I’m trying to wrap up my first semester of teaching intermediate macro. After surveying all of the major schools of thought I’m concluding with discussions about spontaneous order and some Austrian business cycle theory.
One of my students has brought up, what I have come to realize is a brilliant question:
What if the knowledge benefits of a new technology produced during the boom outweigh the physical capital losses of the bust?
If they do then new money is less disruptive to the economy when it is spent on R & D development. But the question could be a moot point if empirically R & D is not responsive to changes in interest rates. I would assume that this data is easily available, but if anyone knows specifically where I could track it down or knows of anyone writing on similar topics I’d appreciate a note.
PS–Hat tip to Adam Martin for the helpful discussion.
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Morning! That’s my first comment here.
The student’s question is interesting, but I can’t help you on the R&D data. Anyway, I think that I may or may not agree with the idea that R&D investments are less dangerous depending on the argument behind the conjecture.
If the argument is: “R&D investments are not fixed, as soon as they don’t use large labs and facilities, so that huge investments in R&D do not cause liquidation and sudden unemployment at the onset of the bust” I agree that there may be a case to consider R&D less dangerous.
If the argument is “R&D fuels productivity, productivity reduces prices and boosts production, and the boom becomes more sustainable”, I’d guess that miscoordination and malinvestment could last longer, but this would hardly be an advantage.
In other words, I don’t believe that booms actually increase (counterfactually) production, because each boom is accompanied by an increase in consumption, and investments can rise as soon as this trade-off is hidden by chinese workers and technological progress, but unless we consider these two factors endogenous with monetary expansion, there is no reason to believe that inflation boosts growth. If consumption really increases (if there is no monetary illusion by part of workers, and if there is no irrationally idle capacity waiting for some piece of paper with the face of Washington to be employed), than funds available for investment shall decrease. Technological improvements and chines workers can only make this fact less evident, as far as the trick works.
The problem I have with the argument is that I don’t believe the boom causes capital losses at a physical level, but at a coordination level, and busts will be more or less severe depending on how many plants have to be liquidated (due to their specificity and duration).
I hope that my arguments are clear, and if they are also correct still better. 😀
Congratulations for the interesting blog and good luck for your studies. Bye!
LF,
I’ve considered the counterfactual concern you bring up and tend to agree with it. I think it is reasonable to criticize the labeling of the boom period as a boom. We don’t know how much we could have been producing had we not been investing in production lines that were inevitably going to fail. In other words, it could be that we are impoverishing ourselves even in the boom.
I consider the student’s question as a follow up to this point. If we are going to level a counter factual critique against the ABCT we need to recognize that multiple counter factual scenarios exist. In other words, we might not recognize how big of a boom, the boom really is. Maybe without it we never would have had the chance to get some of the technologies and new understandings that we got.
Now like I said I’m inclined to agree with you because if I had to choose between the state and the market making R and D investments I would always choose the market because of Public Choice and rent seeking concerns. But the debate between the two counter factual positions has to be an empirical one otherwise it is just our beliefs and opinions.
Both because the topic is theoretically interesting per se, and because I can draw methodological conclusions from the growth example, I try an answer, even thoug I agree with you. There is enough philosophy in this comment to bother anyone, anyway…
Resources for higher growth shall be taken somewhere. I can see only these possibilities:
1. Laborers may be willing to work more
In this case, inflation increases growth but reduces leisure value, and I wouldn’t consider it an improvement because otherwise I would have worked more anyway. RBCists and monetarists may agree with me.
2. Real resources which would have been unemployed without inflation are put to work
Two cases can occur. If these resources are really submarginal, it is suboptimal to employ them (I recently wrote a short article about it on the Austrian Forum); if there is some reason (sticky prices, animal spirits…) for these resources not to be employed, despite the suboptimality of their idleness, and if inflation helps reducing this irrational idleness, then there is a case to believe that inflation can boost growth.
3. Consumption is decreased during the boom
I think this goes against all available evidence.
4. Investments funds are obtained by capital consumption
In this case, the growth boost is illusory, unless one argues that consuming capital is good because capital accounting is too risk-averse and conservative, or for other reasons. I believe that if new technologies may be obtained by some additional investment, if they are a capital improvement, and if they don’t need to curtail consumption (a clear case of free lunch), then it is necessary to show where the capital accounting has failed, which is somewhat a rearranging of point 2, with animal spirits waiting a gnosis from Bernanke.
I agree that these four options are counterfactual, and in order to have a theory that can be applied there should be some way to recognize their occurrence. I consider this defect inherent in the nature of economics, and not a problem with Austrian Economics per se. In order to judge whether a capital good is submarginal or irrationally idle I should be some sort of an omniscient social planner.
If I’m not, and no one is, then the judgement of whether we live in a world of one type or another (historical judgment) cannot be based solely on my previous apriori reasoning. But we don’t have much alternatives…
I’d guess that the solution which the mainstream prefers is to reduce the scope of theorizing so that it is possible to employ the empirical method as a testbench of relevance. But I don’t think it is a good thing to reduce the scope of scientific inquiry by apriori (metaphysical) discarding possible explanations because of methodological problems that are embedded in the nature of the object of inquiry itself.
Unfortunately, by taking the previous reasoning too literally, Austrians have probably lost time that could have been employed in increasing our capability of “operationalizing” theory in order to obtain better practical judgements.
I probably reconstructed the whole rationale of the misesian history/theory dicotomy, and recognized its limits (what I need in real life are historical answers, not aprioris!). But these limits cannot be overcome (even though they can be reduced by inquiries on the historical method, which we may call econometrics, but it would be a partial description of what’s needed).
I know that there is a limit with my argument: I say that the nature of economics is X and criticize others because they claim it is non-X, but I have no apriori reasons to say that it is really X because of the nature of X itself. It is an instance of the Church theorem: there are statements that can neither be proven right nor wrong. Unfortunately, it is not an irrelevant quibbling…
Sorry for the length: I always inflict lenghty arguments when I understand something new but I still haven’t it enough clear to state it briefly.
It is interesting that your student would ask this, because Hayek at one point seems to support the idea of R&D as possibly outweighing the physical damage done.
“And even if it is a mistake- as the recurrence of the crises would demonstrate – to suppose that we can, in this way, overcome all obstacles standing in the way of progress, it is at least conceivable that the non-economic factors of progress, such as technical and commercial knowledge, are thereby benefited in a way which we should be reluctant to forego” (Monetary Theory and the Trade Cycle 190-191).
Hayek goes on so state that there would be an increase in R&D (in his usual language of knowledge and new combinations) in a cyclic economy. Unfortunately, I do not think he is adequately taking into consideration periods of bust, when there would possibly be a large decrease in R&D, not to mention the adverse mental effects on entrepreneur-promoters aways being worried about the next downturn and how long it may last.