Why are Hayekian triangles the shape of a triangle? Why not two axes with an irregular line between them?
Let's pretend the yield curve doesn't exist and there's actually a linear relationship between time and the interest rate. That still doesn't guarantee that it should be a triangle. Although in that case the marginal cost of capital is linear over time, the marginal cost of capital at the point that it is equal to the marginal product of capital need not have this linear relationship with time.
Another way of posing the question is, why can't higher order processes be very heavy in the addition of factors of production, lower order processes be very light in the addition of factors of production (but perhaps time intensive). Or vice versa to such an extreme extent that the capital structure is hyperbolic rather than triangular.
This seems to make a big difference when we get around to:
1. Empirically looking at changes in the capital structure, as Andrew Young does in his forthcoming RAE article, and
2. Thinking about how the capital structure rebalances during a downturn.
And yet I've never heard anyone really ask this question - why is the Hayekian triangle a triangle? I'm not sure if there is a good answer, and if the answer is "there's no reason for it to be", I'm still not quite sure what all the implications of that are.
Second, Ryan Murphy has some really great thoughts up on ABCT and QEII. Everyone should read through it carefully. Ryan can correct me if I'm wrong, but I think Garrison offers this to us on pages 161-163. This section of my book is laced with outraged margin notes. The reason, as you might guess, is his neglect of the liquidity preference theory of interest in presenting the Keynesian argument, which allows him to easily refute it later on.
What is new that Ryan brings to the discussion, I think, is thinking about these dynamics in the context of QEII, IOR, and money demand.
Enjoy.
UPDATE: Ryan shares these thoughts over email - "Garrison had the supply curve moving rightwards because they were increasing savings at the expense of consumption (I, too, see no reason for this to screw things up). What I have is a leftward shift in the supply of loanable funds as consumers build up greater cash reserves. Or in the case of today, banks continually stockpiling money so they can earn more interest."
John Papola and Russ Roberts' new Keynes v. Hayek video is up. It is very high quality and entertaining, like the last one. I have a few reservations about the content, though (also like the last one) - but it's still worth a watch.
First and foremost, is this really "the fight of the century"? The contrast between Keynes and Hayek just seems so artificial to me. I've always been a proponent of what's been called "Hayekian micro" and see no contradiction with Keynes on that front. In some ways, Hayekian micro is more consistent with Keynesianism than more traditional neoclassical micro. As for Hayekian macro, I've always thought there was something to that too (Keynes thought there was something to it as well), it just doesn't seem to provide a viable counter-argument to the liquidity preference theory of the interest rate, and therefore it doesn't displace Keynes. Keynes still provides the best view of the macroeconomy that we have, and I think Hayek provides a good treatment of a more specific process that probably also goes on. Of course, when we juxtapose Keynes and Hayek it's often a stand-in for the libertarian and non-libertarian strains of the classical liberal tradition. OK, fine. There is some conflict on that front. But they seem to be allies in the liberalism vs. fascism or liberalism vs. central planning fight. In economics itself their conflict doesn't really exist in any real way in micro (Keynes didn't weigh in there and there's nothing about Hayek's micro that contradicts Keynes), and their conflict in macro is fairly marginal compared to other macro fights (I know it doesn't seem this way from some corners of the blogosphere, but it really is).
Another issue with the video is that Keynes is referred to as "central planning", "top-down", "chessmen moved on a board at a whim", etc.. Oh please. If this is artistic license, then OK. As I said, I enjoyed the video and don't want readers here to get the impression that I'm disparaging it over what amounts to artistic license. The concern, though, is that people that are starting to get interested in these subjects and are relatively new to Keynes and Hayek are going to get a very skewed idea of Keynesianism.
A recurring problem in this video is that it distorts Keynesianism in much the same way that the first one did - namely, Keynesianism is reduced to "C+G+I=Y, so if we boost G we boost Y". This is exactly what you're supposed to learn that Keynes was not saying. John and Russ are confusing accounting identities with behavioral laws. They're confusing a static economy with a dynamic Keynesian economy. This is a very bad habit in economics. In the last video, we had the Austrian theory of the interest rate, but no Keynesian theory of the interest rate. In this video we have neither theory. So once again, John Papola gets hung up on this "you can spend on anything - it doesn't matter" issue. That sounds very strange if you think that Keynesianism is "if we boost G, we boost Y". It makes more sense when you realize it's about government note creation - Keynes's version of the helicopter drop.
Econometrics makes its way into this video as well, in some funny ways. First, I'm not sure why the Hayek character thinks that econometricians have a predisposition to Keynesianism. Any macroeconomic theory is going to have its cadre of econometricians and empirical evidence. Second, it's odd that Russ keeps making this claim about how unscientific this work is... we're still waiting for Russ's "Great Austerity Hoax" post about the Heritage analysis where two economists formerly affiliated with GMU use exactly the same models that stimulus advocates used!
Another thing that might be worth noting is that the Austrian inferiority complex comes out here, as in the last one. Hayek isn't recognized at the door again and gets a cavity search (the Hay-eksplosives line was great!), he loses in the end despite punching out Keynes, etc. This is all a little silly too. Hayek won a Nobel Prize. He's widely recognized as a towering figure in economics. He's not a marginal figure. Keynes is lionized too, of course - and for good reason. And he's not celebrated today despite being proven wrong. He's celebrated because most of what he predicted has been borne out by the data. We can note that you can squeeze Austrian theory into the data too if we are so inclined. Predictions about interest rates and inflation that Keynesians got right are a little embarassing for some Austrians, but you can make a case for them. But it's simply not true that Keynes has been knocked out here. John and Russ and many others want to ascribe Keynes's success to politicians - because apparently politicians love Keynes (you could have fooled me - I thought everyone's been trying to outdo each other on deficit reduction). Personally, I think it's more than a little condescending for John and Russ to keep repeating this sort of thing. Politicians get elected on promises to "rein in spending" - you don't see me going around saying that the only reason Hayek is having a revival is that politicians love him. I know that's condescending and I know that's simply not true, despite the apparent coincidence between what some politicians say and what Austrians say. That's not the reason why a large share of the profession is coming around to ideas they had rejected for decades in the case of Keynes or Hayek.
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So in summation, it's a great video. It's always tough to talk critically about this or the last one because I do think there's a degree of artistic license and I do thoroughly enjoy the videos. But you have to be careful with these as well. I think people could really enjoy this if they come at it knowing something about the economics of Keynes and the economics of Hayek. But for less informed viewers, a lot of these videos can be extremely misleading. And the "central planning" lines, etc. are very unfortunate - even from an artistic license perspective. It makes me less interested in taking part int he discussion if that's what "the other side" thinks of me, and I'm sure I'm not alone. If you want to fight with a central planner over the pretense of knowledge go find a central planner, and stop wasting your time with Keynesians.
- This is an old post on the prospect of a Keynesian-Austrian synthesis. Also here and here. I sketched out some of the math on this a couple weeks ago in response to a conversation at Coordination Problem where - again - commenters insisted on this false choice between Keynes and Hayek. I hope to finish that this fall. The posts above actually don't get into exactly what that entails - essentially I was working on an IS-LM models with a capital structure. Or, if you prefer, a capital structure model with a liquidity preference theory of the interest rate.
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What are people's thoughts on the video? I want to draw people's attention to my new comment policy - I'm not going to put up with drive-bys anymore.
UPDATE: One more point I meant to mention on the substantial WWII segment in the video. I think the episode is suggestive, and it's suggestive in clear favor of Keynes - but it's very hard to make much of it because as Hayek says in the video, it's just one datapoint. However, one of the things that bothers me about this talk about WWII is the idea that all wars are all waste. I am always stunned that people talking about WWII from a Bastiatian angle are so loathe to note that keeping fascists from dominating Europe was a very, very good thing. War is hell. It's not something to be excited about. It causes lower standard of living at home. It does all these things. But Nazis are more hellish, and I wish people would do less insinuating about how the draft tinkers with unemployment figures and be more explicit about the fact that those soldiers were fighting for a free world.
Tyler Cowen challenges Bob Murphy and ABCT on the grounds of what he considers to be an embarassing co-movement of investment, capital maintenance, and consumption during the boom. Murphy had originally claimed that investment and consumption can move together because capital maintenance is neglected.
A few obvious questions emerge from this explanation from Murphy. The first one that comes to my mind is also mentioned by Cowen - why would monetary expansion encourage investment but not capital maintenance? Wouldn't those same low interest rates that encouraged malinvestments also encourage capital maintenance? It seems to be an awfully convenient thing for Murphy to grab for.
But the whole discussion also reminded me of something that Hayek said in Prices and Production (lecture 2) that has bothered me since I first read it. It solves the co-movement problem without resorting to Murphy's capital maintenance explanation. The problem is, I'm not sure why we should believe this "solution". Hayek writes:
"The raison d'etre of this way of organizing production is, of course, that by lengthening the production process we are able to obtain a greater quantity of consumer' goods out of a given quantity of original means of production. It is not necessary for my present purpose to enter at any length into an explanation of this increase of productivity by roundabout methods of production."
So Hayek says that you don't even need to resort to the neglect of capital maintenance. Investment and consumption move together because the lengthening of the capital structure makes investment more productive.
I wish he had explained it more because I see absolutely no reason to think this is true. He's not talking about technological progress that happens to elongate the capital structure. He's simply talking about increased roundaboutness itself. Why does that - in and of itself - make things more efficient? Does anybody believe this?
This line always bothered me for precisely the reason that I think Murphy's explanation bothers Cowen - it seems like a very convenient solution to the problem that is also conveniently short on details, citations, or empirical support. Take this assumption away and (it seems to me) you still have a theory of the business cycle that makes some sense (unsustainable changes in the capital structure - malinvestments that might need to be liquidated later on), but one that seems less binding theoretically (why can't we just grow into these malinvestments - clearly some roundabout production is necessary, and regular growth rates should allow us to eventually make use of investments that, just a few years ago, where malinvestments) and less convincing empirically (Tyler's co-movement problem reemerges).
Jorge Nascimento Rodrigues interviews William White, the former chief economist at the BIS and currently employed by the OECD, about a Keynesian-Austrian synthesis. White suggests that Keynesians need to drop "neo-Keynesianism" and incorporate more of the Austrian School and Minsky. He makes the same case in an earlier paper here.
It was an interesting read, but I thought a little lacking. The most he took from the Austrian school was a warning against pro-cyclical policies. That's fine, but its not really exclusively Austrian. Who does support pro-cyclical policies? Nobody that I'm aware of. It's also very unclear about where he comes out on policy - he seems to forcefully advocate fiscal policy, but then he seems to only incorporate the Austrians as a caution against fiscal policy (except for one point where he briefly alludes to Hayek on secondary depressions).
He seems to be heavily influenced by Axel Leijonhufvud, and is thus not sympathetic to Hicksian Keynesianism. The fact is, Keynes was not sympathetic to Hicksian Keynesianism either, but I personally think that was a mistake.
I've said in the past quite clearly that I think what the Austrians bring to the synthesis is a treatment of the structure of production as it relates to interest rates. Keynes himself thought that basic idea made sense (see section 2). He just didn't think it seemed like a substantial enough process to form the centerpiece of an economic theory (and I tend to agree with him on that). So White ends up not even mentioning what I think is probably the most important piece that the Austrians bring, dropping one of the more important advances in Keynesianism, and being generally wishy-washy about implications. Still - it's another voice in the chorus noting that Keynesianism and the Austrian school need not be at war - we just have to be smart about integration.
Another good example of how to approach it from Matt Yglesias - and he calls it "Austrian" which is very good. (I previously blogged on empirical Austrian economics here, here, here and I'm sure some other places).
One thing I've harped on is that you can't just point out what everybody knows - that investment spending and prices are more cyclical than consumption spending and prices - and call that "empirical evidence for the Austrian school". Why? Because any business cycle theory worth its salt predicts this or can accomodate this.
To offer empirical evidence for Austrian business cycle theory what you really need to do is break out the structure of production by its time structure, demonstrate that investment and employment over that time structure is sensitive to the interest rate, and demonstrate that unsustainable roundabout investments are a result of money creation and drive the bust. Showing that "cheap money causes asset bubbles" doesn't cut it. That's just common sense and its really not the central point of ABCT as Hayek or Garrison espouse it anyway.
Yglesias offers a start, simply by breaking employment losses out by industry (well, he shares a guy at NPR that did this). He is by no means the first to do this and this is by no means sufficient but it seems to me to be a hell of a lot better than a lot of what's out there. It's an industry-based approach at least, which is bizarrely rare in the empirical Austrian literature. Here is his chart:
What is wrong with approach this as Austrian? Well, first and foremost I would have liked to see job loss rates rather than total job losses. The point of ABCT is that more roundabout processes have to contract to a greater extent, not that the total number of people employed in more roundabout processes has to be the highest. To call this "Austrian" I would also like to actually identify a time structure to the production process. Retail seems to be very close to the consumer. Finance seems much farther away except for consumer finance. Leisure and hospitality are very close to the consumer, but a lot of professional services are much farther away (although some, like legal services, may be closer). Transportation and administration are interspersed all throughout the time structure of production. Yglesias titles this "Austrian", and people see construction and manufacturing way over on the left hand side, and I think that gives the illusion that we have something like a time structure of production here. We don't.
I also think we oughta take into account secular trends in these industries. Health care is indeed close to the consumer, and manufacturing is indeed farther from the consumer on the Hayekian triangle. But health care has been growing before, during, and after the downturn, and manufacturing has been shrinking (in employment at least) before, during, and after the downturn. We need to differentiate secular from cyclical trends here and not attribute this to the business cycle.
This may seem like much ado about nothing from me. But I think it's very significant and extremely encouraging that a liberal blogger like Matt Yglesias even knows enough about "the Austrian School" to connect sectoral trends with this "Austrain School", and map it out in an effort to roughly empirically verify the theoretical insights. The Austrian school is on the upswing, guys. This is good. But it has to withstand scrutiny and empirical verification. I have taken great personal interest in seeing that that gets done right. I think if you want this upswing to last and not just be a footnote to the Tea Party fad, one important shift is going to have to occur: you are going to have to abandon knee jerk praxeology that rejects empiricism and the scientific method or you are going to stay wallowed in heterodox irrelevancy. Keep your affiliated praxeologists and rebrand them as "social epistemologists" or something. Let them make their case if they can on their own. But for God's sake don't tie the millstone of praxeology or libertarian politics around the neck of a quite interesting, quite plausible business cycle theory that is just starting to pierce through to the mainstream.
UPDATE: The comment section on that Yglesias post is utterly pointless. Nobody is taking a cue from the title or talking about ABCT. There was very little of it in Yglesias's post to discuss, granted. But nobody took the bait from the title. Still got a lot of work to do on ABCT education.
I know "Austro-Keynesianism" rolls off the tongue easier, but I just can't bring myself to put the Austrian school first.
Anyway, in response to Steve Waldman: YES. Steve jumps into a debate that's been going on for a couple days about "hangover theory" and "morality plays" and a lot of other quite roughshod framing and comparison of Austrianism (which rarely gets named explicitly) and... I don't know... "general gluttism": Keynesianism writ large to include all descendants of Thomas Malthus and occasionally Jean-Baptiste Say. Steve writes:
"Austrian-ish “hangover theory” claims, plausibly, that if for some reason the economy has been geared to production that was feasible and highly valued in previous periods, but which now is no longer feasible or highly valued, there will be a slump in production. It wisely asks us to consider not only the prosperity we measure today, but the sustainability of that prosperity going forward. I am not “Austrian”, and have no interest in defending specific claims regarding the roundaboutness of activity or the role of central banks in causing bursts of quasiprosperity. But as Brad DeLongwisely reminds us, it is good to be somewhat catholic in our evaluation of macroeconomic schools, and to take what is useful from each. I consider myself Keynesian at least as much as I am Austrian, but I recognize good and not-so-good offshoots of both schools. (Austrian and Keynesian ideas are more complementary than most people acknowledge. The Austrians focus on unsustainable arrangements of real capital, while the Keynesians focus on unsustainable arrangements with respect to money, debt, savings, and income. I think both approaches are fruitful.)".
I don't agree with all of it, but I agree with the general thrust of the post. This whole "schools of thought" approach to macroeconomics seems sillier and sillier to me by the day. What we are doing is hitting on various and sundry economic processes that show up in varying combinations from time to time. And yes, sometimes we're just wrong too. But for the most part what separates "schools of thought" is not their rightness or their wrongness but their applicability in any given situation.
So why do I still call myself a "Keynesian"? Partly because a lot of people still think and talk in terms of schools of thought so I'm in a way forced to take a side (or too cowardly to resist... whatever the case may be). Partly because my formative years as an economic thinker have been in the midst of a classically Keynesian depression. But a lot of it is because I agree with Keynes that he presents (and his descendants have elaborated on) a genuinely general theory that tells us how what we think of as traditionally "Keynesian" depressions can occur, but also tells us how other things can occur as well. In other words, Keynesianism has a better chance of incorporating and featuring the insights of others in its more general theory than vice versa.
I provide some discussion of what I think of as fabricated "differences" between the Austrian school and the mainstream in the comment section of this recent Coordination Problem post, and I also talk a little about what I think the real differences are (the irreconcilable differences being methodological, and the reconcilable differences being analytic).
First Brad DeLong - you've gotta appreciate this: Austrians as the "mutant descendants" of Marxism. Now that sounds pretty cool even if you're not a DeLong fan, doesn't it? I wish I was someone's mutant descendant... ya'll would probably say I'm the mutant descendant of John Law or something, I don't know.
BTW - I kinda sorta defended you guys against Brad recently here.
There are problems with prominent non-Austrian treatments of the Austrian school to be sure, and I'll try to highlight those and highlight what I like in the Austrian school (yes, there are a few things I do like). I'll muster more moral indignation when I see a higher share of Austrians being reasonable in their approach to Keynesianism.
...and IMO, people should temper their outrage at a post with goofy Grecian dialogue and mutants.
It's been a pretty busy week or two with the NSF application, so I haven't gotten a chance to jump into Lecture 2 of Prices and Production as easily as I was able to review Lecture 1. On top of that, readers know that this lecture can be pretty confusing at points. Talking through some of these difficulties with Jonathan and EdP has helped me understand the chapter better, which is great - that's what these reading groups are for. I have a collection of thoughts I want to share, though, in at least two posts.
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1. W.C. Mitchell: First, I want to reiterate a point I made earlier about Hayek's treatment of W.C. Mitchell (p. 225), which I think was a little much. Hayek writes "I cannot agree that Professor Wesley Mitchell is justified when he states that he considers it no part of his task "to determine how the fact of cyclical oscillations in economic activity can be reconciled with the general theory of equilibrium, or how that theory can be reconciled with the facts." On the contrary, it is my conviction that if we want to explain economic phenomena at all, we have no means available but to build on the foundations given by the concept of a tendency toward equilibrium.". The statement is a little vague on the part of both Hayek and Mitchell. I'm not sure exactly what Mitchell means by "how that theory can be reconciled by the facts" (I'm not very familiar with him). Is he talking about working up a new theory that better fits the facts? If that's the case, then I think that's perfectly legitimate. If he means that he has no obligation to seek out a correspondence between fact and theory, then I don't agree with that. It's also unclear what "tendency toward equilibrium" Hayek is referring to, but I'm wary of the claim that we are forced to build on the equilibrium theory we've always had. Many other economists besides Mitchell were concerned about the correspondence between what he observed and the existing equilibrium theory. The two that I know best are Joan Robinson at Cambridge and Edward Chamberlin at Harvard. Both independently developed theories of monopolistic competition in 1933 precisely because of the perceived inadequacies of the "foundations" they had received in explaining the facts. Hayek sees his project as taking a foundation and moving forward with it. That's fine, but I can certainly sympathize with people who have less reverence for former foundations.
2. The time structure of demand: When I first read Keynes's account of Bohm-Bawerk's views on roundabout production (well, when I read it for the second time I suppose, because I didn't see as much significance in it when I read it the first time), it sounded really odd to me. I had by that point learned ABCT through Garrisonesque emphasis on the structure of production. Keynes, on the other hand, talked about roundaboutness in terms of the time structure of demand (demands that are less immediate support more roundabout production). That sounded weird, although the conclusions essentially worked out the same. What's interesting is that that's largely how Hayek approaches the question, at least in his discussion on page 226: "What I have here in mind are not changes in the methods of produciton made possible by the progress of technical knowledge, but the increase in output made possible by a transition to more capitalistic method of production, or, what is the same thing, by organizing production so that, at any given moment, the available resources are employed for the satisfaction of the needs of a future more distant than before." I think a lot of modern renditions of ABCT move away from this question of the time structure of demand, although many of these still note that facet of the theory (Garrison, page 48).
3. Assumed productivity of roundaboutness: Hayek asserts but does not explain why more roundabout methods of production are more productive. He writes "It is not necessary for my present purpose to enter at length into an explanation of this increase of productivity by roundabout methods of production. It is enough to state that within practical limits we may increase the output of consumers' goods from a given quantity of original means of production indefinitely, provided we are willing to wait long enough for the product" (pg. 227). I wish he had taken the time to demonstrate the point. Abstracting away from actual improvements in technology (as Hayek does and which I agree is appropriate to do), the primary impact that time will have on productivity is through interest costs and inventory costs. Indeed, these are the determinants of the relative productivity of a given "roundaboutness" when Keynes discusses Bohm-Bawerk (and I imagine these are the relevant factors in Bohm-Bawerk too). But there is no presumption that more roundabout methods are more productive. Does anyone know what Hayek is referring to here? Clearly, we may also get into his reasons for claiming this in future lectures.
4. Income, expenditures, and capital: I want to clarify for fellow readers that the numbers in Hayeks figures represent expenditures, not income. This is an issue that took some hashing out in this post on Jonathan's blog. Figure 2 is the clearest. The level of income in the economy (i.e. - GDP) is 40 here. The level of total expenditures is 120 (80 on intermediate goods, 40 on final goods). The savings rate, as far as I can tell, is 0%. Figure 3 is more confusing. Income is 30 in this figure because 10 is saved. Total expenditure is still 120 (90 on intermediate goods, 30 on final goods). What is confusing is that Hayek is still not including capital as a factor of production. So capital investment - which we normally think of as "final output", and income from capital - which we normally think of as part of income, isn't included at all! I'm hoping in subsequent lectures these will be brought in, but right now its a little confusing. We've just removed a portion of income because it's not counted as income to an "original factor of production", and we've removed a portion of output because it's not "consumer output" (although at another point - p. 236 - he says that capital is intermediate goods... so at that point it is included in the model, but it's still not a factor of production earning income!), so an important portion of economic output and income (i.e. - capital and capital's income) just evaporates from the model. On page 231 he writes "interest is then received by the owners of the original means of production with wages and rent", but then he completely neglects this point later when he has the original means of production earn 30 instead of 30 + interest. I'm guessing when capital is explicitly introduced later (as he promises) this will all get cleared up. But it's off to a muddy start.
5. Unused resources: Hayek acknowledges that the question of why some resources lay idle is something that needs to be explained (pg. 224). This is good, but he also insists that we should not start there. He writes "it is not true that the existence of unused resources is a necessary condition for an increase of output, nor are we entitled to take such a situation as a starting point for theoretical analysis". This is kind of an odd approach in my mind, particularly with his original point that we have to start from a foundation of theoretical equilibrium. Why should we expect unused, idle resources to emerge from a system that is assumed from the outset to be stable? Aside from frictions and disturbances, we generally wouldn't. So you can see where Hayek's business cycle theory is heading from the very beginning - by virtue of how he chooses to conduct his analysis, it's going to be some external force such as government that is going to be required to disturb the system, by virtue of how he sets up the problem. Hayek says the starting point has to be the full employment of resource (p. 224). Why? He gives no reason at all and it's not clear to me why we should assume that idle resources emerges from full employment of resources and theorize it as such. Hayek suggests we theorize such that full employment is normal and then explain why idle resources can happen. The alternative, of course, is to theorize such that full employment or idle resources are natural. What's especially strange about this point is that Austrians have always critiqued Friedman for his version of positivism, which rejects the need for realistic assumptions... and yet Hayek is here engaging in what I think can fairly be called "unrealistic assumptions" (Garrison did this too and it was one of my biggest complaints about him - for details, see this post).
6. The role of the entrepreneur: On page 236, I think there's an interesting discussion of the role of the entrepreneur, "whether the structure of production remains the same depends entirely upon whether entrepreneurs find it profitable to reinvest the usual proportion of the return from the sale of the product of their respective stages of production in turning out intermediate goods of the same sort. Whether this is profitable, again, depends upon the prices obtained for the product of this particular stage of production on the one hand and on the prices paid for the original means of production and for the intermediate products taken from the preceding stage of production on the other." So again, the terminology is a little confused... profit is the difference between costs and revenue (so far so good), which means that it is a portion of the value added at successive stages of production. This would suggest that the entrepreneur is included in the "original factors of production". That's fine - it's a special type of labor, specifically it is labor that organizes the structure of production. What is still confusing, of course, is this reinvestment question. So now income from capital seems to be included in the original means of production (because it's the entrepreneur's profit). But since capital right now is still just intermediate goods (see p. 236) it's completely removed from the income figure (which, by 239, declines from 40 to 30). What you need is to bring capital and capital's income explicitly into the model. Garrison does this - Hayek may do this in the future.
7. Aggregates: I just want to note that this lecture is chock full of aggregates. One of the frustrating things to me about complaints from Austrians about using aggregates (aside from the fact that the complaint is simply misguided) is that they regularly use aggregates in their own work. Anyway, you should note the use of aggregates when you read and then maybe reevaluate how damaging aggregates really are and how sincere Hayek's later critique of Keynes on this front really was.
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OK - I should have another post on the capital structure itself as I finish the lecture. So far, this has been a very confusing presentation. I think there are much better modern renditions of ABCT than this (I would say the same for Keynes, btw - he has some great insights in the General Theory, but his exposition of the mechanics of the theory itself are not as good or clear as later revisions). Obviously I'd point readers to Garrison because I'm the most familiar with him - but aside from that I think he is widely recognized as being one of the best expositors of ABCT. His approach is not without problems, but I think it's tighter than Prices and Production so far. However - we are still near the beginning!
I want to quickly share this article in The Economist on the Austrian school. It's a nice, accessible overview. Probably no readers here need anything this basic, but still good to see.
It raises the question of why nobody pays attention to the Austrian school. I think there are two reasons:
1. The version of malinvestments highlighted in the article is not exclusive to the Austrian school at all. I don't know any economist that wouldn't say "credit was cheap, it was poorly invested, and when everyone realized this the market crashed". Now, the arguments for what caused the cheap credit varies... some blame the Fed, some blame the Chinese, some blame the federal government, some blame the market's inability to price credit correctly on its own. There are more Austrian and less Austrian versions of "credit was cheap", but you can get the rest of the story from any school of thought. So why go to the Austrians for the simple point that when money is sloshing around people make bad decisions?
2. Austrians do a good job explaining the boom and bust, but then sort of stop. This is my opinion at least. There's nothing about the distortions or the malinvestments that I fundamentally reject. My concern with the Austrian school has always been that it doesn't recognize the even greater damage that can be done by the demand deficiency induced by a financial crisis that wreaks havoc on balance sheets. Sometimes you get a "secondary deflation" story from Austrians, etc. But you don't get everything that Keynes gives us. I think a lot of people see Austrians engaging in fundamental fallacies when talking about aggregate demand and then are tempted to just plug their ears about the rest that Austrians have to say.
There is good reason for hope on both points! On the first point, even though you don't need the Austrian school at all to explain the dangers of cheap credit, what's unique that the Austrians do provide is insights about the capital structure. In other words, you don't need Austrianism to warn you about cheap credit - but Austrianism will tell you how the danger of cheap credit may manifest itself. That story oughta be told. On the second point, there's reason for hope because as far as I've been able to tell there is no conflict at all between Keynesian aggregate demand dynamics and Austrian business cycle theory (conceived of as the artificial elongation of the capital structure). Many Austrians challenge Keynesian aggregate demand stories but (1.) they're wrong, and (2.) nothing in that challenge is required to make the Austrian capital structure arguments.
So... good article in The Economist, and I maintain my hopes for a synthesis of sorts.
"Words ought to be a little wild, for they are the assault of thoughts on the unthinking" - JMK
- The Wall Street Journal describes Robert Shimer's suggestion that sticky wages are a major contributor to the current depression. Shimer, of the University of Chicago, is one of the major figures in the worker flows/job flows literature that I'd like to work in in graduate school. He may very well be right that sticky wages are a factor here. How much, I don't know. It seems pretty hard to deny that this is a balance sheet recession, and I'm not sure what would lead me personally to put any undue weight on wages. But I'm sure it's part of the story. So what's the best way out of that, and what can we expect from more flexible wages in the current environment? For the answer to that question, I'd advise going to the nineteenth chapter of the General Theory.
- Brad DeLong shares an anecdote about Keynes from Skidelsky: "when Keynes lectured at Cambridge about monetary theory, he would begin by reading an article from the FT (or occasionally the Economist), and then ask: "What is the theory that lies behind this argument? Is it coherent? Could it be correct? How can we find out?" And that is how he would teach monetary theory at Cambridge."
- Brad DeLong also comments on how a macroeconomics course should be taught now. No explicit mention of capital-based macro, although I think he's thinking of that sort of thing with his second bullet point ("The theory that high unemployment today is the unavoidable consequence of past overinvestment"). This probably isn't entirely satisfying to Austrians (no detailed mention of roundaboutness, etc.), but should it really be entirely unsatisfying either? I've never gotten a straight answer on this "malinvestment vs. overinvestment" point. When I emphasized the malinvestment facet that Hayek emphasizes in a blog post several months ago, I got a sharp reply from Jonathan insisting I knew nothing about Austrian economics. But whenever you call it an overinvestment theory they get bent out of shape too. If you act like it's a sectoral readjustment model, you're wrong - if you act like it's an overinvestment model with some sectoral features, you're wrong - if you act like it's a general overinvestment model, you're wrong. It's a moving target. Rothbard claims that it is "overinvestment in higher stages" only, Skousen here suggests it is undifferentiated overinvestment. Mises here seems to argue that malinvestment in earlier production stages is the point (much like Rothbard). Sechrest presents a combination of malinvestment and overinvestment here. Garrison (pg. 81, Time and Money) also notes that the Austrian school is both a malinvestment and overinvestment theory (and that malinvestments alone would be inadequate), while Anderson calls perspectives like Garrison's a "willful distortion" of Austrian economics (here, of course, Anderson is critiquing Krugman specifically, not Garrison). Jonathan presents a view much like Sechrest's here and here. Jonathan says "So, for those who continue to claim this overinvestment nonsense as an interpretation of what I write, it is only due to your lack of understanding of Austrian business cycle theory," while Garrison writes "over-investment is a critical enabling aspect of the theory. Without the over-investment, the malinvestment would be as short-lived as Hicks's critical remarks suggest". For Jonathan, overinvestment is "nonsense", while for Garrison it is "critical". How are non-Austrians supposed to navigate this? How can Austrians navigate this? Is it perhaps time to consider the prospect that, non-Austrians are not the ones that have understood you wrong, but that it is Austrians who have explained it inconsistently and in an extremely confusing way? I initially just wanted to share the DeLong link and ask what Austrians thought of his second bullet point. Then I figured I had to qualify it or else I'd be confused of distorting things. I generally approach the issue how Garrison does - that's how I think of ABCT. But please, share thoughts -and do it without accusing others of being ignorant.
You can find it here. It's gated, but if you subscribe you can read it. I'm not sure how long it takes articles to migrate from "Online First" to the journal itself. Yay! Working with the Review of Austrian Economics has been a very good experience - I'm grateful to Steve Horwitz for encouraging me to submit here.
Jonathan Catalan is organizing one and I'll be participating in it. The book, where Hayek outlines his version of what has come to be called Austrian Business Cycle Theory, is organized as a set of four lectures. We'll be reading a lecture a week or so, and Jonathan will kick off the discussion with a blog post. He invites other bloggers to post on it as well and cross link, which I'll likely be doing. I think this is a great format and if this is successful it should not be the last of these.
The Mises Institute provides the book for free here. The first lecture starts on page 221.
Feel free to join in - maybe leave a post on Jonathan's blog to let him know and thank him for organizing this.
The post is a decent catalog of some of the problems with Krugman's take on things, a good start for explaining the congruence of the crisis with ABCT, but a very bad attempt to draw conclusions from that.
1. First, Murphy is right to point out indices of decline rather than absolute declines (which Krugman does). Construction has seen a higher rate of job loss than manufacturing, which is of courses consistent with ABCT.
2. Murphy notes that Austrians opposed a suite of government actions. He writes: "Now say what he will about the Austrian economists, surely Dr. Krugman will concede that they opposed the above actions, and that they would have predicted at any time that these policies would lead to economic stagnation". It's true that they opposed these actions, but then again Krugman said many were inadequate or just plain wrong too. It's worth probing what each side predicted the effect would be. Krugman (and I for that matter) suggested we would have continued deflation and low interest rates. Not all, but a sizable portion of Austrians predicted inflation and high interest rates. This makes sense - both of those results are easily derived from Keynesian and Austrian approaches, respectively. So Krugman and the Austrians were both right here - but who was right for the right reasons? Generally speaking, I'd say Krugman.
3. Robert Murphy is being entirely disingenuous when he writes this: "In contrast to the Austrian story, what does the Keynesian view predict? Well, if a recession is really just about a general drop in aggregate demand, then we shouldn't see any particular relationship among individual sectors, and how they respond both in magnitude and across time. If you reread Krugman's commentary on his chart, that's exactly what he himself says the Keynesian story means." What can spark a demand shock? Lots of things, of course - but one major cause is a popped bubble that leaves people with a lot less income and wealth than they previously had. Murphy abstracts away from the bubble completely and acts like this is all a question of the capital structure and roundaboutness. You can't remove the housing crash from this narrative - that was the aggregate demand shock which brought the rest of the economy down. The question shouldn't be "how do Keynesians account for the construction employment" - that's obvious - there was a housing crash after some standard bubble psychology and bad policy. The question should be "how do Austrians account for the breadth of unemployment". Clearly the basic rebalancing of the capital structure can't explain this. You need some story about malinvestments as overinvestments or overproduction in addition to the standard malinvestment story. The case can be made, but the onus doesn't seem to be on the Keynesians.
4. So where do we end up with Murphy? Well he's using the same fallacious logic that I had to correct from him with my 1920-21 depression paper. Is this downturn consistent in some important respects with ABCT? Sure. Of course it is. My feeling is that that is because ABCT is a logical and accurate theory of a real macroeconomic process. So of course you're going to see it in the real world. Does that mean the Keynesian explanation is wrong or not also consistent? Of course it doesn't. These are not mutually exclusive processes that we're describing here, and the theories that you're promoting are only mutually exclusive because you have defined them as such. You don't just assume that oil embargoes can't cause recessions because you've attached the "Keynesian" or "Austrian" label to your lapel, do you? No - because the supply shock of an oil embargo isn't inconsistent with additional demand shocks or capital structure adjustments. Robert Murphy lives in a Manichean world, not a scientific world. He wants economic theories to engage in a battle of the titans. This was how it was with his explanation of the 1920-21 downturn too. For Murphy, if ABCT fit the facts (he didn't make that much of a case that it did - he barely talked at all about the capital structure), then Keynesianism couldn't fit the facts. Part of this was simply because he grossly misunderstood Keynesianism, but a lot was also because he couldn't accept the fact that under some circumstances Keynesianism and ABCT predict much the same thing.
So long story short, I think Murphy makes some decent points and a good beginning of a case for ABCT, but draws some very bad conclusions from it.
OK so a little while ago I blogged on how fricken paranoid people over at the Mises Institute were. You had a great New York Times article covering the influence of Hayek and Bastiat and they managed to be insulted by it. They just knew there had to be some sort of nefarious motive behind the Times article. The author was a known liberal, and the thinking was that that liberalism had to spill over into what she was writing. There was no way that a liberal could be dispassionately interested in reporting on the influences on the Tea Party. And they even admitted that you had to "read between the lines" (i.e. - make shit up) to get this.
So they're back at it. First is Jeff Tucker responding to Ben Bernanke's speech. In any other economics blog you could have woken up this morning to lots of good commentary about the economics of Bernanke's speech. Jeff pulls out one passage where Bernanke highlights the simple point that inflation is a function of both (1.) the money supply and (2.) expectations - he takes the point about expectations and he says that Bernanke is saying "If inflation goes wild, it is your fault for not trusting the Fed". Persecution complex, just like before. Something is seriously wrong with the way Jeff Tucker sees the world.
The next one is J. Grayson Lilburne who writes a long post disputing a year and a half old anonymous Youtube video criticizing the Austrian school. Lilburne makes some good points - the video was a little sloppy on some claims. The thrust of the video, though, is fine and similar to points I've made on here. But the point is it's an anonymous Youtube video that's pretty old as Youtube videos come. How defensive do you have to be to see that and think "I need to go and write a response to this thing!"? If I wrote an extended critique of every poorly reasoned video disputation of Keynesianism it would (1.) be all I write about on here, and (2.) probably crash the Mises.org server from all the searching I'd be doing on their video library.
Paranoia and hypersensitivity is not a healthy quality to have in a community of scholars. There are days I wish the Mises Institute would just convert into a publishing house and leave it at that. And I've thought of saying this out loud for a while but have withheld - I really think Jonathan Finegold Catalan's considerable talents are wasted on the Mises Institute. I understand it's a great venue to get started at. God knows breaking into publishing is tough for young scholars. But I think Jonathan would be better off getting out of the Mises echo chamber. Or at least submit things to the QJAE if you submit there.
Speaking of publishing in Austrian venues, I got the official word last weekend that my article on the 1920-21 depression was accepted for publication in the Review of Austrian Economics (it had been in an R&R holding pattern for a while). They're typesetting and all that right now - very exciting stuff.
Mario Rizzo has up what Peter Boettke has called a "rallying call" to Austrians. There's a lot of intro stuff about how Keynesianism is a "religion", how we "rationalize, complicate, and immunize against criticism", and how Keynesianism set us on the road to serfdom - etc., etc.. I still find it really disappointing that these smears and suspicions still go on. I take cracks at Austrians, of course. And certainly I don't prance around the issue when I find an Austrian point unconvincing. That sort of thing is fine, but this assuming the worst about the other side gets really old. Anyway - I want to get that out of the way because it's laid on pretty heavy in Rizzo's post. But then, if you just skip down to the beginning of the seventh paragraph of the post you get to the really important stuff that Rizzo brings up:
"Of course, the consequences both for policy and the future of economics depend on the interpretation of the financial crisis and the Great Recession. What caused them? What policies are conducive – or at least do not inhibit – recovery. (My late colleague Ludwig Lachmann used to say, “People no doubt learn from experience, but what do they learn?”)
Austrians failed to carry the debate within the economics profession and among the public intellectuals and economic historians after the Great Depression. Will they once again?...
[more "Keynesianism is a religion" stuff]
... Yet there is a critical deficiency. We continue to lack empirical work, on a large enough scale, to convince other economists that we have something relevant to say. The macro-economic framework has created a demand and supply for certain kinds of aggregated data at the expense of data that might be more useful to Austrians. (But I am reminded that George Stigler used to say, “It is no excuse to say the data are not available – you just must be clever.”)
This is where, perhaps, those non-Austrians with a similar mindset may be very important. We need good empirical researchers. I am, quite frankly, not interested in reviewing all of the qualms about certain kinds of econometric work. No single econometric result is definitive but little by little a case for taking a theory seriously can be built.
As I have said many times, I am not a macro or monetary economist. I entered into to all of this discussion as a political economist. I saw (and still see) the fate of free institutions and decent economic policy in the balance. With a little bit of luck, lots of hard work, and a smart sense of making intellectual alliances, we can do better than Ludwig von Mises and Friedrich Hayek did during the Great Depression and its aftermath. We have their legacy as well as the new legions to make the case."
I agree whole-heartedly with the point that the area where the Austrians could make the greatest inroads is by taking up empirical work. Notice what guys like Krugman (sorry, he's the best example despite his lack of currency in your community) say when they dismiss what he calls "liquidationism". He gets the theory wrong, of course - but he doesn't say readjustment doesn't make sense as a concept (what economist would?) he says he doesn't see it in the data. When I discount regime uncertainty arguments which have been virtually adopted as a part of the Austrian school, I don't say that it doesn't make sense. In fact I claim it makes a lot of sense and it is certainly one factor. I just say it doesn't seem to show up as a primary element in the data. Some Austrian arguments are a little unfamiliar to people, but the critique usually isn't that they're crazy or wrong-headed. It's that they're interesting and plausible but don't seem to be a major feature of what we see.
Which begs the question - is that true or not? It's not like people have been doing rigorous empirical tests on behalf of the Austrians or anything. Usually the "I don't see it in the data" claims are just eye-balling the data sort of statements. So there's a lot of potential work to be done here.
Several times before (including in the comment section of Rizzo's blog) I've advocated a specific empirical project that I think would be especially fruitful for Austrians or non-Austrians interested in the Austrian school (like me) to pursue. I think there needs to be a reunion of sorts between the Kiel school and the Austrian school. The Kiel Institute of World Economics was founded in 1914 in Germany, but the in the crucial pre-Nazi years (1926-1931) it was headed by Adolph Lowe. Lowe's research on the business cycle focused on multi-sector readjustment and endogenous business cycle theory (as opposed to the previously disparate theories of economic equilibrium and the business cycle). His work would go on to inspire two towering Nobelists that took the insights of the Kiel school into two very different directions: Wassily Leontief and Friedrich Hayek. Hayek's work on multi-sector understanding of the business cycle doesn't need elaboration. Leontief, for those of you who weren't aware, developed the now famous input-output tables produced by the Bureau of Economic Analysis and I would assume many other statistical agencies across the world. IO tables are matrices that detail the inputs for different industries from other industries and the subsequent products produced by those industries (or the subsequent industries where their outputs are used). From a policy perspective, the IO tables were instrumental in economic planning. But from a theoretical perspective the revived Walrasian general equilibrium theories most famously in the work of the Cowles Commission.
That's all history, though. What is most relevant, I think, is that the Bureau of Economic Analysis publishes tables of the structure of production and the production and use of progressively higher order goods. My empirical analysis of Austrian business cycle theory would look something like this:
1. Take the columns of a "Use of Commodities" table and scale them by the "sum of final uses" column minus the "private investment" and "inventories" column. This is the y-intercept of the Hayekian triangle.
2. Subtract out value added by these scaled sectoral contributions. This leaves the value of the intermediate goods used as inputs.
3. Use the IO table to allocate the scaled inputs left after subtracting the value added to the various sectors supplying inputs to final goods producers.
4. Repeat steps 2. and 3. until subtraction of the percent of output that is value added reduces output to zero.
This iterative process should leave you with a rough view of the capital structure. It will incorporate the complications that Garrison and Hayek mention (that different industries can appear in different stages). It will also produce the value of output at each stage (so you don't have to assume a linear Hayekian triangle), and the sectoral composition of each stage (this way you can attach things like labor market information to each stage of production to test ABCT labor market theories). I see one major problem with this method: you don't have a measurement of time. You can get several iterative stages, and you can get the incremental reduction in output for each stage, but you can't get the incremental increase in time for each stage.
I don't think this is a major obstacle, although it's certainly a caveat to include. The way I read ABCT, a lot of the lengthening of the capital structure is due to compositional shifts. Producers rely on higher and higher order goods, they don't just take a longer time working through the same production process. If that's the case, then the lack of a specific time increment for each stage of production in my method shouldn't be too problematic.
So what to do with this? Well, the BEA produces this information for 1997-2008, which is a good place to start. I'd simply map out a Hayekian triangle for those years and see how it shifts over time, to begin with. Then I'd try to see whether changes in the interest rate influence the shift. After that, I'd see how labor markets at each stage change in response to changes in the Hayekian triangle.
Ultimately, ten years of data is not nearly enough to establish an empirical relationship between changes in the interest rate and changes in the capital structure. If ABCT is right you oughta be able to see it pretty clearly in the 1997-2008 period - and that's good - the problem would be that that would remain more anecdotal without more data. The BEA produces benchmark IO tables back to the forties, but they only did them every couple of years. You could impute intermediate years, but that may be harder. The data might not be high frequency enough to look at a period beyond 1997-2008. The next place to look would be other countries that more regularly collect this information. The problem is, the countries that were on the ball collecting this information were usually countries where central planning was going on, which makes them poor test cases for ABCT dynamics.
That's my idea - it's been stewing for a long time. When I dangled the idea out on Rizzo's blog in this older post it didn't get any bites. Maybe people will be more interested now.
If any young scholar (or hell, even a more established one) wants to collaborate with me on this and write a paper on it, I would be happy to. I have a pretty busy fall, but could at least get started - and then the spring definitely looks clearer. Empirical work is the way to go. As I've said in the past, I (as a Keynesian) think Austrians overstate the extent to which a lot of their stuff is really rejected by the mainstream. All the market process stuff, all the subjectivity stuff, all the efficiency of free markets stuff maybe emphasized or phrased in slightly different ways, but there's really no monolithic conflict with the mainstream on that stuff. The biggest difference and biggest contribution is ABCT. It's worth testing. That let's you understand the veracity of your theory, perhaps improve upon it, and it also lets you convince others and most importantly assess how important it is for actual economic downturns.
It's always surprising to see areas where Austrians or libertarians pronounce that there is some sort of disagreement where there really isn't. It makes me wonder (1.) how much of the rift is caused by misconceptions, and (2.) what am I asserting about Austrians or libertarians that they actually agree with me on?
Two things bring this to mind - first, Jerry O'Driscoll responded to a point on Coordination Problem about demand deficiencies and the impact on the labor market. O'Driscoll responds (quite politely), "There is more to unemployment than a "labor demand deficit." I have a post at ThinkMarkets on the issue." The post he's refering to is very good - I read it several days ago when he first posted it. It's on labor heterogeneity and you can read it here. It's unclear, I suppose, whether he thought that I was saying demand deficiency was all there was to the labor problem. I never said it was all there was to it, so I don't see why someone would assume that that's what I thought. It's the major issue right now, though. Anyway - I know this is minor, but it was surreal to be pointed towards labor heterogeneity by a guy like O'Driscoll. I've been well aware of the issue of labor heterogeneity and the kinds of things that it leads to for quite a while - it's important in a lot of the New Keynesian literature and it was something that I had written on for school long before I even heard of the Austrian school. This is pretty common-ground stuff. This was a more ambiguous case, but it just makes me wonder if O'Driscoll realizes he's preaching to the choir. Hopefully he realizes that and is just sharing a new post of his (God knows I self-promote).
"According to an article in the September 6th issue of the New York Times, more and more “experts” are now saying that the government should not try to prop up the housing market but should let prices adjust to their correct levels as rapidly as possible.
Well, you read that here as early as November, 2008 and then again in March 2009. It is part of the continuing myopic harping on aggregate demand which ignores all of the relative price adjustments that a post-bubble economy must experience. The Keynesian habit of ignoring the causes of depressions and dealing only with the analytically-secondary phenomena of aggregate expenditure is or should be unacceptable among intelligent economists.
I repeat what I said in 2008: Let the housing market collapse — fast."
Can someone clarify to me in what universe an aggregate demand or Keynesian perspective thinks that relative price adjustment shouldn't occur or is unimportant? The whole idea is that even when relative prices adjust naturally - as they should - aggregate equilibria can still be below full employment. Keynesianism assumes and expects the adjustment of relative prices - there is a call for price level stabilization, but explicitly and implicitly you don't touch or distort relative prices. I'm not even sure how distortion of relative prices even makes sense from a Keynesian position - it's not simply that Keynesians have never raised an argument against microeconomic efficiency, it's that there's nothing in their macroeconomic inefficiency story that would justify doing anything about relative prices.
So what exactly does Rizzo have in mind here? I had no idea, so I asked. He came around to saying "I am simply saying that if you concentrate exclusively on aggregate demand you would look at the decline of housing prices as bringing about a negative wealth effect and thus (further) decline in demand." This, of course is a very different claim. Yes, I would agree - if you plug your ears and close your eyes and pretend microeconomics doesn't exist at all (i.e. - "concentrate exclusively on aggregate demand"), then you will end up saying some dumb things. Who does that, though???
Keynesian macroeconomics assumes an underlying microeconomic foundation. You can't simply erase that microeconomic foundation and call it "Keynesianism". Neoclassical microeconomics is the microeconomic assumption of Keynesian macroeconomics. You'll see all kinds of frictions and asymmetries and fun things like that introduced, but none of that roams outside of neoclassical microeconomics.
It just gets a little silly to single out Keynesians on a post where the simple point is "housing prices need to deflate" - I point that has been made repeatedly across different economic schools of thought. As I said to Rizzo, I've always interpreted the home price shibboleth as being pushed by politicians who are concerned about the homeowner vote. Odd stuff.
As with most misunderstandings like this, it's a human fallacy rather than a fallacy that any single group is prone to. I'm sure I do it too - are there any areas that I comment on where Austrians/libertarians think "Surprise! I agree!"? Is there any area where I regularly make strange, needless conflict?
UPDATE: Joe Stiglitz, Keynesian grand poo-bah, certainly doesn't find aggregate demand thinking to be an impediment to basic points about relative price adjustment.
Also - I coined a term for this in a prior blog post: the "presumption of ideological orthogonality", or the idea that "because I think X, and their group disagrees with my group, they must think not-X". It's a bad assumption to make.
Commenter Barbarossa asks me for my opinion on this selection from Mises on externalities, as well as examples of cases where I think Mises is vague and confused. Thankfully, I'll be able to kill two birds with one stone.
Mises actually starts off quite well. The whole first half of the piece is fine (with the exception of the first paragraph which offers an odd little romanticist, inverse-Marxist genesis of the state). I was initially thinking my only comment would be to raise a few critiques of the coercion of tort law. Mises leads with a pretty standard explication of externalities, but then it all starts to head south when he lists "two alternatives" facing a market actor considerin a positive externality. This was the tip-off for the degeneration of the piece, and this is precisely where Mises could use some of Tom Sargent's precision. Mises offers two options:
1. The agent enjoys the project in question so much he'll do it anyway even if it means giving away free benefits to the "gullible masses" (Mises's words lower down - not mine), or
2. One person alone can't benefit enough from the project so it's not done unless many people band together.
What could clean this up that math might help with - where to start. Three things come to mind:
a. A little aggregation that recognizes we're never talking about a single investment decision but a family of similar investments
b. A distinction between extensive and intensive margins, perhaps, and
c. Marginalism anyone?!?!?! Menger would be rolling in his grave if he read this selection.
It's not just that there's no math. That's not necessary. I talk about these issues all the time on here without using any math. There's the complete absence of an understanding of any of these concepts in the discussion and it shows as you continue reading.
"A project P is unprofitable when and because consumers prefer the satisfaction expected from the realization of some other projects to the satisfaction expected from the realization of P. The realization of P would withdraw capital and labor from the realization of some other projects for which the demand of the consumers is more urgent. The layman and the pseudoeconomist fail to recognize this fact. They stubbornly refuse to notice the scarcity of the factors of production. As they see it, P could be realized without any cost at all, i.e., without foregoing any other satisfaction. It is merely the wantonness of the profit system that prevents the nation from enjoying gratuitously the pleasures expected from P."
OK, here he has completely abandoned his earlier points about externalized benefits. He says essentially that consumers prefer other projects with higher internalized benefits, and then goes on to blame "the layman and pseudoeconomist" for the alleged crime of ignoring opportunity costs - when the real problem is that Mises himself forgets what he wrote just a few paragraphs earlier about external benefits. He blames other economists (or in his passive-aggressive words, "pseudoeconomists") for something as ridiculous as ignoring opportunity costs (who is guilty of this? of course Mises never says*) when he forgets the problem he identified in the first place with the consumers' choice to forgo projects with externalized benefits. He says the unnamed "laymen and pseudoeconomists" think that the project could be realized "without any cost at all". Excuse me? And you all blame Keynes for erecting strawmen? Who, precisely, thinks this? Can anyone provide an answer? Barbarossa?
He goes on to describe the mainstream response - a little ham-fistedly but more or less accurate, and then continues:
"For every unprofitable project that is realized by the aid of the government there is a corresponding project the realization of which is neglected merely on account of the government's intervention. Yet this nonrealized project would have been profitable, i.e., it would have employed the scarce means of production in accordance with the most urgent needs of the consumers."
Once again, he completely forgets what he himself wrote about externalized benefits at the beginning of this piece! The alternative project is only profitable because of the distortion of the property rights regime. Profit maximizing is not the same thing as welfare maximizing. Profit-maiximizing means that you've made all the tradeoffs necessary to maximize all internalized net benefits. Mises is essentially complaining that "these mainstream economists are wrong when they try to maximize total net benefits because now they're not maximizing internalized net benefits!". Who the hell cares about maximizing internalized benefits? In what universe does that meet any sort of reasonable welfare criteria? It makes zero sense. He goes on:
"The gullible masses, who cannot see beyond the immediate range of their physical eyes, are enraptured by the marvelous accomplishments of their rulers. They fail to see that they themselves foot the bill and must consequently renounce many satisfactions they would have enjoyed if the government had spent less for unprofitable projects. They have not the imagination to think of the possibilities that the government has not allowed to come into existence."
A twofold confusion on Mises's part here. First, he assumes strict crowding out. Of course you can never assume that. But let's say we're at full employment of all factors of production and you can assume that. Again, he's essentially saying "these mainstream economists are wrong when they try to maximize total net benefits because now they're not maximizing internalized net benefits". If he had any rigor in his writing. If he at all applied what he should have learned from Menger, that is how this paragraph would have read. That is what he is saying - and that is absurd on its face. Any undergraduate that pays attention in micro would laugh at that. The concluding three paragraphs just work through the crowding out theme, and doesn't require much treatment. If crowding out is going on and there's no legitimate externality then of course Mises is right - it's elementary.
Mises demonstrates that he (1.) doesn't understand marginalism, (2.) doesn't understand or at least can't apply the concept of externalized costs and benefits, (3.) doesn't understand what other economists argue, and (4.) makes extremely cavalier assumptions about things like crowding out. This is very sloppy economics.
I have read reams of Hayek that I've found quite enlightening. Some Hayek I thought he put the emphasis in the wrong place, and in a few points (mostly methodological, as I've said before) I think he's actually wrong. The same with Rothbard, actually. I've read a lot that I like from him - he most definitely puts the emphasis in the wrong place in many instances and he has Mises's flare of being entirely ignorant of what the opposition thinks (or at least if he's cognizant of what his opposition thinks, he strawmans it for rhetorical purposes - which may be the case). I've never had this feeling with Mises. I've read a couple chapters of Human Action, a chapter or two of Liberalism, and the odd essay of his that gets thrown up on Mises. So as Mattheus regularly points out, I really don't know Mises. But in what I have read I've come across nothing of value yet, which has not been my experience at all with Hayek, with Rothbard, with Garrison, with Ropke, with Lachmann, or with any of the GMU crowd (Don Boudreaux is slim pickings, I must admit though). I sincerely do not understand why Mises has the following that he does.
I have no inclination at all to read one of Mises's books - but please, pass on selections from him and I'm happy to read and review them like this. I like to like people. It would be great to say "hey that's a good point" to something other than his ability to start an essay by correctly defining "externality" or explain something as basic as opportunity cost. This is not a promise to read whatever you suggest - so if you suggest something, give me a good reason why.
And while I did not find much of value in this piece, I do want to express my gratitude to Barbarossa for sharing it with me.
*Mises is not the only Austrian guilty of this bizarre, uncited accusation regarding the opportunity cost of factors of production. A couple weeks back Steve Horwitz at Coordination Problem, asked "Other than EWOT [Economic Way of Thinking, an Austrian textbook], how many intro books derive the supply curve using an approach that emphasizes the rising marginal opportunity cost of alternative uses of the inputs?" My immediate reaction was "how the hell do you get a supply curvewithout talking about the opportunity cost of alternative uses of inputs?" I couldn't even conceive of what an alternative explanation would be. I promptly found ten textbooks that talked about it. It wasn't hard because... well... every textbook on the market talks about it. Why do Austrians think other people ignore this stuff? Why do Mises and Horwitz accuse others of ignoring it without any evidence that they do? When they spread untruths like this, you get younger Austrians running around spouting complete fabrications about "mainstream economics".
Daniel Kuehn is a doctoral candidate and adjunct professor in the Economics Department at American University. He has a master's degree in public policy from George Washington University.
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