Short Essay Regarding: "The Use of Knowledge in Political Economy: Paretian Insight into a Hayekian Challenge"
The motivation of this response is to extract and extend a particular line of thought relevant to the article. The article does not pretend to be a holistic summary, response, or extension of <a href="https://ssrn.com/abstract=2776985">Wagner (2016). Instead, the agenda of this article is to cherry-pick support for my own agenda, which is the synthesis of Austrian and Neoclassical economics.
Per Wagner, Austrian economics and Neoclassical economics are not competitive programs and they explain different things. This leaves the door open to the possibility that the programs are complimentary and may therefore be open to synthesis.
Hayek never explicitly argued for market movements are Pareto-superior movements, but it is understandable why his critics may have read this into his early use of Walrasian equilibrium. The fact that Hayek’s later thought grew out of a beginning in Walrasian equilibrium leaves open the possibility of synthesis. One strategy would be to frame Walrasian equilibrium into process grounds, another to bring process into the competitive model, and a third would be to find a middle ground.
In particular, Transaction Cost Economics presents the concept of efficiency as the maximum feasible level of utility, whether such level is pareto-optimal or not. The TCE notion of efficiency is essentially Kaldor-Hicks efficiency, without the notion that a market failure is equivalent to inefficiency. In this way, TCE utilizes the same principles of behavioral symmetry found in Public Choice Economics.
This notion of non-remediable efficiency is framed in a rigorous mathematical way using utility functions. This has been objected to by some Austrians, but per <a href="http://econfaculty.gmu.edu/bcaplan/e812/micro6.htm">Caplan the broadly accepted utility functions in behavioral economics are robust to affine transformations. In other words, standard utility functions are order-preserving and therefore need not be incompatible with the Austrian notion of ordinal preferences.
Clearly the economy is in part kaleidic or perpetually disequilibrated, but it seems to me that this component is non-dominant. Logically, dominant uncertainty rules out human action as rational. We cannot conceive of any means to our ends if we are dominated by uncertainty on the efficacy of various means. So if radical uncertainty is understood as the dominance of uncertainty it is in fact highly anti-Austrian, anti-Mises, and non-praxeological.
The dominance of uncertainty would also undermine the possibility of historical determinacy. Historical determinacy is consistent with Smith’s invisible hand and mainline economics both classical and modern.
Finally, the dominance of uncertainty is indefensible on empirical grounds. Research shows that outcomes correlate with expectations, and there is strong empirical evidence for determinant movements of certain facets of the economy. For example, GDP predictably increases in the moderate to long run.
On the other hand, to assert that uncertainty is an essential but dominated component of an economy seems to be a brilliant insight and key contribution of Austrian Economics. As long as the uncertainty in economics is subjugated then it need not lead to nihilism, the maldeduction of which has inspired some criticism.
While I have defended the idea of a kaleidic economy particularly understood, I want to pause and criticize Hayek as not fully conceiving of the creativity of the economy. For Hayek, the entrepreneur is <a href="http://www.afterecon.com/economics-and-finance/the-kirznerian-delta-fsr-or-abundance/">merely an agent of equilibration, not an agent of genuine invention. In fact, Austrian economics as a whole lacks a real explanation of genuine innovation or invention. The closest I have seen is the <a href="https://books.google.com/books?id=AJLGKdOZneMC&pg=PA340&source=gbs_selected_pages&cad=3#v=onepage&q&f=false">JH De Soto (2012) idea of capital deepening due to increased savings as a means of making new technical plans feasible.
The fact that Austrian economics has no coherent model of invention is another opportunity for synthesis with the Neoclassical school, which also lacks such a model. Ostensibly, a reasonable model of invention might be adopted by both schools, unifying them to some degree.
Hayek’s insistence on generated rather than stipulated equilibria can help satisfy the Neoclassical demand for finer and finer microfoundations. The Neoclassical school and TCE in particular have a very strong theory of the firm where there is no uniquely Austrian theory of the firm. Indeed, <a href="https://www.mercatus.org/system/files/Austrian_Firm.pdf">Langois (2013) seems to be happy to adopt a modified TCE approach.
The Theory of the Firm provides a strong foundation for the microfoundation of macroeconomics and the dominance of microeconomics as the main field of the science. However, the Theory of the Firm can be further founded on the Theory of the Individual. Austrian Economics brings a logically and empirically more robust rendition of the individual compared to the Neoclassical rational agent, distinguished without compliment as homo economicus so as to distinguish the particular Neoclassical notion of rationality from the notions of rationality held by other schools.
Behavioral economics also focuses on the perpetual disequilibrium of real economies, an idea echoed in Hayek. Like Public Choice and Austrian economics, behavioral economics seeks to analyze man as he really is, in contrast to the heroic assumptions made in Neoclassical economics.
Behavioral economics provides evidence for the Austrian concept of the individual as an individual of ecological, bounded, or constrained rationality. That is, individuals pursue their own interests under uncertainty, with cognitive biases, with limited information, and otherwise as imperfect individuals.
Policy solutions based on Behavioral Economics are tempered through Public Choice Economics which realizes behavioral symmetry. Public Choice further defends the market against accusations of market failure by revealing the possibility of political failure and demanding efficiency be construed, as under TCE, by the notion of remediableness rather than by the notion of strict Pareto or Kaldor-Hicks optimality. Introducing Public Choice Economics into the synthetic alliance allows us to take the positive findings from behavioral economics without admitting the disturbing conclusions generally advocated by that field.
Both Neoclassical and Austrian economics can reach further microfoundations. While the individual is certainly the atom of either school, the atom must organize in its system, which is the market. The mechanism of organization is the transaction, but both the Austrian School and the Neoclassical School are guilty of stipulating property rights, where property rights and individuals are all that are required for a transaction to rationally emerge, and where rational emergence is further determined by the existence of gains from trade.
The stipulatory granting of such rights as granted and protected by the state serves to legitimize the role of the state on inaccurate positive grounds. Instead, property rights are emergent, generated as a de facto claim to property. If any agent can maintain physical or mental ownership of some property despite attacks from other agents, then the former implicitly demonstrates a de facto claim to such property in a positive manner, without the need to invoke moral or political philosophy on rights.
Preferences are another factor which is stipulated rather than generated, certainly by the Neoclassical school a la <a href="http://www.jstor.org/stable/1807222">Stigler-Becker (1977). Behavioral economics in particular emphasizes the emergence of preferences. Austrian Economics emphasizes the heterogeneity of preferences, but the emergent or dynamic nature of preferences is less emphasized. Genuinely altered preferences are neither ruled out nor endorsed on strict Austrian economics. The difference is either negligible or perhaps attitudinal: Behavioralists emphasize the malleability of preferences, while Austrians emphasize individual sovereignty and tend to construe a change in preferences as a natural optimizing response by an individual to discovery. In fact, in the Neoclassical model on which behavioralists work out their calculations, the informational context of a transaction and individual preference are indistinguishable, both being represented uno actu by the preference curve.
Perhaps the introduction of some game-theoretic or agent based models would help unify Austrian and neoclassical economics.
This would provide a choice-theoretic model required by Austrian economics but allow calculative rigor as demanded under Neoclassical economics. As an added bonus, the inclusion of moves by nature might allow for the introduction of a mechanism for innovation. Just as market entrepreneurs operate by trial and error, as mentioned in Wagner’s article, so does nature operate by trial and error, with natural selection, per evolutionary models. In fact, evolutionary economics is one of few fields in economics which presents plausible and rigorous models for technological innovation. By adding this field to the synthetic alliance we have perhaps the most complete picture of economics possible.
Just as intelligent design theories are challenging basic evolutionary models, though, we can extend the Austrian teleological story to augment the basic evolutionary economic model story. If it is possible for an individual to be alert to their own areas of intellectual strength and weakness, then an individual can plausibly influence their own rate of discovery by engaging in actions associated with their own intellectual weakness. Or perhaps the relationship works opposite, where focusing on areas of intellectual deepness and expertise yield exponentially more discovery than areas of intellectual shallowness. The direction of the relationship doesn’t matter, but the key is the plausibility of the individual’s ability to influence their own rate of discovery. If such a thing is possible then individuals may directly demand technological discovery and they may directly act toward it as a goal. This is related to, but distinct from, the need to reconcile Austrian uncertainty with Neoclassical search costs and risk theory. None of that is easy, but I think it is all possible, and I think the establishment of these things would create a new era in economic theory which is structurally and logically rich as well as empirically useful in predictive, forward-looking ways, in addition to descriptive, backwards-looking ways.
Citations:
Wagner, R. E. 2010. Mind, Society, and Human Action: Time and Knowledge in a Theory of Social Economy. London: Routledge
Wagner, R. E. 2016. The Use of Knowledge in Political Economy: Paretian Insight into a Hayekian Challenge. GMU Working Paper in Economics No. 16-15. Available at SSRN: https://ssrn.com/abstract=2776985
Langlois, R. N. 2013. The Austrian theory of the firm: Retrospect and prospect. The Review of Austrian Economics. 26: 247. doi:10.1007/s11138-012-0171-y
De Soto, JH . 2012. Money, Bank Credit, and Economic Cycles. 3rd edition. P 340.