Ludwig M. Lachmann · 1940
Lachmann’s article is a reconstruction of Austrian cycle theory after Keynes and after the first reception of Hayek. He argues that the theory was weakened by being presented in quasi-static form, as if it depended on full employment or on a simple contrast between saving and credit expansion. Its real subject is dynamic: the way investment decisions alter the interdependence of industries, prices, expectations, profits, and real wages over time.
On the contrary, it would be true to say that the Austrian theory is a theory about the inter-industrial effects of certain dynamic processes.
The central theoretical point is irreversibility. In static analysis, disturbances can appear as temporary deviations from equilibrium. In Lachmann’s capital theory, however, investment changes the concrete structure of production. Resources once held in fluid form become specialized buildings, machines, and complementary arrangements. If entrepreneurs’ expectations prove wrong, the economy cannot simply retrace its steps, because the pattern of capital has already been transformed.
Once "free Capital" has been converted into buildings and machinery, any failure of events to conform to expectations will upset everything.
Lachmann then gives the Austrian theory a sectoral anatomy. He distinguishes consumers’ goods industries, equipment industries, raw-material industries, and “dynamic key industries,” the last of which supply the means for innovation and capital intensification. This makes growth a process of entrepreneurial reorganization rather than the aggregate accumulation of homogeneous capital.
Growth then is the cumulative effect of individual efforts directed towards the improvement of the productive apparatus of society.
The cycle begins most clearly in depression. Idle resources, low costs, and accumulated stocks make innovation attractive. Investment in key industries expands employment and income; consumers’ goods industries replace postponed equipment; and the early recovery is marked by complementarity between replacement investment and new capital-deepening projects. The boom changes character only when mobile resources become scarce, especially raw materials or first-line equipment. At that point sectors begin to compete for common inputs, marginal costs rise, and real wages fall as consumers’ goods prices move upward.
This is where Lachmann joins the “Lundberg effect” to the “Ricardo effect.” Investment in key industries depends on comparisons between present costs and uncertain future yields, while the level of real wages affects the inducement to substitute machinery for labour. A fall in real wages during the boom can therefore divert entrepreneurs away from long-period capital deepening toward shorter-period, speculative, or consumption-oriented uses of resources. Credit expansion cannot abolish this conflict; it may intensify competition for scarce inputs and worsen the calculations underlying long-term investment.
We may thus conclude that, where there are scarce resources, no monetary device will overcome the consequences of the simple fact that the economy as a whole cannot have its cake and eat it.
The article also refines the Austrian view of wages. Lachmann denies that the theory recommends a general wage cut. In key industries, lower costs may assist capital formation; in consumers’ goods industries, however, recovery may require rising real wages relative to prices, because capital intensification depends on the incentive to economize labour. His argument is thus sectoral rather than doctrinaire.
The final historical section is deliberately restrained. Lachmann finds nineteenth-century railway booms broadly compatible with the theory: long-period investment outran available saving and mobile resources, raw materials became scarce, and foreign capital sometimes postponed the reckoning. But he refuses to force the 1929 crisis into the same explanatory mold. Stable consumers’ goods prices and rising raw-material stocks after 1925 make it difficult to identify the decisive scarcity his model requires.
It is thus not easy to account for the crisis of 1929 by the help of the Austrian theory.
The essay’s importance lies in this disciplined mixture of defense and limitation. Lachmann recasts Austrian fluctuation theory as an expectations-centered account of heterogeneous capital, sectoral maladjustment, and irreversible investment, while acknowledging that not every crisis need fit the Austrian pattern.
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