I've mentioned before that I think there are a number of problems in the Austrian business cycle theory as it is usually expounded. Some of these problems are small and only of theoretical importance. They relate to the intricate and subjective nature of the capital structure and the role of expectations. Although the theory may be correct for a simple economy (or in a single sector of an economy) which is relatively stable and has easily identifiable stages of production, this does not mean, a priori, that the theory generalizes to a complex and dynamic economic system.
I am trying to communicate the idea that in a complex system, we may be unable to apply the standard theory. In a world where the lattice-work of heterogenous goods in subjectively interpreted relationships is constantly shifting, are Hayekian triangles any more than an easy to understand piece of pedagogy, not unlike Samuelson's pitiful defense of the production function as a mathematical "parable"?
Currently,
many experts are denying the claim that a government run healthcare service
would need to ration out care to patients. However, this impossible. Just like
the free-market, which "rations" according to ability and willingness to pay, a
government healthcare service does not have unlimited resources (although it
may be well-funded), so it must also ration care to its clients. Therefore, the
question is not whether there will be rationing, but how it will occur and who
will guide it. In itself, this doesn't show that free-market healthcare or
government healthcare will be inherently better. But we can use the insights of
public choice and standard theory to show that, at the least, we shouldn't
expect the government to outperform the market without extremely extenuating circumstances.
In particular, without real market entrepreneurs guiding the healthcare process,
it seems unlikely that a dynamic system with ever-changing and improving
medical technology would result. As Lachmann constantly emphasizes, the marketplace
is a zone of incredibly dynamic and often unpredictable progress, guided by entrepreneurs
who must interpret data and form expectations in accordance with their accumulated
knowledge. Government, on the other hand, often seems to be in a sort of
stasis, only changing at regular intervals and unbothered by the threat of
competition.
The School's...
View of the scope of Economics: science
of human action, science of objective wealth, science of scarcity and
allocation, etc.
Method of formalism: verbal logic,
mathematical logic, acceptance of ambiguity and lack of formalism
Basic assumptions about rationality: perfect
rationality, bounded rationality, reasonable rather than rational, irrational
(driven by animal spirits)
Use of time: comparative statics
(extremely limited use of time), equilibrium (out of time), real time
(Bergsonian time)
Fellow
travelers are often treated as annoying gadflies, whose only effect is to
distract the hard core of a group. However, they serve in a number of
underappreciated roles. In the Austrian case, they help to bridge the gap
between the mainstream and the Austrian school. Economists like Leland Yeager,
who sympathizes with market process theory, can make a marginalized movement
appear more respectable to the mainstream.They can also help bridge gaps and
create dialogue between different heterodox movements. For example, Theodore
Burczak has recently attempted to synthesize Marx and Hayek, provoking
conversation between Marxist and Austrian economists. Most importantly, such
people help prevent groupthink and insularity within a school of thought.
I’ve tried to make an attempt to formalize the Austrian notion of utility. This seems to be a praxeologically sound formalization which does not imply that mathematics can be used in economic theory. This formulation does not state that utility functions are continuous or differentiable, so forming a Walrasian system with them would be nearly impossible. Nevertheless, it is at least an interesting exercise. Feel free to critique it:
The good's first unit will
satisfy the most important end, the second unit will indulge the next most
important, the third unit will tend to the third most important, and so on.
Thus we get a set of ends E = ( e1, e2, e3, .
. . ,ei) with the following property: For all e1, e2,
in E, ej, is preferred to ei, if and only if i < j.
The ranking of the elements of E is the basis for ordinal marginal utility. Let
X = (x1, x2,
. . . xi, . . . ) be a set where x, denotes the number of units of good x at a consumer's disposal. Let xj >
xi,
if and only if j > i. Define a
marginal utility function f: X --> R+ such that f(xi) >
f(xj)
if and only if xi, < xj. This is a result of the fact
that a consumer will utilize additional units of good x to satisfy sequentially less
important goals. f is thus a decreasing marginal utility function on X . To show
that marginal utility is ordinal, let S = (f, g, . . .) be the set of all
functions on X defined as above. Then for all f, g in S, and for all xi,
xj in X, f(xi) > f(xj) implies
g(xi)
> g(xj).
S is consequently an ordinal measure of marginal utility.
If the subscripts aren't working, the sets are
meant to be ordered sets.
“On the one hand we want to have a time structure of production in order to have our theory of the trade cycle. On the other hand we often cop out by describing it as purely subjective; the time structure of production describes something about the plans of entrepreneurs and in this sense varies from entrepreneur to entrepreneur. But we can't have it both ways. If it supports ATBC, then it's an "objective" notion. If it is a "subjective" notion, the ATBC cannot be sustained. I wish we would pick up on a suggestion by Peter Lewin and cut the Gordonian knot with the idea of "duration." Before we can do that, however, we have to see the problem and it's my impression that almost no Austrians see the problem.”
-Roger Koppl
This is an interesting point, although I’m not sure whether I entirely agree with it. However, if this dichotomy of subjective entrepreneurial plans and objective physical capital really cannot be bridged, I think that I would have to take the side of subjectivism.
After giving more thought to this, I think that we should discard the time component as a critical part of the theory. While we can say that inflation alters the number of stages of production and introduces greater uncertainty into the system, we can’t talk about the process in a uni-dimensional manner. Because of the existence of looping in the capital structure (some production processes may produce materials that later end up in that same process), the order of any production process is an entirely subjective phenomenon, existing only in the interlocking plans of entrepreneurs. Therefore, a distorted rate of interest can only be said to disfigure and warp the web of interconnected capital. Although we might be able to empirically discern more specific tendencies, given a particular capital structure, the theory itself cannot give us any more information. We need to accept that we cannot derive a satisfying business cycle theory without empirical insight.
Critical Realism is a philosophical movement that has been gaining some ground in the past few years. It is an approach to philosophy that encompasses epistemology, ontology, and to some extent, morality. It approaches the world as being made up of “structures,” each with certains “powers.” These structures (think gravity) are always exerting these powers, even when there are other powers at work preventing the previous powers from achieving its full effect. For example, gravity works upon a bird, but the bird’s power to fly counters this.
You might ask: why is this so novel? In contrast to positivism, it is quite new. Positivism looks only at conjoined events of the form: A, then B. Realism attempts to look at the structure of events and denies that the prediction of such conjoined events is the purpose of science.
This is relevant to economics because this philosophy is incompatible with many forms of econometrics. If the purpose of science is to study “structures,” rather than laws, then the mainstream approach to economics is bankrupt.
Unfortunately, this philosophy is almost invariably used solely by the left, often to justify Marxism. However, Austrian economics could certainly make use of this philosophy to justify its methodological attack on the mainstream.
Andrew Collier’s book on Critical Realism would be a good place to learn about this topic, if you can ignore the Marxist ideas strewn throughout it.
Anyone who thinks the Austrians are not
influential really needs to do his homework on the subject. Penrose, Lawson, and
Lewin have all been influential in their fields and were heavily influenced by
Austrian ideas. Tullock and Buchanan
have both said that Hayek greatly influenced them. Even some Marxists have
become Austrians, such as Burczak. Just because a school's influence is diffuse
doesn't make it inconsequential.
More importantly,
there have been attempts by other heterodox movements to reach out to the
Austrians. For example, Tony Lawson has made the case that the philosophy of
Critical Realism is to some extent compatible with Austrian teachings. He uses
Hayek as an example of a proto-Critical Realist. In itself, this shows that our
school of thought has influence in the general sphere of heterodox economics.
Although it's true that Hayek's influence has been more widely felt than most
other Austrians, Mises has influenced many as well. For example, Mises has
influenced many classical liberal historians, such as Leonard Liggio.
Aristotle,
upon whom Menger based some of his ideas, believed in the concept of akrasia.
Akratic action is action that is known to be against an agent's own interests,
but is pursued regardless. This is obviously incompatible with any rational
choice-based theory of action, since the agent is purposely acting
irrationally. An example is the drunk who knows his alcohol addiction is
harmful and regrets his problem, yet continues drinking. Is this a problem for
a realistic economic theory based on the assumed rationality of economic
agents?
One
first step to deal with this problem is relaxing the standard of rational
action to the Misesian notion of purposeful action. This does not solve the
problem fully. In this case, we can understand the agent as having two opposing
beliefs about the usefulness of their action. The agent only acts on one of
these beliefs, leading to feelings of regret from the other. However, this
leads to a new problem: why would an agent choose only to pay attention to an
inferior belief?
Elster attempts to solve this problem by
positing a rapid change in time preference of the agent during the akratic act.
When the actor soberly examines his options ahead of time, he may choose X over
Y. However, when confronted with the imminent choice, he chooses Y due to a
rapid increase in his discount rate. This solution does not provide an answer
to the deeper question of why the agent would feel regret simultaneous with the
action. It seems that the only way out of this puzzle is to admit that this
increased discount rate is caused by a weakness of will, perhaps due to
impulsiveness. The actor knows that his choice is problematic, yet is unable to
impede the force of his passions. This is not incompatible with any Misesian
theory of choice, since praxeology makes no claims about the motivations of an
action.
There are at least three distinct, but
overlapping, research programmes (to use Lakatos' term) in Austrian economics,
at least according to Rothbard. Each of these styles of thought can rightfully
claim to be based on Mengerian insight.
There is the Mises-Rothbard strand,
which emphasizes rationality, equilibrium as a mental construct, and theorizing
based on axioms and logical deduction. This comes directly from Menger's search
for "exact laws" of economics and human action.
A more prominent mode of thought, at least
among the mainstream, is the Hayek-Kirzner paradigm. Although this group can
easily be split up further, it generally emphasizes spontaneous order,
discovery procedures, and entrepreneurship. This can be derived from Menger's
discussion of organic and pragmatic orders and organizations. The classic
example of an organic order is the means of exchange, which spontaneously arose
to fulfill the need created by the problem of finding a "double coincidence of
wants".
Another, more controversial, research programme
is the Lachmann-Shackle school of radical subjectivism. This method of analysis
focuses on expectations, sociology, and disequilibriating elements in the
economic process. It shares some elements with the Post-Keynesians, although
these ideas are taken in drastically different directions. This draws on
Menger's role as one of the founders of subjectivism and claims to complete the
subjectivist revolution.
How should we decide whether a school of
economic thought is heterodox or mainstream? The line is not always very clear.
We can safely say that economics in the style of Paul Samuelson, the neoclassical
synthesis, is mainstream, but that is an easy case. One way to draw the line is
to look at other areas of study that the school resembles. Does it resemble
physics? Philosophy? Or perhaps sociology? I would suggest that any school
which resembles physics or mathematics is mainstream. Even this is not always a
good heuristic, since econophysics is not particularly mainstream. Another
method of categorizing is to look at who founded or popularized the school. If
the founder was English, it is probably mainstream. There are a number of other
interesting ways of categorizing schools, based on differing perspectives on
capital, interest, and other concepts, as well.
I believe that any kind of interventionism
is incompatible with subjectivism. For example, suppose that a cluster of
entrepreneurial errors occur in the economy, possibly as a result of the ABCT.
The capital structure has become inconsistent with the demands of the consumers
and relative prices are out of balance.
What could an
interventionist Austrian suggest to deal with this? He could recommend that the
government create incentives to invest in industries that would have done well
had the cluster of errors not occurred (these would likely be producers of
consumer goods). How would the government determine the proper industries to
prop up? It could not. To do so would require precise knowledge of a
counter-factual state of affairs. Since the correct capital structure is a
reflection of consumers' needs, the only option is to let the entrepreneurs
slowly discover their mistaken investments and correct them. Therefore, Lachmann was inconsistent with his
own methodology when he advised certain kinds of intervention to alleviate the
business cycle.
Part of my goal in this blog will be
showing how Lachmann can be read in a Misesian light. Although the early
Lachmann is much more explicitly Misesian, the later Lachmann can be read this
way as well, to some extent. The later Lachmann can be seen as practicing the
historical side of Mises' Theory and History. Even his kaleidic society can be
taken as a sort of "what if?" historical exercise. Much of his early work also
fits into the history category since it is not praxeological in nature. Rather,
it attempts to understand how man can function in a changing environment.
During the current financial crisis and
subsequent government actions, the institutions that provide a framework for
our society have been significantly altered. The damage to financial
institutions, which are internal institutions that allow people to allocate
their financial assets and hedge risk, has created a greater degree of
uncertainty in the market. Does this mean the government should step in to
create a less uncertain business environment? Not necessarily. If the
government starts acting erratically, as it has been recently, then the
external institutions which are necessary for society will also begin to fail
at serving their purpose. If the actions of the government lead to a changing
legal order, the level of uncertainty will increase. People will no longer be
able to use the institution of, for example, bankruptcy in order to plan their investments.
The common points of reference around which we can plan will no longer be
useful. Expectations of the future will vary more widely as people attempt to
guess how government will act. Expectations of the "practical range" of
possible government actions will not converge because of the changing legal
order that results from those actions.
I'm currently
listening to David Harvey's graduate course on Das Kapital. The whole
conceptual framework of the book makes no sense. Marx admits multiple
"exceptions" to the labor theory of value, yet still keeps it. He even cites a
case where a commodity can have a price, but no value. What kind of value
theory is that?
The
methodology of the book is simply incoherent. Marx seems to slip between a
class-based analysis and a more rational-choice-like analysis with no
explanation as to why one method should be used in any particular situation. At
times, he seems to recognize that individuals have incentives, but will
subsequently explain why the capitalist class does so and so without any regard
to the individual interests of any actual capitalists.
Many
of the problems are caused by Marx's reliance on classical economics. Ricardo's
introduction of equilibrium reasoning has greatly hurt the development of
economic thought, and Marx is just one of the notable casualties. Another
problem is Marx's belief that in an exchange, the two goods are equivalent in
value. This is obviously not true, as is constantly emphasized by Austrian
economists.
Even worse, when Marx
can't find a particular justification for a theory, he introduces an ad hoc
psychological reason for it. For example, the "drive to accumulate" and the
need for "social power" are the reasons given for why capitalists invest in
capital and desire money, respectively.
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