Response to Boettke

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Boettke's Austrian critique of mainstream economics:

An empiricist's responseThomas Mayer

a

aDepartment of Economics, University of California, Davis Phone: (510) 5490504 Fax: (510)

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Version of record first published: 06 Mar 2008.

To cite this article:Thomas Mayer (1998): Boettke's Austrian critique of mainstream economics: An empiricist's response,Critical Review: A Journal of Politics and Society, 12:1-2, 151-171

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Thomas Mayer

BOETTKE S AUSTRIAN CRITIQUE OFMAINSTREAM ECONOMICS:

AN EMPIRICIST S RESPONSE

ABSTRACT: Many ofBoettke's criticismsofformalist economics are justified.However, he defines formalism so broadly that it becomes practically synony-mous w ith m ainstream economics, while hiscriticisms primarily targetthesinsof formalist economics more narrowly defined.And since he treats Austrianeconomicsas theonly viable alternative tomainstream economics,heincorrectlyawards victory toAustrian economics. While Austrian economicshas somevaluable ideastocontribute to mainstream economics,it hasserious deficienciesof itsown.

Startingin thelate 1940s, economics u nderw entamajor revolution,arevolution atleastasmuchinmethodology and scientific taste asinsubstantive doctrine. Previously economists, like other scientistsandserious scholars, treated rigoras animportant virtue.But in thelasthalf-century thevalue attachedtorigor, relativeto theothe r desirablecharacteristicsof atheorysuchasempirical confirmationandrele-vance topractical problems rose sharply. The leadersofthis fo rma l-ist revolutionnowseemtoclassifyalleconomic analyses thatare notmathematically formalized modelingas mere talk. Onemightbeexcusedforgainingtheimpression that formalists consider thisdi-Critical Review12,nos.1-2(Winter -Spring 1998). ISSN 0891-3811.1998 Critical Review Foun-dation.Thomas Mayer, DepartmentofEconomics, UniversityofCalifornia, Davis, telep hone (510)549-0504, telefax (510)549-9472, wishes to thank Peter Boettke, Kevin Hoover, MichaelMontgo mery, Nan cy Wulw ick, and Andrea Salantiforhelpful c omm ents.


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chotomy to be more important than the contrast between analysesthat are empirically confirmed and those that are empirically discon-firmed.Despite its insistence on explicit statements and rigor, the formalistrevolution was not itself founded on a detailed and rigorous analysisof why formalism is superior to the older way of doing economics.Typically, formalists recite the advantages of rigorous mathematicaltreatment, but fail to compare them to the advantages of less formaltreatment (cf. Backhouse 1997; Montgom ery 1997). Th e great successof formalism should therefore be attributed no t entirely, or necessarilyeven in large part, to superior logic, but, at least in part, to its advo-cates being brilliant scholars, highly respected for their substantivework. Another explanation is thatat least to those who confusemathematics and empirical scienceformalism fits the image of eco-nomics as a science, and that is the image economists want to project.Moreover, becausewithin the confines of mathematical modelsformalist analysis provides a high degree of certitude, many econo-mists find formalism comforting. That it sharply differentiates theprofessional economist's product from cocktail-party chatter is alsosatisfying. In addition, it has allowed the young, who generally hadbetter mathematical training than their elders, to achieve dom inance.

But although the formalist revolution succeeded in establishingrules to which economists must adhere if they want to publish onmainstream topics in the respectable journals, it did not capture thehearts and minds of all economists. It is not certain even that it com -mands the adherence of half of all the academic economists, and it islikely that outside of academia only a distinct minority of economistsaccept it. But the tone of economics is set by those who publish inthe leading jou rna ls and teach in the m ajor research universities.The re, formalism dominates.

But by now counterrevolutionaries are active. Peter Boettke is oneof them. Being a counterrevolutionary myself,I applaud h is attack onformalism, though I define it much more narrowly than he does (seeMayer 1993 and 1995). Counterrevolutionaries, like other revolution-aries, are a quarrelsome lot, so rather than endorse Boettke's criticismsby repeating them, or repeating my own previous criticisms (MayerIO 93). I will criticize some aspects of Boettke's case against what hecalls formalism, while omitting the many points about which I canonly say righ t on.

Th ere are two them es run nin g thro ugh Boettke's essay, a powerful


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criticism of contemporary economics for ignoring important olderinsights that do not fit into the Procrustean bed of formalized analy-sis,and an acclaim of Austrian econom ics as the best alternative. I willdeal primarily w ith the second them e. In summary, I criticize Boettkemainly for confounding formalism with a broader version of main-stream economics, thus posing a false dichotomy between formalistand Austrian economics and overstating the contribution of the lat-ter.

Before coming to these criticisms one should note two of thestrong points of Boettke's essay. One is his distinction between theidealizations used in economic theory and the criteria that should beused to judge the functioning of an economic system, a point dis-cussed below. Another is his insistence that when discussing broad is-sues of economic policy, we have to look beyond what economictheory on its own can tell us. Institutions d o m atter.Since Boettke gives a prom inent role to A bba Lem er as a formalistand proponent of market socialism who got that subject wrong be-cause he ignored institutions, it may be appropriate to digress with astory Lerner once told me. After he wroteT heEconomics ofControl,abook that pays scant regard to institutions, he believed that he haddemonstrated that it matters little whether a country is capitalist orsocialist, as long as its managers follow the correct optimization ruleshe had set out. But he added that he preferred socialism because (if Iremember correctly) it allows a better distribution of income. How-

ever, he said tha t subsequently he changed his mindbecause of falseteeth. On a visit to Israel he noticed that it did a thriving exportbusiness in false teeth. This, said Lerner, was logical because makingfalse teeth is a business that requires m uch skilled labor and little cap i-tal.But, Lerner added, no government planning agency intending toincrease ex ports w ould ever think of false teeth . Since Boe ttke stressesthe importance of innovation under capitalism, there is thereforemuch less disagreement between him and Lerner than he suggests.

Boettke's Critique ofFormalismBoettke writes that in describing economic behavior in mathematicallanguage, formalists underplay the complexity of the real world.He nce formalism swept away historical work on th e complex webof institutions that underg ird capitalist dynam ics (1997b, 21). For-


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malists, such as Samuelson, have drained econom ic theo ry of institu-tional c o n te x t. .. . Parsimony won out over thoroughness. Formalismdenied sc ien t i f ic s ta tus to realistic theory. . . . Ideas that defied th e tech-niques of formal analysis came to be considered unworthy of serious considera-tion (ibid., 21 ,22, emphasis in original.)

Boettke's delineation of what he calls formalism thus focuses ontwo separate characteristics. One is formalism's extensive abstractionfrom institutional context. He is right in believing that this is re-quired for1and fostered bymathematical modeling. But not onlyby mathematical modeling. As he himself points out,a llthinking re-quires abstraction from a wealth of detail. When Austrian economiststalk about entrepreneurship, they, too, are abstracting from the realworld, ignoring, for example, such irrelevant details as wh ether thefirm (entrepreneur) is a closely held corporation, or one with widelydispersed stockholders wh o have litde power over m anagement.What matters is whether it is the important or die peripheral char-acteristics that are being abstracted from. But how do we knowwhich are the important ones? When Austrians complain that for-malist economics abstracts from die fact diat historical time is irre-versible, formalists can reply that time being irreversible is an irrele-vant characteristic that does not affect the insights and predictionsgenerated by their theories.Milton Friedman (1953, ch. 1) has argued that until we knowwherfier a theory's predictions are accurate we cannot say whether

the unrealistic nature of its assumptionsthat is.its abstractionsmatter. An alternative criterion stresses explanation in place of pre-diction. Accord ing to this criterion, the right abstractions yield a the -ory that makes usunderstand the phenomenon, providing what FritzMachlup (1978 ,145) called a sense of Ahaness, because it elucidatesthe mechanism by which the supposed cause generates the claimedeffect. Though philosophers of science and methodologists argueabout the choice between these criteria, most of us pay some atten-tion to both, though we differ in the relative weight we give them.Even if a theory seems to explain well, in die sense of linking a par-ticular phenomenon smoothly to our prior beliefs, we do not acceptit if its prediction s are consistendy falsified. Conversely, we usually re -jec t as a m ere spurious correlation a hypothesis mat predicts well, but makes no sense. Bu t neidier approach rejects a theory m erely be -cause it abstracts.

One might perhaps respond diat some abstractions are so obviously


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wron g that even without knowing how well a theory based on thempredicts or explains, we can say with confidence that this theory mustbe incorrect. But even though there are instances where this is true(e.g., abstracting away self-interested behavior, so that w e assume thatfirms are driven only by altruistic motives), are there many such casesin economics? Bo ettke is able to say Yes only because he takes it as agiven that Austrian theory is correct. Hence, if formalist economicsignores some variable that plays a significant role in Austrian theory,the formalist theory must be wrong. But why assume, a priori, thatAustrian the ory is correct?A more nuanced version of Boettke's criticism of formalist abstrac-tion is possible, however. This is the view that often mathematical

modeling not only requires more abstraction than verbal analysis, butalso that it is harder to be mindful of some of the abstractions thathave been m ade w hen we read a mathematical analysis than w hen weread a verbal analysis (see Keynes 1936, 297-98). Moreover, it istempting to decide what part of reality to model and what part toabstract from by the criterion of what is mathematically tractable,rather than by the criterion of what is important for the question athand. What makes this temptation worse is that modelers usually donot point out that, since they are abstracting from some characteris-tics that may be salient, their conclusions are of limited value. To besure, they may seem to guard against this possibility by showing thattheir model gives a good fit to the data, but that is a necessary andnot a sufficient condition for acceptance. The good fit may well bethe result of extensive data mining. Moreover, even thou gh the m odelgives a good fit, previously published rival models may give a betterfit.1What is important here (and incidentally is also basic to Friedman's1953 essay) is that we use a theory and its abstractions to deal with aparticular problem or question. A valid abstraction when addressingone question can be an invalid one when addressing another.2 Whentrying to determine whether there is a stable relationship betweenchanges in bank reserves and the money supply, we can safely abstract

away the fact that the actions of government officials are influencedby their self-interest. But we cannot abstract away the fact that theratio of the public's demand for currency relative to deposits varies.Conversely, when we ask, as Boettke does, whether market socialismcould work effectively, we can abstract away the stability of the pub-


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lie 's dem and for currency, but n ot th e motives of governm ent offi-cials.

Boettke's criticism of formalism for its heroic abstractions is there-fore too general. He would have to show that these abstractions resultin theories that neither predict well nor foster understanding. To besure, he does discuss wh y abstracting away the motives that wo ulddrive government officials under market socialism invalidates any fbr-malistic case for such a system. And although he does not provide anyhard evidence, I find his argument plausible. But market socialism ishardly a central topic in the work of formalists, and it was originallypresented without formal models by Oskar Lange (1939) and devel-oped further by Abba Lern er (1944), wh ose use of mathematics gen -erally consisted of simple geometry. Formalists might therefore read-ily concede that Boettke's criticism of market socialism is correct, andyet go abou t mos t of their business undisturbed.

Th e second part of Boettke ' s cr i t ic ism of formalism that themedium tends to become the messageis valid. Formalists tend toevaluate ideas by their suitability for mod elin g, and to ju dg e m odelsmuch too much by their technical sophistication and elegance, andmuch too little by the insights they provide into economic behavioror by their predictive success. Deirdre McCloskey (1985) is right inobjecting that economics departments have appropriated the criteriathat are proper for a mathematics department: rigor, generality, andelegance. Th us, a leading mathematical econom ist and math ema ti-cian, Gerard D ebr eu (1991,5), writes:

In the past two decades, economic theory has been carried away fur-ther by a seemingly irresistible current that can be explained onlypartly by the intellectual successes of its mathematization. Essential toan attempt at a fuller explanation are the values imprinted on an econ-omist by his study of mathematics. When a theorist who has been sotyped judges his scholarly work, those values do not play a silent role:they may play a decisive role. The very choice of the questions towhic h h e tries to find answers is influenced by his mathematical back -ground. Thus, the danger is ever present that the part of economicswill become secondary, if not marginal, in that judgment.3The issue is therefore not the fact that formalist economists use

math ema tics , bu t wh at they use i t for, and the role mathem aticaltechniques play in the criteria by which they evaluate work. Some-one might use a mathematically sophisticated and complex model to


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solve a problem that is central to the study of mankind in the ord i-nary business of life Alfred Marshall's (1947, 1) definition of eco -nomicswithout abstracting away those institutional details that arerelevant for the applicability of the conclusion. He may thereby pro-duce good economics. Someone else who uses no mathematicsmight tackle a trivial problem, or use too restrictive abstractions, andthus produce bad economics.

There is another kind of formalism on which Boettke does nottouch (see Mayer 1993, ch. 3). As an ideal type, this formalism insistson deriving conclusions to every problem explicitly from first princi-ples,which in economics means the assumptions of utility m aximiza-tion {in practice often narrowed to mean income maximization) andrational behavior, along with a minimum of other assumptions. Thistype of formalism takes as its model not the natural sciences, butmathematics and logic, with their greater stress on demonstrative rea-soning. By contrast, there is what can be called empirical-scienceeconomics, again an ideal type. It is more concerned with predictingor explaining empirically observable characteristics of the economy,and less with rigor, parsimony, and elegance.In practice, formalist economists also want their models to tell ussomething that is applicable to the real world: they do not, for exam -ple,work with models that assume that agents are completely altruis-tic.O n the othe r side, empirical economists may sometimes start withthe same propositions that formalists use. The difference is that for-

malists are much more likely to treat these propositions as axioms,while empirical economists are more likely to treat them as workingassumptions tha t are usually, bu t no t necessarily always, correct.Such a distinction is alien to Boettke's framew ork because, thoughexplicitly contrasting the older neoclassical economics with formalisteconomics, in much of his essay he divides economists into Austrians,(old) institutionalists, Marxists, and formalists. Since he quickly dis-misses institutionalists and M arxists, he has only to show the fallacy offormalism to award victory to the Austrians. But that is too facile. Ittars the substantial majority of economists with the same brush, de-spite major methodo logical differences amon g them . Those wh o take

an empirical approachand there are manyare thereby made toshare responsibility for the extreme degree to which abstraction iscarried by those w ho are formalists by my m uch narrower definition.To accuse th e likes of M ilton Friedman , Charles Go odha rt, JosephStiglitz, or Paul Krugman, to name only a few leading mainstream


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econom ists, of ignorin g the com plex we b of institutions, or ofputting the m edium above the message, is surely wrong.Boettke's discussion of the Chicago school illustrates this tendencyto place too many economists into the formalist camp. He stronglyapproves of the early Chicago school led by Frank Knight, who usedthe equilibrium concept as an ideal type. He is then critical to someextent of Milton Friedman, and to a much greater extent of RobertLucas, for treating equilibrium, not as an ideal type, but as a descrip-tion of the economy. But even Lucas, wh o is much more formalistthan Friedman and Knight, did not always see the economy as in al-most permanent equilibrium, at least not in his early work on tht ag-gregate supply function (Lucas 1973). Th ere h e dealt with an ec on -omy in which it takes time for economic agents to discover when thequantity of money changes and adjust their prices accordingly. Simi-larly, Friedman attributes fluctuations in o utput and em ployment p ri-marily to changes in the quantity of money to which prices have notyet adjusted. In general, it is a mistake to see Friedman as a formalist(my definition) on the basis of his famous methodological essay; farfrom advocating formalism, Friedman rejects it (Friedman 1953,n - 1 2 , 24- 25, 277-300; Hirsch and de M achi 1990; Ha mm ond 1996,ch. 2). It is only real-business-cycle theorists who see the economy inalmost continuous equilibrium.

But even if one were to interpret Boettke's attack on what he callsformalist econom ics only as a criticism o f formalism on my narrow erdefinition, it would still go too far. Like most methodologists, Boettkeis a monotheistthere is only one true methodology. No tradeoff atthe margin is allowed. This might be appropriate if economics hadonly on e purpo se. No w in a sense it does: to provide an explanatoryand predictive apparatus that ranks high on the criteria of rigor, ele-gance, generality, and parsimony, as well as on the criteria of accuracyand applicability to many real-world situations. But a theory that fullysatisfies all of these criteria would be a rare find indeed. So there isusually a need for tradeoffs, or for multiple theories operating at dif-ferent levels of abstraction.

O ne can justify some formalist econ omics on Van pour Vartgrounds because, like any oth er piece of rigorous and elegant reason-ing, it provides intellectual satisfaction. If we support research in puremathematics and in art history for the glory of mankind, we shouldalso support some research in formalist economics.4Moreover, someformalist models can be justified, not as the end produc t o f econom ic


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analysis, but as an intermediate product. Allan Gibbard and Hal Var-ian (1978) have argued that many econo mic models are caricaturesintended to highlight some particular feature of the economicprocess, even though they give a distorted picture of the economy.Other economists can then combine the lessons learned from carica-ture models to build a more balanced model of the economy. Thetrouble is that putting these caricature models together into a realisticdescription of the economy seems less attractive or more difficultthan building additional caricature models, so that too little of theformer and too much of the latter gets done.

The question is therefore not whether some formalist economicsshould be done, but how much. The glib answer that some econo-mists give, Let the academic market decide, will no t do. Th e acade-mic economist's market consists of othe r academics, no t consumerswho pay with their own money for what they demand, or institu-tions that are held closely accountable by the general public or bystudents (the ultimate customers of this research.) Academic econo-mists tend to treat as interesting problems those that are technicallydifficult, even if they do not have much bearing on how the econ-omy functions or o n policy choices. Thu s, in academia (or more pre -cisely in those fields of academia where the influence of academicspredominates over those of practitioners), the interests of producerstend to outweigh those of consumers, a clear example of market fail-ure.I therefore agree with Boettke that there is far too m uch formal-ist research (on my narrow definition), but I would not like to seeal lof it eliminated.

Markets versus PlanningAnother problem with Boettke's analysis is that he focuses so muchon the problem of free markets versus planning, an issue on whichthe Austrians have centered much of their attention. This is obviouslyan important issue for economics. But it is only one of many. Mostpapers in economics journals either deal with completely different is-sues,or, if they do deal directly with the question of free markets ver-sus planning, they do so in a specific and narrow context, such asflexib le versus fixed exchange rates. Mainstream econom ics devotesmuch of its effort to small questions rather than basic systemic ques-tions. For example, the first paper in the September, 1997 issue of the


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merican EconomicReviewdeals with an em pirical m odel of inte rna-tional specialization, and the next three papers have the following ti-tles: Th e International Transmission of Financial Shocks: Th e Caseof Japan, A Political-Econom ic Analysis of Free-Trade Agree -ments, and An Empirical Assessment of the Proxim ity-Conce ntra-tion Trade-off between M ultinational Sales and Trade. Even th e tw opapers in that issue that do compare economic systems ( Privatiza-tion in Eastern Germany: Mana gement Selection and Econom icTransition and Co mp etition or Com pensation: Supplier Incentivesund er th e Am erican and Japanese Subcontracting Systems ) do so innarrow ly circum scribed w ays. Th is narrow focus has proved fruitful.No rmal-sc ience research is how a mature field, which economics hasbeco me by now, makes its day-to-day advances.

Boettke and David L. Prychitko (1994) tell us that in recent yearsAustrians have moved away from their traditional emphasis on ideol-ogy. But their research agenda is still too strongly influenced by the bi g issue of markets versus plann ing.In addition, the issue of planning versus free markets is a problemthat belongs only partly within economics. As Boettke rightly pointsout, it does little good to contrast an idealized picture of market so-cialism with capitalism as it works in practice. But determining howmarke t socialism wou ld work in practice raises some exceedingly dif-ficult issues for which an economist's expertise is not sufficient. Forexample, wou ld pressure groups induce the state to prop up firms thatshould be allowed to fail? This is a question for political science, andnot for the unreflective application of economic assumptions to polit-ical phenomena. Sociological questions also arise: what elites wouldreplace the capitalist elites, and what effect would that change have?We know by now that social engineering is fraught with uncertaintyand danger; the law of unintend ed consequences rules. The re is a say-ing in the military: no plan survives contact with the enemy. Some-thing similar applies to economic policy.

What economists can do much better than evaluate how marketsocialism would work in practice is to compare the actual workingsof a market system with the workings of an idealized market sys-tem. And wha t o ne can do well is what one does, particularly if oneis an academic. This creates a natural bias against the free market(though one that may perhaps be fully or more than fully offset bybiases in the other direction.) Boettke is fully justified in complain-ing ab out this bias. W he re Boe ttke is less justified is in rejecting the


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work of those who, like Stiglitz, George Akerlof,or Herbert Simon,among others, have analyzed the implications of factors such asasymmetric information and limited rationality. To be sure, suchanalyses can be used to demonstrate that the actual functioning of amarket system falls short of its ideals. Stiglitz et al. generally do notquantify the losses from these shortfalls, and perhaps they are minor.All the same, they exist. Students of market processes, such as theAustrians, should welcome, rather than deplore, any work, that tellsus more about how markets operate, even if it creates a bias in favorof planning on the part of those who fail to reflect sufficiently onthe shortfalls of actual, as opposed to ideal, socialism. In general, wedo not object to increased knowledge because some people maymisuse it.

Ideology in EconomicsAnother problem is Boettke's treatment of rival schools as driven byideology. In one sense ideology is the metaphysical core of a researchprogram, and therefore unobjectionable.5 In another sense, used bythose who complain about the ideology of their opponents, ideologyis a tendency to accept or reject evidence on the basis of whether itfits one's preconceptions, or a tendency to select theories on the basisof their policy implications, instead of the other way round . As such,ideology demonstrates obtuseness or lack of intellectual honesty, atleast with oneself, if not with others. To accuse someone or someschool of being ideological is therefore to make a serious charge, al-beit in relatively polite language. Unless one has evidence to back upthat type of charge it is better no t to make it. To be sure, if an intelli-gent and well-informed person rejects my excellent arguments, I amtempted to attribute this to willfulness rather dian to the unconvinc-ing na ture of my argumentsw hich, after all, I find utterly con vinc-ing. But this temptation should be resisted.

However, there is still another way of looking at ideology: to treatit as undesirable in many cases, but also as natural and sometimes asjustified. It is natural to give more credence to evidence that supportsone's position than to evidence that rebuts it, if only because thiseliminates an unpleasant feeling of cognitive dissonance. Moreover, insome cases this tendency may be justified. Suppose I have much evi-dence that a proposition is correct. I am now presented with evi-


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dence that it is false. Hence, I must usually reject either all the old ev-idence that supports it, or else the new evidence.6Suppose that, uponcareful reflection, I c annot find any errors either in the supportive ev -idence or in th e ne w contradictory evidence. O ne possibility is to saythat I do not know whether the proposition is true. But suppose Ihave to make some decision, or that the supportive evidence is verystrong. It may then be reasonable for me to adhere to my former be-lief, and to treat the new, contradictory evidence as an anomaly thatwill sooner o r later be somehow resolved, even though this makes meseem ideological.7For all of these reasons, it is better not to attributeideology to one's opponents.

Moreover, it is far from clear that one should blame antimarketideology on the rise of formalism, as Boettke does. Institutionalism,too, can be used to justify interventionism. Indeed, institutionalismhas been the traditional source of interventionist arguments in eco-nomics, while neoclassical theorists have usually defended the marketsystem.

New Keynesian TheoryBoettke's treatment of the New Keynesians does not do them justice.New classical economists had attacked Keynesian theory for lackingmicrofoundations for its basic assumption of wage or price inflexibil-ity. In response, N ew Keynesians have shown that due to a num ber offactors (among which the efficiency wages that Boettke stresses arenot necessarily the most important), wage and price inflexibility areconsistent with rational income maximization, thus refuting the newclassical criticism. To be sure, New Keynesians have not succeeded inmeasuring th e absolute or even th e relative importance of the variousfactors they analyze, so their demonstration of the mere existence ofthese factors does not allow us to claim that we necessarily live in aKeynesian (or monetarist) rather than a new classical world. How-ever, their primary task was no t to do that, but merely to demonstratethat models with wage or price inflexibility are consistent with a be -lief in rational utility m aximization, and do not require any implausi-ble ad hoc assumptions. That wages and prices actually are not veryflex ible is an em pirical claim (for wh ich there is substantial empiricalevidence) that needs to be added to New Keynesian theoretical mod-els to refute new classical theory.


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Austrians and Post KeynesiansThe criticisms of mainstream economics that Boettke and other Aus-trians make from a right-wing perspective have much in common(both substantively and in style of argument) with the criticisms ofthe Post Keynesians, who represent the left wing of Keynesianism.Post Keynesians are, like Boettke, critical of formalism and its focuson equilibrium, and like the Austrians, they want to reintroduce his-torical time into economics. They also stress the prevalence of unce r-tainty, and its distinction from mere risk where the probability distri-bution is unknown. Thus, suppose one accepts Boettke's argunientsabout the inadequacy of mainstream economics in these respects.O ne does not then have to draw the same conclusions as he does; in-stead one could become a Post Keynesian. Again, Boettke's tendencyto see methodological disagreements in economics as a dichotomybetween the Austrians on one side and everyone else on the othermuddies the waters.

The Role of Austrian EconomicsBoettke's paper is at least as much a pro-Austrian tract as it is a criti-cism of formalism. It is useful to distinguish two roles that Austrianeconomics could play. One is to supplement mainstream economics,and th e oth er is to replace it.As a substitute for mainstream economics, Austrian economics isnot likely to be successful, and for good reason. Mainstream econom-ics does have many shortcomingsparticularly the version I havecalled formalist economics. But it also has many successes, especiallywhen accompanied by an empirical mindset, as it is in the work ofeconomists such as Anthony Atkinson, George Akerlof, Friedman,Franco Mod igliani, R ob er t Solow, and James Tobin, to m ention just afew modern masters. It has produced testableand confirmedhy-potheses about important aspects of economic behavior (see Mayer1995,ch. 11). We would be the p oorer if this work w ere to cease, or ifit were to become only a minor tributary to the stream of econom-ics.

Moreover, Austrian economics suffers from several weaknesses.One is the Austrians' tendency to address their discussions primarilyto each other, to spend too much time questioning the purity of each


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other's doctrine, and to debate minor deviations among the elect; inother words , to behave like a stereotypical sect.An other weakness is the Austrians' concentration on big pro b-lems instead of on the day-to-day problems that constitute the workof a normal science. In Lakatosian terms, too much of Austrian re-search deals with the metaphysical core, and too little with the pro-tective belt. Austrian economics needs fewer generals making grandplans, and more privates fighting the war one hill at a time. (ButBoettke should not be blamed for this failing of Austrian economics.On the contrary, he has been a leader among Austrians in emphasiz-ing small, m anageable problems.)

What is discouraging is that when Austrians have dealt with smallproblems, often the results have no t been fruitful. Boettke's TheElgarCompanion to ustrian Economics (1994) has a section of short paperson applied economics, presumably intended to illustrate the fruitful-ness of Austrian economics when applied to specific problems. I donot think that the section succeeds in this effort. Many of these essaysdo make valid points, but too often these are points originally madeby economists who are more closely identified with mainstream thanwith Austrian economics. Showing that they are also consistent withAustrian economics is not enough to show that Austrian economicsshould replace mainstream economics. When these papers do citespecific Austrian contributions, these are usually insights that origi-nated a long time agosuggesting, again, that A ustrian economics isnot a progressive research program.All in all, despite its intellectual ferment in the 1980s (see Lavoie,1994a), modern Austrian economics has so far, at least, not been veryproductive with respect to those problems that interest mainstreameconomists, and also, I would argue, those that interest the generalpublic. Part of this is due, of course, to A ustrian theory no t providingthe rationalizations for government intervention that much of thepublic and many economists welcome. But that is not the wholestory. W hile in the hands of an intellectual giant like Hayek, Austrianeconomics is a powerful tool, in the hands of lesser economists it isnot as powerful a tool as mainstream theory is. And that is a seriousdrawback. Inevitably, most researchers are not giants, and a productivemethodology is one that provides ways in which they, too, can makeuseful contributions. We should evaluate methodologies not only inthe conte xt of verification, but also in the context of discovery.

The lesser fruitfulness of Austrian economics in the hands of most


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econom ists is due no t only to its previously discussed focus on bigproblems, but also to the much smaller role that Austrians accord tothat great reservoir of tasks for many economists, empirical work.Many Austrians consider econom etrics to be useless. Leading Austri-ans reject on methodological grounds the validity of aggregates, suchas the price level. Thu s Hayek (1935, 5) wro te: From the very natureof economic theory, averages can never form a link in its reasoning.Austrians therefore reject as inapplicable to the study of society theinstrumentalism that is used so much in th e natural sciences. This p o-sition strikes me as mistaken, but not being a philosopher, I will notattempt to discuss it further.

If they reject econometrics, Austrians could instead use qualitativeeconomic history as a testing ground, particularly if they are willingto use averages. Although some have done sofor example, by argu -ing that an unregulated banking system has worked well in the past(for a summary see Schuler 1994)on the whole, Austrians do littlehistorical work, because of their strong abhorrence of historicismwith its disdain of economic theory. But economic history can beused both to support and to make use of economic theory, instead ofas a substitute for it. So it is not surprising thatsome Austriansin-cluding Boettkeare now urging their colleagues to make more useof economic history, and to test both the correctness and the ex-planatory power of their theories (see Boettke, Horwitz, andPrychitko 1994). Indeed, Boettke (1994, 5) has argued that the claimthat Austrians reject empirical research is a misreading of the Aus-trian tradition, thou gh he adds that Austrians also believe that thesignificant debates in the social sciences are theoretical debates.

All the same, Austrians do less empirical work than mainstreameconomists do, perhaps because they w ant to engage in the m ore sig-nificant debates. Another reason might be that many Austrians ad-here to a mentalist subjectivism that suggests that empirical work isno t likely to b e successful (see Lavoie 1994b). By rejecting eco no met-rics and m aking only very limited use of econo mic history, Austrianshave denied themselves the opportunity to test their theories, thoughthis,too , has changed somew hat in recent years (see Lavoie 1994a).Austrians might respond, along with some mainstream economists(for instance, Robbins 1932), that empirical testing is not needed,that it suffices to construct a valid logical chain beginning with ax-ioms we know from introspection and casual observation to be true,and ending with whatever conclusion follows deductively. But while


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that may allow us to argue that a certain effect does occur, it usuallycannot tell us whether it is significant or not. For example, Hayek(1935) attributed business cycles to the changes in the relative pricesof various goods induced by changes in the money supply. Skepticsmight respond that, while such relative price changes contribute tobusiness cycles, it is possible that they explain only a trivial propor-tion of the fluctuations we experience as business cycles. Similarly,for a long time Austrians have talked about the importance of com-plementarity among various types of capital. But how much com-plementarity is there? Only recently has an economist (and one whohas only tenuous links with the Austrians) provided empirical evi-dence that such complementarity does matter empirically (Mont-gomery 1996).

Austrian Econom ics as a Com plement to Mainstream Econ omicsViewed as a supplement to, and not a replacement for, mainstreameconomics, Austrian economics has something to contribute. Main-stream economics has narrowed its vision to a limited set of ideas thatmodelers find tractable. Th e Austrians therefore have something valu-able to contribute when they insist that the entrepreneur is morethan some nondescript graduate of an MBA program w ho mechani-cally grinds out the profit-maximizing solution to a standardizedproblem. Similarly, their insistence that price competition is only oneaspectand not necessarily the most important aspectof the com-petitive process adds a valuable insight that game-theoretic models ofoligopoly are likely to miss. Insistence on entrepreneurs being inno-vators operating in a fog of uncertainty, as well as insistence on irre-versible historical time, are other Austrian ideas that may deservemuch more attention than the mainstream gives them.

One might liken the difference between mainstream and Austrianeconomics to the difference between a flashlight and a lantern. Th eformer illuminates sharply along a narrow beam. The latter providesall-round but less sharp illumination. Which one is preferable de-pends on one's purpose, and neither should necessarily be rejectedbecause the o ther is better at solvingsomeproblems. Consider, for ex -ample, Boettke's criticism of the equilibrium concept used in m ain-stream e conom ics. He is right in saying that its beam misses much ofwh at w e should see, such as the entrepreneur's creation of new goods


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Mayer Austrian and Mainstream Econom ics 16 7

and new markets, so that some of the standard criticisms of productdifferentiation are simplistic. On the other hand, the insight that mar-kets tend toward equilibrium provides us with a powerful tool forpredicting how they will respond to certain shocks. If we were to re-linquish standard equilibrium analysis we would lose much. But if wefail to see that there is much more to market behavior than a ten-dency toward narrowly defined equilibrium, we also lose much. 8Mainstream economists and Austrians have something to learn fromeach other.

Improving CommunicationUnfortunately, the lines of communication between Austrian andmainstream economics are feeble. I doubt that many mainstreameconomists read any Austrian economics, though this situation seemsto have improved recently. Some economists who are not identifiedas Austrians now take Austrian ideas seriously (see Caldwell 1982,Hoo ver 1988, Mo ntgom ery 1996). But comm unication still needsmuch improvement. One factor hindering it is the somewhat arro-gant belief of many mainstream economists that the writings of het-erodox economists, or for that matter just about all economics writ-ten pr ior to the 1970s, has nothin g to teach them .

On the other side, it is still the case, though perhaps to a lesser ex-tent now than before, that an Austrian discussion of a mainstreamproposition often consists in large part of showing that it is inconsis-tent with Austrian economics, perhaps even that it has been explicitlyrejected by one of the Founding Fathers. Given the disdain withwhich most mainstream economists treat Austrian economics, suchintroversion is understandablenor is it necessarily worse than theintroversion of the formalists, who tend to treat economics as thestudy, not of the economy, but of other economists' models. But in-troversion on either side hinders progress.

Even when Austrians go beyond condemning some work as beingun-Austrian, their criticisms usually deal in generalities, such as themainstream's use of illegitimate aggregate concepts, instead of gettingdown into the trenches. It is easy for mainstream economists to ig-nor e such broad criticism and say: Yes, rig ht, but o ur theorie snonethelesswork ' It would be more difficult to ignore the Austrians'criticisms if these would more often consist of evidence (or, more


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6 8 Critical Review Vol. 12 Nos. 1-2

specifically, what mainstream economists consider evidence) that aparticular mainstream theory or model fails to predict or explain be-cause it ignores a specific poin t m ade by Austrians.While few mainstream economists are likely to become converts toAustrian economics in its entirety, more might take specific Austrianideas seriously if these were shown to be relevant to their specificconcerns, and were reformulated in a way that is compatible withmainstream methodological criteria. Granted that Austrian econom-ics is built o n ph ilosophical foundations that differ sharply from thoseof mainstream economics, it would sell better if the methodologyand the contents were marketed separately. Similarly, a more politi-cally neutral version of Austrian eco nom ics might ii nd additionalmarkets.Austrians may, of course, object that they want to do more thanbring about a few changes in mainstream economics. But aiming atan attainable goal is better than aiming at one that is out of reach.Moreover, a series of small changes may add up to a large change.O ne should no t exaggerate the incompatibility of paradigms.This is not to deny that over the years Austrian economics has al-ready made some major contributions to mainstream economics. Itsinsight into the problem of rational resource allocation under social-ism is one, and so is Hayek's work on the role of decentralized infor-mation in general. But more interaction is needed. Since Austriansare in the minority, as a practical matter it is up to them to build the

needed bridges.

In summ ary, then , Boettke's criticism of wh at he calls formalismgoes too far. He defines formalism too broadly because he seesmethodological disputes as pitting Austrians plus a few neoclassicaleconomists against everybody else, thus ignoring some basic distinc-tions amo ng the everybody else. In particular, he overlooks the im -portant empiricist tradition in modern economics.All the same, though I have not discussed these points, there ismuch in Boetke's criticisms of contemporary mainstream economicsthat is correct and well argued. Moreover, his essay does serve an im-portant and useful purpose in drawing attention to Austrian econom-ics, which has some important ideas to contribute. But substitutingAustrian economics for what Boettke calls formalism, or awarding itthe main role in such a synthesis, would be a mistake


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NOTES

1. For other problems w ith m odeling see Mayer 1996.2. Physicists on a practical level also use different theories when dealing withlarge objects and with subatomic particles, though, of course, their theories fittogether. In econom ics, too, we can wo rk with general enough premises t ocover the entire field, but th en our analysis tends to be vacuou s. W het her thisreflects a fundamental difference between the natural and the social sciences,or is merely a difference in the stages of their development, is another ques-tion.

3. The last sentence should be read only as a qualification and warning againstovervaluing the beneficial role of mathematics in economics, since elsewhereDeb reu (1984 and 1986) has stressed the virtues of mathematical eco nom ics.

4. In Bergamo , Italy, I saw just below the d om e of a church a fresco that can beseenand seen only faintlyfrom the to p of a certain tower. Presumably itwas painted for the glory of God , no t for people's enjoyment o r instruction.O ne can justify some papers in Econometrica, which almost nobody can read,in the same way, given ho w few readers there are even for m ost of the less-technical papers in economic journals, and how unlikely it is that they willhave any influence on policy or on economists' thinking.

5. O ne migh t, however, object that in th e social sciences, knowledg e is so pre -carious that one should limit as much as one reasonably can those proposi-tions that are privileged as uncontroversial. Many ideological propositionswould then not qualify for the core.

6. But that is not always so. In some situations it is reasonable to hold two con-flicting views (see Foley 1979).

7. He re is 3 concrete examp le. Phillip Cagan (1965) found that be ing covered bya corporate pension scheme induces households to save more on their own.Th is implies an increasing marginal utility of wealth, and therefore conflictswith the well-established belief that marginal utility decreases as one obtainsmore. I therefore did not accept Cagan's findings, though I could find no faultwith his analysis. Subsequently, when Cagan's data were reanalyzed, it turnedout that his conclusion had been wrong.

8. B oettke (1997b, 30) recognizes this wh en he writes that equilibrium theo riz-ing is not to be rejected, according to Hayek, but its real purpose must beconstantly kept in m ind. Formal mo deling can be a very go od servant, bu t apo or m aster. How ever, the general impression that Boettke gives is of a strongcondemnation of equilibrium theory.

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