The flaw in Austrians’ Mal-investment idea.

Austrians think recessions are good in that they dispose of mal-investments.

The flaw in this Austrian argument is thus.

First, there are businesses or investments which are only just viable during a particular boom, and which will fail come a recession, but which will get their act together, and become much more profitable in the long term. Having a recession that wipes out these businesses is pointless.

Second, there are businesses like the above but which will remain only just viable when the economy is at capacity. These businesses are clearly “bottom of the class” They are the businesses that we least need. But what of it? As long as pay their way (only just), why get rid of them?

Third, there are businesses which will go from bad to worse. These will fail even if demand is kept at the maximum level that is consistent with acceptable inflation. That is, a recession is not needed to get rid of these businesses.

Conclusion: recessions do get rid of mal-investments, but recessions involve throwing babies out with the bathwater: bathwater which will be disposed of anyway. Therefore recessions achieve nothing.

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