Lesson 6 of 8
Two critics from nearby
Two critics argue the mechanism, taken at its word, produces bankruptcies without mass unemployment, and that other theories explain the facts better.
By Javier Sanz
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In one minute
- Tullock's main objection: sunk capital keeps producing, so the described process yields bankruptcies and transitional unemployment in capital goods, not an economy-wide slump.
- Salerno's reply is that abandonment, not incompletion, is the point, and that resources are bid away from the higher stages by the lower ones.
- Caplan adds two internal objections: the consumer goods industries should boom in the bust, and the theory predicts a short-run rise in current output rather than a fall.
Both critics in this lesson write from inside the liberal tradition rather than against it, and both published their objections in outlets the tradition reads. That is why they are worth a lesson of their own.
Tullock's accounting of an Austrian bust
What happens to capital already built
- Equipment inherited from before the boom keeps working.
- New capacity completed during the boom is a sunk cost and keeps producing.
- Output is sold at prices covering operating cost but not capital cost.
- Owners lose; the equipment does not stop.
What happens to capital not yet built
- Projects far enough advanced are still worth completing at the higher rate.
- Only projects a long way from completion stop.
- Those sit in capital goods industries, a small part of the economy.
- So unemployment is transitional and concentrated.
On this reading the mechanism redistributes from capitalists to workers rather than idling the economy.
Tullock's objection, and the exchange that followed
Tullock's 1987 article works through the described process step by step and reaches a conclusion he states bluntly: there would be many bankruptcies, and only minor transitional unemployment, with measured output higher rather than lower. He also picks three smaller quarrels: that the theory does not explain why the inflation cannot simply continue, that it assumes business people never learn, and that statistical tests find a random walk rather than a cycle.
Salerno replied in the following volume of the same journal. His core answer is that Tullock has missed intertemporal complementarity: a higher-stage project can be technologically complete and still be abandoned, because the non-specific inputs it needs, above all labour, have become more expensive as they are bid back toward the later stages. His iron ore mine, finished and then left idle because the ore price will not cover operating costs, is the example he uses. He also disputes the framing of the three smaller points, arguing each has a literature Tullock did not engage.
Tullock's rejoinder, printed alongside, concedes less than it appears to. He says the two of them agree on the mechanism and disagree on the word: if the Austrian depression is a qualitative sequence detectable only through theory, then it is not the thing ordinary people mean by a depression, which is mass unemployment. That exchange is the clearest single place to watch the argument being had.
Caplan's two internal objections
Caplan's essay adds objections that do not depend on expectations at all.
If the boom diverted resources away from consumer goods, then when the original preferences reassert themselves the consumer goods industries should enjoy a boom while capital goods contract. The theory predicts a reallocation of employment, and something extra is needed to explain why total employment falls.
Second, and sharper, he argues that shortening the production structure should raise current output in the short run and lower it later, because that is what switching to less roundabout methods means. A theory that identifies the readjustment with falling output has, on his reading, assumed the conclusion.
He also denies that the theory is needed to explain why capital goods industries swing hardest, offering the standard durable goods explanation: any durable purchase, consumer or producer, responds more violently to a change in expected income, because buyers can postpone replacing the stock.
What a reader is left holding
Nobody in this lesson denies that credit expansion changes the pattern of investment. The dispute is about the size and the shape of the consequence, and specifically about whether the mechanism can produce a general contraction rather than a sectoral one.
The best defence on offer is the complementarity argument: that idle higher-stage capital and rising costs of non-specific inputs interact to produce a general dislocation. Whether that is enough is exactly what the empirical lesson at the end of this course is for.
Check yourself
What is Tullock's main objection?
- That credit expansion does not lower interest rates
- That the described process produces bankruptcies and sectoral unemployment, not an economy-wide slump
- That the theory ignores the money supply
Show the answer
Answer: B.
His 1987 article argues sunk capital keeps producing and that only projects far from completion stop, which concentrates the effect in capital goods industries.What is Salerno's central reply?
- That Tullock used the wrong data
- That completed higher-stage projects can still be abandoned once non-specific inputs are bid back toward the later stages
- That the theory only applies to the 1930s
Show the answer
Answer: B.
His comment in the next volume makes intertemporal complementarity the issue, with the newly completed iron ore mine as the example.Which objection of Caplan's does not depend on expectations?
- That business people would read the theory and anticipate the policy
- That consumer goods industries should boom during the bust, so something extra is needed to explain falling total employment
- That professional speculators price the long rate correctly
Show the answer
Answer: B.
That objection is internal: it takes the mechanism as given and asks why a reallocation produces a general contraction rather than a sectoral shift.Sources
- Tullock, 'Why the Austrians Are Wrong About Depressions', Review of Austrian Economics, volume two, 1987: the three smaller objections, the sunk-cost argument, the treatment of projects part-completed at the turn, and the conclusion about bankruptcies without general unemployment.
- Salerno, 'Comment on Tullock's Why Austrians Are Wrong About Depressions', Review of Austrian Economics, volume three: intertemporal complementarity, the abandoned mine, malinvestment rather than general overinvestment, and the claim that the cycle is a qualitative sequence detectable only through theory.
- Tullock, 'Reply to Comment by Joseph T. Salerno', in the same volume: the response that the two agree on the mechanism and differ on what the word depression refers to.
- Caplan, 'Why I Am Not an Austrian Economist', an essay published on the author's university page at George Mason University, section 3.4.2: the consumer goods objection, the short-run output objection, and the durable goods explanation of capital goods volatility.
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.
- The mine example is Salerno's, restated. It is an illustration inside an argument and reports no mine.
- The volume of the journal carrying Salerno's comment and Tullock's reply is volume three; the copies consulted carry no year on the article pages, so none is stated here.