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Capital and Its Structure (Studies in economic theory)

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Lachmann is recognized (among Austrians at least) for stressing the importance of disequilibrium more so than most Austrians. Capital is always in disequilibrium, so we can only understand capital structure by thinking in terms of disequilibrium. While there is no doubt that Lachmann criticized neoclassical general equilibrium theory, there are other elements of his analysis that deserve attention.

Lachmann stressed the role of financial markets. Lachmann insisted that "When left free of political intervention, the market grows institutions in response to challenges ... Among these institutions forward markets and the stock exchange call for our particular attention" (p67). This is a critical point. Neoclassical economists never tire of pointing out that general equilibrium require a complete set of markets, including forward markets. Lachmann thought of capitalism as an evolutionary system, and certain financial markets evolve to solve coordination problems. Of course, financial markets are incomplete. But what is the alternative?

In my own interpretation, Lachmann's insight into how financial markets evolve to solve coordination problems is his most important contribution. His insight into financial markets explains his discontent with general equilibrium analysis, as well as the primary advantages of the capitalist system over its alternatives. Capital and its Structure is a short and insightful book. More economists should read it, including more Austrians.

This is Ludwig Lachmann's best work on economics. Written in 1956, this small book made little to no impact upon the then dominant neo-classical paradigm, even though it should have. This can be explained because Lachmann was an advocate of Karl Menger's Austrian method and a pupil of Fredrick von Hayek at the London School of Economics. Both Hayek and the ideas of Menger were unfashionable during the publication of this work.

Lachmann dissects most neo-classical economic models for relying too heavily upon a homogeneous concept of capital. He reminds us in this small volume that capital goods are heterogeneous and valued as such through the eyes of the entrepreneur/individual actor.

In his own words:

"The generic concept of capital... has no measurable counterpart among material objects; it reflects the entrepreneurial appraisal of such objects. Beer barrels and blast-furnaces, harbour installations and hotel-room furniture are capital not by virtue of their physical properties but by virtue of their economic functions. Something is capital because the market, the consensus of entrepreneurial minds, regards it as capable of yielding an income (Lachmann 1956: xv)."

The impact of such a work is important, especially when thinking about business cycle theory. If integrated with other Austrian works, this idea solidifies the concept of Malinvestment, a distinctly Austrian term.

Peter Lewin is the only contemporary Austrian who has written at length on Lachmann's capital theory. This is almost ironic because, as Lewin himself notes, capital theory is probably the most important topic in Austrian economics and yet no Austrian since the 1970 revival has written about it.

Well for those who ever develop an interest in capital theory, the Austrian position can be found here in this short little book. Lachmann's book is a tour de force. It is important to remember that Lachmann is describing a world in perpetual disequilibrium (i.e., the real world). This means that the prices for goods are not yet equlibrium prices. Therefore, it makes no sense at all to speak of aggregate values of capital goods. We cannot add up all the capital goods (in monetary terms) and hope to get a reliable or meaningful measure of the value of capital. Now while it is clear that we cannot add computers and automobiles, Lachmann goes even further and argues that we cannot even add up their monetary values (prices) because these prices are disequilibrium prices. This is because all capital goods are used in some production plan. But not all production plans succeed. Business is about success AND failure. Therefore, the prices of these capital goods are not accurate because the use to which they are put will result in failure and error. Prices of capital goods in a disequilibrium world cannot serve as accurate indicators of value. This is why Lachmann spoke of capital as a "structure."

This is the theory of capital Lachmann employs in this book. He makes use of several illustrative examples throughout the book. This theory is also applied to financial markets and the Austrian business cycle theory, among other things. Austrian economists have yet to fully appreciate the implications of Lachmann's analysis. For example, how cogent is Mises' calculation argument if prices in a capitalist market are always inaccurate indicators of value? Kirznerian entrepreneurship cannot even rescue Mises' point because Lachmann challenged the very ability of prices (even in disequilibrium) to convey meaningful information in the second chapter of this book "On Expectations." There is must to be done with Lachmann's capital theory. I only hope that the silence of the contemporary Austrian school will not prevent future generations from developing Lachmann's theory further.