An Overview and Critique
Recently, discussion with a few other Austrians on capital theoretic paradoxes have made me aware of Robert P. Murphy’s old article on reswitching, attempting to evaluate the effect of reswitching on Austrian “capital theory”; the crown jewel of Austrian Economics. Austrian capital theory undergirds the (in)famous “Austrian Business Cycle Theory”; a theory of the business cycle which derives the causal factor within industrial fluctuations to be injections of money into the economy which “distort the structure of production” in the economy. Presuming constant intertemporal preferences, the “structure of production” gets “over-roundabout” caused by the Ricardo effect and a lower market rate of interest. What results is a consequent necessity to liquidate “over-roundabout” projects, i.e., the recession phase within industrial fluctuations. The entire argument rests upon the “Ricardo effect” and the distorted structure of production, i.e., if one were to demonstrate the logical invalidity of equivocating a lower rate of interest or an increased gross amount of money in the economy with higher capital intensity, what would result is causal indeterminacy or a possibility of complete invalidity of the Austrian theory of the business cycle. Murphy, taking up the challenge of dealing with such an intricate capital paradox, attempts to demonstrate the invalidity of applying reswitching as a critique of the Austrian theory of industrial fluctuations. Unfortunately, Murphy seems to be quite unaware of the literature outside of Samuelson’s 1966 singular article “A Summing Up”.
“The so-called neo-Ricardians, on the other hand, insisted that interest was not determined by supply and demand, but rather by the technological conditions of production and by the distribution of income. In particular, the neo-Ricardians challenged the implicit neoclassical apology for interest payments as a factor return no different from the wages received by productive laborers. The neo-Ricardians believed, in contrast to this view, that the flow of interest to capitalists served no social purpose whatsoever, and constituted exploitation of the working class.”
A recurring theme within this article is supposing that the rate of interest’s determinant is the sole problem at hand, i.e., the Cambridge critique solely supposes that the entire problem is with the productivity determinants of the rate of interest. This misses the fact that the approach also applies to determination of the rate of profits and consequently wages. The reswitching critique in my opinion served an important function of demonstrating the logical invalidity of the marginal productivity, or better termed partial derivative, approach to distribution. Most economics textbooks and even the Austrians1 believe that the marginal productivity of labor and of capital determines the rate of profit and wages, a standard example in economics textbooks following the standard notation:
The standard production function:
P = P(L, K)
Then:
∂P/∂L
Represents the rate at which the production process transforms with regards to “units” of labor added. The marginal production with regards to labor is called the marginal product of labor, and wages, wp, equal to the marginal product of labor. More cleanly:
Wp = ∂P/∂L
What this means for economic theory, is that in a capitalist economic system wages are not determined by the classical surplus-subsistence approach to wages, rather, through the manner of which labor contributes to the production process. The more a worker contributes to the production process, w, the higher Wp would be. In this manner, marginalists assert that wages are not determined unfairly, wages are perfectly fair and distributed symmetrically across the economy and the economy is fundamentally harmonious, in contrast to the Marxist-Classical approach to distribution which is inherently conflict ridden. If one were to prove that the return to capital was not to be symmetrical, i.e., MPK was not equal to the rate of profits, it stands to reason that wages were also not determined by MPL and consequently asymmetrically. This concept is still adopted by Austrians as pointed out above, which means that even supposing it did not pose a problem for the Austrian theory of industrial fluctuations it essentially demonstrated the logical invalidity of equivocating MPL with Wp.
Another problematic point with Murphy’s claim is attempting to make the Cambridge economists equivalent to Marxians. It is true, that the invalidation of the marginal productivity approach to distribution does provide a new avenue to the Marxian approach to distribution based off of surplus value, but Piero Sraffa nor Luigi Pasinetti, the major critics of the marginalist approach to distribution based off of reswitching of production techniques, were Marxians. Sraffa was quite critical of the Marxist approach to value and exploitation2; to equivocate a somehow Marxist angle to Sraffa is ignorant. Sraffians do not find there to be no social purpose to the delivery of interest and rates of profit, as accumulation is an important part of the capitalist economy in most analysis’ by Sraffians and Non-Sraffian Post-Keynesians such as Joan Robinson, who has an entire book on it!3
“For Mises's pure time preference theory…capital productivity is neither a necessary nor a sufficient cause for interest. Interest is seen not as the value of any additional product but as expressing the difference between the valuations of a given prospective receipt by a consumer, made at different earlier dates. So Mises's theory of interest cannot possibly incur Cantabrigian wrath on account of its identifying interest with additionally produced product. (Kirzner p. 6)”
Murphy attempts to claim, citing Kirzner, that there are no possible implications for the Austrian approach if the determinants of the rate of interest is independent of marginal productivity, i.e., if it is dependent on “time preference” rather than productivity, the Austrian theory up to this point comes out unscathed. However, as pointed out already, that the Austrians use MPL to determine the level of wages in the economy, along with MPK to determine the return on capital in the economy. There is a distinction to be made between rate of interest and rate of profit, which are two distinct things that Murphy seems to be equivocating as the main cause of the critique. It’s utterly nonsensical to claim that the Austrian approach to distribution, better titled marginalist theory of distribution for being practically indistinguishable from the New-Classical/New-Keynesian approach to distribution, comes out unscathed due to misidentifying the two phenomenon of interest and the rate of profit as the intended point of contention with the demonstration of reswitching.
“Thus, to the extent that the neoclassical defense of interest (against charges of exploitation) may rest on a faulty theory of interest, it is up to Austrians to provide a more accurate scientific description on which one may base a moral argument.”
The general Austrian argument for time preference determining the rate of interest is by the loanable funds market. However, as has been pointed out by multiple Post-Keynesians, the loanable funds model is completely off-base and institutionally backward for a real economy based on credit and the existence of uncertainty and liquidity preference. There does not need to be any equality between savings and investment and savings does not consist of deferred consumption. To claim this is somehow “scientific” when it is in fact institutionally backward is quite amusing.
Skipping through the explanation of reswitching which seems relatively accurate, aside from the non-existence of a wage-profit curve to demonstrate graphically the phenomena of reswitching and “switch-points”, using Kurz & Salvadori (1995)’s diagram:
More easily demonstrated, the phenomena of reswitching in this example occurs within a continuum of two techniques, i.e., technique α and technique β. Technique α, being less capital intensive, is adopted at a higher rate of interest. At the intersection of Ra and Wa, what forms is a “switchpoint”, i.e., where a new production technique is adopted at a certain profit or interest rate. Technique α is re-adopted at the intersection of rb and wb, i.e., a more labor intensive process which is more profitable is readopted with a lower quantity of capital. The immediate implications for the marginalist analysis of distribution was that the quantity of capital did not determine the rate of profit, i.e., the rate of profit could be higher at a more labor intensive and less capital intensive technique, e.g., technique α. The implications for the Austrian theory, outside of distribution and determinants of the wage and profit rate, will be explored in the following section.
“But does this mean that the conclusions of Austrian capital and interest theory are incorrect? Not at all! What Samuelson has done is simply invent a fictitious world in which there are only two ways of producing a particular good. And yes, in such a world, as Samuelson gleefully points out, "It is no longer literally true to say, 'Society moves from high interest rates to low by sacrificing current consumption goods in return for more consumption later…'"
Murphy in this situation mistakes the existence of reswitching within Samuelson’s model with that being the only possible manner of which reswitching exists. This is however false, reswitching is perfectly possible with an infinite or finite amount of techniques lying along a factor price frontier, the only reason most “Sraffian” or “Neo-Ricardian” authors adopt a relatively simplistic analysis of two production techniques α and β to explain quite succinctly the existence of higher profit rates but a lower quantity of capital, i.e., the rate of profit is not determined by the quantity of capital and its marginal product, MPK. Murphy is quite off-point here, most likely due to his unfamiliarity with the Sraffian literature before making such a ridiculous comment on the possibility/validity of reswitching.
“More generally, the basic Austrian vision of the effects of saving can be summed up like so: If individuals are willing to sacrifice consumption goods (on the margin) now, this allows the creation of more tools, machines, factories, etc. than would have existed otherwise. This in turn renders labor more productive, so that after the new capital goods are produced and have been integrated into the economy, average output (and hence consumption) is higher than it would have been without the increased saving. Böhm-Bawerk felt that this story was accurate, because at any given time there are more technically efficient but very time-consuming processes "on the shelf" that are unprofitable at the market rate of interest, but would become profitable at lower rates.”
Murphy does not discuss reswitching’s implications for the ABCT, i.e., no correlation of higher capital intensity with lower rates of interest, but does bring up a very outdated explanation of saving and its relation to technical progress in the economy. However this situation is clearly institutional backward, as most Austrian monetary analysis’ of growth are. What funds new production ventures is credit, and the lending of credit is not reserve constrained. Unlike the standard money multiplier story of the economy that even the heterodox Austrians adopt, bank lending is constrained by demand for credit and risk averse-ness, not the amount of savings in the economy. An increased amount of saving is not correlated with an increased amount of loans, the amount of credit in the economy is not supply-side constrained but rather demand-side constrained. What does spur increased investments is the prospects of increased employment and economic growth, i.e., expectational variables, which can be influenced by fiscal policy. The Austrian story originally posited by Böhm-Bawerk is simply institutionally outdated, it was only relevant for a commodity based or fiat money economy, not a modern credit economy. It’s illogical to claim that this analysis holds in the case of a completely different institutional setting of “money”.
“In other words, after demonstrating the logical possibility of a world in which Böhm-Bawerk et al. are wrong, Samuelson admits that when it comes to the real world, his own suspicion is that these writers are exactly correct.”
What Murphy seems to be doing is taking the easy way out, done by both vulgar Neo-Classical economists and Austrians seemingly, to minimize the importance of reswitching. Pointing to the empirical impossibility of reswitching, or at least near-impossibility, Murphy attempts to minimize the relevance of reswitching, in a similar manner to that of Ferguson (1969)4.The unfortunate problem with this argument is methodological, it doesn’t matter if reswitching exists 3.5% of the time or 85% of the time, the demonstration of the existence of such a paradox serves to invalidate the argument that it’s possible to correlate the amount of capital to the rate of profit, how empirically frequent it is, is not a consideration Sraffians are concerned with. Reverse capital deepening is another capital paradox which demonstrates the erroneous nature of equivocating an inverse monotonic relationship between the rate of interest and the amount of capital employed, when in fact there is a paradox in which capital is directly correlated to the rate of interest employed, i.e., assuming a continuum of techniques starting from technique γ to δ ranked from least capital intensive to most capital intensive, a rise in the interest rate means that the capital employed also rises, e.g., a rise of 5% in the rate of interest has a direct non-inverse relationship with the capital employed and a consequent “traveling” of the techniques of production along the continuum of techniques which become increasingly capital intensive. Of course in the real world, ranking techniques according to capital intensity is illogical especially considering reswitching, but it is a consideration to help the mind conceive of such a phenomena better theoretically.
The empirical approach and the theoretical approach employed by Robert P. Murphy's attempts to invalidate (validate) the use (disuse) of reswitching in Austrian models to avoid causal indeterminacy are both invalid and shockingly ignorant of the condition of current Sraffian theorizing. Murphy does also make unfounded comments on the ethical nature of reswitching and Sraffian distribution models, attempting to paint it in a socialistic light. It is possible for Sraffians to be “socialist”; but nothing in the invalidation of the partial derivative approach or roundabout approach to distribution implies that Sraffians must be socialists, it’s merely a route to be taken from the invalidation. It’s possible to take other routes too, one need not be confined to a singular path of distribution. To claim that somehow Sraffians are “socialists” from there is nonsensical. Reswitching provides economists with an ability to return to more valuable theories of distribution and growth, i.e., the classical surplus approach to political economy. The objections raised by Robert Murphy are unconvincing and at times blatantly false.
Also, check this: https://menghublog.wordpress.com/2013/05/27/austrian-business-cycle-theory-on-the-interest-rate-and-the-cambridge-capital-controversy.
ReplyDeleteFrom a surface level glance I can generally see that his entire argument follows Yeager's/De Soto's argument based off of time preference which tells us literally nothing as Machaj points out. I might review it on this blog.
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