Capital and Finance Theory and History
This book applies finance to the field of capital theory. While financial economics is a well-established field of study, the specific application of finance to capital theory remains unexplored. It is the first book to comprehensively study this financial application, which also includes modern financial tools such as Economic Value Added (EVA®).
A financial application to the problem of the average period of production includes two discussions that unfold naturally from this application. The first one relates to the dual meaning of capital, one as a monetary fund and the other one as physical (capital) goods. The second concerns its implications for business-cycle theories. This second topic (1) provides a solid financial microeconomic foundation for business cycles and, also (2) makes it easy to compare different business-cycle theories across the average period of production dimension. By clarifying the obscure concept of average period of production, the authors make it easier to analyze the similarities with and differences from other business-cycle theories.
By connecting finance with capital theory, they provide a new point of view and analysis of the long-standing problems in capital theory as well as other related topics such as the use of neoclassical production functions and theorizing about business cycles. Finally, they emphasize that the relevance of their application rests on both its policy implications and its contributions to contemporary economic theory.
List of Figures
List of Tables
CAPITAL, PRODUCTION, AND TIME
1. Capital, Income, and the Time-Value of Money
1.1 Capital and Income
1.1.1 Ideas matter
1.1.2 Assets and liabilities, income and expenditure
1.2 The Time-Value of Money and the Money-Value of Time
1.2.1 The Time-Value of Money: Investment decisions
1.3 Investment decisions and the money-value of time – the important concept of duration
2. Discount rates and time
2.2 The uses and limitations of D
2.2.1 Modified duration and immunization
2.2.3 Too many unknowns?
2.3 Using polynomial roots
2.4 Summary Conclusion
HISTORY OF CAPITAL THEORY
3. Menger and Böhm-Bawerk: Foundations of Austrian Capital Theory
3.1 Menger’s theory of capital
3.1.1 Value is subjective, all the way down
3.1.2 Production takes time
3.2 Böhm-Bawerk’s capital theory
3.2.1 Productivity, average period of production, and roundaboutness
3.2.2 Further issues: Is Böhm-Bawerk’s APP value free?
3.2.3 Further issues: A Böhm-Bawerkian production function?
3.3.1 Böhm-Bawerk’s APP with simple and compounding interest
4. Hayek’s Capital Theory and Austrian Business Cycle Theory
4.1 Hayek’s Austrian Business Cycle Theory
4.1.1 Hayek’s triangle – a special case of Böhm-Bawerk’s special case
4.1.2 Introducing stages of production
4.1.3 The Legacy of Hayek’s Triangle
4.4 Hayek’s Capital theory
4.4.1 Hayek and the Average Period of Production
4.4.2 Beyond the APP, to what?
4.4.3 Capital Consumption and Maintenance when Capital Goods are Heterogeneous and the Future is Uncertain
4.4.4 Permanent Income, it depends on what is Foreseen and What is not Foreseen
5. Ludwig Lachmann and the Capital Structure
5.1 The Heterogeneity of Production Goods and the Austrian school
5.2 The macroeconomic implications of heterogeneity, investment and technological change 57
5.3 Lachmann’s contributions to Austrian Capital Theory in Relation to "Capital as Finance"
5.4 Problems with the Aggregate Production Function
6. Ludwig von Mises and Capital from a Financial Perspective
6.1 Mises’s Financial View of Capital
6.2 Capital as an Historically Specific Concept
6.3 Capital and Production
7. John Hicks and Capital in the Aggregate Production Function
7.1 John Hick’s Neo-Austrian Capital Framework: Time is Irreversible
7.2 Subjectivising Hicks’s Simple Conceptual Framework
7.3 A Simple Financial Formalization
7.4 Looking forward and looking backward
8. The EVA® Framework
8.1 From Free-Cash-Flow (FCF) to Economic Value Added (EVA®) – separating profit and loss results from investment decisions.
8.2 A Deeper Look: Value Drivers
8.3 What is Capital Intensity?
8.4 Duration, time, capital, and W
8.5 Appendix: The EVA® derivation
9. EVA and Microeconomics
9.1 Relative prices and economic profit in the EVA framework
9.2 International trade
9.3 Cantillon effects
9.4 EVA and the problem of economic calculation under socialism
10. EVA and Macroeconomics
10.1 The Austrian Business Cycle Theory (ABCT): A Credit Induced Business Cycle
10.2 Financial Foundations of ABCT
10.3 Rational Expectations and ABCT
10.4 Extensions of the ABCT
10.4.1 Exchange rates
11. EVA and Institutions
11.1 Why are Institutions Important?
11.2 EVA and Macroeconomic Performance
11.3 Mapping economic freedom into an EVA analysis
11.3.1 EFW Area 1: Size of Government
11.3.2 EFW Area 2: Legal System and Property Rights
11.3.3 EFW Area 3: Sound Money
11.3.4 EFW Area 4: Freedom to Trade Internationally
11.3.5 EFW Area 5: Regulation
11.4 Conclusions and Summary
12. Concluding Remarks