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.