===== PAGE 1 =====

THE
QUARTERLY JOURNAL

ECONOMICS

FEBRUARY, 1936

THE MYTHOLOGY OF CAPITAL

With every respect for the intellectual qualities of my
opponent, I must oppose his doctrine with all possible
emphasis, in order to defend a solid and natural theory
of capital against a mythology of capital.—E. v. Bohm-
Bawerk, Quarterly Journal of Economics, vol. xxi/2,
February 1907, p. 282.

SUMMARY

I. Professor Knight's argument, 199.— II. On some current miscon-
ceptions: 1. The investment periods and technological progress, 204;
2. They refer to factors, not products, 205; 3. The aggregate of such
periods cannot be reduced to an average, nor is measurability essential,
206; 4. The periods refer always to the future, never to the past, 208;
5. The concept does not depend on a distinction between original and
produced means of production, 209; 6. Nor is it only the original means
of production whose investment periods can be changed, 209.— III.
Professor Knight's criticism based on a misunderstanding, 210.— IV.
His own position prevents him from giving any explanation of how
the limitation of capital restricts the increase of output, 213.— V. An
erroneous assertion following from his fundamental position: the value
of capital goods when interest disappears, 222.— VI. Problems of capital
and “perfect foresight,” 225.

I

Professor Knight’s crusade against the concept of the
period of investment! revives a controversy which attracted
much attention thirty and forty years ago but was not satis-

1. The following are the main articles in which Professor Knight
has recently discussed the problem in question, and to which I shall
refer in the course of this article by the numbers given in square
brackets [ ]:

[1] Capitalist Production, Time and the Rate of Return. Economic
Essays in Honour of Gustav Cassel, London 1933, pp. 327-342.

[2] Capital Time, and the Interest Rate. Economica (new series),
vol. i, No. 3, August 1934, pp. 257-286.

199


===== PAGE 2 =====

200 QUARTERLY JOURNAL OF ECONOMICS

factorily settled at that time. In his attack he uses very
similar arguments to those which Professor J. B. Clark
employed then against Bohm-Bawerk. However, I am not
concerned here with a defense of the details of the views of
the latter. In my opinion the oversimplified form in which
he (and Jevons before him) tried to incorporate the time ele-
ment into the theory of capital prevented him from cutting
himself finally loose from the misleading concept of capital
as a definite “fund,” and is largely responsible for much of the
confusion which exists on the subject; and I have full sym-
pathy with those who see in the concept of a single or average
period of production a meaningless abstraction which has
little if any relationship to anything in the real world. But
Professor Knight, instead of directing his attack against
what is undoubtedly wrong or misleading in the traditional
statement of this theory, and trying to put a more appropri-
ate treatment of the time element in its place, seems to me to
fall back on the much more serious and dangerous error of its
opponents of forty years ago. In the place of at least an
attempt of analysis of the real phenomena, he evades the

[3] Professor Hayek and the Theory of Investment. Economic
Journal, vol. xlv, No. 177, March 1935, pp. 77-94.

In addition, certain other articles by Professor Knight which bear
closely on the subject and to some of which I may occasionally refer
may also be mentioned.

[4] Professor Fisher’s Interest Theory: A Case in Point. Journal of
Political Economy, vol. xxxix, No. 2, April 1931, pp. 176-212.

[5] Article on Interest, Encyclopaedia of Social Sciences, vol. viii,
1932, pp. 131-144.

[6] The Ricardian Theory of Production and Distribution. The

Canadian Journal of Economics and Political Science, vol. i, No. 1,
February 1935, pp. 3-25.

The classical “Austrian” position has recently been ably and lucidly
restated and defended against Professor Knight's criticism by Professor
Fritz Machlup in an article, ‘Professor Knight and the ‘Period of
Production,’ ”” which appeared, together with a Comment by Professor
Knight, in the Journal of Political Economy for October 1935. But
this as well as Professor Knight’s answer to Mr. Boulding (The Theory
of Investment Once More: Mr. Boulding and the Austrians, in the last
issue of this Journal) reached me too late to refer to them in the body
of the article. But one or two references to these latest publications
have been added in footnotes where I refer to the Comment and the
Reply to Mr. Boulding with the numbers [7] and [8] respectively.


===== PAGE 3 =====

THE MYTHOLOGY OF CAPITAL 201

problems by the introduction of a pseudo-concept devoid of
content and meaning, which threatens to shroud the whole
problem in a mist of words.

It is with profound regret that I feel myself compelled to
dissent from Professor Knight on this point, and to return his
criticism. Quite apart from the great indebtedness which all
economists must feel towards Professor Knight for his con-
tributions to economic theory in general, there is no other
author with whom I feel myself so much in agreement, even
on some of the central questions of the theory of interest, as
with Professor Knight. His masterly expositions of the rela-
tionship between the productivity and the ‘“time-preference”
element in the determination of the rate of interest? should
have removed, for all time I hope, one of the worst misunder-
standings which in the past have divided the different camps
of theorists. Under these conditions anything which comes
from him carries great weight, particularly when he attaches
such importance to it that he tries “to force his views on
reluctant minds by varied iteration.” It isnot surprising that
he has already gained some adherents to his views. But this
only makes it doubly necessary to refute what seems to me to
be a series of erroneous conclusions, founded on one basic
mistake, which already in the past has constituted a serious
bar to theoretical progress, and which would threaten to balk
every further advance in this field, if its pronouncement by an
authority like Professor Knight were left uncontradicted.

This basic mistake — if the substitution of a meaningless
statement for the solution of a problem can be called a mis-
take — is the idea of capital as a fund which maintains itself
automatically, and that, in consequence, once an amount
of capital has been brought into existence the necessity of

2. Of. particularly articles [4] and [5] quoted above.

3. Cf. H. S. Ellis, Die Bedeutung der Productionsperiode fiir die
Krisentheorie, and P. Joseph and K. Bode, Bemerkungen zur Kapital-
und Zinstheorie, both articles in Zeitschrift fiir Nationalokonomie,
vol. vi, 1935. R. Nurkse, The Schematic Representation of the
Structure of Production, Review of Economic Studies, vol. ii, 1935.

wi. Carlson, On the Notion of Equilibrium in Interest Theory, Economic
Studies, No. 1, Krakow, 1935.


===== PAGE 4 =====

202 QUARTERLY JOURNAL OF ECONOMICS

reproducing it presents no economic problem. According to
Professor Knight ‘all capital is normally conceptually, per-
petual,”’* “its replacement has to be taken for granted as a
technological detail,”’® and in consequence ‘there is no pro-
duction process of determinate length, other than zero or
‘all history,’ ’”® but ‘“‘in the only sense of timing in terms of
which economic analysis is possible, production and consump-
tion are stmultancous.”” Into the reasons why the capital
maintains itself thus automatically we are not to inquire,
because under the stationary or progressive conditions, which
alone are considered, this is ‘“axiomatic.”’® On the other
hand it is asserted that “making an item of wealth more
durable” or “using a longer period of construction,”? i.e.
lengthening the time dimension of investment in either of the
two possible ways, is only one among an ‘accurately speak-
ing, infinite number” of possible ways of investing more
capital, which are later even described as ‘really an infinite
number of infinities.””! According to Professor Knight, ‘what
the Bohm-Bawerk school’s position amounts to is simply
selecting these two details which are of the same significance
as any of an infinity of other details’? while in fact “additional
capital is involved in very different ways for lengthening the

4. [2], p. 259; a few pages later (p. 266) the treatment of capital
once invested as “perpetual” is even described as the “realistic” way
of looking at the matter.

5. [2], p- 264. At one point Professor Knight does indeed say that
“the most important fact requiring clarification is the nature of capital
maintenance’ ([3], p. 84). But instead of the patient analysis of how
and why capital is maintained, which after this we feel entitled to
expect, we get nothing but a concept of capital as a mystical entity,
an ‘integrated organic conception’ which maintains itself automati-
caily. Professor Knight does not actually use the word “automatic”
in this connection, but his insistence on the supposed fact that the
replacement of capital ‘has to be taken for granted as a technological
detail” can hardly have any other meaning but that it needs no explana-
tion in economic terms and is, therefore, from the point of view of the
economist, “automatic.”

6. [3], p. 78, cf. also [8], p. 64.

7. [2], p. 275.

8. [3], p. 84.

9. [2], p. 268.

1. [2], p. 270.

2. 2], p. 268.


===== PAGE 5 =====

THE MYTHOLOGY OF CAPITAL 203

cycle and for increasing production without this lengthen-
ing.””® “Time is one factor or dimension among a practically
infinite number, and quantity of capital may and does vary
quite independently of either of these time intervals.’’
Against this I do indeed hold that, firstly, all the problems
which are commonly discussed under the general heading of
“capital” do arise out of the fact that part of the productive
equipment is non-permanent and has to be deliberately
replaced on economic grounds, and that there is no meaning
in speaking of capital as something permanent which exists

3. [3], p. 81.

4. [6], p. 82. An attempt to clear up by correspondence at least
some of the differences between us has only had the effect of making
the gulf which divides our opinion appear wider than ever. In a letter
written after reading an earlier draft of the present paper, Professor
Knight emphasizes that he “categorically denies that there is any deter-
minate time interval’ ‘which elapses between the time when some
product might have been obtained from the available factors and the
time the product actually accrues.” This can hardly mean anything
more than either that no postponement whatever of consumption is
possible, or at least that, once such a postponement has taken place, it
is impossible to use for current consumption any of the factors which
would be needed to maintain or replace the capital goods created by the
first investment. I find it difficult to believe that Professor Knight should
want to assert either. Quite apart from the fact that such statements
would, as it seems to me, stand in flagrant contrast to all empirical
evidence, the contrary has been asserted by Professor Knight himself
as the first of “the three empirical facts that form the basis of a sound
theory of capital.” This, in his words ([2], p. 258), is ‘the simple
‘technological’ fact that it is possible to increase the volume (time rate)
of production after any interval by the use during that interval of a part
of existing productive resources — in large part the same resources
previously and subsequently used for producing ‘current consumption
income’ — to produce, instead of current consumption income, instru-
ments of agencies of various sorts, tangible or intangible, which when
produced become ‘productive’ of additional current income. This
activity or process we call investment.”” (In giving permission to quote
the above sentence from his letter Professor Knight adds: “It would
induce to clearness to add that it is my view that the interval in question
approaches determinateness as we impose stationary or given condi-
tions in a sense so rigid that such an expression as ‘might have been
obtained’ loses all meaning.” I am afraid this explanation leaves me
more perplexed than ever. As I have tried to show in the last section
of this paper, all Professor Knight’s former argument against the con-
cept of a determinate investment period depends exactly on the most
rigid static assumptions of this kind.)


===== PAGE 6 =====

204 QUARTERLY JOURNAL OF ECONOMICS

apart from the essentially impermanent capital goods of
which it consists. Secondly, that an increase of capital will
always mean an extension of the time dimension of invest-
ment, that capital will be required to bring about an increase
of output only in so far as the time dimension of investment
is increased. This is relevant, not only for the understanding
of the transition to more capitalistic methods, but equally if
one wants to understand how the limitation of the supply of
capital limits the possibilities of increasing output under sta-
tionary conditions.

This is not a dispute about words. I shall endeavor to show
that, on the one hand, Professor Knight’s approach prevents
him from seeing at all how the choice of particular methods
of production is dependent on the supply of capital, and from
explaining the process by which capital is being maintained
or transformed, and that, on the other hand, it leads him to
undoubtedly wrong conclusions. Nor does this discussion
scem necessary solely because of the objections raised by
Professor Knight. In many respects his conclusions are
simply a consistent development of ideas which were inherent
in much of the traditional treatment of the subject,’ and
which lead to all kinds of pseudo-problems and meaningless
distinctions that have played a considerable rdle in recent
discussions on the business cycle.

II

Before I can enter upon attempting to refute Professor
Knight’s assertion, it is necessary to dispose of certain pre-
liminary matters. There are certain ideas which Professor
Knight and others seem to associate with the view I hold but
which in fact are not relevant to it. I do not want to defend
these views but rather to make it quite clear that I regard
them as erroneous. Practically all the points to which I now
call attention were either implicitly or explicitly contained in

5. For an effective criticism of related earlier views cf. particularly

F. W. Taussig, Capital, Interest and Diminishing Returns, in this
Journal, vol. xxii, May 1908, pp. 339-344.


===== PAGE 7 =====

THE MYTHOLOGY OF CAPITAL 205

that article of mine which Professor Knight attacks.® As he
has chosen to disregard them, it is necessary to set them out
in order.

(1) It should be quite clear that the technical changes
involved, when changes in the time structureof production are
contemplated, are not changes due to changes in technical
knowledge. The concept of increasing productivity due to
increasing roundaboutness arises only when we have to deal
with increases of output which are dependent on a sufficient
amount of capital being available, and which were impossible
before only because of the insufficient supply of capital. This
assumes in particular that the increase of output is not due
to changes of technical knowledge. It excludes any changes
in the technique of production which are made possible by
new inventions.

(2) It is not true that the periods which it is contended
are necessarily lengthened when investment is increased are
periods involved in the production of a particular type of
product. They are rather periods for which particular factors
are invested, and it would be better for this reason if the term
“period of production” had never been invented and if only
the term “period of investment” were used. To give here
only one example: it is not only conceivable, but it is probably
a very frequent occurrence that an increase in the supply of
capital may lead not to a change in the technique of produc-
tion in any particular line of industry, but merely to a transfer
of factors from industries where they have been invested for
shorter periods to industries where they areinvested for longer
periods. In this case the periods for which one has to wait
for any particular type of product have all remained unal-
tered, but the periods of investment of the factors that have
been transferred from one industry to another have been
lengthened.”

6. On the Relationship between Investment and Output, Economic
Journal, June, 1934, cp. particularly p. 212, note 1, and p. 226 for point

(2), p. 217 for (3), p. 210, note 1, and p. 227 for (4), p. 230, note for (5),
and p. 228 for (6).

7. A similar case is that where an addition to the supply of capital
makes it possible to employ factors (say labor) which before were


===== PAGE 8 =====

206 QUARTERLY JOURNAL OF ECONOMICS

(3) It is not proposed, and is in fact inadmassible, to reduce
the description of the range of periods for which the different
factors are invested to an expression of the type of a single lime
dimension such as the average period of production. Professor
Knight seems to hold that to expose the ambiguities and
inconsistencies involved in the notion of an average invest-
ment period serves to expel the idea of time from capital
theory altogether. But it is not so. In general it is sufficient
to say that the investment period of some factors has been
lengthened, while those of all others have remained un-
changed; or that the investment periods of a greater quantity
of factors have been lengthened than the quantity of factors
whose investment periods have been shortened by an equal
amount; or that the investment period of a given quantity of
factors has been lengthened by more than the investment
period of another equal amount has been shortened. It is true
that in some cases (e.g. when the investment period of one
factor is shortened, and at the same time the period for which
a greater quantity of another factor is invested is lengthened
by a smaller interval) the determination of the net effect of
the changes of the investment periods of different factors in
unemployed. The first question to ask here is how exactly is it that an
increase of capital makes their employment possible. We shall have to
assume that without this capital the marginal product of this labor
would have been lower than the wage at which they would have been
willing to work. In what sense can it now be said that an increase of
their marginal product is conditional upon more capital becoming
available, i.e. why was it impossible, without this increase of capital, to
employ them in the more productive processes? 1 cannot see that the
necessity of previous accumulation can mean anything but an increase
of the periods for which either the factors immediately concerned, or
some other factors employed in providing the former with equipment,
are invested.

In the traditional exposition of the theory of roundabout production
this case, where only total capital, but not necessarily capital per head
of those employed, has been increased, has been taken account of by
saying that the average period of production (i.e. the average period for
which the labor actually employed is invested) will only increase when
capital per head increases, but will remain constant when capital is
increased by an extension of its “labor dimension’ instead of its ‘time
dimension.” Altho this mode of expression is sometimes useful, I think

it has to be abandoned together with the concept of the average period
of production.


===== PAGE 9 =====

THE MYTHOLOGY OF CAPITAL 207

different directions raises problems which cannot be so easily
answered. But the concept of the average period, which was
introduced mainly to solve this difficulty, does not really
provide a solution. The obstacle here is that the reinvest-
ment of accrued interest has to be counted equally as the
investment of an amount of factors of corresponding value for
the same period. In consequence the only way in which an
aggregate of waiting can be described, and the amount of
waiting involved in different investment structures can be
compared, is by means of a process of summation, in the form
of a double integral over the function describing the rates, at
which the factors that contribute to the product of any
moment are applied, and at which interest accrues.

It should, however, be especially noted that the assertion
that it is conceptually possible to conceive of the aggregate
capital of a society in terms of possible waiting periods does
not mean that the total period of production (or the aggregate
of all periods of production) of an economic system is neces-
sarily a phenomenon capable of measurement. Whether this is
the case (and in my opinion it is very unlikely) is altogether
irrelevant for the problem at issue. What is essential is solely
that whenever a change occurs in any part of the economic
system which involves that more (or less) capital is used in the
industry or industries concerned, this always means that some
of the factors used there will now bring a return only after a
longer (or shorter) time interval than was the case in their
former use. As Professor Knight himself rightly says, ‘the
rate of interest which determines the value of all existing
capital goods is determined exclusively at the margin of
growth, where men are comparing large, short segments of
income flow with thinner streams reaching out to the indefi-
nite future.” It is at this margin of growth (of every indi-

8. [2], p. 278. Cp. also [8], p. 45. The disagreement here concerns
the question whether it is true that men directly and irrevocably
exchange ‘short segments of income flow” against “thinner streams
reaching into the indefinite future” or whether it is not essential to take
into account that the immediate result of the sacrifice of present income

is an equally limited income flow of a different time shape which must be
clearly defined as regards size and shape in order to make it possible to


===== PAGE 10 =====

208 QUARTERLY JOURNAL OF ECONOMICS

vidual firm and industry) where the extensions of investment
occur and where the decisive question arises whether the
productivity of investment is a function of time and whether
the limitation of investment is a limitation of the time we are
willing or able to wait for a return.?®

(4) It is quite erroneous to regard propositions concerning
the greater productivity of roundabout methods as depend-
ing upon the possibility of identifying the contribution of the
“original” factors of the remote past. In order to be able to
give an intelligible description of a continuous stationary
process in which factors are invested at any one moment,
some of whose products will mature at almost any later
moment, one of two methods is possible. Either we can con-
centrate on all factors invested in any one interval, and relate
them to the stream of product derived from it. Or we can
concentrate on the product maturing during a short interval,
and relate it to the factors which have contributed to it. But
whichever of the two methods we select, in all cases only the
Julure tvme intervals between the moments when the factors
are, or will be invested, and the moment when the product
will mature are relevant, and never the past periods which have
elapsed since the investment of some “original factors.” The
theory looks forward, not back.l
decide in the particular case whether the sacrifice is justified. And this
limited income stream which is the result of the first investment becomes
a permanent income stream only by an infinite series of further decisions
when the opportunity of consuming more now and less in the future
has to be considered every time. By jumping directly to the desired
result, the permanent income stream, Professor Knight slurs over so
much that is essential for an understanding of the process that any use
of his concept of capital for an analysis of the rdle of this capital in the
course of further changes becomes quite impossible.

9. As Professor Knight now admits “that in so far as any single
investment, negligible in size in comparison with the economic system
of which it is a part, represents things consumed and reproduced in a
regular cycle, the quantity of capital in that investment does bear a
mathematical relation to the length of the cycle’”’ and that in this con-
nection some of his “previously published statements have been too
sweeping,” there is perhaps some hope that ultimately some sort of
agreement can be reached along these lines. (Cf. [7], p. 627.)

1. In so far as Professor Knight’s aim is merely to drive out the
remnants of a cost-of-production theory of value which still disfigure


===== PAGE 11 =====

THE MYTHOLOGY OF CAPITAL 209

(5) It is equally erroneous to regard the theory as depend-
ing on any distinction between ‘original’ or ‘primary’ and
produced means of production. It makes no fundamental dif-
ference whether we describe the range of investment periods
for all factors existing at the beginning of the period,? or
whether we just describe the range of periods for which those
services of the permanent factors are invested that only
become available for investment at successive moments as
they accrue. I think it is more convenient to use the second
method, and to describe the investment structure by what I
have called the investment function of the services of these
permanent factors. But whether this distinction — which is
based on the fact that some of the productive resources have
to be deliberately replaced, while others are regarded as not
requiring replacement on economic grounds — is accepted
or not, in no case is a distinction between ‘primary’ or
“original” and ‘produced’ means of production necessary
in order to give the concept of the investment function a
definite sense.

(6) Last and closely connected with the preceding point,
it is not necessarily the case that all ‘intermediate products’
or “produced means of production’ are highly specific, and
many expositions of the theory of capital (cf. [8], p. 45) I am all with
him. But while I fully agree that there is no necessary connection
between the present value of capital and the volume of past investment,
I do maintain that there is a very close connection between the present
and anticipated future values of capital on the one hand and the periods
for which resources are invested at present on the other.

2. A peculiar confusion in this respect occurs in the article of Miss
Joseph and Mr. Bode quoted above (p. 174) where it is asserted that if
all existing productive resources were taken into account, the period of
production would ‘of course’”’ become zero. It is true that the impossi-
bility of drawing a fundamental distinction between the ‘original fac-
tors” and the ‘intermediate products’ is one of the considerations which
invalidate the construction of an “average” period of production. But
whether we describe the investment structure by an expression repre-
senting the rate at which the product of all resources existing at any one
moment will mature during the future, or by an expression representing
the rate at which the marginal additions will mature which are due to the
services of the permanent factors applied at that moment, is merely a
difference of exposition. As will be easily seen, the former is simply the
integral of the latter and can be represented by the area of the figure
which is bounded by the investment curve which represents the latter.


===== PAGE 12 =====

210 QUARTERLY JOURNAL OF ECONOMICS

that in consequence any change in the investment structure
can only be brought about by investing the “original” fac-
tors for longer or shorter periods. This seems frequently to
be implied in analysis which follows Bohm-Bawerkian lines.
But of course there is no reason why it should be true. The
periods for which non-permanent resources are being invested
are as likely to be changed as the periods of investment of the
services of the permanent resources.

III

Most of the critical comments in Professor Knight’s
articles are due to misunderstandings of one or more of these
fundamental points. But while each of them seems to be the
source of some confusion, probably none was in this respect
quite as fertile as number two. The idea that lengthening the
process of production must always have the result that a par-
ticular kind of product will now be the result of a longer
process, or that a person who invests more capital in his
enterprise must therefore necessarily lengthen the period of
production in this business, seems to be at the root of his
assertion that capital can be used otherwise than to lengthen
the time dimension of investment, as well as of his statement
that I have practically admitted this.

As a proof of the former contention Professor Knight cites
a single concrete example, taken from agriculture. ‘Taking
population as given,” he writes,* “raising more plants of the
same growth period will also require more ‘stock,’ but well not
affect the length of the cycle, while the addition to total pro-
duction of varieties of shorter growth, say yielding two har-

3. It is perhaps necessary, in order to forestall further misunder-
standings, to add as point (7) the main conclusion of the article of mine
which Professor Knight attacked. It is that the periods of investment
are not in all cases given as technical data but can in many instances
only be determined by a process of value-imputation. This is particu-
larly true in the case of durable goods, where the technical data only
tell us how long we have to wait for a particular unit of its services, but
not to what share of the factors invested in it this unit has to be attrib-
uted. This attribution, however, involves an imputation purely in

value terms.
4. [3], p. 81.


===== PAGE 13 =====

THE MYTHOLOGY OF CAPITAL 211

vests per year instead of one, will involve an increase of
capital while shortening the average cycle.” Unfortunately
Professor Knight only adds that “additional capital is
invelved in very different ways for lengthening the cycle and
for increasing production without this lengthening,” but does
not tell us how exactly the additional capital is used for
increasing production otherwise than by lengthening the
period for which some resources are invested. If he had
stopped to inquire he would soon have found that even in the
cases where his quite irrelevant “cycle” of the particular
process remains constant, or is actually shortened, additional
capital will be used in order to invest some resources for
longer periods than before, and will only be needed if this is
the case.

As Professor Knight has not stated why, in his example,
either of the two new methods of cultivation will only be
possible if new capital becomes available, it will be necessary
to review the different possibilities which exist in this respect.
Changes in technical knowledge must clearly be excluded and
apparently Professor Knight also wants to exclude changes
in the amount of labor used, altho it is not quite clear what
the assumption “taking population as given’ exactly means.
If it is to mean that the quantity of all labor which con-
tributes in any way to the product is assumed to be constant,
and to be invested for a constant period, it is difficult to see
how, with unchanged technical knowledge, they should sud-
denly be able to raise more plants and to use more capital.
There seem to be only three possibilities, and all of them
clearly imply a lengthening of the period for which some of
the factors are invested.

(1) It may be assumed that the additional capital is used to buy
instruments, etc., which are now made by people who were before
directly employed in raising the crop;

(2) or it may be used to buy instruments to be made by people who
before were employed to produce something else and have been attracted
to making instruments, and thereby contributing to the output in
question, by the new capital which has become available for the instru-
ments;

(3) or that the additional capital is used to employ additional people.


===== PAGE 14 =====

212 QUARTERLY JOURNAL OF ECONOMICS

Case (1) clearly contradicts the assumption that the peri-
ods for which the units of the given labor forces are invested
are not lengthened, since the amount of time that will elapse
between the making of the instrument and the maturing of
the crop will clearly be longer than the period which elapses
between the direct application of labor in raising the crop and
its maturity. Cases (2) and (3) seem to be in conflict with
the assumption of constant population. But in these cases,
too, an increase of stock in society will only take place if the
labor drawn to this particular line of production from else-
where is now invested for a longer period than before. (I take
it for granted here that additional capital means capital
newly saved, and not merely transferred from elsewhere,
since nobody, of course, wants to contend that a mere transfer
of capital from one line of industry to another, which is
accompanied by a similar transfer of the labor for whose
investment the capital is required, need lead to an extension
of the period for which any resources are invested.) Only if
the labor which is now drawn to the process in question has
before been invested for shorter periods than it will either
in producing agriculture implements (case (2)), or in directly
raising the crop (case (3)), will its diversion to the new use
cause a temporary gap in the stream of consumable income,
which will fall short of the value of the current services of the
factors of production, and therefore require some saving or
“new capital.”

In Professor Knight’s second case, that of additional pro-
duction of shorter duration, he has again neglected to state
why this should only become possible if additional capital
becomes available. For the same reasons it seems to me to
follow that this new production can be dependent on a new
supply of capital coming forward only if the other factors
required have before been invested for shorter periods.

Evidently this example in no way proves that a case is
conceivable where additional capital is used without having
the effect of lengthening the investment period of some factor

5. Tam afraid I am unable to see to what case the sentence in the same
paragraph beginning with ‘in the third case’ refers.



===== PAGE 15 =====

THE MYTHOLOGY OF CAPITAL 213

Yet this example is the only thing in Professor Knight’s
article which even attempts a demonstration of his main thesis.

The same failure to see the point here involved at all leads
Professor Knight also to misinterpret completely a statement
of my own, and to describe it “as very nearly a ‘give away,’ ”’
while in fact it simply refers to this case, where the length-
ening of the investment structure is brought about not by
lengthening any particular process (choosing a more time-
consuming technique in the production of a particular prod-
uct) but by using a greater share of the total factors of pro-
duction than before in the relatively more time-consuming
processes. What I actually said was, that a fall in the rate of
interest would lead to the production of a greater quantity of
durable goods, and that — explaining this further — “more
goods (or, where possible, more durable goods) of the kind will
be produced simply because the more distant part of the
expected services will play a greater role in the considerations
of the entrepreneur and will lead him to invest more on
account of these more distant returns.” Even if this state-
ment was not very fortunately phrased® it should have been
evident to anyone who has ever made an effort to understand
the different ways in which extensions in the time dimension
of investment may take place that it referred to the case
where the periods for which particular factors are invested is
being lengthened in consequence of their transfer from a less
to a more capitalistic process of production. The production
of more goods of the same (relatively durable) kind does
therefore mean a change in the investment function for
society as a whole in the direction of lengthening the time
dimension of production.

IV

More serious than these misunderstandings about what the
“period of production’ analysis implies is the failure to see

6. My meaning would have been expressed better if, instead of
speaking of the production of more goods of the kind, I had said “a
greater quantity of the relatively more durable goods will be produced,”
or “goods of still greater durability made in place of those produced
before.”


===== PAGE 16 =====

214 QUARTERLY JOURNAL OF ECONOMICS

that without such an analysis no answer whatever can be
given to the fundamental question: how the limitation of the
available capital limits the choice among the known methods
of production. This question is closely connected with the
further problem, whether, and in what sense, the non-
permanent resources existing at any one moment can be
regarded as one homogeneous factor of determinate magni-
tude, as a “fund” of definite size which can be treated as a
given datum in the sense in which the “supply of capital” or
simply the “existing capital” is usually treated.

It is necessary first to say a few words about the reason why
it is only in connection with the non-permanent resources
that the problems which can properly be called problems of
capital arise. The very concept of capital arises out of the
fact that, where non-permanent resources are used in pro-
duction, provision for replacement of the resources used up
in production must be made, if the same income is to be
enjoyed continually, and that in consequence part of the gross
produce has to be devoted to their reproduction. But the
fact that it may be regarded as the “normal” case that
people will do so, with the aim of obtaining the same income
in perpetuity, does not mean that therefore capital itself
becomes in any sense perpetual. On the contrary the very
problem of capital accounting arises only because, and to the
extent that, the component parts of capital are not perma-
nent, and it has no meaning, in economic analysis, to say that
apart from the human decision, which we have yet to explain,
the aggregate of all the non-permanent resources becomes
some permanent entity. The problem is rather to say how
the existence of a given stock of non-permanent resources
makes possible their replacement by newly produced? instru-

7. I am afraid I feel compelled to disregard the special meaning which
Professor Knight wants to attach to the term production. A concept
of production which would compel us to say that a man engaged in the
production of some instrument which is to replace some similar existing
instrument, and which at some time in the future will contribute to the
satisfaction of a desire, either produces not at all or produces not the
final product in whose manufacture the instrument he makes is actually

used, but a similar product which is consumed at the moment when he
applies his labor to the instrument, seems to me an absurd abuse of


===== PAGE 17 =====

THE MYTHOLOGY OF CAPITAL 215

ments, and at the same time limits the extent to which this
can be done.® And this raises the question in what sense
these different capital goods can be said to have a common
quality, a common characteristic, which entitles us to regard
them as parts of one factor, one “fund,” or which makes
them to some extent substitutable for each other. What
creates the identity which makes it possible to say that one
capital good has been effectively replaced by another one, or
that the existence of the one makes its replacement by
another possible? What is that medium thru which the sub-
stance, commonly called capital in the abstract, can be said
to be transformed from one concrete form into another? Is
there such a thing, as is implied in the habitual use of terms
by economists? or is it not conceivable that the thing which
they all have in mind is that condition affecting the pos-
sibilities of production which cannot be expressed in terms of
a substantive quantity?

Altho Professor Knight rather overstresses the case where
a stock of capital goods is maintained by the preservation or
replacement of the same items, his assertion that capital is
permanent is of course not based on this assumption. The
crucial case on which its meaning must be tested, and the
words. But it is on this ‘“‘ concept” and nothing else that the assertion
that production and consumption are simultaneous is based (like J. B.
Clark’s theorem of the ‘synchronization’ of production and con-
sumption).

8. On the general subject of the amortization of capital Professor
Knight is not only rather obscure but his different pronouncements are
clearly inconsistent. In [2], p. 273 he writes: ‘In reality most invest-
ments not only begin at a fairly early date to yield their income in
consumable services . . . but in addition they begin fairly soon to yield
more than interest on cost in this form, and entirely liquidate themselves
in a moderate period of time. This additional flow of consumable services
is ordinarily treated as a replacement fund, but is available for consump-
tion or for reinvestment in any form and field of use at the will of the
owner.” But in [3], p. 83, in order to support his thesis about the per-
petuity of capital, this periodic liquidation is denied: “It cannot now
escane observation that ‘capital’ is an integrated, organic conception,
and the notion that the investment in a particular instrument comes
back periodically in the form of product, giving the owner freedom to

choose whether he will re-invest or not, is largely a fiction and a
delusion.”


===== PAGE 18 =====

216 QUARTERLY JOURNAL OF ECONOMICS

only case where the question arises whether capital as some-
thing different from the individual instruments is permanent
at all, is the case where capital goods that are worn out are
replaced by capital goods of a different kind, which in many
cases will not even help to produce the same services to the
consumer but will contribute to render altogether different
services. What does the assertion that the capital is perma-
nent mean here? It must evidently mean more than that
there will always be some capital in existence. If it has any
sense it must mean that the quantity of capital is kept con-
stant. But what is the criterion which determines whether
the new capital goods intended to replace the old ones are
exactly their equivalent, and what assures us that they will
always be replaced by such equivalent quantities?

To these questions Professor Knight provides no answer,
but, altho admitting that he has no exact answer, postulates
that the idea must be treated as if it had a definite meaning
if we are to get anywhere. ‘The notion of maintaining any
capital quantitatively intact” he writes,® ‘cannot be given
exact definition; but this limitation applies to all quantitative
analysis in economics, and the notion itself is clear and indis-
pensable, and measurement, even, is fairly accurate.”

Now, as I have tried to show in considerable detail in
another place,! the notion of maintaining capital quanti-
tatively intact, far from being either clear or indispensable,
presupposes a behavior of the capitalist-entrepreneurs which
under dynamic conditions will sometimes be impossible and
rarely reasonable for them to adopt. To assume that under
changing conditions capital will be maintained constant in
any quantitative sense is to assume something which will
never happen and any deductions derived from this assump-
tion will therefore have no application to anything in the
real world.

In some places?’ Professor Knight does, it is true, come

9. [3], p- 90. Footnote.

1. The Maintenance of Capital. Economica, August 1935.

2. [3], p. 86, note: “Wealth, which is identical with capital, can be

treated quantitatively only by viewing it as capacity to render service.”
Also [2], p. 267: “As long as capital is maintained by replacing the


===== PAGE 19 =====

THE MYTHOLOGY OF CAPITAL 217

somewhat nearer a realistic assumption by stating that what
people aim to maintain constant is not some physical or
value dimension of capital, but its ‘capacity to render
service.” But even accepting this assumption it proves in
no way that people will also always be capable of maintain-
ing this capacity to render service, and, what is more impor-
tant, it does not in any way help us to explain in what way
this “capacity to render service’ is limited, why and how it
1s possible to transfer it from one concrete manifestation in a
capital good into another one. It still leaves us with the
impression that there is a sort of substance, some fluid of
definite magnitude which flows from one capital good into
another, and it gives us no indication of the set of conditions
which actually at any given moment allows us to maintain
output at a particular figure.

The fact that we possess at any one moment, in addition to
those natural resources which are expected to render services
permanently without any deliberate replacement, an amount
of non-permanent resources which enable us to consume more
than we could if only the former were available, will help us
to maintain consumption permanently above this level only
if by investing some of the services of the permanent resources
for some time they will bring a greater return than they
would have given if they were used for consumption when
they first became available. If this were not the case no
existing quantity of ‘capacity to render service’ in a non-
permanent form would enable us to replace it by some new
instruments with the same capacity to render service. We
capital goods, of their life is limited, by others of any form with equal
earning capacity in imputed income . . .”’

3. Professor Knight, however, by no means consistently adheres to
this view. The idea that the quantity of capital which is to be regarded
as ‘perpetual’ is a quantity of value occurs again and again. He says,
for example, that ‘there is ‘of course’ no product yielded by an agency
until after full provision has been made for maintaining it, or the invest-
ment in it, intact, tn the value sense.” ([2], p. 280.) And similarly, a few
pages later (p. 283): “New investments represent additions to all the
investment previously made in past time. The amount of such invest-
ment cannot indeed be stated quantitatively in any other way than as

the capitalized value of existing income sources under existing con-
ditions.”


===== PAGE 20 =====

218 QUARTERLY JOURNAL OF ECONOMICS

might spread the use of the services of these non-permanent
factors over as long a period as we like, but after the end of
this period no more would be available for consumption than
could be obtained from the current use of the permanent
services.

That actually we are able to replace the ‘‘capacity to
render service’ represented by the non-permanent resources,
and by doing so maintain income permanently higher than
what could be obtained from the permanent services only, is
due to the two facts: first, that the existence of the non-
permanent resources allows us to forego for the present some
of the services of the existing resources without reducing con-
sumption below the level at which it might have been kept
with the permanent resources only, and, second, that by
investing certain factors for some time we get a greater prod-
uct than we would have otherwise got from them. Both
these factors, the extent to which any given stock of non-
permanent resources enables us to ‘“wait’’ and the extent to
which investment enables us to increase the product from the
factors invested, are variable. And it is for this reason that
only a very detailed analysis of the time structure of pro-
duction, of the relationship between the periods for which
individual factors have been invested and the product derived
from them, can help us to understand the forces which direct
the use of the current resources for the replacement of capital.

By stressing this relationship the period-of-production
analysis (and to some extent already the older wage-fund
and abstinence theories) introduced an element into the
theory of capital without which no understanding of the
process of maintenance and transformation of capital is pos-
sible. But the idea was not sufficiently worked out to make
it quite clear how exactly the existence of a given stock of
capital goods affected the possibilities of renewed investment.
The Bohm-Bawerkian theory in particular went astray in
assuming, with the older views that Professor Knight now
wants to revive,* that the quantity of capital (or the “pos-

4. [8], p. 57: “The basic issue is the old and familiar one of choice
between two conceptions of capital. In one view, it consists of ‘things’


===== PAGE 21 =====

THE MYTHOLOGY OF CAPITAL 219

sibility to wait’’) was a simple magnitude, a homogencous
fund of clearly determined size. The particular assumption
made by Béhm-Bawerk and his immediate followers, which
may have some justification as a first approximation for
didactic purposes, but which is certainly misleading if it is
maintained beyond the first stage, is that the existing stock
of capital goods corresponds to a fixed quantity of consumer’s
goods and is therefore, on the further assumption of a given
rate of consumption, uniquely associated with a definite
total or average waiting period which it makes possible. The
basis of this assumption was apparently the idea that every
existing capital good was completely specific in the sense
that it could be turned into only one particular quantity of
consumers’ goods by a process which could in no way be
varied. On this assumption any present stock of capital
could, of course, be regarded as equivalent to one, and only
one, quantity of consumers’ goods which would become
available over a fixed period of time at a predetermined and
invariable rate. This simplified picture of the existing stock
of capital representing a ‘‘subsistence fund’ of determined
magnitude which would provide a support for a definite
period and therefore enable us to undertake production
processes of a corresponding average length is undoubtedly
highly artificial and of little use for the analysis of more
complicated processes.

Actually the situation is so much more complicated and
requires a much more detailed and careful analysis of the
time element because any existing stock of capital goods is
not simply equivalent to a single quantity of consumers’
goods due to mature at definitely fixed dates, but may be
turned by different combinations with the services of the
permanent factors into a great many alternative streams of
consumers’ goods of different size, time-shape and composi-
of limited life which are periodically worn out or used up and repro-
duced; in the other, it is a ‘fund’ which is maintained intact tho the
things in which it is invested may come and go to any extent. In the
second view, which of course is the one advocated here, the capital

‘fund’ may be thought of as either a value or a ‘capacity’ to produce a
perpetual flow of value.”


===== PAGE 22 =====

220 QUARTERLY JOURNAL OF ECONOMICS

tion. In a sense, of course, capital serves as a ‘subsistence
fund,” but it is not a fund in the sense that it provides sub-
sistence for a single uniquely defined period of time. The
question which of the many alternative income streams
which the existing stock of capital goods potentially repre-
sents shall be chosen will depend on which will best combine
with the services of the permanent factors which are expected
to become available during the future — best in this context
meaning that it will combine into a total stream of the
most desired time-shape. The role of the existing capital
goods in this connection is that they fill the gap in the income
stream which would otherwise have been caused by the
investment of resources which might have been used to
satisfy current needs. And it is only by making their invest-
ment for these periods possible that those resources will yield
a product sufficient to take the place of the products rendered
in the meantime by the already existing capital goods. But
there 1s mo other ‘‘identity” between the mow existing capital
goods and those that will take their place than that the results of
current investment, which leads to the creation of the latter,
dovetail with one of the potential income streams, which the
former are capable of producing, into a total income stream
of desired shape. And what limits the possibility of increas-
ing output by investing resources which might serve current
needs is again nothing but the possibility of providing in the
meantime an income ‘‘equivalent’ to that which will be
obtained from the investment of current resources. (‘“Equi-
valent,” strictly speaking, means here, not equal, but suffi-
ciently large to make it worth while to wait for the increased
return that will be obtained from the invested resources
because of their investment.)

It should be clear that an analysis of this effect of the
existence of capital goods on the direction of the investment
of current resources is possible only in terms of the alterna-
tive time structures of production which are technically
possible with a given equipment. What makes this analysis
so particularly difficult, yet the more necessary (and at the
same time lets the traditional approach in terms of an aver-


===== PAGE 23 =====

THE MYTHOLOGY OF CAPITAL 221

age investment period appear so hopelessly inadequate except
as a first approach), is the fact that the existing capital goods
do not represent a particular income stream of unique shape
or size (as would be the case if it consisted of goods which
were completely ‘““specific’’) but a great number of alterna-
tive contributions to future income of different magnitude
and date. Nothing short of a complete description of these
alternative time-shapes can provide a sufficient basis for the
explanation of the effect of the existence of the capital goods
on current investment and, what means the same thing, of
the form and quantity of the new capital goods that will
replace the old ones.

In this article no positive attempt can be made to provide
the technical apparatus required for a real solution of these
problems. Apart from the particular aspect which I have
discussed in the article which Professor Knight attacked,
this task must be reserved for a more systematic study. I
may mention that most of the serious difficulties which this
analysis presents are due to the fact that it has to deal largely
with joint-product and joint-demand relationships between
goods existing at different moments of time. For the present
discussion the task has been only to demonstrate why such
an analysis of the time structure is necessary and why no
description of capital in terms of mere quantity can take its
place. The main fault of the traditional analysis in terms
of the period of production was that it tried to argue in terms
of a single time dimension in order to retain the connection
to the conventional but misleading concept of capital as a
definite fund. But it has at least the merit of stressing that
element in terms of which the real relationship can be
explained.

All the other attempts to state the assumptions as regards
the supply of capital in terms of a definite fund and without
any reference to the time structure, whether this is attempted
by postulating given quantities of ‘“waiting,” or “capital
disposal,”’® or a ‘subsistence fund,” or ‘true capital,” or

5. It is not surprising that Professor G. Cassel, to whom we owe this
particular version of the mythology of capital, should now have joined


===== PAGE 24 =====

222 QUARTERLY JOURNAL OF ECONOMICS
‘“carrying powers,” are just so many evasions of the real
problem of explaining how the existence of a given stock of
capital limits the possibility of current investment. Without
such an analysis they are just so many empty words, harm-
ful as the basis of that noxious mythology of capital which by
creating the fiction of a non-existing entity leads to state-
ments which refer to nothing in the real world. And the con-
cept of capital conceived as a separate factor of determinate
magnitude which is to be treated on the same footing with
“land” and ‘“‘labor’’ belongs to the same category.® It is no
better to say, as Professor Knight did at an earlier stage,
that ‘“time as such” is a factor of production,” since no
definite ‘‘ quantity’ of time is given in a way which would
enable us to distribute this “fund” of time in alternative
ways between the different lines of production so that the
total of ‘time’ used will always be the same. But it is cer-
tainly much worse to attempt, as Professor Knight does now,
to eliminate time entirely from the analysis of the capitalist
process of production. This inevitably prevents him from
giving any answer to the question how the limitation of
capital limits the possible size of the product and why and
how capital is maintained, and compels him to treat this as
a datum. And, as we shall see in the next section, it also leads
him into positive errors about the function of interest.

A

How the neglect of the fundamental fact that capital con-
sists of items which need to be reproduced, and that these

forces with Professor Knight. Cf. his book On Quantitative Thinking
in Economies, Oxford, Clarendon Press, 1935, p. 20.

6. If, as seems generally to be the case, one can never be certain that
one will not be carried away occasionally by the construction of a
quantitatively fixed “fund” which undoubtedly attaches to the term
capital, it would probably be advisable to follow Professor Schumpeter’s
suggestion and avoid the use of the term altogether. (Cf. article
Kapital, in Handworterbuch der Staatswissenschaften, 4th ed., 1923,
vol. v, p. 582.)

7. [4], p. 198: “It has long been my contention that the best form of
statement to indicate the essential fact on the technical side is simply
to say that time as such is a factor of production—the only really dis-
tinct, homogeneous ‘factor,’ as a matter of fact.”


===== PAGE 25 =====

THE MYTHOLOGY OF CAPITAL 223

serve as capital only in so far as and to the extent that their
existence is a condition for taking advantage of more pro-
ductive time-consuming methods, led to the most erroneous
conclusions is well illustrated by Professor Knight’s remark-
able assertion that ‘‘the rate of interest could be zero only
if all products known, empirically or in imagination, into the
creation of which capital in any way enters, were free goods.”’
This statement seems to me to be about as plausible as if it
were asserted that the price of air could fall to zero only if
all commodities in the production of which the presence of
air were an indispensable condition were free goods. Clearly,
unless one of several factors cooperating in the production of
a number of goods can be substituted for the others without
limit, the fact that this one factor becomes a free good will
never mean that the product itself must become a free good.
In the case in question, however, not even the capital goods
need become free goods in order that the rate of interest may
fall to zero. All that is required is that the value of the serv-
ices which depend on the existence of a certain capital good
be no higher than the cost of reproduction of a good that will
render the same service or, what amounts to the same thing,
than the value in their alternative current uses of the serv-
ices of the factors of production required for this reproduc-
tion. There is no reason why, in order that this may come
about, these services should also become free goods.

I do not, of course, contend that a fall of the rate of interest
to zero is an event in the least likely to occur at any future
time in which we are at all interested. But, like all questions
of what is probable, this is altogether irrelevant for theo-
retical analysis. What is of importance are the conditions
under which this would be possible. Now if a condition were
reached in which no further lengthening of the investment
periods of individual resources (either by lengthening the
process or by increasing the durability of goods in which they
are invested) would lead to a further increase of output, new
savings could not help to increase output. In the usual ter-
minology the marginal productivity of capital would have

8. [2], p. 284.


===== PAGE 26 =====

224 QUARTERLY JOURNAL OF ECONOMICS

fallen to zero because no more satisfaction would depend on
a particular capital good (‘stored up labor’) than would
depend on the quantity of labor and other products which
are needed to replace it. So long as any of the factors required
for this purpose remain scarce, the capital goods themselves
and a fortiort the final consumers’ goods made with their help
will also remain scarce. And there can be no doubt that this
point where further accumulation of capital would no longer
increase the quantity of output obtainable from the factors
used in its production, even if almost infinitely distant,would
still be reached long before the point where no satisfaction
whatever would be dependent on the existence of these
factors.

It is not difficult to see how Professor Knight’s habit of
thinking not only of capital in the abstract but even of par-
ticular capital goods as permanent has led him to his peculiar
conclusion. Permanent goods which can be produced — if
there is such a thing, namely a good which is expected not
only to last forever physically, but also to remain perma-
nently useful — stand in this respect in a somewhat excep-
tional position. The value of such a good expected to render
permanently useful services would at a zero rate of interest
necessarily be infinite so long as its services have any value
at all, and goods of this kind would therefore be produced
until the value of the services of one more unit would be zero.
And until the services of these goods had become free, there
would be a demand for capital for producing more and the
rate of interest could not fall to zero. The person making a
final investment of this kind, bringing the value of the serv-
ices down to zero, would of course find that he had made a
mistake and lost his investment; and the demand for capital
for this purpose would stop when it became known that the
investment of one further unit had this effect.

But even if the value of the permanent goods should have
to fall to zero in order that the rate of interest may become
zero also, this does, as shown above, by no means imply that
the value of the non-permanent goods should also have to
fall to zero. On each good may depend no more utility than


===== PAGE 27 =====

THE MYTHOLOGY OF CAPITAL 225

can be had from the current use of the factors required for its
reproduction, but the value of such goods will still be equal
to that utility.

In concluding this section it may be pointed out that there
is, of course, a very important reason why in a changing
world the rate of interest will never fall to zero, a reason
which Professor Knight’s assumption of the permanence of
capital would exclude, namely, that in a world of imperfect
foresight capital will never be maintained intact in any sense,
and every change will always open possibilities for the profit-
able investment of new capital.

VI

There remain a number of points of not inconsiderable
importance which, however, if this article is not to grow to
disproportionate size, can be touched upon but shortly.
Perhaps the most interesting is the suggestion, which occurs
here and there in Professor Knight’s articles, that all his
deductions about the nature of capital are based on the
assumption of perfect foresight.® If this is to be taken quite
seriously it would represent a main addition to the older
Clarkian doctrine of the permanence of capital and to some
extent also justify it. It would do so, however, at the expense
of restricting its validity to a sphere in which problems of
capital in the ordinary sense do not occur at all and certainly
deprive it of all relevance to the problems of economic
dynamics. But since Professor Knight’s purpose is, inter alia,
to demonstrate that my analysis of certain types of industrial
fluctuations is based on a fallacy in the field of the theory of
capital it can evidently not be his intention to base all his
argument on this assumption. Hence it seems worth while

9. Cf. particularly [2], pp. 264 (n.2), 270, 273, and 277. In his latest
articles ([7] and [8]) Professor Knight seems however inclined to concede
that the period of production analysis has some limited application to
static conditions most rigidly defined, and is inapplicable under dynamic
conditions! Are we to understand that Professor Knight now wants to
abandon all that part of his earlier criticism which was based on the most

extreme static assumptions imaginable, i.e., on the assumption of
perfect foresight?


===== PAGE 28 =====

226 QUARTERLY JOURNAL OF ECONOMICS

to explore shortly the question what problems of capital still
exist under such an assumption.

If we assume that perfect foresight has existed from the
beginning of all things, a question of how to use capital as a
separate factor of production would not arise at all. All
processes of production would have been definitely deter-
mined at the beginning and no further question would arise
of how to use any of the instruments created in the course
of the process which might be used for other purposes than
those for which they were originally intended. If indeed
there are natural non-permanent resources in existence at
the beginning, a “capital problem’ might arise in connection
with the original plan.! But once this original plan is made
and so long as it is adhered to, no problem of maintenance,
replacement or redistribution of capital, nor indeed any
other economic problem, would occur.

Economic problems of any sort, and in particular the prob-
lem how to use a given stock of capital goods most profitably,
arise only when it is a question of adjusting the available
means to any new situation. In real life such unforeseen
changes occur, of course, at every moment and it is in the
explanation of the reaction to these changes that the existing
“capital” is required as a datum. But the concept of capital
as a quantitatively determined self-perpetuating fund does
not help us here in any way. In fact, if the justification of
this concept lies in the assumption of perfect foresight it
becomes clearly inapplicable, since a “factor” which remains
in any sense constant only if complete foresight is assumed
cannot possibly represent a ‘“‘datum’ on which new deci-
sions can be based. As has been shown, it would be erroneous
to assume that this given ‘factor’ is given as a definite

1. It might be mentioned, incidentally, that this would not be a
problem of the preservation of natural resources in the usual sense, i.e.,
of preservation of the particular resource, but only of its replacement by
some produced means of production which will render services of equiv-
alent value. This applies equally to the practical problem of the
preservation of exhaustible natural resources where it is by no means
necessarily most economical to extend their life as far as possible rather

than to use their amortization fund for the creation of some new capital
goods.


===== PAGE 29 =====

THE MYTHOLOGY OF CAPITAL 227

quantity of value, or as any other determinate quantity which
can be measured in terms of some common unit. But while
the only exact way of stating the supply condition of this
factor would be a complete enumeration and description of
the individual items, it would be hasty to conclude that they
have no common quality at all which entitles us to class
them into one group. This common quality of being able to
substitute to some extent one item for another is the pos-
sibility of providing a temporary income while we wait for
the services of other factors invested for ionger periods. But,
as we have seen, no single item represents a definite quantity
of income. How much income it will yield and when it will
yield it depends on the use made of all other goods. In conse-
quence the relevant datum which corresponds to what is
commonly called the supply of capital and which determines
for what period currently factors will be expediently invested
is nothing but the alternatively available income streams
which the existing capital goods can produce under the new
conditions.

It would be difficult to believe that Professor Knight
should for a moment have really thought that the concept
of capital as a self-maintaining fund of determinate magni-
tude has any application outside a fictitious stationary state
if he had not himself — at least at an earlier date — clearly
recognized that the problems of capital fall largely outside
the framework of static analysis.? In view of these utter-
ances it would seem unlikely that he should now take pains
to develop a concept which is valid only on the most rigidly
“static” assumptions. The emphasis which he now places
on the complete mobility of capital certainly conveys the
impression that he wants to apply his concept to dynamic
phenomena. It is at least difficult to see what other purpose
this emphasis can serve, because certainly nobody has ever
doubted that where all the future is correctly foreseen and

2. [4], p. 206: “The one important difference between price analysis
in the case of interest and that of ordinary prices arises from the fact
that saving and investment is a cumulative process. It is a phase of

economic growth, outside the framework of the conventional ‘static’
system, unfortunately so called.”


===== PAGE 30 =====

228 QUARTERLY JOURNAL OF ECONOMICS

always has been so no problem of mobility of capital will
arise. And altho he qualified his statements about the mobil-
ity of capital by the assumption of complete foresight? this
does not prevent him from disparaging the value of any
reasoning based on the limitations of the mobility of capital
under dynamic conditions. This attitude is not very far
from the assertions sometimes found in the literature that
apart from “frictions” invested capital ought to be regarded
as completely mobile between different uses (presumably
without any loss in value), and that “any theory that is
based on partial immobility of invested capital is essentially
a frictional one.”* This clearly assumes the existence of a
separate substance of capital apart from its manifestation
in concrete capital goods, a “fund” of a mystical quantity
which cannot be described or defined but which, if Professor
Knight has it his way, is to have a central position in our
analytical apparatus. It has the somewhat questionable
advantage that there is no way of deciding whether any
statement about this quantity is true or false.

F. A. v. Hayek
UN1vERSITY OF LONDON
3. [2], p. 270.

4. H. Neisser, ‘Monetary Expansion and the Structure of Produec-
tion,” Social Research, vol. I/4, November, 1934.