History of Political Economy 35.3 (2003) 469-490
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The Hayek/Knight Capital Controversy:
The Irrelevance of Roundaboutness, or Purging Processes in Time?
Avi J. Cohen
Neither changes in the durability of goods nor changes in their construction period . . . exerts an identifiable effect on a definable "period of production" in society as a whole. Moreover, they are similarly unconnected with quantity of investment, and quantity of investment is likewise unconnected with any production period. Correspondences in this field are limited and accidental, without theoretical significance for the nature and rôle of capital. It is extremely difficult to give any intelligible meaning to a "period of production," and it certainly has no meaning of the sort assumed in the Böhm-Bawerk–Hayek theory of capital.
—Frank Knight, "Professor Hayek and the Theory of Investment" (1935)
[Knight's permanent, homogeneous fund of capital and J. B. Clark's true capital] are just so many evasions of the real problem of explaining how the existence of a given stock of capital limits the possibility of current investment. Without such an analysis they are just so many empty words, harmful as the basis of the noxious mythology of capital which by creating the fiction of a non-existing entity leads to statements which refer to nothing in the real world.
—Friedrich A. von Hayek, "The Mythology of Capital" (1936)
The 1930s controversy between Friedrich A. von Hayek and Frank Knight over capital theory has been briefly summarized by many authors [End Page 469] (Ahmad 1991; Blaug 1997; Skousen 1990; Valiente 1980; Weston 1951) and often referred to in passing because of similarities to the Cambridge capital controversies (Hennings  1990; Hicks 1974; Kurz  1990; Milgate 1979; Solow 1963). More detailed discussions of the Hayek/Knight controversy have appeared recently in the broader contexts of Knight's wide-ranging intellectual activities during the 1930s (Emmett 1998) and the debate over socialism (Boettke and Vaughn 2002). Missing from the literature is a detailed chronicle and analysis of the controversy and its issues on their own terms. This article attempts to fill that gap, supplementing the public record with correspondence between the authors.1
Knight and Hayek held fundamentally different conceptions of capital (Cohen 1997, 1998; Emmett 1998). Knight emphasizes a fund of value which is homogeneous, malleable, and permanent. He follows J. B. Clark's (1899) emphasis on capital as a permanent fund of value, while having interest determined entirely by the technical marginal productivity of capital, without reference to either the measurement of capital or time preference. In contrast, Hayek emphasizes heterogeneous, specific capital goods. He follows Eugen von Böhm-Bawerk's ([1884–1912] 1959) emphasis on heterogeneous capital goods and the period of production, but disavows entirely Böhm-Bawerk's subsistence fund determination of the interest rate (Hayek 1941, 146–47). In its place, Hayek (1941, 265, 266) substitutes an intertemporal price system that determines multiple own-rates of interest, but which Hayek believes will tend toward a uniform rate.
The Hayek/Knight controversy, as the opening quotations illustrate, revolves around these fundamentally different conceptions. Given Knight's conception of a homogeneous, permanent fund of capital, specific periods of production are irrelevant and unmeasurable concepts "without theoretical significance for the nature and role of capital." Given Hayek's conception of heterogeneous capital goods, Knight's homogeneous, permanent fund of capital purges any analysis of processes in time and of how a given specific "stock of capital limits the possibilities of current investment." There are subsidiary issues in the controversy—the origins of cycles, what determines the rate of interest, [End Page 470] and the limitations of equilibrium analysis for explaining issues in which each author is interested—but all are connected to the differing conceptions of capital.
We begin with a chronological overview of the controversy, and then clear away the considerable areas of agreement between Hayek and Knight. This will provide context for the detailed examination of the key issues that takes up the greater part of the article.