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Austrian Capital Theory A Prelude to Capital-Based Macroeconomics The Knightian Stock-Flow Model The Hayekian Stages-of-Production Model July 22, 2013.

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Presentation on theme: "Austrian Capital Theory A Prelude to Capital-Based Macroeconomics The Knightian Stock-Flow Model The Hayekian Stages-of-Production Model July 22, 2013."— Presentation transcript:

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2 Austrian Capital Theory A Prelude to Capital-Based Macroeconomics The Knightian Stock-Flow Model The Hayekian Stages-of-Production Model July 22, 2013 Two Views: The Keynesian “Animal Spirits” Model

3 “Capital Structure”:The Temporal Pattern of Heterogeneous Capital Goods “Capital Stock”:The Stock of Productive Factors that Yield a Flow of Consumption Goods “Human Capital’: Present Value of (Skilled) Worker’s Future Earnings “Capitalized Value”Present Value of (net) Future Receipts “Working Capital”:Goods in Process e.g. sheet steel, crude oil “Capital Goods”:Plant, Equipment, Stocks of Raw and Semi-Finished Materials “Financial Capital”:Cash and Funds Raised by e.g. stock and bond sales “Bank Capital”: Assets minus Liabilities, i.e., Net Worth. The Many Meanings of “Capital”

4 “Capital Structure”:The Temporal Pattern of Heterogeneous Capital Goods “Capital Stock”:The Stock of Productive Factors, which Yields a Flow of Consumption Goods “Human Capital”: Present Value of (Skilled) Workers’ Future Earnings “Capitalized Value”:Present Value of (net) Future Receipts “Capital Goods”:Plant, Equipment, Raw Materials and Semi-Finished Goods “Financial Capital”:Cash and Funds Raised by e.g. stock and bond sales “Bank Capital”: Assets minus Liabilities, i.e., Net Worth. The Many Meanings of “Capital”

5 The Measuring of “Capital” Capital is heterogeneous. Capital is radically heterogeneous. Capital is dimensionally heterogeneous.

6 The Measuring of “Capital” (units) units worker-hours acres doseschunks hunks Not all ____________ of land are alike. Not all ____________ of labor are alike. Not all ____________ of capital are alike. dosechunk hunk

7 Knight and Hayek Butted Heads about Capital Frank H. Knight 1885 — 1972 Friedrich A. Hayek 1899 — 1992 Clark and Bohm-Bawerk Butted Heads about Capital John Bates Clark 1847 — 1938 Eugen von Bohm Bawerk 1851 — 1914

8 Black-Box Capital Theory (Clark and Knight) THE CAPITAL STOCK DO NOT OPEN A flight recorder on an aircraft. Any complex piece of equipment, typically a “plug-and-play” unit in an electronic system, with contents about which the user has “no need to know.”

9 FLOW OF CONSUMPTION MAINTENANCE OF CAPITAL DO NOT OPEN THE CAPITAL STOCK A flight recorder on an aircraft. Any complex piece of equipment, typically a “plug-and-play” unit in an electronic system, with contents about which the user has “no need to know.” A STEADY-STATE ECONOMY Black-Box Capital Theory (Clark and Knight)

10 The Capital Stock is permanent, in a sense. MAINTENANCE OF CAPITAL DO NOT OPEN THE CAPITAL STOCK The Capital Stock in this theory includes maintenance as a technical detail. Hence, the Capital Stock is “permanent.” The Capital Stock is permanent, as it were.The Capital Stock is permanent, so to speak. A STEADY-STATE ECONOMY And accordingly: The “permanent” Capital Stock yields a “perpetual” income. Black-Box Capital Theory (Clark and Knight) QUALIFICATIONS: “in a sense,” “as it were,” “so to speak,”….

11 FLOW OF CONSUMPTION MAINTENANCE OF CAPITAL DO NOT OPEN THE CAPITAL STOCK The economy is a system of “sources” yielding “services.” SOURCES MAINTENANCE OF SOURCES SERVICES There is only one factor of production. It’s “capital” ---in the broad sense of “sources.” Land, labor,* and capital are all “capital” in the broad sense. Black-Box Capital Theory (Clark and Knight) The economy is a system of “capital” yielding “consumable output.”

12 DO NOT OPEN THE CAPITAL STOCK Black-Box Capital Theory (Clark and Knight)

13 AN EXPANDING ECONOMY THE CAPITAL STOCK THE CAPITAL STOCK DO NOT OPEN Black-Box Capital Theory (Clark and Knight)

14 THE CAPITAL STOCK A CONTRACTING ECONOMY Black-Box Capital Theory (Clark and Knight)

15 Once a Steady State is reached, production time is irrelevant. Each period, a sapling is set out, and a mature tree is harvested. It is the setting out that “enables” the harvesting. Setting out the sapling (now) “produces” the harvestable tree (now). Production and consumption are “simultaneous.” What about production time in a Clark-Knight vision? YEAR 1YEAR 2 QUALIFICATIONS: “in a sense,” “as it were,” “so to speak,”…. The trees have a linear maturity structure (log-linear, actually). George Stigler defends Clark and dismisses Bohm-Bawerk on the basis of the simultaneity of production and consumption: “We can say that any one row [of trees] takes fifty years to mature, but since there is a constant output of timber forever, there is simply no point in saying it.” George Stigler, Production and Distribution Theories, 1941 The next period presents us with the same maturity profile.

16 Knight and Hayek Butted Heads about Capital Frank H. Knight 1885 — 1972 Friedrich A. Hayek 1899 — 1992 Maintenance is a technical detail.Maintenance is a matter of choice. Capital is permanent.Capital is ever changing. Capital is the only factor.Capital is unique and heterogeneous. Production time is irrelevant.Production time is a key variable. It’s all about sources and services.It’s all about temporal capital structure. It’s about steady-state equilibrium.It’s about dynamic market processes.

17 GOODS OF THE FIRST ORDER GOODS OF THE SECOND ORDER GOODS OF THE THIRD ORDER GOODS OF THE FOURTH ORDER GOODS OF THE FIFTH ORDER GOODS OF THE SIXTH ORDER GOODS OF THE SEVENTH ORDER MENGER’S LAW Production Proceeds Top to Bottom Value Imputation goes from Bottom to Top H I G H E R O R D E R G O O D S CONSUMPTION GOODS The value of higher order goods derives from the value of the respective consumer goods. Bohm-Bawerk’s Maturity Classes RICH COUNTRY POOR COUNTRY

18 GOODS OF THE FIRST ORDER GOODS OF THE SECOND ORDER GOODS OF THE THIRD ORDER GOODS OF THE FOURTH ORDER GOODS OF THE FIFTH ORDER GOODS OF THE SIXTH ORDER GOODS OF THE SEVENTH ORDER O R D E R S O F G O O D S S T A G E S O F P R O D U C T I O N

19 The Hayekian Triangle PRODUCTION TIME (A SEQUENCE OF STAGES)

20 ---from F. A. Hayek’s The Pure Theory of Capital, 1941

21 The temporally defined stages are arrayed graphically from left to right, the output of the final stage constituting consumable output. Early-stage investment activity is exemplified by product development. The Structure of Production Capital-based macroeconomics disaggregates capital intertemporally. Consumable output is produced by a sequence of stages of production, the output of one stage feeding in as input to the next. STAGES OF PRODUCTION CONSUMPTION PRODUCT DEVELOPMENT INVENTORY MANAGEMENT Late-stage investment activity is exemplified by inventory management.

22 WE ARE HERE The directory at the front gate includes the conventional YOU ARE HERE sign but no Hayekian WE ARE HERE sign. YOU ARE HERE

23 CONSUMPTION The Structure of Production STAGES OF PRODUCTION For pedagogical convenience, the initial capital structure is shown as having five stages. With growth, the number of stages will increase. Although all five of these stages are in operation during each time period, resources can be tracked through the structure of production over time. Watch the resources, or “goods in process,” move through the stages.

24 CONSUMPTION The Structure of Production STAGES OF PRODUCTION For pedagogical convenience, the initial capital structure is shown as having five stages. With growth, the number of stages will increase. Although all five of these stages are in operation during each time period, resources can be tracked through the structure of production over time. Watch the resources, or “goods in process,” move through the stages. NOTE: Hayek introduced his triangle in 1931, when Henry Ford was still producing the Model A. If only Hayek had had PowerPoint, he could have shown how the abstract triangle aligns with real world output.

25 STAGES OF PRODUCTION CONSUMPTION Together, the sequence of stages form a Hayekian triangle, a summary depiction of the economy’s intertemporal structure of production. In an economy experiencing secular growth, the triangle increases in size but not in shape.

26 STAGES OF PRODUCTION CONSUMPTION Together, the sequence of stages form a Hayekian triangle, a summary depiction of the economy’s intertemporal structure of production. In an economy experiencing secular growth, the triangle increases in size but not in shape. Watch the Structure of Production expand.

27 Together, the sequence of stages form a Hayekian triangle, a summary depiction of the economy’s intertemporal structure of production. In an economy experiencing secular growth, the triangle increases in size but not in shape. Watch the Structure of Production expand. STAGES OF PRODUCTION CONSUMPTION

28 STAGES OF PRODUCTION CONSUMPTION When people choose to save more, the change in their preferred temporal pattern of consumption is registered by the market, first and foremost by a reduction in interest rates. Reduced current consumption frees up resources in the late stages ---which can then be employed in the early stages. Lower interest rates favor more time-consuming production processes.

29 STAGES OF PRODUCTION CONSUMPTION Watch the structure of production respond to an increase in saving. Note the emergence of a sixth stage of production. When people choose to save more, the change in their preferred temporal pattern of consumption is registered by the market, first and foremost by a reduction in interest rates. Reduced current consumption frees up resources in the late stages ---which can then be employed in the early stages. Lower interest rates favor more time-consuming production processes.

30 STAGES OF PRODUCTION CONSUMPTION In the Hayekian construction, increased saving results in a reallocation of resources among the stages of production. Here, the differential interest-rate sensitivities are at work. THE CAPITAL STOCK DO NOT OPEN In the Knightian construction, increased saving (i.e., saving beyond the technical requirement of maintaining capital) results in a an increase in the capital stock (and a decrease in the flow of consumables) with no implications about capital’s temporal structure.

31 THE CAPITAL STOCK DO NOT OPEN The increased output of consumer goods emerges over time as the early and intermediate products move through the more time- consuming structure of production. STAGES OF PRODUCTION CONSUMPTION In the Knightian construction, increased saving (i.e., saving beyond the technical requirement of maintaining capital) results in a an increase in the capital stock (and a decrease in the flow of consumables) with no implications about capital’s temporal structure. This is the construction that allows us to depict both economic growth and the boom-bust cycle.

32 We can clearly see the critical difference between Knight and Hayek. If we burn through the casing of the Knightian Black Box, we see the Hayekian temporal structure of capital that allows for differential interest-rate sensitivity and hence reveals the market mechanism that tailors production plans to intertemporal preferences. If interest rates are telling the truth about people’s willingness to save, we get genuine, sustainable growth. If interest rates are being held down by the central bank we get an artificial boom followed by a bust. STAGES OF PRODUCTION CONSUMPTION THE CAPITAL STOCK LET’S DO OPEN

33 Knight and Hayek Butted Heads about Capital Frank H. Knight 1885 — 1972 Friedrich A. Hayek 1899 — 1992

34 Austrian Capital Theory A Prelude to Capital-Based Macroeconomics The Knightian Stock-Flow Model The Hayekian Stages-of-Production Model July 22, 2013 Two Views:


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