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The Journal of Private Enterprise 27 ( 1 ), 2011 , 9 27 Contrasting Concepts of Capital : Yet Another Look at the Hayek-Keynes Debate Steven Horwitz * St . Lawrence University Abstract I argue that the economics of Hayek and Keynes diverges most significantly not with respect to policy but in their understanding of the role of capital in a market economy , and how capital relates to issues of savings and investment . Specifically , Hayek s Austrian conception of capital provides a different , and very disaggregated , vision of the market process that can help identify the flaws in Keynesian theory and policy . Hayek s view of capital forces the economist to consider the microeconomic foundations of macroeconomic phenomena in a way that validates Hayek s complaint that Keynes s aggregates conceal the fundamental mechanisms of change . JEL Codes : B22 , B31 , E12 Keywords : Keynes ; Capital theory ; Business cycles ; Macroeconomics ; Hayek I . Introduction The Great Recession of recent years has rekindled an economic debate that first erupted around 80 years ago between future Nobel Laureate Friedrich Hayek and Lord John Maynard Keynes , perhaps the most important economist of the 20 th century . From thousands of pages of text in academic journals , popular magazines , and online , to a rap video that has been seen by more than 2 million viewers , this round of the Hayek-Keynes debate is , quite plausibly , even largerscale and more intense than the original . Much of the current conversation has focused on the ways in which the two thinkers visions of the economy were so different and thereby led to very different policy conclusions . The general idea is that Hayek had much more confidence in the self-correcting powers of markets while Keynes was more focused on the ways in which those processes could break down . In turn , the Hayekian perspective on recessions * I thank Chuck Baird and Jeff Young for comments on an earlier draft . 9
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10 S . Horwitz / The Journal of Private Enterprise 27 ( 1 ), 2011 , 9 27 has seen the boom that precedes the bust as being the period that deserves the most attention , as it is there that government manipulation of the monetary system leads to intertemporal discoordination and the mistaken investments that are eventually revealed as the boom turns to bust . Keynesians , by contrast , have devoted their energy to the bust phase of the cycle , perhaps unsurprisingly as Keynes s magnum opus was written and published during the very depths of the Great Depression . Although these differences are certainly real and meaningful , they only scratch the surface of what I will argue is the most fundamental difference between Hayek and Keynes . To understand why they disagreed on the degree to which markets were self-correcting and therefore the degree to which governments were needed and able to improve on the outcomes markets produced , we need to get behind the broad visions of self-adjustment and the role of government to their actual economics . Here too , much has been written about the very different approaches to what is now known as macroeconomics that can be found in each thinker s work . However , the differences are unlikely to be found at the level of , say , the Austrian business cycle theory as such versus the Keynesian income-expenditure model as such . Those macro models rest on very different visions of the underlying microeconomic processes . Each thinker s view of the stability of the macroeconomy is really a reflection of how each understood the coordination processes of the microeconomy . More specifically , I will argue that it is how each thinker understood , or failed to understand , the role of capital in the market economy that is at the core of their contrasting visions of the economy as a whole . These contrasting conceptions of capital are crucial for their understanding of the broader issue of whether the market is capable of generating intertemporal coordination or whether it is prone to systematic failures . Keynesianism has long believed the latter , and I will argue that Keynes s flawed view of capital can help to explain why , as well as why his view of intertemporal coordination is mistaken . Finally , I will look at how these views of capital contribute to how Hayek and Keynes saw the business cycle and especially policy during the bust phase . II . The Austrian Conception of Capital The concept of capital that underlies Hayekian approaches to the boom and bust has to be understood within the broader context of
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S . Horwitz / The Journal of Private Enterprise 27 ( 1 ), 2011 , 9 27 11 the Austrian school out of which his work emerged . Austrian capital theory begins where the Austrian school began , with Carl Menger s ( 1981 ) Principles of Economics . Specifically , it is Menger who delineated the difference between goods of the first order and goods of the higher orders .” First-order goods are those devoted to the direct satisfaction of consumer wants . Goods of the higher orders are those that contribute to the making of first-order goods . The piece of bread I eat for breakfast is a first-order good , while the flour , eggs , milk , etc . that went into making it are second-order goods . The inputs that went into making the flour or the milk ( e . g ., the milking machines at the dairy where the milk was produced ) are third-order goods , and so on . For Austrians , capital can be understood generally as any input that contributes to the production of a first-order good , either directly or indirectly . That is , capital is all of the goods of higher orders . Another way of viewing the question of what makes something capital is to see it as a matter of function . Capital is what capital does : playing a role in the plans of entrepreneurs . This observation s importance is that the same good can be capital in one situation and not another . A ham sandwich would be a consumer good and not capital if I have prepared it at home for the purpose of direct consumption . However , if I had taken that exact same sandwich , put it in a picnic basket , and then sold it in my store , it would be a capital good , as it is an unfinished element of my plan to sell complete picnic lunches . What makes the sandwich capital or not is its relationship to other goods and services and the plans of actors . It is context or , better yet , the place a good sits in the structure or network of production that determines its capital quality . The Austrian theory of capital denies that one can look at a good or service , or even a non-material asset , standing alone and determine whether or not it is capital . It is not the physical qualities of the good that make that determination but where it sits in the network of plans of actors . This is why Ludwig Lachmann ( 1956 , p . 4 ) continually refers to the structure of capital : It will be our main task in this book to study the changes which this network of capital relationships , within firms and between firms , undergoes as the result of unexpected change . To this end we must regard the stock of capital not as a homogenous aggregate but as a structural pattern . The
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12 S . Horwitz / The Journal of Private Enterprise 27 ( 1 ), 2011 , 9 27 Theory of Capital is , in the last resort , the morphology of the forms which this pattern assumes in a changing world . This emphasis on relationships and unexpected change also highlights the dynamic nature of the theory . Because being capital depends upon a good s location within a plan , it is possible , and quite likely , that the same good can serve as capital in more than one imaginable plan . Any single good has what Lachmann ( 1956 , p . 2 ) calls multiple specificity ,” which is the quality of being used in multiple but not infinite uses . What is central for the Austrian theory is that capital is not homogenous ; capital goods are not perfect substitutes for one another . Any given good can serve in only a limited number of production plans , and it is not possible to create any given production plan out of any capital goods . Goods are not infinitely substitutable , and not all goods have the requisite complementarity necessary to be part of any particular production plan . This emphasis on the heterogeneity of capital distinguishes Austrian capital theory from many of its predecessors , especially those , most obviously Knight s Crusonia plant or Solow s shmoo ,” that viewed capital as a homogenous fund of resources from which equally useful ladles could be applied to any production process . Recognizing that capital is heterogeneous in this way suggests the importance of the complementarity and substitutability of capital . When viewed as part of a production plan , the various capital inputs must fit together in order for that plan to be executed . How well various capital inputs can be fit together in this fashion is their degree of complementarity . What entrepreneurs do in constructing their plans is to integrate complementary capital inputs . In the mind of the entrepreneur at the moment the plan is put in motion , the various capital inputs are all in a complementary relationship to one another . Substitution , by contrast , is a feature of capital goods when we consider dynamic change . The plans of entrepreneurs are always constructed in a world of uncertainty and may fail to play out as intended . When plans fail to one degree or another , entrepreneurs may choose to reshuffle their capital inputs and formulate a new plan . At this point , the central question is the degree to which one capital good can substitute for another in the plan . The substitutability of capital is what matters when change is necessary .
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