Sunday, March 27, 2011

MY OLD POST AUSTRIAN ECONOMICS BLOG

This is a collection of blog posts written by me in 2008, when I was twenty-one years old.  I had a strong interest in Austrian economics and political economy, and I endeavored, by means of a blog, to re-invigorate critical research and discussion into libertarian-oriented scholarship.

I decided to re-post these old entries to serve primarily as an introduction to students interested in this exciting literature.  Unfortunately, many of the links no longer work and the stimulating comments have been lost.

Please enjoy.

The Tyranny of Reason


I am reading an excellent book now: Max Horkheimer's Eclipse of Reason. After slugging through Dialectic of Enlightenment (which, admittedly, I did not fully understand), this book is really a joy to read. The author argues that our current conception of reason is dangerous and tyrannical.

He calls this subjective reason: "It attaches little importance to the question whether the purposes [ends] as such are reasonable. ... The idea that an aim can be reasonable for its own sake --- on teh basis of virtues that insight reveals it to have in itself --- without reference to some kind of subjective gain or advantage, is utterly alien to subjective reason. ... There is no reasonable aim as such, and to discuss the superiority of one aim over another in terms of reason becomes meaningless. From the subjective approach, such a discussion is possible only if both aims serve a third and higher one, that is, if they are means, no ends."

This is the Austrian (Misesian, really) conception of rationality. Ends must be taken as given, because there is no way we can arbitrate between them. We can only speak of the appropriateness (rationality) of the employment of means in relation to given ends. Here we can say, for example, that one set of means is more reasonable than an alternative one in fulfilling a given end. But ends must be taken as given.

Horkheimer thinks this sytem of rationality is tyrannical. Here he is:

"The formalization of reason has far-reaching theoretical and practical implications. If the subjectivist view holds true, thinking cannot be of any help in determining the desirability of any goal in itself. The acceptability of ideals, the criteria for our actions and beliefs, the leading principles of ethics and politics, all our ultimate decisions are made to depend upon factors other than reason. They are supposed to be matters of choice and predilection, and it has become meaningless to speak of truth in making practical, moral, or esthetic decisions."

Now Horkheimer believes in an objective reason. But I will come to this later. Let us first see just what is so tyrannical about subjective (Misesian) reason. Here are some examples:

1.) It puts ethics in a different category from science.

2.) It prohibits passing judgment on man's actions and thereby contributes to cultural relativism.

3.) It emasculates critical inquiry (see this example:)

"Today, when you are summoned into a traffic court, and the judge asks you whether your driving was reasonable, he means: Did you do everything in your power to protect your own and other people's lives and property, and to obey the law? He implicitly assumes that these values must be respected. What he questions is merely the adequacy of your behavior in terms of these generally recognized standards. In most cases, to be reasonable means not to be obstinate, which in turn points to conformity with reality as it is.

4.) It actually destroys rationalism (in the tradition of Spinoza et al.) and privileges empiricism, whereby "Reason has liquidated itself as an agency of ethical, moral, and religious merit."

5.) Similarly, it turns reason into a mere instrument: "Meaning is supplanted by function or effect in the world of things and events. ... Truth is no end in itself." Also:

"What are the consequences of the formalization of reason? Justice, equality, happiness, tolerance, all the concepts that, as mentioned, were in preceding centuries supposed to be inherent in or sanctioned by reason, have lost their intellectual roots. They are still aims and ends, but there is no rational agency authorized to appraise and link them to an objective realty. ... According to the philosophy of the average modern intellectual, there is only one authority, namely, science, conceived as the classification of facts adn the calculation or probabilities. The statement that justice and freedom are better in themselves than injustice and oppression is scientifically unverifiable and useless."

6.) It creates the possiblity (and increases the liklihood) of political tyrrany:

"Since ends are no longer determined in the light of reason, it is also impossible to say that one economic or political system, no matter how cruel and despotic, is less reasonable than another. According to formalized [subjective] reason, despotism, cruelty, oppression are not bad in themselves; no rational agency would endorse a verdict against dictatorship if its sponsors were likely to profit by it [because it is useful to them in a purely instrumental sense]."

I could go on, but I think you get the idea. Now against this model of reason is presented a different kind of reason, what the author calls "objective reason." He defines it in the following way:

"This view asserted the existence of reason as a force not only in the individual mind but also in the objective world. ... The emphasis was on ends rather than means. ... [For example,] freedom by nature is not identical with freedom in fact. His political doctrine is based on rational insight and deduction rather than on empirical research.."

And here:

"Less and less is anything done for its own sake. A hike that takes a man out of the city to the banks of a river or a mountain top would be irrational and idiotic, judged by utilitarian standards; he is devoting himself to a silly or destructive pastime. In the view of formalized reason, an activity is reasonable only if it serves another purpose, e.g. health or relaxation, which helps to replenish his working power. In other words, an activity is merely a tool, for it derives its meaning only through its connection with other ends."

I like this contrast, and think it has a lot to tell Austrians. Where does praxeology, natural rights, etc. fit into all this? One thing I cannot yet accept, however, is the claim that this system "calls for a specific mode of behavior in each specific case ... there are more comprehensive structures demanding other lines of action equally independent of personal wishes and interests. "

In this sense, objective reason prescribes ends, while presumably subjective reason creates scope for the arbitrary selection of them. For this reason I think that objective reason also facilitates "the emergence of barbarism" if misused. Also, if two sides are making philosophical statements of absolute truth founded on reason, how do we arbitrate between them? Cannot subjective reason help us here? It seems that it would have to because the discovery of universal truths still remains fundamentall a subjective experience, and is therefore subject to variations in its interpretation and material application.

Now Austrians may wish to stick to their subjectivism and criticize "objective reason" for its emphasis on an "objective reality," but I think that Horkheimer attacks instrumental (subjective) reason quite effectively in this little book. He criticizes positivism, empiricism, pragmatism, and many other schools founded on subjective reason. I am inclined to agree that it is very dangerous to transform reason into a mere tool in the service of useful activities. We first have to rationally deduce the appropriate ends. Subjective reason cannot help us here.

Stocks and Flows: In Response to Grant

In an earlier post Grant asks a question concerning Professor Maclachlan's treatment of savings and the interest rate:

"How could additional savings not affect rates of interest if they do affect bond prices? By definition, the price of a bond reflects its interest rate. Or was Maclachlan only referring to the safe rate of interest (T-bills), and if so, why is that rate necessarily more important in intertemporal coordination than the other rates of interest in bond markets?"

First, Maclachlan states what she means in the chapter entitled "Methodology and Definitions." She there writes that she is concerned with the rate on long-term bonds since "short-term rates can be seen as derivatives from long-term rates." She also argues that it is incorrect to conceive of the real (natural) interest rate apart from money and that it is useful to abstract from default risk, and brokerage (transaction) costs, in addition to the inflationary premium. Recognizing all the problems that follow these assumptions, Maclachlan concludes that "we seek to explain the nominal rate of interest that would exist if the inflationary premia were all zero." This enables Maclachlan to focus on "The theory of interest from an 'essentialist' perspective." Her work is theoretical.

As to the nexus between new savings and the interest rate, let me quote Maclachlan's best passage on this subject:

"On any given trading day, a certain number of bonds are sold to raise money to purchase investment goods and a certain number are bought to serve as a vehicle for new saving. But then there are trades that are unrelated to the current flows of investment and saving. Existing bonds are bought and sold by wealth-holders who are only rearranging their existing portfolios. It is customary to think of the latter type of trading as speculation. The primary motivation behind much of the trading is the expectation of securing a profit from future price changes. ... In an economy in where there are a large number of speculative trades between cash and bonds, there arises the possibility that, in any period, the non-speculative trades arising from saving and investment are overwhelmed to such an extent that they exert little effect. Such a situation could arise when speculators are highly responsive to small changes in the interest rate. Suppose, for instance, that there is a sharp increase in corporate investment causing an influx of new bonds into the loanable funds market. Traditional theory would predict a rise in the interest rate. But if speculators are active, they may see a small change in the interest rate arising from the new bond issues and immediately respond by selling or buying bonds: those who think that the small rise is an indication that bond prices have peaked will sell and those who think that it is an indication that they are on an upward trend will buy. No-one can say a priori whether the bulls or the bears will dominate but what one can say is that the resulting level of the interest rate will probably be different from what it would be if the speculators were not involved."


What a great passage, one of the best available. Maclachlan then spends the next few pages qualifying her statement by introducing several consideration involving elasticity, responsiveness the the state of financial markets. But the message is clear and direct: the loanable funds model is not as simple as it seems.

Other Post Keynesians have written on this subject, and let me quote a few passages:

Greg Hill:

"There is, however, another important dimension to the problem, for the market in which new bonds are issued is the same market in which existing bonds are traded. And the very same scheme of interest rates that must balance the supply and demand for new bonds must also balance the supply and demand for old bonds. What would happen, then, if there were a conflict between (1) the rate of interest that would balance the flows of new saving and investment and (2) the rate of interest that would balance the supply and demand for existing bonds? According to Keynes's account, the outcome will be determined by decisions concerning the existing stock of bonds because, at any given moment in time, the quantity of old bonds that can be released onto the market dwarfs the quantity of new bonds entering the market. ... Against the massive, preexisting stocks of old bonds and of money poised to enter the market in response to a change in the interest rate, the relatively small flows of new lending and borrowing can have little effect."

In another article (one in response to Professor Horwitz), Greg Hill writes:

"If a preponderance of those who hold these assets decide to sell bonds because they believe interest rates are going to rise and bond prices are going to fall, their fears will overwhelm any increase in the flow of saving. Horwitz does not come to grips with this problem (he does not even mention it), but as long as the interest rate remains tethered to the expectations of those who hold the pre-existing stock of financial assets, it cannot effectively carry out the task assigned to it by the neoclassical and Austrian schools." (my emphasis).

Another great economist, Victoria Chick, similarly writes:

"only sales of new issues represents borrowing and lending; the rest is transactions amongst current savers and existing security-holders. ... So long as there are existing as well as new assets, the direct link between saving and lending is broken. ... savings as money-flows were swamped in their effect on the rate of interest by transactions amongst existing wealth-holders."



Is anyone aware of how Austrians have responded to this challenge? I think it is a powerful argument. Greg Hill accuses Horwitz of not even mentioning it in their exchange.

The New Critics of F. A. Hayek


Any serious student of Austrian economics should be familiar with the arguments made by its critics. A sustained and honest attempt at intellectual engagement should be made in addressing their arguments, and efforts should be taken in effecting a possible synthesis between different views. As an example, I will use the work of three important critics of F. A. Hayek of late, and show that Austrian economics has failed to confront their criticisms directly.

1.) Ted Burczak. Ted Burczak has published in many areas related to Austrian economics (Keynes and uncertainty, Kirznerian entrepreneurship, and Hayekian subjectivism), but I think his most important contribution has been his critique of Hayek's incomplete subjectivism. Burczak describes Hayek as a postmodernist, but criticizes him for *failing* to extend his subjectivism to the area of law and jurisprudence. Burczak shows that Hayek's own subjectivism prevents him from defending the principle of the rule of law. Common law is, according to Burczak, non-neutral, and depends on subjective knowledge and interpretation of the facts. Moreover, rules are indeterminate and do not invariably follow the rule of precedent.

Austrians have not addressed this argument. And it is an important argument. It is true that the SDAE has recognized this book as important, but no serious discussion has taken place. Steven Horwitz wrote a review of the book for Reason, but the central themes are not addressed. Horwitz instead makes a libertarian defense of what he sees as the free society. Austrians need to decide whether Hayek's subjectivism is incomplete and flawed, or complete and immune from this criticism. As yet, no serious discussion has occurred.


2.) Fiona Maclachlan. Professor Maclachlan's book "Keynes' General Theory of Interest" is one of the best books on Austrian interest rate theory I have ever read. Maclachlan is the economist responsible for taking me into the fascinating field of Post Keynesian economics. She is a serious scholar, and is deeply knowledgeable about both Austrian and Post Keynesian economics. It is a shame she is not more widely recognized. Two basic points are made in her book: (1) the stock vs. flow debate is important to Austrian economics; and (2) Hayek's Ricardo Effect theory is seriously flawed. On the first point, Professor Maclachlan shows that the link between new savings (flows) and movements in the natural interest rate is impeded by the movement of existing bonds (stocks). Any new addition of savings will influence existing bonds in ways that overwhelm the effects new savings would have on the interest rate. This is an important criticism of Austrian economics. On the second point, Maclachlan shows that while increases in consumer demand lead typically to a fall in investment, decreases in consumer demand will not lead to an increase in investment.

I am not aware of any Austrian attempt to address these concerns.

3.) And finally I come to the economist who has done more than any other in attacking Austrian economics: Greg Hill. Greg Hill has published several important articles in Jeffrey Friedman's Critical Review. Students of Austrian economics must read his two articles "G. L. S. Shackle and the Economics of Ignorance" and "Keynes' Moral Critique of Capitalism" (these are not the exact titles), in addition to the two exchanges he had with Professor Horwitz. Greg Hill follows Shackle in showing that radical uncertainty prevents markets from achieving intertemporal coordination. Greg Hill has been influenced by Paul Davidson and Victoria Chick (and also, I would argue, Fiona Maclachlan), and has used this to great effect in challenging Austrian economics. The exchange he had with Steven Horwitz will show readers how far behind Austrians are in coming to grips with these important criticisms. For example, Professor Horwitz spends most of the space in his replies making the distinction between neo-classical economics and Austrian economics, while it is clear that Professor Hill already recognizes this distinction. He thus fails to address the more important criticisms of Professor Hill. Greg Hill attacks Austrian economics on the subject of capital and time, and also attacks both neo-classical and Austrian economics on the areas in which they are similar (loanable funds model and marginal productivity theory).

Three Austrian critics to read:

1.) Ted Burczak
2.) Fiona Maclachlan
3.) Greg Hill


Am I missing anyone?

An Interesting Article on Karl Popper


I am now making my way through several back issues of Critical Review, the journal edited by Jeffrey Friedman. I just finished reading a very good article on Karl Popper written by Fred Eidlin. I have never heard of him before, but it is clear that he understands Popper, although his interpretation of Popper's work differs from my own. I know that there are some readers on here who are similarly interested in Popper, so I thought I would discuss the areas in which I believe my views on Popper differ from those of Eidlin.

1.) Eidlin spends most of the early part of the essay talking about Popper's failure in effecting a paradigm shift within the sciences. He believes this is because Popper was misunderstood (more on this later). Here is Eidlin:

"Outside the advanced natural sciences, however, there is seldom anything analogous to a crucial experiment that would tip the scales in favor of a new paradigm. Hence, in the "softer" disciplines it is far more difficult to upset dominant approaches by means of evidence or rational argument. The emergence, survival, and death of traditions of inquiry in these fields have a great deal to do with such factors as reputation, personalities, and the politics of academic professions."

Eidlin concludes by arguing that Popper's "personality" is responsible for his failure in establishing a "Popperian" school. Now just some thoughts on the quoted passage. Is it true that it is more difficult to effect a paradigm shift in the social sciences than in the natural sciences? One would have to argue, inter alia, that (1) the natural sciences operate by means of "crucial experiments"; (2) the natural sciences are not subject to "academic politics"; and (3) paradigm shifts do not occur in the social sciences (e.g. postmodern literary criticism in English departments?).

2.) Now the author connects this discussion to his conclusion, which is quite controversial. Eidlin argues basically that Popper has been misunderstood chiefly because his key followers have failed to consistently follow Popper's own philosophy. He writes:

"Popperians, no less than their adversaries, can be (and have been) dogmatic, insensible to falsification, and prone to identify themselves personally with their theories. This suggests that there may be a utopian aspect to Popperian norms. ... If we reflect on Popperian norms, it becomes clear how difficult they are to practice."

Now it may be true that falsificationism is difficult to practice, but have his key followers also failed to practice them consistently? Do Popperians avoid criticism and the discovery of mistakes in the explication of their own philosophy?

3.) I really enjoyed Eidlin's discussion of Popper's political philosophy. The author agrees with Bryan Magee (who wrote an excellent book on Popper) that Popper's political philosophy is a theory of "democratic socialism." He does this by arguing that in criticizing Marx and Plato, Popper was actually trying to improve their work, rather than "undermining" it. Now this was not my reading of The Open Society and its Enemies. It was quite clear to me that Popper selected Plato and Marx for criticism because he rejected their theories, not because he wanted to improve them. In fact, in the preface to the first volume, Popper writes that he has chosen to focus on Plato because of his positive reputation. Why "improve" a theory that is already revered? Popper, I believe, was trying instead to "raze it to the ground."

But Eidlin is not concerned with this. He takes it for granted that Popper was trying to improve the theories of Plato and Marx, and then uses this interpretation to attack conservatives who sympathize with Popper's work. Eidlin argues that Popper followed Marx in viewing economic freedom as unjust and inhumane. Eidlin writes:

"It is also a philosophy requiring that we do something to bring about a better society, and that we not rely upon something outside ourselves (whether the 'invisible hand' of the market or the 'inexorable laws of history') to do it for us. ... Even violent means may be permissible in the pursuit of just ends provided that sufficient consideration has been given to such questions as the liklihood that these means will actually lead to the expected ends."

I would have never thought that such an interpretation of Popper's political work would be possible. It has been some time since I read his Open Society, but I remember it as being the most sophisticated defense of a free and "open" society available.

It seems to come down to the interpretation of "piecemeal engineering." Now Eidlin wants to use this theory to positively implement "democratically socialist" policies. The problem I have with this argument is that it smacks too much of "utopian engineering." For Popper, the point never was to "make society better," but to "remove evils." This is more consistent with his falsificationist approach. A writer (I can't remember who) once used the example of public schooling: Our goal should not be to build the best school we can, but rather to improve the schools that are currently worst off. That is what "piecemeal engineering" is all about as I see it.



Anyway, this was an excellent paper. I would encourage anyone else interested in Popper to read it.

Source:

Fred Eidlin "Karl Popper, 1902-1994: Radical Fallibilism, Political Theory, and Democracy, Critical Review 10, no. 1 (winter 1996): 135-153.

Cowen and Fink on the ERE

I finally got around to reading Cowen and Fink's great article on the "Inconsistent Equilibrium Construct" of Mises and Rothbard's Evenly Rotating Economy (ERE). This short piece is really great, and, in my view, strikes a death blow to the Austrian model of equilibrium.

Cowen and Fink describe the model accurately: (1) it is used to predict the direction of change; (2) it freezes all the data so that it can be used as a first step toward an analysis of complex change; and (3) it is used as a foil.

The paper makes three important criticisms of this model. First, Cowen and Fink claim that there is no tendency for a market to move toward equilibrium because "sequential transactions are not consistent with the notion of an intertemporal general equilibrium." In other words, for a tendency toward equilibrium to prevail, the equilibrium system must already be pre-ordained.

Second, and perhaps most important, is the idea that there can be no prices in equilibrium because "prices are institutions that have evolved over time in order to help coordinate the plans of market participants. [Therefore,] in a world in which all plans are already coordinated, and actors possess all relevant information, prices would not serve any function." This is an excellent point, and illustrates the absurdity of the Austrian ERE model. Technical general equilibrium theorists (for example, Frank Hahn) have recognized that money cannot exist in equilibrium, and have rightly excluded it from their analyses of equilibria.

And third, the ERE cannot be used as a foil because in equilibrium there is no human action. "If, as Mises claims, the ERE has no human action, then we cannot claim there is a tendency towards equilibrium, since this would imply the nonsensical conclusion that there is a tendency for human action (and human institutions) to disappear."


I thought this short article was really great. For anyone familiar with this literature, has there been any Austrian responses to this piece? Have Austrians accepted these criticisms, or simply ignored them? My impression is that Austrians have still retained the ERE as a model for analyzing change, although they are quick to admit its real world inapplicability. I would be very interested in reading any Austrian responses to this article.


Reference: Tyler Cowen and Richard Fink "Inconsistent Equilibrium Constructs: The Evenly Rotating Economy of Mises and Rothbard" The American Economic Review, vol. 75, no. 4 (September 1985), pp. 866-869.

Tyler Cowen on Keynes' General Theory: Chapter Four


I have been following Professor Cowen's discussion of Keynes' General Theory with some interest, and found his post on chapter 4 particularly provocative. Cowen claims that this chapter attempts to address the problems raised by Hayek concerning capital theory. A few thoughts:

(1) I am not sure how this chapter destroys Austrian capital theory; Keynes' more immediate concerns appear to me to be quite different.

(2) Keynes is concerned in this chapter rather with the volume of current output, and not its money value. This is important because in chapter 6 (Income, Saving, Investment) Keynes shows that value is not difficult to measure; only volume is. (Thus the equation A + G - A1. G measures the value of equipment.)

(3) With volume thus occupying a predominant position, Keynes next concerns himself with the question of net output (viz. physical additions to the capital stock). This of course is difficult to calculate because capital is heterogeneous. Thus Keynes proposes that we deal with this "as for example when all the items of one output are included in the same proportions in another output."

(4) The measures proposed by Keynes concerning the problem of net output are "quantities of money-value" and "quantities of employment." For Keynes, money-value is "strictly homogeneous," and labor "can be made so."

(5) Now in trying to understand how Keynes attempts to make labor homogeneous, it is important to refer back to his chapter 2 (postulates of classical economics). It will be recalled that Keynes abandoned only one of the postulates, namely, "the utility of the wage when a given volume of labour is employed is equal to the marginal disutility of that amount of employment." Keynes shows this to be false. However, Keynes retained the presumed validity of the first postulate, namely, "the wage is equal to the marginal product of labour." We can see now why he chose to do this. Keynes' unwillingness to abandon postulate 1 in the classical theory can be traced to his need to measure changes in output, and he could do this only by assuming that labor is homogeneous. In support of this view, please consider this passage:

"This assumption of homogeneity in the supply of labour is not upset by the obvious fact of great differences in teh specialised skill of individual workers and in their suitability for different occupations. For, if the remuneration of the workers is proportional to their efficiency, the differences are dealt with by our having regarded individuals as contributing to the supply of labour in proportion to their remuneration. ... We subsume, so to speak, the non-homogeneity of equally remunerated labour units in the equipment, which we regard as less and less adapted to employ the available labour units as output increases, instead of regarding the available labour units as less and less adapted to use a homogeneous capital equipment" (pages 41-42, emphasis mine).

However, I follow Shackle in his abandonment of both of the postulates of classical economics, and I think Keynes was wrong in retaining the first postulate. But we can see why Keynes chose to do so; it was essential for chapter 4.

I think Tyler Cowen missed the whole point of this chapter. But this is just my reading. I would urge Professor Cowen to try to tie in the various arguments from different chapters into the one he is currently considering; you cannot read chapter 4 in isolation. It is very important to know how it relates to chapters 2 and 6, and possibly many others.

Entrepreneurs vs. Regulators and the "Alchian Thesis"


An interesting discussion has started in the comments section to a post I wrote in response to Paul Davidson. Jeffrey Friedman is again seen leading the charge, and this time the problem concerns the relative superiority of entrepreneurs vis-a-vis regulators. This passage by Mr. Friedman is central to the discussion:

"With epistemic uncertainty, *if* there's an empirical, credible argument for market participants doing better, overall, than regulators, then generally libertarian conclusions do follow ... when coupled with a view of entrepreneurs and investors that sees them as not wise, relative to regulators, because of the profit motive; but as being weeded out by losing money if they are relatively unwise, compared to other entrepreneurs and investors."

The point here is that entrepreneurs are not performing optimally relatively to regulators, but only that comparatively they are more efficient. Now TGGP was correct in noting that this discussion is similar to Armen Alchian's 1950 paper and the now famous "Alchian Thesis." However, there is a difference here between Alchian's 1950 paper and the "Alchian Thesis" --- the latter being put forward by Milton Friedman in his 1953 essay. The Alchian Thesis does hold that, as TGGP says, "Armen Alchian relied on the elimination of inefficient firms to explain why businesses will tend to maximize profits." But in fact this is not what Alchian argued. Alchian said that firms realizing any "positive" profits will succeed, and those who fail to make positive profits will disappear. This is true, Alchian believed, because in an uncertain world there is no way to know what conditions are required for maximizing profits. I also think this is what Jeffrey Friedman was getting at. Markets are not more efficient than regulation because they maximize profits, but only that they are more successful at realizing positive profits.

Next we come to Professor Steve Miller's interesting comment. My argument here is that Professor Miller is mistaken in believing that knowledge and incentives are responsible for the market's success relatively to that of government regulation. Even if everyone was ignorant of the relevant knowledge and completely lacking in incentives, there would still be competition in the realization of positive profits. As Alchian said "Even in a world of stupid men there would still be profits." He also argued that the greater the uncertainty, the more likely it is that the "lucky" ones will be those that succeed, and not the logical and prudent ones. Also his comment here:

"Only with experience do entrepreneurs develop heuristics that give them a fighting chance over the long term. Does Warren Buffet really know nothing? He may have biases, but the most dangerous of those biases have been shed... or at least diminished, no?"

indicates that through trial and error one can learn from his mistakes and survive "over the long term." Again, the conscious elimination of bias is immaterial. Intentions do not matter in competition; only those who behave in accordance with the requisite conditions for success will succeed --- not because they "wanted to," but because their behavior was favorable to survival. Also, trial and error procedures do not work because, as Alchian noted, it is (1) difficult to specify a success and a failure; and (2) trial and error does not work in a changing environment.

Alchian's 1950 paper is very important because, in my reading, it takes "knowledge" and "incentives" off the table. One can "try" to succeed all one wants, in the same way that plants can "try" to grow. But if they are not positioned in such a way as to receive the necessary sunlight, then they simply will not survive, no matter how much they "try" to. Could a defense of libertarianism and free markets be made from this analysis? Why or why not?

In Response to Paul Davidson

Paul Davidson makes a most welcome appearance on this blog by commenting on an old post here. He summarizes his position by writing:

"But recent history shows that leaving it to the unfettered market almost always ends in a collapse of the system -- not necessarily immediate but potentially some time in the future."

I agree with this. In fact, Professor Davidson's work is directly responsbile for my belief in this statement. Markets are inherently unstable for the reason that "In order for a market to be efficient it must be possible to reliably predict the future (at least in a statistcally reliable sense)". This is true not because of the complexity of the relevant data, but of the ontologically uncertain environment in which entrepreneurs have to calculate prospective returns. I am on board here, and I think Mr. Davidson makes a mistake in writing of me that:

"I am afraid tht you neither understand my argument or the importance of the difference between ontological uncertainty and eistomological uncertainty, where complexity wopuld be an example of the latter."

My point was that I think Mr. Davidson makes a mistake in believing that government institutions can control and reduce uncertainty. There is no reason to believe that they can. Here is Mr. Davidson again:

"If the future is nonergodic and not reliably predictable without government institutions that constrain possible future outcomes, then market economies are inhenerently volatile, if market outcomes are not regulated or are under regulated. Government has a role in stablizing potentially unstable markets and therefore providing some market benefits to all the population."

Now markets are unstable. This is a fact we must learn to live with. But it does not follow that governments have a role in taming them through appropriate regulation. The first question that comes to mind would be: How would they go about doing this?

If the source of market instability comes from ontological uncertainty (and not complexity), then we should expect government to be helpless in this matter. And this is precisely what Professor Davidson's analysis implies, his theory of uncertainty being in this order: (1) ontological uncertainty; (2) a non-ergodic (i.e., unpredictable) choice environment; and (3) a transmutable reality. The inapplicability of "probabilities calculated from historical data" also supports my argument the economy is not sufficiently stable to provide scope for positive regulation.

For example, if aggregate demand falls on account of an increase in saving, Mr. Davidson believes that government should act to increase its expenditure on goods and services produced by the private sector in order to "increase the sales of industries, thereby, encouraging entrepreneurs to increase employment especially in the industries from which the government directly purchases, e.g., military hardware." For this reason he dismisses the view that there exists an "automatic mechanism that ensures that private spending on consumption will be just sufficient to assure full employment." The stimulus to employment provided by government expenditure must wipe out, according to Mr. Davidson, any unfavorable positions in industry and promptly establish a new equilibrium at full employment. Mr. Davidson thus regards government fiscal policy as a "balancing wheel" that is responsible for keeping aggregate demand at its full-employment level, in spite of the argument he advances in favor of a "transmutable reality."

Mr. Davidson's explanation is that the aggregate demand function, which represents total spending on producibles at every level of employment, will not have "the same values as the value of aggregate supply function at each level of employment, i.e., the aggregate supply function and the aggregate demand function would not be identical for all possible levels of employment." From this, in his view, all the rest follows. But this not correct.

Now, in so far as the direct effect of government expenditure is concerned, its influence depends largely on the ability of policy makers to determine the areas that have been most affected by falling demand. The government can, of course, consult the "historical data" gathered by the Bureau of Labor Statistics. This option is useful however only in an ergodic world, e.g., if "the outcome at any future date is the statistical shadow of past and current market data." The existence of a non-ergodic world, which was used by Mr. Davidson to demonstrate that "unregulated financial markets" cannot optimally allocate resources at the full-employment level, transforms every act into a crucial decision, e.g., that decision which is made "changes forever the economic environment so that the identical decision conditions are never to be repeated."

This is why I believe Professor Davidson has failed to extend the implications of his theory to government regulation. Take, for example, this passage: "For Keynes and the Post Keynesians, long-run uncertainty is associated with a nonergodic and transmutable reality concept. A fundamental tenet of Keynes's Revolution ... is that probabilistic risks must be distinguished from uncertainty where, for the latter, probabilities calculated from historical data are not reliable guides to future performance." The consequence of this is that the optimal level of income and activity is ontologically indeterminate.

-----

Paul Davidson makes a powerful concession here: "Keynes did not think everything occuring in the economy was uncertain in the nonergodic sense. But he emphasize that decisions that will result in possible payoffs five years or ten years from now were an act of faith -- relying on animal spirits -- gambles that could result, in an unfettered market, in the possibility of huge mistakes."

I would like to know what things are not uncertain in a non-ergodic sense? What of Shackle's crucial decision theory, or the idea that all knowledge claims are mere conventions that are designed to mask the reality of uncertainty? What of the transmutable reality of which Mr. Davidson spoke earlier?

Mr. Davidson concludes his post by suggesting that I have failed to distinguish non-ergodic uncertainty from complexity. In fact, however, I believe myself to be completeing Professor Davidson's non-ergodic uncertainty paradigm.

----

With all that being said, let me conclude by saying that I really admire Professor Davidson's work. He has been one of the most influential people on my thinking. Shackle was great on uncertainty, but Professor Davidson actually put this to use in his analysis of financial markets and industry. Everyone should read his 1972 book "Money and the Real World" to get an idea of what Post Keynesian Economics is all about.

The Economics of Ludwig Lachmann


Ludwig Lachmann is probably most responsible for sustaining my interest in Austrian economics. His writings are powerful, and his thought is very unorthodox. He writes like a true gentleman. One can trace the development of his thinking from (1) trade cycle theory, (2) capital theory, (3) subjectivism and expectations, (4) the history of Austrian economics, and finally (5) the philosophy of hermeneutics.

Most contemporary Austrians study his work by using (3) to understand (5). Now I have to admit that I haven't been very interested in the hermeneutic aspect of Lachmann's work. What I have found most challenging and insightful in Lachmann's work is his discussion of capital theory (2). I think this is an underappreciated aspect of his work, although admittedly a few Austrians make frequent mention of it (for example, Peter Lewin and Steven Horwitz). Lachmann does a lot with capital theory, and I cannot discuss it all here. Some points that stand out:

1.) It is impossible to measure capital because relative prices are incorrect in situations outside equilibrium. From this it follows that it is also impossible to measure a country's GDP or the history of its productivity.

2.) The law of diminishing marginal utility is false for the reason that capital is always being re-shuffled in new complementary ways. BTW, this is probably one of the most powerful criticisms of Keynes' theory of investment in relation to the marginal efficiency of capital (and the assumption of a falling rate of profit in conditions of capital accumulation).

3.) Since capital cannot be measured, then neither can investment. This is a point that is generally overlooked by Austrians, and Lachmann said as much in an article entitled "Reflections on Hayekian Capital Theory." In support of this view, Lachmann quotes Hayek saying:

"if we cannot determine the size of either saving or investment by any reference to changes in the quantity of capital, then with the abandonment of this basis for the distinction there must go the economists' habitual practice of separating out the part of general investment activity which happens to leave the capital stock in some sense constant, as something different from activities which add to that stock."

But if investment cannot be measured, can malinvestment be? And if not, what then becomes of the Austrian theory of the business cycle? The many critical remarks by Professor Lachmann of this theory boils down essentially to this point. Capital heterogeneity precludes talk of capital measurement in terms of either investment or malinvestment.

What have others made of Lachmann's work on capital theory?

Also, to Rober Vienneau: Does Lachmann's theory have anything to say of the Cambridge (UK) theory of capital? Lachmann mentions this literature several times in his work, but only briefly and in passing. Here is an example:

"Everybody seems to agree today that the stock of capital cannot be measured outside equilibrium, viz. outside entirely artificial conditions. But there are two reasons for it of which we may call one the 'Ricardian' or 'objectivist', the other the 'Austrian' or 'subjectivist' reason. We may also say that the one is backward looking, the other forward looking. The former rests on the fact that any change in the mode of income distribution, in rate of profit or wage rate, will affect relative prices and thus deprive us of any solid yardstick. It is particularly germane to any view of capital which links the present value of capital resources to their current cost of reproduction, a 'backward looking' view."

The Battle for George Shackle


I was emailed earlier today by a reader of this blog who alerted me to a comment made by Peter Boettke. Here is the passage:

"BTW, and this is directed at Matt Mueller, you made a claim earlier -- Shackle taught us that scarcity doesn't apply in the 1930s because of expectations, I wrote back and gave you a citation from 1959 in which Shackle fully embraces not only scarcity, but the importance of relative price movements (Economics for Pleasure [Cambridge University Press]) and you remained silent --- why? The Shackle you present us with, is not the G. L. S. Shackle who actually made contributions to ECONOMICS. Why should we value your Shackle over the real Shackle? I also might recommend to you Shackle's Expectation, Enterprise and Profit ... I don't agree with all the economics in this book, but it is Economics and that means that there are preferences and constraints, prices and profits, and systemic forces and equilibrating tendencies. Words such as uncertainty and process, cannot substitute for economic analysis, they have to instead be part of the analysis."

Economics for Pleasure is a book that was directed at a popular audience, and the book on the firm to which Mr. Boettke refers is a contribution of Shackle's that never really received much attention save for a few close British colleagues of his like Professors Ford and Earl (see in particular the interview of Shackle conducted by Peter Earl entitled "Coping with Uncertainty in Economics"). I cannot believe that Mr. Boettke is quite seriously of this opinion. It is like saying the real Mises is the one who wrote "Marxism Unmasked" and that the Mises of Human Action and The Ultimate Foundation of Economic Science is just a caricature. This is the position Mr. Boettke has taken in his assessment of Shackle's work. Shackle's most important and enduring works have been those that have expounded most clearly and cogently the imporance and necessity of uncertainty in economics. He used this insight to great effect in demonstrating the absurdity of rationality.

Pete Boettke is a strong defender of price theory, and I like that about him. I too enjoy reading about and learning price theory. Last summer I actually read through the textbooks written by Alchian & Allen, and Stigler. I also plan to read through Donald McCloskey's textbook on price theory this summer. But this sort of economics must not be accepted as the necessary and universal criterion by which all other insights and discoveries are judged. Economists set themselves too easy a task if they wish this to be their sole aim.

To give just one example. Shackle showed that uncertainty destroys the theory of marginal productivity, for if the value of a marginal unit can only be ascertained once the product sells for a price in the future, then how do we go about pricing that marginal unit today? Now Mr. Boettke is making the mistake in using standard price theory as the criterion in judging this contribution of Professor Shackle. He wishes to argue that "uncertainty ... cannot substitute for economic analysis." I am afraid that Mr. Boettke has shut himself off to possible new developments in theory with an attitude like this. The whole point to Shackle's 1967 book was to show that in the 1930's economic theory moved beyond the economics of scarcity and into the realm of expectation. Does Mr. Boettke wish to suggest that one's understanding of price theory can stop at 1920?

Pete Boettke on the Legacy of Lord Keynes


Pete Boettke has recently written a post on the failed policies and intellectual legacy of Lord Keynes. I did not like it. The Austrians are probably the least charitable readers of "the economics of Lord Keynes" --- and this is different from "Keynesian economics." In fact, Austrians often fail to explictly note this difference!

What is so remarkable about Keynes is that he anticipated much of the criticism that has been directed at his "general" theory, and, in my opinion, that he was very effective at refuting much of the prevailing orthodoxy. To give one example, Mr. Boettke writes that: "But what of Knight's judgment that "what is new isn't true, and what is true isn't new?" --- In fact, in the preface to The General Theory, Keynes actually writes that many orthodox economists will say just that ---- "Those, who are strongly wedded to what I shall call 'the classical theory', will fluctuate, I expect, between a belief that I am quite wrong and a belief that I am saying nothing new." Lord Keynes took the words right out of Frank Knight's mouth!

Moreover, Mr. Boettke also makes a mistake by writing as though economic policy is the only "revolutionary" message in Keynes' General Theory. Those who have followed Keynes' work very closely are quick to point out that these policies are not even understood by Keynesians themselves because these economists have failed to grasp the true message of the General Theory: uncertainty, liquidity preference, and effective demand.

And the last thing young Austrians should do, if they really want to understand what Keynes said, is read Henry Hazlitt or Robert Higgs. There is much more to Keynes than what we today call public works and deficit spending. The good interpreters of Keynes's message have been: Paul Davidson (and nearly every Post Keynesian who has followed him), Hyman Minsky, Alan Meltzer, Victoria Chick, Greg Hill, Fiona Maclachlan, among others.

Before Austrians make any progress on this front, they first have to understand what the economics of Lord Keynes is all about. And they should know this by now. People like Steve Horwitz, Roger Koppl, William Butos, and David Prychitko have all debated with some of the best followers of Keynes, and yet they have failed to recognize the limitations Keynes' message imposes on the continued validity (and relevance!) of Austrian economics.

In fact, these same followers of Keynes have been equally critical of "Keynesian economics." Paul Davidson, for example, in commenting on the neoclassical Keynesian synthesis, wrote that this literature "robbed Keynes's message of its theoretical bite."

Mr. Boettke is writing here more as the libertarian and not the economist. Austrians have a great deal to learn from Keynes regarding pure economic theory. Chapters 13 and 14 of The General Theory present an accurate picture of the Austrian theory of the loanable funds model, followed by a devastating critique of its main assumptions. Chapters 12 and 17, moreover, are probably the two best chapters any young economist can read (supplemented, of course, by the writings and commentary of Paul Davidson and G. L. S. Shackle).

Jeffrey Friedman on Public Ignorance


Jeffrey Friedman has for some time now managed one of the most exciting journals I have come across: Critical Review. Austrian themes are developed, rational choice theory attacked, and, most importantly, the theory of public ignorance is discussed and analyzed. Jeffrey Friedman is the leader of this movement. The idea is that democracy is incoherent because the public are woefully ignorant of politics and government. Most decisions involving important political questions are made on account of "extremely ill-informed judgments about 'the nature of the times' (prosperity? peace?)" and so leaves democracy open to the "manipulation and manufacture" of public opinion by effective demagogues. For example, it has been shown that close to 90% of voters do not know which party currently controls Congress, or what issues are being discussed, and bills introduced, or the reasons various people have for supporting and/or rejecting them.

This theory is very important for at least two reasons. First of all, it challenges the idea of democratic sovereignty because such an idea "presupposes the existence of a public will." But without well-informed voters, there is no "will" to exercise. And secondly, democratic instrumentalism is also challenged because not only can the outcome no longer be considered good by virtue of its preservation of core democratic principles, but such an appeal to public opinion as a criteria of the public interest is inherently incoherent.

Jeffrey Friedman's arguments are always good, and very subtle. One can read Jeffrey Friedman's movement as a direct attack against democracy. I would like to focus on one issue, however, and that is the issue of the "ideology/public ignorance" continuum. Jeffrey Friedman argues that:

"the alternative to sheer ignorance is reliance on ideology ... to organize one's knowledge. The cognitive elite knows more about politics than the masses, but its superior knowledge is both enabled and "constrained" by the very belief systems, left and right, of which the masses are largely ignorant. ... Ideologies are, in fact, simply more sophisticated heuristics than the primitive judgments of the 'nature of the times' or 'group interests' that guide the mass public."

I think this argument is good. But it introduces a problem to the argument. Ideology cannot be considered knowledge as such. Rather, as Jeffrey Friedman notes, it is simply "a more sophisticated heuristic." This theory is therefore not just one of public ignorance, but instead one of genuine ignorance. The public is ignorant of politics; this much is true. But in our attempt to escape ignorance, and in our search for a means by which we can organize our knowledge, we necessarily become ideological. One is either ignorant or ideological in varying degrees. But one is never truly informed or in possession of knowledge.

I am not sure if Jeffrey Friedman would agree with this, but this is the point I always take away from his articles. Anyway, I attribute my political views to the theory of public ignorance developed by Mr. Friedman. His ideas are very important, and should be read by anyone with an interest in politics and ignorance.

The Economics of Joseph T. Salerno


I think Joseph Salerno is an important member of the contemporary Austrian movement. He is a serious historian of Austrian economics, and has contributed some excellent papers to the literature. Although I find his writing style somewhat difficult to engage and understand, he is clearly the most learned expositor of the Rothbardian economic tradition.

Israel Kirzner also considers Mr. Salerno an important member of Austrian economics. In defending his theory of entrepreneurship, Kirzner repeatedly makes mention of the criticisms of both Ludwig Lachmann and Joseph Salerno. When I first read this, I was shocked to see Kirzner compare the work of Lachmann with that of Mr. Salerno. I resolved immediately to read everything I could find by Professor Salerno. I found a lot of his work really good. I think Salerno is better when it comes to interpreting the historical development of Austrian economics. (His papers "The Place of Human Action in the Development of Modern Economic Thought" and "The Rebirth of Austrian Economics" are excellent.) However, I found his other important paper, "Mises and Hayek Dehomgenized" more difficult, partly because the exposition is executed poorly. But Kirzner has much respect for the ideas contained in this essay. Here is his assessment of Professor Salerno's work:

"Although their position is a relatively new one and has not yet generated sustained debate within the Austrian camp, it has already elicited a good deal of attention, and seems likely to stir up vigorous discussion in the immediate future. Rothbard and Salerno's understanding of the market process sees it not as a continual process of knowledge acquisition, but as a continual process of entrepreneurial decision making which, at each moment, encourages the most perceptive entrepreneurs to make their best judgments in a world of incessant change, through the use of monetary calculation of estimated profits and losses."

Kirzner then goes on to argue that Salerno's entrepreneur does not bring the market into coordination through the acquisiton of knowledge, but rather through his ability to consult market prices. Moreover, according to Mr. Salerno, there is no long run tendency toward equilibrium; "exogenous changes are continually frustrating any tendencies toward eventual equilibration."

A few thoughts. When Kirzner writes that this argument has "already elicited a good deal of attention," I take him to be referring to the debate over economic calculation between Leland Yeager on the one hand, and Hoppe/Herberner/Salerno on the other. Yeager's position is that there is no real substantial difference between Hayek and Mises on the possibility of economic calculation. Salerno et al want to argue that there is.

I have to admit that I have never really understood this argument. Does Salerno reject the idea of market equilibration? If so, then perhaps we should welcome him as a Post Austrian! But I am not so sure he does. It seems that he is simply substituting price calculation for knowledge acquisiton in his understanding of the market process, with the additional assumption of incessant change frustrating any systematic movements toward equilibrium. But how then are we to judge the efforts of the perceptive entrepreneur? What standard are we to use in measuring success against failure? The obvious answer would seem to be profits and losses. Does it not then follow that profits represent systematic market equilibration? If this is not the case, then why?

Any help in these matters would be greatly appreciated. I understand Lachmann's position very well. But I could use a little more help with Salerno's position.

G.L.S. Shackle and the Economics of Uncertainty


One of the most fascinating exchanges I have read has been that of G. L. S. Shackle and Alan Coddington. Shackle wrote a great big book, Epistemics and Economics, in 1972. This prompted a very thoughtful response by Mr. Coddington in 1975 in the form of a lenghty review essay. From these events there ensued a lively and insightful exchange between these two theorists that led to, among other things, the coining of the phrase "Chapter 12 Keynesian" and the distinction between the syntactic and the semantic aspects of formal economic theory.

Both authors thought very highly of one another. In a review article of Coddington's book Keynesian Economics, Shackle writes of Mr. Coddington in the following way:

"Coddington was sometimes present at the seminars of untrammelled thought organised by Professor Littlechild at Birmingham, where the ultimate questions could be broached and long thoughts entertained. Littlechild himself, Jack Wiseman, Brian Loasby, Israel Kirzner, Murray Rothbard, Terence Hutchison, Professor Mahoney and others set going a discussion oriented to subjectivism, and Coddington of course was fully in the swim of such high-powered explorations."

What a great discussion this must have been! However, Shackle continues on, "Yet in his book he has by implication somewhat reproved us." This is true, as any reader of Mr. Coddington's book well knows. Mr. Coddington took a very different attitude to Shackle and his idea of radical uncertainty in the 1983 book from that which he entertained in the 1975 article. Here is Coddington in his later book:

"Although I have come to take a far more critical attitude than was evident in this review article to Shackle's interpretation of Keynes's work, the experience of getting to grips with Shackle's ideas has nevertheless left its traces."

Indeed, later in the book he even refers to Shackle's work as "analytically nihilistic." But this is different from the view Coddington advanced in the 1975 review article. There Coddington understood and appreciated Shackle's work greatly. In summarizing Shackle's work, Mr. Coddington quotes him saying "the theoretician is confronted with a stark choice. He can reject rationality or time." Reason, in other words, is incapable of application due to the existence of time. This is because all conduct is concerned with future affairs, and these do not yet exist. Moreover, an understanding of these future state of affairs requires the knowledge of the actions that will be performed by others because the future is the product of the conduct of everyone's actions. Here is Mr. Coddington:

"To be 'fully informed' about the consequences of one's own decision, one would have to know what everyone else is deciding at the same time. ... There is thus a simultaneity problem."

This is Shackle for you, in all his glory. Reading Shackle is like reading no other economist; it is quite a ride. Shackle forever changed the way I approach economics. But how does one get around this? How can one still do "economics" after admitting the radical uncertainty of the future and the consequent impossibility of rational decision making? Well, the later Coddington (1983 book) would argue that this cannot be done. Coddington argues in his later book that once the Shacklean succeeds in convincing the rest of the profession as to the veracity of this claim, "there would be nothing left but for the whole profession to shut up shop." This is surprising, because the earlier Coddington (1975 review) had an answer to this: abandon formalization as an ideal. Here is Mr. Coddington in his earlier review article:

"carefully imprecise concepts [radical uncertainty] can give a more accurate expression of the economic world than precise ones. On these grounds, the kind of precision aimed at by the axiomatisers can be seen to be quite artificial in that to increase the precision of formalisms in no way contributes to a clarification of the mode of correspondence between the formalism adn the economic world it is supposed to represent."

This is an excellent defense of Shackle's economics. In fact, it is consistent with Aristotle's warning that "it is the mark of an educated man to look for precision in each class of things just so far as the nature of the subject admits." The existence of uncertainty does not permit the precise formalization of economic concepts, precisely because human conduct involves creativity and daring, not probable estimates of likely consequences.

Austrians interested in uncertainty should give this literature a careful and close reading. Here are the references:

1.) Alan Coddington "Creaking Semaphore and beyond: A Consideration of Shackle's 'Epistemics and Economics' " The British Journal of the Philosophy of Science, 26 (2), June 1975.

2.) G. L. S. Shackle "The Romantic Mountain and the Classic Lake: Alan Coddington's Keynesian Economics" reprinted in Shackle, Business, Time and Thought: Selected Papers of G. L. S. Shackle.

3.) G. L. S. Shackle "Sir John Hicks's 'IS-LM': an explanation'; a Comment" reprinted in Shackle, Business, Time and Thought.

4.) Alan Coddington Keynesian Economics: The Search for First Principles, George Allen & Unwin, 1983.

Paul Rosenstein-Rodan: An Appreciation


I have benefited greatly from the close reading of several of Mr. Rosenstein-Rodan's essays. The two essays of his that have been most infuential on my thinking are "The Coordination of the General Theories of Money and Price" and "The Role of Time in Economic Theory." The last essay in particular, published in 1934, has challenged me to think about time in new and challenging ways.

Rosenstein-Rodan discusses the concept of time from every angle, and leaves no area unexamined. He is also an excellent essayist. The three problems Mr. Rosenstein-Rodan identifies are (1) the economic period; (2) time as an economic good (the disposition of it); and (3) the actual process of change through time. While the last problem is the most interesting, I found the first one the most important.

For one thing, the equilibrium values of wants in relation to goods depend on the period of time under consideration. This subtle point is sometimes lost in the minds of professional economists. An optimal distribution of resources will obtain with every new change in the period of time for which one is economizing. This implies that there is no single equilibrium value in a market process involving time. This problem is heightened when imperfect foresight is introduced as an ancillary assumption to the main analysis. The presence of uncertainty makes the specific character of goods demanded in the future unknowable. Consequently, no exact planning as to the procurement of these goods can be made; people can only estimate these goods en bloc. It follows from this that the farther one looks into the future, the more uncertain the character of goods demanded becomes. As Rosenstein-Rodan puts it, "these wants cannot be foreseen concretely."

I found all this intensely interesting. I even have some notes in scholia. I will reproduce them for you to read. Comments are welcome:

"the role of time in the Austrian theory of production raises important problems concerning the relationship between productivity and human foresight. If, as a general rule, uncertainty increases as the "time element" expands outward, then, as a consequence, the nexus between productivity and capital intensity is destroyed. In other words, uncertainty and productivity via increasing stages of production cannot rise together because the proportion of wants affected are forced to move in two directions in response to the conflicting forces of production and ignorance. It is true that the Austrian production process has as its aim the satisfaction of future wants, but the "time element" introduces uncertainty into the model so that now no direct nexus can exist between capital productivity and time."

It is very rare for an article to cause me to write so much! Rosenstein-Rodan is a neglected Austrian. But his work is very important. Just look at what it has done to the Austrian theory of capital!

Economics and Theology


TGGP, a participant on this blog, has recently called my attention to the Austrian view of the relationship between economic theory and theology. See here and here. This was prompted by a comment I made on the Austrian economists blog concerning the importance of theology for the development and revision of economic theory. Austrians, however, wish to assert that economists have very little to learn from the theological literature.

I think there is some confusion here. Walter Block, for example, in his assessment of theology, relates economics to the concern of theologians with issues like "the just price" or "fairness." This is not what I meant. I am concerned rather with the philosophical implications of theology for the science of economics. It seems like Walter Block is simply picking up on Rothbard's discussion of the "just price" in his Power and Market, and wishes to argue that theologians do not understand economics.

But I think theology has a lot to teach us. I am by no means an expert on the subject, but I am currently reading the secondary literature on the philosophy of Baruch Spinoza with an eye to its relevance for economic theory. Spinoza is concerned primarily with the implications of God's omniscience. He argues that this fact reduces all phenomena --- mental and physical --- to God himself. Thus, omniscience guarantees the existence of only one entity, namely, God. To have perfect information of something is to have knowledge of that thing directly, rather than having knowledge of a representation of it. In other words, to have perfect knowledge of everything is the same thing as saying that everything is a part of me. There no longer is any distinction either in terms of temporality or space/extension. God is all and everything because he is omniscient.

This is all well and good you might say, but how does this relate to economics? Well, economists also use the concept of "perfect information" to justify the operation of a perfectly decentralized market economy. In fact, equilibrium in the economy requires the assumption of perfect knowledge. But for Spinoza, perfect knowledge would destroy the economy because it would preclude the existence of multiple individuals and exchange. Social cooperation and the division of labor are impossible under conditions of perfect knowledge. But for economic theory, perfect knowledge is required for social cooperation and the division of labor to operate optimally!

A lot follows from this if we accept Spinoza's logic (and what economist could deny it?). First of all, Hayek's notion of equilibrium as mutual plan coordination is incorrect because all plans are the product of a single agent in conditions of equilibrium. Also, one could also use this to attack Coase's theory of private property and externalities with zero transaction costs (perfectly available information).

I plan on spending the next semester (Spring 2009) reading up on Spinoza and the literature that surrounds his mature work to better understand this idea of omniscience. All the economist has to do is substitute the economy for God, and everything falls into place. Spinoza had a lot to say about knowledge and omniscience, and I think a lot of it is germane to the study and theory of economics.

This is what I meant when I said that economists should start reading the literature in theology. I also believe that John Duns Scotus had many important things to say on these matters. Someday I hope to write all this up in the form of a paper that will conclusively refute the entire corpus of economic theory (and the assumption of equilibrium as a prerequisite for economic optimality).

Some Notes on Popper and Mises


Karl Popper is the father of "falsificationism," the idea that a hypothesis must be falsifiable if it is to be scientific. Scientific theories are tentative and speculative "conjectures" that, through careful testing, are "refuted" as we systematically learn from our mistakes. Science progresses by trial and error. This process continues indefinitely. Therefore, no theory can ever really be "true;" it can only mean that a theory is currently superior to its predecessors in the sense that it can withstand the tests that "falisified" those predecessors.

That is Karl Popper's theory of falsificationism. How does this relate to Mises? I will show you. For Karl Popper, if a theory is to be scientific (and have informative content), it must be falfisifiable, ---i.e., it must be capable of refutation. Karl Popper gave several examples of theories that were posing as "scientific" ---- Marx's theory of history, Freudian psychanalysis, and Adlerian psychology. It is impossible to refute any of these theories. For example, a Marxist can open the newspaper and read everything as a confirmation of his theory of history.

In other words, in their concern to explain everything, the Marxists really explain nothing. A theory must be capable of refutation. Now to this list I would add the work of Mises. Mises started from the a priori (infallible) dictum of human action: "Human action is purposeful behavior." This for Mises was irrefutable. And from this it followed that the entire corpus of economic theory could be deduced. Very well; but how scientific is this theory? According to Popper, it is not scientific at all. It is a poser, like the theories of Marx and Freud. For a theory to be scientific, it must be falsifiable; but Mises' approach precludes even the consideration of this requirement. We do not have to find a flaw in the logic in order to challenge Mises' system of praxeology. We need only show that a theory that is not falsifiable is not scientific.

Is it possible to reformulate Mises' system of praxeology to make it consistent with Popper's concept of falsificationism, or is it rather Popper's theory that is incorrect? As it stands, I don't think Mises' system holds. How is it any different from Freudian psychology or Adlerian psychology?

Institutional Economics


My decision to attend UMKC for graduate school has brought with it a recent change in my research interests. I will always consider myself an Austrian economist, but mine will be a Post-Austrian economics. I am going to learn everything I can in the heterodox tradition and attempt, gradually, to synthesize this literature with my interpretation of Austrian economics. A big part of the program at UMKC is Institutional Economics, and I have been reading lately a lot of survey articles on the subject. In particular, I have been reading a lot of stuff written by Warren Samuels, Geoffrey Hodgson, William Dugger, and Marc Tool.

Institutional Economics is a very rich field of thought without much scope for concrete application (or so it seems at this stage of my reading). The basic idea is that economic structures (institutions) are fluid and evolutionary entities that mold and shape human behavior, and are themselves determined and influenced by the interactions of individual agents. Therefore, it is wrong to take the individual as given, rationally purusing certain aims, purposes, and ends.

Into this mix a lot is added. We have Veblen and his emphasis on the effects of pecuniary culture. A very powerful implication of his analysis is the denial of downward sloping demand curves (Take that Pete Boettke!). Basically, people attempt to outperform one another in the demonstration of wealth. I find this whole discussion remarkably accurate. Veblen was a serious social theorist, and his work should be re-visited by Austrian scholars.

Veblen also took pains to distance himself from both neoclassical economics and Marxism/German Historicism. Veblen represents everything that I would want to be as a scholar. He carefully and brilliantly attacks everything without endorsing anything!

Clarency Ayres is another interesting figure. I just finished reading a paper of his entitled "The Role of Technology in Economic Theory." Ayres attempts to explain human behavior --- and cultural evolution --- in terms of its "tools and gimmicks." This reminds me of Lachmann's work on capital theory. Consider this passage:

"All culture derives from past experience. But because technology is objectified in physical tools and apparatus, it is always capable of progressive development. Every tool contains ... the possibility of being applied in new situations to different materials and in different ways from its historic use. This process is the universal pattern of invention and discovery."

Recently, however, new institutional scholars (Tool, Dugger, Swaney, etc.) have abandoned Ayres' analysis and its emphasis on the progressive nature of technology by affirming the importance of resistance to technological development and the inherent power structure exercised through it. Dugger's work is really good on this.

The work of John Commons and Wesley Mitchell is also of tremendous importance in Institutional Economics.

Does anyone else have any experience with Institutional Economics? If so, how would you define/describe it, and who has most influenced you and why?

Let me paraphrase Keynes: "I am studying Institutional Economics with the belief that I am not wasting my time."

I sure hope I am not. Institutional Economics has a lot of interesting things to say, but it just doesn't have that special kind of rigor that is found in traditional economic theory. It ain't like reading Harold Demsetz! I feel like I am being shown the world when I read Institutionalist writers (especially the old ones). It is so rich and abundant with implications, yet it remains so ambiguous and vague.

I am sure my attitude will change in the coming months, and I look forward to re-reading this post at that time to see exactly in what way my attitude has changed. But for the meantime, I will be reading up on Institutional Economics. I want to enter UMKC as a scholar on Institutional Economics. (This is no easy task, considering the literature and subject matter.)

The Horwitz and Hill Debate: Or, Why the Austrians are Wrong about Financial Markets


Steve Horwitz, a contemporary Austrian economist, had an exchange with Greg Hill in the pages of Critical Review over the merits of the Post Keynesian challenge to the "self-correcting" properties of capitalism. Mr. Horwitz makes it quite clear that the loanable funds model guarantees that all savings will be invested save for that which is hoarded. Savings and investment are, of course, in this model coordinated through changes in the interest rate. This requires flexibility not only in interest rate changes, but also in prices and wages. But Keynes argued that an economy with perfect wage/price flexibility will still produce unemployment. And this is because there is no direct relationship between decisions to save and decisions to invest. Now Mr. Horwitz recognizes this point and seeks to refute it. Now, Post Keynesians do not mean by savings "hoarding under the mattress." Horwitz is mistaken when he attributes to Post Keynesians this view of savings. For Post Keynesians, the income earner has two decisions to make: (1) how much to consume; and (2) in what liquid forms to store that which is not consumed (i.e. saved). This saving can take a variety of forms: bank deposits, bonds, mutual funds, equities, etc. Horwitz summarizes his position by writing:

"The key to a more appreciative vision of the market's intertemporal coordination powers is recognizing that what is not "spent" does not disappear into oblivion but must be devoted to some other use; indeed, it is not spending but saving that drives economic growth."

Two things. First of all, Horwitz is accepting as true what he must first prove. That saving does generate investment and economic growth. This is not as easy as he makes it out to be. And secondly, and somewhat related, is the claim that what is not spent must, according to Post Keynesians, "disappear into oblivion." Post Keynesians have never argued this. What they say is that savings will never finds its way into the industrial sector because the industrial sector provides no liquidity, and this is what savers demand. Instead, savings find their way into the financial sector, because financial assets possess a great deal of liquidity. And depending on one's appetite for risk, one can attempt to sacrifice a little liquidity for the possibility of capital gains (speculation); but because most financial assets have orderly markets, it is relatively easy to sell these assets for money. Capital goods, however, are not easily resalable (liquid).

For Post Keynesians, the financial sector is very different from the industrial sector. The financial sector deals principally with liquidity, and aims to provide people with liquidity (savers). The industrial sector, on the other hand, deals with real tangible (not easily substitutable) capital goods. These goods do not provide liquidity, because they cannot easily be sold. People who deal with capital goods must therefore look to its prospective yield and not its liquidity properties. These people are generally capitalists, and not savers.

Next, Mr. Horwitz argues that interest rates coordinate savings and investment (loanable funds model).
He writes:

"The interest rates banks charge and pay serve as signals about the apparent willingness of savers to lend and borrowers to borrow. High interest rates suggest that savers are relatively reluctant to wait for the future ... and/or that borrowers are pushing relatively hard for funds. Low interest rates suggest that savers are comparatively patient ... and/or that borrowers are comparatively uninterested in investing in projects that will not produce output until the future."

Now what Mr. Horwitz is overlooking here is the importance of speculation in financial markets. Many people in the financial world deal in short-term speculation in the hopes of realizing capital gains. And they look to the interest rate in making their decisions. So, taking up from Mr. Horwitz's example, if savers are "comparatively patient" and interest rates are expected to fall, what is stopping bondholders, for example, from buying bonds now in order to realize capital gains when their price goes up? Nothing is stopping them, and this is what usually happens. But this interrupts the smooth picture Mr. Horwitz has presented us with. Any new savings will likely be swamped by changes in assets among existing wealth-holders.

Austrians have pushed this simplistic loanable funds model theory of financial markets for as long as I can remember. This has prevented them from "appreciating" (to use Mr. Horwitz's phrase) the complexities of the financial world. Speculation triumphs over "industry", and the financial sector is very different from the industrial sector.

Paul Davidson on John Maynard Keynes


Post Keynesian economics has an interesting history in the context of Keynesian economics more generally. For roughly the first 25 years after the publication of the General Theory, there was little controversy over how to interpret it. But, beginning in the 1960's, several different interpretations began to surface, and the battle over Keynesian economics was now underway. Two interpretations that eventually found their way into what would later become Post Keynesian economics were those of G. L. S. Shackle and Sidney Weintraub. Shackle, of course, emphasized the primacy of uncertainty in Keynes' message, while Weintraub attempted to elucidate the concept of the aggregate supply curve and its impact on wage-induced inflation. We can see both these influences in all of Paul Davidson's work. Paul Davidson talks about money and uncertainty in the same way as did Shackle, and he almost always includes a chapter on inflation and the Z-D model in all of his published books.

Paul Davidson's most recent book is entitled "John Maynard Keynes" and was published in 2007. Paul Davidson summarizes his life work on Keynes in this short book. The basic message is that, while Bastard Keynesian had economic policy right, they failed to understand the underlying theory behind it. Davidson then proceeds to explain what Keynes' new theory was all about. When it comes to economic policy, Post Keynesians are Keynesians; on matter of pure theory, however, they are radically different.

Thus Paul Davidson argues that government should occupy a central place in economic policy. Here are some quotes:

"the inability of the enrpreneurial system to provide full employment can be ameliorated by developing corrective fiscal policies and regulatory institutions for stabilizing financial markets."

"Keynes's rejection of the ergodic axiom meant that realistic theories cannot demonstrate that unregulated financial markets can optimally allocate investment funds into those projects that in the future will earn the greatest return."

Now, for Davidson, this is true because the world is non-ergodic (i.e. unpredictable). But Davidson's insistence on a "transmutable" reality seems to me to defeat and undermine any principled advocacy of government fiscal policy and regulation. Just because markets cannot cope with an uncertain future does not mean that governments can fare any better. Davidson spends several pages attacking (Austrians included) economic theories that rely on an immutable reality with epistemic ignorance. Davidson, however, believes, with Shackle, that the world is "ontologically uncertain," that it "remains to be written," and depends on the choices we make today.

Does it make sense to take this radical view of the world and then argue that governments should play a central role in increasing (stabilizing) effective demand? Shackle didn't think so. In his 1967 book, he argued quite forcefully that uncertainty "is beyond the reach of legislation."

Post Keynesians have the "theory" right; but their economic policies are all confused. Their own theory doesn't even permit them to defend "Keynesian policies." I get the impression when reading Davidson and others that Post Keynesians haven't yet fully traced out all the implications of "ontological uncertainty" and "transmutable reality." They are basically Keynesians who have enjoyed reading Shackle.

The Beauty of Heterodoxy: Frank H. Knight

When the history of economics in the mid- to late 20th century comes to be written, one of the more puzzling questions will be the intellectual legacy of Frank Knight. The Chicago school has claimed him as one of their own --- indeed, in most cases, as the progenitor of the Chicago tradition --- but his work has done more to question my faith in markets than any other economist I have read. Frank Knight is certainly like no other. He has one of those fantastic, inimitable wits like Thorstein Veblen and Voltaire.

In several of his essays ("Ethics and the Economic Interpretation," in particular), Knight attacks markets on account of their inability to satisfy consumer wants. Now this is an assumption that undergirds the entire laissez-faire philosophy -- competition (rivalrous or perfect) drives the market to respond efficiently to consumer demands. But Knight objects to this by arguing that ends (desires and wants) cannot be taken as given because they are not the ultimate source of action. Individuals do not actually try to satisfy given wants. They are concerned instead with the discovery and pursuit of higher, more enlightened wants. This is a remarkable insight. The market relies for its defense on the principle of efficiency in want satisfaction. And Knight does not question this. He goes much further and questions the very nature of the wants themselves, and arrives at the conclusion that an individualistic competitive market order creates wants that have as their aim emulation and rivarly rather than personal satisfaction and the promotion of happiness. This applies to production as well, with businessmen engaged in a "game" where the goal is to dominate your opponent much like you would in a game of chess.

Another important theme in this book concerns the ethical character of economics. Knight argues that economics is more than a branch of mechanics. And although ethical judgments can never claim to possess the status of objectivity, there is a very real sense in which the actions and motives to which they give rise are influenced by "social ideals." From here, Knight also argues that these social ideals can be used to criticize the outcomes generated by a laissez-faire economic arragement, even if all available alternative economic systems fare no better. Ethical judgment is never "a purely relative matter", but is instead concerned with the question of "ideals."

Now, traditional debates surrounding the virtues of competing economic systems have focused on the way in which resources are most efficiently allocated in direction of the satisfaction of wants. But Knight undermines this literature by observing that "wants" are never simply given; they are constantly changing and are inherently dynamic in character. Here is Knight:

" The individual who is acting deliberately is not merely and perhaps not mainly trying to satisfy given desires; there is always really present and operative, though in the background of consciousness, the idea of and desire for a new want to be striven for when the present objective is out of the way. ... [A]ll intelligently conscious activity is directed forward, onward, upward, indefinitely."

Knight also questions the traditional conception of "happiness." Consider this passage: "A man who has nothing to worry about immediately busies himself in creating something, gets into some absorbing game, falls in love, prepares to conquer some enemy, or hunt lions or the North Pole or what not."

This is all perfectly consistent with my (quite radical) interpretation of Mises and equilibrium (see earlier post "Austrians on Equilibrium"). Knight is saying everything that was already in my mind. I will end with one final quote by Knight: "It is a stock and conclusive objection to utopias that men simply will not live in a world where everything runs smoothly and life is free from care." This is exactly what Mises was getting at. Men who live vegetative existences are not really men; men are insatiable, erring, and explorative creatures. To put them in equilibrium is to deny them their humanity.

Frank Knight as a Post-Austrian!