Ludwig Lachmann, “Investment and Costs of Production” (1938)

Ludwig Lachmann’s journal article examines how an economic expansion can generate its own reversal through changes in production costs and relative profitability. Its seven sections move from criticism of cumulative-process theories to an account of factor scarcity, durable investment, commodity speculation, and the limits of monetary stabilization. The central contention is that rising consumption does not necessarily reinforce the investment that initiated prosperity. By raising current construction and production costs without correspondingly raising expected long-term yields, expansion can undermine durable investment even while unemployment persists and money remains readily available.

Section I establishes the appeal—and incompleteness—of contemporary accounts of cumulative expansion. Investment creates incomes, consumption rises, and further investment follows. Unemployment and an elastic banking system appear to permit this sequence to continue without immediate resource or monetary constraints. The difficulty is explaining why it stops. Lachmann criticizes Keynes’s appeal to disappointed expectations for leaving the origins of excessive optimism unexplained. Against Kalecki, he argues that speculative asset markets can anticipate the consequences of investment before new equipment is delivered; technical production lags alone therefore do not explain a sudden collapse. Harrod correctly emphasizes profits, but his proposed redistribution toward profits does not convincingly explain the termination of prosperity. Lachmann instead turns to differences among industries:

Fluctuations in relative profitability therefore appear to be the most convenient starting point for a causal-genetic analysis of the trade cycle.

This shifts the inquiry from aggregate income identities to the investment decisions those identities conceal. Section II asks whether investment stimulated by favorable prospective returns and investment stimulated by rising consumption will eventually conflict. That entrepreneurs’ aggregate receipts equal their aggregate outlays does not establish that every kind of investment remains profitable. A rise in income somewhere in the economy need not compensate the investor whose present costs have increased.

Section III supplies the real-resource mechanism. Immobile labor and specialized equipment cannot be treated as an interchangeable reserve awaiting employment. Production requires particular combinations of complementary factors, and output becomes constrained when the scarcest necessary factor reaches capacity. Unemployment can consequently coexist with labor shortages, idle plant with fully utilized specialized equipment. Expansion raises costs unevenly before any economy-wide employment maximum is reached:

These "bottle-necks" cannot be overcome by any dose of credit expansion whatever.

The argument does more than qualify the notion of full employment. It removes a supposedly clear boundary between beneficial credit expansion and inflationary expansion: different factors become scarce at different moments. Lachmann thus rejects the objection that explanations of crisis through relative cost movements presuppose universal full employment.

Section IV connects these constraints to investment duration through Lundberg’s distinction between interest-sensitive and consumption-sensitive investment. A durable asset yields services over decades; today’s consumption demand has comparatively little influence on its expected average return. Its initial cost, however, is determined by current prices, while its valuation is particularly sensitive to interest rates. Lachmann extends this reasoning beyond interest:

It follows that, in the case of durable investment, the average yield of which is independent of present conditions, a rise in costs will check the inducement to invest and vice versa.

Even a cost increase believed permanent can end investment previously undertaken to exploit unusually cheap construction. Crisis is nevertheless conditional: declining “primary investment” might be offset by investment in consumption-goods industries. Lachmann considers timely compensation unlikely. It must occur before falling investment reduces employment and consumption, and the accelerator’s technically implied investment need not become an actual entrepreneurial decision. Greater durability increases potential replacement requirements but weakens responsiveness to a temporary demand increase. Conversely, costs that have fallen and are believed to have reached their limits can stimulate durable investment despite weak consumption. This helps explain housebuilding’s role in recovery. The American downturn of 1937 is offered as an apparent instance of the cost mechanism, rather than systematically demonstrated evidence.

Sections V and VI investigate whether monetary intervention can prevent the reversal. Lachmann initially separates long-term finance for fixed capital from short-term finance for commodity stocks. Speculators anticipating rising costs accumulate inventories, pushing prices, output, and costs upward faster and bringing forward the point at which durable investment becomes unprofitable. Keeping short-term rates fixed removes a restraint on this activity. Lowering long-term rates may likewise encourage speculation by signaling continued accommodation; actual connections between the markets, including securities used as collateral, undermine selective control.

"Expansionist policy," whatever meaning we may attach to it, emerges therefore as a somewhat doubtful panacea.

This skepticism does not become a simple recommendation for restriction. Tighter credit might lower commodity prices enough to improve investment costs, but wages may resist falling and monopolistic producers may restrict output. Policy can therefore create expectations of cheap investment that rigid costs subsequently frustrate. Nor can economic theory alone settle the interpersonal welfare comparisons involved when expansion reduces real wages.

Section VII explicitly identifies the argument as a vindication of Austrian cycle theory, reached without initially invoking its terminology, production-time structure, or saving controversies. The substantive connection is that increased consumption can damage durable investment—the earlier stages of production—through rising marginal costs, without universal full employment. Yet Lachmann ends by limiting what this explanation establishes:

It is by no means certain that even with the most flexible cost structure it will be possible to complete processes of production which, owing to some shock, have once been interrupted.

The article’s relevance lies in replacing aggregate assurances with an analysis of heterogeneous resources, investment horizons, and expectations. Its account of the upper turning point does not guarantee automatic recovery: interrupted production and secondary depression expose the limits of static equilibrium reasoning.