Capital Interest and Time

Mises built solidly on die Bohm-Bawerkian insights concerning time; where he differed with Bôhm-Bawerk was in his insistence on a more radically subjective perspective on the role of time than he found in his mentor's work. Mises emphasized his debt to "the imperishable merits of Bôhm-Bawerk's contributions," in regard to the role of time (ha, 489); but he was not satisfied with his teacher's treatment. Bôhm-Bawerk had emphasized the fact that production is a time-consuming ("roundabout") process; he had used this time-dimension of prodtic-

tion as the source of explanation for the phenomenon of interest in a producing economy. For Bohm-Bawerk, interest emerged because entrepreneur-producers must, in order to engage today in time-consuming processes of production, persuade owners of resources to advance the services of their resources in processes, the fruits of which can be expected only at a later date. Resource owners mil not, Bdhm-Bawerk believed, be prepared to do so (i.e., to forgo more immediate extraction of consumer satisfaction from these owned resources) unless the fruits of these time-consuming production processes exceed in value alternative rewards available to these resource owners through immediate exchanges in today's spot markets. They will not be prepared to do so because of what came to be called "positive time preference"—a term loosely referring to preference for immediate, rather than postponed, reward. Mises took issue with the reliance which Bohm-Bawerk placed on the psychological basis for positive time preference (we shall refer briefly to this issue later on). In addition, he believed that Bohm-Bawerk had, surprisingly, become a victim of a fallacy which Bdhm-Bawerk had himself prominendy refuted: the belief that interest emerges as a result of die productivity of capital.

Earlier theorists had believed that since time-consuming processes of production require capital, it is the productivity of capital, manifested in the enhanced value of the fruits of time-consuming production processes, which is die source of interest.

Interest was seen as the fruit of a tree called "capital." Mises read Bohm-Bawerk's theory of interest as somehow still recognizing a role, in the generation of interest, played by the higher productivity of longer, more "roundabout" processes. Mises (following, in this regard, earlier work of the U.S. economist F. A. Fetter) found this to be inexplicable. Bohm-Bawerk had himself demonstrated the fallacy of the productivity theory of interest. If a tree is expected today to produce a steady annual stream of fruit in future years, this productivity will be entirety reflected in the tree's current market value. If a capital good can, through its investment today in a time-consuming process of production, generate a high-valued stream of output in the future, the value of that output will tend to be fully anticipated in todays market value of that capital good. This value will, in the absence of other causes for an interest phenomenon, rise to die point where the physical productivity of the capital good will be utterly unable to provide any flow of value return like the kind that we find in the real-world phenomenon of interest. Mises found it simply unintelligible that Bohm-Bawerk, who had so thoroughly and trenchantly deployed this kind of reasoning to refute the earlier productivity theorise, should have himself reverted to a theory which included productivity elements.

Mises found Bohm-Bawerk's treatment to be also faulty in the latter's discussions of time as if it somehow comes to be "congealed" in die durable things produced during time-con suming production processes. For Mises, time enters our understanding of the phenomena of interest strictly in its ex ante sense. In making decisions in a multi-period world, producers, consumers, and resource owners treat time in a forward-looking manner. An economics that focuses analytically (as Austrian economics does) upon decisions rather than upon things, cannot, therefore, treat time in its elapsed sense. It is this fact which led Mises to reject an important dement in die Bohm-Bawerkian system: the elapsed, "average period of production." For Mises, the role that time "plays in action consists entirely in the choices acting man makes between periods of production of different length. The length of time expended in the past for the production of capital goods available today does not count at all The average period of production' is an empty concept" (ha, 488-9; emphasis supplied). Mises had apparently carefully studied the ideas of philosophers regarding the nature of time, drawing particularly on Henri Bergson. Mises identified the idea of time as "a praxeological category." "Action is always directed toward the future." "The present offers to acting opportunities and tasks for which it was hitherto too early, and for which it will be hereafter too late" (ha, ioo-i). From this perspective, it is dear that Mises could not endorse the Bohm-Bawerk-Hayek notion that the capital stock of a society, at a given point in time, possesses a "time-structure." (Hayek's use of this concept constitutes one significant difference between his own elaboration of the Austrian Theory of the Trade Cycle and that of Mises.)

Indeed, Mises objected altogether to the use of the term "capital" to refer to the "totality of the produced factors of production." Such a totality is "a description of a part of the universe" that is "of no use in acting." Moreover, the use of a notion like aggregate "real capital" had been responsible for the "blunder" of explaining interest "as an income derived from the productivity of capital" (ha, 263). Instead, Mises endorsed Menger's use of the term capital as an accounting concept. "Capital is the sum of the money equivalent of all assets minus the sum of the money equivalent of all liabilities as dedicated at a definite date to the conduct of the operations of a definite business unit" (ha, 262). Capital is a correlate of the accounting notion of income. "Hie calculating mind of the actor dram a boundary line between the consumer's goods which he plans to employ for the immediate satisfaction of his wants and goods of all otders...which he plans to employ for providing by further acting, for the satisfaction of future wants That amount which can be consumed within a definite period without lowering the capital is called income." This use of the term "capital" is sharply distinguished, in Mises' terminology, from the term "capital goods." The presence of capital goods (produced factors of production) attests to the adoption by producers of time-consuming production processes. But there is no need whatsoever to refer to die totality of such capital goods. And "[t]here is no question of an alleged productivity of capital goods" (ha, 493); if it is profitable to engage in a tune consuming process of production this is attributable entirely to the selection by the producer of die appropriate time-profile for die production process.

For Mises, then, the phenomenon of interest is in no sense a correlate of anything that might be called capital or capital goods. Although interest typically emerges in a world that uses capital goods, and in which capital accounting plays a crucially important role, interest is not the productivity return on any abstract totality that might be called "capital," nor is it the expression of the "productivity" of capital goods.

Instead, interest represents the economic manifestation of what Mises believed to be a universal (a "categorial") element in human action, the element of positive time preference, this element generates a characteristic pattern in the structure of inter-period prices, which expresses itself, in the loan market, as what we know as the phenomenon of interest. The element of time preference and the existence of the phenomenon of interest do not in any way depend on the role of production in economic life. "Productivity" is not the source of interest. Interest would occur even in a world in which no production takes place. But in our world, in which production does take place, die phenomenon of interest generates profoundly important implications. Because production takes time, the market decisions of producers, resource owners, and consumers, must very definitely take ac count of die interest phenomenon. The choice by producers of a process of production must pay careful attention to the length of time involved, for the duration of which interest will have to be paid. The choices made will of course determine (and be expressed in) the kind and durability of the tools (die "capital goods") that will be developed and deployed, the technology that will be utilized, and the kind and durability of the produced consumer goods. The inter-temporal market, the market in which producing entrepreneurs necessarily function, tends to ensure that prices (including the rates of interest) guide decision makers to take appropriate account of both the time preferences of market participants (resource owners and consumers) and the production possibilities associated with alternative production processes (involving different technologies and different time profiles).

It is this perspective upon the nature and market function of interest which undergirded Mises' lifelong concern with the dangers represented by ideologies and political programs that considered it possible and desirable to eliminate interest, or at least to engineer reduction in its rate. As we have seen in this chapter, it was this kind of ideological misunderstanding concerning interest that Mises blamed for the pain and suffering implicit in the trade cycle. Artificially low interest rates resulting from the expansion of the money supply (through "fiduciary media" creation) tends to distort production decisions, misleading producers to undertake processes of production unwarranted

(in the length of their time profiles) by the inter-period structure of consumer preferences. As we saw earlier, a portion of the stock of capital goods assembled by producers will sooner or later suffer a severe loss of market value, as projects come necessarily to be abandoned as the true time preferences of market participants reassert themselves.

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