We Need to Shift the Focus Away from Stages of Production and Back to Average Period of Production

The Hayek-Garrison treatment is missing the Hicksian component. It seems that neither Hayek nor Garrison made the same connection as Hicks did. The Hayek-Garrison framework shifts the emphasis away from the APP [Average Period of Production] toward relative changes in stages of production. However, even though stages of production (the particular order in which production needs to take place—i.e., mining first, retailing last) are a clear conceptual device, they do not have an objective counterpart in reality. Because of this, empirical studies that try to test the ABCT [Austrian Business Cycle Theory] following Garrison’s model face significant difficulties. . . .

To save the structure of production, we need to shift the focus away from stages of production and put it back into the APP.⁶ To do this, we need to follow Hicks’s lead, with the advantage of modern financial analytical tools and mathematics.

⁶While related to each other, APP and stages of production are conceptually different. We can imagine a production process with fewer stages of production but a higher APP and another production process with more stages of production but a shorter APP. This is possible because stages of production have to be arbitrarily delimited. The number of stages of production may or may not shed light on how long a production process is.

—Nicolás Cachanosky and Peter Lewin, “The Role of Capital Structure in Austrian Business Cycle Theory,” Journal of Private Enterprise 33, no. 2 (Summer 2018): 25, 25n6.

The “Hayekian Triangle” Is a Faulty Tool Because “Stages of Production” Is a Confused Concept

Although the concept of “stages of production” is often illustrated by an example; e.g., mining, refining, manufacturing, distributing, and retailing, this is not analytically satisfactory. These are but arbitrary categories. Any specific production process can be broken down into ever more discrete stages, or combined into fewer of them. The limit to the number of stages is set only by the number of individual human actions involved. Thus, the number of stages depends upon the judgment of the individual decision maker analyst. This is not to deny that the concept may be useful in providing the flavor of production through time, but it is not analytically sound in the sense necessary to be measured along the horizontal axis of a triangle that purports to represent the structure of production from an analytical (in this case, geometrical, and, therefore, mathematical) perspective.

Further, these examples are intrinsically confusing. Consider steel in this regard. If anything “deserves” to be located in an early stage of production, this item certainly does: it is the backbone of so much else, and these other productions cannot take place until the steel comes along on line. However, steel also occurs in very late orders of production. Indeed, steel may be found throughout the structure of production. For example, it is used pretty much at every stage in the production of bread, and its delivery to the final consumer. So, where does steel properly go? At an early stage of production? All through out?

—William Barnett II and Walter Block, “On Hayekian Triangles,” Procesos de Mercado: Revista Europea de Economía Política 3, no. 2 (Autumn 2006): 59-60.

Macaulay’s D Better Captures What Austrians Have Struggled to Express in their Capital Theory

In the esoteric history of capital theory, as originated by Carl Menger and William Stanley Jevons and developed further at great length by Eugen von Böhm-Bawerk, one can find the concept “average period of production” (henceforth APP). It was formulated by Böhm-Bawerk to give concrete expression to the notion of “roundaboutness”—the idea that production projects that “take more time” will, if wisely chosen, be more productive than those that are shorter in duration.

For the Austrians, roundaboutness was a crucial manifestation of Adam Smith’s division of labor, thus a key ingredient in the explanation of the prosperity of capital-using economies. Though the idea of roundaboutness continued to exert some influence on economic thinking over the years, the APP all but disappeared. It was, for a while, a matter of some energetic controversy, featuring prominently in the debate between Böhm-Bawerk and his critics, a theme in what became known as one of the famous “capital controversies” that mark significant episodes in the history of capital theory. It had a rocky start and went downhill from then.

At first, it seems to be an intuitive concept. Given that production takes time, it would seem there had to be an APP. But intuition runs into serious difficulties the moment one tries to formulate this idea more precisely and to measure it. Indeed, serious problems arose as soon as Böhm-Bawerk proposed a measure of the APP. His specific formulation was decisively criticized. Nevertheless, the idea of “time embedded in production” continued to exercise the imagination of capital theorists and those working in related areas. Time is an important, though neglected, aspect of production, and this influences how production is treated in economic models. The (modern) Austrians continue to use the idea in their analyses of economic cycles. The APP makes a (sometimes implicit) appearance through the Mises–Hayek, or Austrian, business-cycle theory (ABCT). This theory has been influential to a greater or lesser degree since the 1930s and the Great Depression, with a notable renewed interest since the 2008 financial crisis. . . .

Austrian capital theory tried to capture the intuitive and basically undeniable importance that time plays in economic life, but arguably was diverted down a blind alley with Böhm-Bawerk’s APP. Böhm-Bawerk attempted a purely physical measure of roundaboutness to capture the length of the production process. Such a measure is a chimera. But the intuition is strong, and the idea survived and reappeared at various points in the history of capital theory. Almost unknown to economists, an alternative value measure of roundaboutness has existed at least since Hicks’s formulation of his average period in 1939, which, coincidentally, was exactly the same measure discovered by the financial actuary Frederick Macaulay in 1938, called by him “Duration.” Macaulay’s D, more richly interpreted as Hicks’s AP, is a measure that more appropriately captures what the Austrians struggled to express over many years in their capital theory and in their analysis of the business cycle. It remains to be seen whether this will provide a basis for future work along these lines.


—Peter Lewin and Nicolás Caachanosky, “The Average Period of Production: The History and Rehabilitation of an Idea,” Journal of the History of Economic Thought 40, no. 1 (March 2018): 81-82, 96.

Keynes Does Not Study the Production Structure, But Suppresses It in the Concept of “Aggregate Investment”

From Hayek’s point of view, the major deficiency in The General Theory is that it is not based on a theory of capital (Hayek [1941] 1952). According to Hayek, the market is a network of millions of companies that complement and coordinate with each other intertemporally and synchronically, forming an extremely complex production structure. In order to understand how and why this structure is coordinated or discoordinated, we need to apply a theory allowing us to study the way it works. However, Keynes does not study this production structure, but suppresses it in the concept of aggregate investment. This is why Hayek thought that Keynes was not able to understand the causes of and the solutions to economic fluctuations.

According to Hayek, the absence of a theory of capital meant that in the model developed in The General Theory, time is not considered as a relevant variable. In the Keynesian world, when demand increases, a parallel increase in the supply of goods appears almost instantaneously. Therefore, for Keynes, the structure of production does not need a significant amount of time to produce the necessary additional final goods to meet additional consumer demand (Hayek [1941] 1952). Thus, The General Theory never considered that a shortage of supply may occur. In Hayek’s opinion, this approach is wrong.

According to him, time is a central variable in understanding any production process. The dynamic “balance” of any structure of production depends on an adequate coordination between the “ripening” of investments in the form of final goods and services and the income generated by such investments in the form of final demand. Thus, for Hayek, the biggest economic problem is that consumers should be willing to “wait” long enough to allow the consumer goods to emerge in final markets. Otherwise the phenomenon of inflation will appear, and, as it will be explained later, this phenomenon will seriously endanger the sustainability of the production structure. This is why, for Hayek, savings are so important.

—David Sanz and Juan Morillo, “Hayek's Hidden Critique of The General Theory,” Journal of Reviews on Global Economics 4 (2015): 214-215.

In Almost All Cases, A Reduction in Capital Means a Reduction in the VALUE of Available Production Equipment

The reason that it is so difficult to recognize capital consumption in this situation [of economic crisis] is that people view existing capital equipment predominantly or exclusively from a technical point of view without taking its economic meaning, that is, its value, into account. In almost all cases, however, a reduction in capital means above all a reduction in the value of available production equipment, which continues to exist for some time in unaltered form and which only gradually diminishes physically as a consequence of its loss in value. It is quite conceivable that, as a result of changed price constellations, the best-equipped factory, the most wonderful machine that only recently could have been used to greatest advantage in production and therefore represented a large capital value, quite suddenly loses its value and consequently ceases to be capital. The fact that this factory or machine continues to maintain the same high technical quality makes it difficult for anyone who envisages things from a technical rather than an economical point of view to understand that capital has been destroyed and that we have become that much poorer because of it.

—F. A. Hayek, “Capital Consumption (1932),” in The Collected Works of F. A. Hayek, vol. 11, Capital and Interest, ed. Lawrence H. White (Chicago: University of Chicago Press, 2015), 55.

Economics Does Not and Cannot Show “A Priori” That Roundabout Methods MUST Lead to a Greater Product

That roundabout methods lead to greater results than direct methods is one of the most important and fundamental propositions in the whole theory of production. It must be emphatically stated that the only basis of this proposition is the experience of practical life. Economic theory does not and cannot show a priori that it must be so; but the unanimous experience of all the technique of production says that it is so. And this is sufficient; all the more that the facts of experience which tell us this are commonplace and familiar to everybody. But why is it so? The economist might quite well decline to answer this question. For the fact that a greater product is obtained by methods of production that begin far back is essentially a purely technical fact, and to explain questions of technique does not fall within the economist's sphere. For instance, that tropical lands are more fruitful than the polar zone; that the alloy of which coins is made stands more wear and tear than pure metal; that a railroad is better for transport than an ordinary turnpike road;—all these are,matters of fact with which the economist reckons, but which his science does not call on him to explain.

But this is exactly one of those cases where, in the economist's own interest—the interest he has in limiting and defining his own task—it is exceedingly desirable to go beyond the specific economic sphere. If the sober physical truth is once made clear, political economy cannot indulge in any fancies or fictions about it; and, in such questions, political economy has never been behind in the desire and the attempt to substitute its own imaginings! Although, then, this law is already sufficiently accredited by experience, I attach particular value to explaining its cause, and, after what has been said as to the nature of production, this should not be very difficult.

—Eugen von Böhm-Bawerk, The Positive Theory of Capital, trans. William Smart (1891; repr., New York: G. E. Stechert and Co., 1930), 20.

For Menger, The Term “Capital” Belongs to the Sphere of Economic Calculation, Not Production

A considerable part of the paper of Endres and Harper is dedicated to the demonstration that Carl Menger and Ludwig Lachmann endorse the same concept of capital and that their approach has to be distinguished from those of other members of the Austrian School. In this short comment, it has been shown that this interpretation cannot be upheld at all. Rather, the opposite is true. Lachmann strongly rejects the capital concept envisioned by Menger. Their notions of capital are diametrically opposed to each other, and it is very misleading to lump them together and call them the Menger–Lachmann Trajectory. This does not imply that Lachmann’s capital theory does not build upon some central ideas contained in Menger’s Grundsätze. Even in his monograph, Menger (1888, p. 9) refers to his classification of goods into those of lower and higher order as a very important one. However, Menger makes clear that these ideas have nothing to do with capital theory. For him, “capital” is a term that belongs to the sphere of economic calculation, not to the theory of production. Menger (1888) does not elaborate on this point because his intention is mainly to criticize other theories of capital. But, in view of the evidence provided in this short comment, it should be clear that it constitutes a misclassification to lump Menger and Lachmann together.

—Eduard Braun, “The Menger-Lachmann Trajectory on Capital: A Comment on Endres and Harper,” Journal of the History of Economic Thought 36, no. 1 (March 2014): 101.

Extracting Drinking Water Was a Favorite Böhm-Bawerkian Example of “Roundabout Production”

Most important of all, time was a key factor in the decisions made by business firms about how to produce goods and services. Firms might use production techniques that yield goods relatively quickly; unfortunately, these methods usually yield few goods. Alternatively, the firm could use more roundabout techniques of production, wait longer for the goods to be produced, and in the end get more goods. To take one of Böhm-Bawerk’s favorite examples, we can extract drinking water from a spring either by hand, by bucket, or by pipes. Each successive method of production is more roundabout; and each method is also more efficient and yields more water.

Roundabout production means using more tools or capital to produce final goods for the consumer, producing more intermediate goods, and having production take place in many different stages. . . .

However, the notion of roundabout production contains a key insight — production involves a trade-off between having things soon, but having few things, and having more things, but having them in the distant future. One could have more goods in the future by giving up consumption for a long period of time; or one could consume goods now, but have fewer goods over the long haul.

Böhm-Bawerk analyzed this choice in terms of the subjective time preferences of economic agents. People decided whether they wanted goods now or whether they preferred to give up something now in order to get more in the future; and business owners determined whether more or less roundabout techniques are employed in producing goods based on whether they wanted to make some money now or more money in the future.

This idea of subjective time preference also provides the basis for Böhm-Bawerk’s theory of interest. Böhm-Bawerk first laid the groundwork for his theory of interest by presenting and critiquing all previous theories. This was done in Volume 1 of his (1884) Capital and Interest, which showed that prior attempts to explain interest based on the productivity of capital, the abstinence from consumption, or the exploitation of workers, lacked any merit and made little sense. Volume 2 (1889) then went on to present a theory of interest based on time. It also tried to show that a positive rate of interest was inevitable and therefore justified.

—Steven Pressman, Fifty Major Economists, 2nd ed. (London: Routledge Taylor and Francis, 2006), 122-123.

Hayek's Analysis Helped Changed the Direction of Austrian Economics from Micro Theory to Macro Theory

Hayek’s Prices and Production became the catalyst of controversy with the Keynesian circle at Cambridge. His book established a new approach which rivaled Keynes’s blossoming theory of aggregate demand and countered demands for big government during the great depression. What made Hayek’s analysis so appealing was his ability to change the direction of Austrian economics from micro theory to macro theory. This shift was essential if free-market economists were going to justify a laissez faire anti-depression policy. Hayek employed the Mengerian stages-of-production approach to develop a new way to analyze the whole economy, monetary policy and the business cycle, quite apart from the contemporary economic orthodoxy. This novel method was essential since standard classical economics seemed to be unable to cope with the growing economic abyss in the 1930s.

As O’Driscoll summarized Hayek’s efforts:

Hayek called for an entire restructuring of economic theory. In part, he was attempting to counter the revived interest in the general equilibrium theories — the neo-Walrasian and neo-Paretian theories of the 1930s as found, for example, in John R. Hicks’ writings.

[H]is work is viewed as providing a basis for a radical alternative to the “neo-classical” paradigm of efficient allocation with timeless production, perfect anticipation, costless exchanges, (almost) instantaneous attainment of equilibrium, and a world of no institutions . . .

—Mark Skousen, The Structure of Production, new rev. ed. (New York: New York University Press, 2015), 42.

The Transformation of Goods of Higher Order into Goods of Lower Order Takes Place in Time

Menger talks of higher-order goods [production goods or produced instruments of production] being sequentially “transformed” until their emergence as consumption goods [first-order goods, lowest order goods]. At an early stage in the development of civilization people learn that they can do more than simply “gather the goods of lowest order that happen to be offered by nature” and can deliberately and carefully fashion more productive means of production, production goods. Doing so, however, takes time.

The transformation of goods of higher order into goods of lower order takes place, as does every other process of change, in time. The times at which men will obtain command of goods of first order from the goods of higher order in their present possession will be more distant the higher the order of these goods.

Production goods thus exist at any moment in time in a structure of production. The structure of production reflects the fact that production takes time. Some production services must be used sooner than others, and some production services must be used together as complementary inputs. Because production takes time, and because time is valuable, the “longer” the process of production the more productive of utility it must be in order to be economically justifiable. And the longer one takes in production, the more opportunity is available to perfect the quality and/or increase the quantity of what is being produced.

—Peter Lewin and Nicolas Cachanosky, Austrian Capital Theory: A Modern Survey of the Essentials, Cambridge Elements in Austrian Economics (Cambridge, UK: Cambridge University Press, 2019), 5-6.