Tuesday, October 26, 2010
This week's article on Collective Theory is a gift in my attempts to explain away liberal jabbering on the tragedies of common resources. It happens that, while I was unfamiliar with the name, I have been discussing the conclusions of collective theory for quite some time. The Taylor Grazing act has been around for more than half a century. Permits are granted on a long term basis, giving incentive to use their rangelands responsibly in order to ensure continuing profit. Water resources in the Western US are allocated in a manner that forces an economic expression of ecological principles. As a final example, the permits granted to fishermen in the Gulf of Alaska are bestowed as a sort of property where holders have direct monetary incentives to adhere to sound ecological principles.
Naturally, there are a great number of examples that have nothing to do with natural resources where governments have managed to build an effective system to regulate collective action. My peers here may have a greater number of examples to nullify this selection; I hope there can be a discussion that I can bring back to those professors of mine who pick one perspective to indoctrinate with.
I suppose the question I find most thought provoking is: Is government by nature less capable of dealing with collective action? I am inclined to believe that there are cases where a central regime can more effectively promote wellness than the spontaneous cooperative relationships proposed by Ostrom.
Just the same way, when someone buys stock, it is an investment, and when one buys stock he/she hopes to make a profit off it, just like the person who built the house. When buyer 2 buys this stock from the seller wealth is created, as the buyer 2 values this stock to be higher than what is was purchased for, just like the case of the person who bought the house for a higher price than what it was made at. I think that in the transactions that follow wealth is created, as the worth of the stock increases. Wealth is not a zero sum game, I think, therefore stocks are not a zero sum game either!
I also had a chance to think about social welfare safety nets, as I went to the Unemployment office for the first time today. As you all know the unemployment rate is very high lately, so you can guess this office was packed to the brim with people. Out of all twenty or so of the computers present all of them were full. Here's the factor though that impacted me the most all (but one lady who was "ironically" looking at pursues) had their browsers on job searching websites and all but three were minorities (Black, Alaskan Native, Hispanic). Seeing all of these job hunters that were all literally validating to me that they are trying to move up, in front of my eyes made me think about safety nets.
I understand and won't argue with people who might disagree, but I am going to pose the question. Granted there is abuse of social welfare programs, there are also people out there trying so hard but can't make it. The major spur of the recession may have been due to government, but market failures can occur too (due to things like asymmetrical info). If we completely abolished government where would those 19 people be who where looking for jobs?
This when it hit me Ostrom's work on collective action allowed me to apply this day to theory. Collective action which can fight off the externalities people face and help to provide them with public goods, this can explain why I CARE about these people when standard rational choice says I should not. I think the trust she mentions is a key component to collective action and provision of safety nets. There is a certain "you help me I help you" factor that allows the birth of public goods that provide net social benefit for all even if they don't equate with profit. Plus life is full of RANDOMNESS that makes this trust more paramount. Why I had such a good day today I don't know (I have not had a day like this for a very long time) I'm sure I'll have my bad days too. This randomness allows me to realize that I never truly know where I'll be and why it is important to have both collective action and safety nets in society.
PS- I really like Ostrom's work. I have really been wanting to read her stuff, but I was afraid that I wouldn't be able understand any of her papers. However, cheers to her she is really a clear and effective writer. I can actually follow her work (perhaps we should give the Nobel prize in Economics to political scientists more often).
Now, if we restrict our conversation to competitive firms, we can make some pretty good (although not perfect) predictions about decision making strategies based on the premise of profit maximization. Nash equilibrium, competitive output and pricing schemes, the whole gambit of ideas based on self-interested action tend to loosely hold*. However, if we attempt to use the dual to this equation by projecting profit maximization onto individual consumers, we get paradoxical results. “Normal” people don’t usually do what we expect them to do. I think this article brings up some very valid reasons why. This topic is what got me hooked into economics, so forgive the gittiness. Here’s the one thing that I want to reiterate:
Altruistic behavior is generally a utility maximizing choice. Whether it is in the form of reciprocity, warm glow, or some other reason, people help because it makes them better off. I believe that this may be a genetic phenomenon. In the generations of even our great-grandparents, social cooperation was necessary for survival. Therefore, people with genetic pre-disposition to be non-cooperative proved to carry a lethal gene. If you don’t buy that, then call in a meme. The result still persists. In this case tradition and culture emblazon “fairness” onto us. In modern times, this gene is either no longer lethal, or the tradition is being lost. People are now able to defect without fear of death and have profited from it. Seeing that, the game has changed. What is unfortunate is that we are quickly becoming more individualistic, pessimistic, and opportunistic as a species. The cold-hearted, cut-throat reality of the world we live in is far below the potential social welfare that could be created through cooperation rather than competition. It is very sad that not only are we moving in that direction, we have moved so far as to base our entire study on that presupposition. I am always encouraged when I see social cooperation, reciprocal altruism, and generally nice behavior. It would be very hard to teach my son to only care about himself, because others only care about themselves. I firmly believe this is why our country has the highest rates of suicide and depression in spite of our wealth. I realize that government can’t force cooperation, but occasionally it can help. If only we could get back to helping each other without being in a state in which we would die otherwise.
*In my experience, I have found that there is a mutually higher maximizing solution that doesn’t rely on cost minimization or price fixing. It is a difficult solution to obtain, but even in a competitive market you can increase profits by cooperating with the buyers and employees. For a case study, read Henry Ford’s autobiography.
Last week, Ed was trying on an argument for size. Buying and selling stocks is a zero sum game. It makes sense to me. I mean think about it. How do we know what things are worth? I can think of two ways. One, we try and sell it. The thing is only worth what we can get for it. You only know something’s monetary value the minute we no longer own it. The other way would be its opportunity cost. What you had to give up in order to get it. That is kind of a backward way of saying things are only worth what you can sell them for. I guess things are only worth what you can buy them for too… This argument is kind of stupid, because it’s simple and ignores emerging complexity of a larger market. Please bear with me for a minute as I try and expand it.
Let’s assume stocks don’t have any other value besides being available to buy and sell. Ok, they have value as a free society detector, thank you Mises. Alright, individual shares of Playboy have other value as well, they act as d-bag detectors and can alert young women that the dorm they are about to enter is potentially dangerous. (You reading this Paul?) Fine, they also have value because some of them pay dividends. I get it, they also have value by allowing people to take ownership of, and in sufficient quantity, take control of corporations. Other than that, they are only worth what you can sell them for. They are only valuable as instruments of trade.
How is wealth created in a stock market? It is created by making more stocks. That’s it. Read the zero sum post Sherri emailed us: http://tradingandriskmanagement.blogspot.com/2009/05/stock-market-is-not-zero-sum-game.html. The guy argues that it would only be a zero-sum game if there were an equal number of short and long positions. To quote: “The question is not "Is there a buyer for every seller?" but "Is there a short position for every long position?" to determine if it is a zero-sum game. As long as there is a short position for every long position, every time one person makes a dollar someone else loses a dollar. That makes the total average return (before expenses) zero. With a stock, there can never be as many short positions as long positions. When a company first issues shares there are no short positions. After that, every time someone shorts a share one new long share is essentially created, so there will always be more long shares than short shares.”
I think this argument is stupid. If you sell a stock, someone has to buy it, and the stock is only worth the price it sold for. If the guy who bought it sells it for more later, no wealth was created, because someone had to give up the amount of money the stock was ‘worth’ to buy it! The second guy has more money then he used to, but there hasn’t been any wealth generated. If you buy into the ‘imaginary poverty’ thing like most economists do, then the original owner ‘lost money’ because he sold it for less than he could have. In other words the stock is now worth more than the original owner sold it for. Stop creating new stocks. Trade the current ones for one hundred years. Look at the total value of every share. Compare that value to the total from one hundred years ago. It might be 10 times higher it might be 30 times less, but no wealth was created or destroyed. You’ve just spent a century detecting free economies and detecting d-bags.
Friday, October 22, 2010
The stock market is like a bookie. If you would like to bet on the winner of a football game, you either have to pay odds, or you bet the line. The line is an interesting concept, basically you place your bet on which “side” of the line you like. If you think the Seahawks will win by more than 3 points, you put your money on that side. How that line is established is by the bettors actions. If too many people like the Seahawks minus 3, the bookie will shift the line to minus 4 or maybe 5. How does he decide where to set it? …equilibrium. When there is equal money on each side of the line, it is properly established. This means that all the losers pay all the winners and the bookie collects a fee from the winners (the vig or juice). This is the same thing that the stock market is doing. The constantly changing, opposing pressures of wanting to sell and wanting to buy at any price, move the price such that it is equal and the broker collects a fee. Truly a zero sum (negative sum if you count the fee).
Let’s look at this from another angle. If a trade is said to be positive sum, both parties must be better off as a result of the trade than if the trade had not occurred. Even though the stock is increasing in value, the beneficiary is the holder of the stock. Had the trade not occurred, the seller would have that additional value. So, the same amount of net value is created with or without the trade. The trade doesn’t create value, it transfers it.
Here’s where it gets a little dicey and what kept me up all night. When the trade occurred, both parties believed they were getting a good deal. At the surface, this appears to be a positive sum. But remember that the value they are attaching to the trade is based on expectation of a future event. Maybe an illustration will help. Say you buy an apple from a fruit stand. Since this was a voluntary exchange, we know that both parties are better off…right? Well, what happens when you get home and bite into that apple? Your decision on the purchase (which is now a sunk cost) was based on your expected “utility” from eating eat. If when you bite into the apple, you also bite into a worm, how does that change your utility? It turns out that your net gain from the exchange is the total benefit you actually receive minus the total costs you actually paid. We can now look back in time and see that you made an “irrational” decision, because of imperfect information. If you’re buying this, look back at the stock market example again. The actual net benefit from the exchange of the stock is exactly zero.
Finally, what about time preference, present value bias, future discounting or liquidity value? I contend those all are essentially the same thing. This is the very tough to handle idea of a person knowing that the stock is going to increase but selling anyways; something that happens quite a bit (and was captured in the earlier example). The reason this is difficult is that it suggests that a person can generate a different utility value for money itself, the unit of measure we use as a metric for utility. I am not going to try to argue that this is not true, but I am going to say that the result is inconclusive. Josh’s “imaginary poverty” will help out here. Remember that for a transaction to have a positive sum, both parties must be better off as a result of the trade. It is not possible to determine if the net is positive when one person gains and the other one loses because of the ordinal and unique nature of utility. So, if we are to say that the result of the trade is undoubtedly positive, both individual utility levels must rise relative to the trade not happening. We have to compare the utility level of each individual at the point of the transaction versus the same point in time in the future in both possible planes of existence (with the trade versus without it). Then, the trade has to generate more utility than the not-trade. Since it is clearly impossible to evaluate the two situations after the full effects are known, not based on the expectations of the future, we cannot know if the person is actually better off. So, although it may be possible to conceive such a case where the trade itself creates a utility increase (but not a monetary one), the actual analysis is indeterminate.
Oh, I should probably clean up on more issue. The stock itself is a financial instrument. Any “value” it has is captured by its price. It has no flavor, aroma, shimmer, melody or texture. There is no consumption value, only value in trade.
Thanks for your time.
Wednesday, October 20, 2010
I definitely appreciate the articles we read this week. For those who are not as familiar with the stock market, such as myself, this was very informative. Hopefully, this will help shape our discussions even more. However, I have to strongly disagree with the attack on government bailouts. I know I may be the loner on this one, but I am going to take one for the team. It was said in one of the articles, for instance, that "bailing out 'too big to fail' corporations weakens the self correcting process." What am I basing this on. Well, this week I am going to think like an Austrian, but with Keynesian views. I believe with no empirical and no historical evidence that bailouts of companies will positively affect the stock market. There are absolutely no historical examples that I can think of that would indicate this idea would fail in the long run. Even if there is, I fully reject this premise because any numbers that may support this claim are false based on the flaw of empirical evidence in the first place. Thank God for those who intervene in the stock market in such ways.
Tuesday, October 19, 2010
In Robert Murphy's work, some of his arguments as to why the stock market does have a functioning price system were easier to follow. However some of the points were harder to follow due to the gaps within his logical framework. I think that most of the gaps were in effect the result of over simplification, below are some of the gaps that stuck out:
1.) This starts in the quote used in the first paragraph "Murray Rothbard once asked Ludwig von Mises if there were a sharp dividing line between a heavily interventionist state versus an outright socialist one. Mises answered, "There can be no genuine private ownership of capital without a stock market: there can be no true socialism if such a market is allowed to exist."" I would like to mention (perhaps I am being a bit to literal here), but what about the Swedish stock market,the German stock market, and the Canadian stock market. Since I tend to think of socialism as a spectrum where a country can be more or less socialized. There are inconsistencies in this logic that the presence of a stock market is an indicator as to whether a country is socialist or not.
2.) The next point that was a little over simplified was his mention, that to obtain the price tag of a corporation all one needs to do is take the share price of the corporation x and multiply this by the number of shares. At first this makes sense however, if you think about the real U.S. stock market you can obtain the corporation by holding 51% of the stock meaning that the price tag can change depending on the situations created between stock owners rather than just the value of the corporations. I believe that to make his point it was necessary to over simplify the concept of a corporate price tag. If this wasn't simplified one would find their thoughts wandering to the class of stocks that are available to a buyer (in a sense here the market is often one which is often not fully open).
3.) Another point that leads me to think outside of this argument was the mention of how the stock market channels savings to production investment through the creation of new equity rather than debt. However, maybe someone could make this more clear for me but in a sense don't corporations basically change the they supply of stock when this is done (wouldn't the effect of this be similar to how the value of our dollar decreases if the money supply is artificially increased)Aren't the stocks now worth less to the owners?....This makes me question the author and I'm not sure if I can run down the bunny trail with him here.
Murphy then moves to a focus on how people just distrust stock traders as they are spectators who profit by being middlemen. We forget that middlemen are important, as they create information. Yes, this is a point that I can follow. However, I think the article lacks a focus on asymmetric information problems that are fervent in the stock market were. This is a shame as I think this could actually aid Murphy's argument. As the number one argument that I hear for government regulation of the stock market is that this should occur to conquer externalities that stem from asymmetric information. And if we look at the Securities and Exchange Commission many of it's regulations, such as making it mandatory for corporations to post their 10-k's on the website for easy access also create information. Too bad the situation isn't always as clear as one tries to present it, huh Murphy?
Speculation is not buying or selling based on crests or troughs, at least it shouldn't be. Speculation is investment based on quantifiable signals such as current events business trends or known market demands. A practical investor will not merely invest in stock a or b, they will look to the various businesses for signs of good investment possibilities. The habit of 'trend' speculation is a stupid one. At our previous meeting David said that trend speculation was accurate fifty-one percent of the time. The idea that people will devote an exorbitant amount of capital in a practice of guessing the flip of a coin is STUPID. Regardless of how stupid or not this practice would be less common if actual speculators could make informed investments. This is where the government is typically to blame but rather than hopping on that bandwagon I will focus on a market based issue.
Let us look at the issue of creative accounting and Enron.
In the 1990s Enron and several other large firms went through scandals in which they employed 'creative accounting' and essentially lied about their profit margins in a manner that caused their businesses to expand and stock sales to soar. When this unsustainable practice failed as it was destined to, many lost large portions of their investment capital when the companies liquidated. Many will argue that greater government oversight would have prevented this and that in the event of failure the bailouts were necessary to protect people's investment capital.
This creates two prevalent issues: Moral Hazard and unwieldy government interference. Rather than employing a government solution let us examine a market based one. Without moral hazard investors will be less risky with their funds and unsustainable business practice becomes less prevalent. With this businesses will focus on long term viability.
An issue to this assertion with the long term viability argument is that some individuals who have very low morals and exceedingly high time preference and can still gain from a company that has to liquidate.(Those Pricks at Tyco) The market response to this used to be internal auditors. A problem however is that Enron's internal auditors were the ones lying and that perhaps auditing the company you work for entails some perverse incentives.
This is where creative destruction comes into play. The market can still adapt to these small issues and investors can demand companies hire reputable external audit companies. Any possible bad practices that these audit companies such as creative accounting or information privacy will be removed by the market.
Educated people have a natural goal of long term viability. With with the removal of moral hazards and the adaptation to market demands, they will move in the direction of pragmatism. The derogatory connotation of speculator is the antithesis of the pragmatist and merely the perverted stereotype.
Reading the creatively titled essay by Murphy "The Stock Market." was interesting. I thought the essay in general, especially the introduction was quite a basic outline of what the stock market is. It was an easy read, and quite interesting. The part in the paper where he started talking about how people with the most amount of stock are responsible for making decisions with sometimes millions of dollars at stake, usually make good decisions was interesting. I thought so because I had never really thought of the stock market as an incentive system before. On further thought it makes sense that an incentive system must be in place so that good decisions are made. However, it should be noted that many companies go bankrupt, others like enron commit fraud, therefore is the incentive not good enough?
I also thought that the example the author used of the acme stock not changing was interesting. Here too I saw the lack of an incentive structure. There obviously doesn’t seem to be a good incentive structure for a speculator to reinvest in stock after selling their share rather than say buy “fancy” clothes! However isint there the incentive that if you invest in more stock you might make more profit later, rather than buying clothes, that usually depreciate in worth (unless you buy a coco chanel vintage trench perhaps).
Also the author points out that Gordon Gekko in the movie “Wall street” was wrong in saying that when you win in the stock market, you do so at someone else’s expense. I think this is incorrect too. My thought son it are that its not about intrinsic worth but about the value the stock has. I would like to compare it to a shoe shopping example. If I had bought a pair of Brian Atwood’s say 10 years ago, and never wore them (that’s like stock right, because you never really use it), and lets say they were a classic black leather pump, 5 inch stiletto (in other words, never went out of date). Ten years ago I was correct in thinking that Brian Atwood was the next big thing even though he was the new kid on the block in shoe design, well today I could probably sell those shoes to someone for a 1000 dollars even though I maybe paid $200 for it. Im not really ripping them off, it is the what having an original Atwood shoe is worth, and that’s what the bidder is happily willing to pay to have perhaps a work of art. Its similar to why people pay a lot more for art as it grows older, or even first publications of famous books.
I believe that both of these authors are leaving out some very basic and important information about how the stock market works, how the banking systems work, and how to conduct a CBA in general. After trying to pick through the rhetoric about Acme and XYZ corporations, I am still unsure how Mr. Jasay thinks the stock market works. In my world, every single stock purchase is a speculation. So is every single act of entrepreneurship in which a person lays out capital in the pursuit of profits while exposing himself to risk. Every seller of a stock speculates it will decrease, every buyer speculates it will increase and in every transaction there is a winner and a loser. That is not the case in a normal market; the stock exchange truly is a zero sum game. The only thing I can give credit for is the realization that it is in fact animal spirits that create bubbles and busts, not some phantom credit creation monster. People make decisions based on the information they have, the expectations of costs and benefits, and the risk they are willing to bear. So long as those people are provided correct information (think Enron) about what they are buying and are able to identify the actual risks (think SEC ratings), then people should be required to accept losses when they knew the risk.
The natural rebuttal for that statement is going to be about bail-outs. Mr. Murphy, among many others, would like us to believe that we should allow the market to clear out the losers of what turns out to be bad decision making. Naturally, I agree with the logic. However, we must evaluate the impact of allowing such a situation to occur versus an intervention in terms of social welfare. The fact that past actions led to the current state become sunk costs when evaluating present decision making. Since we can clearly see that the negative impacts of allowing “the market to clear naturally” will not be neutralized but systemic, it is prudent to evaluate the costs of doing nothing versus the costs of doing something. When preforming that CBA, the obvious choice was to be proactive and deal with the moral hazard it creates in the future.
As a final point, if “raiders” where merely in existence to act as vultures, cannibalizing the salvage value of weakly performing firms, they provide no service at all. In that event, the same result would manifest without them when the firm shut down. The fact that they are still a company suggests that they are covering their short-run marginal costs. Killing them off early is as beneficial as euthanasia. Hostile takeovers are generally a pull to increase profits by disrupting competition. That is not in the best interest in anyone but the aspiring monopolist.
Sunday, October 17, 2010
If you're not familiar with the popular conservative book franchise just imagine if Conservapedia and the "For Dummies" series had a child. It's sort of like that, only if Conservapedia and "For Dummies" were brother and sister and "For Dummies" drank heavily and smoked meth while pregnant.
Although I suppose that if you enjoy drinking paint thinner and brain damage you might also enjoy some of the other titles in the collection. There's "The Politically Incorrect Guide to Darwinism" by Christian fundamentalist, creationist, AIDS denialist, and all-around tool John Wells. Or maybe try the "Politically Incorrect Guide to Global Warming" by
No seriously. That's an actual book.
Enjoy learning all about how science, facts and reality are nothing but a satanic-liberal-homosexual-socialist plot to take away your freedoms and abort your babies... or whatever the hell these teabagging Glenbeckophiles are ranting about. Meanwhile I'll be reading the second article Sherri assigned in the hope that it will be better than the first.
ADDENDUM (10-19-2010): It wasn't.
Saturday, October 16, 2010
Here is an excerpt relating to what we talked about last Thursday:
"Another concern associated with additional securities purchases is that substantial further expansion of the balance sheet could reduce public confidence in the Fed's ability to execute a smooth exit from its accommodative policies at the appropriate time. Even if unjustified, such a reduction in confidence might lead to an undesired increase in inflation expectations, to a level above the Committee's inflation objective. To address such concerns and to ensure that it can withdraw monetary accommodation smoothly at the appropriate time, the Federal Reserve has developed an array of new tools. With these tools in hand, I am confident that the FOMC will be able to tighten monetary conditions when warranted, even if the balance sheet remains considerably larger than normal at that time."
The next FOMC meeting is in about 3 weeks, meanwhile Mr Bernanke is preparing for a conference with the congress on the Fed's actions thus far. Should be interesting.
Wednesday, October 13, 2010
From the abstract:
This article extends interplanetary trade theory to an interstellar setting. It is chiefly concerned with the following question: how should interest charges on goods in transit be computed when the goods travel at close to the speed of light? This is a problem because the time taken in transit will appear less to an observer traveling with the goods than to a stationary observer. A solution is derived from economic theory, and two useless but true theorems are proved.
An exciting time to be an Earthling and an economist.
Some choice quotes:
Complications make the theory of interstellar trade appear at first quite alien to our usual trade models; presumably it seems equally human to alien trade theorists...
It should be noted that, while the subject of this paper is silly, the analysis actually does make sense. This paper, then, is a serious analysis of a ridiculous subject, which is of course the opposite of what is usual in economics.
Google is using its vast database of web shopping data to construct the ‘Google Price Index’ – a daily measure of inflation that could one day provide an alternative to official statistics. The work by Google’s chief economist, Hal Varian, highlights how economic data can be gathered far more rapidly using online sources.This is similar to an idea I proposed during a SWEET meeting last semester about using data from Amazon or other popular internet retailers to develop a real time online price index. I remember the general consensus was that it was a stupid idea. Maybe my next stupid idea will be taken a little more seriously...
Also, pay close attention to this bit:
Mr Varian said that the GPI shows a “very clear deflationary trend” for web-traded goods in the US since Christmas.
Tuesday, October 12, 2010
In this I reference one of the most important parts of free market economics: consequences and liquidation. In the free economy of an Austrian, the economy will punish bad business by removing it from the market. With this assumption, in the long run, the market will balance and the aggregate of businesses will be financially sustainable. This is only possible if government (financial policy) problems of moral hazard are removed.
Businesses, however, need to be proactive and impose customer and employee incentives in order to compete. This type of behavior can be equated in modern economics with things like modeling and econometrics. Prudence can only be possible if information is valued. Businesses can and will learn from their mistakes.
The distinction I am creating here is one of incentives; as I stated earlier, there is a dynamic difference in the application of economic thought. In a simple statement I believe that, financially, businesses and individuals learn from their mistakes and governments do not. The core incentive I am using is one of ownership. In business or investment one's personal capital or private property is on the line. A government can use capital in the same fashion but as the Voluntaryists correctly state, they are using stolen capital. When one is handling something they own they understand its cost or value; perhaps because their cost is measured in labor or personal sentimental value. They will treat their capital with certain reverence. The government does not have the ability to understand the value of this. Nor do they need to.
Yes, I pay my taxes. I believe that right now some things are not offered by the market because the government must offer them (police). However, I believe that taking power away from the individual, even the power to fail, is crossing the line.
In closing, I believe that the Austrian criticism of government is very relevant and correct (most of the time). Nevertheless, other forms of economics should not be undervalued simply because they do not work for government application.
For instance the Austrian's odd assumptions about the stupidity of investors.
The problem is supposed to be that businessmen just look at current interest rates, figure out the PDV of possible investments, and due to artificially low interest rates (which can't persist forever) they wind up making malinvestments. But why couldn't they just use the credit market's long-term interest rates for forecasting profitability instead of stupidly looking at current short-term rates?Why don't investors recognize that the Fed induced deviation from the natural interest rate "can't presist forever", and plan their projects accordingly? David (and other Austrians) have tried to explain this irrationality away by appealing to the "the madness of crowds". Fair enough, but that's essentially a Keynesian argument. Just replace "madness of crowds" with "animal spirits" and you've got the same case Keynes had about investment market volatility. If you take that argument seriously the Austrians should be as enthusiastic as the Keynesians about the merits of financial sector regulations.
You could also argue that investor irrationality isn't irrational at all. That seemingly crazy, short-sighted investment decisions can be explained in game theoretical terms as a Prisoner's Dilemma of sorts. A competitive investor can't just pass up what they recognize as artificially low rates if they expect others to do the same. Of course if this were the case why would we ever expect investment markets to function in the first place, regardless of Fed interference with the interest rate, and why haven't repeated iterations of the game resulted in the same sort of learning curves we would expect to see over the nearly one hundred years the Fed has been tinkering with interest rates?
Anyone interested in an additional critique of the Austrian school from another former Austrian should also read Tyler Cowen's book, Risk and Business Cycles. Hopefully after this week we'll be able to put the final nail in the coffin of the Austrian school and move on to discussing something more relevant.
In his definition of the scope of Austrian economists Caplan discusses why he chooses the work of Mises and Rothbard over that of Hayek to be more “Austrian”. In other words Jack of All Trades aka Hayek vs Master of one aka Mises+ Rothbard . Now I am no expert on Austrain Economists, or economics in general, but from the discussions we have had at SWEET it is very apparent to me that maybe this is not the best way to judge whether someone’s economic ideas are well founded or developed enough. In our conversations at SWEET we always diverge off to talk about sciences relating to economics. We have also recently been talking about the importance of psychology in economics. This makes me think that maybe Hayek is a better rounded individual, maybe the fact that he is interested in “philosophy, law, and intellectual history after the 1930's” is not such a bad thing after all. Caplan’s first point about Mises and Rothbard rejecting many of the key elements of modern neoclassical economics seems to be valid but disregarding an economist who is also well versed in subjects that clearly relate to economics is not!
A Taste of New-
Finally! I have not been a fan of Austrian economics, but I really enjoyed reading this article because it really brings about light to newer economists, and how their thinking has evolved and changed. Reading Mises and Rothbard sounds outdated, something irrational, however I enjoyed reading neoclassical views like those that Caplan mentions about cardinal utility, and how this was viewed by Rothbard, and how neoclassical economists avoid it!
"Every market transaction benefits all participants”-
Welfare economics is where I think I most greatly differ in view from the Austrians. The above statement sounds very accurate. In simple terms I would think of this as the market allows for comparative advantage, which leads to resources being allocated fairly, which leads to the perfect balance between demand and supply. All this is fine and dandy, but where my criticism comes in is what type of equation does one use to determine market players? In other words who are these participants? It seems fair that some participants can afford a Ferrari whereas other participants like me will have to make do with a second hand Subaru. However, what if there exist participants that can afford medication for genetic disorders like cystic fibrosis and there are other participants that cannot. Does the market have a solution to this? The pharmaceutical industry cannot really cut costs because of crucial research that needs to be done in order to release drugs, research that costs billions of dollars. If government intervention is not key here, then what is the other solution?
Caplan also talks about how neoclassical thought can come up with, “Communism was inefficient, or rent control is inefficient, or piracy was inefficient.” I think that in the above example, taxes going to help the patient with cystic fibrosis are inefficient too, but inefficiency is not always the worst method to apply to an economy.
One of the main failures in the economic school of Austrian thought, which is presented throughout this article is plain and simple...the matter of being stubborn. It is a good practice as an economist stick to a stance. However, typically we also hold some generally accepted principles (few but yes there are some). If we reject a theory or stance it should for the reasoning that it is illogical rather than an ego thing.
I get the sense that there is an ego problem with the Austrian school. I think back to the Rothbard article we read spring semester about Keynes that was pure slander with little to no reference to how his economics made no sense but more of this emotional "your're a pansy" that's why your wrong approach. He had a personal vendetta. After all he did state about Karl Marx that, "At least he wasn't a Keynesian." This statement would have more value if it mentioned really what are the flaws in the Keynesian school rather than going for the emotional grip. Because there is one thing that economists can agree on is feelings and econ don't mix well. I do like the way in Caplan's article that he focuses on the inconsistencies of logic to explain why he disagrees with the Austrians and how he left non-applicable arguments out of story.
I don't mean to single Rothbard out here lots of economists can get caught up in this trap. And the Austrian school is not the only felon in economic schools of thought. The problem is that different schools of thought need to hear out each other before they proclaim, "Your WRONG!." As the "la la la" I can't hear you approach only can last for so long before you start to become a joke. You see this in a lot of the responses to the argument we brought up last week and also present in the reading in regards to the views of empirical analysis within the Austrian school.
I think the best approach is one which is open that that of others.
Thursday, October 7, 2010
This survey keeps coming up at the meetings so I thought I'd take the liberty of posting it
EDIT: Now with working link.
My other critique comes in when Mises talks about prediction in natural sciences. He talks about how in science we make assumptions, and there is no way of knowing whether something will work or not. What he fails to mention is that in science things tend to work on principles and rules. A chlorine atom is always negatively charged, or some molecules and always polar and others non polar. Scientists use this proved and worked out theory to help guide them when making predictions. It is not a random prediction, and in most cases the study and theory do end up with a hypothesis that is correct. Im most cases scientists don’t get results they didn’t expect, all they get is new directions, or new leads to discovering new rules/ laws. I feel like the author misrepresented the scientific method.
Wednesday, October 6, 2010
Tuesday, October 5, 2010
A Direct Quote
Hoppe, page 9:
“Could it be that Blaug’s and others’ rejection of Mises’s apriorism may have more to do with the fact that the demanding standards of argumentative rigor which anapriorist methodology implies, proves too much for them?"
I can't resist calling the author on this point. The critics he speaks of have often been studying economic theory for decades, building on the contributions of their mentors and colleagues. The author needs to be reminded that disagreeing is not a character flaw.
Here it is: I do not agree that praxeology and logical constructions are the only acceptable methodology in economic theory. Hoppe offers what I believe to be in incomplete interpretation of the methods of natural sciences in order to contrast them with the field of economics. There are two questions that must be considered. Is it true that the hypotheses of natural science force infinite examination, and do economic activities fall victim to the same troubles?
If I am forced to respond to the first question, I would need to clarify after saying yes. There should be continuing confirmation that the natural sciences have evaluated in interaction and predicted the outcome of the events. Given this, why don't we see physicists trying to confirm the effect of gravity through continuing experimentation. Why are baking soda volcanoes not being documented in the leading peer-reviewed journals of our time? The reason our experiments are not infinitely repeated is that we have more interesting things to do than continue to deal with the same hypotheses (or hypotheticals, in the vernacular of Hoppe). We have theories, identified through past experiments and generally accepted by well informed persons. Every field of the natural sciences allows for generally accepted ideas that cannot be fully confirmed.
With their theories, natural scientists take on questions and attempt to make predictions. Certainly these predictions can be flawed, skewed, or made difficult by chaos and randomness. Still, there can be value in the predictions. Consider the example of the Citric Acid Cycle, the process which breaks sugar apart to make energy available in a cell. Each sugar may yield somewhere between 29 and 38 ATP units, depending on the efficiency of conversion and random, chaotic factors (did someone sneeze?). There is uncertainty in exactly the number of energy units produced, and further study is likely to try to reduce uncertainty, but certainly the aggregated evidence is substantial enough to claim that the Citric Acid Cycle breaks down glucose and yields more than 20 energy units.
In the same way, a price floor has resulted in surpluses when economists have seen examples of the practice. We accept that unemployment can stem from minimum wages, and we accept that wheat could end up rotting if the mandated price is too high for the market. Although I accept these concepts, I cannot agree with Hoppe that these ideas are absolute and ineffable fact. I believe there is still some chance that possibly a situation exists where these examples are not true. Now, I am not interested in setting up an infinite volume of market studies with price floors in every conceivable setting and reviewing the results of this potentially infinite series of confirmations of my opinion. Someone else can stress about that while I sort out my sock drawer.
Self Evident Axioms
Hoppe cites Kant and Mises to support the division of economic thought into some basic unit where it would be self-evident. Mises in particular proposes the axiom of action, which clarifies for anyone who was confused that humans act. I will admit that there is an elegance in the derivation of economic concepts from the simple idea that people act, this axiom of action. Certainly there are useful conclusions to be drawn from this application of praxeological thought, but theories can be flawed and still be useful.
This is not the only such axiom of a metaphysical activity pondered throughout the ages. Cogito, ergo sum is one particularly popular one. I think, therefore I am (after all, if I am thinking than something must exist that as able to think). One may continue and build a praxeological universe, with axiology defining every meticulous existence and event. In that praxeological universe, guided by metaphysics and logic, I hope you'll find some value in inviting me to exist. I'll tell you that I know that I know nothing, and this sentence is false; you can derive an axiom of faction so we are allowed to have opposing views on the question.
We can admit that the Periodic Table doesn't need to be flawless (it's not), the 54th digit of pi is irrelevant (it's 0), and the exact number of unemployed people from minimum wage laws is impossible to determine. We can study market trends without presuming to have a perfect awareness of the actions. We can make economic predictions if we acknowledge the uncertainty inherent in our predictions.
Also, Humans don't Act, sorry Mises. I thought the bit about siding with Liebniz was interesting: "He sides with Leibniz when he answers Locke's famous dictum "nothing is in the intellect that has not previously been in the senses" with his equally famous one "except the intellect itself." The problem is that the more we look into how consciousness works, the more we realize that it isn't above and separate from the universe, or even the senses. Consciousness itself may actually be an illusion! For more on this I'd like to refer you to Consciousness Explained by Dan Dennett. As we are able to peer closer and closer into the brain and how that three and a half pound organ generates what we call "the mind" we realize that humans don't necessarily "act" the way Mises defines action. It's more like we react.
I'd also like to recommend the book, How We Decide, by Jonah Lehrer. It shows how decisions are made often before the person consciously knows he made them. We are learning that the brain isn't one coherent machine guided and focused by the consciousness. It's more like a mish-mash of misappropriated mini mind modules that fight with each other and try to override each other. We have a patchwork of brain components that each may have had one purpose way back in our evolutionary history but are doing something different now. Our consciousness often makes up a story about how we actually 'decided' to do something or 'acted' in a certain way after the fact.
It's telling that a brain scientist can pop your head in an fMRI machine and ask you to 'act' in an economic sense. He can then look at the data on his screen in real time and determine what you are going to do, often before you 'make up your mind'. I wish I could do a better job explaining this, but HUMANS don't ACT. We react. And when we are done reacting, we tell ourselves a lie about how we planned to do what we just did all along.
As far as Mises is concerned, he may have gotten many things right about economics, but it wasn't based on the strengths of his givens. It was a happy accident. I don't think any less of him, just like I don't think any less of Aristotle just because the universe is made of atoms (and things even smaller) rather then different mixtures of dirt, water, fire, and air.
"Economics, the study of money"
"Economics, the dismal science"
"Economics, the science of decision making"
"Economics, what do you think about the recession?"
Though, the occurrence of facing these statements often seems very daunting (especially the last one, which always makes me cringe and think, "ok here we go again.") I can always try to take something from these statements about what the general person thinks of the discipline of economics.
To these people economics is something thats somewhat abstracted and in some cases overly simplified. The one I agree with the most is the idea of economics as being the science of decision making. This view is very similar to that of what Hoppe sites Mises as having. The idea of Economics being a "Praxeolgy." I can agree with this when I think of base economic theory, I think of pure logic. So much of economics is reliant on simple logic and I think this is a notion that those in the Austrian school have which is spot on with the foundation of the economic way of thinking.
However, I think that there is more. I want to recognize that if economics is to be taken seriously it needs to have an approach that utilizes multiple angles. And this is were I disagree with the Austrians. I believe that both the application of logic and empiric practices are necessary for the advancement of the field. I don't believe that a scientific approach has hurt the way economics is. We already face the challenge of studying something so huge and every changing it would be ignorant to add the constraints as to how we are to study our dynamic systems of production and exchange.
As my brother stated when I was talking to him about Econ grad school programs last year, "Macro is dead...Experimental is where it's at." The attacks on the empirical scientific study of economics in this weeks reading is focused on taking down the Keynesian macro models, which center on the idea of "oh, if we can find the trends we can also control the economy to a certain extent." However, the branch of economics which has been developing and progressing at an increasing rate (experimental economics) also has an empirical focus, but it is going in a whole different direction then ol' macro and this should be recognized.
If we think right down to the basic idea of "praxeology"/logic, it makes sense to develop and use multiple ways of looking at both the aggregate economy and its individual decision makers with both a logical and scientific approaches, as economics is a discipline which has developed over time in a dynamic manner....it's an ever ongoing process there is no reason to add constrains as to how we should look at it but moreover we should ask what we can learn? and how can we apply this learning?
The axiom of action is one the foundational assumptions on which most Austrian theories are based on, and it's probably a perfectly valid starting place. But you can only take such an initial assumption so far before you're forced to start making heroic leaps in your successive assumptions and end up reasoning your way into absurdity. In Mises' case when you go from a fairly uncontroversial truism like "action is an attempt to substitute a more satisfactory state of affairs for a less satisfactory one" to dubious claims like "deflation and credit restriction never played a noticeable role in economic history" you've obviously taken a logical misstep somewhere along the road. If your conclusion doesn't follow from the premise your deduction is invalid and it's time to go back to the drawing board.
Therin lies one of my problems with the Austrian methodology. The Austrians are so convinced of the validity of their own axioms and what should logically follow, that they assume to even bother testing their predictions against the reality of the observable world would just be a waste of time. Sure you can try, but doing so will only confirm their self-evident truth and make you look silly, so why bother? Fair enough. But just for kicks let's say we want to put one of Austrians' "perfect" deductions to the test anyway, Austrian Business Cycle Theory for example. We gather our data, analyze it, and compare it to what theory would predict only to find that it totally fails to accurately model the reality of human behavior. People are acting, but they're not acting how the ABCT would expect them to. What now?
Well when reality contradicts theory, most economists would agree that we made a mistake somewhere along the road and it's the theory that needs to be thrown out, not reality. But the Austrians do just the opposite. When the real world contradicts their simplistic assumptions about what must follow, given the axiom of action, they simply distort reality to fit what their over-exerted reasoning should've predicted. This axiomatic fundamentalism and an inability to admit to flaws when their theories fail to stand up to facts and evidence is one of the reasons scholars of the Austrian tradition haven't made any worthwhile contributions to modern economics in decades and the reason mainstream economists rightly ignore them.