Section [ ]. Austrian Business Cycle Theory
In light of the problems with other potential explanations discussed in
the preceding section, a theory is needed which would formulate a
mechanism through which economic crises are caused by the economy
becoming temporarily less capable of producing enough of what consumers
actually want in a genuine way. One promising candidate is the Austrian
Business Cycle Theory (ABCT).
In this paper, I will attempt to apply to the US Great Depression and
the period preceding it in which its causes should be sought the version
of ABCT formulated in more detail elsewhere .
The version of ABCT in question tries to assign a definite meaning to
the rather vague intuition that the unsustainable boom preceding the
bust and economic decline consists in an unjustified lengthening of the
economy’s temporal production structure in comparison to the time
structure of consumer demands. The proposed answer is to put into the
focus the micro-level elements of such deviations – the excessively
long investment projects.
The latter projects are excessively long because they divert certain
types of resources (the “contested goods”) away from competing
projects (the “closer-to-production projects”) which would have
resulted in the production of final consumer goods earlier, and whose
product would have been in keeping with the consumer demands. There does
not need to be an absolute difference in duration among these two
clusters of projects; just that by the time the excessively long
projects are launched they must be further than the closer-to-production
projects from resulting in the production of final consumer goods.
The excessively long projects may manage to divert the contested goods
from the closer-to-production projects because the credit expansion may
temporarily provide them with funds for investment at interest rates
which makes them more profitable than they were before with nothing else
changed. In contrast to this scenario, an increase in the amount of
investable funds through increased savings would first have led to
decreases in the prices of some consumer goods and then, in turn, in
some of the inputs used to produce them. This would serve as a signal
which of the previously unprofitable projects have become more
profitable and would motivate entrepreneurs to seek credit financing for
exactly such projects. Overall, this would tend to channel the
savings-based additional credit into non-distorting applications.
In the ABCT scenario, the originators of the excessively long projects
are capable of securing the supply of part of the contested goods needed
for their undertakings at prices which do not properly reflect the fact
that the demand for these goods for the relevant period has
significantly increased compared to the expectations based on the past
realities. This leads to the excessively long projects becoming
illusorily more profitable than they actually are. The economic
realities reestablish themselves when the originators of the
closer-to-production projects discover that they are suddenly in
competition with the excessively long projects for the contested goods,
and that they are not able to secure the full supply of the needed
contested goods at the current prices. The shortage of the relevant
final consumer goods leads to the increasing prices which, in turn,
allows the originators of the closer-to-production projects to bid up
the prices of the contested goods. This frustrates the calculations on
which the excessively long projects are based and creates cost overruns
which may be fatal for them.
The economy-wide problems arise from the resultant malinvestments
because part of economy’s capital goods are trapped in the troubled
excessively long projects and it takes time and resources to reallocate
it. The time factor does not just concern mere physical reallocation,
the new uses for the capital need to be discovered by entrepreneurs who
also need to secure funding for the reallocating projects.