Salerno’s Response to Krugman on Mises and the Great Depression

Salerno’s recent response to Krugman is here:

Joseph Salerno, “Paul Krugman Attacks Ludwig von Mises: Another Win for Austrian Economics!,” Mises Economics Blog, January 28th, 2014
http://bastiat.mises.org/2014/01/paul-krugman-attacks-ludwig-von-mises-another-win-for-austrian-economics/

Salerno’s post is unintentionally hilarious, given the quotation that opens his post (comparing the righteous and poor persecuted Austrians with Gandhi!):

“First they ignore you, then they laugh at you, then they fight you, then you win.”

(Mahatma Gandhi).

Funny you use that quote, Salerno, because it would appear to be a perfect description of how you (and other Austrians) treatment me and my blog.

First of all, arguments stand and fall on their own merits, not on the obscurity or identity of the author. But it appears Salerno doesn’t agree with that and resorts to exactly the tactics described above.

Salerno says the following of my post here:

“Actually, our jaded scribe [sc., Krugman] could not be bothered to train his sites on Mises’s actual views but rather rests content to attack a caricature of Mises’s position as presented in a pseudonymous post by an individual calling himself ‘Lord Keynes’ on the blog Social Democracy for the 21st Century: A Post Keynesian Perspective. Blithely accepting ‘Lord Keynes’s’ claims at face value, Krugman declares ‘von Mises, faced with the reality of depression, basically dropped Austrian business cycle theory.’”
Joseph Salerno, “Paul Krugman Attacks Ludwig von Mises: Another Win for Austrian Economics!,” Mises Economics Blog, January 28th, 2014
http://bastiat.mises.org/2014/01/paul-krugman-attacks-ludwig-von-mises-another-win-for-austrian-economics/

No, Salerno, I did not say that “von Mises, faced with the reality of depression, basically dropped Austrian business cycle theory.”
Here is what I said (with my quotation from Mises following):

“However, it is interesting that Mises thought that his Austrian monetary theory of the cycle could not adequately explain the severity and length of the Great Depression (as also noted by Hülsmann 2007: 617–618):

“The crisis from which we are now suffering is also the outcome of a credit expansion. The present crisis is the unavoidable sequel to a boom. Such a crisis necessarily follows every boom generated by the attempt to reduce the ‘natural rate of interest’ through increasing the fiduciary media. However, the present crisis differs in some essential points from earlier crises, just as the preceding boom differed from earlier economic upswings. The most recent boom period did not run its course completely, at least not in Europe. Some countries and some branches of production were not generally or very seriously affected by the upswing which, in many lands, was quite turbulent. A bit of the previous depression continued, even into the upswing. On that account—in line with our theory and on the basis of past experience—one would assume that this time the crisis will be milder. However, it is certainly much more severe than earlier crises and it does not appear likely that business conditions will soon improve.

The unprofitability of many branches of production and the unemployment of a sizable portion of the workers can obviously not be due to the slowdown in business alone. Both the unprofitability and the unemployment are being intensified right now by the general depression. However, in this postwar period, they have become lasting phenomena which do not disappear entirely even in the upswing. We are confronted here with a new problem, one that cannot be answered by the theory of cyclical changes alone.” (Mises 2006 [1931]: 163–164).

So it appears that Salerno either (1) did not read the post or (2) did not read it properly or ignored what I actually said. Since Salerno later repeats one of my quotations from Mises, it would appear to be (2).

But if Salerno did not read the post properly or “ignored” what I said, then Salerno appears to have fulfilled the first of these failings of his quotation (“First they ignore you, then they laugh at you, then they fight you, then you win”).

It also follows that Salerno’s charge that my post was “a caricature of Mises’s position” is a straw man, though perhaps unintentionally.

This is reinforced when Salerno borrows a quotation of mine from Mises and uses it to prove that “Mises did not deny that the Great Depression was initiated by credit expansion.” That is correct, but then I did not assert that Mises abandoned his business cycle theory.

Salerno’s following charge that Krugman is unable “to grasp a multi-causal explanation of a complex and multifaceted historical episode” that was the Great Depression is so stupid, it’s laughable, and is actually more appropriate for the grossly oversimplistic explanation of Mises himself, who ignored the complex factors in the 1930s that thwarted any strong inducement to hire labour and clear the labour market via lower wages, such as the level of demand for output, the degree of uncertainty of capitalists about the future, business expectations, the general state of expectations, and the state of the financial system and credit markets, and so on.

After this Salerno links to a paper by Ohanian (2009) arguing that Hoover’s “high wage” policy was a major cause of the US depression, which is rather strange because Mises was talking about the Great Depression in Europe, not the United States.

Be that as it may, it is clear that, firstly, Hoover’s “high wage” policy was not some alien, evil government intervention imposed on unwilling and hostile business people and industrialists: it was a policy they largely agreed with. But secondly and more importantly, Jonathan D. Rose (2010) presents some evidence that Hoover’s “high wage” policy actually did not have much effect on the timing of US wage cuts during the depression.

Thirdly, even when wages fell, this induced severe debt deflationary effects, because price deflation was quite uneven, and the burden of fixed nominal debt soared. So the smooth and rapid market clearing as postulated by Mises as the cure for high involuntary unemployment simply could not and did not happen.

Next, Salerno admonishes Krugman to “stop trawling obscure blogs for biased material” on Austrians – referring to my blog.

This seems like a rather good example of the second part of Salerno’s opening quote (“First they ignore you, then they laugh at you, then they fight you, then you win.”).

Even the charge that my blog is “obscure” (though irrelevant) is, I think, wrong. I’ve made it into the Onalytica Influence Index’s “Top 200 Influential Economics Blogs” (August 2013). Even though I am at no. 178 (at the moment), there are thousands of economics blogs all over the internet, so I’m not quite so “obscure” as Salerno thinks.

And, in point of fact, Robert Murphy seems to have already moved onto the third stage (“fighting” me): he promised here to respond in greater detail to me later this week. I look forward to that.

Finally, Salerno’s links to his paper “A Reformulation of Austrian Business Cycle Theory in Light of the Financial Crisis,” in his attempts to provide Krugman with “an honest and accurate account of the Austrian theory.”

That is priceless, because a “reformulation” implies that there was something inadequate about the original theory, which does not say much for the ABCT if it needs to be regularly reformulated.

I would go so far as to say that the Austrian business cycle theory is a sad history of “reformulations” as Austrians encountered severe and cutting criticisms of their theory.

For example, Hayek’s first version of the ABCT in Prices and Production (London, 1931) encountered devastating criticisms from Sraffa (1932a, 1932b) and others and he was forced to “reformulate” the theory in Profits, Interest and Investment (London, 1939).

If we turn to Salerno’s new ABCT, one of the main purposes of his paper is to address the criticism that the ABCT “cannot explain the positive correlation of consumption and investment that occurs over the course of the business cycle” (Salerno 2012: 5). But such a charge against the ABCT is only one of the minor problems with the theory.

The main problem with the classic ABCT was always its use of the Wicksellian natural rate of interest: an irrelevant and non-existent concept, as Sraffa showed a long time ago (Sraffa 1932a and 1932b). Outside of an equilibrium state, there could be as many natural rates of interest as there are factor inputs. So what natural rate should banks target when setting interest rates?

I will leave a more detailed critique of Salerno’s paper for another post, but for the moment it is sufficient to note that Salerno (2012: 6, 37–38) invokes and indeed needs the non-existent natural rate of interest for his “new” ABCT to work, just like most of the other versions of the theory.

On this point alone, Salerno’s “reformulation” of the ABCT is as worthless as any other of the pathetic “reformulations” over the years.

Further Reading
“Hoover’s High Wage Policy and the Great Depression,” July 30, 2013.

“Austrian Business Cycle Theory: The Various Versions and a Critique,” June 21, 2011.

BIBLIOGRAPHY
Mises, Ludwig von. 2006 [1931]. “The Causes of the Economic Crisis,” in Percy L. Greaves (ed.). The Causes of the Economic Crisis, and Other Essays Before and After the Great Depression. Ludwig von Mises Institute, Auburn, Ala. 155–181.

Murphy, Robert P. 2003. Unanticipated Intertemporal Change in Theories of Interest, PhD dissert., Department of Economics, New York University.
https://files.nyu.edu/rpm213/public/files/Dissertation.pdf

Murphy, Robert P. “Multiple Interest Rates and Austrian Business Cycle Theory.”
http://consultingbyrpm.com/uploads/Multiple%20Interest%20Rates%20and%20ABCT.pdf

Ohanian, Lee E. 2009. “What – or Who – Started the Great Depression?,” NBER Working Paper Series, 15258
http://www.nber.org/papers/w15258

Salerno, Joseph. 2012. “A Reformulation of Austrian Business Cycle Theory in Light of the Financial Crisis,” Quarterly Journal of Austrian Economics 15.1: 3–44.
http://mises.org/journals/qjae/pdf/qjae15_1_1.pdf

Sraffa, P. 1932a. “Dr. Hayek on Money and Capital,” Economic Journal 42: 42–53.

Sraffa, P. 1932b. “A Rejoinder,” Economic Journal 42 (June): 249–251.

Rose, J. D. 2010. “Hoover’s Truce: Wage Rigidity in the Onset of the Great Depression,” Journal of Economic History 70: 843–870.

Salerno on Market-Clearing Prices in Austrian Theory

Joseph T. Salerno describes it here in his comments on the role of “price coordination”:

“Price coordination must not be confused with plan coordination, a concept originally formulated by Friedrich von Hayek. In his article ‘Economics and Knowledge,’ which has heavily influenced modern Austrian writers, Hayek suggested a concept of equilibrium based on ‘coordination of plans’ as a substitute for the concept of equilibrium based on ‘constancy of the data.’ In contrast, price coordination, as I elaborate the concept below, is the indispensable complement to the concept of an evenly rotating economy based on constant data. As Ludwig von Mises has repeatedly emphasized, the evenly rotating economy, although an imaginary state which can never be realized in the unfolding of the historical market process, is yet indispensable to the identification and analysis of the entrepreneurial function of the real world.

Entrepreneurs, however, can formulate and execute production plans only in a world in which economic calculation is possible, that is, in which catallactic competition generates market-clearing prices which, at every moment of calendar time and without fail, reflect, promote, and coordinate those uses of the available scarce resources that are expected to be the most highly valued by consumers. Price coordination, therefore, is not a phenomenon associated with an unrealizable state of equilibrium, however the latter is conceived; rather, price coordination is the essential characteristic of the plain state of rest, which, as Mises tells us, ‘… is not an imaginary construction but the adequate description of what happens again and again on every market.’” (Salerno 2010: 182–183).

The absurdity of this passage takes one’s breath away.

First, although there is sometimes confusion about whether Austrian price theory is meant to be merely an ideal or prescriptive vision of economic coordination, here it seems that flexible prices moving towards their market clearing values is meant to be a descriptive theory describing how real world markets actually function (although of course it can be a prescriptive and ideal vision at the same time, as, for example, when Austrian think governments or unions are supposed to interfere with the system of flexible prices).

Secondly, can entrepreneurs “formulate and execute production plans only in a world in which economic calculation is possible, that is, in which catallactic competition generates market-clearing prices”? Of course, Salerno’s phrase “generates market-clearing prices” can be understood to mean prices that move towards their market-clearing values (or the “equilibrium prices” at which demand and supply are equal), and not that all prices do indeed reach such equilibrium values, since he rejects the real world existence of equilibrium states (such as Walrasian general equilibrium or the Misesian final state of rest).

But is successful capitalist production only possible in a world generating and moving towards market-clearing prices? The answer is, of course, no.

So much of any real world capitalist economy consists of fixprice markets with administered prices, where private businesses shun flexible prices in the conventional sense. Yet production continues, economies can have strong and indeed historically unprecedented real GDP growth, employment can be high, living standards and real wages can rise significantly, and productivity growth can be strong. We need only think of the golden age of capitalism from the 1946–1970s period.

The Austrian notion that capitalist economies can only work successfully with flexible prices and a tendency to market clearing prices is wrong, absurd and contrary to empirical reality.

BIBLIOGRAPHY
Salerno, Joseph T. 2010. Money, Sound and Unsound. Ludwig von Mises Institute, Auburn, Ala.

Salerno on Mises’s View of Coordination in Market Economies

This is presented in Salerno (1993) and is of some interest.

First, the role of flexible prices:

“prices that are generated by the market process and serve as the data for economic calculation. These are realized prices; or, in other words, they are the actual outcome of the historical market process at each moment in time and are determined by the value scales of the marginal pairs in each market. They are, therefore, also market-clearing prices the establishment of which coincides with a momentary situation, what Mises calls the ‘plain state of rest’ (PSR), in which no market participant, given his existing marginal-utility rankings of goods and money and knowledge of prevailing prices, can enhance his welfare by participating in further exchange. However, despite their character as market-clearing prices, these are also disequilibrium prices. Thus as a consequence of the unavoidable errors of entrepreneurial forecasting and price appraisement under uncertainty, most goods are sold at prices that do not conform to their monetary costs of production, thereby generating realized profits and losses for producers.” (Salerno 1990: 121).

So prices are “disequilibrium prices” in the sense that they are not equal to costs of production, but allow profit and loss. Nevertheless, supply and demand are equated by a tendency to market-clearing prices:

“Mises conceives the market process as coordinative, ‘the essence of coordination of all elements of supply and demand.’ This means that the structure of realized (disequilibrium) prices, which continually emerges in the course of the market process and whose elements are employed for monetary calculation, performs the indispensable function of clearing all markets and, in the process, coordinating the productive employments and combinations of all resources with one another and with the anticipated preferences of consumers.” (Salerno 1993: 124).

Present prices or prices of the immediate past (or “realised prices” in Mises’s terminology) are the basis for monetary calculation when entrepreneurs guess or forecast prices in an uncertain future (Salerno 1993: 123).

But the market process is open-ended, because continuous change always shifts the end point equilibrium state which Mises calls “final state of rest” and into a new state, then a new state and so on.

Therefore economies do not have a long-term tendency to equilibrium (Salerno 1993: 122), but rather at most shifting, very short term tendencies, which are always thwarted.

But the Misesian theory is not the same as that of Hayek.

For example,

“The Hayekian paradigm stresses the fragmentation of knowledge and its dispersion among the multitude of individual consumers and producers as the primary problem of social and economic cooperation and views the market’s price system as the means by which such dispersed knowledge is ferreted out and communicated to the relevant decision-makers in the production process.” (Salerno 1993: 115).

In contrast to this,

“Salerno points out that for Mises, knowledge and appraisal on the market are complementary, and have very different natures and functions. Knowledge is an individual process, by which each individual entrepreneur learns as much as he can about the largely qualitative nature of the market he faces, the values, products, techniques, demands, configurations of the market, and so on. This process necessarily goes on only in the minds of each individual. On the other hand, the prices provided by the market, especially the prices of means of production, are a social process, available to all participants, by which the entrepreneur is able to appraise and estimate future costs and prices. In the market economy, qualitative knowledge can be transmuted, by the free price system, into rational economic calculation of quantitative prices and costs, thus enabling entrepreneurial action on the market.

As Salerno notes: ‘competition therefore acquires the characteristic of a quintessentially social process, not because its operation presupposes knowledge discovery [as with Hayek-Kirzner], which is inescapably an individual function, but because, in the absence of competitively determined money prices for the factors of production, possession of literally all the knowledge in the world would not enable an individual to allocate productive resources, economically within the social division of labor.’

In short, the entire Hayekian emphasis on ignorance and ‘knowledge’ is misplaced and misconceived.” (Rothbard 1992: 19–21).

BIBLIOGRAPHY

Rothbard, Murray N. 1992. “The Present State of Austrian Economics,” Working Paper from the Ludwig von Mises Institute, November.

Salerno, Joseph T. 1990. “Ludwig von Mises as Social Rationalist,” Review of Austrian Economics 4: 26–54.

Salerno, Joseph T. 1993. “Mises and Hayek Dehomogenized,” Review of Austrian Economics 6.2: 113–146.

Mises and Hayek Dehomogenized?: A Note on a Schism in Modern Austrian Economics

If you are not interested in the fratricidal minutiae of Austrian economics, skip this post!

In the late 20th century, Austrian economics was troubled by a controversy between Misesians and Hayekians.

On the one hand, Misesians like Joseph T. Salerno (1990, 1991, 1993, and 1994) and Murray Rothbard (1991, 1992, and 1994; see also Herbener 1991) charged Hayek and his followers (like Israel M. Kirzner) with deviating from the “pure” Misesian orthodoxy on the nature of coordination in market systems.

Two of major antagonists – Rothbard and Kirzner – were both students of Mises.

In short, the Misesians charged that there was serious chasm between Mises’s and Hayek’s understanding of markets. It is a surprisingly interesting debate, and elucidates some important points about modern Austrian economics.

First, the nasty nature of the debate drove an exasperated Israel M. Kirzner to this astonishing statement:

“Salerno (quite unsuccessfully, it must surely appear) seeks to refute Leland Yeager’s definitive paper (Yeager, 1994) demonstrating that Mises’s thesis does, after all, require that we attribute to Mises at least implicit recognition of Hayek’s “knowledge problem,” Salerno sums up as follows: ‘Thus market oriented PC [i.e., perfect competition] theorists, such as Hayek and Yeager, and neoclassical socialist GE [i.e., general equilibrium] theorists are brothers under the skin’” (Kirzner 2000: 157). ….


“The biting sarcasm employed in this assertion is but a relatively mild example of the rhetorical excesses appallingly to be found in the ‘two paradigm’ literature against such writers as Hayek, Lachmann, and others charged with having diverged from the asserted ‘Misesian paradigm.’ I take this opportunity strongly to protest the use of verbal terrorism in Austrian economics. Even if (which is far from being the case) the asserted criticisms of Hayek, Lachmann, and others were valid, there would be absolutely no justification for the manner in which these great economists have been treated in the literature under discussion. The near-demonization of Hayek and Lachmann for alleged deviations from an asserted Misesian orthodoxy is a most distressing phenomenon. If Austrian economists (and the Review of Austrian Economics) are to be able to work constructively in the rough and tumble of the intellectual market place, anything approaching rhetorical brawling must once and for all be rejected.” (Kirzner 2000: 162–163, n. 2).

So on the face of it, this must have been a serious dispute!

What was the dispute about? Let us review it below.

I. Misesian Socialist Economic Calculation versus the Hayekian Knowledge Problem
First, the dispute concerns the differences between Mises’s original “socialist calculation problem” and Hayek’s “knowledge problem.” Kirzner argues that Salerno and Rothbard came to the “unwarranted conclusion … that the Misesian calculation problem has nothing whatever to do with Hayek’s knowledge problem” (Kirzner 2000: 157).

In contrast, Salerno argues that Hayek’s “knowledge problem” is different from Mises’s original “socialist economic calculation problem,” and even Kirzner concedes that Mises did not formulate the “calculation problem” in terms of knowledge (Kirzner 2000: 158).

And, indeed, according to Rothbard, Hayek misunderstood Mises’s socialist calculation problem:

“It is now universally acknowledged that Ludwig von Mises, allegedly the loser in the famous socialist calculation debate that he launched in 1920, was really right: clearly, socialism cannot calculate, it cannot run a complex modern economic system. But it has only recently become clear, through the insights of Professor Salerno, precisely why Mises was right, and also how the Misesian message was systematically distorted, from the 1930s until recent years, by F.A. Hayek and his followers. For Hayek and the Hayekians, obsessed with the alleged ‘problem of knowledge,’ have systematically misinterpreted Mises as maintaining solely that the Socialist Planning Board, facing the uncertainty of a dynamic economy, lacks the knowledge enabling it to plan the production and allocate the resources of a socialist economy. In contrast, the market economy, through its price signals, conveys that needed knowledge from and to the various participants in the market economy.

Mises, while not disputing the importance of knowledge and its dissemination through the price system, was, however, arguing a totally different point. From 1920 on, he reasoned as follows: assume the best for the Social Planning Board. Assume that, by some magical process, it has been able to discover and know absolutely all the value-scales of consumers, all technological methods, and compile an inventory of all resources. Suppose, then, Mises says, we grant total knowledge of all these data to the Socialist Planning Board. It still will not be able to calculate, still will not be able to figure out costs and prices, particularly of land and capital goods, and therefore will not be able to allocate resources rationally. The real problem of the Planning Board, then, the major thing denied that Board by absence of a market, is not knowledge but economic calculation.

Thus, to Hayek, if the Planning Board could by some magic know, as people come to know through the market, consumer values, technologies, and resources, it could rationally plan and allocate resources fully as well as the market. As usual for Hayek and the Hayekians, the argument for the free market and against statism rests only on an argument from ignorance. But to Mises, the problem for the Planning Board is not knowledge but calculability. As Salerno puts it, the knowledge conveyed by present (or ‘immediate past’) prices rests on values, techniques, and resources of the immediate past. But what acting man is interested in, especially the entrepreneur in committing resources into production and future sale, is future prices and future costs. The entrepreneur, who commits present resources, does so because he appraises—anticipates and estimates future prices—and allocates resources accordingly. It is, then, the appraising entrepreneur, driven by his quest for profits and for avoidance of losses, who can calculate and appraise because a genuine price system exists in the means of production, in land and capital goods, that is, a system of exchanges of privately-owned capital resources. Only such a pricing system allows for calculation.

Salerno points out that for Mises, knowledge and appraisal on the market are complementary, and have very different natures and functions. Knowledge is an individual process, by which each individual entrepreneur learns as much as he can about the largely qualitative nature of the market he faces, the values, products, techniques, demands, configurations of the market, and so on. This process necessarily goes on only in the minds of each individual. On the other hand, the prices provided by the market, especially the prices of means of production, are a social process, available to all participants, by which the entrepreneur is able to appraise and estimate future costs and prices. In the market economy, qualitative knowledge can be transmuted, by the free price system, into rational economic calculation of quantitative prices and costs, thus enabling entrepreneurial action on the market.

As Salerno notes: ‘competition therefore acquires the characteristic of a quintessentially social process, not because its operation presupposes knowledge discovery [as with Hayek-Kirzner], which is inescapably an individual function, but because, in the absence of competitively determined money prices for the factors of production, possession of literally all the knowledge in the world would not enable an individual to allocate productive resources, economically within the social division of labor.’

In short, the entire Hayekian emphasis on ignorance and ‘knowledge’ is misplaced and misconceived.” (Rothbard 1992: 19–21).

The difference between Mises’s and Hayek’s idea on the price system is summarised by Salerno:

“The price system is not—and praxeologically cannot be—a mechanism for economizing and communicating the knowledge relevant to production plans. [which is position of Hayek – LK] The realized prices of history are an accessory of appraisement, the mental operation in which the faculty of understanding is used to assess the quantitative structure of price relationships which corresponds to an anticipated constellation of the economic data. Nor are anticipated future prices tools of knowledge; they are instruments of economic calculation. And economic calculation itself is not the means of acquiring knowledge, but the very prerequisite of rational action within the setting of the social division of labor. It provides individuals, whatever their endowment of knowledge, the indispensable tool for attaining a mental grasp and comparison of the means and ends of social action.” (Salerno 1990: 44).

“There is a significant implication of our interpretation of Mises’s critique of socialism. Although the market economy has perfectly solved the problem of economic calculation—its very existence attests to the veracity of this conclusion—praxeologically, at least, it is on all fours with socialism with regard to the knowledge problem. For the imperfection of knowledge deriving from uncertainty of the future is a category of all human action, which cannot be overcome by recourse to the market price system, entrepreneurial alertness, the competitive discovery process, and so on.” (Salerno 1990: 48).

So according to the Misesians both a market economy and a socialist planned economy are subject to the “knowledge problem.”

According to the Misesians, the primary reason why a socialist, planned economy cannot work is (allegedly) that it lacks money prices for factors of production.

II. Hayekian Prices as Signals that Solve the “Knowledge Problem”
Secondly, we have the role of prices as signals for communicating knowledge in Hayek’s thought.

Salerno argues that Kirzner’s entrepreneurial discovery process is derived from Hayek’s view of prices as communicating knowledge to ignorant market participants so that their ex ante plans for production and consumption are coordinated (Salerno 1993: 126), even though Kirzner himself recognises that exogenous change thwarts such a long-run equilibrating tendency and that the market is “never in or near a state of equilibrium” (Salerno 1993: 128).

But Hayek apparently held a different view. Even when Hayek abandoned his belief in the real existence of an equilibrium state and the belief in strict ex ante plan coordination, he still required a real world condition of close correspondence or proximity to such a state (Salerno 1993: 127–128).

Salerno contends that:

“as Hayek points out, in order for prices to fulfill their knowledge-disseminating and plan-coordinating functions, the economy must subsist in a state of what I will call ‘proximal equilibrium,’ wherein realized prices are always fairly accurate indicators of future prices.” (Salerno 1993: 128).

Thus, in Hayek’s view, there is a real-world tendency for “market prices to conform to their equilibrium levels” (Salerno 1993: 128).

Rothbard points to the distinction between Mises’s concept of equilibrium and that of Hayek:

“The Misesian concept of equilibrium is as a remote goal, toward which economic processes are tending, but which they would only reach if divine intervention froze for many years all the relevant data of the economy: values, knowledge, technology, resources, expectations. But for Hayek ever since the 1920s (and for Kirzner following him), general equilibrium, while not actually extant, is right around the corner: in what Salerno calls ‘near equilibrium.’ It is only in near, or virtual, equilibrium, whether that of Hayek, Kirzner, or Schumpeter, that entrepreneurial creativity would be at all disruptive or disequilibrating; in a Misesian market economy, on the other hand, creativity would simply and smoothly change the remote equilibrium toward which the economy will be tending.” (Rothbard 1994: 560).

In a world where the economy is in a state close to equilibrium and prices are normally near their long-run equilibrium values, expectations become “a trivial byproduct of the knowledge culled from past prices” (Salerno 2010: 232). That is to say, Hayekian theory has an utterly unrealistic view of the economy and of expectations. And this is according to Misesians, not non-Austrian critics of Hayek.

On the other side, Kirzner agreed that, for “Mises (as Salerno and Rothbard correctly point out) prices are not primarily signals economizing on the cost of communicating information” (Kirzner 2000: 159), but nevertheless Kirzner maintained the fundamental compatibility of Mises’s and Hayek’s viewpoints.

III. Conclusions

So what are the conclusions from all this? They are as follows:

(1) Austrians are deeply divided on the significance and even truth of Hayek’s “knowledge problem”;

(2) the Austrians cannot get their story straight on what it is that makes rational economic calculation in a planned economy impossible;

(3) there is some merit to the Misesian critique of Hayek, in that the Hayekian idea of an economy normally in “near equilibrium” or “proximal equilibrium” is wholly unrealistic and the role of prices in Hayek’s thought is erroneous.

But the Misesians, even with their criticism, have no better theory.

Both Misesians and Hayekians live in a fantasy world, with respect to the price system. Both are dependent on the notion of universally flexible prices created by the dynamics of supply and demand curves, tending towards their market-clearing values. Both have failed to grasp the widespread reality and significance of fixprice markets and price administration. The real-world and widespread existence of fixprice markets “necessarily means that administered prices are not market-clearing prices and nor do they vary with each change in sales (or shift in the virtually non-existent market or enterprises ‘demand curve’)” (Lee 1994: 320, n. 18). Hence there is no reason why a market economy in general (outside of its flexprice markets) tends to equate supply with demand by means of flexible prices, and “in actual adjustment of supply and demand, prices play only a very subordinate role, if any [sc. role]” (Kaldor 1985: 25; my emphasis).

Hayek’s “knowledge problem” and his attempted solution are mostly a pseudo-problem and pseudo-answer, because Hayek was assuming a world in “proximal equilibrium,” without genuine uncertainty and without a proper role for diverging and subjective expectations.

To the extent that markets have coordination (as opposed to fictitious tendencies to long-run equilibrium states), they do so largely by “quantity signals,” that is, demand, sales volume, and signals from changes in inventories/stocks.

Moreover, profits are actively created and managed by means of cost of production plus profit markup pricing. The profit markup is often stable, which leads to some degree of stability of profits (Gu and Lee 2012: 461). Stable profits in turn allow stable margins for internal financing of investment (Melmiès 2012). The advantages of price setting to businesses include the reduction of the occurrence of price wars, goodwill relationships with customers, and stable selling costs (Gu and Lee 2012: 461). Empirical studies show that, outside given limits, businesses find that variations in their set prices produce no significant change in sales volume, and, above all, when prices are cut, this does not necessarily lead to changes in short term market sales (Gu and Lee 2012: 462). And experiments with prices adjusted downwards to a significant extent show that this causes a severe blow to profits, so severe indeed that enterprises quickly abandon all such experiments (Gu and Lee 2012: 461).

This is the reality of prices in a capitalist economy.

There is a further criticism of Hayek’s knowledge problem that can be made, according to Michael Emmett Brady.

Brady argues that Hayek’s concept of uncertainty and the role of knowledge are quite distinct from that of fundamental uncertainty as defined by Frank Knight and Keynes:

“Uncertainty for Hayek means that each individual decision maker only has a small piece of the puzzle. However, as a whole, the aggregated set of all decision makers have a complete set of all relevant knowledge. There are no pieces missing, lacking or unavailable from the puzzle. Market prices organize and synthesize the aggregate amount of knowledge so that market price signals, understood only by savvy, knowledgeable entrepreneurs, [eliminate] … any uncertainty.” (p. 14)

“Keynes, Knight and Schumpeter deny Hayek’s claim that the market generates price vectors which concentrate the knowledge so that savvy, knowledgeable entrepreneurs can act on this information and solve the problem of uncertainty. Uncertainty means vital important information is missing. Pieces from the puzzle are missing and will not turn up in the future” (p. 14).

“Hayek could not accept the standard concept of uncertainty as defined by Keynes, Knight and Schumpeter because it would then be impossible for market prices to concentrate knowledge that did not exist. In conclusion, nowhere in any of Hayek’s three articles on Knowledge in Economics in 1937, 1945 and 1947 does Hayek deal with the standard view that uncertainty means knowledge that is not there.” (p. 15).

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