Saturday, June 2, 2012

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?

16 comments:

  1. If one accepts that monetary policy can cause "a phoney boom "then it is hard to see how this would not have an affect on the structure of production (in terms of moving it away from the optimal one). Starting with an optimum structure then if the govt artificially lowers interest rates or takes other measure that will increase investment then these investments must be in something and so they must change the structure of production. Logically they will then need to be "liquidated" were the incentives to the higher level of investment taken away and the economy had to return to its previous state. I don't see anything "Austrian" about that. (What the Austrians add is that when the monetary expansion is achieved via lower than equilibrium interest rates then there will be an incentive to invest in areas where interest payments make up a larger share of total costs - that is lnger term investments, but I don't that is key here).


    So: Once the boom ends why must there be a bust ? I think most Austrians believe that if at the point the boom ends the economy could be transformed quickly into an unhampered free-market with totally flexible prices and wages then the bust would be short. Total capacity may be diminished by the :liquidations" but resource utilization would quickly reach "normal" levels. The reasons that busts are longer is because the market is not free - wages and prices tend to be rigid and the govt insists on intervening to protect the areas of mal-investment. The bust become a recession.

    I do not know enough about the post-war period but I would agree that end of the war would seem to have many of the attributes of a bust in terms of the need to rebuild the structure of production. I believe that the reason this did not become a recession is because one of the major reasons for it do so - inflexible wages - was missing. It seems likely that as people moved our of the army and the war industries they simply negotiated a market wage and reentered the labor market. This is very different from the current recessions where the unemployed are simply unable to find employment at above their reservation wage.

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    1. Plus I'm not sure that moving to war industries and having people in combat counts as lengthening the production of structure - there is likely capital consumption taking place so the structure of production is shortening.

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  2. Very interesting observations from Professor Steele and very provocative speculations by you. Thanks.

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  3. I think Steele is right and this correlates with my prior statements. Exactly how and where Keynesian-style policy is going to screw up the economy is an empirical question and the forms of the screw ups are more complicated and multifarious than a “mere” distortion of the capital structure. Probably as important or more important is the tendency of fiat funny money dilution to mess up contractual obligations and the debt structure. These are simply alternative forms of potential malinvestment. It’s not exactly the capital structure per se that makes our current re-setting so painful. It’s that people went into debt to purchase real estate as a hedge against future money dilution. Then the value of housing collapsed, those people still owe the mortgage debt and must pay back the funny money loans with real money while the US bankruptcy code does allow for residential mortgage loan modifications.

    As Steve Keen has noted, after WWII there was not significant unpayable debt overhang. Heck, most of the debts from the depression would have been uncollectable due to the running of the statute of limitations.

    As I’ve also said before, this doesn’t get the Keynesians anywhere since it was their policies of money dilution that induced the malinvestment in the first place. As is always the case.

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    1. "It’s not exactly the capital structure per se that makes our current re-setting so painful."

      LOL!! Bob Roddis the Rothbardian cultist repudiates the ABCT as an explanation of the current crisis.

      "It’s that people went into debt to purchase real estate as a hedge against future money dilution. Then the value of housing collapsed, those people still owe the mortgage debt and must pay back the funny money loans with real money while the US bankruptcy code does allow for residential mortgage loan modifications.

      As Steve Keen has noted, after WWII there was not significant unpayable debt overhang."


      Let me get this straight: you're essentially quoting and approving of a Post Keynesian explanation of business
      cycles?

      "As I’ve also said before, this doesn’t get the Keynesians anywhere since it was their policies of money dilution that induced the malinvestment in the first place.

      Pure garbage.
      Keynesians do not support or advocate economic growth base don asset bubbles.
      They support financial regulation to stop this sort of thing.

      Typical of Austrian buffoons running their mouths off in complete ignorance.

      Keynes himself condemned asset bubbles and asset price speculation:

      "Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise become the bubble on a whirlwind of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done."

      The General Theory of Employment, Interest and Money (2006), p. 142.

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    2. Steve Keen and the Minsky-ites come right up to the truth but can't handle it. The problem is caused by funny money dilution, but you "post-Keynesians" refuse to think it through because that would be the end of Keynes.

      I said what I said. I think I've said it before. The essence of the Austrian school is not the ABCT but "subjective values expressed as objective prices" and how interventionism in all of its forms screws that up. The concept of economic calculation is like Kryptonite to a Keynesian. Deal with it.

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    3. This is the point where your comments are little better than a good laugh.

      Again and again you say you do not have any actual objection or ability to stop the private sector from creating money such as bills of exchange, promissory notes or FR money because it is not fraud or immoral, contrary to ravings of the cult of Rothbard.

      Examples of your comment:

      "If the depositors aren’t misled and the payees aren’t misled, who cares?"

      http://socialdemocracy21stcentury.blogspot.com/2011/10/if-fractional-reserve-banking-is.html?showComment=1317650068819#c5701869836754102910

      "I don’t think free market fractional reserve banking can work. What I have said was that, pursuant to the non-aggression principle, if banks, depositors and payees have a contractual meeting-of-the minds to create such a commercial venture, I would not be in a position to interfere."

      http://socialdemocracy21stcentury.blogspot.com/2012/04/keen-versus-krugman-great-debate.html?showComment=1333719048682#c1115210019499344145

      You are therefore equally logically committed to an endogenous money system ("funny money system") as any Keynesian.

      You are also a walking joke.

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  4. "Funny money" is becoming the "M$" or "Amerikkka" of these discussions.

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  5. I'm now referring to your last sentence: "x is true because I can't come up with another explanation."
    Is a logical fallacy. You cannot assume something without evidence.

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  6. I've never thought of it this way. Good stuff! I am rapidly losing faith in my misesian friends.

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  7. "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?"
    Because those factories could still be used to generate profit. In ABCT, much of what ends up getting made during the malinvestment-boom wouldn't have been profitable without the massive money supply/credit-expansion.

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    1. That argument is an incoherent ad hoc explanation, symptomatic of blind faith.

      No, logically -- if ABCT were true --, the war should have produced massive malinvestment that had to clear.

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  8. "That argument is an incoherent ad hoc explanation, symptomatic of blind faith."
    I don't see why that's the case because you didn't provide an argument. So what was the point of writing that? You're not going to convince anyone by insulting them.
    Also, I'm just telling you what the answer to your question is according to Austrian theory. You seem to be implying with your insult that I'm a supporter of Austrian economics, but I'm not. I'm just trying to get you to understand Austrian theory better. You should take an interest in responding to these comments if you want to be persuasive when criticizing Austrian theory in the future.
    "if ABCT were true --, the war should have produced massive malinvestment that had to clear."
    Why? I already provided an answer to your rhetoric question, "Why was the whole system...", which I believe is consistent with ABCT (not to imply it's true). Do you have an actual response?

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    1. You provided no answer.

      "those factories could still be used to generate profit"

      This cannot be true of all factories. It might have been true of some, or true of some that were *adapted and changed* to produce consumer goods etc.

      But in fact a vast of amount of war production was folded up at the end of the war, and a lot of production curtailed and capital liquidated.

      That requires that there was massive "malinvestment" in the Austrian sense. Yet the system was not affected by a severe slump with rising unemployment as predicted by Austrian theory.

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    2. There was also -- according to Austrian theory -- massive distortion of prices and wages in the wartime inflation and price controls.

      Yet prices and wages did not magically adjust to clear product markets and labour markets after 1945, as required in Austrian theory.

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    3. I see what you're saying. Basically, "there was no recession".
      Ok, *but*, from '41 to '45, consumption of consumer goods declined in the US because of the wartime controls. So there was a lot of potential for production of consumer goods that wasn't being used. So why according to ABCT would there be a recession after the war ended? ABCT basically says that when the 'false-boom' ends, you're gonna have not just too much of some stuff, but also *too little* of other things. But during WW2, Americans willingly sacrificed having a lot of goodies to make room for the new production--they didn't just expand the money supply and lower interest rates without sacrificing them goodies (like in the 2000s).
      During WW2, there was a lot of potential for expansion of consumer goods production. In other words, a lot of factories that made consumer goods switched to military, and, I suppose, that meant most of them could be switched back. And, there were also some retoolable factories that were built during the war. So, between old factories that got switched, and new factories initially made for the military, there were plenty of factories available for a big expansion of production. But in an Austrian-false-boom, like the 2000s, there isn't a decline in consumption of consumer goods to make room for the new production, just money supply/credit/interest rate changes, so people didn't 'make room' for the new production, thereby making the situation unsustainable.
      "Yet prices and wages did not magically adjust to clear product markets and labour markets after 1945, as required in Austrian theory."
      I've no disagreement with you here. Sounds like Say's Law, right? But I was limiting my analysis to ABCT, which, I think, you did in your post as well. I'm not trying to promote Austrian theory here, just note when I think you're making unfair arguments against Austrian theory.

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