Ebeling versus Cowen on Lachmann by Robert Wenzel

Tyler Cowen has found another reason to call for government intervention in the economy. He comes out in support of a German government program that subsidises companies to keep employees on the payroll. At Marginal Utility, he wrote:

Here is another factor behind the recent German economic success:

• A vast expansion of a program paying to keep workers employed, rather than dealing with them once they lost their jobs, was the most direct step taken in the heat of the crisis.

 There is much more of interest here. I would describe this as a major, still uninternalized lesson of the recent crisis, with its roller coaster-rapid dips. In a highly specialized modern economy, it is much easier to prevent jobs from being destroyed than to create them again, at least assuming those are "good" jobs in the first place. (Yes, people thought they knew this but it's an even stronger difference than had been believed.) The U.S. auto bailout, for instance, worked better than did most of the stimulus program. Most of the Austrians would disown this point, but you can pull it right out of Lachmann's Capital and its Structure.

Aside from the fact that such government subsidies can't do anything but distort the natural flow of employment in an economy, I also found curious Cowen's comment that Ludwig Lachmann was someone who held a view similar to his.

I asked Richard Ebeling, who has studied Lachmann intensively, to comment. Note Ebeling also knew Lachmann personally: In Political Economy, Public Policy and Monetary Economics, Ebeling writes:

Conversations with Ludwig Lachmann were always a great and challenging delight. I would enter his NYU office, and immediately after closing the door, he would say in his slightly gravelly and sing- song German accent, “Well, Mr.Ebeling, in these four walls we can speak our mind.” Soon we were lost in fascinating talk about the trials and tribulations of the economics profession, and its failure to successfully grapple with the dilemmas of radical uncertainty, kaleidic expectations, and disequilibrium dynamics.

Here's Ebeling on Cowen and Lachmann:

No, I would not agree with Tyler Cowen on his interpretation of Lachmann's position on supposedly the cost-minimization of keeping people employed in their current employment, rather than having to deal with reemploying them once they have lost their jobs.

A crucial element in Lachmann's view of capital (that he formulated in a number of articles and then in his book, "Capital and Its Structure,") is that the relationships between and among capital goods are those of substitutes and complements.

The Keynesian fallacy, Lachmann implies, is that Keynes tended to view and consider the capital stock has a more or less homogeneous aggregate under which all capital goods might be considered as interchangeable substitutes. Thus, any increase in capital investment lowers the "marginal efficiency of capital" (Keynes' term) of every other unit of capital, since every unit of capital is a substitute with all other capital.

But once we disaggregate the capital stock, i.e., investigate their more microeconomic interrelationships we realize that every specific capital good is brought into existence within the context of a capital investor's production plan. The capital good is expected to perform various productive "functions" in conjunction and in a complementary interdependency with already existing (or also being brought into existence) capital goods.

Each capital good fits within a time structure of production in a particular "stage" of the "orders " of production (along the lines that Carl Menger and Bohm-Bawerk formualated) from "higher order" stages of the production process to the "lower order" (closer to the consumption stage) of the production process.

Now labor, too, is not homogeneous and interchangeable. (To view it as so is to commit the "lump of labor" fallacy.) In an intensive capital using market economy, an inevitable complement is a growing specificity of skills and experience within the "labor supply." A medical doctor is not an interchangeable substitute for the knowledge skills of a lawyer, or an accountant, or an economics professor, or a computer programmer, or an auto mechanic, or an interior decorator, or a hair stylist, or . . .

As Hayek taught us long ago, the division of labor involves an inseparable division of specialized knowledge or various types.

Thus, if monetary manipulation brings about an increase in money and credit, and a resulting distortion of the rates of interest, and if this generates a tendency for misguided capital and related investments, and as a consequences capital goods and various types of labor are drawn into particular sectors of the economy and "stages" of the time structure of production, then . . .

Once the economy goes into a "correction" phase of the business cycle it is discovered that there has been a misallocation of the factors of production among those sectors and "production stages" of the market, which will require a reallocation of many of those specific capital goods and labor-skilled individuals into post-boom sustainable alternative employments.

In Lachmann's schema, this will require a revision of human plans -- including production plans. It is discovered that particular capital goods and specific "human capital" suppliers have been employed in complementary relationships that are unsustainable. These structures of physical and human capital have to be dissolved to some extent (or in some cases completely).

Each of these physical capital goods and specific-skilled workers will have to search out alternative ("substitute") production and investment plans into which they can now re-fit themselves in terms of another capital-complementarity production activity for which their production potentials and qualities would be appropriate.

In some cases, specific capital goods may be temporarily or even permanently "idle," in that their characteristics are not easily usable for alternative production plans.

With labor, some workers may discover that their skills are not easily adaptable for an alternative production plan, and they may have to "re-skill" themselves through re-training, etc. Or they may have to accept a lower rate of remuneration (given an alternative employer's anticipated lower estimate of the value of their marginal product compared to their previous employment). Or they may have to relocate geographically to find employment as a complementary factor of production in an alternative investment plan.

The knowledge and "re-coordination" problem in this process is that it is mostly impossible to know the answer to these necessary readjustments and adaptations other than allowing the individual actors in the market to search, explore, discover, and be "alert" to what the opportunities may or may not be in a post-boom competitive market environment (in terms of price and wage flexibility, resource mobility, etc.).

Government interventions and "stimulus" gimmicks merely serve to delay the adjustments and further distort an already distorted market. It is an attempt to maintain capital and labor complementary production and investment structures that are unsustainable in many of the patterns generated during the boom phase of the business cycle.

Understanding Ludwig Lachmann's insightful analysis of capital complementarity and substitutability, and its application to labor skills, reinforces why the Keynesian macro approach is inherently flawed. It only hides from view all the relevant microeconomic relationships that bind all consumption and production activities into one interdependent market process.