Sunday, March 27, 2011

The Austrians on Equilibrium: Some Divergent Views

Pete Boettke has recently written an excellent blog post on the "epistemic turn" in Austrian economics. It was F. A. Hayek, according to Mr. Boettke, who introduced the idea of competitive entrepreneurial market discovery, and in so doing challenged standard economic theory's understanding of "knowledge." This is classic Boettke:

"The Austrian understanding of the market process explicitly rejects the mechanical interpretation of human behavior, and instead sees man as imperfect in perception, biased and often in error of judgment. Rather than a lightening calculator of pleasure and pain, man within the Austrian "model" is caught between alluring hopes and haunting fears. The importance of the "Epistemic Turn" is that it is precisely by taking this step that we switch the argumentative burden from behavioral assumptions to institutional coping devices for our ignorance."

Subsequent generations of Austrian scholars have followed this conception of knowledge, and have used it to great effect in developing a more refined model of competition and entrepreneurship. Market imperfection creates the possibility for entrepreneurial discovery, according to the Austrians. This is quite different from other theories of laissez-faire (Chicago/UCLA, for example) which argue that "whatever is is best" due to the existence of information and transaction costs. Austrians, on the other hand, emphasize sheer ignorance and market imperfection as a precondition for the emergence of market processes.

However, contra Mr. Boettke, I would instead interpret the "epistemic turn" as the moment when Austrian economics moved in two different directions. Mr. Boettke hints at this when he writes:

"The Behavioral critic would do well to read both Mises and Hayek on their rejection of "economic man". But they do retain a model of man as a purposeful being (admittedly Mises more so than Hayek, but I would argue both maintain a commitment to human action)."

In fact, the theory of Mises is quite different from that of Hayek. Mises spoke of human action, while Hayek spoke of market coordination. Now indeed these theories are complementary, and exhibit considerable overlap, but, in my opinion, the fundamental assumptions are profoundly different. Take equilibrium for example. According to Hayek, equilibrium can be understood only in connection to the mutual compatibility of individual plans (i.e. market coordination). For Mises, however, equilibrium signifies the destruction of the science of economics (i.e. human action). Conceiving of market activity as a competitive discovery procedure that gradually eliminates imperfection is tantamount to believing that the economy is perennially moving towards a system without institutions and purpose (see the paper by Boettke, Prychitko, and Horwitz 1986). For Hayek (and most other Austrians), the entrepreneur is responsible for correcting market imperfection. But for Mises, the entrepreneur, as understood by contemporary Austrians, is responsible for destroying human action. Economics must preserve purpose in human action. But equilibrium is the state without purposeful action. All men are vegetables in equilibrium. Therefore, economics, for Mises, is the science of non-equilibrium (and not the science of disequilibration or market equilibration).

Austrians have failed to identify this difference in outlook between the two leaders of the contemporary Austrian movement. Mises took economics down an entirely different path from the one created by Hayek. Austrians have continued to speak of market coordination as increasing plan coordination. But this is not Misesian economics. Austrians need to decide if they want to define Austrian economics as "Hayekian" or "Misesian."

Post-Austrian economics picks up and revives Mises' project, and conceives of economics as purposeful human action. Once this is understood, all references to equilibrium suddenly lose meaning. Equilibrium is the enemy of human action. Equilibrium should be used only to illustrate the importance of human action for economics. Arguing that competitive market proceeses are an imperfect representation of equilibrium destroys Mises' main project. Economics is the science of human action. This is what Post-Austrian economics is all about. Basically, the Hayekians (i.e. contemporary Austrians) are wrong.

So, to answer Mr. Boettke's question, viz.,:

"What do you think are the most effective ways we deal with the "constitutional limitations of man's knowledge and interests" and what are the best papers out there that attempt to address the limitations?"

I would say this is it. Mises was right on in his conception of economics as human action. Purposeful action is possible only in a world of uncertainty. With uncertainty removed, e.g., equilibrium, human action becomes impossible because choice is no longer necessary. This is how we should deal with the "constitutional limitations of man's knowledge and interests." And as for papers, I have one addressing this topic currently under review. Mr. Boettke has read it.

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