Tuesday, February 7, 2012

Economic Calculation, Part 3

Jonathan Finegold Catalán writes a response to my last post:
Jonathan Finegold Catalán, “Economic Miscalculation: A Reply,” Economic Thought, 7 February, 2012.
My response:
(1) Catalán appears to concede that the ABCT is not a minor “facet of the [sc. Austrian] theory of economic coordination,” as he did in his original post. That ABCT is one important part of broader Austrian theories of economic calculation is something I don’t deny. We are clearly talking at cross purposes. I have never denied Austrians can put ABCT within a larger framework of “economic calculation.” The point was that ignorant internet Austrians engage in the rhetorical trick of diverting attention from their inability to deal with critiques of the ABCT with lazy appeals to this concept.

My other point that, for capitalist economies, ABCT is clearly the most important theory that Austrians have whenever they complain about “economic calculation” problems stands.

Catalán asserts:
“what I call the “theory of intertemporal discoordination” is Austrian business cycle theory — I prefer my term, because I think it gets across what the theory is about much better than the conventional one. Furthermore, as I posited in my original post, the new term suggests that the theory is only one facet of many within the body of theory of economic coordination (and discoordination). More accurately, it describes an artificial tendency of discoordination between investment and societal time preference (the latter dictating the aggregate stock of savings at any given point in time).”
The theory of “artificial tendency of discoordination between investment and societal time preference” is precisely a fundamental part of ABCT, so it is absurd beyond works for anyone to deny that somehow I don’t understand this alleged process.

Catalán states that “price floors/ceilings, subsidies,” etc., distort prices, and form part of the Austrian obsession with economic calculation, which is something I’ve always been well aware of. However, it is obvious that the ABCT is still far more important for the standard Austrians claims of “economic coordination problems” in modern capitalist economies, than price floors/ceilings. Is Catalán really saying that the existence of some government subsidies are interventions so severe they cause an Austrian trade cycle? That the ability of the private sector to engage in production of commodities based on price signals would now be distorted so badly that nobody could engage in “economic calculation”?

(2) Catalán states:
“That Austrians ‘reject Walrasian equilibrium’ does not mean that some Austrians reject the use of equilibrium as an ideal type, which is how Hayek used equilibrium theory in Prices and Production.”
The assertion that Hayek only used equilibrium as an “ideal type” or only as “a pedagogical tool” in Prices and Production (1931; 2nd edn. 1935) is wrong.

An equilibrium state is the starting point of a real world economy allegedly subject to Hayek’s Austrian trade cycle (Loasby 1997: 54: “Hayek began … with a monetary expansion … impinging on a perfectly co-ordinated economy”). Hayek explicitly stated that he had assumed full employment equilibrium in Prices and Production (1931):
“As it is sometimes alleged that the ‘Austrians’ were unaware of the fact that the effect of an expansion of credit will be different according as there are unemployed resources available or not, the following passage from Professor Mises’ Geldwertstabilisierung und Konjunkturpolitik (1928, p. 49) perhaps deserves to be quoted: ‘Even on an unimpeded market there will be at times certain quantities of unsold commodities which exceed the stocks that would be held under static conditions, of unused productive plant, and of unused workmen. The increased activity will at first bring about a mobilisation of these reserves. Once they have been absorbed the increase of the means of circulation must, however, cause disturbances of a peculiar kind.’ In Prices and Production, where I started explicitly from an assumed equilibrium position, I had, of course, no occasion to deal with these problems. (Hayek 1975 [1939]: 42, n. 1).
Hayek’s assumption of a real world full employment equilibrium state is confirmed in a letter that Hayek wrote to John Hicks in 1967, regarding the assumptions of his theory, where Hayek confirms that his theory required equilibrium and full employment as the initial stage at the beginning of the process leading to the trade cycle:
Hicks to Hayek, November 27, 1967
“... We have (a) full employment, (b) static expectations, (c) ‘equilibrium’ at every stage, so that demand = supply in every market, prices being determined by current demand and supply. Add to these the Wicksell assumption, of a pure credit economy and we clearly find that if there were in lags, the market rate of interest cannot be reduced below the natural rate in an equilibrium position; ....”

Hayek to Hicks, December 2, 1967
“I accept assumption (a), full employment. I am not sure that I quite know what (b) ‘static expectations’ means, but if it means that at each stage of the process everybody acts in the expectation that future prices will be the same as present prices, I accept that too – though we shall see that these expectations must be disappointed.

Of (c) I can accept that at each stage in every separate market demand = supply in the sense that at the ruling price all buyers and sellers buy and sell as much as they want to buy at that market, but not in the sense that any change in the supply which a change in price will bring about in the course of time has already taken place or that prices correspond to the marginal costs at which producers now begin to produce.

Nor need there [be] at any but the initial stage an overall equilibrium between the different markets, because a change of price necessary to secure equality between demand and supply in any one market will make at the next stage a change of other prices inevitable as a result of the changed receipts in the first market being spent.

Let us now start with a system in full stationary equilibrium: constant prices and no net saving or investment and no changes in the supply of factors or tastes and a constant flow of money (which may be a token or partly credit money) ...” (Hayek 1999: 100–102).
Moreover, Hayek, on pages 265–266 of Prices and Production, explicitly tells us his purpose in the book:
“My present task is to fill in the details of that rough sketch and to show what happens in the interval before a new equilibrium is attained.” (Hayek 2008: 265–266).
U. Witt has identified the severe problem running through Hayek’s reliance on general equilibrium for his trade cycle theory:
“In Mises’s understanding (general) equilibrium is a fictitious, imaginary construction useful as a logical basis of comparative statics … Though often arguing similarly in this respect, Hayek takes a different position. While Mises’s apodictic apriorism did not require Mises to derive empirical hypotheses, it is quite clear, e.g., from Hayek (1933) that he aimed at empirically meaningful propositions about the business cycle. For this reason, he was forced to identify general equilibrium in some way or other with an empirical state of the economy, and his theory indeed seems to suggest the state of the markets in the pre-upswing stage of the business cycle. However, in an empirical economic theory it is difficult to determine the conditions under which general equilibrium should be observable. It is even more obscure to see how individual imaginations of, and plans for, future events come to be coordinated so that prices can converge to their equilibrium values. The latter question is crucial in an individualistic approach where subjective expectations are supposed to play a key role.” (Witt 1997: 49).
If economies never reach equilibrium, then Hayekian ABCT is already completely useless and worthless: how can the cycle effects happen if factor inputs for the (alleged) unsustainable higher-order capital goods investments are idle or relatively abundant in a disequilibrium economy?

(3) Catalán misinterprets my statement about Lachmann. This was Catalán’s original statement:
“For instance, an Austrian will tell a Keynesian that the market does not fail at intertemporal allocation, whereas a Keynesian (at least one loyal to Keynes’ business cycle theory) will tell you that it does.”
This is an assertion that markets can never fail at intertemporal allocation, and by extension Catalán imputes that view to Lachmann and radical subjectivists. That is completely false.

Lachmann is perfectly clear that endogenous factors in markets can result in coordination failures:
“Because of his focus on uncertainty, Lachmann came to doubt that, in a laissez-faire society, entrepreneurs would be able to achieve any consistent meshing of their plans. The economy, instead of possessing a tendency toward equilibrium, was instead likely to careen out of control at any time. Lachmann thought that the government had a role to play in stabilizing the economic system and increasing the coordination of entrepreneurial plans. We call his position ‘intervention for stability.’” (Callahan 2004: 293).
Not only did Lachmann believe this, but was prepared to accept Keynesian stimulus during times of depression, as he himself says in the lecture of Lachmann I posted here.
You can also listen here.

From 55.38 in the audio, in response to a question about policies for the macroeconomy, Lachmann explicitly allows government intervention in a depression: he notes that Hayek retreated from his liquidationism of 1932 (“Hayek has now realised that that was wrong,” he says from 56.53). “In a situation in which nothing really is scarce,” Lachmann says, there can be government intervention to increase employment (56.57).

Lachmann also said the same thing in print. In many respects, there is a gulf between Austrians like Catalán and Lachmann.

Callahan, G. 2004. Economics for Real People: An Introduction to the Austrian School (2nd edn), Ludwig von Mises Institute, Auburn, Ala.

Hayek, F. A. von. 1975 [1939]. Profits, Interest and Investment, Augustus M. Kelley Publishers, Clifton, NJ.

Hayek, F. A. von, 1999. Collected Works of F.A. Hayek, Volume 6: Good Money, Part II: The Standard, Routledge, London.

Hayek, F. A. von, 2008. Prices and Production and Other Works: F. A. Hayek on Money, the Business Cycle, and the Gold Standard, Ludwig von Mises Institute, Auburn, Ala.

Loasby, B. J. 1997. “Co-ordination Failure in Economic Theory: Economists in the 1930s,” in A. Jolink and P. Fontaine (eds.), Historical Perspectives on Macroeconomics: 60 Years After the General Theory. Routledge, London. 53–64.

Witt, U. 1997. “The Hayekian Puzzle: Spontaneous Order and the Business Cycle,” Scottish Journal of Political Economy 44: 44–58.


  1. What exactly does Lachmann mean when he states:

    "In a situation in which nothing really is scarce..."

  2. He means a situation of depression or even the aftermath of a depression, where there is relative abundance of resources, from labour, idle stocks of commodities, unsold inventory, idle capital goods.

  3. I just want to let readers know that all these points are being disputed in the comments section of my reply. I rather not have to duplicate my comments here.