WWII and Intertemporal Discoordination

6 Replies

I have always meant to address this in a more in-depth piece, but I either never found the time or it just passed my mind.  World War II, by some, is considered a natural experiment that disproves Austrian business cycle theory.  I have heard this twice, to my recollection: recently by a commentator on Bob Murphy’s blog and when I had the pleasure of speaking to Wladimir Kraus (related: check out the second comment nested after the first by “Iwaaks” on Murphy’s blog for an explanation of the argument).

This will have to be a short post to illustrate the most important differences between an industrial fluctuation and the structural reallocation that occurred after the Second World War.  I will have to go into more detail in a future post.

The Austrian theory of intertemporal discoordination is not just about structural readjustment.  It describes an industrial fluctuation, where production is thrown into chaos by changes in the pricing process.  The task of structural readjustment is fundamentally different here, because industry is facing the consequences of pricing chaos (due, in part, to monetary fluctuations) and the financial sector has to deal with a growing loss in assets.  What this requires is a stabilization, from where the structure of production can re-adjust.

What happened after the Second World War is completely different.  Industry did not suffer a fluctuation; a mass of entrepreneurs did not suffer sudden losses.  Instead, the Second World War represented a long period of massive capital consumption.  When the war ended and war controls were eliminated, industry was able to allocate now-free resources towards more productive ends.  It was, as Robert Higgs writes, a transition from planning to market allocation.  This is a much different transition than that which occurs as a result of industrial fluctuation — one obvious difference is that industry did not find itself in the midst of chaos.

To emphasize the crucial difference: allocating resources in the midst of pricing chaos makes structural re-adjustment difficult.  This is what characterizes the bust period of the Austrian business cycle.  Following the Second World War, there was no “artificial” lengthening of the structural of production that caused pricing chaos.  Capital had been bid away from private allocation by the government towards the production of war material, but this is a different process with different consequences than severe intertemporal discoordination.  Both can lead to capital consumption, but the consumption is conducted in two different ways.  More broadly, in one case private industry is contracting and has to readjust during and after the structure of production is liquidated of all its malinvestments; in the second case, industry does not have to deal with a contraction.

The most important contribution to economics that the Austrian School has provided is a theory — perhaps incomplete — of the pricing process.  The Austrian business cycle theory is a part of this theory, as it explains the consequences of a certain type of price distortion.  To differentiate between Austrian business cycles and what occurred following the Second World War you have to understand how each scenario differently affects prices and how this defines the consequences.  The structural readjustment that occurred post-1945 is incomparable to that which occurs after an industrial fluctuation.

I will try to differentiate between the two in greater detail in the future, when I have time (and if I remember).  But, I hope that this short post at least serves to highlight the crucial difference between the two events.

  • kenderes

    Could you elaborate what your stance on debt-deflationists like Minsky and Keen is? It seems to me that ABCT leads to supply-side narratives of problems with the structure of industrial system. Yet, after reading this blog I am under impression that you acknowledge the demand-side problems and debt-driven fluctuations in effective demand too, so I am rather confused.

    • Jonathan Finegold Catalán

      I don’t think that there is a debt-deflation cycle, but liquidation of malinvestment necessarily implies the liquidation of debt. This is one cause of the subsequent credit contraction.

  • http://socialdemocracy21stcentury.blogspot.com Lord Keynes

    “To emphasize the crucial difference: allocating resources in the midst of pricing chaos makes structural re-adjustment difficult.”

    You seriously deny that WWII, from a free market perspective, did not impose pricing chaos on commodities in America??

    The US still had price controls on many goods until late 1946, when a huge surge in private sector investment and employment was in progress.

    “Following the Second World War, there was no “artificial” lengthening of the structural of production that caused pricing chaos. “

    So there was no “artificial” lengthening” during the war? There were no ongoing capital projects in 1945 that were abandoned when the war ended?

    “More broadly, in one case private industry is contracting and has to readjust during and after the structure of production is liquidated of all its malinvestments; in the second case, industry does not have to deal with a contraction.”

    No contact in real output or liquidation of capital goods? Are you serious?

    Be so kind as to explain what happened here:

    Year | GDP* | Growth Rate
    1942 | $1,618,200 | 18.45%
    1943 | $1,883,100 | 16.37%
    1944 | $2,035,200 | 8.07%
    1945 | $2,012,400 | -1.12%
    1946 | $1,792,200 | -10.9%
    1947 | $1,776,100 | -0.89%
    1948 | $1,854,200 | 4.39%
    1949 | $1,844,700 | -0.51%
    1950 | $2,006,000 | 8.74%
    * Millions of 2005 dollars
    http://www.measuringworth.com/datasets/usgdp/result.php

    • Jonathan Finegold Catalán

      You seriously deny that WWII, from a free market perspective, did not impose pricing chaos on commodities in America??

      Two different sources of price distortions. During a period of severe intertemporal discoordination the price distortion is “endogenous,” in the sense that it’s caused by the entrepreneurs themselves. During the Second World War, the price distortions were “exogenous,” in that they were caused by government. After the Second World War, entrepreneurs did not have to deal with vast malinvestments based on price miscalculations.

      So there was no “artificial” lengthening” during the war? There were no ongoing capital projects in 1945 that were abandoned when the war ended?

      Re-read the second part of the sentence you quoted.

      No contact in real output or liquidation of capital goods? Are you serious?

      Again, re-read what you quoted. There was no contraction in private industry; the contraction was in industry geared towards public contraction.

      You ought to respond by taking the context of the entire post into consideration, instead of responding to isolated sentences which you take out of context.

  • http://socialdemocracy21stcentury.blogspot.com Lord Keynes

    “during a period of severe intertemporal discoordination the price distortion is “endogenous,” in the sense that it’s caused by the entrepreneurs themselves. During the Second World War, the price distortions were “exogenous,” in that they were caused by government. After the Second World War, entrepreneurs did not have to deal with vast malinvestments based on price miscalculations.”

    Let me get this straight: severe price distortions caused by exogenous government actions don’t cause Austrian business cycles, but “endogenous” price distortion caused by the entrepreneurs does.

    Yet Austrians are forever complaining that exogenous and “evil” central bank intervention causes ABCs. Logically this would now require the conclusion that it isn’t really the central bank causing ABCs but “endogenous” price distortion caused by the entrepreneurs in using excessive credit.

    “There was no contraction in private industry;

    This statement is blatantly false. It was private industry producing output under government contract.

    ... the contraction was in industry geared towards public contraction.”

    The contraction of output occurred in private enterprises geared for war production. But this comes to the same thing as saying that there was contraction in private industry.

    • Jonathan Finegold Catalán

      I’m not sure what’s so difficult to grasp — this is pretty basic stuff. I tried to explain my use of “endogenous” and “exogenous,” in my reply; but, apparently, you rather not take that into consideration in your response. In one, growth in the supply of circulating money to entrepreneurs (unrelated to movements in savings) causes changes in the prices of capital goods relative to each other, causing a lengthening of the structure of production. This leads to extreme pricing chaos and an industrial fluctuations. The other is price setting by the government; when these are lifted there is no malinvestment that needs to be liquidated — it involves only the re-allocation of capital. We are talking about two fundamentally different scenarios.

      About central banks and exogenous price changes, you have already read a prior post of mine where I discuss that — apparently, you also refuse to consider this.

      But, refusing to understand what other people are actually writing won’t actually make your responses correct.

      The contraction of output occurred in private enterprises geared for war production. But this comes to the same thing as saying that there was contraction in private industry.

      Right, but after the Second World War the prices of relevant capital goods weren’t in the midst of pricing chaos, due to problems in price imputation caused by changes in the distribution of income/money.