AEF Spring 2016 #1--Hayek's "The Meaning of Competition"

For the spring semester at NC State University, we decided to continue to look at some of the more foundational articles in Austrian Economics.  One of the more famous is F.A. Hayek's "The Meaning of Competition."  It was originally presented as a lecture at Princeton University on May 20, 1946.

Our session took place on January 29, 2016.  It was attended by several graduate and undergraduate students.  Roy Cordato and I (Paul Cwik) were the hosts.  Cordato presented the article this week and outlined four major points in Hayek's article.

1. There are major conceptual flaws in the model of Perfect Competition (PC).
2. The use of Perfect Competition (PC) as a Normative Benchmark is misleading and dangerous.
3. Hayek presents a proper role in which to view competition.
4. Hayek creates a brief outline of the Austrian Theory of Monopoly.

Let's take a closer look at each.

The major conceptual flaws in the PC model begin with the assumption of Perfect Knowledge.  By making the assumption of perfect knowledge, the economist is essentially assuming away the problem.  In fact with the assumption of perfect knowledge the entire need for competitive behavior disappears.  It is the absence of competitive activities.  Why?  It is simply due to the fact that all of the supply curves (cost curves) and demand curves are fully known.  If all of the curves are known then the problem is one of simply grinding through a mechanical process.  The problem reduces to "given these two lines, please compute where they cross."  Austrians define "competition," which we will see in Point #3 below, as a rivalrous process.  Furthermore, the question of how the market actually works in the real world is never really investigated.  The perfectly competitive model is a static (no time) and competition is a sequential series of equations to be solved.

The second point that Cordato presented was using the PC model as a benchmark.  The PC model was originally designed to be a tool to show a sequence of cause and effect.  For example, suppose that a firm or an industry was using steel as an input.  If we see that the price of steel rises, what will the effects of this change have on the industry?  The PC model does a good job of tracing out the cause and effects of this question.  Unfortunately, the tool has become the entire toolbox.  It was originally supposed to look at very narrow questions.  However if you walk into a mainstream International Trade class, one of the very first assumptions that is made is to assume perfect competition.  This assumption is the beginning of the building of the Heckscher-Ohlin model.  (I just pulled my old International Trade textbook off my shelf and it literally says, "First, we assume that perfect competition prevails in both output and factor markets."  When every model starts with the PC model, it creates a false standard.  On one end of the spectrum is perfect competition and on the other end is monopoly.  Everyone knows that monopoly is bad and so the thing on the other end must be good.  What's that thing?  Why it is nothing less than perfect competition.  And if we even look at the name, we know that it is something to desire--it's even called PERFECT.  What's not to like?

Actually, there is a lot not to like about using the PC model as the benchmark.  The rules and regulations that government policies create set the PC model as the goal.  This goal setting is misleading and dangerous.  Let's take a look at a simple example.  In the PC model, there are many, many sellers.  In fact there are so many that not a single one of them can influence or affect the price; they are "price takers."  If a company is larger than simply being a mere price taker, then to get us closer to perfect competition, the government needs to intervene and make it smaller.  Think of how silly this standard truly is.  When I go to work I drive past two gas stations and one's price is a penny lower than the other.  Clearly, one of them is not a price taker.  So they are too big!  When I look for used DVDs, I see that there are several prices.  Clearly these sellers are also not price takers.  The idea of setting "price taking" as a goal is confusing an assumption of the PC model with an outcome.

The third point that Cordato brought up was on how we should look at competition.  Competition is a rivalrous process.  Why do sports teams play the game?  They do so because regardless of what the teams looks like on paper, any one team can beat another team on a given day.  Furthermore, how many are needed to have competition?  When I ask my students this question, most will say at least two.  However, I ask how many run or swim.  I then ask if they ever keep time.  Why would they do that?  With whom are they competing?  They are competing with themselves.  The minimum number needed for competition is one.  Even if you are the only producer in a market, there are always potential rivals.  Leonard Read once said that getting rid of competition was like standing in a stream with a broom trying to sweep the water away.  With one stroke, the water is gone for a moment, but then it comes rushing back in.  To be a natural monopolist, it means that one must out compete everyone else on every single vector of competition there can be.  That means one must have better prices, better quality, better hours, better location, better customer service, and so forth.  It must be better in absolutely everything.  If one area slips, say customer service, then that opens the door for a niche competitor to get into the market.  And besides, how would a customer view such a monopoly? If it has better everything, then consumers would be very happy.  However, the PC model says that only small price taking companies are good for customers.  How counter-intuitive!  In the real world, the companies that please the customers by doing a better job grow larger.

Hayek says that competition is the mechanism that allows entrepreneurs to acquire the knowledge that the PC model assumes to be known.  Competition tells us who will serve us well.  It is a "Discovery Process."

Finally, Hayek presents an Austrian Theory of Monopoly.  Cordato was surprised at how well Hayek and Rothbard line up on this point.  For them, the only barrier is government.  In contrast to this point are Mises and Kirzner.  They allow for the possibility of a resource monopoly.  While this might seem to be a minor technical point that never occurs in the real world (and it truly is), it is one of the few instances where Rothbard and Hayek are not on the same side as Mises.

And finally, finally, we do have fun in these sessions.  One of the fun things that arose (at least to a geeky economist such as myself) was this turn of phrase:

Private Sector:
"Where there's a problem, that's where the money is."

Public Sector:
"Where there's money, that's where the problem is."

Austrian Economics Forum Spring #1 2013 (Part 2)--Buchanan and Artifactual Man

The second reading in the first AEF meeting centered on an article by Buchanan called, "Natural and Artifactual Man."  While this article is found in volume 1 (The Logical Foundations of Constitutional Liberty--1999) of the collected works of James M. Buchanan, Liberty Fund does not have electronic rights to the first volume.  (So I can't link to it, sorry.)

Oddly we started with the end of the article.  In fact Roy Cordato said he posted the last few lines on his Facebook page and someone replied asking why he was quoting a long forgotten President.  (Buchanan immediately preceded Lincoln.)  So what is the last paragraph?

Man wants liberty to become the man he wants to become.  He does so precisely because he does not know what man he will want to become in time.  Let us remove once and for all the instrumental defense of liberty, the only one that can be derived directly from orthodox economic analysis.  Man does not want liberty in order to maximize his utility, or that of the society of which he is a part.  He wants liberty to become the man he wants to become.  (page 259.)

This article is clearly one of the most Austrian of his writings for in it he takes apart mainstream Neo-Classical economic theory.  In Buchanan's words:

My purpose [this article was originally a lecture, hence the informal style], however, is not to criticize particular areas of concentration, but to advance a broad criticism against economic theory generally.  If I may resort to philosophical terms, what I am objecting to in modern economic theory is its teleological foundations, its tendency to force all analyzable behavior into the straitjacket of "maximizing a utility or objective function under constraints."  In one way, I am suggesting that the utilitarian origins of nineteenth-century political economy may have come to haunt us and to do us great danger. (pages 249-250.)

What Buchanan is getting at fits neatly into the Mengerian/Mises tradition.  According to Mises, I act because of a "felt uneasiness."  I envision myself in a better future situation.  According to Menger I imagine my ends and I think of employing means to achieve those ends.  What Buchanan is pointing out is that the very act of accomplishing these ends changes me.  I am no longer the same person I was when I started.  I am able to artificially construct a new me, hence we are all "artifactual."

A few of the examples Buchanan uses are quitting smoking or going on a diet.  "As the smoker abstains, ..., he will find that he does become different from the person that he was.  He preferences shift; he becomes the non-smoker that he had imagined himself capable of becoming."  (page 253)  Under this umbrella, we find "any aspect of human behavior that represents 'civility.'"  This includes more than simply manners and codes of conduct, it contains morals.  (As an aside, it is worth noting that this inculcating and transference was a traditional purpose of a liberal arts education.)

Today, higher-level modern economics has been reduced to essentially a study of pattern recognition.  Modern economists collect data and attempt to find patterns and derive economic laws from regularities that are "uncovered" in the data.  While some economists dress their findings up in Positivism, most economists do not think about these "meta" issues.  They are more concerned with "doing research."

Unfortunately, that approach is ultimately fruitless.  Thomas Tooke, the German Historical School and many others have all gone down this very path.  If economics is truly a social science, if it can contribute to the betterment of mankind and enrich our understanding of our world, we should pay heed to this article.  Buchanan is able to undercut the whole of the utility maximizing model and simultaneously argue in favor of a free and open society.  His method is to essentially adopt the Austrian view of "ends and means" and how Austrians view cost and choice.  (Yes, that was a reference to part 1.)

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: 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).

Austrian Economics Forum Fall 2012 #1--Caldwell on Hayek

Sadly, this year started off with me getting rather sick, and as a consequence, I have not been able to update the blog as I would like.  Fortunately I am on the mend and new posts will be forthcoming soon.

The first AEF event at NC State University had Hayekian expert Bruce Caldwell as the speaker.  Unfortunately I was unable to attend, however Alex Gill, graduate student and coordinator of the AEF, was able to write up his notes of the event.  Here are his words...

Talk on "How to do Archival Research" with Caldwell's work on Hayek as the motivating example...

Caldwell began by explaining how his interest in methodology led to an interest in the Austrian school, which led to the Hayek's challenge project.  He became interested in the Austrians because disputes with socialism and positivism shaped their arguments.

 

As part of the Hayek's Challenge project, he went to the Hayek archives at the Hoover Institute at Stanford and met then current general editor for Hayek, Bartley and his partner Stephen Kresge.  He quickly learned the importance of personal relationships, both between the researcher and those he encounters as well as the relationships between the subject of research and the people the researcher interviews or otherwise encounters in the course of research.  

 

When Bartley died, the editorship of Hayek's collected works moved to Kresge, who soon requested that Caldwell take it over.  Caldwell's position changes from having to ask for permission to quote unpublished material to being in charge of who has said permission (and for what). 

 

Dr. Douglas Pearce at this point asked Caldwell to clarify rules on quoting from unpublished letters.

 

Caldwell explained that one can paraphrase unpublished material without the editor's permission, but to quote directly or extensively one needs the general editor's permission.

 

Prof. Caldwell went on to explain that being general editor requirs fundraising (for instance, to hire volume editors), a skill he learned by doing.  He credits part of his career success to fundraising talent.

 

Caldwell then began discussing Hayek's divorce, both to reinforce the point about personal relationships and to make a point about following through to correspondents' archives (to get the other halves of conversations).  He learned that Hayek's father (a medical doctor and botanist) was highly nationalistic and embraced many of the opinions associated with Nazism, as did Hayek's brother.  His mother blamed his father for making F.A. a liberal, as she believed said liberalism was a reaction to the father's nationalism.  Without following through to correspondents' archives, Caldwell never would have found this fact out (and others), which would have changed the story he will end up telling in the forthcoming biography, especially with regard to Hayek's family relationships.

 

Hayek's archives include notecards he made while studying the literature (where he would list quotes from others and citations, etc.)  Through the painstaking process of reading many boxes of these notecards, Caldwell gained insight into Hayek's thinking about his Nobel prize and the person he shared it with (Gunnar Myrdal).  Caldwell was previously curious about Hayek's apparent change of tone beginning in this period (from relatively passive and softspoken to more aggressive and willing to attack others), and he realized that Hayek in this period was incensed that he had to share the prize with Myrdal, and that furthermore Myrdal disparaged him (Hayek) and later Nobel recipient Friedman publicly, which to Hayek displayed a complete lack of class and professionalism.  Hayek was furthermore upset that his Nobel address was refereed when submitted to Economica, a journal Hayek used to edit while he was at LSE.  He was offended that it was not accepted as is without an editing process.  So in this period (1970s) Hayek struck back, and began, for instance, attacking Mill (unfairly, according to Caldwell's interpretation) and Mill's interpreters (more fairly, perhaps).

 

Caldwell met with Hayek's children Larry and Christine, and obtained much of interest from them.

 

Dr. Lee Craig then asked, "Were Hayek's children or wives ever interested in his work/economics?"

Answer (paraphrased): No

Dr. Roy Cordato asked, "Where did Hayek place himself intellectually among other Austrians?"

Answer: He was a student of Weiser, but called Mises his "mentor."  He wasn't too close personally with Mises and Popper, though intellectually these two were the closest to Hayek.

 

Dr.Roy Cordato then asked, "Are Hayek's mentions of public goods, welfare economics and the like an artifact of his studying under Weiser?"

Answer: Not that I see.

 

Tim G. then asked, "Is there a connection between Hayek's economics and The Sensory Order?"

Answer: There is not a connection between Sensory Order and Misesian economics.  There is a similarity between Hayek's capital and cognitive theories, though (both self-organizing systems).  Current science is  largely in accord with Hayek's psychological theories.  Read the book and see what you think (the book is hard to understand).

 

Austrian Economics Forum Spring '12 #6--Fractional Reserve Banking?

The final session of the Spring Semester Austrian Economics Forum at NC State University cover the topic of Banking.  There are basically two camps in the Austrian School when it comes to banking—100% reserve banking and free banking with fractional reserves.  For this session we covered the article “Fractional Reserve Free Banking: Some Quibbles” by Philipp Bagus and David Howden in The Quarterly Journal of Austrian Economics (2010, vol. 13, no. 4, pp. 29-55) and Selgin’s response found here or here.

Personally, I am in the free banking camp, but I think that there are strong economic arguments for getting close to 100% reserves.  As I will explain below, it might be the case that while the objections to Fractional Reserve Free Banking (FRFB) are true, they might be so small that the positives outweigh the negatives.

Overall, I cannot express how disappointed I was with the Bagus and Howden article.  We have already covered Bagus’ book, The Tragedy of the Euro, in the first session this semester (here) and I thought the sections that we read were thin.  While there is a decent underlining argument there, the scholarship was weaker than what I was expecting.  Unfortunately, this article proved to have the same flaw—weak scholarship.  Furthermore, Howden gave a named lecture at the Mises Institute’s Austrian Scholar’s Conference.  He explained what he meant by a “quibble.”  He meant that the argument for free banking was so weak that to argue in favor of it is a mere quibble!  [Wow!] 

When presenting an argument of an opponent, one should always give the benefit of the doubt, define the terms in the most generous manner and cast it in the most favorable light.  If you can still destroy the argument, then your case is solid.  Unfortunately, this is not the approach that Bagus and Howden take in their article.  They assume narrow interpretations and unfavorable conditions.  Simply put, they are not generous to their opponents.  As a result, the FRFB side can point out that the overly narrow case does not apply and that the argument was misconstrued.  In the session, the criticism actually fell less on Bagus and Howden and more on the editorial staff and reviewers at the QJAE.  Basically, the sentiment was, “How did this article see the light of day?”

Due to the poor scholarship, Selgin is able to destroy their argument and make them look ridiculous and arrogant, which is too bad because Bagus and Howden are not dumb guys.  Let’s take a quick look at the exchange, from Selgin…

According to Bagus and Howden (2010, p. 36), “Selgin starts his analysis by assessing changes in the demand for money, not distinguishing between the demand for commodity money (money proper) and money substitutes.” Actually, my chapter concerning how free banks deal with changes in the demand for money is titled “Changes in the Demand for Inside Money” (my emphasis), where “inside money” means more or less the same thing as Bagus and Howden’s “money substitutes.”

It is simple points such as these that allow Selgin to skewer Bagus and Howden.  It is as if they simply did not take the time to understand Selgin’s argument.  If this was an isolated incident, maybe we can let that slide by, but it is unrelenting.  Bagus and Howden are simply misrepresenting the FRFB argument. 

Last summer, I finished reading Rothbard’s Conceived in Liberty, which is a history of the American Revolution.  From there I was propelled into reading Rothbard’s A History of Money and Banking in the United States.  Then in the Fall I had to teach a Money and Banking Class and so I reread and then assigned Rothbard’s The Mystery of Banking, The Case Against the Fed, The Case for a100% Gold Dollar, and What Has Government Done to Our Money?  To round myself off for this year, I read through White’s Free Banking in Britain, Selgin’s The Theory of Free Banking and Sechrest’s Free Banking.  (I also read, a while ago, Horwitz’s Microfoundations and Macroeconomics.)  So I have been getting myself grounded for the 100% Reserve versus FRFB roundtable panel at FEE’s Introduction to Austrian Economics Summer Seminar (link here).

So here is my analysis (take away) from the ongoing exchange.  First, I think that those who support the Free Banking position are better debaters than those on the 100% Reserve side.  I say this because it seems that the 100%ers are willing to fall back to the moral argument as opposed to fighting on economic ground.  While there is nothing inherently wrong in arguing against the legitimacy of converting a bailment into a deposit (an asset for the bank), my point is that it is not an economic argument.

The Bagus and Howden article does identify the weak points of the FRFB position, but they discredit their position against FRFB with their sloppy scholarship.  There are two major (economic) weaknesses in the FRFB position and it is due to these weaknesses that I have strong reservations on the FRFB position.

Before we can get into these points, we first need to make the distinction between the different types of credit.  A problem in the literature is that it seems that each author has his own way of defining credit and thus the arguments become confusing.  I will use the definitions Machlup uses in The Stock Market, Credit and Capital Formation (1931).  He distinguishes between transfer credit and created credit.  (While there is a third category, we don’t need to worry about it here.)

Transfer credit is the sort that stems from my placing money into a loaning institution and it is borrowed by another.  This form of a loan matches the deposit banking that Rothbard outlines in The Mystery of Banking.  The second type of credit is the sort that materializes out of nowhere.  An example of this is when the Federal Reserve buys a bond and credits the sellers account.  Where did that new money come from?  It came from a big, black hole of nothingness.  The money (credit) was created.

So the first weakness in Selgin’s presentation of the FRFB system is that he starts his analysis with an economy, and a banking system, that is fully loaned up.  In other words, he is starting with banks balancing their “average net reserve demand” equal to zero. (Selgin 1988, p. 73)  I think that this is a weakness, not because of the logic that Selgin engages in, but because that this assumes way a major point of credit fueled inflation—the process to get to a fully loaned up system.  I think that it is true that if we start with a fully loaned up banking system with no malinvestments, then yes, the system is fairly stable.  However, if in the process of getting to this fully loaned up state, we create malinvestments along the way, then the system is not stable.  There will be the classic Austrian Boom/Bust Cycle.

The next weakness that is found in the FRFB system centers on the precautionary reserves.  If the banking system is fully loaned up, it is vulnerable to any fluctuations in people’s willingness to hold on to cash (or not hold onto cash).  Thus, each bank will hold onto some reserves to insulate itself from the day-to-day fluctuations and from any unforeseen changes in market conditions.  The bank will lose money if it holds onto too much cash reserves and put itself at risk if it holds onto too few.  So far, so good.  This choice is an entrepreneurial one and markets should be able to handle this. 

So here is my concern.  Suppose that for whatever reason there is an increase in the demand to hold onto cash.  This holding onto cash is deferred consumption.  In other words, it is saving.  Now, if nothing else happens there is a decrease in the demand for the goods and services that the cash holders are choosing not to buy.  This change in demand will then spread throughout the economy and the relative price changes will signal to entrepreneurs how to re-coordinate the economy. 

Many who support FRFB system (like Selgin and Horwitz) argue that this savings can be converted into transfer credit.  If the cash holders are holding onto an additional $1,000 per time period (e.g., each month), then the banks can loan out that additional sum of $1,000.  They argue that this is merely transfer credit and not created credit.  Therefore, this is not a problem to worry about.  While, it is true that this is not created credit, because the cash holders are indeed saving, there are, however, a few concerns.

First, as soon as these cash holders revert to their prior spending/cash holding patterns, then the banks need to call in those loans.  In the example above, the banks need to call in the $1,000.  Calling in loans may create a large disruption in the economic patterns.  If a business started a project and the loan is called in, there is no effective difference between liquidating this sort of a project and liquidating a malinvestment from an artificial boom.

Secondly, when the loan is made, there are nonneutral economic effects that stem from this loan.  When businessman A gets the loan, he will create a spending pattern that is unique.  New equilibria are generated.  This pattern will necessarily be different from the pattern generated by the reduction in demand by the saver.  While this may not seem to big a major problem to a well functioning economy, it is a point of concern to the extent that these patterns are at odds with the savers.  Most likely, the extent of concern on this point seems to be an empirical matter. 

The 100%ers are assuming that prices are flexible and will quickly adjust.  The FRFB supporters are assuming that prices are not quite as flexible and so they convert the savings into transfer credit.  However, to me this seems to be compounding the problem instead of solving it.  If prices adjust slowly, then why are we creating a second pattern to overlay which will reinforce or offset the prior pattern generated from savings?  I think that prices are stickier as we get closer to consumers.  While gasoline prices change by the penny each day, most consumer items target price points (e.g., $9.99, $29.99, etc.).  As we move further away from the consumer, we see less fixation on price points, but we do see more longer term contracts.  Again, this is a call for further research.  I suspect that there is some economic research on this, but since the other schools of economic thought tend to ignore the structure of production, I doubt that the answers are readily available.  If someone has a suggestion of where to look, I would be interested in these sources.

Austrian Economics Forum Spring '12 #5--Efficiency in an Open-Ended Universe

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.


Such an approach, I believe, fits well with Mises' conception of Interventionism.  Mises argued that there were three manners in which the government could intervene in an economy.  The first is the role of the impartial judge and enforcer of private property rights. When there is a dispute, the government can resolve the dispute.  Mises thought that this was a normal and healthy function of government.  The second manner is when the government buys items from the market.  Suppose that the government wants to publish its annual budget.  To do so, it needs paper.  The government taxes people and then spends that money on paper.  While there are distortionary effects that result from the governmental action, the normal market process is intact.  The demand curves for the items that the taxed people would have purchased are reduced and the demand curve for paper is increased.  The market mechanism operates normally.  


The third type of intervention is where the government stops or hinders the market mechanism from operating normally.  In this form, the government prevents trades to take place by rules, regulations, or price controls.  For example, if the government passes a law that says all toys need to be tested for lead before they can be sold, this interferes with the normal market process.  If the government says that during "a state of emergency" prices can only rise above the 30-day average by 10% interferes with the normal market process.  In the first example, people will not be able or willing to sell toys and in the second, the goods  will not be rationed according to price.  Long lines will emerge and shortages will persist.


Cordato's "Catallactic Efficiency" standard and Mises' third type of interventionism go hand-in-hand.  They both focus the analyst's attention to the coordination process of the market.  How is new information generated and incorporated into the greater social order?  When obstacles restrict the market's ability to do this, we have catallactic inefficiency and interventionism.

Austrian Economics Forum Spring '12 #4--Kirzner & Cwik

For our fourth meeting, it was decided that we would discuss the paper that I presented at the Austrian Scholars' Conference in Auburn.  While I love to talk about myself, I decided to include a paper by Kirzner as well. 

The Kirzner paper is "The alert and creative entrepreneur: a clarification."  Basically, this is Kirzner responding to supporters and critics of Capitalism and Entrepreneurship, and then telling them that they are all wrong.

Kizner says that his work is not about how to become a successful entrepreneur.  Rather his work focuses on how the market process is set in motion be entrepreneurial decisions.

The interesting points he puts forward is an almost rewritting of his stance on Schumpeter.  He says that everyone knows of Schumpeter's creative-destroyer and so he did not want to dwell on that aspect of entrepreneurship.  He wanted to show how entrepreneurship coordinates the economy.

He then argues that many misinterpreted his writings to say that the entrepreneur was a passive noticer of opportunities.  He says that a false tension was created between the Schumpeterian "bold, disruptive, innovators or [the] passively alert, harmony-restoring responders to changes that have already occurred."  He then states,

[T]here must be scope for both a creative ("Schumpeterian") entrepreneur (one who generates pure profit) and a "passive," alert ("Kirznerian") entrepreneur (one who snuffs out given profit opportunities by promptly exploiting them.) p. 149 (italics in the original)

Cordato argued that his own work tends to connect the two positions.  He argued that we live in an "open-ended universe."  He means that there is no such thing as a final equilibrium to strive for.  In fact, as new information is added, the equilibrium point changes. 

It was based upon this point that we decided that the next week would center on Cordato's book, Efficiency and Externalities in an Open-Ended Universe.  And so we tabled further discussion on this point for the next week.

****************************************************************************
Then the discussion turned to my paper, "Greed in Public and Private Institutions."

My paper, as is too often the case, was based upon frustration.  There is a general attitude that anything that happens in the private sector is due to greed, but when we switch to the nonprofit sector, motives are now made of pure light.  Indeed!

Of course people in every walk of life are greedy.  (As an aside, economists throw out the word "greed" because it cannot be precisely defined.  A typical definition of greed is the wanting of something too much.  However, what is "too much"?  Who decides?  As a result, economists use levels of self-interest.)  Self-interest is omnipresent and it propels Adam Smith's butcher, brewer and baker to serve others.  On the other hand, we have a separation of self-interest and the interest(s) of the overall organization.  It is a question of aligning incentives.  In other words, we are examining a principal-agent problem.  What if Bernie Madoff, Ken Lay or other suitable villain was in charge of the State Department or the US Treasury?  Would we even know what they would be up to?

My paper suggests that two questions arise: Can the institution efficiently allocate resources to satisfy the most intense wants and desires of consumers?  And can the principal-agent problem be overcome to ensure that the leadership will carry out its intended purpose or will the leadership use the entity as a means to a selfish (greedy) end?

In my paper, I looked at three institutional settings: for-profit companies, bureaucracies and nonprofits.  I conclude that the for-profit sector can answer both of the questions.  The bureaucracies cannot calculate efficiency, but it does issue rules, orders and regulations to control and guide the behavior of beaucrats.  It is in this way that bureaucracies have a chance of overcoming the principal-agent problem.  The nonprofit sector, on the other hand, is incapable of answering either question.

Overall, the discussion was friendly and supportive.  During the course of the discussion, Cordato asked a good question, "When it comes to bureaucracies, who are the principals?"  I did not have a ready answer for him.  When I wrote the paper, I had Mises' Bureaucracy in the back of my mind.  In it, he uses the model of a king that basically is in charge issuing orders.  And so in my mind, the king was the principal and the bureaucrat was the agent.  How that translates into a representative government is much more complex.  Although, the point that there is a potential solution remains.

Additionally, a student suggested that when it comes to the nonprofit organizations, we can split them into two groups.  The first group is primarily donation driven, while the second is endowment supported.  The first group "has its feet to the fire."  They must be very aware of what the donors expect, otherwise the funding disappears.  The second group is insulated from today's donors because an endowment has been built up.  (For example, think of colleges and universities that have large endowments.)  They are able to upset today's donors because they have the resources in place for tomorrow.  Of course, such an institution cannot upset significant donors forever, but they have a lot more room to be independent.  This insight certainly adds to the discussion that I make in separating the true-believers from the careerists.

Austrian Economics Forum Spring '12 #3--Calculus and Consent

After a few years of attending the AEF, the third meeting was my first disappointment with this group.  (I suppose it was bound to happen.)  Yes, there was basketball that diverted some; and yes, there was severe weather; and so attendance was very low, but the real reason was that the topic really just did not fit our group.  It was on Chapters 4-6 of Buchanan and Tullock's The Calculus of Consent (1962). 
For me, the discussion went around and around in a large circle.  The problem actually stems from the last sentences in Chapter 2.

It seems futile to discuss a "theory" of constitutions for free societies on any other assumptions than these.  Unless the parties agree to participate in this way in the ultimate constitutional debate and to search for the required compromises needed to attain general agreement, no real constitution can be made.  An imposed constitution that embodies the coerced agreement of some members of the social group is a wholly different institution from that which we propose to examine in this book.  pp. 19-20.  (emphasis added)

Which political entity, then, could they be talking about?  Even my Home Owners Association fails to fit this definition!  Government is different than another human institution in this sense: it is the only institution that has the legal right to coerce and use force.  Without this definition at the heart of the analysis, the rest is fluff. 

To me the problem with government is the imposition of rules and regulations on groups that do not agree with the "choices" made by government.  We were to discuss the groupings of external costs that Buchanan and Tullock divided into a ("expected costs resulting from purely individualistic behavior"), b ("expected costs of an activity embodying private contractual arrangements designed to reduce [internalize] externalities") and g (total costs imposed by collective decision-making).  But if we agree that there is no coercion to keep people in the constitution, then why would I not just veto everything that I disagree with?  Now repeat that reasoning for everyone.  The result is that groupings fall apart.  Thus, the discussion went in circles and my disappointment.

Austrian Economics Forum Spring '12 #2--Emerging Rules

At our second AEF meeting, we discussed the work of one of the NC State University's Graduate Students, Richard Hammer.  He presented his work, "Life Grows Through Discovery of New Social Rules." 

He argues that life is thermodynamic.  If we start with some simple assumptions about basic life needs (rules to exist), he wants to know how far can we get with this line of analysis.  Can it circle around to be useful for analyzing our own behavior? 

He starts with single cell organisms (SCOs).  They need food and water.  If they lack enough food or water, they will die.  If food and water are distributed homogenously, then we really do not get interesting results, because there is no reason to act--other than simply consume. 

The interesting results begin when we assume that there are pockets of food and water that the SCOs have to go to.  If the food and water are too far apart, the SCOs die.  If they can travel back and forth, then they can survive. 

A fundamental law in economics, The Law of Comparative Advantage (Mises called it The Law of Association), is based upon specialization and the division of labor.  It says that when we trade, we can benefit.  We have certain advantages over others.  It might be that our skill set or natural talents are better than another's.  It might be as simple as being closer to a natural resource than another.  The point is that it is our differences that allow up to benefit.

So if we posit that food and water is irregularly distributed, then some SCOs will have a comparative advantage over others.  Some SCOs will be closer to the food and the others will be closer to the water.  This means that if they cooperate, both groups will be better off than if they opertated in autarky. 

So far, so good.  I agree, but I didn't really see much benefit to this line of analysis.  However, others did.  They asked, "Why do cells in our bodies perform particularized functions for the benefit of the overall body?"  Their reasoning followed along these lines...

When SCOs start to cooperate, they are able to specialize.  When they specialize, they give up other functions and become dependent upon other SCOs.  Thus, we see the inklings of the transformation from SCOs to multi-cellular organisms.  Additionally, a side discussion of meme theory took place.

All-in-all, it was an interesting disucssion, but I fail to see how such theories can circle back and inform economic theory.  Why make an argument by analogy?  Why not just make the argument?

I am reminded of a quote by Böhm-Bawerk, where he attacks arguing by analogy.  It took place in his debates on Capital and Interest theory with John Bates Clark.  He says,

There seems to dwell in the human heart an enervating proneness for playing the poet in matters of science, and for placing by the side of the common natural things and forces with which we have to do in the world of prose visionary doubles in the form of all sorts of mystical beings and powers, to which a semblance of reality is imparted by means of an ‘elegant’ abstraction. I hold this practice to be fraught with greatest danger to science. If one departs from the bare truths of nature by only a hair’s breadth, scientific accuracy of thought is irretrievably lost the sway of truth gives place to that of words and sounding phrases.

Until next time...

Austrian Economics Forum Spring '12 #1--Tragedy of the Euro

We kicked off the latest round of the Austrian Economic Forum at North Carolina State University on January 27th, 2012.  It was well attended and everyone seemed excited to get the semester under way.  This semester is going to be a little different for us in that for each meeting a different Graduate Student will be either presenting his own work or a reading which interests him. 

The first session's reading was selected by Alex Gill.  He picked chapters 8 and 9 in Philipp Bagus' Tragedy of the Euro (2010).

The European Central Bank (ECB) has powers that are slightly different than those of the US Federal Reserve System.  The difference we focused on was the ability of the ECB to expand the money supply. 

The system works by the ECB loaning money to banks, which use national governments' bond as collateral.  Suppose a national government (e.g., Greece) decides that it must spend more than it takes in from tax revenues; it has a budget deficit.  (Hard to imagine I know, but hang in there.)   The Greek Government cannot simply create new money to cover its budgetary shortfall.  So it borrows the money by selling bonds.  The bonds are (either directly or indirectly) purchased by banks.  These banks then go to the ECB and ask for a loan.  The ECB accepts the Greek government bonds as collateral and credits Euros to the banks' accounts.  Where did this money come from?  It comes from a big, black hole of nothingness.  It is simply brought into existence by the recording of Euros in the banks' accounts.

Bagus also illustrated another difference.  The Treaty of Maastricht said that no bail-outs are allowed.  If a government overexpands and cannot meet its spending "obligations" then that's its own problem.  The national governments were allowed deficits of no more than 3% of GDP and Total Debt to not be greater than 60% of GDP.  Clearly, politicians care little about such restrictions.  

Today's situation reminds me of the addage that if you borrow $1 million from your banker and cannot pay if back, you are in trouble.  However, if you borrow $1 billion from your banker and cannot pay it back, then he is in trouble! 

No one who agreed to the treaty should have been under any illusion that these clauses would have been tossed aside in the midst of a crisis.  Austrian (or any decent economic) insight into the incentives of a crisis should have led one to this conclusion.  Bagus takes a slightly different approach to this analysis.
 
Bagus argues that the Euro Zone is analagous to the Tragedy of the Commons.  Since each country can run a deficit, and then monetize it, they will exploit the "common" value of the currency before others can.  Some governments spend more than their revenue and cover the deficit spending with bonds.  The governments that run deficits are able to exploit the "commons."  The value of the common resource, the Euro, is diminished for the rest of the users of the Euro. 

The analogy is a bit of a stretch.  The problem with the commons analogy is that "the commons" are unowned resources.  When a fisherman catches a fish, he is privatizing it for his own use.  The "Tragedy" is that the resource is overused and depleted.  The problem with this analogy is that all of the money is always owned by someone.  There is not some unowned resource, a pool of value, that then gets exploited when the Greek government runs a deficit.  I see what Bagus is trying to do, which is argue that the first to print new money is the winner.  But if this is the case, why not just make the standard Austrian non-neutral money argument and be done with it?  I think that making the argument on the grounds of non-neutral money is better because it is direct.  However, perhaps, Bagus' approach opens Austrian insights and arguments to an audience that otherwise would reject the Austrians out-of-hand. 

A conclusion that falls out of this analysis is that Greece will not reduce its deficit.  It has no incentive t0 do so.  It has been benefitting from the monetary might (stability) of other countries, such as Germany.  As a result, the Germans are upset with the Greek.  (See Chapter 9)  Will it lead to the collapse of the common market, balkanization, or even war?  Unfortunately, that is a question that cannot be answered.

***

There is another point on theory that I think needs to be addressed. I think that Bagus is conflating the property rights argument in money production with that of some right to a value of money. In Chapter 8, Bagus contends that money production has external effects, and that the costs and benefits to money production are skewed due to these external effects. So far so good.

However, now he states, "Private gold money with clearly defined property rights was replaced by public fiat money. This money monopoly itself implies a violation of property rights." (p. 79) Hmmm… The problem is that in one sense this is true, but there is a second sense where it is not true. In the first sense, when we switch to a fiat money system, I can no longer demand gold in exchange for my labor services. Thus, this law violates my ability to freely contract on my own terms. However, the negative externality of the loss of value of the gold-in-my-pocket due to demonetization is not a violation of property rights. Nor is it a violation of property rights when there is monetary expansion that leads to a loss in purchasing power for the dollars-in-my-pocket. As my friends who deny intellectual property rights are fond of pointing out, there is no right to the value of anything. All value is subjective.

I think that Bagus is leaning toward the second sense when he says, "By giving fiat money a privileged position and by monopolizing its production, property rights in money are not defended and the costs of money production are partially forced upon other actors." (p. 79)

It would have been better if Bagus stuck to the traditional Hoppean/Rothbardian property rights argument that says that fractional reserve banking assigns the right of the same dollar to two different individuals. but he doesn’t. Instead, Bagus goes after Selgin and White, in footnote #8, for missing the property rights argument. He states that they “do not see any property rights violation in the issuance of fiduciary media.” Then, in addition to citing Hoppe, Hülsmann and Block, he cites entirety of the nearly 900 page book Money, Bank Credit, and Economic Cycles by Jesús Huerta de Soto. Why relegate such an important, and unproven, assertion to a footnote? The way I see it, expanding the money supply, even if it is 100% pure fiat money, is not a violation of my property rights. To claim otherwise means that I have a right to the value of my money, which is simply untrue.

Regardless, I think that the property rights argument is weak and a better case against fiat money and a central bank can be made on pure economic grounds.

Next, I want to address Bagus’ discussion of the "quality" of money, pages 79-80. This line of reasoning makes sense when a country is on a pure commodity standard, but makes little sense when we are talking about fiat money, which is only exchange value. If he simply means seigniorage, then okay, why not just say that? But if he is making a larger assertion, he needs to come out and say what he means and then differentiate it from seigniorage. Especially puzzling are statements like, “In contrast to fiat paper situations, where an increase in the supply of money dilutes the quality of the currency, there is no dilution in the quality of the currency by gold mining.” (p. 80.) He is using “quality” to mean “purchasing power” the first time, but means “percentage of content” in the second. Puzzling and troubling, indeed.

Finally, Bagus misses the big reason there is a check on the overexpansion of the money supply (beyond extent of the money multiplier) in a free banking system. The threat of bankruptcy in a free banking system does not have to come from a bank trying to drive a competitor into the ground. (See pages 83-84.) As Rothbard demonstrates in The Mystery of Banking (Chapter 8, page 114+), we can suppose that all economic actors are fully wanting fractional reserve banking to expand as much as they can. The check on bank expansion comes from the fact that some people have deposits at different banks. Suppose that I bank at Bank A and you bank at Bank B. When I get a check from you, I will deposit that check in my bank so I can access the funds. When I do so, Bank A asks Bank B for the money. That's the check against infinite bank expansion. Bank B had better have the money available for my bank and me or it will go out-of-business. The check is not because a bank might be trying to drive its competitor out of business, instead the check comes from the fact that I want to access my money from my bank.

Overall, it was a good discussion and a good beginning to another semester of thoughtful Austrian Economic Analysis. The next session will cover the idea of using artificial intelligence as an analogue for economic theorizing. The session that follows that will cover The Calculus of Consent by Buchanan and Tullock.

Austrian Economics Forum Fall '11 #5--Chapters 5 & 6

I know that this should have been written up earlier, but life intervened.  I also think that I have been dragging my feet on this entry because I was not particularly impressed with the conclusion of Kirzner's book Competition and Entrepreneurship. 

Is it heresy to say that I did not think that his book was all that great?  Of course Cordato is right when he says that the book needs to be looked at in the context of the time it was written.  However, why hasn't Kirzner released a second edition?  There have been several objections raised about Kirzner's book, so why hasn't he written the second edition to clear up some of the misunderstandings?  I would find it interesting to know if anyone has ever asked him about this.  Anyway to the book...

Chapter Five is an odd chapter.  Eleven pages into it, he says that what you just read is prelude and that we can finally get to his point and the real purpose of the chapter.  Kirzner states:

"I will show that because market phenomena frequently represent the outcomes of long chains of decisions (each one a prerequisite for the later decisions), a market process which is seen as competitive from one point of view may turn out to be monopolistic when evaluated from a different vantage point.  This highly important insight is the real purpose of this chapter, and the discussions thus far are to be viewed as introductory."  p. 198.

Then why did I just bother to read the first eleven pages?  Why not just get to the point?  One of the frustrating things about reading Kirzner, at least for me, is that he is so verbose!  Can we not write a sentence without all the hand-waving and qualifications?  Perhaps this is a product of the time he was writing.  Perhaps it is written this way because this was written in a time where these ideas were not just going against the grain, they were moving in the completely opposite direction.  Okay fine, I'll accept this argument, but still it makes the book exhausting to read.

Okay the ranting is over.

The point that he does (eventually) make is a good one.  We should reject the standard usage of Long- and Short-Runs.  Instead, we should focus on decision points.  At each decision point there is a weighing of options and opportunity costs.  The "Long-Run" then becomes a whole stream of decision points.  It occurs "earlier" in a production process.  The "Short-Run" is a decision point "later" in the production process.  Of course, the terms "earlier" and "later" are problematic.  If we are looking at a production process that is a point-input and point-output, then we can make that distinction.  If the production process is a closed, one-time, system, then we can easily see "earlier" and "later."  Unfortunately, most production processes are not like this.  Most have continuous input and continuous output production periods filled with recursive loops. 

Nevertheless, this is a step in the right direction.  When we start to focus on the nature of the decisions, then instead of talking about Long- and Short- production runs, we can look at "Decision Horizons."  A decision horizon can either be long or short.  The point is that it is the entrepreneur (and the rest of the market indirectly) who is determining the time horizon.  The time horizon is then only useful within the context of the decision.  The result is that we can basically jettison the standard terminology and focus on the contexts without all the misleading verbiage.

Chapter Six's main contribution is to drive home the point that best way to judge the "efficiency" of an economic system is by how well it brings together and incorporates information into active plans and then how well it reacts and adjusts to changes as new information is revealed.  Thus, Kirzner makes the point that the absence of coordination is "inefficiency." (See page 216.)  Perfect Knowledge assumes away this problem.  Thus Kirzner is adopting and extending Hayek's argument in "The Use of Knowledge in Society." 

So when we are to examine the welfare implications of a policy, we need not create some fanciful social utility criterion.  Instead, we look to how well information is absorbed and acted upon.  The entirety of profit and loss calculation becomes the feedback mechanism that we use as the benchmark.  Government's incorporation (of information) and feedback mechanisms are slow and imprecise by comparison.  Thus, we (Auistrian economists) have a very different approach to governmental policies to "solve" market outcomes.  Instead of having some omniscient, god-like bureaucrat standing in judgement over outcomes and adjusting players like pawns on a chess board where every move is as correct as the chalk-board allows, we look to how well does the policy absorb new information.  Then we look to see how well it adjusts as conditions, such as taste and preferences, change. 

If the welfare policy criterion was the only point to come from the book, then I would say that it is worth reading.  Luckily there are many more good points in the book. 

One last dig, I find it odd that Kirzner continuously returns to the Natural Resource Monopolist case.  I think that such a case is so rare that one cannot actually list a historical example of one.  My point is that I think that if we edit those sections out, the book would be greatly improved.  In Kirzner's defense, these are my just my opinions looking at it from a perspective from 39 years after it was written. 

Overall, it must be read by anyone who claims to be an Austrian economist.  It can be a challenge, frustrating at times, and a bit of a slog through several sections, but it frames the debate through which the Austrians approach monopoly theory, welfare theory, entrepreneurship and the role of knowledge for most of the past 40 years.  Do not just read summaries like this to understand Kirzner.  Perhaps I have missed something.  Perhaps a $20-bill-of-knowledge is just sitting there.  You may be more alert to it than I, and then, you'll be able to take advantage of your entrepreneurial acumen and show me up. 

Austrian Economics Forum Fall '11 #4--Selling Costs, Quality and Competition

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…

This week we discussed Chapter Four, "Selling Costs, Quality, and Competition."  Kirzner spends much of the chapter arguing against i) Chamberlin’s (early) views on product quality determination and his distinction between production costs and selling costs and ii) Marshall’s (and Hicks’s) views on advertising.  Most of the chapter was non-controversial to the group since his arguments seem to follow rather directly from his notions of entrepreneurship and competition he developed thus far.  For instance, on product quality he writes:

     In the decision about which quality of product is to be produced the really significant aspect is not how to economize with given resources in attaining given ends, but the alertness with which the producer recognizes the kinds of goods consumers are eager to buy, the kinds of goods available technology and resources can create, and the kinds of resources that can be marshaled.  It is the successful identification of relevant ends and means (rather than the efficient utilization of means to achieve ends) which marks the “right” decision on product quality. (p. 139)

No surprises here.  In similar fashion, he argues that the distinction between production costs (“necessary for a particular product to be forthcoming”) and selling costs (which “alter the demand curve for that product”) is false.  We can’t discuss demand for a nonexistent product, and we can’t distinguish between actions that enhance demand and actions that change the product.  For the same reasons, it is a mistake to argue that advertising provides “a separate, distinct service” from the advertised product itself.  In the course of his argument, though, Kirzner seems to contradict himself when he explicitly concedes (p. 155) that a “substantial portion of advertising may…be viewed as providing a service quite distinct from the advertised product.” 

This statement, in fact, was the starting point for the forum’s discussion.  Kirzner’s theory states that “selling effort” does not allow the separation of information into categories based on relevance or irrelevance with regard to demand determination.  Indeed, the group could not even maintain that an individual could reliably make this distinction in his or her own mind.  When Kirzner says that “some of that information is to be considered as inseparable from the product itself,” perhaps he should have replaced the “some” with “all.”  After brief digressions on the relative merits of Kirzner and Ayn Rand’s personalities and RBC theory, we turned to page 168:

     For us, the crucial question (in evaluating the claim that advertising “monopolistically” differentiates the product in the eyes of the consumer) must always be whether the advertising activities engaged in by the differentiating “monopolist,” are or are not open also to his competitors. (p. 168)

Then can trademarks be anticompetitive?  Not if the trademark is viewed as a contract between the producer and the consumer and competitors are allowed to form their own trademarks.  In a sense, a trademark monopolizes a particular logo, but it also conveys information to the consumer.  A producer who uses another’s trademark is engaging in fraud and misrepresenting the origin of a product.

As would be expected at a gathering like this, the conversation then turned to intellectual property issues in general. 

I was able to attend the last two AEF meetings and will write up and post those after I finish grading Final Exams!