The Genius of Mises, and the Brilliance of Kirzner

|Peter Boettke|

That is the title of a new working paper that focuses on Mises's identification of the market process as the analytical focus of economic theory, and Kirzner's further development of that theory via his work on the market as a process of entrepreneurial discovery.

Comments/criticisms most welcomed.

Comments

[Pietro M.]

I just needed something like this today. Printed. :-)

[Lee Kelly]

So, can I assume this is an impartial and critical assessment of the work of Mises and Kirzner?

[Rafe Champion]

That looks a lot like mundane economics:)
HT Peter G Klein.

[Mario Rizzo]

Pete and Frederic,

I think we should have a debate one day. I don't want to appear as a "d-k" but I think you are constantly overplaying Kirzner's contributions.

First, you under-estimate the deficiency of his self-imposed refusal to admit psychology into his theory of entrepreneurial alertness. You cannot simply start from the FACT of alertness and say that you have a theory of the market process.

Second, the idea that he has shown how we go from disequilibrium to (or toward) equilibrium is not true. Or, at least, it requires so many assumptions (frozen data -- but what does that mean to a subjectivist) that I do not know what has been shown about the real world. There are empirical, not simply theoretical issues here.

We all love Israel Kirzner and he has made contributions, to be sure. And, as his colleague at NYU, I don't like being put in the position of criticizing him. However, you are vastly overplaying your points.

You are familiar with G.B. Richardson's book *Information and Investment*. He raises important challenges. Not to mention other books...

Sorry for this. I don't like raining on my friends' parades. But we are engaging in professional discourse.

[Peter Boettke]

Mario,

We should have an open debate over this. I am probably more guilty than anyone of playing up Israel's contributions --- I am on record claiming that he deserves the Nobel Prize in economic science for providing the answer to Arrow's fundamental challenge from 1959 in his Theory of Price Adjustment.

If you look at the "debate" with Dan Klein in the Journal of Private Enterprise as well, you will see the intellectual context within which I think the Kirznerian theory of the entrepreneurial market process must be put to be appreciated. I have no doubt that you are even more familiar with this than anyone, and you don't find his argument convincing because of the issues raised by Richardson etc. But I think those issues (along with Lachmann's issues) are secondary complications to the fundamental point about disequilibrium adjustment through price making by entrepreneurs.

Kirzner solves Arrow's fundamental lacuna in core theory --- ceteris paribus price adjustment through entrepreneurial action clears the market. He does it endogenously to the system, not through some mysterious auctioneer pre-reconciling plans, but through the higgling and bargaining in the market guided by the quest for pure profit.

So I think we simply disagree as to the importance of this result, we don't disagree that complications due to change and imperfections in addition to the one's already permitted to allow an agent of change to act endogenously to the system to move the system to equilibrium.

Arash asked me the other day what I thought were the most important formal results. I would argue that Arrow's identification of the problem with the theory of price, Fisher's disequilibrium foundations, etc. is the line of literature that I would point to, and I think Kirzner contributions have to be understood in that context --- 1960-1980 fundamental theory in microeconomics (prior to the acceptance of multiple equilibria). It is the determinant result and the welfare consequences of that determinant result. It is that literature that Kirzner is attempting to fix via the Austrian understanding of the market as a process.

What Fred and I are trying to argue (for a paper which will be in a volume honoring Kirzner) is the Mises gave Kirzner the "vision" of the market as a process, and Kirzner provided the "analysis" of the entrepreneurial element in human action which fills out that scientific vision of the market order.

Pete

[Adriano G. G.]

Kirzner quotes Samuelson (in "Entrepreneurship, entitlement and economic justice" and in other articles) in regard to the theory of profit. I would like to know if Samuelson ever replied

[Jerry O'Driscoll]

Pete,

I want to support Mario both on substance and in the respectful tone he adopted to both you and Kirzner.

Our dissatisfaction with Kirzner's account animated The Economics of Time and Ignorance. I do not accept that Krizner successfully demonstrated a movement to equilibrium. His hostility to our book reflected his understanding of what we were about.

I do not understand how you could call Lachmann's critique as "secondary." It was fundamental. His critique inspired us (as the dedication to him exemplifies) to provide an alternative framework.

You also confront the curious problem that Kirzner denied he was original. He believed he was just elaborating on Mises. He was emphatic on that point (at least to me).

[Peter G. Klein]

Pete: Do you really think Arrow's 1959 paper offers such a fundamental critique of price theory, such that the field was in limbo until Kirzner filled the "lacuna"? Much of Austrian economics from its founding through the 1920s was devoted to price theory. You're saying it was totally inadequate? Bohm-Bawerk, Clark, Wicksteed, Fetter, Davenport -- none of them had a decent price theory? Mises? Marget? Hutt?

It seems to me you confuse Arrow's (legitimate) complaint against Walras with a more fundamental critique about price theory more generally. Why should a Mengerian care about a minor dispute among Walrasians?

[Gary Shiu]

Dear Pete:

Not related to your piece, but guess this would be the right place to bring your attention, as well as readers of this blog, to this provocative paper by two heavy weights in financial economics:

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1734504

[Pietro M.]

Debate! Debate!

I think that a theoretical demonstration of the movement toward equilibrium is impossible, at least if we define theory in its pure form. Equilibrium is like a true theory: you can't recognize one even if you have it in your hands. We can never assume away entrepreneurial errors, unperceived opportunities, misunderstood causal links.

It is not a matter of frozen data, but of ignorance. Maybe with forzen data it would be easier to expect that sooner or later people will notice arbitrage opportunities, but there is a distinction between false positive and true negative errors: you recognize an error when you see bad effects, you don't recognize a lost opportunity. I'm not sure I remember the paper by Kirzner in which this distinction was done. Probably in "the meaning of the market process"? As far as I know, it is possible to live millennia without spotting an opportunity.

I find it troubling, for instance, when I have to say whether financial markets would be stable without government interventions: I think there cannot be any positive proof of it. Markets may be wrong (something also Kirzner accepts) and we can never know whether we have been the best we can.

The problem is important in monetary theory because as I see it, without understanding how the market process works in detail, it is impossible to make definite claims regarding the impact of money on market coordination. On one hand we have worthless models in which the response to monetary shock can be analyzed in formal ways without understanding the very essence of money, on the other a putty-like theory which doesn't say enough to develop detailed explanations of the effect of monetary shocks. In "The neutrality of money" Mises said that money has to be non-neutral because we need money to coordinate the market process. Going from this truism to a more general theory of why monetary injections have those precise effects as assumed by ABCT has proved so challenging a task that I haven't found a full argument proving this point in all the books and papers I read on this topic, from Mises to the most recent literature (and considering the tremendous waste of time involved in the "what is ethical in money?" debate, I'm rather depressed by this.

In the end the best that can be done is to trust an empirical generalization: the existence of economic order is evident to all, "si monumentum requiris, circumspice" (if you want to see his monument, just look around), as Mises wrote in Human Action. However, this doesn't deny the possibility of occasional spontaneous disorderly behavior.

Surely it is all a matter of cognition. But a reliable theory of cognitive processes does not exist, so if we need it to start doing economics, well, it's better to look for another job. Electronic engineering, maybe.

In a seminar in Rome, professor Cubeddu has stressed the important notion of non-finalism in Austrian Economics: there is no way to know where the market process will lead. However, general patterns can be recognized without referring to cognitive processes (for instance, policy moral hazard will induce financial instability), as as far as it is possible, this is surely better than nothing.

[arash]

@ Peter

Here is a nice statement by T.C. Koopmans that resembles Arrow's point:

"The interpretative weakness of [Arrow-Debreu economies] lies in the information handling requirements implicitly placed on the agents without regard to cost or even feasibility. [...] Optimizing responses of economic agents are simultaneously feasible only if the proper prices are already known to them. But these prices must somehow themselves be the result of the same responses. Thus there is something circular in the description of events. The market participants must be endowed with extrasensory perception (if acting simultaneously) or with supernatural premonition (if acting successively)." American Economic Review, Vol. 64, No. 2, Papers and Proceeding (May, 1974), p. 327

It comes as no surprise that I side with Mario Rizzo and cannot see that Kirzner's alterness concept solves this problem. After all, he believes that entrepreneurs acting on alterness bring about general equilibrium. In formal parlance, Kirzner believes the system is globally stable. How does he know? Here, alterness is of no help. It is alterness of profit opportunites. Profit opportunities arise whenever the RULING price system doesn't aggregate GIVEN data truthfully. Alertness may explain why people act on such opportunities, but it does not tell us why the system is supposed to converge to overall market-clearing! As far as I remember, Kirzner believes in convergence.

Further, if we allow entrepreneurs to set prices (such that prices are part of the individual choice variables), alertness asks for too much information processing skills ... at least if the system is supposed to be globally stable. This is already a mistake in Schumpeter, who suggested that the entrepreneur is somehow smarter than the market, i.e., able to identify 'new' general equilibria by means of his mental capabilities.

Bottom line: If the economy is a complex adaptive system, coordination is probably not due to the smartness, alterness, or rationality of individuals.

[arash]

May I add that you (two) introduce formal competetive equilibrium theory (CET) in a a too harsh way? You write:

"The “invisible hand” [...] does not require any of the assumptions associated with the formal theory of general competitive equilibrium
— neither large numbers, price taking, homogenous goods, nor perfect knowledge."

#1 CET does not ask for homogenous goods. Quite to the contrary, the most striking strength of CET is its generality with respect to the kinds of commodities. The consumption and production of billions of commodities are coordinated (each characterized not only by physical properties, but also by time and location of delivery).

#2 CET does not assume perfect knowledge. Another strength of CET is that it provides a precise formulation of how local informed agents are coordinated by a impersonal system. Perfect foresight, as pointed out by Hayek, circumvents this problem and imposes general equilibrium by assumption. CET has shown that existence of such a solution does not depend on omniscient agents.

#3 A sufficiently large number of agents implies price-taking behavior. Thus, the latter is no additional assumption. Existence is proved for the continuum economy (infinite and thus atmoless agents) and then show that equilibria can be approximated by a large but finite number of agents. And this assumption is one of the harmless one. The global economy approximates seven billion people. If you substract the bottom billion, who may not impact your equilibrium in the US, we still have six billion people whose preferences, endowments, and knowledge impact your daily choices.

[arash]

sorry for the typos.

[MarioS]

Pete:
Is this the "debate" Klein-Boettke(Kirzner) you've mentioned above?
http://austrianaddiction.rationalmind.net/JPE%20Spring%202010.pdf

[Peter Boettke]

MarioS --- YES.

Arash --- note the dates I am picking 1960-1980 for formal theory, and also I suggest you look at Robert Leonard's latest book and the formal theory work that emerged in the 1930s (namely A. Wald) and then also the presentations (and the conditions required) as laid out in Hahn's work --- e.g., in the essay that we cite, but also take a look at his "Winter of Our Discontent" essay.

Peter Klein --- I am going to do a blog post in a few minutes on this, but it is because Kirzner is trying to solve a problem as perceived by the mainstream using Mises. If he rejected the mainstream understanding of economics, he would have not framed his discourse that way. That is what I mean by the context within which he is making his contribution.

Mario and Jerry -- by "secondary" I simply meant complicating factors, rather than immanent critique of Kirzner; the closest to the immanent critique is Loasby in my opinion, but even there it doesn't appreciate completely the problem Kirzner set out to solve. Look at Competition and Entrepreneurship (1973) and consider who he is trying to address --- the problem of market clearing in a world of price taking; the problems of the structure conduct performance paradigm in IO (including the notion of advertising) and the welfare economics of market process economics as opposed to traditional equilibrium based welfare economics.

We can criticize Kirzner, and we have to in order to advance economic theory (as you guys do in Economics of Time & Ignorance), but I think we have to first acknowledge what he actually accomplished in the context of his time. He offers a bridge between Austrian economics and mainstream economics circa 1970 that was vital for forging an alliance with other slightly out of sync but mainstream economists that were his contemporaries, such as Buchanan, et al.

At least this is how I understand the history, and that comes from someone who in his youth "rejected" Kirzner's efforts as merely "neoclassical Austrianism" (see my paper Beyond Equilibrium Economics with Steve and Dave from the mid-1980s). My change of mind came upon reading Kirzner's "Meaning of Market Process" combined with a study and discussion with Prychitko for years over the formal theory questions of adjustment paths and stability (see our 2 volume reference work, Market Process Theories, and our introduction "Varieties of Market Process Theories".

[arash]

Peter,

all theory I refer to is in debreu 1959, aumann 1964, hahn/arrow 1971, brown/robinson 1972, thus, app. written during the period you mention. further, you don't make this restriction in your paper. there, it seems as if you talk about CET in general. but thanks for the references. I've added them to the reading list.

[Mario Rizzo]

There are different traditions in microtheory (even today). But going back several decades and more it is evident that some people went in the Walrasian direction as did Samuelson. Arrow is in this camp worrying about it. (He didn't do much about it however).

But if you look at the early work of John Bates Clark, for example, you find process stories. In fact, Clark talks about a process in which profits are created by changes in data but, due to entrepreneurial efforts, profits are grasped but, alas, they cannot be held. They are transient returns. As a result of these entrepreneurial actions, however, an equilibrium continually is restored. (Clark says that static state keeps re-asserting itself.)

Not exactly Kirzner, but very similar ideas such as these were there in pre-Samuelsonian "price theory."

They were abandoned by many perhaps because the processes seemed too simple, even ad hoc.

[Mario Rizzo]

"...welfare economics of market process economics as opposed to traditional equilibrium based welfare economics"

Again, I would say that this is clearly a failure (though a valiant attempt). Years ago David Harper produced a paper on coordination connundrums that went into all of this. Happily, David has re-written it and submitted it somewhere. I need to find out more.

But the coordination criterion fails essentially because there is no way to measure (increasing or decreasing) coordination. Some plans, during any process, may suffer discoordination with regard to each other while others are more coordinated, etc. And then there is the whole problem of not being to distinguish the changes in property rights that say a minimum wage creates from the discoordination it may create. ETC. ETC.

Pete is a little like Lachmann who acknowledged flaws in his position but then went on either to forget the concessions or to act as if they were just "secondary."

Now, Mises -- on the other hand -- frequently used a different welfare criterion. He asks simply what did the interveners want to accomplish? Did they accomplish it? Usually they do not (unless they want "bad" things) and so that is that.

Mises 1 Kirzner 0.5

[Peter Boettke]

Mario,

You are raising very good points both about the history of ideas and the valiant but failed effort. But let me push you on putting ideas in context (my preferred method of intellectual history).

Kirzner at the time he came to professional awareness lived in a world where the dominant micro economic framework was the formal theory of the competitive market in equilibrium. This was true for Stigler price theory, and also the Samuelson type (once the macro economy was in balance!). As Hirshleifer argues in an early version of his price theory book, partial equilibrium is really only sectoralized general equilibrium. Or as was pointed out in the JEL paper on Chicago economics permanence and change, the "tight prior". Enter Kirzner's intellectual context. As he has put it several times, rather than the Monday/Wed micro versus macro cognitive dissonance that Lucas et al experience, but a micro versus micro cognitive dissonance (mainly Stigler versus Mises). In working through this problem Kirzner is capturing older theories no doubt --- Shorey Peterson is one big influence on him, as was the McNulty articles on classical theory of the competitive market. But if he just harked back to those contributions he would have (1) been considered to be _only_ a historian of thought, and (b) would have not been able to engage the policy debates over market structure and antitrust, or advertising and selling costs, or welfare economics of the market economy in general.

It is important to remember that Israel's own self-description of his career is that he started out being a THEORIST only to wake up one day in the 1960s and realize that people considered him a HISTORIAN OF ECONOMIC IDEAS.

On the welfare economics issue --- Kirzner took Hayek 1937 very seriously and thus was (as Steve put it in another comment thread) providing a Misesian answer to a Hayekian problem. But I agree with praxeological point you are making about ends and means, etc.

[Michael]

The question that I have is about the first paragraph in the section starting on page 12, specifically the first sentence.

I have always been fond of the following quotes by Alchian: "In the presence of uncertainty a necessary condition for the existence of profits there is no meaningful criterion for selecting the decision that will "maximize profits." The maximum-profit criterion is not meaningful as a basis for selecting the action which will, in fact, result in an outcome with higher profits than any
other action would have, unless one assumes nonoverlapping potential outcome
distributions. [...] Even in a world of stupid men there would still be profits. Also, the greater the uncertainties of the world, the greater is the possibility that profits would go to venturesome and lucky rather than to logical, careful, fact-gathering individuals" (1950, pp.212-213)

I know that both Alchian and Friedman had attended lectures by Hayek prior to writing these papers (so there is a similar connection to Mises), but the 1950 paper leads me to believe that there are active discussions, perhaps Kirzner just got further than anyone else (a different type of compliment).