WEBVTT NOTE 11.18. The Fallacy of the Acceleration Principle 1 00:00:00.000 --> 00:00:06.280 18. The Fallacy of the Acceleration Principle 2 00:00:06.280 --> 00:00:13.200 The Acceleration Principle has been adopted by some Keynesians as their explanation of 3 00:00:13.200 --> 00:00:20.360 investment, then to be combined with the multiplier to yield various mathematical models of the 4 00:00:20.360 --> 00:00:26.840 business cycle. The Acceleration Principle antedates Keynesianism, however, and may be 5 00:00:26.840 --> 00:00:42.600 The essence of the acceleration principle may be summed up in the following illustration. 6 00:00:42.600 --> 00:00:50.080 Let us take a certain firm or industry, preferably a first-rank producer of consumers' goods. 7 00:00:50.080 --> 00:00:56.820 Assume that the firm is producing an output of 100 units of a good during a certain period 8 00:00:56.820 --> 00:01:05.220 of Time and that 10 machines of a certain type are needed in this production. If the period is a year, 9 00:01:05.220 --> 00:01:13.940 consumers demand and purchase 100 units of output per year. The firm has a stock of 10 machines. 10 00:01:14.500 --> 00:01:22.820 Suppose that the average life of a machine is 10 years. In equilibrium, the firm buys one machine 11 00:01:22.820 --> 00:01:29.940 as a replacement every year, assuming it had bought a new machine every year to build up to 10. 12 00:01:30.820 --> 00:01:37.940 It is usually overlooked that this replacement pattern necessary to the acceleration principle 13 00:01:37.940 --> 00:01:46.900 could apply only to those firms or industries that had been growing in size rapidly and continuously. 14 00:01:46.900 --> 00:01:54.900 Now suppose that there is a 20% increase in the consumer demand for the firm's output. 15 00:01:54.900 --> 00:02:04.900 Consumers now wish to purchase 120 units of output. Assuming a fixed ratio of capital investment to output, 16 00:02:04.900 --> 00:02:15.900 it is now necessary for the firm to have 12 machines, maintaining the ratio of 1 machine to 10 units of annual output. 17 00:02:15.900 --> 00:02:22.900 In order to have the twelve machines, it must buy two additional machines this year. 18 00:02:22.900 --> 00:02:33.900 Add this demand to its usual demand of one machine, and we see that there has been a 200% increase in demand for the machine. 19 00:02:33.900 --> 00:02:43.900 A 20% increase in demand for the product has caused a 200% increase in demand for the capital good. 20 00:02:43.900 --> 00:02:51.220 Hence, say the proponents of the Acceleration Principle, an increase in consumption demand 21 00:02:51.220 --> 00:03:00.060 in general causes an enormously magnified increase in demand for capital goods, or rather 22 00:03:00.060 --> 00:03:08.780 it causes a magnified increase in demand for fixed capital goods of high durability. 23 00:03:08.780 --> 00:03:16.180 Obviously, capital goods lasting only one year would receive no magnification effect. 24 00:03:16.180 --> 00:03:21.740 The essence of the acceleration principle is the relationship between the increased 25 00:03:21.740 --> 00:03:27.820 demand and the low level of replacement demand for a durable good. 26 00:03:27.820 --> 00:03:34.060 The more durable the good, the greater the magnification, and the greater, therefore, 27 00:03:34.060 --> 00:03:36.820 the acceleration effect. 28 00:03:36.820 --> 00:03:45.080 Now suppose that in the next year consumer demand for output remains at 120 units. 29 00:03:45.080 --> 00:03:51.340 There has been no change in consumer demand from the second year when it changed from 30 00:03:51.340 --> 00:03:55.360 100 to 120 to the third year. 31 00:03:55.360 --> 00:04:03.040 And yet, the accelerationists point out, dire things are happening in the demand for fixed capital. 32 00:04:03.040 --> 00:04:09.760 For now, there is no longer any need for firms to purchase any new machines beyond what is 33 00:04:09.760 --> 00:04:12.680 necessary for replacement. 34 00:04:12.680 --> 00:04:17.520 Needed for replacement is still only one machine per year. 35 00:04:17.520 --> 00:04:23.980 As a result, while there is zero change in demand for consumers' goods, there is a 36 00:04:23.980 --> 00:04:32.540 200% decline in demand for fixed capital, and the former is the cause of the latter. 37 00:04:32.540 --> 00:04:39.460 In the long run, of course, the situation stabilizes into an equilibrium with 120 units 38 00:04:39.460 --> 00:04:43.160 of output and one unit of replacement. 39 00:04:43.160 --> 00:04:50.420 But in the short run, there has been consequent upon a simple increase of 20% in consumer 40 00:04:50.420 --> 00:04:51.420 demand. 41 00:04:51.420 --> 00:05:01.700 First, a 200% increase in the demand for fixed capital, and next, a 200% decrease. 42 00:05:01.700 --> 00:05:07.620 To the upholders of the Acceleration Principle, this illustration provides the key to some 43 00:05:07.620 --> 00:05:13.700 of the main features of the business cycle, the greater fluctuations of fixed capital 44 00:05:13.700 --> 00:05:20.240 goods industries as compared with consumers goods, and the mass of errors revealed by 45 00:05:20.240 --> 00:05:24.060 the crisis in the investment goods industries. 46 00:05:24.060 --> 00:05:30.900 The Acceleration Principle leaps boldly from the example of a single firm to a discussion 47 00:05:30.900 --> 00:05:35.380 Transformation of Aggregate Consumption and Aggregate Investment 48 00:05:35.380 --> 00:05:41.740 Everyone knows, the advocates say, that consumption increases in a boom. 49 00:05:41.740 --> 00:05:48.380 This increase in consumption accelerates and magnifies increases in investment. 50 00:05:48.380 --> 00:05:54.980 Then, the rate of increase of consumption slows down, and a decline is brought about 51 00:05:54.980 --> 00:05:57.740 in investment in fixed capital. 52 00:05:57.740 --> 00:06:06.140 Furthermore, if consumption demand declines, then there is excess capacity in fixed capital, 53 00:06:06.140 --> 00:06:09.480 another feature of the depression. 54 00:06:09.480 --> 00:06:13.440 The acceleration principle is rife with error. 55 00:06:13.440 --> 00:06:19.480 An important fallacy at the heart of the principle has been uncovered by W. H. Hutt. 56 00:06:19.480 --> 00:06:27.260 We have seen that consumer demand increases by 20 percent, but why must two extra machines 57 00:06:27.260 --> 00:06:30.100 must be purchased in a year. 58 00:06:30.100 --> 00:06:33.380 What does the year have to do with it? 59 00:06:33.380 --> 00:06:39.940 If we analyze the matter closely, we find that the year is a purely arbitrary and irrelevant 60 00:06:39.940 --> 00:06:44.080 unit, even within the terms of the example itself. 61 00:06:44.080 --> 00:06:48.920 We might just as readily take a week as the period of time. 62 00:06:48.920 --> 00:06:55.980 Then we would have to say that consumer demand, which after all goes on continuously, increases 63 00:06:55.980 --> 00:07:05.660 20% over the first week, thereby necessitating a 200% increase in demand for machines in 64 00:07:05.660 --> 00:07:13.100 the first week, or even an infinite increase if the replacement does not precisely occur 65 00:07:13.100 --> 00:07:23.300 in the first week, followed by a 200% or infinite decline in the next week, and stability thereafter. 66 00:07:23.300 --> 00:07:29.980 A week is never used by the accelerationists, because the example would then be glaringly 67 00:07:29.980 --> 00:07:36.660 inapplicable to real life, which does not see such enormous fluctuations in the course 68 00:07:36.660 --> 00:07:38.720 of a couple of weeks. 69 00:07:38.720 --> 00:07:43.020 But a week is no more arbitrary than a year. 70 00:07:43.020 --> 00:07:50.260 In fact, the only non-arbitrary period to choose would be the life of the machine, for 71 00:07:50.260 --> 00:07:52.540 example, ten years. 72 00:07:52.540 --> 00:08:00.780 Over a 10-year period, demand for machines had previously been 10 in the previous decade, 73 00:08:00.780 --> 00:08:09.400 and in the current and succeeding decades, it will be 10 plus the extra 2, that is, 12. 74 00:08:09.400 --> 00:08:16.260 In short, over the 10-year period, the demand for machines will increase precisely in the 75 00:08:16.260 --> 00:08:32.660 Since businesses buy and produce over planned periods covering the life of their equipment, 76 00:08:32.660 --> 00:08:39.100 there is no reason to assume that the market will not plan production suitably and smoothly 77 00:08:39.100 --> 00:08:46.100 without the erratic fluctuations manufactured by the model of the acceleration principle. 78 00:08:46.100 --> 00:08:54.200 There is in fact no validity in saying that increased consumption requires increased production 79 00:08:54.200 --> 00:08:56.560 of machines immediately. 80 00:08:56.560 --> 00:09:04.440 On the contrary, it is only increased saving and investment in machines at points of time 81 00:09:04.440 --> 00:09:12.240 chosen by entrepreneurs strictly on the basis of expected profit that permits increased 82 00:09:12.240 --> 00:09:16.240 Production of Consumers' Goods in the Future. 83 00:09:16.240 --> 00:09:23.600 Secondly, the Acceleration Principle makes a completely unjustified leap from the single 84 00:09:23.600 --> 00:09:27.520 firm or industry to the whole economy. 85 00:09:27.520 --> 00:09:36.680 A 20% increase in consumption demand at one point must signify a 20% drop in consumption 86 00:09:36.680 --> 00:09:38.560 somewhere else. 87 00:09:38.560 --> 00:09:44.140 Or how can consumption demand in general increase? 88 00:09:44.140 --> 00:09:50.140 Consumption demand in general can increase only through a shift from saving. 89 00:09:50.140 --> 00:09:56.200 But if saving decreases, then there are less funds available for investment. 90 00:09:56.200 --> 00:10:04.560 If there are less funds available for investment, how can investment increase even more than 91 00:10:04.560 --> 00:10:05.560 consumption? 92 00:10:05.560 --> 00:10:13.320 In fact, there are less funds available for investment when consumption increases. 93 00:10:13.320 --> 00:10:18.760 Consumption and investment compete for the use of funds. 94 00:10:18.760 --> 00:10:24.720 Another important consideration is that the proof of the acceleration principle is couched 95 00:10:24.720 --> 00:10:28.600 in physical rather than monetary terms. 96 00:10:28.600 --> 00:10:35.860 Actually, consumption demand, particularly aggregate consumption demand, as well as demand 97 00:10:35.860 --> 00:10:41.240 for capital goods, cannot be expressed in physical terms. 98 00:10:41.240 --> 00:10:48.480 It must be expressed in monetary terms, since the demand for goods is the reverse of the 99 00:10:48.480 --> 00:10:53.020 supply of money on the market for exchange. 100 00:10:53.020 --> 00:11:00.860 If consumer demand increases either for one good or for all, it increases in monetary 101 00:11:00.860 --> 00:11:05.980 terms, thereby raising prices of consumers' goods. 102 00:11:05.980 --> 00:11:12.260 Yet we notice that there has been no discussion whatever of prices or price relationships 103 00:11:12.260 --> 00:11:14.860 in the acceleration principle. 104 00:11:14.860 --> 00:11:22.620 This neglect of price relationships is sufficient by itself to invalidate the entire principle. 105 00:11:22.620 --> 00:11:29.700 The neglect of prices and price relations is at the core of a great many economic fallacies. 106 00:11:29.700 --> 00:11:37.420 The acceleration principle simply glides from a demonstration in physical terms to a conclusion 107 00:11:37.420 --> 00:11:39.900 in monetary terms. 108 00:11:39.900 --> 00:11:47.980 Furthermore, the acceleration principle assumes a constant relationship between fixed capital 109 00:11:47.980 --> 00:11:51.780 and output, ignoring substitutability. 110 00:11:51.780 --> 00:11:58.660 The possibility of a range of output, the more or less intensive working of factors. 111 00:11:58.660 --> 00:12:05.800 It also assumes that the new machines are produced practically instantaneously, thus ignoring 112 00:12:05.800 --> 00:12:09.600 the requisite period of production. 113 00:12:09.600 --> 00:12:16.820 In fact, the entire acceleration principle is a fallaciously mechanistic one, assuming 114 00:12:16.820 --> 00:12:24.560 automatic reactions by entrepreneurs to present data, thereby ignoring the most important 115 00:12:24.560 --> 00:12:32.660 fact about entrepreneurship, that it is speculative, that its essence is estimating the data of 116 00:12:32.660 --> 00:12:34.620 the uncertain future. 117 00:12:34.620 --> 00:12:40.900 It therefore involves judgment of future conditions by businessmen, and not simply 118 00:12:40.900 --> 00:12:45.180 blind reactions to past data. 119 00:12:45.180 --> 00:12:49.480 All entrepreneurs are those who best forecast the future. 120 00:12:49.480 --> 00:12:56.760 Why can't the entrepreneurs foresee the supposed slackening of demand and arrange their investments 121 00:12:56.760 --> 00:12:58.040 accordingly? 122 00:12:58.040 --> 00:13:00.900 In fact, that is what they will do. 123 00:13:00.900 --> 00:13:06.260 If the economist, armed with knowledge of the acceleration principle, thinks that he 124 00:13:06.260 --> 00:13:12.500 will be able to operate more profitably than the generally successful entrepreneur, why 125 00:13:12.500 --> 00:13:19.220 Why does he not become an entrepreneur and reap the rewards of success himself? 126 00:13:19.220 --> 00:13:25.100 All theories of the business cycle attempting to demonstrate general entrepreneurial error 127 00:13:25.100 --> 00:13:29.100 on the free market, founder on this problem. 128 00:13:29.100 --> 00:13:36.540 They do not answer the crucial question, why does a whole set of men, most able in judging 129 00:13:36.540 --> 00:13:42.140 the future, suddenly lapse into forecasting error? 130 00:13:42.140 --> 00:13:48.440 A clue to the correct business cycle theory is contained in the fact that buried somewhere 131 00:13:48.440 --> 00:13:55.180 in a footnote or minor clause of all business cycle theories is the assumption that the 132 00:13:55.180 --> 00:14:03.160 money supply expands during the boom, in particular through credit expansion by the banks. 133 00:14:03.160 --> 00:14:09.940 The fact that this is a necessary condition in all the theories should lead us to explore 134 00:14:09.940 --> 00:14:17.220 for this factor further. Perhaps it is a sufficient condition as well. But, as we have seen, there 135 00:14:17.220 --> 00:14:24.540 can be no bank credit expansion on the free market, since this is equivalent to the issue 136 00:14:24.540 --> 00:14:31.180 of fraudulent warehouse receipts. The positive discussion of business cycle theory will have 137 00:14:31.180 --> 00:14:37.700 to be postponed to the next chapter, since there can be no business cycle in the purely 138 00:14:37.700 --> 00:14:47.700 Business cycle theorists have always claimed to be more realistic than general economic theorists. 139 00:14:47.700 --> 00:14:53.700 With the exceptions of Mises and Hayek correctly, and Schumpeter fallaciously, 140 00:14:53.700 --> 00:15:00.700 none has tried to deduce his business cycle theory from general economic analysis. 141 00:15:00.700 --> 00:15:06.700 It should be clear that this is required for a satisfactory explanation of the business cycle. 142 00:15:06.700 --> 00:15:15.200 Some, in fact, have explicitly discarded economic analysis altogether in their study of business cycles, 143 00:15:15.200 --> 00:15:24.200 while most writers use aggregate models with no relation to a general economic analysis of individual action. 144 00:15:24.200 --> 00:15:34.200 All of these commit the fallacy of conceptual realism, that is, of using aggregative concepts and shuffling them at will, 145 00:15:34.200 --> 00:15:40.440 without relating them to actual individual action while believing that something is being 146 00:15:40.440 --> 00:15:42.680 said about the real world. 147 00:15:42.680 --> 00:15:48.880 The business cycle theorist pours over sine curves, mathematical models and curves of 148 00:15:48.880 --> 00:15:50.120 all types. 149 00:15:50.120 --> 00:15:55.640 He shuffles equations and interactions and thinks that he is saying something about the 150 00:15:55.640 --> 00:15:59.160 economic system or about human action. 151 00:15:59.160 --> 00:16:01.120 In fact, he is not. 152 00:16:01.120 --> 00:16:07.280 The overwhelming bulk of current business cycle theory is not economics at all, but 153 00:16:07.280 --> 00:16:13.040 meaningless manipulation of mathematical equations and geometric diagrams.