If in the short run labour is, as we have assumed, highly specific to its particular employment, the unemployment caused by the decline in investment activity will disappear only when investment of the kind in question becomes once again profitable — or in the long run when labour has been gradually transferred to other industries.
— Friedrich Hayek,Profits, Interest, and Investment (Clifton: Augustus M. Kelley Publishers, 1939), p. 35.
Since I have brought up Profits, Interest, and Investment up as a “must read” for anybody who wants to judge Hayekian capital theory, it only makes sense for me to discuss it here. This includes things which it does not quite sell me on. Like any major piece of Hayek’s on capital theory, this 1939 monograph is complicated and difficult to understand on a first reading. But, some of it seems disjointed and unsupported — since I have not read it yet, I am not sure that The Pure Theory of Capital improves on some of this. Or, maybe I just misunderstand parts of Hayek’s argument.
The above quote encapsulates a theme which Hayek heavily relies on to show how an increase in demand for consumer goods will lead to a fall in employment. But, I think his argument is woefully incomplete and susceptible to the common criticism of Austrian capital theory: why is there “full employment” when the capital structure is elongating and widening, but unemployment when it is contracting? Indeed, should there not be just as many mobility problems when workers are being transferred away from lower order to higher order firms? But, in the first part of this monograph, this is Hayek’s main argument: the specificity of labor.
In fact, assuming perfect mobility of labor, an increase in consumption would just lead to a redistribution of labor. The graph to the left (p. 27), imperfectly, shows how this would be the case. An increase in demand for consumer goods may increase demand for less durable or non durable capital goods, or what Hayek here calls ‘Stage II’ goods over ‘Stage III, IV,’ et cetera (area represents demand for higher order goods; here we note a change from ABC to ADE). The main impediment in Hayek’s story is not a lack of opportunities to employ laborers, but trouble with the specificity of labor and the difficulty of transferring workers to new industries.
Did I miss something? While I am sure that specific of labor is, to some degree, a problem, why does it not surface during the boom stage? Is it because booms are gradual and collapses in investment tend to be sudden? Also, my first question is sort of misleading, because booms are characterized by a stable or growing demand for consumer goods; but, my question would be relevant to someone trying to explain a healthy pattern of growth in a market economy. A possible answer is that more ‘capitalistic’ forms of production usually hire a greater proportion of machinery, meaning there is a lesser cost of training involved (less employees to train). Laborers in these industries are more “spread out” over a greater number of firms.
In any case, rather than focusing on consumer versus capital goods, it seems to me that a better approach to understanding the recovery period ought to revolve around the post-boom pricing process, the role of uncertainty, and drops in productivity (including an increase in idle, no longer useful, durable equipment). In this context, Hayek’s argument has more relevance, since an increase in saving might save the market from a long readjustment from more ‘capitalistic’ to ‘less capitalistic’ forms of production.
In Hayek’s defense, this post is also highly disjointed (and as I write it, I realize that I am not considering parts of his argument — a reason I add “possible answers” and caveats to my “criticism). My intention here is two-fold: (a) to better understand what Hayek is trying to get across, and (b) to stimulate some discussion.