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 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.