WEBVTT NOTE Production: Entrepreneurship and Change 1 00:00:00.000 --> 00:00:04.700 This area, the capital interest theory in general, is extremely difficult, alright? 2 00:00:04.700 --> 00:00:09.100 So if you're trying to read this and you're like, wow, I just don't get it, I must be dumb, 3 00:00:09.100 --> 00:00:14.800 not necessarily, you might be, but it could just be because the material is really difficult, alright? 4 00:00:14.800 --> 00:00:19.500 It's literally been called the black hole of economics, and not just in terms of the Austrian School, 5 00:00:19.500 --> 00:00:23.100 but just in general, capital and interest theory is extremely difficult. 6 00:00:23.100 --> 00:00:27.900 The controversies that raged throughout the 20th century on that, 7 00:00:27.900 --> 00:00:57.900 most economists just run from it they say no I don't want to get sucked into that it's just too difficult so but it's important so I'm not saying you need to be an expert in this but it really if you understand what's going on in this chapter you really are in a much better position to understand the real world I mean this I don't want to say it's the essence of Austrian economics but it's extremely important to understand what's going on in this chapter and this really is one of the things like I said in my first talk that distinguishes Austrian 8 00:00:57.900 --> 00:00:59.900 The Theory of Money and Credit 9 00:01:27.900 --> 00:01:57.900 The benefit from learning this material and really understanding it is you'll have a much better appreciation for Boehm-Bawerk and Hayek, that if all you knew of Hayek was the road to serfdom, you could kind of think, he's kind of overrated, but the stuff that Hayek does in Capital Theory is really impressive, his book Pure Theory of Capital in particular is just an incredible illustration of just the guy's mental powers, so I'm not saying everything he does in there is correct or that I agree with it, but as I'm saying, if you think Hayek's really 10 00:01:57.900 --> 00:02:04.900 The Theory of Money and Credit 11 00:02:27.900 --> 00:02:40.900 and Capital Theory. So Rothbard is very clear, but again, if you go and look at some of the stuff you get from Hayek, Rothbard has limited amount of space to work with it. 12 00:02:40.900 --> 00:02:45.900 So there's things that you can get from Hayek and Boehm-Bawerk that have not, in my opinion, survived. 13 00:02:45.900 --> 00:02:55.900 So this is sort of like the, you know, against the Whig theory that I think there are things in Boehm-Bawerk that Mises didn't carry through. 14 00:02:55.900 --> 00:03:12.900 One last sort of profitory comment. In case I forget to mention it, in terms of advances in the future, if I'm a young Austrian, what can I do with my career? 15 00:03:12.900 --> 00:03:23.900 I'm not sure, but I think it's possible that somebody who was familiar with quantitative finance that understood the put-call parity and all the things, the Black-Scholes formula, 16 00:03:23.900 --> 00:03:31.380 formula, that sort of approach, mean variance, modeling of Wall Street activities, who understood 17 00:03:31.380 --> 00:03:38.300 that material and then also read this chapter from Rothbard and could somehow come up with 18 00:03:38.300 --> 00:03:39.940 something maybe in between the two. 19 00:03:39.940 --> 00:03:44.340 I think there's scope for something along those lines because Rothbard alludes to it. 20 00:03:44.340 --> 00:03:48.340 He mentions risks and uncertainty and he says how, you know, actually in the real world 21 00:03:48.340 --> 00:03:53.860 There's not just an interest rate and then entrepreneurial profit or loss. 22 00:03:53.860 --> 00:03:57.100 There's also this thing about different levels of riskiness. 23 00:03:57.100 --> 00:04:00.940 And so anyway, the quantitative finance people, yeah, I think they take it too far 24 00:04:00.940 --> 00:04:04.540 and they assume specific functional distributions and things like that. 25 00:04:04.540 --> 00:04:10.500 But they're thinking a lot more, they're taking it a lot further when they say, 26 00:04:10.500 --> 00:04:14.860 what if we really want to deal with the fact that there are different levels of risk 27 00:04:14.860 --> 00:04:17.340 in different enterprises or if you want to call it uncertainty, you know, 28 00:04:17.340 --> 00:04:37.340 I don't want to talk about that issue right now, but the point is Rothbard leaves open huge avenues of potential research and I think current Austrians who are just trying to pick research agendas, they might be able to benefit and then it would also be marketable that you could apply this financial stuff to Austrian theory or capital theory. 29 00:04:37.340 --> 00:04:53.340 Okay, so what I'm going to do with the time I have here, I'm going to go through and I'm going to mostly focus on, when I get to that point, those diagrams showing what happens with the original structure of production, how it gets to the one after net savings and investment. 30 00:04:53.340 --> 00:04:57.340 But let me just mention a few things along the way leading up to that point in the chapter. 31 00:04:57.340 --> 00:05:06.340 So in the early on, Rothbard says, in the real world then, quality of judgment and accuracy of forecast play an enormous role in the income acquired by capitalists. 32 00:05:06.340 --> 00:05:11.340 and so he's what he's saying there again he's contrasting that we've talked about 33 00:05:11.340 --> 00:05:16.420 in the last chapter that one way you earn income is for labor services and 34 00:05:16.420 --> 00:05:20.380 then also is an interest return just because of the passage of time because 35 00:05:20.380 --> 00:05:26.060 of time preference and then you know you can earn it as a labor excuse me as a 36 00:05:26.060 --> 00:05:30.340 landowner but then if you think that that was capitalized even that in a sense is 37 00:05:30.340 --> 00:05:33.820 is an interest return so that's why he makes the the statement that you might 38 00:05:33.820 --> 00:05:37.820 I thought it was a mistake in the beginning of the chapter I'm talking about now where he says 39 00:05:37.820 --> 00:05:41.820 the only two types of income in the ERE are interest and wages 40 00:05:41.820 --> 00:05:45.820 and you might have thought what about the rents for landowners but he's 41 00:05:45.820 --> 00:05:49.820 including that in interest because if it gets capitalized then it's really 42 00:05:49.820 --> 00:05:53.820 the rent for land is also interest. But in the real 43 00:05:53.820 --> 00:05:57.820 world there's another category of income and that's entrepreneurial profit and loss and that 44 00:05:57.820 --> 00:06:01.820 specifically is due to the ability of someone to 45 00:06:01.820 --> 00:06:09.820 to rearrange the structure of production to better serve the consumer's desires than if that entrepreneur hadn't intervened. 46 00:06:09.820 --> 00:06:14.820 Or if you suffer a loss, it's because of the opposite, that you made things even worse. 47 00:06:14.820 --> 00:06:18.820 The original structure of production was a certain way and it was going to satisfy consumer ends, 48 00:06:18.820 --> 00:06:22.820 and then you came in and you tinkered with it and it wasn't a good tinkering. 49 00:06:22.820 --> 00:06:29.820 And so you hurt consumers in a market economy, you get penalized for that by suffering a loss. 50 00:06:29.820 --> 00:06:39.820 Now what's interesting, the reason I like that quote is that he says the quality of judgment, the accuracy of your forecasts and that's really how you're getting this type of income. 51 00:06:39.820 --> 00:06:52.820 And so you won't see that really in other schools of thought very much that the Austrians are fairly unique in that they recognize that in the market economy there is a definite role for someone to play that you know you say to someone, 52 00:06:52.820 --> 00:06:57.820 What do you do? I'm a really good singer. What do you do? I'm a good pitcher. 53 00:06:57.820 --> 00:07:02.820 And there are certain people in the market, what do they do is they see the future better than other people do 54 00:07:02.820 --> 00:07:08.820 and then they go and make money off of it. Some people that sounds very crass, but no, that's crucial. 55 00:07:08.820 --> 00:07:15.820 We're in a world of uncertainty and so the people that anticipate the future better than others, that's a very important thing. 56 00:07:15.820 --> 00:07:20.820 And we want to make sure, depending on how much their advantage is, that they're aware of that fact. 57 00:07:20.820 --> 00:07:25.240 And so instead of them being a school teacher, if no, they really can anticipate IBM's share 58 00:07:25.240 --> 00:07:28.820 price better than anyone else on the planet, maybe that's what they should be doing with 59 00:07:28.820 --> 00:07:31.800 their lives, is speculating on the stock market. 60 00:07:31.800 --> 00:07:35.900 So the market economy, now they don't have to do that of course, they're free to be a 61 00:07:35.900 --> 00:07:41.300 school teacher, but the point is they need to know what am I missing out on, and again 62 00:07:41.300 --> 00:07:45.200 in a market economy where people are allowed to keep the fruits of their efforts, that's 63 00:07:45.200 --> 00:07:46.200 what would happen. 64 00:07:46.200 --> 00:07:48.920 They would know if I went and speculated in the stock market, I think I could make a bunch 65 00:07:48.920 --> 00:07:55.920 and actually that's that's really almost the purest form of entrepreneurship in a 66 00:07:55.920 --> 00:07:59.840 sense is someone who speculates just when purely financial matters because 67 00:07:59.840 --> 00:08:03.320 there if you think oil prices are going to be higher or lower and you think the 68 00:08:03.320 --> 00:08:06.680 markets wrong on that you don't even ever have to actually physically deal 69 00:08:06.680 --> 00:08:11.600 with oil you can just go into the futures market and either buy or sell 70 00:08:11.600 --> 00:08:15.080 depending on what you think the trend is going to be and then you can get rid of 71 00:08:15.080 --> 00:08:18.560 the contract before it matures and so you you've never dealt with anything 72 00:08:18.560 --> 00:08:25.560 anything except electronic transactions, and yet you are influencing production if you make profits. 73 00:08:25.560 --> 00:08:31.560 We can argue and go through the steps later if you want as to how that is serving consumers. 74 00:08:31.560 --> 00:08:39.560 So again, the market economy is really amazing in the fact that the specialization is more of these financial derivatives become available. 75 00:08:39.560 --> 00:08:46.560 This ability of people just in terms of pure speculation, their ability to forecast the future better than most other people, 76 00:08:46.560 --> 00:08:55.560 and allows them to earn an income and they are certainly performing a service just as the guy who goes and tills the soil is performing a service and that's why he gets paid for it. 77 00:08:55.560 --> 00:09:09.560 And the other point there too is Rothbard says that a profit opportunity means that some factors are underpriced and so what Rothbard has in mind is entrepreneurs buying factors of production, 78 00:09:09.560 --> 00:09:13.840 production, waiting for the product to be produced and then selling it and that the 79 00:09:13.840 --> 00:09:17.280 return they get exceeds the interest return. 80 00:09:17.280 --> 00:09:21.520 And so that's the standard benchmark case and that's why Rothbard's saying also a profit 81 00:09:21.520 --> 00:09:25.620 opportunity means factors are underpriced but of course if you thought factors were 82 00:09:25.620 --> 00:09:29.740 overpriced and you had sophisticated enough markets where you could short sell things 83 00:09:29.740 --> 00:09:34.360 then you could profit from the other way too, that if you thought a stock was overpriced 84 00:09:34.360 --> 00:09:38.260 you could short it and then when the price came down you'd earn your profit that way. 85 00:09:38.260 --> 00:09:44.900 So, again, in the more general case with modern markets, as long as factors are mispriced, 86 00:09:44.900 --> 00:09:49.140 an entrepreneur can profit by speculating one way or the other. 87 00:09:49.140 --> 00:09:54.620 So this leads into another point that Rothbard stresses is that, okay, so first of all, mainstream 88 00:09:54.620 --> 00:09:59.980 economists, they almost never talk about economic profits except maybe in an intro micro class 89 00:09:59.980 --> 00:10:03.080 when they're trying to get you to see the difference between accounting and economic 90 00:10:03.080 --> 00:10:10.520 Profit. But then really that drops out especially at graduate school. I might never have heard the term 91 00:10:10.520 --> 00:10:16.360 entrepreneur at NYU except in the Austrian colloquium. I think that's a true statement that they never 92 00:10:16.360 --> 00:10:20.600 talk about profit once you get to the level where you're doing general equilibrium theory and everything's 93 00:10:21.240 --> 00:10:25.400 in equilibrium. What role would there be for entrepreneurship or profits and losses? 94 00:10:26.200 --> 00:10:30.360 But then Rothbard says okay but sometimes they do talk about profit but what you'll never hear 95 00:10:30.360 --> 00:10:33.360 The thing that our mainstream economists focus on is the role of loss. 96 00:10:33.360 --> 00:10:38.360 That they just talk about profits as if they're natural, and they talk about, well, what's the natural rate of profit? 97 00:10:38.360 --> 00:10:43.360 And so Rothbard is emphasizing that, well, no, that's silly. There's no such thing as a natural rate of profit, 98 00:10:43.360 --> 00:10:47.360 because if you think that way, well, then I'm going to ask you, what's the natural rate of loss? 99 00:10:47.360 --> 00:10:53.360 And that just sounds crazy. And so it's the same thing with profits, that if there is a profit in an industry, 100 00:10:53.360 --> 00:10:58.360 then people flock to it, and it gets competed away just like if there's a loss going on right now in a certain industry, 101 00:10:58.360 --> 00:11:01.360 will get out of it, and so the loss disappears. 102 00:11:01.360 --> 00:11:04.600 All right, so that's, and it's crucial to understand 103 00:11:04.600 --> 00:11:06.180 that that also performs a function, 104 00:11:06.180 --> 00:11:08.680 that it's not, that oh yeah, profits are great, 105 00:11:08.680 --> 00:11:11.440 and then unfortunately we have to accept losses as well, 106 00:11:11.440 --> 00:11:13.740 that no, if losses are being suffered, 107 00:11:13.740 --> 00:11:15.400 it's showing that the structure of production 108 00:11:15.400 --> 00:11:19.300 is not designed to best satisfy the wants of the consumers, 109 00:11:19.300 --> 00:11:22.680 and so the losses are a necessary signal, if you will, 110 00:11:22.680 --> 00:11:24.640 to tell entrepreneurs you're messing up, 111 00:11:24.640 --> 00:11:27.360 you gotta reform what you're doing. 112 00:11:28.360 --> 00:11:58.360 And another point that he mentions is that the profit and loss, so it's not only that somebody rearranges the structure of production, takes factors from what other people were going to use them for and devotes them somewhere else, and if that's, if the consumers in a broad sense approve of what you did, you earn profits, but, or if you do it and the consumers don't like what you did, you suffer losses, so there's that fact, but on top of it, it's proportionate, so that if you really improve things, then you earn a lot of profit, or if you really screw it up, then you earn a lot of money. 113 00:11:58.360 --> 00:12:08.360 And so that's what's, that point's good when you're trying to understand different government programs and they're trying to subsidize things or they're trying to penalize things. 114 00:12:08.360 --> 00:12:16.360 And it's really, for example, there's all this talk now about, oh, well, let's come into the oil and commodities markets. 115 00:12:16.360 --> 00:12:25.360 And if speculators are behaving in a certain way and if we think they're manipulating the price when they ought to be selling, if they're hoarding it and they ought to really be selling for a profit, 116 00:12:55.360 --> 00:13:02.360 So the point is again that people don't talk about profit very much. They almost never talk about loss and then they also don't ever really talk about the fact that it's not just those categories but it's the quantitative amount that's necessary to get entrepreneurs to have the right incentives in terms of doing the thing, to have the right incentives. 117 00:13:25.360 --> 00:13:32.360 If your goal is, how do we motivate the most able, talented people in our society to help the masses? 118 00:13:32.360 --> 00:13:37.360 If you were like a socialist or something, or not a socialist, but if you were just some humanitarian, 119 00:13:37.360 --> 00:13:43.360 what kind of system could we invent that gets the smartest people, the greediest people, the most ambitious people 120 00:13:43.360 --> 00:13:47.360 to devote their lives to improving a lot of the common man? 121 00:13:47.360 --> 00:13:51.360 If you just were locked in a room and thought through it, you'd probably come up with the market economy, 122 00:13:51.360 --> 00:13:54.360 or you could come up with the market economy, that'd be a good answer. 123 00:13:54.360 --> 00:14:00.960 Okay, one little quibble here I have with Rothbard. He says at one point, every 124 00:14:00.960 --> 00:14:06.000 entrepreneur believes that the market has underpriced factors. I mean, there's 125 00:14:06.000 --> 00:14:11.120 dots in there that he's, I'm shortening it, but his point is that Rothbard is 126 00:14:11.120 --> 00:14:14.840 saying, look, in order for somebody to enter the factor markets, buy factors and 127 00:14:14.840 --> 00:14:19.080 then hope to transform them and sell a product and earn entrepreneurial profit, 128 00:14:19.080 --> 00:14:22.680 that particular entrepreneur must believe that the market has underpriced 129 00:14:22.680 --> 00:14:52.680 And I'm not sure that might be, of course we understand what he's talking about, but I'm just wondering about the case where somebody who's just investing because they want to maintain their money or they want to grow it at interest, that you know, someone who puts their money in a mutual fund or whatever, they're certainly not picking those stocks because they think the market has underpriced those particular stocks. And even if you're not thinking of the stock market just in general, if someone comes into inheritance and has a bunch of money, you know, back in the 1800s, 130 00:14:52.680 --> 00:14:56.680 What do I do with this? I don't want you to sit here. I want to earn interest. 131 00:14:56.680 --> 00:15:02.680 Maybe his buddy says, oh, why don't you get into the shoe business and buy things. 132 00:15:02.680 --> 00:15:07.680 My point is just that I'm not sure if that's necessarily true. 133 00:15:07.680 --> 00:15:13.680 Obviously, if you thought there were underpriced factors, you would tend towards that line if you had money to invest. 134 00:15:13.680 --> 00:15:19.680 But it is possible, I think, that somebody could not expect to beat the market as it were. 135 00:15:19.680 --> 00:15:24.680 But yet because of their time preferences, they don't want to consume everything in the present, they want to earn interest. 136 00:15:24.680 --> 00:15:30.680 And so that's a possible slight mistake or understatement by Rothbard there. 137 00:15:30.680 --> 00:15:38.680 Okay, another good point that Rothbard makes is he says profit is a sign of a prior male adjustment. 138 00:15:38.680 --> 00:15:47.680 And so if you see firms that are earning lots of profits, people think that's a sign of, you know, something's, I don't know, something's wrong with the world. 139 00:15:47.680 --> 00:15:54.680 in the world, and Rothbard says, yes, in a sense that's true, but it's not the people earning the profits, they're the ones fixing it. 140 00:15:54.680 --> 00:16:02.680 So yes, if there are huge profit opportunities and you see some company earning a bunch of money, profit, that in a sense it's correct for us to say, 141 00:16:02.680 --> 00:16:10.680 oh wow, you know, things weren't, all wasn't well with the situation, but again, it's why are we getting mad at the companies or the individuals 142 00:16:10.680 --> 00:16:15.680 who are doing more than anyone else on the planet what they need to do to address the situation. 143 00:16:15.680 --> 00:16:19.280 and just the recent news with the oil companies. 144 00:16:19.280 --> 00:16:21.320 I mean, the reason oil is so expensive 145 00:16:21.320 --> 00:16:23.600 is because it's appreciating dollar, 146 00:16:23.600 --> 00:16:26.680 but also just the fact that demand has risen a lot more 147 00:16:26.680 --> 00:16:30.340 the last few years than most people anticipated. 148 00:16:30.340 --> 00:16:33.500 And ironically, so who are we mad at? 149 00:16:33.500 --> 00:16:34.560 So we don't have as much oil 150 00:16:34.560 --> 00:16:36.560 as we really ought to have for our desires. 151 00:16:36.560 --> 00:16:37.800 And so who are we mad at? 152 00:16:37.800 --> 00:16:39.520 Well, let's get mad at the companies that are out there 153 00:16:39.520 --> 00:16:41.800 spending billions of dollars finding more oil 154 00:16:41.800 --> 00:16:43.920 because we're really mad that we don't have much oil. 155 00:16:43.920 --> 00:16:45.080 And so we're gonna go punish the people 156 00:16:45.080 --> 00:16:48.080 who are the ones doing something about getting more oil for us. 157 00:16:48.080 --> 00:16:52.080 So that's what Rothbard's point is there. 158 00:16:52.080 --> 00:17:01.080 All right, let me read this quote from Hayek that he talks about on 517. 159 00:17:01.080 --> 00:17:06.080 And this was, so this is the bottom of 517 if you've got it. 160 00:17:06.080 --> 00:17:08.080 So again, quoting Hayek, and Hayek says, 161 00:17:08.080 --> 00:17:13.080 The continuance of the existing degree of capitalistic organization depends, accordingly, 162 00:17:13.080 --> 00:17:18.080 on the prices paid and obtained for the product of each stage of production. 163 00:17:18.080 --> 00:17:25.080 And these prices are therefore a very real and important factor in determining the direction of production. 164 00:17:25.080 --> 00:17:27.080 So that really struck me. 165 00:17:27.080 --> 00:17:32.080 Before looking over this last night when I was preparing my remarks, 166 00:17:32.080 --> 00:17:36.080 it had never really struck me why did Hayek entitle his book, Prices in Production. 167 00:17:36.080 --> 00:17:42.080 I think most people don't realize if they don't have this view, this Austrian view of the structure of production, you know, 168 00:17:42.080 --> 00:17:46.080 that the market prices really do help coordinate things. 169 00:17:46.080 --> 00:17:50.080 And so entrepreneurs behave differently depending on what market prices are. 170 00:17:50.080 --> 00:17:54.080 So it's not that the entrepreneurs are robotic. I mean the prices don't determine action, 171 00:17:54.080 --> 00:17:58.080 but the prices certainly do influence what the entrepreneurs end up doing. 172 00:17:58.080 --> 00:18:02.080 And so that's what I think most people don't realize if they don't have this view, 173 00:18:02.080 --> 00:18:07.680 They don't have this view, this Austrian view of the structure of production, you know, with the housing bust and all this, 174 00:18:07.680 --> 00:18:14.080 the government needs to come in, or whenever there's a recession, the government needs to come in and keep prices at their prior levels. 175 00:18:14.080 --> 00:18:21.080 Well, no, I mean, how are people going to rearrange themselves and get into the correct lines of production, adjust to the new realities, 176 00:18:21.080 --> 00:18:27.480 if prices aren't allowed to move, to signal to entrepreneurs that this isn't working, this is what needs to happen now? 177 00:18:27.480 --> 00:18:33.480 Okay, so again, that's a very subtle point. I just want to make sure you didn't miss that. 178 00:18:33.480 --> 00:18:45.480 And then on 518, Rothbard talks about the paradox of saving, and he refers to, in footnote 6 there, an article by Hayek with the same title. 179 00:18:45.480 --> 00:18:53.480 And let me just encourage you, again, this isn't for everybody, but if you are interested in capital theory and you want to see more, 180 00:18:53.480 --> 00:18:59.480 This is an excellent article by Hayek that even if you've read Human Action, Man Economy and State, 181 00:18:59.480 --> 00:19:06.480 I think if you read this article by Hayek, you would come away understanding the structure of production better than before you read it. 182 00:19:06.480 --> 00:19:13.480 And what's going on in there, and maybe in the Q&A, maybe David Gordon might be able to give us the full story, 183 00:19:13.480 --> 00:19:21.480 but it's something along the lines of these guys, they had a contest, and they set out the paradox of savings, 184 00:19:21.480 --> 00:19:27.880 was, you know, if all of a sudden consumers or individuals in the economy, they save more, 185 00:19:27.880 --> 00:19:35.080 so they spend less on consumption, how can it possibly be that businesses will expand? 186 00:19:35.080 --> 00:19:40.880 Because if the final chain in the link of production, if people are spending less down there, 187 00:19:40.880 --> 00:19:44.280 well then those businesses are going to, you know, reduce their volume of activity, 188 00:19:44.280 --> 00:19:47.380 they're going to buy less from their suppliers and so on. 189 00:19:47.380 --> 00:19:51.420 So if consumers in general are spending less, because they're saving more, 190 00:19:51.420 --> 00:19:55.220 how could it possibly be anything other than a general recession? 191 00:19:55.220 --> 00:19:59.340 And yet we know at the micro level that an individual household, 192 00:19:59.340 --> 00:20:02.580 what do you do if you want to consume more and more into the future? 193 00:20:02.580 --> 00:20:06.380 If you cut back now and invest those funds and earn interest, 194 00:20:06.380 --> 00:20:10.060 then your disposable income can grow over time. 195 00:20:10.060 --> 00:20:13.980 And so that was the... And what some of these guys did is they... 196 00:20:13.980 --> 00:20:17.340 My understanding is they literally had a contest where they were going to pay people 197 00:20:17.340 --> 00:20:25.340 to say, you know, in our opinion, if you can answer this question or solve this riddle, we'll, I think they're going to give them some financial reward. 198 00:20:25.340 --> 00:20:30.340 And in their opinion, nobody answered the question right. And Hayek, in this article, agreed with those guys. 199 00:20:30.340 --> 00:20:36.340 And he said, they're right, no one answered it, but now I'm going to. And I don't think Hayek got money for it. 200 00:20:36.340 --> 00:20:46.340 But the point is that he was saying this is a very tricky concept, and it's understandable that mainstream economists were sort of duped by the Keynesian Revolution 201 00:20:46.340 --> 00:20:49.620 Revolution, because they don't have this appreciation. 202 00:20:49.620 --> 00:20:53.140 Without understanding Austrian capital theory, 203 00:20:53.140 --> 00:20:55.100 it really would be difficult to get out 204 00:20:55.100 --> 00:20:56.580 of the paradox of saving. 205 00:20:56.580 --> 00:21:00.140 But once you understand Austrian capital theory, you can see. 206 00:21:00.140 --> 00:21:03.300 And Hayek points out there, and we'll talk about it in a minute. 207 00:21:03.300 --> 00:21:05.220 And Hayek just shows, graphically, 208 00:21:05.220 --> 00:21:06.980 this is the answer to their question. 209 00:21:06.980 --> 00:21:09.820 This is why you could have a lower volume of consumer 210 00:21:09.820 --> 00:21:14.020 spending, and yet that can support more investment. 211 00:21:14.020 --> 00:21:16.500 and there's no one along the way that's losing money. 212 00:21:16.500 --> 00:21:19.220 It's all internally consistent, there's no paradox. 213 00:21:21.680 --> 00:21:25.940 Okay, so yeah, why don't we get into that now? 214 00:21:32.940 --> 00:21:35.340 All right, let me, I'll just do them one at a time. 215 00:21:38.660 --> 00:21:41.220 So this is obviously from the study guide. 216 00:21:41.220 --> 00:21:48.820 okay let me just make sure this is probably going to be review for most of 217 00:21:48.820 --> 00:21:51.180 you but let me make sure we all understand there's a lot going on in 218 00:21:51.180 --> 00:21:57.580 these diagrams let me make sure you see all the little bells and whistles okay so 219 00:21:57.580 --> 00:22:02.220 first of all again it's the the hundred ounces the bottom that is the amount 220 00:22:02.220 --> 00:22:09.700 being spent by consumers on the consumer good and and also let me also 221 00:22:09.700 --> 00:22:16.700 So whenever I go look at these things, I haven't seen them in a while, I always get tripped, I'm always off by a level, so if that's happening to you, don't worry, it happens to me too. 222 00:22:16.700 --> 00:22:24.700 So let's look up here, so what's happening is this entrepreneur, and I know this is review, but I want to make sure we see this one so that we understand the next one. 223 00:22:24.700 --> 00:22:35.700 This high level, I guess it would be the sixth stage, gives 19 ounces to the land and labor factors, because at this point there's no capital, but there's nothing, it's just all land and labor. 224 00:22:35.700 --> 00:23:05.700 gives 19 ounces and they work on something and then a year later sells a capital good, a good in progress, for 20 ounces to somebody else, so that's ideally if we had a bunch of money I would pay a computer programmer to take this thing and turn it into like a neat little presentation on the computer where you could see the capital good ripening as it went down because with these numbers it's kind of hard to picture that we were saying oh a passage of time so that's why it has to earn an interest return but no the reason this 225 00:23:05.700 --> 00:23:09.700 The reason why this person here is paying 20 is because that thing is something useful. 226 00:23:09.700 --> 00:23:12.700 It's a capital good that he says, yeah, I'll pay 20 ounces of gold for that. 227 00:23:12.700 --> 00:23:16.700 So it's not that he cares about the time preference of the capitalist from the prior stage. 228 00:23:16.700 --> 00:23:19.700 He's paying 20 ounces of gold for this thing. 229 00:23:19.700 --> 00:23:26.700 This guy who's paying 20 for this, it's not that he even needs to know what land and labor went into it. 230 00:23:26.700 --> 00:23:29.700 He could know that, but he doesn't need to know that. 231 00:23:29.700 --> 00:23:34.700 So again, this is a little bit abstract and it would be helpful when you're thinking through this 232 00:23:34.700 --> 00:23:42.700 So you can really picture that as the good is moving down, I mean it is physically being transformed step by step so it's not just the mere passage of time. 233 00:23:42.700 --> 00:23:50.700 These land and labor factors are doing stuff to this thing to turn it into the eventual consumer good that's worth 100 ounces of gold. 234 00:23:50.700 --> 00:23:58.700 Okay, so the 19 ounces there go to these land and labor factors and again so that you know some worker, somebody says hey what do you do for a living? 235 00:23:58.700 --> 00:24:04.700 So I take raw material from the land and I transform it into whatever the capital good is 236 00:24:04.700 --> 00:24:07.700 and then the guy goes and sells it for 20 ounces of gold. 237 00:24:07.700 --> 00:24:14.700 And so that's what they do and those people get, and some landowners also, they're selling the materials, 238 00:24:14.700 --> 00:24:18.700 the virgin materials that are being used to create this capital good from scratch. 239 00:24:18.700 --> 00:24:20.700 And again, that's what they get their income. 240 00:24:20.700 --> 00:24:24.700 So that's 19 ounces every period going to those two groups of people. 241 00:24:24.700 --> 00:24:32.700 And then the period later when this entrepreneur sells it for 20, that's where that one is coming from, right? 242 00:24:32.700 --> 00:24:42.700 He put out 19, a year later was then able to sell it for 20, and so the interest return on the invested 19 was one ounce, okay? 243 00:24:42.700 --> 00:24:49.700 And then again, the interest right there, you're earning a return of one for an investment of 19, it's a little bit more than 5%, 244 00:24:49.700 --> 00:24:55.420 5%, but it's because of rounding, that Rothbard is trying to get around 5% for these things. 245 00:24:55.420 --> 00:24:57.900 Okay, and then I'll just do a couple more. 246 00:24:57.900 --> 00:25:03.300 The next stage, what happens to the guy at this stage pays 20 for the good in progress 247 00:25:03.300 --> 00:25:09.660 that kept a little bit from somebody else, then he hires 8 ounces of, again, raw inputs 248 00:25:09.660 --> 00:25:15.560 and other workers to work on this thing that he just paid 24, and then also for the additional 249 00:25:15.560 --> 00:25:25.560 And so he spends a total of $28. He invests a total of $28. That process takes a time period, whether it's a year or whatever the period is, and then he sells it for $30. 250 00:25:25.560 --> 00:25:41.560 And so then his net return is $2 on the investment of $28. And so that's how it unfolds. So you see here these vertical lines. This $83 is $19 plus $8 plus $13 plus $12. 251 00:25:41.560 --> 00:25:48.400 This 83 is 19 plus 8 plus 13 plus 12 plus 16 plus 15 okay so that's that's 252 00:25:48.400 --> 00:25:53.760 what's going on there and this 17 is the sum of all these ones going off the side 253 00:25:53.760 --> 00:25:59.720 and the 17 plus 83 is 100 so that's not coincidental that that's all you know 254 00:25:59.720 --> 00:26:05.200 makes sense it needs to be like that the other thing I wanted this with this note 255 00:26:05.200 --> 00:26:10.000 I want to make sure I didn't forget to tell you is we're tending to think of 256 00:26:10.000 --> 00:26:40.000 in the Evenly Rotating Economy, once it all settles down and the system keeps repeating itself so that, you know, every period the stuff all shifts forward one and then these guys who are getting 19 take the virgin material and the raw labor and create a new one to enter the pipeline up here and then every period the consumers are unloading the finished good from the bottom and consuming it and so every period this stuff shifts down one. But before that can happen, if you first started this from scratch, 257 00:26:40.000 --> 00:26:44.500 This process, you would have to wait six years or six time periods for it to happen. 258 00:26:44.500 --> 00:26:52.000 Originally, you would have to spend the 19, get this thing, and then buy eight units more 259 00:26:52.000 --> 00:26:55.600 of land and labor and then sell it for 30 the next period. 260 00:26:55.600 --> 00:27:00.640 So it would take six periods just for the first amount of the consumer good to come 261 00:27:00.640 --> 00:27:05.340 off the line for consumers to get. 262 00:27:05.340 --> 00:27:12.340 Another tangential point, if you want to, if you're interested in seeing that intermediate 263 00:27:12.340 --> 00:27:18.780 adjustment process, that what happens when you go from one stationary state, then there's 264 00:27:18.780 --> 00:27:24.100 more net saving and investment, and you end up in a new stationary state, but we're just 265 00:27:24.100 --> 00:27:27.860 looking at snapshots after the adjustment has happened, what if I wanted to look at 266 00:27:27.860 --> 00:27:34.220 the intermediate process, like what does the consumer do for those six periods, okay, we 267 00:27:34.220 --> 00:27:46.220 We only spend $80 now, we're investing $20, and what happens down here is after everything is settled down again, 268 00:27:46.220 --> 00:27:53.220 but what happens in the intermediate six or seven periods when you're waiting for the results of that higher investment. 269 00:27:53.220 --> 00:27:59.220 If you want to see an analysis like that, actually, so first of all, higher pure theory of capital, 270 00:27:59.220 --> 00:28:04.220 But a very short statement of it is actually in Paul Samuelson's article of summing up. 271 00:28:04.220 --> 00:28:09.220 So I mentioned the last talk that, believe it or not, Paul Samuelson really understands. 272 00:28:09.220 --> 00:28:16.220 He thinks it's wrong, but he came up with this really clever mathematical example with numbers that were very convenient, 273 00:28:16.220 --> 00:28:21.220 nice round numbers to show, to illustrate what would happen during the adjustment process. 274 00:28:21.220 --> 00:28:26.220 So again, it's a very clever little result. I disagree with Samuelson's conclusions, of course, 275 00:28:26.220 --> 00:28:32.700 But if you like this sort of thing, like I said, Samuelson actually came with a pretty good one to show the intermediate steps. 276 00:28:32.700 --> 00:28:45.900 So this here, I'm just showing you a possible steady state if you want to talk a bit like that after we've adjusted to the new amount of gross investment. 277 00:28:45.900 --> 00:28:54.540 OK, so here what's going on, let me stress this is not this is just one possibility. 278 00:28:54.540 --> 00:29:01.140 So this is consistent with the numbers Rothbard talks about in the book, but there's no reason that you say, 279 00:29:01.140 --> 00:29:07.380 oh, if consumers all of a sudden who used to spend $100 now spend $80, this is what the new structure of production is going to look like. 280 00:29:07.380 --> 00:29:12.860 That, no, you can't say that you don't know, but this is just an example of what it could look like, all right? 281 00:29:12.860 --> 00:29:17.300 And in particular, you'll see that 1.6 is kind of funny. 282 00:29:17.300 --> 00:29:19.300 And you may say, well, why did I pick that number? 283 00:29:19.300 --> 00:29:49.300 Well it was just because there's a lot of different things that had to be true that these numbers all had to be a certain way to work out like I knew this had to be 80 I knew gross investment had to be what was it 418 ounces and things like that you knew that this number plus this number had to add up to 80 so there's a lot of things that had to be true and they're also I wanted there to be seven steps step seven stages and I wanted the interest rate the spread between each stage to be less than 5% because we had to show a lower interest so there's 284 00:29:49.300 --> 00:30:19.300 There's a lot of things and so I wrote out this, you know, the things that had to be true and I could solve it and so my brother's getting a PhD in math so I asked him how the heck do you solve this thing and he showed me how you did it and you know these were the best numbers I could come up with and like I said I just said well I wish I didn't have that weird 1.6 in there because it's so much lower than the other ones but that was the best I could do so again the point is there's nothing magical about these numbers this is just to try to show you what it might look like with specific numbers in there so again just very quickly 285 00:30:19.300 --> 00:30:29.300 You'll see what's going on here. You'll see that there's an extra layer now, that there's now a longer structure of production. 286 00:30:29.300 --> 00:30:37.300 And so you'll see this solves the paradox of savings. How could it be if all of a sudden they restrict consumption to 80 ounces? 287 00:30:37.300 --> 00:30:44.300 Wouldn't all these people be going out of business? Well, no. Look at this diagram and tell me who's losing money here. 288 00:30:44.300 --> 00:30:59.300 There's no problem, and as Hayek points out in that article, The Paradox of Saving, it's because if you're not picturing producers earning returns in this fashion, then yeah, it really doesn't make sense if the people at the end of the chain are spending less. 289 00:30:59.300 --> 00:31:09.300 Isn't that just going to have ramifications throughout the economy, and so everyone's going to earn less over time, and no, there's no reason for that to be the case. 290 00:31:09.300 --> 00:31:27.300 Now it's true, as Rothbard points out, the monetary returns are lower in the sense of the nominal returns but again, production is going to actually be higher now because goods are invested in a longer, or as von Boehm-Bawerk said, a more roundabout production process. 291 00:31:27.300 --> 00:31:36.300 One last point about why these tables are kind of neat is if you want to say, well, what's the interest return to the capitalists? 292 00:31:36.300 --> 00:31:41.300 One way to do it, so this 10.1, one way to figure that out is to just sum up these numbers. 293 00:31:41.300 --> 00:31:47.300 But another way to do it is to multiply the gross investment by the interest rate. 294 00:31:47.300 --> 00:31:57.300 And so you would know the interest rate by saying, okay, you know, this guy spent 17 and they turned around and sold it for 17.5, so it's 0.5 divided by 17. 295 00:31:57.300 --> 00:32:02.300 It's roughly, I think it's 3%, right? Is that what I said? Yeah. 296 00:32:02.300 --> 00:32:09.300 Okay, so you could deduce the, so if I just handed you this chart, you could figure out what the interest rate was in this economy. 297 00:32:09.300 --> 00:32:18.300 And then, like I say, it also works out. It's not a coincidence that if you multiply the interest rate by the gross investment, that is the sum of these numbers. 298 00:32:18.300 --> 00:32:23.300 Okay, so these are pretty neat little diagrams. There's a lot packed into them and they all fit together. 299 00:32:23.300 --> 00:32:32.580 and again just a contribution of Rothbard to boil down something very difficult into a neat little diagram like this. 300 00:32:32.580 --> 00:32:38.500 Okay, let me take that off so you're not mesmerized by it. 301 00:32:38.500 --> 00:32:44.340 Let me see what time we got. Okay, I'll just go about five more minutes and then I'll open it up for Q&A. 302 00:32:44.340 --> 00:32:47.740 Let me say a word about Boehm-Bawerk. 303 00:32:47.740 --> 00:32:55.940 I think you're going to find that if you go and read von Boehm-Bawerk in the original, 304 00:32:55.940 --> 00:33:00.460 I think Mises dismisses him too easily or too quickly in human action. 305 00:33:00.460 --> 00:33:04.700 For those of you who have read the critique there, I'm not saying that von Boehm-Bawerk's 306 00:33:04.700 --> 00:33:09.020 theory is a good one and that we ought to embrace it, but I'm just saying that Mises 307 00:33:09.020 --> 00:33:13.940 seems to think he gave him a knockout blow in two sentences and it really wasn't. 308 00:33:13.940 --> 00:33:16.620 I think von Boehm-Bawerk would just say, yeah, that's exactly what I just said, what you're 309 00:33:16.620 --> 00:33:17.620 talking about. 310 00:33:17.620 --> 00:33:23.940 in any event let me just mention that now in terms of roundaboutness because 311 00:33:23.940 --> 00:33:28.620 Rothbard talks about this and he's arguing that it's really an unfortunate 312 00:33:28.620 --> 00:33:33.940 choice of terminology let me just explain again why did Boehm-Bawerk pick 313 00:33:33.940 --> 00:33:37.140 that word he obviously didn't pick the English word but you know what I mean 314 00:33:37.140 --> 00:33:42.020 because he was thinking look there's different ways you can you can produce 315 00:33:42.020 --> 00:33:46.060 something so if I want to let's say I have a cottage somewhere and there's a 316 00:33:46.060 --> 00:33:55.060 The stream that's a football field length away, 100 yards away, and I want to get the water from the stream to my cottage, well, there's different ways I can do it. 317 00:33:55.060 --> 00:34:01.060 And what do I have to work with? Well, I have my labor, and then I'm in a forest. There's all sorts of natural raw materials there. 318 00:34:01.060 --> 00:34:07.060 And the issue is, well, how do I get water into my cottage? That's the consumption that I'm aiming for. 319 00:34:07.060 --> 00:34:13.060 And so a very direct method, it would be I go down to the stream and I just cut my hands and pick the water up like that. 320 00:34:13.060 --> 00:34:25.060 So that's not roundabout, that's very direct, but of course the volume of water per unit of my labor input is very low. 321 00:34:25.060 --> 00:34:31.060 And so then Boehm-Bawerk wants to say, but instead of doing that, why don't I adopt a more roundabout approach? 322 00:34:31.060 --> 00:34:41.060 Instead of directly going for what I want, what if I use my labor and I go and I find a coconut and then I cut it open and I hollow it out. 323 00:34:41.060 --> 00:34:54.060 So now I have this thing that's like a bowl, and then I go down and scoop up the water that way, surely I'm going to, you can see that the physical quantity of water per unit of my labor input is going to be much higher that way. 324 00:34:54.060 --> 00:35:01.060 Okay, so the reason he's calling it roundabout is that if someone saw me grabbing a coconut and said, what are you doing? 325 00:35:01.060 --> 00:35:06.060 And I said, oh, because I'm really thirsty. Well, they might think I was going to drink the coconut milk, but okay, you know what I mean. 326 00:35:06.060 --> 00:35:08.140 So anyway, that's why he calls it roundabout. 327 00:35:08.140 --> 00:35:14.500 And then of course, you know, if you really wanted to get a lot of water per unit of your labor input, 328 00:35:14.500 --> 00:35:20.020 you would go and first create a shovel and you would dig a trench from your cabin to the stream. 329 00:35:20.020 --> 00:35:22.580 And then, you know, you would do all sorts of things that I have no idea. 330 00:35:22.580 --> 00:35:24.300 I would die if I were put in the woods right now. 331 00:35:24.300 --> 00:35:26.220 So I don't know exactly what you would do. 332 00:35:26.220 --> 00:35:32.820 But I know somebody who is more resourceful than I am would figure out a way to get water from the stream into their cottage. 333 00:35:32.820 --> 00:35:42.020 and they would, and so the point is, what is this, the superior productivity of roundabout production processes, 334 00:35:42.020 --> 00:35:46.260 specifically what it is, it's a purely physical concept and he's saying, 335 00:35:46.260 --> 00:35:54.500 if you want to look at how many gallons or how many liters of water per unit of my labor input do I get, 336 00:35:54.500 --> 00:35:59.860 clearly you could, you see that I get more, if I do the more roundabout processes, 337 00:35:59.860 --> 00:36:09.860 But of course, they're further in the future, that it takes me time to go and hollow out the coconut or it takes me time to build the shovel, to dig the trench. 338 00:36:09.860 --> 00:36:14.860 So if I really need water, if somebody's dying of thirst in my cabin, I'm not going to go find a coconut. 339 00:36:14.860 --> 00:36:17.860 I'm going to run to the stream and run back and forth ten times. 340 00:36:17.860 --> 00:36:23.860 But the point is, if I want to increase my standard of living over time, I'm going to adopt these other processes. 341 00:36:23.860 --> 00:36:32.860 So it's that insight. That's why Boehm-Bawerk thinks saving and investing in capital goods enhances the productivity of our labor. 342 00:36:32.860 --> 00:36:36.860 So that's where he's coming from. That's the way he views it. 343 00:36:36.860 --> 00:36:48.860 And that's why Austrians think that capital goods, in a sense, really are just embodiments of inputs of labor and land and then the time savings. 344 00:36:48.860 --> 00:37:11.860 One last thing, and then I'll stop, is this issue of, Rothbard makes a big point about, if there's, let me find it specifically, so I mentioned it, there's the last point in the study guide chapter, 345 00:37:11.860 --> 00:37:25.860 Okay, yeah, so he says that in any equilibrium situation, net saving is zero by definition, since net saving means a change in the level of growth saving over the previous period of time. 346 00:37:25.860 --> 00:37:36.860 Alright, and he uses that a lot, and it's also tied into his argument about why net saving and investment go hand in hand with a progressing economy and vice versa. 347 00:37:36.860 --> 00:38:04.860 If you're in a graduate economics program, this is going to trip you up and you're not going to understand it because in a mainstream program, when they talk about net saving and gross investment and things like that, what they have in mind is you have a capital stock and then every period some of it's going to depreciate and so you need to invest at least the amount to offset the depreciation just to maintain the capital stock from period to period. 348 00:38:04.860 --> 00:38:09.500 and then if you invest more than that, that's net investment and that's going 349 00:38:09.500 --> 00:38:13.100 to expand the capital stock and so that's the way the mainstream is thinking 350 00:38:13.100 --> 00:38:18.140 about it and that doesn't dovetail with what Rothbard's talking about it and for 351 00:38:18.140 --> 00:38:22.740 example you could in a mainstream solo growth model or something you can 352 00:38:22.740 --> 00:38:27.740 certainly have net investment over time and it's an equilibrium situation 353 00:38:27.740 --> 00:38:31.700 everybody sees it coming and there's no profits being earned and it's the the 354 00:38:31.700 --> 00:38:40.700 Capital stock expands over time and I think, if you want to say, why are they coming to such different conclusions? 355 00:38:40.700 --> 00:38:48.200 I mean, they're, given their definitions, they're both valid, but I think the reason Rothbard thinks of it this way, 356 00:38:48.200 --> 00:38:55.700 in a, you know, solo thought of it the different way, is mainstream economists tend to think of capital as fixed capital. 357 00:38:55.700 --> 00:39:04.700 They're picturing a machine that, you know, sits in the factory and is useful for 10 years and then it wears out and then you have to buy a new machine. 358 00:39:04.700 --> 00:39:10.700 And so, if you've got 100 machines, you know, every year you've got to buy 10 more or else your machines are going to dwindle over time. 359 00:39:10.700 --> 00:39:12.700 That's the way a mainstream economist is thinking of it. 360 00:39:12.700 --> 00:39:20.700 Whereas Austrians tend to think of, I'm going to think about gross investment in capital, they're thinking of the goods in process moving down the pipeline. 361 00:39:20.700 --> 00:39:26.340 and so there every period you need to go buy more flour if you're a baker it's 362 00:39:26.340 --> 00:39:28.900 not that all right so I got you that's maybe a good way to think about the 363 00:39:28.900 --> 00:39:32.860 mainstream economist is picturing the oven in the bakery and that you have to 364 00:39:32.860 --> 00:39:37.820 put aside money for the depreciation fund whereas the Austrian tends to think 365 00:39:37.820 --> 00:39:42.420 of the raw material inputs and how you have to replenish them every period and 366 00:39:42.420 --> 00:39:45.580 if some period you just decide you know what I got was money from selling bread 367 00:39:45.580 --> 00:39:50.220 I'm not going to buy any flour then the process comes to a standstill all right 368 00:39:50.220 --> 00:39:56.620 So I think that's partly why they adopt different definitions of what does net saving mean.