WEBVTT NOTE The Continuing Relevance of Austrian Capital Theory 1 00:00:00.000 --> 00:00:05.000 Good morning and welcome to our first named lecture, the F.A. Hayek Lecture. 2 00:00:05.000 --> 00:00:12.000 Our speaker this morning, Nikolai J. Foss, was invited by me to give this lecture. 3 00:00:12.000 --> 00:00:16.000 I had been familiar with some of his work and I thought I knew most of his work. 4 00:00:16.000 --> 00:00:21.000 But as it turns out, I was merely familiar with a fraction of it. 5 00:00:21.000 --> 00:00:27.000 Nikolai is one of the most productive Austrian scholars in Europe, if not in the world. 6 00:00:27.000 --> 00:00:28.960 He was born in Denmark. 7 00:00:28.960 --> 00:00:31.920 He has residences in both Denmark and Norway. 8 00:00:31.920 --> 00:00:33.840 He received his PhD degree 9 00:00:33.840 --> 00:00:38.080 from the Copenhagen Business School in 1993. 10 00:00:38.080 --> 00:00:41.640 Currently, he's the professor of strategy and organization 11 00:00:41.640 --> 00:00:43.600 at the Copenhagen Business School, 12 00:00:43.600 --> 00:00:47.100 a part-time professor of knowledge-based value creation 13 00:00:47.100 --> 00:00:49.360 at the Norwegian School of Economics 14 00:00:49.360 --> 00:00:51.000 and Business Administration, 15 00:00:51.000 --> 00:00:53.800 and the head of the Department of Strategic Management 16 00:00:53.800 --> 00:00:56.940 and Globalization at the Copenhagen Business School. 17 00:00:56.940 --> 00:00:59.900 He also holds part-time and visiting professorships 18 00:00:59.900 --> 00:01:03.300 at several other leading universities in Europe. 19 00:01:03.300 --> 00:01:06.340 He's the founder of the Center, now the Department 20 00:01:06.340 --> 00:01:08.620 of Strategic Management and Globalization 21 00:01:08.620 --> 00:01:10.700 at the Copenhagen Business School 22 00:01:10.700 --> 00:01:13.260 and currently serves as its director. 23 00:01:13.260 --> 00:01:16.580 Fors is a panel member of the European Research Council. 24 00:01:16.580 --> 00:01:19.340 He was one of the founders of the Danish Research Unit 25 00:01:19.340 --> 00:01:22.000 for Industrial Dynamics and a co-founder 26 00:01:22.000 --> 00:01:25.720 of the Libertarian-Conservative Center for Policy Studies, 27 00:01:25.720 --> 00:01:30.720 the most influential privately funded think tank in Denmark. 28 00:01:30.800 --> 00:01:33.680 Professor Faust's prodigious publications 29 00:01:33.680 --> 00:01:38.360 include 136 journal articles, 81 book chapters. 30 00:01:38.360 --> 00:01:41.280 In addition, he has authored or edited 22 books 31 00:01:41.280 --> 00:01:44.240 and several have been published by very high profile 32 00:01:44.240 --> 00:01:46.880 publishers such as Cambridge University Press 33 00:01:46.880 --> 00:01:49.480 and Oxford University Press. 34 00:01:49.480 --> 00:01:51.280 His work has been published in 35 00:01:51.280 --> 00:01:52.680 the Academy of Management Review, 36 00:01:52.680 --> 00:01:55.960 to Academy of Management Journal, Organization Science, 37 00:01:55.960 --> 00:01:57.560 and several other leading journals. 38 00:01:57.560 --> 00:02:01.100 And he serves on the boards of 18 journals. 39 00:02:01.100 --> 00:02:04.200 Several of his articles and books have been translated 40 00:02:04.200 --> 00:02:06.780 into Chinese, Spanish, and Russian. 41 00:02:06.780 --> 00:02:08.960 So I could go on and on, believe it or not. 42 00:02:08.960 --> 00:02:11.040 I had to edit this down. 43 00:02:11.040 --> 00:02:13.600 But without further ado, it's my great pleasure 44 00:02:13.600 --> 00:02:15.460 to introduce Nikolai Foss. 45 00:02:15.460 --> 00:02:27.460 Well, thanks a lot for the very kind introduction and the invitation. 46 00:02:27.460 --> 00:02:35.460 I'm particularly honored and delighted that this lecture is named after Friedrich Hayek. 47 00:02:35.460 --> 00:02:43.460 Back in the mid-1980s, while I was still an economics student and discovered Austrian economics, 48 00:02:43.460 --> 00:02:49.500 Hayek's works, particularly his knowledge essays, if you like, were really my first discoveries of Austrian economics. 49 00:02:49.500 --> 00:02:56.660 A discovery that was prompted by the writings on Keynes of Axel Leyenhoferd. 50 00:02:56.660 --> 00:03:08.700 If you're familiar with Leyenhoferd, he's a great Swedish now retired economist who tried to make sense of Keynes through a Hayekian lens. 51 00:03:08.700 --> 00:03:12.700 A project, I suppose, was pretty much doomed to failure. 52 00:03:12.700 --> 00:03:27.700 But that's what he tried to do and his book from 1968 on Keynesian economics and the economics of Keynes is most definitely worth a read for Austrians who are interested in macroeconomics. 53 00:03:27.700 --> 00:03:34.700 But back to Hayek, his works have influenced me ever since I discovered them about 30 years ago or 25. 54 00:03:34.700 --> 00:03:41.700 So it's only appropriate to pay homage to Hayek in this lecture and I shall really try to do so. 55 00:03:41.700 --> 00:03:55.700 One way I'll do that is by diverting from my usual business school professor presenting format, which is about jumping frenetically in front of my PowerPoint slides and strolling the aisles and so on. 56 00:03:55.700 --> 00:04:05.700 I'll adopt a relatively civilized posture and stand here and read my talk in an appropriate Germanic perhaps, style perhaps, Hayekian. 57 00:04:05.700 --> 00:04:16.700 But I should also pay homage in a more substantive way, namely by talking about a favorite Hayek topic, namely that of capital theory. 58 00:04:16.700 --> 00:04:25.700 As we all know, much of Hayek's early work, of course, concerns capital theory, either directly or more indirectly, 59 00:04:25.700 --> 00:04:29.700 as of course in Hayek's elaboration of Austrian business cycle theory. 60 00:04:29.700 --> 00:04:38.700 But I would go so far as to argue that capital theory may really be in some sense a foundation of all, virtually all Hayek's work in economics. 61 00:04:38.700 --> 00:04:55.700 This is obviously the case for what was intended to be the first volume of Hayek's projected but unfinished magnum opus, namely the Pure Theory of Capital, which as the title indicates is indeed a book about capital theory. 62 00:04:55.700 --> 00:05:01.420 some of you may have tried to read read it and you some of you may also know 63 00:05:01.420 --> 00:05:07.420 it's a true classic it's cited by very few people it's not read by even fewer 64 00:05:07.420 --> 00:05:13.180 and it is certainly I think unreadable one of the most one of the most 65 00:05:13.180 --> 00:05:18.900 difficulties difficult books I ever tried to read definitely I've argued 66 00:05:18.900 --> 00:05:24.020 myself in an old paper published back in 1996 in the history of political economy 67 00:05:24.020 --> 00:05:37.020 that capital theory played a crucial role in prompting Hayek's thinking about the challenge to economic theory represented by dispersed knowledge. 68 00:05:37.020 --> 00:05:47.020 Roughly the argument in my old paper is that the knowledge-based challenges of inter-temporal coordination of a structure of heterogeneous capital, 69 00:05:47.020 --> 00:05:54.020 Capital, which, as Roger Garrison has often told us, is the essence of Austrian macroeconomics, 70 00:05:54.020 --> 00:06:00.020 led Hayek to think carefully about the role of knowledge in economic affairs. 71 00:06:00.020 --> 00:06:08.020 So it's quite crucial, foundational even, to significant parts of Hayek's thinking. 72 00:06:08.020 --> 00:06:15.020 But there are many other interesting ways in which capital theory makes an essential 73 00:06:15.020 --> 00:06:21.020 and the potential connection to other parts of the Austrian corpus, as it were. 74 00:06:21.020 --> 00:06:26.020 There's, for example, an obvious relation between heterogeneous capital 75 00:06:26.020 --> 00:06:30.020 and the Misesian calculation problem. 76 00:06:30.020 --> 00:06:36.020 Mises was probably not led to the discovery of the calculation problem 77 00:06:36.020 --> 00:06:40.020 merely by noting the presence of heterogeneous capital in economy per se. 78 00:06:40.020 --> 00:06:45.740 Because even if capital were homogeneous, there would still be calculation problems left, for example, 79 00:06:45.740 --> 00:06:52.260 how much homogeneous capital, in this case, to devote to production now versus later. 80 00:06:52.260 --> 00:06:57.660 So calculation problems wouldn't evaporate if capital were homogeneous. 81 00:06:57.660 --> 00:07:06.860 But these calculation problems would surely be much more trivial compared to the situation with heterogeneous capital. 82 00:07:06.860 --> 00:07:12.540 So to Mises, the entrepreneur and heterogeneous capital goods are really complementary phenomena. 83 00:07:12.540 --> 00:07:15.660 To some extent, two sides of the same coin. 84 00:07:15.660 --> 00:07:22.820 As Mises says, and I quote, the various complementary factors of production cannot come together spontaneously. 85 00:07:22.820 --> 00:07:34.740 They need to be combined by the purpose of efforts of men aiming at certain ends and motivated by the urge to improve their state of satisfaction. 86 00:07:34.740 --> 00:07:39.740 Lachman, in the book on capital theory that Peter Klein mentioned earlier this morning, 87 00:07:39.820 --> 00:07:43.580 echoes Mises stating that, quote again, 88 00:07:43.660 --> 00:07:51.260 the entrepreneur's function is to specify and make decisions on the concrete form the capital resources shall have. 89 00:07:51.340 --> 00:07:54.660 Specifies, modifies the layout of his plant. 90 00:07:54.740 --> 00:08:04.380 As long as we disregard the heterogeneity of capital, the true function of the entrepreneur must also remain hidden. 91 00:08:04.380 --> 00:08:10.340 I think these various examples of the role that cattle theory play in Austrian economics 92 00:08:10.340 --> 00:08:16.540 offers to indicate that cattle theory is really fundamental in the sense of foundational and 93 00:08:16.540 --> 00:08:23.540 indispensable as part of Austrian economics on par with subjectivism, dispersed knowledge 94 00:08:23.540 --> 00:08:30.100 and entrepreneurial appraisement and that it is in fact intricately woven together with 95 00:08:30.100 --> 00:08:33.180 exactly these things. 96 00:08:33.180 --> 00:08:38.820 So the implications of capital heterogeneity, capital theory, go really much beyond the 97 00:08:38.820 --> 00:08:41.580 Austrian theory of the business cycle. 98 00:08:41.580 --> 00:08:48.260 Of course, my sense is that Austrians are perfectly aware that they stand apart on the 99 00:08:48.260 --> 00:08:55.540 issue of capital theory, insisting that there is meaningfully such a thing as capital theory, 100 00:08:55.540 --> 00:09:00.980 which goes beyond corporate finance and the theory of investment behaviour is almost a 101 00:09:00.980 --> 00:09:06.980 is a bit of an oddity in contemporary economics, as Roger Garrison again has noted. 102 00:09:07.060 --> 00:09:12.060 However, it seems to me that surprisingly Austrian capital theory 103 00:09:12.140 --> 00:09:18.220 is also a bit of an oddity in contemporary Austrian economics. 104 00:09:18.300 --> 00:09:20.900 So to illustrate just loosely, 105 00:09:20.980 --> 00:09:27.380 out of the 197 articles that were published in the Review of Austrian Economics 106 00:09:27.380 --> 00:09:37.380 From 2002 to 2011, both years included, only 11 dealt directly with capital theory. 107 00:09:37.380 --> 00:09:43.380 The quarterly journal of Austrian economics is doing better, but only slightly better. 108 00:09:43.380 --> 00:09:51.380 There are 189 articles in the same period and there are 15 of them that deal directly with capital theory. 109 00:09:51.380 --> 00:09:54.380 That's somewhat better performance. 110 00:09:54.380 --> 00:10:19.380 One may fear, of course, that this reflects a belief, even among Austrians, that Austrian Catall Theory somehow lost the historical debate that the Cambridge Catall controversies of the 1960s proved that this is just one big mess, that Schraffer and Knight really proved that Austrian Catall Theory was full of internal contradictions and so on. 111 00:10:19.380 --> 00:10:34.380 Whatever that may be, I want in this talk to argue that Austrian capital theory should make something of a comeback as a really crucial item on the Austrian research agenda. 112 00:10:34.380 --> 00:10:47.380 I should say that in arguing this point, I'm also wearing my management scholars hat, it should make a comeback as essentially a part of the theory of production. 113 00:10:47.380 --> 00:11:00.380 That is, the theory of the economic process of converting inputs to outputs perhaps rather than as a part of the theory of distribution or even the theory of interest. 114 00:11:00.380 --> 00:11:11.380 But as a part of the theory of production the Austrian theory of capital stresses the heterogeneous nature of capital assets, 115 00:11:11.380 --> 00:11:17.380 The subjective nature of capital as a part of the entrepreneur's plan 116 00:11:17.380 --> 00:11:21.380 and of course the time dimension of production. 117 00:11:21.380 --> 00:11:26.380 Thus understood, I think this is pretty uncontroversial, but thus understood at least, 118 00:11:26.380 --> 00:11:34.380 the Austrian theory of capital has opportunities for theoretical developments that are not yet fully explored. 119 00:11:34.380 --> 00:11:38.380 And what I shall do today is to examine some of those opportunities 120 00:11:38.380 --> 00:11:41.260 in the context of business firms, 121 00:11:41.260 --> 00:11:44.980 drawing on my work with Peter Klein, among others, 122 00:11:44.980 --> 00:11:49.580 and I should also argue that looking at heterogeneous capital 123 00:11:49.580 --> 00:11:51.860 in the context of business firms 124 00:11:51.860 --> 00:11:57.180 provide an important underpinning of our understanding 125 00:11:57.180 --> 00:12:01.500 of the sources of economic growth, 126 00:12:01.500 --> 00:12:06.300 a perennial issue in economics since Adam Smith. 127 00:12:06.300 --> 00:12:13.140 Here's my title, Austrian ideas on heterogeneity represent an important challenge 128 00:12:13.140 --> 00:12:19.940 to homogenizing assumptions in much of mainstream economics and in management theory. 129 00:12:19.940 --> 00:12:30.940 These ideas, these Austrian ideas, not only challenge, but they can also constructively further our thinking on firms and the growth process, 130 00:12:30.940 --> 00:12:42.940 Potentially establishing Austrian economics as a highly relevant voice in the contemporary discourse on firm organization and economic growth. 131 00:12:44.940 --> 00:12:50.940 Now in his treatise on Austrian Capital Theory, called Capital Theory and Disequilibrium, 132 00:12:51.940 --> 00:12:59.940 Peter Lewin notes that Austrian Capital Theory has become synonymous in literature with Boehm-Bawerkian Capital Theory. 133 00:13:00.940 --> 00:13:06.380 So capital theory is often equated with questions like, is capital a fund? 134 00:13:06.380 --> 00:13:11.580 What's the nature of the earning of capital? What determines these earnings and so on? 135 00:13:11.580 --> 00:13:16.780 And one of the latest restatements and refinements of Austrian capital theory, 136 00:13:16.780 --> 00:13:24.140 namely Rothbard's and Man Economy and State, of course deals with these important questions as well. 137 00:13:24.140 --> 00:13:28.220 These are conceptual questions obviously, they're distributional, 138 00:13:28.220 --> 00:13:33.660 and they are quite often couched in a macro-language. 139 00:13:33.740 --> 00:13:39.660 If you look at Boehm-Bawerk and Hayek, at least in prices and production, 140 00:13:39.740 --> 00:13:44.940 there are impressions of a leaning to the macro side. 141 00:13:45.020 --> 00:13:51.900 Hayek Boehm's concentric circles, if you remember them in his Capital Interest Treatise, 142 00:13:51.980 --> 00:13:55.420 Hayek's triangles in prices and production, 143 00:13:55.420 --> 00:14:04.620 Of course, allowful imply perhaps capital heterogeneity of capital goods at least between those stages of production. 144 00:14:04.620 --> 00:14:10.620 Very little is actually being said about heterogeneity within the stages of production. 145 00:14:10.620 --> 00:14:18.620 But there are also notions of the average period of production, the total value of flow capital and so on. 146 00:14:18.620 --> 00:14:22.580 They are macronotions. 147 00:14:22.580 --> 00:14:25.540 And these macronotions are still pretty much 148 00:14:25.540 --> 00:14:29.380 the notions that are associated in the mind 149 00:14:29.380 --> 00:14:33.620 of mainstream economists, at least those few 150 00:14:33.620 --> 00:14:35.620 mainstream economists who have heard 151 00:14:35.620 --> 00:14:39.940 about Austrian capital theory with Austrian capital theory. 152 00:14:39.940 --> 00:14:42.380 So try reading Mark Blauch's Economic Theory 153 00:14:42.380 --> 00:14:45.980 of Retrospect, where he deals with and smashes 154 00:14:45.980 --> 00:14:58.980 I think there's a danger that these macro concepts may direct attention away from something very basic 155 00:14:58.980 --> 00:15:07.980 and very, very important in Austrian capital theory, namely the fundamental heterogeneity of capital. 156 00:15:07.980 --> 00:15:14.980 It seems to me that heterogeneity is a theme that becomes increasingly important in Austrian thinking 157 00:15:14.980 --> 00:15:19.300 and Capital from about the mid-1930s. 158 00:15:19.300 --> 00:15:21.700 My guess, my conjecture, if you like, 159 00:15:21.700 --> 00:15:25.620 is that the development and the fate 160 00:15:25.620 --> 00:15:28.820 of Austrian business cycle theory 161 00:15:28.820 --> 00:15:32.380 in the interwar period played a role here. 162 00:15:32.380 --> 00:15:36.460 So in, for example, Boehm-Bawerk's basic stationary state, 163 00:15:36.460 --> 00:15:39.220 the specificities and the complementarities 164 00:15:39.220 --> 00:15:42.500 between all sorts of heterogeneous capital goods 165 00:15:42.500 --> 00:15:44.860 are very easily missed 166 00:15:44.860 --> 00:15:53.380 Because all productive operations proceed smoothly as they must in a stationary state. 167 00:15:53.380 --> 00:15:59.020 The downturn of the business cycle, on the other hand, which Hayek had difficulties theorizing 168 00:15:59.020 --> 00:16:05.220 I think, is very much about capital goods that simply cannot be profitably deployed to 169 00:16:05.220 --> 00:16:09.220 other users for which they are not really fit. 170 00:16:09.220 --> 00:16:16.060 Because as Dennis Robertson said in his variation on Austrian business cycle theory, 171 00:16:16.140 --> 00:16:19.860 work on the new Cunardos will be suspended. 172 00:16:19.940 --> 00:16:26.580 We are left with a big mass of heterogeneous capital goods that just cannot be easily deployed. 173 00:16:26.660 --> 00:16:33.700 So heterogeneity in the downturn suddenly becomes of overriding importance. 174 00:16:33.780 --> 00:16:39.140 This is the Aquitania, supposedly the most beautiful of them all. 175 00:16:39.220 --> 00:16:45.580 It survived both the boom-bopped cycles of meddling politicians and the German torpedoes 176 00:16:45.660 --> 00:16:50.500 before it was finally retired from service in 1950. 177 00:16:50.580 --> 00:16:53.460 But the point here is that from... 178 00:16:53.540 --> 00:16:57.180 There's a conjecture again, a conjecture in doctrinal history. 179 00:16:57.260 --> 00:16:59.620 But I would like to go further into this. 180 00:16:59.700 --> 00:17:03.500 And perhaps Roger Garrison or someone else here has thoughts on this. 181 00:17:03.580 --> 00:17:06.020 It seems to me that from about the mid-1930s, 182 00:17:06.020 --> 00:17:13.540 is we see an increasing interest among Austrians in the heterogeneity properties of capital. 183 00:17:13.540 --> 00:17:18.180 I think Richard von Striegel in Capital und Produktion is a really good example. 184 00:17:18.180 --> 00:17:24.700 Lachmann's 20 or so years later Capital and Structure is another good example. 185 00:17:24.700 --> 00:17:30.580 So is Kirzner's neglected an essay on capital and Pierre Luin's contemporary work pretty 186 00:17:30.580 --> 00:17:37.100 very much exemplifies this very strong emphasis on heterogeneity as perhaps the important 187 00:17:37.100 --> 00:17:39.620 aspect of Austrian capital theory. 188 00:17:39.620 --> 00:17:46.260 Now it seems to me that the key notion in all of this is the Mengerian one that capital 189 00:17:46.260 --> 00:17:56.380 goods are essentially forward-looking components of multi-period plans and as Mises argued 190 00:17:56.380 --> 00:18:00.500 this conceptualization in itself invalidates 191 00:18:00.500 --> 00:18:02.660 the aggregation of capital goods. 192 00:18:02.660 --> 00:18:06.780 As Mises says, the totality of the produced factors 193 00:18:06.780 --> 00:18:10.380 of production is merely an enumeration of physical quantities 194 00:18:10.380 --> 00:18:12.980 of thousands and thousands of various goods. 195 00:18:12.980 --> 00:18:17.820 Such an inventory is of no use to acting. 196 00:18:18.700 --> 00:18:23.700 So as I indicated already, this emphasis on heterogeneity 197 00:18:23.700 --> 00:18:28.700 and the subjectivity of capital goods in the entrepreneurs' production plan 198 00:18:28.700 --> 00:18:36.700 seemed to me to move the theory of capital somewhat away from its traditional concerns 199 00:18:36.700 --> 00:18:44.700 with distribution and with interest theory and move it more towards the theory of production. 200 00:18:44.700 --> 00:18:51.700 But it's a special kind of theory of production I'm talking about here. 201 00:18:51.700 --> 00:18:59.140 Austrian capital theory has actually often been compared to the economics of the classical economists. 202 00:18:59.140 --> 00:19:09.940 Higgs, as you may know, famously made the argument that the Austrians and the classicists shared pretty much the same emphasis on capital as a fund. 203 00:19:09.940 --> 00:19:17.140 In the process, he lumped together Boehm-Bawerk and Hayek with Clark and Knight rather absurdly. 204 00:19:17.140 --> 00:19:22.140 Israel Kirzner has a great comment on this in the 1976 book. 205 00:19:22.140 --> 00:19:23.300 I think it's the... 206 00:19:23.300 --> 00:19:25.340 Is that the Salter-Royalton one or is it the later one? 207 00:19:25.340 --> 00:19:27.540 I think it's the Sparadero one. 208 00:19:27.540 --> 00:19:30.900 But the point here is that the classical theory of capital 209 00:19:30.900 --> 00:19:33.340 is a part of the theory of production. 210 00:19:33.340 --> 00:19:35.900 The classical theory of distribution, sorry, 211 00:19:35.900 --> 00:19:39.260 the classical theory of production, on the other hand, 212 00:19:39.260 --> 00:19:44.260 is a theory of the progressive division of labor. 213 00:19:44.260 --> 00:20:09.260 And it seems to me that the Austrian emphasis on heterogeneous capital aligns closely with this aspect of classical economics, the progressive division of labour aspect, as Alan Young argued in a famous paper many years ago, both involve time and heterogeneity and therefore the need for coordination. 214 00:20:09.260 --> 00:20:17.060 Both the classical theory of production and the Austrian theory of capital are sharply 215 00:20:17.060 --> 00:20:24.340 opposed to the way production is portrayed in modern economics, what we may call the 216 00:20:24.340 --> 00:20:26.580 production function U. 217 00:20:26.580 --> 00:20:33.900 Here's Axel-Lyon Hoofwood, whom I mentioned earlier, and here's how he characterizes 218 00:20:33.900 --> 00:20:40.140 The view of production in modern mainstream economics, the production function view. 219 00:20:40.140 --> 00:20:46.620 He says that the neoclassical constant returns production function does not describe production 220 00:20:46.620 --> 00:20:51.540 as a process, i.e. as an ordered sequence of operations. 221 00:20:51.540 --> 00:20:57.060 It's more like a recipe for bouillabaisse, where all the ingredients are dumped in a 222 00:20:57.060 --> 00:20:58.060 pot. 223 00:20:58.060 --> 00:21:04.620 Well, it's heated up, this is a function, and the output X is ready. 224 00:21:04.620 --> 00:21:10.020 This abstraction from the sequencing of tasks is largely responsible for the well-known 225 00:21:10.020 --> 00:21:15.780 fact that neoclassical production theory gives us no clue to how production is actually organized. 226 00:21:15.780 --> 00:21:20.540 Smith's Division of Labor, the core of his theory of production, slipped through modern 227 00:21:20.540 --> 00:21:26.100 production theory as a ghostly technological change coefficient or as an equally ill-understood 228 00:21:26.100 --> 00:21:29.020 and the economies of scale, the property of the function. 229 00:21:30.780 --> 00:21:37.500 Now, what's the U of capital that is implied in the neoclassical production function U? 230 00:21:38.620 --> 00:21:42.620 I've discussed this at length with my more mainstream colleagues 231 00:21:42.700 --> 00:21:45.940 and they argue that, you know, as a purely mathematical approach, 232 00:21:46.020 --> 00:21:52.220 the production function U is capable of handling both heterogeneity and time. 233 00:21:52.740 --> 00:21:54.860 In actuality, I think it is not. 234 00:21:54.860 --> 00:22:24.860 And this is perhaps best seen in modern mathematical macroeconomics models, of course mainstream macro models given their focus on economy-wide phenomena, you know, gross domestic and national products, employment, growth rates and so on, they tend to focus on aggregates, industries, sectors, whole economies, aggregation in turn, per definition. 235 00:22:24.860 --> 00:22:28.180 leads to some kind of homogenization. 236 00:22:28.180 --> 00:22:31.080 As a minimum, there must be some shared unit 237 00:22:31.080 --> 00:22:33.780 that the relevant items can be measured in terms of. 238 00:22:34.860 --> 00:22:37.720 Often, however, the assumption is explicitly made 239 00:22:37.720 --> 00:22:42.300 that everything within the aggregate is homogeneous. 240 00:22:42.300 --> 00:22:44.520 So mainstream macroeconomic theories, 241 00:22:44.520 --> 00:22:47.580 whatever their stripe, all adopt the assumption 242 00:22:47.580 --> 00:22:51.300 that production, firms, industries and the economy 243 00:22:51.300 --> 00:22:53.900 are homogeneous and fungible. 244 00:22:54.860 --> 00:22:57.260 So labor means homogenous labor units. 245 00:22:57.260 --> 00:23:00.120 Capital has the same interpretation. 246 00:23:01.620 --> 00:23:06.620 You know, Paul Samuelson, later Robert Solow, 247 00:23:06.620 --> 00:23:08.860 it's Paul Samuelson to the left in the slide, 248 00:23:10.100 --> 00:23:14.900 adopted the imagery of Smoog from a comic called 249 00:23:14.900 --> 00:23:18.380 Lil Abner that some of you may recall. 250 00:23:18.380 --> 00:23:20.340 Smoogs are identical creatures, 251 00:23:20.340 --> 00:23:22.860 you can see them at the top of the slide. 252 00:23:22.860 --> 00:23:27.260 Identical creatures shaped like bowling pins with legs. 253 00:23:27.260 --> 00:23:28.700 And they, of course, adopted this imagery 254 00:23:28.700 --> 00:23:32.180 to capture exactly this kind of homogeneity. 255 00:23:32.180 --> 00:23:34.300 So, Samuelson essentially said, 256 00:23:34.300 --> 00:23:37.980 for many purposes, it's perfectly fine to treat capital 257 00:23:37.980 --> 00:23:41.220 as if capital was shmoo. 258 00:23:41.220 --> 00:23:43.740 I think the plural of this is shmoo, naturally, 259 00:23:43.740 --> 00:23:46.300 but there's a whole website dedicated to, you know, 260 00:23:46.300 --> 00:23:49.700 to Lille Abner and these subtle details 261 00:23:49.700 --> 00:23:53.220 of High Interest to Capital Theorists, obviously. 262 00:23:55.060 --> 00:23:58.260 This is a kind of reasoning, as Ludwig Lachmann reminded us, 263 00:23:58.260 --> 00:24:01.700 that originated pretty much with David Ricardo, 264 00:24:01.700 --> 00:24:04.340 who, of course, founded a very useful simplification 265 00:24:04.340 --> 00:24:06.180 in theorizing about distributional concerns 266 00:24:06.180 --> 00:24:10.020 and other things in the United Kingdom 200 years ago. 267 00:24:10.020 --> 00:24:13.100 It can be, but sometimes, and perhaps usually, 268 00:24:13.100 --> 00:24:17.660 economists' assumption of schmoo-like capital, 269 00:24:17.660 --> 00:24:26.220 in particular and homogeneity in general sacrifices explanatory scope on the altar of the tractability 270 00:24:26.220 --> 00:24:31.580 that formal mathematical economists so adore. 271 00:24:31.580 --> 00:24:36.580 And the underlying, the subtext is, you know, the heterogeneity of capital doesn't really 272 00:24:36.580 --> 00:24:38.460 matter that much. 273 00:24:38.460 --> 00:24:41.060 Let's proceed as if capital was schmoo. 274 00:24:41.060 --> 00:24:54.060 So let me give you a few examples of why capital heterogeneity seriously matters. Examples that go beyond the Austrian business cycle theory. 275 00:24:54.060 --> 00:25:04.060 And I'll go as away from macroeconomics down to the level of firms and then again from firms up to the level of economic growth. 276 00:25:04.060 --> 00:25:16.060 Now, so the bottom line here is that the Austrian perspective on heterogeneity as something quite essential has mostly been lost in contemporary macroeconomic discussion. 277 00:25:16.060 --> 00:25:31.060 There's a great quotation from Kenneth Bolding who had certain Austrian leanings from his review of Samuelson's Foundations of Economic Analysis, the review and book was published in 1948. 278 00:25:31.060 --> 00:25:52.060 And Bolding says the following, it's a question of acute importance for economics as to why the macroeconomics predictions of the mathematical economists have been on the whole less successful than the hunches of the mathematically unwashed, this seems very contemporary, doesn't it? 279 00:25:52.060 --> 00:26:05.060 The answer seems to be that when we write for instance, let I, Y and capital I stand respectively for the interest rate, income and investment, 280 00:26:05.060 --> 00:26:14.060 we stand committed to the assumption that the internal structures of these aggregates or averages are not really important for the problem in hand. 281 00:26:14.060 --> 00:26:27.060 In fact, of course, they may be very important, and no amount of subsequent mathematical analysis of the variables can overcome the fatal defect of the heterogeneity. 282 00:26:28.060 --> 00:26:43.060 And as I said, this sounds very, very contemporary, because so much of the discussion surrounding, for example, the stimulus packages in the US and in Europe has occurred at a very high level of aggregation. 283 00:26:44.060 --> 00:26:52.680 So despite the highly populous failures of the particular financial institutions, AIG, Lehman Brothers and so on, 284 00:26:52.680 --> 00:27:01.360 government officials spoke in terms of the banking system, the financial system, the economy as a whole. 285 00:27:01.360 --> 00:27:09.280 Henry Paulson told Congress, you'll probably remember that back in September 2008, that radical steps were needed 286 00:27:09.280 --> 00:27:16.800 to avoid a continuing series of financial institution failures and frozen credit markets that threaten American families. 287 00:27:16.800 --> 00:27:27.000 American families' financial well-being, the viability of businesses, both small and large, and the very health of our economy. 288 00:27:27.000 --> 00:27:36.920 So, for example, the discussion of frozen credit markets focused on high-level indicators with a focus on total lending, 289 00:27:36.920 --> 00:27:42.920 not the composition of lending across individuals, firms and industries. 290 00:27:42.920 --> 00:27:54.920 The Federal Reserve System's actions noted by Bernanke were needed to increase liquidity and stabilize markets and so on and so forth. 291 00:27:54.920 --> 00:28:04.920 But it seems clear that a decline in average home prices, reductions in total lending, volatility in asset price indexes and so on 292 00:28:04.920 --> 00:28:09.920 reveals very little about the prices of particular homes, 293 00:28:10.280 --> 00:28:13.760 the cost of capital for specific borrowers, 294 00:28:13.760 --> 00:28:18.440 and the prices of individual assets. 295 00:28:18.440 --> 00:28:20.120 So in analyzing the credit crisis, 296 00:28:20.120 --> 00:28:22.120 the critical question really is, 297 00:28:22.120 --> 00:28:25.840 which loans aren't being made to whom and why? 298 00:28:26.680 --> 00:28:30.200 Indeed, it's impossible perhaps to understand the origins 299 00:28:30.200 --> 00:28:32.440 of the credit crisis without looking at the lending 300 00:28:32.440 --> 00:28:37.480 practices of government-sponsored enterprises like Freddie Mac and Fannie Mae, and I don't 301 00:28:37.480 --> 00:28:42.880 really need to tell you this, and the various policies that encourage lenders to lower their 302 00:28:42.880 --> 00:28:49.320 underwriting standards on the assumption, on the assumption that in a sense all borrowers 303 00:28:49.320 --> 00:28:57.120 were really equally credit worthy. So there is a sense in which assumptions about homogeneity 304 00:28:57.120 --> 00:29:02.280 during of course a period of rapid central bank credit expansion is at the root of the 305 00:29:02.280 --> 00:29:04.680 and the current financial crisis. 306 00:29:04.760 --> 00:29:10.520 The critical issues here are the composition of lending, not really the amount. 307 00:29:10.600 --> 00:29:17.560 Total lending, total liquidity, average equity prices and the like, 308 00:29:17.640 --> 00:29:22.080 all obscure the key questions about how resources are being allocated 309 00:29:22.160 --> 00:29:24.440 across sectors, firms and individuals, 310 00:29:24.520 --> 00:29:29.480 whether bad investments are being liquidated and so on. 311 00:29:29.480 --> 00:29:38.880 The aggregate notions homogenize, and in doing so, they suppress critical information about relative prices. 312 00:29:39.880 --> 00:29:45.480 The main function of capital markets, after all, is not really to moderate the total amount of financial capital. 313 00:29:45.480 --> 00:29:50.680 It is to allocate capital across activities, of course. 314 00:29:52.080 --> 00:29:57.080 Now, if not all borrowers are the same, it's even more true that not all banks are the same. 315 00:29:57.080 --> 00:30:09.080 And yet the Treasury's Troubled Assets Relief Program was designed explicitly on the premise that the banking system itself, rather than the individual banks, was in trouble. 316 00:30:09.080 --> 00:30:20.080 To avoid signaling the financial conditions of specific banks to the market, the Treasury insisted that all large banks take top funds, whether they want it or not, as you would recall. 317 00:30:20.080 --> 00:30:25.080 Some 250 banks ultimately refused to participate in this. 318 00:30:25.080 --> 00:30:30.440 Such programs, of course, create strong adverse selection problems. Banks that followed more 319 00:30:30.440 --> 00:30:36.400 prudent lending policies did not invest in complex mortgage-based securities and the like. 320 00:30:36.400 --> 00:30:42.080 They have little incentive to take government subsidies accompanied by government control 321 00:30:42.080 --> 00:30:49.620 of future lending and investment and even practices such as executive compensation. 322 00:30:49.620 --> 00:30:56.260 By bolstering inefficient banks creating incentives to keep issuing mortgages that ought not to 323 00:30:56.260 --> 00:31:02.300 be issued in the interest of reviving the macroeconomy policies such as the top scheme 324 00:31:02.300 --> 00:31:08.140 are repeating the mistakes that caused the problems in the first place. 325 00:31:08.140 --> 00:31:14.260 And it all has to do with assumptions about homogeneity. 326 00:31:14.260 --> 00:31:27.260 Of course, generally, the US stimulus packets and similar schemes and proposals around the world are characterized by Keynesian-style reliance on macroeconomic aggregates. 327 00:31:27.260 --> 00:31:34.260 The common wisdom still really is that the bank crisis led to a collapse of effective aggregate demand, 328 00:31:34.260 --> 00:31:41.260 and only massive increases in government expenditure and certainly debt can kickstart the economy. 329 00:31:41.260 --> 00:32:03.260 But in a world of heterogeneous capital resources, spending on some assets, but not others, alters the pattern of resource allocation in the economy, and in a sort of path-dependent process, the overall performance of the economy in the future. 330 00:32:03.260 --> 00:32:06.740 In a world of capital heterogeneity, our world, 331 00:32:06.740 --> 00:32:11.220 capital assets just cannot be costlessly shifted 332 00:32:11.220 --> 00:32:13.620 from one activity to another activity, 333 00:32:13.620 --> 00:32:18.780 as many of these schemes tacitly presuppose. 334 00:32:18.780 --> 00:32:22.380 And this is particularly the case in a modern economy 335 00:32:22.380 --> 00:32:27.940 in which so much capital is embodied in industry-specific, 336 00:32:27.940 --> 00:32:35.340 firm-specific and worker-specific capabilities, for example, human capital. 337 00:32:37.340 --> 00:32:43.540 So there is a strong potential here for really deploying Austrian ideas on capital heterogeneity 338 00:32:43.540 --> 00:32:52.140 effectively in the context of a critique of conventional macroeconomics and crisis management. 339 00:32:52.140 --> 00:32:57.140 And I think we can all agree that this is a very worthwhile use indeed. 340 00:32:57.940 --> 00:33:13.940 The function of economics, as Mises reminds us, as a weapon in the service of exploding fallacies and nonsense, is not one of its least important social functions. 341 00:33:13.940 --> 00:33:28.940 But there are also sort of a little bit more constructive implications in a sense for the building of theory of the Austrian insistence on capital heterogeneity. 342 00:33:28.940 --> 00:33:41.940 Specifically, there seem to me to be very strong implications, theory implications, of the very point that capital assets just cannot be costlessly shifted from one activity to another activity. 343 00:33:41.940 --> 00:33:49.780 I argued earlier that we may think of the Austrian theory of capital as a theory of production, 344 00:33:49.780 --> 00:33:56.500 which seems to me to imply that the firm level becomes relevant. 345 00:33:56.500 --> 00:34:04.660 Indeed, the idea that resources, firms and industries are very different from each other, 346 00:34:04.660 --> 00:34:11.660 that capital and labor are specialized to specific activities and projects, 347 00:34:11.660 --> 00:34:18.420 that people are, in terms of human capital, are really distinct is key in the theory 348 00:34:18.500 --> 00:34:24.220 and practice, of course, of management, notably strategic management. 349 00:34:24.300 --> 00:34:28.380 It seems to me that Austrian ideas on capital find, therefore, a close parallel 350 00:34:28.460 --> 00:34:36.140 in management thinking on firms as bundles of heterogeneous resources, assets and activities. 351 00:34:36.220 --> 00:34:39.820 Peter Lewin has recently argued that Austrian capital theory 352 00:34:39.820 --> 00:34:46.460 We may therefore form the basis for what he calls a capital-based theory of the firm. 353 00:34:46.460 --> 00:34:56.540 Of course, as Peter and I told you this morning, Peter Klein and I have developed similar arguments 354 00:34:56.540 --> 00:35:03.860 in a string of papers, many of which are essentially summarized in this book, Organizing Entrepreneurial 355 00:35:03.860 --> 00:35:04.860 Judgment. 356 00:35:04.860 --> 00:35:15.900 To get a basic idea of some of our over-arguments, consider the world of Samuelsonian schmoo, 357 00:35:15.900 --> 00:35:20.860 the world in which capital is indeed homogeneous. 358 00:35:20.860 --> 00:35:28.540 This is a world where individuals face very low costs of searching for assets. 359 00:35:28.540 --> 00:35:34.780 For example, capabilities of potential takeover targets or suppliers, assets that may fit 360 00:35:34.780 --> 00:35:40.180 existing operations. They don't really have any cost of measuring or ascertaining 361 00:35:40.180 --> 00:35:46.500 the inherent characteristics of assets because one asset is just like another 362 00:35:46.500 --> 00:35:53.860 capital asset. There are trivial costs if any of coordinating assets and so on and 363 00:35:53.860 --> 00:35:58.820 most of those very real problems of exchange and organization that 364 00:35:58.820 --> 00:36:04.220 economists put under the transaction cost rubric they simply disappear. 365 00:36:04.220 --> 00:36:09.220 that go away in a world of homogeneous capital assets. 366 00:36:10.780 --> 00:36:14.700 So per implication, the understanding of the sources 367 00:36:14.700 --> 00:36:17.300 of transaction costs in a modern economy 368 00:36:17.300 --> 00:36:19.620 involves, it seems to me, the understanding 369 00:36:19.620 --> 00:36:24.060 of capital heterogeneity and its implications. 370 00:36:24.060 --> 00:36:26.500 Conversely, it also seems to me that a significant part 371 00:36:26.500 --> 00:36:29.540 of the problems of what Joseph Salerno calls, 372 00:36:29.540 --> 00:36:31.700 and drawing on Ludwig von Mises obviously, 373 00:36:31.700 --> 00:36:33.780 called entrepreneurial appraisement, 374 00:36:33.780 --> 00:36:37.820 and indeed a significant part of the Misesian calculation 375 00:36:37.820 --> 00:36:41.940 problem itself involve transaction costs. 376 00:36:41.940 --> 00:36:44.500 This is an argument that Peter Klein made 377 00:36:44.500 --> 00:36:48.420 in a great paper in 1996, 378 00:36:48.420 --> 00:36:50.980 and I believe the Rio of Austria in economics. 379 00:36:52.380 --> 00:36:55.380 So to some, namely those of us who specialize 380 00:36:55.380 --> 00:36:57.820 in the economics of the firm, 381 00:36:57.820 --> 00:37:00.180 or like me, work in business schools, 382 00:37:00.180 --> 00:37:02.380 These ideas are inherently attractive. 383 00:37:02.380 --> 00:37:05.900 They matter a lot to me and to Peter. 384 00:37:05.900 --> 00:37:09.300 But many of you may not be interested in firms, 385 00:37:09.300 --> 00:37:11.340 management, strategy per se. 386 00:37:11.340 --> 00:37:15.340 What you're interested in may be the economy-wide 387 00:37:15.340 --> 00:37:20.100 implications of these ideas, linking together, 388 00:37:20.100 --> 00:37:24.900 for example, capital heterogeneity and transaction costs. 389 00:37:24.900 --> 00:37:28.780 So are there economy-wide implications of these ideas? 390 00:37:28.780 --> 00:37:43.780 It seems to me that there are plenty of absolutely important economy-wide implications of looking carefully at capital heterogeneity at the firm level. 391 00:37:43.780 --> 00:37:57.780 For example, John Matsusaka has argued that the processes of mergers and divestments matter to the overall performance of the economy and which antitrust authorities are very interested in. 392 00:37:57.780 --> 00:38:15.780 These processes should be understood as experimental learning processes that must be undertaken precisely because it is not obvious exactly what is the efficient combination of a bundle of highly heterogeneous capital assets. 393 00:38:15.780 --> 00:38:28.780 These micro-level processes, they are essentially entrepreneurial ones because an important part of the entrepreneur's role is to arrange and organize heterogeneous resources. 394 00:38:28.780 --> 00:38:34.780 Peter quoted Lachman's take on this this morning. I'll do it again because it's a great quotation. 395 00:38:34.780 --> 00:38:51.780 So what Lachman says is, we are living in a world of unexpected change, hence capital combinations will be ever-changing, will be dissolved and reformed in this activity, we find the real function of the entrepreneur. 396 00:38:53.780 --> 00:39:02.780 On the aggregate level, and I hope you'll excuse me for indulging in a little bit of mainstream economics terminology now, just a temporary lapse, I hope I'll be excused. 397 00:39:02.780 --> 00:39:12.780 But these processes are what make the economy track its moving production possibility frontier, 398 00:39:12.780 --> 00:39:19.780 as a mainstream economist would say, improving the efficiency with which resources are utilized. 399 00:39:19.780 --> 00:39:30.780 So these dynamic firm level processes have been estimated to account for about half of so-called aggregate productivity growth. 400 00:39:30.780 --> 00:39:42.780 It's been found that the automatic restructuring of industries in developed countries really imply a very serious penalty in terms of foregone growth. 401 00:39:42.780 --> 00:39:53.780 So the constraints, the incentives, the opportunities faced by appraising entrepreneurs trying to combine heterogeneous capital assets 402 00:39:53.780 --> 00:40:04.780 must really ultimately enter as an absolutely crucial element in the understanding of economy-wide phenomena connected, for example, to economic growth. 403 00:40:04.780 --> 00:40:22.780 Now, much of the understanding of the growth process in mainstream economics has been based on models of accumulating Samuelsonian smooth along equilibrium growth paths. 404 00:40:22.780 --> 00:40:28.060 So, the accumulation of homogeneous capital, essentially. 405 00:40:28.060 --> 00:40:33.420 There are applications of Austrian capital in the context of growth theory 406 00:40:33.420 --> 00:40:38.620 that do allow for heterogeneity, but otherwise portray growth as a smooth process 407 00:40:38.620 --> 00:40:43.900 of accumulation of physical capital along, again, an equilibrium growth path. 408 00:40:43.900 --> 00:40:49.180 Hicks' work, John Hicks' work from the 1970s, is a good example of that. 409 00:40:49.180 --> 00:41:04.180 Hicks, in fact, interpreted the Austrian cycle theory as fundamentally a theory of how this kind of smooth equilibrium growth can be disturbed by government intervention. 410 00:41:04.180 --> 00:41:13.180 And according to Hicks, that's a famous essay from 1967 where Hicks looks back at his career and how he interacted with Hayek. 411 00:41:13.180 --> 00:41:24.740 And to Hicks, the essence of the Hayek story, as he called it, was that no one really understood that Hayek was fundamentally talking about growth, 412 00:41:24.740 --> 00:41:33.820 which seems to me to be a rather far-fetched interpretation of Hayek. 413 00:41:33.820 --> 00:41:38.620 Now, of course, also those who have taken a different approach to the growth process, 414 00:41:38.620 --> 00:41:43.580 one that perhaps Austrians would be more sympathetic to, 415 00:41:43.580 --> 00:41:50.580 they argue that the growth process is driven by improvements in total factor productivity, 416 00:41:50.580 --> 00:41:58.780 which is again an aggregate umbrella term for a host of very diverse, very heterogeneous processes 417 00:41:58.780 --> 00:42:03.780 is that to a large extent takes place on the firm level. 418 00:42:04.780 --> 00:42:06.500 There's been long been recognized 419 00:42:06.500 --> 00:42:09.340 that this total factor productivity 420 00:42:09.340 --> 00:42:14.180 is about much more than technology, 421 00:42:14.180 --> 00:42:18.420 technology in the sense of recipe-like advances 422 00:42:18.420 --> 00:42:20.980 in scientific knowledge. 423 00:42:21.860 --> 00:42:25.060 There's been a lot of attention of course to R&D 424 00:42:25.060 --> 00:42:27.140 in the economics of growth 425 00:42:27.140 --> 00:42:32.340 since Solow's work in the 1950s, but it's not R&D, of course, 426 00:42:32.420 --> 00:42:34.580 that in itself drives growth. 427 00:42:34.660 --> 00:42:40.580 Innovations that emerge from R&D research and development drive growth. 428 00:42:40.660 --> 00:42:46.420 And in turn, innovations are introduced by enterprising individuals, 429 00:42:46.500 --> 00:42:48.900 by entrepreneurs. 430 00:42:48.980 --> 00:42:52.140 And of course, innovations at the firm level 431 00:42:52.220 --> 00:42:54.580 have many other sources than the R&D function. 432 00:42:54.580 --> 00:43:01.900 and they include your process innovations, innovations of management practices, innovations of organizational practices. 433 00:43:01.900 --> 00:43:17.700 All these processes are entrepreneurial ones. They amount to appraising, combining, recombining heterogeneous assets in the uncertain pursuit of profitable opportunities. 434 00:43:17.700 --> 00:43:25.140 The economy-wide level implications of productivity advances and improvements in resource utilization, 435 00:43:25.140 --> 00:43:31.140 that is, increases in total factor productivity. 436 00:43:31.140 --> 00:43:37.980 Surprisingly, because we know that the entrepreneur is the prime mover of progress, 437 00:43:37.980 --> 00:43:46.980 it's only very recently that growth economists have begun to take seriously the entrepreneurial function in the economy, 438 00:43:46.980 --> 00:43:51.420 Model it, measure it the way they go about things. 439 00:43:51.420 --> 00:43:55.780 And the reason lies exactly in something I talked about earlier, 440 00:43:55.780 --> 00:44:02.980 namely the dominance of the production function framework in mainstream economics, 441 00:44:02.980 --> 00:44:06.340 and therefore also in growth economics. 442 00:44:06.340 --> 00:44:13.580 If production factors are assumed to be homogeneous within categories, capital, labor, land, 443 00:44:13.580 --> 00:44:17.660 and production is always at its efficient frontier. 444 00:44:17.740 --> 00:44:23.820 There is, of course, extremely little for entrepreneurs to do. 445 00:44:23.900 --> 00:44:26.540 Everything has been taken care of already 446 00:44:26.620 --> 00:44:31.740 by assumptions of perfect knowledge and equilibrium and so on. 447 00:44:31.820 --> 00:44:36.860 Of course, capital in actuality is heterogeneous 448 00:44:36.940 --> 00:44:41.740 and the combination of those heterogeneous capital assets 449 00:44:41.740 --> 00:44:48.140 requires technical and commercial processes that in a very real sense are experimental. 450 00:44:48.140 --> 00:44:54.940 The optimum combination of inputs, capital inputs for example, just isn't a datum. 451 00:44:54.940 --> 00:44:59.540 And what is at any moment the optimum combination 452 00:44:59.540 --> 00:45:04.540 will change as a result of changes in the underlying scarcities. 453 00:45:04.540 --> 00:45:06.940 As Lachman reminds us. 454 00:45:06.940 --> 00:45:13.340 These processes again are driven by the judgment and the appraisement of capitalist entrepreneurs. 455 00:45:13.340 --> 00:45:33.940 So the basic message here is entrepreneurship matters to economic growth because entrepreneurship influences these processes that we put under the rubric of total factor productivity, at least if we are economic growth theorists. 456 00:45:33.940 --> 00:45:50.940 So it seems to me that there really is an opportunity for engaging profitably, even with some of those, you know, suspect mainstream types to talk about growth, because they are interested in these ideas about capital heterogeneity. 457 00:45:50.940 --> 00:46:01.940 Now, something related has to do with the influence of institutions on growth, which has been a huge theme in recent growth economics. 458 00:46:01.940 --> 00:46:14.940 So there are scholars who argue that institutions rule, they specifically rule in the sense that institutions overwhelm all other determinants of growth. 459 00:46:14.940 --> 00:46:24.940 It's not always entirely clear why this is so. So there are missing micro-foundations for many of these arguments, I think. 460 00:46:24.940 --> 00:46:40.940 But a key reason to expect institutional quality to affect growth positively is that it has to do with the transaction cost dimensions of the Misesian calculation problem. 461 00:46:40.940 --> 00:46:52.940 So institutions matter because they influence transaction costs through reduced uncertainty of economic transactions and productivity enhancing incentives. 462 00:46:52.940 --> 00:47:07.940 The institutional economist Douglas North tells us that the major role of institutions in a society is to reduce uncertainty by establishing a stable, not necessarily efficient, but stable structure to human interaction. 463 00:47:07.940 --> 00:47:16.940 The overall stability of an institutional framework makes complex exchange possible across both time and space. 464 00:47:16.940 --> 00:47:29.940 In turn, higher certainty implies lower transaction costs because the costs of entering into embarking, monitoring, protecting, contractual rights, ownership rights, they're reduced. 465 00:47:29.940 --> 00:47:38.940 This increases the expected value of projects and makes them more likely to be undertaken. 466 00:47:38.940 --> 00:47:46.940 So, this in turn establishes a link to total factor productivity, which I talked about earlier. 467 00:47:46.940 --> 00:47:54.940 We know that increases in total factor productivity, the efficiency with which factors of production are used, 468 00:47:54.940 --> 00:48:04.940 result from new processes, new modes of organization, ways of better allocating resources to their preferred users and so on. 469 00:48:04.940 --> 00:48:18.940 Given all this, the flexibility with which appraising entrepreneurs can carry out these processes becomes highly important to the growth performance of the economy. 470 00:48:18.940 --> 00:48:29.940 And no classical economists capture this by the notion of the aggregate elasticity of factor substitution. 471 00:48:29.940 --> 00:48:39.940 And this is, again, this is a measure of the flexibility of the economy, for example, with respect to reacting to external shocks. 472 00:48:39.940 --> 00:48:46.940 The aggregate elasticity of substitution, the flexibility of the economy is endogenous. 473 00:48:46.940 --> 00:48:57.940 Austrian capital theory would seem to me to matter here greatly because it suggests that there may be inherent technical constraints that reduce flexibility 474 00:48:57.940 --> 00:49:04.940 and flexibility, because what Lachman called multiple specificities may obtain. 475 00:49:04.940 --> 00:49:12.940 But the bottom line here is that this endogeneity of the elasticity of substitution, 476 00:49:12.940 --> 00:49:19.940 the flexibility with which we can combine and recombine, for example, heterogeneous capital assets, 477 00:49:19.940 --> 00:49:24.940 is influenced by institutional determinants. 478 00:49:24.940 --> 00:49:39.940 For example, those that we sometimes call freedom variables, such as the quality of the legal framework, sound money, how secure property rights are, and so on. 479 00:49:39.940 --> 00:49:53.940 So they influence the flexibility of the economy, which in turn leads to high factor productivity, because it means that resources can be more easily allocated to highly valued users. 480 00:49:53.940 --> 00:50:07.940 Now there are huge litigates in economic history that essentially make a number of these points in a verbal manner that perhaps formal growth economists are not particularly fond of. 481 00:50:07.940 --> 00:50:18.940 But they are going in the right direction. They stress the importance of entrepreneurial activity, of property rights being well defined and enforced. 482 00:50:18.940 --> 00:50:23.940 I have in mind work by Douglas Northigan, by Joel MacKayer and so on. 483 00:50:23.940 --> 00:50:33.940 So well-defined and enforced property rights matter because they reduce the transaction costs of carrying out entrepreneurial activities. 484 00:50:33.940 --> 00:50:41.940 So again, with secure property rights, there are low costs of searching for, negotiating with and concluding bargains 485 00:50:41.940 --> 00:50:47.940 with owners of those capital inputs that enter into entrepreneurial ventures. 486 00:50:47.940 --> 00:51:12.940 Similar reasoning applies to sound money. Inflation, particularly erratic inflation, jams the signalling effect of relative prices, harms the process of allocating resources to their most highly valued uses and therefore negatively influences total factor productivity and therefore economic growth. 487 00:51:12.940 --> 00:51:19.940 For many reasons, the size of the government, of course, also influences total factor productivity. 488 00:51:19.940 --> 00:51:25.940 If, for example, economic activities in certain industries or sectors have been nationalised, 489 00:51:25.940 --> 00:51:32.940 the scope for entrepreneurship in those industries or sectors is correspondingly reduced 490 00:51:32.940 --> 00:51:37.940 because nationalisation so often implies a public monopoly. 491 00:51:37.940 --> 00:51:45.940 And most parts of the western world, this is a case of child care, health care, care for the elderly and so on. 492 00:51:45.940 --> 00:51:57.940 And as Mises of course reminds us, the effective nationalization of all of these industries means that the operation of the price mechanism becomes severely hampered. 493 00:51:57.940 --> 00:52:11.940 and eliminating entrepreneurship and reducing therefore the adaptability of these industries to adapt to changing circumstances. 494 00:52:11.940 --> 00:52:22.940 Christian Bjornskog, a Danish colleague and myself have tried to make these ideas empirical 495 00:52:22.940 --> 00:52:27.940 and subject him to statistical testing. 496 00:52:30.980 --> 00:52:34.260 We argue in these two papers essentially 497 00:52:34.260 --> 00:52:38.920 that economic freedom, including the rule of law, 498 00:52:38.920 --> 00:52:43.540 easy regulations, low taxes, limited government 499 00:52:43.540 --> 00:52:45.860 and interference in the economy, 500 00:52:45.860 --> 00:52:50.020 that these things are good, not just for more reasons, 501 00:52:50.020 --> 00:52:54.740 but because they allow entrepreneurial experimentation 502 00:52:54.740 --> 00:52:59.700 with combining productive factors to take place 503 00:52:59.700 --> 00:53:02.640 in a low transaction cost manner. 504 00:53:03.920 --> 00:53:08.000 So this micro-mechanism that I have sketched 505 00:53:08.000 --> 00:53:12.660 from institutions to experimental processes 506 00:53:12.660 --> 00:53:16.060 of combining heterogeneous capital assets 507 00:53:16.060 --> 00:53:19.820 on the level of firms up to economic growth 508 00:53:19.820 --> 00:53:22.100 are things that we try to talk about 509 00:53:22.100 --> 00:53:26.260 in an empirically informed manner in these two papers 510 00:53:26.260 --> 00:53:27.460 that are shown here. 511 00:53:30.340 --> 00:53:34.700 So again, the argument is that institutions of liberty 512 00:53:34.700 --> 00:53:37.380 increase the aggregate elasticity of substitution. 513 00:53:37.380 --> 00:53:39.660 They increase the overall flexibility 514 00:53:39.660 --> 00:53:44.820 of the economy, which translates into increasing total factor 515 00:53:44.820 --> 00:53:49.100 productivity and therefore growth. 516 00:53:49.100 --> 00:53:52.380 And we assess these ideas empirically again. 517 00:53:52.380 --> 00:54:00.700 So we build a panel data set of 25 countries from 1980 to 2005. 518 00:54:00.700 --> 00:54:04.300 And we test the influence of entrepreneurship 519 00:54:04.300 --> 00:54:09.060 and institutions on total factor productivity. 520 00:54:09.060 --> 00:54:12.340 And we find, lo and behold, that entrepreneurship 521 00:54:12.340 --> 00:54:16.460 very strongly, significantly, influence total factor 522 00:54:16.460 --> 00:54:22.460 and Productivity, and that some, not all, of the institutions of liberty, sound money, for example, 523 00:54:22.460 --> 00:54:30.460 as well as classical liberal economic policies more broadly, liberal economic policy regimes, 524 00:54:30.460 --> 00:54:36.460 promote growth and productivity across these countries. 525 00:54:36.460 --> 00:54:43.460 And I don't summarize these arguments to try to convince you, 526 00:54:43.460 --> 00:54:49.460 I'm not sure I can convince that many of you that this is the way we should do Austrian economics at all. 527 00:54:49.460 --> 00:54:54.460 This is about pretty conventional positivist hypothesis testing. 528 00:54:54.460 --> 00:55:03.460 We draw on a lot of pretty mainstream economics, but the point here is that there are certain key Austrian ideas 529 00:55:03.460 --> 00:55:08.460 that you can actually place in more of a mainstream economics argument. 530 00:55:08.460 --> 00:55:16.460 and perhaps this is one way to sell some key Austrian ideas to the mainstreamers. 531 00:55:16.460 --> 00:55:21.460 At least that's what we try to do in this paper, these two papers. 532 00:55:21.460 --> 00:55:25.460 Right, so to sum up here, what I've been doing, 533 00:55:25.460 --> 00:55:34.460 I have made a plea essentially for the continuing relevance of Austrian Capital Theory. 534 00:55:34.460 --> 00:55:41.980 Historically, Austrian capital theory has, of course, been a central research area in Austrian economics. 535 00:55:41.980 --> 00:55:47.380 And, substantively, it is an integral part of Austrian economics. 536 00:55:47.380 --> 00:55:56.540 It has, however, had a reputation of being, I think, a particularly difficult part of the Austrian corpus. 537 00:55:56.540 --> 00:56:04.380 And, perhaps for this reason, it could be argued that it is one of the least intensely researched areas 538 00:56:04.380 --> 00:56:08.700 in the Austrian revival of the last four decades. 539 00:56:09.700 --> 00:56:11.980 I think it's time to change that. 540 00:56:12.060 --> 00:56:17.660 The Austrian capital theory has the potential to make interesting advances. 541 00:56:17.740 --> 00:56:21.700 I think there's still a lot to do with respect to understanding 542 00:56:21.780 --> 00:56:25.820 the role of heterogeneous assets in entrepreneurial appraisement. 543 00:56:25.900 --> 00:56:29.980 There are many fertile links to related thinking in management theory 544 00:56:30.060 --> 00:56:32.860 and other parts of economics, as I've argued, 545 00:56:32.860 --> 00:56:36.860 such as, perhaps, empirical growth economics. 546 00:56:36.860 --> 00:56:41.860 So perhaps Austrian Capital Theory can serve a strategic purpose for Austrians, 547 00:56:41.860 --> 00:56:46.860 namely by extending the theorizing into new areas 548 00:56:46.860 --> 00:56:51.860 while sort of keeping intact a central core of Austrianism. 549 00:56:51.860 --> 00:57:00.860 There's definitely room in the Austrian tent for applied research on anarchism and pirates. 550 00:57:00.860 --> 00:57:08.860 There's room for telling, instructing mainstream economists about how they should do economics. 551 00:57:08.860 --> 00:57:14.860 There's room for integrating Austrian economics and complexity theory, 552 00:57:14.860 --> 00:57:18.860 we call it Bryce, and other trendy topics. 553 00:57:18.860 --> 00:57:28.860 But the core of Austrian economics remains mundane topics such as capital theory. 554 00:57:28.860 --> 00:57:31.860 Theory. And I'll stop here. Thank you.