Further Thoughts on Economic Calculation

5 May 2006 at 8:29 am 2 comments

| Peter Klein |

Nicolai asks important questions about the Austrian critique of socialism. I agree that a fresh look at these issues is warranted. My $0.02:

1. Mises's understanding of economic calculation is not exclusively, or even primarily, related to socialism. It is part of Mises's general explanation of how an advanced economy — i.e., an economy with a complex structure of heterogeneous capital goods — allocates resources to their highest-valued uses.

2. Mises's work on socialism flowed from his work on money. (It’s no coincidence that the 1920 article on calculation followed the 1912 book Theory of Money and Credit.) Entrepreneurs need actual numbers, not ratios of marginal utilities, to perform cost accounting. In a non-monetary economy there can be no "calculation," which for Mises means the comparison of anticipated future receipts and present expenditures on factors.

3. The key to all this, for Mises, is his concept of the "plain state of rest" (PSR). The PSR obtains every day in the real world, each time a buyer and seller agree on a price and make an exchange, momentarily exhausting the gains from trade. (Menger called these "points of rest"; Boehm-Bawerk, "momentary equilibrium.") PSR prices are not necessarily those that would emerge in the “final state of rest” (FSR), a hypothetical situation (never actually achieved) in which the basic data of the market are frozen but market participants continue to trade, revising their beliefs about other participants' reservation prices and obtaining better information about technological possibilities and consumer demands, until all feasible gains from trade are exhausted.

Marshallian and Walrasian equilibrium prices are FSR prices. Implicit in the neoclassical concept of the market is the idea that actual prices will tend to equal their FSR values, the only ones that “count” for assessing the welfare properties of the market. The objective of Kirzner’s research program, as I understand it, is to show that the movement from PSR prices to their Marshallian/Walrasian FSR equivalents is not automatic and instantaneous, but dependent on the actions of entrepreneurs alert to the profit opportunities created by temporary trading at “false,” i.e. non-FSR, prices. For Kirzner, PSR prices themselves are not terribly interesting or important; what matters is whether they tend to converge toward their FSR values. Echoing this line of reasoning, Vaughn (1994, p. 19) describes Menger’s price theory as that of a “half-formed neoclassical economist,” seeing Menger’s lasting contribution as not his theory of value and exchange but rather “his many references to problems of knowledge and ignorance, his discussions of the emergence and function of institutions, the importance of articulating processes of adjustment, and his many references to the progress of mankind.”

4. Salerno's innovation is to argue that Kirzner has it wrong: Mengerian price theory is primarily a theory of PSR prices, not FSR prices. In Salerno's interpretation of Mises, the question of whether or not there is a tendency toward (FSR) equilibrium — the “Kirzner vs. Lachmann” debate that dominated Austrian discussion in the 1980s — is relatively unimportant. (The “market process” most important to Mises is the selection mechanism in which unsuccessful entrepreneurs — those who systematically overbid for factors, relative to eventual consumer demands — are eliminated from the market.) In short, the reason Salerno’s reinterpretation of Mises has generated so much confusion is because he is not simply nit-picking about minor aspects of the calculation debate, but proposing an entirely new interpretation of Austrian microeconomics, a microeconomics that differs in important ways from the Marshallian/Walrasian analysis that fills the contemporary textbooks. (This comes as something of a shock to modern Austrians, many of whom have been trained that Austrian economics equals neoclassical microeconomics + the Mises-Hayek theory of the business cycle + knowledge, market process, spontaneous order, etc.)

In a recent response to Salerno, Kirzner takes a characteristically subtle position on the relationship between PSR and FSR prices. He argues the PSR is an “equilibrium” only in a trivial sense, that PSR prices are not meaningful for assessing the welfare properties of markets. He also recognizes that PSR analysis was important to Mises. To solve this seeming contradiction, he says that Mises used the PSR only to defend the concept of consumer sovereignty, not for analysis of the market process. But if PSR prices are sufficient to assure that production is satisfying consumer wants, why care about FSR prices and the alleged tendency to reach them? I find this puzzling.

5. Salerno’s attempt to distinguish between Misesian calculation or appraisal and Hayek’s knowledge problem should be seen in the context of Salerno’s revisionist history of the Austrian School. He identifies two distinct strands of Austrian economics, both starting from Menger: a Menger-Wieser-Hayek-Kirzner strand that focuses on FSR prices, assuming that real-world market prices are “close” to their FSR values, and a Menger-Boem-Bawerk-Mises-Rothbard strand that focuses on PSR prices, assuming that real-world prices are never close to their FSR values because the underlying data are constantly in flux.

6. For me, the interesting issues concern these larger questions of interpretation and the “mundane” details of Austrian price theory as articulated by Menger, Boehm-Bawerk, Fetter, Wicksteed, Davenport, Mises, Hutt, and others, not the semantic or doctrinal problem of whether we’re “really” talking about knowledge or about calculation or whatever.

Entry filed under: - Klein -, Austrian Economics.

Ranking Mania Among the Euro-weenies

2 Comments Add your own

  • 1. Nicolai Foss  |  6 May 2006 at 6:05 am

    Very interesting. However, there are certain things in your argument with which I am a bit uneasy (what else would you expect from a muzzy management type):

    1. You write that “The PSR obtains every day in the real world, each time a buyer and seller agree on a price and make an exchange, momentarily exhausting the gains from trade.” Strictly speaking, any exchange therefore gives rise to PSR prices. This, however, is not how Mises characterizes the PSR. To him, it clearly is a kind of temporary equilibrium construct, akin to what Hicks called “market-day equilibrium.”

    2. For this reason, I am not sure that Kirzner really deals with PSR prices.

    3. I doubt whether Marshallian prices are really FSR prices. Prices that are established in the Marshallian short-run might be Misesian PSR prices.

    4. Maybe I am wrong, but to me Mises simply seems to restate Hicks’ distinction between temporary (PSR) and full intertemporal (FSR) equilibrium. Mises, as widely read as he was, must have read Hicks’ Value and Capital (1939). Some of these distinctions are also central in Hayek’s early work (e.g., the Pure Theory of Capital).

  • 2. Peter Klein  |  6 May 2006 at 3:55 pm

    We're getting into increasingly muddy waters here, but, briefly:

    * Mises's PSR and FSR are based on older concepts developed by Menger and Boehm-Bawerk, and used also by Wicksteed and Arthur Marget; they developed independent of Hicks (who borrowed from Marshall, I assume). It's been a long time since I read Hicks and don't have a copy handy, so I can't provide a point-by-point comparison, though.

    * I was a little too glib regarding Marshall. It would be more accurate to say that Marshall's short-run equilibrium is somewhere between Mises's PSR and FSR. The PSR allows traders to have inconsistent beliefs about other trading opportunities; i.e., even without any exogenous changes in the data, including market entry and exit, the price will eventually converge, at the end of Marshall's "market day," to a uniform price as traders adjust their beliefs. Kirzner, in the Cato Journal piece linked above, argues similarly that Mises's PSR is a momentary, ephemeral condition that does not correspond to the intersection of the Marshallian supply and demand curves, which impose stricter informational requirements. (For more gory details, see also Salerno's 1994 "Ludwig von Mises's Monetary Theory in the Light of Modern Monetary Thought.")

    Why should management scholars care about any of this? Is it just obscurantist doctrinal trivia? I don't think so. If nothing else, it suggests that management theorists and evolutionary economists and others who worry about disequilibrium, about whether markets tend to equilibrate, etc. should be more precise about what they mean by "equilibrium." Is it Walrasian general equilibrium, Mises's PSR, or something in between? For economists, what concept of equilibrium is sufficient to make general claims about the welfare properties of markets? At one extreme are neoclassical economists who argue that only perfectly competitive, Arrow-Debreu general equilibria are "efficient." At the other extreme is Mises, who argues that consumer welfare is maximized (he would say "consumer sovereignty obtains") every time a PSR obtains, i.e., all the time.

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