The Divide in Austrian Economics on Equilibrium

There is arguably a split in Austrian economics on the issue of equilibrium (Vaughn 1994: 162). Lewin (1999: 27) speaks of a “rift within the subjectivist Austrian family” on the issue of a tendency to equilibrium.

On the one hand, the early Hayek, Mises, Kirzner, and Rothbard see markets as having a real tendency to equilibrium states (whether defined as some Walrasian general equilibrium state in Hayek’s pre-1937 work, Hayek’s “plan coordination” after 1937, Mises’s “final state of rest”, or Rothbard’s evenly rotating economy [ERE]).

From 1937, Hayek redefined equilibrium from the notion of a set of market clearing prices to the new concept of “plan coordination,” a situation where individual plans are coordinated (Vaughn 1994: 169). This state of affairs means that an economy might be on a path toward a type of equilibrium without all markets having to clear (Vaughn 1994: 169). Hayek’s notion of plan coordination was taken up and used by Kirzner, Lavoie, Garrison and other later Austrians (Vaughn 1994: 169; O’Driscoll and Rizzo 1996: 80). Indeed, according to Charles W. Baird (1987: 197), “Hayekian equilibrium” or “plan coordination” is “the notion that most Austrians consider useful.”

Furthermore, Hayek’s work on the Austrian trade cycle theory (pre-1937) was done when he was using Walrasian general equilibrium theory, and, as I have demonstrated in the previous post, once Hayek saw the problems with general equilibrium theory the difficulties in his business cycle theory became insuperable.

And one can’t help but notice that, in Hayek’s later statements and thought, he does not entirely dispense with the idea of market clearing equilibrium prices as an explanation of unemployment either. In a talk to the American Enterprise Institute in Washington DC on April 9, 1975 Hayek sounds like a neoclassical:

“These discrepancies of demand and supply in different industries, discrepancies between the distribution of demand and the allocation of the factors of production, are in the last analysis due to some distortion in the price system that has directed resources to false uses. It can be corrected only by making sure, first, that prices achieve what, somewhat misleadingly, we call an equilibrium structure, and second, that labor is reallocated according to these new prices.

Lacking such price readjustment and resource reallocation, the original unemployment may then spread by means of the mechanism I have discussed before, the “secondary contraction,” as I used to call it. In this way, unemployment may eventually become general.

The primary cause of the appearance of extensive unemployment, however, is a deviation of the actual structure of prices and wages from its equilibrium structure. Remember, please: that is the crucial concept. The point I want to make is that this equilibrium structure of prices is something which we cannot know beforehand because the only way to discover it is to give the market free play; by definition, therefore, the divergence of actual prices from the equilibrium structure is something that can never be statistically measured.” (Hayek 1975: 6–7).

This demonstrates that, despite his 1937 notion of “plan coordination,” Hayek was still capable of reverting to neoclassical equilibrium ideas as late as 1975.

The stream of Austrian economics that asserts the idea of a tendency to equilibrium may well be more a supplement to neoclassical economics than a replacement (Vaughn 1994: 166). For example, Kirzner’s entrepreneurial theory is one method by which Austrians can posit a real world tendency to market coordination.

Occupying an intermediate position are Rizzo and O’Driscoll. They rejected even Hayek’s “plan coordination” idea (which they saw as just another type of static equilibrium concept: O’Driscoll and Rizzo 1996: 80–82). Instead, Rizzo and O’Driscoll argue that markets have a tendency to “pattern coordination,” a weaker concept of economic coordination which consists merely of some degree of order in which individual actions “are coordinated with respect to their typical features, even if their unique aspects fail to mesh” (O’Driscoll and Rizzo 1996: 85).

On the other side of the Austrian school are Ludwig Lachmann and those influenced by him. Vaughn argues that Lachmann thought that markets are subject to both disequilibrating and equilibrating tendencies, but took no position on exactly what tendency dominates the market system (Vaughn 1994: 160; see also Prychitko 1993: 375). Prychitko holds that there is no a priori basis on which to assert that markets tend to equilibrium states (Prychitko 1993: 375).

Whether there is an inherent tendency to disequilibrium is a different question, of course.

Even a Post Keynesian economist like Paul Davidson does not argue that free market economies are inherently disequilibrating (Davidson 1993: 436). Rather, Post Keynesians argue that there is nothing in market systems that ensure that the economy will converge automatically to full employment equilibrium (Davidson 1993: 436). For Keynes, the most serious flaws in capitalism were as follows:

“The outstanding faults of the economic society in which we live are its failure to provide for full employment and its arbitrary and inequitable distribution of wealth and incomes.” (Keynes 1936: 372).

BIBLIOGRAPHY

Baird, Charles W. 1987. “The Economics of Time and Ignorance: A Review,” The Review of Austrian Economics 1.1: 189–206.

Davidson, P. 1993. “Austrians and Post Keynesians on Economic Reality: Rejoinder to Critics,” Critical Review 7.2–3: 423–444.

Hayek, Friedrich A. von. 1975. A Discussion with Friedrich A. von Hayek. American Enterprise Institute, Washington.

Keynes, J. M. 1936. The General Theory of Employment, Interest, and Money. Macmillan, London.

Lewin, Peter. 1999. Capital in Disequilibrium: The Role of Capital in a Changing World. Routledge, London.

O’Driscoll, G. P. and M. J. Rizzo. 1996. The Economics of Time and Ignorance (2nd edn.). Routledge, Oxford, UK.

Prychitko, D. 1993. “After Davidson, Who needs the Austrians: Reply to Davidson,” Critical Review 7.2–3: 371–380.

Vaughn, K. I. 1994. Austrian Economics in America: The Migration of a Tradition. Cambridge University Press, Cambridge and New York.