Saturday, February 2, 2013

Austrian Economics Forum Spring #1 2013 (Part 1)--Buchanan and Methodology

It has been awhile since I made a AEF post.  Let's just chalk up last semester as a mess.  I might get back to posting them, but I realize that I need to move forward.

Yesterday, February 1st, was the 2013 kick-off meeting for the AEF at NC State University. There was quite the group there.  In addition to the group of graduate (and a few advanced undergraduate) students there were Prof. Stephen Margolis, Dr. Roy Cordato and his wife Dr. Karen Palasek, and additionally there was Dr. Mike Munger--Chair of Duke University's Political Science Department and all around nice guy.

There were two readings for this session, both written by Nobel Laureate James Buchanan (1919-2013).  The first reading was from Chapter 3 of his book Cost and Choice: An Inquiry in Economic Theory (1969).  The Chapter is called Cost and Choice.  It is found here: 3, Cost and Choice

This chapter is really an attack on the Neo-Classical approach to economics.  While I think that his criticisms are excellent when directed to the Neo-Classical approach, I don't think they have much impact on the Austrian approach to economics. 

To start, Buchanan says that mainstream economists say that science (and hence economics) must rest on something measurable.  There must be empirical and objective content.  Buchanan states, "the behavioral postulate" and the subsequent predictions of economic man are "drained of power," unless "specific descriptive content is given to 'costs' and to 'benefits' or to 'revenues.'"  He further states that, "There is no implied presumption that men should behave economically."  And then, "The motivational assumption is vital in that this allows the scientist to use the objectively observable magnitudes of money cost and money revenue streams as representations of the subjectively evaluated alternatives of choice in individuals' behavior patterns."

This simple insight is devastating to the Neo-Classical approach.  As Buchanan points out, "Objectively observable cost-revenue streams cannot serve as surrogates for the subjectively evaluated alternatives in which noneconomic elements are influential."  In other words, when I actually buy something, I am making an unobservable, subjective valuation of the product and another valuation of my next-best alternative, what eventually becomes my opportunity cost.  The seller is also making a similar calculation, albeit from the other point of view.  However, the core of the Neo-Classical approach depends upon observable, objective data.  All they can observe is the final trading price, not all the "stuff" that actually is needed for a trade to occur.  There is no action in the Neo-Classical system it is assumed that individuals will just maximize according to constraints. 

The reason I think that this is not a criticism of the Austrian approach is because Austrians do not rely on objective empirics as a foundation to economic science.  For the Austrian following Menger's approach, we start with the Ends/Means framework.  An individual thinks of an end and then imagines how to best achieve that end.  This assessment leads to action and thereby we can deduce economics.  This is the Praxeological approach.  

The next section of Buchanan's chapter centers on the idea of cost.  For me, there is only one kind of cost--opportunity cost.  Opportunity cost is a marginal cost.  It is the subjective value of the next-best (foregone) alternative when a decision is made.  To illustrate, I use this example in my class.  Suppose I want to buy a soda from the store and the price is $1.  What is the cost of the soda?  The answer is NOT $1; that's the price, but it is not the cost.  The cost, the true cost, the opportunity cost is the value of the next best thing that I could have purchased with that dollar.  Perhaps it was a bag of chips.  The value I would have received from that bag of chips is foregone because I bought the soda.  That foregone value is the cost of the trade.  Another example...  Suppose that you are an entrepreneur and you have a choice between Project A and Project B.  Each have an upfront expenditure of $100.  Project A will yield revenues of $150 and Project B will yield $130.  So which do you choose?  Project A of course, because it has a return of 50% while Project B is only 30%.  The cost of choosing Project A is not the $100 expenditure, it is the 30% return that I am unable to get because I am not doing Project B.  Suppose that for whatever reason the initial expenditure for Project A climbs to $110.  Now the rate of return drops to 36.36%  I still pick Project A and my cost is still the 30% return from Project B even though my expenditures for Project A have increased.  If the initial expenditures climb high enough, I will choose Project B and my "cost" will change, but the point is that the initial expenditure is NOT a "cost."

Buchanan argues along these lines, however, he makes a distinction between three types of costs.  He uses opportunity cost in the same way that I outlined above and uses "objective costs" for what I was calling "expenditures" in the above example.  Buchanan adds a third type of cost in his analysis "choice-influenced cost."  He states that there can be "opportunities lost" and that these lost opportunities should be counted as a type of cost.

On this point Cordato and I parted ways.  Cordato argued that since Buchanan was defining terms, that this was a perfectly appropriate thing to do.  I understand that point and it is valid, nevertheless I disagree.  I object to the notion that a reduction of future choices is a cost.  I think that all costs are only opportunity costs.  They cannot be borne by another.  They are completely subjective and they only occur when a decision is made.  I can imagine a situation where I shut down my business and that creates "a reduction in future choices" for those who are no longer employed.  Some may argue that this is a cost, but they would also have to argue that I am imposing a cost on another.  But where is these former employees' decision?  They are not making a decision and so I reject the notion that they are incurring a cost.  Another in the discussion group said, what if someone got bone cancer.  Is that a cost?  I want to push that example further and just take simple aging.  As one gets older, there are future choices that I am unable to do.  The body aches and I can't run as far or for as long.  Is aging now a "choice-influenced cost"?  There is too much that can be put into this concept and as a result, its meaning is confused, watered-down and eventually lost.  

One person did point out that in order to read the rest of the book, you had to take Buchanan's definitions.  So on that point I conceded and we moved onto the next reading.  

One last point, this reading and discussion reminded me of a quote from Wicksteed.  Wicksteed wrote in 1888 in The Alphabet of Economic Science, "When two men give the same thing, it is not that same thing they give."  Brilliant!  If two people give a $5 bill away, they are giving up (incurring) their opportunity cost for that $5 note.

The second reading was Buchanan's "Natural and Artifactual Man."  It was originally a lecture to a Liberty Fund Conference in 1978.  It has been reprinted in vol. 1 of Liberty Funds collected works of Buchanan.  

Since this post is already a little long, I will hold off and break this into two parts.  So part 2 will follow shortly.

The next AEF meeting will be a lecture by Prof. Ed López newly employed at Western Carolina University.  He will be talking about his book, Madmen, Intellectuals, & Academic Scribblers (2013).


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