What Is Capital and Why Is It Essential?

Time is essence of capital

As an economist, Israel Kirzner is best known for his contributions to the theory of entrepreneurship. His renown in this area extends into the literature on management studies where recently his insights have become the focus of spirited discussions about the discovery of entrepreneurial opportunities. Ranging from his view of the entrepreneur as essentially a complex intertemporal arbitrageur (1973) to the ethics of entrepreneurship as value-creation analogous to the “finders-keepers” doctrine (1989), this body of work constitutes a professional lifetime of impressive and influential achievements.

Three early full-length works of his deal with other subjects. The first, based on his doctoral dissertation under Ludwig von Mises, The Economic Point of View (1960), is something of an Austrian Economics classic—an in-depth methodological examination of the means-ends framework of human action in a dynamic, open-ended social world. The second is a work on the principles of microeconomics from an Austrian perspective, Market Theory and the Price System (1963) accessible to economists ignorant of the Austrian School. It is a work that is deserving of more attention, even today. The third is this book, An Essay on Capital, originally published in 1966.

It is a rather unusual work, a work at once embedded in the controversies of the past yet transcending its temporal context. Capital theory is arguably the most esoteric and complex topic in pure economic theory, made more so by the notorious controversies that surround it. Yet, the Austrian Theory of Capital, from Menger to Böhm-Bawerk to Hayek to Lachmann, is also the most well-known contribution of the Austrian School. At the time this book was written, however, capital theory had moved far out of the spotlight that it had occupied at various times in the preceding decades. The Austrian revival of 1974 had not yet begun. Ludwig Lachmann’s Capital and its Structure had been published in 1956 and had received little attention. So it was, for these reasons, an ambitious work, received nevertheless, with the praise it deserved as a scholarly tour de force.

Time is of the essence in capital.Its republication now is timely. Once again, if not within the pages of mainstream economics, certainly within those of mainline economics (in the political-economic tradition from Adam Smith to Friedrich Hayek), the nature and role of capital is under investigation. As a result of the Austrian revival, new generations of Austrian scholars are eagerly exploring this legacy. Kirzner’s Essay on Capital will reward their curiosity handsomely.

Capital is at the core of not only entrepreneurial activity, forming the calculational framework necessary for entrepreneurial perception and action, it is also central to Austrian Business Cycle theory, and, more generally, to the perils of government regulation (1983). It is crucial to understand the essentials of capital if one wants to understand the essentials of capitalism. This book is an invaluable and enduring contribution toward that end.

An Essay on Capital is composed of four sub-essays. Each is an examination of a particular aspect of capital theory. Upfront is perhaps Kirzner’s most original contribution to the subject—the proposition that capital-goods must be viewed as ‘unfinished plans’. It is a logical application of the principles of methodological individualism and methodological subjectivism - applied to human action within the stream of real time. Time is of the essence in capital.

Capital is the way that individual producers can plan for events distributed over time in the future. The individual production plan involves the assembly and use of heterogeneous productive resources over time with the aim of producing valuable outputs for sale. These resources draw their economic meaning from this singular purpose. There is no other way to intelligently comprehend them. They are a part of someone’s ongoing, unfinished production plan. In the first chapter Kirzner provides a compelling account of capital-goods as unfinished plans exploring the implications of this approach. Different individuals have plans based on different expectations of the future, some of them contradictory. Thus, individual plans are codependent, may be contradictory, and may fail, in whole or in part, and have to be reformulated through time as individual decision-makers struggle to adapt. Production plans are necessarily multi-period plans, an implication that bears on the perennial issue of ‘how much’ time is involved in any production process, the subject of chapter 3.

Capital is a difficult subject in part because it has a time, a quantity, and a value dimension.The relationship of Austrian theorists, and capital theorists in particular, to Frank Knight, is a highly ambiguous one. In many ways Knight’s work is very Austrian in character, as in his view of the entrepreneur for example (1921). And, in some ways, this is even true of his views on capital, albeit that he was a severe critic of Hayek’s capital theory. His view of capital in the macro-economy is something of a puzzle in that he provides no account of how individual production plans are integrated to yield what he sees as a permanent source of consumption services. For Knight, capital is a stock that inexorably yields a permanent flow of consumption services. Knight may well be helpful when he opines that “What is in fact consumed in economic life is exclusively [flows of] services, and accordingly, the primary meaning of production is the rendering of [a flow of] service”, yet rather unhelpful when he invites us to view the macroeconomic world in terms of an indestructible capital stock yielding a perpetual consumption flow. In chapter 2 Kirzner investigates the nature of stocks and flows in economics, of which Knight’s view is but one aspect, an important aspect. Clarity on this is vitally important for an understanding of capital theory, and, indeed, for understanding economics.

Eugen von Böhm-Bawerk was the most influential contributor to the theory that became known as the Austrian Theory of Capital. Yet, Carl Menger, the founder of the school, was less than enthusiastic about particular aspects of Böhm-Bawerk’s work. In his treatment of the role of time in production Böhm-Bawerk had departed from the vision of his mentor-predecessor. Indeed, this aspect of Böhm-Bawerk’s capital theory, namely, the characterization of time in production processes, became the source of energetic controversy. At the center is Böhm-Bawerk’s attempt to measure the ‘quantity’ of time involved in any production process. As a simplification he offered a formulation known as the ‘average period of production’. It turns out that this formulation contains serious internal tensions and contradictions. The controversy surrounding these issues, which returned again in slight variation in debates surrounding Hayek’s use of Böhm-Bawerk’s ideas in discussing the business cycle in the 1930’s and 1940’s, detracted from understanding the connection between time and production in individual decision-making. A key distinction is that between time in production conceived in a backward-looking historical perspective and time in production from a forward-looking perspective. It is the latter that is the authentic Austrian approach. In chapter 3 Kirzner seeks to clarify.

Capital is a difficult subject in part because it has a time, a quantity, and a value dimension. Controversies about time and capital are only one aspect of the general issue of how to measure, how to calibrate, capital. This is the subject of chapter 4 in which Kirzner relates these considerations to the then current developments in neoclassical mainstream economics, most particularly to the emerging literature on economic growth and the aggregate production-function. Kirzner explains the incoherence of the notion of ‘quantity of capital’ as an economy-wide aggregate. In this Kirzner was something of an unnoticed pioneer. Franklin Fisher (1993) has since provided a devastating immanent critique of the neoclassical production function literature. Yet, Kirzner was also channeling some aspects of the view of his teacher Ludwig von Mises in explaining that for the individual producer the only way to ‘quantify’ capital is to ‘value’ it (Braun et al. 2016).

In this Essay Kirzner is at his articulate systematic best. Each chapter builds carefully on those preceding it to yield a penetrating and comprehensive view of a fascinating subject. I envy the reader entering here for the first time and am delighted to provide these few words by way of introduction to the republication of this important work.

Peter Lewin

Dallas, July 2017

References

Braun, Eduard, Peter Lewin, and Nicolas Cachanosky. 2016. "Ludwig Von Mises's Approach to Capital as a Bridge between Austrian and Institutional Economics." Journal of Institutional Economics doi: 10.1017/S1744137416000102.

Fisher, Franklin M. 1993. Aggregation: Aggregate Production Functions and Related Topics. Cambridge, MA: MIT Press.

Kirzner, Israel. 1960. The Economic Point of View: An Essay in the History of Economic Thought. Menlo Park: Institute of Humane Studies.

———. 1963. Market Theory and the Price System. New Jersey: van Nostrand.

———. 1973. Competition and Entrepreneurship. Chicago: University of Chicago Press.

———. 1983. The Perils of Regulation: A Market-Process Approach. Miami: Competitive Economy Foundation and Law and Economics Center, University of Miami.

———. 1989. Discovery, Capitalism and Distributive Justice. New York: Basil Blackwell.

Knight, Frank. 1921. Risk, Uncertainty and Profit. Boston: Hart, Schaffner & Marx; Houghton Mifflin Co. available at: http://www.econlib.org/library/Knight/knRUP.html