From Solipsism to Social Order --- the function of the price system

Both Mises and Hayek argued that Walrasian and Marshallian traditions in economics (let alone heterodox traditions) missed the crux of the problem with socialism due to insufficient understanding of subjectivism.  The problem with socialism was not just a problem of incentives, but a problem of calculation.

Just as viewing the capital structure of an economy as consisting of heterogenous goods that have multiple-specific uses intensifies the coordination problem associated with capital combinations, so the focus on subjectivism intensifies our understanding of the coordinative properties of the price system.

Anthony Evans recently had a great post on Shackleian price theory which captures the essence of the dilemma. How is it that the private assessment of trade-offs in ones head become public information so that other can take that into account in making their private assessment of trade-offs in their heads, and how indeed does this take place in a way that coordinates the plans of actors in an economy in such a way that the most willing demanders and most willings suppliers exhibit a systemic tendency to realize the mutual gains from trade.  As Anthony's choice quote from Shackle clearly demonstrates, while Shackle might have been enthralled with Keynes's "dark forces of time and ignorance" ultimately he never loss sight of his teacher Hayek and his main lesson that with the division of labor comes the division of knowledge in society, and that the price system serves to coordinate the dispersed and often disparate plans of economic actors within the economy.

Comments

[Madison Classical Liberal]

Is it possible that middlemen (distribution specialists) are the main agents of bringing together the many privately-calculated (subjective) buy and sell prices? Buyers and sellers make their own value judgments but maybe they are paying the middleman for his service of collecting the many other subjective valuations so that the buyers and sellers can plan their future production or consumption levels given others' price valuations.

[Bill Stepp]

Has any Austrian ever written a criticism of Solow's growth theory? It seems to me that he doesn't even recognize that there are such things as (heterogeneous) capital goods and a structure of production.

[matthew mueller]

Shackle wrote a whole lot in his career, and I am sure one can find passages that allude to the coordinating properties of market prices in his work, but my reading of Shackle suggests nothing of the sort. Shackle was concerned early in his career with time and capital, then moved into the area of expectations (potential surprise, etc.). This led finally to his analysis of uncertainty (of the most radical sort!).

Shackle understood traditional price theory, and, as Boettke has argued, has written two books on the subject; but his own positive contribution to economics represents one of the most violent attacks on price theory (marginal productivity, distribtution, coordination, and equilibrium).

The economist who EVERYONE should read on this matter is GREG HILL. He has published several articles in Critical Review that subtly attack Austrian economics (and neoclassical orthodoxy) using the insights of Shackle. Now Horwitz is somewhat correct in noting that Austrians are different from neo-classical economists, and that it is therefore wrong to conflate Austrians with neo-classicals, but Greg Hill also recognizes this. He notes the ways in which Austrians have borrowed concepts from neo-classical orthodoxy to defend their conception of the coordinating properties of market prices (the loanable funds model, for example).

I am convinced that Keynes destroyed the foundation on which Austrian economics rests. Any careful reading of his work makes this clear, and only ideology can prevent the concession of this point. However, I think Austrians have something important to say when it comes to Keynes' view of capital and his emphasis on its scarcity rather than its productivity. He says that the prospective return on capital is a function of its relative scarcity, and that increases in capital goods will drive down its price. Now Lachmann is perfect here, and his work is a direct response to this theory (Lachmann quotes Keynes more than any other economist in his 1956 book). Unfortunately, contemporary Austrians don't seem much interested in capital theory, and so they have ignored this part of Austrian economics and have instead championed Misesian calculation and Hayekian coordination, which the libertarians are all too ready to eat up.

In short, economic calculation presumes the efficacy of market prices in disseminating knowledge. My impression is that Austrians more or less take this point for granted, while others (Keynes and Shackle) resisted this point by looking to uncertainty and time.

[Grant]

"I am convinced that Keynes destroyed the foundation on which Austrian economics rests. Any careful reading of his work makes this clear, and only ideology can prevent the concession of this point."

You've said this numerous times, but you've never gone down to brass tacks on what exactly Keynes destroyed. Unfortunately, Keynes is far from clear in his writings, especially compared to some of his critics. Can you explain precisely what he blew up?

I agree that in his General Theory he brings up some shortcomings of the loanable funds model, but I don't believe he successfully falsifies it, only shows it to be incomplete. He tries to show that investment doesn't follow savings, but by my reading he only shows that investment might not follow savings depending on how the dependencies work out.

Re: the efficacy of the market price in disseminating knowledge, I believe experimental results in prediction markets (as well as the theoretical results of mechanism design, though I am only familiar with the former) have shown markets to work in this regard. I'm sure many of the GMU profs here will correct me, but I believe Vernon Smith's experiments have also shown market prices to reflect underlying value under certain conditions (such as knowledgeable traders; a condition we'd usually, though not always, expect to find in real markets).

[Peter Boettke]

Grant,

Vernon's experiments were designed to demonstrate precisely that we get market clearing even in environments where agents have limited to little information.

Matthew,

Have you come to the position that the world can be neatly divided into those who are evil, those who are stupid and those who agree with Matt Mueller? This will be a very unhealthy position to settle on. You will in fact drive yourself nuts as you isolate yourself from others. No, there are many people in the world that have nothing but the best of intentions, and in fact are quite bright, but who just don't see the world the way you do. I am not saying that we throw up our hands and just say we can all agree to disagree. Some "readings" are more justifiable than others. But charges of ideological blinders really should be a last resort in attempting to understand anothers position that deviates from yours. This is why I also thought the "hermeneutics of suspicion" to be a very unhelpful way to do critical review of the literature.

Better to try to understand what others are saying, and why their reading is the plausible one, and how to criticize that.

Pete

[Dave Prychitko]

The potential of Keynes's argument to smash the Austrians fell to pieces once he introduced his choice of units discussion. Keynes develops something altogether different -- not a theory of choice, however broadly or narrowly construed, but a theory of aggregate interactions that are no longer tied to any clear notion of choice and decision (ah, Shackle's notions).

This did put the Austrians and others on the defensive, and wasted their time in the process.

[Steve Horwitz]

Matt wrote:

"In short, economic calculation presumes the efficacy of market prices in disseminating knowledge."

If prices weren't "effective" at serving as knowledge surrogates, Paris would never get fed. The Austrian argument doesn't "presume" efficacy. The fact that economic calculation, despite all of its imperfections (recognized from Mises on down through modern Austrians), enables individuals to navigate through the fog of uncertainty, is not a presumption but a falsifiable claim backed by empirical evidence. Economic calculation does, in Mises's words, "suffice" to provide that guiding function. We see it every day.

Recognizing the "efficacy" of the price system at guiding economic action is not the same as saying it's perfectly efficient, or that it can't involve disequilibrium prices. If you think the Austrians are claiming otherwise Matt, you need to do some more reading.

[liberty]

Even without a complete understanding of the subjectivism underlying the price system, and the calculation problem, some of the "Walrasian and Marshallian traditions" I think have come to understand the problems of socialism; and I think Austrians would do well to give them credit where it is due.

For example, Stiglitz got a bunch of it in his book Wither Socialism. I pointed out a few in a recent blog post, I'll copy the most relevant here:

"3. Stiglitz does as well as Hayek showing the paradox of perfect competition assumptions, such as complete markets and perfect information (or "informed" markets), see e.g. p. 38

4. Stiglitz points to the incentive/calculation problem of using targets which specify output not according to profit, but according to a single measurement that so plagued socialist economies, calling it the problem of not fully specifying commodity prices. p. 85

He points to this later as a way in which planning failed in precisely the way that the neoclassical model failed, when he invokes the planners inability to specify commodities as creating "an incomplete set of markets" and concludes that it is "one of the reasons that the neoclassical model fails" and "Exactly the same set of factors are at work in explaining why socialism fails." p. 198-99

5. The theory of contests as a replacement for perfect competition-- isn't this very similar to the Austrian concept of competition as a driving force (Kirzner) or a market process (Mises)? Although he finds some areas in which he believes competition can be destructive, he indicates that the active role of the competitive driving force of competition is crucial to its ability to induce innovation, cost minimization, and improving quality. Hence he finds "not only that the ordinary usage of the term competition is not well reflected in the traditional economic paradigm of 'perfect competition' but that the traditional perfect competition model may give us only limited insights into the roles that competition plays." p. 115"

[Bill Woolsey]

What would be specific examples of the dark forces of time and uncertainty resulting in market prices failing coordinate?

For example, in the aftermath of Hurricaines earlier in the year, there were periods of time when people couldn't find gasoline in cities like Greenville, SC. This seems to me a situation like Paris not being fed. Would this be the type of thing that are supposedly caused by time and uncertainty?

A second example would be the the housing price bubble. Contruction firms built a large number of homes. I presume they anticipated profits by
comparing the selling prices of houses in 2006 to the prices of the resources. I don't know for sure, but I presume they have purchased durable equipment specific to housing construction whose expense will not be covered. Is that something caused by the dark forces of time and uncertainty?

During the third quarter of 2008, real production appeared to drop by .5%. Nominal consumption spending fell at a 5% annual rate in November. The unemployment rate is rising. Investment expendure has been dropping rapidly for some time. Is this somthing that is caused by the dark forces of time and uncertainty?

The nominal interest rate on one month T-bills is about .01 of one percent. It seems likely that this is much less than the opportunity cost of the funds to finance round about methods of production. (OK, I'm guessing. But on the Cato-Unbound blog, DeLong explained that interest rates should reflect 2% productivity growth plus some some kind of proper risk provision.) Is this the problem caused by the dark forces of time and uncertainty?

[matthew mueller]

Grant,

I cannot take up the space to write what it is I think Keynes did in his revolution; I even doubt I could recall now everything it is I believe he did. But Keynes did explicitly challenge the logic of neo-classical economics, and this required him to re-state things in new and novel ways. Professor Prychitko is correct in pointing out the importance of Chapter 4 in The General Theory (choice of units). In fact, all of Book II is very important in explaining and introducing the definitions (e.g., savings, investment, time, income, etc.) Keynes uses in his more direct attack on neo-classical economics contained in Books III and IV. It seems that if one wanted to challenge Keynes, one would have to go back to the definitions found in Book II. Although Keynes gave the impression that Book II was not terribly important, it seems obvious to me that it is.

Professor Boettke,

I affirm nothing in the positive but our own fallibility. I therefore don't quite understand your criticism. I suppose you can take my hostility of the Austrian dogma as itself being a kind of dogma, but that is certainly not what I intended. My point in writing on this blog is not to convince you that I am right, but to get you to see that you *might* be wrong (this is not the same thing). My impression is that very few contemporary Austrians are of this view. I read the professional journal articles, the pieces in the Freeman and the Free Market, and the blog posts, and I basically see political statements being made by followers of a dogma. The only reason you have isolated me from the Austrian community is because I have challenged this dogma. It is a good thing we live in an Open Sociey. The heretic need to fear for his life!

Professor Horwitz,

I have read Thomsen's book. I understand that the Austrian position is one of disequilibrium prices. It is a compelling theory. But A LOT is involved in this. The society in which the market is embedded is terribly complex. It is not a question of markets vs. government. Also, the question of what criteria to use in the evaluation of the efficacy of market prices is also important. Psychology, sociology, and philosophy have a lot to say on this. Suffice it to say that it is not simply a matter of physically moving material goods to certain locations (say, Paris).

Bill,

Some good examples, but beware of the Austrian response. Any perceived failure in markets is invariably attributed to government intervention. You first have to challenge the dogma before you can adduce empirical evidence in favor of the dark forces of time and ignorance.

[Steve Horwitz]

Matt writes of the Austrians:

"Any perceived failure in markets is invariably attributed to government intervention."

Once again, Matt, you reveal your lack of understanding. Austrians agree that markets "fail" all the time - if by "fail" one means "do not perfectly coordinate human behavior." Feel free to read Heyne, Boettke, and Prychitko if you want to see this argument presented in its most simple form.

The question for Austrians then becomes whether alternatives to markets can *better* coordinate human behavior given the consistent failure of the market to do so perfectly. For several generations of economists, the "failures" of the market were an ipso facto case for attempts at government intervention. The Austrian argument (buttressed by public choice) suggests that such attempts are very likely to make matters worse than the imperfect market.

I know you know all of this Matt, but I'm simply not going to let you get away with repeating your nonsense to the readers of this blog. You want to criticize Austrian economics? Fine, but get the story right.

And as for Pete's comments: you should re-read what you wrote on your own blog about the rejection of your journal submission.

http://post-austrianeconomics.blogspot.com/2009/01/my-paper-on-economic-rationality.html

Your reaction to those comments is a perfect example of what Pete's talking about. Nowhere in your post or in the comments do you give any sense at all that *you might be wrong or that you might not have represented ideas fully and accurately.* You're so convinced of your own brilliance that you start to complain about the editorial/peer-review process. Doing so is a sure sign of having divided the world precisely as Pete says: the evil, the stupid, and those who agree with Matt.

I have over 20 years of experience with the journal submission process, and a stack of rejection letters to show for it (and a few acceptances). My advice? It's a poor scholar who blames the process and referees rather than engaging in serious self-criticism.

I don't care what sort of graduate program you decided on - your attitude is a surefire path to academic isolation and crankdom.

[Steve Horwitz]

One more thing Matt: I know Bill Woolsey pretty well. I believe you've utterly misread his post. Bill is a damn fine economist and one who is quite sympathetic to Austrian economics, not to mention being a long-time libertarian activist. Each of his examples can be understood as the result of various government policies interfering with market coordination processes, rather than the forces of time and uncertainty per se.

If you think those are "good examples" that support your point, I now understand why you have so much trouble reading scholarly work with accuracy.

[Bill Woolsey]

Thank you for your response, Matt Mueller, but I wasn't coming up with a list of problems that I thought were caused by time and uncertainty. I was rather hoping that people (including you) who have a better understanding of this literature would rank those problems I listed along the lines of "more like this kind of problem, less like that kind of problem." I wasn't listing things where I would be able to respond--aha..that specific problem was caused by some government intervention. I have varying degrees of confidence in my ability to provide evidence for such a claim in those specific situations. What I was asking from anyone, including those skeptical of these worries about the dangers to market coordination due to time and uncertainty, is which sort(s) of problem(s) would be likely to show up, in the absense of some government intervention, because of time and uncertainty. All I have so far, is, the implication that it is all of them in equal measure.

Thank you Steve Horwitz for your kind words. I certainly count myself as a libertarian economist and share the perspective Steve shared in the earlier post--market are imperfect, but the alternatives are generally worse. But, of course, perhaps I am wrong.