Monday, September 8, 2014

"Capital and its Structure" is being translated into Chinese - My preface and introduction.

It is an honor to be able to write this upon the occasion of the translation into Chinese of Ludwig M. Lachmann’s Capital and its Structure. Ludwig Lachmann was my teacher, the one who introduced me to Austrian Economics, and the inspiration for my work as an economist. Professor Lachmann was a dedicated teacher and an honorable man. And though his academic contributions are, relatively speaking, not very large, he was a scholar of profound insight and prodigious learning. His personal network of scholars from around the world was impressive. 
Lachmann came to capital theory when as a student at the London School of Economics he was able to work with Friedrich Hayek. Hayek himself was actively working on capital theory in order to bring to English speaking readers an appreciation of the Austrian Theory of Capital, which he felt was necessary for an understanding of the shortcomings of the provocative work of John Maynard Keynes. It was from Hayek that Lachmann derived the inspiration for his own capital theory, which took Hayek’s work in a different direction. During the 1930’s and 1940’s, Lachmann published many articles on capital theory and this book is the unification of that work in its most mature form.
Perhaps most notable about Lachmann’s vision is the centrality of expectations. He agreed with Keynes that expectations were important but felt strongly that Keynes had neglected to account for the them sufficiently, particularly in regards to the theory of investment. Keynes and all other theorists tended to gloss over the heterogeneous nature of capital goods and to treat capital as a homogeneous stock rather than a structure of complimentary items, some more substitutable than others. It was primarily around this insight that he built his capital theory.
By the time this book was first published in 1956, the Keynesian revolution was triumphant and interest in capital theory had faded. Lachmann had left England for South Africa. Its early reception was, therefore, disappointing. It was mostly ignored. By the time of the publication of the second edition in 1978 however, the Austrian School’s star was rising again. Hayek had been awarded the Nobel prize in economics and work in Austrian economics was increasing. Since then it has gained momentum until today and is now a vibrant research program across the world. This book is now regarded as a classic within that program.
Ludwig Lachmann would be very pleased to know that a new audience of readers will now be able to read his work. I am equally pleased.

Dallas, TX

September 2014.

Though he could, with justification. be described as an ‘Austrian Economist,’ Ludwig Lachmann was born and educated in Germany, not in Austria. He became acquainted with and enamored of Austrian economics as a young student in his twenties, discovering the work of Ludwig von Mises. (He met Mises for the first time in 1932.) He spent his long professional life working within and fighting to promote and understanding and appreciation of the ‘Austrian School’ (Mittermaier 1992 ; also Grinder 1977b).
In 1933, after his early education, he left Germany (with his future wife Margot) for England. He thus evaded the rise of the Nazi party for whom, being Jewish, he would have been a target for extermination. He was unable to find an academic appointment in England and thus decided to go to the London School of Economics as a student of Friedrich Hayek, even though he already had a doctorate from Berlin (Mittermaier 1992: 9). This placed him at the very center of the vibrant new ‘Hayekian’ school of economics, together with such scholars as Lionel Robbins, John Hicks, Nicolas Kaldor, Abba Lerner, George Shackle and others, and at the very center of the fast developing battle between the Hayekians and the emerging Keynesians. He already had an appreciative interest in Friedrich Hayek’s work on the Austrian theory of capital and the business (trade) cycle.
Thus, Lachmann’s interest in capital theory grew out of these topical preoccupations with the Austrian version of the business cycle, deriving from Mises, and from the Austrian theory of Capital which was a crucial building block for that theory. The Austrian Theory of Capital (ATC), originating with Carl Menger (1871) was the most well-known contribution of the Austrian School at that time, owing mainly to the extensive work of Eugen von Böhm-Bawerk on the subject. Böhm-Bawerk’s work had achieved world-wide recognition (1959, three volumes originally published in the period 1884-1912). In his influential work on the trade cycle (1933, 1935) Hayek had referred to, and made use of, a highly stylized version of the ATC. And much of his work in the 1930’s was dedicated to the attempt to elaborate and make this theory more widely accessible, especially to English speakers. In the process, he was led to a thorough reexamination of the ATC, writing a number of important articles (some of which are collected in Hayek 1939) and culminating in The Pure Theory of Capital (1941). It was this body of work that was the greatest influence on Lachmann, that crucially shaped his own subsequent work on capital theory and also his enduring preoccupation with the topic of expectations so prominent in this book.
Lachmann had for a while been troubled by the influence of people’s expectations on their actions, and felt that in Price and Production (1935) and Monetary Theory and the Trade Cycle (1933) and in his debate with Keynes subsequent to the publication of Keynes’s Treatise on Money (1930), Hayek had neglected to adequately address expectations in the trade cycle story offered as a counter-argument to Keynes’s. Reading Keynes General Theory (1936) upon its publication he was surprised to find Keynes’s extensive treatment of expectations. Lachmann came to the conclusion that the Austrians had given expectations insufficient attention and the implications of subjectivism for expectations became a theme that motivated his work for the rest of his life and is a distinguishing aspect of his work on capital.
His work on capital theory began in the late 1930’s, continued into the 1940’s and developed together with his work on expectations (Lachmann 1937, 1938, 1939, 1941, 1943, 1944, 1945, 1947, 1948). This work begins in the context of the Hayek-Keynes debate and the onset of the Great Depression, with Lachmann exploring the nature of ‘secondary depressions’ but soon develops beyond this. It culminates ultimately in this book Capital and its Structure published much later in 1956 (Lachmann 1978 [1956]) by which time he was far away and interest in capital theory had disappeared with the triumph of the Keynesian revolution.
            Lachmann’s capital theory is clearly Hayekian in spirit. It is, however, also closely connected to the work of Böhm-Bawerk, whose insights Lachmann sought to carefully and critically reconstitute in a form applicable to modern real world production contexts. His approach reflects what he saw to be the inextricable connection between capital, knowledge and expectations, the implications of which he thought needed to be spelled out clearly in order to provide a satisfactory answer to the Keynesian challenge.
In a famous quotation Lachmann explains:
The generic concept of capital without which economists cannot do their work has no measurable counterpart among material objects; it reflects the entrepreneurial appraisal of such objects. Beer barrels and blast furnaces, harbor installations and hotel room furniture are capital not by virtue of their physical properties but by virtue of their economic functions. Something is capital because the market, the consensus of entrepreneurial minds, regards it as capable of yielding an income. . . . [But] the stock of capital used by society does not present a picture of chaos. Its arrangement is not arbitrary. There is some order to it. (Lachmann 1978:xv).
The value of the capital-stock, being dependent on individual expectations and evaluations is not an objectively observable phenomenon. Only in equilibrium, where all individuals’ expectations were consistent one with the other, would such a value have any meaning. He thus offers a theory of the capital-structure rather than the capital-stock and emphasizes the heterogeneity of capital. The fact that capital goods are physically very dissimilar is significant precisely because of the existence of disequilibrium. Physical heterogeneity could be reduced to value homogeneity if the values of the various capital goods could be simply added together. Where disequilibrium means that individuals have different and frequently inconsistent expectations, one cannot simply add together individual valuations. This means that aggregate measures of the capital stock are no coherent and cannot be understood to indicate the objective worth of the economy’s productive capital.
            According to Lachmann, though the capital-stock is heterogeneous, and cannot be meaningfully aggregated, it is not amorphous or meaningless. The various components of the capital-stock stand in a sensible relationship to one another because they perform specific functions together. That is to say, they are used in various capital combinations. If we understand the logic of capital combinations, we give meaning to the capital-structure and, in this way, we are able to design appropriate economic policies or, even more importantly, avoid inappropriate ones.
Understanding capital combinations entails an understanding of the concepts of complementarity and substitutability. These concepts pertain to a world in which perceived prices are actual (disequilibrium) prices, in the sense that they reflect inconsistent expectations and in which changes that occur cause protracted visible adjustments. Capital goods are complements if they contribute together to a given production plan. A production plan is defined by the pursuit of a given set of ends to which the production goods are the means. As long as the plan is being successfully fulfilled, all of the production goods stand in complementary relationship to one another. They are part of the same plan. The complementarity relationships within the plan may be quite intricate and no doubt involve different stages of production and distribution.
Substitution occurs when a production plan fails (in whole or in part). When some element of the plan fails, a contingency adjustment must be sought. Thus some resources must be substituted for others. This is the role, for example, of spare parts or excess inventory. Thus, complementarity and substitutability are properties of different states of the world. The same good can be a complement in one situation and a substitute in another. Substitutability can only be gauged to the extent that a certain set of contingency events can be visualized. There may be some events, such as those caused by significant technological changes, that, not having been predictable, render some production plans valueless. The resources associated with them will have to be incorporated into some other production plan or else scrapped—they will have been rendered unemployable. This is a natural result of economic progress which is driven primarily by the trial-and-error discovery of new and superior outputs and techniques of production. What determines the fate of any capital good in the face of change is the extent to which it can be fitted into any other capital combination without loss in value. Capital goods are regrouped. Those that lose their value completely are scrapped. That is, capital goods, though heterogeneous and diverse, are often capable of performing a number of different economic functions.
Lachmann’s analysis of capital in terms of complementarity and substitutability are linked to the theory of investment (which he points out must contain an implicit theory of capital) and specifically to Keynes’s marginal efficiency concept (which lacks any recognition of such a theory). The effect of an increase in investment on the demand for capital depends, in his account, on the shape of the already existing capital structure and the degree of its complementarity with the new investment.
The relationship of this book to the work on capital theory by his mentor and colleague Friedrich Hayek is of some interest. When asked about his Pure Theory of Capital Hayek once remarked, “I think the most useful conclusions drawn from what I did are really in Lachmann’s book on capital” and he suggests that what Lachmann said is perhaps as much as could be said. Hayek continues: “Like so many things, I am afraid, which I have attempted in economics, this capital-theory work more shows a barrier to how these things I’ve stressed – the complexity of the phenomena in general, the unknown character of the data, and so on- really much more point out limits to our possible knowledge than [are] contributions that make specific predictions possible.” (quoted in Kresge and Wenar 1994:142).
            Lachmann’s capital theory, as expressed in this book, in chapters one through six, is well-known and much admired by scholars working in the Austrian tradition. Chapter seven is something an outlier, however. It contains puzzles in that the policies that Lachmann recommends do not seem to fit well with his view of capital in a dynamic economy. Many have ignored this chapter and a few have tried to explain it. Chinese readers can now add their voices to this discussion.
            The concept of capital is central to an understanding of the “capitalist” economy. Ludwig Lachmann’s Capital and its Structure is a work of striking originality and insight. Its translation into Chinese is to be celebrated.  


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