G. R. Steele, Hayek’s river analogy

The river analogy indicates the complexity of time-lapse relationships that can exist between investments, the volume of sales of final goods and the level of employment. The river represents the continuous flow of capitalistic production, that can vary quite independently of the level of the tide (demand for final goods) at its mouth. In its upper reaches the volume of water is affected by the immediate flows from tributaries to the main stream (variations in new and replacement investment) that are determined by relative factor prices, technological change and the interest rate. Both theoretically and empirically, there is no single correspondence between changes in the upper reaches and sales of final goods. However, Hayek believes it to be more generally the case that a revival of final demand in a slump is ‘an effect rather than a cause of a revival in the upper reaches of the stream of production’ (Hayek 1983: 46).

Hayek’s most important claim is that there is no direct causal relationship between sales of consumer goods and changes in the upper reaches of the stream of capitalistic production; nor between sales of consumer goods and the level of employment. It is upon the basis of this claim that Hayek rejects Keynes’s argument that the path to full employment might begin with general measures to boost expenditure; that a modest boost to consumer goods prices would encourage output and investment.

Within the Austrian framework, the use of more time-consuming (roundabout) processes can enhance productivity by exploiting techniques, resources and raw materials that otherwise would have remained uneconomic; and it is in this context that a general reduction in consumer goods prices can enhance the relative profitability of more capitalistic processes against more direct production methods. (For example, in many markets, capital intensive methods have brought the demise of traditional brewing that can no longer compete on price. Even if labour services were free, empirical work indicates that traditional labour-intensive methods can remain the more expensive; see Ojegibile, 1983.) The superior cost advantages that derive from the use of capital is a function of its superior productivity that derives from the consequences of taking more time to bring consumer goods to the market.

The opportunity to vary the allocation of a constant flow of investment funds (across projects of different life duration) is analogous to a constant rainfall (but changing dispersion) within the catchment area of the river and its tributaries. The river represents the flow of capitalistic production, that (given the dispersion of rainfall) presents a varying amount of water (potential sales of final goods) into the estuary, and which is independent of the level of the tide (demand for consumer goods) at its mouth. A constant flow of investment is consistent with different (sustainable) levels of capital stock and varying (both fleeting and sustainable) levels of final output.

Although Hayek recalls that, on one occasion, Keynes had become ‘momentarily interested in the possibility that a fall in product prices might lead to investment in order to reduce unit costs, he soon dismissed this brusquely as nonsense!’ (Hayek 1983: 46). No doubt, this confirmed Hayek in the view that Keynes had a poor grasp of capital theory.

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