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Hayek on Industrial Fluctuations / Artikel mises.org

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Hayek on Industrial Fluctuations
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by Roger Garrison

[Posted May 1, 2003]

<img alt="The Mises Family Coat of Arms" src="http://www.mises.org/images/coatofarms3.gif" align="left" border="0" width="100" height="136">[img][/img] As
reported in Alan Ebenstein's recent biography (2001),"Mr. Fluctooations"
emerged as Hayek's nickname at LSE in the 1930s—because he so often used
that word, pronouncing it each time with a heavy Austrian accent. And his
lectures on industrial fluctuations were accompanied by a full complement of
graphics that depicted the economy's capital structure and the effects of
credit creation on that structure. One LSE student (Ben Higgins) lamented that
the significance of the lectures was"buried in the cumbersome three
dimensional diagrams with which Hayek presented his ideas and which made them
seem like something in the field of engineering" (Patinkin and Leith,
1978, p. 74).

Whatever became of those 3-D diagrams and the insights they
represented? Why did Hayek see the economy's capital structure as being so
central to our understanding of industrial fluctuations? Just how did his
ideas line up against those being developed by John Maynard Keynes? And why
did Hayek eventually all but abandon the research program that had so
energized him in those early years? 

The initial lectures that Hayek delivered at LSE in early
1931 set out his own understanding of Ludwig von Mises's theory of the
business cycle. These lectures, which were the basis for his being awarded the
Tooke Chair, appeared later that same year as Prices and Production.
It was a full decade later that Hayek published The Pure Theory of Capital (1941),
a long and tedious volume that incorporated some of those 3-D diagrams (such
as the one shown here from p. 197). This book was intended to provide the
theoretical undergirding for his early work on business cycles. A follow-on
volume to have been titled The Dynamics of Capital (Hayek, 1983, p.
413) was never written. It is not difficult to imagine, though, that Dynamics
would have been Prices and Production in full theoretical dress. 

After the Pure Theory, Hayek's interests shifted to
the broader issues of his day. His milestone"Economics and Knowledge"
(1937) was also a stepping stone from the economics of industrial fluctuations
to the field of political philosophy. Hayek became widely known for his 1944 Road
to Serfdom and for subsequent writings in the classical liberal tradition.
In time, all his pre-Road work became widely ignored. And if
acknowledged at all, his insights into the nature and significance of cyclical
variation were dismissively dubbed Hayek's"technical economics." 

Harsh criticisms of the early Hayek—from his adversaries,
his erstwhile defenders, and his political-science allies—are prevalent in
the literature. Keynes (1931, p. 394) referred to Prices and Production
as a"frightful muddle." Joan Robinson (1972, p. 2), referring
explicitly to the triangles that punctuated Hayek's 1931 lectures, condemned
his business cycle theory as a"pitiful state of confusion." 

Lionel Robbins, whose 1934 Great Depression was a
skillful application of Hayekian theory to the boom and bust of the interwar
period, recanted in his 1971 Autobiography (p. 154), confessing that
he would"willingly see [his 1934 book] forgotten." Commenting on
Hayek's"technical economics" during an interview (Ebenstein, 2001,
p. 81), Milton Friedman emphasizes that he is"an enormous admirer of
Hayek, but not for his economics. I think Prices and Production is
a very flawed book. I think his capital theory book [The Pure Theory]
is unreadable. On the other hand, The Road to Serfdom is one of the
great books of our time." 

Ebenstein's biography provides only a brief and unsatisfying
account of Hayek's early theorizing about business cycles. In a chapter titled
"LSE," he writes that"Hayek's basic misconception of economic
production was concerning the nature of capital" (p. 54). In a subsequent
chapter titled"Capital," Ebenstein indicates that the essential
aspect of Hayek's conception of a capital structure is that capital is
heterogeneous. He then brings this episode of Hayekian thought to an abrupt
end by noting that"If this empirical assumption of capital's
heterogeneity is false, [Hayek's] theoretical system of economic activity
falls" (p. 83). It is trivially true, of course, that homogeneous capital
would imply the absence of structure and hence the irrelevance of any theory
based on considerations of structure. 

Hayek considered it too obvious to have to prove that there
is a capital structure—a structure that can be modified but not instantly
and not costlessly. The costs of restructuring capital are easily absorbed
during a policy-induced boom when credit is cheap and profit expectations are
high. But after the bust, the costs of undoing the misallocations caused by
unduly cheap credit take the forms of business losses, bankruptcies, and
unemployment. 

Hayek's conception of the production process entails a
temporal sequence of activities that transform inputs into consumable output.
Capital of various sorts—plant and equipment, tools and machinery, raw
materials and goods in process—are put to use in the various stages of
production. The structure of capital, then, is defined in terms of this
temporal arrangement of heterogeneous capital goods. For pedagogical purposes,
Hayek divides the economy's production process into a finite number of stages,
such that the output of one stage constitutes the input of the next—with the
final stage yielding consumable output. Though simplistic, the notion of a
sequence of stages served the purpose of incorporating into his theorizing the
time element of the production process. 

This, then, is the significance of the capital structure—and
of those 3-D diagrams: Capital structure captures the time element. The
analytically simplest way to deal with production time is the Hayekian
triangle—a right triangle in which the stages of production are arrayed
along the horizontal leg and the market value of the final output is
represented by the height of the vertical leg. Capital restructuring, as might
be induced by a change in the rate of interest, is represented by a change in
the shape of the triangle. In hindsight, we might make the judgment that the
simplicity of the Hayekian triangle is its greatest virtue. 

Not long after Hayek delivered the 1931 lectures, however,
he became aware of all the modifications and qualifications that would be
required for his analytics to capture the many features of the economy's
capital structure and hence to better serve as a basis for theorizing about
the production process. But actually making those modifications and
qualifications—that is, writing The Pure Theory of Capital—did
not have the intended effect of strengthening his analytical framework; rather
it had the effect of weakening his stature and credibility on the issues of
money and business cycles. Keynes, we can imagine, could have set out to do
something similar. His Chapters 6 and 7 of the General Theory ("The
Definition of Income, Saving and Investment" and"The Meaning of
Saving and Investment") could well have been elaborated into a
book-length, pure-theory treatment complete with some very complicated
diagrams depicting all the interconnected stocks and flows. Instead, the
qualifications, nuances, and imponderables acknowledged in those chapters were
set aside in favor of the simple circular flow of income and expenditures. 

For driving home the basics of macroeconomics, simplest is
best. The time-consuming production process that lies at the root of Hayek's
analytical framework stands in stark contrast with the circular flow that lies
at the root of Keynes's. This contrast is perfectly and memorably symbolized
by the Hayekian triangle and the Keynesian circle. For Keynes, the time
element—the period of analysis—is an arbitrary accounting period,
conventionally taken to be one year. What matters for him is the relationship
within any given period between earning money and spending it. Time in a more
substantive sense comes into play only as expectations about the level of
expenditures in future periods. 

The circularity—in both the circular flow of income and
expenditures and the logic of the Keynesian system-readily lends itself to the
conclusion that expectations are self-fulfilling and that market economies are
unstable. The only two auxiliary propositions needed—both supplied by
Keynes—is that expectations about the profitability of current investment
spending are essentially baseless and that those expectations are subject to
dramatic changes. 

The Hayekian triangle has its own logic—and one very
different from that of the Keynesian circle. Hayek was able to show that the
allocation of resources among the temporally sequenced stages of production
corresponds to a particular temporal pattern of consumable output. If this
resource allocation is consistent with the preferred pattern of consumption,
then the ongoing economic activity (earning incomes by working in the various
stages and spending those incomes on final-stage output) is sustainable.
Further, ordinary market-driven movements in the rate of interest nudge the
economy towards this internally consistent and temporally sustainable pattern
of producing and consuming. The system is not inherently unstable. 

Hayek's theorizing was guided from the beginning by a
critical methodological maxim: We must first explain how an economy can
possibly work right before we can meaningfully ask what might go wrong.
Hayek's theory of industrial fluctuations respected this maxim and followed
straightforwardly as a matter of logic: If the interest rate is held below its
market, or"natural," rate by credit expansion, the decisions of
producers will be inconsistent with the preference of consumers. The economic
expansion will be unsustainable. The boom will end in a bust. Only with a
market-determined rate of interest can cyclical variations be avoided. 

The sharp difference between the Keynesian and Hayekian
frameworks would have been fairly easy for Hayek to exploit in a review of
Keynes's General Theory: Keynes's system is inherently unstable while
Hayek's system is potentially stable but particularly vulnerable to the
destabilizing pro-growth policies of the central bank. Though Hayek never
actually reviewed Keynes's book, he does in fact argue in precisely this vein
in the closing pages of his Pure Theory (p. 408), where he
recognizes that money constitutes a"loose joint" in our modern,
complex credit structure:"But the existence of such a loose joint is no
justification for concentrating attention on that loose joint and disregarding
the rest of the mechanism, and still less for making the greatest possible use
of the short-lived freedom from economic necessity which the existence of this
loose joint permits." 

Though Hayek's account of boom and bust had an essential and
compelling logic about it, his interests turned to other matters, beginning
even before the publication of his book on capital. His 1937 article is
commonly regarded as a major shift in his thinking—a shift that calls his
own earlier work on industrial fluctuations into question. An alternative
interpretation, however, is that Hayek became increasingly aware of the
significance of the methodological maxim that he had always respected and that
Keynes and many others had wantonly flouted. 

In the early LSE years Hayek was concerned with the question
of how the market process had to operate if the preferences of consumers were
to get transformed into the production plans of producers and how credit
expansion could interfere with this process. In his later writings he was
concerned with the question of how this same market process could in fact
operate even though the information on which it is based is incomplete and
dispersed throughout the economy. 

Hayek was fully aware of this second question well before
his going to LSE. In fact, by his own account (Hayek, 1994, p. 1), he was
already working with and under the influence of Mises when Mises's Socialism,
which dealt at length with the issue of economic calculation, appeared in
1922. Hayek may have believed at this early point that the economics
profession had or soon would understand the full significance of Mises's book.
His own efforts, then, could focus on the intertemporal coordination made
possible by unhampered credit markets and the intertemporal discoordination
caused by misguided bank policy. If anything, the 1937 article marks Hayek's
realization that the profession had in fact not absorbed Mises's insights at
all. Hayek's fellow economists could not appreciate Prices and Production because
they lacked a fundamental understanding of the market economy. In an attempt
to overcome this obstacle, Hayek began to deal in a more explicit way with the
coordination of individual plans on the basis of dispersed and incomplete
information. 

With this alternative interpretation, Hayek's"technical
economics" and his subsequent political philosophy can be seen as
exhibiting a certain continuity of thought—the later phase involving more
fundamental and even remedial concerns. This interpretation is consistent with
Hayek's own retrospective offered in the foreword to Gerald O'Driscoll's Economics
as a Coordination Problem: The Contributions of Friedrich A. Hayek (1977,
p. ix):

<blockquote dir="ltr" style="MARGIN-RIGHT: 0px">

"That it seems in principle possible to recast a
great part of economic theory in terms of the approach which I had found
useful in dealing with such different problems as those of industrial
fluctuations and the running of a socialist economy [is] gratifying to me....
Professor O'Driscoll has almost persuaded me that I ought to have continued
with the work I had been doing in the 1930s and 1940s rather than let myself
be drawn away to other problems which I felt to be more important." 

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However much we admire Hayek's writings in political
philosophy, we can still lament that"Mr. Fluctooations" didn't stay
the course in his efforts to provide a full-fledged alternative to the
emerging Keynesian orthodoxy.

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Roger W. Garrison is Professor of Economics at Auburn University, Auburn,
Alabama (U.S.A.) and Visiting Hayek Fellow at LSE during May/June 2003. He is
the author of Time and Money: The Macroeconomics of Capital Structure
(London: Routledge, 2001). See the Mises
Classroom for more details of his upcoming lecture series, presented in
cooperation with the Mises Institute. Click
here for the advertising poster. This essay appears in Ama-gi
(5.1), the journal of the London School of Economics Hayek Society. rgarrisn@buinsess.auburn.edu
. For more on Hayek, see his bio and
study
guide entry.

References

Ebenstein, Alan. (2001) Friedrich Hayek: A Biography.
New York: St. Martin's Press. 

Hayek, F. A. (1931) Prices and Production. London:
George Routledge and Sons, Ltd.

____. (1937)"Economics and Knowledge," Economica, vol. 4 (new
series), pp. 33-54.

____. (1941) The Pure Theory of Capital, Chicago: University of
Chicago Press.

____. (1983) Interviews:"Nobel Prize-Winning Economist Friedrich A. von
Hayek," Los Angeles: UCLA Oral History Program (spiral-bound manuscript).

____. (1994) Hayek on Hayek: An Autobiographical Dialogue, ed. by
Ste[jem Lresge amd:eof Wemar. Chicago: University of Chicago Press. 

Keynes, John M. (1931)"The Pure Theory of Money: A
Reply to Dr. Hayek," Econometrica, vol. 11 (November), pp.
387-97.

____. (1936) The General Theory of Employment, Interest, and Money.
New York: Harcourt, Brace, and Company. 

Mises, Ludwig von. ([1922] 1951) Socialism. New
Haven: Yale University Press. 

O'Driscoll, Gerald, P., Jr. (1977) Economics as a
Coordination Problem: The Contributions of Friedrich A. Hayek Kansas
City: Sheed, Andrews, and McMeel, Inc. 

Patinkin, Don and J. Clark Leith. (1978) Keynes,
Cambridge and the General Theory. Toronto: University of Toronto Press. 

Robbins, Lionel, ([1934] 1971) The Great Depression,
Freeport, N.Y.: Books for Libraries Press.

____. (1971) Autobiography of an Economist. London: Macmillan. 

Robinson, Joan (1972)"The Second Crisis in Economic
Theory," American Economic Review 62 (1-2): pp. 1-10.