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An Austrian in Grad School: Confronting the Mainstream / Artikel mises.org

verfasst von - Elli -, 01.08.2003, 15:25

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An Austrian in Grad School: Confronting the Mainstream
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By
Robert P. Murphy

[Posted August 1, 2003]

<img alt src="http://mises.org/images3/15greats.gif" align="right" border="0" width="181" height="262">Because
of their minority status, most budding Austrian economists must endure
graduate training in the mainstream orthodoxy before earning their Ph.D.s. As
a recent graduate of New York University, I thought it might be useful to
highlight some of the major differences I perceived between Austrian economics
and the neoclassical, New Keynesian paradigm. The following list is by no
means exhaustive, nor do I claim that it represents the essential tenets of
Austrian theory. However, I hope my discussion will encourage current graduate
students to keep their spirits up and finish their dissertations.

I.
Method

The most obvious difference between the Austrians and the mainstream
is the choice of method. The Austrians start from the fact that human beings
act purposively to achieve their subjectively chosen ends. From this"action
axiom" the Austrians (in the tradition of Ludwig von Mises) derive as
many implications as possible. So long as the deductive chains of reasoning
are free from error, the conclusions reached are a priori true,
containing as much validity as a proof in Euclidean geometry.

The mainstream,
in contrast, practices economics by the construction of simplified models of
the world. From the outset, unrealistic assumptions are made when establishing
the"laws" governing behavior in the artificial world being studied.
Typical models contain either one or a continuum ("uncountably
infinite" number) of agents, who usually live forever and have the
selfish preferences mocked by critics of the homo economicus view of
man. Macro models will very often have only one or two goods in the entire
economy.

The
justification for such admittedly unrealistic assumptions is a pragmatic one;
because the mainstream economist is concerned primarily with the determination
of equilibrium states in the model, the equations describing such
states cannot be too difficult to solve. Appeal is often made to the natural
sciences, and above all else to physics, where simpler models are sought which
best"approximate" the results of Nature. On this point, all I will
say is that the Austrians have
certainly devoted more careful thought than
the mainstream to the methodological problems involved. The Austrians have
argued that economics is an entirely new branch of science, whose problems are
not at all suitable for the approach of physicists.

II.
Individual Choice

If you study Austrian economics, you will learn that a central tenet
of the school is methodological individualism. This means that for an
Austrian, an"explanation" of an economic phenomenon must ultimately
start from the choices of individual actors. This doesn't mean that Austrians
only focus on"micro" phenomena; indeed, many of the most important
Austrian insights involve macro problems such as unemployment and inflation.
Nonetheless, even here the Austrian always couches his analysis in terms of
the incentives and behavior of the typical individual, in order to understand
the aggregate effects that require explanation.

On a formal
level, the neoclassical mainstream too involves the individual and his
subjective preferences. An equilibrium state (in a market setting) is defined
as a set of prices and behaviors for each agent such that every agent
maximizes his utility, given his budget and the (exogenous) prices. However,
notice that even at this stage there is a problem:  If everyone acts as a
"price taker," i.e. if everyone takes market prices as data to which
behavior must be adjusted, then how do these prices get established in the
first place?<a id="_ftnref1" title href="http://www.mises.org/fullstory.asp?control=1285#_ftn1" name="_ftnref1">[1]</a>,<a id="_ftnref2" title href="http://www.mises.org/fullstory.asp?control=1285#_ftn2" name="_ftnref2">[2]</a>

On this point,
another difference between the Austrians and the mainstream is the latter's
focus on indifference. In an equilibrium state, an agent in a
neoclassical model is indifferent to any small change in his consumption
decisions; an extra penny spent on any available good (so long as the agent
has purchased at least some of the good in question) will yield the same
increment in utility. The Austrians, in contrast, stress that human action
involves the choice of a over b, where alternative a
must be strictly preferred (as demonstrated by the choice itself).

Beyond this,
however, there is another sense in which the mainstream focuses on
indifference. This occurs when, because of the assumptions going into the
model, the analyst wants to ensure that no trading takes place. In
these cases, the goal of the analyst is to find the prices necessary to ensure
that the individual agent (who doesn't care about the economy-wide constraints)
doesn't want to trade.

For example, I
had a macro exam question in which there was only a single, perishable
consumption good; in this world, physical saving was impossible. Moreover, all
agents were identical, and so there was no room for intertemporal exchange at
all. The question asked,"What is the equilibrium interest rate in this
economy?"  The answer was to find the interest rate at which every (identical)
agent would be happy to consume his endowments every period, rather than
altering his consumption path through exchange (which was impossible by
stipulation).

In another
exam question, I was told that a single agent owned a tree, which would
periodically yield fruit (the consumption good). The question asked the
equilibrium price of a share to the tree. Inasmuch as there were no other
agents who could buy the tree, this seemed an odd question. But again,
the point was to find the price of a share such that the agent would be indifferent
between selling ownership of the tree (to a nonexistent second party) versus
retaining ownership and consuming the flow of fruit dividends.

III.
Money

If I could pick just one area of economic theory in which the
mainstream is weakest, it would be money. Simply put, there is no role for
money whatsoever in the typical mainstream model. In a hyper-rich general
equilibrium model, there are markets for every conceivable good, in every
period of time, in every possible state of the world, and agents have either
perfect foresight or rational expectations (in which there is no systematic
bias in predictions). In this setting, there is no need for a unit of account
or medium of exchange, because all future actions can be specified (perhaps
contingent on random events) in the initial period. On the other hand, grossly
simplified macro models contain only one or two goods, and hence render a
medium of exchange superfluous.

Naturally, the
mainstream models (especially macro ones) do contain money; there is
simply no other way to deal with issues such as inflation and Federal Reserve
policy. But in order to get the agents of the model to hold money, all
sorts of ad hoc assumptions are employed. For example, the desire for
liquidity might be built right into an agent's utility function, so that cash
itself gives satisfaction the same way owning a Picasso might. Another
approach is to assume"cash-in-advance constraints," in which the
agent needs a certain amount of money in order to complete transactions.

The problem
with these remedies, of course, is that in the world of the neoclassical model,
there is generally no reason for an agent to gain utility from money,
or for firms to insist on cash-in-advance. This problem casts doubt on the use
of the models themselves; how do we know that"optimal" Fed policy
in the model will translate into the real world, when the true function of
money is absent in the model?

In contrast to
the ad hoc approach of the mainstream, the Austrians have a solid grasp of the
place of monetary theory in economics. Indeed, even an unbiased historian of
economic thought would acknowledge that Ludwig
von Mises was one of the earliest and strongest proponents of
a unified theory of exchange, in which marginal utility analysis explained not
only the valuation of consumption goods, but of units of money as well.

IV.
Time

Another huge difference between the Austrians and the mainstream is
the former's emphasis on time. Although the mainstream has improved
considerably on this issue—most notably in the work of Sir John Hicks—nonetheless
the Austrians have a superior grasp of the time structure of production.
Austrian theory does not avoid the heterogeneity of capital goods, and the
tremendous problems this heterogeneity poses for long-term coordination of
production and consumption plans.

The typical
mainstream macro model, in contrast, still assumes that there is a single
good, serving as both capital and consumption,<a id="_ftnref3" title href="http://www.mises.org/fullstory.asp?control=1285#_ftn3" name="_ftnref3">[3]</a>
and that the entire body of produced
means of production in an economy can be summarized by a single number
indicating the"capital stock."  Moreover, it is typical to
"solve" macro models not merely by calculating the equilibrium state,
but the equilibrium steady state, i.e. a position in which all actions
repeat themselves, every period, forever. It is quite rare indeed for the
mainstream economist to consider the convergence path to such steady states (or
to consider the adverse consequences of various government policies during the
adjustment period).

V.
Institutions

Because of the Austrians' more modest view of the capabilities of
human computation and foresight, there is a far greater role for institutional
analysis in the Austrian paradigm. Earlier I explained that the institution of
money itself cannot be easily analyzed from a neoclassical point of view. The
issue, however, is not merely technical. Failure to understand the role of
money can have profound political implications.

The best
example is Ludwig
von Mises's famous critique of socialism.
Mises argued that without market prices for the means of production, socialist
planners—even if they were truly benevolent and wished only to help their
subjects—could not rationally allocate resources. Mainstream economists
eventually conceded that some system of"prices" would be necessary
in a socialist State, but felt that the government could still retain formal
ownership of all capital goods. Hayek and others argued that the proposals of
"market socialism" would still fail, and with the demise of the
Soviet Union many academics began to take the Austrians seriously.

In my own
experience, I realized the mainstream's failure to understand institutional
differences during a lecture from a mathematical economist. He was explaining
a puzzle that had arisen with the use of a certain type of production function.
If I recall correctly, the problem was that the relationships between interest
rates, capital per worker, and GDP were not consistent between the United
States and the Soviet Union.

One
possible explanation was that the U.S. had better technology, but this wasn't
satisfactory because Soviet plant managers could obviously attend American
engineering schools. What struck me was that it never even occurred to the
professor, or to the students who offered suggestions, that the fact that one
system was capitalist and the other communist might have some relevance.
Instead, they sought a purely technical solution to the apparent paradox.

VI.
Business cycle

Finally, the last area of comparative advantage for the Austrians I
wish to highlight is the business cycle. Relying on (in my opinion) their
superior understanding of the complexity of the capital structure, and of the
vital role money prices play in the coordination of intertemporal plans, only
the Austrian economists can hope to offer a satisfactory explanation of the
widespread errors that characterize a recession.

The Austrians
argue that recessions are the inevitable outcome of prior booms, in which
entrepreneurs—goaded by artificial government reductions in the interest
rate—make overly optimistic guesses as to the profitability of their
projects. In consequence, the entrepreneurs hire labor and buy capital goods
for which there are insufficient real savings to finance. When the
entrepreneurs realize their errors, they attempt to scale back their plans,
and the widespread occurrence of this adjustment is what we know as a
recession.

The mainstream,
in contrast, offers Keynesian models in which the economy becomes trapped in a
state of insufficient demand, or real business cycle models in which
"technology shocks" cause recessions. Aside from the inherent
problems with these models, there remains the empirical failure of the
mainstream advisors to prevent recessions with their"scientific"
management of the economy.

Conclusion

The above points focus on some of the major differences between
Austrian and neoclassical economics. I have been harsh with my treatment of
the mainstream, but I believe my criticism has been fair. It is true that
there are many areas (e.g. game theory) in which the formal rigor of the
mainstream allows for precision that the verbal approach of the Austrians
cannot provide. However, when it comes to the central and crucial areas of
economic theory, I still believe that the Austrian school offers the best
foundation for a young economist.


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Robert Murphy is a recent graduate of New York
University. He will be teaching economics at Hillsdale College in the Fall.
robert_p_murphy@yahoo.com

 

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<a id="_ftn1" title href="http://www.mises.org/fullstory.asp?control=1285#_ftnref1" name="_ftn1">[1]</a>
This is not merely an Austrian
quibble; even noted theorist Frank Kahn has recognized the logical problems
involved. See his"General Equilibrium Theory," in The Crisis in
Economic Theory, Daniel Bell and Irving Kristol, eds., New York: Basic
Books, Inc., 1981.

<a id="_ftn2" title href="http://www.mises.org/fullstory.asp?control=1285#_ftnref2" name="_ftn2">[2]</a>
In
a previous article, I have
shown the difficulties of the mainstream approach to modeling stock market
prices.

<a id="_ftn3" title href="http://www.mises.org/fullstory.asp?control=1285#_ftnref3" name="_ftn3">[3]</a>
I explain some of the problems with
this procedure
in a previous article.

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An Austrian in Grad School: Confronting the Mainstream / Artikel mises.org - - Elli -, 01.08.2003, 15:25