10 Dec 2011

Austrian Business Cycle Theory: Malinvestment, Not Overinvestment

Economics, Federal Reserve 20 Comments

Apropos of the recent flurry–the Austrians are apparently the Charlie Sheen of the blogosphere right now–here is an interesting quotation from Mises:

The erroneous belief that the essential feature of the boom is overinvestment and not malinvestment is due to the habit of judging conditions merely according to what is perceptible and tangible. The observer notices only the malinvestments which are visible and fails to recognize that these establishments are malinvestments only because of the fact that other plants — those required for the production of the complementary factors of production and those required for the production of consumers’ goods more urgently demanded by the public — are lacking.

The whole entrepreneurial class is, as it were, in the position of a master builder whose task it is to erect a building out of a limited supply of building materials. If this man overestimates the quantity of the available supply, he drafts a plan for the execution of which the means at his disposal are not sufficient. He oversizes the groundwork and the foundations and only discovers later in the progress of the construction that he lacks the material needed for the completion of the structure. It is obvious that our master builder’s fault was not overinvestment, but an inappropriate employment of the means at his disposal.

20 Responses to “Austrian Business Cycle Theory: Malinvestment, Not Overinvestment”

  1. Joseph Fetz says:

    I did give DK a range of pages to read from that very chapter (specifically, part 6) and from his remark he apparently did take the time to read it. Unfortunately, I made a followup comment that seems somewhat unintelligible to me after re-reading it later (bah, oh well. It happens).

    In either case, it was my hope that if DK read that portion that I supplied to him that he may be more interested in reading all of Chapter 20, because this is the chapter that pretty much lays out the foundation for the ABCT.

    It should be quite clear that it is indeed malinvestment that both Hayek and Mises are speaking about, not over-investment. I hope that DK at least agrees with that.

    • Daniel Kuehn says:

      I agree that Mises seems genuinely dedicated to the idea that it’s not overinvestment. Hayek and Austrians that have followed him definitely seem dedicated to the idea that it is both overinvestment and malinvestment.

      Maybe I need to check the comments again – I’ve been doing other things – but I had a lot of questions about the way Mises was approaching the problem, particularly this thing he says over and over again about “using r+p1+p2 as if you had a r+p1+p2+p3+p4”. This sort of inflexibility of the capital stock and complete unawareness of what capital you can procure seems strange to me, and that’s the thing he keeps saying when he says it’s not overinvestment.

      Yes, if the capital stock is completely inelastic obviously it’s impossible to “overinvest” but you can still malinvest. But unless someone can give me a reason not to, I’m going to persist in thinking that that’s not the way the world works and a better rendition of ABCT is offered by Hayek and Garrison – who both clearly think there is overinvestment with malinvestment.

      Think about what you’re saying guys. The subtle part of all this – the comparative advantage of ABCT – is in thinking about how an artificially low interest rate distorts the capital structure – ie, causes malinvestments. That’s the hard part to get across to people. The easy part is in noting that when the interest rate is artificially low, the level of investment will be artificially high. I’m not sure why that wouldn’t hold.

      Perhaps someone could explain to me WHY Mises thinks an artificially low interest rate wouldn’t cause overinvestment but would cause malinvestment?

      My guess is that he simply doesn’t want to be associated with Marxists. I certainly can’t find a more compelling reason in Mises.

      • Jonathan M.F. Catalán says:


        You missed Mises’ point. There is an underinvestment in the goods that are most urgent in accordance with actual preferences. That is, there is an underinvestment in the production of producers’ goods closer to the consumer good and in the production of consumer goods themselves. The scarcity of capital goods affects the entire structure of production, not just production farthest away from the final stage.

        So, there is both over and underinvestment, which is why Mises just distinguishes it by calling it malinvestment.

        • Joseph Fetz says:

          Thank you, Jon. I was thinking that underinvestment could just as easily be a part of malinvestment, I just didn’t have the stones to say it. Well, there is that and the fact that I am not articulate enough to explain it. However, you must admit that the ABCT does focus on the wasting of capital toward ends that are unsustainable, and that after the fact (with subjective reflection), these are the things that ultimately many people see as an over-investment.

          The problem lies, in my opinion, with the fact that the capital structure is far too slow to accommodate the inflated price changes caused by the effortless increase of the calculating unit (money/credit), that some lines of production will (due to their price) outstrip the capital structure’s ability to see them through.

          I think that this is why many like to focus on the subsequent “over-investment” dynamic, because it is something that they can see after the fact. They certainly aren’t thinking in terms of investments foregone.

          • Major_Freedom says:

            Exactly. The problem of focusing on overinvestment is due to not having learned Bastiat’s lesson of understanding what is seen and what is NOT SEEN. The underinvestment is what is not seen. This takes a little imagination and creativity to fully comprehend. What is seen doesn’t take imagination at all, because you can actually see it.

            I blame Hegel for this. I think “What is rational is actual and what is actual is rational” has corrupted the economics profession, leading practitioners to believe ABCT is an overinvestment doctrine. I think it also compelled Marx to believe capitalism will eventually collapse because of overinvestment and its alleged propensity for a permanently declining rate of profit.

            My guess is that Kuehn’s hilariously wrong suspicion that Mises was only trying to not sound like a Marxist, is really due to his inability to not think like one himself. “What else could Mises have been talking about? Obviously Mises, just like the rest of us, cannot help but fall back on Marxism somehow, so Mises must have just used a different term to refer to the same thing we all “know” is correct. This is just my sneaky way of inferring that Marxism is alive and well in the Austrian camp. Join usssssssssssssss.

            • Daniel Kuehn says:

              I really hope this whole comment is just a joke.

              • Joseph Fetz says:

                I didn’t consider it a joke when I wrote it, I was just speaking my mind.

                Which part(s) do you find comically amusing?

              • Daniel Kuehn says:

                Your last paragraph mostly the idea that I think like a Marxist, that I assume Mises does, or that this has anything to do with what I was saying about him.

              • Joseph Fetz says:

                Ah, ok. Formatting problem. I thought that you were referring to my comment, when in fact you were responding to Major Freedom.

                Don’t worry, I won’t hold it against you. I’ve done it more that a few times myself.

              • Major_Freedom says:

                I found your post to be a joke, but no, I don’t consider my whole comment to be a joke. I’m serious.

              • Major_Freedom says:

                Your last paragraph mostly the idea that I think like a Marxist, that I assume Mises does, or that this has anything to do with what I was saying about him.

                About overinvestment, yes you think exactly like Marx did.

                For if you understood Mises’ argument, then you would have known that it has nothing to do with the Marxian conception of overinvestment at all. By saying “Mises just wanted to separate himself from the Marxists” what I hear is “I think like a Marxist when it comes to overinvestment, and Mises thinks like us too, he’s just using a different word in order to distance himself from the rest of us.”

        • Daniel Kuehn says:

          I’ve taken overinvestment to be a reference to the total amount of national income going into investment.

          You’re talking about relative investment, i.e. malinvestment, which is quite different. I haven’t missed this – I’ve been talking about it all along.

          • David says:

            I’ve taken overinvestment to be a reference to the total amount of national income going into investment.

            That’s not what Mises took it to mean.

            If you take overinvestment to be a reference to the amount of incomes going to investment, then even in that view, there is no such thing as general overinvestment. For there is no limit to the amount of savings that can be profitable invested. Just one city alone could absorb the entire world’s supply of savings.

            You seem to adhere to the fallacious “paradox of thrift” doctrine, in that there is allegedly an upper limit to the amount of savings that can be profitably invested.

            In reality, there is far more profitable investment opportunities in the economy than savings could ever meet. This is because there is no practical limit to people’s desire for more real wealth. More and better houses, more and better cars, more and better food, clothes, medicine, transportation, communication, etc, etc.

            Because of this, the economy could potentially be so capital intensive so as to result in consumption representing as little as 1% of spending, while the rest is constituted by savings financed investment. Time preference will of course prevent savings and investment taking up 100% of all spending, and because of that, aggregate costs will tend to remain below aggregate revenues.

  2. Bob Roddis says:

    If I make tuna sandwiches for my kids’ friends but they hate tuna and won‘t eat them, and then I have to make them pancakes, did I over-invest in tuna sandwiches or mal-invest in them? Or both? Does it matter that I find someone else to eat the tuna sandwiches? as opposed to letting them rot? Or are we splitting hairs that don’t exist?

    BTW, I assumed that the blog hiatus was nothing but a well-planned respite.

    • Major_Freedom says:

      Roddis, obviously the solution here is for the government to print and spend money to prevent tuna fish capital and labor from being reallocated whereby production is more in line with real consumer preferences.

      I mean, come on, if the tuna fish workers got laid off, they’d make less income. How will the pancake makers then earn an income? Aggregate demand would fall if tuna fish workers got laid off. Prices would then fall (and here, conveniently, prices somehow lose their inflexibility in the downward direction), and then people would hold off on making purchases by hoarding money, which will then just make aggregate incomes fall more, which will lead to falling prices again, and before you know it, deflationary death spiral will spell doom for the economy.

      Therefore, we MUST redefine tuna fish production as “too big to fail”, and then demand that the government stand ever ready with their paper money bazookas, to bail the tuna fish producers out regardless of the consumer’s desires, because after all, we aren’t working and investing and producing for the sake of enjoying consumption, no, we’re working and toiling for the sake of working, so that the government has a source of taxation, which means employment becomes more important than what employment is directed towards. Now, since we’re not pro-capitalist, we have to retain some authority over businesses that get free money, because heck, they’re evil, so we must demand that the government “regulate” tuns fish production more (don’t ask me what specific regulations, because that’s not the actual point), so that the tuna fish producers never make the same mistakes again, that lead to the depression in the first place. Yes, the government can regulate the economy out of depressions so that they never happen again. No, the last 150 years of increasing regulations were clearly not enough, so we must label it as a time of deregulation, so that we can rescue governmental regulations away from being understood as unnecessary, and destructive.

      Clearly, tuna fish production is a microcosm of general overproduction, because after all if we can’t see what was underproduced (thus contradicting the very meaning of underproduction), then we should not consider it economically relevant. We technocrats only take into account what can be measured. I mean, that’s how physicists and chemists do it, right? The scientific method works for atoms and molecules, so surely it must work in the realm of teleology as well, right?

      Yes, the logical conclusions of my belief system is that we must eventually abolish free markets and eventually impose socialism, through piecemeal social engineering, which the Fabians LOVE LOVE LOVE, but you see, I didn’t actually explicitly advocate for socialism, so you can’t actually tell me that socialism is what I am advocating. If you did that, I’d respond with vicious attacks against you and declare a straw man. By doing so, any potential detractors will then see that free market advocates are nothing but ideological demagogues who are attacking us poor little social engineers who only have good intentions. You see, we want to retain both socialism and capitalism. It can be done. I mean, if you look at US history, government intervention into the economy has clearly stabilized. We’re not getting more regulated. No, saying that your kids are able to open a lemonade stand on the sidewalk without the government’s permission is just free market ideologue cherry picking. You have no less economic freedom today than people did when their kids could open up lemonade stands without the government’s permission. Blah blah blah, we’re fighting a war on terror, blah blah blah, the free market doesn’t work, blah blah blah, so the rules have changed and that’s why there’s more government intervention. Yes I just contradicted myself, but I am allowed to do that because the government approves of this message, and they are society’s standard of value, so you’re wrong and I’m right. The government represents the majority, and the majority defines and enforces the social contract on you, so you cannot resist. If you do, then you must move to Somalia. If you resist but stay, then clearly you are a social deviant who must be kidnapped by SWAT teams and sent away from the public discourse where you will cease corrupting our precious and fragile youth from these “dangerous” ideas.

      BTW, I assumed that the blog hiatus was nothing but a well-planned respite.

      I am not saying I actually believe this is the case, but in my mind I am thinking to myself it’s too bad you and I know some of the viewers here would not respect Murphy’s decision to take a hiatus if he did want to take one, and would use that opportunity to be classless and infer vicious accusations that would call into question Murphy’s clear devotion and forthrightness. Sometimes I am in awe at how patient he is and how much abusive language he receives. I would still respect him even if he stopped this blog entirely. I view this blog as a PRIVILEGE. Too bad some of the viewers take advantage of Murphy’s good faith, open demeanor, and no censorship policy, to wield disgusting smears and ad hominem attacks. I know, without a doubt, that these people are just praying on goodness because Murphy is fundamentally good. I’ve seen this before in other contexts, and I can only say from personal experience that the only solution that worked was for the good person/people to stop accepting it and making a stand. Murphy is against censorship, but if he one day decided to start censoring comments that are nothing but inflammatory and full of ad hominem, then speaking for myself I would support it, as it would send a message that this site really shouldn’t be a daily affirmation site for anti-social opportunists to spew their attacks for their own psychological fixation. I mean, when was the last time Murphy said something vicious to someone here? Never. Yes, Jesus took a ton of punishment, but we’re mortal humans who are more valuable than taking unjustified abuse. I don’t know if holding as a role model someone who took a lot of abuse, will “work” on those who PRAY on those who accept such abuse. Or maybe it’s not meant to be such a tactic, I don’t know. I do know that some people in the world seek out and look for such people, in order to release their hatred and anti-social tendencies. Accepting such abuse, on the basis that Jesus took way more, so it can’t be all that bad, is, I think, ultimately, what allows the bad to spread. It’s why good people tolerate the state and allow destructive behavior to spread. I think only if good people stop accepting bad things to happen to them, because good humans are more valuable than that, can the bad retreat, which is the only way the good can spread.

      But again, this is all just what I am thinking. I won’t say it’s in any way relevant to what is actually happening.

      • Silas Barta says:

        Stop mirroring mainstream economics so accurately.

        • Major_Freedom says:

          But I want to be respected by most other economists. I value being more popular in the eyes of those whose ideas collapsed the economy, than avoiding fallacies. I want to gain credentials from peers, get a cushy job with tenure, and then pretend I am more intelligent than 300,000,000 million people.

          I mean, how can you not want this? It’s all so tempting. I don’t want to be rejected by the mainstream anymore. We must join them Gandalf. We must join with the dark lord. It would be wiiiiise my friend.

    • Silas Barta says:

      Dur, what’s the problem? My Meaningful Aggregate Number Table shows your house as having produced $3 worth of sandwiches. Awesome! Now you have to produce different food, because the kids rejected the sandwiches. That means more production. EVEN MORE AWESOME!

      The only thing that could make this picture even better is if you burned your house down and had to rebuild it! That’s like, a TON more production!

      No, no, maybe if you had to fight of aliens while rebuilding it…

    • Tel says:

      … did I over-invest in tuna sandwiches or mal-invest in them? Or both?

      If your strategy to fix the tuna sandwich glut is to make even more tuna sandwiches then you might be practicing Keynesian economics.

      Remember that to a Keynesian, the economy is not made of tuna sandwiches, nor is it make of pancakes for that matter… the economy is made of Aggregate Demand which does not consist of anything in particular, and it is not divisible into anything. There is only “more” and “less” not “more of” or “less of”.

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