WEBVTT NOTE 8.03. Capital Values and Aggregate Profits in a Changing Economy 1 00:00:00.000 --> 00:00:07.000 3. Capital Values and Aggregate Profits in a Changing Economy 2 00:00:07.860 --> 00:00:14.400 Net saving, as we have seen, increases gross investment in the economy. This increase in 3 00:00:14.400 --> 00:00:21.400 gross investment at first accrues as profits to the firms doing the increased business. 4 00:00:21.520 --> 00:00:27.400 These profits will accrue particularly in the higher stages, toward which old capital 5 00:00:27.400 --> 00:00:32.080 Capital is shifting and in which new capital is invested. 6 00:00:32.080 --> 00:00:39.560 An accrual of profits to a firm increases, by that amount, the capital value of its assets, 7 00:00:39.560 --> 00:00:43.800 just as the losses decrease the capital value. 8 00:00:43.800 --> 00:00:49.760 The first impact of the new investment, then, is to cause aggregate profits to appear in 9 00:00:49.760 --> 00:00:56.160 the economy, concentrated in the new production processes in the higher stages. 10 00:00:56.160 --> 00:01:02.760 As the transition to the new ERE begins to take place, however, these profits more and 11 00:01:02.760 --> 00:01:10.800 more become imputed to the factors for which these entrepreneurs must pay in production. 12 00:01:10.800 --> 00:01:17.020 Eventually, if no other interfering changes occur, the result will be a disappearance 13 00:01:17.020 --> 00:01:24.480 of profits in the economy, a settling into the new ERE, an increase in real wages and 14 00:01:24.480 --> 00:01:31.180 and Other Real Rents and an Increase in the Real Capital Value of Ground Land. 15 00:01:31.180 --> 00:01:36.720 This latter result, of course, is in perfect conformity with the previous conclusion that 16 00:01:36.720 --> 00:01:44.000 a progressing economy will lead to an increase in the real rents of ground land and a fall 17 00:01:44.000 --> 00:01:46.040 in the rate of interest. 18 00:01:46.040 --> 00:01:52.800 These two factors, in conjunction, both impel a rise in the real capital value of ground 19 00:01:52.800 --> 00:01:54.960 and Land. 20 00:01:54.960 --> 00:02:02.040 Future rises in the real values of rents can be either anticipated or not anticipated. 21 00:02:02.040 --> 00:02:08.560 To the extent they are anticipated, the rise in future rents is already accounted for and 22 00:02:08.560 --> 00:02:12.600 discounted in the capital value of the whole land. 23 00:02:12.600 --> 00:02:18.840 A rise in the far future may be anticipated but will have no appreciable effect on the 24 00:02:18.840 --> 00:02:25.240 in the present price of land, simply because time preference places a very distant date 25 00:02:25.240 --> 00:02:29.540 beyond the effective time horizon of the present. 26 00:02:29.540 --> 00:02:36.180 To the extent that rises in the real rate are not foreseen, then of course entrepreneurial 27 00:02:36.180 --> 00:02:42.600 errors have been made, and the market has undercapitalized in the present price. 28 00:02:42.600 --> 00:02:48.920 Throughout the whole history of landholding, therefore, income from basic land can be earned 29 00:02:48.920 --> 00:02:50.840 in only three ways. 30 00:02:50.840 --> 00:02:54.200 We are omitting, improving the land. 31 00:02:54.200 --> 00:02:55.200 1. 32 00:02:55.200 --> 00:03:00.600 Through entrepreneurial profit in correcting the forecasting errors of others. 33 00:03:00.600 --> 00:03:01.600 2. 34 00:03:01.600 --> 00:03:04.640 As interest return, or 3. 35 00:03:04.640 --> 00:03:11.480 By a rise in the capital value to the first finder and user of the land. 36 00:03:11.480 --> 00:03:15.720 The first type of income is obvious and not unique. 37 00:03:15.720 --> 00:03:19.020 It is pervasive in any field of enterprise. 38 00:03:19.020 --> 00:03:24.420 The second type of income is the general income earned by ground land. 39 00:03:24.420 --> 00:03:30.960 Because of the market phenomenon of capitalization, income from ground land is largely interest 40 00:03:30.960 --> 00:03:35.420 return on investment, just as in any other business. 41 00:03:35.420 --> 00:03:43.060 The only unique component of income that ground land confers, therefore, is three, accruing 42 00:03:43.060 --> 00:03:49.800 to the first user, whose land value began at zero and became positive. 43 00:03:49.800 --> 00:03:54.980 After that, the buyer of the land must pay its capitalized value. 44 00:03:54.980 --> 00:04:01.740 To earn rent on ground land, in other words, a man must either buy it or find it, and in 45 00:04:01.740 --> 00:04:06.820 In the former case he earns only interest and not pure rent. 46 00:04:06.820 --> 00:04:14.420 The capitalized value can increase from time to time and not be discounted in advance only 47 00:04:14.420 --> 00:04:21.100 if some new and unexpected development occurs, or if better knowledge of the future comes 48 00:04:21.100 --> 00:04:27.740 to light, in which case the previous owner has suffered an entrepreneurial loss in profit 49 00:04:27.740 --> 00:04:34.640 for Gone, for not having anticipated the new situation, and the current owner earns an 50 00:04:34.640 --> 00:04:37.160 entrepreneurial profit. 51 00:04:37.160 --> 00:04:43.720 The only unique aspect to ground land, then, is that it is found and first put on the market 52 00:04:43.720 --> 00:04:51.260 at some particular time, so that the first user earns pure rent as a result of his initial 53 00:04:51.260 --> 00:04:54.380 Capital Discovery and Use of the Land. 54 00:04:54.380 --> 00:05:00.780 All later increases in the capital value of the land are accounted for in the value either 55 00:05:00.780 --> 00:05:08.660 as entrepreneurial profits resulting from better forecasting or as interest return. 56 00:05:08.660 --> 00:05:15.180 The first user earns his gain only at first and not at whatever later date he actually 57 00:05:15.180 --> 00:05:17.180 The Theory of Money and Credit 58 00:05:45.180 --> 00:06:15.060 This is not the same as assuming an E.R.E., for in the E.R.E. there are no changes to 59 00:06:15.060 --> 00:06:16.700 to be foreseen. 60 00:06:16.700 --> 00:06:23.180 The first finder will reap the net gain immediately, and from then on, all that will be earned 61 00:06:23.180 --> 00:06:29.900 by him and by successive heirs or purchasers is the usual interest return. 62 00:06:29.900 --> 00:06:35.540 When future rises are too remote to enter into the capitalized price, this is simply 63 00:06:35.540 --> 00:06:41.980 a phenomenon of time preference, not a sign of some mysterious breakdown in the market's 64 00:06:41.980 --> 00:06:43.820 process of adjustment. 65 00:06:43.820 --> 00:06:50.820 The fact that complete discounting never takes place is due to the presence of uncertainty, 66 00:06:50.820 --> 00:06:57.140 and the result is a continual accretion of entrepreneurial gains through rising capital 67 00:06:57.140 --> 00:06:59.700 values of land. 68 00:06:59.700 --> 00:07:05.680 Thus we see, this time from the landowner's point of view, that aggregate gains in capital 69 00:07:05.680 --> 00:07:10.200 value are synonymous with aggregate profits. 70 00:07:10.200 --> 00:07:27.200 Profits begin with the higher order firms, then filter down until they increase real wages and the aggregate profits of landowners, particularly owners of land specific to the higher order stages of production. 71 00:07:27.200 --> 00:07:39.200 Land specific to the lower stages will, of course, bear the brunt of decreases in capital value, that is, losses in the progressing economy. 72 00:07:39.200 --> 00:07:49.200 As the only income to ground land that is not profit or interest, we are left with the original gains to the first finder of land. 73 00:07:49.200 --> 00:07:55.200 But here again there is capitalization and not a pure gain. 74 00:07:55.200 --> 00:08:02.200 Pioneering, finding new land, that is, new natural resources, is a business like any other. 75 00:08:02.200 --> 00:08:07.200 Investing in it takes capital, labor and entrepreneurial ability. 76 00:08:07.200 --> 00:08:31.200 The expected rents of finding and using are taken into account when the investments and expenses of exploration and shaping into use are made, therefore these gains are also capitalized backward in the original investment, and the tendency will be for them, too, to be the usual interest return on the investment. 77 00:08:31.200 --> 00:08:38.200 Deviations from this return will constitute entrepreneurial profits and losses. 78 00:08:38.200 --> 00:08:45.200 Therefore, we conclude that there is practically nothing unique about incomes from ground land, 79 00:08:45.200 --> 00:08:53.200 and that all net income in the productive system goes to wages, to interest and to profit. 80 00:08:53.200 --> 00:08:58.200 A progressive economy is marked by aggregate net profits. 81 00:08:58.200 --> 00:09:04.960 When there is a shift from one savings investment level to a higher one, therefore a progressing 82 00:09:04.960 --> 00:09:11.120 economy, aggregate profits are earned in the economy, particularly in the higher stages 83 00:09:11.120 --> 00:09:12.560 of production. 84 00:09:12.560 --> 00:09:18.880 The increased gross investment first increases the aggregate capital value of firms that 85 00:09:18.880 --> 00:09:20.880 earn net profits. 86 00:09:20.880 --> 00:09:26.360 As production and investment increase in the higher stages, and the effects of the new 87 00:09:26.360 --> 00:09:36.360 When new savings continue, the profits disappear and become imputed to increases in real wage rates and in real ground rents. 88 00:09:36.360 --> 00:09:45.360 The latter effect, added to a fall in the rate of interest, leads to a rise in the real capital values of ground land. 89 00:09:45.360 --> 00:09:55.360 What happens when there is a shift in the reverse direction, a changed proportion such that gross saving and investment decline 90 00:09:55.360 --> 00:09:57.920 consumption increases. 91 00:09:57.920 --> 00:10:03.020 For the most part, we may simply trace the earlier analysis in reverse. 92 00:10:03.020 --> 00:10:12.280 That is, consider the shift from a 338 to 80 situation to a 318 to 100 situation. 93 00:10:12.280 --> 00:10:19.600 During the transition to a new equilibrium, there would be a net dis-saving of 20 ounces, 94 00:10:19.600 --> 00:10:25.320 since gross saving decreases from 338 to 318. 95 00:10:25.320 --> 00:10:29.780 There would also be a net disinvestment of the same amount. 96 00:10:29.780 --> 00:10:36.000 The cause of such a shift would be an increase in the time preference schedules of the individuals 97 00:10:36.000 --> 00:10:37.640 on the market. 98 00:10:37.640 --> 00:10:43.420 This would increase the rate of interest and widen the interest spread between cumulative 99 00:10:43.420 --> 00:10:46.320 prices in the production stages. 100 00:10:46.320 --> 00:10:52.460 It would broaden the consumption base but leave less money available for saving and 101 00:10:52.460 --> 00:10:53.460 investment. 102 00:10:53.460 --> 00:11:02.460 will be higher prices for consumers' goods, and therefore a greater demand for factors in this and other lower stages. 103 00:11:02.460 --> 00:11:10.460 On the other hand, there would be general abandonment of the higher stages in the face of the monetary attractions of the later stages, 104 00:11:10.460 --> 00:11:17.460 the decline in investment funds, and the shift of these funds from the higher to the lower stages. 105 00:11:17.460 --> 00:11:28.460 Specific factors will bear the brunt of lowered incomes and sheer abandonment in the higher stages, and they will gain in the lower stages. 106 00:11:28.460 --> 00:11:38.460 There will be a rise in net income and consumption in monetary terms, and therefore a rise in aggregate factor income. 107 00:11:38.460 --> 00:11:44.460 The interest rate increases, while the gross investment base declines. 108 00:11:44.460 --> 00:11:58.460 In real terms, the important result is a lowering in the physical productivity of labor and of land because of the abandonment of the most productive processes of production, the lengthiest ones. 109 00:11:58.460 --> 00:12:11.460 The lower output at every stage, the lower supply of capital goods, and the consequent lower output of consumers' goods leads to a lowering in the standard of living. 110 00:12:11.460 --> 00:12:18.100 Money wage rates and money rents may rise, although this possibly might not occur because 111 00:12:18.100 --> 00:12:24.140 of the higher interest rate, but the prices of consumers' goods will rise further because 112 00:12:24.140 --> 00:12:28.080 of the reduced physical supply of goods. 113 00:12:28.080 --> 00:12:34.540 The rise in general money prices in monetary terms is accounted for by the decreased demand 114 00:12:34.540 --> 00:12:41.220 for money as a result of the lower number of stages for the monetary unit to turn over 115 00:12:41.220 --> 00:12:50.180 The case of decreasing gross capital investment is defined as a retrogressing economy. 116 00:12:50.180 --> 00:12:55.800 The definitions of the progressing and the retrogressing economy differ from those of 117 00:12:55.800 --> 00:12:58.060 Mises in human action. 118 00:12:58.060 --> 00:13:05.000 They are defined here as an increase or a decrease in capital in society, while Mises 119 00:13:05.000 --> 00:13:12.560 Mises defines them as an increase or a decrease in total capital per person in the society. 120 00:13:12.560 --> 00:13:18.680 The present definitions focus on the analysis of saving and investment, population growth 121 00:13:18.680 --> 00:13:23.420 or decline being a very different phase of the subject. 122 00:13:23.420 --> 00:13:29.840 When we are making an historical welfare assessment of the conditions of the economy, however, 123 00:13:29.840 --> 00:13:34.900 the question of production per capita becomes important. 124 00:13:34.900 --> 00:13:41.780 The decreased investment is first revealed as aggregate losses in the economy, particularly 125 00:13:41.780 --> 00:13:49.300 losses to firms in the highest stages of production, the firms which are now losing customers. 126 00:13:49.300 --> 00:13:56.280 As time proceeds, these losses will tend to disappear as firms leave the industry and 127 00:13:56.280 --> 00:14:00.480 abandon the now unprofitable production processes. 128 00:14:00.480 --> 00:14:16.480 The losses will thereby be imputed to factors in the form of lower real wage rates and lower real rents, which, combined with a higher interest rate, cause lower real capital values of ground land. 129 00:14:16.480 --> 00:14:22.480 Particularly hard hit will be the factors specific to these lines of production. 130 00:14:22.480 --> 00:14:34.480 The reason why there are aggregate profits in the progressing economy and aggregate losses in the retrogressing economy may be demonstrated in the following way. 131 00:14:34.480 --> 00:14:43.480 For profits to appear there must be under-capitalization or over-discounting of productive factors on the market. 132 00:14:43.480 --> 00:14:51.480 For losses to appear there must be over-capitalization or under-discounting of factors on the market. 133 00:14:51.480 --> 00:14:52.480 Market. 134 00:14:52.480 --> 00:14:59.440 But if the economy is stationary, that is, if from one period to another the total gross 135 00:14:59.440 --> 00:15:06.120 investment remains constant, the total value of capital remains constant. 136 00:15:06.120 --> 00:15:12.320 There might be an increase of investment in one line of production, but this is made possible 137 00:15:12.320 --> 00:15:15.720 only by a decrease elsewhere. 138 00:15:15.720 --> 00:15:24.240 capital values remain constant, and therefore any profits, the result of mistaken undercapitalization, 139 00:15:24.240 --> 00:15:30.960 must be offset by equal losses, the result of mistaken overcapitalization. 140 00:15:30.960 --> 00:15:36.520 In the progressing economy, on the other hand, there are additional investment funds made 141 00:15:36.520 --> 00:15:43.480 available through new savings, and this provides a source for new revenue not yet capitalized 142 00:15:43.480 --> 00:15:45.500 anywhere in the system. 143 00:15:45.500 --> 00:15:51.020 These constitute the aggregate net profits during this period of change. 144 00:15:51.020 --> 00:15:57.420 In the retrogressing economy, investment funds are lowered, and this leaves net areas of 145 00:15:57.420 --> 00:16:01.580 overcapitalization of factors in the economy. 146 00:16:01.580 --> 00:16:06.980 Their owners suffer aggregate net losses during this period of change. 147 00:16:06.980 --> 00:16:12.700 It is possible that the changes in investment were anticipated in the market, to the extent 148 00:16:12.700 --> 00:16:27.700 The fact that an increase or a decrease was anticipated, the aggregate profits or losses will accrue in the form of a gain in capital value before the actual change in investment takes place. 149 00:16:27.700 --> 00:16:35.700 Losses arise during retrogression because previously employed processes have to be abandoned. 150 00:16:35.700 --> 00:16:46.700 The fact that the highest stages, already begun, have to be abandoned, is an indication that the shift was not fully anticipated by the producers. 151 00:16:46.700 --> 00:17:00.700 Thus, another conclusion of our analysis is that aggregate profits will equal aggregate losses in a stationary economy, that is, profits and losses will equal zero. 152 00:17:00.700 --> 00:17:10.700 This stationary economy is not the same construct as the evenly rotating economy that has played such a large role in our analysis. 153 00:17:10.700 --> 00:17:20.700 In the stationary economy, uncertainty does not disappear and no unending constant round pervades all elements in the system. 154 00:17:20.700 --> 00:17:26.700 There is in fact only one constancy, total capital invested. 155 00:17:26.700 --> 00:17:33.620 Clearly, the stationary economy, like all other economies, tends to evolve into the 156 00:17:33.620 --> 00:17:41.960 ERE given constant data. After a time, market forces will tend to eliminate all individual 157 00:17:41.960 --> 00:17:48.540 profits and losses, as well as aggregate profits and losses. 158 00:17:48.540 --> 00:17:55.260 We might pause here to consider briefly the old problem, our capital gains, increases 159 00:17:55.260 --> 00:17:58.440 in Capital Value, Income. 160 00:17:58.440 --> 00:18:06.540 If we fully realize that profits and capital gains and losses and capital losses are identical, 161 00:18:06.540 --> 00:18:08.680 the solution becomes clear. 162 00:18:08.680 --> 00:18:13.160 No one would exclude business profits from money income. 163 00:18:13.160 --> 00:18:16.300 The same should be true of capital gains. 164 00:18:16.300 --> 00:18:23.480 In the ERE, of course, there are neither capital gains nor capital losses. 165 00:18:23.480 --> 00:18:30.960 Let us now return to the case of the retrogressing economy and a decrease in capital investment. 166 00:18:30.960 --> 00:18:37.120 The greater the shift from saving to consumption, the more drastic will the effects tend to 167 00:18:37.120 --> 00:18:42.620 be, and the greater the lowering of productivity and living standards. 168 00:18:42.620 --> 00:18:49.640 The fact that such shifts can and do happen serves to refute easily the fashionable assumption 169 00:18:49.640 --> 00:18:56.840 that our capital structure is, by some magical provision or hidden hand, permanently and 170 00:18:56.840 --> 00:19:01.140 eternally self-reproducing once it is built. 171 00:19:01.140 --> 00:19:07.640 No positive acts of saving by capitalists are deemed necessary to maintain it. 172 00:19:07.640 --> 00:19:13.960 The ruins of Rome are mute illustrations of the error of this assumption. 173 00:19:13.960 --> 00:19:21.160 Fail to maintain the value of capital, that is, the process of net dis-saving, is known 174 00:19:21.160 --> 00:19:24.200 as consuming capital. 175 00:19:24.200 --> 00:19:30.760 Granting the impossibility of measuring the value of capital in society with any precision, 176 00:19:30.760 --> 00:19:34.400 this is still a highly important concept. 177 00:19:34.400 --> 00:19:41.040 Consuming capital means, of course, not eating machines as some critics have scoffingly referred 178 00:19:41.040 --> 00:19:48.480 to it, but failing to maintain existing gross investment and the existing capital goods 179 00:19:48.480 --> 00:19:55.020 structure, using some of these funds instead for consumption expenditure. 180 00:19:55.020 --> 00:20:01.840 It is often assumed that only depreciation funds for durable capital goods are available 181 00:20:01.840 --> 00:20:09.200 for capital consumption, but this overlooks a very large part of capital, so-called circulation 182 00:20:09.200 --> 00:20:16.320 and Capital, the less durable capital goods which pass quickly from one stage to another. 183 00:20:16.320 --> 00:20:22.840 As each stage receives funds from its sale of these or other goods, it is not necessary 184 00:20:22.840 --> 00:20:28.280 for the producer to continue to repurchase circulation capital. 185 00:20:28.280 --> 00:20:33.960 These funds, too, may be immediately spent on consumption. 186 00:20:33.960 --> 00:20:39.400 Professor Frank H. Knight has been the leader of the school of thought that assumes capital 187 00:20:39.400 --> 00:20:42.160 to be automatically permanent. 188 00:20:42.160 --> 00:20:49.480 Knight has contributed a great deal to economics in his analysis of profit theory and entrepreneurship, 189 00:20:49.480 --> 00:20:55.880 but his theories of capital and interest have misled a generation of American economists. 190 00:20:55.880 --> 00:21:01.160 Knight succinctly summed up his doctrine in an attack on the Austrian investment theory 191 00:21:01.160 --> 00:21:07.760 History of Boehm-Bawerk and Hayek, Knight said that the latter involved two fallacies. 192 00:21:07.760 --> 00:21:14.120 One is that Boehm-Bawerk viewed production as the production of concrete goods, whereas 193 00:21:14.120 --> 00:21:19.200 in reality what is produced and consumed is services. 194 00:21:19.200 --> 00:21:21.840 There is no real problem here, however. 195 00:21:21.840 --> 00:21:28.760 It is not to be denied, in fact it has been stressed herein, that goods are valued for 196 00:21:28.760 --> 00:21:35.180 for their services, yet it is also undeniable that the concrete capital goods structure 197 00:21:35.180 --> 00:21:40.300 must be produced before its services can be obtained. 198 00:21:40.300 --> 00:21:47.300 The second alleged correction, and here we come directly to the problem of capital consumption, 199 00:21:47.300 --> 00:21:54.760 is that the production of any service includes the maintenance of things used in the process, 200 00:21:54.760 --> 00:22:01.860 And this includes reproduction of any which are used up, really a detail of maintenance. 201 00:22:01.860 --> 00:22:04.960 This is obviously incorrect. 202 00:22:04.960 --> 00:22:10.800 Services are yielded by things, at least in the cases relevant to our discussion, and 203 00:22:10.800 --> 00:22:16.480 they are produced through the using up of things, of capital goods. 204 00:22:16.480 --> 00:22:22.960 And this production does not necessarily include maintenance and reproduction. 205 00:22:22.960 --> 00:22:29.580 This alleged detail is a completely separate area of choice and involves the building up 206 00:22:29.580 --> 00:22:35.480 of more capital at a later date to replace the used up capital. 207 00:22:35.480 --> 00:22:41.680 The case of the retrogressing economy is our first example of what we may call a crisis 208 00:22:41.680 --> 00:22:42.680 situation. 209 00:22:42.680 --> 00:22:49.680 A crisis situation is one in which firms in the aggregate are suffering losses. 210 00:22:49.680 --> 00:22:56.200 The crisis aspect of the case is aggravated by a decline in production through the abandonment 211 00:22:56.200 --> 00:22:58.960 of the highest production stages. 212 00:22:58.960 --> 00:23:07.400 The troubles arose from under-saving and under-investment, that is, a shift in people's values so that 213 00:23:07.400 --> 00:23:14.640 they do not now choose to save and invest enough to enable continuation of production 214 00:23:14.640 --> 00:23:17.640 processes begun in the past. 215 00:23:17.640 --> 00:23:23.920 We cannot simply be critical of this shift, however, since the people, given existing 216 00:23:23.920 --> 00:23:29.680 conditions, have decided voluntarily that their time preferences are higher, and that 217 00:23:29.680 --> 00:23:36.800 they wish to consume more proportionately at present, even at the cost of lowering future 218 00:23:36.800 --> 00:23:38.800 productivity. 219 00:23:38.800 --> 00:23:45.200 Once an increase to a greater level of gross investment occurs, therefore, it is not maintained 220 00:23:45.200 --> 00:23:47.240 automatically. 221 00:23:47.240 --> 00:23:53.240 Those have to maintain the gross investment and this will be done only if their time preferences 222 00:23:53.240 --> 00:24:00.000 remain at the lower rates and they continue to be willing to save a greater proportion 223 00:24:00.000 --> 00:24:02.720 of gross monetary income. 224 00:24:02.720 --> 00:24:08.640 We have demonstrated further that this maintenance and further progress can take place without 225 00:24:08.640 --> 00:24:15.080 any increase in the money supply or other change in the money relation. 226 00:24:15.080 --> 00:24:21.320 This can occur, in fact, with falling prices of all products and factors.