Austrian Economics Reading Group Session 4 Spring 2010

The NC Austrian Forum met for the fourth time this past Friday (March 26, 2010) and discussed “Equilibrium Versus Market Process,” by Israel M. Kirzner and “On the Central Concept of Austrian Economics: Market Process,” by Ludwig M. Lachmann.

There were unfortunately almost as many professors as there were students—fortunate if you’re one of the students. There were only 2 graduate students and three undergraduates. Hopefully, now that Spring Break is behind us, there will be more next time.

One of the first issues that were brought up was by Stephen Margolis. He thought a critical point was when Kirzner asks, “If no one raises or lowers price bids, how do prices rise or fall?” In the model of perfect competition, the solution is through perfect knowledge. No adjustment process is necessary because we are always in equilibrium. However, that is not the world in which we live. So then how does it get done? Without the actions of the entrepreneur, it doesn’t get done. We also looked at what several principles economics textbooks had to say and it was not encouraging.

Kirzner next draws a distinction between Robbins (Robbinsian) and Mises (Misesian) conception of economics. As Kirzner states,

“Lord Robbins defined economics as dealing with the allocative aspect of human affairs, that is, with the consequences of the circumstance that men economize by engaging in the allocation of limited resources among multiple competing ends. Mises, on the other hand, emphasized the much broader notion of purposeful human action, embracing the deliberate efforts of men to improve their positions.”

Here we see the fundamental difference: for Neo-Classicals it is a simple, static maximization problem. For Austrians on the other hand, it is the searching for means to accomplish ends through time.

For Kirzner, the entrepreneur is the key to the market moving toward equilibration. While we might not ever get to such a point in the real world, the fact that the market equilibrates allows us to engage in comparative analysis.

In the next article, Lachmann rejects this position. He argues that each transaction might coordinate one person’s plans, but at the same time it might throw another’s plans into chaos. Thus, there is no such thing as moving closer to equilibrium for there is no such thing as equilibrium outside of the static state.

In Lachmann’s words, “The market process is the outward manifestation of an unending stream of knowledge. This insight is fundamental to Austrian economics. The pattern of knowledge is continuously changing in society, a process hard to describe. Knowledge defies all attempts to treat it as a 'datum' or an object identifiable in time and space.”

While it is hard to deny such a position, it also leaves one in a state of economic nihilism. How does one conduct any comparative analysis if everything is kaleidic?

Lachmann argues, “To say that the market gradually produces a consistency among plans is to say that the divergence of expectations, on which the initial incoherence of plans rests, will gradually be turned into convergence. But to reach this conclusion we must deny the autonomous character of expectations.”

I agree that we do have to deny the autonomous character of expectations. I think that expectations are shaped by experience. In a market setting, if one raises price and expects to sell more units, then that person will not be in business for too long. The nature of our expectations is shaped by how the market works. Expectations cannot be random and to the extent that Lachmann means this, he is wrong.

What do you think?

On a separate note, the NC Austrian Forum decided not to cover the next two readings on Capital Theory because the readings assume some background knowledge of people and issues. As a result, the two readings for next week will instead be: F. A. Hayek, (1935) “The Conditions of Equilibrium between the Production of Consumers' Goods and the Production of Producers' Goods,” Prices and Production, 2nd edition, Lecture 2, pp. 32-68. (The pdf is for the whole book, so don't just hit "print.") The second one is, Ludwig M. Lachamann (1977) “Complementarity and Substitution in the Theory of Capital,” Capital, Expectations, and the Market Process, pp. 197-213. Again, the pdf is for the whole book, so don't just hit "print."

Then we will cover Rothbard’s article “The Austrian Theory of Money,” and O’Driscoll and Shenoy’s article “Inflation, Recession and Stagflation.” These will round out the semester and then it will be on to Fall Semester. (Wow, time has moved fast!)

Austrian Economics Reading Group Session 3 Spring 2010

For the third session of the reading group, I was unable to attend because I was instead at the Austrian Scholars Conference at the Ludwig von Mises Institute in Auburn, AL. At the third meeting the readings, “Philosophical and Ethical Implications of Austrian Economics” by Israel M. Kirzner and “Praxeology, Value Judgments, and Public Policy,” by Murray N. Rothbard, were discussed.

The two articles center upon the economist’s ability to practice a Wertfreiheit or value-free economic science. The reason for this question is one of power and limitations. Suppose that the economist can say something like Policy X will not work, in the same way that a chemist can say one oxygen atom and one hydrogen atom cannot make water, then that economist must be listened to. However, this situation is never the case. The economist either has to use his own value set of “goods” and “bads” or he has to adopt that of his client. The result is that there are no objectively good or bad policies, not even on issues like price controls or even market equilibration.

My thoughts on this are that as long as one is clear about their point of view, then that will minimize misunderstanding. However, if someone is looking to discredit you and says that you’re a "free market economist" and so of course you'd support.... Well, there’s really not a whole lot one can do, because they’re just looking to attack you personally. So why not just be up front about it and then deal with those attacks as they come up?

I am sure that there were many interesting points that were made on these readings, but unfortunately I was not there. Maybe if you have thoughts on this, you’d like to leave some comments? You are always welcome to do so.

Democracy in America?

On the day after the "Health Care" legislation was "passed," I am reminded of a lengthy quote by Alexis de Tocqueville. It comes from his book, Democracy in America. This quote comes from the second volume, written in 1840, section 4, chapter 6, "WHAT SORT OF DESPOTISM DEMOCRATIC NATIONS HAVE TO FEAR." It is well worth reading the whole thing.

"I seek to trace the novel features under which despotism may appear in the world. The first thing that strikes the observation is an innumerable multitude of men, all equal and alike, incessantly endeavoring to procure the petty and paltry pleasures with which they glut their lives. ...

"Above this race of men stands an immense and tutelary power, which takes upon itself alone to secure their gratifications and to watch over their fate. That power is absolute, minute, regular, provident, and mild. It would be like the authority of a parent if, like that authority, its object was to prepare men for manhood; but it seeks, on the contrary, to keep them in perpetual childhood: it is well content that the people should rejoice, provided they think of nothing but rejoicing. For their happiness such a government willingly labors, but it chooses to be the sole agent and the only arbiter of that happiness; it provides for their security, foresees and supplies their necessities, facilitates their pleasures, manages their principal concerns, directs their industry, regulates the descent of property, and subdivides their inheritances: what remains, but to spare them all the care of thinking and all the trouble of living?

"Thus it every day renders the exercise of the free agency of man less useful and less frequent; it circumscribes the will within a narrower range and gradually robs a man of all the uses of himself. The principle of equality has prepared men for these things;it has predisposed men to endure them and often to look on them as benefits.

"After having thus successively taken each member of the community in its powerful grasp and fashioned him at will, the supreme power then extends its arm over the whole community. It covers the surface of society with a network of small complicated rules, minute and uniform, through which the most original minds and the most energetic characters cannot penetrate, to rise above the crowd. The will of man is not shattered, but softened, bent, and guided; men are seldom forced by it to act, but they are constantly restrained from acting. Such a power does not destroy, but it prevents existence; it does not tyrannize, but it compresses, enervates, extinguishes, and stupefies a people, till each nation is reduced to nothing better than a flock of timid and industrious animals, of which the government is the shepherd.

"I have always thought that servitude of the regular, quiet, and gentle kind which I have just described might be combined more easily than is commonly believed with some of the outward forms of freedom, and that it might even establish itself under the wing of the sovereignty of the people.

"Our contemporaries are constantly excited by two conflicting passions: they want to be led, and they wish to remain free. As they cannot destroy either the one or the other of these contrary propensities, they strive to satisfy them both at once. They devise a sole, tutelary, and all-powerful form of government, but elected by the people. They combine the principle of centralization and that of popular sovereignty; this gives them a respite: they console themselves for being in tutelage by the reflection that they have chosen their own guardians. Every man allows himself to be put in leading-strings, because he sees that it is not a person or a class of persons, but the people at large who hold the end of his chain.

"By this system the people shake off their state of dependence just long enough to select their master and then relapse into it again. A great many persons at the present day are quite contented with this sort of compromise between administrative despotism and the sovereignty of the people; and they think they have done enough for the protection of individual freedom when they have surrendered it to the power of the nation at large. This does not satisfy me: the nature of him I am to obey signifies less to me than the fact of extorted obedience. "
The rest is found here.

The End of Mercy?

This past weekend I attended the Austrian Scholars Conference at the Mises Institute, Auburn AL. There were many excellent papers there and I need time to digest them all; nevertheless a line of reasoning hit me that I have to share. It comes from Paul Cleveland's paper, "Social Justice: Neither Social nor Just." The argument runs like this:

The people who are pushing for "Social Justice" have tried to make Mercy a part of Justice. (We see this everywhere. We see this whenever there is a call for a government program to "help the less fortunate.")

However, Mercy is unmeritted.

Therefore, Mercy cannot be apart of Justice.

Thus the Social Justice-ers are destroying Mercy.

Profound!

The Purpose of Corporations

What is the purpose of a corporation? If you said that it’s to create jobs, think again. Not only are jobs not the purpose of a corporation, they are not even the purpose of the economy. The goal of an economy (if such a thing can ever really be put forward) is to increase our standard of living. That means that our goal is to use our resources ever more efficiently in the creation of goods and services.

In a market economy, the market harmonizes the production of suppliers with the wants and desires of consumers. It does so through the price system. Prices are little packets of information that convey the relative scarcity of resources. A rising market price indicates a resource is becoming more scarce. The higher price tells entrepreneurs to use less and look for substitutes. A lower price shows that the resource is less scarce. The change in price not only tells people in which direction to move, but it also tells us by how much. If the price of a ton of steel rises by 3-cents, then it’s no big deal. However, if it rises by 300%, then more significant action is needed. The upshot of all of this is that the market coordinates the activities of producers and consumers so that we are minimizing waste. Economic profits guide entrepreneurs. Profits are the reward for correctly coordinating the economy. Losses are the result of not doing so.

Some people think that corporations are heartless and soulless entities that are only looking at the bottom line. Well, yes. While corporations on paper have the same rights as individuals, corporations are not really people. General Electric is not a real general. All too often we mix up the way we use English. We use collective nouns and then personify them. For example, you might hear on the news that “the market was feeling sluggish,” or “the EPA is regulating a new chemical,” or “General Motors is coming out with a new car.” All of these, “the market,” “the EPA,” and “General Motors,” are collective nouns. We use these phrases as shorthanded expressions, but we should not ascribe to them personal feelings and motives. Furthermore, since they are not really people, they have no morally responsibilities. The people who work within these institutions have moral responsibilities, but the organization does not.

The owners of a corporation are the shareholders. They have invested money into this form of productive organization to make a return. If the company is not making a large enough return, the shareholders sell and reinvest their funds elsewhere. Who owns stock? Most people do. Anyone who has an IRA, 401k or pension plan does. Basically, anyone who is attempting to save for retirement is a part owner of a corporation. The point is that it’s not just rich people.

The shareholders vote for a Board of Directors to oversee and supervise the operation of the company. (Usually, it is one share equals one vote.) The Board then hires a CEO for the day-to-day operations. The CEO and the rest of the management team are employees of the firm. Their job is to make as much profit as they can. That means keeping costs down while serving customers.

The CEO may be asked if he wants the corner office or a cubicle; if he wants a big mahogany desk or a small metal desk; or if he wants to schmooze clients at Waffle House or take the corporate jet to Tahiti for nine rounds of golf. When the CEO picks the expensive choice, he is taking perquisites (or perks). In other words, the CEO is spending the shareholders’ money on himself. It is the job of the Board of Directors to oversee this and attempt to curtail such practices. Clearly people get upset when they see this happening because the company’s funds are not the CEO’s personal money. In the same way, when the CEO donates corporate funds to a charity, say cancer research, he is again using someone else’s money. It’s not his to spend. It is tantamount to stealing. The corporation has no moral duty to help cancer patients and the employees of the company cannot use corporate money without breaking moral codes themselves. If the CEO feels so passionately about cancer research, let him donate his own money.

Sometimes we might see, at a little league game, players with shirts with “Joe’s Plumbing” on them. Is this also stealing? Maybe. If Joe’s Plumbing is able to generate goodwill and sales from the bestowal of the T-shirts, then that is considered good marketing. If not, then it may very well be stealing. It’s a grey area and has to be determined on a case-by-case basis. Nevertheless the bottom line is that employees should not be using company funds for their own benefit.

Thus, we have our answer: shareholders create a corporation to make profit—the bigger the profit, the better. The goal of corporate management is to increase the company’s share price. Corporations are not created for jobs, or for providing health care, or for providing a living wage, or for promoting social justice, or for any of that. It is to make profit, no more, no less. And that is a good thing.

Austrian Economics Reading Group Session 2 Spring 2010

An Austrian Forum has started in Raleigh, NC. The selection is "The Foundations of Modern Austrian Economics." By "Modern" we mean 1976. :-) This week we are to read the second 2 chapters. The book is here.

This past week we had a good showing at the NC State University Austrian Forum. While, there were a few more students this time, I think that a couple of students did not return for this second meeting. I don’t know if they couldn’t make it or if they simply were not interested in the Austrian perspective. On the plus-side, Karen Palasek joined us. She is usually a quiet participant, but when she does make a point, it is something that one should pay heed to.

The two readings for this week in the Dolan book, The Foundations of Modern Austrian Economics were: Kirzner’s “On the Method of Austrian Economics” and Rothbard’s “New Light on the Prehistory of the Austrian School.” Unbeknownst to me, there was a change in the readings this week. The group decided to skip the Rothbard reading and instead extend a point that we covered in the last session.

In the last session we were talking about the differences between the Austrian foundation and that of the Neo-Classicals. A difference is that in the construction of the demand curve, the Neo-Classicals say that Giffen goods are a possibility, while in the Austrian formulation, they are not.

Thus, we had a short reading by Peter Klein called, “A Note of Giffen Goods,” which can be found here. or try http://web.missouri.edu/~kleinp/misc/giffen.pdf

The reading is only 2 ½ pages long (which is why I read it before the session started), and is very powerful. There are several points in it that I simply have not thought of before. Klein points out that Menger and the Austrians look at discrete units and apply the logic of action, which allows us to derive the Law of Diminishing Marginal Returns. From this law, we can derive the Law of Demand.

From the Neo-Classical perspective, they start with bundles and not goods. The bundles are infinitely divisible and can be mapped on to a set of indifference curves and constrained by budgets. The Neo-Classical will place a single good on the horizontal axis and “all other goods” on the vertical. Then by changing the price of the single good, they can derive a demand curve in a separate (but connected) graph. Using this analysis, the Neo-Classical can decompose the effect of the price change into a substitution effect and an income effect. An inferior good yields a negative income effect, and a sufficiently strong negative income effect is the sign of a Giffen good.

One of the most interesting points that Klein makes is that Neo-Classicals are not actually using marginal utility in their analysis. They are actually comparing different levels of total utility (different indifference curves) and looking at the marginal rate of substitution of the respective bundles. Klein points out that “the adjective ‘marginal’ refers to the units, not the ‘utilities.’”

Brilliant!

The second reading was Kirzner’s “On the Method of Austrian Economics.” I think that this article is interesting, but is in desperate need of context. This essay was written in the early 1970s. At this time NYU was one of the last bastions of Austrian Economics, at least at the graduate level. During this time, there were few professors in the Austrian tradition and so their opinions, I think, were magnified. I don’t mean to belittle the ideas, but I think that if an Austrian professor embarked upon a discourse of economic kaleidics today, it would have less influence because the profession is so much larger.

Anyway, Kirzner separates the Austrian School into two basic “tenants.” The two sides are represented by Hayek and Lachmann. In a nut shell, Hayek argues that markets coordinate the actions and plans of individuals and that the market process moves us toward “equilibrium.” (There was some discussion about using the word, “equilibrium.” Cordato and I don’t really like to use it. I prefer Bastiat’s notion of Harmony, while Cordato prefers the use of error reduction.) On the other hand, Lachmann argues, “How can we know that markets equilibrate?” For Lachmann, the actions of one person discoordinate the plans of another person. The result of which might not be a movement toward anything like an equilibrium. As a result, while there are patterns, they are not something that we can use for prediction, hence, the use of the term “economic kaleidics.”

While the Austrian profession has never definitively answered Lachmann’s challenge, most modern Austrians (35 years later) have decided not to follow in his footsteps. This point, to me, says volumes about the over-emphasis of Lachmann’s position. Nevertheless, perhaps it is also high time that an answer be made to Lachmann’s challenge once and for all. The only question is: “Who’s up for it? “