Some Quick Thoughts on Austrian Economics

Someone has made the following comment:

You’ve essentially dealt with Rothbardian economics. No big blows have been dealt to the modern Mises/Kirzner/Hayekian branch, or the Lachmannian branch.

On the contrary, I have already dealt with Mises and his praxeology:

“Mises’ Praxeology: A Critique,” October 1, 2010.

“Was Mises a Socialist?: Why Mises Refutes Himself on Government Intervention,” October 7, 2010.

“Rothbard on Mises’ Utilitarianism: Why the Systems of Mises and Rothbard both Collapse,” October 8, 2010.

“Mises on the Ricardian Law of Association: The Flaws of Praxeology,” January 25, 2011.

As I have pointed out before, the Lachmann radical subjectivists have ideas in common with the Post Keynesians, and there might well be scope there for mutual constructive dialogue – and that is why I have not attacked them. There are certainly ideas in various strands of Austrian economics that Post Keynesians can agree with, such as:

(1) money is not neutral;
(2) capital goods are heterogeneous;
(3) we face fundamental uncertainty in economic life, uncertainty in the sense of Knight and Keynes which is not measureable risk;
(4) expectations are subjective.

For example, one important similarity between the Lachmann radical subjectivists and Post Keynesians is the view that expectations are subjective:

“The natural extension of the subjectivist concept from preferences to expectations implies that Austrian views on human action and market processes and Keynesian theory on the instability of investment are complementary. Within the Keynesian understanding Shackle did much to ensure consistency and clarity in the Keynesian understanding of the role of subjective expectations. Lachmann did the same for Austrian economics. Because both Lachmann and Shackle were open to the views of subjectivists from other schools, the result is a large measure of similarity in (some) Austrian and post-Keynesian theories on the role of expectations. The similarity is such that Lachmann (1978: 15) considered Shackle an Austrian even though Shackle considered himself a Keynesian” (Burger 2003: 104-105).

Indeed, the Austrian school is itself split between the Lachmann-wing and the moderate subjectivists who have not dealt with the consequences of radical uncertainty and subjective expectations:

“Kirzner initially saw his project as improving neoclassical economics and providing a ‘story’ as to how markets adjust, whereas the kaleidic Lachmann-inspired wing (including Shackle and Loasby) seems to have been reaching out to Post keynesians such as Davidson. Indeed, in their debate with Davidson [1989, 1993] both Prychitko (1993) and Torr (1993) acknowledged the tension between the kaleidic wing of Lachmann, Shackle and Boulding, with their stress on divergent and disequilibrating expectations, and the more dominant, market-as-an-equilibrating-process axis of Mises, Hayek and Kirzner” (Dunn 2008: 136).

Subjective expectations and the instability of investment are factors that destroy the myth of equilibrating markets that return to what neoclassicals call full employment equilibrium. These factors also destroy the basis of the neoclassical view from loanable funds theory that, if there is an increase in saving, then the rate of interest would fall, which will stimulate investment in production by an equal amount. This idea that an increase in saving due to a fall in consumption would not decrease aggregate demand because there is a corresponding increase in investment in capital goods to compensate for the fall in consumption is an assumption underlying Say’s law, from which it is concluded that aggregate demand will remain the same and only its composition will alter. But subjective expectations in the investment decision destroy any such automatic process to create the necessary investment.

It seems to me that Austrian business cycle theory (ABCT) as (for example) described in Garrison (1997), which also relies on loanable funds theory, makes a similar mistake: ABCT assumes a mythical “natural rate of interest” that occurs when increased savings in loanable funds (and not fiduciary media or fiat money created by the central bank) lowers the interest rate and that money is borrowed by business in a “sustainable” growth path. But what guarantee is there that business will even use those increased savings in capital goods investment under subjective expectations? If those increased savings are not borrowed for investment, you have a failure of aggregate demand. ABCT also makes the mistake of assuming an economy running at full capacity and full employment (a false assumption clearly in Garrison 1997), when in reality there are many periods when capitalist economies have very significant idle resources.

To return to the other Austrians: as for the moderate subjectivists like Kirzner or even O’Driscoll and Rizzo, I think Paul Davidson has already dealt with them:

“The Economics of Ignorance or Ignorance of Economics?,” Critical Review (1989) 3.3/4: 467–487.

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

I have always enjoyed Gerald P. O’Driscoll and Mario J. Rizzo's The Economics of Time and Ignorance (1st edn, Oxford, UK, 1985), though I don’t agree with its conclusions. Furthermore, I have always said the ThinkMarkets blog is well worth reading.

In particular, O’Driscoll and Rizzo made some favourable comments about Post Keynesian economics:

“[i]t is evident that there is much more common ground between post-Keynesian subjectivism and Austrian subjectivism …. the possibilities for mutually advantageous interchange seem significant” (The Economics of Time and Ignorance, Oxford, UK, 1985, p. 9).

That is why they stand out in my mind, as opposed to the frankly crude, ignorant and often idiotic line up of other Austrians and their supporters on the internet.

BIBLIOGRAPHY

Burger, P. 2003. Sustainable Fiscal Policy and Economic Stability: Theory and Practice, Edward Elgar, Cheltenham, UK.

Davidson, P. 1989. “The Economics of Ignorance or Ignorance of Economics?,” Critical Review 3.3/4: 467–487.

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

Dunn, S. P. 2008. The ‘Uncertain’ Foundations of Post Keynesian Economics, Routledge, London.

Garrison, R. W. 1997. “Austrian Theory of Business Cycles,” in D. Glasner and T. F. Cooley (eds), Business Cycles and Depressions: An Encyclopedia, Garland Pub., New York. 23–27.

Lachmann, L. 1978. “An Austrian Stocktaking: Unsettled questions and Tentative Answers,” in L. M. Spadaro (ed.), New Directions in Austrian Economics, Sheed Andrews and McMeel, Kansas City. 1–18.

O’Driscoll, G. P. and M. J. Rizzo, 1985. The Economics of Time and Ignorance (1nd edn), Oxford, UK.

Prychitko, D. 1993. “After Davidson, who needs the Austrians: reply to Davidson,” Critical Review 7.2/3: 371-380.

Runde, J. 1993. “Paul Davidson and the Austrians: reply to Davidson,” Critical Review 7.2/3): 381-397.

Torr, C. 1993. “What can Austrian Economists learn from the Post Keynesians? Reply to Davidson,” Critical Review 7.2/3: 399-406.