Commentary on Political Economy

Friday 30 September 2011

THE STATE OF EQUILIBRIUM: Historical Antecedents of ‘Supply-Side Economics’ in the Austrian School – Prices, Production, State Policy – Part 4

If “prices” are the empirical, “visible” manifestation of the exchange of the “utility” of goods at the margin, if as Bohm-Bawerk and the Austrian School insisted it is purely a “metaphysical” exercise to linger on the “value” that goes into the “pro-duction” of exchange values – it follows necessarily (though tautologously) that “market prices” are the only “reality” that counts, the only effective social “validation” of the “social synthesis”, the “co-ordination of production and consumption”, the “equivalence” of the different individual plans of market participants. The market’s “price mechanism” is scientifically “true” because it is “valid” – because it “works”, because “it tends toward equilibrium”.
The Austrian School’s approach removes completely the need to inquire into the essence, “stuff”, the “substratum” or quidditas, the “inputs” that lie beneath or behind or inside “prices”. In the “new classical” theory, prices merely reflect a “subjective” entity, one just as “metaphysical” as the “labour value” of Classical Political Economy, but a “metaphysics” that can now finally throw away this inscrutable “teleological/conative” entity and concentrate on the “effectiveness” of the “price mechanism” in achieving “equilibrium”.
But if “production” of goods is now an “inscrutable black box”, a lucus a non lucendo, then how can the “empirical existence” of interest and profit as the most “visible” attributes of “capital” – how can these be explained, accounted for, in a manner that does not include “production”? Quite obviously, not by physical or material “inputs” as in the “labour theory of value”, but by “negative” means, by the “renunciation” (Entsagung) or “delay” of present consumption. “Interest” is the “price” paid by the users of capital to compensate its owners for “waiting”, for delaying its consumption so that it can be used “to produce” goods for immediate consumption. In Bohm-Bawerk’s version, interest derives from the fact that “more roundabout” methods of production (methods that “delay” consumption) are more “productive” than “less roundabout” methods (see his deceptively-named ‘Positive Theory of Capital’).
(On the “negative” scientific approach, cf. Mach, ‘Con.etErr.’, ch1. On the equivalent of “roundaboutness” in sc.meth. see p.368, ch. on ‘Sens et Valeur des Lois Scntfq.’!)
(Schumpeter proffers an analogous version: “Interest is a premium on present over future means of payment, or, as we will say a potiori, balances. Interest is the price paid by borrowers for a social permit to acquire commodities and services without having previously fulfilled the condition which in the institutional pattern of capitalism is normally set on the issue of such a social permit, i.e., without having previously contributed other commodities and services to the social stream,” (Business Cycles, p.124)).
If indeed the “market price mechanism” has an irresistible tendency to move toward “equilibrium” because it is the best mechanism available to ensure that individual plans (utilities) are satisfied by the exchange of goods, it follows that no “collective” social institution (no government, let alone something like Rousseau’s “volonte’ generale”) can be allowed to interfere with it. Even government economic policies aimed at maintaining broad economic “aggregates” such as employment or the price level or the money supply, would not “balance” the economy because of the “differential” impact of such policies on the demand schedules of consumers and producers. Given the “positive theory of capital” outlined by Bohm-Bawerk, any economic stimulus that was not “neutral” in terms of the demand schedules of independent individuals would necessarily and detrimentally affect market “equilibrium”. As Hayek put it in ‘Prices and Production’: "It would be easy to demonstrate by the same type of analysis which I have used in the last two lectures that certain kinds of State action, by causing a shift in demand from producers' goods to consumers' goods, may cause a continued shrinking of the capitalist structure of production, and therefore prolonged stagnation. This may be true of increased public expenditure in general or of particular forms of taxation or particular forms of public expenditure. In such cases, of course, no tampering with the monetary system can help. Only a radical revision of public policy can provide the remedy."
The “kinds of State action” Hayek has in mind include all except “neutral” forms of monetary policy. Hayek takes pains to show that monetary policies aimed at avoiding deflation by maintaining “aggregate demand”, in particular, will shift demand toward consumption goods, lowering real interest rates as “more roundabout” production methods become less profitable and resulting ultimately in a spiral of higher prices for consumer goods as well as unemployment. In an oft-quoted passage, Hayek illustrates starkly the effects of Keynesian-style “redistributive” economic policies:
"It seems something of a paradox….But the fact is that when the growing demand for finished consumers' goods has taken away part of the non-specific producers' goods required,
those remaining are no longer sufficient for the long processes, and the particular kinds of specific goods required for the processes which would just be long enough to employ the total quantity of those nonspecific producers' goods do *not yet exist. The situation would be similar to that of a people of an isolated island, if, after having partially constructed an enormous machine which was to provide them with all necessities, they found out that they had exhausted all their savings and available free capital before the new machine could turn out its product.
They would then have no choice but to abandon temporarily the work on the new process and to
devote all their labour to producing their daily food without any capital. Only after they had put themselves in a position in which new supplies of food were available could they proceed to attempt to get the new machinery into operation.1 In the actual world, however, where the accumulation of capital has permitted a growth of population far beyond the number
which could find employment without capital, as a general rule the single workman will not be able to produce enough for a living without the help of capital and he may, therefore, temporarily become
unemployable. And the same will apply to all goods and services whose use requires the co-operation of other goods and services which, after a change in the structure of production of this kind, may not be available in the necessary quantity," (ibidem, p.94).
 That is why “a revision of public policy” is called for – and this means necessarily a reduction of taxation burdens on “producers”. Here, in a nutshell, are the foundations of “supply-side economics”.
(See O’Driscoll’s “Economics as Co-Ordination Problem” at ‘Ricardo Effect’ ff for a discussion of Hayek’s ‘Prices and Production’ and ‘The Pure Theory of Capital’.) http://www.econlib.org/library/NPDBooks/ODriscoll/odrCP.html

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