Why Isn’t the Boom of 1946-1948 a Problem for Austrians?

The Austrians charge that the US boom of 1946 to 1948 is a problem for Keynesian economics; it is, of course, no such thing, as I have shown here and here.

But a commentator on Robert Murphy’s blog called “Lwaaks” made an insightful remark on why the boom might be a problem for Austrians, by quoting one David Ramsay Steele, which I reproduce here:

“Here is the full context. His comment appeared on the Libertarian Alliance discussion group (Yahoo Groups):

[David Ramsay Steele]: I haven’t given much attention to these issues for the past 20 years, no doubt mainly because I am no longer in frequent contact with anyone who wants to argue for the Austrian position.

As to ‘rating the Austrians,’ some Austrians had good things to say: Boehm-Bawerk’s criticism of Marx, and so forth. There are really two kinds of Austrians today: Misesians and people like Hayek who reject Misesian apriorism. I have a brief section on Misesian apriorism in FMTM [From Marx to Mises: Post-Capitalist Society and the Challenge of Economic Calculation, 1992] explaining why it won’t work and Hayek, for instance, would agree completely with what I say there.

As to the trade cycle, I long ago rejected the Austrian theory in both its Misesian and Hayekian forms. In 1977-1980 I was greatly preoccupied with this, and talked a lot with people like Jeff Hummel, who had been reared, so to speak, on the Misesian theory (as a typical born-again Rothbardian of that day) and was questioning it.

I actually had more or less rejected the theory before I read ‘The Hayek Story’. Rantala read ‘The Hayek Story’, discussed it with LSE faculty, came to agree with it, and convinced me it was correct.

The distinctive thing about Austrian trade cycle theory is its view of ‘real’ factors in the onset of the slump. Of course, much of what Mises and Hayek say overlaps with the ‘purely monetary’ theories of people like Milton Friedman, and long before that, of people like Hawtrey. So there is no dispute that inflation of credit may create a phoney boom, followed by an uncomfortable period of adjustment. What is distinctive about the Austrian theory is that it says the specific physical form of the capital which is malinvested plays a crucial role in the onset of the slump. So, for example, if lengthening the production structure requires a particular type of big, expensive machine that has no use with a shorter production structure, then that machine will have to be written off as a loss, since it is not suitable to the ‘return to reality’ when the boom is over.

What struck me very early about this (I think it crossed my mind when I read Rothbard’s book on the 1930s depression, around 1971) was that it’s an empirical claim, and at a quick glance, such physical incongruities don’t seem to loom all that large. So, if the production structure lengthens, you change the shape of investment into something more appropriate to a lower time-preference. Fair enough. But what does this really mean? Let’s say you have a factory. You start to use different types of machine tools, let’s say. Still, most of your factors will be just the same, or almost the same, as before: electricity, computers (or in the old days, office stationery), unskilled workers, workers with various types of skill such as accountants, engineers, salespeople, and managers, your factory building itself, your use of trucks to get materials into the factory and products out, and so on. In other words, the overwhelming majority of the factors you employ are not specific to higher or lower orders of production. It’s true that their application to specific tasks will shift a bit, but this goes on all the time, and is an inexact science at best.

Since the claim that physical incongruities are crucial is an empirical claim, I was then struck by the experience of the US at the end of World War II. If ever there was a case of an abrupt, almost overnight, mismatch between prior allocations of capital and today’s applications, we could hardly imagine a more spectacular example. Millions of people left the army and found civilian work. Hundreds of thousands of factories which had been producing military goods had to transform their operations into civilian production. Why was the whole system not seized by a violent slump?

To the purely monetary approach, this is simple and obvious. There was no violent contraction of the money supply, so there was no slump. But to the Austrians, what explanation could there possibly be? Their claim is that once the boom has got going it cannot be ended without a slump, and that this is so because of the need to suddenly re-allocate physical assets to completely new uses. But that re-allocation was obviously thousands of times greater in 1945 than it could ever be as the result of a few years of bank credit expansion, and yet there was no slump! The whole system adapted to the utterly changed conditions with amazing ease and smoothness.

This was what I thought before 1980, and I still think it today.

‘The Hayek Story’ was a revelation because it raised a different issue. Consumers are continually asserting their time preference by their buying every day. So there is no ‘lag’. Credit expansion cannot really change the allocation of capital in the higher order direction required by the Austrian theory, because consumers keep going into the stores and buying just as many groceries as they were before.

I actually had had a glimmering of something like this earlier. As I read Rothbard and Mises, I thought ‘How can the boom go on for so long? Why isn’t it all over within a few months?’

The Hayekian response to ‘The Hayek Story’ is in terms of Hayek’s metaphor of the pile of honey. This has always struck me as quite feeble. The ‘purely monetary’ theorists don’t dispute, they have always insisted, that inflation causes misallocation of capital. What they do deny is that this misallocation takes the form of an unsustainable lengthening of the production structure. And this bold vision of the Austrians is, I think, incorrect. Purely monetary disturbances are enough to account for the government’s role in creating slumps (though the government makes matters worse by other measures, for example trying to stop wages from falling at the end of a boom, which is precisely what ought to happen to get the slump over with quickly).

Actually, I now see a parallel between the Austrian trade cycle theory and other notions which used to be popular among libertarians. What a lot of these different notions share is the premiss that the spontaneous market order is a frail bloom that can easily be killed. So libertarians fifty years ago used to talk as if a welfare state or a lot of regulation would quickly take us to the Soviet system and thus the end of civilization.

The truth is that the market is amazingly resilient and capable of amazing adaptations, and this keeps growing all the time with higher real incomes and faster and more accurate communications. What this resilience means is that the market can take a lot of punishment and still function surprisingly well. And what that means is that a heavily regulated welfare capitalism is a lot less unstable than we used to suppose. Of course, deregulating would lead to greater efficiency and benefit everyone, and various crises will crop up now and then, like the crisis of the NHS in Britain and the crisis of ‘social security’ (old age pensions) in the US, but a continual heavy burden of regulation and unfortunate sabotage by government is compatible, as a simple matter of fact, with indefinitely rising real incomes for everyone. Or if you want to translate this into Randian terms, Atlas never gets round to shrugging because Atlas is doing okay, and both Atlas and the looters can keep on improving their situation indefinitely. Atlas doesn’t notice the burden because his muscles are fully up to it, and they improve their tone with every passing year, despite the increasing absolute weight of the looters.”
http://consultingbyrpm.com/blog/2012/05/federal-government-outlays-and-receipts-as-of-nominal-gdp.html#comment-39021

Some quick points:

(1) The author of this comment makes reference to a book by David Ramsay Steele called From Marx to Mises: Post-Capitalist Society and the Challenge of Economic Calculation (Open Court, La Salle, Ill. 1992), which bears further scrutiny. I am also not quite sure what “The Hayek Story” refers to (a book, article, or seminar paper?).

(2) It is not correct to say there was no slump in 1946. A contraction of real output did occur, as the wartime command economy ended:

Year | GDP* | Growth Rate
1941 | $1,366,100 | 17.07%
1942 | $1,618,200 | 18.45%
1943 | $1,883,100 | 16.37%
1944 | $2,035,200 | 8.07%
1945 | $2,012,400 | -1.12%
1946 | $1,792,200 | -10.9%
1947 | $1,776,100 | -0.89%
1948 | $1,854,200 | 4.39%
1949 | $1,844,700 | -0.51%
1950 | $2,006,000 | 8.74%
* Millions of 2005 dollars
http://www.measuringworth.com/datasets/usgdp/result.php

But the point that the private sector was expanding in other areas at the same time is well taken: this period was one of massive capital conversion and liquidation, and yet unemployment did not become a problem and the normal private economy producing consumer goods expanded rapidly.

Jonathan Finegold Catalán attempts a response to this question in a way that I do not find convincing:

Jonathan Finegold Catalán, “WWII and Intertemporal Discoordination,” Economic Thought, 1 June, 2012.

It is not possible to deny that WWII, from a free market perspective, imposed pricing chaos on commodities in America. And the US still had price controls on many goods until late 1946, when a huge surge in private sector investment and employment was in progress.

From the Austrian perspective, there must have been “artificial lengthening” of the structure of production processes during the war, and ongoing capital projects in 1945 that were abandoned when the war ended. Also, there was a large contraction of real output or liquidation of capital goods, but the private sector managed to absorb the huge increases in the labour force and increase private investment.

If the Austrians really deny that there was no significant “artificial lengthening” of the structure of production during WWII, are they saying that Keynesian demand management (by demand contraction through tax hikes, bond issues, rationing and the command economy) was so good that it avoided such problems? If not, then what was the reason?