You can learn a thing or two about the theory of the business cycle by watching reality TV. Specifically, there are lessons to be learned about recessions, depressions, and what the economists of the Austrian school like Ludwig von Mises and F.A. Hayek called "malinvestment" from a show like celebrity chef Gordon Ramsay's Kitchen Nightmares.
The show's setup is predictable, as are its patterns: every week, Gordon Ramsay visits and helps revamp and resuscitate a restaurant that is ailing and failing. The restaurant is a disaster, the owner or chef hates Chef Ramsay at the outset, the narrator wonders if he can do it, and eventually everybody is happy at the end of the show. It's clear, though, that without Gordon Ramsay's help, the restaurant would almost certainly fail. Kitchen Nightmares is a very fun show to watch, and it's usually a story of trial and redemption. For every restaurant saved by Gordon Ramsay, however, there are probably another hundred or so that go under.
Malinvestment occurs when resources are used to make tables, spatulas, and stoves for restaurants that ultimately won't be profitable.
These restaurants almost certainly represent resources that have been malinvested. And what is "malinvestment?" It isn't what happens when there is too much investment. Rather, malinvestment occurs when resources are invested in the wrong things. One of the most important contributions the Austrians bring to the table is their emphasis on the fact that capital goods are heterogeneous. You can do a lot with a hammer, a computer, or a spatula, but they aren't perfect substitutes for one another.
The same is true of the tables, chairs, spatulas, stoves, and other things that go into a restaurant. Malinvestment occurs when resources are systematically used to make tables, chairs, spatulas, and stoves for restaurants that ultimately won't be profitable. These resources would have been better used elsewhere, but they become restaurant supplies because people are making their calculations based on distorted interest rates. The source of malinvestment, according to the Austrian theory, is the systematic distortion of the structure of production that has its origins in government manipulation of the interest rate.
Good Money, Bad Projects
What does the Austrian theory of the trade cycle have to do with Gordon Ramsay? Plenty. On a lot of episodes, it's pretty clear that the people running the restaurants should probably be doing something else. The Austrian theory of the trade cycle explains why loans are systematically granted to people who will almost certainly not be successful restaurant owners.
The stories can be heartbreaking: family members have fallings out, couples who pour their life savings into failing restaurants, and so on. You begin to wonder who in their right mind lends money to people who are clearly not qualified to run a restaurant. Economists like Ludwig von Mises and Friedrich Hayek have an answer: credit is too cheap and resources are malinvested. Specifically, people who wouldn't open restaurants if the interest rate were set by a free market look like profitable investments when the interest rate is artificially low.
Distorted interest rates cause more people to open and close restaurants than otherwise would.
Credit expansion is seductive because it looks great at first: businesses are investing, people are getting hired, food is being cooked. It isn't sustainable, though, because an artificially low-interest rate creates a tug-of-war for resources between investors and consumers who have been misled (Roger Garrison explains in this lecture). When prices adjust and the economy recalculates, the malinvestments are revealed and liquidated. This includes a lot of restaurants that don't have the benefit of Gordon Ramsay's intervention.
The human cost is substantial, too. People invest in relationships and skills that ultimately aren't consistent with what consumers want. Restaurants are very risky to begin with. When the interest rate is distorted, more people open restaurants than otherwise would and, ultimately, more people close failed restaurants than otherwise would.
The strain on flesh-and-blood human beings can be considerable. Financial problems can lead to divorce and depression, for example. People don't mean to make bad investments, but they do anyway because they are being lied to by the interest rate. Unfortunately, most of the people who are investing in restaurants that are doomed to policy-induced failure won't have Gordon Ramsay to save them.