Saturday, April 2, 2011

Man, Economy, State - book study 1.1



In the chapter 1 discussion of capital, Rothbard makes a powerful point that is unfortunately not well understood:

Capital is a way station along the road to the enjoyment of consumers’ goods. He who possesses capital is that much fur­ther advanced in time on the road to the desired consumers’ good. . . . Thus, the role of capital is to advance men in time toward their objective in producing consumers’ goods. This is true for both the case where new consumers’ goods are being produced and the case where more old goods are being produced.

I am now coming to an insight that I regret is a long time developing - in order to fully appreciate capitalism it is helpful to have a clear idea of the nature and source of capital and how time impacts this understanding. Rothbard goes on:

Thus, any actor, at any point in time, has the choice of: (a) adding to his capital structure, (b) maintaining his capital in­tact, or (c) consuming his capital. Choices (a) and (b) involve acts of saving. The course adopted will depend on the actor’s weighing his disutility of waiting, as determined by his time preference, against the utility to be provided in the future by the increase in his intake of consumers’ goods.
At this point in the discussion of the wearing out and replace­ment of capital goods we may observe that a capital good rarely retains its full “powers” to aid in production and then suddenly lose all its serviceability. In the words of Professor Benham, “capital goods do not usually remain in perfect technical con­dition and then suddenly collapse, like the wonderful ‘one-hoss shay.’

While I am tempted to think today of applications of the final statement - both at my place of employment and in a broader sense the infrastructure of our country, a more important rumination is the process by which the individual consumption, savings and investment decisions emerge and . . . I hate to use this term but struggle to find a substitute . . . aggregate in society. This process of intermediation and capital allocation is a vital one as societies evolve in complexity and character.

In our study guide Murphy offers a final study question for chapter 1:

Suppose that a farmer normally sets aside ten percent of his harvest as seed corn. His son says, “That’s silly! We should sell all of our harvest and make as much money as possible.” What would this policy lead to?

This is a great question for it implies a number of important issues that I read beneath the surface of chapter 1. The first is the Hayekian notion of competition as a discovery procedure - that is the discussion of factors of production and capital formation as well as the work v leisure tradeoff imply a process as work by the individual agents in society. So, the farmer has a rule of thumb that has evolved as he "normally" allocates 10 per cent of his crop to capital. This example illustrates a number of elements of capital - its perishability in particular. But more importantly this 10 per cent rule is one that has evolved over time. The development of the rule was based upon experience, trial and error and a reflective consciousness on the part of the producer.

Now the son presents an alternative to the evolved rule. A great opportunity to demonstrate the next issue that came to my mind in this reading - adaptive efficiency. As North uses this concept and the son illustrates, a flexibility and willingness to confront risk and uncertainty is evident in the son's proposal. The trial and error that was certainly at the basis of the 10 per cent rule is found in the son's proposal - he is a chip off the old block. The revenue from the additional 10 per cent of crop he proposes to sell is the opportunity cost of the father's investments. That income could be used for a number of purposes - purchasing insurance, expanding the family farm, diversification in capital investment, emergency savings, hedging. By confronting uncertainty and risk the son is allowing the 10 per cent rule to be tested and the application of freedom in action which is inherent in adaptive efficiency leads to a second test - the test of trial and error. This trial may or may not lead to a higher level outcome than the father's approach - but the family (and we as interested bystanders in society) will never know if the rule is not tested.

Rothbard's analysis in chapter 1 seems to support my reading. He writes:

Any actor will continue to save and invest his resources in various expected future consumers’ goods as long as the utility, considered in the present, of the marginal product of each unit saved and invested is greater than the utility of present con­sumers’ goods which he could obtain by not performing that saving. The latter utility—of present consumers’ goods forgone—is the “disutility of waiting.” Once the latter becomes greater than the utility of obtaining more goods in the future through saving, the actor will cease to save.

Allowing for the relative urgency of wants, man, as has been demonstrated above, tends to invest first in those consumers’ goods with the shortest processes of production.


Following in Rothbard's description - the father and son now have diverging views of the future and that divergence changes the calculus of present value of net marginal utilities between the two. So, this question is a great real world application - this type of divergence is ubiquitous, and doesn't even require multiple agents - how many times have I faced this type of dilemna in my everyday decision making?

So, all actions in the future are subject to both risk and uncertainty. To the extent that the costs and benefits of this risk and uncertainty are internalized the results of the decisions made by the farmer and his son will transmit information through society in a productive and positive way.

However, lurking within Bob's question is the spectre of moral hazard. I hope I am not being overly sensitive, but there is the possibility of social costs and benefits that are not in line with the private costs and benefits. Moreover, the market in which this farmer and his son operate may have been altered in a way that makes this question and speculation about outcomes more interesting and more significant.


I have to wonder if Bob selected this question with a further intent. In the US it is indeed hard to think of farming without immediately thinking of the state. The government is so deeply involved in US agriculture - and Bob did pick corn as the example - a crop profoundly influenced by government policy and action - that a reader is invited to wonder - why did the father set aside 10 per cent in the past, and what change (government or otherwise) has motivated the son to make a significant change in capitalization and investment.

To answer the question Bob asks - What would this policy lead to?

The wonderful answer that Hayek provides is . . . .

We don't know.

And isn't this wonderful. The ability of individuals to use information for their own ends in the absence of coercion is a indeed at the heart of a free and responsible society.

But Bob pushes the reader with the implications behind this question. I might ask, what motivated the son's proposal? Was it a government action - an increase for example in the subsidy that the government provides to corn farmers? A subsidy or credit to a consumer of corn (ethanol) that may have raised the demand for corn? Actions by another state (foreign government) that increased the demand for corn?

Price is a signifier of great information and the son's action is the result of that information.

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