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Structured, rational thinking about community, cooperation, and the market
Austrian Economics is Not More of the Same

Austrian Economics is Not More of the Same

Whether or not it is true, as they say, that they first ignore you, then ridicule you, then attack you, and then you win, the financial crisis as well as Ron Paul’s candidacy for becoming the republican party’s presidential nominee have made Austrian economics somewhat of a household name. So it is no longer ignored, but it is certainly is both ridiculed and attacked (more of the latter more recently). So if Gandhi was right, then we’re transitioning from ridicule to attack. An example of such an attack is a (rather unbelievably ignorant and disturbingly dishonest) hit piece by Noah Smith, a professor of Stony brook university who’s dedicated to his career as an internet troll (as “Noahpinion”). I took a previous piece of his apart over at the Mises Institute blog a couple of months ago, to which he responded on Twitter as a true troll (in stark contrast to a true scholar) saying he would not even read my rebuttal because the post’s title wasn’t sufficiently original or witty. (He later deleted his tweet, but my initial and response tweets still exist…) Apparently the attention only made Smith more dedicated to trolling. His hit piece on Austrian economics as “brain worms”…

It Is Best to Ignore Economists

It Is Best to Ignore Economists

This may sound strange, coming from an economist, but it is unfortunately quite true that we would all be better off not listening to economists. What I mean by this is that economics over the past eight or so decades has been misguided and therefore blind, which means pretty much everything economists have to offer in terms of explanations, predictions, and policy recommendations are… wrong. I have already argued (for example, here and here) that the method used in economics is wrong because it is the so-called Scientific Method (better capitalized) that is a pretty good fit for the natural sciences but a disaster in the study of social phenomena. The reason for this can, though it is a gross simplification, be illustrated by the fact that the Scientific Method relies on experiments that are repeatable and rely on comparatively simple causality. You can let a stone roll down a hill and measure the gravitational pull as well as frictions and other things. You can even take the same stone from the bottom and place it at the top to do it again. If you take human beings and put them through a specific experiment they may behave in a…

The Great Problem of Planning

The Great Problem of Planning

The issue of economic planning has been a major component of Austrian theorizing since Mises’s 1920 article on the impossibility of calculating in a socialist commonwealth. But as both Mises and Hayek noted, the position is not one against planning per se but about who does the planning. Ronald Coase made a similar point, though from the very opposite perspective, saying that there is a large degree of planning even in market economies – but it is decentralized (through firms). Whatever we may think of the concept in economic or political terms, planning is a core part of human endeavor. In fact, it is the reason we are vulnerable to changes in nature and that we spend vast sums on trying to stop more or less natural processes. The reason is that we develop capital, and the capital structure (a path-dependent, cumulative development of the prerequisites for production) is productive only by being specific – and therefore lacking in flexibility. This is the reason natural changes are so very costly. Consider as an example a city harbor in the delta of a large river, which supplies a great service to people in the city as well as upstream the river and, likely,…

When the Market Suffers a Specialization Deadlock

When the Market Suffers a Specialization Deadlock

Whereas economic theory, especially the Austrian variety, discusses and ‘problematizes’ the coordination of plans, interests, and production in the market, these theories tend to emphasize generalized phenomena and, consequently, aggregates. For instance, Hayek’s interesting and highly relevant Pure Theory of Capital provides well over 400 pages discussing the intricacies of capital, production, and entrepreneurship. Yet Hayek never gets to the bottom of things. He only talks about production structures, processes, investments, and interest rates. When the interest rate (which he, in stark contrast to Moses, defines as the return on capital) changes, how does this affect the production structure? The question is important, but Hayek (as many economists, including Austrians) discusses adjustments in the market as though they are automatic – without specific or at least important problems. But this is not the same world as individual actors face. The latter never deal with aggregates, and therefore the problems that do not emerge on the aggregate level (for instance, when “adjusting a production process”) can in fact be prohibitively costly or difficult to overcome. One such potential problem is the lack of density through the division of labor, which effectively makes implementations of innovations activities that take place outside the market and…

Economists Do It With Models

Economists Do It With Models

It is funny, really, how the general perception of economists is that they are math geeks who simply draw conclusions (that is, inductively) from statistical data. Whereas there may be some truth to that, what is it in the math and stats that make economists different from other social scientists? What is it that makes such economics economics? To say that economists do it with models is not really to point to an obvious distinction from other social scientists. Anyone going through advanced studies in political science, business management or (yes, even) sociology have to take courses in advanced statistical analysis (though they’re called different things: econometrics, psychometrics, and so on). So “doing it with models” is hardly an economics deal – it is a scientistic deal, it is how “we” do research in this highly positivistic, empiristic day and age. It is distinct for economics in one way only: economics was the first of the social sciences to seriously adopt the “mathods” of the natural sciences. And, sort of consequently, economics therefore has the most developed and advanced methods – which is why for example many doctoral students in business get to (must) study econometrics. But it is really…

Theory, Exaggerated or in Moderation?

Theory, Exaggerated or in Moderation?

F. A. Hayek notes in his introduction to Mises’s autobiography Memoirs that “considering the kind of battle that he [Mises] had to lead, I also understand that he was driven to certain exaggerations, like that of the a priori character of economic theory, where I could not follow him” (p. xx). The comment refers to the many setbacks and unfortunate developments that Mises experienced during his life. But the conclusion is very interesting, and parallels with a common sentiment in present science as well as public debate: the threat of extremism or radicalism. Hayek’s statement is very interesting from a theoretical point of view, since it subjects theorizing and science to a type of Aristotelian (okay, Nicomachian) moral standard. The latter is the well known golden middle, where e.g. courage is a virtue but deviating exaggerations in both directions are vices: neither recklessness nor cowardice are virtuous. It should be noted that these “exaggerations” of both ends of a virtue create vices not because the virtue is virtuous in moderation – but because the virtue itself is moderated by the unvirtuous extremes. It is not the case that the “middle” is necessarily better, just like the middle ground “hungry” is not…

What Economists Do Isn’t Economics

What Economists Do Isn’t Economics

Jacob Viner (1892-1970) famously claimed that “economics is what economists do.” While this is a fun play on words, it really means nothing at all. And this has become even more the case over the past decades as economists have almost completely turned their backs on their discipline’s history and tradition and instead gone “all in” with advanced-seeming statistical methods and mechanist design of economic systems through oversimplified models. Considering the over-use of mathematical notation and statistical mumbo-jumbo rather than economic logic, it is safe to say that whatever economists do is not economics. Or, at least, it is nowhere close to what economics used to be and always has been. There are two parts to this statement, both of which are equally interesting on their own: (1) the lack of proper methods and (2) the refusal to consider the real market in economic research. These are fundamentally related, and I have already treated the first of these points in other posts (see e.g. The Fundamental Importance of the Trade-Off). I doubt I will have to elaborate on the second point. Whether or not these points have been made sufficiently clear, they should at least suggest that there is a…

It’s Not About the Money

It’s Not About the Money

I would probably give my left arm to once and for all rid the world of all misconceptions about economics. One such frustrating misconception is how everybody assumes that “economy” necessarily has to do with money – and only money. Perhaps this is the reason why I, as an economist, frequently get asked about investment tips, how to “beat the market” on the stock exchange, and things like that (you really don’t want my investment advice). If anything “economy” is about money, then obviously an “economy-ist” knows how to make money. In a sense I do know how to make money. I understand the Federal Reserve. Seriously, however, there is some truth to the assumption that people make regarding economics. In our advanced specialized economy money is a central and very important institution. But money is far from the only phenomenon of import, so there is much more to economic theory than dollar signs. Money, as Menger showed in his 1892 essay “Geld” (On the Origins of Money), is important because it provides a vital function to the market: it radically lowers the cost of exchanging by relieving actors in the market from the double coincidence of wants limitation of barter trade.…

Ha-Joon Chang, Yet Another Economics Skeptic

Ha-Joon Chang, Yet Another Economics Skeptic

The Huffington Post recently published an excerpt of Cambridge University economist Ha-Joon Chang’s book Economics: The User’s Guide. It has then caused a little bit of a stir, mainly through progressive followers eagerly regurgitating some of Chang’s not-so-well-founded one-liners (this article, by almost ridiculously ignorant Tyler Darden, is a good example). But these regurgitations aside, it is interesting to look at the excerpt of Chang’s book and what it tells us about Chang and his view of economics. (I will not, out of respect for Chang, assume that the excerpt was chosen because it was one of the better parts of the book, though this may be an intuitive assumption.) Chang is a development economist, which may not mean anything to those who are not well versed in economic lingo and the academic study of economics. This particular field is one of the very few where central planning is hailed as not only possible – but preferable to market. Development economists overall look at how underdeveloped or developing nations can or should bring about economic growth, but they are as much proponents of schemes to raise health, education levels, and other “welfare” measures as they are in markets and economic…

The Mysterious Endowment Effect

The Mysterious Endowment Effect

The development of modern neoclassical economics is the story of how a discipline lost its way. Before the mathematization of economics, economists tried to explain prices and macro patterns in the market place from individual human action. But modern “mathonomics” has evolved into a subfield of mathematics with no obvious ties to the real economy. Assuming “perfect” conditions and general equilibrium, the conclusions of economic analysis follow directly from the premises — as one would expect from solving mathematical equations — and are hence of little scientific interest. It follows that phenomena in the real economy that do not seem to fit the “perfect” models should be dismissed as imperfections; what remains to explain is the causes of action rather than its effect. The task of economics has therefore shifted from explaining the effect of human action to tracking the causes of it. This radical shift suggests that we already know all there is to know about markets (at least to the limited extent predicted by mathematical models), while it provides a breeding ground for analysis of behavior instead of action. In other words, in order to track the ultimate causes of our mathematically precise economic models, economists shift focus…

The Fundamental Importance of the Trade-Off

The Fundamental Importance of the Trade-Off

Whereas the natural sciences study the physical world under the fundamental assumption that it is purely subject to the law of causality and therefore strictly laws-based, the social sciences wrestle a very different problem. In the social world, as Mises reminds us, there are no constants and no constant relations. This ultimately makes the mathematical, quantitative, and statistical methods of the natural sciences inapplicable (at best). Granted, there are many who disagree with Mises’s statement and that claim that even social phenomena are subject to quantitative analysis – that idiosyncracies are balanced out if the population studied is just big enough. There is perhaps an argument for the law of large  numbers in the sense that an “average” can be identified even in some social actions. But the argument must be based on the assumption that human action is rather evenly distributed in a bell curve. Yet why should this assumption be a reasonable starting point? The fact is that it appears reasonable only if we strip the study of the social world of the typically social aspects, i.e. of will, purpose, values and valuations, and intentions. If we study only “choice” (not action) and assume all necessary information is known…

The Problem of Production

The Problem of Production

Believe it or not, but there is no good explanation in economic theory for why there are firms. This may seem like a rather fundamental oversight, but it actually has good reason. Economic theory, whether Austrian or mainstream, shows beyond reasonable doubt that the market is the least inefficient and therefore “best” means to allocate resources. While the market is terribly imperfect and subject to constantly changing conditions (consumer preferences, changing policy, etc.), it still beats the impossibility of “rational” top-down planning. There are several reasons for this, which we can discuss in a future post. But what is interesting to note here is that if the market is in fact as good as theory says, then why are there firms? Obviously, following theory, it should be better to use the market and rely on the price mechanism than to sort of avoid the market through establishing colossal hierarchical structures that are only indirectly dependent on the price mechanism. Even though classical economists studied the firm (see Adam Smith’s discussion of the pin factory in Wealth of Nations, and e.g. Marx’s Capital), they didn’t really get anywhere. Perhaps they weren’t interested. Then there was a huge literature on the organization…

Missing the Forest for a Tree or Two

Missing the Forest for a Tree or Two

Being an economist in the field of entrepreneurship makes for a scary experience. The reason is that many of the “new” disciplines in business schools are developed without and sometimes as a contrast to existing, older disciplines. Rather than making use of what we have learned over the centuries in philosophy, economics and other disciplines, entrepreneurship and (though to a lesser extent) strategic management borrow individual concepts or theoretical approaches stripped of their contexts. It is true that economics as a field, as well as most economists, have done pretty much everything possible to make sure others discount their discipline. The outcome of any type of matheroizing on strictly rational actors in specific situations under perfect information is, as one would expect, very limitedly applicable on real phenomena. For this, economists have themselves to blame; they have willingly adopted the Lange-Lerner view of the world, later formalized and introduced large-scale by Paul Samuelson, where any problem can be parameterized and mathematically solved. The number of babies that have been thrown out with this bathwater is approaching infinity. Nevertheless, economics has amassed an impressive body of knowledge since the early and mid-18th century. Especially the theories of classical economics are as valid today as…

How Visible Subsidies Cause Invisible Destruction

How Visible Subsidies Cause Invisible Destruction

Schumpeter’s “creative destruction” describes how the free market’s new and more efficient industries push out old ones, creating economic growth. The state’s perversion of this process we may call uncreative destruction. The state overtly subsidizes some industries and groups (including itself and its employees), while covertly it destroys society’s overall wealth and well-being, lowering economic growth and welfare. The state’s magic act and trickery consists in attracting attention to the subsidies of its right-handed spending while obscuring the even greater destruction of its left-handed taxes and regulations. As French 19th century economist Bastiat wrote, in his essay That Which Is Seen, and That Which Is Not Seen, there are two effects of the state’s actions: the visible and the invisible. The state points to the economic activity of fixing real and imaginary broken windows (the subsidies), while avoiding all mention of the windows it breaks, the houses it bulldozes, and the people diverted from building new and better houses (the destruction.) The state, for example, advertises the stimulative effect of wartime spending, which subsidizes all those businesses producing war matériel and supports all those working in war industries. But its taxes to pay for the war are extracted from a…

Discussing Why ‘Ceteris Paribus’ Matters with Jeff Tucker

Deflation is the Normal “State” of the Market

Deflation is the Normal “State” of the Market

Austrians often stress that the definition of inflation used by both the State and the economics profession is “incorrect” and that the “general increase in price levels” definition should be replaced by the Austrian “increase in money supply” definition. It is true that the latter is a whole lot more correct in both explaining and describing the problem while pinpointing what is really going on and how these problems could be overcome. However, it is not simply the fact that the generally accepted definition is “wrong” — it is also “evil” in that it includes quite a bit of propaganda for State control of the marketplace and the rest of society. It should be clear to anyone with some knowledge in how the economy works that all the individuals in it work together like an invisible hand to produce goods and services and that they tend to do so ever more efficiently. This is true even in a regulated market, which is why even monstrous welfare states talk about the importance of and try to “encourage” economic growth. The concept is a bit confusing, though, since the economy doesn’t only grow — “it” strives to get increasingly efficient in the…

Reasoning: Structured versus Strange

Reasoning: Structured versus Strange

I recently experienced first-hand the terrible state of people’s reasoning. It should come as no surprise that emotions almost always beat rational reasoning in discussions and debate, even though this is a sad state of affairs. Especially in politics, calls to emotions attract votes or at least an emotional response that can be somewhat predicted and therefore exploited. It is easy to see how this could contribute a core explanation to political correctness, which is a structural public morality that “teaches” people how to emotionally respond to certain opinions. As it does away with sound reasoning and therefore shuts out logical thinking for the benefit of an immediate emotional response, it levels the playing field for political actors while expanding the political realm of arbitrary opinion. We can think of emotions and reasoning as opposite end points on a continuum of means to produce an understanding of some phenomenon. The emotional endpoint is direct, immediate, and uncritical. Where it is a response to experiential data it is as instantaneous as our senses permit: we see blue and have an emotional reaction; we see (what we think is) an injustice and immediately react; and so on. Where it is a response to…

Ceteris Paribus for Dummies

The economist’s analysis based on ceteris paribus (lat. “all other things being equal”) can, at least in certain contexts, seem almost laughable. After all, isn’t it pretty obvious that any economic system is a web of interdependent relations and interactions dependent on signaling through for instance the price system? Even so, certain so-called scientific models may require the ceteris paribus statement simply because we do not have powerful enough tools and lack sufficient knowledge of the interrelationships. It could make sense, in a scientific setting where some progress is the best possible (since aiming too high simply means no progress), to use simplified models of simplified relationships and interdependencies and conduct experiments with simple tools to try to increase our understanding of our complex social world. This does not, however, offer an excuse for all those experiments claiming to provide models that can make very exact forecasts. All such claims, when the models on which these forecasts are made are ceteris paribus models, are at best ignorant if not consciously deceiving. An economic model accepting exact values and providing exact forecasts based on ceteris paribus reasoning is fraudulent. But this should not be interpreted as if economics needs to be…

The Minimum Wage

The Minimum Wage

Though a classic example of sound economic analysis, the doctrine on the effects of a minimum wage has lately been under heavy fire from progressive liberals. The President, naturally, favors an unprecedented increase in the minimum wage to “help the poor.” But aside from political rhetoric, which hardly ever even resembles the facts of reality, there are also open letters from many renowned economists calling for an increase in the minimum wage. Nobel laureate Joseph Stiglitz has recently been one of the more vocal proponents of using political measures to rid society of the “costs of inequality.” The Piketty frenzy is along the same lines. But what is the truth about the minimum wage? As anyone who has taken an introductory economics course in college should know, mandating a price above the market-clearing price creates a surplus in supply. The reason is obvious: more are willing to supply at this price than the market-clearing price, and fewer are willing (and able) to purchase at this price. Hence, at least in the short term or for as long as the mandate is in place, we will see a surplus. A surplus indicates a wasteful use of resources in the economy and…

Why Is Inflation So Bad?

Why Is Inflation So Bad?

A cornerstone of government economic policy is to “fight” inflation and make sure we do not have too much of this problem, to make sure we minimize the costs of inflation. This is in a sense why we are taught there is a need for the Federal Reserve: they manage the currency and interest rates in such a way that inflation is kept at a minimum. This is an important task, and that is why the news media so frequently reports on inflation and talks of “inflationary” policies, etc. But why is inflation a problem? According to the common definition used in the media, in politics, as well as in economics, inflation is an “increase in the price level of goods and services.” It is therefore pretty obvious why inflation is bad for most of us: with higher prices we get less for our hard earned dollars. Indeed, the latter is sometimes made part of the definition: “prices for consumer goods rise, eroding purchasing power” (emph. added). So we, i.e., all of us, would definitely have an interest in keeping inflation “as low as possible,” or – even better – at zero (if possible). In other words, we should be…