Posts Tagged Austrians
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.
The final chapter Steve Keen’s Debunking Economics is a brief overview of the major competing alternative economic schools of thought. The question posed is whether these schools present a viable alternative to neoclassicism and marxism, both of which Keen has already dismissed. He now goes on to evaluate Austrian, Sraffian, post-Keynesian and evolutionary economics, as well as Econophysics. I will look at Keen’s evaluation of these schools of thought and discuss his conclusions.
Keen’s view on the Austrian school is similar to that of myself and other post-Keynesians: it shares many characteristics with neoclassicism. These include but are not limited to: an exogenous money supply (ex. Lachmann and Schumpeter), Say’s Law, a variant of marginal productivity theory, reductionism and a government versus markets perspective. Hence, many of his earlier critiques – Sraffa’s work on capital, the excessive focus microeconomics, and post-Keynesian views on banking and the money supply – could equally be applied to Austrians. Keen himself thinks that Austrians deal with uncertainty, but (again, ex. Schumpeter and Lachmann) I’m not even sure this is true – for example, Hayek completely misused the term. Hence, criticisms of neoclassical models based on irreducible uncertainty may also apply to some Austrian arguments.
While Keen applauds Austrians’ analysis of capitalism as more dynamic than that of neoclassical economics, he notes that they do seem to retain the belief that capitalism has a ‘natural’ state that should not be ‘interfered with,’ and they actually seem to take it much further than their neoclassical counterparts. This is particularly apparent – also something that I have noted – with Hayek’s ‘spontaneous order.’ Though it is an interesting concept, it has been misused as an ideological tool against government, without considering the ‘spontaneous order’ that may evolve inside government, or the possibility the dichotomy between governments and markets may be a false one.
All in all, it’s hard to deny Austrians are part of the marginalist tradition, something Mises explicitly said. Hence, I don’t consider the school a truly ‘alternative’ way of thinking about economics, even if it has something to offer.*
Keen praises Sraffa’s work as “the most detailed and careful analysis of the mechanics of production in the history of economics,” and notes the importance of the interesting conclusions that it brought to light. Nevertheless, Sraffa’s analysis is a static one that seems to be dependent on the existence of a long run equilibrium (here Keen quotes the Sraffian Ian Steedman as evidence). Due to the lack of dynamism in Sraffian models, Keen’s previous comments about dynamics and equilibria could be applied to Sraffa. Keen ends by noting the subtitle of Sraffa’s magnum opus: “Prelude to a critique of economic theory.” He suggests Sraffa’s main aim was to provide a basis with which to critique other theories, rather than present a positive alternative. I’ve no doubt Sraffian readers will disagree.
This school of thought is characterised by the application of modern chaotic modeling techniques to economics. Hence, the models produced are far better suited to generating the kind of instability we observe in capitalist economies than are those used in neoclassical economics. Keen comments that the school isn’t really a direct critique or challenge of neoclassical economics, instead dismissing it outright and presenting an alternative.
Bearing the lack of direct engagement with economists in mind, it’s not surprising that the physical scientists suffer somewhat from a curse of being a mirror image of economists. Keen says that they have been rediscovering old insights such as IS-LM, then using them with other, incompatible models such as rational expectations. They also seem to have an ‘everything looks like a nail when you have a hammer’ problem, and are applying inappropriate laws, such as conservation to the distribution of wealth, or electromagnetism to immigration.
Perhaps econophysicists should be more willing to read through the history of thought – as I noted in my post on mathematics, this type of imperialism/arrogance in physicists is no prettier than in economists (commenter Blue Aurora told me that some econophysicists have been more willing to engage with the discipline recently, which is a good development). Despite these flaws, the tools of modern chaotic modeling are surely a promising area for the future of economics.
Keen’s discussion of this field is the first time I have been properly introduced to it, so I’ll be brief. Keen seems to think that evolutionary science is an appropriate and promising field, but one that lacks maturity. Many evolutionary concepts, such as adaption and survival of the fittest, are surely applicable to capitalist firms and product evolution. Having said that, economics lacks the equivalent of the gene to ground the evolutionary approach, so many evolutionary models are often forced to rely on analogy. Perhaps – and hopefully – the evolutionary school will be able to establish a coherent grounding in the future, but for now it is not a strong enough alternative to neoclassicism.
As this is the school Keen and I both most closely align with, you’ll not be surprised to hear the many advantages we think it has to offer: dealing with uncertainty; the relative lack of ideological commitment to any particular system; paying sufficient attention to money, debt and banking; more reality based models of the firm; freedom from reductionist constraints, and much more.
The main problem with this school is the lack of coherency. It’s almost defined as ‘not neoclassical economics’ (and, Keen might add, not Marxism either). Post-Keynesiansism does not really have an agreed upon methodology, something that has worked against its status as a fully fleshed out alternative.
As a brief aside: personally I don’t see why class shouldn’t be adopted as the ‘official’ methodology of post-Keynesians. It is compatible with many of the core tenets of the school – for example, the idea that individual actions should be understood in their class context fits in with the post-Keynesian idea that microeconomics should have ‘macrofoundations.‘ Furthermore, there is also an element of ‘reclaiming classical economics’ to post-Keynesianism, and the classicals generally used class as a methodological starting point. Finally, many of the models – including Keen’s – already use classes as agents, so it seems like a natural progression.
Overall, it seems post-Keynesianism is simply less rigid and more reality-based than its neoclassical counterpart, and is more fleshed out than other alternatives, save a problem with a unified methodology.** Although I suggested that this methodology should be class, perhaps – and this something to which Keen alludes – the lack of a rigid methodology is a strength rather than a weakness. Viewed from this angle, post-Keynesian economics can accept and develop concepts from all of the alternative fields (as well as institutional economics, which Keen doesn’t mention). This also solves the ‘divide and conquer’ problem – part of the reason for neoclassicism’s dominance seems to be the splits between its rivals, which as you can see are many. Generally, I think cooperation between the alternative schools of thought may be the key to building a robust alternative to the curiously resilient school of neoclassicism.
*Obviously there are strong divides within the Austrian school. Rothbardianism is barely worth exploring, while Hayek and Mises have some insights but were fairly tainted by the government-market dichotomy. As I have noted above, Schumpeter and Lachmann seemed the most willing to abandon certain pretenses and come to interesting conclusions.
**Actually, judging from the constructive comments on my marxist economics post, I have more faith in marxist economics than does Keen. However, I will need to explore it more fully before I can come to a definitive conclusion.
Recently, a debate erupted between Austrians and Keynesians on Daniel Kuehn’s blog, and then later elsewhere, concerning matters that I, in my naivete, had long thought were settled. Sadly, it appears that once again, Henry Hazlitt’s supposed chapter by chapter ‘refutation‘ of TGT has been dredged up from the gutters of history, along with assertions about Keynes’ alleged totalitarianism.
I will start by briefly addressing some comments on Robert Vienneau’s previous exposition of Hazlitt’s book. There seems to be some confusion among the commenters who criticise Vienneau. It is quite clear that Hazlitt does not understand the concept of the marginalist supply curve, which posits that workers trade off leisure for work. Here he mistakenly asserts:
The ‘supply schedule’ of workers is fixed by the wage-rate that workers are willing to take. This is not determined, for the individual worker, by the ‘disutility’ of the employment – at least not if ‘disutility’ is used in its common-sense meaning.
He blatantly confuses the equilibrium between demand and supply with the curves themselves, an incredibly elementary mistake. Vienneau is correct to say that:
Obviously, then, the equality of the wage and the marginal productivity of labor is not enough to determine either wages or employment.
The marginalist theory require us to know both the wage rate and the hours worked to determine employment. Do these people really expect us to take Hazlitt seriously when he can’t even describe the marginalist theory of employment?
Anyway, let’s move on to another section – hopefully everyone can agree that Liquidity Preference is central to Keynes’ theory, so I will focus on Hazlitt’s criticisms of this. Here is Keynes:
Thus the rate of interest at any time, being the reward for parting with liquidity, is a measure of the unwillingness of those who possess money to part with their liquid control over it.
Hazlitt begins with a typically snarky comment:
The economic system is not a Sunday school; its primary function is not to hand out rewards and punishments.
How petty. Keynes’ use of the word ‘reward’ is irrelevant in this case; he’s merely saying that interest is an incentive to get people to part with liquidity. Hazlitt is latching onto something quite meaningless here. Let’s continue:
If you wish to sell me tomatoes, for example, you will have to offer them at a sufficiently low price to “reward” me for “parting with liquidity”—that is, parting with cash. Thus the price of tomatoes would have to be explained as the amount necessary to overcome the buyer’s “liquidity-preference” or “cash preference.”
Keynes is obviously saying that cash has a role as a store of value as well as a medium of exchange. If it is not currently being used for the latter then it will be stored; should it be stored, a certain rate of interest will be necessary to make the buyer part with their liquidity and buy a bond or deposit it in a bank. Hazlitt completely fails to distinguish between the two uses and offers up a false equivalence based on this misunderstanding.
Hazlitt then appears to agree with Keynes for a while:
[People] hold cash (beyond the needs of the transactions-motive) because they distrust the prices of investments or of durable consumption goods; they believe that the prices of investments and/or of durable consumption goods are going to fall, and they do not wish to be caught with these investments or durable goods on their hands.
Here Hazlitt isn’t actually criticising Keynes at all, but simply restating his theory of the speculative motive. He tries to paint this as a disagreement by splitting hairs over the word ‘speculative’ – which is fairly typical of the blunderbuss contrarianism you will find throughout his book – but it’s quite clear that this is simply a restatement of Keynes.
Hazlitt goes on:
If Keynes’s theory were right, then short-term interest rates would be highest precisely at the bottom of a depression, because they would have to be especially high then to overcome the individual’s reluctance to part with cash—to “reward” him for “parting with liquidity.” But it is precisely in a depression, when everything is dragging bottom, that short-term interest rates are lowest.
That interest rates move pro-cyclically is no sufficient to disprove the LP theory of interest, as it is not the only factor determining the interest rate – in a boom demand rises and this pushes up interest rates; the latter happens in a depression. This is entirely compatible with Keynes’ economics and does not mean LP effects are absent or unimportant.
It is worth noting at this point that Keynes was mostly concerned with long term rates, which are what businesses actually use when making investment decisions. To this end, Hazlitt resumes agreeing with Keynes:
It is true that in a depression many long-term bonds tend to sell at low capital figures (and therefore bear a high nominal interest yield), but this is entirely due, not to cash preference as such, but to diminished confidence in the continuation of the interest on these bonds and the safety of the principal.
Right, in other words: their preference for cash or liquidity over more uncertain bonds. Which is what Keynes said.
As a brief note on Keynes totalitarianism: this seems to be based on Keynes mentioning several times that certain policies – both flexible wages (of which he disapproved) and various exchange rate mechanisms & capital controls, as well as active fiscal & monetary policy (of which he approved) – are more easily applied under totalitarian conditions. These observations are quite clearly true - any economic policy, implemented word for word, is easier to apply under totalitarian conditions. This does not mean that totalitarianism is desirable, and you will not find Keynes saying anything of the sort. Furthermore, even if he did say such things, this is irrelevant to his economics.
There are good criticisms of Keynes to be made, but you will not find them with the likes of Hazlitt and Rothbard, who were quite clearly motivated by an overarching desire to ‘own’ Keynes, rather than debate. Rothbard actually wrote an entire book attacking Keynes as a person, which really is all you need to know about what he had to say. These people were not scholars, and their work is best consigned to the dustbin of history.
Addendum: Daniel Kuehn strengthens the argument about Keynes’ preface to the German edition of TGT.
I have alluded to the fact that I see neoclassical and Austrians economics as broadly part of the same intellectual movement. At first, I was unable to pinpoint exactly why this was, other than the fact that they both shared a governments versus markets mentality, and the only major policy difference between neoclassical libertarians and (minarchist) Austrian libertarians was the latter’s disdain for central banking (I am also informed that Milton Friedman repudiated his support for Central Banking later in life. But didn’t he argue…eh, forget it).
Regardless, I have realised that the more substantive reason for this equivalence is that the two share the same methodology. Whilst Austrians might reject this at first glance, allow me to go through each methodological tool, as expressed by Arnsperger & Varoufakis, used by neoclassical economics and compare it to Austrian analysis:
(1) Methodological individualism. This one is not particularly controversial – both neoclassicals and Austrians build up their economic models from the behaviour of individual agents. Austrians are generally more reductionist, whilst neoclassicals are prepared to abandon it for AD/AS analysis, but the majority of neoclassical theories retain this approach.
(2) Methodological instrumentalism. This means behaviour is generally preference driven, and action is defined to attain some end state. For neoclassicals this is utility maximisation:
Economists use the term utility to describe the satisfaction or enjoyment derived from the consumption of a good or service. If we assume that consumers act rationally, this means they will choose between different goods and services so as to maximize total satisfaction or total utility.
For Austrians it does not necessarily revolve around maximising anything, but still shares the same ‘actions are aimed to achieve some end’ characteristic:
Human action is purposeful behavior. 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.
In both cases the theories revolve around revealed preference – what people actually do is meaningful, and we will build our theories around that assumption.
(3) Methodological equilibration. This means that analysis asks what behaviour we should expect, given the economy is in equilibrium. This is the one most likely to be resisted by Austrians, who generally insist that they study the economy as if it is permanently evolving and in disequilibrium. However, this paper on the subject disagrees:
Mises’ understood the of market process as a series of shifting imperfect equilibria, or plain states of rest. Hayek had views similar to Mises on equilibrium, but he added in the concept of a personal state of rest to Austrian theory. Lachmann accepted the basic elements of the Mises-Hayek theory of shifting equilibrium.
Mises and Hayek’s approach of starting in equilibrium and then asking whether that equilibrium is unique and stable echoes the approach of neoclassical economics, which generally assumes equilibrium to begin with, then looks at whether the system has a tendency away from that equilibrium, towards others or to stay in the same place.
Blogger ‘Lord Keynes’ has also commented on the reliance of many Austrians on some form of equilibrium analysis, noting that Mises and Rothbard thought the economy had a long term tendency towards equilibrium, whilst Hayek used equilibrium as an epistemological starting point. LK appears to think that Lachmann did not fall into these traps, in opposition to the paper above, but I am not sufficiently well versed in Lachmann’s work to comment.
It’s reasonably uncontroversial to note that elements of the neoclassical and Austrian school have the same origins in Menger and Walras, and the Austrians originally split from the neoclassicals to pursue a different path. However, it seems they still took many of the important concepts with them when they left, and to me its clear that many of these remain today.
This post isn’t really intended as a comprehensive and rigorous critique of Austrian economics – I’ll leave that to others. Instead, it’s a brief summary of why I reject Austrianism (the brand most common on the internet, anyway*).
To start, I’ll take the liberty of quoting a commenter from Brad Delong’s blog, who summed up my overall impression of Rothbardians (and to a lesser extent, Miseans) pretty nicely:
The weird thing about Austrians, it seems to me, is that they don’t like empiricism, but they don’t seem to really like deriving any conclusions that they didn’t already know from their axioms either. The rejection of empiricism, along with claims like how empirical economists can’t explain people commuting on subways, are part of Mises’s though. Also, though, look at the case of Austrian rejection of modern microeconomics on the grounds that its use of utility functions and such is inconsistent with preference rank-based description of human choice-making. Basically, that’s a rejection of the Von Neumann-Morgenstern theorem as far as I can tell. (Even though Morgenstern may have been something of an Austrian himself.) I’ve never read an Austrian actually explicitly reject the theorem, or explain his view on it in any way, but the rejection seems to be implicit in their discussions of conventional, non-Austrian micro. Why reject Von Neumann-Morgenstern? As far as I can tell, because it doesn’t fit their conception of how economic analysis should be done.
So, if you don’t look at the world empirically, and you don’t want to extend your axioms to their logical implications to conclusions that you didn’t already know, what’s left? The axioms themselves, and some thoughts hanging around their immediate vicinity. Or, to put it another way, your initial prejudices. Your thought starts where it ends, exactly where you wanted it to.
That’s what I take from Austrian economics, at least.
Internet Austrians have declared capitalism to be infallible and as such are unable to blame anything on the private sector – their conclusion is always that it’s the state’s fault. I just can’t align myself with something that seems to come to the same policy conclusions, whatever the question, whatever the situation, whatever the starting point and methodology.
Another reason I find the Austrian school to be unsatisfactory is its failure to predict and explain the 2008 crisis.
As LK has documented, Austrian claims to ‘predict’ the crisis with anything like the accuracy of Michael Hudson or Steve Keen are spurious. At best, the Austrians spotted a housing bubble, no more. Furthermore, their theory doesn’t even appear to explain the crisis particularly well, for the following reasons:
Put simply, ABCT is based on a misallocation of investment in capital goods. The imbalances created by this result in a recession, which is necessary as the capital is liquidated and put to ‘proper’ usage elsewhere. But this isn’t what happened in the financial crisis; in the crisis people were simply buying and selling the same assets to each other – housing, mortgages and their derivatives – and most of the debt taken on went into consumption. Murray Rothbard himself said:
To the extent that the new money is loaned to consumers rather than businesses, the cycle effects discussed in this section do not occur.
Even if you accept that low interest rates caused the boom, the Austrian prescription of liquidation does not follow, as there was very little capital to ‘reallocate’. After all, derivatives are just contracts, an there is currently an undersupply of housing in many Western countries.
And, of course, sectors unrelated to the crisis have slumped at least as much as ones that were central:
On top of this, there is simply too much historical counter evidence against the idea that credit expansion/CBs cause business cycles. The Dutch Tulip Mania occurred under 100% reserve banking. The Melbourne Land Crisis occurred under a private gold standard system. The South Sea Bubble occurred without a Central Bank (The BoE did exist but was the same as the one we know and love only in name). Furthermore, the period of fewest crises was post-WW2, with universal Central Banking. This list is far, far from exhaustive.
Since this is a scattered post, I’ll also add that Austrians have completely failed to rebut Sraffa’s demolition job on Hayeks P&P (no, the response that there is schedule of interest rates does not qualify as it is simply restating the criticism), and also that their use of uncertainty appears not to recognise the term in the Knightian sense.
So, there you go. That’s why I’m not an Austrian.