After quite the hiatus, I suppose that I should try to get back to blogging.
North Carolina State University is the location for the open to the public campus club: "Austrian Economics Forum." Since its founding the idea was to promote the development of Austrian Economics from the Graduate-Student level and above. This year we have decided to open it up to include undergraduate students and any other interested parties. The idea is to go back and start filling in the foundations.
In an attempt to get back to the roots I presented several lectures. The first was on October 16, 2015. Here is the link: Dr. Paul F. Cwik 10-16-2016 NCSU - Menger & the Early Austrians
(The preview picture, which was automatically edited by this cite, clearly thinks that I was excited about this point on the Methodenstreit.)
In this talk I cover the four most significant contributions made by Carl Menger. I also take a look at Eugen von Bohm-Bawerk and Friedrich von Wieser. I present a little of who they were and I explore their most important contributions to the science of economics. Additionally, I add some important points made by Philip Wicksteed, William Smart and David I. Green.
The second lecture that I presented took place on November 1, 2015. Here is the link to that lecture: Dr. Paul F. Cwik on Austrian Capital and Interest Theory
In this lecture, I build on the first lecture. I begin with Bohm-Bawerk's review of others' ideas on Capital and Interest. Then we build his positive theory and compare it with John Bates Clark. In addition to this, I also look at the way in which the Austrians view interest rates (based upon the subjective notion of time preference) and compare it with the mainstream view, which is based upon both subjective and objective factors.
I then build the Structure of Production and stress the importance of not only capital substitution, but capital complementarity.
The third lecture was a presentation of the Austrian Theory of the Business Cycle, which builds upon the first two lectures. At some point in the near future, it will be posted to Youtube and I will link it here.
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: http://www.econlib.org/library/Buchanan/buchCv6c3.html#Ch. 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).
This weekend I had the pleasure to speak before the 12th Annual Economics Teaching Workshop co-sponsored by UNC-Wilmington and Cengage Learning. My topic was "Teaching Austrian Economic Theory." The attendees were professors and instructors (with a few grad students thrown in for flavor). I was happily surprised to see several hands go up when I asked how many have heard of Austrian Economics.
When I was asked to give the talk, I was given a wide latitude about what I could say. While having such discretion is a wonderful thing, I found that I had very little idea who my audience would be. After thinking about it, I realized that I had to do the following:
Hollywood is known for making "magic," likewise the staff at FEE TV should also be congratulated for making me look presentable. Thank you guys.
For the week of June 4th – 9th, the Foundation
for Economic Education (FEE) held the first seminar for the summer in
The fifth Austrian Economics forum centered on Roy Cordato's book, Efficiency and Externalities in an Open-Ended Universe. In particular we focused on Chapter 3, "Catallactic Efficiency: Welfare Economics."
In traditional welfare economic analysis, we make judgments about net effects of policy. Does this policy help more people than it hurts, or is it the reverse? Usually, this means that the economist must make a comparison between people's subjective utilities. This analysis is called "interpersonal utility comparisons." Since values are subjective, such a feat is impossible. There is no way we can judge how much a person values something, and nearly all economists agree on this point. However, this is where the Austrians an the neoclassicals part company.
The neoclassical economists will waive their hands and say that interpersonal utility comparisons are impossible, but then they do exactly that; they make interpersonal utility comparisons. There are some theoretical constructs that confront the problem head-on, like the Pareto Optimality measure of efficiency. However, these sorts of approaches have very little real world application. For example, the Pareto condition says that a policy is good if, and only if, at least one person is made better-off while no one is made worse-off. In the real world, this is never the case. And so, as a mental exercise, such methods are fine, but the reality is that these end up calling for maintaining the status quo.
Cordato's chapter avoids this problem.
The first thing that needs to be made clear is the distinction between positive and normative economics. Positive economics is pure theory. Normative economics is a value judgement made by the analyst. For example, positive economic analysis says that whenever the price is below the market clearing price, there will be a shortage. An example of a normative judgment is the statement that we should set the price below the market clearing price. Normative economics deals with "should statements." We should do policy X but should not do policy Y. Cordato's chapter sets positive economics aside and focuses exclusively on normative economics.
The next thing that we need to examine is the concept of an open-ended universe. So what's that? The opposite of a closed universe, duh. (I know, not helpful, but I couldn't resist.) A closed universe is one that has a final state of rest, an equilibrium point toward which the market tends. The neoclassical position tends to start in this state, which is fine for positive analysis. However, we are dealing with normative analysis for the real world and the real world is definitely not in equilibrium. Even if the real world does manage to get itself into an equilibrium, it would only be there for a moment. This is because the demand curve is based upon things like tastes and preferences and the supply curve is based upon things like expectations. When any of those factors change, the curves shift and a new market clearing relationship emerges.
Kirzner's approach says that we are constantly chasing these market clearing prices. It is the entrepreneurs' actions that coordinate the economy and move us closer to market equilibria. Cordato argues that for normative economic analysis, we should jettison the very notion of equilibrium. Let me be clear, Cordato is not saying we should jettison equilibrium altogether. In fact, he does say that it is perfectly legitimate to still use it for positive economic analysis. (Personally, I like the concept of "harmony" better, but that is a different discussion.)
It is when we deal with normative economics that we should discard equilibrium. The reason is that we have no idea where such an equilibrium would be. We cannot argue that in the real world that each transaction moves us closer to an equilibrium, because each transaction adds new information into the system--information that was unknown before. As new information is added into the system, the theoretical equilibrium changes. Thus, it is impossible to determine (either before or even after the fact) whether a trade moves us "closer" to an equilibrium or not. So an open-ended universe says that we cannot know where these equilibria are and whether a transaction moves us closer to or further from any of these points.
While this analysis is close to the Lachmann/Shackle position of economic kaledics, it is not the same. The difference is that Cordato says that the use of equilibrium is legitimate when doing positive economics. Lachmann and Shackle reject the concept of equilibrium for both normative and positive economics.
So then how are we to judge which policy is better, or in economic jargon, which policy is welfare enhancing? Cordato proposes that we use a standard of "Catallactic Efficiency." Catallaxy is an alternate word for the economy/economics. It comes from the Greek root "katallasso" (καταλλάσσω), which means trade or exchange. It also means "to befriend."
Anyway, Cordato argues that methodological individualism holds that each person has his own set of goals and his own set of information. "[Efficiency] is to be judged by the extent to which the catallaxy encourages individuals existing in a social context, to pursue their own goals as consistently as possible." (page 62) Cordato continues,
By its very nature, then, questions of catallactic efficiency must focus on the institutional settings in which individual actors operate. In particular there are two overriding issues. The first centers around the institutional settings that will best facilitate the use and discovery of information, the appropriateness and relevance of which can only be known by those who need to discover and use it. The second concerns the institutional setting that will allow individuals to gather the necessary physical resources [and use them]. pages 62-3.So there are two conditions to be met: the first is the ability to discover information and the second is the ability to use resources to achieve the goals sought. The conclusion is that a laissez-faire policy is best for enhancing the welfare of the community.
Of course, there is no economic definition of "price gouging," but let's set that issue aside for a moment and focus on a particular objection in favor of price controls I recently came across.
Suppose that a storm knocks out water in the city and the price for water jumps from $1 to $10 for a single 16 oz. bottle. If the government imposes price controls that limit the increase to 10% above the 30-day moving average, as many states do, then there will be a shortage.
So the economist argues that the price spike is good because it reduces use of water and encourages suppliers to bring more in.
The objection runs like this, if you are a poor guy, you can't afford the $10 price and so you go without. Alternatively, if we have to stand in line for rationed water, he has a chance to get some water.
This scenario is a false dichotomy. Regardless of the method of distribution (by price, by 1st come/1st served, etc.), some people will be without water. The reason is that a storm has knocked out the water supply.
The correct question to ask is, "Which system gets water to the damaged area faster, so that the time is minimized for those who are without water?"
The correct answer is the price system. High prices send a signal, to all, that water is needed in the area and rewards those who are there first with high revenues. As the water comes "flooding" in (yes, a pun), the price falls and then even the "poor guy" will be able to get water.
Disasters are horrible situations to live through. I remember the eye of a hurricane passing overhead. It was an interesting experience. The point is which system puts into place a system of incentives that gets the most relief to the most people in the shortest period of time. And the best answer we have is the open and free market.
As you have noticed, I have fallen woefully behind in my commentary for the Austrian Economics Forum, The Austrian Readings Group that meets at North Carolina State University. This was, in part, due to the birth of the third child. Since then, my writing has dipped off a bit. In fact, I was unable to attend the fourth session of the semester, because she was born that day. So I asked Alex Gill, the Graduate Student who basically put together and runs the AEF, to write up a summary of what happened that session. In his words…
Every once in a while I get a comment that can be used as a teaching tool. Here is a comment I received on my post on “The Purpose of Corporations.” It may be crossing the line of proper etiquette, but I could not help myself. I have basically gone line-by-line examining the comment. The comment is in red and my responses are below them.
I can't believe a supposed doctor wrote this.
Starting an anonymous response with an attack like this is always a sign of class.
It's so woefully shortsighted and is pretty much everything wrong about the modern economy.
Then I hope that you clearly explain how shortsightedness creates an error that encompasses the whole of the modern economy.
Is the system working as you describe right now? A resounding NO!
Actually, I agree that the current system is not working as I described it. I described how a system would work in a free market. We do not live in a free market. We live in a world permeated with government rules and regulations that tip the scales in favor of some at the expense of others. I am very much in favor in getting rid of the government’s ability to intervene in the economy. Please join me in rejecting crony capitalism and crony socialism. No more bail-outs for businesses. And no bail-outs for students either.
Profits are being made with no real resource being managed.
What does this mean? Why is a real resource needed to gain a profit? The problem with this point is the word “real,” meaning that there is a dividing line between the tangible and intangible, where only the tangible matters. This idea of an objective value is simple-minded. Providing information can be a very profitable business. Education might be considered to be a business in which no real resource is being managed, so does this mean that there are no gains to education? (Remember: Profits are the surplus of the gains over opportunity costs.)
It's profit being made off of profit itself, leeching away the value of real labor resources from the working classes. That's the problem!
The idea that value comes from the labor of the working classes is clearly a labor theory of value reference. While this theory has been smashed time and again, it keeps coming back in different incarnations--like a bad zombie film. Value does not stem from any class nor does it stem from the time or effort of the labor involved. To say otherwise is to say that the amount of time working is directly related with value or the amount of effort has a direct relationship with value. (“Directly related” in this sense means the opposite of “inversely related.”) In other words, my anonymous friend is saying that the longer one works, the more valuable the output. A watch that has 1,000 labor hours is twice as valuable as a watch made with 500 labor hours. Or “he” is saying that a watch made with twice the effort is twice as valuable as another watch.
Of course, both of these propositions are ridiculous. My students earn their grade based upon the correctness of the answer and nothing else. If one student studies twice as long or works twice as hard has no bearing on the grade received. All that matters is what is put on the answer sheet. The same is true when it comes to goods and services. It does not matter if one producer worked twice as long or twice as hard as another. All that matters is the judgment of the consumer. The value of the good is a product of the consumer’s mind and nothing else. If the consumer values the good at $5, then he will be willing to pay up to $5 for it. If the consumer values the good at $0, then the amount of time and effort of the producer is irrelevant. It is all wasted.
Prices do not simply function as pieces of information, they are extremely powerful implements of social control.
“Implements of social control?” In a sense, yes of course they are. They signal to any one who wishes to use a resource its relative scarcity. It allows the user to calculate the opportunity cost of using that resource. When the price rises, it tells the users of such resources that the resource in question is more scarce. It gets users of the resource to reduce their use, conserve. The least important uses of the resource are dispensed with first. It gets users to look for substitutes. It is in this sense that prices “control” society. But in saying this it is no more control than a red stop light saying, “Stop.” If the entrepreneur ignores the price signals, he will be out of business. If I ignore the red stop light, I will likely get into a car accident.
If fact, prices are such important signals that without them very little economic calculation could be done. Society could not exist without prices. Indeed, prices are what allow societies to exist. So I suppose that in this sense, there could be no “social” to control without prices.
Who is the consumer in a stock transaction?
The buyer of the share of stock.
The answer today is really no one, there is no person deriving use from a good that is sold. The primary "use" of stocks today is as placeholders of value -- their prices.
The owner of the share derives a dividend, a portion of the profit generated by the company serving its customers. The cash flow, the dividend, is the benefit of the stock and is the reason for its ownership. The cash flow is the return on the money saved. The money saved was invested into the company. The company combines resources to serve customers. The extent to which people trade with the company is a reflection of how well it is combining resources to meet consumers’ needs, wants and desires. And not just random or trivial needs, wants and desires, but the most intense needs, wants and desires first. The value of the company is reflected in the stock, the equity. Call it a “placeholder” if you want, it does not change its nature as the reflection of how well a specific group of people are pleasing customers.
How then does a "good" get priced when its value is its price? The answer is that it cannot be priced in any way that is beneficial to an economy, by any system that makes any sense.
Again this is naïve. Here is a quick lesson in Corporate Finance…. A firm looks into the future and must project what it will do to combine resources to meet future needs, wants and desires of its customers. It creates a pro forma statement. It looks at the projected revenues and the projected costs. It creates a projection of cash flows occurring in future periods. Then it uses its opportunity cost, the Weighted Average Cost of Capital (WACC) to discount all of those future cash flows to the present. Then it subtracts the upfront costs of the endeavor. This process yields a Net Present Value (NPV) of the project. If the NPV is positive, the endeavor should be undertaken. If the NPV is negative, the firm looks for something else. The greater the NPV, the more valuable is the company’s endeavor. As the company announces its future plans, the eyes of the world evaluate the firm’s decision. If they agree that this project adds value (or more precisely will add value) to the firm, then this increase in value is reflected in the share price of the firm. Bad decisions (in the eyes of the market) lower the price of the company. The benefit of these capital markets is merely the efficient allocation scarce resources to good decision makers and away from bad decision makers. Without profit and loss, without economic calculation, without the ability to value projects and companies, there is no ability to efficiently allocate scarce resources. The opposite of the stock market is evaluating which is a better user of resources: the DMV, the Post Office, or the Judicial System? There is no method to know. But I can easily tell you which for-profit company is a better user of resources. And I can do it at a glance. We can’t even come close with bureaucracies.
This is how the global financial system has essentially turned into a gigantic casino game. And that is not good at ALL.
The idea that the financial world is the same as a casino game is an argument by analogy and wrong on its face. There is no house. When I win a chip, someone must lose a chip. It’s all just random luck based upon probabilities. Apple Inc. was not random chance. Successful corporations are not just random luck based upon probabilities. Creating a successful company is hard work and long hours. It is being “others focused.”
You have to know what will please your customers and then constantly strive to please them. And customers are fickle. They don’t tell that they are coming to your store in advance. They just show up and you have to be ready. They don’t tell you what they are looking for, but you had better have it on your shelves. They don’t tell you what they think is a good price, but if you don’t meet their price, they walk out without a word. Running a business is hard. Being successful is harder. Going global, that’s mindboggling!
And yet, we take it for granted. I expect to walk into a Walmart at 2am in the middle of rural North Carolina and buy Kiwi 3/$1! How insane is that? We need to take the time and marvel at this economic system, which has built the highest standard of living ever known in the last 5,000 years of recorded human history. Before we tear it down and decry the free market and the role of corporations, we had better take a very close look at what it is that we intend to do away with. I absolutely know that if we tear down the market economy, we sentence ourselves to a life of future poverty. I cannot and will not sentence my children to that fate.
The AP posted a story where the Department of Justice paid $16 apiece for the morning muffins at a recent conference. While the author rightly condemns the government for wasting tax money, the article takes an odd turn. The article states,
"Which all kind of misses the most compelling issues. If you did spend $16 on a muffin, what would it look like? How would it taste? Is it even possible?"
It then goes on to say,
"The typical muffin baked in an institutional setting such as a hotel costs about 50 cents or less, not counting labor. If you go crazy extravagant and reach for the top-shelf organic flour, maybe some hand-harvested wild blueberries from Maine and fancy sugar, you're still going to max out around $1 per muffin on raw ingredients."
Talk about missing the "most compelling issue!" The author makes a typical economic error, which should have been learned in the most basic economics class, and that point is this: the price of any good or service is determined by the interaction of supply and demand. It is NOT determined by the price of the inputs. If the cost of materials determined the price of anything, then no business would go out of business, ever.
Let me repeat this necessary fact: Costs do not determine price.
Too many people simply do not understand this principle. Too many people think that retailers simply take wholesale prices, mark them up and then viola! Done. If we stop to think for a moment, if this were the case, then why are there sales?
Let's take a simple example...
You may have noticed that the price of corn is not that same as it was a few years ago. Today you might see ears of corn selling 3/$1, while just a year or two ago it was selling for 4/$1 or even 5/$1. A few years before that it may have even been 10/$1. Setting aside inflation, the grocer might tell you that the reason he raised his prices is because the wholesaler’s price has gone up. In other words, he says his costs have gone up.
In order to correctly analyze the problem, we need to look beyond the seen and think about the unseen. This technique is called Counter-Factual Reasoning. Counter Factual Reasoning is being able to compare the “seen” world with a hypothetical alternative. When we apply counter factual reasoning, we realize that we need to ask why the wholesalers’ price of corn rose. We begin the process of tracing the change in price to its root causes. After some thought, we realize that the problem is ultimately caused by an increase in demand. Corn has a wider variety of uses than just eating it on the cob. For example, it is used as a sweetener in drinks and it is also used to create ethanol for cars. With the increase in the number of uses for corn, the demand for corn rises. These competing uses each bid for the corn. The result is an increase in the demand for corn, which causes the wholesale price to rise. So while the grocer may tell you that the price is increasing because of supply reasons, the unseen fact is that it is really demand that is driving the price change.
I suppose that I cannot fault the author of the article for getting it wrong. I see that it was just a segue to talk about expensive muffins. But really, using economic fallacies to get to your topic, come on! Can't we do better than that?
