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THE PURE THEORY OF CAPITAL THE COLLECTED WORKS OF F.A. Hayek VOLUME XII
The University of Chicago Press Copyright © 2007 the Estate of F. A. Hayek
All right reserved.
ISBN: 978-0-226-32099-1



Chapter One THE SCOPE OF THE INQUIRY

The subject of this study is indicated in the title by the heading under which it is conventionally treated. It gives, however, no indication of the approach which we shall adopt. The contents of the following pages would perhaps have been more appropriately described as an Introduction to the Dynamics of Capitalistic Production, provided the emphasis were laid on the word Introduction, and provided that it were clearly understood that it deals only with a part of the wider subject to which it is merely a preliminary. The whole of the present discussion is essentially preparatory to a more comprehensive and more realistic study of the phenomena of capitalistic production, and it stops deliberately short of some of the most important problems that fall within that wider context.

Aims and Limitations of the Investigation

The central aim of this study is to make a systematic survey of the interrelations between the different parts of the material structure of the process of production, and the way in which it will adapt itself to changing conditions. Insofar as these complex problems have been explicitly discussed in the past they have been treated as part of the theory of capital and interest. Here they will be treated from a somewhat different viewpoint. Our main concern will be to discuss in general terms what type of equipment it will be most profitable to create under various conditions, and how the equipment existing at any moment will be used, rather than to explain the factors which determined the value of a given stock of productive equipment and of the income that will be derived from it. As will appear presently, there are in this field a number of fairly important and difficult problems which fall into what is usually regarded as the sphere of equilibrium analysis, but which have not yet received adequate attention. By far the greater part of the present investigation will be confined to that part of the subject which belongs to equilibrium analysis proper. A full treatment of the economic process as it proceeds in time, and of the monetary problems that are connected with this process, is outside the compass of this book. The discussion in justification of the distinction that is involved here, and of the methodological issues underlying it, will be reserved for the two following chapters. All that I wish to explain at this point is why the task of merely putting those elements of the theory of capital which are commonly treated as belonging to general equilibrium analysis into a form in which they will prove useful for the analysis of the monetary phenomena of the real world, is important enough to merit a separate study.

Why These Problems Discussed Here Were Neglected in the Past

It may at first be somewhat disconcerting to be told that the theory of a subject which has been so widely and so vigorously discussed right from the beginning of economic science as the theory of capital, should need almost complete recasting as soon as we try to use its results in the analysis of the more complex phenomena of the real world. But there are very good reasons why the theory of capital in the form in which it now exists has proved less useful than we should wish for the purposes for which we now need it. The fact is that the problems of capital as here understood, that is, the problems arising out of the dependence of production on the availability of 'capital' in certain forms and quantities, have hardly ever been studied for their own sake and importance. And, as we shall see, the theory of stationary equilibrium, within which they were treated, did not really offer any opportunity for their explicit discussion. Such analysis as they have received has been almost entirely subordinate to another problem, the problem of explaining interest. And the treatment of the theory of capital as an adjunct to the theory of interest has had somewhat unfortunate effects on its development. This for two reasons.

Firstly, it was carried only just so far as seemed necessary for the main purpose of explaining interest, and this explanation aimed at illustrating a general principle by the simplest imaginable cases rather than at providing an adequate account of the interrelationships under more complex conditions.

Secondly, and this is even more important, the attempts to explain interest, by analogy with wages and rent, as the price of the services of some definitely given 'factor' of production, has nearly always led to a tendency to regard capital as a homogeneous substance the 'quantity' of which could be regarded as a 'datum', and which, once it had been properly defined, could be substituted, for purposes of economic analysis, for the fuller description of the concrete elements of which it consisted. It was inevitable in these circumstances that different authors should have singled out different aspects of the same phenomenon as the relevant ones, and the consequences of this were those unending discussions about the 'nature' of capital which are among the least edifying chapters of economic science.

Attempts in the Right Direction Were Stultified by the Treatment of Capital as a Single Factor

There were of course praiseworthy exceptions, the most notable of which are to be found in the works of Jevons, Böhm-Bawerk, and Wicksell, who did at least begin with the analysis of the process of production and the rôle of capital in it, instead of with a concept of capital defined as some quasi-homogeneous magnitude. But even these authors and their followers used this analysis only in order to arrive ultimately at some single definition which, for the purposes of further analysis, lumped together as one quasi-homogeneous mass all or most of the different items of man-made wealth; and this definition was then used in the place of the fuller description from which they had started.

The Proper Starting Point Is a Full Description of the Component Parts of the Capital Structure

As we shall see, it is more than doubtful whether the discussion of 'capital' in terms of some single magnitude, however defined, was fortunate even for its immediate purpose, i.e., the explanation of interest. And there can be no doubt that for the understanding of the dynamic processes it was disastrous. The problems that are raised by any attempt to analyse the dynamics of production are mainly problems connected with the inter-relationships between the different parts of the elaborate structure of productive equipment which man has built to serve his needs. But all the essential differences between these parts were obscured by the general endeavour to subsume them under one comprehensive definition of the stock of capital. The fact that this stock of capital is not an amorphous mass but possesses a definite structure, that it is organised in a definite way, and that its composition of essentially different items is much more important than its aggregate 'quantity', was systematically disregarded. Nor did it help much further when it was occasionally emphasised that capital was an "integrated organic conception", so long as such hints were not followed up by a careful analysis of the way in which the different parts were made to fit together.

Concentration on Single Capital Concepts also Caused Neglect of Important Aspects of the Problem

This concentration on a particular capital concept to the neglect of all the multitudinous meanings which attach to the word capital in everyday speech has a further disadvantage. It is not only that the term capital in any of its 'real' senses does not refer to a homogeneous substance. There is the further difficulty that even if we describe physically all the items of which the real structure of production is composed we have not described all the factors which will dictate their mode of utilisation. The various meanings of the term capital in everyday speech are an unconscious tribute to the complexity of the problem, and it has been unfortunate that the majority of authors seem to have assumed that somewhere or other there was some single substance corresponding to the singleness of the term which had discharged so many functions.

The Two Relevant Quantitative Relationships

In fact there are at least two kinds of relevant magnitudes or rather proportions which must be taken into account if we want to understand the working of the price mechanism in this field; neither of them is a simple 'quantity', and neither of them stands in a unique relationship to the rate of interest except through its relation to the other. The first is the dimensions of the real structure of productive equipment, describing how it is organised for, or capable of, yielding various quantities of final output at different dates. The second is the proportional demands, or the relative prices, which are expected to rule for these different quantities of output at different dates. The first of these two quantitative relationships describes the proportions between the existing quantities of concrete resources in terms of their relative costs, while the second describes the relative demand for the two kinds of resources. But only together do these two sets of quantitative relationships or proportions determine what is usually regarded as the supply of capital in value terms.

These Differences Have Been Disregarded Because They Disappear in Stationary Equilibrium

The treatment of the capital problem in terms of the demand for and supply of one single magnitude is only possible on the assumption that the proportions just described stand in a certain equilibrium relationship to one another. On this assumption the result of a given supply of concrete capital goods meeting an exactly corresponding demand for them could be represented as a single-value magnitude, a quantity of capital in the abstract which could be set against a marginal productivity schedule for capital as such; and in this sense there would be a unique correlation between 'the' quantity of capital and the rate of interest. As a first explanation of the rate of interest, the consideration of such an imaginary state of ultimate equilibrium may have certain advantages. There can be little doubt that the traditional theories of interest do little more than describe the conditions of such a long-term stationary equilibrium. Since this concept of long-term equilibrium assumes that the quantities of the individual resources measured in terms of costs are in perfect correspondence with their respective values, the description of capital in terms of an aggregate of value is sufficient. Even for the purposes of what is sometimes called 'comparative statics', that is the comparison of alternative states of stationary equilibrium, it is still possible to assume that the two magnitudes move in step with each other from one position of equilibrium to another, so that it never becomes necessary to distinguish between them.

For Dynamic Analysis the Two Concepts Must, However, Be Carefully Distinguished

The problem takes on a different complexion, however, as soon as we ask how a state of stationary equilibrium can ever be brought about, or what will be the reaction of a given system to an unforeseen change. It is then no longer possible to treat the different aspects of capital as one, and it becomes evident that the 'quantity of capital' as a value magnitude is not a datum, but only a result, of the equilibrating process. With the disappearance of stationary equilibrium, capital splits into two different entities whose movements have to be traced separately and whose interaction becomes the real problem. There is no longer one supply of a single factor, capital, which can be compared with the productivity schedule of capital in the abstract: and the terms demand and supply, as referring to magnitudes which affect the rate of interest, take on a new meaning. It is the existing real structure of productive equipment (which in long-term equilibrium is said to represent the supply) which now determines the demand for capital; and to describe what constitutes the supply, writers have usually been compelled to introduce such vague and usually undefined terms as 'free' or 'disposable' capital. Even those writers who at earlier stages of their exposition have most emphatically decided in favour of only one of the meanings of the term capital, and that a 'real' capital concept, later find it necessary either to use the word 'capital' in another sense, or to introduce some new term for something which in ordinary language is also called capital. The consequent ambiguity of the term capital has been the source of unending confusion, and the suggestion has often been made (and in one or two instances even put into practice), that the term should be banned entirely from scientific usage. But much as there may be to be said in favour of this procedure, it seems on the whole preferable to use the expression as a technical term for one of the magnitudes in question, without, however, ignoring the other magnitudes which are sometimes denoted by this term. As will be more fully explained below (Chapter 4), we shall use the term capital as a name for the total stock of the nonpermanent factors of production.

Some Causes and Consequences of the Treatment of Real Capital as a Homogeneous Quantity

We cannot go into too many details at this stage. But it may be helpful to add a few words, by way of illustration, about the reasons for the general failure seriously to take account of the essentially non-homogeneous nature of the different capital items, and about the consequences of this failure. Two ideas in particular have had a very harmful effect on the whole theory of capital. The first is the idea that particular capital items represented a definite value independently of the use that could be made of them, a value which was apparently thought to be determined by the amounts 'invested' in these items. This idea is a remnant of the old cost-of-production theories of value whose influence has lingered longer in the theory of capital than perhaps anywhere else in economic theory. The second is the conception that additions to the stock of capital always mean additions of new items similar to those already in existence, or that an increase of capital normally takes the form of a simple multiplication of the instruments used before, and that consequently every addition is complete in itself and independent of what existed previously. This treatment of capital as if it consisted of a single sort of instrument or a collection of certain kinds of instruments in fixed proportions-a treatment which has won favour from the fact that it has sometimes been used explicitly as a supposed simplification-is perhaps more than anything else responsible for the idea that capital may be regarded as a simple, physically determined quantity, and that the rate of interest may be explained as a simple (decreasing) function of this quantity. It would of course follow from these assumptions that the rate of interest must steadily and continuously fall in the course of economic progress since every addition to the stock of capital would tend to lower it; and the familiar fact that the rate of interest fluctuates widely over comparatively short periods would appear to be without any foundation in the real facts and would therefore have to be ascribed entirely to the influence of monetary factors.

This Leads to an Over-Simplified Theory of Derived Demand

The organisation of the structure of real resources corresponding to any expected aggregate value of the existing stock of capital will of course depend on the kind of productive technique that is possible with that amount of capital. And the assertion that under equilibrium conditions a different structural organisation will be associated with a different value of the stock of capital means that changes in the supply of capital will bring about changes in the productive technique. The widely held idea that capital consists of (or is) a definite collection of instruments combined in fixed proportions, and the corollary of this idea, that there is at any one time only one practicable productive technique (which is supposed to be determined either by the state of technological knowledge or by the already existing durable instruments) leads to another fallacy. This fallacy, which may be conveniently described as the 'theory of derived demand', has played an important rôle in recent discussions of trade cycle problems.

(Continues...)

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