Tuesday, April 24, 2012

About Austrian economics

I find Steve Horwitz, along with George Selgin (prominent advocate of free banking and supporter of a productivity norm [pdf] for monetary policy), the most accessible of contemporary Austrian school economists as they are both clear writers who seek to engage with those who are not of their school and are refreshingly free of the nastiness that so many Austrian school commentators seem prone to. (Little, if any, of what I have to say in the following applies to Selgin and some applies to general tendencies in Austrian commentary rather than Horwitz.)*

 Horwitz has written a very useful paper on Hayek and Keynes’ different understanding of capital. Points that strike me reading the paper, and particularly Horwitz’s presentation of the Hayekian/Austrian concept of capital, include: (1) The Austrian view of capital is over-impressed by differentiation, as when Horwitz writes:
What is central for the Austrian theory is that capital is not homogenous; capital goods are not perfect substitutes for one another. Any given good can only serve in a limited number of production plans, and it is not possible to create any given production plan out of any capital goods. Goods are not infinitely substitutable, and not all goods have the requisite complementarity necessary to be part of any particular production plan. This emphasis on the “heterogeneity” of capital distinguishes Austrian capital theory from many of its predecessors, especially those, most obviously Knight's “Crusonia plant” or Solows “shmoo,” that viewed capital as a homogenous fund of resources from which equally useful “ladles” could be applied to any production process
Yes, once resources are allocated to specific capital, they are difficult to shift to other uses. Nevertheless, the ongoing process of allocating resources to creating capital is important in its own right. Capital is not homogeneous (neither is labour; something which seems to figure rather less in Austrian analysis) but there is enough flow of resources in an economy that heterogeneity is not all there is to grapple with.

 (2) Thus, there is, in the Austrian approach, a somewhat “frozen” view of capital: that it can be difficult to reallocate, does not make it impossible. As Horwitz notes later in the paper, the loss of value in capital no longer allocated to its original use measures how difficult but not impossible it is. Conversely, heterogeneity of labour would suggest that labour markets also have adjustment delays and constraints, which sits rather poorly with Austrian confidence in fully flexible wages if there were no regulatory interventions.

 (3) At the same time, there is a perfectionist view of markets, that there is a “correct” arrangement of capital. As when Horwitz writes:
... the capital structure and the process of monetary calculation that drives it is the fundamental coordinating process of the market economy. Fitting those pieces together as correctly as possible, in response to knowledge and incentives produced by the pleasurable and unpleasureable beeps of profit and loss, is what ensures ongoing economic coordination and growth.
Yes, profit and loss direct resources to more valuable uses, but the notion of a single “correct” outcome glides over a whole lot of issues about incentives, constraints, information flows, etc. Yes, the “pieces” have to fit together, but they are constantly being created and replaced, with a fair bit of “good enough” going on because of various constraints, varied incentives, information asymmetries, etc.

 (4) The emphasis on the role of money in economic calculation is somewhat one-sided, as when Horwitz writes:
What guides this process of plan formation, deconstruction, and reconstruction is monetary calculation. In a market economy where capital goods have money prices, those prices enable entrepreneurs to prospectively formulate budgets and retrospectively calculate profits and losses. Budgets based on those prices are what enable entrepreneurs to decide which capital goods will effectively serve as complements in an integrated production plan. After that plan has been executed, profits and losses signal owners of capital whether or not the plan was successful, which enables them to decide whether the uses of capital were, in fact, sufficiently complementary to continue. If not, then the money prices of other capital goods provide the information necessary to engage in another round of calculation and budgeting to see what sorts of capital goods might serve as substitutes for pieces of the failed plan.
Yes, the various “swap values” of money (for goods and services) matter, but what entrepreneurs are really interested in is expected income; that is, price x transactions. It is not that there is no concept of demand/expected income in the Austrian analysis, it is that, at crucial points in the argument, price is emphasized to the extent that transaction levels, and so income expectations, disappear from view. (David Beckworth has a nice post connecting collapsing transaction levels, and so income expectations, as reported by business survey respondents, with the economic downturn in the US; or, to put it another way, it’s the level of transactions,... .) Price is not a perfectly flexible lever; particularly given the different time scales between stages of production, to use Austrian language, and constraints in labour markets.

 (5) Following on from (4), the fundamental role of money in an economy is to facilitate transactions, including across time. The typical Austrian emphasis on money-for-calculation, and presumption of state monopolies as over-suppliers of money, leads to an obsession with inflation and the risk of hyperinflation. (Hence my comment that an internet Austrian is someone who has predicted 10 of the last 0 bouts of hyperinflation.) As a matter of historical fact, deflation (and unexpected disinflation) can be much more destructive of economic activity than inflation. Both inflation and deflation interfere with money as a means of economic calculation, but deflation (and unexpected disinflation) also drives down income/economic activity, which makes is much more destructive. But the Austrian view of business cycles is so focused on finding reasons for busts in the previous booms (those money over-supplying central banks) that it, in effect, blames the effects of deflation on previous inflation. Yet inflation and deflation are equally monetary phenomena, one is not causally dominant over the other. 

[Read the rest at Skepticlawyer or at Critical Thinking Applied.]

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