Arnold Kling  

Austrian Economics

PRINT
Knife-edge Macroeconomics... Price Discrimination and Profi...

After taking a quiz on Austrian Economics, I wrote about my agreements and disagreements with that school.


Much of what I believe about economics is based on the concept of imperfect knowledge. Imperfect knowledge implies that as we gain knowledge, our standard of living improves. However, we still have much to learn. We know how to treat strep throat, but we do not have a cure for cancer.

As a process for learning, free markets and private property are extremely valuable. The market system provides an incentive to experiment and to adopt successful experiments. To me, this core insight is the key contribution of Austrian economics.


On the other hand, I argue that Austrian business cycle theory is less consistent with this concept of imperfect knowledge than is Keynesian business cycle theory. I suggest that a less doctrinally strict form of Austrian economics will emerge going forward.

For Discussion. Austrian economics was developed before what we think of as the Information Age. Has the revolution in data processing and communications produced an advantage for central planning or for decentralized markets?


Comments and Sharing


CATEGORIES: Austrian Economics



TRACKBACKS (1 to date)
TrackBack URL: http://econlog.econlib.org/mt/mt-tb.cgi/34
The author at The American Mind in a related article titled Kling's Take on Austrian Economics writes:
    Arnold Kling is confusing the Austrian School of economics with the paleolibertarianism of the Ludwig von Mises Institute and Lew [Tracked on November 12, 2003 12:04 AM]
COMMENTS (17 to date)
Eric Krieg writes:

I urge everyone to go over to businessweek.com and check out their special section on wireless technology and how businesses are adapting to their use.

One example which shows that IT is aligned against central planning:

Fed-Ex is equiping its drivers with wireless communications devices (Blackberries of steroids, basically).

Curently, if a driver gets a question, he tells the customer to call customer service (central planning model). With the new devices, he can look up the answer online himself (decentralized model).

A large organization is not neccesarily better at analyzing information than a smaller one, so more information does not make it more efficient. In fact, it probably makes it less efficient, as the bureacracy has more to analyze.

Lawrance George Lux writes:

Arnold,
It is a mixed bag! The Information Age allows Business to pick up on Opportunities almost immediately, and find pitfalls more quickly. This has led to better performance. The downside of the equation comes in Government increased ability to interfere in Business operations with micromanagement. lgl

Boonton writes:

I thought the model of the market in Austrian Economics is of an imperfect information processing machine, none of the participants have perfect information but the market is able to combine millions of diverse perferences into one consensus.

Ross Emmett writes:

Amazingly, I was just discussing this topic with a legal scholar at lunch. Here is my dilemma with the "imperfect knowledge" literature : if knowledge is understood to be the accumulation of information, and the accumulation of information is understood to place us closer to "what is really happening" (i.e., the truth), then the Information Age should make us better off. But does all the information actually give us better knowledge? And at what cost?

Here is a concrete application: security monitoring in airports has increased the volume of information accumulated, and presumably reduces the risk to travelers. The risk of what? An unimaginable event? Known risks can certainly be reduced, if we are willing to pay for it. But has the accumulation of greater and greater security information lessened our exposure to unimaginable events? How could it?

Furthermore, the comfort that comes from knowing that every minute a massive pile of security monitoring information is accumulating may create "rigidities" in the monitoring system that allow those unimaginable events to occur. "Planning" comes to substitute for innovative thinking.

Of course, innovative thinking was the context within which Hayek (and Frank Knight before him in Risk, Uncertainty and Profit) talked about knowledge. Their understanding of uncertainty is not overcome by simply accumulating more information, or installing better monitors.

For these reasons, I find the imperfect knowledge literature both insightful, and woefully inadequate.

Tom Dougherty writes:

Arnold,

You write, “Imperfect knowledge implies that as we gain knowledge, our standard of living improves. However, we still have much to learn. We know how to treat strep throat, but we do not have a cure for cancer. As a process for learning, free markets and private property are extremely valuable.”

I agree that knowledge is important for growth, but I think you go to far to say that mere knowledge will improve our living standards. Under-developed countries have access to the same books, recipes and technical knowledge that is available in the U.S. But all of the knowledge in the world will not improve the standard of living in Haiti with out the capital available to put that knowledge into effect. What these countries need more than anything to improve their standard of living is capital. As workers have more access to capital, their labor productivity improves and so does their wages. Further, you could imply from you statement that what a country needs is not free markets and private property, but good libraries. Why go through a process of learning that will entail mistakes (as well as successes) when you can pick up a book that already has the answer to what you seek.


I see the Austrian explanation of the business cycle as one would explain a price control. If the price of apples were set by the government below the price that would have occurred on the market, then as the price fell a situation would develop where the quantity of apples demand would increase and the quantity of apple supplied would decrease. The quantity of apples demanded would exceed the quantity of apples supplied. One could look to psychology and say that the demanders of apples just became to optimistic for their own good, demanding to many apples today that lead to a slump in apples in the future. Or one could say that prices contain information about consumer preferences. The government’s interfering in the price of apples has caused the information in those prices to be distorted. Demanders attempt to consumer more apples than suppliers are willing to supply at the controlled price.

The analogy with the credit market is that the government sets the price of loanable funds below what would have occurred on the market by lowering the market rate of interest through the expansion of credit. This market rate of interest is below the natural rate of interest that would have occurred without the government expansion of credit. Without this expansion of credit by the government, the amount of saving supplied equals the amount of investment demanded. The government’s increase in the money supply shifts the supply of savings to the right. Yet, an increase in money is not the same thing as an increase in actual savings. If it were, then economists would not have to worry about Americans saving to little; all that would be need is for the government to print more money to loan to business.

Artificially lowering the interest rate creates a dynamic where the amount of actual savings supplied no longer equals the amount of investment demanded. Business demands more investment than suppliers are willing to supply with actual savings. People save less during the boom and consume more, causing over consumption during the boom. Artificially low interest rates cause businesses to invest more and take on additional projects than otherwise. For example, businesses invest in projects that have a positive net present value. Lowering the interest rate cause negative net present valued projects to suddenly have a positive net present value, which means lowering the interest rate causes business to take on additional investments they otherwise would not have.

The artificially lowered interest rate causes consumers to be more consumption oriented while business becomes more investment oriented. Consumer plans and business plans are not coordinated and the seeds of a crisis are planted. I find this explanation more convincing than looking to psychology and saying that the businessmen became optimistic during the boom and risk averse during the slump.

Some questions I have or mainstream economists are:

1) Do mainstream economists think that bank credit creation is the same as actual savings through forgone consumption?

2) Do mainstream economists see the government manipulation of interests below the natural rate of interest similar to a price control? If not why not?

3) Do mainstream economists see the interest rate containing information not only about the allocation of resources between consumption and investment, but also allocating resources over time?

Tom Dougherty

Bob Dobalina writes:

Over on Mises blog, they're being slightly less than gentle with Arnold. This is a shame, because, by my calculus, Kling is one of the biggest visible free market proponents in the blogosphere, and rather than bickering about his TCS post (which was evenhanded, in my view), they prove his assertion that the Austrian "school" is a little exclusionary.

Bob Dobalina writes:

"and rather than bickering about his TCS post (which was evenhanded, in my view), they prove his assertion that the Austrian "school" is a little exclusionary. "

Make that: "and by than bickering about his TCS post (which was evenhanded, in my view), they prove his assertion that the Austrian "school" is a little exclusionary."

or:

"and rather than bickering about his TCS post (which was evenhanded, in my view), proving his assertion that the Austrian "school" is a little exclusionary, they ought to work on refuting his claim by being a little more inclusive."

Eric Krieg writes:

Is there a lot of overlap between the Austrians and the Objectivists.

In Fuzzy Logic terms, Arnold is 78% Austrian. Probably most of us are too.

But, man, that last 22% is a hard road to travel.

I think that most people would say that the 100% Objectivists are a little over the top. I wouldn't be surprised if the same held true for the Austrians.

Bob Dobalina writes:

Eric,

What about the last 22% of Objectivism is so tough?

Monte writes:

My $.02 worth:

I’ll admit to being intrigued by the Austrian school and their business cycle theory. Their unwavering support of free markets and epistemological approach to characterizing the economy can be appealing. As Arnold points out, however, their doctrinal attitude (coupled with their stubborn refusal to recognize the value-added of mathematical application in economics) hurts their credibility.

Regarding IT, I believe it has generated benefits for advocates of both central planning and decentralized markets. Obtaining information real-time and in almost unlimited supply strengthens the ability of each to model data, in spite of the fact that economic forecasting continues to remain notoriously unreliable.

Finally, Arnold briefly mentions convergence in his article. Many claim that the information age has paved the way for a full integration of socialism and capitalism. They hold up as proof the ever increasing role of government in our economy and the social reforms that have taken place in Eastern Europe and other areas over the last two decades. However, a careful examination of the facts reveals that, on balance, there has been more of a steady move towards capitalist forms of organization

Tom Dougherty writes:

I apologize for re-posting my thoughts on Austrian economics. The initial posting had numerous errors that made it difficult to read. I was pressed for time and did not proof read it before posting. I hope I have corrected most of the errors. TD

Arnold,

You write, “Imperfect knowledge implies that as we gain knowledge, our standard of living improves. However, we still have much to learn. We know how to treat strep throat, but we do not have a cure for cancer. As a process for learning, free markets and private property are extremely valuable.”

I agree that knowledge is important for growth, but I think you go to far to say that mere knowledge will improve our living standards. Under-developed countries have access to the same books, recipes and technical knowledge that is available in the U.S. But all of the knowledge in the world will not improve the standard of living in Haiti without the capital available to put that knowledge into effect. What these countries need more than anything to improve their standard of living is capital. As workers have more access to capital, their labor productivity improves and so does their wages. Further, you could imply from your statement that what a country needs is not free markets and private property, but good libraries. Why go through a process of learning that will entail mistakes (as well as successes) when you can pick up a book that already has the answer to what you seek?


I see the Austrian explanation of the business cycle the same as one would explain a price control. If the price of apples were set by the government below the price that would have occurred on the market, then as the price fell a situation would develop where the quantity of apples demanded would increase and the quantity of apples supplied would decrease. The quantity of apples demanded would exceed the quantity of apples supplied. One could look to psychology and say that the demanders of apples just became too optimistic for their own good, demanding too many apples today that lead to a slump in apples in the future. Or one could say that prices contain information about consumer preferences. The government’s interfering in the price of apples has caused the information in those prices to be distorted. Demanders attempt to consume more apples than suppliers are willing to supply at the controlled price.

The analogy with the credit market is that the government sets the price of loanable funds below what would have occurred on the market by lowering the market rate of interest through the expansion of credit. This market rate of interest is below the natural rate of interest that would have occurred without the government expansion of credit. Without this expansion of credit by the government, the amount of savings supplied equals the amount of investment demanded. The government’s increase in the money supply shifts the supply of savings to the right. Yet, an increase in money is not the same thing as an increase in actual savings. If it were, then economists would not have to worry about Americans saving too little; all that would be needed is for the government to print more money to loan to business.

Artificially lowering the interest rate creates a dynamic where the amount of actual savings supplied no longer equals the amount of investment demanded. Business demands more investment than suppliers are willing to supply with actual savings. People save less during the boom and consume more, causing over-consumption during the boom. Artificially low interest rates cause businesses to invest more and take on additional projects than otherwise. For example, businesses invest in projects that have a positive net present value. Lowering the interest rate causes negative net present valued projects to suddenly have a positive net present value, which means lowering the interest rate causes businesses to take on additional investments they otherwise would not have.

The artificially lowered interest rate causes consumers to be more consumption oriented while businesses become more investment oriented. Consumers’ plans and businesses’ plans are not coordinated and the seeds of a crisis are planted. I find this explanation more convincing than looking to psychology and saying that businessmen became optimistic during the boom and risk averse during the slump.

Some questions I have for mainstream economists are:

1) Do mainstream economists think that bank credit creation is the same as actual savings through forgone consumption?

2) Do mainstream economists see the government manipulation of interest below the natural rate of interest similar to a price control? If not, why not?

3) Do mainstream economists see the interest rate containing information not only about the allocation of resources between consumption and investment, but also allocating resources over time?

Tom Dougherty

Eric Krieg writes:

>>What about the last 22% of Objectivism is so tough?

I had a friend once who got into objectivism. One day he comes along and says to me that he isn't going to be my friend anymore, because the cost of being my friend exceeded the benefits of friendship I brought to him.

I have found in my experience that the 100% Objectivists are a little over the top. Like Arnold said about the Austrians, they are true believers.

Those of us that are people of faith cannot be 100% Objectivists, because Ayn Rand was virulently anti-religion. She once asked Bill Buckley if he was religious (stupid question, right?) and when he answered in the affirmative she told him that he was too smart to be religious.

Boonton writes:

Objectivists have a deeper problem, IMO, Ayn Rand is their religion. In my less than comprehensive (but more than fleeting) reading of objectivists it appears this so-called philosophy is nothing more than trying to figure out What would Ayn Rand say about it.

Unlike other philosophies or schools of thought, what developments have happened in Objectivism since Rand's death? Have they expanded her ideas and applied them to new areas? Have there been disagreements in doctrine resulting in splits? You can see this in very old religions/philosophies/schools of thought such as Christianity as well as newer ones (Keynesian economics, various right wing schools of economic thought from Friedman's monatary economics to supply siders, rational expectations etc.). I don't see any of this in Rand's 'Objectivist cult' and I don't think it will ever happen.

Eric Krieg writes:

I wonder how many Austrians are Objectivists? There's a lot of overlap.

Greenspan was a Randian. We has an essay in "Capitalism: The Unknown Ideal".

Lawrance George Lux writes:

I took the Quiz and received a 60. I have no real bias against the Austrians, and find much to criticize about other Schools. The real problem was the inclusiveness of the answers to the questions. One was forced to find the least offensive answer in every case, as each answer was so straited that One had to pick the One which generated the least revulsion. lgl

BfloGuy writes:

Objectivism and Austrian economics are pretty deeply intertwined. Ayn Rand developed much of her thought on economics from Mises (much as her theories on human cognition were built on the observations of Maria Montessori).

There has been progress in Objectivism and there have been splits -- primarily between those who want to maintain a cult of the personality and those who want to expand the philosophy and apply it.

And yes, disagreements have arisen about some of Ms. Rand's pronouncements: abortion and homosexuality among them.

StanThe Man writes:

Regarding Austrian economics and Objectivism: there are areas where the two complement each other and there are also areas where the two are almost diametrically opposed. While both camps favor free-markets, Rand used natural rights to reach her conclusions while Mises used utilitarian arguements. In fact, in some of Rand's writings (Capitlaism: The Unknown Ideal, I believe) one can find scornful references to economists who defend laissez-faire because it is best for the common good, not because it is an important part an ethical social order. I tend to think that that was a little dig at Mises. Rothbard also used natural rights to defend his version of free-markets (he was an anarcho-capitalist), but he and Rand had a major falling out in the 1960s or 1970s (See Jerome Tucille's book "It Usually Begins With Ayn Rand"). More recently, many Austrians, at least at the Mises Institute, have been critical of American foreign policy, while Objectivists, and this may be a simplification, are more inclined to support pro-Israel policies and intervention in foreign countries to "make America secure" from Communist/Islamist threats.
I believe the reason why Austrian Economics and Obejectivism are so connected is that when Rand was doing her early writing and developing her economic ideas, the Austrians were one of the few intelectuall movements out there that promoted the same kind of laissez-faire attitude as she did. And while many Austrians (and non-Austrian free-market economists as well) still think of Rand as a comrade in arms, Austrian Economics is not wedded to the Objectivist philospohy.

Comments for this entry have been closed
Return to top