Hot off the press here.
The key paragraph:
Good intentions are not enough in designing public policy. Regulations designed with the best of intentions are likely to lead to more crises if they distort incentives and thereby cause individual "greed" to undermine economic growth and harm millions. History is full of examples of politicians adopting short-run solutions without seeing the harmful long-run consequences.
Excellent! The Austrians are spot on in this matter. However, I would urge the other readers of this blog to note that this observation is hardly a vindication of the self-adjusting mechanisms of the market economy. Pointing to government failure is not evidence of market stability, in the same way that market instability is not evidence of the efficacy of government intervention. How can we in good faith reject the former proposition while simultaneously insisting on the veracity of the latter?
I think Austrians are much too inclined to attribute market disturbances to government malfeasance; and while this inclination is largely consistent with our inability to rationally cope with the complexities of the social world, it is facile, I think, to believe at the same time that markets are invariably self-correcting. In fact, it is a non-sequitur! Markets are inherently unstable by virtue of the features of the world in which we are actually living. Government regulation is just a natural, but hopeless response to this fact.
Posted by: matthew mueller | October 21, 2008 at 04:37 PM
Matt,
It seems that you just like to sound intelligent or are trying to impress someone. To me it appears that this blog has a higher following with those who understand economics than most economic blogs, therefore some of your comments are not new nor necessary. As there was not a comment before yours that seemed to give the perception that some students committed the ad hoc fallacy, I do not see any reason for your comment.
BTW, government response is not the only alternative, if so we have nothing to object to. When the market appears to have failed, it is a signal that there is an opportunity for an entrepreneur to rise. Government regulation is then not natural as it is not the only response.
Posted by: Ian Dunois | October 21, 2008 at 05:24 PM
Matt,
You wrote,
"Pointing to government failure is not evidence of market stability, in the same way that market instability is not evidence of the efficacy of government intervention. How can we in good faith reject the former proposition while simultaneously insisting on the veracity of the latter?"
While there are those who would deny market failures with sweeping claims, few seem to participate in this blog. In this sense, you're preaching to the choir. It is not the existence of government failure that points to market veracity. Instead it is the existence of government failure amidst market functionality, and market failure amidst no similar government functionality which tips the scales away from government and towards markets. At least that's how those of us who avoid the two groups - 1) markets fail therefor government and 2) governments fail therefor markets - tend to see it. Markets fail, governments fail, markets at least work systematically, governments work biased-ly and bureaucratically - therefor markets.
Posted by: Daniel J. D'Amico | October 21, 2008 at 05:24 PM
Ian,
I word my comments in such a way as to provoke discussion. My response to your post is some indication that my efforts are not in vain. While you are correct that these arguments are not new, it is my belief that they are not adequately discussed within Austrian circles. Austrians take for granted the efficacy of market "functionality." In this way they skirt the issue of the possibility of market instability. How do they do this? Well, they invoke the entrepreneur without ever really explaining how he is supposed to operate. I have tried to remedy this problem in a paper I have recently written and will be presenting at the ASSC at Grove City College. You should go. Suffice it to say that the present status of the entrepreneur in Austrian economics is similar to that of Coase's insight of transaction costs in 1945 --- it is much cited and little used. We need to create a set of refutable tests that lend tenability to this very important element in Austrian economics. (Now I know what I have just written sounds arrogant, but I have to be concise in blog posts.)
Dr. D'Amico!,
A very good post. We can both agree that government failure should be taken as a given. The world is just too damn complicated to lend itself to sound regulation via government bureaus. What is in question is the possibility and strength of market "functionality." What criteria are we to use in judging the operation of markets? Keynes pointed to involuntary unemployment. This is tricky, especially in light of the work that has been done in New Classical Macroeconomics. I would instead draw attention to the fluctuations that are commonly observed in capitalist economies. How are to account for market fluctuations --- and violent ones at that? Are these violent disturbances to be seen as evidence of market "functionality." Only Demsetz would argue that. The inducement to invest is just too damn precarious for me to place great faith in the market. If we were omniscient (or, to put it differently, if conditions were stable), there would be no problem. But our knowledge is uncertain. Markets cannot escape this disturbing fact.
Posted by: matthew mueller | October 21, 2008 at 06:05 PM
Matt,
I wouldn't deny the conditions of uncertainty or the potential for fluctuations and wide ones at that. But as a point of evidence in favor of markets I would allude to (hmmm I don't know) THE ENTIRE COURSE OF HUMAN EXISTENCE!!! (not meant to be curt or shouting at you per se, but shouting nonetheless as the message is that powerful).
Business trends and fluctuations are not random, we do not oscillate from stone age to industrial revolution and back to stone age. Instead the progress of human civilization is one marked by real technological improvements spurred and motivated by entrepreneurial incentives. Profit motives work to promote innovations, though eras go through good times and bad on net we're still better off today than we were yesterday. That's what I am trying to allude to when I say "the functionality of the market." With the market we grow stocks of knowledge that do not get washed away even amidst crises and catastrophe. The government has no comparable process of creative destruction - just jeopardy and subsequent destruction.
Posted by: Daniel J. D'Amico | October 21, 2008 at 06:22 PM
The issue of market stability isn't so easy, IMHO. Post Keynesians are right to say that the state of confidence matters. There is no logical contradiction I can see in positing a sudden collapse of confidence happening for no particular reason. Finally, we have real observable instances of collapse. Thus, you can be smart, informed, and so on and completely buy this line of reasoning, concluding that market economies are inherently unstable.
My co-authors and I have tried to take this issue on squarely with Big Players and Hayekian expectations. There are a priori reasons to doubt the Post Keynesian version of events. That's the "horizon principle." If the future was so uncertain, we'd shrink our planning horizons. If the future we're planning for were not so uncertain, we'd lengthen our planning horizons. But this a priori argument is not a logical proof against a collapse of confidence happening for no particular reason. So you gotta look at the empirical record. And you gotta *test* with careful statistics. We've done a bit of that and the Austrian view holds up better than the Post Keynesian IMHO. As far as I know no Post Keynesian has answered our stuff with empirical evidence. But there's lots of room for more testing.
Posted by: Roger Koppl | October 21, 2008 at 07:32 PM
Good job getting another piece out! Keep up the good work!
Posted by: Vedran | October 21, 2008 at 07:49 PM
Hello Dr. Koppl,
I have the highest respect for your work and your discovery of the "horizon principle." However, I am aware of the Post Keynesian responses to this principle. For example, this horizon principle only applies to an ergodic world. The moment you concede the existence of "crucial decisions" I am afraid this principle loses all bearing. Each new decision of crucial importance (for Post Keynesians this includes every investment decision) destroys the environment in which such decisions are made. Replicability, learning, and trial and error are impossible in such a world, and the lovely entrepreneur ends up in no man's land.
But that is the typical "Paul Davidsonian" response. I, on the other hand, have recently submitted a paper to a journal that takes a different approach. My approach would rebuke your theory's starting point by pointing out that it is incorrect to state that we begin from a state of knowledge and approach increasing degrees of uncertainty the farther we project into the future. In fact, the starting point for all action is in a position of uncertainty. This is Keynes's basic message. An uncertain world requires the creation of certain "conventions" in order to permit scope for positive action. You cannot confuse conventions for knowledge. What appears as knowledge is really just a false heuristic designed to mask the reality of uncertainty. That is Keynes's basic point. So now the "horizon principle" becomes the "conventions spectrum" that can be represented in the following way.
------- +1 (certainly true)
-
-
-
------- 0 (uncertainty)
-
-
-
------- -1 (certainly false)
Obviously, 0 is the starting point (uncertainty). If we are to act at all, we must move along this conventions spectrum by believing that certain things are true and other things are false (for example, 2 + 2 = 5). Keynes's point is that the farther we move from the starting point of all action (uncertainty), the more likely it is that things will go very badly (observed fluctuations and market instability). This is the case because these "knowledge conventions" have no foundation; they are "conventional judgments."
Anyway, hopefully this paper of mine will get accepted so that you can read it. I am making a more fundamental case for uncertainty than any Post Keynesian has to date.
Posted by: matthew mueller | October 21, 2008 at 11:28 PM
In the Review of Political Economy (13:1; 2001), Ted Burczak addresses the reliability of expectations by comparing Hayek's and Keynes's views ("Profit Expectations and Confidence: Some Unresolved Issues in the Austrian/Post Keynesian Debate"). Both Hayekian (reliable) and Keynesian (unreliable) expectations seem possible on a priori grounds, which means that we're ultimately dealing with an empirical problem. The problem, as I see it, is that neither Post Keynesians nor Austrians (especially a priori Misesians, not so much semi-Popperian Hayekians) like to get their hands dirty with empirical testing, with the exception of Koppl. So we need more Koppl-style studies!
Also note that North discusses "non-ergodic" phenomena in his recent publications, while reaffirming the importance of stable institutions, the rule of law, markets etc. (but relying mostly on long-term descriptive statistics of the Angus Maddison type).
Posted by: David | October 22, 2008 at 12:41 AM
"Replicability, learning, and trial and error are impossible in such a world, and the lovely entrepreneur ends up in no man's land."
1- That doesn't seem to be the world we live in. The world we live in is roughly predictable. If it wasn't then civilization could not exist.
2- Actually, I think that socialism would suffer from these instability problems that the post keynesians think that occur on the market. Socialism doesn't work because the central planner has to work the system out without the help provided by discrepancies formed by the price system with harness the knowledge of millions of individuals.
"Each new decision of crucial importance (for Post Keynesians this includes every investment decision) destroys the environment in which such decisions are made."
While it seems to be unrealistic to say that the underlying variables are precisely reflected in the minds of the agents, with means that any changes in the economic enviroment are anticipaded, it seems even more unrealistic to assume that agents cannot predict successfully the consequences of their actions. This radical subjectivism seems to imply in the nonexistence of any systematic coordinative tendencies of the system and reality appears to indicate that this conclusion is wrong. In fact everybody has the incentive to know what they need to know to act successfully, and if changes in the economic environment are caused by the actions of the acting individuals, then these individuals will show the tendency to learn with the passage of time about how their actions influence the environment so to plan their actions with all their consequences in mind.
Posted by: Rafael Guthmann | October 22, 2008 at 02:04 PM
Matt said, "In fact, the starting point for all action is in a position of uncertainty. This is Keynes's basic message." Right. There are no marginal gradations in Keynes' epistemics. There only the short run of current output, in which feedbacks keep you on track, the complete void of the long run in the face of which we are epistemically armless. Where's the middle ground?
Matt, is river flow ergodic or non-ergodic?
Posted by: Roger Koppl | October 22, 2008 at 02:30 PM
Rafael,
1.) Yes, we have every reason to believe that the problems market economies face are amplified considerably under socialist ones. I would quarrel, however, with your understanding of the price system. Austrians have slavishly followed Hayek's description of price determination reflecting material scarcity. We have seen, however, that psychological expectations often overwhelm any influence scarcity conditions bring to bear on the formation of market prices. Moreover, it is incorrect to believe that changes in material supply can keep up with changes in expectations, which suggests that the latter force has primacy on the determination of market prices. Socialism does not work, this is true; but it is not because markets reflect material conditions accurately through the freely functioning price system.
And action still occurs in an uncertain world. There is speculation, bold conjectures, and competition. Frank Knight described the market as a game of chess, where the object is to defeat your opponent, and I think that is right. So on the contrary, I would argue that civilization could ONLY exist in an uncertain world. After all, as Mises has said, civilization without uncertainty would be a world without acting men.
2.) Ok, the second point you are making refers to market coordination. Now there are several ways to defend the market's ability to coordinate economic activity, but you have chosen to defend it by arguing that individuals have "the incentive to know what they need to know to act successfully." This argument is old and not very persuasive. Karen Vaughn, for example, has convincingly shown this to be false. Here she is:
"Certainly entrepreneurs *try* to choose the right means-ends framework, certainly they *try* to recognize past error, certainly they *try* to make their anticipation of the future "the" correct one. But what guarantee do we have that they will succeed? Certainly, being motivated to succeed does not ensure success. They simply may be mistaken in their judgement about the course of future events."
Amen.
Dr Koppl,
The ONLY reason Paul Davidson uses the terms "ergodic" and "non-ergodic" is to emphasize the extent to which the social sciences are distinct from the natural sciences. Ergodic events apply ONLY to the natural world, river flows included. Human action, however, which is a moral science, cannot be subject to these same laws.
Now there is an interesting question on this point. The brilliant Shackle raised this question in his 1967 book, namely, Does uncertainty exist because we simply do not know enough about the social world yet, or is uncertainty present because it is a fundamental feature of social phenomena? Now I am sure psychologists want to argue that we still believe in uncertainty because we just don't know enough about the human brain YET, but I am inclined to believe that uncertainty is an inescapable feature of the world in which we live. And you can get this from Mises.
Posted by: matthew mueller | October 22, 2008 at 05:50 PM
Wrong. River flow is non-ergodic. The great pioneer of non-ergodic processes, H.E. Hurst was a hydrologist known as "father of the Nile." He showed that most natural time series exhibit non-ergodicity.
Posted by: Roger Koppl | October 22, 2008 at 06:01 PM
Once again, Matt makes a sweeping assertion unbacked by evidence:
"Austrians have slavishly followed Hayek's description of price determination reflecting material scarcity."
Wrong. Please provide me citations from modern Austrians who make this argument. Even in the textbook presentation in Heyne, Boettke & Prychitko, prices are clearly explained as the outcome of expectations and subjectivity interacting with the "real" world.
Austrians have not said that prices "reflect material conditions accurately." We've only said they reflect them *better* than alternative systems.
Again, do show me where any Austrian makes this argument. And, I would argue, I'm not convinced that HAYEK even makes this argument (if he does, it's only in the long run).
Posted by: Steve Horwitz | October 22, 2008 at 07:39 PM
Dr Koppl,
You tricked me!! Back to the drawing board...
Posted by: matthew mueller | October 22, 2008 at 11:21 PM