Malinvestment

Malinvestment is a concept developed by the Austrian School of economic thought, that refers to investments of firms being badly allocated due to what they assert to be an artificially low cost of credit and an unsustainable increase in money supply, often blamed on a central bank.

This concept is central to the Austrian Business Cycle Theory, which has been criticized by such as Nobel laureate economists such as Paul Krugman and Milton Friedman.^{[1][2][3][4][5]}

The concept dates back at least 1867. ^[6] In 1940, Ludwig von Mises wrote, "The popularity of inflation and credit expansion, the ultimate source of the repeated attempts to render people prosperous by credit expansion, and thus the cause of the cyclical fluctuations of business, manifests itself clearly in the customary terminology. The boom is called good business, prosperity, and upswing. Its unavoidable aftermath, the readjustment of conditions to the real data of the market, is called crisis, slump, bad business, depression. People rebel against the insight that the disturbing element is to be seen in the malinvestment and the overconsumption of the boom period and that such an artificially induced boom is doomed. They are looking for the philosophers' stone to make it last."^[7]

Austrian Business Cycle Theory and Malinvestment

Main article: Austrian Business Cycle Theory

Though mainstream studies, such as those by Nobel laureate Milton Friedman, have delivered conclusions against the theory,^[1][2] Austrian economists such as Nobel laureate F. A. Hayek largely advocate the idea that malinvestment occurs due to the combination of fractional reserve banking and artificially low interest rates misleading relative price signals which eventually necessitate a corrective contraction—a boom followed by a bust.^[8]

Government intervention

Government interference can also distort market information signals. For example, 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.^[9] Austrian economists, such as Murray Rothbard, have derided government spending and public 'investments' as simply interfering with the complex resource-allocating properties of the price mechanism.^[10]

References

1. ^ ^{a b} Friedman, Milton. "The Monetary Studies of the National Bureau, 44th Annual Report". The Optimal Quantity of Money and Other Essays. Chicago: Aldine. pp. 261–284. 
2. ^ ^{a b} Friedman, Milton. "The 'Plucking Model' of Business Fluctuations Revisited". Economic Inquiry: 171–177. 
3. ^ Gordon Tullock (1988). "Why the Austrians are wrong about depressions" (PDF). The Review of Austrian Economics 2 (1): 73–78. doi:10.1007/BF01539299. http://mises.org/journals/rae/pdf/RAE2_1_4.pdf. Retrieved 2009-06-24. 
4. ^ Caplan, Bryan (2008-01-02). "What's Wrong With Austrian Business Cycle Theory". Library of Economics and Liberty. http://econlog.econlib.org/archives/2008/01/whats_wrong_wit_6.html. Retrieved 2008-07-28. 
5. ^ Krugman, Paul (1998-12-04). "The Hangover Theory". Slate. http://www.slate.com/id/9593. Retrieved 2008-06-20. 
6. ^ John Mills, Article read before the Manchester Statistical Society, December 11, 1867, on Credit Cycles and the Origin of Commercial Panics; As quoted in Financial crises and periods of industrial and commercial depression, Burton, T. E. (1931, first published 1902); see online version. New York and London: D. Appleton & Co; "Panics do not destroy capital; they merely reveal the extent to which it has been destroyed by its betrayal into hopelessly unproductive works."
7. ^ Ludwig von Mises, Human Action: A Treatise on Economics, 1966 [1]
8. ^ Larry J. Sechrest. "Explaining Malinvestment and Overinvestment" (pdf), October 2005, referenced 2010-07-01.
9. ^ 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 2010-07-01.
10. ^ Murray N. Rothbard. "Man, Economy and State". http://mises.org/rothbard/mes/chap12e.asp. Retrieved 2010-05-11.. "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."