Austrian Economics as the Middle Ground: Comment on Loasby
Roger W. Garrison
In Chapter 10, which deals with the economics of dispersed and incomplete knowledge, Brian Loasby discusses a broad range of topics that have traditionally been of interest to the Austrian school. In fact, the headings of the chapter's ten sections could well serve as a syllabus for a survey course dealing with the Austrian contribution. It will be instructive to identify the implicit organizing theme that underlies much of Loasby's discussion. Critical passages can then be evaluated in the light of this theme.
The underlying theme is exemplified by the phrase incomplete knowledge, which appears in the title of the chapter. This phrase delineates a middle-ground between omniscience and total ignorance. In the Austrian view it is only with respect to this middle ground that economists have anything of consequence to say. At either extreme of the "knowledge spectrum" economic theory loses most, if not all, of its relevance. This aspect of the economics of extrema-or what might better be called the "noneconomic" nature of extrema-has more manifestations in economic theory than are conventionally recognized. Identifying a number of spectrums to be labeled with such terms as "knowledge," "uncertainty," "stability of expectations," and so forth, and considering the nature of the extrema for each spectrum will take us a long way toward understanding the nature of economics. It will also help to locate the Austrian position on many of the issues raised by Laosby and to compare the Austrian school with the more conventional approach to economic issues.
It might be helpful to begin with an idea that spans all, or nearly all, schools of thought. The concept of scarcity or scarce goods and services has rightly been accorded a prominent place in every introduction to economic theory. We can imagine a "scarcity spectrum" with one extreme representing the complete absence of goods and services and the other representing a complete satiation with respect to all goods and services. Theories of resource allocation, whether Robbinsian or Kirznerian, are simply inapplicable to these polar positions. The economic void and the economic bliss point serve only to bracket the wide band of the scarcity spectrum to which economic theory is applicable. And the virtual inconceivability of the two polar positions serves to dramatize just how wide that band is.
The Knowledge Spectrum
Although nearly all schools of thought stay between the poles of the scarcity spectrum, the modern mainstream has gravitated to one of the poles of the knowledge spectrum. This marks a sharp break between the Austrian economics and the mainstream. Perfect knowledge-or perfect knowledge camouflaged beneath an assortment of frequency distributions-has been the primary domain of standard theory for several decades now. But this pole on the knowledge spectrum has no more relevance to the "economic problem" than does the bliss pole on the scarcity spectrum. This was the message in F. A. Hayek's now-famous article on "The Use of Knowledge in Society." The determination of the optimal allocation of resources given all the relevant information "is emphatically not the economic problem with society faces."(1) Hayek was urging that we move away-a long way away-from the polar position on the knowledge spectrum. But he was not urging that we rush to the opposite pole. This, unfortunately, has been the interpretation of many readers both inside and outside the Austrian camp. Loasby, it appears, has embraced this particular misinterpretation. Excerpts from Chapter 10 can be offered as evidence: "[T]here is no need for information about [resources, technology, and preferences] to be communicated. [A]s F. A. Hayek ... has emphasized, no one needs to know why the price of some particular commodity is whatever it is.... The increased price provides the only signal needed." (Emphasis added.) Loasby prefaced his discussion of Hayek with the assessment that things "are not quite as simple as they appear in the Austrian literature." He went on to conclude that "Hayek's explanation of the economy of knowledge through the use of the price mechanism still leaves us with one problem of general-equilibrium theory: how are ... prices to be arrived at?" If only we recognize that Hayek stopped just short of the perfect-ignorance pole on the knowledge spectrum, we see that this problem does not in fact arise. I quote Hayek's celebrated example of the use of knowledge in society in which the price of tin has risen:
The Existence of Equilibrating Tendencies
Yet another spectrum can shed some light on one of the most fundamental issues in economics. At several points in Loasby's chapter, he touches on the question of whether there is a tendency toward equilibrium. This is a question that all schools of thought have had to answer either explicitly or implicitly and a question on which the Austrian writers have poured much ink. The issue can be put into perspective by imagining a spectrum on which we gauge the volatility of economic data (or, alternatively, on which we gauge the conformity of expected changes in the economic data to actual changes). At one end of the spectrum the underlying data, that is, preferences, resources availabilities, and technology, do not change at all. Here, apart from the path-dependency issue, the equilibrating tendency is not in doubt. This pole of the spectrum has been the popular stomping ground for neoclassical theorists who prefer to skirt the more fundamental issues and to get on with the description of alternative equilibrium states. At the opposite pole, the economic data are more volatile than we care to imagine. In these circumstances, we can predict not only that the question of equilibrium tendencies would be answered in the negative but also that economic science, in which such a question could be raised, would itself be nonexistent. Hayek has reminded us that it is only in so far as individual actions result in unintended order that economic science has a subject matter.(4) We must take Ludwig von Mises literally when he suggests that the only way we can conceive of markets is to conceive of a tendency toward equilibrium.(5) Once again, the poles represent the extreme circumstances under which theory is either trivial or impossible. It is on that expansive band between the two poles that Mises's concept of human action, the ultimate source of the equilibrating tendency, has applicability.
As an aside, let me suggest that the modern discussions of the existence of equilibrating tendencies should induce a feeling of déjà vu. They parallel both in form and in substance the debate between Malthus and Ricardo on the issue of gluts. Gluts, after all, are just a particular form of disequilibrium. The similarity of the issues, then, should not be surprising. Their resolutions, it can be argued, are also similar. Although we can conceive of a temporary glut in a particular market or even a short-run economywide glut caused, say, by the collapse of the currency, the thought of a sustained economywide glut of goods and services is totally alien to the economic way of thinking. Similarly, we can conceive of equilibrium tendencies being blocked for a particular market, and we can understand how, say, perverse monetary policy can disrupt the equilibrating tendencies on an economywide basis, but the idea of a general lack or ineffectiveness of equilibrating tendencies in a market economy is alien to our way of thinking. To deny the existence of equilibrating tendencies or even to plead agnosticism on the issue is to deny or doubt the possibility of an economic science.
Framing these issues in terms of polar positions and the spectrum between the poles helps to put other related issues into perspective. For instance, general-equilibrium theory, whose applicability is confined to one of the polar positions, is sometimes described as institutionless. Economic institutions would be superfluous in a world where perfect order already exists. At the opposite pole, where no order is attainable, institutions could not emerge. It is only in that broad middle ground, where individual actions give rise to a spontaneous order, that economic institutions have a role to play. This accounts for the Austrians' continual attention to the role on institutions in their economic theory and for the inattention on the part of general-equilibrium theorists.
Finally, let me suggest a spectrum that has relevance to sections of Loasby's chapter dealing with intertemporal coordination and monetary disturbances. In an illuminating discussion of these issues Hayek referred to money as the "loose joint" in the system.(6) This view clearly marks off a middle-ground position between two polar views. Theorists whose attention is confined strictly to the real factors are implicitly viewing money as a tight joint; theorists who reason in terms of fixed price levels and liquidity traps see money as a broken joint. Clearly, Hayek's view is the most insightful. The fact that money joins nominal supply and nominal demand is what validates Say's law correctly understood. The fact that the joint is a loose one is what keeps Say's law from being true in the vulgar sense.
Loasby sees Mises as recognizing that the looseness of the monetary joint can give rise to malinvestment in an unhampered market and takes Hayek to believe that only a misguided monetary authority can induce malinvestment. But unless we take Prices and Production as Hayek's final word, this contrast is unfounded. Both theorists took a middle-ground position. Whereas Hayek used the imagery of the loose joint, Mises viewed money as a tool, but not a foolproof tool, of economic calculation. In each case it was understood that individual investors can and do make investments that turn out to be unsound. This is unavoidable so long as we reject the polar position of tight-jointed money. (It is true that Mises and Hayek were more concerned with the attempts of government to take political advantage of the loose joint, in the process inducing systematic economywide distortions in the structure of production. Loasby recognizes that difference between individual investment errors and government-induced malinvestment when he remarks that "no firm can make investment errors as big as those of government.")
On many key economic issues, such as economic knowledge, equilibrating tendencies, economic institutions, and the nature of money, the Austrian theorists take a a middle-ground position when compared to the mainstream counterpart. This is the theme that underlies much of Loasby's discussion. There may be some Austrians who are uncomfortable with this characterization. After all, are not the Austrians supposed to be radicals? Indeed they are. And rejecting a contrary-to-fact polar position in today's academic environment can be a radical thing to do. Let me conclude this portion of my comments with a casual observation about the Austrian school and the modern mainstream. On the analytical issues the mainstream adopts a polar position, but the corresponding policy prescriptions, for example, those concerned with monopoly, externalities, and public goods, can be characterized as middle-ground. That is, perfect-knowledge models yield interventionist policies. Conversely, the Austrians, who take a middle-ground position in analyzing the market process, tend to adopt a polar position on policy issues. The economics of dispersed and incomplete knowledge tend to imply a policy of laissez faire.
Loasby on Business Cycles
Loasby's chapter contains a fairly standard exposition of the Austrian theory of the business cycle. Rather than to comment specifically on this exposition, it my be more worthwhile to ask why this theory is so poorly received by the more conventional macroeconomic theorists. There are clues to an answer in Loasby's chapter. In raising the business-cycle issue Loasby off-handedly describes Hayek's Prices and Production as a comprehensive explanation of monetary disorder. The view that this small book is, or is intended to be, a comprehensive statement and that modern theorists working in the Austrian tradition so regard it may be more common than we realize. In truth the book is, and is intended to be, a skeletal outline of the Austrian theory of business cycles. This is made perfectly clear in the Preface to the second edition. Hayek explains that the book is based on a series of lectures he was invited to deliver at the University of London during the session of 1930-1931. He further explains that the invitation "came at a time when I had arrived at a clear view of the outlines at a theory of industrial fluctuations but before I had elaborated it in full detail or even realized all the difficulties which such elaboration presented."(7) In recent years Hayek has remarked that if he had been invited a year earlier, he could not have given those lectures, and had he been invited a year later, he would not have given them. However thankful we may be that the invitation came in 1930, we should not take the lectures as the last word in business-cycle theory. To so regard Prices and Production is to misrepresent Hayek and to do a disservice to the Austrian school.
The extent of the difficulties in elaborating the theory is evidenced by the sheer volume of Hayek's Pure Theory of Capital published ten years after the London lectures. This volume, as its preface indicates, was intended to serve as a foundation for a more adequate analysis of the problem of industrial fluctuations.(8) The follow-on volume, which was to have analyzed monetary disturbances in the light of this capital theory, was never written primarily because of the shift in Hayek's interest from theoretical economics to political science. Modern theorists working in the Austrian tradition, notably, Murray Rothbard, Gerald O'Driscoll, and Richard Wagner, have partly filled the void left by Hayek. These more modern contributions are evidence that the theory of monetary disturbances is a living issue in the Austrian tradition. Unfortunately, economists outside the Austrian school persist in the belief that Austrian business-cycle theory consists of some pat story fabricated in final form in the 1930s. If the modern Austrians can overcome this misunderstanding, they will have gone a long way toward greater acceptance.
A second source of misunderstanding is manifest in Loasby's discussion of knowledge and expectations. This issue was treated separately form the theory of the business cycle but has direct relevance for the particular course of events that constitute any given monetary disturbance. In effect Loasby criticizes that Austrians for not explaining why different people know different things and have different expectations. The issue of differential knowledge is symptomatic of a larger problem faced by any school of thought that does not follow every trend in the way of thinking of the mainstream. The repeated use of a contrary-to-fact assumption, such as perfect knowledge or homogeneous products, can blunt our ability to deal with reality as it actually exists. The standardization of such assumptions can eventually lead us to require that the recognition of facts-as-they-are be accompanied with special justification. A hypothetical example can serve to illustrate this problem.
Suppose that in the near future an economist devises a model in which it becomes convenient to assume that all goods are made out of rubber. (The otherwise outrageous assumption may initially be justified on the basis of the empirical soundness of the model's predictions.) If this rubber-goods model were to sweep the profession, it would eventually become unnecessary to restate the underlying assumption each time the model is employed. Eventually, it would be necessary to reject explicitly the all-rubber assumption if the fact that different goods are made from different materials is instrumental for a particular line of reasoning. The first theorist to make this explicit rejection would be regarded as having a brillian insight by some, while others would demand an explanation for the multimaterial view of the world. Soon enough, historians of thought would begin combing through the early literature looking for clear evidence that Smith, Ricardo, and Menger realized that some things are not made out of rubber. Such is "life among the jEcon"- to use a phrase coined by a modern Econ-watcher.
In the Austrian tradition the fact of differential knowledge literally goes without saying. The "assumption" that different people know different things is on a par with the "assumption" that not all goods are made out of rubber. In fact, to a methodological individualist the idea that different people know different things is inherent in the very concept of an individual. Differential knowledge remains a puzzle only to those economists whose understanding has been numbed by the continual contrary-to-fact assumptions of identical individuals and identical firms as represented by the corresponding homothetic indifference curves and production functions. Yet, Loasby considers the fact of differential knowledge a "major theoretical issue" and calls on the Austrians to justify their assumption. Surely this demand should be seen as a commentary on the current mind set of the modern mainstream and not as an imperative for modern Austrian scholars.
These remarks, inspired by Loasby's discussion of Austrian business-cycle theory, are intended to suggest that those who are convinced of the basic soundness of the Mises-Hayek theory should proceed on two fronts. They should strive, of course, to elaborate and refine the analysis offered by these earlier Austrian theorists. But they should also attempt to advance on the strategic front. Identifying and overcoming misunderstandings can be as important-and as difficult-as arriving at the understanding in the first place.
Loasby has touched on many more issues than I have been able to consider. But the general approach I have taken to put a few of the issues into perspective could well be extended beyond Loasby's discussion. If nothing else, the approach has served to keep one important distinction in sharp focus. It has made us realize which issues are truly controversial and which ones are only controversial in the light of some contrary-to-fact mainstream view. This is a distinction that modern Austrian theorists should keep in mind.
4. "It is only in so far as some sort of order arises as a result of individual action but without being designed by any individual that a problem is raised which demands a theoretical explanation." F. A. Hayek, The Counter-Revolution of Science (New York: Free Press of Glencoe, 1955), p. 39.
5. "The only method of dealing with the problem of action is to conceive that action ultimately aims at bringing about a state of affairs in which there is no longer any action...." Ludwig von Mises, Human Action, 3rd rev. ed. (Chicago: Henry Regnery, 1966), p. 244.