There are three shortcomings of the Hayekian triangle I wish
to bring to light.
1) Empirically, prices in all stages of production tend to
move together.
2) Related to critique 1, the Hayekian triangle assumes an
economy at full employment equilibrium.
3) The Hayekian triangle is an incoherent representation of the macroeconomy.
In his book, Risk and
Business Cycles, Tyler Cowen considers points 1) and 2)
Positive comovement [in prices of goods at both the early
and latter stages of production] poses a dilemma for theories of the business
cycle which start with the assumption of full employment. Comovement requires
that all, or nearly all sectors of the economy expand at once, as we usually
find in the data. (30)
This poses a problem for Hayek’s analysis where resources
are moving from the latter stages to the earlier stages of production. This
process is depicted below (Prices and Production, 44, 52).
Notice that the triangle gained two rows. This gain comes at
the loss of the length of the already existent rows. That is, investment
increases at the expense of consumption in the early stages of the boom. Hayek’s
model is a static one where the economy starts at a full-employment equilibrium. In the case of credit expansion it is pushed
from this equlibrium. Consumption does not
reduce to compensate for the lengthening of production and there is even an increase
in consumption as wages rise. Consumers compete with producers for resources in
an unsustainable boom that is inevitably followed by a bust. Hayek’s model describes an aspect of reality, but how
significant is that aspect? Is artificial expansion of credit necessary for this scenario?
The model assumes that the economy is at the
edge of the PPF, that it is at a full-employment equilibrium. A more likely
scenario is that the economy is constantly oscillating between the edge of the
PPF and the origin. Of course, an economy with well-functioning markets likely
operates in greater proximity to the PPF than the origin. Central bank
intervention will distort this natural fluctuation, though it is unclear in
what ways and to what extent. The state of the economy is always in flux, so
the same intervention will not always lead to the same results. The assumption
of full employment equilibrium obscures the interaction between natural
fluctuations and central bank intervention, and thus the model overemphasizes a
unique case. This might be corrected by
expanding the model to include different levels of employment.
As a model of the macroeconomy the triangle is represents a snapshot at a given point in time. In this interpretation, the
triangle is an aggregation which describes the macro economy in a misleading manner.
We might represent an individual good in Hayekian form, and trace out changes
in different stages with only minor distortion, but when used to represent the entire economy the triangle
must implicitly assume price levels similar to those for which he critiques his
peers. In his critique of Hawtrey’s discussion of the price level Hayek writes,
But the main concern of this type
of theory is avowed, with certain suppositions ‘tendencies, which affect all prices equally, or at any rate,
impartially, at the same time in the same direction.’ And it is only after the
alleged causal relation between changes in the quantity of money and average
prices has thus been established that effects on relative prices are
considered. (5)
But Hayek refers to the price ratios between the stages of
production. In referring to the macro economy, he must be referring to the ratio of price levels between the stages (assuming that stages can be neatly represented at this level of analysis). Hayek
did not to apply this critique to his own theory.
As a representation of the macro economy, the triangle also
errs in predicting the nature of new investments. Consider Hawtrey’s critique
of Hayek’s stages.
It is quite likely that the
additional investment will be predominantly in the earlier stages, but it is
not necessarily so. It might happen that the next most remunerative openings
for investment are mainly or exclusively among the later stages. There is no
necessary connection between the margin of investment and the stages, and the
introduction of the stages into the exposition of the extension of investment
serves no useful purpose. (243)
There may be a tendency
for increased investment in the later earlier stages, but that tendency ought not
preclude a broadening of the triangle’s base. Hawtrey also argues that there is
a continual deepening of the capital structure during booms and depressions.
Expansion may augment this deepening but it can also broaden the capital
structure during the boom period if there are unrealized gains in the later
stages that result from the lowering of the interest rate.
Unlike the problem first discussed, I am not sure that these last two can be easily corrected. In terms of macroeconomic analysis, we are left with a triangle whose usefulness is exceeded by its obscurantism.
