The Austrian Economists

Are people “naturally” libertarian (in the virtual world)?

I recently listened to Edward Castronova’s EconTalk podcast (hosted by Russ Roberts) on the Exodus to the Virtual World (e.g. Second Life, see here).   Castronova’s comments on the rising importance of the virtual world are worth listening to. There are plenty of ideas that relate in one way or another to Austrian economics and freedom. For instance:

• Real people buy and sell land and other things in the virtual world spending real money. Why would anyone spend money to buy land in a world that doesn’t exist? Well, why not? Isn’t valuation subjective? (Artificial) scarcity is necessary in the virtual world because a world without any scarcity would not be interesting in the end. It is because we have to strive for things that we find the quest valuable—even in the virtual world. We shouldn’t be surprised that scarce virtual things are valuable.
• The numbers show that more and more people are “migrating” from the real world to the virtual one. Castronova made the comment that one important aspect of the virtual world is that there are no barriers to migration: people can go in and out without any problem (and the capital costs necessary to migrate, such as having a computer and Internet access, are small). As one would expect, the freedom of movement of persons (whatever that means in this case) is valued by individuals.
• The virtual world could become, to some extent, a competing alternative to real life. Hmmm, perhaps. I think until we have games such as the ones described in eXistenZ or in Cypher, it is hard to see how this could happen.
• Castronova also made the comment that people could perhaps one day vote with their feet and migrate to the virtual world to escape bad politics in the real one. I am not sure in which way this could be true, but that’s an interesting thought.
• Finally, one of the most fascinating reasons why people like the metaverse seems to be (libertarian) social justice. Indeed Castronova argues that because everyone starts on an equal footing in terms of distribution of physical assets (i.e. zero), people seem to accept the distribution of incomes and the allocation of property that result. Game participants are not envious of each other. Some people choose to work and invest more than others, some people are smarter than others, but nobody cares whether this makes the end result more “unequal.” In other words, it is as if the system of natural liberty based on deontological ethics (i.e. a situation is just if the process that led to it is just), as cherished by most libertarians, was a well accepted standard in the virtual world. That’s interesting. It may be true precisely because people know that it is not reality. This may also be a selection bias issue. And perhaps it is too early to tell, the future may see a rising demand for the virtual redistribution of virtual incomes and assets…

Call for Papers: "Orders and Borders"

Last October, I had the pleasure of being invited to an event sponsored by the Atlas Foundation's Fund for the Study of Spontaneous Orders that brought together about 15 thinkers from various disciplines and places in the ideological arena for a weekend of excellent conversation and company under the guidance of Gus DiZerega.  One of the (emergent) outcomes of that weekend was a listserv.  If anyone is interested in signing up, send me an email.

Gus and Atlas have arranged for a second such conference and the Call for Papers is below the fold.  I would encourage any of our readers with an interest in spontaneous orders along the lines sketched below to consider proposing a paper.  It was a wonderful event and I would expect the same of this year's.

More Evidence That Andrei Shleifer Is the Most Insightful Economist of His Generation

In recent years economics has entered into the public imagination in a way that it hadn't for a generation.  It was not the policy disputes between Milton Friedman and John Kenneth Galbraith this time around, but instead economics as a tool of reasoning, and its wide application outside of concerns with inflation and unemployment, and growth and development.  Popular books in economics offered explanations why drug dealers still live with their Moms, the consequences of names on future earnings, and how to get your kids to wash the dishes.  These fascinating works in "freakonomics" demonstrate to all the great versitility of the "economic way of thinking".  But the issues of inflation and unemployment, and growth and development didn't disappear.  They just didn't get explained in this new brand of economic writing.

But the full coming to grips with economics after the Keynesian divergence is hard for many to deal with.  First, we have to recognize that while there may be macroeconoimc questions, there are only microeconomic solutions.  Second, we have to recognize that attempts to pursue command and control strategies with the policy tools of old Keyensianism (fiscal and monetary policy) are counter-productive for long term growth and economic development.  In short, scientististic pretension that affects both our analytical and policy work must be rejected.  Instead, the logic of choice, institutional analysis, and a variety of empirical approaches must replace highly formalistic models which get their realism only through ad hoc assumptions, and refined statistical estimation techniques that subtitute extended discussion of econometric methods for the analysis of the real-world problems they were intended to address.

While Andrei Shleifer will not agree completely with my assessment of modern economics, his work reflects in my opinion the concern with the logic of choice, institutional analysis, and a variety of empiricism to make sense of the important issues in economics, political economy, and public policy.  In his latest paper forthcoming in the Journal of Economic Literature, Shleifer demonstrates once again his status as the most insightful top-flight economist of his generation. 

Milton Friedman once famously remarked that there is only good economics and bad economics, not different schools of thought that define the terms good or bad internally.  As I have argued elsewhere, I think Friedman is correct in that assessment, but I would just add that good economics must be an economics that deals with our ignornance, the arrow of time, the role of special interests in political processes, and questions of the framework within which economic activity takes place.  If you read Friedman's review of Lerner's The Economics of Control, what I just said is what Milton Friedman himself also argued when he rejected economic analysis of practical problems as if it was in done in a vacuum. 

And as Shleifer points out in this paper --- Friedman was correct on the big picture questions of policies of economic freedom and economic growth and development as well.  The key issue for us as researchers, teachers, and as economic communicators to the general public is to see the link between the analytical approach and the big picture vision.  It may be the case that 9 out of 10 top tier academic economists don't, but the 1 who does (Andrei Shleifer) has had enough intellectual energy that for the past two decades he has done more than any other mainstream economists to identify the institutional pre-conditions of economic development and prosperity.

More on the Inflation Debate

Paul Walker reacted to my post on inflation and the RBNZ (see here). It is not clear, in his view, that central banks can distinguish relative price changes from price inflation (defined as an ongoing increase in the prices of all goods in terms of money). Relative price changes may impact the CPI in the short run. Thus, by having a price stability objective defined in terms of CPI, a central bank such as the RBNZ may react to relative price changes when it should remain neutral. I agree with Walker's view and I don't think my post implied otherwise. Here is my view of the issue (and those who are specialists of the discipline are welcome to comment).

The CPI is an imperfect measure of inflation, as it may capture, in the short run, relative price changes (which are not to be confused with inflation). However, a pure relative price change will only create a temporary change in the CPI, as it will be followed by a counteracting change once households adjust their spending pattern. However, the impact on the CPI may last for a while (depending on how it is defined). It is also complicated by the fact that households may borrow, which may dampen relative price effects to some extent (as their budget constraints vary). But borrowing should not have any impact if it is based on pure savings transfers. However, if household debt is based on money creation, it will have an inflationary effect until it is serviced (i.e. the reflux). Also, productivity increases may make it difficult to capture changes in relative prices from inflationary price increases, as they improve households’ budget constraints and mask the two effects to some extent.

Another issue with the CPI is the statistical measurement of true inflation. When statisticians tell us that there is one percent inflation, it may be overstated. For instance, the Boskin Commission came up with the view that the CPI in the US was overstating inflation by 1.1%. This is due to the difficulty of capturing quality improvements, new products, etc in the CPI (e.g. new cars priced at the same nominal price but that are of improved quality). From what I recall Stats NZ uses hedonic pricing measurements to capture the measurement problem (they may use other techniques as well), and they still have a bias in the realm of 0.5 to 1 percent.

This being said, in the medium to long run, one cannot hide inflation, as it always shows up in the CPI. This is why the inflation target central banks use should cover a period long-enough to enable central banks to adjust for the problems associated with measuring true inflation. One could have a -1% to +1% range (or -1.5% to +1.5%) over a two to three year period for instance, which is what the NZ Reserve Bank Act tried to achieve without complete success. The problem is that this could entail some deflation at times and deflation is politically difficult to sell. Deflation also reduces the seignorage of the central bank and thus is not in its interest.

In any case, it is crucial to distinguish the short run from the medium to long run because of the inability of central banks to assess correctly short run changes in the demand for money. I understand that the stance of RBNZ is that it shouldn't respond to “first round” effects (see its Monetary Policy Statement), meaning that it should let relative price changes follow their course without altering its policy.

The fundamental issue here is the extent to which central banks can assess changes in the demand for real balances in the economy in the short run. They cannot do it well. To some extent, central banks grope in the dark, as Mises explained (and the graph depicting inflation in my previous post is an illustration of this). This is why we should go back to a system of commodity money where the market, not central banks’ officials, is in charge. In the mean time, I believe a well-defined objective of price stability can go a long way to improve outcomes under a monopoly central bank system (which has happened in the last 15 years in NZ), even if price stability as such is difficult to define. In any case, remember that there is no money (including commodity money such as gold and silver) that is a perfect measuring rod of value: the value of money (in terms of all the other goods) will always vary to some extent (cf. Mises’s Theory of Money and Credit). Because of the nature of money, a perfectly unchanging price level (i.e. perfect price stability) is not achievable. However, good money is. As often, the question is one of alternative institutional systems.

My New Freeman Article

The January/February 2008 issue of The Freeman is now available online.  I have an article therein entitled "Free-Market Money:  A Key to Peace," (PDF) based on this blog post.  I argue that the classical liberal concern with keeping money production out of the hands of the state was, and is, a means by which its anti-imperialism could be effected.  Without recourse to the printing press, the State is that much less likely to be able to afford foreign aggression.  In fact, most central banks have grown out of the need for surreptitious forms of revenue, especially for war. The free bankers and the peaceniks need to get together and see their common ground:  if one believes in peace and opposes the warfare-imperialist state, one needs to consider seriously the arguments against central banking.  The beast needs to be starved.

One of the great things about having the time to blog this year (thank you SLU for your generous sabbatical/leave policy) is that it really can be a platform for first drafts of other things, or just a space to organize your thoughts in a less than fully formal way.  The transformation of a blog post into a Freeman piece is precisely why blogging is, or at least can be, really productive for a scholar.

Cross-posted at Liberty and Power.

Hayek Quote of the Day

Just read this in "The Trend of Economic Thinking" (it's the final paragraph) and it struck me as incredibly insightful as to the bind that those of us trained in economics, but with very strong desires to make the world a better place especially for the worst off among us, frequently find ourselves in even 75 years later when we engage in political discussions with those on the left and right.  Hayek's optimism and confidence at the end is an attitude well worth adopting, as is his belief that our differences with the Left are mostly "intellectual."

“And so I come back to the point from which I started – the isolation of the contemporary economist and the refusal of modern progressivism to avail itself of the knowledge he can provide – a knowledge which is the product of the only persistent attempt systematically to explore the possibilities of change. The peculiar historical development which I have sketched has brought it about that the economist frequently finds himself in disagreement in regard to means with those whom he is agreement with regard to ends; and in agreement in regard to means with those whose views regarding ends are entirely antipathetic to him – men who have never felt the urge to reconstruct the world and who frequently support the forces of stability only for reasons of selfishness. In such a situation, it is perhaps inevitable that he should become the object of dislike and suspicion. But if he recognizes the circumstances from which they spring, he will be able to bear them with patience and understanding, confident that he possesses in his scientific knowledge a solvent for differences which are really intellectual, and that although, at present, his activities have little effect, yet in the course of time they will come to be recognized as serving more consistently than the activities of those he opposes, the ends which they share in common.”

 - F. A. Hayek, “The Trend of Economic Thinking” 1933, reprinted in Collected Works Vol 3, p. 34.

The Disastrous Effects of Central Banking: Let’s Get the Story about Inflation in New Zealand Straight

As the prices of some traded goods have gone up and house prices are relatively very high, the New Zealand economy is experiencing “inflationary pressures.” This has opened the door to a debate on the sources of inflation (see for instance here)—with the current and the ex-Governor of the Reserve Bank of NZ (RBNZ) holding surprising views.

The New Zealand Reserve Bank Act of 1989 is one of the best pieces of legislation ever designed (by a government, that is). It has a single focus on price stability. Originally, the government and the RBNZ signed policy agreements to specify the inflation target (something that the US Federal Reserve doesn’t have). In 1990, the inflation target was 0-2%; it is now 1-3%.

In recent years, broader economic goals have been added to the mission of the RBNZ including avoiding “unnecessary instability in output, interest rates and the exchange rate” (Alan Bollard, Governor). There is now more fuzziness in the medium term about when inflation needs to be within the band. In other words, the RBNZ is in charge of doing more than strictly focusing on price stability. This raises some issues.

First, central banks have tried to do many other things (than focusing on price stability) in the past and they failed. Second, having different objectives enables the central bank to find excuses when the goal of price stability has not been met. And that’s exactly what has happened in the last three years in NZ: inflation has overshot the 3% band (up to 3.4% in 2006). Inflationary pressures have been mounting and it’s getting “harder” for the RBNZ to mitigate them. (To continue reading, click on the link below.)

 

Leeson in the JPE

Pete Leeson’s paper, “An-arrgh-chy: The Law and Economics of Pirate Organization,” appears in the current issue of the Journal of Political Economy. In the paper, Pete provides a detailed analysis of the mechanisms of self-governance that facilitated cooperation among pirates. You can read the entire paper here. Here is the abstract:

This article investigates the internal governance institutions of violent criminal enterprise by examining the law, economics, and organization of pirates. To effectively organize their banditry, pirates required mechanisms to prevent internal predation, minimize crew conflict, and maximize piratical profit. Pirates devised two institutions for this purpose. First, I analyze the system of piratical checks and balances crews used to constrain captain predation. Second, I examine how pirates used democratic constitutions to minimize conflict and create piratical law and order. Pirate governance created sufficient order and cooperation to make pirates one of the most sophisticated and successful criminal organizations in history.

The JPE also released a press release discussing Pete’s paper. Here is an excerpt:

While economists have long been fascinated with the financial organization of criminal enterprises, the impact of their political structure has long been overlooked. Piracy was a capital crime, so both the costs and benefits were quite high. But, as Leeson shows, pirates never lacked for “Brethren in Iniquity.” Plumbing the (often entertaining) court records of pirate trials, Leeson allows the pirates to speak for themselves as to why the pirate’s life was for them. Piracy exploded along with trade to the far-flung colonies. A captain of a trading ship was the representative of land-based merchants, and thus wielded complete authority—which was often abused—over the crew. Although a captain of a pirate ship wielded absolute authority in battle the pirates, in the words of one of their own, “constituted other Officers besides the Captain; so very industrious were they to avoid putting too much power into the hands of one Man.” Foremost among these officers was the quartermaster, who oversaw the distribution of provisions, division of booty, and general order aboard the ship.

This paper is part of Pete’s larger research project exploring the economics and governance of criminal organizations. He is also working on a book, The Invisible Hook, which is under contract with Princeton University Press and is scheduled to appear in 2009.

Please join me in congratulating Pete for these significant achievements.

Is Buffet a Misesian?

A little while ago, Warren Buffet explained that financial institutions that have bad-looking balance sheets because of the subprime loans and mortgage crisis should deal with the problem on their own, i.e. without the help of taxpayers (see here). This is pretty much what Austrians, especially Mises, have always advocated. When the downturn is on its way, there is nothing the Central Bank or the government can do to speed the recovery up. As Mises famously put it: “There is no means of avoiding [the] consequences of the preceding boom.”

Many of the mortgages the banks securitized in the last five years were bad to begin with. When a bank sells a mortgage to someone who has no outside collateral, at a variable rate, and with no deposit, it cannot be a good thing. The problem is that banks started doing this en masse in the early 2000s. The question is why?

The Economist last week (see here) had an article presenting recent academic works on debt securitization. They explain for instance that “by breaking the link between those who vet borrowers and those who bear the cost when they default, securitization led to the lax lending that both fuelled and felled America’s housing market.” They add: “the incentives to check on the creditworthiness of the borrowers were likely to be the weakest” in the situations where mortgage originators made bad decisions. In other words, “poor screening by mortgage originators intent on selling on loans was a significant factor in the housing boom and bust.” However, the article doesn't say much about the source of these bad incentives.

As Pete and Steve have explained it before, the FED’s easy monetary policy is THE main reason why banks came to face the wrong incentives. When inflation expectations are such that people believe house prices will continue to go up in the foreseeable future, even bad loans go through (and many went). All this was bad risk management and banks are now paying the price. Because securitization is now very complex, the question is whether there is a systemic risk for the whole economy as some have said. Buffet doesn’t seem to think this is the case as long as the natural clean up can take place. It will take some time, but if the government doesn’t interfere, the US economy will clean itself up of all its malinvestments. This sounds very Misesian to me...

Lastest Issue of Critical Review

I had been meaning to post something on this for awhile, but never got around to it.  For those of you who have been around Austrian Economics and libertarianism for awhile, you have probably come across Critical Review, edited by Jeff Friedman, in one way or another.  It's been around for about 20 years and has been a great outlet for a lot of Austrian and libertarian material over the years, and Pete, Dave and I can say we were in Vol. 1, Issue 1, way back in the day.

Starting with volume 19, it is now being published by Routledge and it looks terrific.  The latest issue contains an introductory essay by Friedman that both summarizes CR's history and provides a nice overview of the "project" he sees the journal engaged in:  bringing Hayekian-Austrian ideas about ignorance to the study of politics.  Rather than assuming, a la public choice, that political actors are self-interested and sufficiently knowledgeable to know which policies will best forward that self-interest, what does politics look like if we assume that both voters and political actors are ignorant in the Hayekian sense?  It will come as no surprise that Bryan Caplan has an article in this issue along with several contributions from political scientists on expertise, ignorance, and public opinion.

You can find the abstracts of the current issue here, along with subscription information.  Back issues are not currently available online but I know that Jeff is in the process of making that happen.  When it does, I'll let you know because there's a lot of classic articles in those old issues that are useful for those interested in Austrian economics.