Praxeology and Understanding: An Analysis of the Controversy in Austrian Economics

Equilibration and Coordination

Central to the current controversy in Austrian economics is the debate concerning whether or not the market harbors a tendency toward equilibrium. The skeptical position, represented by Lachmann, is that no such tendency exists. It is opposed in particular by Kirzner, who attempts to defend the more traditional, praxeological position.

In this section, an attempt is made to show that there is a strictly logical sense in which action may be said to be equilibrating (rather than disequilibrating), which may be interpreted as implying a tendency toward equilibrium in markets with freely adjusting prices. However, the view defended here contrasts sharply with those of both Kirzner and Lachmann, who are criticized for adopting an analytical framework that is not consistently subjective. The praxeological notion of equilibration defended here is also distinguished from the empirical or “common-sense” notion of coordination suggested by Hayek, according to which the relevant “tendency” for theorists to be concerned with is one in which the “expectations of the people and particularly of the entrepreneurs will become more and more correct.”1

To give equilibration a praxeological status is one thing; to show that it is a notion useful in drawing conclusions concerning the efficacy of particular economic arrangements and policies is another. The latter task is undertaken in the second part of the section. The conclusion reached is that, with reference to the purely logical concept of equilibration, it is possible to derive many fundamental results concerning conditions that promote successful action of the sort that Hayek had been so anxious to uncover.

Equilibration

In an autarkic economy composed of a single individual, or in any isolated exchange, all action is equilibrating in the ex ante sense; that is, it is expected by the actors involved to lead to the removal of felt uneasiness. In this context, “disequilibrating” action (again viewed in the ex ante sense) is impossible; it is the logical equivalent of “irrational” action. For the solitary individual, a tendency toward equilibrium means a tendency for action to systematically eliminate perceived sources of uneasiness. The continuing existence of action is proof that equilibrium proper is never achieved. It is equally proof that it is constantly being striven for. In the case of voluntary exchange between two individuals, equilibrium proper may be said to exist when there is no longer any basis for mutual profit (from the point of view of the actors) so that exchange ceases. This “final state of rest,” to use Mises’s terminology, is the relevant notion of equilibrium in the context of binary exchange. Equilibration in this context means a process by which opportunities for mutual profit are eliminated.

Things are more complicated in the marketplace where there are numerous individuals and indirect exchange. Here, the question of equilibration must address the influence of individual actions upon those not directly involved. In this case, a “tendency toward equilibrium” must be defined in terms of the categories of entrepreneurial profit and loss. The tendency is one in which entrepreneurial profits and losses are made to systematically disappear.

The praxeological notion of equilibration applied in catallactics can be summarized as follows: entrepreneurial profit and loss are subjective phenomena, having no “objective” basis outside of the minds of market participants. The praxeologist cannot, therefore, conceive of these phenomena apart from actions of market participants that at once imply imagination of and response to the phenomena in question. Thus for every profit “opportunity,” there corresponds an action that eliminates the opportunity (or proves that it was illusory).

Even where there is monetary calculation, only the event of an entrepreneur taking action allows us to distinguish (praxeologically) profits from compensation for opportunity costs and from the pervasive phenomenon of rent. It is necessary, therefore, for praxeology, when dealing with the unhampered market, to treat entrepreneurial profit opportunities as the unique products of the subjective valuations and understanding (verstehen) of actors who will seek their exploitation. Upon the fact of action, these “imagined” or “understood” (rather than “perceived”) profits are, logically and temporally, destroyed. Thus action leads to the systematic elimination of entrepreneurial profit and loss; it is equilibrating. Wherever there is action, there is an imagined profit opportunity. Where there is no action, there are no such imagined opportunities; and where there are no imagined profits, there is no action—that is, viewing things in a dynamic context, there is no basis for the modification of plans.

It must be stressed that equilibration makes no reference to the state of knowledge of market participants. The fact that new information constantly provokes imagination or acknowledgment of new profits and losses (and, hence, their renewed elimination) is recognized by praxeology. Nevertheless, this fact does not contradict the fact of equilibration: it only means that equilibration never ceases and is never replaced by a state of equilibrium proper. This is not to say that questions of knowledge acquisition are unimportant; only pure theory does not address these problems, which have to do with the question of coordination. So far, we have not claimed that equilibrating actions generally lead to desired or anticipated results.

In discussing market phenomena, praxeology does not group commodities according to any “objective” or technological qualities. When it speaks of apparently identical goods bearing different prices, it assigns the discrepancy to a difference in services offered by the goods or by circumstances of their sale or else it must refer to entrepreneurial actions that, in an unhampered market, eliminate the discrepancy. In other words, praxeology recognizes price discrepancies among identical goods only to the extent that such discrepancies may be identified with subsequent acts of successful arbitrage. In the same manner, entrepreneurial profit opportunities in general are ephemeral phenomena, formed in the imaginations of enterprising people and defined by the very actions that “eliminate” them.

It follows that praxeology must refrain from grouping the services of enterprising people according to “objective” standards, referring to earnings differentials as entrepreneurial profit. It instead assigns these differentials to the category “rent to labor services.” Such rent may be said to include an element of profit only insofar as it actually gives rise to imitation by other individuals or to replication by the entrepreneur in question. As each such process of “profit seeking’’ ceases, remaining money surpluses (differences between money outlays and money receipts) are once again to be viewed as rent or other elements of compensation for opportunity cost. If, however, actors subjectively see in this surplus an element of profit or loss (by way of their imagination or understanding and the use of monetary calculation), they act again to replicate the profit or to eliminate the loss; if they do not so act, it means that neither profit opportunities nor available losses are understood to exist. Every entrepreneurial action therefore begins with the subjective imagination of a profit opportunity (or belief that a loss may be avoided) and ends with the destruction of the imagined opportunity. This, to repeat, is what praxeology means when it asserts that all action is “equilibrating,” i.e., that action leads to the systematic elimination of profit and loss.

According to praxeology, competition involves the identification of what had previously been regarded as service rent as “profit” and the resulting efforts to replicate the profit. If, following a series of competitive processes, monetary surpluses still accrue, a renewed sequence of entrepreneurial acts may or may not follow. The important fact is that these surpluses are subjectively (and hence praxeologically) identified with “service rents” or “costs” except when action redefines some portion of them as entrepreneurial profit and thereby proceeds to replicate (and, thus, to eliminate) that profit. It is a mistake to confuse profit with monetary surplus and to describe competition and the tendency towards equilibrium in terms of the “whittling away” of the surplus. This procedure depends upon an objective definition of entrepreneurial profit; it looks upon it as an ideal-type or empirical category to be identified historically by appeal to psychological understanding. In doing so, it confuses the “common sense” point of view adopted by historians and by entrepreneurs themselves with that view of things that is essential to the drawing of conclusions regarding the necessary implications or “pure logic” of action. So far as praxeology is concerned, if markets are unhampered (for example, by “rent-seeking” activities), there can be no “unexploited” profit opportunities or lacunae in the competitive process.

Kirzner, Lachmann, and the
“Tendency toward Equilibrium”

Entrepreneurs succeed or fail in generating monetary surpluses to the extent that they succeed or fail in anticipating consumer actions. These actions are not predetermined by an unchanging set of preferences. According to praxeology, preferences do not exist at all apart from acts of choice. It follows that all entrepreneurial action is, as this article has insisted, not merely speculative, but imaginative. This is true even for “mere” arbitrage (meaning arbitrage as understood by the business community).2 There is no listable set of profit opportunities (the basis for additions to monetary surpluses) existing independent of entrepreneurial actions because there are no consumer preferences apart from consumer actions taken in response to entrepreneurial offers. Thus it is misleading to treat profit opportunities as having an objective basis (i.e., as existing “out there”) because it is improper to treat consumer preferences as if they existed apart from realized acts of choice.

Israel M. Kirzner, in his analysis of entrepreneurship,3 suggests the possibility, in the unhampered market, that action may fail to eliminate entrepreneurial profit and loss systematically, i.e., may fail to equilibrate. This impression results from Kirzner’s use of the metaphorical, “common sense” notion of profit opportunities existing “out there” in some objective sense independent of their perception or discovery by enterprising individuals. Kirzner’s approach has encouraged the treatment of equilibration as an empirical matter subject to doubt. It is necessary to challenge such interpretations insofar as they confuse necessary features of action with contingent ones and imply that action in the unhampered market may be “disequilibrating” or “insufficiently equilibrating” and that praxeological theorems that presume a “tendency toward equilibrium” are necessarily open to empirical falsification.

The category of objective profit opportunities is praxeologically meaningful only as an ex post concept, in which case there is no question of undiscovered opportunities.4 Yet, the contrary is implied within the framework of Professor Kirzner, who is led to adopt the metaphorical notion of “objective” profit opportunities existing ex ante (and hence capable of going undiscovered) in order to counter the opinion that entrepreneurial innovation is disequilibrating. By treating profit opportunities as existing “out there” and by positing their eventual “discovery,” Kirzner is able simply to dismiss the innovative (and allegedly disequilibrative) aspects of entrepreneurship.5 In doing so, he is drawn uncomfortably close to the Robbinsian outlook according to which entrepreneurship merely involves the “efficient” administration of given means and ends, that is, the exploitation of given profit opportunities.

In fact it is unhelpful to view, as general equilibrium theorists do, the direction in which market processes are aimed as one that can be represented by a stable system of simultaneous equations. This view entirely neglects human imagination and innovation. It refers to a world where the means and goals of acting people are fixed, so that a hypothetical “optimal solution” can be defined. This kind of equilibrium solution presupposes definite limits to entrepreneurial achievement. Nonetheless, Kirzner apparently accepts the static concepts of Pareto optimality and general equilibrium as standards against which entrepreneurial actions must be judged. It is only in such a context of “existing” or “given” opportunities that profitable actions can be relegated to the category of “arbitrage,” while actions not undertaken can be related to “missed” profit opportunities.

More fundamentally, whenever one speaks of unexploited opportunities for profit one departs from the domain of theoretical science and exemplifies the perspective of the historian or would-be entrepreneur. Kirzner’s “profit opportunities” exist in the mind of the analyst but are somehow divorced from “the already constituted meanings of active participants in the social world.”6 In other words, the ends-means framework recognized by the analyst differs from that recognized by market participants. The procedure of injecting an independent “imagination” into one’s analytical framework takes its revenge by begging important questions, (1) Why should equilibration be a feature of the real world (where actors may be chronically “unalert”)? (2) Do praxeological theories that presume equilibration in fact depend upon the soundness of certain empirical assumptions?7 In contrast, the praxeological approach does away with the question of “alertness” as it disallows the category of “unexploited profit opportunities.”

Subjectively defined, equilibration refers to the systematic exploitation of profit opportunities as they exist in the understanding of market participants. It makes no reference to any set of “objective” opportunities as determined by the conjectures of the social scientist. Either the set of opportunities is delimited in this strict, praxeological manner, or it is not scientifically delimitable at all.

The claim that all action is equilibrating does not imply that actors are ever actually in a state of equilibrium proper. The concepts “equilibrium” and “disequilibrium” have for the praxeologist a purely heuristic significance. Theorists wishing to explain a process of market price adjustment require a framework upon which to hang the components of their analysis. Thus they adopt a terminological expedient: they refer to the outmoded price, a price that has become incompatible with changes in the apprehended ends-means framework, as a “disequilibrium” price. The appropriate price, that which ineluctably replaces the disequilibrium price as a consequence of actions manifesting the revised understanding of means and ends, is labelled the “disequilibrium” price. The process of price adjustment can only be comprehended by viewing it as a dynamic process of prices which are at once equilibrium prices in relation to those that they have replaced and disequilibrium prices in relation to those that will follow. Because individuals’ understanding of ends and means are in constant flux, prices undergo constant revision. But their adjustment is always in the direction of, and never away from, equilibrium, so long as it reflects free entrepreneurial acts. As each price adjustment is itself a vehicle of information about means and ends, it follows that the adjustment of one price may lead to the obsolescence of others. The statement that action is “equilibrating” merely refers to the logical proposition that action continuously accounts for changes in the imagined framework of means and ends, i.e., changes in the structure of imagined profit opportunities.

Ludwig M. Lachmann, who questions the claim that the market harbors a tendency toward equilibrium, takes a view just opposite of Kirzner’s by embracing the Schumpeterian argument that entrepreneurial action is mainly disequilibrating. However, like Kirzner, Lachmann attempts to address the issue of equilibration by employing Walrasian (or Robbinsian) criteria. Equilibrium is viewed by him, not as the focal point of a heuristic lens through which all action can be analyzed, but as a determinate state of affairs defined with respect to some objectively given set of exploitable means and ends. Of course, with respect to such a static ideal, many actions (and innovative actions especially) are disequilibrating. They confound achievement of the equilibrium “solution” by altering the set of “existing” means and ends. People’s imaginations equip them to extend the boundaries of the possible. Given that this is so, the idea of equilibration or of a tendency toward equilibrium ought to refer, not to a tendency to approach some given, concrete state, but to the tendency of plans to be modified in a systematic way according to the changing imagination, aspirations, and capacities of market participants. Praxeologically, one can abstract from such ever-present change, thereby forcing the means-ends framework to stand still. However, by doing so, one does not succeed in identifying the prerequisites for the achievement of general equilibrium. On the contrary, one defines a state of nonaction wherein equilibrium in one sense is already achieved, but, in another, equally meaningful sense is forever out of reach. In other words, the only meaningful sense in which action can be said to be equilibrating is the dynamic one which assumes continually changing means and ends and the absence of equilibrium proper. In contrast to this subjective, praxeological view, Lachmann’s position, like Kirzner’s to which he is in part responding, is distinctly nonsubjective: entrepreneurship can only be disequilibrating in the main with respect to a nonsubjective, Walrasian, or static vision of some general equilibrium “target.”

The praxeological view just presented attempts, where those of Kirzner and Lachmann have failed, to make sense out of the idea of a tendency toward equilibrium while totally rejecting Walrasian criteria and their implications. By adopting a strictly subjective approach, praxeology also immunizes itself from Lachmann’s skepticism (insofar as the logical validity of its inferences is concerned—the empirical question of coordination must be addressed later on), preserving the apodictic status of its conclusions which rest upon the premise that entrepreneurial action is equilibrating.

To summarize, “general equilibrium” is a moving target. Its location is determined, not by any objective conditions, but by the confines of people’s imaginations. In order for the target to be reached, people either must become perfectly dull or they must become perfectly content. In either case, it must be true that they have exhausted their abilities to conceive of new means for the elimination of uneasiness (the general end of all action). So long as people are neither completely dull nor completely content, they must necessarily act. To ask whether general equilibrium can ever be achieved is therefore to ponder the exhaustibility of people’s imaginations. It is to wonder whether innovation and unexpected change will disappear. This is an area of inquiry that concerns philosophy of mind and not praxeology, which is concerned with action. All that can be said with certainty is that people, in acting, employ imagined means to their fullest extent (action is equilibrating) and that, if their actions are successful, their imagination and understanding are not based upon illusion and result in increased well-being (action is socially coordinating).

Denial of the existence of coordination is in fact the more important part of the current assault upon the praxeological method. We are now prepared to consider this empirical issue. Only first it is necessary to respond to the charge that the praxeological concept of equilibration is “tautological,” “empty,” and therefore useless as a means for gaining practical knowledge about the real world.

Prerequisites for Successful Action

The concepts of monetary surplus and loss are based on economic calculation using market prices. Such calculation is possible only in an order characterized by exchange, the social division of labor, and private ownership of the means of production. With the aid of monetary calculation, entrepreneurial profit and loss—the stimuli that determine the direction of equilibrative adjustments—become social phenomena distinct from the ex post categories of psychic profit and loss. Calculation makes possible a link between equilibrating action and entrepreneurs’ satisfaction of the wants of others. It allows entrepreneurs to perceive the wants of others as if they were the means toward fulfillment of their own ends.

Monetary surplus represents a reward to enterprise for the successful satisfaction of consumers. But this ex post surplus is not itself to be confused with the ex ante concept of entrepreneurial profit: it is a confirmation of the fact that entrepreneurs’ imagination and understanding (of means and ends, including their own, possibly unique, capabilities) were not based upon illusion or incorrect anticipation of the future. Entrepreneurial profits exist, as it were, only at the “margin” of action, not before or after.

The crucial point is that monetary calculation provides essential guidance for entrepreneurial understanding and action. In the absence of such calculation, the imagination of profit opportunities, i.e., entrepreneurial speculation, would indeed become an entirely haphazard process, bearing no meaningful relationship to the state of consumer preferences: “Monetary calculation is the guiding star of action.... [Man] calculates in order to distinguish the remunerative lines of production from the unprofitable ones, those of which the sovereign consumers are likely to approve from those of which they are likely to disapprove.”8

Without monetary calculation, entrepreneurs would lose vital evidence with which to form their conjectures and would not even be able to judge whether their previous conjectures were accurate or not. They therefore would be without means for informed direction of their future actions. It is only when market prices exist that calculation, the meaningful ascertainment of profit or loss, success or failure, is possible. In particular, the entrepreneurial function of subjectively distinguishing “profit” from rents and other factor returns is not conceivable without market prices: “The different sources of income can be separated only be referring to these incomes as determined by prices on the market.”9

Only in this way can an entrepreneur estimate implicit (opportunity) costs and thereby determine that, for example, “he is suffering a loss in his business.” Then, “If the loss continues ... he will be impelled to shift his various resources to other lines of production. It is only by means of such estimates that an owner of more than one type of factor ... can determine his gains or losses in any situation and then allocate his resources to strive for the greatest gains.”10

The existence of market prices, which itself depends upon private ownership and exchange of the means of production, is therefore a necessary prerequisite to economic calculation.11 This is the fundamental conclusion of the praxeological critique of socialism. The necessity (not sufficiency) of market prices for entrepreneurial success, including entrepreneurial calculation and understanding, can be ascertained without appeal to other, necessary assumptions regarding the use and dissemination of knowledge. Its truth does not depend on the “alertness” of entrepreneurs in the unhampered market. It derives from consideration of the pure logic of the equilibration process: in the context of market prices, this process might promote coordination. Otherwise, an essential ingredient is lacking, for which there are no promising substitutes.

Many other important, practical conclusions of praxeology are based upon the insight that interference with market prices may disrupt enterprise and competition. Such interference acts to lessen the potential for successful entrepreneurial adjustments in the affected markets. Every act of free exchange provides clues to the preferences and, indirectly, the ends, of actors engaged in the exchange. Market prices convey information reflecting understanding derived through a continuing process of such exchanges. Such prices are essential instruments by which entrepreneurs, employing verstehen or common sense, attempt to form judgments of consumer desires using past preferences as evidence.

By the same token, interference with market prices may also corrupt entrepreneurial understanding, causing the disappointment of expectations and fostering discoordination. Any nonmarket price—a price fixed by fiat rather than through voluntary exchange—confronts numerous entrepreneurs, not with potentially useful information, but with a lie; it presents to them a façade of preferences and priorities which in fact have no basis in the valuations of market participants. Consumer uneasiness may even be aggravated by entrepreneurial actions guided by nonmarket prices. Hence, the praxeological concern with this type of government intervention.

Praxeology does not attribute the failure of socialism to its inability to achieve the conditions of static equilibrium: on the contrary, socialism cannot succeed, according to praxeology, because entrepreneurial action (which includes also the speculative decisions of central planners) cannot succeed without the aid of market prices. Moreover, praxeology sees interference with or absence of competitive market prices as a key to explanation of the failure of many particular market processes.12 For example, the trade cycle is explained as a phenomena initiated by disruption of rates of interest from their “natural” levels, i.e., the levels that reflect consumer time-preference and that would prevail under a system where banks (including central banks) functioned purely as intermediaries of voluntary savings. An artificially lowered rate of interest and accompanying expansion of credit necessarily leads to the distortion of a wide range of other market prices (by provoking overestimation of the real supply of loanable funds). The necessary consequences that arise from this include widespread alteration of profit and loss signals and a greater channeling of entrepreneurial activity into undertakings that eventually prove unsustainable.13

In its references to the effects of intervention, praxeology naturally engages in conjectural history. Nevertheless, whenever the described intervention is present, all of the consequences that praxeology attributes to it will follow. It is the task of history proper to determine whether any actual event corresponds to a certain hypothetical counterpart examined by praxeology. This matter of historical identification is, contra Hayek, the only “question of fact” to which praxeological conclusions, including ones that (as we have seen) are relevant to catallactics, need to defer.14 There is no question here of any need for or possibility of “verification” or “falsification” of praxeological theories either in the manner suggested by positivists or by appeal to common sense.

We have still to deal with the implication, present for instance in Hayek’s essay, that the results of praxeology, although varied and profound, are nevertheless “tautological” and, therefore, of no independent, practical significance. Here it may simply be answered that if, in fact, praxeological results are tautologies, then they are tautologies of great importance. In a sense, they resemble tautologous statements of the sort: 2 + 2 ≠ 5. This statement, one might claim, provides no fresh knowledge of the real world. Nevertheless, it is essential to insist upon its truth whenever anyone is bold enough to deny it. Similarly, the conclusions of praxeology would perhaps be of little value were there not people anxious to defy them, for example, by seeking to avoid the harmful consequences of inflation by means of price controls, by throwing obstacles in the way of rivalrous competition and entrepreneurial innovation, or by advocating socialism as a means for the rational allocation of resources. The demonstration of the inappropriateness of such programs is the prime contribution of (praxeological) economic theory to human welfare. It is a contribution of more than merely verbal significance.

Thus far, we have seen that many praxeological conclusions (relevant to catallactics) do not depend upon assumptions about knowledge, alertness, and entrepreneurial understanding; they deal with people as such and do not require appeal to common sense or empirical assumptions. We have also seen that, although logically necessary, conclusions derived by praxeology are not intrinsically empty or without practical importance. However, a complete answer respecting this last point cannot be given until the issue of coordination is addressed. We have not yet entirely escaped the claim that praxeology may, after all, be useless.

The “Common Sense” of Coordination

As used in this article, coordination and equilibration are not synonyms. Coordination, which depends upon the correctness of entrepreneurial expectations, is not a praxeological concept. While we cannot think of free action as nonequilibrating, we can conceive of actions that are noncoordinating. In order to establish whether a particular concrete state of affairs exemplifies coordination or the compatibility of plans, social scientists must resort to the common-sense method of specific understanding employed in historical analysis. They must therefore abandon the strict subjectivism or praxeology and allow themselves to impute specific ends and aspirations to individuals. Then, in order to determine whether the actions of individuals are compatible with one another, they contrast them with an ideal-type “plan” of their own construction. In other words, they treat the actions of other individuals as means and judge their efficacy with regard to a set of imputed ends.

To maintain that individual plans can be coordinated is to affirm the existence of social causation. The idea that such causation operates is related to the belief that social actions are or may be largely successful.15 Praxeology conceives of a sequence of social events as coordinated insofar as they result mainly in psychic profit rather than psychic loss. The notion of coordination thus becomes a corollary to the praxeological construct of the progressing economy.16

But to say that progress actually exists requires an appeal to understanding: “Whenever economic history ventures to classify economic evolution within a certain period according to the scheme stationary, progressing, or retrogressing, it resorts in fact to historical understanding [verstehen] and does not ‘measure.’” 17 There can thus be no question of an answer to the question of coordination in any sense admitting to either “apodictic certainty” or to empirical “falsifiability”: psychic profit and loss are subjective, immeasurable phenomena.

A progressing economy requires, first of all, that entrepreneurs are neither so dull nor so content as to never imagine opportunities for profit at all. Otherwise, there would be no innovation or accumulation, and society would settle into the praxeological fiction of the “evenly rotating economy.” In such a situation, coordination is complete in the sense that there is equilibrium, but it is obviously not coordination in the sense of compatibility of plans, for the evenly rotating economy presupposes the absence of true plans aimed at the elimination of felt uneasiness. It involves, in place of changing plans, the cyclical mechanical motions of lifeless automatons.

Ignoring the extreme case of the evenly rotating economy, coordination requires also that there be adequate entrepreneurial foresight; an ability to anticipate future change and to thereby avoid psychic disappointment. Here is where expectations enter into the analysis. It is also where the doctrines of Shackle and Lachmann assert themselves concerning the kaleidic character of the future.

In a world in which the future is truly kaleidic, coordination and its counterpart, economic progress, are not possible. Action in such a world, even in the unhampered market, leads not to “spontaneous order,” but to chaos. Speculation becomes a matter of sheer guesswork, useless and counterproductive—and this will be the case even where there is a freely functioning price system. Under such conditions, action cannot truly be said to be “purposeful” at all, for the actors’ belief that they are able to achieve their purposes can only be an illusion. Praxeology would in this case be a body of tautologous assertions of academic interest only.

Thus, for example, although the existence of market prices is necessary for coordination because it provides the only reliable means for people’s actions to be guided by the wants of others, it may not be sufficient. It could be that anticipations are generally disappointed, so that wealth does not accumulate. Coordination and its representative, economic progress, will then be impossible even with an unhampered price system.18 Such possibilities form the crux of the Shackleian challenge to praxeology.

On the face of things, it is easy to sympathize with Kirzner’s desire to dismiss the divergent expectations or kaleidic future hypothesis. “Paris,” Kirzner observes, “gets fed.” This seems to be an appropriate empirical answer to what is in essence an empirical assertion. It might easily be supplemented by a litany of trite observations regarding the accumulation of capital, general improvement of well-being, remarkable scientific and technical achievements, etc., that have been sponsored by the capitalist system. Such a response is also inviting because it suggests that praxeology is not, after all, at loggerheads with historical understanding; that, in general, markets do generate order whereas interference tends to have the destructive effects that praxeology predicts. Nevertheless, the response, based as it is upon appeal to common sense, is always vulnerable to rejection. Those who understand by “order” and “progress” something other than what Kirzner has in mind when he refers to the arrival of food at Paris may freely disagree with him. In so doing, they do not, of course, deny the praxeological notion of equilibration. They merely claim that this notion—and the central role it assigns to the existence of market prices—evade the fundamental issues.

In short, praxeology, having broken away from the “fully informed” schema of neoclassical economics, finds its conclusions challenged by alternative views of precisely the opposite extreme. Its new opponents claim the future to be marked by complete (“radical”) uncertainty; a kaleidic future in which action is futile and purposefulness is merely an illusion.19 If, in fact, this view of reality is correct, then the theories of praxeology are, to repeat Hayek’s words, merely “formal” and “tautological.” They cannot then tell us anything of practical value, for they are based upon inferences drawn from a faulty premise, namely that qualitative regularity and causality exist in the sequence of social events. The truth, it is suggested, is just the opposite: the future is unknowable; there is no link between it and the past. Expectations are bound, as often as not, to “diverge” and, therefore, to be disappointed. Choice—whether informed by market price signals or not—can only be haphazard under these conditions. Action may make life more and more chaotic. It generates, at best, merely a stationary economy—one with efforts at improvement continually frustrated—and certainly not a progressing economy. It would be just as well if people did not act (i.e., adjust their plans) at all.

 

________________

20Hayek, “Economics and Knowledge,” p. 45.

21It is therefore necessary to reject Lawrence H. White’s attempt to distinguish between arbitrage and entrepreneurship by suggesting that in the former, profit opportunities may be said to have an “objective” existence. See White’s essay “Entrepreneurship, Imagination, and the Question of Equilibrium” (unpubl. ms., 1976), p. 4.

22Israel M. Kirzner, Competition and Entrepreneurship (Chicago: University of Chicago Press, 1973).

23While profit opportunities cannot be defined ex ante by “objective” criteria (being fundamentally products of entrepreneurial imagination), this does not mean that their successful exploitation ex post does not ultimately rest upon appeal to consumer wants. The success of entrepreneurial imagination depends crucially upon existence of market prices, which inform entrepreneurial understanding. More will be said about this in later sections.

24Lawrence H. White, “Uncertainty and Entrepreneurial Expectations in Economic Theory” (unpubl. ms., 1977), pp. 68-69.

25Schutz, Phenomenology of the Social World, p. 9.

26Thus, even Kirzner is forced to hedge on such fundamental issues as the “completeness” of the competitive process by remarking (in Competition and Entrepreneurship, p. 97) that competition is “at least potentially present” even if entrepreneurs fail to be alert.

27Mises, Human Action, p. 229.

28Murray N. Rothbard, Man, Economy, and State: A Treatise on Economic Principles (Princeton, N.J.: D. Van Nostrand, 1962), p. 542; emphasis in the original.

29Ibid., p. 543.

30Yet these conditions are not sufficient. Successful calculation also depends on entrepreneurial understanding.

31Attempts to explain market phenomena by referring to “divergent expectations” or other uncaused “natural” failures of entrepreneurial understanding are not truly explanations at all.

32In his article, “The Role of Expectations in Economics as a Social Science” (Economica 14 [February 1943]: 108-19) reprinted in Capital, Expectations, and the Market Process (Kansas City, Kans.: Sheed Andrews and McMeel, 1977), pp. 65-80, Lachmann denies that the conclusions drawn by the Austrian theory of the trade cycle follow necessarily from the premises involved in that theory. Lachmann claims that a timely adjustment of entrepreneurial expectations may prevent the usual consequences from arising due to the existence of a market rate of interest (r) below the natural rate (n). Mises, in his reply (“‘Elastic Expectations’ and the Austrian Theory of the Trade Cycle,” Economica n.s. 10 [August 1943]: 251-52) concedes the validity of Lachmann’s claim. Nevertheless, properly worded, the theory remains logically valid; its conclusions refer to consequences that arise if authorities succeed in promoting investment beyond levels warranted by the supply of voluntary savings (Sv) by way of the issue of created credit (Sc). Now the market rate of interest, r, is the rate that equates the total demand for bank credit, D, with its total supply, Sv + Sc, so that the market clears. In the absence of created credit, the market rate r equates Sv with D and so is equal to the natural rate, n. The adjustment of expectations described by Professor Lachmann can only refer to a reduction in D such as is needed to prevent it from exceeding Sv even in the face of the banks’ offer of credit at cheaper prices. In other words, the banks’ attempt to issue created credit are frustrated. (Alternatively, expectations may operate through the anticipatory raising of prices, so that although the nominal demand for credit rises, there is no increase in real demand.) In either case, the effect is to prevent a divergence between r and n from ever occurring. Therefore, the “elasticity of expectations,” far from suggesting a possibility wherein a discrepancy between r and n does not have trade-cycle implications, merely suggests that entrepreneurs may frustrate attempts by banks to create the necessary discrepancy in the first place. The validity of the trade-cycle theory is not affected.

33This is not to deny that certain propositions generally granted praxeological status may be seen at some point to depend upon unacknowledged empirical assumptions. Yet it is not the case that the greater part of catallactics is comprised of such propositions merely because they presume a “tendency toward equilibrium.” This conclusion is defended in the final section of this article.

34See Mises, Human Action, pp. 22-27.

35An exception is the evenly rotating economy, which is a limiting case, as will be discussed later in this article.

36Mises, Human Action, p. 251.

37Lachmann is led to note, concerning the importance of market prices (“Reflections on Hayekian Capital Theory,” p. 129), that “The beacon that had been designed to keep entrepreneurs from straying from the narrow path of convergent expectations turns out, on most nights, to be rather dim.” It might be countered that a dim beacon is better than none at all, but this answer will not persuade those who believe that the future is truly kaleidic.

38It is respecting the extremes of perfect knowledge (neoclassical schema) and complete uncertainty (“kaleidic society”) that Roger Garrison upholds the view of “Austrian Economics as Middle Ground” (in Kirzner, Method, Process, and Austrian Economics (pp. 131-38). Garrison notes that these polar views “represent the extreme circumstances under which economic theory is either trivial or impossible. It is on that expansive band between the two poles that Mises’ concept of human action . . . has applicability.” See also Oskar Morgenstern, “Perfect Foresight and Economic Equilibrium,” in Selected Economic Writings of Oskar Morgenstern, Andrew Schotter, ed. (New York: New York University Press, 1976), pp. 169-83.

• 1Hayek, “Economics and Knowledge,” p. 45.
• 2It is therefore necessary to reject Lawrence H. White’s attempt to distinguish between arbitrage and entrepreneurship by suggesting that in the former, profit opportunities may be said to have an “objective” existence. See White’s essay “Entrepreneurship, Imagination, and the Question of Equilibrium” (unpubl. ms., 1976), p. 4.
• 3Israel M. Kirzner, Competition and Entrepreneurship (Chicago: University of Chicago Press, 1973).
• 4While profit opportunities cannot be defined ex ante by “objective” criteria (being fundamentally products of entrepreneurial imagination), this does not mean that their successful exploitation ex post does not ultimately rest upon appeal to consumer wants. The success of entrepreneurial imagination depends crucially upon existence of market prices, which inform entrepreneurial understanding. More will be said about this in later sections.
• 5Lawrence H. White, “Uncertainty and Entrepreneurial Expectations in Economic Theory” (unpubl. ms., 1977), pp. 68-69.
• 6Schutz, Phenomenology of the Social World, p. 9.
• 7Thus, even Kirzner is forced to hedge on such fundamental issues as the “completeness” of the competitive process by remarking (in Competition and Entrepreneurship, p. 97) that competition is “at least potentially present” even if entrepreneurs fail to be alert.
• 8Mises, Human Action, p. 229.
• 9Murray N. Rothbard, Man, Economy, and State: A Treatise on Economic Principles (Princeton, N.J.: D. Van Nostrand, 1962), p. 542; emphasis in the original.
• 10Ibid., p. 543.
• 11Yet these conditions are not sufficient. Successful calculation also depends on entrepreneurial understanding.
• 12Attempts to explain market phenomena by referring to “divergent expectations” or other uncaused “natural” failures of entrepreneurial understanding are not truly explanations at all.
• 13In his article, “The Role of Expectations in Economics as a Social Science” (Economica 14 [February 1943]: 108-19) reprinted in Capital, Expectations, and the Market Process (Kansas City, Kans.: Sheed Andrews and McMeel, 1977), pp. 65-80, Lachmann denies that the conclusions drawn by the Austrian theory of the trade cycle follow necessarily from the premises involved in that theory. Lachmann claims that a timely adjustment of entrepreneurial expectations may prevent the usual consequences from arising due to the existence of a market rate of interest (r) below the natural rate (n). Mises, in his reply (“‘Elastic Expectations’ and the Austrian Theory of the Trade Cycle,” Economica n.s. 10 [August 1943]: 251-52) concedes the validity of Lachmann’s claim. Nevertheless, properly worded, the theory remains logically valid; its conclusions refer to consequences that arise if authorities succeed in promoting investment beyond levels warranted by the supply of voluntary savings (Sv) by way of the issue of created credit (Sc). Now the market rate of interest, r, is the rate that equates the total demand for bank credit, D, with its total supply, Sv + Sc, so that the market clears. In the absence of created credit, the market rate r equates Sv with D and so is equal to the natural rate, n. The adjustment of expectations described by Professor Lachmann can only refer to a reduction in D such as is needed to prevent it from exceeding Sv even in the face of the banks’ offer of credit at cheaper prices. In other words, the banks’ attempt to issue created credit are frustrated. (Alternatively, expectations may operate through the anticipatory raising of prices, so that although the nominal demand for credit rises, there is no increase in real demand.) In either case, the effect is to prevent a divergence between r and n from ever occurring. Therefore, the “elasticity of expectations,” far from suggesting a possibility wherein a discrepancy between r and n does not have trade-cycle implications, merely suggests that entrepreneurs may frustrate attempts by banks to create the necessary discrepancy in the first place. The validity of the trade-cycle theory is not affected.
• 14This is not to deny that certain propositions generally granted praxeological status may be seen at some point to depend upon unacknowledged empirical assumptions. Yet it is not the case that the greater part of catallactics is comprised of such propositions merely because they presume a “tendency toward equilibrium.” This conclusion is defended in the final section of this article.
• 15See Mises, Human Action, pp. 22-27.
• 16An exception is the evenly rotating economy, which is a limiting case, as will be discussed later in this article.
• 17Mises, Human Action, p. 251.
• 18Lachmann is led to note, concerning the importance of market prices (“Reflections on Hayekian Capital Theory,” p. 129), that “The beacon that had been designed to keep entrepreneurs from straying from the narrow path of convergent expectations turns out, on most nights, to be rather dim.” It might be countered that a dim beacon is better than none at all, but this answer will not persuade those who believe that the future is truly kaleidic.
• 19It is respecting the extremes of perfect knowledge (neoclassical schema) and complete uncertainty (“kaleidic society”) that Roger Garrison upholds the view of “Austrian Economics as Middle Ground” (in Kirzner, Method, Process, and Austrian Economics (pp. 131-38). Garrison notes that these polar views “represent the extreme circumstances under which economic theory is either trivial or impossible. It is on that expansive band between the two poles that Mises’ concept of human action . . . has applicability.” See also Oskar Morgenstern, “Perfect Foresight and Economic Equilibrium,” in Selected Economic Writings of Oskar Morgenstern, Andrew Schotter, ed. (New York: New York University Press, 1976), pp. 169-83.
• 20In this section, an attempt is made to show that there is a strictly logical sense in which action may be said to be equilibrating (rather than disequilibrating), which may be interpreted as implying a tendency toward equilibrium in markets with freely adjusting prices. However, the view defended here contrasts sharply with those of both Kirzner and Lachmann, who are criticized for adopting an analytical framework that is not consistently subjective. The praxeological notion of equilibration defended here is also distinguished from the empirical or “common-sense” notion of coordination suggested by Hayek, according to which the relevant “tendency” for theorists to be concerned with is one in which the “expectations of the people and particularly of the entrepreneurs will become more and more correct.”
• 21Entrepreneurs succeed or fail in generating monetary surpluses to the extent that they succeed or fail in anticipating consumer actions. These actions are not predetermined by an unchanging set of preferences. According to praxeology, preferences do not exist at all apart from acts of choice. It follows that all entrepreneurial action is, as this article has insisted, not merely speculative, but imaginative. This is true even for “mere” arbitrage (meaning arbitrage as understood by the business community). There is no listable set of profit opportunities (the basis for additions to monetary surpluses) existing independent of entrepreneurial actions because there are no consumer preferences apart from consumer actions taken in response to entrepreneurial offers. Thus it is misleading to treat profit opportunities as having an objective basis (i.e., as existing “out there”) because it is improper to treat consumer preferences as if they existed apart from realized acts of choice.
• 22Israel M. Kirzner, in his analysis of entrepreneurship, suggests the possibility, in the unhampered market, that action may fail to eliminate entrepreneurial profit and loss systematically, i.e., may fail to equilibrate. This impression results from Kirzner’s use of the metaphorical, “common sense” notion of profit opportunities existing “out there” in some objective sense independent of their perception or discovery by enterprising individuals. Kirzner’s approach has encouraged the treatment of equilibration as an empirical matter subject to doubt. It is necessary to challenge such interpretations insofar as they confuse necessary features of action with contingent ones and imply that action in the unhampered market may be “disequilibrating” or “insufficiently equilibrating” and that praxeological theorems that presume a “tendency toward equilibrium” are necessarily open to empirical falsification.
• 23The category of objective profit opportunities is praxeologically meaningful only as an ex post concept, in which case there is no question of undiscovered opportunities. Yet, the contrary is implied within the framework of Professor Kirzner, who is led to adopt the metaphorical notion of “objective” profit opportunities existing ex ante (and hence capable of going undiscovered) in order to counter the opinion that entrepreneurial innovation is disequilibrating. By treating profit opportunities as existing “out there” and by positing their eventual “discovery,” Kirzner is able simply to dismiss the innovative (and allegedly disequilibrative) aspects of entrepreneurship. In doing so, he is drawn uncomfortably close to the Robbinsian outlook according to which entrepreneurship merely involves the “efficient” administration of given means and ends, that is, the exploitation of given profit opportunities.
• 24The category of objective profit opportunities is praxeologically meaningful only as an ex post concept, in which case there is no question of undiscovered opportunities. Yet, the contrary is implied within the framework of Professor Kirzner, who is led to adopt the metaphorical notion of “objective” profit opportunities existing ex ante (and hence capable of going undiscovered) in order to counter the opinion that entrepreneurial innovation is disequilibrating. By treating profit opportunities as existing “out there” and by positing their eventual “discovery,” Kirzner is able simply to dismiss the innovative (and allegedly disequilibrative) aspects of entrepreneurship. In doing so, he is drawn uncomfortably close to the Robbinsian outlook according to which entrepreneurship merely involves the “efficient” administration of given means and ends, that is, the exploitation of given profit opportunities.
• 25More fundamentally, whenever one speaks of unexploited opportunities for profit one departs from the domain of theoretical science and exemplifies the perspective of the historian or would-be entrepreneur. Kirzner’s “profit opportunities” exist in the mind of the analyst but are somehow divorced from “the already constituted meanings of active participants in the social world.” In other words, the ends-means framework recognized by the analyst differs from that recognized by market participants. The procedure of injecting an independent “imagination” into one’s analytical framework takes its revenge by begging important questions, (1) Why should equilibration be a feature of the real world (where actors may be chronically “unalert”)? (2) Do praxeological theories that presume equilibration in fact depend upon the soundness of certain empirical assumptions? In contrast, the praxeological approach does away with the question of “alertness” as it disallows the category of “unexploited profit opportunities.”
• 26More fundamentally, whenever one speaks of unexploited opportunities for profit one departs from the domain of theoretical science and exemplifies the perspective of the historian or would-be entrepreneur. Kirzner’s “profit opportunities” exist in the mind of the analyst but are somehow divorced from “the already constituted meanings of active participants in the social world.” In other words, the ends-means framework recognized by the analyst differs from that recognized by market participants. The procedure of injecting an independent “imagination” into one’s analytical framework takes its revenge by begging important questions, (1) Why should equilibration be a feature of the real world (where actors may be chronically “unalert”)? (2) Do praxeological theories that presume equilibration in fact depend upon the soundness of certain empirical assumptions? In contrast, the praxeological approach does away with the question of “alertness” as it disallows the category of “unexploited profit opportunities.”
• 27The crucial point is that monetary calculation provides essential guidance for entrepreneurial understanding and action. In the absence of such calculation, the imagination of profit opportunities, i.e., entrepreneurial speculation, would indeed become an entirely haphazard process, bearing no meaningful relationship to the state of consumer preferences: “Monetary calculation is the guiding star of action.... [Man] calculates in order to distinguish the remunerative lines of production from the unprofitable ones, those of which the sovereign consumers are likely to approve from those of which they are likely to disapprove.”
• 28Without monetary calculation, entrepreneurs would lose vital evidence with which to form their conjectures and would not even be able to judge whether their previous conjectures were accurate or not. They therefore would be without means for informed direction of their future actions. It is only when market prices exist that calculation, the meaningful ascertainment of profit or loss, success or failure, is possible. In particular, the entrepreneurial function of subjectively distinguishing “profit” from rents and other factor returns is not conceivable without market prices: “The different sources of income can be separated only be referring to these incomes as determined by prices on the market.”
• 29Only in this way can an entrepreneur estimate implicit (opportunity) costs and thereby determine that, for example, “he is suffering a loss in his business.” Then, “If the loss continues ... he will be impelled to shift his various resources to other lines of production. It is only by means of such estimates that an owner of more than one type of factor ... can determine his gains or losses in any situation and then allocate his resources to strive for the greatest gains.”
• 30The existence of market prices, which itself depends upon private ownership and exchange of the means of production, is therefore a necessary prerequisite to economic calculation. This is the fundamental conclusion of the praxeological critique of socialism. The necessity (not sufficiency) of market prices for entrepreneurial success, including entrepreneurial calculation and understanding, can be ascertained without appeal to other, necessary assumptions regarding the use and dissemination of knowledge. Its truth does not depend on the “alertness” of entrepreneurs in the unhampered market. It derives from consideration of the pure logic of the equilibration process: in the context of market prices, this process might promote coordination. Otherwise, an essential ingredient is lacking, for which there are no promising substitutes.
• 31Praxeology does not attribute the failure of socialism to its inability to achieve the conditions of static equilibrium: on the contrary, socialism cannot succeed, according to praxeology, because entrepreneurial action (which includes also the speculative decisions of central planners) cannot succeed without the aid of market prices. Moreover, praxeology sees interference with or absence of competitive market prices as a key to explanation of the failure of many particular market processes. For example, the trade cycle is explained as a phenomena initiated by disruption of rates of interest from their “natural” levels, i.e., the levels that reflect consumer time-preference and that would prevail under a system where banks (including central banks) functioned purely as intermediaries of voluntary savings. An artificially lowered rate of interest and accompanying expansion of credit necessarily leads to the distortion of a wide range of other market prices (by provoking overestimation of the real supply of loanable funds). The necessary consequences that arise from this include widespread alteration of profit and loss signals and a greater channeling of entrepreneurial activity into undertakings that eventually prove unsustainable.
• 32Praxeology does not attribute the failure of socialism to its inability to achieve the conditions of static equilibrium: on the contrary, socialism cannot succeed, according to praxeology, because entrepreneurial action (which includes also the speculative decisions of central planners) cannot succeed without the aid of market prices. Moreover, praxeology sees interference with or absence of competitive market prices as a key to explanation of the failure of many particular market processes. For example, the trade cycle is explained as a phenomena initiated by disruption of rates of interest from their “natural” levels, i.e., the levels that reflect consumer time-preference and that would prevail under a system where banks (including central banks) functioned purely as intermediaries of voluntary savings. An artificially lowered rate of interest and accompanying expansion of credit necessarily leads to the distortion of a wide range of other market prices (by provoking overestimation of the real supply of loanable funds). The necessary consequences that arise from this include widespread alteration of profit and loss signals and a greater channeling of entrepreneurial activity into undertakings that eventually prove unsustainable.
• 33In its references to the effects of intervention, praxeology naturally engages in conjectural history. Nevertheless, whenever the described intervention is present, all of the consequences that praxeology attributes to it will follow. It is the task of history proper to determine whether any actual event corresponds to a certain hypothetical counterpart examined by praxeology. This matter of historical identification is, contra Hayek, the only “question of fact” to which praxeological conclusions, including ones that (as we have seen) are relevant to catallactics, need to defer. There is no question here of any need for or possibility of “verification” or “falsification” of praxeological theories either in the manner suggested by positivists or by appeal to common sense.
• 34To maintain that individual plans can be coordinated is to affirm the existence of social causation. The idea that such causation operates is related to the belief that social actions are or may be largely successful. Praxeology conceives of a sequence of social events as coordinated insofar as they result mainly in psychic profit rather than psychic loss. The notion of coordination thus becomes a corollary to the praxeological construct of the progressing economy.
• 35To maintain that individual plans can be coordinated is to affirm the existence of social causation. The idea that such causation operates is related to the belief that social actions are or may be largely successful. Praxeology conceives of a sequence of social events as coordinated insofar as they result mainly in psychic profit rather than psychic loss. The notion of coordination thus becomes a corollary to the praxeological construct of the progressing economy.
• 36But to say that progress actually exists requires an appeal to understanding: “Whenever economic history ventures to classify economic evolution within a certain period according to the scheme stationary, progressing, or retrogressing, it resorts in fact to historical understanding [verstehen] and does not ‘measure.’” There can thus be no question of an answer to the question of coordination in any sense admitting to either “apodictic certainty” or to empirical “falsifiability”: psychic profit and loss are subjective, immeasurable phenomena.
• 37Thus, for example, although the existence of market prices is necessary for coordination because it provides the only reliable means for people’s actions to be guided by the wants of others, it may not be sufficient. It could be that anticipations are generally disappointed, so that wealth does not accumulate. Coordination and its representative, economic progress, will then be impossible even with an unhampered price system. Such possibilities form the crux of the Shackleian challenge to praxeology.
• 38In short, praxeology, having broken away from the “fully informed” schema of neoclassical economics, finds its conclusions challenged by alternative views of precisely the opposite extreme. Its new opponents claim the future to be marked by complete (“radical”) uncertainty; a kaleidic future in which action is futile and purposefulness is merely an illusion. If, in fact, this view of reality is correct, then the theories of praxeology are, to repeat Hayek’s words, merely “formal” and “tautological.” They cannot then tell us anything of practical value, for they are based upon inferences drawn from a faulty premise, namely that qualitative regularity and causality exist in the sequence of social events. The truth, it is suggested, is just the opposite: the future is unknowable; there is no link between it and the past. Expectations are bound, as often as not, to “diverge” and, therefore, to be disappointed. Choice—whether informed by market price signals or not—can only be haphazard under these conditions. Action may make life more and more chaotic. It generates, at best, merely a stationary economy—one with efforts at improvement continually frustrated—and certainly not a progressing economy. It would be just as well if people did not act (i.e., adjust their plans) at all.