There is a YouTube going around in which Ron Paul’s applause line at a rally is “We’re all Austrians now!” Conveniently enough, in this interview, Pete Boettke explains Austrian economics superbly.
Austrians want to talk about the institutional environment within which economic activity takes place. They want to talk about cultural frames of reference that form the priors that rational actors have. They want to talk about the fact that we each have different priors, because we’re diverse individuals who have different perspectives on the world. Somehow, we have to reconcile these differences through the exchange processes in the market. …It’s a very broad notion of social science, of which economics is a part, rather than the idea that economics is somehow separated from all the social sciences.
Read the whole thing. I could have quoted many paragraphs. More below the fold.On the topic of Austrian economics and Ron Paul, Matt Yglesias writes,
Unfortunately, however, it’s the Austrian school, which preaches despair and demands no action at all, that has the most effective political champion and the most dedicated followers. If I’m wrong, and the economy doesn’t recover in 2012, then these faddish views may gain more steam and perhaps we really all will be Austrians someday soon. But let’s hope not. The developed countries that have done best in the recession–places like Israel and Sweden–are the ones that have pursued the least “Austrian” courses of action, while the European Central Bank’s insistence on pursuing a somewhat Austrian-style course in Spain and Italy is creating a deepening crisis.
Separately, Yglesias writes,
I have a pet theory that one of the main reasons the policy response to the current economic crisis has been so bad is that we had the wrong crisis.
What he is saying is that the crisis we got is not the crisis that economists were predicting. This is a very important point. A lot of economists predicted crisis X. Instead we got crisis Y. And now the economists who predicted crisis X jump to claim credit for predicting the crisis. What Yglesias adds to this narrative is the claim that policy is responding to the crisis that was predicted rather than to the actual crisis.
I think that the best illustration of Yglesias’ point is the policy response to Freddie Mac and Fannie Mae. The crisis people expected was that a sudden move in interest rates would expose risks in their portfolio management. No one expected them to suffer from too many mortgage defaults. And even after the fact, many “reform”proposals call for a new entity that no longer takes interest-rate risk (the risk that didn’t hurt Frannie) but takes credit risk (the risk that killed them). In short, the reformers act as if we had the crisis they predicted, not the one that we had.
Anyway, in macroeconomics, the crisis that was predicted was a huge capital outflow, leading to higher interest rates and a depreciation of the dollar. This would have forced a reorientation of the economy away from consumer spending and housing and into producing internationally competitive goods and services. If you are a policy wonk, this requires all sorts of government management to help with this complex transition to a weak dollar with high interest rates. Yglesias writes,
But this is not the crisis we’re having. Interest rates are low. Headlines tell us that “U.S. Factories Could Suffer From Dollar’s Appeal”. I’m inclined to think that we will, at some future point, face the crisis we should have had and it will need to be addressed in complicated ways. But the crisis we’re having is, for all its horror and scale, a pretty banal monetary crunch
Circling back to Austrian economics, the crisis we are having does resemble the crisis that Austrians were predicting. That is, they thought that money was too easy and that this would result in malinvestment. In his essay on Austrian economics, Yglesias dismisses this because the decline in the economy proved to be so widespread. However, I would argue that the patterns of specialization and trade are so complex and interdependent that the crash in housing could in fact lead to widespread disruptions. It affects real estate agents, attorneys, firms involved in the manufacture and distribution of household durables, and so on. It has huge relative regional effects. It reverberates through the financial industry. It affects people overseas who had counted on an ongoing mortgage securities market.
I do not want to assert that the crisis we are having is precisely what Austrian business cycle theory predicts. I am not such a firm believer in any macro model. Let me finish with another quote from Boettke on Austrian thinking:
What the position makes you have is not libertarianism, or anything like that, but humility. The economist is nothing more than a student of society, and any economist that tries to represent themselves as a saviour of society should be subject to ridicule.
READER COMMENTS
Dave
Jan 15 2012 at 12:19pm
Mish addressed the widespreadness of the recession from an Austrian perspective years ago.
Jim
Jan 15 2012 at 12:43pm
Macro issues aside, under Boettke’s definition(s), almost everyone except the purest mathematical economist is an Austrian. You just have to think a little about institutions.
lwaaks
Jan 15 2012 at 12:55pm
The Austrians have repeatedly emphasized that their theory only attempts to account for the boom. The policy errors committed before and after the boom — as related in Friedman and Kraus’ _Engineering the Crisis_, specifically those errors committed by regulators that led to the banking crisis, would not be part of their general theory.
vlad
Jan 15 2012 at 4:14pm
@Jim
You can define Austrian economics as the theory that all costs are subjective. Their view about entrepreneurship as more than just search stems from this. And if you apply this to transaction costs, it leads to a markedly different view about the nature and dynamics of institutions.
Curt Doolittle
Jan 15 2012 at 5:57pm
@vlad
Could your rephrase that statement or flesh it out? It’d be quotable. -thx. 🙂
Jeff
Jan 15 2012 at 6:40pm
That is, they thought that money was too easy and that this would result in malinvestment. In his essay on Austrian economics, Yglesias dismisses this because the decline in the economy proved to be so widespread. However, I would argue that the patterns of specialization and trade are so complex and interdependent that the crash in housing could in fact lead to widespread disruptions.
I would think the nature of the bubble plays into it quite a bit. If you have a bubble in real estate prices bursting, and lots of people own real estate (or have made leverage investments in real estate), that means widespread deterioration of household balances sheets. If that’s the case, why wouldn’t you expect big spill over effects? Those people are going to have to reduce their consumption across the board, aren’t they?
Vangel
Jan 15 2012 at 7:49pm
I think that the best illustration of Yglesias’ point is the policy response to Freddie Mac and Fannie Mae. The crisis people expected was that a sudden move in interest rates would expose risks in their portfolio management. No one expected them to suffer from too many mortgage defaults….
I do not believe that this is exactly true. Many of the Austrians pointed out that when you lend money to poor credits it should not be a surprise when you do not get your money back. And when I go over this in my mind I think that many of the analysts who missed the crisis over-thought the problem. Things were a lot simpler than the Keynesians thought and anyone with some common sense and knowledge of economics could have figured out what had to happen.
http://www.youtube.com/watch?v=mzJmTCYmo9g
Chris Koresko
Jan 15 2012 at 9:17pm
Vangel: Things were a lot simpler than the Keynesians thought and anyone with some common sense and knowledge of economics could have figured out what had to happen.
In response to people who try to blame the crisis on complex financial instruments, I like to say that you can’t inject trillions of dollars of toxic assets into the financial system and expect nothing bad to happen.
Is that what you have in mind?
david
Jan 16 2012 at 1:05am
Neoclassical ordinal utility deals just fine with subjective costs. The core of ABCT is in the assertion of a particular kind of capital structure in the macroeconomy, without it the policy recommendations of Austrian theory collapse.
UnlearningEcon
Jan 16 2012 at 5:17am
Austrians are an alternative to neoclassical economics. We look at disequilibrium, irrationality, imperfect information…
???
markets = good government = bad
Great school of thought. No preordained conclusions whatsoever.
david
Jan 16 2012 at 5:41am
But the Keynesians, post-Keynesians, New Keynesians, etc. all also consider disequilibrium, irrationality, and imperfect information in assorted areas. Austrians hardly have a monopoly on these.
jomama
Jan 16 2012 at 8:06am
Without doubt. It ain’t rocket science, altho predicting the effects accurately is way beyond rocket science, that is to say impossible. Austrians understand that.
fundamentalist
Jan 16 2012 at 9:12am
Don’t trust Yglesias for an explanation of Austrian econ. He is ignorant as Krugman about it.
Austrians have always realized that depressions will become widespread. They emphasize the the bad investment in capital goods because that is what triggers the depression. But the effects of the trigger always spread and cause a general depression.
Yglesis sees the general depression and blinds himself tot he cause.
If you want to know how bad Yglesia’s understanding of Austrian econ is, just visit mises.org or other sites of Austrian econ and search for the thrashings he gets.
Shayne Cook
Jan 16 2012 at 11:29am
What I learned from the Yglesias essay that he knows a great deal about propaganda, precious little about economics and exactly nothing about investing.
I may be able to help with the investing ignorance part. I started investing 40 years ago with my first purchase of 10 shares of Boeing stock. Things affecting investment decisions have changed over the past 40 years – and I’ve earned a pant-load of graduate management degrees in that time – so I’ll explain investment decisions with my contemporary version of “I, Pencil”.
I’m going to invest in a new factory. This factory, owing to available technology, will be fully automated, taking at most 6 people to operate. It will rely, of course, on robotics – robotics of Japanese design and German manufacture. They, in turn, will initially be programmed by software developers in India and China. (The actual computers that drive the robotics are manufactured in Taiwan and Korea.)
The raw materials that are inputs to my factory will be mined primarily in South America and Africa. Of course, they’ll have to be shipped to my factory using Greek dry-bulk shippers, incorporated in the Maldives and Caymans, using ships designed in Europe and manufactured in Europe and China – registered in Liberia. Oh, and they’ll be burning bunker fuel originating from Canada, Russia, the North Sea, Venezuela, Mexico, Africa and the ever-popular Middle East. Similar arrangements will be made for shipping my factory’s output to global markets, except container ships are typically of Singapore origin/ownership. Of course,I’ll retain the services of the logistics experts in Hong Kong and Singapore to work out the details.
Now to the optimal location of my factory. Being fully robotic and automated, my factory will of course require abundant supply of electrical energy. So the location must either have that, or be willing to create/enable it fairly quickly (not insisting on postponing the decision to create it “until after the next election”, as it were).
Additionally, the whole point of the factory investment is to provide a return on that investment, so locating it in a legal jurisdiction that has the highest combined investment and corporate tax rate on the planet is decidedly sub-optimal. The same applies to legal jurisdictions where the regulatory environment stifles innovation and adaptation – not only for the operations of my factory, but also ALL of the factors affecting smooth flow of inputs to and outputs from my factory. Decidedly, sub-optimal. So, quite frankly, given the requirements above, locating my factory almost anywhere outside the United States will NOT be sub-optimal.
Now we get to the really clever part – the real reason for the robotic/automated factory. At first blush, one might think the reason is that I’m bent on minimizing returns to labor and maximizing returns to my capital. That’s not the case at all. I intend to compensate my 6 laborers very, very highly. As a matter of fact, it’s critical that I do so in order to ensure long-term returns to my capital. The real reason for the emphasis on automation has to do with the output[s] of my factory and my market for those outputs. Well, the market (at least initially) is the United States. And the outputs will be – wait for it – whatever the Washington D.C. decided subsidy-flavor-of-the-month will make my factory’s output most profitable!
That’s why my factory made door knobs and kitchen faucets 5-6 years ago, but has been rapidly re-programmed to crank out scalpels and defibrillators today! (We had a brief stint of programming the robots to crank out solar panels in the interregnum, but that wasn’t destined to be nearly as profitable as health care stuff.) The key point being, this factory, in order to provide at least 20 years of viability (justifying the initial investment), has to be programmable to adapt to the ever-changing vagaries of U.S. subsidy/regulatory policy!
I will, of course, use U.S. manufactured currency to capitalize my factory. Federal Reserve coupons are both cheap and abundant. (They’re actually cheap because they’re abundant, but that gets into economics theory that probably is beyond Matt’s understanding.)
Hunter
Jan 16 2012 at 11:32am
The problem I have with Austrian economics is their view that bad investment in capital goods is ONLY because of monetary inflation. My view is that bad investment in capital goods can come from a number of errors including not figuring out how much demand for a particular product there is outstanding and oversupplying that product.
James
Jan 16 2012 at 1:40pm
Hunter,
No Austrian claims that inflation is the ONLY source of capital misallocation.
David,
ABCT only requires that production occurs in stages, that people dislike waiting and that money is non-neutral. Old Keynesian theories only work if consumption is a function of current period income and investment decisions are determined by sentiment. New Keynesian and RBC theories only hold if there is only one project to invest in and entrepreneurs’ ability to gage the profitability of various projects is unaffected by inflation.
Unlearning,
Was it your ability for sarcasm that let you to believe Austrians assume their conclusions? Because so far, that’s all you’ve offered.
Greg Jaxon
Jan 16 2012 at 3:41pm
david said:
“The core of ABCT is in the assertion of a particular kind of capital structure in the macroeconomy, without it the policy recommendations of Austrian theory collapse.”
Not sure what “policies” Austrians recommend.
It’s more anti-policy: i.e. stop synchronizing errors by making policy; let free markets re-diversify the capital structure.
I’m also not sure why you use the word “collapse”.
Yes, when Austrians get their way, their demand for freer markets will “collapse” as in go to zero. Why the connotation that this would be some kind of a market collapse?
BTW, ABCT is hardly the essence of the Austrian school – the madness of crowds is a common observation, Austrians just happen to be good at spotting how policy keeps herding us into crowds.
vlad
Jan 16 2012 at 6:06pm
@Curt Doolittle
Here’s a quote from O’Driscoll & Rizzo about the subjectivity of cost (pp. 47-50):
And one about institutions (p. 39):
vlad
Jan 16 2012 at 6:21pm
According to the standard economic view about institutions institutions emerge as a way to minimize transaction costs, but if costs are subjective, this view is somewhat undermined. The same problem that exists in regard to aggregating utilities now exists about aggregating transaction costs.
So you are led to a more sociological perspective on institutions, like the one cited above. Institutions are not so much mechanisms for minimizing transaction costs, as they are mechanisms for transmitting certain kinds of information and facilitating collective action (not necessarily in the most efficient fashion). The Austrian view and the “minimize transaction costs” view are not entirely disconnected in their implications, but they’re not equivalent.
Robert
Jan 24 2012 at 8:39am
To understand Austrian economic theory you must go back to Karl Menger in 1871 who had shown that value is subjective. Some of you kept using “cost” as being subjective in your posts. Thus we now have the theory of Marginal Utility. Von Mises, Wieser and Boehm-Bauwerk later followed and laid the ground work for capital theory. Along with Hayek, Rothbard and Kirsner, to name a few. Austrain business cycle theory simply states that government manipulation of the supply of money (inflation)and credit (interest) leads to malinvestment by entrepreneurs since this obscures the price mechanism. Interest is the price of credit. Investments are made into long term projects that would not have been made had the interest rate and thus the price of credit had not been obscured. These projects do not get completed and labor is unemployed when interest rates rise again. A correction ensues. The correction is to liquify the malinvestment and redistribute resources and capital to more proper uses. When unhampered the correction lasts for only a short time, depending on bankruptcy laws.
There is much much more pertaining to Austrian economics but space only allows for so much.
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