More Thoughts on Austrian Theory

A while back I wrote a short post on why I reject Austrian theories of the business cycle (ABCT). Austrians were not impressed. I still retain similar objections, though over time I have realised there are more reasonable adherents of the Austrian school (though being reasonable basically forces them to conclude demand-side recessions are a possibility). This post will hopefully be more comprehensive than my previous one, but again is only based on a few major observations/objections, and will echo some of my previous comments.

I have said a few times that I see Austrian economics as part of the marginalist tradition (as did Mises). Since I am critical of this tradition, a part of my objection is the application of the same criticisms to Austrians: the idea that ‘factors of production’ are rewarded according to their productivities is subject to all sorts of critiques; similarly, the Austrian treatment of capital is sometimes vulnerable to the problems  highlighted in the Capital Controversies. However, since I have already posted on this, and will likely do so again in the future, I will avoid this issue and instead criticise the Austrian school directly.

This post will be two pronged: first, I will explore the Austrian methodology in general; specifically, praxeology. Second, I will ask whether the theoretical implications of Austrian economics -regardless of praxeology – can be sustained.

Praxeology

Praxeology is the notion that economic theory can be built up a priori from the action axiom, or, as Mises stated it:

Human action is purposeful behaviour  Or we may say: Action is will put into operation and transformed into an agency, is aiming at ends and goals, is the ego’s meaningful response to stimuli and to the conditions of its environment, is a person’s conscious adjustment to the state of the universe that determines his life. Such paraphrases may clarify the definition given and prevent possible misinterpretations. But the definition itself is adequate and does not need complement of commentary.

It is worth stating that Hayek, and other Austrians, probably rejected this, at least as a rigid rule. So the critique applies mostly to Miseans. I have two points to make about it:

First, I think the axiom itself is flawed. While it is fair to say human action can be a purposeful response to stimuli in order to obtain certain ends, that is not the same as saying that this is always the case. Action can be purposeful; it can also be knee-jerk, confused, accidental, arbitrary or even meaningless. Sometimes the action itself is the end. This poses a problem for the ‘try to disprove the action axiom‘ test, which asserts that by trying to disprove the axiom you validate it through your purposeful behaviour (yes, it is an intellectual ‘I know you are but what am I?’). But all this does it show that action can be purposeful. By trying to disprove it, I am acting purposefully, but this doesn’t mean all of my actions are purposeful.

Second, even if we accept the action axiom, we run into problems. It’s simply not at all clear how to get from a tautological statement to elaborate theories of the central bank. Blogger ‘Lord Keynes’  has discussed this - it’s clear that Mises had to introduce other assumptions and propositions to build his theory. Mises even admitted this directly with the disutility of labour:

The disutility of labor is not of a categorical and aprioristic character. We can without contradiction think of a world in which labor does not cause uneasiness, and we can depict the state of affairs prevailing in such a world.

Ultimately, I see no need to invoke praxeology when talking about theory. We can discuss the logic of whether low interest rates cause bubbles, or look at the evidence. We can examine other propositions of Austrian theory. But why do we need the human action axiom? The substantive theory is  where we must turn to determine whether or not Austrians are correct.

The Natural Rate of Interest

Hayek’s original theory of the business cycle, first fully expounded in Prices and Production, rested on an equilibrium between saving and borrowing different goods.* The market would set the equilibrium rate at which different goods were borrowed, meaning the savings were matched to investment and there was no excess credit expansion. However, Piero Sraffa – in what is widely regarded as a devastating review of the book – observed that in a monetary economy, the money rate of interest would be an aggregate of all the ‘natural rates’ between different goods. Hence  there was no reason to believe it would correspond to an equilibrium between every, or perhaps even any, particular good.

This issue comes up again and again, and while the overwhelming majority of Austrians appear to have conceded Sraffa’s criticism that the is no natural rate of interest. However, many seem to think it doesn’t matter – and this is not unique to Austrians. For me, the natural rate of interest matters: if there is no ‘natural’ or ‘correct’ rate of interest, how do we measure a deviation from the ideal?

It is true that fluctuations in the base rate do affect house prices – being directly linked to mortgages as they are – but nevertheless, Austrian theory doesn’t seem to deal well with housing bubbles. This is because they generally involve people continually buying and selling the same houses to each other and hence have small amounts of capital misallocation; in fact, there is a shortage of housing in many developed countries, while existing houses remain highly priced. This doesn’t make sense under an Austrian framework, which would require overinvestment in houses and hence liquidation of existing surplus stocks.

For me, interest rates are nothing special. They represent a cost for businesses, to be factored into their decision-making along with other costs. As Joseph Stiglitz says, is it a problem when business’ supply costs are too low? Does it lead them to expand too much? It seems to me that when banks are lending money for the wrong things, it’s a regulatory rather than monetary problem (insofar as it is a monetary problem, I would say it’s caused by high interest rates, but that’s for another time).

Furthermore, this ‘naturalistic’ problem with Austrianism isn’t limited to the rate of interest. There always seems to be some supposedly neutral laissez-faire, baseline state, which is never defined. Surely limited liability laws affect the decisions of businesses? What about the practical problems with property rights and contract law: the limited resources of the legal system (and hence dismissal of small cases); implicit contracts; rental laws, car crash liabilities, insurance claims and much more? All of these will contain somewhat arbitrary decisions, and all will impact the workings of a capitalist economy, possibly leading to capital misallocation. Overall, it is difficult to find a solid foundation for the supposedly ‘natural’ baseline on which Austrian theory seems to be built.

Overall, I remain unconvinced. I expect Ludwig Lachmann and similar economists are well worth reading, particularly for their stances on expectations and entrepreneurial strategies. But nothing I’ve seen from ‘mainstream’ Austrians has yet convinced me that it is worth delving into either 1000 page tomes by Mises or Rothbard, or practically unreadable (economic) works by Hayek, in order to try to further my understanding of their theories. There are just too many issues – conceptual, logical or evidential – with what I know so far.

But then, the internet is surely the place for Austrians to prove me wrong.

*It is worth noting that Austrians appear to rely on an exogenous money model with their talk of equilibrating savings and investment, and their idea that credit expansion results from central bank expansion. As I have documented, this is not how banking works. However, some Austrians have incorporated this insight, while others are against FRB altogether, so it’s not a problem for all of them.

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  1. #1 by john77 on December 17, 2012 - 11:37 pm

    Without wanting to get into a discussion of books that I haven’t read, you need some better links: Jon Geeting is a waste of space by comparing housebuilding with population instead of growth in population (and the second reference talks about overbuilding with homes that will never be occupied). “Jingle Mail” has been invented as a phrase because so many US families have left their houses empty and found somewhere else to live because there are far more house than households in the USA.
    The UK does have a housing shortage but that is not due to a market failure but to the *non-market* planning constraints;the shortage has been exacerbated by 3+ million immigrants coming into the UK in the last decade, so the new housebuilding failed to cover the demand from immigrants. We are a nation of immigrants; (one of my ancestors was an immigrant in the 19th century, many in the “Dark Ages”, most in the pre-Roman period) but the combination of New Labour policies encouraging immigration and discouraging building lots of cheap houses, rather than market failure is the cause.

    • #2 by Unlearningecon on December 18, 2012 - 1:47 pm

      I think your comment demonstrates my point about the largely meaningless dichotomy between markets and government. For example, a truly ‘free market’ would surely have unlimited immigration, right?

      In any case, regardless of the cause of the housing shortage, it still poses a problem for Austrian solutions of liquidation, as there is nothing to liquidate.

      • #3 by Aziz on December 19, 2012 - 7:47 am

        For example, a truly ‘free market’ would surely have unlimited immigration, right?

        Yes. I endorse unlimited immigration. Most “free market” people don’t.

  2. #4 by Steve on December 18, 2012 - 3:44 am

    Austrians like every other economic school have some observations of phenomena if not insights which seem to be relevant. But ultimately they are all economic theory, abstraction, even as you pointed out, their human action axiom. Actually this characterizes nearly every economic school. Most Austrians I have interacted with on the internet are free market theory worshipers. They cannot confront or countenance the possibility that there may be an aspect of, or a factor within free market theory ITSELF which is flawed. If a factor is a continuous present part of the “woof and warp” of the system itself, in other words a systemic economic REALITY…it’s not actually a THEORY….and due to its ever present and systemic nature it must be a deep and operative factor, in fact a basic cause.

    I assert that cost accounting’s conventions are such an ever present reality/factor/cause. The effects of enforced scarcity of total individual incomes in comparison to total prices caused by those conventions over rule and dispel THEORIES of money’s quantity or velocity.

    The relationship between prices and incomes is a mirror of the power relationship of the system and the individual as well. The one increasing, the other falling behind.

    Because cost accounting applies to everything and every dollar actually in the economy the answer to the scarcity it causes…can only be remedied by a supplement to individual incomes that does NOT go through the normal process of the economy from production through to retail sale. And that supplement along with a retail discount mechanism as well are the most basic solution to the economy’s instability.

    • #5 by Unlearningecon on December 18, 2012 - 1:51 pm

      If a factor is a continuous present part of the “woof and warp” of the system itself, in other words a systemic economic REALITY…it’s not actually a THEORY….and due to its ever present and systemic nature it must be a deep and operative factor, in fact a basic cause.

      Yeah, absolutely. This also reminds me of neoclassical economists: they don’t realise that by assuming away certain things, they are assuming away how a capitalist economy actually functions. Austrians retain this framework but only seem to be able to meet specific challenges with the largely meaningless statement ‘the market will sort it out.’

      Accounting practices are indeed such an example of arbitrary operations within a capitalist economy.

  3. #6 by Hedlund on December 18, 2012 - 3:07 pm

    I believe your critique of praxeology is vulnerable to claims that you’ve misunderstood it. Not saying I disagree with you, mind; just that some of the more thoughtful Austrians I’ve encountered would. Without resorting to outright mimicry, since this is not an ideological turing test, I will try to articulate some of their possible contentions:

    While it is fair to say human action can be a purposeful response to stimuli in order to obtain certain ends, that is not the same as saying that this is always the case. Action can be purposeful; it can also be knee-jerk, confused, accidental, arbitrary or even meaningless. Sometimes the action itself is the end.

    Actually, “human action” can only be purposeful. The reason for this is that Mises has assigned the phrase that meaning for the specific context of praxeological considerations; obviously, any theory needs definite terms. Further, he specifically contrasts it with kneejerk/reflexive operations, which are not human action in this scope. Thus, the action axiom is more of a definition than anything: “Let N be purposeful behavior.”

    Early on in Human Action, he also notes:

    Human action is necessarily always rational. The term “rational action” is therefore pleonastic and must be rejected as such. When applied to the ultimate ends of action, the terms rational and irrational are inappropriate and meaningless.

    As you can imagine, this led to decades of confusion, since “rational” in economics is already a contested-as-all-hell term. Here Mises introduces yet another meaning for it; when he uses the term “rational,” he does so not in the sense that a conclusion necessarily follows from a premise, or that a premise is sound, or that someone is better or worse at prediction, but rather simply in the broad sense of it being formulated as per “rationalism,” or the result of thought — however rudimentary or stunted. In discussions of human action, while other forms of rationality are contingent, Misesian rationality is necessary.

    In other words, I think he could have saved everyone an enormous headache if he had just used “teleological” instead of “rational,” since that’s what he actually means.

    With that out of the way, this is not without its issues. For one thing, it is not, as Mises contends, a synthetic a priori proposition. It is saying that X is Y and is therefore a definition — thus, it is analytic a priori. Mises fancied mathematical foundations, likening his action axiom to those of geometry, which he assumed to be synthetic a priori. Whereas his brother was a mathematician, I would expect that he must have had some notion that we’ve known for at least 100 years that the synthetic a priori is a fallacy. Attempts to rigorously found mathematics over the past two centuries have revealed that mathematics itself is, at root, despite everything we hear to the contrary, an empirical science.

    And of course, in the last century we’ve learned much to dispel the notion that humans are somehow special in terms of problem solving, tool use, communication of ideas, recreation, and other such “rational” pursuits.

    We’re left with a tautology, as you’ve noted: “Human (purposeful) action is purposeful [action] (by humans).” It is true ex vi terminorum, and utterly uninteresting. Obviously, we’re going to need a lot more than this to kick off an economic theory. Thus, Mises moves on to incorporating things like time and preference, which are far and away more useful than the action axiom, which for some odd reason still gets like 90% of praxeological airtime. Even then, his development of those subjects has thus far not impressed me with any particularly unique insight.

    Second, even if we accept the action axiom, we run into problems. It’s simply not at all clear how to get from a tautological statement to elaborate theories of the central bank

    In fairness, this rings of an argument from incredulity. He does have to add other postulates and such to get there (again, remember, he’s trying to be a geometer, and even Euclidean geometry uses multiple axioms), but as far as I know, Mises does wind up spelling it all out (to his own satisfaction at least) in Human Action. I’m only a few chapters in, myself, though, so someone like Mr. Finegold-Catalán might be better poised to attempt to elaborate on it.

    For what it’s worth, I think I’ve met (maybe) one Austrian capable of actually showing how the high-level bits are derived from their first principles. (Hopefully within another year or so I’ll be able to do so myself.)

    • #7 by Unlearningecon on December 19, 2012 - 6:42 pm

      Thus, the action axiom is more of a definition than anything: “Let N be purposeful behavior.”

      Ah. That is interesting. But why is action that does not fit this criteria beyond the scope of economic science? Does Mises discuss this?

      In fairness, this rings of an argument from incredulity.

      I see what you mean, but I do back it up with direct examples and a quote from Mises himself.

      In many ways, however, it was a plea for an Austrian to state to me the logical train of thought that follow from the action axiom. I have not seen anybody do it yet. I was hoping Jonathan would comment but he hasn’t.

    • #8 by Hedlund on December 19, 2012 - 8:04 pm

      But why is action that does not fit this criteria beyond the scope of economic science? Does Mises discuss this?

      I don’t have the book in front of me, but as I recall the idea is that conscious, purposeful behavior is the only thing capable of expressing preferences by way of deciding between different activities (up to and including doing nothing, which is also action in Misesian terms). Insofar as the marginalist tradition views economics as a science of distribution and consumption arising from human preferences, I suppose it only makes sense to take consciousness as an ultimate given and set a particular focus on expressions of preferences through it.

      I see what you mean, but I do back it up with direct examples and a quote from Mises himself.

      In many ways, however, it was a plea for an Austrian to state to me the logical train of thought that follow from the action axiom. I have not seen anybody do it yet.

      Fair enough! I suppose I was reacting to the phrasing more than the idea itself, since I do agree with you; scant few are willing (or able) to walk one through the axioms and theorems, such as they are. I have yet to find any source so helpful as to provide even a simple bulleted list of propositions. Considering the enthusiasm of Mises’s internet following, this comes as something of a shock.

      • #9 by Unlearningecon on December 19, 2012 - 8:58 pm

        So Mises would presumably argue that all economic behaviour is purposeful? Perhaps that is a defensible proposition. Though I’ve no doubt it is compatible with any school of thought.

      • #10 by Hedlund on December 24, 2012 - 3:40 am

        That’s probably an acceptable way to phrase it.

        The Misesian approach has three major categories of study: praxeology, economics, and catallactics. It took me a bit to make sense of where one begins and the next ends, and for all I know there may still be some nuance I’ve missed, but here’s how I think it goes: praxeology (human action) is the broad category; economics (ordering and acting on preferences under conditions of scarcity) is a sub-field of it, contrasted with, e.g., hostile action and war and the like; then catallactics (interpersonal exchange mediated through money) is a subcategory of economics, since the broader economics also includes individual preference ordering.

        So, I think all economic behavior is purposeful — again, by the definition employed.

        Quite a lot of praxeologically informed Austrian School thought seems to hinge on twiddling definitions. To give an example: I once witnessed a debate in which a Mises/Rothbard-tradition Austrian chided the other participant for referring to “artificial scarcity”; the former insisted that there is no such thing as artificial scarcity, and that scarcity is an unavoidable, objective condition presupposed by human action. The other offered a definition of scarcity along the lines of (paraphrasing) “a good is scarce when, if its price is 0, demand will exceed supply,” and asked if the Austrian knew of a better definition. The Austrian responded by defining scarce objects as objects of economic action.

        And though he didn’t say as much, we already know that economic action pertains to human choices under conditions of scarcity. Suddenly, that tidy little definition appears extremely unhelpful.

        I’ve come to view this exchange as sort of totemic of these “rationalist” strains of the Austrian School.

      • #11 by Unlearningecon on December 24, 2012 - 12:43 pm

        It seems Mises’ praxeology was far weaker (in that he meant it to be weaker, not that it was ‘wrong’) than his modern day adherents make out.

  4. #12 by Will on December 19, 2012 - 8:14 pm

    I agree about praxeology. Note that Mises, with his qualification on the disutility of labor, admits that economists’ great “Laws” are actually assertions that people will choose to behave in a particular way. This ignores that people are free and prone to change. I would observe with regard to the disutility argument: people dislike having nothing to do much more than they dislike the satisfaction of a job well done. Test it on a roomful of students and you’ll take my point.

    I also agree that ABCT is a rather poor fit for booms and crashes in the housing market. My question for you is: does Henry George’s account of housing booms and busts (which he naively believed to be an account of business cycles in general), stressing the unusual properties of land, do a better job? I think it’s an interesting question in part because George shared a lot of common ground with, say, Menger.

    • #13 by Unlearningecon on December 19, 2012 - 8:28 pm

      I have not read George first hand, but from what I know he over egged the LVT as a Panacea.

      Having said that, theoretically it does seem that it would eliminate the incentive to hold land for speculative purposes. Ultimately it comes down to the evidence, and I have indeed heard that Pennsylvania – the only U.S. state with an LVT – had a less severe housing bubble. But I have no direct evidence to support that, and nothing else at all.

      • #14 by Will on December 19, 2012 - 9:13 pm

        Definitely. I wasn’t proposing an LVT. As nice as it is on paper, all evidence suggests that it’s too politically difficult in practice to implement it and keep it in place. I believe that in every place it has been tried, politically well connected landowners have over time either watered it down or done away with it. This suggests that even if we agree that private ownership of land (meaning space and location, not housing proper) is bad, other means of appropriating the land rent should be pursued.

        George is among the most readable of economists. His chapter on the business cycle is here: http://www.econlib.org/library/YPDBooks/George/grgPP23.html#Book V, Chapter 1

        My first reaction is to say that he’s basically wrong; with a modern financial system, a speculative advance in land values does not necessarily starve labor and capital. But he includes so many qualifications — including the inelasticity of the currency — that I’m just not sure. (Adam Smith is another writer who operates this way, making it hard to ever pronounce him wrong).

      • #15 by Unlearningecon on December 20, 2012 - 9:44 pm

        The land issue is a major issue indeed, but under capitalism landlords simply have too much power to expect them to relinquish it. To give an indicator of their power, one of the most powerful prime ministers (Churchill) was unable to introduce the tax just after winning the war. I think it’s one of the Central European or Scandinavian countries where local councils lend out land for set periods of time. This prevents the ownership from becoming entrenched.

      • #16 by Alan on December 20, 2012 - 9:41 pm

        Land value taxes were common in the Pittsburgh area, including in the city itself, and Pittsburgh is very intensely settled in much of the core city.

        In my estimation, however, Pittsburgh avoided the housing bubble because it lost essentially an entire generation of workers around 1980, when the local steel industry imploded and just about everyone who could moved away, meaning there’s a huge supply of houses available dirt cheap, with many bad neighborhoods crumbling into the hillsides. Moreover, since most of the population is either very old or young, there will continue to be a great many houses appearing on the market as the elderly move to retirement homes or pass on.

      • #17 by Unlearningecon on December 20, 2012 - 9:45 pm

        Thanks for clearing that up.

  5. #18 by Skeptic Griggsy on January 5, 2013 - 3:44 am

    Reblogged this on .

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