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Critique of Austrian Economics

Part I:  The Legacy of Friedrich Hayek 

Section II:  Wealth or Income?

Skousen asserts, “Let A be defined as the area of the APS.  Thus, A represents the gross output of an economy during the year [GNO]” (1990, p. 195).  Clearly, his APS graph describes a flow of goods.

What did Hayek, the originator of the structure of production, intend it to represent: a yearly flow of goods or a distribution of wealth?  These are, after all, very different things.  Hayek (1967, p. 40, italics added) writes:

The area of the triangle shows the totality of the successive stages through which the several units of original means of production pass before they become ripe for consumption.  It also shows the total amount of intermediate products which must exist at any moment of time in order to secure a continuous output of consumers’ goods.

Also?  In the first sentence, the word “pass” implies a flow of goods passing by during a certain amount of time.  The second sentence refers to the total amount of goods that exist at a moment in time.  It is highly irregular for a graph to mean one thing and also something else.

This confusion persists throughout Prices and Production.  Hayek writes, “When I use the expression producers’ goods, I shall be designating all goods existing at any moment which are not consumers’ goods” (1967, p. 37).  But then, when moving from triangles to histograms, he writes that he will “make cross sections through our first figure [the triangle] at intervals corresponding to the periods chosen, and to imagine observers being posted at each of these cross cuts who watch and note down the amount of goods flowing by” (1967, p. 43).  “All goods existing at any moment” is not the same thing as “the amount of goods flowing by.”

Later, Hayek repeatedly refers to the “stock of capital” (1967, p. 137 et passim) and writes, “any given demand for consumers’ goods can lead to methods of production involving very different demands for producers’ goods, and the particular method of production chosen will depend on the proportion of the total wealth not required for immediate consumption” (p. 143).  His use of the word “wealth” here clearly refers to a stock of capital.

By 1935 this confusion had been brought to Hayek’s attention, but he failed to act decisively.  His four-year-old lectures, destined to become his best-known work, had much room for improvement, both in style, to reflect his mastery of the English language, and in substance, to reflect the firestorm of criticism they had provoked.  Instead, in the preface to the revised edition of Prices and Production (1967, pp. x-xi), he wrote:

‘[D]emand’ for capital goods... does not consist exclusively or even primarily in a demand exercised on any market, but to a perhaps even greater degree in a demand or willingness to continue to hold capital goods for a further period of time.  [i.e. stock is more important than supply]  On the relationship between this total demand and the monetary demand for capital goods which manifests itself on the markets during any period of time, no general statements can be made....  [i.e. stock and supply are different things, measured in different units, and not directly related]  The simplest assumption of this kind that I could make was to assume a fixed relationship between the monetary and the total demand for capital goods so as to make the amount of money spent on capital goods during a unit period of time equal to the value of the stock of capital goods in existence.

Retaining this “simplest assumption” was a big mistake.  He should have abandoned consideration of the money spent on capital goods during a unit period of time and focused only on the stock of capital goods in existence.

This confusion persists even today.  Garrison writes, “The time dimension that makes an explicit appearance on the horizontal leg of the Hayekian triangle has a double interpretation.  First, it can depict goods in process moving through time from the inception to the completion of the production process.  Second, it can represent the separate stages of production, all of which exist in the present, each of which aims at consumption at different points in the future” (2001, p. 47).  Then, incredibly, he “resolves” this issue by putting two labels on the horizontal axis of his graph.

The problem is that most economists, not just the Hayekians, seem incapable of distinguishing between a supply, or flow, of goods and a stock of goods.  It is easy to find examples in almost any economist’s writings where the words “supply” and “stock” are used interchangeably, often in the same sentence.  Rothbard has written a long book about economics (1970), yet it is unclear whether his aggregate production structure depicts a supply or stock of goods.  Maybe, like Hayek, he means one and also the other.

Skousen is at least consistent but, unfortunately, he is consistently wrong.  He definitely means the amount of goods flowing by every year.  My work is about stock, not supply.

I assert that the stock of phenomena is more important than the supply because all of the decisions made regarding a phenomenon are based on its stock (how much of it is in existence), and not on how much of it happened to be produced in some arbitrary time period.  Phenomena are the same whether they are produced in one time period or another.  Most people do not know and none care what the supply of phenomena is, they are concerned with the stock; this week's or month's supply is only a small part of the available stock (Aguilar 1999, pp. xxxvii-xxxviii).

This is one reason why I made no mention of Skousen’s aggregate production structure.  Mainstream economists have rightly criticized Skousen for double counting.  But their GNP/GNO debate is irrelevant to a theory concerned only with stock, not supply, so I did not want to get involved.  Now, however, in an effort to reach out to the Hayekians, I propose a new statistic:  The Distribution of Wealth over the Capital Structure, DWCS.

A distribution of wealth cannot be criticized for double counting because every item is counted only once.  Durable goods are spread out over time according to their depreciation function, weighted by time-preference, so the area under it is the item’s current value.  Inventory items that do not depreciate are discounted for time-preference on the expected time until they make their contribution to final consumption.  Thus, the height of the DWCS graph at each point on the time axis is the present value of all the capital goods that are contributing to consumption at that future date.

Conceptually, the economist’s job is easy.  He can just mark everything with its present value and the time until it will contribute to consumption.  Of course, most of those numbers would be pure guesswork since they concern predictions about the future, but the concept is an easy one.

This is in contrast to Skousen’s instructions (1990, pp. 184-185), which are conceptually difficult because they require people to remember the date of an item’s manufacture and when its costs of production were paid.  Economists trained in the subjective theory of value would have trouble seeing the relevance of such information.  Admittedly, though, there is little guesswork in collecting it, provided that people have saved their receipts.

2 This seems to be the modern interpretation of Hayek’s structure of production. For example, Mulligan writes, “This paper examines the extent to which general productive activity [i.e. a flow of goods], measured by sectoral labor employment, responds to interest rates of various maturities” (2002, p. 24).

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