The Theory of Capital

At the end of the academic year, Samuelson’s second article was published, not on consumer theory but on “Some Aspects of the Pure Theory of Capital.”⁵² The theory of capital was a widely discussed topic in the 1930s, mainly because of its use by Friedrich Hayek to provide an explanation of the Great Depression.⁵³ Hayek, a prominent opponent of Keynes in 1930, blamed the business cycle on over-expansionary monetary policy, but he used a theory about capital and production to explain why a downturn would trig­ger dislocation and unemployment, rather than simply a fall in prices.

While Hayek was the main proponent of such views, taking a hard line on measures to alleviate the slump, this view was held by many others as well; traces of it can be found, to varying degrees, in both Hansen’s and, as has already been seen, Schumpeter’s analyses of the cycle. Significantly for Samuelson, the theory of capital was one of the subjects on which his Chicago idol, Frank Knight, had written extensively, challenging Hayek’s claim that the capital stock could be represented by a single magnitude, the “period of production”—the average time between investing in a project and obtain­ing a return.^u The theory of capital was also central to the theory of the rate of interest, about which Knight and Schumpeter took opposing positions.

February 1937, implying that it had probably been written before the exchange with Haberler took place, given that the pure theory of trade was covered at the end of the course.

u. An example of a “short” period of production would be using workers’ shovels to build a canal. A longer process of production would involve first making mechanical diggers and then using these to dig the canal. An even longer process of production might involve designing and building machine tools that are used to make mechanical diggers, Given that two of his most important teachers were arguing about the topic, Samuelson could hardly avoid becoming involved.

However, Samuelson did not get into the larger literature on the theory of capital, despite alluding to its existence. Instead, he tackled a more iso­lated problem in pure theory: the objectives that should be pursued by a single company undertaking investment. His starting point was not Hayek, or any of those who were using capital theory to argue about the business cycle, but an article by a relatively unknown economist just five years older than himself, Kenneth Boulding (1910—1993). Boulding was British, graduating from Oxford in 1931. After a year of graduate work in Oxford, he went to Chicago for two years on a Commonwealth Fellowship, spending the fall of 1933 at Harvard working with Schumpeter.⁵⁴ He met and engaged with Knight. Samuelson was there, but there is no reason to think they met.

Boulding's aim in “The Theory of a Single Investment” (1935) was to extend the theory of the company to decisions taking place over time. He pointed out that the theory of profit maximization could be applied to any activity defined by a single income account. This could be an entire com­pany or an activity within a company; if there was a single account (even if a notional one) through which all receipts and payments passed, then this account could be treated as a single investment, to which the theory of profit maximization could be applied.