Sunday, March 27, 2011

The Economics of Ludwig Lachmann

Ludwig Lachmann is probably most responsible for sustaining my interest in Austrian economics. His writings are powerful, and his thought is very unorthodox. He writes like a true gentleman. One can trace the development of his thinking from (1) trade cycle theory, (2) capital theory, (3) subjectivism and expectations, (4) the history of Austrian economics, and finally (5) the philosophy of hermeneutics.

Most contemporary Austrians study his work by using (3) to understand (5). Now I have to admit that I haven't been very interested in the hermeneutic aspect of Lachmann's work. What I have found most challenging and insightful in Lachmann's work is his discussion of capital theory (2). I think this is an underappreciated aspect of his work, although admittedly a few Austrians make frequent mention of it (for example, Peter Lewin and Steven Horwitz). Lachmann does a lot with capital theory, and I cannot discuss it all here. Some points that stand out:

1.) It is impossible to measure capital because relative prices are incorrect in situations outside equilibrium. From this it follows that it is also impossible to measure a country's GDP or the history of its productivity.

2.) The law of diminishing marginal utility is false for the reason that capital is always being re-shuffled in new complementary ways. BTW, this is probably one of the most powerful criticisms of Keynes' theory of investment in relation to the marginal efficiency of capital (and the assumption of a falling rate of profit in conditions of capital accumulation).

3.) Since capital cannot be measured, then neither can investment. This is a point that is generally overlooked by Austrians, and Lachmann said as much in an article entitled "Reflections on Hayekian Capital Theory." In support of this view, Lachmann quotes Hayek saying:

"if we cannot determine the size of either saving or investment by any reference to changes in the quantity of capital, then with the abandonment of this basis for the distinction there must go the economists' habitual practice of separating out the part of general investment activity which happens to leave the capital stock in some sense constant, as something different from activities which add to that stock."

But if investment cannot be measured, can malinvestment be? And if not, what then becomes of the Austrian theory of the business cycle? The many critical remarks by Professor Lachmann of this theory boils down essentially to this point. Capital heterogeneity precludes talk of capital measurement in terms of either investment or malinvestment.

What have others made of Lachmann's work on capital theory?

Also, to Rober Vienneau: Does Lachmann's theory have anything to say of the Cambridge (UK) theory of capital? Lachmann mentions this literature several times in his work, but only briefly and in passing. Here is an example:

"Everybody seems to agree today that the stock of capital cannot be measured outside equilibrium, viz. outside entirely artificial conditions. But there are two reasons for it of which we may call one the 'Ricardian' or 'objectivist', the other the 'Austrian' or 'subjectivist' reason. We may also say that the one is backward looking, the other forward looking. The former rests on the fact that any change in the mode of income distribution, in rate of profit or wage rate, will affect relative prices and thus deprive us of any solid yardstick. It is particularly germane to any view of capital which links the present value of capital resources to their current cost of reproduction, a 'backward looking' view."

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