What I’ve been reading (relatively) recently

Here’s short list of what I've been reading over break, with some comments:
“Central Banks as Sources of Financial Instability”; George Selgin. This is a very light rehash of the argument for free banking, along with an overview of central banking.

“Self-Governance in San Pedro Prison”; David Skarbeck.
This study, if accurate, is even more amazing than Peter Leeson’s study of pirate societies. According to Skarbeck, the prison in question spontaneously turned, thanks to the benign neglect of corrupt guards, into a flourishing, self-contained society. Not only does it have the equivalent of homeowners’ associations and restaurants, children and wives of the criminals often live there, and prefer it to their home communities. This article really is a must read, although it does not address possible effects of culture on this story of emergent order.

“From “Porous” to “Ruthless” Conscription, 1776–1917”; David Henderson.
A light, somewhat polemical retelling of how the conscription of the civil war, combined with the ideology of progressivism, led to a people willing to accept mass, inescapable conscription during WWI, and an intellectual elite who favored this policy.

“An Analysis of the Concordance Among 13 U.S. Wine Competitions”; Robert Hodgson.
According to this study, winning a gold medal at a wine competition is solely the result of chance. They try to make the case by arguing that winning a medal at a competition is statistically independent of winning one at another completion. However, I’m not entirely convinced. The correlation coefficients between the competitions are all positive, which I think might signify some sort of correlation, although they don’t provide confidence intervals.

“The ‘Justice’ That Overrules the Rules of Justice”; Anthony de Jasay.
This is part of a festschrift for a philosopher I had never heard of before: Hartmut Kliemt. It was a rather bland, if well-written commentary social justice, although it did include a nice anecdote from James Buchanan.

“The Effect of Prayer on God's Attitude Toward Mankind”; James Heckman.
The fun part of this paper is discovering the logical flaw in Heckman’s reasoning (of which I assume he is aware). From what I understand, there are two problems: the random variables are not from the same population, and he assumes a distribution for the conditional expectation that we are expected to take “on faith.” In addition, since he assumes he is using normalized data, his data do not fit the proposed model.

I am also working through some of “Mr. Sraffa on Joint Production and Other Essays,” by Bertram Schefold. This is a comprehensive look at joint production in the Sraffian system. I have found that it also functions well as a textbook in the approach, since the first few chapters take the time to lay out definitions and methodically formalize them. I recommend this work to anyone who wants to get better acquainted with the neo-Ricardian approach, since the more difficult middle section, which contains the author’s dissertation on joint production, can easily be skipped. I had previously read somewhat extensively in the methodological underpinnings of the Sraffian system, but had not grappled with formalizations of this system. Most of the math is rather basic matrix algebra, so I have had little trouble with it other than learning the many layers of notation.

Second Thoughts on Classical Economics

Looking back on a previous blog post on Marxism, I realize how my views on the classical have changed. Over the past few months, I have tried to rigorously study various interpretations of the classical economists, with an emphasis on Ricardo and the Sraffian interpretation of him. With this study, I have come to realize that my previous criticisms were ill-founded or, at least, questionable.

The classical system is based on entirely different methodological foundations than the marginalist system of analysis. In fact, it’s plausible to interpret the classical as having an entirely different aim and purpose for economics. They rejected methodological individualism. They treated population as an endogenous variable. They only cared about natural values, as opposed to market prices. Suffice to say, given their foundational concerns and methodology, the system they built was surprisingly elegant. Even the labor theory of value can be seen as useful and semi-plausible (although perhaps unnecessary) when examined as part of this paradigm.

With that said, we can still criticize the classical economists by critiquing their foundations. Austrian economics gives an explanation of the real world. Classical economics has a much harder time making that claim.

Complexity and Business Cycles

I’ve mentioned before that I think there are a number of problems in the Austrian business cycle theory as it is originally expounded. Some of these problems are small and only of theoretical importance. They relate to the intricate and subjective nature of the capital structure and the role of expectations. Although the theory may be correct for a simple economy (or in a single sector of an economy) which is relatively stable and has easily identifiable stages of production, this does not mean, a priori, that the theory generalizes to a complex and dynamic economic system.
I am trying to communicate the idea that in a complex system, we may be unable to apply the standard theory. In a world where the lattice-work of heterogenous goods in subjectively interpreted relationships is constantly shifting, are Hayekian triangles any more than an easy to understand piece of pedagogy, not unlike Samuelson’s pitiful defense of the production function as a mathematical “parable”?

Healthcare and Rationing

Currently, many experts are denying the claim that a government run healthcare service would need to ration out care to patients. However, this impossible. Just like the free-market, which “rations” according to ability and willingness to pay, a government healthcare service does not have unlimited resources (although it may be well-funded), so it must also ration care to its clients. Therefore, the question is not whether there will be rationing, but how it will occur and who will guide it. In itself, this doesn’t show that free-market healthcare or government healthcare will be inherently better. But we can use the insights of public choice and standard theory to show that, at the least, we shouldn’t expect the government to outperform the market without extremely extenuating circumstances.

In particular, without real market entrepreneurs guiding the healthcare process, it seems unlikely that a dynamic system with ever-changing and improving medical technology would result. As Lachmann constantly emphasizes, the marketplace is a zone of incredibly dynamic and often unpredictable progress, guided by entrepreneurs who must interpret data and form expectations in accordance with their accumulated knowledge. Government, on the other hand, often seems to be in a sort of stasis, only changing at regular intervals and unbothered by the threat of competition.

The Importance of Fellow Travelers

Fellow travelers are often treated as annoying gadflies, whose only effect is to distract the hard core of a group. However, they serve in a number of underappreciated roles. In the Austrian case, they help to bridge the gap between the mainstream and the Austrian school. Economists like Leland Yeager, who sympathizes with market process theory, can make a marginalized movement appear more respectable to the mainstream. They can also help bridge gaps and create dialogue between different heterodox movements. For example, Theodore Burczak has recently attempted to synthesize Marx and Hayek, provoking conversation between Marxist and Austrian economists. Most importantly, such people help prevent groupthink and insularity within a school of thought.

Formalizing Ordinal Utility

I’ve tried to make an attempt to formalize the Austrian notion of utility. This seems to be a praxeologically sound formalization which does not imply that mathematics can be used in economic theory. This formulation does not state that utility functions are continuous or differentiable, so forming a Walrasian system with them would be nearly impossible. Nevertheless, it is at least an interesting exercise. Feel free to critique it:

The good’s first unit will satisfy the most important end, the second unit will indulge the next most important, the third unit will tend to the third most important, and so on. Thus we get a set of ends E = ( e₁, e₂, e₃, . . . ,e_i) with the following property: For all e₁, e₂, in E, e_j, is preferred to e_i, if and only if i < style="">X = (x₁, x₂, . . . x_i, . . . ) be a set where x, denotes the number of units of good x at a consumer’s disposal. Let x_j > x_i, if and only if j > i. Define a marginal utility function f: X --> R⁺ such that f(x_i) > f(x_j) if and only if x_i, < x_j. This is a result of the fact that a consumer will utilize additional units of good x to satisfy sequentially less important goals. f is thus a decreasing marginal utility function on X . To show that marginal utility is ordinal, let S = (f, g, . . .) be the set of all functions on X defined as above. Then for all f, g in S, and for all x_i, x_j in X, f(x_i) > f(x_j) implies g(x_i) > g(x_j). S is consequently an ordinal measure of marginal utility.

Subjectivism and Traditional Austrian Business Cycle Theory: Could They Be Incompatible?

“On the one hand we want to have a time structure of production in order to have our theory of the trade cycle. On the other hand we often cop out by describing it as purely subjective; the time structure of production describes something about the plans of entrepreneurs and in this sense varies from entrepreneur to entrepreneur. But we can't have it both ways. If it supports ATBC, then it's an "objective" notion. If it is a "subjective" notion, the ATBC cannot be sustained. I wish we would pick up on a suggestion by Peter Lewin and cut the Gordonian knot with the idea of "duration." Before we can do that, however, we have to see the problem and it's my impression that almost no Austrians see the problem.”
-Roger Koppl

This is an interesting point, although I’m not sure whether I entirely agree with it. However, if this dichotomy of subjective entrepreneurial plans and objective physical capital really cannot be bridged, I think that I would have to take the side of subjectivism.

After giving more thought to this, I think that we should discard the time component as a critical part of the theory. While we can say that inflation alters the number of stages of production and introduces greater uncertainty into the system, we can’t talk about the process in a uni-dimensional manner. Because of the existence of looping in the capital structure (some production processes may produce materials that later end up in that same process), the order of any production process is an entirely subjective phenomenon, existing only in the interlocking plans of entrepreneurs. Therefore, a distorted rate of interest can only be said to disfigure and warp the web of interconnected capital. Although we might be able to empirically discern more specific tendencies, given a particular capital structure, the theory itself cannot give us any more information. We need to accept that we cannot derive a satisfying business cycle theory without empirical insight.

Critical Realism: What is it and what does it have to do with economics?

Critical Realism is a philosophical movement that has been gaining some ground in the past few years. It is an approach to philosophy that encompasses epistemology, ontology, and to some extent, morality. It approaches the world as being made up of “structures,” each with certains “powers.” These structures (think gravity) are always exerting these powers, even when there are other powers at work preventing the previous powers from achieving its full effect. For example, gravity works upon a bird, but the bird’s power to fly counters this.

You might ask: why is this so novel? In contrast to positivism, it is quite new. Positivism looks only at conjoined events of the form: A, then B. Realism attempts to look at the structure of events and denies that the prediction of such conjoined events is the purpose of science.

This is relevant to economics because this philosophy is incompatible with many forms of econometrics. If the purpose of science is to study “structures,” rather than laws, then the mainstream approach to economics is bankrupt.

Unfortunately, this philosophy is almost invariably used solely by the left, often to justify Marxism. However, Austrian economics could certainly make use of this philosophy to justify its methodological attack on the mainstream.

Andrew Collier’s book on Critical Realism would be a good place to learn about this topic, if you can ignore the Marxist ideas strewn throughout it.

Is regret compatible with Praxeology?

Aristotle, upon whom Menger based some of his ideas, believed in the concept of akrasia. Akratic action is action that is known to be against an agent’s own interests, but is pursued regardless. This is obviously incompatible with any rational choice-based theory of action, since the agent is purposely acting irrationally. An example is the drunk who knows his alcohol addiction is harmful and regrets his problem, yet continues drinking. Is this a problem for a realistic economic theory based on the assumed rationality of economic agents?

One first step to deal with this problem is relaxing the standard of rational action to the Misesian notion of purposeful action. This does not solve the problem fully. In this case, we can understand the agent as having two opposing beliefs about the usefulness of their action. The agent only acts on one of these beliefs, leading to feelings of regret from the other. However, this leads to a new problem: why would an agent choose only to pay attention to an inferior belief?

Elster attempts to solve this problem by positing a rapid change in time preference of the agent during the akratic act. When the actor soberly examines his options ahead of time, he may choose X over Y. However, when confronted with the imminent choice, he chooses Y due to a rapid increase in his discount rate. This solution does not provide an answer to the deeper question of why the agent would feel regret simultaneous with the action. It seems that the only way out of this puzzle is to admit that this increased discount rate is caused by a weakness of will, perhaps due to impulsiveness. The actor knows that his choice is problematic, yet is unable to impede the force of his passions. This is not incompatible with any Misesian theory ofchoice, since praxeology makes no claims about the motivations of an action.

Principled Agents

Timothy Besley’s recent book on political economy, “Principled Agents?” attempts to chart a course between the skepticism of Virginia School public choice and the credulity of traditional political economy. That is, he tries to show how government could work without assuming either perfect benevolence or complete self-interest on the part of politicians. Rather, he tries to show how democracies are likely to elect politicians who will serve the public good, using a comparative statics framework. He believes that the key problem of political economy is creating systems where these principled people are most likely to be elected to office.

This kind of approach has a fair number of problems, many of which are detailed in the RAE symposium on the book. The most obvious is that he assumes that there are people who are inherently principled and those who are not. This goes directly against Gary Becker’s belief that the best economics is done when we assume that all agents have the same utility function. Using that method, we can see how incentives affect individuals without relying on certain kinds of individuals. Put differently, if we just assume that there are certain principled politicians, we are blinded to how previously moral politicians are tempted by the new incentives of office and end up acting against the public good.

Another very important point is one that has been made by Bryan Caplan. If voters are irrational and demand public bads of their politicians, democratic failure may be a feature, not a bug. Since the information on voter preferences seems to confirm that they habitually demand policies that have detrimental effects, it is entirely possible that unprincipled politicians will craft better policies than principled ones.

The Debate on Indifference

In the latest QJAE, there is another debate over the role of indifference in economic analysis. Like the previous debates, this is an outgrowth of the response to Nozick’s critique of Austrian economics. Since Mises, AE has rejected the use of indifference in economic analysis, which also means that indifference curves cannot be used. The reasoning behind this break from the mainstream is this: indifference cannot be demonstrated through action (we always choose something; we cannot choose to be indifferent) and is therefore only a vague psychological concept, not an economic concept.

Suppose that the above reasoning is valid. Nozick points out that we cannot use the concept of marginal utility or other economic concepts, since these depend on a stock of homogeneous goods. The individual must be indifferent between these goods for these concepts to be valid.

Block attempts to solve the problem in a very practical way. Until the moment of choice, the individual is indifferent between the homogeneous goods in a psychological sense. At the point when he chooses, he is no longer indifferent; he picks a specific dollar to trade (even though he valued all his dollars the same previously), for example. This solves the problem, although it seems to be an ad hoc solution.

Hoppe has a more elegant solution to the problem. He says that we are not indifferent between homogeneous goods, it is just that the matter of picking a particular member of that group does not matter for human choice. For example, if I am trading loaves of bread for ounces of butter, I do not care which loaf I trade for the butter. My action shows that I prefer butter to bread, but it does not show that I am indifferent to which loaf I get rid of. The matter of which particular loaf is not relevant for human action. Hoppe gives the example of walking to a park. At the start of my walk, I must either put my left foot or right foot forward. Am I indifferent between them? No, the choice is not one I make. I make a choice of walking to the park; the foot I start with is irrelevant.

Institutions and the Current Situation

During the current financial crisis and subsequent government actions, the institutions that provide a framework for our society have been significantly altered. The damage to financial institutions, which are internal institutions that allow people to allocate their financial assets and hedge risk, has created a greater degree of uncertainty in the market. Does this mean the government should step in to create a less uncertain business environment? Not necessarily.

If the government starts acting erratically, as it has been recently, then the external institutions which are necessary for society will also begin to fail at serving their purpose. If the actions of the government lead to a changing legal order, the level of uncertainty will increase. People will no longer be able to use the institution of, for example, bankruptcy in order to plan their investments. The common points of reference around which we can plan will no longer be useful. Expectations of the future will vary more widely as people attempt to guess how government will act. Expectations of the “practical range” of possible government actions will not converge because of the changing legal order that results from those actions.

Preventing Cultism

Austrian economics is sometimes accused of being an Objectivist-like cult. We are said to have our sacred texts: Human Action, Principles of Economics, Man, Economy, and State. We have our idols who we constantly cite: Hayek, Mises, Menger. Some of us have dire predictions of an inflation-generated financial apocalypse. I disagree with this interpretation, since one could say the same thing about philosophy in general.

How do we prevent ourselves from becoming cultists? The competition within our group certainly helps, as does the constant confrontation of the mainstream. Another healthy development is that some of us see ourselves in the mainstream tradition. However, we must also be willing to question received gospel and perform more empirical research. There is a general lack of empirical analyses of ABCT.

Unfortunately, many members of the public who subscribe to the Austrian viewpoint act like it is a cult. They unquestioningly shout “end the fed!” without having anymore than a basic understanding of the theory. This is a problem that is difficult to address, since it also has positive effects. It means that people are interested in ideas. However, it also means that people associate market process theory with a political outlook, predictions of catastrophe, and simplified theory. This is certainly not true in the academic world. This might be interpreted as elitism. If it is, so be it.

There is a good post on this kind of thing here.

Three Trends in Austrian Economics

There are at least three distinct, but overlapping, research programmes (to use Lakatos’ term) in Austrian economics, at least according to Rothbard. Each of these styles of thought can rightfully claim to be based on Mengerian insight.

There is the Mises-Rothbard strand, which emphasizes rationality, equilibrium as a mental construct, and theorizing based on axioms and logical deduction. This comes directly from Menger’s search for “exact laws” of economics and human action.

A more prominent mode of thought, at least among the mainstream, is the Hayek-Kirzner paradigm. Although this group can easily be split up further, it generally emphasizes spontaneous order, discovery procedures, and entrepreneurship. This can be derived from Menger’s discussion of organic and pragmatic orders and organizations. The classic example of an organic order is the means of exchange, which spontaneously arose to fulfill the need created by the problem of finding a “double coincidence of wants”. This draws on Menger’s role as one of the founders of subjectivism and claims to complete the subjectivist revolution.

Another, more controversial, research programme is the Lachmann-Shackle school of radical subjectivism. This method of analysis focuses on expectations, sociology, and disequilibriating elements in the economic process. It shares some elements with the Post-Keynesians, although these ideas are taken in drastically different directions. This draws on Menger’s role as one of the founders of subjectivism and claims to complete the subjectivist revolution.

Conclusion

We can see how the concept of the plan can be used to create a theory of institutions that takes into account the complexities of the social world. These institutions help to generate coordination in society and reduce the uncertainty caused by the subjective character of human expectations. That is, they allow us to use common knowledge to coordinate our forward-looking plans. In this way, they prevent the kaleidic society of Shackle and permit the economy to act as Mises predicted, organizing the actions of individuals into a harmonious spontaneous order.

This marks the end of my blog of “The Legacy of Max Weber.” If anyone has any questions about the book or feels I left out something, please let me know in the comments. I highly recommend checking this book out. It combines economics, sociology, and philosophy, with a bit of historical analysis thrown in for good measure.

Political Institutions

Political institutions show the weakness of the internal/external dichotomy. At times, stable political institutions can act as a comprehensive and reliable framework which individuals can rely upon. Other times, such as during the 1930’s, political institutions do little to generate stability and are drastically altered by other factors.

In a way that is analogous to the capital structure, the institutional structure is dependent on the circumstances and perceptions of individuals. If people treat government and the legal order as being fluid, then it is not an external institution, which acts as a framework for society.

Institutions In Weber’s Own Time

During the late 1800’s, there was some institutional stability in Germany’s political sphere, thanks to the devotion to Rechtsstaat, or rule of law. This meant that all of those in the government were duty-bound to uphold the legal order, creating stability for the majority of Prussians. Unfortunately, because the compromises which had created the legal order had never been supported by the growing class of industrial workers, dissent began to arise among educated Germans. They thought that the “labor question” could only be solved through the state’s intervention. Max Weber heavily criticized the political arrangement, believing it to be solely the product of elites. However, the political elites had much more tacit support from the different classes of society than might be expected.

Unlike the previous regimes, the Weimar Republic had a weak institutional basis to begin with. After WWI, many socialist leaders found themselves in power. Not only were they completely unprepared to govern, they also had no confidence in the permanence of the republic. Their Marxist beliefs led them to think that Weimar was only a transitional period between capitalism and socialism; therefore they failed to attempt to cement their government’s legitimacy. They scorned the defense of ancient institutions as reactionary. Why bother to build strong governmental foundations if every change was a step toward socialism?

Internal vs. External

We can differentiate between two main kinds of institutions, internal and external. Internal institutions have a greater degree of flexibility and are constantly evolving too fit the needs of individuals. An external institution, such as the overall legal order, is more permanent and certain. These two types of institutions may overlap in certain functions.

It’s also worth noting that this simple model should not be taken overly seriously. Institutions are not objectively external or internal. Their place in the hierarchy depends on their particular functions at particular points in time. These relationships are always shifting, as new institutions arise and novel relationships of complementarity come to exist.

Institutions and Permanence

Institutions exist for long periods, but they are not necessarily permanent. At any time, there are some institutions which have become obsolete, either because the goals they help individuals accomplish are no longer desired or because they have been replaced by more efficient institutions.

BTW: This and the last few posts have been the live-blog of "Legacy of Max Weber." Unlike some other bloggers, I prefer to do many short posts rather than five really long posts.

Institutions and Knowledge

Institutions also act, in a way similar to prices, as knowledge surrogates (it’s important to point out the difference between a knowledge surrogate and embodied knowledge; see Steven Howitz’s “Monetary Calculation and the Unintended Extended Order: The Misesian Microfoundations of the Hayekian Great Society”). They allow us to accomplish tasks and achieve goals without fully understanding the means we use in the process. For example, we do not have to have any knowledge of banking in order to use the banking system to save for retirement.