Butos, W. N. and R. Koppl, 1997. “The Varieties of Subjectivism: Keynes and Hayek on Expectations,” History of Political Economy 29.2: 327–359.There appear to be other downloadable versions of it on the web.
This is an excellent paper, and is thought-provoking, enjoyable and intelligent. I will summarise the paper, with comments on some points.
Keynes and Hayek, Butos and Koppl note, held a subjectivist approach to economics and Keynes’s early work on the business cycle shared Wicksellian foundations with that of Hayek (Butos and Koppl 1997: 327). Keynes’s epistemology is seen as “a form of foundationalism or justificationalism” (Butos and Koppl 1997: 330–331, quoting O’Donnell 1989: 93), which is a “constructivist” or “Cartesian” rationalism (Butos and Koppl 1997: 331). Some remarks on Keynes’s view of ethics follow (Butos and Koppl 1997: 331–333). I know that Keynes was influenced by Moore’s Principia Ethica. Keynes said that he rejected the consequentialist portions of that treatise, though this statement is perhaps questionable when looking at Keynes’s practical moral reasoning (see Braithwaite 2005 : 243-244). My own view is that the virtue ethics that Keynes said he adhered to is merely a subspecies of teleological/consequentialist ethics: virtue ethics and utilitarianism all come under the same general category.
To return to Butos and Koppl, Hayek, they argue, repudiated rationalism for an “evolutionary epistemology” (Butos and Koppl 1997: 333) and Hayek came to identify himself with Popper’s Critical Rationalism (Butos and Koppl 1997: 334). Hayek held that human thought and even rational thought were “a patterned behavioral response to environmental stimuli” (Butos and Koppl 1997: 336; 334–336). On reading this, I immediately thought that Hayek’s view of human thought seems to verge on a crude form of behaviourism. Yet, according to Butos and Koppl, that is not so (Butos and Koppl 1997: 336).
Butos and Koppl make a crucial point about Hayek’s view of how we have reliable knowledge of the future:
“Hayek .. equated knowledge with practice. This matters for our argument because social practice is largely the product of blind evolution. From a Hayekian perspective, we shall argue, the reliability of our knowledge of the future, of our long-term expectations, does not depend so much on the rationality of our projections as on the properties of the economy’s selection processes. If Hayek’s view holds water, it undercuts the sort of general epistemic critique attempted by Keynes, Shackle, and Lachmann. Alternatively, if Keynes’s views on knowledge are substantially correct, then Hayek's faith in the efficacy of social evolution was misplaced.” (Butos and Koppl 1997: 337).I think there is a great deal of merit in the remark highlighted in yellow, but not without qualification. Strangely, Butos and Koppl never develop it and overlook its importance. This is arguably the best insight of the whole paper, and I will devote attention to it in what follows.
Now Hayek’s view is that cultural evolution is group selection (Butos and Koppl 1997: 340). I would argue that human societies have certain social practices and institutions which have indeed developed to reduce uncertainty associated with the future, and economic uncertainty. Institutions influence modern capitalism (such as law courts that enforce contracts, buffer stocks, and even central banks) and have been developed precisely to deal with uncertainty. We can conceive them as external entities capable of reducing uncertainty by interventions designed to influence the state of the economic system. If I lend money, what happens if the debtor refused to pay? Law and order and contract law are basic human institutions without which commerce would be impossible. I would call in the law to demand repayment. The threat of force, or its actual use, by an entity with a monopoly on force is how it has been historically done (we call it government).
Other social conventions or institutions that reduce uncertainty (for example, forward/future markets for commodities, and even money) are so deeply ingrained that we think of them now as a fundamental part of capitalism. To the extent that such social practices and institutions exist, they do indeed help to reduce uncertainty about the future. For example, central banks developed in the 19th and 20th centuries precisely because business and financial interests wanted a system that would reduce the uncertainty caused by liquidity crises and financial panics in unregulated financial markets and banking systems.
But what happens when there remain economic phenomena that are still affected by fundamental uncertainty? The level of investment is just such a phenomenon. There is a massive hole here in Hayek’s view of the “properties of the economy’s selection processes.” Before macroeconomic interventions designed to stabilise the business cycle, there were no mechanisms to reliably end recessions and depressions. The crucial Keynesian insight is that the postulated neoclassical equilibrating mechanisms to restore full employment do not work, do not even exist, or are simply unreliable (e.g., wage and price flexibility, an alleged market-clearing equilibrium interest rate for the capital market, belief in the gross substitution axiom, etc.).
I also take issue with the idea that the “social practices” that reduce uncertainty (including institutions which underlie the market or that we now think of as a fundamental part of it) are merely the product of blind evolution. If “blind” is supposed to mean unconscious, undirected or unplanned, I think this is patently false. Human design is highly relevant. Law and order systems (such as contract law and its enforcement) have been designed and directed, and developed; they are not products of blind evolution.
Butos and Koppl discuss Keynes’s distinction between short-term and long-term expectation (Butos and Koppl 1997: 340). Events in the future relevant for long term expectation – and essentially investment decisions – are subject to fundamental uncertainty. A discussion of Keynes’s views on probability follows (Butos and Koppl 1997: 342–347). There is a statement early in Chapter 12 of Keynes’s The General Theory of Employment, Interest, and Money that supports this:
“It would be foolish, in forming our expectations, to attach great weight to matters which are very uncertain.1 It is reasonable, therefore, to be guided to a considerable degree by the facts about which we feel somewhat confident, even though they may be less decisively relevant to the issue than other facts about which our knowledge is vague and scanty. For this reason the facts of the existing situation enter, in a sense disproportionately, into the formation of our long-term expectations; our usual practice being to take the existing situation and to project it into the future, modified only to the extent that we have more or less definite reasons for expecting a change.The footnote can only refer to radical uncertainty, and it is obvious that this concept is crucial to Keynes’s theory of long-term expectation.
The state of long-term expectation, upon which our decisions are based, does not solely depend, therefore, on the most probable forecast we can make. It also depends on the confidence with which we make this forecast-on how highly we rate the likelihood of our best forecast turning out quite wrong. If we expect large changes but are very uncertain as to what precise form these changes will take, then our confidence will be weak.
The state of confidence, as they term it, is a matter to which practical men always pay the closest and most anxious attention. …
1. By ‘very uncertain’ I do not mean the same thing as ‘very improbable’…” (Keynes 1936: 148).
Butos and Koppl refer to “animal spirits” in Keynes’s thought (Butos and Koppl 1997: 349), but I think that concept, as Keynes understood it, is largely irrelevant to the theory of subjective expectations, and certainly in the modern Post Keynesian theory of subjective expectations, which can draw on modern psychology and behavioural literature.
From p. 349, Butos and Koppl try to identify Hayek’s theory of expectations. They note that Hayek’s famous 1937 paper “Economics and Knowledge” (1937: 33–54) does not, in the end, provide any such theory. Hayek’s view of knowledge is “that the evolutionary conditions of the economic environment influence the reliability of economic expectations” (Butos and Koppl 1997: 350–351). But here is precisely the problem: modern capitalist economies lacked an “evolutionary condition of the economic environment” to provide macroeconomic stability and stabilise the level of investment until the Keynesian revolution. In other words, if Hayek’s view is that economic expectations of the future influencing investment will be made reliable by some social convention or institution produced by social evolution, then they were unreliable exactly because until the 1930s there are no such effective social conventions or institutions. Keynesianism provided the solution.
Hayek argues that
“‘the process of selection that shaped customs and morality could take account of more factual circumstances than individuals could perceive, and in consequence tradition is in some respects superior to, or “wiser” than, human reason’ … . Hayek’s position suggests something similar for the market place. The homegrown traditions bred by market competition are shaped by more factual circumstances than market participants can perceive, and in consequence tried and true business practices may sometimes embody greater wisdom than rational calculation can achieve. In short, … Hayek advances a ‘rational theory of tradition.’” (Butos and Koppl 1997: 351),This eventually leads to Kirzner’s view of the entrepreneur in capitalism, I have little doubt.
But I don’t see how this at all overcomes Keynes’s views on subjective expectation in the investment decision, and long term expectations in particular. In fact, one can conclude that Hayek’s view of expectations is a serious flaw in his whole thinking, and inferior to Keynes’s.
All in all, this is an excellent paper, raising many issues that deserve further treatment. I think, however, that Austrians would do better to engage directly with the modern Post Keynesian theory of subjective expectations, rather than simply look at Keynes.
Braithwaite, R. B. 2005 . “Keynes as a Philosopher,” in M. Keynes (ed.), Essays on John Maynard Keynes, Cambridge University Press, Cambridge.
Hayek, F. A. 1937. “Economics and Knowledge,” Economica n.s. 4.13: 33–54.
Keynes, J. M. 1936. The General Theory of Employment, Interest, and Money, Macmillan, London.
O’Donnell, R. M. 1989. Keynes: Philosophy, Economics and Politics, St. Martin’s Press, New York.