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The Austrian School:

Part 1: A Legacy outside the institution
Part 2: Currents in Austrian School; fundamentalism, scholarship, media, etc..
part 3: Financial economics: The Efficient Market Hypothesis
Part 4: Classsical economics and Market Socialism; Updating classical
Part 5: Hayek vs. Central Planning; Hayek Vs. Rational Expectations
Part 6: The Cycle and Rational Expectations; island Parables
Part 7: The Cycle as a Prisoner's Dilemma -- in "Anarcho Capitalism"?
Part 8: 2008 Crisis and Market Efficiency; Keynes vs. Chicago vs. Hayek vs. Warren Buffett

In a post I wrote months ago responding to Droopy's Austrian School cites, I noted some of the eccentricities of the movement and one thing I mentioned that got some attention was the Austrian suspicion of math. What a great find for painting the Austrians as ignorant fundamentalists, and duly, when certain parties hurl the charge of "Leftist" any time Von Mises is disagreed with. But it's also true that positions that seem utterly irrational are often not as bad as they first appear when understood in proper context, and while I think modern resistance to math in the Austrian community strains credibility, I do think at minimum, understanding why Mises and Hayek distrusted math helps in understanding their unique position that has led to the rejection of both the liberal and conservative mainstream. Something to bear in mind as I write this, those of us who took econ 101 in school receive Adam Smith as the father of the free market, but for Murray Rothbard, he was just another socialist. The Austrian world is different.

I proceed now with a caveat. While I'm not an economist, I'm even less of a historian, economic historian, or intellectual historian, and my foray into this territory has been brief. If there is any merit to what I write here, it won't be rigorous history, but the perspective of a former student indoctrinated by mainstream free-market theories trying to understand how it is that a small, but respected little band of libertarians came up with market ideas that in places are 180 degrees opposed to what I understand market economics to be about.

As I understand it, Mises and Hayek were not alone in distrusting mathematics and they certainly were not rebelling against an established social science best known by the theoretical and empirical research of libertarian academics winning Nobel Prizes for their accomplishments. What a formal science of economics might be was yet to be determined. And as I understand it, it was common for academics to distrust formal models that describe real people. Keynes shared these same beliefs, Hayek, in fact, drew more graphs in his life than Keynes did. Keynes's General Theory of Employment is a prosaic work, and though said to define macroeconomics, the General Theory would first be interpreted by Paul Samuelson and published as a textbook called, Economics. This was not just a textbook but the textbook. Ardent critics of Keynes sometimes feign dismay at how Paul Samuelson accomplished such a thing, possibly suggesting that Keynes was incoherent to a degree that Samuelson was pressed to fill in gaps, slighting Keynes's work.

But the core project of Mises and Hayek was not Keyenes. Keynes was a side problem, a way to replicate the problems of communism in another media, as will be discussed in a later post. Their enemy was market socialism. What on earth? Classical, market economics, economics that at its base acknowledges the "invisible hand" of personal greed, married to socialism? "Married" might not be the right word. Perhaps the equilibrium models of the classicists along with all the mathematical formalization that goes with it finds its true end in socialism? Consider the difficulty western thought has had in making distinctions between description and prescription, not to mention appreciating practical limitations of reason or even scientific inquiry. From the force of various intellectual currents, there have been beliefs about how history could be approached as a science in the sense of the past predicting the future, or that (Hegel-Marx) history is headed in a direction toward a predictable end. As evolution got a foothold in genetics, eugenics was on the table. How often do the apologists accuse Darwin as justifying Nazi experiments? If science can understand "economics," if it can reduce people to equations, then ought it be the place of such a science to best anticipate and calculate for the needs of people and even uncover what their needs truly are?

Reading Mises in Human Action, as he makes his protracted case about market pricing, you get this sense that market agents are engaged in a human, blood-and-guts groping, reaching for the true prices of things, while austere central planners use "equations" and "calculus" to make production decisions. You get a sense of where the bias towards math might come from if it's the tool of the central planner. Science fiction often turns in some way on the prospect of people becoming cogs within a cold, uncaring, and mistake-prone system. And if I were a disciple of Mises, first rejecting market socialism, and then witnessing the rise of formal economics in America around Keynes, with graphs and plans about estimating employment such that government can know precisely how much to intervene, then I might worry that math and graphs are part of the problem.

As I understand it, the market socialists, who are best represented by Oskar Lange, abandoned the socialist ideals of people just getting along. They accepted that competition must be the basis for an economy, but had this notion that through trial-and-error market experiments, they could reverse engineer the market process and base production decisions from these calculations. But isn't what's actually behind the graph more important than the graph itself, in this case, real individual preferences and desires clashing? Hayek thought real entrepreneurs taking real risk was something that equations and experimental conditions could never replicate, even if experiments could find clearing points in some static conditions. He might be right about this, though, sending a copy of SimCity back in time for Hayek and Lange to play might make the discussion more interesting. For my purposes, however, a detailed understanding of the calculation arguments are less interesting than the line of reasoning the market socialists used to construct them:

D.W. MacKenzie wrote:Taylor (1929) suggested that socialist officials could emulate market competition- as described in the works of Walras and Marshall...This attempt derived from a close analogy with perfect competition...Perfect competition assumes conditions where the problem of economic calculation has already been solved.

http://www.adelinotorres.com/economia/M ... lation.pdf

(MacKenzie has a blog at LvMI)

To unpack those fragments, first, who was Walras? From wiki:

wiki wrote:In 1874 and 1877 Walras published Elements of Pure Economics, a work that led him to be considered the father of the general equilibrium theory. The problem that Walras set out to solve was one presented by Cournot, that even though it could be demonstrated that prices would equate supply and demand to clear individual markets, it was unclear that an equilibrium existed for all markets simultaneously...Walras created a system of simultaneous equations in an attempt to solve Cournot’s problem.

Walras created a system of equations, "the only work by an economist that will stand comparison with the achievements of theoretical physics," that can describe the economy as a whole. And knowing that equilibrium conditions imply the calculation problem is already solved, what might we infer from here?

Well, who was Taylor? From Wiki:

Wiki wrote:Of a libertarian ideology, he was noted as a clear and rigorous expositor of economic theory in the partial-equilibrium lineage of Alfred Marshall.

In his American Economic Association presidential address, Taylor (1929) laid out the conditions under which a socialist economy could in theory achieve an efficient allocation of resources.

Fascinating. Market socialism wasn't invented by a leftist perverting the gospel, but rather, it was the brainchild of a libertarian contemplating the results of classical economics. Perhaps classical economics isn't as guarded from socialism as lip service to "competition" and "the invisible hand" seem to guarantee?

I think the foregoing helps to understand Austrian positions today. Consider the Efficient Market Hypothesis I introduced in part 3, indeed, if there is a model of a market where the "calculation" has been done, it is here. But does this imply that Austrians see mainstream market models as tending to socialism? If so, I have yet to see this. Perhaps it's accurate to say that from their perspective, Chicago and the socialists demonstrate the two problematic sides of the same coin. As a case in point, economist, hedge fund manager, and Austrian, Frank Shostack writes articles rebutting the Efficient Market Hypothesis. From his work a few years ago published in the Austrian Review, his concludes his thesis against EMH with these remarks:

Shostack wrote:The main shortcomings of the EMH are similar to those of the long-run competitive theories that focus exclusively on equilibrium outcomes while ignoring the entrepreneurial activity that generates those outcomes.

http://mises.org/journals/rae/pdf/RAE10_2_2.pdf

Somehow, the blood-and-gut actions of a human entrepreneur resist the assimilating power of an equation, and the Austrian avoids porridge that is too cold and too hot by shying away from formalism. I will flesh this out in the next post the best I can. EMH, of course, isn't the primary target of today's Austrians, the prevailing monetary theories of both liberal and conservatives are. But these discussions will help digest that discussion.

From a Chicago perspective, a panel of Austrian fund managers could sit on a central planning committee and use their analyst tools to pick out the products that will sell best the next year. The state could direct money into those products, and circumvent all the money wasted from the actual market activity that results in lost investments.

Fantastic posts, Gad. Really, really great.

How on earth do you know all this stuff?

It's instructive to remember that the Austrians were influenced by ideas on human behavior and whether it is possible to study the "mind" that are no longer in fashion. There's a broad skepticism in what we understand to be modern social science. For instance, Von Mises has argued

Epistemologically the distinctive mark of what we call nature is to be seen in the ascertainable and inevitable regularity in the concatenation and sequence of phenomena. On the other hand the distinctive mark of what we call the human sphere or history or, better, the realm of human action is the absence of such a universally prevailing regularity. Under identical conditions stones always react to the same stimuli in the same way; we can learn something about these regular patterns of reacting, and we can make use of this knowledge in directing our actions toward definite goals. Our classification of natural objects and our assigning names to these classes is an outcome of this cognition. A stone is a thing that reacts in a definite way. Men react to the same stimuli in different ways, and the same man at different instants of time may react in ways different from his previous or later conduct. It is impossible to group men into classes whose members always react in the same way.

http://mises.org/th/intro.asp

These ideas are so thoroughly in the dustbin of thinking that unless you meet an Austrian actively advocating them, you might not be aware of where a significant portion of their skepticism in mathematical modeling of behavior is even coming from. Mises was fond of arguing that human action is not a measurable thing. The mental world was treated an impenetrable black box. Many Austrians do not consider mental harm to be meaningful for legal sanction because they regard it as essentially unverifiable. To my ear this reads as an naïve interpretation of nadir behaviorism, which it was, but Austrians have an almost sacred relationship with the original major figures.

thanks JSM -- good to see you around.

Shades, my knowledge here is minimal, but I admit that I have an advantage in that I know reading the entire book Human Action is pointless, so I can spend the same time it would take to read a few chapters of that studying the "pain points."

my knowledge here is far, far less impressive than say, your knowledge of grammar. I will trade any day.

EA- It's time to have a little father and son chat. You may be smarter than your old man and more sober, but sometimes I just can't pin you down. You seem kind of like a "liberal" yet you're a libertarian. So let's have "the talk". Do you believe in the strong form, the semi-strong form, or the weak form of the Efficient Market Hypothesis? I have no idea if you know the answer right off the top of your head or if you have to look it up and think about it. I don't care. But whatever your answer is to this question will tell me exactly what kind of libertarian you are.

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So Droopy has left the board forever eh? And didn't have anything to add here. Oh well, so much for trying to have a discussion with substance, what he said was lacking here. While he is away, I think he should boil down the years of studying he's done and come to grips with his issue over market intervention.

Does he believe policy is bad because people are rational? Because markets are rational? Because information assymetry doesn't exist in free markets? Because government causes information assymetry? All the arguments somehow revolve around these basic points; well you can add things like "heterogeneous capital" for the Austrians per what EA posted here, but that is still not essential in my view given the huge Austrian migration to the "prisoner's dilemma" argument. As "liberals" have taken the bait, (many/most?) Austrians now accept that people are rational -- which is assumed by PD -- and turns the discussion of market failure on information assymetry (though they might not all realize what they're assenting to).

So when Droopy claims the government can't create wealth, is it because he disagrees with fiscal policy and/or monetary policy (macro), and for what reasons -- because of ABC or because of RE? Because he doesn't believe in prisoner's dilemmas or public goods, etc.(micro)? I'm not saying any of these positions are invalid, I am skeptical of government myself, at best considering it a necessary evil in many cases. But Droopy fails to communicate, or better, demonstrate within his communication that he has an actual position on why policy/government fails. Because he mixes positions by pundits like Sowell with the mostly incompatible Austrian positions, it's very hard to figure out what his issue is with government, I'm not sure he understands it himself, though I do believe he has the intelligence and knowledge to figure it out if he's inclined to reason and understanding rather than just blind ideology.

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ps. I have to credit Droopy to a large extent with trying to figure out the Austrian School, but this "series" was not just to argue with him (I figured he wouldn't respond) but a lot of my motivation came from just not finding any satisfactory material discussing the Austrian ideas from non-Austrians, outside of what Bryan Caplan has written online, of course.

Hi Gad,

I'm familiar with the efficient market hypothesis. I had to read about the internal debates over it and I'm not sure where I stand. My inclination would be semi-strong. Up to this point, I've believed that the market can be delayed in how quickly actors' information is incorporated into the price - thus allowing insiders to take advantage for instance - but you asking this question makes me think about how much and what that means in a way I haven't before. I don't know. Coincidentally, a few minutes before you were writing that post I was writing this post about Intrade:

http://www.rottentomatoes.com/vine/show ... count=1039

I believe that market price is the collective sum of information about people's preferences and people's projections about others' preferences that is so complicated that it is superior to any planners' ability. Thus planners are doomed to misallocating resources in egregious ways. Hence Venesuala screwing up their sugar market. This was at the heart of Hayek's critique of communist central planning, so I'm not entirely down on the Austrians. They, well Hayek in particular, tend to be reliable for critiques of collectivism if not for their own economic theory.

As far as my libertarian cred goes, here's a thread from the same board that I'm reserving for pimping my preferred candidate this election:

http://www.rottentomatoes.com/vine/show ... ?t=2275823

I don't want to endorse everything Johnson might think, but we are extremely close in terms of positions and priorities.

Semi-strong eh? Sounds about right.

heh, you have far more libertarian cred than I do. I was curious though about how this translates into some of these ideas. thanks.