|
PureBytes Links
Trading Reference Links
|
Group-
Some time ago; there was a question about how the
Austrian School of economics differed from
the other schools of economic thought. Here's
an article on that subject.
Chas
====
----- Original Message -----
From: <A
href="" title=article@xxxxxxxxx>Mises Daily Article
To: <A href=""
title=article@xxxxxxxxxxxxxxxxx>Mises Daily Article
Sent: Friday, August 01, 2003 8:09 AM
Subject: An Austrian in Grad School: Confronting the Mainstream
<A
href=""
target=_self><IMG border=0
src="">
<FONT color=#002864
size=1>
<A
href="">http://www.mises.org/fullstory.asp?control=1285
<FONT color=#002864
size=1>
An
Austrian in Grad School: Confronting the Mainstream
By Robert
P. Murphy
[Posted August
1, 2003]
<A
href=""><IMG
align=right alt="" border=0
src="">Because of their minority
status, most budding Austrian economists must endure graduate training in the
mainstream orthodoxy before earning their Ph.D.s. As a recent graduate of New
York University, I thought it might be useful to highlight some of the major
differences I perceived between Austrian economics and the neoclassical, New
Keynesian paradigm. The following list is by no means exhaustive, nor do I claim
that it represents the essential tenets of Austrian theory. However, I hope my
discussion will encourage current graduate students to keep their spirits up and
finish their dissertations.
<FONT face="Verdana, Helvetica"
size=2>I. MethodThe most obvious difference between the
Austrians and the mainstream is the choice of method. The Austrians start from
the fact that human beings act purposively to achieve their subjectively chosen
ends. From this "action axiom" the Austrians (in the tradition of Ludwig von
Mises) derive as many implications as possible. So long as the deductive chains
of reasoning are free from error, the conclusions reached are a priori
true, containing as much validity as a proof in Euclidean geometry.
The mainstream, in
contrast, practices economics by the construction of simplified models of the
world. From the outset, unrealistic assumptions are made when establishing the
"laws" governing behavior in the artificial world being studied. Typical models
contain either one or a continuum ("uncountably infinite" number) of agents, who
usually live forever and have the selfish preferences mocked by critics of the
homo economicus view of man. Macro models will very often have only one
or two goods in the entire economy.
The justification
for such admittedly unrealistic assumptions is a pragmatic one; because the
mainstream economist is concerned primarily with the determination of
equilibrium states in the model, the equations describing such states
cannot be too difficult to solve. Appeal is often made to the natural sciences,
and above all else to physics, where simpler models are sought which best
"approximate" the results of Nature. On this point, all I will say is that the
Austrians <FONT
face="Verdana, Helvetica" size=2>have certainly devoted more careful
thought than the mainstream to
the methodological problems involved. The Austrians have argued that economics
is an entirely new branch of science, whose problems are not at all suitable for
the approach of physicists.
II.
Individual ChoiceIf you study Austrian economics, you will
learn that a central tenet of the school is methodological individualism.
This means that for an Austrian, an "explanation" of an economic phenomenon must
ultimately start from the choices of individual actors. This doesn't mean that
Austrians only focus on "micro" phenomena; indeed, many of the most important
Austrian insights involve macro problems such as unemployment and inflation.
Nonetheless, even here the Austrian always couches his analysis in terms of the
incentives and behavior of the typical individual, in order to understand the
aggregate effects that require explanation.
On a formal level,
the neoclassical mainstream too involves the individual and his subjective
preferences. An equilibrium state (in a market setting) is defined as a set of
prices and behaviors for each agent such that every agent maximizes his utility,
given his budget and the (exogenous) prices. However, notice that even at this
stage there is a problem: If everyone acts as a "price taker," i.e. if
everyone takes market prices as data to which behavior must be adjusted, then
how do these prices get established in the first place?<A
href="" id=_ftnref1
name=_ftnref1 title=""><SPAN
class=MsoFootnoteReference><FONT face="Verdana, Helvetica"
size=2>[1]<FONT face="Verdana, Helvetica"
size=2>,<A href=""
id=_ftnref2 name=_ftnref2 title=""><SPAN
class=MsoFootnoteReference><FONT face="Verdana, Helvetica"
size=2>[2]
On this point,
another difference between the Austrians and the mainstream is the latter's
focus on indifference. In an equilibrium state, an agent in a
neoclassical model is indifferent to any small change in his consumption
decisions; an extra penny spent on any available good (so long as the agent has
purchased at least some of the good in question) will yield the same increment
in utility. The Austrians, in contrast, stress that human action involves the
choice of a over b, where alternative a must be
strictly preferred (as demonstrated by the choice itself).
Beyond this,
however, there is another sense in which the mainstream focuses on indifference.
This occurs when, because of the assumptions going into the model, the analyst
wants to ensure that no trading takes place. In these cases, the goal of
the analyst is to find the prices necessary to ensure that the individual agent
(who doesn't care about the economy-wide constraints) doesn't want to
trade.
For example, I had a
macro exam question in which there was only a single, perishable consumption
good; in this world, physical saving was impossible. Moreover, all agents were
identical, and so there was no room for intertemporal exchange at all. The
question asked, "What is the equilibrium interest rate in this economy?"
The answer was to find the interest rate at which every (identical) agent would
be happy to consume his endowments every period, rather than altering his
consumption path through exchange (which was impossible by
stipulation).
In another exam
question, I was told that a single agent owned a tree, which would periodically
yield fruit (the consumption good). The question asked the equilibrium price of
a share to the tree. Inasmuch as there were no other agents who could buy
the tree, this seemed an odd question. But again, the point was to find the
price of a share such that the agent would be indifferent between selling
ownership of the tree (to a nonexistent second party) versus retaining ownership
and consuming the flow of fruit dividends.
III.
MoneyIf I could pick just one area of economic theory in which
the mainstream is weakest, it would be money. Simply put, there is no role for
money whatsoever in the typical mainstream model. In a hyper-rich general
equilibrium model, there are markets for every conceivable good, in every period
of time, in every possible state of the world, and agents have either perfect
foresight or rational expectations (in which there is no systematic bias in
predictions). In this setting, there is no need for a unit of account or medium
of exchange, because all future actions can be specified (perhaps contingent on
random events) in the initial period. On the other hand, grossly simplified
macro models contain only one or two goods, and hence render a medium of
exchange superfluous.
Naturally, the
mainstream models (especially macro ones) do contain money; there is
simply no other way to deal with issues such as inflation and Federal Reserve
policy. But in order to get the agents of the model to hold money, all
sorts of ad hoc assumptions are employed. For example, the desire for liquidity
might be built right into an agent's utility function, so that cash itself gives
satisfaction the same way owning a Picasso might. Another approach is to assume
"cash-in-advance constraints," in which the agent needs a certain amount of
money in order to complete transactions.
The problem with
these remedies, of course, is that in the world of the neoclassical model, there
is generally no reason for an agent to gain utility from money, or for
firms to insist on cash-in-advance. This problem casts doubt on the use of the
models themselves; how do we know that "optimal" Fed policy in the model will
translate into the real world, when the true function of money is absent in the
model?
In contrast to the
ad hoc approach of the mainstream, the Austrians have a solid grasp of the place
of monetary theory in economics. Indeed, even an unbiased historian of economic
thought would acknowledge that <A
href=""><FONT
face="Verdana, Helvetica" size=2>Ludwig von Mises was one of the earliest and
strongest proponents of a
unified theory of exchange, in which marginal utility analysis explained not
only the valuation of consumption goods, but of units of money as
well.
IV.
TimeAnother huge difference between the Austrians and the
mainstream is the former's emphasis on time. Although the mainstream has
improved considerably on this issue—most notably in the work of Sir John
Hicks—nonetheless the Austrians have a superior grasp of the time
structure of production. Austrian theory does not avoid the heterogeneity of
capital goods, and the tremendous problems this heterogeneity poses for
long-term coordination of production and consumption plans.
The typical
mainstream macro model, in contrast, still assumes that there is a single good,
serving as both capital and consumption,<A
href="" id=_ftnref3
name=_ftnref3 title=""><SPAN
class=MsoFootnoteReference><FONT face="Verdana, Helvetica"
size=2>[3] and
that the entire body of produced means of production in an economy can be
summarized by a single number indicating the "capital stock." Moreover, it
is typical to "solve" macro models not merely by calculating the equilibrium
state, but the equilibrium steady state, i.e. a position in which all
actions repeat themselves, every period, forever. It is quite rare indeed for
the mainstream economist to consider the convergence path to such steady states
(or to consider the adverse consequences of various government policies during
the adjustment period).
V.
InstitutionsBecause of the Austrians' more modest view of the
capabilities of human computation and foresight, there is a far greater role for
institutional analysis in the Austrian paradigm. Earlier I explained that the
institution of money itself cannot be easily analyzed from a neoclassical point
of view. The issue, however, is not merely technical. Failure to understand the
role of money can have profound political implications.
The best example
is <FONT
face="Verdana, Helvetica" size=2>Ludwig von Mises's famous critique of
socialism. Mises argued that
without market prices for the means of production, socialist planners—even if
they were truly benevolent and wished only to help their subjects—could not
rationally allocate resources. Mainstream economists eventually conceded that
some system of "prices" would be necessary in a socialist State, but felt that
the government could still retain formal ownership of all capital goods. Hayek
and others argued that the proposals of "market socialism" would still fail, and
with the demise of the Soviet Union many academics began to take the Austrians
seriously.
In my own
experience, I realized the mainstream's failure to understand institutional
differences during a lecture from a mathematical economist. He was explaining a
puzzle that had arisen with the use of a certain type of production function. If
I recall correctly, the problem was that the relationships between interest
rates, capital per worker, and GDP were not consistent between the United States
and the Soviet Union.
One possible
explanation was that the U.S. had better technology, but this wasn't
satisfactory because Soviet plant managers could obviously attend American
engineering schools. What struck me was that it never even occurred to the
professor, or to the students who offered suggestions, that the fact that one
system was capitalist and the other communist might have some relevance.
Instead, they sought a purely technical solution to the apparent
paradox.
<FONT face="Verdana, Helvetica"
size=2>VI. Business cycleFinally, the last area of
comparative advantage for the Austrians I wish to highlight is the business
cycle. Relying on (in my opinion) their superior understanding of the complexity
of the capital structure, and of the vital role money prices play in the
coordination of intertemporal plans, only the Austrian economists can hope to
offer a satisfactory explanation of the widespread errors that characterize a
recession.
The Austrians argue
that recessions are the inevitable outcome of prior booms, in which
entrepreneurs—goaded by artificial government reductions in the interest
rate—make overly optimistic guesses as to the profitability of their projects.
In consequence, the entrepreneurs hire labor and buy capital goods for which
there are insufficient real savings to finance. When the entrepreneurs realize
their errors, they attempt to scale back their plans, and the widespread
occurrence of this adjustment is what we know as a recession.
The mainstream, in
contrast, offers Keynesian models in which the economy becomes trapped in a
state of insufficient demand, or real business cycle models in which "technology
shocks" cause recessions. Aside from the inherent problems with these models,
there remains the empirical failure of the mainstream advisors to prevent
recessions with their "scientific" management of the economy.
<FONT face="Verdana, Helvetica"
size=2>ConclusionThe above points focus on some of the
major differences between Austrian and neoclassical economics. I have been harsh
with my treatment of the mainstream, but I believe my criticism has been fair.
It is true that there are many areas (e.g. game theory) in which the formal
rigor of the mainstream allows for precision that the verbal approach of the
Austrians cannot provide. However, when it comes to the central and crucial
areas of economic theory, I still believe that the Austrian school offers the
best foundation for a young economist.<FONT face="Verdana, Helvetica"
size=2>
Robert Murphy
is a recent graduate of New York University. He will be teaching economics at
Hillsdale College in the Fall. <A
href=""><FONT face="Verdana, Helvetica"
size=2>robert_p_murphy@xxxxxxxxx
<A
href="" id=_ftn1
name=_ftn1 title=""><SPAN
class=MsoFootnoteReference><FONT face="Verdana, Helvetica"
size=2>[1] This
is not merely an Austrian quibble; even noted theorist Frank Kahn has recognized
the logical problems involved. See his "General Equilibrium Theory," in The
Crisis in Economic Theory, Daniel Bell and Irving Kristol, eds., New York:
Basic Books, Inc., 1981.
<A
href="" id=_ftn2
name=_ftn2 title=""><SPAN
class=MsoFootnoteReference><FONT face="Verdana, Helvetica"
size=2>[2] <A
href=""><FONT
face="Verdana, Helvetica">In a previous article<FONT
face="Verdana, Helvetica" size=2>, I have shown the difficulties of the
mainstream approach to modeling stock market prices.
<A
href="" id=_ftn3
name=_ftn3 title=""><SPAN
class=MsoFootnoteReference><FONT face="Verdana, Helvetica"
size=2>[3] I
explain some of the problems with this <A
href=""><FONT
face="Verdana, Helvetica" size=2>procedure in a previous article<FONT
face="Verdana, Helvetica" size=2>.
<A
href="">[Print
Friendly Page]
<FONT face=Arial
size=3>
<A
href=""><IMG alt="" border=0 hspace=0
src=""
>
<A
href="">Mises Email List
Services
<A
href="" target=_blank><FONT
face=Arial>Join the Mises Institute<FONT
face=Arial> <A href=""
target=_blank>Mises.org
Store<FONT
size=2>
<FONT
size=2>
<A
href="" target=_blank><FONT face=Arial
size=1>Home |
<FONT
face=Arial size=1>About<FONT face=Arial
size=1> | <A href=""
target=_blank>Email
List | <A
href="" target=_blank><FONT face=Arial
size=1>Search |
<FONT
face=Arial size=1>Contact Us<FONT face=Arial
size=1> | <A href=""
target=_blank><FONT face=Arial
size=1>Periodicals |
<FONT
face=Arial size=1>Articles<FONT
face=Arial> | <A href=""
target=_blank>Games &
Fun<A href=""
target=_blank>News<FONT
face=Arial size=1> | <A
href="" target=_blank><FONT face=Arial
size=1>Resources |
<FONT
face=Arial size=1>Catalog<FONT
face=Arial> | <A
href="" target=_blank><FONT face=Arial
size=1>Contributions<FONT
face=Arial> | <A href=""
target=_blank>Freedom
Calendar<FONT
size=2>
You are subscribed as: chaze@xxxxxxxxTo unsubscribe,
click here: <A
href="">http://mises.biglist.com/unsub.php/article/chaze@xxxxxxxxor
e-mail: <A
href="">article-unsubscribe-chaze=cvtv.net@xxxxxxxxxxxxxxxxx
Yahoo! Groups Sponsor
ADVERTISEMENT
To unsubscribe from this group, send an email to:
realtraders-unsubscribe@xxxxxxxxxxxxxxx
Your use of Yahoo! Groups is subject to the Yahoo! Terms of Service.
|