June 05, 2003

Roger Garrison explains why the false Krugman/Phelps "overinvestment" account of the Mises-Hayek boom-bust cycle gets everything wrong in the sense that it leaves out everthing which is important in the theory, including its central causal mechanism -- sort of like a criticism of the Darwinian theory of evolution which betrays a complete lack of awareness of the causal mechanism of natural selection (Hayek-L posting):

Fiona writes: >>But, on another issue, I wonder why the great aversion to the term "overinvestment" if Austrians regard I/GDP increasing out of sync with consumers' preferences as a part of their story?<<

The aversion stems from the popular misinterpretation of the Austrian theory as a theory that's all about overinvestment, a characterization that overlooks the malinvestment emphasized by the Austrians. The malinvestment is the first phase of the self-reversing process. In my own view, the Austians need not deny--and in fact should affirm--that there is overinvestment during the boom. What they should deny is that overinvestment is the whole story .. As understood in the context of a macroeconomy, it would seem that while malinvestment is unique to the Austrian theory, both malinvestment and overinvestment (along with overconsumption) are essential to it. Malinvestment without overinvestment would allow the counter-movements to set in early, nipping the boom in the bud. Overinvestment (along with overconsumption) without malinvestment would allow the economy to experience a temporarily high growth rate, moving first beyond and then back to the PPF but without there being any intertemporal misallocations requiring painful adjustments that can send the economy inside the frontier. Only with both prefixes (mal- and over-) in play do we have (1) a problem of intertemporal misallocation and (2) time for that problem to fester before the internal conflict of market forces eventually turns boom into bust.

Posted by Greg Ransom