Tuesday, June 7, 2011

Clarification on the marginal efficiency of capital

Gene Callahan laments a poster who writes of Keynes "I admit that I’m commenting as someone who’s not intimately familiar with Keynes’ work...". He responds "My interpretation: "not intimately familiar" can be translated as "I have not read a single word of Keynes's." So why does he have any opinion on it at all?". Gene specifically avoids naming the blog where he read this (perhaps he's embarassed he visits it?) but I have no such restraint. He read it on Cafe Hayek in the post about Smith and Keynes's shared birthday that Jonathan pointed us to.

That wasn't the only person on that blog post that seems to have some degree of unfamiliarity with Keynes - but at least he admitted it. Don Boudreaux himself wrote in the comments:

"I’m sorry, but I do believe that on matters of economics Keynes was indeed a simpleton. I offer here but one quotation, from page 220 of The General Theory, as evidence of Keynes’s simple-mindedness on matters of economics: “I should guess that a properly run community equipped with modern technical resources, of which the population is not increasing rapidly, ought to be able to bring down the marginal efficiency of capital in equilibrium approximately to zero within a single generation.”

Keynes here argues that capital can be made non-scarce (and, as he puts it in the preceding paragraph, that one key to making it non-scarce is “that State action enters in as a balancing factor to provide that the growth of capital equipment shall be such as to approach saturation-point….”). These are the words of an economic simpleton – a simpleton about the nature of capital, about the nature of scarcity and human wants, and about the nature of the state and “State action.”" [emphasis is mine]

Let's nip this one in the bud, shall we? Because this is a line that has been adopted by much more dangerous people than Don Boudreaux: people who wield video cameras and youtube channels.

If capital were non-scarce we would expect its price to be very low, right? If it were truly infinite, the price would be zero. Marginal productivity would go right down with it for the normal reasons. That's the diamond/water paradox for you - water is cheap because it is (relatively) non-scarce (and of course where it is scarce it's not cheap!). As far as I can tell, this is what Don thinks is going on here when he quotes Keynes as saying that we can drive the marginal efficiency of capital down to zero within a generation.

Don Boudreaux is wrong.

I don't know why these things even pass the smell test for people, but apparently they do. Does Keynes come across as a utopian? He doesn't come across as a utopian because he's not a utopian.

The marginal efficiency of capital is not the same thing as the marginal cost of capital or the marginal productivity of capital. Keynes defined the marginal efficiency of capital as the discount rate at which the price of capital was just equal to the present value of the stream of benefits proceeding from that capital. So the marginal efficiency of capital could be zero at a time when the marginal cost and the marginal benefit of capital were both very, very high (but equal). A high marginal cost and marginal benefit of capital, of course, means that capital is scarce. A lower marginal efficiency of capital is associated with more capital, to be sure - because a lower discount rate means more investment becomes viable, driving down the marginal benefit of capital. So certainly a more capital-rich future is part of the Keynesian vision. But "non-scarcity"? Of course not. He never says that anywhere, and the marginal efficiency of capital is not the marginal cost or the marginal productivity of capital. The point is this - since the level of investment is determined by the interest rate (through the marginal efficiency of capital - what investments are viable at what interest rates), capital owners commanded a return simply by virtue of the scarcity of capital (or - put another way - by virtue of artificially high interest rates). A low interest rate and potentially even a zero marginal efficiency of capital was Keynes's way of separating out the rentier from the entrepreneur.

And in Keynes's vision there were entrepreneurs. Why? Because capital is still scarce and the expertise of the entrepreneur was still needed.


  1. Kuehn, how many times does Don have to say it? Don read that book in the 70's and there's nothing in it worth reading. If Don must Don will quote part of the book that doesn't bear on it's main conclusions. Such is Don's force of argument that the entire edifice will collapse at Don's slightest touch. DON SMASH!!

  2. Cmon Daniel, even you've admitted his post-scarcity fantasies were weird. Give Don his due. That paragraph bothered me too.

  3. Mattheus I am not aware of any post-scarcity fantasy. Certainly there wasn't one in the passage he cited.

    The closest Keynes came to saying that was Economic Possibilities for Our Grandchildren - and that was weird not because it saw an abolition of scarcity (it didn't), but because it saw an abolition of unsatisfied demand for goods and services (ie - all we would have left to satisfy would be leisurely pursuits). That's "weird" you could say - Keynes didn't see how consumption-oriented our leisure would be in the late twentieth century. But he certainly didn't suggest we would have a situation of post-scarcity that I'm aware of.

    I'll go back and reread the passage, but I read it closely this morning when I posted this.

  4. It's not about consumption-oriented leisure. An abolition of wants is the same thing as an abolition of purposeful action. As long as we have ends we want to attain then there will always be a demand for the means to attain these ends.

  5. Well purposeful action is another issue entirely. I was under the impression we were talking about market action.

    Keynes thought more of our wants would be of the sort that could not be traded on the market, like "I want to sit on the grass, enjoy the sun, and discuss art with my friends". There is still quite a bit of purposeful action in that, but there is much less market action.

    Anyway - my point is that that is the most speculative (and most wrong) that Keynes was on this sort of questions, and even that isn't the sort of post-scarcity story that Don and Mattheus imagine they've read.

  6. "Gene specifically avoids naming the blog where he read this (perhaps he's embarassed he visits it?)"

    Nah, I just didn't mean to be picking on that commentator in particular -- I wanted the focus to be on the general phenomenon.

  7. re: "Nah, I just didn't mean to be picking on that commentator in particular -- I wanted the focus to be on the general phenomenon."

    Oh great - now I look like the jerk!!!


  8. "Well purposeful action is another issue entirely."

    Absolutely not. The reason we demand anything is because of purposeful action; it is because economize means amongst ends. Demand is a corollary of purposeful action.

    Wanting to sit on grass still requires grass and the maintenance that comes with it. Discussing art still requires the art. That we still economize ends means that there's still work to be done.

  9. OK - apparently I need to be more specific.

    All market action is purposeful action. Not all purposeful action is market action.

    Economization is not commodification.

    I know sometimes Austrians slip into mushing these things together, but economics and psychology and sociology seem to me to be investigations of quite distinct phenomena.

  10. I beg to differ. All purposeful action is market action. Economics, psychology, and sociology are different subjects, but that doesn't mean that all purposeful action is market action. The different social sciences study different aspects of human action. Economics deals with the objective causal phenomena which arise out of purposeful human action.

    And, all of this is ultimately irrelevant to the point I made. My point is that as long as humans have ends that they wish to attain then there always be demand for something (they are demanding, in fact, those ends). So, the idea the idea that individuals will stop demanding is just simply absurd.

  11. We were discussing market demand, and not all purposeful action is market action.

    Certainly we'll continue to demand things.

    My cat demands things. Children demand things of their parents. Teachers demand things of their students. So?

  12. Over at the Cobden Centre I've written an article about this:


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