{"id":2610,"date":"2014-06-26T21:40:14","date_gmt":"2014-06-26T21:40:14","guid":{"rendered":"http:\/\/www.rationalargumentator.com\/index\/?p=2610"},"modified":"2014-06-26T21:45:20","modified_gmt":"2014-06-26T21:45:20","slug":"heterogeneity-capital","status":"publish","type":"post","link":"https:\/\/www.rationalargumentator.com\/index\/blog\/2014\/06\/heterogeneity-capital\/","title":{"rendered":"Heterogeneity: A Capital Idea! – Article by Sanford Ikeda"},"content":{"rendered":"
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\"The<\/div>\n<\/div>\n
Sanford Ikeda
\n<\/big><\/big><\/strong><\/span><\/div>\n
June 26, 2014<\/span>
\n<\/big><\/div>\n
******************************<\/div>\n<\/div>\n
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When Thomas Piketty\u2019s Capital in the 21st Century<\/em><\/a>\u00a0was released in English earlier this year it sparked vigorous debate on the issue of wealth inequality. Despite the prominence of the word in the title, however, capital has not itself become a hot topic. Apparently none of his defenders have taken the opportunity to explore capital theory, and, with a few exceptions<\/a>,\u00a0neither have his critics.<\/p>\n

To prepare to read Mr. Piketty\u2019s book I\u2019ve been studying Ludwig Lachmann\u2019s Capital and Its Structure<\/em>, which, along with Israel M. Kirzner\u2019s Essay on Capital<\/em><\/a>,\u00a0is among the clearest expositions of Austrian capital theory around. A hundred years ago the \u201cAustrian economists\u201d\u2014i.e. scholars such as Eugen von B\u00f6hm-Bawerk<\/a>\u00a0who worked in the tradition of Carl Menger<\/a>\u2014were renowned for their contributions to the theory of capital. Today capital theory is still an essential part of modern Austrian economics, but few others delve into its complexities. Why bother?<\/p>\n

Capital is Heterogeneous<\/strong><\/h4>\n

 <\/p>\n

Among the Austrians, B\u00f6hm-Bawerk viewed capital as \u201cproduced means of production\u201d and for Ludwig von Mises \u201ccapital goods are intermediary steps on the way toward a definite goal.\u201d (Israel Kirzner uses the metaphor of a \u201chalf-baked cake.\u201d)\u00a0 Lachmann then places capital goods in the context of a person\u2019s plan<\/em>: \u201cproduction plans are the primary object of the theory of capital.\u201d You can combine capital goods in only a limited number of ways within a particular plan. Capital goods then aren\u2019t perfect substitutes for one another. Capital is heterogeneous<\/em>.<\/p>\n

Now, mainstream economics treats capital as a homogenous<\/em> glob. For instance, both micro- and macroeconomists typically assume Output (Q) is a mathematical function of several factor inputs, e.g. Labor (L) and Capital (K) or<\/p>\n

Q = f(L,K).<\/p>\n

In this function, not only is output homogenous (whether we\u2019re talking about ball-bearings produced by one firm or all the goods produced by all firms in an economy) but so are all labor inputs and all capital inputs used to produce them. In particular, any capital good can substitute perfectly for any other capital good in a firm or across all firms. A hammer can perfectly replace, say, a helicopter or even a harbor.<\/p>\n

On the other hand, capital heterogeneity implies several things.<\/p>\n

First, according to Mises, heterogeneity means that, \u201cAll capital goods have a more or less specific character.\u201d A capital good can\u2019t be used for just any purpose:\u00a0 A hammer generally can\u2019t be used as a harbor. Second, to make a capital good productive a person needs to combine it with other capital goods in ways that are complementary within her plan: Hammers and harbors could be used together to help repair a boat. And third, heterogeneity means that capital goods have no common unit of measurement, which poses a problem if you want to add up how much capital you have:\u00a0 One tractor plus two computers plus three nails doesn\u2019t give you \u201csix units\u201d of capital.<\/p>\n

Isn\u2019t \u201cmoney capital\u201d homogeneous? The monetary equivalent of one\u2019s stock of capital, say $50,000, may be useful for accounting purposes, but that sum isn\u2019t itself a combination of capital goods in a production process. If you want to buy $50,000 worth of capital you don\u2019t go to the store and order \u201cSix units of capital please!\u201d Instead, you buy specific units of capital according to your business plan.<\/p>\n

At first blush it might seem that labor is also heterogeneous. After all, you can\u2019t substitute a chemical engineer for a pediatrician, can you? But in economics we differentiate between pure \u201clabor\u201d from the specific skills and know-how a person possesses. Take those away\u2014what we call \u201chuman capital<\/a>\u201d\u2014and then indeed one unit of labor could substitute for any other. The same goes for other inputs such as land. What prevents an input from substituting for another, other than distance in time and space, is precisely its capital character.<\/p>\n

One more thing. We\u2019re talking about the subjective<\/em> not the objective properties of a capital good. That is, what makes an object a hammer and not something else is the use to which you put it. That means that physical heterogeneity is not the point, but rather heterogeneity in use<\/em>. As Lachmann puts it, “Even in a building which consisted of stones completely alike these stones would have different functions.\u201d Some stones serve as wall elements, others as foundation, etc. By the same token, physically dissimilar capital goods might be substitutes for each other. A chair might sometimes also make a good stepladder.<\/p>\n

But, again, what practical difference does it make whether we treat capital as heterogeneous or homogenous? Here, briefly, are a few consequences.<\/p>\n

Investment Capital and Income Flows<\/strong><\/h4>\n

 <\/p>\n

When economists talk about \u201creturns to capital\u201d they often do so as if income \u201cflows\u201d automatically from an investment in capital goods. As Lachmann says:<\/p>\n

In most of the theories currently in fashion economic progress is apparently regarded as the automatic outcome of capital investment, \u201cautonomous\u201d or otherwise. Perhaps we should not be surprised at this fact: mechanistic theories are bound to produce results that look automatic.<\/p><\/blockquote>\n

But if capital goods are heterogeneous, then whether or not you earn an income from them depends crucially on what kinds of capital goods you buy and exactly how you combine them, and in turn how that combination has to complement the combinations that others have put together. You build an office-cleaning business in the hopes that someone else has built an office to clean.<\/p>\n

There\u2019s nothing automatic about it; error is always a possibility. Which brings up another implication.<\/p>\n

Entrepreneurship<\/strong><\/h4>\n

 <\/p>\n

Lachmann:<\/p>\n

We are living in a world of unexpected change; hence capital combinations, and with them the capital structure, will be ever changing, will be dissolved and re-formed. In this activity we find the real function of the entrepreneur.<\/p><\/blockquote>\n

We don\u2019t invest blindly. We combine capital goods using, among other things, the prices of inputs and outputs that we note from the past and the prices of those things we expect to see in the future. Again, it\u2019s not automatic. It takes entrepreneurship<\/a>,\u00a0including awareness and vision. But in the real world\u2014a world very different from the models of too many economists\u2014unexpected change happens. And when it happens the entrepreneur has to adjust appropriately, otherwise the usefulness of her capital combinations evaporates. But that\u2019s the strength of the market process.<\/p>\n

A progressive economy is not an economy in which no capital is ever lost, but an economy which can afford to lose capital because the productive opportunities revealed by the loss are vigorously exploited.<\/p><\/blockquote>\n

In a dynamic economy, entrepreneurs are able to recombine capital goods to create value faster than it disappears.<\/p>\n

Stimulus Spending<\/strong><\/h4>\n

 <\/p>\n

As the economist Roger Garrison notes<\/a>,\u00a0Keynes\u2019s macroeconomics is based on labor, not capital. And when capital does enter his analysis Keynes regarded it the same way as mainstream economics: as a homogeneous glob.<\/p>\n

Thus modern Keynesians, such as Paul Krugman, want to cure recessions by government \u201cstimulus\u201d spending, without much or any regard to what it is spent on, whether hammers or harbors. (Here\u00a0is just one example<\/a>.)\u00a0 But the solution to a recession is not to indiscriminately increase overall spending. The solution is to enable people to use their local knowledge to invest in capital goods that complement existing capital combinations, within what Lachmann calls the capital structure<\/em>, in a way that will satisfy actual demand. (That is why economist Robert Higgs\u00a0emphasizes<\/a> \u201creal net private business investment\u201d as an important indicator of economic activity.)\u00a0 The government doesn\u2019t know what those combinations are, only local entrepreneurs know, but its spending patterns certainly can and do prevent the right capital structures from emerging.<\/p>\n

Finally, no one can usefully analyze the real world without abstracting from it. It\u2019s a necessary tradeoff. For some purposes smoothing the heterogeneity out of capital may be helpful. Too often though the cost is just too high.<\/p>\n<\/div>\n

Sanford Ikeda is an associate professor of economics at Purchase College, SUNY, and the author of The Dynamics of the Mixed Economy: Toward a Theory of Interventionism<\/em>.<\/strong><\/div>\n
***<\/span><\/div>\n
This article was originally published by The Foundation for Economic Education<\/a>.<\/strong><\/div>\n<\/div>\n","protected":false},"excerpt":{"rendered":"

Sanford Ikeda June 26, 2014 ****************************** When Thomas Piketty\u2019s Capital in the 21st Century\u00a0was released in English earlier this year it sparked vigorous debate on the issue of wealth inequality. Despite the prominence of the word in the title, however, capital has not itself become a hot topic. Apparently none of his defenders have taken the opportunity to explore capital theory, and, with a few exceptions,\u00a0neither have his critics. To prepare to read Mr. Piketty\u2019s book I\u2019ve been studying Ludwig…<\/p>\n

Read More Read More<\/span><\/a><\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[419,7],"tags":[641,655,3052,3049,818,18,1262,1087,3055,3053,3054,2849,1813,2347,1691,3051,648,1004,95,204,890,900,899,1009,3050],"class_list":["post-2610","post","type-post","status-publish","format-standard","hentry","category-business-2","category-economics","tag-austrian-economics","tag-capital","tag-capital-goods","tag-capital-theory","tag-economist","tag-economy","tag-entrepreneur","tag-entrepreneurship","tag-eugen-von-bohm-bawerk","tag-heterogeneity","tag-homogeneity","tag-income","tag-investment","tag-israel-kirzner","tag-john-maynard-keynes","tag-ludwig-lachmann","tag-ludwig-von-mises","tag-paul-krugman","tag-progress","tag-revenue","tag-robert-higgs","tag-sandy-ikeda","tag-sanford-ikeda","tag-stimulus","tag-thomas-piketty"],"_links":{"self":[{"href":"https:\/\/www.rationalargumentator.com\/index\/wp-json\/wp\/v2\/posts\/2610","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.rationalargumentator.com\/index\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.rationalargumentator.com\/index\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.rationalargumentator.com\/index\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/www.rationalargumentator.com\/index\/wp-json\/wp\/v2\/comments?post=2610"}],"version-history":[{"count":3,"href":"https:\/\/www.rationalargumentator.com\/index\/wp-json\/wp\/v2\/posts\/2610\/revisions"}],"predecessor-version":[{"id":2613,"href":"https:\/\/www.rationalargumentator.com\/index\/wp-json\/wp\/v2\/posts\/2610\/revisions\/2613"}],"wp:attachment":[{"href":"https:\/\/www.rationalargumentator.com\/index\/wp-json\/wp\/v2\/media?parent=2610"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.rationalargumentator.com\/index\/wp-json\/wp\/v2\/categories?post=2610"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.rationalargumentator.com\/index\/wp-json\/wp\/v2\/tags?post=2610"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}