Posts filed under ‘Austrian Economics’
Measuring Tacit Knowledge
| Peter Klein |
The concept of tacit knowledge — knowledge that is difficult or impossible to parameterize, or to express in words or numbers — is central to organization theory, as well as philosophy (Polanyi) and social theory more generally (Hayek). Most of the research literature on tacit knowledge is conceptual and theoretical, such as Hayek’s famous “Use of Knowledge in Society” (1945) or more recent pieces like Jensen and Meckling’s “Specific and General Knowledge, and Organizational Structure” (1992). Empirical studies of tacit knowledge are rare, which is not surprising given the idiosyncratic, personal, subjective, and often ephemeral nature of such knowledge.
An interesting new NBER paper by David Chan estimates the effects of tacit knowledge using matched pairs of physician trainees with similar levels of explicit knowledge but different levels of experience and hence accumulated know-how. The hospital setting allows for some clever tricks, e.g., exogenous sorting into occupational roles by experience, rather than ability. Measuring outcomes via spending is problematic to me, though standard in the medical economics and management literatures. Check it out:
Uncertainty, Tacit Knowledge, and Practice Variation: Evidence from Physicians in Training
David C. Chan, Jr
NBER Working Paper No. 21855, January 2016Studying physicians in training, I investigate how uncertainty and tacit knowledge may give rise to significant practice variation. Consistent with tacit knowledge accruing only with experience, and empirically exploiting a discontinuity in the formation of teams, experience relative to a peer substantially increases the size of variation attributable to the physician trainees. Among the same physician trainees, convergence occurs for patients on services driven by specialists, where there is arguably more explicit knowledge, but not on the general medicine service. This difference is unexplained by formally coded patient information. In contrast, rich physician characteristics correlated with preferences and ability, and quasi-random assignments to high- or low-spending supervising physicians explain little if any variation.
Baylor University PhD Program in Entrepreneurship
| Peter Klein |
Much as I hate to use this blog for self-promotion, … Hahahahaha. OK, seriously. As many of you know I joined Baylor University this fall and will be heavily involved with Baylor’s new PhD program in Entrepreneurship. Prospective students interested in entrepreneurship, strategy, organizational economics, innovation, creativity, institutions, business history, governance, the theory of science, Austrian economics — i.e., the regular topics of this blog — should consider applying. Detailed information about the program, including application materials and instructions, are on the program website. The formal deadline for Fall 2016 admission is next Friday, January 15, so time is short! I’m happy to answer any questions.
Review of Organizing Entrepreneurial Judgment
| Peter Klein |
David Howden’s generous review of Organizing Entrepreneurial Judgment appears in the March 2015 issue of the International Entrepreneurship and Management Journal. Excerpt:
This ambitious book has a three-fold purpose. First, it seeks to clarify “entrepreneurship” in a manner amenable to both modern management and economics literature. Second, it redefines the theory of the firm in order to integrate the role of the entrepreneur more fully and give a comprehensive view on why firms exist. Finally, and most successfully, it sheds light on the internal organization of the firm, and how entrepreneurship theory can augment our understanding of why firms adopt the hierarchies they do. . . .
Organizing Entrepreneurial Judgment is a massive undertaking, and one that ambitiously spans the unnecessary divide between management studies and economics literature. For the scholar seriously contemplating exploiting this gap further, the book is highly recommended. Having thoroughly enjoyed reading this rendition of their entrepreneurial theory of the firm, it is this reviewer’s hope that Foss and Klein continue to carve out this growing niche straddling the two disciplines. Following up with a more direct and focused primer on their firm would be a welcome contribution to further the growing field.
Also, at last November’s SDAE conference, the book received the 2014 FEE Prize for best book in Austrian economics.
We have several new papers coming out that develop, extend, and defend the judgment-based perspective. Details to follow.
The Medieval Enlightenment in Economic Thought
| Dick Langlois |
Attending academic presentations as a spectator – a pure consumer – can be great fun. On November 20, I drove up to Boston for one day of a wonderful conference, put together by the Business History program at Harvard Business School, on the History of Law and Business Enterprise (which probably merited its own separate blog post). This is an area that I am starting to get interested in. The conference was in many ways a showcase for the GHLR perspective on the history of corporate organization – the acronym referring to the work of Timothy Guinnane, Naomi Lamoreaux, Ron Harris, and Jean-Laurent Rosenthal, all of whom were there. The conference took place across the street from Harvard Stadium on the weekend of the Harvard-Yale game. Harvard won the football game (alas), but the conference was a Yale rout.
And last week I attended a presentation here at UConn that was even more vicarious fun. Our Humanities Institute invited Joel Kaye from Barnard to talk about his new book, A History of Balance, 1250-1375: The Emergence of a New Model of Equilibrium and Its Impact on Thought, which has just appeared from Cambridge. I was the token economist in the audience, even though two of his chapters are about economics. His argument is that medieval scholastic thought changed radically over this period, and produced by its end a different and arguably more sophisticated model of how the economic world works. This “new” model is not the standard Aristotelian version we are normally told about but was in fact something far closer to the views of the Scottish Enlightenment. (Needless to say, his telling of this was far more nuanced.) In addition to Nicole Oresme, whom I had heard of, he relies heavily on the work of Peter John Olivi, an earlier Franciscan theologian, whom I had never heard of. In Kaye’s telling, Olivi came close to something like the idea of the invisible hand. I took a quick look at standard history-of-thought texts, and nobody mentions Olivi at all – except Murray Rothbard, who credits him with discovering the subjective theory of value.
This is really a story about the Enlightenment of the High Middle Ages, which took place among academic clerics in an age of population growth, (extensive) economic growth, and urbanization. As Kaye apparently argues in an earlier book, these academics were constantly confronted with the market – especially in the thriving city of Paris – and were well versed in market practice; indeed, this knowledge of the market and money contributed to advances in physical and biological as well as social sciences. The medieval academic Enlightenment went into decline after the Black Death in the early fourteenth century. The resulting dislocations and the swing in relative prices – in favor of peasants and against landholders, including importantly the Church – reduced the centrality and authority of academic thought, even as they spurred institutional changes that would set the stage for growth in the early modern period. Population in Europe did not return to its pre-plague levels until the sixteenth or seventeenth century, and economic thought took just as long to recover. (I know this is whiggish, but I can’t help it.)
There was perhaps one connection between the two events. At HBS, Ron Harris talked about his ongoing research on the earliest history of the corporate form in the East and the West. Here the commenda contract is the centerpiece. That is presumably what schoolmen like Olivi called by the Latin term societas, which was not, however, the same institution as the societas publicanus of ancient Rome.
It’s the Economics that Got Small
| Peter Klein |
Joe Gillis: You’re Norma Desmond. You used to be in silent pictures. You used to be big.
Norma Desmond: I *am* big. It’s the *pictures* that got small.
— Sunset Boulevard (1950)
John List gave the keynote address at this weekend’s Southern Economic Association annual meeting. List is a pioneer in the use by economists of field experiments or randomized controlled trials, and his talk summarized some of his recent work and offered some general reflections on the field. It was a good talk, lively and engaging, and the crowd gave him a very enthusiastic response.
List opened and closed his talk with a well-known quote from Paul Samuelson’s textbook (e.g., this version from the 1985 edition, coauthored with William Nordhaus): “Economists . . . cannot perform the controlled experiments of chemists and biologists because they cannot easily control other important factors.” While professing appropriate respect for the achievements of Samuelson and Nordhaus, List shared the quote mainly to ridicule it. The rise of behavioral and experimental economics over the last few decades — in particular, the recent literature on field experiments or RCTs — shows that economists can and do perform experiments. Moreover, List argues, field experiments are even better than using laboratories, or conventional econometric methods with instrumental variables, propensity score matching, differences-in-differences, etc., because random assignment can do the identification. With a large enough sample, and careful experimental design, the researcher can identify causal relationships by comparing the effects of various interventions on treatment and control groups in the field, in a natural setting, not an artificial or simulated one.
While I enjoyed List’s talk, I became increasingly frustrated as it progressed, and found myself — I can’t believe I’m writing these words — defending Samuelson and Nordhaus. Of course, not only neoclassical economists, but nearly all economists, especially the Austrians, have denied explicitly that economics is an experimental science. “History can neither prove nor disprove any general statement in the manner in which the natural sciences accept or reject a hypothesis on the ground of laboratory experiments,” writes Mises (Human Action, p. 31). “Neither experimental verification nor experimental falsification of a general proposition are possible in this field.” The reason, Mises argues, is that history consists of non-repeatable events. “There are in [the social sciences] no such things as experimentally established facts. All experience in this field is, as must be repeated again and again, historical experience, that is, experience of complex phenomena” (Epistemological Problems of Economics, p. 69). To trace out relationships among such complex phenomena requires deductive theory.
Does experimental economics disprove this contention? Not really. List summarized two strands of his own work. The first deals with school achievement. List and his colleagues have partnered with a suburban Chicago school district to perform a series of randomized controlled trials on teacher and student performance. In one set of experiments, teachers were given various monetary incentives if their students improved their scores on standardized tests. The experiments revealed strong evidence for loss aversion: offering teachers year-end cash bonuses if their students improved had little effect on test scores, but giving teachers cash up front, and making them return it at the end of the year if their students did not improve, had a huge effect. Likewise, giving students $20 before a test, with the understanding that they have to give the money back if they don’t do well, leads to large improvements in test scores. Another set of randomized trials showed that responses to charitable fundraising letters are strongly impacted by the structure of the “ask.”
To be sure, this is interesting stuff, and school achievement and fundraising effectiveness are important social problems. But I found myself asking, again and again, where’s the economics? The proposed mechanisms involve a little psychology, and some basic economic intuition along the lines of “people respond to incentives.” But that’s about it. I couldn’t see anything in these design and execution of these experiments that would require a PhD in economics, or sociology, or psychology, or even a basic college economics course. From the perspective of economic theory, the problems seem pretty trivial. I suspect that Samuelson and Nordhaus had in mind the “big questions” of economics and social science: Is capitalism better than socialism? What causes business cycles? Is there a tradeoff between inflation and unemployment? What is the case for free trade? Should we go back to the gold standard? Why do nations to go war? It’s not clear to me how field experiments can shed light on these kinds of problems. Sure, we can use randomized controlled trials to find out why some people prefer red to blue, or what affects their self-reported happiness, or why we eat junk food instead of vegetables. But do you really need to invest 5-7 years getting a PhD in economics to do this sort of work? Is this the most valuable use of the best and brightest in the field?
My guess is that Samuelson and Nordhaus would reply to List: “We are big. It’s the economics that got small.”
See also: Identification versus Importance
Opportunity Discovery or Judgment? Fargo Edition
| Peter Klein |
In the opportunity-discovery perspective, profits result from the discovery and exploitation of disequilibrium “gaps” in the market. To earn profits an entrepreneur needs superior foresight or perception, but not risk capital or other productive assets. Capital is freely available from capitalists, who supply funds as requested by entrepreneurs but otherwise play a relatively minor, passive role. Residual decision and control rights are second-order phenomena, because the essence of entrepreneurship is alertness, not investing resources under uncertainty.
By contrast, the judgment-based view places capital, ownership, and uncertainty front and center. The essence of entrepreneurship is not ideation or imagination or creativity, but the constant combining and recombining of productive assets under uncertainty, in pursuit of profits. The entrepreneur is thus also a capitalist, and the capitalist is an entrepreneur. We can even imagine the alert individual — the entrepreneur of discovery theory — as a sort of consultant, bringing ideas to the entrepreneur-capitalist, who decides whether or not to act.
A scene from Fargo nicely illustrates the distinction. Protagonist Jerry Lundegaard thinks he’s found (“discovered”) a sure-fire profit opportunity; he just needs capital, which he hopes to get from his wealthy father-in-law Wade. Jerry sees himself as running the show and earning the profits. Wade, however, has other ideas — he thinks he’s making the investment and, if it pays off, pocketing the profits, paying Jerry a finder’s fee for bringing him the idea.
So, I ask you, who is the entrepreneur, Jerry or Wade?
Westgren on Entrepreneurial Opportunities
| Peter Klein |
My colleague Randy Westgren has two thoughtful posts on entrepreneurial opportunities (1, 2). Randy shares my unease with the construct of opportunity, which began as a metaphor introduced by Israel Kirzner, only to be reified by entrepreneurship scholars looking for a central organizing construct. My own view is that the concept of opportunity is redundant at best, misleading at worst. Randy expresses the same idea: “If the opportunity is so important to the entrepreneurial process, why are there so many mediating actions and decisions between the existence and the outcomes? How much of the outcomes does the existence of the opportunity explain?” He goes on to propose some useful taxonomies for making sense of the literature. More to come.
Business Cycles and the Structure of Production
| Peter Klein |
A new paper from former guest blogger Peter Lewin:
A Financial Framework for Macroeconomic Cycles: The Structure of Production is Relevant
Peter Lewin
University of Texas at Dallas – School of Management – Department of Finance & Managerial EconomicsNicolas Cachanosky
Metropolitan State University of DenverA comprehensive understanding business-cycles needs to account not only for the allocation of resources over time, but also for resource allocation across industries at any point in time. Intertemporal disequilibrium has been a common theme of many theories of the business-cycle. But to properly understand how these “time-distortions” take place and how the price-mechanisms that drive them work, a clear and well-defined conceptualization of the “average length” of the structure of production, is required. The insights provided by Macaulay’s duration and Hicks’s Average Period do this. We show that financial duration and related concepts have a direct connection to macroeconomic stability. By doing this we point to important implications for macroeconomic policy. We claim not only that a low interest rate contributes to the creation of asset bubbles, we show also the market mechanism through which the real sector is affected. We argue that to accept that duration matters for resource allocation is to accept the core of the Austrian Theory of the Business Cycle (ABCT) and, therefore, that to reject the ABCT core thesis suggests also rejecting the importance of duration for resource allocation.
Management and entrepreneurship scholars new to business-cycle theory might find this, this, and this to be useful background reading.
A Note on “Human Capital”
| Peter Klein |
Like Peter Lewin, Walter Block, Mario Rizzo, and Peter Boettke, I greatly admire the late Gary Becker, a pioneer in many areas of economics and sociology, a strong proponent of economic and personal freedom, and by all accounts a terrific teacher, mentor, and colleague. But I confess that I have always had qualms about the concept of “human capital,” along with the analogous constructs of social capital, knowledge capital, reputation capital, and so on. These are metaphors for capital in the narrow sense, and I worry that the widespread use of “capital” to denote anything valuable and long-lived obscures important issues about actual, physical capital that can be divided up, measured, priced, and exchanged. Witness the confusion over “capital” as Thomas Piketty uses the term. Here is something I wrote before:
[O]ne of my pet peeves [is] the expansive use of “capital” to describe any ill-defined substance that accumulates and has value. Hence knowledge, experience, and skills become “human capital” or “knowledge capital”; relationships become “social capital”; brand names become “reputation capital”; and so on. I fear this terminology obfuscates more than it clarifies.
I don’t mind using these terms in a loose, colloquial sense: By going to school I’m investing in human capital or diversifying my stock of human capital; if this gets me a high-paying job I’m earning a good return on my human capital; as I get old I forget new things, so my human capital is depreciating rapidly; and so on.
But we shouldn’t take these metaphors too literally. In economic theory capital refers either to financial capital or to a stock of heterogeneous alienable assets, goods that can be exchanged in markets and analyzed using price theory. Their rental prices are determined by marginal revenue products and their purchase prices are given by the present discounted value of these future rents. Knowledge is not, strictly speaking, capital, because it is not traded in markets does not have a rental or purchase price. What markets trade and price is labor services, and it is impossible to decompose the payments to labor (wages) into separate “effort” and “rental return on human capital” components. Some labor services command a higher market price than others because they have a higher marginal revenue product. Some of this wage premium may be due to intelligence or experience, some due to complementarities with other human or nonhuman assets, some due to hard work, and so on. But these are all determinants of the MRP, and hence the wage, not different kinds of factor returns.
Moreover, the entrepreneur needs cardinal numbers to compute the value of his capital stock, to know if it is increasing or decreasing in value, and so on. I can’t measure my stock of human capital, I don’t know for sure if it is increasing or decreasing over time, I can’t calculate the ROI of a specific human-capital investment, etc., because there are no prices and no measurable units. Knowledge may be “like capital,” in the sense that it lasts, that you can add to it, that you benefit from it, etc., but it isn’t literally a capital good like a machine or a refrigerator.
If we think going to school is valuable and increases lifetime earnings, why don’t we just say, “going to school is valuable and increases lifetime earnings,” rather than, “there is a positive return on investments in human capital”? Is there a good reason to prefer the latter, besides scientism?
Essentialism in Economics and Art
| Peter Klein |
Carl Menger’s methodology has been described as essentialist. Rather than building artificial models that mimic some attributes or outcomes of an economic process, Menger sought to understand the essential characteristics of phenomena like value, price, and exchange. As Menger explained to his contemporary Léon Walras, Menger and his colleagues “do not simply study quantitative relationships but also the nature [or essence] of economic phenomena.” Abstract models that miss these essential features — even if useful for prediction — do not give the insight needed to understand how economies work, what entrepreneurs do, how government intervention affects outcomes, and so on.
I was reminded of the contrast between Menger and Walras when reading about Henri Matisse and Pablo Picasso, the great twentieth-century pioneers of abstract art. Both painters sought to go beyond traditional, representational forms of visual art, but they tackled the problem in different ways. As Jack D. Flam writes in his 2003 book Matisse and Picasso: The Story of Their Rivalry and Friendship:
Picasso characterized the arbitrariness of representation in his Cubist paintings as resulting from his desire for “a greater plasticity.” Rendering an object as a square or a cube, he said, was not a negation, for “reality was no longer in the object. Reality was in the painting. When the Cubist painter said to himself, ‘I will paint a bowl,’ he set out to do it with the full realization that a bowl in a painting has nothing to do with a bowl in real life.” Matisse, too, was making a distinction between real things and painted things, and fully understood that the two could not be confused. But for Matisse, a painting should evoke the essence of the things it was representing, rather than substitute a completely new and different reality for them. In contract to Picasso’s monochromatic, geometric, and difficult-to-read pictures, Matisse’s paintings were brightly colored, based on organic rhythms, and clearly legible. For all their expressive distortions, they did not have to be “read” in terms of some special language or code.
Menger’s essentialism is concisely described in Larry White’s monograph The Methodology of the Austrian School Economists and treated more fully in Menger’s 1883 book Investigations Into the Method of the Social Sciences. For more on economics and art, see Paul Cantor’s insightful lecture series, “Commerce and Culture” (here and here).
[An earlier version of this post appeared at Circle Bastiat.]
Notes on Inequality
| Peter Klein |
Everyone’s talking about inequality. I confess don’t find inequality terribly interesting, intrinsically. Of course, inequality that results from special government privilege — the incomes of top executives at Lockheed Martin or Goldman Sachs, the speaking fees earned by Hillary Clinton, the wealth of US sugar farmers — should be analyzed and criticized, and those privileges removed. Firm policies that result in pay differentials — pay-for-performance schemes, for example — are important and interesting, not because they generate inequality per se, but because they have systematic and significant effects on firm behavior and performance. Of course, inequality may have important long-run social and cultural effects, but these are highly speculative and not obviously actionable.
I haven’t yet read Thomas Piketty’s new book but am aware of — and amazed by — the buzz it’s generating. I suspect most of the excitement reflects confirmation bias: people who think inequality is the major issue of our time naturally think this is the most important economics book of the decade, probably before reading it. (Naturally, I’d love to exploit that formula in marketing my own books.)
I do have a few thoughts on how the discussion is framed, in light of Piketty’s work. First, Piketty and his admirers define “capital” as a homogeneous, liquid pool of funds, not a heterogeneous stock of capital assets. This is not merely a terminological issue, as those familiar with the debates on capital theory from the 1930s and 1940s are well aware. Piketty’s approach focuses on the quantity of capital and, more importantly, the rate of return on capital. But these concepts make little sense from the perspective of Austrian capital theory, which emphasizes the complexity, variety, and quality of the economy’s capital structure. There is no way to measure the quantity of capital, nor would such a number be meaningful. The value of heterogeneous capital goods depends on their place in an entrepreneur’s subjective production plan. Production is fraught with uncertainty. Entrepreneurs acquire, deploy, combine, and recombine capital goods in anticipation of profit, but there is no such thing as a “rate of return on invested capital.” (more…)
Gordon Winston
| Dick Langlois |
I was saddened to learn of the recent passing of Gordon Winston, an interesting economist who should have been better known (to readers of this blog) than he was.
I’m sure I knew of Gordon when I was a student at Williams in the early 1970s, but as I didn’t take any economics as an undergraduate, I never had any contact with him. I really first met him when he interviewed me for a job at Williams in 1983 (which I didn’t get — not his fault). We kept in contact for a number of years after that, including during at least one Liberty Fund conference in the 1980s.
Gordon is probably best known for his later work on the economics of higher education, which I use in teaching. But readers might be even more interested in his earlier work on the timing of economic activities, which resulted in a 1982 Cambridge book by that title. In essence, Gordon was trying to work out in detail how to think about time in a production-function model of economic activity, something that the late Armen Alchian had adumbrated in his famous paper “Costs and Output” (the original 1958 RAND working paper version of which is now available here). Gordon cites Lachmann and Shackle, but I think his biggest influence was Georgescu-Roegen. The book ought to be especially interesting to grad students, since I suspect it opens up a lot of ideas for further exploration.
Top Posts of 2013
| Peter Klein |
It’s been another fine year at O&M. 2013 witnessed 129 new posts, 197,531 page views, and 114,921 unique visitors. Here are the most popular posts published in 2013. Read them again for entertainment and enlightenment!
- Rise of the Three-Essays Dissertation
- Ronald Coase (1910-2013)
- Sequestration and the Death of Mainstream Journalism
- Post AoM: Are Management Types Too Spoiled?
- Nobel Miscellany
- The Myth of the Flattening Hierarchy
- Climate Science and the Scientific Method
- Bulletin: Brian Arthur Has Just Invented Austrian Economics
- Solution to the Economic Crisis? More Keynes and Marx
- Armen Alchian (1914-2013)
- My Response to Shane (2012)
- Your Favorite Books, in One Sentence
- Does Boeing Have an Outsourcing Problem?
- Doug Allen on Alchian
- New Paper on Austrian Capital Theory
- Hard and Soft Obscurantism
- Mokyr on Cultural Entrepreneurship
- Microfoundations Conference in Copenhagen, June 13-15, 2014
- On Academic Writing
- Steven Klepper
- Entrepreneurship and Knowledge
- Easy Money and Asset Bubbles
- Blind Review Blindly Reviewing Itself
- Reflections on the Explanation of Heterogeneous Firm Capability
- Do Markets “React” to Economic News?
Thanks to all of you for your patronage, commentary, and support!
Kirzner and Entrepreneurship Research
| Peter Klein |
Per Bylund and I have written a paper on Israel Kirzner’s influence on the entrepreneurship literature. It’s titled “The Place of Austrian Economics in Contemporary Entrepreneurship Research” but deals mainly with Kirzner. Comments are appreciated.
The paper was written for a forthcoming special issue of the Review of Austrian Economics on Kirzner’s contributions. We take a nuanced position: While Kirzner’s work underlies the dominant opportunity-discovery perspective in the entrepreneurship research literature, this perspective is increasingly challenged among entrepreneurship scholars, for some of the same reasons that Kirzner’s theoretical framework has been criticized by his fellow Austrian economists. Nonetheless, it is impossible to make progress in entrepreneurship studies, or the Austrian analysis of the market, without engaging Kirzner’s ideas.
Solution to the Economic Crisis? More Keynes and Marx
| Peter Klein |
We’ve previously discussed attempts to blame the accounting scandals of the early 2000s on the teaching of transaction cost economics and agency theory. By describing the hazards of opportunistic behavior and shirking, professors were allegedly encouraging students to be opportunistic and to shirk. Then we were told that business schools teach “a particular brand of free-market ideology” — the view that “the market always ‘gets prices right’ and “[a]n individual’s worth can be reduced to one’s worth in the market” — and that this ideology was partly responsible for the financial crisis. (My initial reaction: Where to I sign up for these courses?!)
The Guardian reports now on a movement in the UK to address “the crisis in economics teaching, which critics say has remained largely unchanged since the 2008 financial crash despite the failure of many in the profession to spot the looming credit crunch and worst recession for 100 years.” If you think this refers to a movement to discredit orthodox Keynesianism, which dominates monetary theory and practice in all countries, and its view that discretionary fiscal and (especially) monetary policy are needed to steer the economy on a smooth course, with particular attention to asset markets where prices must be rising at all times, you’d be wrong. No, the reformers are calling for “economics courses to embrace the teachings of Marx and Keynes to undermine the dominance of neoclassical free-market theories.” To their credit, the reformers appear also to want more attention to economic history and the history of economic thought, which is all to the good. But the reformers’ basic premise seems to be that mainstream economics is too friendly toward the free market, and that this has left students unprepared to understand the “post-2008” world.
To a non-Keyensian and non-Marixian like me, these arguments seem to come from a bizarro world where the sky is green, water runs uphill, and Janet Yellen is seven feet tall. It’s true that most economists reject economy-wide central planning, but the vast majority endorse some version of Keynesian economic policy complete with activist fiscal and monetary interventions, substantial regulation of markets (especially financial markets), fiat money under the control of a central bank, social policy to encourage home ownership, and all the rest. We’ve pointed many times on this blog to research on the social and political views of economists, who lean “left” by a ratio of about 2.5 to 1 — yes, nothing like the sociologists’ zillion to 1, but hardly evidence for a rigid, free-market orthodoxy. I note that the reformers described in the Guardian piece never, ever offer any kind of empirical evidence on the views of economists, the content of economics courses, or the influence of economics courses on economic policy. They simply assert that they don’t like this or that economic theory or pedagogy, which somehow contributed to this or that economic problem. They seem blissfully unaware of the possibility that their own policy preferences might actually be favored in the textbooks and classrooms, and might have just a teeny bit to do with bad economic policies.
I’m reminded of Sheldon Richman’s pithy summary: “No matter how much the government controls the economic system, any problem will be blamed on whatever small zone of freedom that remains.”
Easy Money and Asset Bubbles
| Peter Klein |
Central to the “Austrian” understanding of business cycles is the idea that monetary expansion — in Wicksellian terms, money printing that pushes interest rates below their “natural” levels — leads to overinvestment in long-term, capital-intensive projects and long-lived, durable assets (and underinvestment in other types of projects, hence the more general term “malinvestment”). As one example, Austrians interpret asset price bubbles — such as the US housing price bubble of the 1990s and 2000s, the tech bubble of the 1990s, the farmland bubble that may now be going on — as the result, at least partly, of loose monetary policy coming from the central bank. In contrast, some financial economists, such as Laureate Fama, deny that bubbles exist (or can even be defined), while others, such as Laureate Shiller, see bubbles as endemic but unrelated to government policy, resulting simply from irrationality on the part of market participants.
Michael Bordo and John Landon-Lane have released two new working papers on monetary policy and asset price bubbles, “Does Expansionary Monetary Policy Cause Asset Price Booms; Some Historical and Empirical Evidence,” and “What Explains House Price Booms?: History and Empirical Evidence.” (Both are gated by NBER, unfortunately, but there may be ungated copies floating around.) These are technical, time-series econometrics papers, but in both cases, the conclusions are straightforward: easy money is a main cause of asset price bubbles. Other factors are also important, particularly regarding the recent US housing bubble (I suspect that housing regulation shows up in their residual terms), but the link between monetary policy and bubbles is very clear. To be sure, Bordo and Landon-Lane don’t define easy money in exactly the Austrian-Wicksellian way, which references natural rates (the rates that reflect the time preferences of borrowers and savers), but as interest rates below (or money growth rates above) the targets set by policymakers. Still, the general recognition that bubbles are not random, or endogenous to financial markets, but connected to specific government policies designed to stimulate the economy, is a very important result that will hopefully influence current economic policy debates.
Davenport’s Theory of Enterprise
| Peter Klein |
Kudos to Richard Ebeling for a nice piece on Herbert J. Davenport, one of the most American economists of the early twentieth century, mostly forgotten today. (One exception: Daveport was the founding Dean of the University of Missouri’s business school, which named its donor society after him.) Davenport, one of Frank Knight’s teachers, was an early adopter of the subjective theory of value introduced by Carl Menger and, along with Philip Wicksteed and Frank Fetter, helped to spread the marginal revolution in the English-speaking world.
Davenport was also a contributor to the economic theory of entrepreneurship, as noted by Ebeling:
Here was the mechanism by which the logical causality between demands and supplies was brought into actual implementation in the complexity of market activities. The entrepreneur stood, Davenport argued, “as the intermediary in the case, representing in his hiring and buying of productive factors, the demand of the purchasing public, and representing in his cost computations, the degree of scarcity of the productive factors relative to the demand for their products.”
On the one hand, it was “the entrepreneurs who furnished the demand for all . . . the things which are called production goods,” he explained. On the other hand, it was “the competition of the entrepreneurs of each industry with the other entrepreneurs of the same industry, and the competition of the entrepreneurs of each industry with those of other industries” that brought about the emergence of factor prices. All the money outlays, the objectified market “costs” that an entrepreneur had to incur, all traced back to the demand for other things as reflected in the bids of competing entrepreneurs. . . .
“The various markets in which he [the entrepreneur] must hire and buy are fluctuating in their prices,” he said. “And the price at which he will finally market his product is uncertain . . . His alternative lines of activities, also, are subject to uncertainties.” All of the entrepreneur’s calculations, therefore, were expectiational.
His computations of “costs of production,” Davenport went on, “appears to be backward-looking computation,” but in reality was “only a basis for a further and forward-looking computation.” The entrepreneur’s glance was turned towards those future – uncertain – opportunities that still lie before him, and from which he would have to choose the one that he believed offered the greatest net advantages.
Ultimately, then, the entrepreneur’s “cost” of production was reducible to his individual judgments,
Ebeling is quoting Davenport’s 1913 book The Economics of Enterprise, which hints at the “judgment-based view” of entrepreneurship elucidated more fully by Knight.
Bulletin: Brian Arthur Has Just Invented Austrian Economics
| Dick Langlois |
Surprisingly, the following passage is not from O’Driscoll and Rizzo (1985). It is the abstract of a new paper by Brian Arthur called “Complexity Economics: A Different Framework for Economic Thought.”
This paper provides a logical framework for complexity economics. Complexity economics builds from the proposition that the economy is not necessarily in equilibrium: economic agents (firms, consumers, investors) constantly change their actions and strategies in response to the outcome they mutually create. This further changes the outcome, which requires them to adjust afresh. Agents thus live in a world where their beliefs and strategies are constantly being “tested” for survival within an outcome or “ecology” these beliefs and strategies together create. Economics has largely avoided this nonequilibrium view in the past, but if we allow it, we see patterns or phenomena not visible to equilibrium analysis. These emerge probabilistically, last for some time and dissipate, and they correspond to complex structures in other fields. We also see the economy not as something given and existing but forming from a constantly developing set of technological innovations, institutions, and arrangements that draw forth further innovations, institutions and arrangements. Complexity economics sees the economy as in motion, perpetually “computing” itself— perpetually constructing itself anew. Where equilibrium economics emphasizes order, determinacy, deduction, and stasis, complexity economics emphasizes contingency, indeterminacy, sense-making, and openness to change. In this framework time, in the sense of real historical time, becomes important, and a solution is no longer necessarily a set of mathematical conditions but a pattern, a set of emergent phenomena, a set of changes that may induce further changes, a set of existing entities creating novel entities. Equilibrium economics is a special case of nonequilibrium and hence complexity economics, therefore complexity economics is economics done in a more general way. It shows us an economy perpetually inventing itself, creating novel structures and possibilities for exploitation, and perpetually open to response.
Arthur does acknowledge that people like Marshall, Veblen, Schumpeter, Hayek, and Shackle have had much to say about exactly these issues. “But the thinking was largely history-specific, particular, case-based, and intuitive—in a word, literary—and therefore held to be beyond the reach of generalizable reasoning, so in time what had come to be called political economy became pushed to the side, acknowledged as practical and useful but not always respected.” So what Arthur has in mind is a mathematical theory, no doubt a form of what Roger Koppl – who is cited obscurely in a footnote – calls BRACE Economics.
New Paper on Austrian Capital Theory
| Nicolai Foss |
In my Hayek Lecture at last year’s Austrian Economics Scholars Conference I argued that Austrian capital theory is deserving of a comeback as an absolute integral part of Austrian economics. I argued that ACT directs attention to the essential importance of heterogeneity and I argued that notions of capital heterogeneity serves to bring the entrepreneur, transaction costs and institutions directly into our understanding of the growth process.
An essential part of ACT is, of course, the work of Eugen von Böhm-Bawerk. On the one hand, Böhm’s work is absolutely seminal, on the other hand, its too strong emphasis on aggregates and simplifying assumptions arguably side-tracked the development of ACT in some key ways. Needless to say, to mainstream economists ACT is Böhm-Bawerkian capital theory because it lends itself to formalization.
A recent example of formalizing Böhm’s theory is Renaud Fillieule’s “A comprehensive graphical exposition of the macroeconomic theory of Böhm-Bawerk.” Fillieule makes a strong case for Böhm’s theory as a precursor of Solowian growth theory and of macroeconomics in general. In contrast to many other commentators on ACT, he is familiar with modern Austrian work on the subject. A very elegant article and most definitely worth a read. Here is the abstract:
This paper offers a comprehensive graphical exposition of Böhm-Bawerk’s formalised macroeconomic theory. This graphical model is used here for the first time to study the effects of the changes in the explanatory variables (quantity of capital, number of workers and level of technical knowledge) on the dependent variables (interest rate, wage and period of production). This systematic application of the model shows that some of the conclusions drawn by Böhm-Bawerk are incorrect and need to be amended. A comparison with Solow’s model also shows that Böhm-Bawerk can legitimately be considered as one of the main originators of the standard contemporary approach in macroeconomics of equilibrium and growth.
Happy Mises Day
| Peter Klein |
I never miss Hayek’s birthday but sometimes forget to celebrate September 29 as the birthday of Ludwig von Mises (1881-1973), Hayek’s senior colleague and mentor, whose writings are very influential here at O&M. To learn about Mises you should read Guido Hülsmann’s biography but, if you prefer shorter treatments, you can find biographical essays by Mises’s students Murray Rothbard and Israel Kirzner. Organization theorists should pay particular attention to Mises’s 1922 book Socialism as well as his (unfortunately neglected) 1944 book on Bureaucracy.
Organizations and Markets 
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