Lesson 3 of 8
Kaldor, and the concertina
With credit elastic, does the interest rate or the level of real wages decide what gets built? Kaldor said the rate, and doubted the mechanism.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- The dispute is about what governs the form of investment when money is elastic: the interest rate alone, or the rate together with the level of real wages.
- Kaldor's case, as his opponent reported it, assumes a firm can get any quantity of factors at the going price. Hayek's answer is that this assumes away the scarcity the argument is about.
- This course could not obtain either of Kaldor's papers. The objection is taught from the reply, and that is a weaker footing than the rest of the course.
Nicholas Kaldor wrote two papers against this theory in Economica, in 1939 and 1942. The second gave the mechanism the name it is still known by: the concertina effect, for a structure of production said to lengthen in the boom and shorten again in the bust.
What decides which method a firm builds
The rate decides, on Kaldor's side
- With money available at the going rate, the choice is a present-value calculation.
- The method with the highest profit once the equipment exists wins.
- A change in real wages moves all methods' costs together.
- So the rate of interest governs the form of investment.
Wages and scarcity also decide, on Hayek's side
- Building the equipment takes time, and the interval has to be financed with real goods.
- The comparison leaves out the cost of creating the extra capital.
- What one firm can obtain at the going price, all firms cannot.
- So the supply of real resources constrains the choice.
The disagreement is about whether real resources are available at the going price while the new capacity is built.
What the argument is actually about
The theory says a lower interest rate makes longer, more roundabout methods profitable and that the boom therefore changes the shape of production, not just its level.
The objection attributed to Kaldor, and answered by Hayek in 1942, accepts the first half and denies the second is safe. It argues that if an unlimited amount of money can be had at the given rate, the method chosen depends only on which yields the highest profit once the equipment is in place, so the interest rate rules and the level of real wages does not change the ranking.
Hayek's reply is that this compares methods using different amounts of capital without charging for the cost of creating that capital, and that it ignores what happens during the interval before the new equipment is producing. He notes that the assumption doing the work is an infinitely elastic supply of factors to the individual firm, which may hold for one firm and cannot hold for all firms at once.
Why this is the weakest-sourced lesson here
Both Kaldor papers sit behind a paywall and neither was obtained for this course. What is reported above is the objection as Hayek restated it while answering it, which is exactly the arrangement this course warns readers about in its first lesson.
So the honest position is this. The bibliographic facts are verified: Kaldor, 'Capital Intensity and the Trade Cycle', Economica, volume 6, February 1939; Kaldor, 'Professor Hayek and the Concertina-Effect', Economica, volume 9, 1942, with a comment by Hayek in the same issue. The substance is one side's account of the other side's argument. A reader who wants this objection whole should read the two papers rather than trust this page.
What survives regardless of the sourcing
Two things, and they are worth carrying into the rest of the track.
The first is that the mechanism depends on real resources being scarce in a particular way at a particular time, not simply on a rate being low. A version of the theory that skips that step is answerable by the objection above.
The second is that the argument is testable in principle. Whether the structure of production lengthens in booms and shortens in busts is a claim about observable industries, and the last lesson of this course reports what the published attempts to measure it found.
Check yourself
What is the concertina effect a name for?
- The cycle in equity prices
- The claimed lengthening of the structure of production in a boom and its shortening in the bust
- The oscillation of the money supply
Show the answer
Answer: B.
Kaldor's 1942 paper in Economica gave the mechanism that name, and the name stuck in the literature that followed.What assumption did Hayek say was doing the work in Kaldor's argument?
- That interest rates are set by the central bank
- That the supply of factors to the individual firm is infinitely elastic
- That wages are fixed by contract
Show the answer
Answer: B.
His 1942 reply points to that assumption and argues it cannot hold for all firms simultaneously, which is the case the theory is about.Why does this lesson carry a warning the others do not?
- Because the papers are in German
- Because neither Kaldor paper could be obtained, so the objection is reported from the reply to it
- Because the objection has since been withdrawn
Show the answer
Answer: B.
The course's own rule is that a criticism told only by its opponent is a weaker basis, and the lesson says so rather than presenting the account as neutral.Sources
- Kaldor, 'Capital Intensity and the Trade Cycle', Economica, volume 6, February 1939, and 'Professor Hayek and the Concertina-Effect', Economica, volume 9, 1942, with Hayek's comment in the same issue. Cited for the record; neither paper was obtained for this lesson.
- Hayek, 'The Ricardo Effect', Economica, 1942, reprinted in Individualism and Economic Order, 1948, chapter eleven: the restatement of the objection attributed to Kaldor and Wilson, the reply that their comparison omits the cost of creating the extra capital and the interval before it produces, and the identification of the elastic factor supply assumption.
What this leaves out
- This is a heterodox tradition. The mainstream account of the same phenomenon differs, and nothing here is a forecast or a view on any security.
- Kaldor's own papers were not read. His objection is stated here as Hayek reported it while answering it, which is the arrangement this course elsewhere avoids, and a reader should treat the summary accordingly.
- The two-firm example is invented to show the aggregation step. It reports no industry.