Business Cycles and Entrepreneurs: A Heterogeneous Adjustment Process

This paper takes the concept of heterogeneous entrepreneurs (Evans and Baxendale 2008) and investigates how higher quality entrepreneurs are able to adjust their structures of production and economic calculation in face of business cycles to avoid malinvestments and other ill effects that result from credit expansion. In an attempt to overturn opposing views of the Austrian Business Cycle Theory and shed insight on how entrepreneurs can avoid the harmful effects of credit expansion, we look to show that production structure adjustments are different across industries depending on the specificity of the good produced, or how lengthened the structure is. We make the additional claim that the entrepreneurs in charge of the adjustment process have a thymological experience, or specific understanding, that can be relied upon for making the necessary changes in the structure of production to maintain profitability through the business cycle. Introduction Austrian economics has laid out the most definitive argument against credit expansion and business cycles. The theory explains a cycle of booms caused by credit expansion and a lowering of interest rates that eventually leads to busts as a correction process takes place. Austrian theory further explains that business cycles can never be predicted with certainty as to when the actual event will take place. This being said, theory does allow us to identify a boom in its present state, and anticipate when the bust is likely to occur. 1 There are several indicators of a boom’s existence: low real interest rates, rising gold prices, money supply growth above trend levels, lending above trend levels, unemployment below natural rate, and savings rates below trend levels. With these “easily identifiable” indicators of a boom, the question might be asked why entrepreneurs simply do not recognize these features and integrate them into profitability calculations. This is the question Bryan Caplan (1997) raises when he maintains the “rational expectations” criticism—one of many criticisms against Austrian Business Cycle. Caplan writes: Given that interest rates are artificially and unsustainably low, why would any businessman make his profitability calculations based on the assumption that the low interest rates will prevail indefinitely? No, what would happen is that entrepreneurs would realize that interest rates are only temporarily low, and take this into account. [Emphasis in original]. Quoted originally in (Engelhardt 2012). 1 An in depth explanation of the Austrian Business Cycle theory will not be given in this paper. Only a sufficient explanation will be given to understand concepts set out in subsequent sections. Reference Mises (2009 [1912]) and Hayek (2008 [1935]) for the theory in its original form; it has changed very little since its conception.