Ludwig von Mises first formulated the Austrian Business Cycle Theory (ABCT) in his groundbreaking treatise The Theory of Money and Credit (1912). But in the following much earlier passage (1888) by Eugen von Bohm-Bawerk (who, as his teacher, was a great influence on Mises) one can see the theory shadowed forth.
Bohm-Bawerk considers below what would happen if, for some reason an absence of interest (agio) occured. [EDIT: thanks to Martin and Inquisitor for correcting a superfluous and erroneous additional element here] He shows how this situation would be unsustainable.
The possibility of obtaining means of subsistence free of agio would be certain to tempt undertakers into immoderate extension of the production period. If this were to occur only partially and in a few branches of production, naturally the limited stocks of subsistence would leave so much less for the other branches of production; these latter would have to curtail their processes unnaturally; and there would ensue a deficiency in the social provision which would outweigh the increased return got from the favoured branches through the immoderate extension of their processes. But if the excessive extension were to be introduced all over, the community’s stock of subsistence would come to an end sooner than the fruits of processes thus unduly extended could mature; there would be deficiency in provision, want, and distress; famine prices would recall the misdirected natural powers, and put them, with difficulty, to supply provision for the moment. All this could not happen without serious disturbance, expense, and loss.
Now the constant presence of the agio on present goods is like a self-acting drag on the tendency to extend the production period; without checking it all at once it makes it more difficult, and more difficult in proportion to the projected length of the process. Extensions which would be harmful as regards social provision are thus made economically impossible. Moderate extensions over the average process, however, are not absolutely prevented, but are limited to those branches where, from peculiar economic or technical circumstances, the productiveness that goes with the extension of the period is so great that they can bear the progressive burden of the agio. Branches, again, where longer processes are somewhat, but only a little, more productive, are tempted to escape the burden of agio by recurring to periods under the average. Thus, finally, under the influence of the agio, the total fund of subsistence is divided out automatically among the individual branches of production, in such amounts that each branch adopts that length of process which—in the given condition of the fund—is most favourable to the total provision.
Eugen von Bohm-Bawerk, The Positive Theory of Capital, Book VI, Chapter VI, (from The Library of Economics and Liberty)
The theory is almost all here: the immoderate extension of the production period (lengthening of the chain of production), the long-term necessity for savings, investment, and consumption to be in balance, and the role of the interest rate in keeping that balance. All Bohm-Bawerk needed do was to extend this analysis of a situation with a complete lack of agio/interest to situations with artificially low agio/interest, and the Austrian Business Cycle Theory might have come rushing forth from his pen.
My question to Austrian economists: is my characterization of this passage as a prelude to the ABCT sound? My question to historians of Austrian thought: has this passage been noticed/discussed before as a foretoken of the ABCT?
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I believe that Mises’s contributions, at least towards the theory of the cycle, was in a synthesis between Böhm-Bawerk’s capital theory and von Wieser’s theory of money, together with all the original insight provided by Mises himself.
I’ve never read The Theory of Money and Credit neither the Hayek works on the Business Cycle when I read The Positive Theory of Capital. But, when I was reading it, a sound formulation of the ABC Theory came onto my mind and I knew it was coming from Böhm-Bawerk. Now I don’t remember anymore what was that formulation neither the passage of the book which inspired it — I think it was the whole thing (the business cycle theory is implicit in austrian capital theory).
I’m no economist, but it sounds extremely unintuitive (an un-Austrian) to say that a low time preference by itself could wreck the economy. My guess is that Bohm-Bawerk is talking about what would happen if the interest rate were artificially lowered by some mechanism other than time preference, an illustration of how the interest rate coordinates production to fit time preference.
He could be referring to its abolition as advocated by some people and outlining the consequences of what’d happen if interest were banned. I don’t think he’s speaking about low TP.
Yes, that’s totally right. I was correct in making the zero-interest connection in my characterization, but I don’t know why I thought BB was saying that that, in turn, was caused by zero time preference. Thanks, Martin and Inquisitor; I’ve deleted the time preference bit.
This is one of several elements-of-ABCT passages in Bohm-Bawerk.
Count me as a big Bohm-Bawerk fan.
I’m quite sure that Mises’ calculation argument was originally put forth by Bohm-Bawerk as well, though in a relatively crude form:
“How is it conceivable that, under Socialism, a young oak sapling which will be an oak tree, with the value of an oak tree, in two hundred years, can be made equal in value to an oak full-grown now? The central authority directing the national production must base its entire arrangements and dispositions on a calculation of present and future goods having different values, if its dispositions are not to be quite inept and monstrous. If it does not put less value on future goods it must find that a process which promises a greater number of products in the far future is more remunerative than a process which yields a small number in the present or near future, and it must, accordingly, always turn its productive powers to remote productive ends, however remote they are, as being, technically the most fruitful. The natural consequence would be very much as we have pictured it–misery and want in the present.” -Positive Theory of Capital, pp. 386, Interest under socialism.
It’s one of the things I like about Austrianism. The school tends to develop the insights of its founders in new directions and fully credit them for them. Contrary to the myth promulgated on some anti-Austrians that the school is stagnant. It just doesn’t try reinvent the wheel and engage in the vogue tendency of questioning statements like “water is wet”.
It always stings me when people discredit the Austrian school because of recent advances, when its past successes are simply dismissed. It would probably help to see its policy suggestions put into practice to help discover new insights into the theory (of course this isn’t a suggestion that we rely on empiricism but that real-world working models would trigger insights otherwise missed).
*sigh* I guess I gotta buy some Bohm-Bawerk now. Seems legit.
It’s also foreshadowed by various discussions between the Currency school, Banking school and Free banking school in the 19th century and in one of Frank Fetter’s books from ~1904.
So much to read, so much to learn.
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