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The personal insight was poignant. And the economic insight, that the misallocation of resources results in diminished productivity, ties into the idea that congress misallocating our taxes results in recessions and depressions.

There is no such a thing as a misallocation of taxes. If taxes would be spent as the taxpayer wants, they would not be taxes anymore.

Niko, well...there are three types of allocations. There's the callocation (current allocation)...the pallocation (pragmatarian allocation) and the aallocation (anarcho-capitalist allocation). The callocation represents a perfect allocation of private funds and a misallocation of public funds. The pallocation represents a perfect allocation of private and public funds. The aallocation represents a perfect allocation of funds.

If we think about Christmas...the callocation would be like if we hired 538 personal shoppers to purchase all our Christmas gifts. The pallocation would be like our current Christmas system. The aallocation would be like we abolished Christmas altogether.

The goal of pragmatarianism is to help people understand that, all things being equal, it's impossible for a committee to determine the "optimal" level of funding for an organization. Demand is the only thing that can determine the "optimal" level of funding for an organization.

In other words...pragmatarianism is simply applying free-market principles to the public sector. Is there a demand for public goods? Yes. Are there suppliers of public goods? Yes...government organizations. All that is needed to turn the public sector into a free-market would be to give taxpayers the freedom to choose which government organizations they gave their own, individual taxes to.

So it would be extremely worthwhile to sacrifice the current libertarian approach of trying to lower taxes and/or dispute the technicality of public goods...in order to gain getting our foot in the door long enough to help liberals understand how it's a "fatal conceit" to believe that 538 congresspeople can efficiently allocate 150 million people's taxes.

For more information check out... http://pragmatarianism.blogspot.com/2012/03/magna-carta-movement.html

I apologize for engaging you. It will not happen again.

Niko, no no no...I'm the one that owes you an apology. In retrospect I can clearly see that my response to you was completely uncivil. It's something that I really need to work on.

This is a very good post by Don Boudreaux, whom I last saw a year ago while visiting at GMU (Mercatus) for a week. Don clearly does "get" Lachmann now.

Lachmann had the great insight that, for Keynes, all capital are substitutes. For Hayek, some capital goods are complements. The insight is as relevant today as in the 1930s.

I think that some of the Austrian (Lachmannian) insight into capital complementarity is being captured by the literature on "irreversible investments" which is, unfortunately, not widely known. The literature was spawned by Dixit and Pindyck in Investment Under Uncertainty.

http://www.amazon.com/Investment-under-Uncertainty-Avinash-Dixit/dp/0691034109/ref=sr_1_1?s=books&ie=UTF8&qid=1333202141&sr=1-1

It should be more widely known among those seriously interested in the Austrian Business Cycle Theory.

I am aware that there Dynamics Stochastic General Equilibrium models which attempt to incorporate aspects of capital complementarity and substitutability.

So while the mathematical modelling of capital may be unsatisfactory, contrary to what the article asserts, that capital can be both substitutable and complementary is not entirely lost on (some?) mainstream economists.

I was writing another comment...but it ended being a bit lengthy. It's probably not my fault that I get carried away by the mystery of it all. Anyways, I posted it on my blog...

http://pragmatarianism.blogspot.com/2012/03/what-are-taxes-worth.html

John,

Can you give a cite to at least one DSGE model with capital multi-specificity?

Capital complementarity is ignored in practice and in policy. Using monetary and fiscal policy to "stimulate" the economy makes no sense in a world of capital specificity and complementarity.

These issues also arise in labor markets, as has recently been rediscovered by some.

What a great little article on Ludwig Lachmann. I consider Lachmann the most important Austrian economist because he understood and tried to develop what he considered to be the shortcomings in its doctrinal foundations. In fact, Lachmann is the person SOLELY responsible for introducing me to Post Keynesians, which in many respects I consider to be a superior paradigm to Austrian economics. Austrians hostile to that notion should read his articles collected in the edited Lavoie volume. Yes, the edited Grinder volume is good on subjectivism and expectations, but the Lavoie volume explores several themes addressed directly to Keynes and his Cambridge followers.

Only Lachmann really understood that Keynes was a more complete subjectivist than Hayek! This may sound like heresy, but if you really read Lachmann you will see why he made this argument.

Lachmann was great. His contributions to capital theory are indeed important, but again, I think this work was directed more to the Keynesian literature. He showed quite correctly that Keynes' theory of the diminishing marginal productivity of capital is flawed because capital is complementary --- so capital accumulation does not lead necessarily to diminishing marginal returns.

Anyway, Lachmann is great, but it is somewhat ironic that this tribute to Lachmann is printed in a publication called "The Freeman." A serious engagement with Lachmann's writings will lead you to question the laissez faire economic paradigm. Libertarians beware!

austrian away, can you substantiate your claim? Here's Lachmann's perspective from "The Market Economy and the Distribution of Wealth"

http://oll.libertyfund.org/?option=com_staticxt&staticfile=show.php%3Ftitle=97&chapter=3326&layout=html&Itemid=27

"The market process is thus seen to be a leveling process. In a market economy a process of redistribution of wealth is taking place all the time before which those outwardly similar processes which modern politicians are in the habit of instituting, pale into comparative insignificance, if for no other reason than that the market gives wealth to those who can hold it, while politicians give it to their constituents who, as a rule, cannot."

"This process of redistribution of wealth is not prompted by a concatenation of hazards. Those who participate in it are not playing a game of chance, but a game of skill. This process, like all real dynamic processes, reflects the transmission of knowledge from mind to mind. It is possible only because some people have knowledge that others have not yet acquired, because knowledge of change and its implications spread gradually and unevenly throughout society."

"The lesson to be learned here is that once we allow ourselves to ignore fundamental facts about the market, such as differential knowledge, some people understanding the meaning of an event before others, and in general, the temporal pattern of events, we shall be tempted to express “immediate” effects in shor-period equilibrium terms. And all too soon we shall also allow ourselves to forget that what is of real economic interest are not the equilibria, even if they exist, which is in any case doubtful, but what happens between them. “An auxiliary makeshift employed by the logical economists as a limiting notion” can produce rather disastrous results when it is misemployed."

"Moreover, what is a resource today may cease to be one tomorrow, while what is a valueless object today may become valuable tomorrow. The resource status of material objects is therefore always problematical and depends to some extent on foresight. An object constitutes wealth only if it is a source of an income stream. The value of the object to the owner, actual or potential, reflects at any moment its expected income-yielding capacity. This, in its turn, will depend on the uses to which the object can be turned. The mere ownership of objects, therefore, does not necessarily confer wealth; it is their successful use which confers it. Not ownership but use of resources is the source of income and wealth."

All of that free-market goodness fundamentally contradicts what you seem to be saying. Did Lachmann change his mind later on? If so, can you offer a link to an article that explains this?

Xerographica,

In reading the passage you cite, let me just point out one thing that I think Lachmann really appreciated --- recognizing the dynamic nature of the market process in no way guarantees that actual market processes will produce optimal or even efficient outcomes. That is precisely why most Austrians reject Lachmann. This is what the Kirzner-Lachmann debate is all about. Sure, Kirzner hit upon an important idea -- entrepreneurial discovery. But, on this point, Lachmann was quick to point out that not every entrepreneurial discovery will actually generate equilibrating tendencies. In fact, some entrepreneurial discoveries, once they are put into action, may actually distort what would otherwise be equilibrating tendencies.

So, I reject the idea that we need "free-markets" to achieve economic efficiency. It is naive to believe that free markets will mechanically produce equilibrating tendencies.

But, before I am banned from this forum, let me also add that I agree with the Austrians that there is no reason to believe that government regulation can achieve equilibrating tendencies. The market is a complicated process, and centralized bureaucratic decision-making only distorts what would otherwise be the market process at work. But, remember, the market process itself is not infallible. There will always be profit and loss. Businesses will fail, there will be massive unemployment, recessions, and maybe even depressions in a free market economy. To believe otherwise seems to me to just be fallacious reasoning.

Who are we to say that the economy would be free from unemployment and slumps in a truly free market economy. Does a free market economy turn people into "automatons"???? I don't think so.

austrian away, I don't think it's "optimal" that Brittney Spears receives so much money while the bands that I love barely receive enough money to scrape by. In other words...I want them to give up their day jobs...but other people do not.

Once we embrace the idea that values are subjective...then I'm not quite sure what specific examples you could offer that would validate your critiques of the market process...where people freely give up on thing that they value in exchange for another thing that they value even more.

To be clear though, I'm not an Austrian...I'm a pragmatarian. On one hand...I agree with the Austrians that there is a fundamental problem with 538 congresspeople allocating 1/4th or 1/5th or even 1% of our nations resources. Everybody makes mistakes. What happens when 538 people make a mistake with 1/4th of our nation's resources?

What's a "mistake"? A mistake is simply a misallocation of resources. If a business owner purchases the wrong resources then his productivity is diminished. What happens when congress makes a mistake? Our productivity as a nation is diminished. The bigger their mistake the bigger the decline in productivity. This is how we end up with recessions and depressions.

It has nothing to do with businesses failing simply because business owners can't make mistakes with the same amount of resources that 538 congresspeople can. Not only that but venture capitalists hedge their bets. They expect most ventures to fail which is why they don't put all their eggs in one basket.

Unlike the Austrians though...I don't believe we need to throw the baby out with the bath water. The problem has nothing to do with the public sector itself...the problem is simply allowing a committee of 538 people to control too many resources. Therefore, to solve that problem we would simply hedge our bets by giving taxpayers the freedom to choose which government organizations they gave their individual, hard-earned taxes to. In essence this would apply free-market principles to the public sector.

150 million taxpayers would give up one thing that they value...their money...in exchange for something that they value even more...environmental protection, public healthcare, national defense, food safety and so forth.

Of course taxpayers would make mistakes... everybody makes mistakes. We all have limited perspectives but taxpayers would only be able to make mistakes with their own taxes. And given how varied and diverse our values are...it's impossible that a substantial amount of taxpayers would make the same mistakes.

So basically, it's fine if you make a mistake with your limited resources but it's not ok if you make a mistake with my limited resources. And it's really really really not ok when congress makes mistakes with 150 million people's limited resources. It's a huge mistake and a moral hazard to allow 538 people to spend so much money that they did not sacrifice to earn.

I can't tell you what to do with your time. Time is your limited resource and only you know which uses of your time are better than others. Right here we see the entire concept in a nutshell.

My advice is to use your limited time to read my blog... http://pragmatarianism.blogspot.com/
...whether or not you choose to do so will depend entirely on your perspective. Does your perspective matter? Yes...but it shouldn't only matter in the private sector...it should also matter in the public sector as well. You can't block 150 million of our most productive perspectives from the public sector and expect that there will not be substantial repercussions for doing so. This is Bastiat's Seen vs the Unseen.

What Austrian believes any free market economy could ever be "optimal"? That's the mistake made by mainstream economists, believing such nonsense, not Austrians. Complexity implies messiness, redundancy, etc. Complexity implies both coordination and discoordination. That is, it implies equilibrium is impossible to achieve. Which, again, is what all the Austrians I have ever read have ever said. If Austrians believe anything, it's that the economy is a far-from-equilibrium process. Thus, Lachmann's ideas are rightly understood to be Austrian.

Lachmann was indeed a classical liberal but he was skeptical of free banking and believed in a lender-of-last resort.

Troy,

That is the right attitude. However, in my experience, most Austrians talk in terms like this: Government is the problem. If only we had free markets, then the market would coordinate economic activity far better. My point is that there is no reason to believe this to be true. Sure, government is a problem. But a free market is no panacea. The problem is with human actors, whether they be actors in the public or private sphere -- it doesn't really matter. They are prone to make all kinds of mistakes.

We need to wean Austrians off the idea that free markets is the solution to all of our problems. I agree with you, even in a free market economy, we would still see all kinds of economic distortions.

*** And just a quick point. I am NOT talking about equilibrium. I was instead referring to "equilibrating tendencies." Most Austrians believe that free markets will bring the market in the direction of equilibrium (i.e. it will never reach equilibrium [because the market is a process], but it will at least generate equilibrating tendencies). Lachmann's point was that even equilibrating tendencies can't be assumed to be true. The market is simply too "kaleidic" for that to be true a priori.

@Muller:
So free markets are not the solution. What else is there except the government? If you say the middle way, but you accept that the free market is not perfect, neither is the government, what else is there?

Really, you've been on this blog for years and I still can't figure out what you are saying. So please, what is your solution.

Well, Niko, that is precisely my point -- we are simply without the tools to design a system of government that is free from error.

Libertarian Austrians, in attacking government intervention, advocating the adoption of policies that they believe will enable the market to perform better --- free banking, privatization of public industries, etc. etc.

My point is simply that even these systems are prone to error. So I am not so much advocating a "positive" program as I am trying to get people to appreciate the extreme fallibilism of social (human) institutions. That, I would argue, is the real legacy of Ludwig Lachmann.

As I recall, Lachmann was strongly, even dismissively criticized by Rothbard and some other Austrians (the epithet "Lachmania" comes to mind). What's the story on that? Lachmann was out there in the direction of Shackle in seeing radical uncertainty in the marketplace as potentially destabilizing, right? Eventually I picked up his book on capital theory and found a lot of good in it. (And yes, Austrian Away, I'm still a fan of the Austrian approach and the conclusions of the school.)

austrian away, I don't know where the difficulty is. People are fallible...therefore it's not a good idea for too few people to control too many resources. In other words...we shouldn't put too many eggs in one basket. Allowing 538 congresspeople to control 150 million people's resources is a perfect example of putting too many eggs in one basket.

What's the solution? Decentralization...we hedge our bets. It was progress to transfer the power of the purse from 1 king to parliament and it would be progress to transfer the power of the purse from 538 congresspeople to 150 million taxpayers.

"It follows, then, that a less centralized society has the advantage of a greater diversification of its performance across a larger number of preceptors. This is because diversification here dilutes the impact of the ability, or the lack thereof, of each preceptor on the aggregate societal performance." - Raaj K. Sah, Fallibility in Human Organizations and Political Systems

The personal insight was poignant. And the economic insight, that the misallocation of resources results in diminished productivity

Roger Koppl,

Quoc Hung Nguyen's "Mortgage Market Innovations and Housing Investment" (2009) deals with a two-sector model, with sector-specific capital.

On page 3 of his paper, he provides a brief literature survey - pointing out Greenwood and Hercowitz (1991) and Baxter (1996) has models incorporating reversibility of capital.

The modelling attempt may not be satisfactory or yield great insight, but capital complementarity and substitutability is not fully lost on mainstream economists. The challenge is to model these aspects in a realistic, insightful manner.

John,

I checked out Nguyen and both Greenwood & Hercowitz and Baxter. In no case do we have a DSGE model with capital multi-specificity. H&B was not a DSGE model. They had (basically) human and physical capital, which does not count. Nguyen has two separate types of capital used for distinct purposes. That won't get you an Austrian-style recalculation problem. Moreover, there seems to be no margin of adjustment between types of capital. Each type is useless in other applications, and there is no tradeoff. The same seems to be true of Baxter. I don't see how any of that counts as capital multi-specificity.

I asked for A "DSGE model with capital multi-specificity." Maybe I scanned your suggested examples too lightly, but I don't see how they qualify. Indeed, the whole game with DSGE is to boil everything down to a few representative goods, individuals, and markets. The point with multi-specificity is the large number of overlapping markets. It seems doubtful that you *could* have a DSGE with Austrian-style multi-specificity of capital.

Roger, and John

The mainstream macro literature has had 'two sector' models since the mid-80s. I'm familiar with them and they bear little resemblance to Austrian specificity arguments. Essentially two sector models say you can produce two things with the same input- basically guns & butter models applied to macro. You can impose some frictions & so forth, or losses when you switch the input to a different output, but it doesn't capture the structural problems or the idea that idle resources may be socially beneficial.

Seems right to me, J Oxman. A lot of Austrian macro arguments are about complexity. DSGE is not complexity theory.

My intention was to point out that there are 2-sector models which incorporate reversibility/irreversibility of capital. Whether the modelling attempts are satisfactory is another matter.


Oxman and Koppl,

Are you guys aware of mathematical models which have successfully incorporated or display Austrian insights?

John,

Sure, there are some examples. First of all, when you say "Austrian insights," that's pretty broad. So a lot of standard economics fits the bill. We don't think of regular old supply and demand as "mathematical economics," but on a really strict accounting it is. But you mean to ask, I take it, whether there are mathematical versions of the more characteristically "Austrian" insights out there, the stuff that might not be so well appreciated in the mainstream or, at least, in old-fashioned “neoclassical” theory circa 1975.

Well, there have been many attempts. Years ago, Owen & Littlechild published a mathematical model of Kirznerian entrepreneurship. Robert Mulligan is pretty heavy on the math. Yates had piece on entrepreneurial discovery published in JET a while back. Maymin has his paper on P vs. NP and market efficiency, which I think of as "Austrian." And so on. I'm probably forgetting something big. Anyway, there is absolutely some stuff out there. If you count statistical testing, there’s really quite a lot of “Austrian” articles using math.

Drawing back from specific articles, I think Austrians should be into complexity theory. Hayek was a complexity theorist who said things that sound very much like the sort of stuff you get from Santa Fe. Within complexity economics there is computable economics, which uses computability theory. I like it very much. Alain Lewis showed that, basically, general equilibrium is not computable. Somewhat following Lewis, Tsuji, da Costa and Doria showed that even finite games can be non-computable. In that article they specifically draw the connection to the socialist calculation debate. This is a literature I really like and I hope some Austrians will take it up. I should also mention Sheri Markose’s 2005 article in Economic Journal, which does a really good job connecting Hayek to computability theory. Her notion of “Type IV dynamics” is important IMHO. So in the area of complexity economics and, especially, computable economics, I think you have a lot of very “Austrian” things being said with the aid of mathematical symbols.

Anything in the vein of DSGE models, or models with attempts at microfoundations?

John,

You've got me stumped. I successfully challenged your claim that there are Austrian(ish) DSGE models in the literature, and your comeback is to challenge me to provide examples of, ahem, Austrian(ish) DSGE models in the literature! Seriously, John, what do you want? What’s your issue?

So far you have tried to establish that there hasn't been satisfactory treatment of capital in DSGE models. I thought I'd ask if there were any models which had better success at incorporating other aspects of Austrian theory.

It would have been appreciated had you been more civil in your reply.


Perhaps I am just a grumpy old man, John, but I was perfectly sincere about being stumped. I thought we'd established (in response to a mistaken assertion of yours, BTW, and on not to anything I "have tried to establish") that the DSGE literature comes up short on "Austrian" capital theory. I guess we could make a list of "Austrian insights" and ask whether any such "Austrian insights" are "reflected" in any DSGE models. I'm not interested in such an exercise, and I kinda doubt that's what you had in mind. So, you know, I think it's fair to ask what you're after, what your issue is.

Look, tomorrow we might see some clever DSGE model that is "Austrian" in some important way. Why not? But the Lachmannian capital theory Boudreaux discussed points toward complexity theory, not the sort classical analysis used in DSGE models. So the basic mathematical toolbox of DSGE seems ill suited to Lachmannian capital theory. Does that remark at all address your issue?

PS: FWIW, the crisis may have killed DSGE. If so, it will be a long, slow death spiral. DSGE won't disappear overnight. But it might be that any discussion of what is or is not "in" the DSGE literature is moot because the action is in "animal spirits" and radical uncertainty and, especially, network theory.

In the complexity theory I subscribe to, complex processes are in a far-from-equilibrium state. This takes place between equilibrating tendencies (Kirzner) and disequilibrating tendencies (Lachmann). If market economies are in a far-from-equilibrium state, how useful is general equilibrium theory in explaining what is happening in an economy?

I dunno, Troy, I think it depends on what your trying to figure out. Mises' evenly rotating economy is pure GE. I have heard people deny that, but I don't see how it's an ambiguous point. Hayek used it as his baseline in the theory of the trade cycle. Recall that Lucas said he was following Hayek. I like old-fashioned multi-equation GET. It lays out what the economic problem is and how economic interdependence works. It clarifies the sense in which market equilibrium is optimal and the sense in which trade brings about a harmony of interests. And so on. I know many people expect an "Austrian" economist to spit fire at Arrow, but I think he did a lot of great work in the theory of risk and uncertainty (=theory of risk and no uncertainty!) including his spanning results. Limits here and there, radical uncertainty, blah, blah, blah. Absolutely. But the Arrovian theory of risk and uncertainty is still good stuff that makes us smarter IMHO. GET even gets you lots of cool complexity results. I think mostly of Hotelling's brilliant analysis of Edgeworth taxation paradoxes, but also of Alain Lewis's demonstration that GET is, basically, non-computable. Oh, and Mantel/Debreu/Sonnenschein, I suppose. I've seen people describe GET as "linear" and thus apart from complexity theory, but I think that's mistaken or, at best, a half truth.

GET is a part of our thinking, so it is hard to imagine what economics would look like if we could magically wipe out GET.

BTW: I don't think my defense of GET implies that I should like DSGE, which boils everything down to a really small number of goods and a representative actor. Maybe somebody else can tell us why DSGE makes us smarter too, but it never really spoke to me.

I would agree that Mises' evenly rotating economy is GE. However, that is, by Mises' admission, an overly simplistic model from which one builds, adding more and more, moving the system farther and farther away from equilibrium, until one gets a model that more closely approximates reality.

Yes, GET is a part of the thinking of economists. And while it may be hard to imagine what economics would look like without it, if real market economies are in fact in far-from-equilibrium states, it is perhaps time to try imagining it. After all, shouldn't the markets try to resemble reality as closely as possible?

I'm not sure I know what you're saying, Troy. I don't think you can say that Mises was cool with his ERE, but GET is not useful. That seems like a contradiction, at least if you agree that ERE is a kind of GET. If I'm right about that, I can't figure out which one you're saying. Was Mises cool with the ERE or not? Sorry if I'm missing your obvious meaning.

John, and Roger,

Like Roger, I'm not aware of any DSGE models that have real Austrian elements. But then I'm a corporate finance & investments researcher, so there might be a whole subfield in macro that is Austrian-style DSGE. But after searching on Google Scholar and the leading journals, I'm pretty sure not.

That said, some of the literature in finance has some Austrian insights, although it is quite by accident I think. Irreversible investment and real options are two examples that incorporate knowledge problems explicitly.

Much of finance is Fisherian (and thus somewhat Keynesian), though, and EMH is explicitly an equilibrium model.

To the extent people talk about entrepreneurship in finance, it's really only in the context of agency problems. Although entrepreneurship scholars in business schools know and read Kirzner's work.

As I recall, Mises put forward the ERE as an analytical foil, not some ideal the way mainstream theory treats GE. What's so great about the same people doing the exact same thing everyday ad nauseum?

The ERE was a mere simplified model that allowed one to isolate particular elements one wanted to understand to see how it affected the ERE. Thus one came to understand more complex interactions in a real economy. In this sense it is like analytical anarchism, in which one assumes an anarchic economy in order to find out what happens when you add this or that regulation to it. Naturally, the more regulations, the more complex the interactions, but unless you can isolate out the simple cause-and-effect, it is difficult at best to understand the more complex interactions.

If one uses GET in the same way, it can be a useful tool. However, we must always keep in mind that the economy is in fact complex, meaning it is in fact in a far-from-equilibrium state. Further, understanding this, we can come to understand how certain regulations result in simplifications and regularities that may turn the FFE economy into a cyclical one. Unless you understand the economy not as being in equilibrium, but rather being in a FFE state, you will miss this fact. Thus, understanding the economy as being in fact a FFE has profound implications for understanding the economy. GET is okay for isolating out a particular element of the economy, but we need to look at the economy as what it actually is -- a FFE -- if we are going to understanding how complex interactions take place and effect the economy.

Thanks for clearing that up, Troy.

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