I’ve long promised a post on Austrian economics. To organise my thoughts and minimise the risk of attacking a straw man, I’ve taken as my starting point this encylopedia article by Peter Boettke. Boettke sets out ten claims and derives some claimed conclusions. I’ve responded point by point, and then given my own summary.
As I’ve had trouble with various fringe adherents of Austrianism, I’m setting out some strict ground rules for discussion here. Comment should stick strictly to discussion of economics. Anyone making personal attacks of any kind will have their comments deleted and be barred from this thread. Avoid anything that might be seen as insulting other participants in the discussion
Boettke’s points follow, with my responses in itals
The Science of Economics
Proposition 1: Only individuals choose.
Man, with his purposes and plans, is the beginning of all economic analysis. Only individuals make choices; collective entities do not choose.
The primary task of economic analysis is to make economic phenomena intelligible by basing it on individual purposes and plans; the secondary task of economic analysis is to trace out the unintended consequences of individual choices.
So far so good. Methodological individualism seems like a good starting point. But it’s important to remember that individual choices are very much affected (sometimes, effectively determined) by the collective entities of which they are a part.
Proposition 2: The study of the market order is fundamentally about exchange behavior and the institutions within which exchanges take place.
The price system and the market economy are best understood as a “catallaxy,” and thus the science that studies the market order falls under the domain of “catallactics.” These terms derive from the original Greek meanings of the word “katallaxy”—exchange and bringing a stranger into friendship through exchange. Catallactics focuses analytical attention on the exchange relationships that emerge in the market, the bargaining that characterizes the exchange process, and the institutions within which exchange takes place.
Markets are places where exchange takes place, so this is more or less self-evident. But there is more to economics than markets. The extensive attention given to Robinson Crusoe in economic textbooks is evidence of this, as is the huge amount of activity that takes place within firms, households, governments and so on. The absence of any real theory of the firm, or of the household, is a major weakness of Austrian economics, partly reflecting the very limited work done in this framework in recent decades, a period which has seen huge developments in mainstream analysis of contracts, asymmetric information and so on
Proposition 3: The “facts” of the social sciences are what people believe and think.
Unlike the physical sciences, the human sciences begin with the purposes and plans of individuals. Where the purging of purposes and plans in the physical sciences led to advances by overcoming the problem of anthropomorphism, in the human sciences, the elimination of purposes and plans results in purging the science of human action of its subject matter. In the human sciences, the “facts” of the world are what the actors think and believe.
The meaning that individuals place on things, practices, places, and people determines how they will orient themselves in making decisions. The goal of the sciences of human action is intelligibility, not prediction. The human sciences can achieve this goal because we are what we study, or because we possess knowledge from within, whereas the natural sciences cannot pursue a goal of intelligibility because they rely on knowledge from without. We can understand purposes and plans of other human actors because we ourselves are human actors.
The classic thought experiment invoked to convey this essential difference between the sciences of human action and the physical sciences is a Martian observing the “data” at Grand Central Station in New York. Our Martian could observe that when the little hand on the clock points to eight, there is a bustle of movement as bodies leave these boxes, and that when the little hand hits five, there is a bustle of movement as bodies reenter the boxes and leave. The Martian may even develop a prediction about the little hand and the movement of bodies and boxes. But unless the Martian comes to understand the purposes and plans (the commuting to and from work), his “scientific” understanding of the data from Grand Central Station would be limited. The sciences of human action are different from the natural sciences, and we impoverish the human sciences when we try to force them into the philosophical/scientific mold of the natural sciences.
As an objection to naïve behaviorism this is fine. If you want to understand what people do, it’s important to understand what they think. But the facts economists try to explain are what people do.
Microeconomics
Proposition 4: Utility and costs are subjective.
All economic phenomena are filtered through the human mind. Since the 1870s, economists have agreed that value is subjective, but, following alfred marshall, many argued that the cost side of the equation is determined by objective conditions. Marshall insisted that just as both blades of a scissors cut a piece of paper, so subjective value and objective costs determine price (see microeconomics). But Marshall failed to appreciate that costs are also subjective because they are themselves determined by the value of alternative uses of scarce resources. Both blades of the scissors do indeed cut the paper, but the blade of supply is determined by individuals’ subjective valuations.
In deciding courses of action, one must choose; that is, one must pursue one path and not others. The focus on alternatives in choices leads to one of the defining concepts of the economic way of thinking: opportunity costs. The cost of any action is the value of the highest-valued alternative forgone in taking that action. Since the forgone action is, by definition, never taken, when one decides, one weighs the expected benefits of an activity against the expected benefits of alternative activities.
This can be read in two forms. The weak form, which Peter Boettke adopts in comments relies on the opening claim that “all economic phenomena are filtered through the human mind” and are in that sense subjective. This is true of the standard neoclassical theory as presented by Marshall, and it was equally true of the older labor theory of value. The strong form is the implication that a theory of value (different in some substantive sense from the Marshallian) can be developed without reference to objective conditions of production. The strong form is important, but wrong. The weak form consists of claims that are true, as Boettke says, “by definition”, and are therefore tautological. The problem I have with this kind of thing is twofold. First, you commonly get a rhetorical two-step where the strong form of the claim is put forward, then replaced by the weak form when it is challenged. Second, it seems to be supposed that purely tautological claims of this kind justify the kind of a priorist metholodogy favored by Mises and some (but not all) other Austrians, in which economics is supposed to consist of logically self-evident truths.
Proposition 5: The price system economizes on the information that people need to process in making their decisions.
Prices summarize the terms of exchange on the market. The price system signals to market participants the relevant information, helping them realize mutual gains from exchange. In Hayek’s famous example, when people notice that the price of tin has risen, they do not need to know whether the cause was an increase in demand for tin or a decrease in supply. Either way, the increase in the price of tin leads them to economize on its use. Market prices change quickly when underlying conditions change, which leads people to adjust quickly.
True and important, but not the whole truth, as witness the fact that people (including the managers of enterprises) so frequently choose to dispense with prices and rely on direct control to get things done.
Proposition 6: Private property in the means of production is a necessary condition for rational economic calculation.
Economists and social thinkers had long recognized that private ownership provides powerful incentives for the efficient allocation of scarce resources. But those sympathetic to socialism believed that socialism could transcend these incentive problems by changing human nature. Ludwig von Mises demonstrated that even if the assumed change in human nature took place, socialism would fail because of economic planners’ inability to rationally calculate the alternative use of resources. Without private ownership in the means of production, Mises reasoned, there would be no market for the means of production, and therefore no money prices for the means of production. And without money prices reflecting the relative scarcities of the means of production, economic planners would be unable to rationally calculate the alternative use of the means of production.
As with P4, this has a strong and a weak form. The strong form suggests that rational economic calculation is impossible in enterprises where the means of production are publicly owned. This is false, unless the term ‘rational’ is stretched so as to make the claim meaningless. Publicly owned enterprises have operated successfully for decades, sometimes in competition with private firms and sometimes as monopoly providers. There’s a case to be made that, on balance, private ownership yields better performance, but even if you accept this case, this does not sustain the claim above. The weaker view, defended by Boettke in comments, is that an economy needs at least some private ownership to produce informative money prices. This obviously leaves open the question of how large the publicly-owned sector can be without inducing economic collapse. Experience here and elsewhere suggests that substantial public ownership is compatible with continued economic growth. Determining the optimal balance is a matter of empirical assessment not abstract arguments of the kind put forward by Mises.
Proposition 7: The competitive market is a process of entrepreneurial discovery.
Many economists see competition as a state of affairs. But the term “competition” invokes an activity. If competition were a state of affairs, the entrepreneur would have no role. But because competition is an activity, the entrepreneur has a huge role as the agent of change who prods and pulls markets in new directions.
The entrepreneur is alert to unrecognized opportunities for mutual gain. By recognizing opportunities, the entrepreneur earns a profit. The mutual learning from the discovery of gains from exchange moves the market system to a more efficient allocation of resources. Entrepreneurial discovery ensures that a free market moves toward the most efficient use of resources. In addition, the lure of profit continually prods entrepreneurs to seek innovations that increase productive capacity. For the entrepreneur who recognizes the opportunity, today’s imperfections represent tomorrow’s profit.1 The price system and the market economy are learning devices that guide individuals to discover mutual gains and use scarce resources efficiently.
This is probably the most distinctive and valuable point of the Austrian school. But it’s important to remember that discovery is ultimately a public good, and that markets only reward some kinds of discovery
Macroeconomics
Proposition 8: Money is nonneutral.
Money is defined as the commonly accepted medium of exchange. If government policy distorts the monetary unit, exchange is distorted as well. The goal of monetary policy should be to minimize these distortions. Any increase in the money supply not offset by an increase in money demand will lead to an increase in prices. But prices do not adjust instantaneously throughout the economy. Some price adjustments occur faster than others, which means that relative prices change. Each of these changes exerts its influence on the pattern of exchange and production. Money, by its nature, thus cannot be neutral.
This proposition’s importance becomes evident in discussing the costs of inflation. The quantity theory of money stated, correctly, that printing money does not increase wealth. Thus, if the government doubles the money supply, money holders’ apparent gain in ability to buy goods is prevented by the doubling of prices. But while the quantity theory of money represented an important advance in economic thinking, a mechanical interpretation of the quantity theory underestimated the costs of inflationary policy. If prices simply doubled when the government doubled the money supply, then economic actors would anticipate this price adjustment by closely following money supply figures and would adjust their behavior accordingly. The cost of inflation would thus be minimal.
But inflation is socially destructive on several levels. First, even anticipated inflation breaches a basic trust between the government and its citizens because government is using inflation to confiscate people’s wealth. Second, unanticipated inflation is redistributive as debtors gain at the expense of creditors. Third, because people cannot perfectly anticipate inflation and because the money is added somewhere in the system—say, through government purchase of bonds—some prices (the price of bonds, for example) adjust before other prices, which means that inflation distorts the pattern of exchange and production.
Since money is the link for almost all transactions in a modern economy, monetary distortions affect those transactions. The goal of monetary policy, therefore, should be to minimize these monetary distortions, precisely because money is nonneutral.
With a handful of dogmatic new classicals, all economists agree that money is non-neutral. And with a similar handful of exceptions, all economists agree that inflation is undesirable (if sometimes unavoidable)
Proposition 9: The capital structure consists of heterogeneous goods that have multispecific uses that must be aligned.
Right now, people in Detroit, Stuttgart, and Tokyo City are designing cars that will not be purchased for a decade. How do they know how to allocate resources to meet that goal? Production is always for an uncertain future demand, and the production process requires different stages of investment ranging from the most remote (mining iron ore) to the most immediate (the car dealership). The values of all producer goods at every stage of production derive from the value consumers place on the product being produced. The production plan aligns various goods into a capital structure that produces the final goods in, ideally, the most efficient manner. If capital goods were homogeneous, they could be used in producing all the final products consumers desired. If mistakes were made, the resources would be reallocated quickly, and with minimal cost, toward producing the more desired final product. But capital goods are heterogeneous and multispecific; an auto plant can make cars, but not computer chips. The intricate alignment of capital to produce various consumer goods is governed by price signals and the careful economic calculations of investors. If the price system is distorted, investors will make mistakes in aligning their capital goods. Once the error is revealed, economic actors will reshuffle their investments, but in the meantime resources will be lost.3
Again, no one disagrees with this. I was waiting for a claim that capital markets always do a better job of allocating capital than any alternative, or that they would do better in the absence of government regulation, but it hasn’t been made, so I won’t impute it. I will note that the price system may be distorted by all sorts of factors, including systemic biases in capital markets. The dotcom bubble/bust is a prime example of capital market failure in the leadup to the GFC.
Proposition 10: Social institutions often are the result of human action, but not of human design.
Many of the most important institutions and practices are not the result of direct design but are the by-product of actions taken to achieve other goals. A student in the Midwest in January trying to get to class quickly while avoiding the cold may cut across the quad rather than walk the long way around. Cutting across the quad in the snow leaves footprints; as other students follow these, they make the path bigger. Although their goal is merely to get to class quickly and avoid the cold weather, in the process they create a path in the snow that actually helps students who come later to achieve this goal more easily. The “path in the snow” story is a simple example of a “product of human action, but not of human design” (Hayek 1948, p. 7).
The market economy and its price system are examples of a similar process. People do not intend to create the complex array of exchanges and price signals that constitute a market economy. Their intention is simply to improve their own lot in life, but their behavior results in the market system. Money, law, language, science, and so on are all social phenomena that can trace their origins not to human design, but rather to people striving to achieve their own betterment, and in the process producing an outcome that benefits the public.
This is true, but so is the converse: social institutions are often the result of human design.
The implications of these ten propositions are rather radical. If they hold true, economic theory would be grounded in verbal logic and empirical work focused on historical narratives.
This is a gigantic non-sequitur, which reflects the cultural predilections of the Austrian tribe. If anything, the outline above supports an axiomatic and mathematical approach of the type favored by the neoclassical school. Prices are numbers after all, and information is a mathematically precise concept. Why would you throw all that away and stick to verbal methods, except for lack of capacity to do it right? And the claimed focus on empirical work seems to be the exact opposite of the a priori methodology espoused by Mises and supported above.
With regard to public policy, severe doubt would be raised about the ability of government officials to intervene optimally within the economic system, let alone to rationally manage the economy.
Not many people these days would claim optimality for government intervention. But there’s nothing so far to show that government intervention can’t improve outcomes in the standard cases of microeconomic market failure and macroeconomic co-ordination failures.
Perhaps economists should adopt the doctors’ creed: “First do no harm.” The market economy develops out of people’s natural inclination to better their situation and, in so doing, to discover the mutually beneficial exchanges that will accomplish that goal. Adam Smith first systematized this message in The Wealth of Nations.
The first sentence seems entirely inconsistent with the general policy stance of the Austrian school, which involves a wide range of radical policy measures, based on untested hypotheses. “First do no harm” would suggest cautious incremental changes to the existing mixed economy. It’s true that markets develop out of natural inclinations to better our situation, but then so do governments.
In the twentieth century, economists of the Austrian school of economics were the most uncompromising proponents of this message, not because of a prior ideological commitment, but because of the logic of their arguments.
Sorry, but I can’t agree. Maybe this was true at the beginning of the 20th century, but in recent decades, the Austrian school of economics has been a dogmatic sect, characterised by extreme ideological views on all subjects. About the only thing I agree with in this point is that the Austrian message is based primarily on a priori logic and not on openness to empirical evidence.
Summary. The main thing I find useful in Austrian economics is captured by Proposition 7, which encapsulates the limitations of neoclassical general equilibrium theory, where all possible states of nature are assumed known, so that discovery is not really possible. Unfortunately, this is wrapped up with both some misconceived methodological views (for example, the commitment to verbal logic) and a set of ideological blinkers which guarantee in advance that the policy conclusions will be those of laissez-faire.
Final point. Boettke doesn’t talk explicitly about Austrian Business Cycle Theory, which is obviously of some interest. I’ll treat this topic in a later post.
Update I advertised this in comments over at the Austrian Economics Blog. I got a couple of comments from Greg Ransom (thanks!), but I was hoping for a bit more of a response from serious Austrian economists, while avoiding the lunatic fringe. Is there anywhere else I should be looking?
Further update I’ve edited this a bit in response to comments from Peter Boettke. In particular, I’ve changed my treatment of Props 4 and 6. As clarified Prop 4 doesn’t reveal any substantive difference between Austrian and mainstream economics, and Prop 6 is much weaker than it appears.
John Quiggin 
“Prices are numbers after all, and information is a mathematically precise concept. Why would you throw all that away and stick to verbal methods, except for lack of capacity to do it right?”
Markets only make sense as an allocation mechanism if we are substantially ignorant of preferences and costs, otherwise we could simply allocate everything centrally to maximise some measure of welfare. Most formal models assume that preferences and costs are known (at least to the modeller) and so embed the conclusion that welfare could be increased through a centralised allocation. That’s why Austrians don’t like formal models. I guess that’s also why so many excellent mathematical microeconomists are raging socialists 😉
John – I don’t understand why you say that proposition 4 is “clearly wrong.”
As I understand it, Boettke is arguing against the claim that costs are determined purely by objective conditions.
Marshall framed the argument by denying that “the value of a thing tends in the long run to correspond to its cost of production”.
It seems to me that while the “objective reality of scarcity and the constraints imposed by technology” are part of what determines costs, they can’t be the only determinants.
For example, if you accidentally drop your dentures into a public toilet, the objective state of the toilet (and your access to gloves etc) is only part of what determines the cost of getting them back.
Surely your subjective response to the prospect of reaching into the toilet and cleaning the dentures can’t be excluded?
The path from objective scarcity, technology etc to cost measured in dollars has to pass through the subjectivity involved in opportunity costs — doesn’t it?
Don, it seems to me you’ve reversed the positions of the protagonists. Boettke says “costs are subjective” and makes it clear he means “purely subjective”. Marshall, with the analogy of two blades of scissors, says that both objective and subjective factors are relevant.
Joseph, “Most formal models assume that preferences and costs are known (at least to the modeller) and so embed the conclusion that welfare could be increased through a centralised allocation” and, as you say, this conclusion would be correct if the central planner (as opposed to the modeller) had perfect information. But of course most models don’t assume a perfectly informed central planner and don’t yield the conclusions you describe. Moreover, the same error, as well as errors of overstatement on the other side) can be made in verbal reasoning The great socialist calculation debate predated math models and was riddled with errors on both sides.
“But of course most models don’t assume a perfectly informed central planner and don’t yield the conclusions you describe.”
That might be true if they model the planner explicitly — most don’t. It’s tricky to create models that don’t implicitly assume that welfare could be weakly improved with some centralised allocation. I think it might be impossible.
The entire problem I have is the underlying assumption of competitive markets. These days it doesnt apply. In the Austrian view price is all – it freely ranges whenever there is fluctuations in the economy to restore equilibrium. It doesnt. The markets athese days are nowhere near any perfect competition model and in Australia it unlikely they were anywhere near close except for the first fifty years after colonisation. After that we did have as Marx noted the rise of monopolising capitals. With monopoly power comes price control. Since then, through merger acquisition and takeover we have very concentrated markets in many industries and the price is no longer flexible (no matter how much people try to ascribe the inflexibility to labour and want further de-regulation of labour). We went there, it wasnt that, still the price is sticky – so where is it sticky ? try looking at the upper echelons of the labour force – the area where there is jobs for the boys, jobs for those who sack rather than get sacked, jobs for CEOs who oversee asset strippings and raids and short term share price elevations through media spin. The rigidities are there above the middle – time people started looking there and time they stopped using labour market rigidities as the scapegoat for capital market rigidities.
John – Yes, Marshall says that both objective and subjective factors are relevant to the determination of price.
But aren’t Austrian economists complaining that he makes one blade of the scissors subjective (value) and the other objective (cost)?
As I understand it, Austrians argue that costs are not determined by purely by objective factors but that they are also influenced by subjective factors.
As Bohm-Bawerk puts it:
“The Austrian economists found: 1st, that the value of the materials of production needs, first of all, to be explained; and, 2nd, that after this explanation is made, and after the net of complicated relations is untangled, the value of the materials of production is seen in the end to be the effect, and the value of the product the cause.”
For example, you’re enjoying a meal at a waterside restaurant and you ask one of your friends why it’s so expensive.
“It’s because of the high cost of the land,” one of your friends says.
So you ask why the land is so expensive. And, if there’s an Austrian at the table, you’ll get an answer that includes the high value many patrons place on having such an attractive view when they’re eating.
Economics isn’t my field, so I might be wrong about this. But my understanding is that Austrians deny that you can explain costs without invoking subjective factors.
There isn’t an objective blade and a subjective blade.
Have the Austrians misunderstood Marshall?
Don’t you think that there is a circularity in the Austrian view that makes it impervious to critiques in its own eyes? I refer to the notion that free markets *define* the best outcomes. (The concessions to public goods and externalities are not at issue here.)
There is no external standard by which markets can be judged to fail. Prices reflect whatever people are thinking. Value is the net market view of what people currently think something is worth. Full stop.
“It’s true that markets develop out of natural inclinations to better our situation, but then so do governments“.
That last has precious little basis to support it.
And crime syndicates.
And collusion.
“Since the 1870s, economists have agreed that value is subjective” – I think Sraffa would have something to say about this statement.
“Economists and social thinkers had long recognized that private ownership provides powerful incentives for the efficient allocation of scarce resources.
…
Ludwig von Mises demonstrated that even if the assumed change in human nature took place, socialism would fail because of economic planners’ inability to rationally calculate the alternative use of resources.
…
And without money prices reflecting the relative scarcities of the means of production, economic planners would be unable to rationally calculate the alternative use of the means of production.
…
Publicly owned enterprises have operated successfully for decades, often in competition with private firms. ”
These arguments – from both sides – do not mak a clear distinction between *ownership* – public, collective or private – and *planning/decision making* – centralised or decentralised.
Large-scale centralised planning and decision making is the reason of the problems alluded to above. And this is independent of who the nominal owner is.
Greetings
Karl Heinz
“Economics isn’t my field, so I might be wrong about this. But my understanding is that Austrians deny that you can explain costs without invoking subjective factors”
I don’t think anyone claims that you can, certainly not if disutility of labour is subjective. If there is a distinctive claim here, it’s that you can explain costs by invoking only subjective factors. That’s how I read Boettke.
So, on your reading, this point is another statement of the obvious, while on mine it’s an error. Either way, it can’t be both true and original to the Austrian school.
Is it exactly true in a historical sense that an entrepreneur is what Boetkke is inclined to suggest as!? History would suggest something more in line with home economics. So I feel this description then doesn’t always deliver goods of real value,eg. cigarette entrepreneurs.And any evaluation of entrepreneurs as he sees them are both false historically and perhaps destructive ,if legislative aspects aren’t protecting users and maybe competitors for the elusive spending monies,or disposable capital…if that can be dually applied to commercial entities and consumers.The biro pen was a great innovation and a lot of flogging them went on against the ink writing pen,obviously an entrepreneur can be many things if the marketplace represents that use of money behind a product.But an entrepreneur in the original sense wouldn’t have the mass production mass marketing possibility.I think there is a cleverly disguised deceit in the the claims of deciding someone is an entrepreneur.Look what happens to poorer patent holders or intellectual property rights holders.I know with myself an idea and the company that used it was sold to an international market.Economics to me is more a penalty against me,than be worthy of giving much respect too.
Proposition 6 tries to make a clear distinction between private property and socialism. But this is a comparison which is not as relevant for today as it was, say, 20 years ago. What do people think the Austrian economists would say in making a comparison between those views and a modern mixed market economy? Do we need to differ between the owners and the managers (bring in agency theory) into prop 6?
Prop. 1 isn’t Hayek.
Hayek argues in several places that economic analysis begins after we experience problem raising patterns in our experience, and he gives several examples, including the problem raising patterns people experienced with attempts to enforce usury laws, the patterns people saw with debauched coins, the patterns of the business cycle, etc.
I’ve got citation after citation in my dissertation notes where Hayek lays out this position.
Problems come first.
“Proposition 1: Only individuals choose.
Man, with his purposes and plans, is the beginning of all economic analysis.”
Hayek’s work is replete with discussions of this matter — and perhaps no person has ever discussed the individuals place in the social world from as many angles and as scientifically as has Hayek — from the brain to culture to philosophy to learning to language to choice to logic, etc. You name it, Hayek has covered it.
“Methodological individualism seems like a good starting point. But it’s important to remember that individual choices are very much affected (sometimes, effectively determined) by the collective entities of which they are a part.”
Hayek has no, zip, zero “commitment to verbal logic” as a “methodological view”.
There’s math throughout Hayek’s career and work — and Hayek even suggested the idea for some of the most momentous mathematical breakthroughs in the history of economics, such as the indifference curve method, which Hicks developed at Hayek’s suggestion.
So the following is buncombe:
“this is wrapped up with .. some misconceived methodological views (for example, the commitment to verbal logic)”
proposition 4 is the critical one.
“Utility and costs are subjective”.
Whatever your subjective whims may be, final exchange costs are disciplined by:
1) budget constraint
2) circular flow requirements
Of course with crazy expansion of per capita debt, we have been living in a fool’s paradise, but still, these 2 factors mean that costs can never be truely subjective in the final analysis.
this is an appearence one must dig beneath.
#18 I’m responding to your co-blogger, Peter Boettke here. He says, and I’ve quoted above
(emphasis added).
If you think that’s “buncombe”, take it up with him, not me. (Also, to keep the temperature down, please stick to less emotive terms such as “wrong” in future. There’s no need to pound the table here).
Obviously, I can’t adjudicate between competing versions of Austrian economics, or rule on the relative canonical status of, say, Hayek and Mises, but it certainly seems to me (and to Joseph Clark at #1) that hostility to mathematical methods is pretty widespread among self-described Austrians.
If you can point me to a good mathematical presentation of the main points of Austrian theory, I’ll be happy to take a look.
On Greg Ransom, maths and words.
First, I think GR may be distinguishing Hayek from Mises.
Second, is indifference analysis maths? I take it as a pictorial representation of verbal logic. You spend all your money to reach the highest point possible. It purports to generate familiar resullts using an ordinal method.
*Reliance* on maths is when you accept conclusions that you don’t intuitively grasp because these are derived from other equations that you accept, and it tends to be non-realist so far as the truth of assumptions is concerned. In physics we make assumptions about underlying unobservables and are more instrumentalist. In Hayek, do we not proceed from introspective truths; ie things that make direct intuitive sense in the light of common understanding (e.g., people have goals and strive to pursue them effectively)? Things keep in touch with our verbal understanding, and maths is never the master in Hayek, wouldn’t you say?
I have problems with proposition 1 – for me it would be better thought of in terms of individuals being a locus of decision – which I assume is PQ’s point.
I think this is a non-trivial matter as all sorts of problems arise when a simple idea of ‘choice’ is assumed. It is too often a slippery slope down to ‘free choice’ and ‘free will’.
Bruce, the Cartesian plane (in which the indifference curve is drawn) is certainly mathematical. The idea that algebraic concepts could be represented in geometric form was a huge step forward when Descartes introduced it. And the convexity property of indifference curves, which is critical, can only be described in mathematical terms.
The propositions supporting Austrian economics are easily demolished. If I get time, I will address each one.
Proposition 1: Only individuals make choices; collective entities do not choose.
This proposition begins by being trivial. Where is not trivial it presupposes. Where it is does not presuppose it prescribes. As an attempt at empirical description it is simplistic and as a theory of causation it is fallacious. Overall, proposition one represents a crude form of reductionism. It also has more than a hint of solipsism about it. The proposition is making a rhetorical appeal and not an case that is objectively supportable.
The statement that “only individuals make choices” is superficially attractive, true only in a trivial sense and then only if we make a circular definition. It is superficially attractive because it appeals to our subjectivism. Each person identifies himself as an individual, feels he makes choices and feels his choices are important. It is true only in the trivial sense if we describe choice, that is to say human choice, as the sole preserve of human individuals; a circular definition. It is a large and unjustified leap to rush from feeling subjectively that individual choice is important to asserting that individual human choice (and the aggregate of individual human choices) is the sole agent of causation in the economy, or more properly, in the political economy. The proposition makes a fetish of human choice and presupposes that human choice is the only causative agent, the only enabling or constraining factor worth considering in economic analysis. The natural environment, resource availability and wider societal constraints are all left out of such an analysis.
JQ seems prepared to concede proposition one even though he too raises this objection which on its own demolishes proposition one. JQ says, “… it’s important to remember that individual choices are very much affected (sometimes, effectively determined) by the collective entities of which they are a part.” Not only are there the constraints of belonging to collective entities, there are also the natural constraints as I mentioned above. The Wikipedia contains a general passage which happens to illuminate very well the particular reductionist fallacy of proposition one.
“Reductionism is strongly related to a certain perspective on causality. In a reductionist framework, phenomena that can be explained completely in terms of other, more fundamental phenomena, are called epiphenomena. Often there is an implication that the epiphenomenon exerts no causal agency on the fundamental phenomena that explain it. Reductionism does not preclude emergent phenomenon but it does imply the ability to understand the emergent in terms of the phenomena from and processes by which it emerges.” – Wikipedia.
The key sentence for us is this one. “Often there is an implication that the epiphenomenon exerts no causal agency on the fundamental phenomena that explain it.” Proposition one asserts that collective entities do not “choose”. If this means “do not determine any outcomes” then it amounts to a denial of the existence of feedback loops in the dynamic system that is society. It amounts to asserting that I alone choose and determine outcomes and that society never chooses nor determines outcomes for me. This is palpably false as JQ asserts. Society, as a collective, does determine some of our choices, just as it socialises us by training us and by encouraging and discouraging various individual choices.
The Austrians’ reductionism implies that a full explanation of society can be produced exclusively by accounts of individuals. Margaret Thatcher took this view to its “logical” or rather illogical conclusion with her infamous statement “There is no such thing as society.” It is instructive to see how quickly Maggie got herself into trouble with this line of reasoning;
“And, you know, there is no such thing as society. There are individual men and women, and there are families. And no government can do anything except through people, and people must look to themselves first.” – Margaret Thatcher
The “family”, a collective entity, was hastily re-introduced into the argument as Maggie’s political instincts reminded her that she could not deny something which was not only real but also a conservative shibboleth. Another important collective “the government” is added and then “people” are also introduced collectively. Maggie’s self-refutation is so devastatingly effective one scarcely needs to add anything.
The desire to deny the existence of society and the importance of collective choices and decisions is essentially an ideological one. First, it is a denial of the reality of a political economy and a pretence that there is just an economy. It is a denial of the existence of both phenomena as a dynamic working whole (individual choice and collective choice) and therefore a denial of the complex social and political tasks we face in balancing individual choices with collective choices. Democracy is the most important collective phenomenon (or epiphenomenon) which denied most of its essential validity by the Austrian theorists. They want democracy (choices made by methods other than free market forces) to wither away. What they do not highlight is that if free market forces rule exclusively then the choices of the richest and most powerful players in the free market determine, or at the very least, severely constrain the choices of others.
Darn, various typographical and grammatical errors crept in as I rushed and re-edited the text for my post above. Please don’t judge it by those relatively minor errors.
This sort of didactic thread is so contrary to so much of the stuff that turns up in media, eg sleazy and salacious Hanson rubbish in Murdoch press discussed by Media Watch on Monday night.
Much thanks Prof Q- will not comment now- am putting computer to bed, going out for a trip to the shops and then coming home to re-read thread, then comments.
A good steak is worthy of savour and needs digestive time. And something that teases my mind and threatens to provide me with new answers is becoming a bit of a shock, as one becomes more and more conditioned, to laziness and stupour, by commercial schlock.
One has to adopt or readapt one’s approach when worthwhile stuff turns up, not least at the fact of someone making an effort to share and explain, rather than hoodwink, patronise or exploit.
great stuff,
but what i want to know is this, when are you going to deal with the real issues,
because it doesnt matter whether your economic policies are austrian, german, chicagoan or cambridgian,
they are like different dreamcoats placed on a sociopathic zombie
private central banks, mega-corporations, cartels, concentration of media, secrecy jurisdictions, private equity funds of funds, CDS, dark pools, shadow banking and organisations like the DTCC
these things constitute the REAL economy
all the rest is just dancing stooge puppetry,
debating the colours of the dreamcoat is honestly just fiddling while the looters do their thing
Smiths, I know where you are coming from. As a non-rich individual I do feel powerless in the face of the corporate forces you mention. It is true that there is a futile and quixotic aspect to our debating, fulminating and expounding on issues we cannot directly affect.
However, as a counter example, I will point out that democracy is our power, the power of the little people; a collective power I might add. This power is imperfect and has limits but it is all we have and it does work to some extent. Preparatory to the exercise of democracy, by voting, we have the process of debate and sharing ideas.
US citizens exercised their democratic power (albeit in a somewhat flawed system IMO) and elected Obama. I think the change in national mood along with the stance and mettle of Obama himself means that current government responses to the market failure and corporate malfeasance implicated in the GFC will be considerably stronger and more effective than they would have been under McCain.
We can have some hope too that, as this crash is so bad, at least some proper regulation (and re-regulation) of the market economy will come out of it.
John #23 ICs and Descartes
This is not really a digression because I think that maths has two roles in economics: as a didactic means of explanation and as an engine of scientific discovery. I’d punt that Austrians would incline to agree with the former orientation and take a view similar to mine about ICs (though they would not delight in being so openly crass).
Does indifference analysis tell us much that marginal utility analysis doesn’t? (Scitovosky paradoxes are amusing, perhaps, and require explanation, but their practical relevance is a verbal/intuitive judgement call.)
An IC is something you *draw*. It’s common sense tarted up to look formal and scientific. The shape of an IC is not mathematical, I reckon: it reflects the law of diminishing marginal utility (itself based on common sense, despite the trappings of differential calculus) while theatrically avoiding the then dreaded sin of cardinalism. How seriously would one (esp. if “one” were Austrian) take attempts empirically to plot ICs? Or isoquants for that matter.
“Does indifference analysis tell us much that marginal utility analysis doesn’t?”
Not really, but marginal analysis is derived from calculus, which is more “advanced” than the maths used for indifference curves, although the latter is arguably more sophisticated. Value theory was a complete mess for a century before Edgeworth, Jevons, Menger and Walras. And they were in no doubt that they were bringing proper maths to the subject, as titles like this indicate:
“A General Mathematical Theory of Political Economy” (Jevons)
“Mathematical Psychics” (the first appearance of the indifference curve) (Edgeworth)
John #30
Indeed. The self-image of economics has this foundation.
The relationship between the marginalist formalists and the Austrians rather puzzles me. (Greg Ransom may be prepared to steer me succinctly in the right direction.) At some point Austrians spurned neoclassicism, partly due to “excessive” mathematicisation and partly due to the interventionist ethos of the latter in seeing market failures everywhere and wanting to correct them. Writing an equation for something does not imply, of course, that we can pin it down and control it, but it’s the first step.
It’s hard to be stridently anti-mathematical and a subjectivist who adheres to marginalism: I don’t quite see how they do it — if they take a line different from what I’ve espoused earlier (that the maths is largely metaphorical). While GR rejects the idea that Hayek was anti-mathematical, you must be right that some Austrians give the impression of hostility to it.
“The idea that algebraic concepts could be represented in geometric form was a huge step forward when Descartes introduced it”.
Oh, JQ! You’ve got that exactly backwards. What Descartes introduced was the idea that geometric concepts could be represented in algebraic form – analytical or algebraic geometry. The converse did come out in the wash, but it was no big deal. (Geometric algebra is something else again.)
I am extremely skeptical of the efficacy and efficiency of ‘markets’ full stop.
A simple metal trick, swap the work ‘mob’ for ‘market’. Try it, it will do wonders for understanding the mess we are in, and why neo-classical (inc Austrian) dogma that the ‘market’ is the be all and end all, does not and cannot work.
“The MOB discovers the correct price”. The MOB always maximises human desire and utility”. “The MOB is efficient”.
Right?
The real challenge is working out better ways of understanding individual, small group and large group behaviour. In each of these contexts individuals act quite differently, often in quite perverse ways. Until then any economic model is going to be very deficient, at best a first order approximation with very (very) limited predictive capacity.
There are complex behavioural feedback loops here, where people watch other people to see what they do/wear/buy/say/etc, then a critical mass happens and a large scale movement happens. Such as a ‘must have’ product.
A practical example is that modern marketing is often trying to create these movements, to try and create a large enough initial group that then becomes a mass movement. Suddenly everyone wears their cap backwards or has an iPhone.
So, at the level of the base assumption, the Austrian (and many other) schools of economic thought are deeply flawed models, with effectively no analytic or predictive power.
Translated: they cannot explain why things happened and they cannot predict what is going to happen.
Plus, Alice is quite correct. Assuming a ‘free’ market is a pretty dodgy idea anyway.
It is normal for individuals and sub-groups to manipulate MOBs, more often the norm I’d say. Therefore their precious ‘markets’ are going to be manipulated by motivated people (Duh).
Simply put, human ingenuity will always find a way to fiddle/manipulate a ‘market’ to suit some people’s short term interests.
Adam Smith himself warned about this.
From a modelling point of view (and I build mathematical models for a job) unless you can account for these factors in some way (or have them eliminated from the real world) then whatever model you create is inadequate with … no analytic or predictive power.
Oldskeptic says
““The MOB discovers the correct price”. The MOB always maximises human desire and utility”.
“The MOB is efficient”.The real challenge is working out better ways of understanding individual, small group and large group behaviour.”
Agree, economists have supposedly long known that research on data at the disaggregate level may bear little relationship to the same research outcomes at the “mob” level and by analysing the “mob” we do not capture the real relationships, yet we are being asked to accept and implement what is essentially a “mob theory”.
Re Alice 35
James Surowiecki, The Wisdom of Crowds, 2004, reminds us to distinguish between the benign outcomes that occur when large numbers of individuals make independent assessments versus the malignant ones when they observe (or ask) what others are doing and find it individually rational to go with the crowd.
36# Bruce
That is like saying well we put students in classrooms of diverse ability (greater heterogeneity) but we dont change our teaching methods and continue to teach to “the mob.” I dont buy it.
Alice is right again: this is not a MOB theory at all. We know by simple observation that MOBs can be far more irrational than individuals.
Famous example in England a MOB attack on a paediatrician.. because they thought she was a paedophile, the word are similar (I know it does not say much about English education, but are we any better in Oz).
Plus we know, from small group theory, that even small groups of people (ie 5-20+) are far greater risk takers than they are as individuals (distributed responsibility syndrome).
Ok, there is a wonderful set of podcast’s from the ABC’s Science show, from a mother with an high performing autitic child.
From him, she learned the ‘invisable force fields’ (her comment) around every neuro-norm person. The incredible amount of mental processing power we dedicate to looking at everyone else, understanding them, copying them, fitting in with them.
So every ‘normal’ person is someone who watches others and crowds .. with all their mental processing power .. and works out how to fit in, manipulate, survive …
The idea of rationality is nonsense, except for Vulcans and mutants (ie autistic) .. and a tiny, miniscule percentage of the population that can actually train their mind to think.
Again, another nail in the coffin of any ‘economic’ theory that depends on ‘rational’ people.
35-39
Don’t you think there is a spectrum or a wide domain of possibilities here? There are autistics and there are those who observe and care too much about the views and feelings of others (is there a word for this?). There are people on the altruistic end and people on the psychopathic. And there are lots of people with attributes of each.
When I buy baked beans I do so independently of the brand I observe others reaching for. Markets work here. But I am influenced by social factors that gave rise to my desire to consume baked beans in the first place rather than tinned whale. (Group tastes matter here.)
There is also the possibility that markets do a crappy job (if this pairing is not redundant) but that non-markets do an even crappier one.
If each system (market and non-market) has an absolute advantage in some cases or functions, then this is one argument for the mixed economy. It is also an argument for putting and keeping markets (and non-markets!) in their place. What irks so many people about the Austrians is how easily and irreversibly they are persuaded that market solutions apply so widely.
Does it? The baked beans you get are selected by someone else. Yes, you have an illusion of ‘choice’, but realistically the choice was made for you.
Dictatorship of the commons is a term I never forget.
Perfect example: Now I am a person who is objectionable to most people. Yes I say the things to their faces that they dont like (and have been fired a lot of times). Damn tough and independent mind here. Honed by adversity and challenge.
But, today I bought some stockings for my wife (yes the real ones). In David Jones. The social pressures you could feel. Me a male bought stockings. I felt it, especially when the staff thought I was a cross dressor. I actually left there sweating. There were no other guys there, only women .. and you could feel the pressure “I was an interloper”, the staff added to that as well.
So social rules apply, a lot and they will change your behaviour whether you believe or not.
For the guys, do a simple example “buy a pair of stockings”. For females, they get this all the time, talk to your mechanic about your car, realistically.
And then understand ‘markets’.
Oldskeptic Says:
Just an aside, but that didn’t happen.
Now that you are on to that comment about cars and females Oldskeptic – let me tell you there is one price for males at a car repair shop and one price for females in distress with a broken down car. The price for the latter can reach 300 to 400%. How do I know? Ive had to rescue friends and their cars from the clutches of “try it on” motor repair shops (I might also add the large brand ordinary service centres can be the worst chargers for inferior service – male or female). Husband is a second hand car dealer and know “what it should cost”.
is that an example of an efficient price? (even though there are lots of motor vehicle repairers – at least monopolistically competitive?)
Even that isnt an efficient price driven market when a car is broken down and it depends on the producers perceptions of how well the buyer can a) choose or b) has imperfect information.
In fact imperfect information is the norm in many markets and producers will make the most of it if they can (that is why promoting the idea that the market is efficient is so appealing to some, precisely because it is not and there are vast areas of imperfect knowledge, or other factors eg in the case of cars, gross inconvenience and lack of mobility, combined with imperfect knowledge, that can be exploited for the most profit).
Really? From your own link:
“Ms Cloete said the graffiti had been daubed across the front door windows and surrounding woodwork on Monday”.
Having someone paint graffiti on your house does not equal getting attacked by a mob.
Read the headline: “Paediatrician attacks ‘ignorant’ vandals”.
Oldskeptic – hopeless arent they? Black is white and white is black but we have to listen to them tell us that.
Dead Right Alice. Imperfect information .. and the power relationship, or at least the perceived power relationship.
Basically, the ‘market’ so loved by neo -liberals, neo-classical economists and their logical cousins, neo-conservatives (you know the ones that got us into several wars .. still going and expanding, boy just wait until we got to war with Iran).
Is piffle.
Their idea of a market is, because they are far more realistic than we are, is something that the big boys get a personal advantage from, today.
You honestly think (say) Kerry Packer believed in a ‘free market’? ‘Useful idiots’, in the Lenin sense, as he would call them. He spent his life logically creating monopolies, so he could extract a massive ‘rentier’ income .. again Duh.
Adam Smith again .. I told you but no one reads him..
And how much did he paid lobby groups, ‘think tanks’ (yeh sure dud tanks are better) politicians, etc. .. and how much tax did he pay?
Digressing, I find it so fascinating that we are so anti-Russian. We slag them off all the time. Not democratic, authoritarian .. etc. We must buy F-22’s to deter them.
But actually our Govt has powers the Russian Govt doesn’t. We can, and do, lock up children for all of their life. We can, and do, pass our citizens to another Govt to be tortured. And just wait until the Internet is censored.
Sort of a free market I suppose? Rubbish.
Oldskeptic # 47 I am sure virtually none of the Monty pelicans and their friends reads or has ever, in any depth, read Adam Smith. The only part of Smiths they like to quote is “the invisible hand of the market.” That phrase turns them on but most of them dont even know Smith let alone understand Smith.
Sj, have you ever been in a fight, have you ever been attacked. Have you ever quaked in fear when a gang is smashing everything under you.
Have you ever had 10 people try to beat you up. Have you ever been faced by someone with a knife. Have you ever been beaten by a MOB, where everyone takes a turn on hitting or kicking you?
I do, had to face it recently actually.
And JQ, this is very relevent, when I did my lecture in 2003, which as a part of the paper I disproved Schoals-Black. The amount of people, in private who agreed with me, but would never say it in public, bacause it would cost their job.
So social pressure is immense. Plus, just like a manipulated MOB, step out of line and you get fired (or beaten up or both, some places killed).
“Again, another nail in the coffin of any ‘economic’ theory that depends on ‘rational’ people.”
Surely the validity of the above statement depends on the concept of rationality.
To illustrate, is a mathematical economist who is entrepreneurial in the sense of making new discoveries (new theoretical knowledge) irrational because he or she is not motivated by making accounting profits?