ABC vs. Recalculation
By Arnold Kling
A reader asks me to explain the difference. Answer below the fold.I think of Austrian Business Cycle theory as based on the notion that the structure of production can be long or short. Or, if you will, more roundabout or less roundabout. Should I build a car the less roundabout way, using labor on the assembly line, or should I build it the more roundabout way, which consists of first designing and building robots, and then using those robots on the assembly line? Workers are now divided up between working on the auto assembly line and working on building robots. This production process results in more capital per worker and more cars produced per worker.
If the interest rate is really low, that is a signal to use robots. If that signal is a misleading one created by the central bank, then I over-invest in robots. When the interest rate reverts to normal, I realize that I am using too much capital, and I go back to the process of using workers on the assembly line. However, the change-over involves unemployment.
The way I think of Recalculation, all production is roundabout. Take David Friedman’s example (in The Economics of Everyday Life), in which we grow automobiles on the wheat fields of Iowa. That is, we grow wheat, put it on ships, send it to Japan, and the ships come back with cars. That is another way of conducting roundabout production.
The signal to grow automobiles in the wheat fields of Iowa may have nothing at all to do with the interest rate. The signal involves opportunity cost, leading to PSST–patterns of sustainable specialization and trade.
Another sense in which all production is roundabout is that we are in a Garett Jones economy. Workers are not producing final product. Instead, they are producing organizational capital.
I am more with Keynes and Minsky than with the Austrians on what induces firms to invest heavily in either physical or organizational capital. That is, I think that the interest rate may not be the primary factor. I see a role for “animal spirits.” I also see a role for a Minsky cycle, in which there are periods where firms are very conservative, followed by periods where they are more speculative, followed by periods where they create Ponzi schemes.
A problem with both ABC and Recalculation is that you still need to explain unemployment. In the ABC story, why is it that we get unemployment only when firms are shifting from more roundabout production to less roundabout production, rather than the other way around? In the Recalculation story, why is it that sometimes the patterns of production evolve along paths that involve low unemployment, while at other times they involve high unemployment?
I have attempted to answer this question before, perhaps not satisfactorily. My thinking is that when new, more efficient patterns of production emerge, people are “pulled” into them gradually. That does not involve unemployment. However, when existing patterns of production break down because of sudden changes, they are “pushed” out of their jobs and they do not know where to go.
I use an immigration analogy. If people come to this country because employers lure them with good jobs, then the immigrants are employed. Instead, if people come as refugees fleeing war and starvation, they may very well not be employed when they arrive. Eventually, entrepreneurs will figure out what to do with them.
The way I see it, the end of the housing bubble, the death of the mortgage securities market, and the ongoing restructuring of the economy caused by the Internet and globalization all have combined to dump a large number of refugees into the labor market. The process of entrepreneurial trial-and-error to find PSST using these refugees is gradual. Maybe government policies are speeding up the process. Maybe they are slowing it down. I do not claim to know.
Anyway, the differences that I would emphasize with ABC are: I attach less importance to the interest rate, and less importance to the central bank; I emphasize that labor acts like capital; and I think that there are many dimensions along which production can be restructured, not just purely “longer” or “shorter.”