Austrian Economics
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Transcript of Austrian Economics
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LANCASTER UNIVERSITYTHE MANAGEMENT SCHOOL
Lancaster LA1 4YX UK
DEPARTMENT OF ECONOMICS
Austrian EconomicsAustrian Economics
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‘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’
(Robert Solow, 1984)
‘in any issue of any journal there’s a lot of crap ..’ (Robert Lucas, 1984)
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)
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Congratulations on your profile 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.’
(Friedrich Hayek, 1975)3
Congratulations on your profile Congratulations on your profile
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KrugmanismKrugmanism
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‘A researcher who … takes his departure from arbitrary axioms … falls necessarily into error, even if he makes superior use of mathematics’
Plus ça change? Plus ça change?
Carl Menger1840 - 1921
Albert Einstein1842 - 1924
‘Not everything that can be counted counts, and not everything that counts can be counted.’
Pick up a test paper, and remove the words ….
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Though a skilled mathematician, he used mathematics sparingly.
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)
(A C Pigou on Alfred Marshall, 1925 )
Plus ça change? Plus ça change?
Alfred Marshall1842 - 1924
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‘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)
‘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’
REF-2014REF-2014research evaluation frameworkresearch evaluation framework
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)
Austrian SchoolAustrian School
8http://library.mises.org/books/J246rg%20Guidohttp://library.mises.org/books/J246rg%20Guido%20H252lsmann/Mises%20The%20Last%20Knight%20H252lsmann/Mises%20The%20Last%20Knight%20of%20Liberalism.pdf %20of%20Liberalism.pdf 107 ff107 ff
Austrian approach: (dynamic adjustment to shifting equilibria)
marginal subjective evaluations subjective evaluations (variable with circumstances)
Anglo-Saxon approach: (static equilibria)
marginal utility (inherent in the commodityinherent in the commodity)inter-personal comparisons
optimality based on known knownsPareto optimality
Austrian SchoolAustrian School
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Historical School Historical School vsvs Austrian School Austrian School
Gustav Schmoller1938 - 1917
Carl Menger1840 - 1921
Concernshow might the state promote welfarewary of laissez-fairelessons from history rather than theory
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Concernsanalytical science: general propositions human action drives market phenomena subjective values drive choices
Historical School Historical School vsvs Austrian School Austrian School
Concernshow might the state promote welfarewary of laissez-fairelessons from history rather than theory
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J M Keynes1883 - 1946
F A Hayek1899 - 1992
Concernsanalytical science: general propositions human action drives market phenomena subjective values drive choices
Austrian SchoolAustrian School
J M Keynes1883 - 1946
‘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’
‘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’
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F A Hayek1899 - 1992
J M Keynes J M Keynes vsvs F A Hayek F A Hayek
J M Keynes1883 - 1946
F A Hayek1899 - 1992
‘It is an extraordinary example of how, starting with a mistake, a remorseless logician can end up in Bedlam.’
‘‘Mr Keynes aggregations conceal the most fundamental mechanisms of change’
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Hayek: ‘Economics and knowledge’, Hayek: ‘Economics and knowledge’, EconomicaEconomica (1937) (1937)
Hayek: ‘The Pretence of Knowledge’, (1975)Hayek: ‘The Pretence of Knowledge’, (1975)
Henry Plotkin: Henry Plotkin: The Nature of Knowledge The Nature of Knowledge (1994) (1994)
Paul Ormerod: Paul Ormerod: Why Most Things Fail Why Most Things Fail (2005)(2005)
Austrian SchoolAustrian School
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aversionaversion tothe pretence of knowledge (what and to whom?)
the insistence upon mathematical precision
decision-makingdecision-making cannot be reduced to differential calculus
choicechoice is a costly experimententrepreneurship achieves greater economic coherence
prices: prices: a telecommunication systempricesprices: determined by
subjective wants ideas about opportunities
Austrian SchoolAustrian School
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dynamic process of multi-plan entrepreneurial co-ordination:dynamic process of multi-plan entrepreneurial co-ordination:
arbitrage opportunities
trading at disequilibrium prices
moving markets towards ‘equilibrium’
institutional structures institutional structures owing their existence to transactions costs: transactions costs:
money, banks,
law, accountancy, insurance,
salesmen, firms
Austrian SchoolAustrian School
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Austrian School Austrian School dynamic coordination: dynamic coordination: though market processes
catallaxy: spontaneous order achieved by free exchange;
participants’ objectives are irrelevantmarket: non-teleological institution
no judgement about the end-states it fosters
Neoclassical microeconomics Neoclassical microeconomics static problem: static problem: allocating givengiven means among knownknown ends economy: an administered organisation
resources directed to serve given objectives
no social/historical/institutional context
theory of consumer behaviour/the firm/income distribution
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beer
cigarettes
U = f (beer, cigarettes)
Neoclassical Microeconomics, Neoclassical Microeconomics, where mathematicians play ….where mathematicians play ….
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capital
labour
marginal analysis
neo-classical economics
microeconomics
constrained optimisationoutput = f (capital, labour)
Neoclassical Microeconomics, Neoclassical Microeconomics, where mathematicians play ….where mathematicians play ….
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x1
x2
marginal analysis
neo-classical economics
microeconomics
constrained optimisation
vulgar economicsvulgar economics
q = f (x1, x2)
Neoclassical Microeconomics, Neoclassical Microeconomics, where mathematicians play ….where mathematicians play ….
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Entrepreneurship ?Entrepreneurship ?
Neoclassical Microeconomics, Neoclassical Microeconomics, where mathematicians play ….where mathematicians play ….
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Entrepreneurship ?Entrepreneurship ?
Neoclassical Microeconomics, Neoclassical Microeconomics, where mathematicians play ….where mathematicians play ….
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William BaumolWilliam Baumol
Austrian School Austrian School
EntrepreneurshipEntrepreneurship
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Paul OrmerodPaul Ormerod
• notnot few and very clever few and very clever
butbut
• many and (mostly) failuresmany and (mostly) failures
Biological species - 99.9% are extinctUS companies - 10% fail each year
Austrian School Austrian School
EntrepreneursEntrepreneurs
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economic efficiency stemseconomic efficiency stems
• notnot from from ex ante ex ante rational planning rational planning
but from but from ex post ex post elimination of ill-adapted formselimination of ill-adapted forms
• notnot from smart people within simple worlds from smart people within simple worlds
but from dull people within complex worldsbut from dull people within complex worlds
Austrian School Austrian School
EntrepreneursEntrepreneursPaul OrmerodPaul Ormerod
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Austrian School Austrian School
ephemerala reward to being first in applying a new idea
a reward for taking a chance
rarely persistattract emulation (and envy)
protected primarily by state licensing
Entrepreneurial ProfitsEntrepreneurial Profits
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‘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)
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
Hayek: ‘Economics and knowledge’ (1937)Hayek: ‘Economics and knowledge’ (1937)
Austrian School Austrian School
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Markets:Adam Smith: division of labour Friedrich Hayek: division of knowledge
Austrian School Austrian School
‘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)
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The Apostle of Laissez-faire?The Apostle of Laissez-faire?
Austrian School Austrian School
‘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)
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The Apostle of Laissez-faire?The Apostle of Laissez-faire?
evolutionary thesis applied to knowledge
‘universal adaptation-ism’
(no connotation of progress)
adaptation solves problemsknowledge is
end-directed adaptive actionspecie-specific
The Nature of Knowledge (1994)Darwin Machines and the Nature of Knowledge (1997)
Henry Plotkin
Austrian School Austrian School
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Plotkin’s terminology
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’
Austrian School Austrian School
Henry Plotkin
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Keynes had ‘a common sense understanding’
Hayek’s was ‘intellectual rather than practical’
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’
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Nicholas Wapshott
Investment projects are abandoned because there is no demand ‘for ice cream’ by the time ‘ice trays for commercial refrigerators’ are complete.
The exact opposite holdsThe exact opposite holds
Hayek’s business cycle theory:‘higher order’ capital projects are halted because the demand for final goods becomes too urgent.
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Nicholas Wapshott
‘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 investmentsinappropriately structured investments
Austrian Business Cycle TheoryAustrian Business Cycle Theory
19741974 Nobel Prize for Economics citation:
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Austrian Business Cycle TheoryAustrian Business Cycle Theory
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saving falls consumption risesinvestment rises
Austrian Business Cycle TheoryAustrian Business Cycle Theory
‘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.’
19751975
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Austrian Business Cycle TheoryAustrian Business Cycle Theory
19331933
‘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.’
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Mark Twain (1835 - 1910)
‘‘History doesn’t repeat itself, but sometimes it rhymes’History doesn’t repeat itself, but sometimes it rhymes’
Austrian Business Cycle TheoryAustrian Business Cycle Theory
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Mild recession 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
Austrian Business Cycle TheoryAustrian Business Cycle Theory
1920s1920s
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Austrian Business Cycle TheoryAustrian Business Cycle Theory
1970s1970s
‘Stagflation’
StagflationStagflation
monetary distortions examined in the context of monetary distortions examined in the context of the labour market, trade unions and unemploymentthe labour market, trade unions and unemployment
shifting Phillips curve shifting Phillips curve misallocations of labour misallocations of labour
rising inflationrising inflationrising unemploymentrising unemployment
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Information Communication TechnologyInformation Communication Technology
Share prices rose whenShare prices rose when
‘ ‘e-‘ prefix e-‘ prefix and/or a and/or a ‘.com’ ‘.com’
was added to the company namewas added to the company name
The dot.com bubble bursts
Austrian Business Cycle TheoryAustrian Business Cycle Theory
1990s1990s
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The housing bubble bursts
Austrian Business Cycle TheoryAustrian Business Cycle Theory
2000s2000s
Domestic PropertyDomestic Property
the primary feature of unsustainable long-term investments that become viable during a bank credit upswing
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Austrian Business Cycle TheoryAustrian Business Cycle Theory
No panaceas …No panaceas …
No avoiding the pain of liquidating bad investments ...No avoiding the pain of liquidating bad investments ...
No atheists in trenches ... No atheists in trenches ...
No Hayekians in recessions ...No Hayekians in recessions ...
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n
n
VV
rr
n > n
c < c
Capitalised ValuesCapitalised Values
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V = c [1 – (1 + r)-n]/ r
£100.00
0.07
n20
n5
Structural equilibrium (r = 0.07r = 0.07)
VV
rr
Capitalised ValuesCapitalised Values
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20 > 5
c < c
V = c [1 – (1 + r)-n]/ r
£106.80
£102.80
£100.00
0.06 0.07
n20
n5
Interest Rate EffectInterest Rate Effect
VV
rr
Capitalised ValuesCapitalised Values
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£106.80
£102.80
£100.00
0.06 0.07
n20
n5
VV
rr
capital deepening(resource constraints)
Interest Rate EffectInterest Rate EffectCapitalised ValuesCapitalised Values
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£105.00
£100.00
0.07 0.079 0.089
n5
n20VV
rr
Capitalised ValuesCapitalised ValuesRelative Price EffectRelative Price Effect
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V = c [1 – (1 + r)-n]/ r
£100.00
0.07 0.079 0.089
n5
VV
rr
Capitalised ValuesCapitalised ValuesRelative Price EffectRelative Price Effect
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n20 capital shallowing(resource constraints)