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Some "Mainstream" Writers Coming to Terms with the Value of Austrian Business Cycle Theory

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08/07/2015

This must have been very painful for Noah Smith. So painful, in fact, that he felt the need to hurl half a dozen guilt-by-association charges at the Austrian School before admitting that it's the Austrian concept of malinvestment that probably best explains the enormous bubbles in the Chinese economy right now. 

Smith, as some of our readers may remember, really, really hates Austrians. At one point he said that Austrian economics is like a brain worm destroys your ability to engage in rational thinking.

Nevertheless, Smith has been forced to admit that Austrian Business Cycle Theory may be getting it right:

What's interesting to me, however, is that events in China are actually bearing out some of the classic predictions of Austrian thinking. Though most Austrians on the Internet spend their time flogging gold, hyperventilating about inflation and calling various people communists, the original "Austrian school" thinkers -- Ludwig von Mises and Friedrich Hayek -- had some other ideas as well. And some of these might be useful for thinking about China. 

One of these is "malinvestment." Austrian thinkers such as Mises contend that recessions happen because too many resources are funneled into assets that won't actually be productive in the future. By the time businesses realize that they have made a mistake, they are locked into bad lines of business, or bad business locations. 

Note that Smith can’t even slip in this admission without a few made-up charges against Austrians. I don’t know what “Austrian” sites Smith reads, but anyone who actually reads Mises Daily might conclude that Smith is far more obsessed with gold and communists and inflation than any of our writers.  

But he has to maintain his street cred with his “mainstream” pals, so if he’s going to admit that Austrians got something right, he has to make up a bunch of reasons as to why he’s still so much cooler than those Austrian guys.

But Smith only got up the courage to say anything at all, because a couple of days before Smith wrote his Blooomberg column, David Adler at Huffington Post was examining the core Austrian position on malinvestments and the Austrian position that it’s the boom, not the bust, that’s the key problem in business cycles:

There is a very different explanation of what ails the U.S. and other advanced economies. What if the boom itself, rather than just the bust that followed, led to the current stagnation? This possibility is completely lacking from the conventional SecStag debate. Though this concept also lacks an agreed upon name, it is reminiscent of Austrian School of Economics thinking. To use Austrian style terminology, the recent boom caused "mal-investment" (or in more neutral language, "misallocations in investment" or "mis-investment") to low productivity sectors.

The idea that booms themselves, rather than busts afterwards, are inherently damaging to productivity is less straightforward than it may appear. There is no obvious mechanism that explains why a surge in credit should lead to misinvestment in low productivity sectors. But here is one possible avenue in the U.S.: real estate.

Adler lacks Smith's unhinged contempt, but I have to give props to both Adler and Smith for admitting that the established “mainstream” explanations aren’t cutting it. Both writers could have stuck with the Krugman theory that the economy’s only problem is that government isn’t spending enough. Or they might just ignore the economy’s current stagnation and continue to pretend that we live the best possible world — a claim that requires us to portray business cycles and secular trends as unknowable and mystical phenomena of the natural world that we just have to live with.

But, of course, the current permanent sluggishness we now are experiencing is both understandable, explainable, and reversible. But it would require a full admission of the fact that in order to fix the economy, we have to actually let the bust repair the damage of the boom. That would require deflation and a temporary decline in the standard of living, and some laissez faire. Letting that happen is politically untenable, so Smith and Adler have to stick with explanations that support current policy preferences instead. But as long as that’s the case, don’t expect much love from the policymakers, because Austrians aren’t telling them what they’d like to hear. 

Ryan McMaken (@ryanmcmaken) is a senior editor at the Mises Institute. Send him your article submissions for Mises Wire and The Austrian, but read article guidelines first. Ryan has degrees in economics and political science from the University of Colorado, and was the economist for the Colorado Division of Housing from 2009 to 2014. He is the author of Commie Cowboys: The Bourgeoisie and the Nation-State in the Western Genre.

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