Elaborating on the Austrian Time Preference Theory

Elaborating on the Austrian Time Preference Theory
by Alex Merced

I write this article after listening to Robert Murphys lecture Capital and Interest from Mises U 2010

While Listening to this having heard explanations of Time Preference theory plenty of times, I started having flash backs to an Austrian Scholars Conference lecture where Robert Murphey was actually giving a critic of the ATPT based on his dissertation, basically challenging the idea that a future good is always less valued than a present good. This made me start to think, I do understand ATPT, but I'm not sure if it fully explains why this preference exists fully other than a sort of hedonistic view of human nature to want to satisfy all it's wants now. Then again Patience is a virtue, and one can look at virtues as efforts to fight human nature.

First off let's recap the ATPT for those of you unfamilar...


Austrian Time Preference Theory

The Bottom Line: Present Goods are always more valuable then Future Goods

Example: Pre-Sale Tickets (future good) are cheaper than tickets at the door (present good)

This is an important theory for explaining the Austrians view on Capital and the Interest from Capital. For example I have a $100,000 and I have these two choices which would I make.

Buy $100,000 of Bonds and invest them in Bonds that yield 5%

or

Buy a $100,000 of fishing supplies expecting to catch enough fish to make $110,000 (10% yield)

So you see here the capital I have I'll put towards the fish equipment cause In the end I'll have a greater yield from my investments, this is how capital naturally gravitates towards it's most productive purpose. If my calculation was correct I can now buy another $100,000 of fishing equipment and next year catch enough fish to make $220,000. As you can see the more I go through this process the more capital I accumulate and the better my life gets even though no new science or technology has been developed, cause I've accumulated capital and can continue to re-invest that capital for interest.

This is what seperates developed countries from developing countries cause they may only be able to afford $20,000 of fishing equipment so a year later they'd only have $22,000 so it'll take some time and re-investment before the capital accumulation brings them to the developed level.

So where time preference theory comes into play is in the issue of why would someone pay me $110,000 for the fish if they can instead get the same fish by buying the Fishing Supplies for $100,000 and save themselves the $10,000. The reason is cause they have a time preference, they don't want to have to wait for a year of fishing to save $10,000 so they rather pay the extra $10,000 to have the fish now. So as we stated, the current good, these fish I've already fished is worth more than the future good, the fish they'd fish if they made the same capital investment.

Ok, so that should sum it up, so now for my addition...


Is it a "Time" Preference or a "Tangibility" Preference

I think the time preference exists not cause there is a time bias, but because there is a tangibility bias. A future good isn't as tangible as a current good so provokes less of a reaction. This Tangibility preference can not only be applied to intemporal scenarios but also other scenarios of differeing subjective values.

Example 1:

"The Stimulus Bill has saved the Jobs of Teachers and Public Sector Workers"

or

"If the Government had not gotten involved new jobs would've been created from capital reformation"

You ask the typical person which statement seems more plausible, they'd more than likely say the bizzarre keyensian statement I put up first. Why, it's more tangible to them cause they see the jobs that would've been lost, but they can't see the jobs that were prevented from being created. Now of course an Austrian is trained to understand opportunity cost so the increased tangibility from that understanding may have them choose the second statement.

Example 2

"Spend 10% of Income on Your Loved Ones"

or

"Have 10% of your income taxed which hypotheically benefit your loved once objectively just as much"

Which one you'd think a person would subjectvely value more, the first statement cause the results of this same expenditure is tangible, this would probably be true if the tax money got spent in the same way at the same time cause of it's tangibility. Although a left wing Keynesian might actually value the second statement cause they've been trained to value the benefit to society of impersonal expeditures like in the second statement so them it'd be more tangible.

So in conclusion, I feel time preference is a preference that exists but because of the tangibility of intemporal value. I would expect that a Austrian who is trained to think intertemporally would prefer future goods on occasion, cause it's more tangible. For example we prefer the future value of recession that the current good of stimulus spending. While it's a bit more complicated than simply jobs now versus jobs later a lot of Austrian theory actually emphasizes long term benefits over short term.


If you agree, we can still call this the ATPT, it'd just now stand for the Austrian Tangibility Preference Theory

C Corporations and Moral Hazard

C Corporations and Moral Hazard
By Alex Merced

When confronting todays economics problems one thing we can agree across philosophies, theories, and economic frameworks is that Moral Hazard is rampant in the current system. The question then becomes how do you eliminate the moral hazard to return more realistic expectations in economic calculation.

The mainstream view on the left and right is that this moral hazard is created by "irrational" behavior cause by "too much" capitalism, so regulation must be enacted to reform this behavior and bring transparency to the market. As far as to handle the regulation issue, I've discussed how free market regulation can exist.

Now to Austrian Economics aficionados like myself usually take a different approach and believe that this moral hazard took generations of distorting economic calculation to create. This has been done via institutions like the federal reserve, IRS, and FDIC. Although I take it a step farther and say that the modern legal corporate structure is fundamentally flawed to a free market working, cause it separates or moves liability from two major players in enterprise, the executives running the enterprise and the Shareholders.

So let's see the effects...

Shareholders: Since Shareholders in a C Corporations have no direct legal liability or tax liability by virtue of ownership of these shares it makes disposing of these securities a decision made with very little cost except the opportunity cost of future gains that weren't realized if they continued to hold the shares. This makes the shareholder willing to sell the shares at a moment notice when the price goes up, and makes the value of company in itself in the long term a very slight consideration. Unlike this, Limited Partnership shares still separate legal liability as a Limited Partner but you retain the tax liability and you can't just dump the shares at a moments notice, this incentive creates a culture where investors do their due diligence and are concerned about the long term outlook of the company in case it takes time to find a buyer of the share.

Executives of Company: The executives and the Board of Directors are beholden to the shareholders... yet the make up of the shareholders is constantly changing due to shareholders having such a short time horizon as explained above. If the shareholders are not pleased with the short term returns from their investment, they can pressure the removal and change of these executives. Although if the company is built on unsustainable policies for short term growth, the executive doesn't own the capital in the enterprise so the concern of losing their position is a greater incentive to not change these policies to something sustainable. In a limited partnership the General Partner runs the company and must have a 1% interest in the company itself creating a dual incentive since their own capital is tied up in the venture and they have unlimited liability. While they are still beholden to the limited partner, the limited partners do have an interest in sustainable corporate governance because of the liquidity of their investment.

So essentially the C Corporation has opened a greater array of investors to the capital markets, but at the cost of moral hazard and short term thinking that results from the "Liquidity" of these investments. What I conclude is that if we're going to have a more SUSTAINABLE foundation and capital structure we need more active people running these enterprises, meaning they need more active investors which will never happen with the current C Corporation structure of liability. While some advocate creating artificial liability in the C Corp, why bother when you already have a business structure proven to create more sustainable businesses in the Limited Partnership.

Bottom Line, abolish the C Corporation.

Does Wall Street Contribute to the Economy?

Does Wall Street Contribute to the Economy?
by Alex Merced

 One of the complaints I keep hearing about is that Wall Street doesn't contribute anything to the economy. Well, Wall Street, which is just a moniker for the "Finance" industry has done a great job of facilitating it's function in the economy. The function of the finance industry to facilitate financing (lending and investment), and the only way it does this is not only by creating and selling securities as the detractors would like to believe. Derrivatives, Prorietary Trading, and all the other fun politically unpopular stuff that Wall Street does helps create liquidity and demand. If these securities arn't liquid (which really just means has lots of demand), then it makes it hard to sell new securities for new companies cause the amount of investors becomes less. So yes these trading markets where firms and investors make money for themselves do serve this financing function, but does that mean everything is working as it should... no.

Risk and Reward help dictate how investors align their capital over time, and we have seen that investors, company executives, and everyone has seen their time horizons shrink demanding profits and returns on their investments quicker than ever before. When peoples time horizons shrink, more risk must be taken to achieve their goals in this time horizon, so one must study how culturally time horizons have shrank. Here are many factors I would consider:

1) The advent of C Corporations seperated those with Capital at Risk from those making the business decisions. Even in a Limited Partnership the General Partner who ran the business had to at least have %1 stake in the venture but now in a C Corporation the CEO is beholden to shareholders who are looking for short term gains since their securities can easily be sold at a moments notice. In a limited partnership, Limited Partners with Limited Liability can't just sell their shares on the fly so they have a stake in long term stability of the company and invest based on long term outlook instead of short term price fluctuations. C Corporations truly separated the liabilities of failure and liquidity from investors and executives and allowed them to operate in a short term gain framework.

2) Growing Government with low interest rate policies have put inflationary pressures on the returns needed by investors, plus the taxation that comes later on from these policies. So just to preserve the purchasing power they currently had investors had to make more gains faster, and of course Broker/Dealers are going to facilitate finding a way to do so.

So we need to return to free market values with realistic time horizons, but as long as we seperate liability from capital via legal institutions like the C Coporation (SIPC, FDIC, and the Federal Reserve don't help either), and tolerate growing government in distorting economic calculation to finance it's operations the Finance Industry won't have the capacity to return functioning in a sustainable manner, and no amount of regulation can make up for natural risk and reward.