Pure Time Preference Theory of Interest #4

Murphy in Choice portrays Böhm-Bawerk as a champion of the time preference view of interest, but economics professor Jeffrey Herbener says Böhm-Bawerk clearly rejected the PTPT. In the first lines of Böhm-Bawerk's Capital and Interest he states what he considers to be the problem of interest: “Whoever is the owner of a capital sum is ordinarily able to derive from it a permanent net income which goes under the scientific name of interest in the broad sense of the term.” As Böhm-Bawerk makes clear in describing his theory, however, this way of putting the matter allows for both time preference and value productivity influences on interest. ... The PTPT, in contrast, makes no claim about the amount of goods being generated in production, but only about the net (monetary) income earned from trading present money for future money. It states that time preference will always generate a positive difference between the selling prices of output and the buying prices of inputs"  (Herbener, The Pure Time-Preference Theory of Interest, 21).

"Böhm-Bawerk has once for all unmasked the fallacies of the naïve productivity explanations of interest, i.e., of the idea that interest is the expression of the physical productivity off actors of production. However, Böhm-Bawerk has himself based his own theory to some extent on the productivity approach. In referring in his explanation to the technological superiority of more time consuming, roundabout processes of production, he avoids the crudity of the naïve productivity fallacies. But in fact he returns, although in a subtler form, to the productivity approach" (Mises in Herbener, 72).

In the mid-1830s, the Irish economist Samuel Mountifort Longfield worked out the later Austrian theory of capital as performing the service for workers of supplying money at present instead of waiting for the future when the product will be sold. In turn the capitalist receives from the workers a time discount from their productivity. (Rothbard in Herbener, 63).

"We should note, first of all, that this theory is not necessarily vulnerable to the basic Böhm-Bawerkian criticism of all productivity-of-capital theories of interest. Böhm-Bawerk had criticized such theories of interest because they ignore the essential interest problem (as formulated above). It will not do to say that the machine yields interest (in the form of a flow of rentals that is greater than the cost of the machine) because the machine is physically productive (Kirzener in Herbener, 102).

"Interest is, in this view, the marginal productivity return on a scarce factor, viz., waiting. The Fisherian “productivity-of-waiting” theory emphatically recognizes the significance of time preference" (Kirzner in Herbener, 103).

Pure Time Preference Theory of Interest #3

The productivity theory of interest is analogous to wages and labor. Employers pay workers for the output their labor makes possible. Similarly, if capitalists provide a capital good, the capitalist must be paid interest commensurate with the increase in output that the capital good makes possible. Murphy holds that Böhm-Bawerk brilliantly refuted this line of reasoning. He quotes Böhm-Bawerk:

"I grant without ado that capital actually possesses the physical productivity ascribed to it, that is to say, that more goods can actually be produced with its help than without. I will also grant ... that the greater amount of goods produced with the help of capital has higher value than the smaller amount of goods produced without it. But there is not one single feature in the whole set of circumstances to indicate that this greater amount of goods must be worth more than the capital consumed in its production. And that is the feature of the phenomenon of excess value that must be explained" (Choice 227-8)

It seems to me that Böhm-Bawerk attacked a straw man of the productivity theory.

"Literally to ascribe to capital a power of producing value is to misunderstand the essential nature of value, and to misunderstand the essential nature of production completely. Value is not produced at all, and cannot be produced. We never produce anything but forms, shapes of materials, combinations of material, that is to say, things, goods" (Capital and Interest 90).

Probably critics of the Marxist notion of "surplus value" contended that "capital produces value." That can be regarded as a shorter way of saying "capital produces things that have value." Böhm-Bawerk's interpretation makes it a straw man.

After great praise for John Rae (Capital and Interest 208), Böhm-Bawerk even chides Rae for conflating physical returns with value returns, protesting that prices would adjust to normalize the exchange value surplus or rate of return, in the technically more productive processes. Rae could hardly have arrived at this correct result since he lacked “the modern theory of marginal utility.” (Herbener, The Pure Time-Preference Theory of Interest 31).

While Murphy defends the time-preference theory in Choice, he apparently had a little different view not much earlier. "Second, Murphy argues that if pure time preference theorists define time preference in terms of satisfactions and not goods, then time preference is neither necessary nor sufficient to explain the rate of interest as defined as the intertemporal exchange rate of goods. This criticism also misses the mark since in the PTPT the rate of interest is not the intertemporal exchange rate of goods. With the intertemporal exchange of money, pure time preference is both necessary and sufficient to explain the pure rate of interest" (Herbener 55-6).

To be continued.

Taxes

Danielle Kurtzleben at NPR (National Public Radio) here reports on having asked people if they believed the highest earners pay a significantly higher share of federal income taxes than they did in 1980.

I clicked True. Kurtzleben says it is False. She's wrong. See here. The graph shows about 19% in 1980 and about 36% in 2011. Kurtzleben's "justification" fails, because the question is about share of taxes paid and her "justification" is based on rates.

P.S. After I posted the above and wrote to NPR about it, the NPR website was edited. It now reads: True or False: For the highest earners, the percent of federal income taxes they pay now is significantly higher than it was in 1980.

That better fits her explanation, but "percent" is more ambiguous than it was. Is that a percent of all taxes or a percent of high earners' income? It may also differ from the question that was asked respondents.

The page now includes:  Clarification: This story has been updated to reflect that the question about taxes paid by the richest Americans could be interpreted in different ways.

Pure Time Preference Theory of Interest #2

Murphy's Choice uses an example of a tractor to present Böhm-Bawerk's argument for the pure time preference theory and against the productivity theory. Böhm-Bawerk used a different example, but the tractor example serves as well. 

Suppose a tractor is expected to yield an additional $1,000 of revenue each year for the next 10 years before being junked. Böhm-Bawerk in effect argued that the only reason a capitalist could earn money by owning the tractor is that its initial purchase price is less than $10,000. If the tractor would cost $10,000, the capitalist would only break even. If the cost were more than $10,000, the capitalist would expect to lose money. If the tractor cost is $5,000, then the capitalist would earn a 7% [approximate] return, assuming each $1,000 is reinvested until the end of the 10 years.

Note: Assuming no reinvestment, the capitalist could pay $7,022 and earn 7.00%. Solving the equation:

             -7022 + 1000*(1+r)^-1 + 1000*(1+r)^-2 + 1000*(1+r)^-3 + ... + 1000*(1+r)^-10 = 0 

yields r = 0.0700 or 7.00%. The variable r here is commonly called internal rate of return. An equation of this sort is widely used to evaluate capital projects.

"By this procedure, Böhm-Bawerk had transformed his original question. Rather than asking, 'Why do capitalists earn an effortless flow of interest income?', he could instead wonder, 'Why is it that the initial purchase price of capital goods systematically fall short of the future income their use is expected to yield?' Against this metric, Böhm-Bawerk measured all of the explanations of interest that economic theorists had offered before his own writing" (Choice 226).  

Pure Time Preference Theory of Interest #1

Murphy's Choice: Cooperation, Enterprise, and Human Action says a distinguishing feature of Ludwig von Mises's economics is the pure time preference theory of interest, in which positive interest rates are explained by reference to the fact that people prefer goods available in the present versus the same goods available only at a future date. Most professional economists outside the Austrian School would say that interest is a return to the marginal product of capital, like wages are a return to the marginal product of labor (the productivity theory).

Eugene Böhm-Bawerk in Capital and Interest (1884) classified and critiqued existing explanations of interest. He called the productivity theory of interest a category mistake. His own theory was more or less the time preference theory of interest, although he didn't label it that.

Later Frank Fetter (1904) offered a pure time preference theory of interest. Mises adopted Fetter's time preference theory with a twist. Whereas Fetter regarded the theory as empirical, Mises elevated it to a category of action.

Oddly enough, Murphy says, "After explaining the Austrian approach to interest – which has nothing to do with the productivity of capital per se – we will see how the accumulation of capital goods increases the productivity of labor and land resources, thereby increasing income" (Choice 224).

Murphy proceed to explain what Böhm-Bawerk dubbed the naive productivity theory and and their critique of it. It starts on page 225 of Choice. The entire section is not available using the Look Inside feature on Amazon, but the argument more or less follows Murphy's paper Why Do Capitalists Earn Interest Income?, available online here.

In future posts I will briefly present the Austrian arguments for the pure time preference theory and against the productivity theory, and present my reasons for not being persuaded that time preference gives a full explanation without regard to the productivity of capital. 

Murphy's Choice

Choice: Cooperation, Enterprise, and Human Action is a book that presents Ludwig von Mises' Human Action in a more accessible style. A reader with no prior knowledge of economics can get a basic understanding of the magnum opus of one of history’s most important economists. It's a good refresher for those who have read Human Action.  It is also much shorter, 336 pages versus more than 900.

The first seven pages consists of praise from many economists.  

The author, Robert P. Murphy, also wrote A Study Guide to Human Action, available for download here. I haven't read it, so I can't compare them. It is a little longer, 382 pages.

Sports contests

I entered the Post Newspapers NCAA basketball tourney bracket challenge again this year. I finished at the 68th percentile among over 134,000 entries. That's not great but it was better than all but one of the 13 "experts" at CBSSports.com. I did better than Barack Obama on every round through the Final Four, but he beat me overall.  I had two of the Final Four correct versus his one. He picked one of the final two teams and the champion -- North Carolina. Correct picks in later rounds count more.

Surprising teams were South Carolina, a #11 seed that made it to the Final Four, and Xavier, another  #11 seed that made it to the Elite Eight.

I'm playing Fantasy Baseball again this year. It's a long season.