Specialization Gap: Barton, Ricardo, and Hollander,” History of Political Economy 5 (Spring 1973): 6.
David Ricardo, Principles of Political Economy, ed. F. W. Kolthammer (New York: E. P. Dutton, 1948), p. 27. Also: “In proportion as fixed capital is less durable it approaches to the nature of circulating capital” (ibid., p. 24).
Hayek, “Profits, Interest, and Investment,” pp. 13–14; see also table on p. 131.
For a fuller exposition of the argument, see O'Driscoll, “The Specialization Gap and the Ricardo Gap: Comment on Ferguson,” History of Political Economy 7 (Summer 1975): 261–69.
Mark Blaug, Economic Theory in Retrospect, rev. ed. (Homewood, Ill.: Richard D. Irwin, 1968), p. 546.
Hayek, “Profits, Interest, and Investment,” p. 14.
Hayek, “The Ricardo Effect,” pp. 235–38, 238–43.
“The Ricardo Effect” (1942) should not be read apart from “Profits, Interest, and Investment” (1939), as Blaug evidently did (judging from his criticisms and his bibliography). The 1942 work is a virtual amendment to the 1939 work and is not completely understandable by itself. Significantly, Blaug did not mention “Profits, Interest, and Investment” in his bibliography on the Ricardo effect; he did, however, cite Kaldor's “Capital Intensity and the Trade Cycle” (1939), but as though it were a criticism of work that postdated it by three years (Blaug, Economic Theory, pp. 571–72).
William J. Baumol, Economic Theory and Operations Research, 2d ed. (Englewood Cliffs, N.J.: Prentice-Hall, 1965), pp. 431–33.
William J. Baumol, “The Analogy between Producer and Consumer Equilibrium Analysis, Part II: Income Effect, Substitution Effect, and Ricardo Effect,” Economica 17 (February 1950): 69–80.
Mill, Principles, p. 79 (emphasis in the original).
Leslie Stephen, History of English Thought in the Eighteenth Century, p. 297; quoted in Hayek, The Pure Theory of Capital, p. 434.
James H. Thompson, “Mill's Fourth Fundamental Proposition: A Paradox Revisited,” History of Political Economy 7 (Summer 1975): 188.
Thompson offered a good summary of the various interpretations that have been put on the proposition (ibid.).
Hayek, Pure Theory of Capital, pp. 435–36. For an exposition of Hayek's use of “pure input” and other concepts integral to a complete discussion of these issues, see ibid., pp. 51–57, 65–66.
Ibid., p. 436.
J. S. Mill did not rely on changes in relative prices in elucidating the fourth proposition. (See Thompson, “Mill's Fourth Fundamental Proposition,” p. 188).
Mill, Principles, p. 87.
Ibid., p. 88.
Hayek, Pure Theory of Capital, p. 439.
Robert Eagly, Structure of Classical Economic Theory (New York: Oxford University Press, 1974), pp. 126–38.
See Hayek, “Reflections on the Pure Theory of Money of Mr. J. M. Keynes,” part 1, Economica 11 (August 1931): 270.
Hayek, The Pure Theory of Capital (Chicago: University of Chicago Press, 1941), pp. 369–76.
See Hayek, The Pure Theory of Capital, p. 3;also, verbal communication.
See Hayek, “Reflections,” part 1, 277–80.
Don Patinkin, “Keynes Monetary Thought: A Study of Its Development,” History of Political Economy 8 (Spring 1976): 57.
Some of the issues involved in this subject are covered in Axel Leijonhufvud, On Keynesian Economics and the Economics of Keynes (New York: Oxford University Press, 1968), pp. 157–85.
On Keynes's treatment of capital, see Leijonhufvud, Keynesian Economics, pp. 187–314. Noteworthy is Keynes ambivalence on Austrian capital theory: “It is significant that whereas Keynes (like Cassel) was quite critical of Böhm-Bawerk, his ‘observationsș on capital stress the roundaboutness notion of the Austrians” (Leijonhufvud, Keynesian Economics, p. 250n).
Keynes's unsettled and ambivalent feelings toward capital-theoretic questions show in a letter to R. F. Kahn (1 February 1932) about his correspondence with Hayek: “What is the next move? I feel that the abyss yawns—and so do I. Yet I can't help feeling that there is something intersting in it [Hayek's theory]” (Donald Moggridge, ed., The Collected Writings of John Maynard Keynes, 25 vols. [London: St. Martin's Press, 1973] 13: 265).
See Harcourt's remarks on Solow's approach in G. C. Harcourt and N. F. Laing, eds., Capital and Growth (Baltimore: Penguin Books, 1971), p. 17.
See Ludwig M. Lachmann, Capital and Its Structure (London: London School of Economics, 1956).
See Emil Kauder,A History of Marginal Utility Theory (Princeton: Princeton University Press, 1965), pp. 15–57.
“Classical economics is essentially macro economics” (Robert Eagly, The Structure of Classical Economic Theory [New York: Oxford University Press, 1974], p. 21).
Thomas Sowell, Classical Economics Reconsidered (Princeton: Princeton University Press, 1974), p. 33. The dynamic problems of macrotheory were the chief focus in classical economic theory. This is in contrast to contemporary macrotheory.
John Maynard Keynes, The General Theory of Employment, Interest, and Money (New York: Harcourt, Brace & World, Harbinger Books, 1965), p. 32.
Mark Blaug, “Was There a Marginal Revolution?” in The Marginal Revolution in Economics, eds. R. D. Collison Black, A. W. Coats, and Craufurd D. W. Goodwin (Durham: Duke University Press, 1973), p. 14.
Keynes acknowledged this in the Treatise, reprinted as Moggridge, ed., The Collected Writings of John Maynard Keynes, 25 vols. (London: St. Martin's Press, 1971) 5: 178n.
Hayek, “The Pretence of Knowledge,” in Full Employment at Any Price? (London: Institute of Economic Affairs, 1975), pp. 30–42.
Two recent attempts to begin this much-needed reassessment are Ludwig M. Lachmann, “Sir John Hicks as a Neo-Austrian,” South African Journal of Economics 41 (1973): 195–207; and Robert Clower, “Reflections on the Keynesian Perplex,” Zeitschrift für Nationalökonomie 35 (1975): 1–24; esp. 5–12.
Hayek, Prices and Production, 2d ed. (London: Routledge & Kegan Paul, 1935), pp. 4–5.
An explicit example of such an argument is Charles W. Baird, Macroeconomics (Chicago: Science Research Associates, Inc., 1973), pp. 176–80.
On this point, see also the editorial introduction in Sudha R. Shenoy, ed.,A Tiger by the Tail (London: Institute of Economic Affairs, 1972), p. 8.
Axel Leijonhufvud, “Effective Demand Failures,” Swedish Journal of Economics 75 (1975): 28–29.
The theoretical connection between Ricardian classical political economy and Walrasian neoclassical economics has been recently noted by Robert Eagly: “Janus-like, the Walrasian system is situated between two great systems of economic theory. It forms the capstone to classical theory on the one side, and on the other the cornerstone to the modern post-classical theory. It provided answers to questions posed by the normal progression of theoretical inquiry within the classical framework. But at the same time it posed new questions that were to occupy the attention and time of economists during the following century” (Eagly, Structure of Classical Economic Theory [New York: Oxford University Press, 1974], p. 134).
New York: Cambridge University Press, 1960.
Nuti has recently characterized the approach of Sraffa and others as “a general equilibrium approach with the preference side chopped off.” And he argued that “the approach...has no overwhelming advantages over the general equilibrium approach” (Dominco Mario Nuti, “On the Rates of Return on Investment,” Kyklos 27 : 357). Nuti likewise identifies the Sraffa approach as “‘classical’ (Nuti, 357–58).
The term “Neo-Ricardian” is borrowed from L. M. Lachmann, Macro-economic Thinking and the Market Economy (London: The Institute of Economic Affairs, 1973).
Philip H. Wicksteed, “The Scope and Method of Political Economy,” in Readings in Price Theory, George J. Stigler and Kenneth E. Boulding, eds., (Homewood, Ill.: Richard D. Irwin, 1952), p. 19n.
Recent works articulating this view are James M. Buchanan, Cost and Choice (Chicago: Markham Publishing Co., 1969); and James M. Buchanan and G. F. Thirlby, eds., L.S.E. Essays on Cost (London: Weidenfield Nicolsen, 1973).
Leijonhufvud has recently made a persuasive case that the use of “neoclassical” is more confusing than illuminating. As much separated the “‘neoclassical‘ grants” as bound them together. He argued that we dispense entirely with the term. See Axel Leijonhufvud, “The Varieties of Price Theory: What Microfoundations for Macrotheory?” U.C.L.A. Discussion Paper Number 44 (Los Angeles: mimeographed, 1974). William Jaffé has taken up the same theme recently in “Menger, Jevons, and Walras De-Homogenized,” Economic Inquiry 14 (December 1976):511–24. In my defense, I would note that I have tried to limit the use of the term to those cases where the similarities of the various neoclassical schools are greatest. I recognize, however, that these similarities have been greatly exaggerated in recent years.
Mises, Theory of Money and Credit, new ed., trans. H. E. Batson (Irvington-on-Hudson, N. Y.: The Foundation for Economic Education, 1971).
See Don Patinkin, Money, Interest, and Prices, 2d ed. (New York: Harper & Row, 1965), pp. 79, 574–75.
See Joan Robinson, “What Has Become of the Keynesian Revolution?” in Essays on John Maynard Keynes, ed., Milo Keynes (New York: Cambridge University Press, 1975), p. 125.
See Axel Leijonhufvud, On Keynesian Economics and the Economics of Keynes (New York: Oxford University Press, 1968), p. 24. On the other hand, Patinkin apparently sees little role for changes in relative prices in Keynes's theoretical vision. (Don Patinkin, “Keynes' Monetary Thought,” History of Political Economy 8 [Spring 1976], 45).
For the methodological subjectivist, it is an essential feature of human affairs that this be so. And the social scientist must take account of this, as Hayek long ago noted: “In the social sciences the things are what people think they are. Money is money, a word is a word, a cosmetic is a cosmetic, if and because somebody thinks they are” (“The Facts of the Social Sciences,” in Individualism and Economics Order [Chicago: University of Chicago Press, 1948], p. 60).
Some papers in this development appear in Edwin G. Dolan, ed., The Foundations of Modern Austrian Economics (Kansas City: Sheed & Ward, 1976). More will appear in a forthcoming proceedings of a conference on Austrian Economic Theory held at Windsor Castle in 1976.
See Hayek, “Personal Recollections of Keynes,” in A Tiger by the Tail, ed. Sudha R. Shenoy (London: Institute of Economic Affairs, 1972), pp. 101–2.
On this, see Roger Garrison's, “Austrian Macroeconomies,” a paper prepared for the 1976 Symposium on Austrian Economics at Windsor Castle (Menlo Park, Calif., 1976). Forthcoming.
For a synopsis of Shackle's views, see his “Keynes and Today's Establishment in Economic Theory: A View,” Journal of Economic Literature 11 (June 1973): 516–19.
The American Geographical Society is currently engaged in a study of the spatial diffusion of inflation in the United States. This is very much a topic of the kind that I am discussing.
See Gerald P. O'Driscoll, Jr., “Spontaneous Order and the Coordination of Economic Activities,” a paper prepared for the 1976 Symposium on Austrian Economics at Windsor Castle (Menlo Park, Calif., 1976). Forthcoming.
Hayek, “The Place of Menger's Grundsätze in the History of Economic Thought,” in Carl Menger and the Austrian School of Economics, J. R. Hicks and W. Weber, eds. (Oxford: Oxford University Press, The Clarendon Press, 1973), p. 13.
See the references cited in note 6.
Two works written in this tradition are Ludwig M. Lachmann, Capital and its Structure (London: London School of Economics, 1956); and Israel M. Kirzner, An Essay on Capital (New York: Augustus M. Kelley, 1966).
Professor Lachmann first offered this analysis in a talk at the University of Delaware in June 1976.
Some of these can be found in the seected bibliography of the Dolan book cited in note 13.