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Critique of Austrian Economics

Part I:  The Legacy of Friedrich Hayek 

Section V:  Roundaboutness

Both of Böhm-Bawerk’s original contributions (the average period of production and roundaboutness) have been retained a century later and they continue to be weaknesses in the Hayekian position.

The average period of production was the topic of the previous section.  What are the weaknesses in roundaboutness?  Böhm-Bawerk (1959) was unclear (and perhaps confused himself) about the concept, making it seem that longer processes were more productive because they were longer.  In fact, processes both short and long can be productive, but the short ones have already been done because people naturally prefer to accomplish their objectives quickly.  The reason that increased savings make a people more productive is because it allows them to exploit certain productive processes (the long or “roundabout” ones) from which they had previously been excluded.  This was clear at least by 1941 when Hayek wrote:

Against this it has been rightly argued that the discovery of new, hitherto unknown, ways of producing a thing will be just as likely to shorten the duration of the process as to lengthen it.  [Roundaboutness] has nothing to do with technological progress in this sense.  On the contrary, it refers to changes under conditions where knowledge is stationary.  All that is assumed is that at any moment there are known possible ways of using the available resources which would yield a greater return than those actually adopted, but would not yield this return until a later date, and for this reason are not actually used (1975, p. 72).

Skousen seems to be clear about this, writing that “it should be noted that all technical developments involving shorter processes and higher productivity have already been undertaken by entrepreneurs.  Therefore, any new processes being considered must either involve a more lengthy period of production or be more profitable than current processes” (1990, p. 223). 

This confusion is not why roundaboutness is a weakness for post-1930 Hayekians.  A century ago, Böhm-Bawerk’s opacity (1959) had everyone going around about what he meant, but modern Hayekians seem to have this concept pretty well nailed down.  The weakness is that roundaboutness (the specificity of capital goods) is the only nail holding their theory down and they hammer on it relentlessly.  Skousen writes:

The very essence of the market economy is the specificity of capital goods.  Suppose, for the sake of argument, that all capital goods were completely non-specific and totally versatile.  This would mean that they could be transferred from one project to another at no cost.  If this were the case, there would be no structure to the economy and therefore no lags, no structural unemployment of resources or labor – in short, no business cycle.  Capital goods are specific in nature, although some are more specific in use than others.  But the degree to which producer’s goods and machinery are nonspecific – that is, usable in more than one stage – is the degree to which the economy will be flexible in adjusting to monetary disequilibrium (1990, p. 155).

Those are strong words.  It sounds as if we can refute all of Hayekian business cycle theory with one counter-example, the boom and bust of a non-specific capital good – for instance, the dot.com bubble.  Websites are capital because they are not valued directly but only as a means for obtaining the products they advertise.  The dot.coms are highly non-specific, facilitating the sale of products at every stage of production.  Non-specificity is, in fact, the great virtue of the internet.  Television and radio are only useful for consumers’ goods; yellow pages are only useful for local businesses; and trade magazines, the traditional forum for advertisers of producers’ goods, lack the convenience of surfing the net.  When one can obtain anything on the internet that one desires, from machine tools to pornography, I defy Garrison to tell us in which of his five stages (mining, refining, manufacturing, distributing and retailing) the dot.coms belong.12

Rothbard is as emphatic as Skousen: “What are the consequences [of a credit expansion]?  The new money is loaned to businesses.  (To the extent that the new money is loaned to consumers rather than businesses, the cycle effects do not occur.)  These businesses, now able to acquire money at a lower rate of interest, enter the capital goods’ and originary factors’ market to bid resources away from the other firms” (1970, p. 855). An easy counter-example is cycle effects occurring when new money is loaned to consumers.  In the 1990s, banks would make consumer loans up to 125% of the equity in people's houses. Today, foreclosures are skyrocketing and the streets are lined with "We Buy Ugly Houses" billboards.

So, has all of Hayekian business cycle theory been refuted by these counter-examples?  No, for there is still much that it can explain.  The tech boom and bust (excluding the dot.coms), for example, played out mostly according to the Hayekian script, since most tech stocks are higher-order goods.  Their theory can provide a partial explanation of business cycles.

12 The recent paper by Callahan and Garrison, Does ABCT Help Explain the Dot-Com Boom and Bust?, sounds like it might answer our question. Callahan and Garrison write, “conventional macroeconomic aggregates [e.g. the CPI and the PPI] are not the focus of our historical interpretation” (2003, p. 68). Very well. But Hayekian aggregates – the five stages defined by Garrison (2001, Figure 3.5, p. 47) – are never mentioned either. All that Callahan and Garrison really do is quote from Brenner (2002), who is apparently their only authority, and present some data correlating the Federal Funds Rate with the NASDAQ Composite. They write, “We will show Fed funds rates against the NASDAQ Composite index in these tables, since the NASDAQ is the ‘tech stock’ exchange, and most of the dot-com stocks traded on it” (2003, p. 71). Yes they did. But so did many tech stocks that can specifically be placed in one of Hayek’s higher stages. Since the people who compile stock indexes have probably never even heard of Hayek, their decision is far from definitive. I continue to ask: Can Garrison tell us in which of his five stages the dot.coms belong?

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