Lesson 5 of 8
Capital goods need each other
Lachmann's chain from heterogeneity to structure. A machine without the things that belong beside it is worth less than it cost, and often much less.
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
- Almost no capital good produces anything alone. Complementarity, in Lachmann's phrase, is of the essence of capital use.
- Which combinations work is not given to the entrepreneur. Only a few of the technically possible ones are worth anything, and finding them takes time and effort.
- When an unexpected change breaks a combination, some of its parts find good second uses and the rest go to second-best ones. That asymmetry is where capital loses value.
A lathe is worth something because of what sits around it: the power supply, the trained operator, the supplier of blanks, the customer who wants what it makes. Remove enough of those and the lathe is scrap with a serial number.
Lachmann's chain, in five steps
- 1Capital is heterogeneousThe goods differ from one another in kind
- 2So it is heterogeneous in useDifferent goods do different jobs
- 3Which implies multiple specificityEach good fits a limited set of uses
- 4Which implies complementarityGoods have to be used jointly to produce at all
- 5Which gives capital combinationsAnd the combinations are the elements of the structure
The claim
Lachmann states it plainly in the opening chapter of Capital and Its Structure, published in 1956: it is hard to imagine any capital resource which by itself, worked by labour but without other capital resources, could turn out any output at all. For most purposes capital goods have to be used jointly, and complementarity is of the essence of capital use.
The word he uses for a working set is a combination.
Why the right combination is not given
This is the part that matters for a cycle. Lachmann argues that heterogeneous resources do not lend themselves to being combined in any arbitrary way. For any given set, only certain modes of complementarity are technically possible, and only a few of those are economically significant.
The best combination is therefore not a datum. It is not handed to the entrepreneur, who as a rule has to spend a good deal of time and effort finding out what it is, and who does not enjoy the answer for long, because circumstances start changing again.
What a disruption does
Unexpected change makes some new uses possible and forces others. Lachmann's observation is that it opens possibilities for some resources and not for all, so existing combinations disintegrate and the rest of the parts have to be turned to second-best uses.
That sentence is the mechanism by which a bust destroys value without destroying anything physical. No machine is smashed. The set it belonged to stops existing, and the machine is worth what its second-best use will pay.
Why it matters for a thesis
Because it explains a pattern any analyst has seen: a company whose assets look sound on the balance sheet and whose returns have collapsed. Nothing was written down, because nothing broke. What changed was the set of arrangements that made those assets productive together.
The forward question for a reader is narrow and answerable: what has to stay true around this asset for it to keep earning, and is that in the filing.
Check yourself
What does Lachmann mean by complementarity?
- That capital goods compete with labour
- That capital goods have to be used jointly, because almost none produces anything alone
- That every machine has a spare
Show the answer
Answer: B.
He writes that it is hard to imagine any capital resource that, worked by labour alone without other capital resources, could turn out any output at all.Why is the best combination not given to the entrepreneur?
- Because information is deliberately hidden
- Because only some combinations are technically possible and only a few of those are economically significant, so it has to be found
- Because technology changes too slowly
Show the answer
Answer: B.
Lachmann says the entrepreneur as a rule spends considerable time and effort finding it, and does not enjoy the answer for long.How does a disruption destroy value on this account?
- By physically damaging assets
- By breaking combinations, so that some parts find good second uses and the rest go to second-best ones
- By raising the interest rate
Show the answer
Answer: B.
Unexpected change opens possibilities for some resources and not all, which is why the loss shows up in earnings rather than in a write-off of something broken.Sources
- Lachmann, Capital and Its Structure, 1956, chapter 1, on complementarity being of the essence of capital use, on only some modes of complementarity being technically possible and fewer economically significant, on the best mode not being a datum, on unexpected change causing the disintegration of existing capital combinations, and on the chain from heterogeneity through multiple specificity to capital combinations and the capital structure.
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 press and the 10m are invented round figures chosen to show a loss that happens outside the asset. No company is described.
- Lachmann's own position moved over his career towards greater doubt about whether plans converge at all, and that doubt is in the market-process course rather than here.