‘in any issue of any journal there’s a lot of crap ..’
(Robert Lucas, 1984)
Austrian Economics
‘there is no Austrian economics - only good economics and bad
economics’
(Milton Friedman, 1976)
‘I could verify the existence of witches if you give me the chance
every other year to tack on some variables in the regression’
1
(Robert Solow, 1984)
Congratulations on your profile
The profession has been criticised for its adherence to models of
a free market that claim to show demand and supply continually
rebalancing over relatively short periods of time – in contrast to
the decade-long mismatches that came ahead of the banking
crash in key markets such as housing and exotic derivatives,
where asset bubbles ballooned.
Members of the Post-Crash Economics Society said their course
was dominated by models and equations that trained
undergraduates for City jobs without a broader understanding
of the way economies and businesses work.
(The Guardian, 11 November 2013)
2
Congratulations on your profile
The profession has been criticised for its adherence to models of
a free market that claim to show demand and supply continually
rebalancing over relatively short periods of time – in contrast to
the decade-long mismatches that came ahead of the banking
crash in key markets such as housing and exotic derivatives,
where asset bubbles ballooned.
(The Guardian, 11 November 2013)
‘For forty years I have preached that the time to prevent a depression is
during the preceding boom; and that, once a depression has started, there is
little one can do about it. My advice was completely disregarded as long as
the boom lasted. Now suddenly, when my prediction has come true and we
have reached the stage where ... little can be done about the inevitable
reaction which has set in, people suddenly turn to me and ask for my
opinion.’
3
(Friedrich Hayek, 1975)
Krugmanism
4
Plus ça change?
Carl Menger
1840 - 1921
‘A researcher who … takes his departure from
arbitrary axioms … falls necessarily into error, even if
he makes superior use of mathematics’
‘Not everything that can be counted counts, and not
everything that counts can be counted.’
Albert Einstein
1842 - 1924
Pick up a test paper, and remove the words ….
5
Plus ça change?
Though a skilled mathematician, he used mathematics sparingly.
Alfred Marshall
1842 - 1924
He saw that excessive reliance on this instrument might lead us astray in pursuit
of intellectual toys, imaginary problems not conforming to the conditions of real
life: and further, might distort our sense of proportion by causing us to neglect
factors that could not easily be worked up in the mathematical machine
Marshall followed the rule that
1. one should use mathematics as a shorthand and not as an engine of inquiry;
2. one should keep to the mathematics until it is done;
3. then translate the mathematics into English;
4. then provide an illustration of the point with an important real world example;
5. then burn the mathematics; and
6. if you cannot succeed at (4) then burn (3)
6
(A C Pigou on Alfred Marshall, 1925 )
REF-2014
research evaluation framework
‘Internal preparations for REF-2014 reward disciplinary
orthodoxy by resting upon the evaluations of a single reader
per Unit of Assessment and by expecting each member of
staff to fit within the narrative of that Unit’
‘if you know economics and nothing else, you will be a
bane to mankind, good, perhaps, for writing articles for
other economists to read, but for nothing else’
(Friedrich Hayek, 1944)
7
Austrian School
Carl Menger (1840-1921)
Friedrich von Wieser (1851-1926)
Eugene Böhm-Bawerk (1851-1914).
Ludwig von Mises (1881-1973)
Friedrich Hayek (1899-1992)
Contrast with classical labour theory of value:
David Ricardo (1772-1823)
John Stuart Mill (1806-1873)
Karl Marx (1818-1883)
http://library.mises.org/books/J246rg%20Guido%20H252l
smann/Mises%20The%20Last%20Knight%20of%20Liber
alism.pdf
107 ff
8
Austrian School
Austrian approach: (dynamic adjustment to shifting equilibria)
marginal subjective evaluations
(variable with circumstances)
Anglo-Saxon approach: (static equilibria)
marginal utility (inherent in the commodity)
inter-personal comparisons
optimality based on known knowns
Pareto optimality
9
Historical School vs Austrian School
Concerns
how might the state promote welfare
wary of laissez-faire
lessons from history rather than theory
Gustav Schmoller
1938 - 1917
Concerns
analytical science: general propositions
human action drives market phenomena
subjective values drive choices
Carl Menger
1840 - 1921
10
Historical School vs Austrian School
Concerns
how might the state promote welfare
wary of laissez-faire
lessons from history rather than theory
J M Keynes
1883 - 1946
Concerns
analytical science: general propositions
human action drives market phenomena
subjective values drive choices
F A Hayek
1899 - 1992
11
Austrian School
‘In the long run we are all dead. Economists
set themselves too easy, too useless a task if in
tempestuous seasons they can only tell us that
when the storm is past the ocean is flat again’
J M Keynes
1883 - 1946
F A Hayek
1899 - 1992
‘Are we not told that ‘since in the long run we
are all dead’, policy should be guided entirely
by short-run considerations? I fear that these
believers in the principle of après nous le
deluge may get what they have bargained for
sooner than they wish’
12
J M Keynes vs F A Hayek
‘It is an extraordinary example of how,
starting with a mistake, a remorseless
logician can end up in Bedlam.’
J M Keynes
1883 - 1946
‘‘Mr Keynes aggregations conceal the
most fundamental mechanisms of change’
F A Hayek
1899 - 1992
13
Austrian School
Hayek: ‘Economics and knowledge’, Economica (1937)
Hayek: ‘The Pretence of Knowledge’, (1975)
Henry Plotkin: The Nature of Knowledge (1994)
Paul Ormerod: Why Most Things Fail (2005)
14
Austrian School
aversion to
the pretence of knowledge (what and to whom?)
the insistence upon mathematical precision
decision-making cannot be reduced to differential calculus
choice is a costly experiment
entrepreneurship achieves greater economic coherence
prices: a telecommunication system
prices: determined by
subjective wants
ideas about opportunities
15
Austrian School
dynamic process of multi-plan entrepreneurial co-ordination:
arbitrage opportunities
trading at disequilibrium prices
moving markets towards ‘equilibrium’
institutional structures owing their existence to transactions costs:
money, banks,
law, accountancy, insurance,
salesmen, firms
16
Austrian School
dynamic coordination: though market processes
catallaxy:
spontaneous order achieved by free exchange;
participants’ objectives are irrelevant
market:
non-teleological institution
no judgement about the end-states it fosters
Neoclassical microeconomics
static problem: allocating given means among known ends
economy:
an administered organisation
resources directed to serve given objectives
no social/historical/institutional context
theory of consumer behaviour/the firm/income distribution
17
Neoclassical Microeconomics,
where mathematicians play ….
beer
U = f (beer, cigarettes)
cigarettes
18
Neoclassical Microeconomics,
where mathematicians play ….
marginal analysis
capital
neo-classical economics
microeconomics
output = f (capital, labour)
constrained optimisation
labour
19
Neoclassical Microeconomics,
where mathematicians play ….
marginal analysis
x1
neo-classical economics
microeconomics
q = f (x1, x2)
constrained optimisation
vulgar economics
x2
20
Neoclassical Microeconomics,
where mathematicians play ….
Entrepreneurship ?
21
Neoclassical Microeconomics,
where mathematicians play ….
Entrepreneurship ?
22
Austrian School
Entrepreneurship
William Baumol
channelled into activities that
produce wealth
expropriate wealth
government
rent-seeking
organized crime
policy focus:
property rights: well-defined and enforced
incentives: taxation, regulation, moral hazard
sound legal and monetary systems
23
Austrian School
Entrepreneurs
Paul Ormerod
•
not few and very clever
but
•
many and (mostly) failures
Biological species
US companies
-
99.9% are extinct
10% fail each year
24
Austrian School
Entrepreneurs
Paul Ormerod
economic efficiency stems
• not from ex ante rational planning
but from ex post elimination of ill-adapted forms
• not from smart people within simple worlds
but from dull people within complex worlds
25
Austrian School
Entrepreneurial Profits
‘We allow the individual share to be
determined partly by luck in order to make
the total to be shared as large as possible’
(Hayek, 1978)
ephemeral
a reward to being first in applying a new idea
a reward for taking a chance
rarely persist
attract emulation (and envy)
protected primarily by state licensing
26
Austrian School
Hayek: ‘Economics and knowledge’ (1937)
Markets:
Adam Smith:
Friedrich Hayek:
division of labour
division of knowledge
markets utilise local expertise
‘particular knowledge of time and place’
entrepreneurship: a process of discovery
co-ordination of individuals’ actions, based on
imperfect, incomplete, dispersed knowledge
27
Austrian School
The Apostle of Laissez-faire?
‘While the presumption must favour the free market, laissez-faire is not the
ultimate and only conclusion’ (1933)
‘Probably nothing has done so much harm to the liberal cause as the wooden
insistence of some liberals on certain rules of thumb, above all the principle of
laissez-faire’ (1944)
28
Austrian School
The Apostle of Laissez-faire?
‘Our main problems begin when we ask what ought to be the contents of property
rights, what contracts should be enforceable, and how contracts should be
interpreted or, rather, what standard forms of contract should be read into the
informal agreements of everyday transactions’ (1949)
‘Laissez-faire was never more than rule of thumb. It indeed expressed protest
against abuses of governmental power, but never provided a criterion by which
one could decide what were the proper functions of government’ (1973)
29
Austrian School
evolutionary thesis applied to knowledge
Henry Plotkin
‘universal adaptation-ism’
(no connotation of progress)
adaptation solves problems
knowledge is
end-directed adaptive action
specie-specific
The Nature of Knowledge (1994)
Darwin Machines and the Nature of Knowledge (1997)
30
Austrian School
Plotkin’s terminology
Henry Plotkin
primary heuristic (genetic/instinct)
shaped by ‘slow’ moving events
(‘generational deadtime’)
secondary heuristic (intelligence)
shaped by fast moving events
problems of an unfamiliar future
tertiary heuristic (cultural knowledge)
Hayek The Fatal Conceit …. ‘Between Instinct and Reason’
31
Keynes had ‘a common sense understanding’
Hayek’s was ‘intellectual rather than practical’
Nicholas Wapshott
Keynes saw economics as ‘a means of improving the lives of others’
Hayek ‘consumed by economic theory for its own sake’
Keynes confronted ‘real-life dilemmas’
Hayek indulged in ‘pure theory’
32
Investment projects are abandoned because there is
no demand ‘for ice cream’ by the time ‘ice trays for
commercial refrigerators’ are complete.
Nicholas Wapshott
The exact opposite holds
Hayek’s business cycle theory:
‘higher order’ capital projects are halted because
the demand for final goods becomes too urgent.
33
Austrian Business Cycle Theory
1974
Nobel Prize for Economics citation:
‘one of the few economists who warned about the possibility of the
major crisis before the great crash came in the autumn of 1929’
 a warning that derived from Hayek’s early monetary theory
 cheap credit cannot remedy inappropriately structured investments
34
Austrian Business Cycle Theory
saving falls
consumption rises
investment rises
35
Austrian Business Cycle Theory
1975
‘For forty years I have preached that the time to
prevent a depression is during the preceding boom;
and that, once a depression has started, there is little
one can do about it. My advice was completely
disregarded as long as the boom lasted. Now suddenly,
when my prediction has come true and we have
reached the stage where ... little can be done about the
inevitable reaction which has set in, people suddenly
turn to me and ask for my opinion.’
36
Austrian Business Cycle Theory
1933
‘the general disinclination to explain the past boom by
monetary factors has been quickly replaced by an even
greater readiness to hold the present working of our
monetary organization exclusively responsible for our
present plight. And the same stabilizers who believed
that nothing was wrong with the boom and that it
might last indefinitely because prices did not rise, now
believe that everything could be set right again if only
we would use the weapons of monetary policy to
prevent prices from falling.’
37
Austrian Business Cycle Theory
Mark Twain
(1835 - 1910)
‘History doesn’t repeat itself, but sometimes it rhymes’
38
Austrian Business Cycle Theory
1920s
Mild recession
would have followed growth to 1927, but ...
.... easy-money held back by two years
‘the normal process of liquidation’ (Hayek, 1935)
The Wall Street bubble bursts
39
Austrian Business Cycle Theory
1970s
Stagflation
monetary distortions examined in the context of
the labour market, trade unions and unemployment
shifting Phillips curve
misallocations of labour
rising inflation
rising unemployment
‘Stagflation’
40
Austrian Business Cycle Theory
1990s
Information Communication Technology
Share prices rose when
‘e-‘ prefix
and/or a
‘.com’
was added to the company name
The dot.com bubble bursts
41
Austrian Business Cycle Theory
2000s
Domestic Property
the primary feature of
unsustainable long-term investments
that become viable
during a bank credit upswing
The housing bubble bursts
42
Austrian Business Cycle Theory
No panaceas …
No avoiding the pain of liquidating bad investments ...
No atheists in trenches ...
No Hayekians in recessions ...
43
Capitalised Values
V
n
V = c [1 – (1 + r)-n]/ r
n >n
c <c
n
r
44
Capitalised Values
V
V = c [1 – (1 + r)-n]/ r
n20
£100.00
>5
c <c
n5
0.07
20
r
Structural equilibrium (r = 0.07)
45
Interest Rate Effect
Capitalised Values
V
n20
£106.80
£102.80
£100.00
n5
0.06
0.07
r
46
Interest Rate Effect
Capitalised Values
V
n20
capital deepening
(resource constraints)
£106.80
£102.80
£100.00
n5
0.06
0.07
r
47
Capitalised Values
V
n20
Relative Price Effect
V = c [1 – (1 + r)-n]/ r
£105.00
£100.00
n5
0.07 0.079
0.089
r
48
Relative Price Effect
Capitalised Values
V
n20
capital shallowing
(resource constraints)
£100.00
n5
0.07 0.079
0.089
r
49