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Essays on Capital and Interest: An Austrian Perspective, by Israel Kirzner

The Mises Review

Tags Capital and Interest Theory

07/01/1997David Gordon

Puzzles for Economists

Mises Review 3, No. 2 (Summer 1997)

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 to elucidate.

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. 136).

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" (p. 137).

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 it does.

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 Austrian view.

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 embrace it.

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 stranger.

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 value.


Contact David Gordon

David Gordon is Senior Fellow at the Mises Institute and editor of the Mises Review.

Cite This Article

Gordon, David. "Puzzles for Economists," review of Essays on Capital and Interest: An Austrian Perspective by Israel Kirzner. The Mises Review 3, No. 2 (Summer 1997).

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