Thursday, 14 October 2010

Nearly right is all wrong - Austrians again

Another example of how Austrian economics is nearly right but, at the last minute, gets it all wrong.

This article from Peter Boettke on Coordination Problem makes an insightful distinction between order and complexity in two different dimensions. He says:
I often use a 2 x 2 matrix to communicate to students the different schools of thought in economics. The rows reflect the problem situation we are find ourselves in (simple or complex), the columns reflect the outcome of our interactions (order or disorder). Neoclassical economics is found in the simple/order cell; Keynesian and market failure theory is found in the complex/disorder cell; Marxism and critics of economics are found in the simple/disorder cell. What does that leave? The complex/order cell and that is the intellectual home of the Classical economists such as Smith-Say, the Austrian school from Menger to Mises to Kirzner, and the New Institutional school of Alchian, Buchanan, Coase, Demsetz, North, Olson, Ostrom, Smith, Tullock and Williamson, etc.
A very interesting insight, with which I agree. As I've mentioned before, Mises was very thoughtful on the limits of human cognition; markets and the price mechanism do have the power to transcend some of those limits. Of course it is a bit simplistic - Keynesians don't really think that the world is in complete disorder because of the complex problems it faces. But still, a useful thought and helps to make a good case for the Austrian philosophy.

Another good thought:
The traditional perfect market versus market failure debate is stale --- the perfect market folks don't tell us how the story of the market unfolds, and the imperfect market folks stop the story short right when it is getting interesting.
Yes! The interesting theoretical action is understanding why and when markets might fail, and then working through the consequences. Economics is all about trade-offs. Using economic tools to analyse the trade-offs between markets and no markets, is a powerful application for them.

Then he spoils it all by saying:
If money is neutral, then the cost of inflation on society are widely different than if we understand the non-neutral aspect of money...if money is non-neutral, inflation is extremely damaging to the economy through the distortions in the pattern of resource use it engenders.
This assertion is completely unproven. Money, most modern economists agree, is non-neutral (in the short run at least), but this certainly does not automatically make inflation extremely damaging.

Inflation helps to break nominal anchors (a process with economic benefits) and safeguards against deflation (also a benefit); while on the cost side, it makes the allocation of resources harder due to less predictable returns. Are the costs greater than the benefits? That is a tough question, perhaps answerable with empirical data or perhaps with a sophisticated application of theory. But Boettke skips over the question altogether and just assumes the answer that suits the Austrian point of view.

He links to a paper by Steve Horwitz, which is more detailed but not much better; treating the cost side of the equation without mentioning the benefits.

I still think this is because Austrians are in love with rhetoric and philosophical insight, and hate the hard work of following the insights through with maths and empirical data. Occasionally I suspect my view on this is too harsh, but when I've said it before, commenters have turned up on this blog and instead of saying "no, Austrians can do maths" they've said "the reason Austrians don't do math is because..." followed by whatever spurious reason supposedly justifies it. See the comments on Boettke's article for several more examples of this.

The best economists - from Samuelson, Krugman and Diamond to the less famous but very useful Nick Rowe and Rajiv Sethi - all recognise the need for both intelligent economic insight and the mathematical rigour to test and develop your insights.

But to be fair to Pete Boettke, I'll leave you with another one of those insights from the end of his article, in the hope that some heretical Austrian mathematician might take up the challenge of modelling it:
...good economics is to be found in the unfolding story of economic life --- in those economic forces at work, in a world full of imperfections, in how the dynamic adjustments made by men result in a variety of coping mechanism for our ignorance and for the complexity of the world within which we find ourselves interacting with one another.

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