Mises’s Theory of Capital Is a Theory of the Way Monetary Calculation Based on Financial Capital Helps Entrepreneurs Organize the Production Process

Capital, in Mises’s view, is a basic and indispensable tool of economic calculation used by entrepreneurs in capitalist economies, that is, in market economies. He clearly considers it as an historically specific concept:

The concept of capital cannot be separated from the context of monetary calculation and from the social structure of a market economy in which alone monetary calculation is possible. It is a concept which makes no sense outside the conditions of a market economy. It plays a role exclusively in the plans and records of individuals acting on their own account in such a system of private ownership of the means of production, and it developed with the spread of economic calculation in monetary terms. (Mises, 1949: 262)

 Monetary calculation based on capital is possible only under capitalism. Owing to the tools of capital accounting, entrepreneurs are able to compare the economic significance of their inputs and their outputs even in a complicated and dynamically “changing industrial economy” (Mises, 1949: 511). That is what distinguishes capitalism from other economic systems: “[O]nly people who are in a position to resort to monetary calculation can evolve to full clarity the distinction between an economic substance [capital] and the advantages derived from it [income], and can apply it neatly to all classes, kinds, and orders of goods and services” (Mises, 1949: 261). Mises’s theory of capital is a theory of the way monetary calculation based on (financial) capital helps entrepreneurs to organize the production process under capitalism. One could also say that his theory of capital is a theory of capitalism, a theory of how entrepreneurial operations are guided by capital accounting.

 —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), 45-46.

The Cause of Boom-Bust Asymmetry Is NOT Krugman’s Nominal Wage Rigidity But Mass Destruction of Productive Relationships

Paul Krugman (2013), by no means an adherent to Austrian economics, has drawn attention to the asymmetry problem of booms and busts: the phenomenon that increased unemployment occurs during the structural adjustments of the bust, but not during the structural adjustments of the boom, which he explains by reference to downward wage rigidity. During a boom period wages tend to rise, but during the bust they do not fall as much and as rapidly as they should in order to prevent increased unemployment. 

An alternative explanation is provided by Andolfatto (2013), who argues that the most obvious cause for asymmetry is not to be found in nominal rigidities, but rather in the mass destruction of productive relationships, which takes place during the bust. In his view, the labor market is a market for productive relationships, or what he calls relationship capital. Just like physical capital, relationship capital is redirected onto unsustainable paths during the boom. Relationships are built up, intensified, replaced or adjusted during the boom, merely to get destroyed during the bust. In his own words:

The basic idea is very simple. [. . . ] The labor market is a market for productive relationships. It takes time to build up relationship capital. It takes no time at all to destroy relationship capital. (It takes time to build a nice sandcastle, but an instant for some jerk to kick it down.) (Andolfatto, 2013)

—Karl-Friedrich Israel, “The Costs and Benefits of Central Banking: Modern Monetary Economics along a Methodological Dividing Line” (PhD diss., Université d’Angers, 2017), 250-251.

Mises and Menger Are Outliers within the Austrian School When It Comes to Capital Since They Adopt the Financial Capital Concept

Ludwig von Mises never produced a work devoted solely to an exploration of the meaning of capital or its role in the economy. Other Austrian school economists such as Böhm-Bawerk (1890), Hayek 1941a), Lachmann (1956), and Kirzner (1966) all published books on the subject, in addition to numerous articles. Mises’s views must be gleaned from his remarks in works devoted to other specific or general topics. He did not enter into any “capital controversy” or specifically consider them. Yet, his views on capital are interesting and highly suggestive in a way that we believe has been generally underappreciated. In particular, Mises seems to be something of an outlier within the Austrian school when it comes to capital — though his position is arguably foreshadowed in a neglected article by Menger (1888).

Only very recently has the issue of a dissenting view on capital by the older Carl Menger been noted (Braun, 2015 a, b). In this article Menger opposed all attempts to define capital as something physical. He considered it necessary to stick with common terminology where capital relates to sums of money dedicated to the acquisition of income. But, having come this far, Menger does not do much more than criticize other definitions of capital, opting for the abandonment of physical capital concepts in economics. 

In particular, he does not indicate what a capital theory that is based on the financial capital concept he endorses would look like (Braun, 2015a: 91). 

Of the later Austrians, only Mises based his discussion of capital on Menger’s (1888) financial capital concept. Both in his treatise on socialism (Mises, 1922: 123) and in his magnum Opus, Human Action, Mises (1949: 262), he stuck to the more common understanding of capital and chose to orient his definition of capital to business practice. For him, capital is a sum of money which is determined by accounting. As previously quoted:

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. It does not matter in what these assets may consist, whether they are pieces of land, buildings, equipment, tools, goods of any kind and order, claims, receivables, cash, or whatever. (Mises, 1949: 262)

To Mises, it is not physical characteristics that determine whether assets are part of capital or not. Of primary interest is rather which role they play in the operations of business units (Lewin, 1998). Thus, Mises, together with Menger (1888), deviates from the majority view of the Austrian school on capital. Different from Menger (1888), however, Mises (1920, 1922, 1949) actually contains several hints as to what a capital theory based on a financial capital concept would look like. 

 —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), 41-42.

“Regime Uncertainty” and “Big Players” Make the Economy More Dependent on “Animal Spirits” or “Confidence” Instead of “Economic Calculation”

The ‘rules of the game’ are the rules of economic exchange. They include tax law, the law of contract and regulations. If the rules of the game are ambiguous or changeable, investors experience uncertainty and ignorance of the future. If the rules of the game are known and stable, investors experience greater prescience. They have greater confidence in their guesses about the future. Irregular and arbitrary taxes, for example, make it harder to estimate the prospective profit of alternative investments; a simple regular and transparent tax code eliminates one source of uncertainty, helping investors to formulate a serviceable, if not perfectly strict, mathematical expectation of prospective yields. Robert Higgs (1997) has coined the term ‘regime uncertainty’ to describe situations in which the rules of the game are uncertain. As we shall see, regime uncertainty discourages investment (regime uncertainty is the cause, reduced investment the effect). 

Big Players are economic actors with three characteristics. Firstly, they are big enough to influence the market or markets in question. Secondly, they are largely immune from the discipline of profit and loss. Thirdly, they act on discretion and are not bound by any simple rules. Activist central bankers are paradigmatic Big Players. A private actor might be a Big Player, but only in the relatively short run or if it is a protected monopoly. As I argue below, Big Players are hard to predict. They reduce the reliability of economic expectations, which encourages both herding and contrarianism in financial markets. Big Player influence drives investors towards greater ignorance and uncertainty. For example, discretionary monetary policy makes it hard to estimate the future purchasing power of the currency and, therefore, the value of alternative investments: a simple monetary rule eliminates one source of uncertainty, helping investors to formulate a serviceable mathematical expectation of prospective yields. Koppl (2002) has developed the theory of Big Players and I will draw on that and related work in this monograph. 

When there is Big Player influence or regime uncertainty investors become more ignorant, less prescient. As they grow more ignorant their investment decisions cannot depend as fully on strict mathematical expectation, since the basis for making such calculations is correspondingly weakened. They are more likely to follow the crowd and to base their decisions on an overall sense of optimism or pessimism rather than independent judgements of prospective yield. In these circumstances, the state of confidence becomes more arbitrary and more self-referential. More or less arbitrary swings of optimism and pessimism are now more likely. Regime uncertainty and Big Players make the economy look more Keynesian as it is more dependent on ‘animal spirits’ rather than economic calculation, which becomes more difficult. As we shall see, there is a sense in which Big Players and regime uncertainty reflect ‘Keynesian’ policies, which suggests the self-defeating nature of Keynesian macroeconomic policy: Keynesian policies tend to create a Keynesian economy.

—Roger Koppl, introduction to From Crisis to Confidence: Macroeconomics after the Crash, Hobart Paper 175 (London: Institute of Economic Affairs, 2014), 14-16.