Why do Austrians talk about a structure of production? More to the point, why do Austrians categorize goods as being within “orders” or “stages of production?” Does the real world really reflect this kind of model? Does the complexity of the real world discredit, or undermine, the value of the basic Austrian conceptualization of the structure of production? The answer to this last question is ‘no,’ and one of the most fundamental answers to the previous question is that thinking in terms of stages of production helps us get away from thinking of the capital structure as a “fund” or a pool of goods that regenerates itself — indeed, this was the substance in the debates between E.v. Böhm-Bawerk and J.B. Clark and F.A. Hayek and F.H. Knight. Finally, those critics who doubt the usefulness of the notion of “stages of production” because of the complication of those goods that may belong to several stages simultaneously have yet to recognize the differences between a model and the real world that a simplified model is supposed to help explain. They also, no less, are dealing with issues that Austrian capital theorists have tackled and addressed since the birth of the school.

In Principles of Economics (see pp. 55–67, 71–74, 84–87 in particular), Carl Menger introduces us to the ordering of goods by stages to provide a number of insights. He developed a theory of value imputation, by which higher order goods (the means of production or producers’ goods) derive their value from the final consumer good. He extended this theory of value to consider capital complementarity, where some capital good may only be valuable if there are available specific prerequisite complimentary inputs. A car engine, for instance, may not be valuable if there isn’t also the necessary means of productions to connect the engine to the wheels to make the car move. The theory of value and price imputation requires that we vertically separate goods of different stages so that we can study general relationships of value between goods that are removed from the final consumer goods by a varying number of stages.

The most well-known rationale behind the concept of a “structure of production” with multiple stages is to take into account the role of time. Perhaps because of early flirtations with the concept of an “average period of production,” many critics have assumed this to mean that Austrians pretend to establish some relationship between value and the length of time of a particular technique. While value does affect the technique employed, in that the marginal value of particular complimentary goods will help decide how they’re employed, the concept of “stages” is of a much more general character. If we, for the sake of simplicity, call a firm’s technique its production function, the Austrian theory of capital deals with the relationships between various production functions. For the most part, it explores a “vertical” relationship, between the provision of inputs for successive stages of production. For example, if we say that the assembly of a laptop is a second order production function, the manufacturing of the individual pieces may be considered a third order stage, and the manufacturing of the parts for the individual pieces may be the fourth order stage, and so on and so forth. We see that the time required to produce a laptop is not just the time it takes to finish whatever technique the assembly plant adopts, but also the time required to produce all the inputs, plus the time required to produce all the third-order inputs, et cetera.

By developing a theory of value and imputation we can establish some general rules as to changes in the shape of the structure of production, and we can help explain why a given structure looks the way it does. Following Böhm-Bawerk’s development of the time preference theory of interest (and further developed by Frank Fetter during the early 20th century), we can account for the added complexity of intertemporal dynamics. That is, we develop a theory of capital accumulation, investment, and growth. This includes the relationship between the production of machinery and necessary length adjustments to the structure of production, in terms of the provision of inputs of even earlier stages, guided by changes in the relative values of goods of different orders.

Hayek, during the interwar years, elucidated on these relationships and summarized capital theory as a study of the rules which guide the maintenance of capital. Rival capital theories, namely those of J.B. Clark and F.H. Knight (who had debated Böhm-Bawerk and Hayek, respectively, in their time, and had, rightly, criticized the concept of an average period of production), are characterized by their conceptualization of capital as a fund. This fund is considered almost regenerative, and the fund is used to produce current consumption goods. Hayek considered the subject more complicated and was interested in formalizing the microeconomic theory of capital maintenance. Capital maintenance isn’t just about rebuilding what is consumed during the process of production, but also about changing the type of capital employed and, even, increasing the value of the pool of capital over time. In a sense, then, whereas most economists see value in differentiating between capital and consumers’ goods, so that we can establish some general rules about the production of final goods, Austrians differentiate between different capital goods so that we can study the rules which guide changes in the structure of production, meaning changes in the employment of given goods and changes in the nature of the goods themselves.

Coming full circle, then, we see the value of the model of the structure of production. By ordering the means of production by stages, we can study how the prices of these goods are derived and therefore use this knowledge to establish relationships between the valuation of goods belonging to different orders, how many stages there are, and the general allocation of the means of production throughout the separate processes of production. The time element not only helps conceptualize the temporal gap between the production of the initial inputs and the manufacturing of final goods, but also allows us — by incorporating time preference — to study how entrepreneurs may take advantage of intertemporal valuation to increase the structure of production’s productivity.

No matter how many variables we include in our models, though, these models will never perfectly reflect the real world. They’re not meant to. Models are ideal types, where the economist abstracts from certain features to focus on others. If we wanted a perfect representation of the real world we would just study the real world without models; we build models precisely because this task of studying the real world is difficult without them. Reality is complex, so we have to simplify it to understand as much as we can. That some capital good, in reality, belongs to separate stages does not undermine Austrian capital theory;1 it just means that we have to take that into consideration when applying our models. (In The Pure Theory of Capital, Hayek seems wary of this kind of criticism, because he takes care, throughout the book, to distinguish between the model and the real world, and to explain to his reader the purpose of the model.) Austrians have, without a doubt, taken into consideration real world complexities, since they are often the most willing to discuss them (see the capital theory of Menger, Hayek, Mises, Lachmann, and Kirzner). To criticize the concept of a structure of production you have to prove why the insights it provides are not valuable. Nobody has made a convincing case to this effect so far.

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1. Regarding goods that belong to multiple stages, this fact will impute conflicting values onto that good (e.g. someone building a house may value a nail more than someone building a refrigerator, or vice versa). The relationship between the good in question, the alternative uses, and the different valuations of the good will play a role in deciding the good’s price (according to Böhm-Bawerk, the price will be imputed from the least valuable alternative) and its final allocation. With this in mind, we can also divide the separate goods themselves, even if they are of the same “class” (e.g. a nail, , a printer, an apple, et cetera). Remember that, following Menger, the item receives its “good character” not from its physical qualities, but from the subjective value imputed from the user to the item. We can, for instance, argue that a nail being used in a house is a totally different good than a nail, of the same physical qualities, being used in a refrigerator.