Vol. 2, No. 3, Summer 1980    

     

    Introduction to Modern Austrian Capital Theory
    by Malte Faber
    New York: Springer-Verlag, 1979, pp. x, 196

    Six years ago, Sir John Hicks' third book on capital theory appeared, bearing the title Capital and Time: A Neo-Austrian Theory. Critics who consider the tenets of subjectivism and methodological individualism to be central to the Austrian tradition questioned the validity of the subtitle. Ludwig Lachmann, in particular, argued that Sir John's work was inspired by Ricardo and Walras rather than by Menger and Hayek and that his book is to be viewed as a specimen of formalism as opposed to subjectivism. It seemed clear at the time that Lachmann's own Capital and Its Structure and Hicks' Capital and Time were, methodologically speaking, at opposite ends of the spectrum. We now have evidence that only half of the spectrum was in view. In the book presently under review, which is part of a series of "Lecture Notes in Economics and Mathematical Systems," Sir John's subtitle is once again called into question. This time the objection is not that the analysis is formalistic but that the formal analysis is confined to the supply side of the market. Consumer preferences, time preferences in particular, should be given similar treatment.
            If we were to travel the distance from Lachmann to Hicks and then continue in the same direction beyond Hicks for a comparable distance, we would find Malte Faber. We can also locate Faber's end of the spectrum with respect to other contemporary authors who have contributed to the development of Austrian capital theory. While there is only one reference to Lachmann, there is none to Mises, Kirzner, or Rothbard. References to Hayek are limited to his Pure Theory of Capital. Neo-Austrian capital theory owes its existence, in the author's view, to such contributors as Bernholz, Fehl, Hicks, Jaksch, Reetz, and von Weizsacker.
            Faber's treatment of the issues in capital theory is offered in the format of a textbook complete with problem sets at the end of each of the book's nine chapters. The argument builds from chapter to chapter, and continuity is maintained throughout. References and cross-references are abundantly supplied. The organization is remarkable, especially in view of the fact that several of the chapters are reworked papers published earlier, some co-authored with Peter Bernholz and others.
            Although this review is addressed to those uninitiated in mathematical economics, Faber's book is not. The preface indicates that the only prerequisite is a familiarity with Cramer's rule and the Kuhn-Tucker conditions. (Cramer's rule is a procedure that yields a pro forma solution to a set of simultaneous equations whose parameters have unspecified values. Kuhn-Tucker conditions are a set of conditions under which some stipulated variable takes on its maximum value.) But the author freely admits that some passages of the book are mathematically demanding. For the mathematically trained economist the problem is not one of following the sequence of manipulations of the equations presented. As is typical of this literature, the problems are those of understanding precisely what economic concepts are being symbolized and understanding the full implications of all the simplifying assumptions that were required to allow the issues to be cast in a mathematical mold. If these problems are particularly telling in Faber's book, it is because his methodic and meticulous presentation reveals that the problems are inherent in the mode of analysis.
            The limitations of mathematical analysis of economic issues can be illustrated by considering Faber's own introductory chapter. Two questions are identified which, according to the author, are the main concerns of Austrian capital theory: What is capital? Why is the rate of interest generally positive? That the book is aimed almost exclusively at answering the second question is not just a matter of taste. Given the techniques employed, an answer to the first question is completely out of reach. Representing capital with a symbol does not tell us what capital is. Constructing a model that allows for only one capital good and theorizing in terms of units of the capital good serves to skirt, rather than answer, the fundamental questions in capital theory.
            In the second chapter, Faber provided a short guided tour through that portion of the history of Austrian capital theory which is relevant to his own contribution. The tour can be easily put into perspective. Faber begins with Böhm-Bawerk and follows those developments that gravitate toward the identification of purely technological relationships between inputs and outputs. This takes him from Böhm-Bawerk to Wicksell and then on to von Stackelberg, where a "theoretical dead-end" stifles further developments. (Böhm-Bawerk and Wicksell dealt only with continuous-input/continuous-output models. Von Stackelberg's contribution consisted of developing additional models characterized by alternative input-output configurations.)
            In the mid thirties von Neumann provided a way out of the theoretical dead-end by developing a model of general equilibrium based on the work of Walras and Cassel. This is explained in Faber's third chapter. The von Neumann model differs from those of Walras and Cassel in several respects. It recognizes, for instance, the possibility of "circular production," e.g. while coal may be used in the production of steel, steel is used in the production of coal. The model also allows for joint production, for the production of intermediate goods, and for the existence of several different production techniques for each good produced. But if the von Neumann model represents a high-water mark in technique, form, and generality, it represents a low-water mark in substantive economic content. The model contains no primary factors of production and permits no consumption! At the end of each period all outputs are employed as inputs for the next period. As Faber recognizes, the von Neumann model represents a "slave economy with an incessive [sic] increase in production as its only goal." The complete lack of any consumption activity strikes Faber as being "peculiar." The ultimate assessment, however, is that von Neumann's analysis is "clear, concise, and consistent." Faber does note that Koopmans, with support from Champernowne, is on record with the judgment that von Neumann's model is "rather poor economics."
            Faber seeks to preserve the technique while correcting for the deficiencies in substance. The core chapters of his book (Chapters 4, 5, and 6) are directed toward this end. Matrix algebra is used to construct a "modified special case of the generalized von Neumann model." The modification consists of introducing a demand for consumption goods; the speciality derives from restricting the model to a single capital good and a single consumption good; and the generalization is achieved by relaxing the assumption of a steady state. Summarizing the payoff of the core chapters, Faber states that the von Neumann model as modified allows us to "demonstrate that superiority, roundaboutness and impatience or neutrality of time preference are sufficient conditions for the interest to be positive. (This can be compared with the positions of Mises, Fetter, Rothbard, and Kirzner that (positive) time preference alone is both a necessary and a sufficient condition for a positive rate of interest.)
            Chapter 7 discusses the "Schumpeter-von Böhm-Bawerk controversy on the rate of interest in the stationary state" in terms of the modified von Neumann model. The final two chapters compare the author's own work with other approaches to capital theory. Chapter 8 deals with neoclassical capital and growth theory, and Chapter 9 considers Hicks' neo-Austrian theory of capital. The most significant differences stem from Faber's treatment of demand.
             While we should applaud Faber for introducing demand into the analysis, we should applaud with one hand only. For he treats demand (as well as supply) in terms of a centrally planned economy. Even in the short section at the end of Chapter 4 entitled "Decentralizing the Decisions," he finds it necessary to assume that there is only one consumer or that there is a "ministry of consumption," and whoever is pulling the demand strings is a price-taker. This highly stylized formulation draws attention to other features of Faber's analysis which will undoubtedly trouble the reader who learned his Austrian capital theory from Mises and other Austrian subjectivists. There are no market processes in Faber's model. There are no money prices that convey market information. In fact, there is no money in the model. Expectations about the profitabilities of alternative investments (or about anything else) play no role at all. Each investment is immune from risk and uncertainty, and all investments are assumed to be perfectly coordinated. Thus, the model has no use for entrepreneurs. And despite all the discussion about multiple periods, the temporal structure of production, and roundaboutness, Faber is actually offering us a timeless model. It is timeless in the sense that there is no analytical distinction between the past, the present, and the future. This is sometimes called "meta-static" analysis. Production and consumption may take place over time, but all the economic decisions about what to produce and how to produce it are made on the seventh day of creation by the central planning authority and the ministry of consumption.
             What leads an economist to produce such a model? Observers of the economics profession, who have witnessed the emergence in recent years of technique-bound theorists, will recognize Malte Faber as the paradigm case. Throughout his book, Faber has allowed the applicability of the mathematical method to define the scope of his study. As a result, almost all the economic issues traditionally considered important have remained a good distance out of his reach. The willingness to forsake subject matter in order to preserve technique, we should note, has been the hallmark of formalism for some time. It was the profession's formalistic tendencies in the mid thirties that provoked Hayek to remark, "[F]rom time to time it is probably necessary to detach one's self from the technicalities of the argument as ask quite naively what is it all about."

      Roger W. Garrison
      Auburn University