Austrian School of Economics: The Praxeological Synthetic. Thought of the Day 135.0

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Within the Austrian economics (here, here, here and here), the a priori stance has dominated a tradition running from Carl Menger to Murray Rothbard. The idea here is that the basic structures of economy is entrenched in the more basic structures of human action as such. Nowhere is this more evident than in the work of Ludwig von Mises – his so-called ‘praxeology’, which rests on the fundamental axiom that individual human beings act on the primordial fact that individuals engage in conscious actions toward chosen goals, is built from the idea that all basic laws of economy can be derived apriorically from one premiss: the concept of human action. Of course, this concept is no simple concept, containing within itself purpose, product, time, scarcity of resources, etc. – so it would be more fair to say that economics lies as the implication of the basic schema of human action as such.

Even if the Austrian economists’ conception of the a priori is decidedly objectivist and anti-subjectivist, it is important to remark their insistence on subjectivity within their ontological domain. The Austrian economics tradition is famous exactly for their emphasis on the role of subjectivity in economy. From Carl Menger onwards, they protest against the mainstream economical assumption that the economic agent in the market is fully rational, knows his own preferences in detail, has constant preferences over time, has access to all prices for a given commodity at a given moment, etc. Thus, von Mises’ famous criticism of socialist planned economy is built on this idea: the system of ever-changing prices in the market constitutes a dispersed knowledge about the conditions of resource allocation which is a priori impossible for any single agent – let alone, any central planner’s office – to possess. Thus, their conception of the objective a priori laws of the economic domain perhaps surprisingly had the implication that they warned against a too objectivist conception of economy not taking into account the limits of economic rationality stemming from the general limitations of the capacities of real subjects. Their ensuing liberalism is thus built on a priori conclusions about the relative unpredictability of economics founded on the role played by subjective intentionality. For the same reason, Hayek ended up with a distinction between simple and complex processes, respectively, cutting across all empirical disciplines, where only the former permit precise, predictive, quantitative calculi based on mathemathical modeling while the latter permit only recognition of patterns (which may also be mathematically modeled, to be sure, but without quantitative predictability). It is of paramount importance, though, to distinguish this emphasis on the ineradicable role of subjectivity in certain regional domains from Kantian-like ideas about the foundational role of subjectivity in the construction of knowledge as such. The Austrians are as much subjectivists in the former respect as they are objectivists in the latter. In the history of economics, the Austrians occupy a middle position, being against historicism on the one hand as well as against positivism on the other. Against the former, they insist that a priori structures of economy transgress history which does not possess the power to form institutions at random but only as constrained by a priori structures. And against the latter, they insist that the mere accumulation of empirical data subject to induction will never in itself give rise to the formation of theoretical insights. Structures of intelligible concepts are in all cases necessary for any understanding of empirical regularities – in so far, the Austrian a priori approach is tantamount to a non-skepticist version of the doctrine of ‘theory-ladenness’ of observations.

A late descendant of the Austrian tradition after its emigration to the Anglo-Saxon world (von Mises, Hayek, and Schumpeter were such emigrés) was the anarcho-liberal economist Murray Rothbard, and it is the inspiration from him which allows Barry Smith to articulate the principles underlying the Austrians as ‘fallibilistic apriorism’. Rothbard characterizes in a brief paper what he calls ‘Extreme Apriorism’ as follows:

there are two basic differences between the positivists’ model science of physics on the one hand, and sciences dealing with human actions on the other: the former permits experimental verification of consequences of hypotheses, which the latter do not (or, only to a limited degree, we may add); the former admits of no possibility of testing the premisses of hypotheses (like: what is gravity?), while the latter permits a rational investigation of the premisses of hypotheses (like: what is human action?). This state of affairs makes it possible for economics to derive its basic laws with absolute – a priori – certainty: in addition to the fundamental axiom – the existence of human action – only two empirical postulates are needed: ‘(1) the most fundamental variety of resources, both natural and human. From this follows directly the division of labor, the market, etc.; (2) less important, that leisure is a consumer good’. On this basis, it may e.g. be inferred, ‘that every firm aims always at maximizing its psychic profit’.

Rothbard draws forth this example so as to counterargue traditional economists who will claim that the following proposition could be added as a corollary: ‘that every firm aims always at maximizing its money profit’. This cannot be inferred and is, according to Rothbard, an economical prejudice – the manager may, e.g. prefer for nepotistic reasons to employ his stupid brother even if that decreases the firm’s financial profit possibilities. This is an example of how the Austrians refute the basic premiss of absolute rationality in terms of maximal profit seeking. Given this basis, other immediate implications are:

the means-ends relationship, the time-structure of production, time-preference, the law of diminishing marginal utility, the law of optimum returns, etc.

Rothbard quotes Mises for seeing the fundamental Axiom as a ‘Law of Thought’ – while he himself sees this as a much too Kantian way of expressing it, he prefers instead the simple Aristotelian/Thomist idea of a ‘Law of Reality’. Rothbard furthermore insists that this doctrine is not inherently political – in order to attain the Austrians’ average liberalist political orientation, the preference for certain types of ends must be added to the a priori theory (such as the preference for life over death, abundance over poverty, etc.). This also displays the radicality of the Austrian approach: nothing is assumed about the content of human ends – this is why they will never subscribe to theories about Man as economically rational agent or Man as necessarily economical egotist. All different ends meet and compete on the market – including both desire for profit in one end and idealist, utopian, or altruist goals in the other. The principal interest, in these features of economical theory is the high degree of awareness of the difference between the – extreme – synthetic a priori theory developed, on the one hand, and its incarnation in concrete empirical cases and their limiting conditions on the other.

 

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Austrian Economics. Some More Further Ruminations. Part 3.

The dominant British tradition received its first serious challenge in many years when Carl Menger’s Principles of Economics was published in 1871. Menger, the founder of the Austrian School proper, resurrected the Scholastic-French approach to economics, and put it on firmer ground.

Menger spelled out the subjective basis of economic value, and fully explained, for the first time, the theory of marginal utility (the greater the number of units of a good that an individual possesses, the less he will value any given unit). In addition, Menger showed how money originates in a free market when the most marketable commodity is desired, not for consumption, but for use in trading for other goods. Menger restored economics as the science of human action based on deductive logic, and prepared the way for later theorists to counter the influence of socialist thought. Indeed, his student Friederich von Wieser strongly influenced Friedrich von Hayek’s later writings.

Menger’s admirer and follower at the University of Innsbruck, Eugen Böhm-Bawerk, took Menger’s exposition, reformulated it, and applied it to a host of new problems involving value, price, capital, and interest. His History and Critique of Interest Theories, appearing in 1884, is a sweeping account of fallacies in the history of thought and a firm defense of the idea that the interest rate is not an artificial construct but an inherent part of the market. It reflects the universal fact of “time preference,” the tendency of people to prefer satisfaction of wants sooner rather than later.

Böhm-Bawerk’s Positive Theory of Capital demonstrated that the normal rate of business profit is the interest rate. Capitalists save money, pay laborers, and wait until the final product is sold to receive profit. In addition, he demonstrated that capital is not homogeneous but an intricate and diverse structure that has a time dimension. A growing economy is not just a consequence of increased capital investment, but also of longer and longer processes of production.

Böhm-Bawerk favored policies that deferred to the ever-present reality of economic law. He regarded interventionism as an attack on market economic forces that cannot succeed in the long run. But one area where Böhm-Bawerk had not elaborated on the analysis of Menger was money, the institutional intersection of the “micro” and “macro” approach. A young Ludwig von Mises, economic advisor to the Austrian Chamber of Commerce, took on the challenge.

The result of Mises’s research was The Theory of Money and Credit, published in 1912. He spelled out how the theory of marginal utility applies to money, and laid out his “regression theorem,” showing that money not only originates in the market, but must always do so. Drawing on the British Currency School, Knut Wicksell’s theory of interest rates, and Böhm-Bawerk’s theory of the structure of production, Mises presented the broad outline of the Austrian theory of the business cycle. To note once again, his was not a theory of the physical capital, but a theory of interest. So, even if some of the economists of the school had covered through their writings the complexities of the structure of production, that wasn’t really their research object, but rather what their concentration really opted for was interest phenomenon, trade cycle or entrepreneurship.

Ludwig Lachmann in his Capital and its Structure is most serious about the complexities of the structure of production, especially on the heterogeneity of physical capital not only in relation to successive stages of production, but denying any possibility of systematically categorizing, measuring or aggregating capital goods. But, does that mean he is from a different camp? Evidently not, since much of his discussion contains an important contribution to the historically specificity of capital, in that the heterogenous is not itself the research object, but only a problem statement for the theory of the entrepreneur. Says he,

For most purposes capital goods have to be used jointly. complementarity is of the essence of capital use. but the heterogenous capital resources do not lend themselves to combination in any arbitrary fashion. For any given number of them only certain modes of complementarity are technically possible, and only a few of these are economically significant. It is among the latter that the entrepreneur has to find the ‘optimum combination’.

for him, the true function of the entrepreneur must remain hidden as long as we disregard the heterogeneity of capital. But, Peter Lewin’s Capital in Disequilibrium reads Lachmann revealingly. What makes it possible for entrepreneurs to make production plans comprising numerous heterogenous capital goods is a combination of the market process and the institution of money and financial accounting. There, you can see Lachmann slipping into the historical territory. Says Lewin,

Planning within firms proceeds against the necessary backdrop of the market. Planning within firms can occur precisely because “the market” furnishes it with the necessary prices for the factor inputs that would be absent in a fullblown state ownership situation.

Based on these prices, the institution of monetary calculation allows entrepreneurs to calculate retrospective and prospective profits. The calculation of profits, Lewin states, is “indispensable in that it provides the basis for discrimination between viable and non-viable production projects.” The approach is not concerned with the heterogeneity of capital goods as such but, to the contrary, with the way these goods are made homogeneous so that entrepreneurs can make the calculations their production plans are based on. Without this homogeneity of capital goods in relation to the goal of the entrepreneur – making monetary profit – it would be difficult, if not impossible, to combine them in a meaningful way.

 

 

Austrian Economics. Some Further Ruminations. Part 2.

There are two Austrian theories of capital, at least surfacially with two completely different objectives. The first one concentrates on the physical activities roundabout, time-consuming production processes which are common to all economic systems, and it defines capital as a parameter of production. This theory is considered to be universal and ahistorical, and the present connotation of Austrian Theory of Capital falls congruent with this view. This is often denoted by physical capital and consists of concrete and heterogenous capital goods, which is nothing but an alternative expression for production goods. The second and relatively lesser known theory is the beginning point for a historically specific theory, and shies away with the production process and falls in tune with the economic system called capitalism. Capital isn’t anymore dealing with the production processes, but exclusively with the amount of money invested in a business venture. It is regarded as the central tool of economic calculations by profit-oriented enterprises, and rests on the social role of financial accounting. This historically specific theory of capital is termed business capital and is in a sense simply money invested in business assets.

A deeper analysis, however, projects that these divisions are unnecessary, and that physical capital is not a theory of physical capital at all. Its tacit but implicit research object is always the specific framework of the market economy where production is exercised nearly exclusively by profit-oriented enterprises calculating in monetary terms. Austrian capital theory is used as an element of the Austrian theory of the business cycle. This business cycle theory, if expounded consistently, deals with the way the monetary calculations of enterprises are distorted by changes in the rate of interest, not with the production process as such. In a long and rather unnoticed essay on the theory of capital, Menger (German, 1888) recanted what he had said in his Principles about the role of capital theory in economics. He criticized his fellow economists for creating artificial definitions of capital only because it dovetailed into their personal vision of the task of economics. In respect of the Austrian theory of capital as expounded by himself in his Principles and elaborated on by Böhm-Bawerk, he declared that the division of goods into production goods and consumption goods, important as it may be, cannot serve as a basis for the definition of capital and therefore cannot be used as a foundation of a theory of capital. As for entrepreneurs and lawyers, according to Menger, only sums of money dedicated to the acquisition of income are denoted by this word. Of course, Menger’s real-life oriented notion of capital does not only comprise concrete pieces of money but

all assets of a business, of whichever technical nature they may be, in so far as their monetary value is the object of our economic calculations, i.e., when they calculatorily constitute sums of money for us that are dedicated to the acquisition of income.

An analysis of capital presupposes the historically specific framework of capitalism, characterized by profit-oriented enterprises.

Some economists concluded therefrom that “capital” is a category of all human production, that it is present in every thinkable system of the conduct of production processes—i.e., no less in Robinson Crusoe’s involuntary hermitage than in a socialist society—and that it does not depend upon the practice of monetary calculation. This is, however, a confusion (Mises).

Capital, for Mises, is a device that stems from and belongs to financial accounting of businesses under conditions of capitalism. For him, the term “capital” does not signify anything peculiar to the production process as such. It belongs to the sphere of acquisition, not to the sphere of production.  Accordingly, there is no theory of physical capital as an element or factor in the production process. There is rather a theory of capitalism. For him, the existence of financial accounting on the basis of (business) capital invested in an enterprise is the defining characteristic of this economic system. Capital is “the fundamental notion of economic calculation” which is the foremost mental tool used in the conduct of affairs in the market economy. A more elaborate historically specific theory of capital that expands upon Mises’s thoughts would analyze the function of economic calculation based on business capital in the coordination of plans and the allocation of resources in capitalism. It would not deal with the production process as such but, generally, would concern itself with the allocation and distribution of goods and resources by a system of profit-oriented enterprises.

Austrian Economics. Some Ruminations. Part 1.

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Keynes argued that by stimulating spending on outputs, consumption, goods and services, one could increase productive investment to meet that spending, thus adding to the capital stock and increasing employment. Hayek, on the other hand furiously accused Keynes of insufficient attention to the nature of capital in production. For Hayek, capital investment does not simply add to production in a general way, but rather is embodied in concrete capital items. Rather than being an amorphous stock of generalized production power, it is an intricate structure of specific interrelated complementary components. Stimulating spending and investment, then, amounts to stimulating specific sections and components of this intricate structure. Before heading out to Austrian School of Economics, here is another important difference between the two that is cardinal, and had more do with monetary system. Keynes viewed the macro system as vulnerable to periodic declines in demand, and regarded micro adjustments such as wage and price declines as ineffective to restore growth and prosperity. Hayek viewed the market as capable of correcting itself by taking advantages of competitions, and regarded government and Central Banks’ policies to restore growth as sources of more instability.

The best known Austrian capital theorist was Eugen von Böhm-Bawerk, though his teacher Carl Menger is the one who got the ball rolling, providing the central idea that Böhm-Bawerk elaborated. For the Austrians, the general belief lay in the fact that production takes time, and more roundabout the process, the more delay production needs to anticipate. Modern economies comprise complex, specialized processes in which the many steps necessary to produce any product are connected in a sequentially specific network – some things have to be done before others. There is a time structure to the capital structure. This intricate time structure is partially organized, partially spontaneous (organic). Every production process is the result of some multiperiod plan. Entrepreneurs envision the possibility of providing (new, improved, cheaper) products to consumers whose expenditure on them will be more than sufficient to cover the cost of producing them. In pursuit of this vision the entrepreneur plans to assemble the necessary capital items in a synergistic combination. These capital combinations are structurally composed modules that are the ingredients of the industry-wide or economy-wide capital structure. The latter is the result then of the dynamic interaction of multiple entrepreneurial plans in the marketplace; it is what constitutes the market process. Some plans will prove more successful than others, some will have to be modified to some degree, some will fail. What emerges is a structure that is not planned by anyone in its totality but is the result of many individual actions in the pursuit of profit. It is an unplanned structure that has a logic, a coherence, to it. It was not designed, and could not have been designed, by any human mind or committee of minds. Thinking that it is possible to design such a structure or even to micromanage it with macroeconomic policy is a fatal conceit. The division of labor reflected by the capital structure is based on a division of knowledge. Within and across firms specialized tasks are accomplished by those who know best how to accomplish them. Such localized, often unconscious, knowledge could not be communicated to or collected by centralized decision-makers. The market process is responsible not only for discovering who should do what and how, but also how to organize it so that those best able to make decisions are motivated to do so. In other words, incentives and knowledge considerations tend to get balanced spontaneously in a way that could not be planned on a grand scale. The boundaries of firms expand and contract, and new forms of organization evolve. This too is part of the capital structure broadly understood.

Hayek emphasizes that,

the static proposition that an increase in the quantity of capital will bring about a fall in its marginal productivity . . . when taken over into economic dynamics and applied to the quantity of capital goods, may become quite definitely erroneous.

Hayek stresses chains of investments and how earlier investments in the chains can increase the return to the later, complementary investments. However, Hayek is primarily concerned with applying those insights to business cycle phenomena. Also, Hayek never took the additional step that endogenous growth theory has in highlighting the effects of complementarities across intangible investments in the production of ideas and/or knowledge. Indeed, Hayek explicitly excludes their consideration:

It should be quite clear that the technical changes involved, when changes in the time structure of production are contemplated, are not changes due to changes in technical knowledge. . . . It excludes any changes in the technique of production which are made possible by new inventions.

…….