Bronze-level articleAustrian school

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I tremble for the reputation of my subject...
—Paul Samuelson on the Austrians[1]
Most of the elements of Austrianism are so directly contradicted by data that the belief system practically screens itself for people who are out of touch with reality.
—Noah Smith[2]

Austrian economics (or the Austrian school of economics) is a school of economic thought that eschews mathematical modeling and empirical testing in favor of a narrative approach termed "praxeology."[3][4]

As the claims of Austrian economists are difficult to verify through empirical testing (and the same economists openly admit to it), it is generally considered to be a heterodox approach[5] or outright pseudoscience.[6] Austrian arguments as to why statistical methods cannot adequately describe human behavior can seem intuitively compelling, but they fail to provide the mathematical proof demonstrating why normally unbiased estimates suddenly become biased simply because they are dealing with people who make decisions. Perhaps one reason they are so uncomfortable with empiricism is that Austrian economists are more interested in defending the political ideology of libertarianism than they are in advancing economic understanding,[7] and rigorous testing can sometimes undermine deeply held political beliefs.

Can we take anything positive from it? Well, to start, its use can be found in no economy in the world... except Somalia.[8]

Contents

[edit] Praxeology

Murray Rothbard's Praxeology: The Methodology of Austrian Economics describes praxeology as an application of deductive reasoning, applied to a set of "unquestionable" axioms. Of course, any implications derived from these axioms are only as good as the analysis that derived them, and the axiom that they were derived from. This is where praxeology gets into trouble, as they reject less mushy formal analysis in favor of more weasely verbal analysis. Let's look at the axiom that Rothbard refers to as the foundation of praxeological deduction as an example, the "fundamental axiom of action." Almost immediately, the axiom wades into trouble. It states that:

individual human beings act.

The first part of that assertion is simple enough to grasp, but what does it mean to act? One possible definition of act says it is to "perform an action." This seems to be as far as most Austrian school thinker take this. However, as an air conditioner, vacuum cleaner and TV all perform actions, it would seem this axiom places human beings in the rather large set of things that act. It would be pretty embarrassing then, to derive any economic conclusions from the fact that people are part of the set of things that act, as the conclusions deriving from being a member of the set of things that act would apply to other members of that set as well. Fortunately, Rothbard is kind enough to clarify his definition:

...that is human beings take conscious action towards chosen goals.

Note that one under-defined concept has now been replaced with two; conscious action and chosen goals. Let us ignore the validity of this assertion, and try to figure out just what chosen goals are. The word choice would seem to imply some form of conscious action was taken in forming these goals, so is the real statement of this axiom "human beings take conscious action towards a consciously acted upon set of goals?" Perhaps Rothbard meant to differentiate between "choosing" and "acting," but that is never clearly expressed. In either case, it would seem that the definition of goal needs some work to be truly useful. Sound logic relies on clarity of definition, as many arguments are sensitive to subtle changes in meaning, and vague statements hide contradictions.

This approach of verbal deduction also leads to a rather noticeable (ab)use of false analogies and intuition pumps.

[edit] Austrian Business Cycle Theory

Austrian Business Cycle Theory (ABCT) is an attempt to explain the business cycle in capitalist economies through the lens of Austrian theory (obviously). ABCT is probably one of the elements of the Austrian school that helps it spread its laissez-faire meme-plex due to its appealing simplicity.[9]

In short, the business cycle is due to the creation of the central bank (ie. the Federal Reserve in the US) — when it sets interest rates too low, this makes credit much easier to get. This easy credit is confused for "real loanable funds" (ie. hard cash money). In other words, the easy credit sends out "false signals" to banks and other creditors to go into a feeding frenzy and make loans to anyone and his dog. This causes a bubble driven by inflation, not true economic growth which is destined to burst. Recessions and depressions, then, are simply payback for getting drunk on easy credit. They are in fact desirable because they represent a market correction where "misallocated resources" are liquidated and thus free to be "reallocated" to more useful ends.

This has led economist Paul Krugman to dub it the "Hangover Theory," calling it "about as worthy of serious study as the phlogiston theory of fire."[10] Milton Friedman remarked: "The Austrian business-cycle theory has done the world a great deal of harm."[11] Gordon Tullock claims that with the reallocation of capital the model predicts, "Laborers would be exploiting the capitalists."[12]

Of course, there is some grain of truth in it as low interest rates can induce risky lending and will be inflationary, but there are some glaring flaws in ABCT that any Joe should have spotted by this point. Like, umm, the fact that business cycles existed before the Fed. (Some try to skirt this issue by redefining "central bank" as any bank with a state or national charter.[13]) It also relies on two misdefined terms:

  • The Austrians define inflation as an expansion of the base money supply, a consequence of which is rising prices, whereas inflation is defined as simply a rise in prices by mainstream economic theory. While expansion of the money supply can lead to inflation, it does not necessarily do so. Prices do not always track the expansion of the underlying monetary base.[14]
  • The ABCT also relies on a single "natural rate" of interest, but there is no single natural rate of interest.[15]

In addition, the proposal to revert to a gold standard implied by ABCT utterly fails to explain how to deal with the effects of a fixed money supply when population and economic output have been increasing throughout American history. ABCT ultimately is better at explaining why the Austrians and libertarians are such hardcore goldbugs and why they rail against the Fed so much than it is at explaining actual business cycles.

[edit] Peter Schiff

It's impossible to make a post on the Internet about the financial crisis, or even anything economic in general, without being bombarded by "Peter Schiff was right!!11!!" videos.[16] For the new Austrians (i.e., 19-year-olds who read a few newsletters over at the von Mises Institute and think they have achieved enlightenment), the Austrian-influenced investor Peter Schiff's prediction of the housing bubble was vindication of all things Austrian. They believed they had finally shown all other economic theories to be utterly bankrupt and discredited. This is massively ironic for a number of reasons. First, Peter Schiff is still horrifically wrong about many things.[17] Second, Austrians have continuously predicted the economic end times and Weimar-style hyper-inflation as they will never be satisfied with the American economy until all regulation is lifted, the Fed is abolished, and we return to a gold standard. Only then will doom be averted. Of course, it's easy to be a Cassandra when all you predict is doom. (In short, even a stopped clock can be right twice a day.)

Third, they overlook the metric buttload of economists and financial guys who also saw it coming.[18] Those guys just weren't put on CNBC alongside the Wall Street cheerleaders. Even one of Dubya's own economic advisers, Greg Mankiw, warned of problems at Fannie Mae and Freddie Mac back in 2003.[19] Hell, firms like Goldman Sachs were shorting their own securities[20] — the bubble was apparently not a big mystery to insiders.

Fourth, the Austrians claim that their immutable laws of economics are not "scientific" in the sense that they are not empirically derived like the laws of physics, and thus are not subject to falsification and do not make predictions, but "illustrate history" (whatever that means). Yet they are now claiming victory over finally making a correct and falsifiable prediction! That sound you hear is the sound of every sane economist's head exploding.

[edit] Methodological individualism meets Dr. Pangloss

The Austrians get around the problems of market failures, natural monopolies, morality, and rationality through the use of clever wordplay. They rely on an extreme form of methodological individualism based on the "action axiom" as described above. To wit: Because only individuals exist, only individuals can act. Societies cannot act because, to quote Margaret Thatcher, "there is no such thing as society." Therefore, all action can be described at the individual level. If an action is good or moral for one individual, then it must be good or moral in the aggregate because good + good = good. In reality, only basic game theory is needed in order to refute this.[21] Austrians claim, for example, that savings represent money that will be invested in the future, and so money can never be "hoarded." They entirely reject the paradox of thrift.[22]

Some Austrians also use this idea as the basis for an ethical philosophy. This is where they start mixing methodological individualism with methodological subjectivism. As above, if all individual actions are moral, then their aggregate must be moral. In other words, it's a logical derivation of ethical egoism.[23]

This can be used to justify a number of absurdities. Interestingly, the Austrians do not grant the assumption of homo economicus (i.e., that all investors and consumers are endowed with perfect or near-perfect information and rational decision-making skills). However, they redefine "rationality" in subjective terms to mean acting in a way that will fulfill whatever the individual desires. Thus, any action, whether common sense would define it as "rational" or "irrational," is actually "rational" as long as it has utility in meeting a person's needs. This bit of handwaving is often used to deny the importance of self-destructive behavior.

This also allows them to skirt around the creation of monopolies. The Austrians believe that monopolies can only be sustained through government intervention as monopolistic profits and practices will always lead people to create a viable enterprise that will undercut the prices of the company with the monopoly. If this does not happen, it's not because of barriers to entry or insider deals, it's because people must be happy enough with the monopoly at that time to continue paying its prices! Monopolistic practices are not immoral, either, because business practices aren't "enforced at gunpoint" (i.e., the gubmint isn't forcing people to buy their stuff). Why, if there's only one telephone provider in the world, no one's forcing you to use the phone. You are "voluntarily" exchanging your money for their goods. Don't like it? Simple, string up duplicate wires across the entire globe and start your own phone company! Or move to another world that is big enough to support more than one phone company.

[edit] Even they admit they just pulled this stuff out of their asses

The Austrians seem to follow the maxim "If you can't dazzle them with brilliance, baffle them with bullshit." If you couldn't wade through all their econo-speak and arbitrary redefinitions of commonly used terms, however, they literally do the work for you and come straight out and say they just made everything up. Ludwig von Mises himself wrote of his theory:

Its statements and propositions are not derived from experience... They are not subject to verification or falsification on the ground of experience and facts.[24]

F.A. Hayek wrote that any theories in the social sciences can "never be verified or falsified by reference to facts."[24][25]

In other words, it's economic theology. An entire (albeit minor) school of economics has published book after book and paper upon paper just to say all problems can be boiled down to "gubmint did it" and all solutions can be described as "free market always wins." Despite this, their influence (on the internets, at least) seems to be growing, at least since 2008 and the proliferation of "Peter Schiff was right!!11!!" videos.[26] Hayek's book The Road to Serfdom also got the Glenn Beck bump when it was mentioned on his show.[27]

[edit] In fairness

The founder of the Austrian school, Carl Menger, along with William Stanley Jevons and Leon Walras, was responsible for starting the Marginal Revolution in the 19th century, an important step forward in economic thinking.[28] Ludwig von Mises is credited with introducing the economic calculation problem in the 1920s, which argued that a state-run economy could not be efficient because prices could not be "known," only decided by the state.[29] Austrians also argued for the non-neutrality of money.[13] In 1974, Hayek shared the Nobel Memorial Prize in Economic Sciences (with Gunnar Myrdal) for his "pioneering work in the theory of money and economic fluctuations and ... penetrating analysis of the interdependence of economic, social and institutional phenomena."[30]

The school hasn't produced anything of much value since then. Now they are primarily a small group of cranks funded by even richer cranks through the von Mises Institute looking for self-serving rationalizations couched in the form of economic theory.

[edit] See also

Icon fun.svg For those of you in the mood, RationalWiki has a fun article about Austrian school.

[edit] External links

[edit] Footnotes

  1. Samuelson. Theory and Realism: A Reply. The American Economic Review Vol. 54, No. 5, Sep., 1964
  2. Austrian Economists, 9/11 Truthers and Brain Worms, Bloomberg
  3. http://mises.org/journals/rae/pdf/RAE10_2_4.pdf
  4. http://mises.org/etexts/austrian.asp
  5. Caplan, Bryan. "Why I Am Not an Austrian Economist". George Mason University
  6. A Critique of the Austrian School of Economics, Steve Kangas, huppi.com
  7. http://mises.org/daily/4113
  8. Which is probably why the Mises Institute seems so supportive. See "Stateless in Somalia and Loving It."
  9. We dare you to YouTube search it.
  10. Hangover Theory, from Paul Krugman's Crank Economics Page, Alternate link
  11. Taking von Mises to Pieces, The Economist
  12. Gordon Tullock. Why the Austrians are Wrong About Depressions. Review of Austrian Economics
  13. 13.0 13.1 Austrian Business Cycle Theory, John Quiggin
  14. Velocity of Money, Econbrowser
  15. Austrian Business Cycle Theory (ABCT) and the Natural Rate of Interest
  16. A useful primer.
  17. Peter Schiff Was Wrong, Barry Ritholtz, also Peter Schiff Was Wrong, 12-part video series
  18. Here's a list of a few of them: Keen, Roubini, and Baker Win Revere Award for Economics (We're also neglecting those who, while not blowing the whistle yet, clearly identified issues with the status quo, e.g. Mark Thoma and Raghuram Rajan.)
  19. Bush Adviser Warns of Fannie Mae, Freddie Mac Risks, MarketWatch
  20. Goldman Sachs E-Mails: Firm Had the "Big Short" as Economy Fell, Huffington Post
  21. For a game theoretical critique of the Austrian school, see Nicolai Foss. Austrian Economics and Game Theory: A Stocktacking and an Evaluation. Review of Austrian Economics, 13: 41–58 (2000)
  22. See the Wikipedia article on Paradox of thrift.
  23. It should be noted here that the Austrian brand of methodological individualism is their own take on it and not the same as used by sociologists like, for example, Max Weber. See the Stanford Encyclopedia of Philosophy's entry. See also Nozick (1977) on Austrian methodology.
  24. 24.0 24.1 Criticisms of the Austrian School, from Wikipedia
  25. The "Hayek tradition," however, is not considered to be as strictly a priori as the "Mises tradition" of strict praxeology. See Radnitzky 1995.
  26. Then again, so are the Ron Paul fanboys, and we know how brilliant his tactics worked politically.
  27. Glenn Beck and Friedrich Hayek, The Economist
  28. Marginal Revolution in Economics, The Subjectivist, Fort Lewis College
  29. The Socialist Economic Calculation Debate and the Austrian Critique of Central Planning, The Idea Shop
  30. [1]
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