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Malinvestment results from the inability of investors to foresee correctly, at the time of investment, either the future pattern of consumer demand, or the future availability of more efficient means for satisfying consumer demand. Malinvestment is always the result of the inability of human beings to foresee future conditions correctly. However, such errors are most frequently compounded by the illusions created by undetected inflation.
Austrian Business Cycle Theory and MalinvestmentEdit
The complicated and somewhat fragile production structure requires that complementary inputs be available not only in the right magnitudes but also at the right moments in time. If they are not, then projects that appeared profitable are soon revealed to be unprofitable. In other words, what appeared to be capital creation is seen in fact to be capital consumption.
In a monetary expansion, monetary growth cannot produce economic growth. The economy is being pulled in two directions. Entrepreneurs want more capital goods, at the same time that consumers want more consumer goods.
The decline in interest rates means it pays less to save, so consumption is raised beyond levels that would have otherwise taken place. At the same time, more real funding seems to be available for businesses. More resources are used for the production of consumer goods and less for the maintenance and improvement of the wealth-producing infrastructure. This lowers the economy's capacity to produce final consumer goods and so it weakens the pool of funding - contrary to the popular idea that a central bank can grow the economy by keeping interest rates as low as possible. The needed correction comes in the form of a recession, during which many projects are liquidated and unemployment rises.
Austrian Business Cycle Theory focuses on the "medium run", because that is where problems arise. In the short run, the capital structure cannot be changed significantly, and in the long run all errors have been rectified. In the medium run there is time enough for capital projects to be initiated and the direction of production to change, but not enough time for malinvestments to be corrected - at least not without serious repercussions.
The inability to smoothly liquidate or redirect projects stems largely from the heterogeneity of most capital goods. Capital goods cannot immediately be converted into final consumer goods - or other capital goods. Changes in the structure of production cannot easily be reversed. There is a significant degree of "path-dependence" involved with the capital restructuring that occurs in the medium run. The economy cannot simply "erase" the errors and start over.
Malinvestment occurs due to misleading relative price signals, and it necessitates a corrective contraction - a bust following the boom.
- Main article: Austrian Business Cycle Theory
Government interference can also distort market information signals. For example, if the government creates a false expectation of greater trust (e.g. by declaring its backing of one of the parties), it can cause the second party to invest too much in this relation (and thus create "overinvestment"). In the opposite case, it can create distrust, causing people to invest too little and making them lose potential benefits from unconsummated transactions. By generating such fluctuations, the government can "add" or "remove" trust from various private activities or individuals, or it can interfere with them by its own activity and crowd them out. In financial markets, the government in most cases obtains more favorable loan conditions than any other potential borrower. The most common explanation attributes this advantage to the government’s power to tax. As a result, it crowds out private investments that cannot compete.
Similarly, some studies of crowding-out in the area of private philanthropy explain it with reference to private charities’ reduced effort to raise funds from individuals after they receive a government grant.
Rothbard writes, that "government is deprived of a free price system and profit and-loss criteria, and can only blunder along, blindly "investing" without being able to invest properly in the right fields, the right products, or the right places. A beautiful subway will be built, but no wheels will be available for the trains; a giant dam, but no copper for transmission lines, etc. These sudden surpluses and shortages, so characteristic of government planning, are the result of massive malinvestment by the government."
- ↑ Percy L. Greaves Jr. "Mises Made Easier", "Glossary, Malinvestment - Mutatis mutandis", referenced 2010-05-11.
- ↑ Frank Shostak. "The Subsistence Fund", Mises Daily, August 2004, referenced 2010-05-11.
- ↑ Larry J. Sechrest. "Explaining Malinvestment and Overinvestment" (pdf), October 2005, referenced 2010-05-11.
- ↑ Pavel Chalupnicek and Lukas Dvorak. "Health Insurance before the Welfare State The Destruction of Self-Help by State Intervention (pdf), The Independent Review, v. 13, n. 3, Winter 2009, referenced 2010-05-11.
- ↑ Murray N. Rothbard. "Chapter 12—The Economics of Violent Intervention in the Market", Man, Economy and State, 10. Growth, Affluence, and Government, referenced 2010-05-11.
- Malinvestment on Wikipedia
- Is "Malinvestment" enough to go bust? (pdf) by Enrico Colombatto, summer 2005
- Explaining Malinvestment and Overinvestment (pdf) by Larry J. Sechrest, winter 2006
- Capital, Credit Expansions, and the Subsistence Fund (pdf) by Larry J. Sechrest, November 2002
- Malinvestment, Not Overinvestment, Causes Booms by Ludwig von Mises
- Aerial Footage: Portrait of a Housing Bust by Barry Ritholtz, October 2010