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Source link: http://archive.mises.org/6266/investment-that-raises-the-demand-for-capital/

Investment that Raises the Demand for Capital

February 16, 2007 by

The purpose of this article, wrote Friedrich Hayek in 1937, is to state a proposition which underlies the modern “monetary over-investment theories” of the trade cycle in a form in which, as far as I know, it has never before been expressed but which seems to make this particular proposition so obvious as to put its logical correctness beyond dispute.

It should, moreover, clear up some of the confusion and misunderstandings which have made it so difficult to come to an agreement on the purely analytical points involved.

It will surprise nobody to find the source of this confusion in the ambiguity of the term capital. FULL ARTICLE


adi February 16, 2007 at 2:47 am

This article is great and Hayek’s examples are illuminating too!

It takes time to understand Austrian capital theory (even more so if you have been trained in the capital theory of Neo-Classical orthodoxy) but I might still make it…

Now I understand why Neo-Classical macro is so shallow and one dimensional. Too much aggregation and funny concepts makes it virtually impossible to have any real understanding of economies.

Capital is something that economists dont understand. There are too many capital theoretic paradoxes and difficulties that prove this claim.

Few questions still remaining:
If entrepreneur has already made (sunk) investments into plant and equiptments when assuming certain flow of expected future revenues and cost of funds in the future, does this mean that future investments might be very inelastic with respect to changes in the interest rate?
What happens if entrepreneur can move capital goods (if they are not too specific) to another sector if interest rate will change?

Suppose that corporation produces higher stage goods (production goods) when assuming certain future interest rate and expected revenues from those corporations which demand these goods. When interest rate rises Haeyk says that this corporation must lower its prices of production goods and still it’s ready to make new production goods in the future if price covers costs. But is it worthwhile in the future to continue producing at the current level of output if alternative is to not use amortization fund for maintaining level of output? Corporation could just give extra dividens back to owners if rate of return in the production goods sector is not as high anymore.

Alexander Villacampa February 16, 2007 at 8:43 am

Fantastic article. Definitely something to print out and keep for a long time to come.

RogerM February 16, 2007 at 4:09 pm

adi: “…does this mean that future investments might be very inelastic with respect to changes in the interest rate?”

I like the terms “upstream” and “downstream” that the oil industry uses to describe stages of production instead of higher and lower order. But it’s not clear to me why the upstream producer would have to lower prices if interest rates rose after his investment. But I think Hayek was saying that producers downstream from the producer with sunk costs would be inelastic to interest rate increases because their extra costs would be offset by reduced prices from the upstream producer. But if the upstream producer could switch his equipment to a more productive industry, he wouldn’t have to reduce prices and so it seems that the downstream producers would be sensitive to interest rate increases.

“But is it worthwhile in the future to continue producing at the current level of output if alternative is to not use amortization fund for maintaining level of output?”

If the price level doesn’t recover enough to pay interest and amortization, the upstream producer will not last long. The lender will want at least interest payments, and without amortization or depreciation charges, the equipment will wear out. If prices did recover and the producer paid out the increase in dividends, the equipment would still wear out, eventually. But that might be OK if the owner wanted to get out of the business. He could squeeze cash from it until the equipment failed, then sell it for salvage prices.

Don’t take my remarks as the final word on this. I’m still learning ABCT myself.

N. Joseph Potts February 16, 2007 at 9:48 pm

70 years later, I find that the subtlety of Hayek’s points (capital IS a matter in which subtle distinctions are crucial) is not done justice by the sparse examples he uses to illustrate his point.

Of course, I’m an accountant, and so, prone to use numbers (cardinal numbers WOULD be OK in such an illustration, since magnitudes are not the point) in illustrations. Maybe even diagrams. Hayek did, of course, use some percentage numbers in his examples, but I have absolute numbers (miniature income statements) in mind as well.

This thing could be accessible to a lot more people, and easier, even, for those who can and do ultimately work through it, if it were fleshed out with more-tangible scenarios.

One thing this article points up, without explicitly pointing it OUT, is that artificial (Fed-style) tuning of the economy through the interest rate is, as most us already know, doomed to fail, if only for the tendency of adjustments to overshoot, as they did in 1931 and at other times before and since.

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