Tuesday, July 05, 2011

J. R. Hicks' Use of "Malinvestment"

In the influential Value and Capital: An Inquiry Into Some Fundamental Principles of Economic Theory (2nd edition, Oxford, 1946), J. R. Hicks writes:
"...it is the strict interpretation - divergence between expected and realized prices - which is of central importance theoretically. Whenever such a divergence occurs, it means (retrospectively) that there has been malinvestment and consequent waste. Resources have been used in a way in which they would not have been used, if the future had been foreseen more accurately; wants, which could have been met if they had been foreseen, will not be satisfied or will be satisfied imperfectly. Thus, disequilibrium is a mark of waste, and imperfect efficiency of production." -- J. R. Hicks, p. 133, my emphasis.
This passage occurs in Hicks' introduction of the method of temporary equilibrium. I think Hicks relied heavily on Hayek in developing this method1. But I see a large difference in Hicks' use of "malinvestment" here and Hayek's account in Prices and Production.

For Hayek's version of ABCT, malinvestment occurs when entrepreneurs more or less share the same systematic expectations and plans. In explaining business cycles, he abstracts from non-systematic mistakes in capital investments. Hayek thinks entrepreneurs will invest in too capital-intensive techniques when monetary authorities set the interest rate too low. They will tend to adopt a capital structure in too many high-order goods and not enough low-order goods are produced, as compared to the capital-structure justified by consumer tastes2.

Hicks, on the other hand, is considering a case in which all spot markets clear, but some ongoing production could be the result of variation among entrepreneurs in expectations or plans. Since some expectations or plans are incorrect, he characterizes this state as a disequilirium. Hicks does not posit a systematic bias in plans or expectations for his use of the term "malinvestment". Consequently, his business cycle theory is quite different from Hayek's.

  1. Hicks mentions Hayek in his acknowledgments. I'm surprised to see he also acknowledges criticisms from Sraffa.
  2. This theory cannot be sustained.

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