Monday, 12 October 2009

Austrians II

Thanks to Lucas Engelhardt for a thoughtful answer to my questions about Austrian economics.

He points out a few ambiguities and flaws in my posting and explores the "something happens" phrase which I neglected.

I would like to continue the debate on three main points:

Why those sectors?

Lucas says:
When money is cheap, interest rates drop. When interest rates drop, assets that provide payoffs further in the future gain value relative to assets that provide payoffs closer to the present. Therefore, sectors that are expected to offer high returns in the far future will see resources diverted toward them.
So on this argument, all investment assets rise in value compared with goods for immediate consumption.

But is this what we saw in 2001-07? Lucas and I agree that there were too many resources in residential construction, but on his argument we should have seen a general excess of investment as a whole, and a reduction (relatively) in consumption. Contrary to that, most people would say there was not enough investment. What investment there was (which was lower than the long-run average, in the US and UK at least) mostly went specifically into housing and not into productive business investment.

It's too simple to classify business investment as "productive" and housing as not; but the point is, the "misallocation" of resources was sector-specific and not just into all assets with a long-term return.

Logical deduction versus empirical demonstration

Lucas points out that:
Austrian economics is founded on a deductive epistemology. If one has true premises and reasons deductively, then the conclusion absolutely must be true. "Tests" are superfluous. (Similarly, the Pythagorean theorem is true because of the logic underlying it, not because we've failed to find a right triangle for which it wasn't true.)
The problem is that we don't all accept the premises of Austrian economics - or its deductions - as obviously and demonstrably true. They might be, but this is why we have empirical tests - to check whether models and deductions are correct.

The Pythagoras example is a good one. Based on its premises and logical deduction, it appears to be indisputably true. But Einstein managed to set up an empirical experiment after 2500 years which proved it isn't correct after all. General relativity shows that our universe is non-Euclidean, and therefore the Pythagoras theorem is not perfectly true in this world. This is the value of scientific experiment - because we make too many mistakes, or false assumptions, to trust ourselves always to be right.

So what about those numbers?

Lucas points out that my question about numbers didn't exactly fit with my other points. But the question still stands: does Austrian economics predict any specific measurable facts?
Part of the reason that Austrians generally don't provide "the numbers" is because they are keenly aware: (1) that relevant economic data is highly dispersed, (2) the economy is a complex structure and (3) relevant economic laws are all counterfactual.
I feel this makes things a little too easy. A model which essentially makes no predictions is not very useful.

Now of course the economy is complex and the data is dispersed; this comment applies to all economic models. Nobody says it's easy to estimate that NAIRU is 5% or work out a Taylor rule like this one. But these are still valid outputs from standard macroeconomic models, which allow us to test if the models broadly work. If unemployment is 9% and inflation still rises, or unemployment is 3% and inflation falls, that encourages us to question the model that gives rise to a prediction of 5% NAIRU.

Similarly, if the Austrian model makes a strong claim (that recalculation takes time and this time is the main cause of recessions) there should be some way to estimate that length of time and understand the factors that may influence it.

Even if it's impossible to determine the speed of recalculation in a recession, the theory should surely give an understanding of the factors that control recalculation/reallocation in a non-recessionary environment. Then we'd know what to do to help the economy find its natural resource allocation as quickly as possible.

I imagine the Austrian answer to this is that the free market will always allocate to the correct sectors, and only government intervention, if not oriented to correcting market failures (externalities, provision of public goods), interferes with that process. But few economists would disagree with that basic principle - so I am left again wondering what the specific predictions of Austrian economics are.

If it makes no predictions, I'm equally free to accept or disregard the theory and it has no effect on my life. Leaving aside the positivist question of whether the theory is even meaningful, a theory with no predictions is of little value.

There is lots more conversation about this going on in the blogs this week:

...there is another asymmetry. As the housing market expands in the 1990s through 2006, people are drawn into construction because they see the higher wages. They begin to invest in the skills of the construction business.

When it collapses, they have to decide what to do instead and how long to wait before doing it.

I think he falls into a Say's Law style trap here. Let me unpack that more carefully:
Say's Law sounds very plausible when you first hear it: if someone lends money to the government, of course that money is no longer available to spend or invest. But it isn't true, because of the dynamic interaction between saving and lending on the one hand, and spending and income on the other. Income and savings are not exogenously given but are dependent on each other and change quickly in response to various factors.

Similarly, it sounds plausible to say it's easier to move into a sector when it's growing than to find a new sector when the one you're in is shrinking. convincing as this sounds, it pushes back the question beyond the scope of the Austrian model.

Naturally if demand in a sector collapses, there will be dislocation while people find a new job. But what causes demand to collapse?

Bryan Caplan debates Pete Boettke on Austrian economics in a video from 2002. Now I thought 1934 was a long time ago, but 2002 is positively prehistoric.

James Hamilton has some comments suggesting that recalculation is real, and to the extent that it is, simple monetary or fiscal stimulus to increase aggregate nominal demand won't help. But is this true? Surely if general demand is increased, and demand in one sector is falling, it will be much easier for other sectors to absorb the layoffs (indeed this scenario should be equivalent to the recalculation-in-a-growing-economy mechanism which Russ Roberts thinks will work fine). Hamilton mentions "hydraulic macro" which is a nice way to describe an approach which looks at the response of individual actors or sectors in an environment of an overall growing or shrinking volume of demand.

And Tyler, as usual, says something useful. (Update: And something else too)

1 comment:

Lucas said...

My response: