Situating Austrian Economics Within Modern Social Science Peter J. Boettke 2004 Hayek Visiting Fellow London School of Economics October 11, 2004

What Did Marshall Miss? According to Baumol (2000):  Macroeconomics  Entrepreneurial element in the market process According to the ‘Austrians’:  The completeness of subjectivism  Entrepreneurial element in the market process

What are the interesting trends in Modern Economics? Hayek 1974 Nobel Prize Winner  Emphasis on Decentralized Decision making  Information embedded in the price system  Learning function of social institutions  Conditions for Social Coordination as an overarching theme in work on economics, politics and law

What are the interesting trends in Modern Economics? Buchanan 1986 Nobel Prize Winner  Emphasis on behavioral symmetry between economic actors and non-economic actors, in particular political actors in the voting booth, running for office or situated in the bureaucracy Death of Romantic Politics and the Benevolent Despot  Emphasis on exchange behavior and the institutions within which exchange takes place  Focus analytical attention on the constitutional level – the rules of the game

What are the interesting trends in Modern Economics? Coase 1991 Nobel Prize Winner  Emphasis on how alternative legal arrangements impact economic performance Demonstrated the intellectual bankruptcy of Pigovian welfare economics  Focus on the institutional framework within which economic activity takes place  Champion of “dirty” empirical work to get at the contractual record in economic activity.

What are the interesting trends in Modern Economics? North 1993 Nobel Prize Winner  Emphasis on institutions and institutional change in economic performance Institutions as constraints Institutional change as a shift in relative prices  Importance of cognition in understanding institutional change  Emphasis on economic history as a research field focused on institutions and institutional change

What is the Value Added of ‘Austrian Economics’?

First, intellectual history point  Mises emphasized these points prior to any other thinker in 20 th century economics, including Frank Knight  Mises should be recognized as the fountainhead of rational choice theory, new institutionalism and analytical narrative empirical work (friends and foes do injustice to Mises) Second, the missing element in common understanding of New Institutional Economics  Entrepreneurial element in human action and the competitive market process. Knowledge problems in addition to incentive alignment issues  Behavioral Assumptions and Institutional Deficiency in economic theory

What About Information Economics? Stiglitz 2001 Nobel Prize Winner  Emphasis on imperfect information and imperfect market structure Critique of Walrasian economics  Presumption reversed – market failure is the rule, market efficiency is the exception  Relevance of economics to policy world Globalization and Its Discontent  Transition and Development Economics after a decade

What About Information Economics? Akerlof Nobel Prize Winner 2001  Emphasis on asymmetric information “market for lemons”  Broaden economic analysis to address sociological questions Social status, etc.

Austrian Quick Answer to Information Economics Information economics is better than the previous perfect knowledge economics and as such Stiglitz trumps Lucas as a research inspiring figure  Search for Information versus the Discovery and Use of Knowledge Stiglitz’s critique of Walrasian economics is on target, but he fails to appreciate the role of disequilibrium prices in coordinating affairs --- in short, he underestimates the learning properties inherent in the economic processes and thus the robustness of markets Akerlof problems lead to Hayekian solutions – markets are discovery procedures where we learn all sorts of things (like reputation) that enable us to coordinate our plans with others.

‘Austrian’ Theory of the Market Process and Information Economics Kirzner’s emphasis on:  Uncertainty and sheer ignorance as part of the human condition, not assumptions of particular environments – we must always be coping with our ignorance  The role of imperfections in driving entrepreneurial altertness to opportunities for pure profit  The importance of the institutional framework for issues of economic coordination

Other Interesting Trends Andrei Shleifer – JB Clark Award  Work on property rights and privatization Grabbing hand vs. invisible hand  Work on incentive structures within markets, non-profits and governments Role of entrepreneurship in different institutional settings  Work on law, politics and finance  Work on Institutional Possibilities Frontier --- ***  Work on “inefficient” markets But effective markets

The New Comparative Economics Framework Public Predation Private Predation Socialism State regulation Common law courts Self-government Questions: (1) how do you move between different enforcement regimes, and (2) how do you shift the entire institutional possibilities frontier in to get less ‘bads’

Other Interesting Trends: Lab Experiments (continued) Vernon Smith and Experimental Economics – Nobel Prize 2002  ECOLOGY OF ECON LIFE (framing issues) Markets are more efficient than theory would predict  Groping market Trust and cooperation is more common than theory would predict  Trust games with anonymous trading partners

Interesting Trends: Natural Experiments (continued) Steve Levitt – John Bates Clark Award (2003)  Creative and unusual data collection (hockey, TV, abortion, gangs, and gambling)  Point is to see microeconomics come alive in different walks of life (natural experiments) Situations which approximate meeting the ceteris paribus clause and thus approximate controlled experimentation

Other Interesting Trends Theory  Economics of Growth and Development Increasing recognition of the role of institutions and culture in development Focus on questions of well-being beyond aggregation attempts  Economics of Self-governance Recognition of the role of reputation, norms and conventions History  Analytical Narrative Use of theory to do history  Ethnographic turn

A Snap-shot of the Current Landscape in Economics

One set of implications of this change in the intellectual landscape Debate is no longer versus historicists, nor is it with General Equilibrium Theory Neoclassical Economics is extremely adaptable and is just as comfortable with formal proofs of equilibrium and it is with formal proofs of multiple equilibria We have to get more historical before we can re-establish the theoretical perspective

Another Way to Restate the Place of Austrian Economics in the Modern Landscape of Economic Thought If orthodox economics works in a realm where in order to generate propositions of market efficiency the theorist is required to make simplifying assumptions about agent knowledge and structure, and heterodox economics works in a realm where once these simplifying assumptions are overturned the propositions of market efficiency must be rejected, then Austrian economics can best be understood as deriving propositions about market efficiency within a heterodox problem situation.

Snap-shot of the Problem Situation in Economic Analysis Simple Problem Situation Economic Order NEOCLASSICAL Simple Problem Situation Economic Disorder NON-ECONOMISTS Complex Problem Situation Economic Order AUSTRIAN ECONOMICS Complex Problem Situation Economic Disorder HETERODOX ECONOMICS

How do the ‘Austrians’ Accomplish this? Recognition of a Tripartite Division of Knowledge in Economic Science  Exact theory (apriori – logic of choice)  Applied theory (institutionally contingent propositions)  Economic History – Public Policy (interpretative understanding) Uncertainty inherent in all human actions, means that economic actors rely on various norms and institutions to cope with this uncertainty These institutions work to ameliorate conflicts and promote economic coordination and social cooperation  Mises notion of Ricardo’s Law of Association

Conclusion Economics has moved significantly in an Austrian direction since Samuelson. We should declare victory and stop behaving like we are a side show. There is still much that the Austrians can add to the conversation. The economic and social world is just too damn interesting and exciting to let devotion to technique and the incentive system within the modern academy to get in the way of our desire to understand the world. Economics when done best is exceedingly relevant. To regain our theoretical footing, we must first do more historically grounded research which demonstrates the interpretive power of the theoretical insights of the Austrian School.