Austrian Economics Reading Group Session 5 Spring 2010

I have been remiss in my chronically of the Austrian Economics Reading Group for the entire month of April. We covered two readings in each session.

In the 5th session, we covered F. A. Hayek’s second chapter of Prices and Production, which can be found here (pages 223-252); and we also covered Ludwig Lachmann’s article “Complementarity and Substitution in the Theory of Capital” found in Capital, Expectations, and the Market Process, pp. 197-213, which can be found here.

Prices and Production was originally a series of four lectures that he presented at the London School of Economics. The talks were so successful that he was hired to teach economics, which he did from 1931 until 1950.

The power of the second chapter stems from the presentation of what is sometimes called “the Hayekian Triangle.” This was not the first time an economy was depicted in this fashion. Jevons and Wicksell did it before him; and Böhm-Bawerk had also described an economy as ripening stages of capital. However, Hayek's presentation was clearer and established the triangle as an appropriate tool for analyzing the macroeconomy.

The key to the structure of production, the triangle, is that there are definite stages of production. Some things need to be produced before other things can be made. (You can’t assemble a bookcase until after the tree has been cut down.) While the stages are not time specific, nor do they have to have a certain length (of time), they do establish a sequence. Thus, the economist who uses the triangle can represent distortions to the structure of production. For example, the Austrian economist can argue that during a boom, there is a malinvestment (and an over-investment) in two stages, namely the earliest and latest stages, while there is a malinvestment (and an under-investment) in the middle stages. No other economic school has such a conception. The Real Business Cycle Theorists come close, but do not rival the sophistication of the modern Austrians.

The second article might be one of most important overlooked articles in the Austrian literature. Lachmann points out that not only are capital goods substitutable, but they are more often complements. In fact, most capital arrangements consist of complementary capital goods. For example, suppose that I have an axe to cut down the tree and a truck to haul it to the saw mill. The axe and the truck are not substitutes. This point may seem obvious, and it is. However, outside of Austrian economics, capital goods are all perfect substitutes. Capital is reduced to a letter, “K,” and then is assumed to be continuous so we can take the second derivative of it.

Unfortunately, there were no Neo-Classicals who attended that session and so we all just agreed with one another. I was hoping for some debate, but alack and alas, it was not to be.

I will soon cover the last of our Austrian Economics Reading Sessions.