Some Austrian Answers

A reply to Matthew Gagnon

Here’s my reply to last week’s guest post by Matthew Gagnon. He’s in blockquotes, I’m not.

The reason for my note to you is that I recently had cause to revisit your 1997 essay, "Why I Am Not an Austrian Economist," and it prompted me to want to ask what your own thoughts of self-definition are today, almost thirty years later. I find it an interesting question, just knowing what my own experiences have been related to the development of my own philosophy over the years…

Flashing back twenty years ago, I was a fairly typical self-described libertarian, and as such I used to describe myself as broadly “Austrian” in philosophy. My attraction to Austrian economics had little to do with actually understanding it, but instead related to my perception of what Austrians represented in the broad debates about economic policy. 

In my mind, they were the rebellious champions of free markets and individual liberty doing battle against the mindless orthodoxy of Keynesian interventionist thought in economics and government. They were the challengers of conventional wisdom, and didn’t play nice in the sandbox with others. A perfect fit for my youthful non-conformism…

In any event, that brings me to the question I have for you:

Nearly three decades have passed since you wrote your essay distancing yourself from the Austrian School. Given the passage of time and your experiences teaching and collaborating with colleagues who are prominent figures in Austrian Economics, I'm curious whether or not you still hold the same position today?

My fundamental position has barely changed. I am great friends with many Austrians, and I think they make some good points. But their attempt to philosophically debunk mainstream economics and provide a new foundation for the discipline is a failure.

Has your perspective evolved in light of new developments in the field or through interactions with your colleagues?

The biggest non-fundamental change is my view of Austrian Business Cycle Theory. My original critique relied heavily on the rational expectations assumption. As I put it:

Given that interest rates are artificially and unsustainably low, why would any businessman make his profitability calculations based on the assumption that the low interest rates will prevail indefinitely? No, what would happen is that entrepreneurs would realize that interest rates are only temporarily low, and take this into account.

As I’ve learned more empirical psychology, I’ve become more open to the idea that the rational expectations assumption is false, even when incentives for rationality are high. (I still maintain that rationality increases when as the stakes go up; I just wonder if high incentives are sufficient to actually make irrationality disappear).

Upshot: I’m less inclined to dismiss ABCT out of hand. But instead of making me accept their specific story, I’m now more open to a vast range of macroeconomic stories that rely on irrationality. Sure, people make some crazy decisions when money is loose. But people also make some crazy decisions when money is tight. The root problem is human nature, not the current monetary regime.

Example: I now believe the best explanation for the 2007-9 housing crisis is that even very smart insiders irrationally believed that high housing price increases would continue indefinitely. This story violates rational expectations, but that hardly vindicates the Austrian emphasis on central banks. Want me to take ABCT seriously? Then start taking behavioral economics seriously.

Have you found areas of convergence that weren't apparent before, or have you perhaps become more convinced of your original stance?

Around 2000, I discovered that John Haltiwanger, a very mainstream economist, had a pile of empirical evidence vindicating the importance of Schumpeterian creative destruction. That pile is now a mountain. At the time, I tried to get Austrians to start reading Haltiwanger and his co-authors, but as far as I know, they never listened. Still, you could say that I’ve moved toward an Austrian view of entrepreneurial progress, and that’s a kind of convergence.

At the meta level: I’ve grown more dismissive of the value of mainstream empirical work. (I never thought mainstream mathematical theory had much value). Not, like the Austrians, because I have a fundamental methodological objection to empirical economics, but because I now take (the lack of) external validity more seriously. Also, because I think that left-wing bias in economic research has grown from a fairly serious problem in the mid-90s to a dire problem today. In earlier decades, economic research tried to address the markets-versus-government debate. Modern economic research stacks the deck, so the alternative to a failed government intervention can only be a different government intervention.

If I had my way, how would Austrian economists reform their behavior? All of the following:

1. Stop being amateur philosophers. Quantitative probability theory is fine. Indifference curves are fine.

2. Learn and internalize a lot of empirical psychology.

3. Use the psychology they learn to reformulate their criticisms of mainstream neoclassical economics. Weniger philosophieren, mehr psychologisieren, meine Österreicher!

4. Stop worrying about what Hayek, Mises, and Rothbard “really meant.” History of thought just doesn’t matter much.

5. Use Hayek, Mises, and Rothbard not to find The Answers, but to fuel your imagination. Intellectually, Hayek is virtually my least-favorite Austrian economist. But by the power of imagination, to my continuing amazement, this rambler inspired both Wikipedia and crypto.

6. Direct your imagination toward radical libertarian policy ideas. I doubt I would have written either Open Borders or Build, Baby, Build if I’d never read the Austrians. While there is nothing distinctively Austrian about either book, reading Austrian economists has helped me see unconventional free-market possibilities I would otherwise have overlooked. It can and should help Austrians do the same.