Austrian Business Cycle Theory As Uninteresting And Esoteric

I have been unsuccessful in getting my refutation of Austrian Business Cycle Theory accepted for publication in a peer-reviewed journal. My latest publically available version is downloadable from SSRN. I have had a later version rejected a couple of weeks ago. This version's references include Roger Garrison's 2006 "Reflections on Reswitching and Roundaboutness". I hope quoting an extract from a review is acceptable, since some might find this of interest:

"Hayek had washed his hands of the triangles [that ground his theory of the trade cycle] long before the ink was dry on his Pure Theory of Capital... Modern Austrian school economists like Roger Garrison still find the triangle-logic compelling, but I have the impression that, with the possible exception of Leland Yeager’s 1976 Economic Inquiry paper, no systematic attempt has been made to show that Austrian economics is immune to the capital critique; the arguments are intuitive rather than carefully drawn. (Even Yeager’s piece struck me when I read it, many years ago, as largely intuitive.) ...the arguments had never been put forward in a robust way..."

Classical Cross Dual Dynamics

"The actual price at which any commodity is commonly sold is called its market price. It may either be above, or below, or exactly the same with its natural price.

The market price of every particular commodity is regulated by the proportion between the quantity which is actually brought to market, and the demand of those who are willing to pay the natural price of the commodity, or the whole value of the rent, labour, and profit, which must be paid in order to bring it thither. Such people may be called the effectual demanders, and their demand the effectual demand; since it may be sufficient to effectuate the bringing of the commodity to market...

...The natural price, therefore, is, as it were, the central price, to which the prices of all commodities are continually gravitating...

The whole quantity of industry annually employed in order to bring any commodity to market, naturally suits itself in this manner to the effectual demand. It naturally aims at bringing always that precise quantity thither which may be sufficient to supply, and no more than supply this demand." - Adam Smith, The Wealth of Nations, Book I, Chapter VII

1.0 Introduction
Contemporary economists have elaborated Smith's metaphor of the gravitational attraction of market prices to natural prices. Elaborations consist of formal models of cross-dual dynamics.

Systems of equations describing prices and quantitites are dual systems in the post Sraffa/von Neumann tradition. Dynamics are cross dual when changes in prices respond to quantities and changes in quantities respond to prices. In particular, industries expand in which rates of profits are high and contract in industries in which profits are low. And prices fall in industries in which the quantity supplied exceeds the effectual demand. Prices rise in industries in which the quantity supplied is below the effectual demand.

Dupertuis and Sinha (2009) is one immediate impetus for my setting out this model of the reallocation of labor for a given wage. I don't think I thoroughly understand models of cross-dual dynamics. I think they are of interest for exploring the possible dynamics of market prices in competitive capitalist economies. I don't see that they are directly empirically applicable. For that, one needs to worry about markup prices and the degree of utilization of capacity in various industries.

2.0 Natural Prices
The data of our problem are:

• The n x n input-output matrix A, where n is the number of industries and a_{i, j} is the amount of the ith commodity used as input per unit output of the jth industry
• The n-element row vector a₀ of labor inputs, where a_{0, j} is the amount of person-hours hired per unit output in the jth industry
• The money wage w_given
• The composition of net output as expressed in the n-element column vector c_given.

This is a circulating capital model in which all production processes use up their inputs in a year. Labor is assumed to be paid their wages at the end of the year. Only economies capable of producing a surplus product are considered. For simplicity, assume Constant Returns to Scale (CRS) and that every commodity is basic, in Sraffa's sense. This section considers the problem of finding:

• The natural prices, as expressed in the n-element row vector p^*
• The corresponding wages w^*
• The corresponding rate of profits r^*
• The effectual demand as expressed in the n-element column vector of gross quantities q^*
• The n-element column vector of net quantities y^*.

In the system of natural prices, the same rate of profits are made in every industry:

p^* A(1 + r^*) + a₀ w^* = p^*

I take the net output as the numeraire.

p^* y^* = 1

In my formulation here, the wage is taken as a given ratio of the net output:

w^* = w_given

The above equations comprise the price system for natural prices.

Net outputs and gross outputs are related by the following equation:

y^* = q^* - A q^* = (I - A) q^*

where I is the identity matrix. I normalize the units of labor such that one unit is employed throughout the economy:

a₀ q^* = 1

Finally, the net output is assumed to be in the specified proportions. That is, there exists a positive constant k such that

y^* = k c_given

The above systems of equations are sufficient to determine gross and net effectual demands, natural prices, and the distribution of income. (An alternative specification would take the composition of gross output as given, instead of the net output. Perhaps outputs should be in units of Sraffa's standard commodity.)

3.0 Initial Condititions
The problem in the remaining sections is to define a dynamic process for the quantities produced q(t) and the market prices p(t) for t = 0, 1, 2, ... The initial quantities q(0) and market prices p(0) are givens. For the sake of the argument, I consider a dynamic process in which the amount of labor employed and the value of net output are invariant. So the initial quantities and prices must satisfy the following equations:

a₀ q(0) = 1

p(0) y(0) = p(0)(I - A)q(0) = 1

4.0 Reallocation of Labor
Define r_average(t), the average rate of profits for the economy as a whole at time t:

r_average(t) = [p(t)(I - A - a₀ w_given)q(t)]/[p(t) A q(t)]

The numerator in the expression on the right hand side above is the value of the surplus product remaining in the capitalists' possession after replacing the means of production and paying laborers their wages. The denominator is the value of the capital goods advanced.

Typically, the rate of profits will vary from the average among the industries. The rate of profits for the jth industry at time t is:

r_j(t) = [p_j(t) - p(t) a_{., j} - a_{0, j} w_given]/[p(t) a_{., j}]

where a_{., j} is the jth column of the input-output matrix A.

Define R_average(t) to be the n-element column vector with each element equal to the average rate of profits. Let R(t) be the n-element column vector with each element being the rate of profits for the corresponding sector.

Now dynamics of the quantities of produced commodities can be specified:

q(t + 1) = [1/f₁(t)]{[R(t) - R_average(t)] + q(t)}

Or, in terms of scalars:

q_i(t + 1) = [1/f₁(t)]{[r_i(t) - r_average(t)] + q_i(t)}

where

f₁(t) = 1 + a₀[R(t) - R_average(t)]

The denominator f₁(t) above is a normalization that ensures the quantity of labor employed is always unity. The numerator ensures that the more the rate of profits in a sector exceeds the average, the faster that sector will expand in comparison with other sectors. (An alternative formulation might compare the rate of profits in each industry with the rate of profits r^* in the system of natural prices.)

5.0 Price Changes
Price dynamics are here set out more directly:

p(t + 1) = [1/f₂(t)]{p(t) - [q^T(t) - q^*T]}

where x^T is the transpose of the vector x. In terms of scalars, prices are given by:

p_i(t + 1) = [1/f₂(t)]{p_i(t)- [q_i(t) - q^*_i]}

The time series f₂(t) is defined as follows:

f₂(t) = [q^*T - q^T(t)](I - A)q(t + 1)} + p(t)(I - A)q(t + 1)

The denominator f₂(t) above is, again, a normalization condition. In this case, the normalization ensures the value of the net output is equal to unity. Since the composition of net output typically changes over the course of the process, the real wage varies in terms of any fixed commodity basket. It does remain, however, a given ratio of the net output.

6.0 Conclusion
I have set out above a model of a dynamic process, but without an analysis of its properties. An obvious theorem is that if initial quantities and prices happen to be equal to the effectual demands and natural prices, they will be left unchanged by the dynamics of market adjustments. In other words, the natural system is a stationary point of this dynamic process.

An interesting question is the trajectory of market prices, given an arbitrary starting point. I don't expect the process to necessarily converge to the natural system. At this point, I don't have any numeric examples of limit cycles or chaotic behavior. A failure of local stability doesn't bother me; I have often thought of Sraffa's work as pointing towards the possibility of complex dynamics arising in models of capitalist economies.

Questions of structural stability are of interest as well. Do dynamic properties of the system depend on the level of wages, especially if one introduces into the model a choice of technique? And how do the answers to these questions vary, if at all, with alternative modeling assumptions, some of which I have indicated? I do not know that the literature has reached definitive answers to these questions.

Update (28 January 2010): I have redefined the dynamics above in a way that seems more reasonable to me.

References

• Michel-Stéphane Dupertuis and Ajit Sinha, "A Sraffian Critique of the Classical Notion of Centre of Gravitation", Cambridge Journal of Economics, V. 33 (2009): 1065-1087.

Upcoming URPE Conferences

Chris Pepin informs us that the Union for Radical Political Economics (URPE) will participate in the upcoming Eastern Economics Association (EEA) conference. The conference will be held at the Loews Philadelphia Hotel, February 26 - 28. A program is available. This year is the 50th anniversary of the publication of Sraffa's book.

URPE is also participating in the Left Forum, on March 19-21 at Pace University.

Elsewhere

• Eric Rauchway tells us about the Bretton Woods conference, where John Maynard Keynes showed that some economists could be more useful than dentists.
• David Ruccio reprints a cartoon by B. Deutsch making fun of economists prefering a supposedly elegant theory of the minimum wage to empirical results falsifying the theory.
• Bill Mitchell has a negative view of Greg Mankiw's textbook.

Skimming Moshe Adler

A few weeks ago, in a bookstore a couple of hundred miles away from here, I skimmed Moshe Adler's Economics for the Rest of Us: Debunking the Science that Makes Life Dismal. I did not purchase it because I am already too far behind in my reading. It is targeted for those outside the economics profession.

It is a short and approachable book that, as I recall, falls into two main parts.

The first part is about the mainstream economist's concept of (Pareto) efficiency. I hopped over this section fairly quickly, since I see no need to be strongly guided by this criterion in making policy decisions. I gather Adler agrees.

The second part is about income distribution, the theory of marginal productivity, and wages. Adler compares and contrasts neoclassical theory and the more empirically applicable classical theory. If I read this book in more depth, I would probably have some caveats about Adler's interpretation of the classical economists and his assignment to them of one (non-Malthusian) theory of wages. Adler recognizes that in a theory in which wages are determined by well-behaved supply and demand functions for labor, the imposition of higher wages results in less employment. Less security and less employment is a bad thing for many members of that vast majority in capitalist societies who depend on income from labor to live. On the other hand, when wages are the result of class struggle, as in Adam Smith, for example, the theory does not predict that unions, minimum wages, less "flexible" labor markets will result in less employment. And, despite the poppycock mainstream economists teach, that is the world we live in.

I agree with the author. Economics took a mostly wrong turning more than a century ago. I don't think that this book will convince many mainstream economists. If Adler wanted to convince mainstream economists, he would have had to written a more impenetrable book. I think Adler does address some of the questions raised by the current global economic crisis.

(I realize I am behind in responding to comments on previous posts.)

The First Communist

One can find all sorts of things on the internet, such as T-shirts.

And one can find lots of silliness: "Why Jesus Christ is Not a Communist".

Hat tip: My friend Lucas.

Leontief's Work As Applied Sraffianism

Sraffa's critique is formulated in terms of physical quantity flows among industries and labor inputs into each industry. From this data, institutional assumptions, and, for example, the rate of profits, Sraffa deduces the set of constant prices that allow for the smooth reproduction of a capitalist economy.

Leontief independently developed the theory of Input-Output (I-O) analysis, and national income accounts include I-O accounts. The Bureau of Economic Analysis maintains I-O accounts for the United States.

A body of work exists in which the national income accounts are used to examine empirical questions. Sometimes the output of each industry is normalized to one physical unit of each industry, thereby allowing the national accounts to be thought of as closer to Sraffa’s data. Much of this work can be seen as classical in approach, not marginalist. Benjamin H. Mitra-Kahn's "Debunking the Myths of Computable General Equilibrium Models" (2008) shows that the classical nature of one such body of empirical work is often disguised by tendentious and incorrect history.

So Sraffa’s work is empirically applicable, although his own intentions seem to have been more focused on criticism.

Mainstream Economists Unable To Discuss Economics

Over on Economics Job Market Rumors, an anonymous poster asks:

"Despite the neoclassicals admitting that the Post-Keynesians were right, why has the impact of heterogeneous capital on an economy left out of the macro models?"

It will not surprise me if he or she receives no coherent answer. I recently had a chance to skim the transcripts of David Colander's interviews with graduate students at the "best" economics departments in the United States. These are in his book The Making of an Economist Redux. The following phrases seem no connote nothing to such students: "Cambridge Capital Controversy", "Neoclassical Economics", and "Post Keynesian Economics". One student responded to a question about Joan Robinson by asking, "Who's that?" The best students seem to realize that they will have to get an education by themselves in their "spare" time after they receive their doctorate.

Minimum Wages In The U.K.

The Australian Fair Pay Commission's Minimum Wage Research Forum met in Melbourne on 30 and 31 October 2008. Stephen Machin summarized recent experience in the United Kingdom (in the 2008 Minimum Wage Research Forum Proceedings, Volume 1).

Minimum wages were set by industry in the United Kingdom up until 1993. The wage councils were abolished in 1993, except for the Agriculture Wages Board which continues to this day. Outside of agriculture, the UK did not have a minimum wage between 1993 and 1999. From 1999 on, the National Minimum Wage was in effect in the UK, as recommended by the UK Low Pay Commission, established in 1997 by the newly elected Labour government. Notice that the trend in employment visually appears unaffected by the introduction of the national minimum wage and subsequent increases in it. The trend appears the same before as afterwards. This seems like disconfirmatory evidence to me of the simple neoclassical model of wages and employment as determined by supply and demand functions. Some of us know that model is without theoretical foundation anyways.

Hat tip to Bill Mitchell