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What does it mean when one says that "capital is heterogeneous"? Why is this important to the Austrian Theory of Economics, or the Business Cycle Theory?

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What does it mean when one says that "capital is heterogeneous"? Why is this important to the Austrian Theory of Economics, or the Business Cycle Theory?

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ThatOldGuy posted on Sat, Oct 8 2011 5:30 PM

I've heard the phrase "heterogeneous capital" spread around a lot, especially by Austrians. I've never heard, or read, the definition of the phrase spelled out. I think I've inferred that the phrase means that we don't just have a category of goods called "capital," the category can be divided further into "second order capital, third order capital, nth order capital." Is this what is meant by "heterogeneous capital"? And what are the implications of this realization on the Austrian school of Economics or capital theory?

If I had a cake and ate it, it can be concluded that I do not have it anymore. HHH

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Answered (Verified) Esuric replied on Sat, Oct 8 2011 7:05 PM
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OOHH! Okay- that makes perfect sense. So it's more of a reflection of scarcity and Menger's concept of the "goods-character" of a certain good with respect to a certain end?

Some people may read this and think to themselves, "so what? Everyone understands that you can't bake bread with a hammer, and you can't build a house with an oven," but this insight has extremely deep and important theoretical implications.

First, it means that entrepreneurs must determine what kind of capital goods they will invest in. They must asses current and future consumer demand (through the interpretation of various prices) and invest in the correct capital goods that will eventually produce the consumer goods that consumers truly desire.

Next, varrying degrees of heterogeneity necessarily implies varrying degrees of complementarity. In other words, a hammer without nails wont get you very far, and it's impossible to bake bread with just an oven; you need eggs, flour, etc. This means that entrepreneurs must take action and determine how they will arrange and combine the various capital goods which can be combined in seemingly endless combinations, yielding different degrees of output, most of which will not be optimal. But here, optimal doesn't just mean producing the most; the combination which produces the most could also be, and frequently is, extremely wasteful. In other words, it may use too many resources which could have been combined in different ways and used in different, more productive employments (where again, the productivity of these employments are determined by their ability to satisfy true consumer demand, at some point in time).

This variable (capital heterogeneity) makes the existence of the entrepreneur, the price mechanism which attempts to guide his decisions, and the competitive environment that he exists in, and must survive in, absolutely vital for rational and efficient economic coordination and production. The price mechanism and the profit-loss constraint eliminates those who invested in incorrect capital goods and/or combined the various capital goods inefficiently, and redirects those resources to those who have done so correctly.

If you eliminate this variable, as Keynesians do, then the entrepreneur is superfluous. When you assume that capital is a homogenous blob, then there's no room for "malinvestments" and bubbles; investment is simply investment, and the central banker can increase it at will by simply reducing the interest rate through expansionary monetary policy (unless there's a liquidity trap). When you combine Keynesian economics with Marxian dogma, you reach the conclusion that the entrepreneur (or the firm) is nothing but an exploiter, a "rentier."

"If we wish to preserve a free society, it is essential that we recognize that the desirability of a particular object is not sufficient justification for the use of coercion."

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Malachi replied on Sat, Oct 8 2011 5:42 PM

Heterogenous capital refers to the fact that in the real world, the means of production are multivarious and disparate. A framing hammer is less useful in metalworking than in carpentry, and completely useless for baking bread. 

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ThatOldGuy replied on Sat, Oct 8 2011 5:47 PM

OOHH! Okay- that makes perfect sense. So it's more of a reflection of scarcity and Menger's concept of the "goods-character" of a certain good with respect to a certain end?

If I had a cake and ate it, it can be concluded that I do not have it anymore. HHH

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Aristippus replied on Sat, Oct 8 2011 6:07 PM
You might find this interesting: http://mises.org/daily/5626/The-Gnome-Thought-Experiment
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ThatOldGuy replied on Sat, Oct 8 2011 6:23 PM

Aristippus:
You might find this interesting: http://mises.org/daily/5626/The-Gnome-Thought-Experiment

"Of course, the real problem in my thought experiment is that the production structure is a complex, interlocking collection of heterogeneous capital goods. It's not enough to say that the economy has the same number of workers and machines now as it did in 2007. That alone doesn't prove that the measured "real GDP" of 2007 was sustainable. "

Thanks- I read this article- Murphy is always an interesting read. This makes sense then. If all the automobiles in the country were destroyed tomorrow, and the horse and buggy industry had a boom (along with all the filth and disease that came with it in the 19th and early 20th centuries) the GDP may well have not changed to a statistically significant extent, although productivity would have declined substantially!

If I had a cake and ate it, it can be concluded that I do not have it anymore. HHH

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Answered (Verified) Esuric replied on Sat, Oct 8 2011 7:05 PM
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OOHH! Okay- that makes perfect sense. So it's more of a reflection of scarcity and Menger's concept of the "goods-character" of a certain good with respect to a certain end?

Some people may read this and think to themselves, "so what? Everyone understands that you can't bake bread with a hammer, and you can't build a house with an oven," but this insight has extremely deep and important theoretical implications.

First, it means that entrepreneurs must determine what kind of capital goods they will invest in. They must asses current and future consumer demand (through the interpretation of various prices) and invest in the correct capital goods that will eventually produce the consumer goods that consumers truly desire.

Next, varrying degrees of heterogeneity necessarily implies varrying degrees of complementarity. In other words, a hammer without nails wont get you very far, and it's impossible to bake bread with just an oven; you need eggs, flour, etc. This means that entrepreneurs must take action and determine how they will arrange and combine the various capital goods which can be combined in seemingly endless combinations, yielding different degrees of output, most of which will not be optimal. But here, optimal doesn't just mean producing the most; the combination which produces the most could also be, and frequently is, extremely wasteful. In other words, it may use too many resources which could have been combined in different ways and used in different, more productive employments (where again, the productivity of these employments are determined by their ability to satisfy true consumer demand, at some point in time).

This variable (capital heterogeneity) makes the existence of the entrepreneur, the price mechanism which attempts to guide his decisions, and the competitive environment that he exists in, and must survive in, absolutely vital for rational and efficient economic coordination and production. The price mechanism and the profit-loss constraint eliminates those who invested in incorrect capital goods and/or combined the various capital goods inefficiently, and redirects those resources to those who have done so correctly.

If you eliminate this variable, as Keynesians do, then the entrepreneur is superfluous. When you assume that capital is a homogenous blob, then there's no room for "malinvestments" and bubbles; investment is simply investment, and the central banker can increase it at will by simply reducing the interest rate through expansionary monetary policy (unless there's a liquidity trap). When you combine Keynesian economics with Marxian dogma, you reach the conclusion that the entrepreneur (or the firm) is nothing but an exploiter, a "rentier."

"If we wish to preserve a free society, it is essential that we recognize that the desirability of a particular object is not sufficient justification for the use of coercion."

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ThatOldGuy replied on Sat, Oct 8 2011 7:26 PM

That was an awesome reply- thank you for it. The first part of your answer reminds me of Menger's Principles (if it sounds like I'm mentioning Menger a lot, it's because I'm reading Principles of Economics right now- by far one of the most enlightening books that I've read). Right- the reason why a good has a goods-character, apart from it satisfying the basic four prerequisites for goods-character:

1. Human need;

2. Causal relation of some thing to the elimination/mitigation of this need;

3. Knowledge of this causal relation, and;

4. Command of the thing in question;

the good in question must have the complentary goods necessary to fulfill that need or else, on that extension, the good in question loses its goods-character (at least for that one end- it may or may not retain goods-character for a separate end.) And for this reason, we can infer, producers must take the appropriate action to find complementary goods in order to set in place processes that yield the end good that consumers demand. This gives the entrepreneur value- which Menger also defines, but I think the point is made well in your post so I'll leave it as is.

Esuric:
this insight has extremely deep and important theoretical implications.

You're absolutely right- something like this, however obvious the implications are once spelled out, must be spelled out if we are to understand economic theory or for it to have any significance in the first place.

 

Esuric:
If you eliminate this variable, as Keynesians do, then the entrepreneur is superfluous. When you assume that capital is a homogenous blob, then there's no room for "malinvestments" and bubbles; investment is simply investment, and the central banker can increase it at will by simply reducing the interest rate through expansionary monetary policy (unless there's a liquidity trap). When you combine Keynesian economics with Marxian dogma, you reach the conclusion that the entrepreneur (or the firm) is nothing but an exploiter, a "rentier."

My goodness- this is something they believe about capital and entrepreneurship? Now that "circular flow" nonsense, without the entrepreneur in it, makes "sense." 

What is a liquidity trap for that matter? The only time I've heard it used is in that rap video with Hayek vs. Keynes.

And lay off Marx! There was one good thing about him- he wasn't a Keynesian! :)

 

If I had a cake and ate it, it can be concluded that I do not have it anymore. HHH

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Esuric replied on Sat, Oct 8 2011 7:51 PM

The first part of your answer reminds me of Menger's Principles (if it sounds like I'm mentioning Menger a lot, it's because I'm reading Principles of Economics right now- by far one of the most enlightening books that I've read).

Well yes. There is a clear theoretical connection between Menger --> Bohm-Bawerk --> Mises --> Hayek ---> Lachmann when it comes to capital theory. It is true that Menger had many problems with Bohm-Bawerk's work, but it's the same general framework, and every other link in the chain merely built upon and expanded the work of the previous link (though Lachmann really just paraphrased, in about 90 pages, what Hayek attempted to say in about 500 pages. Hayek wasn't the best writer).

You're absolutely right- something like this, however obvious the implications are once spelled out, must be spelled out if we are to understand economic theory or for it to have any significance in the first place.

Indeed. There are many who wouldn't dare question some of the logical foundations of Austrian economics, and yet they fail to comprehend their torrential implications.

My goodness- this is something they believe about capital and entrepreneurship?

Yes, and it's not just the Keynesians. Basically every mainstream economist holds this position, or at least assumes this condition in their models. This condition (theoretical construct) is vital for their economic modeling. But again, it yields untenable conclusions. It comes primarily from Frank Knight's view of capital, as a homogenous and self-replenishing "fund," that merely "expands" and "flows" from one sector to the next.

What is a liquidity trap for that matter?

A liquidity trap is basically the Keynesian justification for expansionary fiscal policy. Because the Keynesian ignore the heterogeneity of capital, and therefore the role of entrepreneurship and economic coordination, they believe that recessions are caused by inadequate aggregate demand which, for whatever reason, suddenly collapses (this can easily be empirically refuted). Monetary policy aims at increasing aggregate demand by increasing nominal (money) incomes. But if the demand for money (which they conflate with saving) rises, then the newly created money never enters circulation. This is why the government must engage in deficit spending; to increase aggregate demand when the private sector wont, and when monetary policy can't.

[Edited: the list was a little too complicated, and would confuse things]

"If we wish to preserve a free society, it is essential that we recognize that the desirability of a particular object is not sufficient justification for the use of coercion."

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ThatOldGuy replied on Sat, Oct 8 2011 8:20 PM

 

Esuric:
(though Lachmann really just paraphrased, in about 90 pages, what Hayek attempted to say in about 500 pages. Hayek wasn't the best writer).

I've actually never heard of Lachmann. What work of his are you citing? And compared to what of Hayek (I agree on Hayek's writing- very obvious he was a brilliant man but I'm going to have to read his works a few times before I feel comfortable with claiming a total understanding his arguments)?

 

Esuric:
It comes primarily from Frank Knight's view of capital, as a homogenous and self-replenishing "fund," that merely "expands" and "flows" from one sector to the next.

It sounds like the scrolls of Knight have told of a mythical creature which, we do not understand but,  must be tamed!

 

Esuric:
Because the Keynesian ignore the heterogeneity of capital, and therefore the role of entrepreneurship and economic coordination, they believe that recessions are caused by inadequate aggregate demand which, for whatever reason, suddenly collapses (this can easily be empirically refuted).

Absolutely. In fact, Higgs had an article recently that showed that Consumer Spending is up 2% from the start of the recession (from the Bureau of Economic Analysis)- based on that, we "should" be out of this. But I don't necessarily believe in the use of empirical data as a means of refuting a theory- in the sense of Rothbard's a priorism- due to the lack of an "empirical test" that would forever settle the question:

"Is this theory a bankrupt ideology due to the fact that what was tried, pursuant to the theory, has failed? Or, is this failure the result that the means, by which this problem could be remedied, were not implemented severly enough?"

We've a stalemate- necessarily we resort to questioning the theory itself and exposing the (blatant) faults within it. I do believe that empirical data is a good tool to see the results of the policy in question- I just feel it's inadequate to use in order to disprove a theory (Not that I believe that that was your intention in mentioning this).

Theoretically, it collapses because people already increased demand, necessarily above what it would have been otherwise due to artificially lowered interest rates, in the superficial "boom" period; and to correct for this, they save more (from what I understand of what I have read on this subject).

So a liquidity trap is the remaining money that people are saving as a result of the reduced demand?

If I had a cake and ate it, it can be concluded that I do not have it anymore. HHH

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Aristippus replied on Sat, Oct 8 2011 8:26 PM
I believe Esuric was referring to: Lachmann, Capital and Its Structure - http://mises.org/resources/520/Capital-and-Its-Structure and Hayek, Pure Theory of Capital - http://mises.org/resources/3032/Pure-Theory-of-Capital-The EDIT: Once again my paragraphing is not working on this forum
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ThatOldGuy replied on Sat, Oct 8 2011 8:29 PM

Thanks broseph- just popped them on the kindle!

If I had a cake and ate it, it can be concluded that I do not have it anymore. HHH

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David Sherin replied on Sat, Oct 8 2011 10:10 PM

"...they believe that recessions are caused by inadequate aggregate demand which, for whatever reason, suddenly collapses (this can easily be empirically refuted)."

Esuric, I'm not doubting that it can be refuted, but do you have data/sources on this? I'd like to see them and use them if need be.

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Esuric replied on Sun, Oct 9 2011 12:12 AM

It sounds like the scrolls of Knight have told of a mythical creature which, we do not understand but,  must be tamed!

It's funny you say this... Hayek's critique of Frank Knight is called The Mythology of Capital.

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ThatOldGuy replied on Sun, Oct 9 2011 8:15 AM

 

Esuric:
It's funny you say this... Hayek's critique of Frank Knight is called The Mythology of Capital.

 

haha

 

If I had a cake and ate it, it can be concluded that I do not have it anymore. HHH

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ThatOldGuy replied on Sun, Oct 9 2011 8:50 AM

Is my understanding of the "liquidity trap" correct then?

(Quoting myself) 'Theoretically, it collapses because people already increased demand, necessarily above what it would have been otherwise due to artificially lowered interest rates, in the superficial "boom" period; and to correct for this, they save more (from what I understand of what I have read on this subject).

So a liquidity trap is the remaining money that people are saving as a result of the reduced demand?'

If I had a cake and ate it, it can be concluded that I do not have it anymore. HHH

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