In the introductory chapter to his “Pure Theory of Capital”, Friedrich Hayek writes:
“It was suggested in the first chapter that most of the shortcomings of the theory of capital in its present form are due to the fact that it has in effect on been studied under the assumptions of a stationary state, where most of the interesting and important capital problems are absent. This is so largely because the characteristic problems of capital theory are problems of the interdependence of different industries and consequently only arise in connection with a theory of general [italics original] equilibrium, and because most of the current systems of economics theory (particularly the most influential, that of Marshal) do not really consider any state of general equilibrium which is not at the same time stationary.” (Page 40)
The problem that Hayek is calling our attention to is that in order to truly examine the problems and questions of capital theory, we have to so with consideration for change. If we ignore this factor, then all of the problems virtually resolve themselves and we are left without any greater understanding of the field as a whole (I’m sure that as Hayek was writing this, there was a particularly flagrant violation of this point that he had in mind). A purely static situation does not meaningfully lend to our knowledge. It is examining capital under change and movement that must capture our attention.
With the idea of change, there always comes an attached idea: time. Change always takes place over time. Any notion of instantaneous change is difficult to imagine, if not incoherent altogether. If capital theory needs change, as Hayek suggests, then capital theory must additionally incorporate the element of time:
“An effective discussion of the problems of capital theory must, however, move precisely in that neglected field which deals with general equilibria that are not at the same time stationary states” (Page 41)
Hayek explains exactly what he has in mind, saying:
“When it is used in contrast to equilibrium analysis in general, it refers to an explanation of the economics process as it proceeds in time, an explanation in terms of causation which must necessarily be treated as a chain of historical sequences. What we find here is not mutual interdependence between all phenomena but a unilateral dependence of the succeeding event on the previous one. This kind of casual explanation of the process in time is of course the ultimate goal of all economic analysis, and equilibrium analysis is significant only insofar as it is preparatory to this main task” (Pages 42–43)
Hayek is staking out a special type of equilibrium, one in which time is accounted for. This equilibrium is much different than a conventional stationary equilibrium, wherein there is no intertemporal movement at all. The term that Hayek calls for this time-sensitive model is “dynamic equilibrium”. It describes the economy as being one in which the same purchases and investments are constantly made, but where production processes are time-consuming and capital goods wear out and need to be replaced. All of this happens at a predictable and consistent pace, of course, but it all happens over time. Hayek had this model in mind for studying capital theory, but he also sees it is being the standard for equilibrium models is economics as whole. As he states, it is only with the element of time being considered that we can examine casual relationships within the economy.
Hayek’s idea of a “dynamic equilibrium” was not a completely novel idea. His mentor, Ludwig von Mises also placed a great deal of importance on the element of time. However, Mises uses a much more nuanced view of equilibrium states. In his treatise, “Human Action”, Mises describes first the “plain state of rest”, which is merely the state of the market in between transactions. The example he uses is that of the stock market, whereas at the end of each day all transactions that the market would bear have been carried out. This is a type of equilibrium, but only in the weakest sense. This is contrasted with the “final state of rest”, which occurs when the existing market forces are allowed to fully play out in order to fully clear the market. This will never occur on actual markets, as new changes in economic data always disrupt this settling process and create a new final state for the market to pursue. The imaginary situation where all changes in the market are totally eliminated Mises called “evenly-rotating economy”. Mises relates this state of affairs specifically to the passage of time:
“The imaginary construction of the final state of rest is marked by paying full regard to change in the intertemporal succession of events. In this respect it differs from the evenly rotating economy which is characterized by the elimination of change and the time element…The system is in perpetual flux, but always remains in the same spot. It revolves evenly around a fixed center, it rotates evenly.” (Page 247)
Mises is also very clear on the purpose of this mental model and what it is supposed to show us:
“The essence of this imaginary construction is the elimination of the lapse of time and of the perpetual changes of the market phenomena. The notion of any change with regard to supply and demand is incompatible with this construction.” (Page 248)
While it sounds like Hayek and Mises have two different ideas of equilibrium-through-time, if we read between the lines, they merely have different perspectives. For Hayek, the passage of time in his dynamic equilibrium is crucial because of the task he has set in mind, a study of capital and the role outlined for it in the market economy. For Mises, time still passes in evenly-rotating economy, but ceases to be a relevant factor because there are no longer any changes in the market data. Even in a state of total market equilibrium, production still takes place through processes which take up time. The existing of a temporal succession in this state is evenly implied in the name, “evenly-rotation economy”; in order to rotate, time must be passing. Mises’ emphasis is on the lack of change in market data, whose change also takes time to incorporate into the existing economic state of affairs, which then makes the passing of time pointless. All transactions are repeated at the same times and places, again and again. In such a world, time has little to no meaning, even though it still exists.
This idea of equilibrium as existing in a temporal space is unique to the Austrian School theorists. Even when time has no relevance, Mises does not remove it completely from his model. This stands in stark contrast with more conventional views of general equilibrium, such as the Walrasian General Equilibrium that Hayek mentioned above. These are constituted of systems of mathematical equations, the solution to which allows a general equilibrium between all markets to exist. These quantified versions of equilibrium don’t easily allow for any dynamic element. Especially in a series of equations, it is difficult to accurately and fully incorporate a temporal element. It was precisely for this reason that Hayek rejected these equilibrium forms as conducive to understanding capital.
The Austrian emphasis on the idea of time within the realm of economics is not an arbitrary attachment. Rather, it is the conscious result of an understanding of economic modeling and its proper usage. Specifically, of the boundaries and limits of what economics models can accurately and meaningfully represent. The recognition of these boundaries leads not only to better economic models, but also an understanding of the purpose that economic models can fulfill. The Austrian emphasis on time is but a single example.
First, let’s talk methodology. The Austrian method for economics is “Praxeology”, or in Hayek’s phrasing, “The Pure Logic of Choice”. Hayek’s term is perhaps more descriptive, as the object of Praxeology is the enumeration of human action. This is done through following a deductive process, starting from the self-evident axiom that “human beings act” and derives conclusions from this statement. Importantly, this deductive process reveals to us certain categories and features of action that are logically inextricable. Time is one such category.
We know that human beings act. However, it makes no sense to conceive of action outside the realm of time. If action could happen instantaneously, then we would be able to instantly achieve everything that we want, making action unnecessary! Action only makes sense as being intertemporal in nature. Consequently, time is a category of action. Murray Rothbard exposits this point nicely in his Man, Economy, and State:
“All human life must take place in time. Human reason cannot even conceive of an existence or an action that does not take place through time. At a time when a being decides to act in order to attain an end, his goal, or end, can be finally and completely attained only at some point in the future. If the desired ends could be attained instantaneously in the present, then man’s ends would all be attained and there would be no reason for him to act; and we have seen the action is necessary to the nature of man” (Man, Economy, and State pg. 4)
If time is a category of action, then we cannot conceive of action without it. Given that human beings are actors, it follows that human beings exist through time. We as human beings are temporal creatures, and if we were not, we would cease to be human beings as we would recognize them.
All economics models claim to model the behavior of human beings (the economics profession is composed of a strange group, but I am unaware of any attempts to model alien economic behavior). As a result, the scope of these models are constrained by the subjects they are studying; namely, ourselves. If one cannot conceive of human beings without any particular quality, that quality must be included within the model. To forgo it or abstract away from it would be to present an inaccurate view of the subject in question. We would know from the outset that the model is flawed and requires correction. However we wish to construct an economic model for whatever purpose, to pass over these necessary traits is inexcusable.
As we have seen, praxeology dictates to us the necessary features of action. Human beings, in their status as actors, also must possess these qualities as well. We demonstrated that action always takes place in time. As such, human beings exist in time. Therefore, if we wish to model human beings and their behavior, we must include the aspect of time within the model. The time aspect does not have to be at the forefront or a major factor in the model’s operation, but it must be present. If it is not, then the model is not modelling human beings; it is modelling something else entirely.
Time is one category of action, and only one of many. The concept of Marginal Utility can be derived from Praxeological first principles, making it a category of action. The Law of Demand, that demand decreases and price increases, is also a category of action. The existence of scarcity, ordinary value scales, and uncertainty of the future are also all categories of action as well. Action cannot be conceptualized apart from them, making them also inseparable from human beings.
Praxeology is primary. Economic models can abstract away from many aspects of human behavior. Change is not a necessary component of action, so it is permissible to abstract away from change in human beings in a model, just as Mises does with evenly-rotating economy. However, these abstractions can only go so far. One can continue to remove all of the contingent features of human action in a model, but they will eventually run up against a logical brick wall. Beyond this wall be can modify his model no further without negligently violating the purpose for which he constructed it: to understand human beings.
The Austrian tradition, equipped with a cognition of Praxeology, is aware of these boundaries. This knowledge of their own restraints leads to results that some might consider odd, such the presence of time in Austrian equilibrium models that we examined above. The Neoclassical tradition does not recognize Praxeology, and consequently, does not recognize the boundaries that it imposes. The result of this ignorance is the Walrasian General Equilibrium model, where time has no presence in the model at all. The absence of time is not just an arbitrary difference between Mises’ Evenly-Rotating Economy and Walrasian General Equilibrium, but a difference in the very subjects being studied. Mises’ model contains human beings, who though acting in constant repetition over and over, are recognizable human beings. The Walrasian General Equilibrium contains something foreign, of which we certainly don’t belong. The result is that the Misesian model helps us properly understand human beings, whereas the Walrasian model needlessly hampers itself in its stated goal.
One might claim that the presence of time in an equilibrium model is of little consequence. While largely correct, the principle is what matters. The lack of Praxeological insight within the Neoclassical tradition doesn’t stop with Walras, but extends into more and more unrealistic models of human behavior. The entire field of so-called “Behavior Economics” has sprung up in recent years to help correct this self-imposed error. The Austrian School plainly saw these mistakes from the start. Not because of a dislike for math or models, but from an understanding of the limits they have. The mainstream needs a strong dose of Praxeology for an overdue course correction. Will they ever accept it? Only time will tell…
