History of ASE [Continued]

Lionel Robbins(1898-1984), the head of the economics department at LSE knew german and had read the works of Böhm-Bawerk, Mises and others. He was probably one of the main reasons for LSE's Austrianism. In 1931 he invites Hayek to LSE and the intensity of Hayek's intellectual battle with Cambridge and other schools reaches its height.

For some reason Hayek encourages John Hicks to read Vilfredo Pareto(Hicks eventually becomes one of the fathers of modern neoclassical economics). Robbins is influenced by those around him and he starts forgetting his Mengerian microeconomics, which can be easily seen by the changes in the reading list for the general economic theory course at LSE. Robbins' macroeconomics remains Hayekian until he becomes Keynesian when everyone else seems to do the same.

In the US the hole in economic theory is filled by the works of Alfred Marshall, who was one of the most influential economists of all time.

In the summer of 1929 Mises was offered a job at Kreditanstalt Bank, but he refused it. His fiancé asked why he'd refuse such an important job, and Mises answered:

A great crash is coming, and I don't want my name in any way connected with it[1].

That bank was one of the first to collapse.

Hayek on the other hand in February of the same year wrote:

...the boom will collapse within the next few months[1].

In the mid-1920s Felix Somary, a Swiss banker, wouldn't give John M. Keynes stock recommendations, because Somary believed that a speculative bubble was emerging. Keynes replied:

There will be no more crashes in our lifetime[1].

Irving Fisher, the "the greatest economist the United States has ever produced" (according to Milton Friedman) a few days before the crash:

Stock prices have reached what looks like a permanently high plateau[2].

Mises moves to Switzerland in 1934 to work at the Graduate Institute of International Studies(the Nazi threat made the move that much easier). He had a full-time job and a private seminar, he taught courses and wrote books and articles when he was in Vienna, but while in Switzerland he does very little. He realizes that the Mengerian branch is dead. Hayek on the other hand thinks that ASE has been a success, as it's been incorporated to the general field of economics with Marshall, Walras and others. In Switzerland Mises in fact started reconstructing economic theory from the ground up along the Mengerian line and he writes a general treatise.

Nationalökonomie comes out in 1940. It's in german, Mises is Jewish and the book makes a case for laissez-faire. Not exactly great selling points with the Nazis in power.

WW II prevents the distribution of the book. The Swiss publisher goes bankrupt and the book practically disappears. Mises moves to the US in 1940 because of the Nazi threat. The man is in his late 50s and hardly speaks english. He then rewrites the book in english and Human Action comes out in 1949.

By then it was too late, however. Marshallian and Walrasian economics had already become dominant and no one really cared about Mises' price theory.

ASE in the 1950s is dead in all of its forms. After The Pure Theory of Capital (1941) Hayek stops contributing to economics as it became clear that even the business cycle theory had shifted in favor of Keynes. Both branches of ASE were essentially gone. Keynesianism only replaced one aspect of Austrian Economics, the reasons for the overall decline are what I've discussed so far.

Then Rothbard happened. Man, Economy, and State (1962), America's Great Depression (1963), What Has Government Done To Our Money (1963), Economic Depressions: Causes and Cures (1969) and Power and Market (1970) were what revived ASE. Why did those people show up for the Royalton Conference in 1974? Because they had read Rothbard.

Hayek's Nobel Prize certainly surprised many and it did help, but it wasn't behind the revival.

[1] Gerard Jackson Safehaven Article January 6 2008
[2] Wikipedia Irving Fisher

Critique of Austrian Economics: A Critique [Part 9]

This is part 9 of my critique of the Critique of Austrian Economics by AustrianCritique.

History

You can go and read what AC says and see where we disagree. I won't concentrate on AC's claims, I'll simply write the real history here. Until the 1990s there was an orthodox history of the Austrian school(that was largely believed by Austrians themselves) that was revealed to be factually inaccurate and illogical(see Joseph T. Salerno's talks and Jörg Guido Hülsmann[1]). In its short form the story goes like this:

ASE(Austrian School of Economics) was mainstream and doing well after its birth in 1871, until the Keynesian revolution came and replaced it in 1936. ASE was almost dead, until the Royalton Conference and Hayek's Nobel Prize of 1974, after which ASE was revived. This is the simplified version anyway.

Most of the information in this post will be from Salerno's talks on the history of thought.

These are the important historical figures in what became the current Austrian School of Economics:
1st generation: Carl Menger (1840-1921)
2nd generation: Eugene von Böhm-Bawerk (1851-1914)
3rd generation: Ludwig von Mises (1881-1973)
5th generation: Murray N. Rothbard (1926-1995)

Almost from the very start ASE had two branches. The first branch presented above is the Mengerian branch and it is the foundation of the current school of thought.

The "general equilibrium branch" is presented here:
2nd generation: Friedrich von Wieser (1851-1926)
3rd generation: Joseph A. Schumpeter (1883-1950)
4th generation: Friedrich A. von Hayek (1899-1992)

I'm obviously simplifying here. The 4th generation for example had a lot of people in it(Machlup, Haberler, Morgenstern etc...). They were all mainly influenced by Wieser and Schumpeter.

Carl Menger was the founder of the Austrian School and one of the three discoverers of marginal utility[2]. Ludwig von Mises has said that Menger's Principles of Economics(1871) is what made an economist out of Mises. Böhm-Bawerk's phenomenal work on capital theory laid the foundation for Mises' business cycle theory and in the late 19th and very early 20th century ASE was indeed recognized worldwide as a serious school of thought.

There were still serious problems with ASE. Many thought ASE could be represented through general equilibrium and that there was no reason to not simply use math. Early Austrians also couldn't incorporate money into their system(until 1912 came along[3]). Some other problems persisted, but they were dealt with in Human Action(1949).

Böhm-Bawerk left academia in 1889 after writing his 3 volume treatise on capital and interest and didn't return until 1905, at which point he was physically in such bad shape that he would no longer contribute to economics. Menger stopped contributing to economics in the 1890s and he refused to have Principles of Economics reprinted(the book would start disappearing from libraries and commanded a high price because it was in such high demand). Menger's chair at the University of Vienna was given to Wieser(since Böhm-Bawerk was in government service at the time, not in academia), which further promoted the general equilibrium approach instead of the Menger/Böhm-Bawerk line of thought.

Schumpeter, who was Wieser's student but was heavily influenced by Léon Walras, published two books at a young age and became to be seen as the star of the 3rd generation. So before Mises' first book, The Theory of Money and Credit, Schumpeter had already published The Nature and Essence of Theoretical Economics(1908) and The Theory of Economic Development: An inquiry into profits, capital, credit, interest and the business cycle (1911) and thus Schumpeter came to be seen as a system-builder, while Mises was seen as perhaps a brilliant economist, but also as someone who had a narrower scope.

In the US the American Psychological School(actually a praxeological or Mengerian school would be a more appropriate name) failed to make an impact, as Herbert J. Davenport and Frank Fetter spent more time on personal disputes than teaching students. They did contribute to interest theory by correcting some of Böhm-Bawerk's mistakes, but they failed to leave any disciples.

As the 4th generation became influencial during the 1920s, the Mengerian tradition was essentially dead. By the early 1930s ASE no longer existed, with The London School of Economics being the only exception and even there general equilibrium dominated. Mises had influenced them with his two books(the second being Socialism(1922)). Most Austrians became much more liberal(in the classical sense) as a direct result of that book. But Mises' books weren't on general economic theory, they were on specialized subjects(money and economic calculation).

[1] Jörg Guido Hülsmann Mises: The Last Knight of Liberalism
[2] Wikipedia Marginal Revolution
[3] Ludwig von Mises The Theory of Money and Credit

Critique of Austrian Economics: A Critique [Part 8]

This is part 8 of my critique of the Critique of Austrian Economics by AustrianCritique.

Gold Standard

AC: "...virtually all economists agree... If there is too much money, then inflation rises. If there is too little money, then unemployment rises. Under the current system, the government fights inflation by contracting the money supply, and fights unemployment by expanding it. This achieves the optimum level of money, and minimizes our economic problems."

Really: Then virtually all economists are wrong. The Philips Curve has been empirically refuted so many times that it's unbelievable anyone would bring it up. It's nonsense pure and simple. In practice the current system is perpetual inflation, so even if this theory was sound on paper(which it isn't), it wouldn't work.

AC: "Austrians call for a 100-percent gold standard (that is, without even fractional reserve banking)..."

Really: Yes and no. Austrians usually want market money(historically it's been gold, but it doesn't have to be) and some Austrians belong to the free-banking school, so they wouldn't oppose fractional reserve banking. But most Austrians oppose fractional reserves and want to return to a gold standard at least initially.

AC: "Under a gold standard, the total amount or value of money would be fixed, determined only by the size of the nation's gold reserves. Sure, unemployment and inflation may rise, but eventually prices will readjust themselves through natural inflation or deflation and solve the problem."

Really: The amount of gold and the amount of money would indeed correlate closely(after being industrially used, gold would probably no longer be regarded as money, so it wouldn't be a 1:1 correlation). However, to say that the value of money would be fixed is fallacious. The price of gold isn't fixed right now. If gold became money, it wouldn't be any more fixed than now. It would simply be money.

Unemployment and inflation may rise? Ok so you're telling me that when we get a relatively stable money supply, then inflation will rise? Utter nonsense obviously. Historically(e.g. the US in 1880s) and theoretically prices should steadily fall, as the growth in the supply of goods outstrips the growth in the money supply. Unemployment shouldn't rise either.

AC: "Austrians believe that this readjustment, painful or prolonged though it may be, is a self-cleansing exercise that rids the economy of malinvestment. That is, it eliminates weak firms that shouldn't have been created in the first place."

Really: AC is no longer talking about going back to a gold standard. Austrians believe that the phony boom brought about by credit expansion should be stopped and the malinvestments should be liquidated. This falls into "business cycle" category.

AC: "But although money inflates easily, it suffers from "price stickiness" when trying to deflate. Often, deflation barely occurs, and the result is high unemployment, recession or even depression instead. In other words, money doesn't adjust itself to the level of economic activity; the level of economic activity adjusts itself to the money. History bears this out: the U.S. suffered eight depressions while on commodity money; in the 60s years since, it has suffered none."

Really: There isn't a single proposition in here that is factually correct. And I don't know if this is ignorance or dishonesty, but normal recessions were called depressions back in the 19th century and early 20th. Not only that, but the "theory" behind this "history" is just as absurd.

AC: "Second, gold standards based on a fractional reserve allow the phenomenon of bank panics or bank runs, which leave depositors holding worthless money. This only exacerbates recessions and depressions."

Really: Historically bank panics have resulted in very small losses on the part of depositors. Besides, they're a good thing. They put limits on credit expansion, the source of the business cycle. Removing bank runs from the picture was one of the greatest policy mistakes of the 20th century.

AC: "The solution to this would be to adopt a pure gold standard. But there is not enough gold in the world to cover the phenomenal amount of economic activity currently in it, without an equally phenomenal revaluation of gold. Furthermore, industry is making increasing demands on gold; a change in dentistry or electronics could deflate an entire economy."

Really: Any amount of money will suffice. The amount of money is irrelevant. I do agree that going back to the gold standard would be difficult, but that's hardly the question here. Gold's industrial uses are such a tiny part of the global supply of gold that I doubt anyone would notice even a major change in technology(not to mention the supply of gold could change to meet this new demand). AC is simply making stuff up here.

Business Cycle

AC: "The theory that the Fed's monetary expansion and easing of credit restrictions results in "malinvestment" is an unsupported claim. It is backed up only by the Austrian's faith and deductive "logic" that such malinvestment occurs."

Really: There are so many ways to answer this, I don't know where to start. Just go read my blog post about the business cycle.

AC: "Austrians often repeat that since the Federal Reserve System was created in 1913, our currency has devalued 98 percent, due to the printing of money. But this is a meaningless statistic. Suppose you need $2,000 a month to buy the necessities of life, but you earn $2,000 a month as well. You're making ends meet. Now suppose that your bills climb to $10,000 a month -- but so does your income. Has anything real changed? Of course not."

Really: The Fed's mandate is to keep the dollar stable, so from that perspective it's a meaningful statistic. Also what about the inflation tax? Every time the money supply grows, those who get the new money first benefit. They get to go into the market and spend that money before prices have risen. Those who get the new money last will have to pay higher prices for a long time before their income rises. And it isn't the poor or the middle class who gets the new money first, I can tell you that.

AC: "At low levels, inflation under fiat money is relatively harmless. However, the deflation caused by the gold standard is truly destructive. If dollars have inflated to 2 percent of their original value, and the price of gold has risen 20 times, then maintaining the gold standard would have deflated the dollar to 2.5 times its original value. That's a lot of unemployment."

Really: 19th century and the classical gold standard. Full employment pretty much. Not to mention AC still has no theory behind his claims.

AC: "No, the real question is not how much money has inflated, but whether or not your absolute standard of living has risen. And in this regard, the current system of fiat money has been a clear success. Between the end of World War II and the early 70s, the U.S. standard of living (adjusted for inflation) doubled -- the fastest rate of prolonged growth in U.S. history."

Really: Bretton-Woods is the same as "the current system of fiat money..." Except that it isn't. Bretton-Woods was bad, but pure fiat money is worse. Oh yeah, correlation is not causation.

AC: "And, of course, there has not been a single depression since World War II, not in this or any other country following Keynesian monetary policies."

Really: Keynesian monetary policy is to always push the rate of interest lower by printing money, so I guess hyperinflation would count as a Keynesian depression?

Critique of Austrian Economics: A Critique [Part 7]

This is part 7 of my critique of the Critique of Austrian Economics by AustrianCritique.

Monopolies

So far this is the most enjoyable part of the critique. Simply the idea that I know the history of the US better than AC(who presumably is a US citizen) is on its own funny. Austrians claim that monopolies in a free market are either not a problem at all or a very small problem at most. AC disagrees:
"The claim that governments cause monopolies defies the historical evidence. History actually shows the opposite: the more unregulated the market is, the worse the problem of monopolies."

That right there is incorrect even on its own terms. Even if we accepted the idea of natural monopoly as a given, state-granted monopolies still far outnumber natural monopolies.

AC: "However, the Austrian claim is not wholly without merit. Utilities are examples of monopolies run or regulated by the government (although they are natural monopolies, and privatizing them doesn't work, as Britain found out in the 80s)."

Really: Here AC has the perfect opportunity to engage in a theoretical exposition of what natural monopoly is and how it emerges on the market. He doesn't do it and simply states something as a fact, even though it's the subject he's arguing about. It's like arguing that democracy doesn't work by saying: "But democracy doesn't work, as we saw in [-insert country and year here-] . In fact let me use this same tactic right now to refute AC. Utilities are not natural monopolies, as we saw with several US cities during the 19th century:

Six electric light companies were organized in the one year of 1887 in New York City. Forty-five electric light enterprises had the legal right to operate in Chicago in 1907. Prior to 1895, Duluth, Minnesota, was served by five electric lighting companies, and Scranton, Pennsylvania, had four in 1906. ... During the latter part of the nineteenth century, competition was the usual situation in the gas industry in this country. Before 1884, six competing companies were operating in New York City . . . competition was common and especially persistent in the telephone industry . . . Baltimore, Chicago, Cleveland, Columbus, Detroit, Kansas City, Minneapolis, Philadelphia, Pittsburgh, and St. Louis, among the larger cities, had at least two telephone services in 1905[1].

I'm not familiar with Britain and the 80s, but if it's the kind of "privatization" I've seen in other cases, then I'd rather call it corporatism. Usually they sell the assets to a company and give some kind of privileges on top of it. After all, the company was probably selected because of its lobbying efforts. Not to mention if there hasn't been any market process in that particular industry for years or decades, then it's no surprise that there is no competition when the industry is "privatized".

AC: "Often companies persuade governments to erect barriers of market entry to potential competitors. Sometimes government subsidies allow one company to overpower its competitors. But such cases are usually the result of money-based lobbying, which is a corruption of the system. Corruption in the public sector no more "refutes" its central principle than does corruption in the private sector. The solution to corruption is to eliminate it by enforcing better laws. European democracies offer broad practical evidence that this sort of corruption can be greatly reduced."

Really: Corruption in the public sector is a perfect rationale for not giving the public sector so much power. After all, without power there's no incentive to corrupt. Corruption in the public sector is vastly different from other kinds of corruption. For starters, politicians don't use their own money. The last phrase is obvious BS. AC apparently idolizes Europe out of ignorance.

AC: "But this Austrian critique completely ignores another, more common type of monopoly: that which forms naturally on the unregulated market. There are many reasons for this tendency, ranging from "it takes money to make money" to the greater efficiency of large corporations. Without antitrust laws or some other countervailing market force, growing companies will not stop until they become monopolies or oligopolies."

Really: Even if natural monopolies did emerge on a free market, it still wouldn't be a "...more common type of monopoly...", that's simply false. Also I'm not sure if I read this correctly, but I think AC is saying that antitrust laws are a "countervailing market force", which I find rather hilarious(market forces are born within the market, not out of legislation). Also of note is the complete lack of theoretical substance here. AC instead tries to back his claims up with rewritten history.

AC: "The height of monopoly growth and abuse in the U.S. coincided with its greatest period of laissez-faire, or government nonintervention in the market. Known as the Gilded Age (the period between the Civil War and World War I), this period saw the phenomenal rise of the Robber Barons and their great trusts (monopolies). John D. Rockefeller monopolized oil under his Standard Oil Company; J.P. Morgan dominated finance; Andrew Carnegie, steel; James Hill, railroads. Historians have well chronicled the ruthlessness of these men..."

Really: It is slightly problematic that AC doesn't list a single monopoly here. He doesn't offer any proof either. To mention Hill is especially hilarious, since Hill was competing against government rail roads(and Hill was far better at it, even though he got no subsidies or land grants). How many domestic competitors did Standard Oil have when it was finally brought to court by the state in 1907? Was it 47? Couldn't quite remember, so I checked it and it was actually 147[2].

Did any of these companies restrict production to drive prices up? No, they expanded production faster than their competitors and slashed prices continuously. Hell, the state eventually outlawed Hill's price cutting in the name of consumer production(Interstate Commerce Act of 1887 & Hepburn Act of 1906).

These men were innovative workaholics who improved the lives of pretty much everyone. To promote state intervention to stop the actions of these people is equivalent to declaring war on human civilization and progress.

AC: "In the late 19th century, trusts formed also in wheat, fruit, meat, salt, sugar refining, lumber, electrical power, rubber, nickel, paper, lead, gypsum, iron, cottonseed oil, linseed oil, whiskey distilling, cord manufacture -- and many others."

Really: Seriously what? Wheat? Salt? Electrical power is the only one that could qualify for a natural monopoly, but the rest is ridiculous.

AC: "Once a trust emerged, it would raise its prices and drop its quality of service, as well as engage in unfair trading practices that drove other firms out of business. The abuses of these monopolies became so great that they became a national scandal. So deep was antitrust sentiment that when both houses of Congress passed the Sherman Antitrust Act in 1890, there was only a single dissenting vote!"

Really: AC has yet to name a single trust that raised its prices by restricting production. The Sherman Act was nothing but a beautiful display of political entrepreneurship by less efficient firms. They wanted to break bigger and better companies up, so they got a law passed. What about the experts at the time? What were economists saying about monopolies? They were saying large-scale production and mergers were not a threat to competition or the consumer. Even self-descrived socialists said this[3].

The theory of monopoly was an ex post rationale for a policy that was created for special interests. The idea that there was some little get-together of experts who then carefully crafted a wise piece of legislation with the public in mind is preporterous.

Why don't we see what Congress said and what actually happened? When the Sherman Act was being passed(1890) Congress claimed that the following industries among others were being monopolized: salt, petroleum, zinc, steel, bituminous coal, steel rails, sugar, lead, liquor, twine, iron nuts and washers, jute, castor oil, cotton seed oil, leather, linseed oil, and matches(that's 17 industries). Let's see some nominal data:

As a general rule, output in these industries expanded more rapidly than GNP during the 10 years preceding the Sherman Act. In the nine industries for which nominal output data are available, output increased on average by 62 percent; nominal GNP increased by 16 percent over the same period. Several of the industries expanded output by more than 10 times the increase in nominal GNP. Among the more rapidly expanding industries were cottonseed oil (151 percent), leather goods (133 percent), cordage and twine (166 percent), and jute (57 percent)[4].

What about real output?

Real GNP increased by approximately 24 percent from 1880 to 1890. Meanwhile, the allegedly monopolized industries for which a measure of real output is available grew on average by 175 percent. The more rapidly expanding industries in real terms included steel (258 percent)[remember the evil Andrew Carnegie?], zinc (156 percent), coal (153 percent), steel rails (142 percent), petroleum (79 percent), and sugar (75 percent)[4].

AC: "The worst period of monopoly formation was between 1898 and 1902. Prior to this, there was an average of 46 major industrial mergers a year. But after 1898, this soared to 531 a year. (3) By 1904, the top 4 percent of American businesses produced 57 percent of America's total industrial production, and a single firm would dominate at least 60 percent of production in 50 different industries."

Really: Yes, exploiting economies of scale is beneficial to us all. Sometimes production should be concentrated. There is absolutely no proof of monopolization in what AC is telling us, even though AC probably thinks otherwise.

AC: "The power of these monopolies easily dwarfed the governments that oversaw them. As early as 1888, a Boston railroad company had gross receipts of $40 million, whereas the entire Commonwealth of Massachusetts had receipts of only $7 million."

Really: It would be very helpful, if you actually told us what company that would be! Google didn't help. But seriously, what's with the phony comparison? The Commonwealth of Massachusetts has a monopoly on the use of legalized force and they have the power to legislate. Besides, what do gross receipts have to do with power? If this railroad company was private and operated on a free market, then it had no power at all. They were at the mercy of their customers and the whims of politicians.

AC: " It wasn't until Teddy Roosevelt launched his great "trust-busting" campaign in 1902 that this process was reversed. Actual enforcement of the Sherman Act reduced monopolies until the Roaring 20s, when laissez-faire policies again returned to Washington. Over that decade, about 1,200 mergers swallowed up more than 6,000 previously independent companies; by 1929, only 200 corporations controlled over half of all American industry."

Really: Yet again, there isn't a single example offered. AC tells us that when the state isn't actively preventing mergers, there are more mergers. Proof of monopolization? No, not at all in fact.

AC: "The New Deal era ushered in yet another era of antitrust policy, again reducing the percentage of monopolies. This was followed by the Reagan era, a period which saw both massive deregulation and another frenzy of mergers and takeovers."

Really: At least the first part of the New Deal(1933-34) was a huge cartelization program and competition was actively restricted by the state. Not suprisingly it was also a time of economic misery. Basically AC has his history as wrong as it can get. The "deregulation" was in fact started by Carter and I still don't see how more mergers equals monopoly.

AC: "...the periods of government trust-busting show the proper role of government, and its effectiveness in restoring market competition."

Really: How so? I'd like to remind everyone that AC here still hasn't managed to prove that trust-busting helps the economy. He didn't even try. He's like Keynes; he has hunches and simply tells it to us as fact. On the other hand I presented the reader with statistics that back my statements up.

AC: "Two objections are possible here ... The second objection is that a wave of mergers may result in a more natural and efficient equilibrium of larger players, and this could be beneficial for the economy."

Really: Well yes. Without mergers we'd all live in personal autarky.

AC: "The result doesn't have to be a monopoly -- perhaps just an oligopoly."

Really: A situation where there are only a few sellers can be competitive. In fact even a monopoly can operate in a competitive environment.

AC: "The problem is that at the top end, mergers become increasingly harmful to the economy, with monopolies merely representing the worst result. Even oligopolies engage in price-gouging and collaboration."

Really: Why do mergers become increasingly harmful? Do mergers keep automatically happening until there is an uncompetitive situation? If so, then why? Why do you equate the number of firms with how competitive the market is? Do we have anything but your hunches?

AC: "A natural equilibrium hardly represents the best equilibrium -- as recessions and depressions show."

Really: To show us how natural equilibrium is bad, you give us two examples of disequilibrium? Besides, to use equilibrium analysis to examine competition is in my opinion misguided.

AC: "How do Austrians deal with the historical correlation between laissez-faire and monopolies?"

Really: By shredding your arguments to pieces one by one.

[1] Burton N. Behling, Competition and Monopoly in Public Utility Industries
(1938), in Harold Demsetz, ed., Efficiency, Competition, and Policy (Cambridge, Mass.:
Blackwell, 1989), p. 78.
[2] Dominick T. Armentano Freedom Daily, May 1992: Monopoly
[3] Thomas J. DiLorenzo The Review of Austrian Economics Vol. 9, No. 2(pp. 44-46): The Myth of Natural Monopoly
[4] Thomas J. DiLorenzo Austrian Economics Newsletter(Summer 1991, pp 1-6): The Antitrust Economists' Paradox

Critique of Austrian Economics: A Critique [Part 6]

This is part 6 of my critique of the Critique of Austrian Economics by AustrianCritique.

The Market Process

AC here starts with the most epic strawman yet.

AC: "According to Austrians, only individuals "on the scene" know what's going on in the market, and any attempt to manage it centrally is bound to fail.

Perhaps the best way to highlight the error of market process theory is by analogy. Suppose you are the chief of a tribe of wandering nomads, and you wander into a region that is unfamiliar to everyone. Soon the tribe becomes thirsty, and everyone agrees to start searching for water.

In the first version of this example, suppose you are an "anarchist" chief, and allow the tribe to conduct its own search without organization, coordination or planning. A lot of effort will be wasted and duplicated in the chaos that follows."

Really: Basically AC is trying to argue that Austrians oppose cooperation. Well they don't, so I guess that's that... FYI "laissez-faire" does not equal "chaos." He later gives examples of a "mixed economy" chief and a "central-planning" chief, but I don't need to go into that.

AC: "All the subjectivism, individualism and market process that exists in the private sector should exist in the public sector as well. Both companies and governments provide goods and services in exchange for money. Customers vote with their dollars; voters vote with their ballots. Both customers and voters are self-interested, seeking the best goods and services for the least money."

Really: AC chooses to completely ignore all that Austrians have written on this and makes the claim that the public sector is really no different from the private one. But they are different. Mises wrote about this already in 1920 in his Economic Calculation in the Socialist Commonwealth[1]. And there's also the works of Thomas DiLorenzo[2].

AC: "Companies and politicians that do not perform well go bankrupt or are voted out of office. And if society should reduce government that has grown too centralized and inefficient, then it should do no less for monopolies, which share the same shortcomings."

Really: Governments are monopolies, but that doesn't mean monopolies are like the government. That's a complete non sequitur. They do share some of the same problems, but I doubt AC would even know what they are.

[1] The Debate on the Socialist Calculation Debate
[2] The Theory of Political Entrepreneurship

Critique of Austrian Economics: A Critique [Part 5]

This is part 5 of my critique of the Critique of Austrian Economics by AustrianCritique. I found the written version online, so there might be slight differences between the YouTube version and the one I will be quoting from now on.

Starting Assumptions

AC: "When mainstream economists build a theoretical model to understand an economic activity, they often -- but hardly always -- make assumptions of perfect conditions. For example, they will assume that consumers have perfect information about the market, that market competition is perfect, that all products are perfectly homogenous, or that there are zero costs to firms entering the market. Austrians point out, however, that these conditions do not exist in the real world, so the results of these models' calculations are worthless. It is even more short-sighted to use these unrealistic results to guide national economic policy. There is a mainstream rebuttal to this argument, but for the moment, let's continue."

Really: Fair enough, but these models also try to measure and quantify things that can't be measured or quantified.

AC: "Austrians call for economic assumptions to reflect the real world -- warts and all."

Really: As we will soon see, this is untrue. In fact AC himself will give us a quote that proves him wrong. Here he is quoting Ken Gaillot, an Austrian:

AC:

Market process theory assumes that there is no force and fraud. Force includes force by individuals in the form of theft and so forth, and force by the government in the form of taxation, regulation, and so forth. Austrians recognize that force by both individuals and governments exists, and that market theory does not completely explain reality. Instead, market theory allow economists to understand the processes at work in a market society and to isolate the effects of force. Attempts to analyze real-world markets must account for government and individual force. Austrian analysis of government policies thus includes not only the direct effects of the policies, but also the effect of the policy on the functioning of the market process.

Really: AC says Austrians do not use false assumptions. Then he quotes an Austrian who says they do use false assumptions... AC fails to realize that false assumptions can be used as a mental tool to understand the market economy. This is completely different from what mainstream economists do with their false assumptions. For example there probably isn't any Robinson Crusoe on an island by himself at the moment. Yet the "Robinson Crusoe Economy" is a very helpful mental tool that many economists use. What about the evenly rotating economy in interest rate analysis?

I'd also like to point out that Ken Gaillot is a nobody and the link AC gives for this quote is broken. I did manage to find Gaillot's text in another place, though[1].

AC: "This remarkable paragraph essentially calls for the utopian perfection of the human race before the Austrian model can be applied or even criticized! All market failures today can be blamed on the fact that we have a government, regardless of the actual level of government involvement in the failure."

Really: This paragraph isn't remarkable at all and it doesn't "call for" anything. That's like saying the Robinson Crusoe Economy is "calling for" us to all live on separate islands by ourselves.


AC: "But what if the U.S. decided to become libertarian, and adopt an Austrian economic policy? Then they would still be protected from accusations of failure, because they can always blame criminals for wrecking the market process. This theory therefore serves to justify a heightened War on Crime. Considering the economic and demographic groups popularly associated with crime, one can easily see the possibilities for demagoguery and scapegoating in the event the new economic system turned out to be inherently flawed."

Really: I'm quoting this simply because AC clearly tries to imply that Austrians are right-wingers who favor the War on Crime. Very deep economic analysis here, guys!

AC: "First, we should note that economists are primarily concerned with how the real world can be modeled, and the accuracy of their models is continually improving."

Really: Too bad they aren't interested in how the real world actually works. I don't know what planet AC exists on, but you'd have to be blind not to realize how completely lost mainstream economics is.

AC: "Studying how assumptions are violated is a major part of economics. For example, William Vickrey and James Mirrlees won the 1996 Nobel Prize for their theories of asymmetric information (unequal information between buyers and sellers). The rise of New Keynesianism in the last 10 years has been based on George Akerlof's fundamental point that human beings are not perfectly rational, but nearly rational. Another liberal school of economics, institutionalism, doesn't even subscribe to static equilibrium models at all, but agree (ironically) with Austrians that the economy is one of constant change. It is really the neoclassical (conservative) economists who rely so heavily on perfect starting assumptions. If Austrians want to criticize their allies, then liberal economists are perfectly happy to let them."

Really: Reading this might leave you with the impression that economics has been going somewhere these last few decades. Let's see... Analysis on asymmetric information hasn't changed since the 60s. Rationality is a subjective term, but in its common sense meaning it was probably dealt with before Akerlof was even born. Ok so Austrians are now right-wingers, libertarians and conservatives? Why are neoclassicals conservatives? AC, you're not making any sense. And Oliver Williamson is an institutionalist and also probably the most "Austrian" nobel laureate in a while[2].

AC: "A neoclassical defense for using perfect assumptions is that countless factors affect activities taking place in the real world, so economists must simplify their starting assumptions if they are to quantify the economy at all. Even so, economists have numerous tools to get around this problem, tools that have been improving with time. They can start by isolating the most important factors. They can also focus the model on a highly specific industry, product or individual, which greatly reduces the complicating factors. Another method is to establish broad groupings or taxonomies with similar characteristics that yield variables that can be applied to smaller categories. The claim that these models do not have applications for the real world betrays the Austrian's own unfamiliarity with statistics."

Really: I suggest listening to Roderick T Long[3]. Even if a model had predicted 100% of past events right, all Austrian criticisms of that model would still hold. In the real world we're not even faced with such a situation, since most models are in fact worthless. Some do have applications and Austrians do not deny this(I mean hell, even private firms employ econometricians to give ball-park figures of possible future events).

[1] The Theory of Market Process
[2] Williamson and the Austrians
[3] Friedman and Mises on Method

Critique of Austrian Economics: A Critique [Part 4]

This is part 4 of my critique of the Critique of Austrian Economics by AustrianCritique.

Methodological Subjectivism

AC: "Austrians claim that attempting to understand individual actions through statistics ... is mistaken ... By comparison, mainstream economists find it useful to know that unemployment has risen from 6 to 12 percent ... There are several problems with subjectivism, both new and old. Even granting the premise that humans are endowed with free will, there is no denying that even impersonal forces affect human actions..."

Really: This entire clip can be easily summarized: AC has no idea what he's talking about. To understand what ASE actually has to say on this, I suggest reading Mises[1].

Methodological Individualism[2]

AC here demonstrates yet again that he's never even seen a book by Mises. This one quote basically demolishes the entire premise of his video.

It is uncontested that in the sphere of human action social entities have real existence. Nobody ventures to deny that nations, states, municipalities, parties, religious communities, are real factors determining the course of human events. Methodological individualism, far from contesting the significance of such collective wholes, considers it as one of its main tasks to describe and to analyze their becoming and their disappearing, their changing structures, and their operation. And it chooses the only method fitted to solve this problem satisfactorily.

~Ludwig von Mises - Human Action Chapter II Section 4 [1]

Unsurprisingly, the methodological sections were quite horrible. After all, you'd have to actually understand Austrian methodology to be able to criticize it. And that would require reading some of the major works.

To be continued...

[1] Human Action
[2] Critique of Austrian Economics: Methodological Individualism

Critique of Austrian Economics: A Critique [Part 3]

This is part 3 of my critique of the Critique of Austrian Economics by AustrianCritique.

Statistics

AC's critique is going downhill and fast. This segment really has no substance in it.

AC starts by saying that Austrians don't think statistics are very good, since they refer only to the past and can never tell us everything we need to know. He does not tell us why we're wrong, but instead gives us the stupidest analogy ever.

The Austrian take on statistics is much more in-depth than what AC here shows us and he quotes Rockwell without understanding why the aggregate "K" is a problem. Then he gives us an example of how the study of gases is and was conducted. With this he tries to argue that aggregates are actually fine and Austrians are idiots. I couldn't make this stuff up if I wanted to.

But wait, there's more! Austrians actually hate statistics, because they prove that Austrians are wrong. The fastest growth period in American history[1933-1973] was a time of big government and high marginal tax rates, so obviously ASE would reject those kinds of statistics. Problem with this:

1. Mises criticized statistics already in 1912[1].
2. 1933-1973 isn't the fastest growth period in US history; late 19th century is and the markets were pretty free back then.
3. Deductions and loopholes enabled people to avoid those marginal tax rates. The amount of people who actually paid the 91% was practically non-existent[2].
4. Why start at 1933? The "New Deal light" already began under Hoover in 1929[3].
5. Bretton-Woods enabled the exportation of inflation, which Austrians understood already in 1944[4].

I wonder... Does AC believe war creates prosperity? After all, GDP usually goes up during war. This is exactly the kind of nonsense that needs an Austrian approach to it[5].

Next AC wonders how Austrians can talk about the real world at all. After all, we get a lot of our information about the economy from statistics, so aren't Austrians simply cherry-picking? Except that as AC himself earlier said, Austrians do use statistics. Simply not always the same way as mainstream economists do.

"Even the Austrian's allies in business would not want to live in a world without statistics."

There are no "allies" and Austrians don't say we shouldn't have any statistics.

AC ends with a quote from Mike Huben:
"Business employs two kinds of economists: those who can create and use statistics, and those who can create and apply corporatist propaganda. Guess which the Austrians are..."

And I thank you AustrianCritique, for making me waste my time on this worthless piece of shit critique.

To be continued...

[1] The Theory of Money and Credit
[2] Bose Needs Lesson in Tax History
[3] America's Great Depression [Chapters 8-12]
[4] Hazlitt's Battle with Bretton Woods
[5] Depression, War, and Cold War: Challenging the Myths of Conflict and Prosperity

Critique of Austrian Economics: A Critique [Part 2]

This is part 2 of my critique of the Critique of Austrian Economics by AustrianCritique.

Critique of Austrian Economics: The Scientific Method

AC: Mainstream economists use the scientific method, while Austrians use deduction from a priori truths. People are free to choose and unpredictable and can act differently even if placed in the same situation twice, which is why according to Austrians positivism doesn't work.

"A priori knowledge is logic, or knowledge that exists in a person's mind prior to, and independent of, outer world experience. For example, the statement "two plus two equals four" is true whether or not a person goes out into his garden and verifies this by counting two pairs of tomatoes."

The mainstream approach is inductive, while the Austrian is deductive. This doesn't mean Austrians don't refer to real-world events and data in their writings. They just don't do it in the usual scientific way.

So Austrians get to critique the real world, while the real world is prevented from informing their theories. Even their predictions are "qualitative" and not "quantitative" so they can call the government "bad" even if the numbers don't show this.

Really: That people are unpredictable and free to choose is indeed a blow against positivism. But that's not all. There is no Ceteris Paribus in the real world, so we can't do experiments like scientists in laboratories do. A myriad of things are not even measurable, so statistics can't help with those even if laboratory-like conditions were achievable.

Austrians get to critique the real world if they have the truth on their side. If they don't, then it shouldn't be hard to demonstrate that there's a mistake in their line of reasoning somewhere. But more importantly it's not like Austrians haven't taken information from the real world to theorize. When the first draft of the business cycle was completed in 1912[1], there probably was no theory behind the overconsumption boom yet. When the real world indicated that this was possible, a theory was formed as to how that was possible within the Austrian framework[2].

Now the part about qualitative vs. quantitative prediction is pretty funny from my perspective. I think that quantitative prediction is nothing but an act of hubris. Basically it's like saying "I can make god-like predictions about the future by making a model out of an entire society." This kind of mentality is one of the reasons mainstream economics is dead from the neck up. Making qualitative predictions is simply acknowledging the limitations of what we can know.

AC: The Austrian approach(rationalism) to philosophy hasn't been considered serious since the 17th and 18th century. It was widely abandoned after its inadequacies were laid bare by other schools of thought: empiricism, positivism and most famously by Immanuel Kant's Critique of Pure Reason. The Austrian approach is a relic of history.

Really: There is something called The Whig Theory of the History of Science[3]. It states that science always progresses onward, becoming always better. What we have now is better than what we had before. Obviously this is not how the world works and just because something is old doesn't mean it's untrue. But here we find something quite ironic. Unsurprisingly AC has not read Mises(actually he probably hasn't read Kant either), or he would realize that Kant was a great influence on Mises and that Mises actually built upon what Kant had previously said. The philosophies of those two aren't incompatible with each other, quite the opposite[4].

AC: "The problem with rationalism is that it makes the search for truth a game without rules. Rationalists are free to theorize anything they want, without such irritating constrictions as facts, statistics, data, history or experimental confirmation. Their only guide is logic."

Really: On the other hand there are no rules, on the other hand it is guided by logic? Logic is a rule! A priori knowledge is obviously another rule. You can't make stuff up and say it's a priori knowledge, because even an amateur philosopher could spot the mistake if you made one. And to quote J. Grayson Lilburne: "The reality of action is an experienced fact.[5]"

AC: "Starting assumptions and trains of logic may contain inaccuracies so small as to be undetectable, yet will yield entirely different conclusions."

Really: There might be a celestial teapot on the orbit right now. It can't be detected, but it's still probably there. Seriously this is his argument? We need to scrap the entire thing, because there might be a mistake somewhere and this mistake is so small it can't be detected?!? This is the most pseudo-scientific critique I've read in months. And hey, doesn't this same argument apply to statistics? Oops!

AC: "In fact, if we accepted all the tenets of the Austrian School, we would have a second reason for why it fails to qualify as science. To be a science, a school must produce theories that are falsifiable --that is verifiable. If a theory's or correctness cannot be verified, then it is not science. ... Austrian economists make claims about the market(such as markets know better than governments), but then deny us the tools for verifying those claims(such as statistics). One might ask: How do they know?"

Really: Unless you argue that collected data is 100% precise, everything in the economy is measurable and that there exists ceteris paribus, then mainstream economists can't verify or falsify anything either. But then again, it's not like Pythagoras' theorem can be verified with empirical evidence, so I guess geometry isn't a science?

Austrians say that the price mechanism and incentive system make it so that governments probably don't allocate resources as efficiently as the private sector. That is not the same as "markets know better" in the mainstream sense.

And in the final part of this "video" AC really messes up. Let me quote him in lenght.

AC: "Austrians claim to know these things by logic. But although their literature frequently evokes the term "a-priori" knowledge, this term appears to be misused. Human are not born knowing "two plus two equals four." It is something they must learn from their environment, namely school. Forging this learned knowledge into axioms comes later, and then through a process of trial and error. So in this sense, "a-priori" knowledge doesn't even exist, unless one refers to a very basic level of knowledge capability, such as the physical construction of the human brain or animal instincts."

Really: Well now we know AC hasn't read any Kant, since he conflates a priori with inborn knowledge; two completely different things. More Lilburne:
"He tries to say that because we learn 2 + 2 = 4 via experience (school), that 2 + 2 = 4 is a posteriori knowledge. But a posteriori knowledge is knowledge that is derived from the facts of experience, not knowledge learned in the course of experience. That 2 + 2 = 4 is necessarily true is derived from pure definition, and is thus a priori."

AC: "Austrians may be using the term “a priori” to mean logical proofs or axioms, such as “If A = B and B = C, then A = C.” But if Austrians were creating economic axioms that were true by logical force, then the Austrian School would become world famous overnight, whether mainstream economists liked it or not."

Really: Many mainstream economists do recognize some of these axioms as true... Marginal utility, law of demand and so on? "Humans act" is an economic axiom too, maybe AC could refute that somehow(without acting would be nice...)?

To be continued...

[1] The Theory of Money and Credit
[2] Can ABCT Explain the Overconsumption Boom
[3] Why I Wrote My Histories of Thought
[4] Was Mises Right?
[5] A Critique of Pure Nonsense

Critique of Austrian Economics: A Critique [Part 1]

So someone actually made a longer critique of the Austrian School of Economics(ASE) and it didn't look as bad as they normally do[1]. Austrians always have an advantage, since we're forced to learn mainstream economics in school. Mainstream economists on the other hand know almost nothing about Austrian theory. This is why many of the so-called critiques out there are quite funny.

Critique of Austrian Economics: Introduction[2]

AC: Youtuber AustrianCritique(AC from now on) starts by stating that ASE is a "...branch of laissez-faire economics..."

Really: Economics is a value-free science. If one values economic welfare and human well-being, then understanding Austrian economics does usually lead to advocating laissez-faire. But it doesn't have to be so. E.g. you can be a communist and an Austrian economist at the same time(that would make sense for misanthropes).

AC: Paul Samuelson says deduction and a priori reasoning are wayyy overrated. Mark Blaug says that Austrian methodologies are(I think it should be "methodology is") "so cranky and idiosyncratic that we can only wonder that they have been taken seriously by anyone."

Really: Obviously this is a clear case of Argument from Authority. Ironically he quotes Samuelson, who wrote things on the Soviet Union that should discredit him completely[3]. And how many absolute economic laws has positivist mainstream methodology produced? The answer: none

AC: The mainstream doesn't agree with the Austrians, which automatically means the Austrians are wrong. In 1974 Hayek wins the Nobel Prize in economics "...for a contribution to monetary theory..." and ASE "...receives a huge burst of academic attention. But it was quickly rejected..."

Really: The mainstream isn't always right. A world where that was the case would be a world without change. Hayek won(shared with Gunnar Myrdal) the prize "for their pioneering work in the theory of money and economic fluctuations and for their penetrating analysis of the interdependence of economic, social and institutional phenomena[4]." Not just "for a contribution to monetary theory." And I don't know what "huge burst of academic attention" AC is talking about. People were a little suprised when Hayek received a Nobel, but that was it.

AC: "In classic crank tradition, Austrians have a conspiracy theory to explain ... [their] failure." AC quotes Patrick Gunning(an Austrian), who says that there are two reasons for the failure of subjectivist economics. "The first is that ordinary people cannot tell the difference between good and bad economics. The second is that the training ground for professional economics is the university. ... In a democracy, government funding [of universities] implies (1) a competition for funds and (2) bureaucracy. Both of these characteristics favor positivism."

Really: Who the hell is Patrick Gunning and why should we care? I've heard a dozen or so theories for why no one cares about ASE. Some of them are probably correct, some probably aren't. And more to the point: Is anything Gunning says there untrue? Does AC even know what a conspiracy theory is?

AC: ASE "...is kept alive by the Ludwig von Mises Institute, a think-tank financed entirely by wealthy business donors." LvMI is just another right-wing institute founded by institutions such as the Bradley, Coors or Koch family foundations, and these right-wing ties help Austrians get on conservative talk shows etc. And something about FEE(Foundation for Economic Education) helping LvMI out.

Really: If we go by AC's definitions, then this would certainly constitute a "conspiracy theory", would it not? LvMI is funded by "...thousands of donors in 50 states and 80 foreign countries.[5]" I don't even know why FEE was mentioned, not that this paragraph had any point to it anyway(guilt by association maybe?). People at the LvMI usually reject the right/left separation, so I don't know why AC identifies them as right-wingers.

Conclusion

AC: Mainstream economists use the scientific method, while Austrians deduce truths from a priori knowledge(pre-scientific).

Really: Good enough, but I've never heard anyone describe deduction as "pre-scientific." Whatever.

AC: Mainstream economists rely heavily on statistics, while Austrians think they have very little value, because of their limitations.

Really: I think the more important distinction is that Austrians use statistics for illustration, not as proof.

AC: Mainstream scientists believe in both objective(absolute) and subjective(personal) truth; Austrian believe only in subjective.

Really: Why did "economists" become "scientists" suddenly? Anyway this is abject nonsense. I don't even know what AC is trying to say, but it sure as hell doesn't have anything to do with Austrian economics. Since when is economics about "believing" in different kinds of "truths?"

AC: "Mainstream scientists seek to explain human behavior on many different different levels: the gene, the individual, the group and the specie. Austrians believe that all explanations of human behavior can be traced back to the individual."

Really: Austrians simply say that only individuals act. AC makes it look like Austrians completely ignore the things he cites. They don't.

AC: Mainstream economists think monopolies can arise for various reasons, while Austrians say only governments cause monopolies.

Really: There is no way for me to explain this briefly, so I'll just point to Rothbard[7]. But AC is 97% right here. But for example Mises believed that some monopolies could emerge under laissez-faire.

AC: Mainstream economists favor fiat money, Austrians favor the gold standard.

Really: Austrians usually favor the money that the market chooses. Historically it has been gold, which is why they talk about it so much. Austrian economics itself doesn't recommend any money, it's simply a theory on money(value-free).

AC: "Mainstream economists assert that the mystery of the business cycle is deep and poorly understood; Austrians claim the government causes it."

Really: This is false. Even a stateless society could have business cycles, if the banking system operated on fractional reserves. The government has only made the process worse.

To be continued...

[1] The Austrian School Deception : Why the Austrian School of Economics would result in Global Genocide
The Hangover Theory by Krugman
[2] Critique of Austrian Economics
[3] Keynesian Predictions vs. American History [17:35 - 24:25]
[4] The Royal Swedish Academy of Sciences
[5] About the Mises Institute
[6] Chapter 10 - Monopoly and Competition

Capitalism and Income Inequality

We can't get rid of income inequality even if we wanted to. But does capitalism create greater or lower income inequality? Are the proponents of greater income equality on the right track when they try to hamper the market economy?

The policies advocated by the welfare school remove the incentive to saving on the part of private citizens. On the one hand, the measures directed toward a curtailment of big incomes and fortunes seriously reduce or destroy entirely the wealthier people's power to save. On the other hand, the sums which people with moderate incomes previously contributed to capital accumulation are manipulated in such a way as to channel them into the lines of consumption.
~Ludwig von Mises

The rich usually save more out of their income. This leads to greater capital accumulation, greater productivity and higher real wages. Obviously wealth transfer programs impede this process. This on the other hand hurts wage earners, as they now have less capital to work with. Setting the morality of welfare programs aside, I'm quite certain that this process hurts precisely those it's supposed to help.

This also creates all the wrong kinds of incentives. Many are stuck in poverty, because unemployment is subsidized and income taxes penalize working. The psychological effect of progressive taxation creates entire generations of people who know that working your way to the top means higher and higher taxes as you work your way up there.

But hey, maybe these problems are worth it? If capitalism creates income inequality, then maybe we don't want more capitalism?

Capitalism is essentially a system of mass production for the satisfaction of the needs of the masses. It pours a horn of plenty upon the common man. It has raised the average standard of living to a height never dreamed of in earlier ages. It has made accessible to millions of people enjoyments which a few generations ago were only within the reach of a small elite.
~Ludwig von Mises

Wealth transfer programs may indeed reduce income inequality, if this inequality is measured in money. But here it gets tricky. We don't want money just to have money(or at least most of the time we don't). We want the goods this money can buy, and this is absolutely critical if we want to understand the inequality capitalism creates.

Most of the land, labor and capital in the world is used for satisfying the needs of the masses. This can be easily seen by simply walking into any supermarket. This results in a disproportionately advantageous price/quality ratio of the goods produced for the common man.

If we go back in time we can easily see what this means. The difference between being poor and rich 1000 years ago could've easily meant the difference between starving to death and not doing so. The rich might've had 100 times more income, but so what? I'd say that life has an infinitely greater amount of "utility" than death(not just 100 times greater).

With capitalism this has been reversed. 200 years ago the transportation the rich could afford was on a different planet compared to the poor. What about now? The poor(in capitalistic countries) have an old car, while the rich might drive a new BMW. But they both have a car and can actually travel. The ultimate end is to get from point A to point B. They can both attain this end, when it used to be that the poor could not. Does a €400 bottle of wine offer 20 times more utility than a €20 bottle? What's the real difference between the internet connections of the rich and the poor nowadays? How about 10 years ago?

Even from a completely utilitarian perspective, there's no way you could argue that the additional enjoyment the rich get from the goods they buy is comparable to how much more income they earn.

If the last few hundred years can tell us anything, it's that capitalism reduces economic inequality in real terms.

Income Inequality

Income(or wealth) inequality is seen as a bad thing for various reasons. I just read an article[1] about how income inequality in Finland is now as bad as it was 40 years ago. Expert Heikki Taimio explains that we're going in the wrong direction and that high income inequality correlates with social and health problems. The article elaborates on this and lists obesity, violent deaths and criminal behavior as some of these problems.

Statistics

There are several problems with how income inequality is treated. First of all many measurements use pre-tax income to measure this inequality. This is obviously extremely misleading to say the least, and when consumption inequality is measured, it becomes apparent that the poor are really not doing as bad as income inequality would have us believe.

How were the correlations between health problems and income inequality achieved? By looking at different countries. Looking at the same country during different time periods leads to completely different conclusions[2].

Talk

I would also like to point out some of common language used in the discussion over income inequality. Normally we are told that the share of wealth owned/earned by the lowest 20% has shrunk. This creates the illusion of the poor getting poorer and the rich getting richer, while most of the time this isn't the case at all.

I also find the talk about correlation infuriating. Causation is clearly implied, but they can't say it because there is no real theory behind it(or if there is, it's rare).

Another annoying term is income distribution. Distribution creates the image of a fixed amount of wealth that's then handed out to members of society, when obviously that doesn't represent the market economy in the slightest. A market economy is a series of voluntary exchanges and the amount of wealth is certainly not fixed. Someone earning more money does not mean someone else has to earn less. In fact if earning more represents greater productivity, then it necessarily benefits others.

Theory

As economists we must resist the temptation to make interpersonal utility comparisons. And that's what most of the discussion boils down to. E.g. applying the concept of marginal utility to money and assuming identical value scales among people makes it very easy to make the case for income equality(and maximum "total utility"). After all, what's one euro to a millionaire?

Ironically by using some (incorrect) armchair logic we can argue that precisely the rich value money much more than others, otherwise they wouldn't have gone to great lenghts to acquire and preserve all that wealth. Here I'm refuting a fallacy with a fallacy, since in reality we can't know people's value scales unless they are acting on them.

Do any of the problems that correlate with income inequality go away or get better if the state confiscates almost all of the wealth of the richest 1% and burns it to the ground? After all if income inequality is the cause, then that should help.

Someone might protest and say that I've got it all wrong. The argument is actually as follows: Taking from the rich and giving to the poor gives the poor better access to (e.g.) healthcare and education, and that's how their situation is ameliorated(and the rich are still rich enough to have good healthcare and education). Ok fair enough, but we're no longer talking about income inequality; we're talking about poverty. I recognize that poverty causes many problems, but poverty is not caused by income inequality(talking about real poverty, not "the lowest 20%").

And hey, what do you know? Poorer countries usually have greater inequalities than rich countries. No strawberry milkshake, Sherlock! That might have something to do with the correlations under discussion. The first applicable scenario that comes to mind is high inflation. Not only does that wreck the economy and make people poorer, it also wipes the middle class out(one of the classic symptoms of an inflationary policy is high income inequality).

Causes

After 15 seconds of Zen-like thinking I've come up with a complex theoretical framework that explains in detail why there is economic inequality. My answer: Some are just better at earning or stealing money. Not only are they better, but the best of the best are way better at it. Grab some online game that tracks how much and well people play it. Compare the differences between the best 100 players, then look at 100 mediocre players and you will understand what I'm talking about. You can look at sports, music or pretty much anything and the same pattern appears. The skill curve is "exponential" if you will.

No different with making money. Income equality has never been achieved on a large scale and schemes sold with it as a promise have ended up rewarding those who can navigate the political process(stealing). In a free society those rewarded know how to navigate the market process(earning) and in a mixed economy reward goes to those who can navigate both.

Consequences

I admit right now that income inequality might indeed have some negative consequences that make sense. However it must be remembered that even if these theories are correct, they must face the fact of opportunity costs(is it worth fighting this "problem?"). Measuring the costs and benefits of greater equality will always hit the wall of interpersonal utility comparison. Econometricians threw that principle out the window a long time ago, so they've obviously done some studies on this. Even so, it doesn't seem to me like the negatives are understood that well(not that I'd expect an econometrician to understand economics).

Income inequality does have one dangerous consequence that I'm aware of. It apparently causes people to lose their minds and come up with some pretty frikin' stupid ideas.

So here's the deal; income inequality allegedly causes depressions. I first stumbled on this idea in a speech given by Thomas E. Woods[3]. Two mainstream historians(David L. Wilson & Eugene P. Trani) wrote a book on the presidency of Warren G. Harding[4] and told us the following:

The tax cuts [after WWI], along with the emphasis on repayment of the national debt and reduced federal expenditures, combined to favor the rich. Many economists came to agree that one of the chief causes of the Great Depression of 1929 was the unequal distribution of wealth, which appeared to accelerate during the 1920s, and which was a result of the return to normalcy. Five percent of the population had more than 33 percent of the nation's wealth by 1929. This group failed to use its wealth responsibly.… Instead, they fueled unhealthy speculation on the stock market as well as uneven economic growth.

Woods' answer:

If this absurd attempt at a theory were correct, the world would be in a constant state of depression. There was nothing at all unusual about the pattern of American wealth in the 1920s. Far greater disparities have existed in countless times and places without any resulting disruption.

In fact, the Great Depression actually came in the midst of a dramatic upward trend in the share of national income devoted to wages and salaries in the United States — and a downward trend in the share going to interest, dividends, and entrepreneurial income.

Stupid ideas never die, so now you can find quite a few articles on how income inequality caused the Great Recession. More importantly someone I know very well(someone who IMO should know better) told me she believes in this theory. As I can't articulate my ideas well without writing them down, I simply said I disagreed with her. Now I write. As Woods already pointed out, historically the theory makes no sense.

The rich save and invest more. So if more goes to them and not the wages of normal people who'll just consume most of their income, it'll create a speculative bubble. I guess the rich have now "too much" to invest and so they take more and more risk. I'd like to point out that one main reason for the demand for higher yields was the fact that central banks kept interest rates too low. Safe investments didn't pay.

This theory resembles the "savings glut from China" argument that we heard so often in 2008(I haven't seen that argument in a while... maybe it actually went away?). Globally the savings rate was actually lower than in the previous decade, so empirically it makes no sense. And why was the bubble biggest in the US? After all, their savings rate went negative, so they should've had the smallest bubble of them all. In China it should be the opposite.

The short answer is that more saving and investment simply creates... more investment projects. Nowhere in this "theory" is the "cluster of errors"[5] made by entrepreneurs explained. To be fair, if no one saved and invested anything, then we indeed wouldn't have business cycles. We wouldn't have anything for that matter, since we'd be living in the stone age.

Equality

"Equal" is a mathematical term that is used when two things are exactly the same. People are not the same, they are all different. It is a blessing that this is so, or social cooperation and the division of labor wouldn't be nearly as beneficial as it is now. A world of income equality isn't real, it is an absurdity that denies the existence of differences between people. One might as well try to create a world without geniuses and dullards.

I do not say that income inequality is "good" or "bad". The only "equality" I believe in is the one before law.

[1] Tuloerot repesivät yhtä isoiksi kuin 40 vuotta sitten
[2] Look at the changes, not at the levels
[3] Why You've Never Heard of the Great Depression of 1920
[4] Presidency of Warren G. Harding
[5] The Positive Theory of the Cycle

Does Capitalism Require Growth?

I just listened to a few speeches by David Harvey(a true socialist), and I noticed something in both his speeches and in the comments written by people who had watched these speeches. Profits were of course evil, many comments talked about how scarcity could be eliminated and capitalism seemed to be some sort of collective will that had a mind of its own.

Something that came up was that capitalism requires growth. I'm going to assume that material well-being is the issue here. If all exchanges in the economy are voluntary, then by definition all exchanges "grow" the economy, as voluntary exchange means all parties in the transaction think they'll benefit. In this sense capitalism can never do anything but grow the economy, so I doubt this is the meaning we're looking for.

The usual aggregate used when determining economic growth is GDP, so I'll use it too to make my point.

So does capitalism require a growing GDP?

To illustrate the fallacy here, let's take an improbable scenario of more leisure. What if people suddenly decided that they actually enjoy leisure a lot more than before and reduced the amount of work they do by 50%? Real GDP would certainly fall, society would still be capitalistic and people would be better off than before(if they weren't, they'd obviously go back to work). The economy would "shrink" and it wouldn't be a disaster(I'm excluding the transition period this would require, as this is an insane example anyway).

People who talk about growth as a requirement of capitalism usually focus on the capitalists(or sometimes they just talk about capital, as if capital by itself could act!) and they come up with these very imaginative stories about how the capitalists are running the show in some way because of that and that. Capitalists aren't a unified group with unified goals; as individuals they are simply a small part of the economy like for example every consumer, employer and employee is.

Capitalism has some prerequisites like private property and the freedom to exchange(otherwise it isn't capitalism), but it does not have wants, needs or goals.

Corrections on Earlier Posts

We don't aquire wisdom until we make a few mistakes. So don't worry if you make a whole lot of mistakes... Just think how wise you're going to be.
~Motivational Poster On the Internet

So yeah I'd like to point out that I misrepresented what "subsistence fund"(also called "pool of funding" in Austrian circles) actually means in my earlier post. I would also like to point out that even though I did not use the term properly, I used it consistently(in the sense that I used it to mean the same thing all the time) and that this mistake does not in anyway compromise my final thoughts on the subject.

To summarize: I used a term in the wrong way in my earlier post; otherwise nothing to see here.

The Austrian Business Cycle Theory

Economics has often been called a "dismal science". Looking at the current discourse on the economic crisis it is probably the only conclusion that any normal person could draw. Real intellectual thought is indeed near extinction in the economics profession. After all that algebra, all those graphs and all those fancy econometric models they were taught in college, economists these days are completely lost(well they're okayish in microeconomics, but macro is horrible).

If you ask a non-economist about the causes of the economic crisis, the answer will probably be as insightful as if you asked an economist. They'll say it's "inherent in capitalism", a result of "deregulation" or maybe they'll confess and simply say that they don't know. The reasons are many, but the solutions are the same without fail: more state intervention in the economy.

"Economics is not a dry subject. It is not a dismal subject. It is not about statistics. It is about human life. It is about the ideas that motivate human beings. It is about how men act from birth to death. It is about the most important and interesting drama of all — human action." ~Leonard P. Liggio

Economics has drifted far from the causal-realist analysis that it is supposed to be. When talking about economic policy, some already use "happiness economics" as a scientific justification for further intervention, when what they are talking about isn't economics or even science really. Or to be more precise; studying how happy people feel they are might be science, but many of the conclusions drawn from the results are normally worthy of no serious attention.

Then we of course have the idea of Rational Expectations that "...assumes that people do not make systematic errors when predicting the future, and deviations from perfect foresight are only random."

The father of the Efficient Market Hypothesis Eugene Fama on the other hand says:
"I don't even know what a bubble means. These words have become popular. I don't think they have any meaning. ... They [bubbles] have to be predictable phenomena. I don't think any of this was particularly predictable."

Keynesians have aggregates and magical multipliers that confuse people with the skim milk fallacy. To quote Michael Levin:
"According to this paradigm [the skim milk fallacy], science always shows that things are the reverse of how they seem. Deep scrutiny of virtually any phenomenon will reveal that everyday convictions about it are wrong. In fact, taking things at face value betrays naiveté, while readiness to debunk is the mark of the sophisticate."
A household spends less if they are facing financial difficulties. According to Keynes the state should do the exact opposite. Creating new pieces of paper(new money) does not create additional wealth. But during a recession it does?

If none of this seems to fit well with reality, that's because it doesn't. Deviations from perfect foresight can be systematic, bubbles are bubbles even if they aren't predictable and the Keynesian stuff is just nonsense.

The Austrian School of Economics is simply the only school of thought that makes any sense. I will now try to briefly explain the Austrian theory of the business cycle.

"Before we can meaningfully ask what might go wrong, we should first understand how things could ever go right." ~F. A. Hayek

In a market economy the most successful entrepreneurs make profits and can thus expand their business. Bad players are automatically weeded out through the profit-and-loss mechanism. Even good entrepreneurs make mistakes, but when almost everyone makes mistakes(often the same kind of mistakes to boot) at the same time, shouldn't there be an explanation for this? Isn't this a question worth asking?

I am not quite satisfied with the usual suspects, whether it be greed, irrational exuberance or just the good old animal spirits. If collective insanity was really the explanation, why does it take so long for the mistakes to be revealed? Why is the economy so completely out of whack when the bust hits? How could there suddenly be such a lack of capital?

A castaway is on an island by himself. To sustain himself he decides to catch fish. He doesn't have any capital(any equipment other than his own body) so he does it with his bare hands and is able to catch only 3 fish each day. After a week or so he decides to make a net, but he knows he'll need a whole day to complete it. But he also needs to eat, so what does he do?

He'll need to eat only 2 fish per day(he'll need to underconsume) for three days to save 3 fish for the day on which he constructs the net. He saves because he thinks those savings will enable greater enjoyment later(remember time preference?). Those savings are his subsistence fund, the net will be his new capital equipment and this way of production is called a more roundabout method of production. It takes a longer time to construct the net and use it than to just keep catching fish with your bare hands, but it is also a more productive method and if it wasn't then there would be no point in doing it. If two methods of production are equally productive, then the one that takes longer will always be rejected.

As we underconsume we release resources into the economy to be used by others. Banks then allocate these funds in various ways and everyone is happy. Savers are paid interest for their sacrifice and borrowers use these savings to fund different activities. As we've already seen, a fall in time preference(less present, more future consumption) lowers the rate of interest. But when the rate of interest falls, what kinds of effect does that have on the structure of production?

Long-term debt is interest rate sensitive. When comparing to short-term debt, the demand for long-term debt changes much more with changes in the rate of interest. This is not surprising, as we always try to use the shortest and most productive processes of production. If there is more to invest and the shorter (less roundabout) processes are already in use, how else could the savings be allocated than to fund more roundabout production processes?

By saving we've indicated that we want to consume less in the present. This obviously lowers the demand for the production of lower-order goods(close to the consumer: warehousing, retailing etc) and releases these resources to be used in the production of higher-order goods(far away from the consumer: research and development, mining etc).

Everything is still in perfect harmony. We save more, we release resources to be used for a lenghtened structure of production and we wish to consume more in the future(this greater consumption in the future is enabled precisely by the lenghtened structure of production).

"The boom produces impoverishment. But still more disastrous are its moral ravages. It makes people despondent and dispirited. The more optimistic they were under the illusory prosperity of the boom, the greater is their despair and their feeling of frustration. The individual is always ready to ascribe his good luck to his own efficiency and to take it as a well-deserved reward for his talent, application, and probity. But reverses of fortune he always charges to other people, and most of all to the absurdity of social and political institutions." ~Ludwig von Mises

Central banks create new money all the time. By doing so they push the rate of interest down. New money is also created through fractional-reserve banking. Now if banks have more to lend, they'll obviously charge a lower rate of interest for it. So everything goes as I described, except that there's one big difference: there are no additional savings. There is certainly additional credit, because the banks create it out of nothing, but no one has underconsumed and the society's subsistence fund hasn't changed.

Entrepreneurs will react to a change in the rate of interest and start more roundabout methods of production. They will start bidding resources away from the rest of the economy. But as these funds trickle back to people through wages, interest, rents and dividends, people will go and spend this money according to their old consumption/saving patterns(maybe they'll save even less; the rate of interest is lower after all). The lower-order stages of production see this demand and a tug o' war with higher-order stages begins, as both sides try to outbid each other. This leads to a rise in the price of capital and the rate of interest is pushed higher.

A modern society has a subsistence fund that isn't composed of just current savings, but also of past savings that have already been "used" to fund projects. The increasing costs of capital may for example lead to a decision that a machine isn't replaced with a new one even though it was supposed to be. In this way the machine(funded by past savings) is acting as a buffer to deal with the diminishing subsistence fund. This is one of the reasons why the boom can go on for so long.

As the price of higher-order goods rises much faster(they also collapse much more severely during the bust) during the boom, illusory profits appear. This creates an illusion of greater wealth while capital is being actually consumed. This perception of wealth can lead to a change in people's consumption/saving patterns, as they will feel richer. This is why the boom can(does not always happen) spread from higher-order goods to consumption.

The central bank can try to fight the rise in the rate of interest by injecting more credit into the economy, but this can only postpone the day of reckoning. At some point the choice will be between hyperinflation or letting the rate of interest rise.

As the rate of interest rises, the mistakes reveal themselves. Profitable ventures become unprofitable and the lack of real savings becomes apparent. There were no additional savings to begin with, but on top of that a lot of the existing savings were mishandled during the boom. The whole thing was unsustainable from the beginning.

Ludwig von Mises, in his book Human Action uses the example of a master builder who is building a house. This master builder thinks that he has 20% more bricks than he actually has at his disposal. If he thinks he has more bricks then he'll obviously build a completely different or at least a larger house than if he knew the real amount of bricks.

While the master builder is contructing the house everything is going well: people are employed, capital is being used, wages are paid and the house is being built. But would it be better for the master builder to realize his error sooner or later? When someone says that we need to inject more credit into the economy, he's basically suggesting that we get the master builder completely drunk, so maybe he won't notice the dwindling supply of bricks. This doesn't change the fact that the master builder is building a house that cannot be completed and he is wasting his time and resources.

The sooner the boom comes to an end, the better. The boom is the problem; it's during the boom that all the mistakes are made. Of course the best policy would be to never start the artificial boom to begin with, but this would require the abolition of central banks and fractional-reserve banking(JFYI: I'd like to abolish them).

The rate of interest should be left alone.