Austrian Economics Forum Spring 2011 #5--Intro. to Austrian Monopoly Theory

The final session of our Austrian Economics Forum took place at Dr. Cordato's house.  He and his wife, Dr. Karen Palasek, made a really nice dinner for us, but the ground rules were that we had to talk economics before anything else.  (Were they afraid we wouldn't talk economics while eating?  Clearly an unfounded fear!)

This session's reading was "A Critique of Neoclassical and Austrian Monopoly Theory" by Dominic Armentano, found here http://oll.libertyfund.org/title/106/6041.  This is a chapter in the book New Directions in Austrian Economics edited by Louis Spadaro (1978).

The Armentano reading was a straight forward, introductory article to monopoly theory from an Austrian perspective.  Cordato added several personal comments about Armentano.  The one anecdote that struck me was that Armentano had formulated much of his criticism of the Neo-Classical Monopoly Theory long before he became (or even really studied) Austrian(ism).

The major, traditional Austrian criticism of standard Monopoly Theory rests upon the definition of the market.  Monopolies are defined as a single seller without any close substitutes.  However according to Austrian theory, a substitute can only be defined in the mind of the user of the goods.  When Saran Wrap first came out there was nothing else like it.  So were there any substitutes?  Actually yes, there were many because the relevant market was "What can I put my sandwich in so I can take it to school/work?"  The substitutes were wax paper, tin foil, aluminum foil, paper bags or even Tupperware.  None of them look like Saran Wrap, but they are all substitutes.  Or an example I use in my class is that helicopters and closed-circuit cameras are substitutes.  Of course, physically they are nothing alike.  However, if we are trying to learn about traffic congestion during our morning commute, then they are substitutes.

Furthermore when it comes to defining the market, we can define it in such a way that we are all monopolists.  I am the only one who supplies my labor.  Or if we broaden the definition, then there is no such thing as a monopolist. 

At the end of our abbreviated discussion (we were hungry), we agreed that the Rothbardian definition of monopoly was the best.  Rothbard uses the old definition of a government created monopoly privilege.  If there is a law, legal restriction, etc. that forcibly prevents others from competing, then that is a monopoly.  Otherwise, there is no monopoly.  There are two objections to this.  The first is a natural resource monopoly.  I find this problematic.  If there was such a monopoly, as soon as it sells some to anyone else, there arises a potential competitor.  From this point we start to get into some rather strangely concocted hypothetical situations.  "Suppose under the following circumstances...blah, blah, blah."  If we need to resort to such narrow assumptions, then we are not really describing the world around us and have started to play mental games.  There's nothing wrong with mental games.  In fact most of the leading economic journals are full of such things.  Just please don't waste my time on them.

The second objection is that of a natural market monpoly where a firm is so good at what it does, no other firm can compete.  To which I ask, "What's the problem with that?"  From a consumer's point of view this is great!  They offer better prices, better quality, better locations, better service, etc.  On every single vector of competition, this firm is better.  If it lags in any one of these areas, then a niche market can arise. 

Neo-Classical economic theory relies far too much on counting the number of firms that are competing.  To them "competition" is a state of being.  It is a noun.  Austrian Theory rejects this view and says that competition is a rivalrous process.  The only way that relative scarcities (prices) can be discovered and determined is through competition--real competition.  It only takes one producer and an open market for there to be competition.  The supposed monopolist must compete against potential competitors, otherwise, they will soon appear.  Leonard Read once said that trying to stop competition in a free market is like standing in a river with a broom, trying to sweep the water away.  For an instant, the water is brushed aside, but then it comes rushing back in.

Austrians view competition differently.  We view it in the same way that sports teams do.  In order to know the outcome, we need to play the game.  This is why Austrian Economics has been gaining so much attention in other business fields like Strategic Management.

Cordato is hoping that the next semester (Fall) will follow the course of more Microeconomic stuff.  I'm thinking that we should look at Mises's Theory of Money and Credit so that we can finish it in 2012, the 100th anniversary of its publication.  I don't know the direction, but I am sure that it will be a fun ride.

Keynes vs. Hayek Round Two Video

The long awaited sequel to the Keynes vs. Hayek rap is out.
Enjoy.



Here is the original first video:

Austrian Economics Forum Spring 2011 #4--Austrian B-Cycle

***I know that it has been some time since the last Austrian Economics Forum update.  The reason is that I missed a session.  I heard that it was nice.  Everyone went outside and sat on the grass and discussed economic theory.  The lesson is, of course, never to miss an AEF meeting!***

This session's discussion centered on two readings: Richard E. Wagner, "Austrian Cycle Theory: Saving the Wheat while Discarding the Chaff" The Review of Austrian Economics, 12(1), 65-80, 1999; and Walter Block, "Yes, We Have No Chaff: A Reply to Wagner's 'Austrian Cycle Theory: Saving the Wheat While Discarding the Chaff'" The Quarterly Journal of Austrian Economics, 4(1), 63-73, 2001.

I was rather disappointed by both of these articles. 

The first thing that caught my attention was the very condescending tone of the Wagner article.  He refers several times to the "canonical" version of the Austrian Business Cycle Theory (ABCT).  It is as if he thinks that there is no independent thought among Austrians, that there is no debate, and that if one doesn't hold to the "cannon" then they are out of the Austrian club.  How ridiculous!  It's insulting and demeaning.

There are two major criticisms that Wagner puts forward in opposition to the ABCT.  They have both been argued and reargued for decades.  Wagner is apparently unaware of these debates or he simply has chosen to ignore them.

The first criticism can actually be traced to Gottfried Haberler.  Haberler wrote a summary of the different theories of the business cycle for the League of Nations.  This work was then converted into the book Prosperity and Depression (1937).  Joe Salerno presented a paper at the 2011 Austrian Scholars Conference on Haberler's portrayal of the ABCT.  Salerno makes the point that Haberler mistakes the malinvestment theory for one of an inefficient use of resources.

Here is Haberler's story.  The Central Bank expands credit and pushes down interest rates.  As a result, entrepreneurs are misled into investing in the earlier stages of production.

So far the story is right, but it is missing an important element.  Haberler's story is that we start with the Structure of Production at point A.  When the new, (lower) interest rates emerge, we slide out to point B.  When the market recognizes the mistake, we slide to back to point A.  Thus Haberler and those who have followed his characterization of the ABCT have dismissed the ABCT as an inadequate theory.  If this were all that the ABCT was, then I would also dismiss it as a simple theory of a misallocation of resources and the resetting of them.

The ABCT is not simply a theory that sloshes capital goods from late stages of production to earlier stages and back again.  What Haberler is missing is the bi-directional signal of the interest rate.  The ABCT is a theory that contains both malinvestment at the higher stages of production and overconsumption!  The modern, Garrisonian version looks like this:

Here we see what John Cochran calls "The Dueling Structure of Pro- duction."  (See QJAE 4(3), p. 19, 2001.)  When the interest rate falls it sends a signal not only to investors and entrepreneurs to invest more.  It also tells consumers that the return on savings has fallen.  As a result, income saved falls and income consumed rises.  Thus, the structure of production is split and torn apart in two directions.  For the mainstream macroeconomist, he sees C (consumption) and I (investment) increasing together, which is solid GDP growth.  Unfortunately, this information is misleading.  The modern macroeconomist is misled due to the overaggregation of his statistics.

The invested capital also has various degrees of specificity and substitutability.  As a result, the conversion of the malinvestment into sustainable capital structures can be long and difficult.  It is that conversion process that is the recession.

The second objection that Wanger raises against the ABCT centers on expectations.  There is an old objection to the ABCT that says, "if people knew the ABCT, then when they look at the actions of the Central Bank, they could adjust and avoid the Boom and the Bust."  This logic is built upon Haberler's mischaracterization of the ABCT.  The ABCT is not about sectoral shifts in resources.  It is about soldifying liquid capital into specific production methods and then breaking them up as the malinvestments are revealed.  Furthermore, the Austrians model money as being non-neutral and so even if an entrepreneur had the knowledge of what has happening, the Cantillon effects are unavoidable.

Block centers his criticism of the Wagner article on this particular point.  The best argument he makes is that, "those who shift resources from the lower to the higher orders of production [will do so] in response to a lowering of the loan rate of interest, even if they know this emanates from Fed machinations, not a change in time preference, and thus [it] can only be temporary."  While the argument is correct, Block does not hammer the point. 

In my opinion the best explanation on why entrepreneurs must expand with lower credit, even if they know that it will lead to a boom / bust cycle, is found in Carrilli and Dempster, "Expectations in Austrian Business Cycle Theory: An Application of the Prisoner's Dilemma," The Review of Austrian Economics, 14(4), 2001.  They set the problem up as a prisoner's dilemma in which the global solution may look like no one should borrow the new credit and invest, but the local solution is that they must.  With money being injected sequentially into the economy and injected at specific points, the non-neutral Cantillon effects show that those who get (and use) the new money first are the big winners.  Those who get the money last (or choose not to use it) lose.

Say's Revenge: Living in Keynes' Long-Run

I gave a talk at the John Locke Foundation today, which I thought went rather well.  It is called, "Say's Revenge: Living in Keynes' Long Run."  Here is a clip from the talk:

For the full video please go here:
http://lockerroom.johnlocke.org/2011/03/21/saying-what-say-said-rather-than-what-keynes-says-say-said/
or here:
http://jlf.streamhammer.com/speakers/paulcwik032111.mp4

A Gold Currency for North Carolina?

In a recent N&O article (found here), it is reported that a state legislator, Glen Bradley-R Youngsville, has introduced a bill to create a State currency backed by gold and silver.  The reporter is perplexed by such an odd bill, and he basically ridicules the sponsor.  In the article, he talked to an economist at the State University, the Democratic State Treasurer and a Democratic State Legislator.  (I guess that's "Fair and Balanced.")

While I know that this bill is going nowhere today, it is worth thinking about.  What would happen if a state decided to go on the gold standard without the rest of the nation?  (I know that the bill says gold and silver, but bimetalism is a whole different set of problems, so let's just focus on the gold standard.)

The advantages of a gold standard, at least nationally, is that it forces the government to live within its means and is a brake on hyperinflation.  Additionally, it reduces the ability of the Federal Government to grow the Welfare/Warfare state.  While it might not eliminate the business cycle, it does help reduce the artificial bubble (boom) the preceeds the painful, but necessary, liquidation process.

Why should a State like North Carolina consider it?  The benefit of owning a currency that is not depreciating is obvious to the guy who has the gold coins in his pocket.  In fact, I'd rather be paid in such a currency.  Furthermore, the adoption of a sound currency would mean a big positive jump in investment into the NC economy.  If the people of the state adopt the gold currency, then it would attract businesses the world over who are afraid of doing business in a coming hyperinflation.  (While those in power cannot forsee a collapse of the US dollar, does not mean that such a thing is all that far off.  I doubt the Germans in 1922 forsaw the inflation awaiting them in the next year.)  And finally, since the State already has a balanced budget rule, the impact on the budgetary process would be small. 

The problem of going it alone, when we have legal tender issues, is that of Gresham's Law.  The law says that with legal tender laws, bad money drives out good money.  (It also says, but is less commonly known, that good money drives out bad money in a competitive market.)

So, unfortunately, Gresham's Law will fully apply to North Carolina.  Why?  Suppose that Bradley is correct on the dollar's purchasing power falling through the floor.  Now to pay my taxes I have the choice of choosing between using a state gold coin or a depreciated dollar.  I will always choose to pay in the least valuable currency.  So I will hoard the state gold coins and spend the increasingly devalued fiat dollars. 

Unless...

The only way that the Gresham's Law will work to the advantage of the state gold coins is if it is allowed to compete with the US paper dollar.  If the paper dollar and state gold coins value are fixed, then the paper money will drive out the gold.  However, if value of the state gold coin was allowed to float against the paper dollar, then it would, indeed, drive out the use of the paper money.  Not entirely, of course, but to the extent that residents of North Carolina can demand payment in gold coins, it would. 

And that is the catch.  The paper dollar says that it is good for all debts public and private.  So that means you have to accept it.  If the buyer can force the seller to accept the paper, then there is no chance of its success.

Getting Back to Breakeven: ASC 2011 paper

This past weekend, I attended the Austrian Scholars Conference at the Mises Institute in Auburn, AL.  There were many papers presented and I plan on commenting (later) on several of them on this blog.

Many have asked for a copy of the paper I presented with Harry Veryser.  The link to it is here or you can find it here: http://www.moc.edu/images/uploads/tsb_files/The_Liquidation_Phase_and_Profit_Margins_Getting_Back_to_Breakeven.pdf

Failure is a Necessary Option

An often repeated and overused phrase is, "Failure is not an option."  How ridiculous!  In fact, the reverse is not only true, but it is a necessity.

One major problem with the public school system is that failing schools do not close.  In fact, a failing school usually gets more funding the next year in order to "turn it around."  Ask yourself if this policy really makes long-term sense.  What sort of incentives are being created when failing schools are given expanded budgets?  An axiom in economics is that people respond to incentives.  If we pay people more for failing schools is it any wonder that we get failing schools?

In the private sector, the customer is sovereign.  The customer chooses what to buy (or not buy) and no one can force such a decision on another.  An entrepreneur who is able to please his customers receives continued business as his reward.  Hopefully, with proper management, profits also accrue to the entrepreneur.  However, if the company does not please the customer, regardless of reason, the business suffers.  Maybe there was rudeness, maybe the product was shoddy, or maybe the price was too high, the reason doesn't matter because the end result is the same: the loss of business.  When the customer is not pleased with the entrepreneur, he takes his business elsewhere.  The entrepreneur had better shape up quickly or the venture will close its doors and the resources will be transferred to others who are better at satisfying customers. 

The continuous process of pleasing customers continually shifts resources to those who are the most efficient users and most effective satisfiers.  This phenomenon is relatively new; it has only been around for the last couple of hundred years.  During this short period of history, we have achieved higher living standards for more people than at any other point in recorded human history.

When we step away from the market and into the world of public provision of goods and services, we see that it operates by a whole different set of rules.  In the public sector, the government collects the revenue to operate the institution.  However, it can't simply hand someone billions of dollars and say, "Go educate some kids."  Along with the dollars come the rules and regulations.  These reorient the focus of the employees and managers away from "customer" and toward the rulebook.  Additionally the same system strips away all vestiges of competition between providers of education.  The children are assigned schools; the parents are not allowed to choose.  Imagine if such were the case with phone and Internet providers.  (Actually I can imagine it, because it was the law of the land for decades.  What was the result?  Poor quality, high costs, lack of convenience, ugly phones, and attaching an answering machine was considered illegal because it was "installing a foreign device.")

Our public education problems are far too complex to simply say that the answer is competition between our schools, but don't discount that simple phrase too quickly.  Imagine the impact the following three changes would have on our public schools:

1. allow parents to choose which school to send their child to;
2. attach the dollars to the child so that a school's budget is based upon the number of students that enroll at their location; and
3. allow schools that cannot cover its costs to close and be sold.

Such a proposal will cause the teachers' and administrators' unions to howl, but I am not concerned with protecting their jobs any more than I am concerned about protecting McDonald's workers' jobs when I go to Burger King.  In fact, our university system has this feature and it seems that we have a large and diverse set of higher educational institutions.

Competition will weed out the bad teachers and they should lose their jobs.  Competition will weed out the bad administrators and they should lose their jobs.  Competition will weed out the unnecessary overhead and reward quality.  It will reward good schools, good teachers and good administrators.  

Many think that competition is scary because some producers are winners and some are losers.  Unfortunately, too many people think this way.  I say "unfortunately," because this thinking is backwards.  There is too much focus on the providers and too little attention paid to the customers, the children.  When there is competition, the customers are the big winners.  And, paradoxically, the only way that we can guarantee a successful school system is if we make failure not only an option, but a necessity.