Situating Austrian Economics Within Modern Social Science

Peter J. Boettke2004 Hayek Visiting FellowLondon School of EconomicsOctober 11, 2004

What Did Marshall Miss?

According to Baumol (2000): Macroeconomics Entrepreneurial element in

the market process According to the ‘Austrians’:

The completeness of subjectivism

Entrepreneurial element in the market process

What are the interesting trends in Modern Economics?

Hayek 1974 Nobel Prize Winner Emphasis on Decentralized

Decision making Information embedded in

the price system Learning function of social

institutions Conditions for Social

Coordination as an overarching theme in work on economics, politics and law

What are the interesting trends in Modern Economics? Buchanan 1986

Nobel Prize Winner Emphasis on behavioral

symmetry between economic actors and non-economic actors, in particular political actors in the voting booth, running for office or situated in the bureaucracy Death of Romantic Politics

and the Benevolent Despot Emphasis on exchange behavior

and the institutions within which exchange takes place

Focus analytical attention on the constitutional level – the rules of the game

What are the interesting trends in Modern Economics? Coase 1991 Nobel Prize

Winner Emphasis on how alternative legal

arrangements impact economic performance Demonstrated the intellectual

bankruptcy of Pigovian welfare economics

Focus on the institutional framework within which economic activity takes place

Champion of “dirty” empirical work to get at the contractual record in economic activity.

What are the interesting trends in Modern Economics? North 1993 Nobel Prize

Winner Emphasis on institutions and

institutional change in economic performance Institutions as constraints Institutional change as a shift

in relative prices Importance of cognition in

understanding institutional change Emphasis on economic history as a

research field focused on institutions and institutional change

What is the Value Added of ‘Austrian Economics’?

What is the Value Added of ‘Austrian Economics’? First, intellectual history point

Mises emphasized these points prior to any other thinker in 20th century economics, including Frank Knight

Mises should be recognized as the fountainhead of rational choice theory, new institutionalism and analytical narrative empirical work (friends and foes do injustice to Mises)

Second, the missing element in common understanding of New Institutional Economics Entrepreneurial element in human action and the

competitive market process. Knowledge problems in addition to incentive alignment issues

Behavioral Assumptions and Institutional Deficiency in economic theory

What About Information Economics?

Stiglitz 2001 Nobel Prize Winner Emphasis on imperfect

information and imperfect market structure Critique of Walrasian

economics Presumption reversed – market

failure is the rule, market efficiency is the exception

Relevance of economics to policy world Globalization and Its

Discontent Transition and Development

Economics after a decade

What About Information Economics?

Akerlof Nobel Prize Winner 2001 Emphasis on asymmetric

information “market for lemons”

Broaden economic analysis to address sociological questions Social status, etc.

Austrian Quick Answer to Information Economics Information economics is better than the previous perfect

knowledge economics and as such Stiglitz trumps Lucas as a research inspiring figure Search for Information versus the Discovery and Use of

Knowledge Stiglitz’s critique of Walrasian economics is on target, but he fails

to appreciate the role of disequilibrium prices in coordinating affairs --- in short, he underestimates the learning properties inherent in the economic processes and thus the robustness of markets

Akerlof problems lead to Hayekian solutions – markets are discovery procedures where we learn all sorts of things (like reputation) that enable us to coordinate our plans with others.

‘Austrian’ Theory of the Market Process and Information Economics Kirzner’s emphasis on:

Uncertainty and sheer ignorance as part of the human condition, not assumptions of particular environments – we must always be coping with our ignorance

The role of imperfections in driving entrepreneurial altertness to opportunities for pure profit

The importance of the institutional framework for issues of economic coordination

Other Interesting Trends

Andrei Shleifer – JB Clark Award Work on property rights and

privatization Grabbing hand vs. invisible

hand Work on incentive structures within

markets, non-profits and governments Role of entrepreneurship in

different institutional settings Work on law, politics and finance Work on Institutional Possibilities

Frontier --- *** Work on “inefficient” markets

But effective markets

The New Comparative Economics Framework

Public Predation

Private Predation

Socialism

State regulation

Common law courts

Self-government

Questions: (1) how do you move between different enforcement regimes, and (2) how do you shift the entire institutional possibilities frontier in to get less ‘bads’

Other Interesting Trends: Lab Experiments (continued)

Vernon Smith and Experimental Economics – Nobel Prize 2002 ECOLOGY OF ECON LIFE

(framing issues) Markets are more efficient

than theory would predict Groping market

Trust and cooperation is more common than theory would predict Trust games with

anonymous trading partners

Interesting Trends: Natural Experiments (continued)

Steve Levitt – John Bates Clark Award (2003) Creative and unusual data

collection (hockey, TV, abortion, gangs, and gambling)

Point is to see microeconomics come alive in different walks of life (natural experiments) Situations which

approximate meeting the ceteris paribus clause and thus approximate controlled experimentation

Other Interesting Trends

Theory Economics of Growth and Development

Increasing recognition of the role of institutions and culture in development

Focus on questions of well-being beyond aggregation attempts

Economics of Self-governance Recognition of the role of reputation, norms and conventions

History Analytical Narrative

Use of theory to do history Ethnographic turn

A Snap-shot of the Current Landscape in Economics

Formal Language

Natural Language

UniversalParticular

1940s-1950s

Samuelson –Arrow, Hahn, Debreu

Formalistic Histocism

Game theory (folk theorem)

Market failure theory and information economics

New Institutionalism, including Austrianism

Historicism

Old Institutionalism

1871 – C. Menger

1776 – A. Smith

One set of implications of this change in the intellectual landscape Debate is no longer versus historicists, nor is

it with General Equilibrium Theory Neoclassical Economics is extremely

adaptable and is just as comfortable with formal proofs of equilibrium and it is with formal proofs of multiple equilibria

We have to get more historical before we can re-establish the theoretical perspective

Another Way to Restate the Place of Austrian Economics in the Modern Landscape of Economic Thought If orthodox economics works in a realm where in order to

generate propositions of market efficiency the theorist is required to make simplifying assumptions about agent knowledge and structure, and heterodox economics works in a realm where once these simplifying assumptions are overturned the propositions of market efficiency must be rejected, then Austrian economics can best be understood as deriving propositions about market efficiency within a heterodox problem situation.

Snap-shot of the Problem Situation in Economic Analysis

Simple Problem Situation

Economic Order

NEOCLASSICAL

Simple Problem Situation

Economic Disorder

NON-ECONOMISTS

Complex Problem Situation

Economic Order

AUSTRIAN ECONOMICS

Complex Problem Situation

Economic Disorder

HETERODOX ECONOMICS

How do the ‘Austrians’ Accomplish this? Recognition of a Tripartite Division of Knowledge in Economic

Science Exact theory (apriori – logic of choice) Applied theory (institutionally contingent propositions) Economic History – Public Policy (interpretative understanding)

Uncertainty inherent in all human actions, means that economic actors rely on various norms and institutions to cope with this uncertainty

These institutions work to ameliorate conflicts and promote economic coordination and social cooperation Mises notion of Ricardo’s Law of Association

Conclusion

Economics has moved significantly in an Austrian direction since Samuelson. We should declare victory and stop behaving like we are a side show.

There is still much that the Austrians can add to the conversation. The economic and social world is just too damn interesting and exciting

to let devotion to technique and the incentive system within the modern academy to get in the way of our desire to understand the world.

Economics when done best is exceedingly relevant. To regain our theoretical footing, we must first do more historically

grounded research which demonstrates the interpretive power of the theoretical insights of the Austrian School.