Tuesday, August 21, 2007

Keynes In Historical Time

Alex Tabarrok praises Phelps desire to develop a non-equilibrium, non-hydralic economics. “GVV”, a commenter, points out that Nicholas Kaldor and Joan Robinson have already developed this theme. This led to a question of whether Austrians or Post Keynesians were first to develop this theme. (Peter Boettke also responds to Phelps and comments by pointing to contributions of the Austrian school.)

I think both schools developed a receptiveness to this theme in parallel. Hayek’s student Shackle emphasized the uncertaintly and money in Keynes. Another of Hayek’s students, Ludwig Lachmann, was important, along with Kirzner, in the revival of interest in the U.S. in the 1970s in the Austrian school. And Lachmann lauded Shackle’s interest in disequibrium.

My point in this post is to point out that these themes of disequilibrum, uncertainty, and historical time were in Keynes’ revolution from the start. Consider:
”Actually, however, we have as a rule, only the vaguest idea of any but the most direct consequences of our acts. Sometimes we are not much concerned with their remoter consequences, even though time and chance may make much of them. But sometimes we are intensely concerned with them, more so, occasionally, than with the immediate consequences. Now of all human activities which are affected by this remoter preoccupation, it happens that one of the most important is economic in character, namely, wealth. The whole object of the accumulatin of wealth is to produce results, or potential results, at a comparatively distant, and sometimes at an indefinitely distant, date. Thus the fact that our knowledge of the future is fluctuating, vague and uncertain, renders wealth a peculiarly unsuitable subject for the methods of the [neo]classical economic theory. This theory might work very well in a world in which economic goods were necessarily consumed within a short interval of their being produced. But it requires, I suggest, considerable amendment if it is to be applied to a world in which the accumulation of wealth for an indefinitely postponed future is an important factor; and the greater the proportionate part played by such wealth-accumulation the more essential does such amendment become.

By ‘uncertain’ knowledge, let me explain, I do not mean merely to distinguish what is known for certain from what is only probable. The game of roulette is not subject, in this sense, to uncertainty; nor is the prospect of a Victory Bond being drawn. Or, again, the expectation of life is only slightly uncertain. Even the weather is only moderately uncertain. The sense in which I am using the term is that in which the prospect of a European war is uncertain, or the price of copper and the rate of interest twenty years hence, or the obsolence of a new invention, or the position of private wealth-owners in the social system in 1970. About these matters there is no scientific basis on which to form any capable probability whatever. We simply do not know. Nevertheless, the necessity for action and for decision compels us as practical men to do our best to overlook this awkward fact and to behave exactly as we should if we had behind us a good Benhamite calculation of a series of prospective advantages and disadvantages, each multiplied by its appropriate probability, waiting to be summed.

How do we manage in such circumstances to behave in a manner which saves our faces as rational economic men? We have devised for the purpose a variety of techniques, of which much the most important three are:

1. We assume that the present is a much more serviceable guide to the future than a candid examination of past experience would show it to have been hitherto. In other words we largely ignore the prospect of future changes about the actual character of which we know nothing.

2. We assume that the existing state of opinion as expressed in prices and the character of existing output is based on a correct summing up of future prospects, so that we can accept it as such unless and until something new and relevant comes into the picture.

3. Knowing that our own individual judgement is worthless, we endeavor to fall back on the judgement of the rest of the world, which is perhaps better informed. That is, we endeavor to conform with the behavior of the majority or the average. The psychology of a society of individuals each of whom is endeavoring to copy the others leads to what we may strictly term a conventional judgement.

Now a practical theory of the future based on these three principles has certain marked characteristics. In particular, based on so flimsy a foundation, it is subject to sudden and violent changes. The practice of calmness and immobility, of certainty and security, suddenly breaks down. New fears and hopes will, without warning, take charge of human conduct. The forces of disillusion may suddenly impose a new conventional basis of valuation. All these pretty, polite techniques, made for a well-panelled board room and a nicely regulated market, are liable to collapse. At all times the vague panic fears and equally vague and unreasoned hopes are not really lulled and lie but a little way below the surface.

Perhaps the reader feels that this general philosophical disquisition on the behavior of mankind is somewhat remote from the economic theory under discussion. But I think not. Though this is how we behave in the market-place, the theory we devise in the study of how we behave should not itself submit to market-place idols. I accuse the [neo]classical economic theory of being one of those pretty, polite techniques which tries to deal with the present by abstracting from the fact that we know very little about the future.” -- John Maynard Keynes (1937).

  • John Maynard Keynes (1937). “The General Theory of Employment”, Quarterly Journal of Economics, V. 51: 209-223.
  • Ludwig Lachmann (1976). “From Mises to Shackle: An Essay on Austrian Economics and the Kaleidic Society”,
  • G. L. S. Shackle (1988). Business, Time and Thought, New York University Press


Anonymous said...

Some of the comments at MR seem right to me. While "Austrians" tend to go on about "disequilibrium" a lot, I do get the impression that their ideas are firmly rooted in equilibrium theory.

This is obviously the case with Hayek who went on about the equilibrium even in the 1970s. For example, the "cause of unemployment . . . is a deviation of prices and wages from their equilibrium position which would establish itself with a free market and stable money. But we can never know at what system of relative prices and wages such an equilibrium would establish itself." Therefore, "the deviation of existing prices from that equilibrium position . . . is the cause of the impossibility of selling part of the labour supply." (New Studies, p. 201)

Their whole business cycle theory is rooted in equilibrium analysis, arguing that actions by the banks and state in lowering the interest rate below its "natural" rate causes it. Which, of course, assumes that the banks could find the equilibrium rate and keep it there when subject to the appropriate regulations/laws.

Even the much hyped discovery theory has its basis in equilibrium analysis. It assumes that entrepreneurial activity will bring the system closer to equilibrium. Yet the claim that markets tend continually towards equilibrium as the consequence of entrepreneurial actions is hard to justify in terms of its own assumptions.

While the adjustments of a firm may bring the specific market it operates in more towards equilibrium, their ramifications may take other markets away from it and so any action will have stabilising and destabilising aspects to it. It strains belief to assume that entrepreneurial activity will only push an economy more towards equilibrium as any change in the supply and demand for any specific good leads to changes in the markets for other goods (including money). That these adjustments will all (mostly) tend towards equilibrium is little more than wishful thinking.

So if they were serious in rejecting equilibrium analysis they would end up rejecting much of their own claims with regards to entrepreneurial activity. It can be as destabilising as it is stabilising. Which was part of the reason Rothbard rejected Schumpeter's theory of creative destruction. As Rothbard put it, "in the Austrian tradition . . . the entrepreneur harmoniously adjusts the economy in the direction of equilibrium." (The Logic of Action Volume 2, p. 41 and p. 234) For the reasons noted above, I doubt that would be the case.

Paul Davidson's essay "The Economics of Ignorance or the Ignorance of Economics?" is well worth reading. Paul is a leading Post-Keynesian and his critique of Austrian claims is excellent.

I expect to hear more about the Austrians as neo-classical dogma becomes more and more of a liability. As Steve Keen notes, it is "an alternative way to ideologically support a capitalist economy . . . If neoclassical economics becomes untenable for any reason, the Austrians are well placed to provide an alternative religion for believers in the primacy of the market over all other forms of social organisation." (Debunking Economics, p. 304)

An Anarchist FAQ

Robert Vienneau said...

I'm still working on updating my critique of Austrian capital theory and Austrian Business Cycle theory.

In both Austrian and Post-Keynesian economics, there is a tension between those emphasizing tendencies towards equilibrium and those emphasizing historical time. Kirzner, with his description of entrepreneurial activity, is indeed in the former group.

I have previously mentioned that Davidson article. Less confrontational is Theodore Burczak's "Profit Expectations and Confidence: Some Unresolved Issues in the Austrian/Post-Keynesian Debate" (Review of Political Economy, V. 13, N. 1 (Jan. 2001): 59-80).

I don't know if Austrian theory will ever supplant neoclassical theory. All that math superficially looks like science. Some Austrian stuff just looks like stringing banalities together.

I'm currently being irritated by a book by Steven Horwitz.