austrian economics

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Fax (+44) 01524 594244 E-Mail G.Steele@lancaste Telephone (+44) 01524 59 LANCASTER UNIVERSITY THE MANAGEMENT SCHOOL Lancaster LA1 4YX UK DEPARTMENT OF ECONOMICS Austrian Economics Austrian Economics 1 ‘there is no Austrian economics - only good economics and bad economics’ (Milton Friedman, 1976) ‘I could verify the existence of witches if you give me the chance every other year to tack on some variables in the regression’ (Robert Solow, 1984) ‘in any issue of any journal there’s a lot of crap ..’ (Robert Lucas, 1984)

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‘in any issue of any journal there’s a lot of crap ..’ (Robert Lucas, 1984). Austrian Economics. ‘there is no Austrian economics - only good economics and bad economics’ (Milton Friedman, 1976). - PowerPoint PPT Presentation

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Page 1: Austrian Economics

Fax (+44) 01524 594244 E-Mail [email protected] Telephone (+44) 01524 594210

LANCASTER UNIVERSITYTHE MANAGEMENT SCHOOL

Lancaster LA1 4YX UK

DEPARTMENT OF ECONOMICS

Austrian EconomicsAustrian Economics

1

‘there is no Austrian economics - only good economics and bad economics’

(Milton Friedman, 1976)

‘I could verify the existence of witches if you give me the chance every other year to tack on some variables in the regression’

(Robert Solow, 1984)

‘in any issue of any journal there’s a lot of crap ..’ (Robert Lucas, 1984)

Page 2: Austrian Economics

The profession has been criticised for its adherence to models of a free market that claim to show demand and supply continually rebalancing over relatively short periods of time – in contrast to the decade-long mismatches that came ahead of the banking crash in key markets such as housing and exotic derivatives, where asset bubbles ballooned.

Members of the Post-Crash Economics Society said their course was dominated by models and equations that trained undergraduates for City jobs without a broader understanding of the way economies and businesses work.

(The Guardian, 11 November 2013)

2

Congratulations on your profile Congratulations on your profile

Page 3: Austrian Economics

The profession has been criticised for its adherence to models of a free market that claim to show demand and supply continually rebalancing over relatively short periods of time – in contrast to the decade-long mismatches that came ahead of the banking crash in key markets such as housing and exotic derivatives, where asset bubbles ballooned.

(The Guardian, 11 November 2013)

‘For forty years I have preached that the time to prevent a depression is during the preceding boom; and that, once a depression has started, there is little one can do about it. My advice was completely disregarded as long as the boom lasted. Now suddenly, when my prediction has come true and we have reached the stage where ... little can be done about the inevitable reaction which has set in, people suddenly turn to me and ask for my opinion.’

(Friedrich Hayek, 1975)3

Congratulations on your profile Congratulations on your profile

Page 4: Austrian Economics

4

KrugmanismKrugmanism

Page 5: Austrian Economics

5

‘A researcher who … takes his departure from arbitrary axioms … falls necessarily into error, even if he makes superior use of mathematics’

Plus ça change? Plus ça change?

Carl Menger1840 - 1921

Albert Einstein1842 - 1924

‘Not everything that can be counted counts, and not everything that counts can be counted.’

Pick up a test paper, and remove the words ….

Page 6: Austrian Economics

6

Though a skilled mathematician, he used mathematics sparingly.

He saw that excessive reliance on this instrument might lead us astray in pursuit of intellectual toys, imaginary problems not conforming to the conditions of real life: and further, might distort our sense of proportion by causing us to neglect factors that could not easily be worked up in the mathematical machine

Marshall followed the rule that

1. one should use mathematics as a shorthand and not as an engine of inquiry;

2. one should keep to the mathematics until it is done;

3. then translate the mathematics into English;

4. then provide an illustration of the point with an important real world example;

5. then burn the mathematics; and

6. if you cannot succeed at (4) then burn (3)

(A C Pigou on Alfred Marshall, 1925 )

Plus ça change? Plus ça change?

Alfred Marshall1842 - 1924

Page 7: Austrian Economics

7

‘if you know economics and nothing else, you will be a bane to mankind, good, perhaps, for writing articles for other economists to read, but for nothing else’

(Friedrich Hayek, 1944)

‘Internal preparations for REF-2014 reward disciplinary orthodoxy by resting upon the evaluations of a single reader per Unit of Assessment and by expecting each member of staff to fit within the narrative of that Unit’

REF-2014REF-2014research evaluation frameworkresearch evaluation framework

Page 8: Austrian Economics

Carl Menger (1840-1921) Friedrich von Wieser (1851-1926)

Eugene Böhm-Bawerk (1851-1914). Ludwig von Mises (1881-1973)

Friedrich Hayek (1899-1992)

Contrast with classical labour theory of value:

David Ricardo (1772-1823)John Stuart Mill (1806-1873)

Karl Marx (1818-1883)

Austrian SchoolAustrian School

8http://library.mises.org/books/J246rg%20Guidohttp://library.mises.org/books/J246rg%20Guido%20H252lsmann/Mises%20The%20Last%20Knight%20H252lsmann/Mises%20The%20Last%20Knight%20of%20Liberalism.pdf %20of%20Liberalism.pdf 107 ff107 ff

Page 9: Austrian Economics

Austrian approach: (dynamic adjustment to shifting equilibria)

marginal subjective evaluations subjective evaluations (variable with circumstances)

Anglo-Saxon approach: (static equilibria)

marginal utility (inherent in the commodityinherent in the commodity)inter-personal comparisons

optimality based on known knownsPareto optimality

Austrian SchoolAustrian School

9

Page 10: Austrian Economics

Historical School Historical School vsvs Austrian School Austrian School

Gustav Schmoller1938 - 1917

Carl Menger1840 - 1921

Concernshow might the state promote welfarewary of laissez-fairelessons from history rather than theory

10

Concernsanalytical science: general propositions human action drives market phenomena subjective values drive choices

Page 11: Austrian Economics

Historical School Historical School vsvs Austrian School Austrian School

Concernshow might the state promote welfarewary of laissez-fairelessons from history rather than theory

11

J M Keynes1883 - 1946

F A Hayek1899 - 1992

Concernsanalytical science: general propositions human action drives market phenomena subjective values drive choices

Page 12: Austrian Economics

Austrian SchoolAustrian School

J M Keynes1883 - 1946

‘In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is past the ocean is flat again’

‘Are we not told that ‘since in the long run we are all dead’, policy should be guided entirely by short-run considerations? I fear that these believers in the principle of après nous le deluge may get what they have bargained for sooner than they wish’

12

F A Hayek1899 - 1992

Page 13: Austrian Economics

J M Keynes J M Keynes vsvs F A Hayek F A Hayek

J M Keynes1883 - 1946

F A Hayek1899 - 1992

‘It is an extraordinary example of how, starting with a mistake, a remorseless logician can end up in Bedlam.’

‘‘Mr Keynes aggregations conceal the most fundamental mechanisms of change’

13

Page 14: Austrian Economics

Hayek: ‘Economics and knowledge’, Hayek: ‘Economics and knowledge’, EconomicaEconomica (1937) (1937)

Hayek: ‘The Pretence of Knowledge’, (1975)Hayek: ‘The Pretence of Knowledge’, (1975)

Henry Plotkin: Henry Plotkin: The Nature of Knowledge The Nature of Knowledge (1994) (1994)

Paul Ormerod: Paul Ormerod: Why Most Things Fail Why Most Things Fail (2005)(2005)

Austrian SchoolAustrian School

14

Page 15: Austrian Economics

aversionaversion tothe pretence of knowledge (what and to whom?)

the insistence upon mathematical precision

decision-makingdecision-making cannot be reduced to differential calculus

choicechoice is a costly experimententrepreneurship achieves greater economic coherence

prices: prices: a telecommunication systempricesprices: determined by

subjective wants ideas about opportunities

Austrian SchoolAustrian School

15

Page 16: Austrian Economics

dynamic process of multi-plan entrepreneurial co-ordination:dynamic process of multi-plan entrepreneurial co-ordination:

arbitrage opportunities

trading at disequilibrium prices

moving markets towards ‘equilibrium’

institutional structures institutional structures owing their existence to transactions costs: transactions costs:

money, banks,

law, accountancy, insurance,

salesmen, firms

Austrian SchoolAustrian School

16

Page 17: Austrian Economics

Austrian School Austrian School dynamic coordination: dynamic coordination: though market processes

catallaxy: spontaneous order achieved by free exchange;

participants’ objectives are irrelevantmarket: non-teleological institution

no judgement about the end-states it fosters

Neoclassical microeconomics Neoclassical microeconomics static problem: static problem: allocating givengiven means among knownknown ends economy: an administered organisation

resources directed to serve given objectives

no social/historical/institutional context

theory of consumer behaviour/the firm/income distribution

17

Page 18: Austrian Economics

beer

cigarettes

U = f (beer, cigarettes)

Neoclassical Microeconomics, Neoclassical Microeconomics, where mathematicians play ….where mathematicians play ….

18

Page 19: Austrian Economics

capital

labour

marginal analysis

neo-classical economics

microeconomics

constrained optimisationoutput = f (capital, labour)

Neoclassical Microeconomics, Neoclassical Microeconomics, where mathematicians play ….where mathematicians play ….

19

Page 20: Austrian Economics

x1

x2

marginal analysis

neo-classical economics

microeconomics

constrained optimisation

vulgar economicsvulgar economics

q = f (x1, x2)

Neoclassical Microeconomics, Neoclassical Microeconomics, where mathematicians play ….where mathematicians play ….

20

Page 21: Austrian Economics

Entrepreneurship ?Entrepreneurship ?

Neoclassical Microeconomics, Neoclassical Microeconomics, where mathematicians play ….where mathematicians play ….

21

Page 22: Austrian Economics

Entrepreneurship ?Entrepreneurship ?

Neoclassical Microeconomics, Neoclassical Microeconomics, where mathematicians play ….where mathematicians play ….

22

Page 23: Austrian Economics

William BaumolWilliam Baumol

Austrian School Austrian School

EntrepreneurshipEntrepreneurship

23

Page 24: Austrian Economics

Paul OrmerodPaul Ormerod

• notnot few and very clever few and very clever

butbut

• many and (mostly) failuresmany and (mostly) failures

Biological species - 99.9% are extinctUS companies - 10% fail each year

Austrian School Austrian School

EntrepreneursEntrepreneurs

24

Page 25: Austrian Economics

economic efficiency stemseconomic efficiency stems

• notnot from from ex ante ex ante rational planning rational planning

but from but from ex post ex post elimination of ill-adapted formselimination of ill-adapted forms

• notnot from smart people within simple worlds from smart people within simple worlds

but from dull people within complex worldsbut from dull people within complex worlds

Austrian School Austrian School

EntrepreneursEntrepreneursPaul OrmerodPaul Ormerod

25

Page 26: Austrian Economics

Austrian School Austrian School

ephemerala reward to being first in applying a new idea

a reward for taking a chance

rarely persistattract emulation (and envy)

protected primarily by state licensing

Entrepreneurial ProfitsEntrepreneurial Profits

26

‘We allow the individual share to be determined partly by luck in order to make the total to be shared as large as possible’

(Hayek, 1978)

Page 27: Austrian Economics

markets utilise local expertise

‘particular knowledge of time and place’

entrepreneurship: a process of discovery

co-ordination of individuals’ actions, based on

imperfect, incomplete, dispersed knowledge

Hayek: ‘Economics and knowledge’ (1937)Hayek: ‘Economics and knowledge’ (1937)

Austrian School Austrian School

27

Markets:Adam Smith: division of labour Friedrich Hayek: division of knowledge

Page 28: Austrian Economics

Austrian School Austrian School

‘While the presumption must favour the free market, laissez-faire is not the ultimate and only conclusion’ (1933)

‘Probably nothing has done so much harm to the liberal cause as the wooden insistence of some liberals on certain rules of thumb, above all the principle of laissez-faire’ (1944)

28

The Apostle of Laissez-faire?The Apostle of Laissez-faire?

Page 29: Austrian Economics

Austrian School Austrian School

‘Our main problems begin when we ask what ought to be the contents of property rights, what contracts should be enforceable, and how contracts should be interpreted or, rather, what standard forms of contract should be read into the informal agreements of everyday transactions’ (1949)

‘Laissez-faire was never more than rule of thumb. It indeed expressed protest against abuses of governmental power, but never provided a criterion by which one could decide what were the proper functions of government’ (1973)

29

The Apostle of Laissez-faire?The Apostle of Laissez-faire?

Page 30: Austrian Economics

evolutionary thesis applied to knowledge

‘universal adaptation-ism’

(no connotation of progress)

adaptation solves problemsknowledge is

end-directed adaptive actionspecie-specific

The Nature of Knowledge (1994)Darwin Machines and the Nature of Knowledge (1997)

Henry Plotkin

Austrian School Austrian School

30

Page 31: Austrian Economics

Plotkin’s terminology

primary heuristic (genetic/instinct) shaped by ‘slow’ moving events

(‘generational deadtime’)

secondary heuristic (intelligence) shaped by fast moving events

problems of an unfamiliar future

tertiary heuristic (cultural knowledge)

Hayek The Fatal Conceit …. ‘Between Instinct and Reason’

Austrian School Austrian School

Henry Plotkin

31

Page 32: Austrian Economics

Keynes had ‘a common sense understanding’

Hayek’s was ‘intellectual rather than practical’

Keynes saw economics as ‘a means of improving the lives of others’

Hayek ‘consumed by economic theory for its own sake’

Keynes confronted ‘real-life dilemmas’

Hayek indulged in ‘pure theory’

32

Nicholas Wapshott

Page 33: Austrian Economics

Investment projects are abandoned because there is no demand ‘for ice cream’ by the time ‘ice trays for commercial refrigerators’ are complete.

The exact opposite holdsThe exact opposite holds

Hayek’s business cycle theory:‘higher order’ capital projects are halted because the demand for final goods becomes too urgent.

33

Nicholas Wapshott

Page 34: Austrian Economics

‘one of the few economists who warned about the possibility of the major crisis before the great crash came in the autumn of 1929’

a warning that derived from Hayek’s early monetary theory

cheap credit cannot remedy inappropriately structured investmentsinappropriately structured investments

Austrian Business Cycle TheoryAustrian Business Cycle Theory

19741974 Nobel Prize for Economics citation:

34

Page 35: Austrian Economics

Austrian Business Cycle TheoryAustrian Business Cycle Theory

35

saving falls consumption risesinvestment rises

Page 36: Austrian Economics

Austrian Business Cycle TheoryAustrian Business Cycle Theory

‘For forty years I have preached that the time to prevent a depression is during the preceding boom; and that, once a depression has started, there is little one can do about it. My advice was completely disregarded as long as the boom lasted. Now suddenly, when my prediction has come true and we have reached the stage where ... little can be done about the inevitable reaction which has set in, people suddenly turn to me and ask for my opinion.’

19751975

36

Page 37: Austrian Economics

Austrian Business Cycle TheoryAustrian Business Cycle Theory

19331933

‘the general disinclination to explain the past boom by monetary factors has been quickly replaced by an even greater readiness to hold the present working of our monetary organization exclusively responsible for our present plight. And the same stabilizers who believed that nothing was wrong with the boom and that it might last indefinitely because prices did not rise, now believe that everything could be set right again if only we would use the weapons of monetary policy to prevent prices from falling.’

37

Page 38: Austrian Economics

Mark Twain (1835 - 1910)

‘‘History doesn’t repeat itself, but sometimes it rhymes’History doesn’t repeat itself, but sometimes it rhymes’

Austrian Business Cycle TheoryAustrian Business Cycle Theory

38

Page 39: Austrian Economics

Mild recession Mild recession

would have followed growth to 1927, but ....... easy-money held back by two years

‘the normal process of liquidation’ (Hayek, 1935)

The Wall Street bubble bursts

Austrian Business Cycle TheoryAustrian Business Cycle Theory

1920s1920s

39

Page 40: Austrian Economics

Austrian Business Cycle TheoryAustrian Business Cycle Theory

1970s1970s

‘Stagflation’

StagflationStagflation

monetary distortions examined in the context of monetary distortions examined in the context of the labour market, trade unions and unemploymentthe labour market, trade unions and unemployment

shifting Phillips curve shifting Phillips curve misallocations of labour misallocations of labour

rising inflationrising inflationrising unemploymentrising unemployment

40

Page 41: Austrian Economics

Information Communication TechnologyInformation Communication Technology

Share prices rose whenShare prices rose when

‘ ‘e-‘ prefix e-‘ prefix and/or a and/or a ‘.com’ ‘.com’

was added to the company namewas added to the company name

The dot.com bubble bursts

Austrian Business Cycle TheoryAustrian Business Cycle Theory

1990s1990s

41

Page 42: Austrian Economics

The housing bubble bursts

Austrian Business Cycle TheoryAustrian Business Cycle Theory

2000s2000s

Domestic PropertyDomestic Property

the primary feature of unsustainable long-term investments that become viable during a bank credit upswing

42

Page 43: Austrian Economics

Austrian Business Cycle TheoryAustrian Business Cycle Theory

No panaceas …No panaceas …

No avoiding the pain of liquidating bad investments ...No avoiding the pain of liquidating bad investments ...

No atheists in trenches ... No atheists in trenches ...

No Hayekians in recessions ...No Hayekians in recessions ...

43

Page 44: Austrian Economics

n

n

VV

rr

n > n

c < c

Capitalised ValuesCapitalised Values

44

V = c [1 – (1 + r)-n]/ r

Page 45: Austrian Economics

  

£100.00

0.07

n20

n5

Structural equilibrium (r = 0.07r = 0.07)

VV

rr

Capitalised ValuesCapitalised Values

45

20 > 5

c < c

V = c [1 – (1 + r)-n]/ r

Page 46: Austrian Economics

   £106.80

£102.80

£100.00

0.06 0.07

n20

n5

Interest Rate EffectInterest Rate Effect

VV

rr

Capitalised ValuesCapitalised Values

46

Page 47: Austrian Economics

£106.80

£102.80

£100.00

0.06 0.07

n20

n5

VV

rr

capital deepening(resource constraints)

Interest Rate EffectInterest Rate EffectCapitalised ValuesCapitalised Values

47

Page 48: Austrian Economics

£105.00

£100.00

0.07 0.079 0.089

n5

n20VV

rr

Capitalised ValuesCapitalised ValuesRelative Price EffectRelative Price Effect

48

V = c [1 – (1 + r)-n]/ r

Page 49: Austrian Economics

£100.00

0.07 0.079 0.089

n5

VV

rr

Capitalised ValuesCapitalised ValuesRelative Price EffectRelative Price Effect

49

n20 capital shallowing(resource constraints)