Friday, October 3, 2014

Forty Years After the Hayek Nobel: Thoughts on Israel Kirzner

Yesterday I attended an event at George Mason University celebrating the fortieth anniversary of Hayek's Nobel Prize. There were two sessions open without invitation - a keynote by Israel Kirzner and a panel discussion with Eric Maskin, Vernon Smith, and Ed Phelps. I was very much looking forward to hearing Phelps but unfortunately he was ill and his remarks were read. I'll talk about my thoughts on the Kirzner session in this post, and the laureates' session in another.

Israel Kirzner, professor at NYU, was described by Peter Boettke in his introductory remarks as the leading light of the modern Austrian school. Kirzner's work focuses on "the market process" (essentially how agents get to equilibrium - or at least how they get to wherever they're getting to) and the role of entrepreneurship in the market process. Kirzner is very much in that line of Austrians where, if you tell him you're a subjectivist he'd trump that by insisting that he (and not you) is a radical subjectivist. Indeed, "radical" came up several times in his talk, primarily to describe the advances made by Hayek and Mises in the 1937 to 1945 period. Kirzner presented what he called a revisionist history of thought to explain the lack of appreciation of Austrian economics between the late 1930s and the 1970s and the reason for the Austrian revival in the 1970s.

Kirzner's proposition is that after the debate with Keynes Hayek and Mises both turned their attention to other matters and the result was a "radical" advance in our understanding of the market process through Hayek's work on knowledge and Mises's work on socialist calculation and Human Action. Allegedly the mainstream did not appreciate how radical these contributions were and so they missed the boat until forty years later Hayek got the Nobel (for other work), the mainstream refocused their attention on the Austrians, and economists like Kirzner, Lachmann, O'Driscoll, Rizzo, and others were ready to demonstrate what the fruitful advances of 1937-1945 really had to offer. The lull and revival was therefore not all that surprising, and it mainly rested on the failures of the mainstream rather than the failures of the Austrians (a rather attractive narrative for an Austrian of course!).

I don't entirely buy this revisionist history, but what I do like about it is that it refocuses us on the work on knowledge, subjectivism, and economic calculation. I suspect the lull in interest in the Austrian school had far more to do with the failure of Austrian macroeconomics than the failure of the mainstream to appreciate this other work, but I like the opportunity to put the 1937-1945 work center stage nonetheless.

What bothers me about the revisionist account is that it relies too heavily on an implausible story about how mainstream economics is full of dunces. Kirzner argues that mainstream economists are preoccupied with equilibrium models where genuine competition and discovery doesn't really go on and most importantly nobody talks about how you get to equilibrium. There is a germ of truth to this insofar as mainstream economists don't spend a large share of their time on this problem (Kirzner does), but the idea that the market process is lost on them strikes me as misleading at best and borderline libelous at worst. I had to laugh to myself when Kirzner went through these points because just a week ago when I was covering an intro micro class for my adviser we were talking about market equilibrium and optimal decision making, and I posed precisely this question to them - what do agents do when they're not at an equilibrium that gets them to equilibrium? The students had a much easier time providing sound answers to that question than when I threw the Slutsky decomposition at them later in the discussion, and the answers more or less conformed to what Kirzner presents. What's more I think every economist has these market process stories in mind when they think about why getting to equilibrium (even if it's a constantly moving target) is reasonable.

I've made this point about Kirzner before (and it's worth saying at this point that I haven't read a lot of him so if someone that has has thoughts to add, please do), and often people think I'm denigrating the guy. I don't think my point should be thought of in this way. It's quite clear that Kirzner has thought about the market process in more depth and in different ways than other economists. He definitely deserves credit for that. What I challenge is the idea that these fundamental points are lost on the profession, or that the profession has gone down the wrong path by working with models that include a lot of equilibria. It should also be clear that I'm challenging the idea that any of this is really all that "radical".

So far I have a disagreement in the emphases of Kirzner. But I also had a problem with many of his actual claims. One astonishing thing he said was that it is a disequilibrium situation when one agent subjectively values the production of a good at $50 while another subjectively values the use of that good at $100. The entrepreneur, in pursuit of profit, takes advantage of this "arbitrage" opportunity, but an equilibrium perspective misses this entire dynamic that's at the heart of the market process. This is nonsense (although it's possible he didn't explain it as clearly as he wanted to). Even if we imagine a market in stable, boring ol' equilibrium there are going to exist agents that differentially value goods in this way. We call the difference between those values and the market price "surplus", and there's nothing at all outlandish about this point. When Kirzner calls this a "disequilibrium" he is confusing values with prices. Values never have to be brought into equilibrium with each other. A price establishes an equilibrium of behavior in the context of widely varying valuations that are likely to continue to be widely varying. The only sense in which we can talk about values being brought into equilibrium is in the case of the marginal good sold, but even that isn't really bringing values into (out of) equilibrium (disequilibrium), it's simply a byproduct of the marginal behavior of rational actors. So this was just an abuse of concepts.

Another thing I actively disliked about the talk was the idea that the mainstream relies on perfect competition, fully informed homogenous agents, and zero profits. We teach freshman some very dumb models that look like this, but for Kirzner to indict the mainstream of the profession along these lines is not becoming of a guy that's supposed to be the modern leader of the Austrian school. This is the stuff of internet Austrians.

Kirzner is clearly a very intelligent man, and he was an interesting speaker. I think he's thought more deeply about the market process and the economic function of entrepreneurs than most anyone. If I had the time to work through his writing, I'm sure I'd find a lot of value along these lines. But I think his vision of his own research program is deeply problematic and too easily discounts how interesting and intelligent his fellow economists are.


  1. Given this, it seems talk of Nobel Prizes is a howler.

    1. I don't know - this is a good time to stress that I'm not deeply familiar with Kirzner's work. Of course you don't have to revolutionize the discipline or point out deep ignorance in predecessors to get a Nobel. It may very well be that his work on entrepreneurship sans the bombastic criticisms of his colleagues is more than sufficient to get the Nobel. Several people seem to think so. I couldn't say.

  2. Daniel, I think you are mischaracterizing Kirzner's point about entrepreneurship and arbitrage, but you might be right that he didn't articulate his point clearly enough for those unfamiliar with his work. Kirzner wasn't talking about consumer surplus or price discrimination of finished goods. He was talking about the difference between costs and market price (aka profit) or arbitrage in the pure sense (two prices in two markets for the same good). For example, let's say I have a concert ticket to a sold out show that originally sold for $50, and I would have paid $60. You were behind me in line and didn't get a ticket, but you would have paid $100. Kirzner isn't saying that the market is in disequilibrium if I don't sell you my ticket, he's talking about the scalper who has no intention of watching the concert but is willing to stand in line in hopes that he can sell you the ticket at a market price.

    Kirzner talks about entrepreneurial alertness and arbitrage with the following example, "Say there were a locked box with $100 inside. How much would you pay for the key in an auction?" And uses this thought experiment to show how alert entrepreneurs move the market towards equilibrium.

    As for how literally the profession takes (or at least took) the standard micro models of perfect competition is something we talked about, and I still think that at the time, and to some extent today, the models were taken literally instead of as a thought experiment. I mean, surely the perfectly competitive model has had influence on the FTC and anti-trust policy. I do think that the profession is less likely to make this mistake than in the past (whether that is due to Kirzner or not, I don't know), but I know that it's still taught in standard textbooks with little to no caveats.

    1. So I'm still not seeing the difference here. That seems to be what I explained - and it's a difference in subjective valuations. Now if you're saying that when these two parties don't meet there is no equilibrium I'd agree with that, but that seemed to be different from what he was saying. He seemed to be talking about an acting entrepreneur (e.g., a scalper actually selling his ticket) as being an example of disequilibrium economics because of the coexistence of differential valuations. Maybe that's not what he said but he seemed to be saying that to me.

      Now if the point is only that entrepreneurial activity consists of identifying opportunities for capturing surplus, that's fine - but again that doesn't seem all that radical a statement to me.

      I've never been taught perfect competition in the dumb way Kirzner and his ilk suggest we're all taught. Perhaps I just got luck I don't know. And you know I had the same reaction to Vernon Smith on game theory. I've only had one game theory class. The guy talked at length about how the model differs from the real world and why that might be. Not waiting till the end came up in several applications. We worked with bubbles explicitly. Again MAYBE I just got lucky but I see no good reason to think I got lucky. The more sensible answer is that they are presenting an inaccurate picture because it makes their contributions look better in contrast. Not necessarily intentionally of course - this is the sort of insight that distinguishes them, they're just emphasizing that more heavily which is only natural.

    2. I think if Kirzner references value you're right, but in Competition and Entrepreneurship he only cares about the price at the margin. His argument is that we don't know what the demand and supply curve look like, so we might be producing a quantity that is less than (or more than) what would be the case in perfect equilibrium. The entrepreneur's role is to notice these things and to invest (or disinvest) accordingly. Suppose we're producing along the supply curve where q < q*; the entrepreneur can buy his inputs at the price that corresponds to that disequilibrium final product market (to avoid complicating things, let's assume that factor markets do work perfectly, given the [dis]equilibrium price in final good markets) and sell his output at the price that corresponds to q*. That's the pure profit that Kirzner (and Knight) have in mind.

  3. I would say that finding a germ of truth in the statement that mainstream economists ignore the market process is probably a bit too generous, at least in my field of interest (ag & natural resource econ). The question of how markets find equilibrium is particularly interesting for ag commodities because you have long a lag between when a grower decides how much to produce and when he can actually sell his product.

    One popular story for how equilibrium was reached in agricultural markets was the Cobweb Model, which relied on producers forming expectations about future prices by looking at previous prices. In Pigou's Economics of Stationary States, he said that whether markets actually tend toward equilibrium was an empirical question that needed investigation. But he expressed some doubt that all markets had self-equilibriating tendencies and cited the 21 month hog cycle as an example of a market that seems to regularly oscillate without approaching equilibrium (prices go up then down then up again at regular intervals). This is what you expect under certain circumstances in the Cobweb Model.

    Ronald Coase actually took up this point in his 1936 paper on Pig Cycles and using data from Great Britain argued that there was no regular 21 month pig cycle to be observed. This casted doubt on how well the Cobweb Model describes market dynamics and these doubts were picked up by John Muth 1961 paper on rational expectations and price movements. Referring back to Coase's Pig Cycle paper and the Cobweb Model literature, Muth argued that producers actually form expectations about future prices by using all information that they have available to them so that on average they are not systematically wrong.

    In agricultural markets this point that farmers are not backward looks is particularly important, because there are many different ways farmers can plan for the future like forward and futures contracts. And there is now an entire literature (growing since at least the 1980s) on what role futures markets play in "price discovery" (google AJAE for "price discovery").

    At least that's the way I understand it. Now that you've read this entire thing, I should confess that I am still getting my head around this literature (it is only tangentially related to my dissertation so I don't spend much time with it). But I figure that you can't make it as an economist, until you fake it for a while. So if anyone wants to correct me, please do.

    1. Cobweb models are also, of course, famously applied to the science and engineering labor market and we also care a lot about how students make these decisions and many of the best people working in the field have reached beyond econ to talk about that.

      Yes, *I AM* generous :)

      But more seriously, I think to the extent that we acknowledge truth in that statement we have to recognize that people talk about different things in different ways. I'm interested in how agents might grope towards equilibrium in a market for education. Kirzner would probably find how I think about this prosaic and certainly not relevant for pure theory. Entrepreneurialism doesn't play much of a role and he thinks it's essential and fundamental. Certainly I'm happy to make use of models that don't consider this directly or consider it naively and he wouldn't see as much value in that too. Then again there are plenty of people who think he considers the problem naively and unrigorously.

      When the differences descend into different ways of talking about a problem and different interests in different sorts of problem I think the point is to proceed with caution. IMO there was little caution in Kirzner's address yesterday. Mainstream economists missed something BIG and the Austrians had the answer.

      I can't be convinced by something like that, but you know what? It sure makes for one hell of a keynote address :)

      And I definitely learned a few things.

    2. +1

      I'm glad that someone mentioned the Cobweb Model, because that is a perfect illustration of how mainstream economists think carefully about dynamic equilibrium formation and have done so for a long time.

      At a broader empirical level, consider how pervasive the use of lagged prices and quantities is in econometric models of supply and demand. Not only are these formally important in helping to overcome simultaneity/endogeneity problems (for example, in a GMM set-up)... Lagged prices and quantities are useful precisely because they show the dynamic linkages between market clearing combinations over time.

      By including lagged prices and quantities in our regression models, we don't simply assume that each market is a new event independent of history; we understand that there is some "memory" in the system that must be accounted for. Even better, failure to consider relevant dynamics in an empirical setting will typically throw up obvious red flags (autocorrelation, etc).

  4. I envy you, Daniel sounds like it was an intriguing session, even though Edmund Phelps couldn't turn up.

    As for your point on "Radical Subjectivism"...well, I don't think you're the only one who feels that way. Please see the following section in an anthology about subjectivism in the Austrian School of Economics:

    Zappia, Carlo. "Radical subjectivism and Austrian economics." Subjectivism and Economic Analysis. London: Routledge (1998).

    Also...I don't know if American University has a subscription to History of Economic Ideas, but it recently became available on JSTOR. I thought this old special issue on Friedrich Hayek might interest you:


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