America's Great Depression (16 page)

Apart from neglecting the price system, the principle’s view of the entrepreneur is hopelessly mechanistic. The prime function of the entrepreneur is to
speculate
, to estimate the uncertain future by using his judgment. But the acceleration principle looks upon the entrepreneur as blindly and automatically
responding to present
data (i.e., data of the immediate past) rather than estimating future data.

Once this point is stressed, it will be clear that entrepreneurs, in an unhampered economy, should be able to forecast the supposed slackening of demand and arrange their investments accordingly. If entrepreneurs can approximately forecast the alleged “acceleration principle,” then the supposed slackening of investment demand, while leading to lower activity in those industries, need not be
depressive
, because it need not and would not engender losses among businessmen. Even if the remainder of the principle were conceded, therefore, it could only explain fluctuations, not depression—not the cluster of
errors
made by the entrepreneurs. If the accelerationists claim that the errors are precisely caused by entrepreneurial failure
Some Alternative Explanations of Depression: A Critique
65

to forecast the change, we must ask, why the failure? In Mises’s theory, entrepreneurs are prevented from forecasting correctly because of the tampering with market “signals” by government intervention. But here there is no government interference, the principle allegedly referring to the unhampered market. Furthermore, the principle is far easier to grasp than the Mises theory.

There is nothing complex about it, and if it were true, then it would be obvious to all entrepreneurs that investment demand
would
fall off greatly in the following year. Theirs, and other people’s, affairs would be arranged accordingly, and no general depression or heavy losses would ensue. Thus, the hypothetical investment in seven-year locust equipment may be very heavy for one or two years, and then fall off drastically in the next years. Yet this need engender no depression, since these changes would all be discounted and arranged in advance. This cannot be done as efficiently in other instances, but certainly entrepreneurs should be able to foresee the alleged effect. In fact, everyone should foresee it; and the entrepreneurs have achieved their present place precisely because of their predictive ability. The acceleration principle cannot account for entrepreneurial error.11

One of the most important fallacies of the acceleration principle is its wholly illegitimate leap from the single firm or industry to the overall economy. Its error is akin to those committed by the great bulk of Anglo-American economic theories: the concentration on only two areas—the single firm or industry, and the economy as a whole. Both these concentrations are fatally wrong, because they leave out the most important areas: the
interrelations
between the various parts of the economy. Only a
general
economic theory is valid—never a theoretical system based on either a partial or isolated case, or on holistic aggregates, or on a mixture of the two.12 In the case of the acceleration principle, how did the 20

11The “Cobweb Theorem” is another doctrine built on the assumption that all entrepreneurs are dolts, who blindly react rather than speculate and succeed in predicting the future.

12Anglo-American economics suffers badly from this deficiency. The Marshallian system rested on a partial theory of the “industry,” while modern
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America’s Great Depression

percent increase in consumption of the firm’s product come about?

Generally, a 20 percent increase in consumption in one field must signify a 20 percent
reduction
of consumption somewhere else. In that case, of course, the leap from the individual to the aggregate is peculiarly wrong, since there is then no overall boom in consumption or investment. If the 20 percent increase is to obtain over the whole economy, how is the increase to be financed? We cannot simply postulate an increase in consumption; the important question is: how can it be financed? What general changes are needed elsewhere to permit such an increase? These are questions that the accelerationists never face. Setting aside changes in the supply or demand for money for a moment, increased consumption can only come about through a
decrease
in saving and investment. But if aggregate saving and investment must
decrease
in order to permit an aggregate increase in consumption, then investment
cannot
increase in response to rising consumption; on the contrary,
it must
decline
. The acceleration principle never faces this problem because it is profoundly ignorant of economics—the study of the working of the means–ends principle in human affairs. Short of Nirvana, all resources are scarce, and these resources must be allocated to the uses most urgently demanded by all individuals in the society. This is the unique economic problem, and it means that to gain a good of greater value, some other good of lesser value to individuals must be given up. Greater aggregate present consumption can only be acquired through lowered aggregate savings and investment. In short, people choose between present and future consumption, and can only increase present consumption at the expense of future, or
vice versa
. But the acceleration principle neglects the economic problem completely and disastrously.

economics fragments itself further to discuss the isolated firm. To remedy this defect, Keynesians and later econometric systems discuss the economy in terms of a few holistic aggregates. Only the Misesian and Walrasian systems are truly general, being based themselves on interrelated individual exchanges. The Walrasian scheme is unrealistic, consisting solely of a mathematical analysis of an unrealizable (though important) equilibrium system.

Some Alternative Explanations of Depression: A Critique
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The only way that investment can rise together with consumption is through inflationary credit expansion—and the accelerationists will often briefly allude to this prerequisite. But this admission destroys the entire theory. It means, first, that the acceleration principle could not possibly operate on the free market. That, if it exists at all, it must be attributed to government rather than to the working of laissez-faire capitalism. But even granting the necessity of credit expansion cannot save the principle. For the example offered by the acceleration principle deals in physical, real terms.

It postulates an increased production of units in response to increased demand. But if the increased demand is purely monetary, then prices, both of consumer and capital goods, can simply rise without any change in physical production—and there is no acceleration effect at all. In short, there might be a 20 percent rise in money supply, leading to a 20 percent rise in consumption and in investment—indeed in
all
quantities—but
real
quantities and price relations need not change, and there is no magnification of investment, in real or monetary terms. The same applies, incidentally, if the monetary increase in investment or consumption comes from dishoarding rather than monetary expansion.

It might be objected that inflation does not and cannot increase all quantities proportionately, and that this is its chief characteristic. Precisely so. But proceed along these lines, and we are back squarely and firmly in the Austrian theory of the trade cycle—and the acceleration principle has been irretrievably lost. The Austrian theory deals precisely with the distortions of market adjustment to consumption–investment proportions, brought about by inflationary credit expansion.13 Thus, the accelerationists maintain, in effect, that the entrepreneurs are lured by increased consumption to overexpand durable investments. But the Austrian theory 13Another defect of the accelerationist explanation of the cycle is its stress on durable capital equipment as the preeminently fluctuating activity. Actually, as we have shown above, the boom is not characterized by an undue stress on durable capital; in fact, such non-durable items as industrial raw materials fluctuate as strongly as fixed capital goods. The fluctuation takes place in producers’ goods industries (the Austrian emphasis) and not just durable producers’ goods (the accelerationist emphasis).

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America’s Great Depression

demonstrates that, due to the effect of inflation on prices, even credit expansion can only cause
mal
investment, not “overinvestment.” Entrepreneurs will overinvest in the higher stages, and underinvest in the lower stages, of production. Total investment is limited by the total supply of savings available, and a general increase in consumption signifies a
decrease
in saving and therefore a
decline
in total investment (and not an increase or even magnified increase, as the acceleration principle claims).14 Furthermore, the Austrian theory shows that the cluster of entrepreneurial error is caused by the inflationary distortion of market interest rates.15

DEARTH OF “INVESTMENT OPPORTUNITIES”

A very common tendency among economists is to attribute depression to a dearth, or “saturation,” of “investment opportunities.” Investment opportunities open themselves up during the boom and are exploited accordingly. After a while, however, these opportunities disappear, and hence depression succeeds the boom.

The depression continues until opportunities for investment reap-pear. What gives rise to these alleged “opportunities”? Typical are the causal factors listed in a famous article by Professor Hansen, who attributed the depression of the 1930s to a dearth of investment opportunities caused by an insufficient rate of population growth, the lack of new resources, and inadequate technical 14See Hutt, “Coordination and the Price System,” p. 109.

15The acceleration principle also claims to explain the alleged tendency of the downturn in capital goods to lead downturns in consumer goods activity.

However, it could only do so, even on its own terms, under the very special—and almost never realized—assumption that the sale of consumer goods describes a sine-shaped curve over the business cycle. Other possible curves give rise to no leads at all.

On the acceleration principle, also see L. Albert Hahn,
Common Sense
Economics
(New York: Abelard–Schuman, 1956), pp. 139–43; Ludwig von Mises,
Human Action
(New Haven, Conn.: Yale University Press, 1949), pp. 581–83; and Simon S. Kuznets, “Relation Between Capital Goods and Finished Products in the Business Cycle,” in
Economic Essays in Honor of Wesley C. Mitchell
(New York: Columbia University Press, 1935), pp. 209–67.

Some Alternative Explanations of Depression: A Critique
69

innovation.16 The importance of this doctrine goes far beyond Hansen’s “stagnation” theory—that these factors would behave in the future so as to cause a permanent tendency toward depression.

For the “refuters” of the stagnation theory tacitly accepted Hansen’s causal theory and simply argued empirically that these factors would be stronger than Hansen had believed.17 Rarely have the causal connections themselves been challenged. The doctrine has been widely assumed without being carefully supported.

Whence come these causal categories? A close look will show their derivation from the equilibrium conditions of the Walrasian system which assumes a constant and evenly rotating economy, with tastes, technological knowledge, and resources considered given. Changes can only occur if one or more of these givens change. If new net investment is considered the key to depression or prosperity, then, knowing that new investment is zero in equilibrium (i.e., there is only enough investment to replace and maintain capital), it is easy to conclude that only changes in the ultimate givens can lead to new investment. Population and natural resources both fall under the Walrasian “resource” category.

Hansen’s important omission, of course, is
tastes
. The omission of tastes is enough to shatter the entire scheme. For it is
time preferences
(the “tastes” of the society for present
vis-à-vis
future consumption) that determines the amount that individuals will save and invest. Omitting time preferences leaves out the essential determinant of saving and investment.

New natural resources, a relatively unimportant item, is rarely stressed. We used to hear about the baleful effects on the “closing of the frontier” of open land, but this frontier closed long before the 1930s with no ill effects.18 Actually, physical space by itself provides 16Alvin H. Hansen, “Economic Progress and Declining Population Growth,” in
Readings in Business Cycle Theory
(Philadelphia: Blakiston, 1944), pp. 366–84.

17For an example, see George Terborgh,
The Bogey of Economic Maturity
(Chicago: Machinery and Allied Products Institute, 1945).

18Curiously, these same worriers did not call upon the federal government to abandon its conservation policies, which led it to close millions of acres of public
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America’s Great Depression

no assurance of profitable investment opportunities. Population growth is often considered an important factor making for prosperity or depression, but it is difficult to see why. If population is below the optimum (maximum real income per capita), its further growth permits investment to increase productivity by extending the division of labor. But this can only be done through greater investment. There is no way, however, that population growth can stimulate
investment
, and this is the issue at hand. One thesis holds that increased population growth stimulates demand for residential construction. But demand stems from purchasing power, which in turn stems ultimately from production, and an increase in babies may run up against inability to produce enough goods to demand the new houses effectively. But even if more construction is demanded, this will simply reduce consumption demand in other areas of the economy. If total consumption
increases
due to population growth (and there is no particular reason why it should), it will cause a
decline
in saved and invested funds rather than the reverse.