Puzzles for Economists
ESSAYS ON CAPITAL AND INTEREST: AN AUSTRIAN PERSPECTIVE
Israel M. Kirzner
Edward Elgar, 1996, viii + 166 pgs.
Israel Kirzner has achieved greatest renown as an Austrian
economist for his work on entrepreneurship. But he is also a
distinguished capital theorist; the present volume usefully
collects several of Kirzner's essays in this field, most notably
his 1966 "An Essay on Capital."
A central theme stands out in Kirzner's essays. For Austrians,
capital is not a disembodied abstraction. Instead, the decision
to invest in capital goods must always be traced to individual
actions. The significance of capital is not its "physical
characteristics or physical history" (p. 44), but its ability to
allow individuals to more readily realize their plans. This
characteristic proves much more illuminating than the classical
notion of capital as "produced means of production."
In the high point of the book, Kirzner deploys his thesis to
great effect in criticism of the capital theory of Frank Knight.
According to Knight, capital, like Topsy, "just growed." It is a
self-perpetuating fund, which replenishes itself as if by magic.
Kirzner will have none of this. Knight's fanciful notion of
permanent capital merely reflects the undoubted fact that if a
decision is made constantly to replace used-up capital goods,
these goods will be maintained indefinitely. But Knight fails to
see that there is nothing automatic about the decision to replace
a capital good.
As always, the individual actor is primary, and his decision to
replace a capital good is far from automatic. Kirzner dismisses
Knight's fantasy of "Crusonia," an economy in which all capital
is derived from a perpetually growing plant, as useless for
understanding how capital functions in the real world.
Kirzner's demolition of Knight is first-rate. But at times in the
present work he advances views that strike me as puzzling or
mistaken. Though our author is a devout disciple of Mises, he
unfortunately does not resemble the great Austrian in clarity of
writing. Rather, he appears to have adopted the clotted style of
David Ricardo as a model; and his remarks often prove difficult
A prime example occurs in Kirzner's defense of the pure time
preference theory of interest. Incidentally, though our author
rightly sees that this theory is central to Mises's thought, he
does not expound it in the precise form held by Mises. He writes:
"This theory solves the interest problem by appeal to widespread
(possibly universal) positive time preference" (pp. 137-38). For
Mises, time preference is an a priori category of action.
But this is not the issue that I find puzzling: if Kirzner
retreats from Mises's ipsissima verba, that is his own affair.
Rather, the problem on which I wish to focus arises from
Kirzner's comments on a rival theory of interest. As he rightly
notes, the pure time preference theory differs entirely from the
view that ascribes interest to the productivity of waiting. In
this view, waiting is a productive input that commands a price.
One might expect Kirzner to challenge the rival theory; but he
fails to do so. He remarks: "As a matter of logic, the Fisher
productivity-of-waiting theory deals with the interest problem"
in "an impeccable manner. The only way through which the validity
of the productivity-of-waiting view (at least as we have
presented it thus far) can be challenged, is by disagreeing with
the concept of 'waiting' as a productive factor service" (p.
Very well then: one would now expect Kirzner to show why waiting
is not a productive factor service. He begins by delimiting the
field of inquiry: the dispute between the pure time preference
view and its rival is "strictly a non-economic 'philosophic' one"
Now comes the surprise. Kirzner does not argue in favor of the
philosophic view of time which he believes lies at the base of
the Austrian position. He confines himself to declaring the pure
time preference view a possible option. By the close of his
discussion, he claims to have "shown that PTPT refusal to
recognize any physical productivity role in the explanation for
the existence of interest income, rests on (the admittedly
arbitrary) view that time and waiting are not to be seen as
productive agents" (p. 152, emphasis added).
If Kirzner's conclusions do not go very far, he displays one
contrasting intellectual virtue: he tackles the most difficult
questions in capital theory. Among these stands that nerve-
wracking conundrum, the reswitching controversy. According to the
Austrian theory of capital, lowering the rate of interest leads
to longer, more roundabout methods of production.
But sometimes, it is alleged, "capital reversal" may occur. In
such a case, lower interest induces the capitalist to switch to a
shorter, less capital-intensive technique. Pierro Sraffa, Joan
Robinson, and other neo-Ricardians used examples of this sort to
assault the neoclassical theory of capital; but, as Kirzner
rightly notes, they threaten the Austrian view as well for the
reason we have seen.
A formidable challenge. Kirzner maintains that the examples of
reswitching rest on a dubious premise. They assume that "each
technique of production involves a simple, unidimensional
'quantity' of time" (p. 9). But this premise cannot stand. "The
cases that yield the capital-reversing paradoxes all arise from
production processes involving more or less complex dating
patterns for inputs and outputs" (p. 9). These complex patterns
cannot readily be unified into a single quantity: hence the
crucial premise on which reswitching depends collapses.
Kirzner's treatment strikes me as suggestive but inconclusive.
Suppose that every case of reswitching involves a complex pattern
of dating. (Must this be true or does this arise from the choice
of example?) Does it follow that we can never say that one
complex pattern takes less time than another? I do not see that
He escapes criticism if his point is only that the reswitching
advocates have not proved that one complex pattern can be ranked
as longer than another. But, as with the pure time preference
theory, he has arrived at a very modest defense of the standard
If Kirzner is right, neo-Ricardians can no longer claim that the
Austrian view fails because lower interest may lead to a shorter
production technique. But neither can Austrians claim that lower
interest always leads to more roundabout methods of production.
Kirzner's point, if valid, tells against both Sraffa and Mises.
"Unreconstructed" Austrians should not rush uncritically to
From the onset of his long career, Professor Kirzner has been
alert to the normative dimension of economic theory. Even if one
agrees with Hume that an "is" does not logically imply an
"ought," surely judgments of fact are often very relevant to
value judgments. If you know that a glass contains poison, you
have a very good reason not to offer it as a drink to a passing
To Kirzner, the pure time preference theory of interest has just
this sort of normative relevance. Opponents of the free market
often condemn interest as unjustified by considerations of
efficiency. By contrast, neoclassicals defend interest as the
reward to a productive service.
Market sympathizers who are inclined to think that the Cambridge
critics of capitalism have the better of the neoclassicals may
find solace, Kirzner thinks, in the pure time preference theory
of interest. Austrians agree that interest does not constitute a
productivity return. "On the other hand, PTPT very definitely
sees market interest as expressing a market- determined rate of
intertemporal exchange" (p. 151). A defender of capitalism can
thus use the pure time preference account to justify interest
without assuming that it rewards productivity.
Here, once more, I am puzzled as to how much Kirzner's point
shows. Certainly, there is something to it: but why must an
opponent of capitalism accept that capitalists should derive
financial gain because time preference exists? If he thinks that
only productivity justifies income, he will remain unconvinced.
If, however, he condemns interest not because it is unproductive,
but because he thinks it fulfills no function, then Kirzner's
point may indeed induce a change of heart. Like much in this
book, this is a modest result, but not for all that, without