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« Ed Stringham: An Austrian in Austria and Critical 'Instigator' of the Youngest Generation of Austrian Economists | Main | The Contemporary Relevance of The Sensory Order »

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Who would you argue is the better price theorist: Stiglitz or Kirzner (and why)?

Kirzner --- see my review of Stiglitz's Whither Socialism in the JEL. The reason, Stiglitz over-estimates the role of equilibrium prices in the defense of the market order, and under-estimates the role of disequilibrium prices in spuring entrepreneurial discovery.

Stiglitz is brilliant, but myopic (he found a hammer and the rest of the world is a nail).

To put this more technically --- I would suggest that Fisher's Disequilibrium Foundations of Equilibrium Economics explains why Kirzner is more important ultimately to economic science than Stiglitz, and Shleifer's Inefficient Markets work on behavioral finance demonstrates that while markets may not be first-best Pareto Efficient, they are nevertheless EFFECTIVE --- it is the idea of effective markets (or what could be called adaptive effiency) and the complex coordination of economic affairs these markets can engender that underlies the defense of the market.

Pete

As a follow up, Esteban Thomsen's very under-appreciated *Prices and Knowledge* remains a very good treatment of Stiglitz's work from an Austrian perspective.

The Thomsen book has no discussion of efficiency wage theory nor credit rationing. They are arguably Stiglitz's big contributions.

Am I missing something?

Efficiency wage theory and credit rationing are but applications of his fundamental theory of asymmetric information and imperfect market structure and it is the fundamental theory of information and the meaning of competition which Thomsen is discussing.

So yes I would say you are missing the legs being cut out from underneath the applications. But this is not a good forum for discussing this. I have some discussion of these issues in my What Went Wrong With Economics paper from many years ago.

Pete

So you would argue that Thomsen has demolished Stiglitz on credit rationing et al even though he does not mention those applications?

I should have been more specific: Thomsen's book addresses the whole issue of equilibrium and disequilibrium prices and the implicit welfare standard that Stiglitz adopts. As Pete says, the other theories are extensions/applications of that argument. Thomsen's book in and of itself is only worthwhile for its discussion of the eq/diseq issues.

And for the record, neither Pete nor I used the word "demolished" or anything like it. Thomsen's book is a "very good treatment" was my phrase and I'll stand by it.

"So yes I would say you are missing the legs being cut out from underneath the applications"

Sounds like PB thinks them demolished to me.

But apologies if I have misread.

Reading through this post I couldn't help but think the same thing about Dr. Boettke: he is a very smart man, but his uncompromising faith in free markets prevents him from appreciating the incisive and technically sophisticated arguments that are made by opponents of laissez-faire. I would not call Dr. Boettke sloppy or myopic, however.

Now, I can only briefly comment on the economists Boettke mentioned. Friedman's work on monetary theory has been challenged by many professional economists, in particular Post Keynesian economists. His thesis that a constrained money supply prolonged and exacerabted the Great Depression gets the causal chain of production and money supply backwards. Money creation chases production, production does not follow increases in the money supply. And for Hayek's work on business cycles and monetary theory (work for which he was awarded the Nobel Price), there are many problems with it. The best article that deals with these problems is probably Shackle's "Hayek as Economist" reprinted in his book "Business, Time and Thought." Very briefly, the most important decision concerning investment is not the length of the production process, but the projected length of the durability of those intermediate goods. For example, while it may take a year or two to build a house, it will remain in use for a hundred years. The latter time-lapse is the most important consideration. Also, the idea of a perfectly "linear" sequence of production stages confuses the way in which one aspect of industry is responsible for the maintenance and performance of other industries. Also, the theories of Buchanan and Lucas only work if we presume that market agents are perfectly rational. And for Coase, the economists that have pursued his original query implicitly assume that all forms of organization are necessarily efficient because this is what we observe in the real world.

My point in all this is that the verdict is still out on not only the tenability of these contributions to economic theory, but their conclusiveness and applicability to the real world as well. Once you adopt the neo-liberal framework, then of course government seems to be the source of all our problems. Reading Coase, Friedman, Hayek and Douglass North will only confirm this because they take the efficiency of market operations as given. Their empirical investigations start from this premiss.

Let's see Matt:

Pete said: "For his work on asymmetric information, Stiglitz was justly awarded the Nobel Prize in Economics."

and he said: "Stiglitz is brilliant, but myopic"

Yeah, he can't appreciate the arguments of his opponents. Nope not at all.

What do you want him to do Matt? Agree with people he actually disagrees with? Isn't it possible that Pete really DOES understand and appreciate Stiglitz's arguments, but just finds them WRONG? Is it only possible to appreciate an argument if you agree with it? What does one have to do in your eyes to be seen as "appreciating" an argument but still disagreeing with it? And why doesn't what Pete has done here qualify?

"Is it only possible to appreciate an argument if you agree with it? What does one have to do in your eyes to be seen as "appreciating" an argument but still disagreeing with it?"

Maybe explain clearly where the argument is wrong (other than just sloganeering about plan coordination, etc). It would surely make for a publication also. Look at Lorne Carmichael's bonding critique. Short and hit well.

Pete said: "I have some discussion of these issues in my What Went Wrong With Economics paper from many years ago."

So, apparently, PKS, he has done so.

Dr. Horwitz,

I wasn't attacking Boettke in my post. I was only pointing out that dismissing the work of Stiglitz by relying on the work of Nobel Price winning economists is not a good way to make a case. Let me stress that I have the highest respect for Austrian economics and you and Dr. Boettke. I am posting my thoughts on this blog because I enjoy hearing how you two will respond to me comments. It is an education for me. I am not out to attack or humiliate you guys.

With that said, I think there could be more dialogue between the Austrians and the proponents of information asymmetry. I admit to having not read Thomsen's book yet, but it looks very good. I have, however, read Boettke's article "What Went Wrong with Economics?" His discussion of Grossman and Stiglitz is very brief, appearing on pages 29-30 of a 55 page article. His point is that Stiglitz's interpretation of Hayek is incorrect because Hayek conceived of disequilibrium prices as being soures for the discovery and elimination of error. Boettke's treatment of Stiglitz and Grossman's own theory is not discussed.

About the role of relative prices as signals for entrepreneurial discovery, I would urge Austrians to consult Lachmann's 1956 book on capital theory. In the second chapter, he makes it very clear that disequilibrium prices cannot convey the sort of information that is required for market adjustment and correction. Read Lachmann's chapter "On Expectations" in his Capital and Its Structure book. Indeed, this point is crucial for Lachmann's analysis of the structure of production. Incorrect prices preclude us from summing up the market values of capital and arriving at an accurate measure of the wealth of an economy. Now I have talked with Peter Lewin about this point, and he is correct in pointing out that elsewhere Lachmann does endorse the Kirzerian theory of entrepreneurship and the positive role disequilibrium prices play in the correction of error. But this does not resolve the conflict that exists between Austrian capital theory and Austrian entrepeneurship.

I'm looking at chapter two and I don't see the argument you do Matt. Yes, LML says disequilibrium's pervasiveness means that prices cannot *perfectly* convey information and assure equilibrium. But he also says:

"Even [in a world of continuous change] price changes do transmit information, though now incomplete information"

He then goes on to discuss the way that markets weed in and out better expectations about the future. He says:

"successful expectations, which stand the test, are on the whole, more likely to reflect 'real forces' than unsuccessful expectations. And those whose expectations are never successful are likely to be eliminated by the market process. Moreover, as we shall see in Chapter IV, the market also tends to evolve institutions which mitigate interpersonal and intertemporal inconsistency."

It's also worth noting that in the same chapter, LML engages in an extended critique of Shackle.

Bottom line Matt, I don't think you can use that chapter to argue that "he makes it very clear that disequilibrium prices cannot convey the sort of information that is required for market adjustment and correction."

He makes it clear that disequilibrium prices cannot produce EQUILIBRIUM because they do not convey ALL of the information, but he believes they are a key part of the process of "market adjustment and correction," short of assuring equilibrium. This is especially the case when you combine his analysis of disequilibrium prices with his analysis of institutions.

I see nowhere that LML denies that disequilibrium prices are not signals for entrepreneurial discovery, although nothing guarantees that any given act of entrepreneurship will be "right". I only see an argument that says we cannot expect them to produce general equilibrium. They do indeed communicate information that informs the expectations of actors.

The point is that disequilibrium prices do this imperfectly but better than any alternative.

It's ironic that some of Stiglitz comments on this article could be classified as 'neo-liberal'.

"Nor did markets prepare us well for soaring oil and food prices. Of course, neither sector is an example of free-market economics, but that is partly the point: free-market rhetoric has been used selectively – embraced when it serves special interests and discarded when it does not."

He discovered that politicians who use free-market rhetoric aren't ardent free-market supporters. What a surprise!

"For all Reagan’s free-trade rhetoric, he freely imposed trade restrictions, including the notorious “voluntary” export restraints on automobiles."

And how the rhetorical use of free-market ideas prove that free-market recommendations are bad? Stiglitz should honestly respond if he prefers the actual or the rethorical policies of Reagan.

"The only time that the Bush administration turned green was when it came to ethanol subsidies, whose environmental benefits are dubious."

Since when ethanol subsidies are 'neo-liberal' policy?

Matt and PKS ---

What is unclear about the statement that Stiglitz overestimates the role that equilibrium prices play in the defense of the market, and underestimates the role of disequilibrum prices in producing market coordination? Apparently Matt is caught in the same trap as Stiglitz as Steve Horwitz pointed out concerning Matt's misreading of Lachmann.

It is also why in response to PKS I recommended Franklin Fisher's Disequilibrium Foundations of Equilibrium Economics, and also Shleifer's Inefficient Markets. No sloaganeering going on, but arguments related to foundational price theory and the market system. On my 1997 piece, I often forget what was in the final version --- I have a more extended paper from that period which was folded into that one and then edited away discussing knowledge conveyance, knowledge discovery, and knowledge use. Like Stiglitz, I tried to develop the argument from Type 1 and Type 2 errors and discuss the bias in systems, but following Kirzner's discussion in Market Theory and the Price System, I point out that the types of errors in a world of scarcity actually imply one another. Thus, the critical question is one of error detection, adjustment, and error eradication through disciplining devices (what Steve Horwitz alludes to in the Lachmann's discussion of weeding in and weeding out ---- see the paper by Leeson, Coyne and myself in the Review of Political Economy on "Does the market self-correct?").

Matt -- I would suggest that beside post Keynesian sort of criticisms you might find more "serious" economic criticisms in the work on irreversible investment by Dixit and Bernanke --- I also think this work has several points of commonality with Austrian work on capital theory. Whereas standard theory is caught in a conundrum by these puzzles, Austrian theory I would suggest offers arguments as a way out.

Finally, Matt I am not sure you have captured the situation correctly if you believe Coase, Friedman, Hayek and North PRESUME market efficiency rather than provide arguments for why market forces tend to work. In fact, Hayek's entire project is against arguments by assumption (as the market socialist did).

Dr. Horwitz,

Yes, those passages are all in the chapter, but you are only entirely there yet. The reading you are giving Lachmann is what he would call a "quasi-stationary state" which he described in the following way: "In this state knowledge is guided by prices functioning as signposts to action." This state is flawed because such a model posits a world in which "changes are few and far between, and each change has had its full repercussions before the next change takes place." It is on this model that Lachmann takes his cue and initiates a grand departure from the "quasi-stationary state".

Again, describing the "quasi-stationary state", Lachmann writes "Every significant change in needs or resources expresses itself in a price change, and every price change is a signal to consumers and producers to modify their conduct. Thus people gain knowledge about each other by closely following market prices." Kirzner couldn't have put it better! But this is not Lachmann's view. Here is Lachmann's own position: "But in the world in which we are living change does not follow such a convenient pattern. Here knowledge derived from price messages becomes problematical." He goes on to say that information that is communicated through prices often get "jammed" or "delayed" and it becomes increasingly difficult to find out the order in which they were sent. And perhaps most importantly, "today's knowledge may be out of date tomorrow, hence no longer a safe guide to action." Also speculation may give rise to anticipations of tomorrow's prices without first fully adjusting to today's prices.

Lachmann then develops his theory of expectation formation on incomplete (and misleading!) information. Now I don't see how you can impose on Lachmann's theory the view that disequilibrium prices are signals for entrepreneurial discovery. But I am not denying that there are "equilibrating" passages of market adjustment in Lachmann's book. But you have to understand Lachmann's project, and how he classifies different approaches. The interpretation you have given Lachmann is not his own; it is instead the "quasi-stationary state [which] is the background of most neo-classical economics" (page 21).

Matt,

Two quick things:

1. Disequilibrium prices provide information. Imperfect and incomplete (to quote Neil Peart), but information nonetheless. Such imperfectly informative prices are part of what entrepreneurs rely on to do what they do. They must interpret those prices and sometimes they're right, and sometimes they're wrong. But without them, there is no chance at getting it right. Thus disequilibrium prices are aids to entrepreneurship. This is Mises's argument as well.

2. I think you have fallen for a false dichotomy where if we can't talk about equilibrium, we can't talk about order in the economy. Rejecting that binary was the research agenda of the BHP "Beyond Equilibrium Economics" paper. It comes in two propositions:

a. Paris gets fed.
b. Equilibrium does not describe the real world.

Our research agenda was to ask the (very Mengerian!) question:

What are the nature of the systematic processes within markets that despite their being constantly in disequilibrium nonetheless produce orderly and pattern-predictable outcomes?

There is a third way. Rejecting equilibrium theorizing does not mean the denial of systematic market processes. And I would suggest that Lachmann agrees with me there.

Matt,

All of those points about incomplete and imperfect information are Hayekian points about why the state of equilibrium does not follow. These points do not undermine market process theory, they undermine general competitive equilibrium theory. However, again see Fisher's Disequilibrium Foundations for why even ge theory can be salvaged IF and ONLY IF the disequilibrium adjustment theory articulated works (not presumed, but works).

We can talk Lachmann all you want when we get to FEE --- at one point I was completely enchanted by him and Shackle. It might sound strange to you, but I was shaken of this by Kirzner's The Meaning of Market Process. Don't get me wrong I am still enchanted by LL, it is just that IK provides an answer.

Pete

I must confess some confusion as to the way this conversation has gone as a reaction to my post. First in my post I relied on Keynes's brilliant biographer Robert Skidelsky's assessment that Stiglitz had lost his way as a scholar and has yet to find his voice as an economic popularizer. My terms myopic was introduced to explain Skidelsky's assessment of intellectual sloopiness. Second, I pointed out that Stiglitz makes empirical assertions, but with no real data analysis in his op-ed. This is tied to his claim that neither economic theory nor economic history provide an argument for liberalism. He is just wrong on the theory and the facts. We should discuss that. Third, I contrasted an op-ed which impacts public opinion on these issues, with a Journal of Economic Literature paper which impacts professional opinion. My claim was that thankfully Stiglitz's attitudes have not YET impacted professional opinion, and in fact that the evidence provided by papers like Shleifer's counters almost every single empirical claim that Stiglitz makes on the relationship between liberalism and growth, development, and even equity.

Why the conversation hasn't really gone in that direction remains a mystery to me.

As far as Austrians are concerned, Stiglitz is not well-founded. To call corporate welfare, enormous defense expenditures and budget deficits free-market policies defies all reason. And why do "liberals" and socialists always insist on calling classical liberals "neoliberals", Hayek "von Hayek," and multinationals "transnationals"? Unfortunately, other pro-market economists are (somewhat) guilty as charged: Buchanan, Becker, and V. Smith have all recently endorsed McCain (and have endorsed W Bush in the past). I really do appreciate that Austrians such as Pete, Steve etc. [and D North] have not made this Chicagoan mistake, and so there is no guilt by association and Stiglitz is just totally wrong.

Matt,

I think Lachmann's point is that Kirznerian/Hayekian market coordination works as far as knowledge coordination is concerned, but not for coordination of expectations (see his 1976 paper). But this argument is actually more pro-market than it seems: rents (e.g. labor markets, rental housing, restaurants) as well as markets for perishable goods do exhibit coordinating tendencies. Markets that deal with the world in 1000 years do not. Institutions may however stabilize expectations in the medium term. Theoretical scorecard:

Short term: Markets 1 Central planning 0
Medium term: Markets .5? Central planning 0
Long term: Markets 0 Centreal planning 0

So even with Lachmann's qualifications, markets are superior in several important instances, even before we look at the empirical evidence!

Pete mentioned Franklin Fisher's book. This is probably the most important neoclassical book written to the contemporary Austrian project.

Steve said "successful expectations, which stand the test, are on the whole, more likely to reflect 'real forces' than unsuccessful expectations."

The problem with this language, Steve, and probably the reason you must place ' ' around real forces, is that you use real forces too vaguely. What are the real forces? The scarcity of inputs? Realized profits and losses? Emerging supply and demand conditions, and their potential to coordinate plans?

If so, why call these real?

(Side point of mine, in three paragraphs: *All* are phenomena of the mind -- including scarcity. Not merely scarcity as a concept of the economist's mind, but scarcity from the chooser's perspective...

... Now we all face scarcity in general. You might wish (or might not wish) to refer somehow to that notion of scarcity as something 'real.' BUT, having said that, what I consider scarce (old time music, for example) you probably don't consider scarce, and so on, and this is important because the actual entrepreneurs out there are trying to profit from serving the demands of *these* particular scarce goods. While demand for all goods emerges from scarcity -- which you might say is somehow a 'real force,' but now you're into a collective or aggregate concept here! -- I can't see how you can call any particular individual or group demand for a *particular* good a 'real' force....

... In short, I am not convinced that any particular supply or demand is 'real.' At least, I'm still not sure how your term is defined or how it applies. Placing quote markets around it allows you to evade THAT issue -- an argumentative strategy, but you've also pushed the Sensory Order analysis so where does it fit with your claims *here*?) This end my three-paragraph side issue, if it is a side issue at all.

---> Most important, you say in the above quote that "successful" entrepeneurial expectations are "more likely" to "reflect" these so-called "real forces" of yours. But is this just a tautology? If the expectations are "more likely," can you provide examples where successful expectations do NOT reflect real forces? (Plus, can unsuccessful expectations actually once in a while "reflect" real forces?)

Pete said "We can talk Lachmann all you want when we get to FEE --- at one point I was completely enchanted by him and Shackle. It might sound strange to you, but I was shaken of this by Kirzner's The Meaning of Market Process. Don't get me wrong I am still enchanted by LL, it is just that IK provides an answer."

"An" answer is a good choice of words. This way, Pete, you can always respond with an "I said an answer, not THE answer." Another argumentative strategy, I suppose.

BUT, I recall that Kirzner also says in the book -- which indeed is his best statement of his theory of entrepreneurship -- that entrepreneurs can be WRONG even though their market is fully coordinated! I think he uses the example of the horse-drawn carriage just prior to the introduction of the automobile. Kirzner argues that we can assume the carriage market is fully coordinated but because people would rather have a car (before they learn it is exists!?) the entrepreneurs, even though they are serving and fully coordinating the present demands of the consumers, HAVE IT WRONG.

So Steve, have I now provided you with an example of "succesful expectations" failing to reflect real forces? Or is it succesful coordination not reflecting real forces? I don't know. I can see where Kirzner -- as an equilibrium/disequilibrium theorist -- might try to say that although we presently have full coordination in the carriage industry we really do not have (a sustainable?) equilibrium because it is all about to change, but Boettke, Horwitz and Prychitko fought against that kind of disequilibrium approach. So how does THAT square with your continued defense of our earlier paper? And Pete, where are you on all of this?

Lastly, Steve said "Rejecting equilibrium theorizing does not mean the denial of systematic market processes. And I would suggest that Lachmann agrees with me there."

Yes, Lachmann would.

You haven't mentioned who wouldn't agree with you there: Kirzner, Rothbard, Garrison and most other Austrians!

Dave,

The quote you spent so much time deconstructing is actually Lachmann's, not mine. You might want to ask him why he put "real forces" in quotes. ;)

I'll try to address the underlying questions another time, as I'm about to board a plane shortly.

Geeze. Again (I've done this before somewhere on this blog) as Roseanne Roseannadanna so often said: "Nevermind."

Sorry Steve. I thought it was part influenced by the "really real" stuff from Boettke and Beaulier. But they can't have a backward influence on the once-living Lachmann, and a once-living Lachmann shouldn't be confused with a now-living Horwitz.

Enough from me. I quit. Too much of a waste of my time making mistakes like this.

"Pete said: "I have some discussion of these issues in my What Went Wrong With Economics paper from many years ago."

So, apparently, PKS, he has done so."

Sorry, but I find no argument in that piece that Stiglitz's efficiency wage model and credit rationing model are wrong.

Why is Stiglitz wrong to argue that the labor market and credit market will not clear?

Does Stiglitz not undermine the Austrian claim that markets 'work'? (Sure, 'work' is fuzzy, etc, etc).

"No sloaganeering going on, but arguments related to foundational price theory and the market system"

Sure - but those books are not by Austrian price theorists.

Also, could someone please explain to me what is going on in that Kirzner essay on induced and underlying variables. On one reading I thought he was pretty much ceding the whole game to Lachmann (but wanting to play a word-game where coordination still takes place in some 'sense'). On another reading, I found him more persuasive. On yet another reading I was just confused.

Incidentally, I highly recommend Dr Prychitko's essays demolishing Austrian welfare theory (the truly stinky work of Rothbard and Cordato). Why are those brilliant essays so little discussed by Austrians and so little known?

PKS,

As I said, I think my discussion of the efficiency wage model might not have made the final edit of that essay. But I actually did try to formulate a criticism in the 1992 period or. Perhaps I should try to write it up again.

Prychitko is by far the most penetrating critical mind in the Austrian camp and his essays should be read by everyone. He is intellectually quite similar to Lachmann in this regard. I guess in my opinion, Rizzo and Prychitko have the sharpest abilities.

Prychitko's point about Lachmann and the rest of the Austrian community is actually right and should be more a focus of these discussions.

Pete

Yes. You should write up the Stiglitz.

Any chance that Dr Prychitko could join the blogging team here as a regular?

Yea, D. Prychitko is the Austrian I know the least about. His comments on here are always sharp, penetrating, incisive, and authoritative. I would really like to read some of his published work.

Where can I find this?? I am sure he is published in places other than the RAE.

miller888sd@yahoo.com Any links would be greatly appreciated.

Stiglitz's claims remind me of the remarkably dumb claim found in a version of Samuelson's textbook to the effect that 'It is an open question whether markets work better than central planing.' Similar is the actual quote "the Soviet economy is proof that, contrary to what many skeptics had earlier believed, a socialist command economy can function and even thrive" in the thirteenth edition.

Although those claims make Samuelson look ridiculous in retrospect, he is perfectly faithful to the toy models of neoclassical economics -- if both the entrepreneurs and the central planners are essentially gods with perfect views of the future, then which institution is better is "an open question."

I thought that maybe Stiglitz is more sophisticated than that and that he realizes that only a welfare criterion which compares the effects of realistic institutions is relevant to policy -- and a comparison with unachievable optimal states is more or less besides the point.
But apparently he is not -- he thinks that since general equilibrium is false, then markets are worse than the governmental alternative.

The moral is that if you use toy models, you can only reach toy conclusions.

Matt - you should probably start with:

Prychitko’s Markets, Planning and Democracy (2002)

Published by Elgar. Has the 2 essays that flatten Rothbard

and much much else.

By the way, why do you think, PKS, that the fact that F. Fisher's book, for instance, is not Austrian is relevant to anything?

In fact Franklin Fisher does mention explicitly that his source of inspiration for one of his main conditions for long term equilibrium --the "No favorable surprise" condition-- is taken from Schumpeter.

He can also be interpreted as making a mild criticism of "those narrowly focused on modern mathematical theories of general equilibrium and stability."

Alex - as Hayek often pointed out Schumpeter was a Walrasian in his price theory.

Does Fisher provide an adequate theory of the path to equilibrium? Or does he rely on a set of highly restrictive conditions to 'torture' all the variables into sync? (like torturing the data - make sense?)

Why is Stiglitz's claim that the labor market and credit market do not clear incorrect? Has any Austrian provided an adequate answer?

Is Fisher telling us what is to all intents and purposes an 'auction' market story?

We know markets work (fuzzy term again) but do we have a good story (an adequate one) as to how they work?

Jochen Runde has provided a nice, Austrian-flavoured analysis of one of Stiglitz's models in his paper, 'Information, Knowledge and Agency: The Information Theoretic Approach and the Austrians.' Review of Social Economy, 54 (3): 183-208.

PKS,

There is a family resemblance --and even a family relation -- between Austrian and broadly Walrasian theories. So I'm not that keen on emphasizing differences between the two approaches, except to the extent that modern mainstream Walrasian analysis has gone on wildly non-realistic extremes. That's why I asked you why is it at all relevant that Fisher is "not Austrian."

Fisher's analysis is limited in many ways: it still has complete markets for instance, and his use of Lyapunov's second method means that his analysis can only tell us at best where the process may end up, not how long it takes to get there, or what happens in the meantime.

Nevertheless, he does NOT tell an "auction" story -- he talks about real time market processes. That's the main point of the book: to get rid of "out of time" adjustment processes. The book was supposed to open the path for such research -- unfortunately nobody seems to have followed the path except in marginal ways. So much the worse for mainstream economics, I say.

I don't think we really know how markets work -- beyond some rather vague, if promising theories -- which is a sign that economics is an old but still immature science.

Thanks for reply Alex. I just ordered Fisher.

Dr Boettke wrote: "I would suggest that Fisher's Disequilibrium Foundations of Equilibrium Economics explains why Kirzner is more important ultimately to economic science than Stiglitz"

How does this square with Alex's Fisher "still has complete markets for instance, and his use of Lyapunov's second method means that his analysis can only tell us at best where the process may end up, not how long it takes to get there, or what happens in the meantime."

Any takers?

How does Dr Boettke suggest that Fisher shows anything about Prof. Kirzner's story?

Thoughts Alex?

And if Fisher is talking "about real time market processes. That's the main point of the book: to get rid of "out of time" adjustment processes" is there any point to it since you said "his analysis can only tell us at best where the process may end up, not how long it takes to get there, or what happens in the meantime"

A lot can happen in the meantime.

I forgot to add this again:

Why is Stiglitz's claim that the labor market and credit market do not clear incorrect?

Where does his argument go wrong?

That is the stuff I'd really like an answer to.

Thanks

The assumptions in Fisher's book are crude, but the conclusion are surprisingly optimistic -- I suspect that's what Dr Boettke was referring to.

You're not the only one that wishes that better economics would exist -- I suspect that we don't have it because even cutting edge economists feel intimidated at the prospect of building a complete disequilibrium model.

I think a defense of the market should accept that it may be the case that some markets will not clear.

There is a completely neoclassical criticism of Stiglitz's credit rationing paper here:

http://www.opus-bayern.de/uni-regensburg/volltexte/2005/476/pdf/sw.pdf

I don't know if that's what you're looking for.

"I think a defense of the market should accept that it may be the case that some markets will not clear"

Does this include the labor market? If so, the market will need a lot of defending.

Also, everyone accepts the market. What there is disagreement over is what types of state intervention and how much.

"Does this include the labor market? If so, the market will need a lot of defending."

It depends on how temporary or serious such non-clearing is.

The criticism of state intervention when non-serious lack of clearing exists, is that bureaucrats do not really know what they're doing anyway -- certainly not when it comes to manipulating the financial system.

This later form of interference is highly dubious even when there is large unemployment.

"Does this include the labor market? If so, the market will need a lot of defending."

It depends on how temporary or serious such non-clearing is.

The criticism of state intervention when non-serious lack of clearing exists, is that bureaucrats do not really know what they're doing anyway -- certainly not when it comes to manipulating the financial system.

This later form of interference is highly dubious even when there is large unemployment.

The fact that some markets don't clear (perhaps none of them ever actually clear!) does not ipso facto condemn such markets nor does it make a case for intervention.

The question is comparative: can imperfect state intervention improve upon imperfect markets?

That's a very different question than whether particular markets might/do not clear.

PKS
"Does this include the labor market? If so, the market will need a lot of defending."

Of course that markets never clear. But markets always shows the tendency to clear. If all markets cleared instantaneously, then we would have a fully coordinated state, and the real world is never fully coordinated.

Also, the market process is fundamentally equilibrating, but equilibration tends to discoordinate the plans of individuals. A full general equilibrium has full plan coordination, but a fully coordinated state is not always a general equilibrium, and a state of partial discoordination can be closer to equilibrium than a fully coordinated one.

Unemployment exists when plans are not fully coordinated. And full employment is not always better than a dynamic economy with unemployment caused to rapid technological progress.

I think that this article by Rizzo explains clearly these problems: http://works.bepress.com/mario_rizzo/18/

"But markets always shows the tendency to clear"

If the efficiency wage model is correct, how does the labor market tend to clear?

I am surprised at Dr Horwitz's apparent 'laissez faire' attitude (and total lack of concern for the unemployed) to involuntary unemployment (which assuming Stiglitz is correct) will not be eliminated by cutting wages.

"Also, the market process is fundamentally equilibrating, but equilibration tends to discoordinate the plans of individuals. A full general equilibrium has full plan coordination, but a fully coordinated state is not always a general equilibrium, and a state of partial discoordination can be closer to equilibrium than a fully coordinated one"

Please could you expand on this Rafael? Or suggest somewhere where I can find the argument in much greater detail. I printed off the Rizzo paper to read. Many thanks for the link.

PKS,

First, look at the 2 volume set that Prychitko and I edited on Market Process Theories, and in particular our introduction where we try to argue the connection between the different literatures.

Second, on Stiglitz and the labor market. The tact I take is similar to Vernon Smith's critique of behavioral economics in his Nobel address --- ecological versus constructivist notions of rationality. Stiglitz has a notion of marginal productivity that is purely technical, rather than contextual and team production related, and his notion of the labor market is a price taking market, rather than a price searching market. Look at any traditional explanation for why efficiency wages work (Ford, etc.) and the argument is one that addresses labor slack and how to increase the productivity of the work team. It is the contextual nature of valuation processes that matter in economic life, not the technological efficiency. There is a relationship between economic and technical efficiency, but that is for a different time to explore. Furthermore, if we look at labor markets as price searching markets, we know the boundaries that are set --- marginal revenue product on the demand side, and opportunity costs on the supply side. Only in the limit do MRP and opportunity costs perfectly align. Yet the market is "orderly" inside of the boundaries set by the demand and supply side --- a corridor so to speak alla Leijonhufvud.

Stiglitz blows up the Walrasian limit theorems, he doesn't blow up market process theory let alone the empirical experience with more or less free market economic forces at work. Not only does Hayek have an answer to the asymmetric information crowd prior to them writing (see his essay The Meaning of Competition, or my paper Turning Lemons into Lemonaide (with Mark Steckbeck), but the UCLA price theorist Armen Alchian helped explain search processes and team production in the labor market much better in the 1960s and 1970s in my opinion.

PKS,

Accusing me of not caring about the unemployed turns my theoretical point into your ad hominem. I care about the unemployed - the questions is whether imperfect markets or imperfect state intervention will do better by them. I think that markets, with all their imperfections, are still the better choice. I could equally well argue that your apparent support of intervention to "fix" such markets demonstrates a lack of concern about the unemployed because I think such intervention does worse by them. But I'm not going to. Instead, I'll just say that we disagree over what's the best way to deal with unemployment (and perhaps over how to define involuntary unemployment).

Is it that hard to assume I'm arguing in good faith?

Apologies if it came across as an ad-hominem.

But I'd say there is a pretty good case for very generous unemployment relief if efficiency wage theory is correct. Do you disagree? How do you propose to make unemployment palatable? (assuming EW theory is correct). If EW theory is correct, then what policy changes would you suggest to eliminate involuntary unemployment?

I don't understand how Dr Boettke's post (Alchian, team production, price searching, etc) rebuts Stiglitz-Shapiro. Am I missing something?

PKS: I think unemployment is a reason to have unemployment relief, not efficiency wages. I must admit I never "got" that theory in the first place. I mean, I think I'm okay with basic analytics: If worker productivity rises with wage rate, then a firm can lower labor costs by raising wages. If I'm willing to keep the same car for 20 years, an Acura will cost me less than a Chevy in the long run. But the model never spoke to me. You have precisely one deviation from the simple model and one coping strategy on one side of market and then we're going to pull relatively important implications out of that? Don't unemployed workers have innovative strategies to get around their problem, like paying the employer to get the job? (Charmichael came out with that one almost immediately.) Shouldn't we assume that there is an indefinite host of such strategies on each side of the market? Why, then, should we assume efficiency wages are some scary cause of widespread unemployment? I just don't get it.

Now, if you want to defend the idea of unemployment insurance, isn't it sufficient to point out that sometimes, for whatever reason, people *are* unemployed and that's a hardship? And if you really need a theoretical cause for such unemployment outside the business cycle, won't Ricardian unemployment do the job just fine? I doubt anyone on this list would deny that Ricardian unemployment is real and sometimes hits a relatively big geographic area relatively hard.

PKS,

Here is one way in which Stiglitz's model of the efficiency wage is just an arbitrary specification of firm organization:

Firms can pay younger and inexperienced workers less than their "marginal product" and pay senior workers more than the "marginal product." By delaying part of the compensation, Stiglitz type agency problems can be alleviated. This line of criticism was initiated by Edward Lazear.

The point is not that Stiglitz's model is completely irrelevant to the real world -- rather, it is just a special case scenario and deriving big macroeconomic implications from it is dubious.


PKS,

What do you think efficiency wage theory says? It is about paying workers above their marginal product and thus a critique of the exhaustion theorem --- which holds only in cases of general competitive equilibrium.

So yes you are missing something, you are missing the entire story!!! There are insider/outsider issues, there are questions of what is the determinant of marginal product, there are questions of the difficulties in marginal product calculations in team production situations, etc. Enter Alchian and the way he and Demsetz dealt with team production, enter Alchian and the price searcher model of markets (as opposed to price taker), etc.

The Lazear line is one way to tackle the questions as Alex suggests, I am saying that the UCLA guys were already tackling it prior to Stiglitz thinking it, and since he didn't acknowledge that work but instead just sought to overturn the standard Walrasian rendition of the market. So to PKS or anyone I would respond to Alex's statement that "The point is not that Stiglitz's model is completely irrelevant to the real world --- rather, it is just a special case scenario and deriving big macroeconomic implications from it is dubious" --- Of course Alex is right, but we could be even stronger. Stiglitz's topic is real-world relevant, but his analysis of it is so removed from real economic forces (and instead so model dependent) that he cannot treat the topic in a manner that has any real world relevance. I would say the say is true for the way he discusses imperfect and incomplete information in general, and imperfect market structure and competition. Stiglitz is (as Lucas is as well) playing with toy economies, and not even replicas of the real economy --- but toys that are science fiction (a point that Bob Clower actually made about RE models).

Alchian's collection of essays published in the 1970s was titled: Economic Forces At Work. I think that is about right ... Alchian was obviously using abstractions (models) to aid his thought, but the thoughts were on real world topics (unemployment, firm production, higher education, etc.) and he sought to explain in simplified form the actual economic mechanisms that were operating in the world --- the incentives actors face, the coping strategies of actors, etc.

This is a different style of economics than that practiced by Stiglitz. Stiglitz's toy economy is broken requiring fixing from outside of the model (namely government officials who listen to Stiglitz), while Lucas's toy economy requires no fixing --- but both are dealing with toy economies. They are brilliant toy makers no doubt --- arguably the best of their generation. But they are not addressing The Economic Forces at Work in the economies we see out our windows.

In other words, the policy advice we can glean from these toy economies is quite limited --- either pro market or pro government. It is also quite limited in what we can actually learn about "real economies" --- this is what separates thinkers like Alchian, Demsetz, and Coase ---- they are grounded to the world in a way the best toy makers never have been --- and this is not an issue of "data" analysis, but of what you view as what you are studying and how to study it.

Friedman once famously wrote that while we curtsy to Marshall we walk with Walras. And indeed that vast majority of economists do "walk with Walras." And this is the problem. Marshall was similar to Alchian, Demsetz, and Coase --- not a toy maker, but a thinker who sought to use an adequate abstraction to address a real world puzzle. The toy makers, instead, use free floating abstractions and then concern themselves with momentary concretes ---- the brilliantly work on the wrong thing with the wrong purpose. To paraphrase Keynes --- "this is how a brilliant theorist can be led into bedlam." Such I fear is the fate of Stiglitz (but also Lucas).

Finally to my good friend Roger --- yes unemployment is the reason for an argument for unemployment relief. But is unemployment relief going to undermine the adjustments in the labor market? (and other markets connected) I worry that our compassion will too easily become luditism with respect to the dynamics of an evolving economy --- whalers of New England might argue that Hicks-Kaldor didn't quite work out.

To put this another way, we have endowments and we have choices --- have we found a way to address unequal endowments without impacting choice incentives? If so, I'd like to know the case.

Two years ago now I sat in a seminar room at LSE and heard Anne Krueger declare that what we have learned from the combined experience of the era of deregulation and the post-communist period is that we want a predominantly free market economy, but one that is subject to "reasonable regulation that is not capturable by interest groups." I raised my hand at the time and said, 'yes, but what if that is a null set.' To which Andrei Shleifer jokingly replied 'why are you so unreasonable?' I smiled and let it drop ... but I am still waiting for examples --- just give me 1 reasonable regulation not captured by interest groups.

To flip back to unemployment policy --- can you suggest an unemployment relief program that will not thwart efforts for labor market adjustment to changing circumstances? What are the incentives at work?

Sort of brings us back to Alchian --- lets look at a real world set of unemployment relief programs, what are the incentives at play?; what are the economic forces at work? Not what are the toy economy depictions, but instead what are the forces at work in the real economy and can we isolate them and study them and describe them so others can see the workings of the system better than they could before.

Let me add one point to Pete's comments:

The way markets get around the "market for lemons" problem is by developing institutions that provide (much of) the necessary information. Markets deal with imperfections (as compared to the "toy economy that works perfectly" economy) in the labor market in much the same way. Those evolved institutions do not perfectly solve the problem - we still have lemons. But as Pete's argument suggests, we have theoretical and empirical reasons to believe that they do so better than would/have various forms of government intervention.

Again: pointing out that markets don't work perfectly does not ipso facto mean that a government intervention to solve it will, in fact, solve it. This is the comparative institutional analysis that has been central to Virgina/Vienna/UCLA economics for decades.

Pete: It goes back to Okun's leaky bucket. If the state is going to transfer money (or whatever) from A to B, there will be an efficiency loss. The transfer is like the water that makes it to B and leak is the inefficiency that creates waste, which is spilled water in the bucket metaphor.

It occurs to me, actually, that I am like Okun's bucket: I leak! I've always leaked just as Hayek leaked. In all the world except the tiny speck occupied by radical libertarians, I am an extreme pro-market guy. But because I am an Austrian economist, I am often seen as weak on markets and too much of a statist! What a hoot -- and what an injustice!

Anyway, to your question. No, I don't imagine I could give you an unemployment relief program that will have *no* tendency to jam up the adjustment process. On the other hand, it is precisely because we don't like aspects of the adjustment process that we are willing to compromise it with social insurance. So the bucket leaks? So what? If we eschew the leaky bucket, those unlucky enough to be hit with Ricardian or cyclicl unemployment must endure a disproportionate share of the inevitable pains of necessary market adjustments. I prefer the leaky bucket, thank you.

"What do you think efficiency wage theory says? It is about paying workers above their marginal product and thus a critique of the exhaustion theorem --- which holds only in cases of general competitive equilibrium."

I am unable to see how this relates at all to Stiglitz-Shapiro's 84 paper (nor how Dr Horwtiz's comments about lemons are relevant to their 84 paper).

Incidentally, Dr Boettke mentioned the Alchian-Demsetz theory of the firm. What do you make of Dr Prychitko's ingenious critique of their theory in his collection of essays (same collection as where he demolishes Rothbard's scientism). Dr P provides an Austrian critique and then a devastating critique on their own terms.

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