Austrian Economics and Roundabout Processes of Production

Among the insights of the Austrian School of Economics-first elucidated by Eugen von Böhm-Bawerk in his 1889 magnum opus, Capital and Interest-is the greater productivity of more roundabout, or capitalistic, methods of creating desired goods.

Böhm-Bawerk's discovery can be aptly illustrated with a hypothetical case study. Suppose Robinson Crusoe, in his quest to attain fish, is faced with an alternative. He can use his bare hands for an hour to obtain 10 fish. Or he can invest an hour into producing a spear which will enable him to catch 100 fish during the next hour, after which the spear will break down from wear. The creation of the spear for later use in fishing is the more roundabout method of production. The act of creating the spear does not directly catch fish, but it furnishes Crusoe with a valuable capital good for this purpose. In one hour Crusoe will be able to use the spear to catch fish-hence, creating the spear temporally advances Crusoe to his desired goal: a greater quantity of fish.

Crusoe's roundabout method of fishing is more physically productive than the more direct approach of fishing with his bare hands. Practicing the direct approach for two hours, Crusoe will only gain 20 fish-10 per hour. In the meantime, the two hours spent building the spear and fishing with it will give Crusoe 100 fish, or 50 fish per hour of labor. The marginal product of the spear-the increase in the amount of fish Crusoe will be able to catch solely as a result of the spear-is 90 fish. Once Crusoe has the spear, using it for an hour will obtain him 90 more fish than he would have gotten without it. Yet building the spear also occupies a prior hour of Crusoe's time, during which he could have otherwise obtained ten additional fish-his opportunity cost in creating the spear. In total, had Crusoe used two hours to pursue the next best alternative open to him-fishing with his bare hands-he would have obtained 80 fewer fish than via the new roundabout approach. Each hour of Crusoe's labor will also become more productive. The marginal product of the hour Crusoe spends to build the spear is 40 future fish; the hour of actual fishing also has a marginal product of 40 fish over what he could have caught without the spear.

A roundabout process begins with original input resources-land and labor-which the economic actor uses purposefully to create a capital good that assists him in the attainment of his goal. By implication, the earlier the actor can use the input and initiate the roundabout method of production-the more he can get from it over time. The earlier Crusoe begins to systematically create spears-spending an hour to build each and then using an hour to fish with it-the more fish he will attain in the long run. If Crusoe invents an even more advanced capital good that requires even more time to complete it, the earlier he begins creating it, the more fish he will obtain as time passes.

The more roundabout a process of production is, the more time the economic actor will need to invest in it. However, the total productivity stemming from the roundabout process is always greater-provided that the capital goods created are legitimate means for attaining the ends sought. The most direct means of production might produce the most immediate returns, but these returns will be dwarfed in the long run by returns from a process aided by advanced capital goods.

Böhm-Bawerk's explanation of the efficacy of roundabout methods of production has lessons to teach many of our contemporaries in politics and economics-who overlook the critical roles of savings, investment, and technology in bringing about economic productivity and whose time horizons are sufficiently broad to only consider the immediate effects of a given action. What seems like the easiest and swiftest process is not necessarily the most productive. Instead, time, prudence, planning, and innovation are critical in bringing about increased economic prosperity.

Note: This essay was approved as an accurate representation of Austrian School economic ideas by Dr. Robert P. Murphy of Hillsdale College, one of the leading contemporary scholars of Austrian Economics.