A RETROSPECTIVE LOOK AT THE HAYEK STORY: ROUNDABOUTNESS, STICKY CONSUMPTION, AND SEQUESTERED CAPITAL BY JAMES E. MCCLURE*, DAVID CHANDLER THOMAS* AND LEE C. SPECTOR* Abstract Friedrich Hayek’s business cycle theory, withered throughout the 1930s as he admitted that its underlying model of Böhm-Bawerkian roundaboutness was incomplete and inadequate. In 1934, Hayek started a two-volume book on capital theory, completing only one volume in 1941. Curiously, Hayek (1941) cites Hicks’ (1939) Value and Capital but not the financial measure of roundaboutness that Hicks suggested as a substitute for Böhm-Bawerkian roundaboutness. In 1967, Hicks criticized the inexplicable lags in The Hayek Story. Hayek maintained his view that consumption was sticky and responded to Hicks with a mound-of-honey analogy. Nevertheless, Hayek maintained that his business cycle theory was fundamentally correct and continued to hope that others might someday discover a capital structure theory to undergird it. Toward fulfilling Hayek’s hope, we suggest augmenting the canonical stages of production with a sequestered-capital stage where products are invented, productized, and inventoried prior to launch, uncoordinated by observable prices. *Ball State University, Department of Economics. This “preprint” is the peer-reviewed and accepted typescript of an article that is forthcoming in revised form, after minor editorial changes, in the Journal of the History of Economic Thought (ISSN: 1053-8372), issue TBA. Copyright to the journal’s articles is held by the History of Economics Society (HES), whose exclusive licensee and publisher for the journal is Cambridge University Press (https://www.cambridge.org/core/journals/journal-of-the-history-of-economic-thought ). This preprint may be used only for private research and study and is not to be distributed further. The preprint may be cited as follows: McClure, James E, David Chandler Thomas and Lee C. Spector. “A Retrospective Look at the Hayek Story: Roundaboutness, Sticky Consumption, and Sequestered Capital”. Journal of the History of Economic Thought (forthcoming). Preprint at SocArXiv, osf.io/preprints/socarxiv May 22, 2020[CITATION Hic39 \n \t \l 1033 ][CITATION Hay094 \n \t \l 1033 ] [CITATION Hic39 \n \t \l 1033 ]A Retrospective Look at The Hayek Story: ROUNDABOUTNESS, STICKY CONSUMPTION, AND SEQUESTERED CAPITAL1 By James E. McClure, David Chandler Thomas, and Lee C. Spector I rather hoped that what I'd done in capital theory would be continued by others. … [Completing it myself] would have meant working for a result which I already knew, but I had to prove. Friedrich Hayek [CITATION Hay941 \p "p. 96" \n \t \l 1033 ] I. INTRODUCTION Soon after the 1929 stock market crash, Friedrich Hayek’s lectures at the London School of Economics (LSE), highlighting an Austrian-school business cycle theory, inspired tremendous enthusiasm. According to Ludwig Lachmann [CITATION Lac82 \p "p. 630" \n \t \l 1033 ], “Hayek’s triumphal entry on the London stage with his lectures on Prices and Production,” meant that, for a time, “all important economists there [at the LSE] were Hayekians”[CITATION Lac82 \p "p. 630" \t \l 1033 ]. In his key LSE lectures, Hayek relied on Eugen von Böhm-Bawerk’s idea of roundaboutness—greater roundaboutness, depending on whether it were achieved by voluntary or “forced” saving, would enhance or diminish future efficiency and living standards. The prominence of Hayek’s Prices and Production, as Mark Skousen explains, was short-lived: 1 For comments and criticisms on earlier drafts, we thank Roger Garrison and Steven Horwitz. Any remaining errors are ours. 1 Joseph Schumpeter said that Hayek’s little book “met with a sweeping success that has never been equaled by any strictly theoretical book,” attracting young disciples John Hicks, Abba Lerner, Nicholas Kaldor, G.L.S. Shackle, E.F. Schumacher, and even Paul Sweezy. But within a few years, most wrote critically of Hayek’s capital theory, ultimately joining the Keynesians, except for Sweezy, who became a Marxist. [CITATION Sko05 \p "pp. 163-164" \t \l 1033 ] Throughout the 1930s, Hayek’s explanation of business cycles withered under the blazing criticisms that Frank Knight2 and others had of the Böhm-Bawerkian model of capital roundaboutness that Hayek’s cycle-explanation was built upon. Admitting inadequacies in the Böhm-Bawerkian undergirding of his business cycle thesis, Hayek began work in 1934 on a two-volume book on capital theory to provide solid undergirding for his thesis. John Hicks (1939), in Value and Capital, provided a financial measure of roundaboutness that overcame many of the apt criticisms that had been leveled at Hayek’s Böhm-Bawerkian model. In 1941, Hayek published the first and only volume of his planned two-volume book. Although Value and Capital is listed in the bibliography of The Pure Theory of Capital, Hayek (1941) makes no reference (in either the main-text or footnotes) to 2 For a detailed chronology and analysis of the debate between Knight and Hayek that took place in the 1930s see Avi Cohen [CITATION Coh031 \n \t \l 1033 ]. Piero Sraffa [CITATION Sra321 \n \t \l 1033 ] [CITATION Sra321 \n \t \l 1033 ]was also highly critical of Hayek’s Prices and Production, bluntly asserting that “a methodical criticism could not leave a brick standing in the logical structure built up by Dr. Hayek” [CITATION Sra32 \p "p. 45" \n \y \t \l 1033 ]. For an insightful retrospective analysis of the duel between Hayek and Sraffa, see Ludwig Lachmann [CITATION Lac86 \n \t \l 1033 ]. 2 Hicks’s (1939) theory of production process duration as an alternative to Böhm-Bawerkian roundaboutness. In 1967, John Hicks challenged, as inexplicable, assumed lags in The Hayek Story (of business cycles). Hayek, who abandoned capital theory in 1941, avoided formal reengagement. This paper offers a fresh look at Hayek’s abrupt 1941 turn away from seven years of trying to discover a theory of capital to replace his much criticized Böhm-Bawerkian model of roundaboutness. Curiously, although Hayek abandoned efforts to formalize a supporting capital theory, he continued to maintain that his thoughts on the nature and causes of business cycles were fundamentally sound. This paper considers this and two related puzzles: First, why did Hayek disregard Hicks’ theory of duration? Second, why did Hayek dismiss Hicks’ criticism that “The Hayek Story” was built upon inexplicable lags via a viscosity-of-honey analogy? In light of new knowledge and recent advances in Austrian economics, we suggest additional insight into Hayek’s transformation.3 3 It has been over three decades since Bruce Caldwell’s [CITATION Cal881 \p "p. 538" \ n \t \l 1033 ] seminal analysis of the transformation of Hayek’s thinking from 1928 to 1942. Caldwell’s emphasis was upon the debates about capital theory in the 1930s and those that played out concurrently regarding the impossibility of the socialist calculation. Caldwell concluded that Hayek’s discovery that “standard equilibrium theory could be used in a defense of socialist planning” was pivotal in Hayek’s transformation: “…because no equilibrium model of the time could handle such an assumption [of subjectively-held and dispersed knowledge], it is understandable that Hayek felt it necessary to leave economics in an attempt to address the question of how plans could be coordinated in a world of subjective knowledge” [CITATION Cal881 \p "p. 536" \t \l 1033 CITATION Cal881 \p "p. 536" \n \t \l 1033 ]. 3 II. HAYEK’S BUSINESS CYCLE STORY In Prices and Production (P&P), Hayek [CITATION Hay31 \n \t \l 1033 ] offered an explanation of business cycles that was built upon a Böhm-Bawerkian model of roundaboutness. According to this theory, the original means of production (land and labor) are combined with capital, where capital is defined in terms of intermediate products that progressively add value in stages of production that ultimately mature into consumption goods. A. THE LONGSTANDING APPEAL OF SAVING-DRIVEN ROUNDABOUTNESS At a high level of abstraction, the underlying basic idea in the above, again of land, labor, and capital being combined in successive stages that culminate in consumption goods, was so straightforward and intuitive that John Hicks initially found it “irresistible” Nearly everyone who comes to the study of capital falls victim to Böhm-Bawerk’s theory at some stage or other. … [His] ideas give the subject an apparent clarity which is, at first sight, irresistible. [CITATION Hic39 \p "p. 193" \t \l 1033 ] Even Frank Knight, who “repeatedly and forcefully” [CITATION Hic39 \p "p. 193" \t \l 1033 ] throughout most of the 1930s criticized the particular details of the Hayek model used in Prices and Production, expressed similar thoughts about the “plausibility” of Böhm-Bawerkian roundaboutness in the abstract: On the face of it, there must be plausible reasons for holding that the use of more capital is equivalent to the use of more time in production; otherwise the doctrine would not have been so generally expounded and believed. It unquestionably requires time to construct capital goods, and since these are subsequently used in processes requiring time, to make a product, and are more or less used up, it is natural to consider their production and use as an indirect in place of a direct 4 application of the productive capacity going into them, and to consider the time involved in their creation, during which no final product is forthcoming, as added to that of their use to form a total production period for final product.[CITATION Kni35 \p "p. 79" \t \l 1033 ] On its face, Knight agrees with Hicks that the concept of roundabout production has an unquestionable appeal. The appeal of these ideas was built upon the common use by early capital theorists of engaging similes and examples to set the stage for analyses of capital in the complex, monetary economy.