3 Problems With Austrian Economics

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EconomistInTraining Posted: Mon, Aug 16 2010 2:17 PM

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Hi guys! I made this post and joined the forums because I'm an economics major looking for discussion on economic issue, I hope we can have many a productive debate!

Let me first point out my history, I used to be a big fan of Austrian economics before I started with university, I read a lot of the big works and was seriously interest, when the time came however I had no time for reading the works of Mises, Hayek, Lachmann and Kirzner. Since then I've not read much so I might have forgotten somethings, however, what I will say is that I don't really hold the beliefs I used to concerning Austrian and "mainstream" economics.

So let me point out my two big problems with Austrian economics. 

The first is a methodological problem, I've seen a few posts on here discuss the issue of upward sloping demand curves, now, this can occur for a few possible reasons as far I can see: Veblen goods, and Giffen goods (and I suppose addictive goods). Now as far as I can tell, the result of Mises' analysis says that demand curves should always slope downwards (it's logically necessary that the marginal utility of goods is diminishing).So I suppose most people here would say that in reality there's is no upward sloping demand curve, there's a set of shifting demand curves that are nonetheless downward sloping. 

Consistent with thorough subjectivism, I suppose, Austrians would say that when somebody sees the price of the good increase and they revise their subjective opinion of the good and now we're dealing with a whole different demand good. This is logically consistent but my problem is simply that there's a huge disconnect here between the "good" that we see in the real world and the good of Austrian theorizing. Hayek saw the same problem in capital theory if I'm correct, all this talk of first and second order goods and so on was meaningless, but in the end with feedback loops and all that stuff those categories didn't refer to anything empirically meaningful. And I suppose I see the same problem here, I don't see the Austrian definition of "goods" as referring to anything we observe in the empirical world, so even supposing that Austrian analysis is logically consistent there's no assurance that it will say anything meaningful about the real economy.

Second problem.

Granting the theoretical validity of the calculation problem, to what extent do firms really engage in economic  calculation as explained by Mises. I mean, for the kid on the lemonade stand with 3 inputs (the prices of which are relatively constant), 1 output and no internal markets economic calculation makes sense. But most firms look nothing like that, most firms have exceedingly large internal market, millions of inputs and a vast number of outputs. Look at an airline, they have absolutely vast fixed costs, demand and supply that vary somewhat and plenty of different outputs. Moreover, there are fixed, joint costs between their different lines of output, if we call the flight to London one good and the flight to NYC as another good, there are costs there cannot be attributed to either production line.

I suppose my point is simply that there is no way these firms stick to the simplistic story of the Austrian calculation argument, there prices are most often somewhat arbitrary (as is the case with phones for example) and based on strategic considerations. 

My third problem is simply a question, how do you guys define a recession?

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Graham Wright replied on Mon, Aug 16 2010 3:23 PM

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Hi - welcome to the forums!

Re your first point.  If we make the subsidiary assumption that humans tend to categorize certain objects into classes, where the objects in the class are all of equal serviceability from the point of view of the actor, then we have our definition of a good.  We can do praxeology in a world without this assumption, but it wouldn't be very interesting.  People really do think this way though, so we might as well study action in a world where this is true, rather than any other possible world.

I don't see the Austrian definition of "goods" as referring to anything we observe in the empirical world, so even supposing that Austrian analysis is logically consistent there's no assurance that it will say anything meaningful about the real economy

I'm not sure what you mean.  Do you dispute the assumption (in italics) above?  Do you always think of the pair of milk bottles in your fridge as two entirely seperate items, like milk and cheese, or do you actually group them together and think of them as "my supply of milk"?

Re your second point, I don't see where the problem is.  The 'optimal size' of a firm is determined by "economies of scale" and "diseconomies of scale".  One of the diseconomies of scale is the inability to internally calculate.

Your third point was discussed here recently.  I will have a look for it.

[EDIT: Here is that discussion: Defining recession, ABCT and unemployment]

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EconomistInTraining replied on Mon, Aug 16 2010 3:40 PM

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Thanks! 

Like I said, my knowledge of Mises might have deteriorated a bit, does he make that assumption explicit? Presumably then we're defining milk in objective terms once we make this assumption. I mean, I view my 3 cartons of milk as my supply of milk because they have certain physical properties that mean they're useful to me.

My point is simply this, when we talk about the business cycles for example we talk about stuff like "higher order goods" and "capital goods" but we're really talking about goods as defined by their physical properties or at least we're making a whole bunch of simplifying assumptions because it's really complicated, messy and somewhat incoherent to look at goods and think whether it's a first, second, third...nth order good, all the more so when we encounter problems like feedback loops and the like. 

I see economics as attempting to explain real world phenomena, and I'm not sure the economics of the Austrian school is especially helpful in doing so. The thorough subjectivism and the like is often unnecessary, when we talk of the price of weed  going up we're defining weed in terms of its physical properties, not any mental categories of actors.

As for my second point. I understand that and I anticipated that answer, you're right, firms have to trade off internal makes with transaction costs. But my point was simply that I don't see anything like economic calculation as Mises described it as being carried out by large firms. 

Here's a subsidiary question by the way, given these tradeoffs between economies of scale and diseconomies of scale where does the state come in? I mean, if grant that the state has problems internally calculation but grant that it can exploit considerable economies of scale is there a roll for it in providing certain goods? I don't think we can tell a priori. So how would you go about deciding this?

Thanks for the link, I'll look into it!

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Jon Irenicus replied on Mon, Aug 16 2010 4:11 PM

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Like I said, my knowledge of Mises might have deteriorated a bit, does he make that assumption explicit? Presumably then we're defining milk in objective terms once we make this assumption. I mean, I view my 3 cartons of milk as my supply of milk because they have certain physical properties that mean they're useful to me.

A good is defined as such only in terms of its serviceability to the agent. "Milk" per se is not a good. "Milk-for-1st-bowl-of-cereal" might be. Serviceability is purely agent-driven in that it depends on their ends. The good's "objective" features only matter insofar as they're suitable to meeting these ends.

My point is simply this, when we talk about the business cycles for example we talk about stuff like "higher order goods" and "capital goods" but we're really talking about goods as defined by their physical properties or at least we're making a whole bunch of simplifying assumptions because it's really complicated, messy and somewhat incoherent to look at goods and think whether it's a first, second, third...nth order good, all the more so when we encounter problems like feedback loops and the like. 

We're referring to goods that go into the production of other goods. What is "messy" here or "complicated"? The fact that their physical properties can point to multiple possible uses is another point in favour of Austrian analysis for analysing what is a good and what role it plays. Whether a brick is a higher order good, as goes in constructing a house, or a consumption good (e.g. throwing it at a window for whatever pleasure that garners...)

I see economics as attempting to explain real world phenomena, and I'm not sure the economics of the Austrian school is especially helpful in doing so. The thorough subjectivism and the like is often unnecessary, when we talk of the price of weed  going up we're defining weed in terms of its physical properties, not any mental categories of actors.

You've provided no argument to this effect.

As for my second point. I understand that and I anticipated that answer, you're right, firms have to trade off internal makes with transaction costs. But my point was simply that I don't see anything like economic calculation as Mises described it as being carried out by large firms. 

Explain in greater detail. They do not rely on profit-and-loss?

Here's a subsidiary question by the way, given these tradeoffs between economies of scale and diseconomies of scale where does the state come in? I mean, if grant that the state has problems internally calculation but grant that it can exploit considerable economies of scale is there a roll for it in providing certain goods? I don't think we can tell a priori. So how would you go about deciding this?

Who says it enjoys economies of scale that are even relevant to servicing consumers and how on earth would this circumvent calculational problems when it has no idea whether its "goods" are even desired and to what degree?

Giffen goods/inferior goods do not arise on the Austrian approach, because Austrians do not treat value in the same way as neoclassicals formulate it.

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Jonathan M. F. Catalán replied on Mon, Aug 16 2010 4:13 PM

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Economistintraining,

Unfortunately, I neither have the patience nor the sufficient reading to cite exact Austrian texts (namely, Human Action and Man, Economy, and State), but I will try to address each of your three points to the best of my own knowledge.

Consistent with thorough subjectivism, I suppose, Austrians would say that when somebody sees the price of the good increase and they revise their subjective opinion of the good and now we're dealing with a whole different demand good.

With a Veblen Good, I would argue that the marginal utility of the good in question grows.  Wikipedia cites as an example the luxury car.  The demand for the luxury car, as price increases, decreases insofar as the amount of people who can afford it.  However, knowing that less people can afford it, and therefore less people will come to own it, the marginal utility of the luxury automobile in question may rise for the individual who can afford it (because, knowing that fewer people own it, his status as an owner will increase, or for whatever other reason). 

So, it's not a question of "dealing with a whole different demand good" (whatever that even means), rather an increase in marginal utility due to subjective preferences.

As for the Giffen Good, even Marshall's bread example seems based on dubious assumptions (i.e. the price of all bread, regardless of maker, rises, and there are no substitutes for bread).  But, were the Giffen Good possible, it would not be mutually exclusive to Mises's methodology.  This isn't a problem with methodology; it's a problem of conclusions reached with that methodology.

I mean, for the kid on the lemonade stand with 3 inputs (the prices of which are relatively constant), 1 output and no internal markets economic calculation makes sense. But most firms look nothing like that, most firms have exceedingly large internal market, millions of inputs and a vast number of outputs.

I have not read Peter Klein's book on entrepreneurship yet, but one Mises University student goes to suggest that Klein argues that the theoritical limit to the firm size is exactly that as outlined by the calculation problem.  In any case, your example of the large firm is exactly what Mises is talking about.  Without a price system to coordinate the distribution of goods throughout an economy, there is no efficient method that a socialist economy will do the same thing.  Klein argues that when firms vertically integrate, or expand, then the price coordination mechanism becomes far more distorted, and this is why there are natural limitations to the size of a firm.

My third problem is simply a question, how do you guys define a recession?

What?

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Graham Wright replied on Mon, Aug 16 2010 5:05 PM

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Like I said, my knowledge of Mises might have deteriorated a bit, does he make that assumption explicit? Presumably then we're defining milk in objective terms once we make this assumption. I mean, I view my 3 cartons of milk as my supply of milk because they have certain physical properties that mean they're useful to me.

Actually I don't think I've ever seen it stated explicitly the way I did.  I don't quite agree with either Mises' or Rothbard's descriptions of praxeology.  (This thread may be of interest). 

And no, I don't think we're ever defining milk in objective terms really.  It's just that there is a very close correlation between an object's characteristics, and the serviceability ascribed to those objects by the actor, and by other actors. 

No two cartons of milk are objectively identical, if only because they occupy different spaces.  The mind is flexible when it is creating classes of goods.  The fact that your cartons occupy slightly different positions in your fridge has been dismissed as irrelevant in your mind, which is what makes them all the same good, part of one supply.  Suppose one carton is due to expire a day before the other two.  Will this now make you think of your supply as "one carton that I must use by Wednesday" and "two cartons that I must use by Thursday" - i.e. two different supplies?  It may do, or it may not if that is irrelevant to you.  In other words, what people consider a supply of goods is all subjective.

The thorough subjectivism and the like is often unnecessary, when we talk of the price of weed  going up we're defining weed in terms of its physical properties, not any mental categories of actors.

I suppose the price of weed is the price of the thing that people think of as weed.  And this in turn is determined by the physical properties of weed.  So it's just shorthand to say "the price of weed".  This is really an abstraction in itself, because the price of weed will vary by location, vendor, etc.  You've gotta love subjectivism. 

My point is simply this, when we talk about the business cycles for example we talk about stuff like "higher order goods" and "capital goods" but we're really talking about goods as defined by their physical properties or at least we're making a whole bunch of simplifying assumptions because it's really complicated, messy and somewhat incoherent to look at goods and think whether it's a first, second, third...nth order good, all the more so when we encounter problems like feedback loops and the like. 

I see the role of translating what is actually a first-order, second-order, n-th order good, in any given time and place, as one for the entrepreneur, not the economist.  As economists we know that there must be a capital structure, because we can trace the development of a consumer good right back through the orders of production, and there can be lots of them.  The economist can say there is a boom in higher-order industries, but cannot say exactly which industries are high-order industries.  In practice they are not very hard to identify - mining, construction, etc - but this is an entrepreneurial function, something that comes from looking at the empirical data.

As for my second point. I understand that and I anticipated that answer, you're right, firms have to trade off internal makes with transaction costs. But my point was simply that I don't see anything like economic calculation as Mises described it as being carried out by large firms.

Mises described calculation as impossible in the absence of free market prices, which means that firms cannot calculate internally.  So they are never sure whether any one particular function of the firm is adding value or wasting resources.  If the function is done by a completely seperate company, it knows exactly whether it is adding value by looking at its P&L.  The firm tries to mimic the market (as does socialism), by giving section manager's control of budgets, etc, but since each section manager is not the owner of his function, there are no market prices formed between the company's various functions.  With internal prices all screwed up, the various functions may appear to be adding value when they are not.

Here's a subsidiary question by the way, given these tradeoffs between economies of scale and diseconomies of scale where does the state come in? I mean, if grant that the state has problems internally calculation but grant that it can exploit considerable economies of scale is there a roll for it in providing certain goods? I don't think we can tell a priori. So how would you go about deciding this?

Test it.  If the State has by some miracle found the optimum size for providing a good, then the market process will give us a firm of the same size.  Nothing to lose by getting rid of the State.  Everything to gain.

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EconomistInTraining replied on Tue, Aug 17 2010 1:49 PM

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Guys, I get that there are tradeoffs involved when determining the size of the firm, that's pretty standard result. Lack of internal markets creates inefficiencies and increasing firm size reduces transaction costs. The point I was making is different, even with regards to external markets firms don't carry out anything like economic calculation as Mises described it. That's not to say that they don't try to maximise profits, just that it's a lot more complicated than the Austrian story implies. Especially when it comes to large firms with large fixed costs, economic inefficiencies could persist for long periods of time without being identified and rectified. 

Like I said, what if the government can achieve economics of scale that private firms can't, or can provide goods that wouldn't otherwise be provided in sufficient quantities or what if the government were to try and correct problems of asymmetric information? Presumably you guys would have to agree that it's an empirical matter whether or not they can do so efficiently.

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Gipper replied on Tue, Aug 17 2010 2:20 PM

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Like I said, what if the government can achieve economics of scale that private firms can't, or can provide goods that wouldn't otherwise be provided in sufficient quantities or what if the government were to try and correct problems of asymmetric information? Presumably you guys would have to agree that it's an empirical matter whether or not they can do so efficiently.

 

They can't. Governments don't have an incentive to.

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hugolp replied on Tue, Aug 17 2010 2:22 PM

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Guys, I get that there are tradeoffs involved when determining the size of the firm, that's pretty standard result. Lack of internal markets creates inefficiencies and increasing firm size reduces transaction costs. The point I was making is different, even with regards to external markets firms don't carry out anything like economic calculation as Mises described it. That's not to say that they don't try to maximise profits, just that it's a lot more complicated than the Austrian story implies. Especially when it comes to large firms with large fixed costs, economic inefficiencies could persist for long periods of time without being identified and rectified. 

Like I said, what if the government can achieve economics of scale that private firms can't, or can provide goods that wouldn't otherwise be provided in sufficient quantities or what if the government were to try and correct problems of asymmetric information? Presumably you guys would have to agree that it's an empirical matter whether or not they can do so efficiently.

How are you going to determine in your empirical data analisys what would have been the goods that would have been provided without government intervention? And even if you make a subjective aproximation to the previous question, how are you going to determine what would have been the best outcome?

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EconomistInTraining replied on Tue, Aug 17 2010 2:24 PM

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You tell me. 

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EconomistInTraining replied on Tue, Aug 17 2010 2:36 PM

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Who says it enjoys economies of scale that are even relevant to servicing consumers and how on earth would this circumvent calculational problems when it has no idea whether its "goods" are even desired and to what degree?

You can imagine they'd do exactly as many private firms do now, employ economists using statistical techniques to estimate market demand. Governments are no different from private firms here, look at pharmaceutical companies. Research and development for a typical drug lasts about 15 years, then there are all sorts of other considerations like marketing and country specific fixed costs. There's a lot of room for mistakes in there, even for the most talented "entrepreneur", as is evidenced by the fact that well over half of drugs don't cover their costs (which are by no means easy to define or calculate). 

A good is defined as such only in terms of its serviceability to the agent. "Milk" per se is not a good. "Milk-for-1st-bowl-of-cereal" might be. Serviceability is purely agent-driven in that it depends on their ends. The good's "objective" features only matter insofar as they're suitable to meeting these ends.

But when we talk of the price rising me talk of the price of something defined by various objective characteristics rising, not "milk for 1st bowl of cereal".

We're referring to goods that go into the production of other goods. What is "messy" here or "complicated"? The fact that their physical properties can point to multiple possible uses is another point in favour of Austrian analysis for analysing what is a good and what role it plays. Whether a brick is a higher order good, as goes in constructing a house, or a consumption good (e.g. throwing it at a window for whatever pleasure that garners...)

But what about the bricks that are used to build the brick factory, what order are they? 

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Jon Irenicus replied on Tue, Aug 17 2010 3:22 PM

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You can imagine they'd do exactly as many private firms do now, employ economists using statistical techniques to estimate market demand.

Yet it still will not function as an entrepreneur capable of appropriating profits and suffering losses for ventures it undertakes. The closer it acts like a private firm, the increasingly weaker the case for a government run venture becomes, because it is adapting precisely those features of the institution it was meant to supplant, and inefficiently at that.

But when we talk of the price rising me talk of the price of something defined by various objective characteristics rising, not "milk for 1st bowl of cereal"

Who is "we"? The serviceability of which varies from agent to agent. All we know is there are conflicting demands for it that serve to increase or decrease the product's price. Prices for the particular physical good will reflect the degree to which the agents are willing to pay for it for their varying ends.

But what about the bricks that are used to build the brick factory, what order are they?

Depends how far away from the end product they are. They're producer goods, hence "higher" order. Could you tell me why this matters?

That's not to say that they don't try to maximise profits, just that it's a lot more complicated than the Austrian story implies. Especially when it comes to large firms with large fixed costs, economic inefficiencies could persist for long periods of time without being identified and rectified.

Which is at divergence with the Austrian view of how firms operate... how? That merely means those firms will begin to suffer losses or diminished profits/returns.

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Jonathan M. F. Catalán replied on Tue, Aug 17 2010 5:07 PM

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The point I was making is different, even with regards to external markets firms don't carry out anything like economic calculation as Mises described it.

No offense, but do you even know what Mises's economic calculation argument is?

That's not to say that they don't try to maximise profits, just that it's a lot more complicated than the Austrian story implies.

I'm afraid that you simply have no idea on what "Mises's" calculation problem actually implies.

Especially when it comes to large firms with large fixed costs, economic inefficiencies could persist for long periods of time without being identified and rectified.

What's your point?

Like I said, what if the government can achieve economics of scale that private firms can't, or can provide goods that wouldn't otherwise be provided in sufficient quantities or what if the government were to try and correct problems of asymmetric information? Presumably you guys would have to agree that it's an empirical matter whether or not they can do so efficiently.

How would it make it an "empirical matter", even if government could do all the above?  Are you saying that one could not provide logical causation through theory?  Also, what if government could provide everything in excess?  One can make a number of assumptions and premises, but it won't make the argument true.