Friday, April 4, 2014

The Comparative Advantage of Austrian Economics: Away from Positivism and Into Historical Time

Since the Great Depression, Austrian economics has moved more in the direction of equilibrium theorizing than it had been previously (I have discussed these issues before, so I will spare you). Austrian economists have, to a far lesser extent, embraced germs of uncertainty inherent in Austrian methodology. Some exception include Ludwig Lachmann, Mario Rizzo,and Gerald O'Driscoll. And of course, Hayek, with "The Use of Knowledge in Society" and numerous other works brings to light the complexity of markets and society in general. Despite this, what is lacking is a systematic way to speak about complexity and uncertainty within economics.

Economics has been locked squarely in the positivist paradigm for over a half-century. Adherence to logical time - that is, a paradigm where the end-state of the economy is determined by its starting point and the parameters and assumptions of the model - under assumptions of efficiency robs Austrian economics precisely of what distinguishes the discipline from competing schools of thought: strict adherence to methodological individualism. The integration of Austrian macroeconomics within modern perspective steeped in assumptions of long-run efficiency has resulted in an approach that ignores market process. As modern macroeconomics is engrossed in positivist methodology, it need not concern itself with microfoundations for modeling. The purpose of these models is prediction, not understanding of process (Friedman 1954).[1] Theories are tested by evaluation of their predictive power using econometric models. It should be no surprise, then, that when positivist theories adopt microfoundations, those microfoundations are not substantive and exist only to fulfill a shallow requirement.[2] The functionality of the models remain largely undisturbed. As long as time is logical, outcomes are predetermined by assumptions and parameters. Making a model more complex by adding new parameters does not alter the assumption that for every input, there is a single output.

Peter Boettke and Kyle O’Donnell state the problem without apology. “Pure economic theory, especially equilibrium analysis, is incapable of shedding light on the process by which the subjective knowledge held by individuals is sufficiently adjusted so as to bring about intertemporal plan coordination (2013, 309).” An economics that considers market process must take into account the nature of decision making within a context of imperfect information. Some actors have access to newer, more accurate information than others. Some are better at interpreting the information to make predictions about the future. Others simply copy the actions of those whom they consider smarter than themselves. Under such conditions, a single input might be capable of multiple outputs. To simplify the problem by assuming rational expectations narrows the decision-making set to whatever set of probabilities a model defines as rational. This assumes away the problem of gathering and interpreting information. The approach is both limiting and unnecessary absent a positivist standard (Rector 1991, 219).

To amend the problem requires nothing less than a paradigm shift. As Ralph Rector notes:
From a positivist perspective, interpretive-type data appear irrelevant because they cannot be formalized as testable for quantitative predictions. In contrast to this view, interpretive economists believe that our understanding of important social phenomena has been hindered by the positivist standard of relevancy. (1991, 220)
The new economic framework should not concern itself with scarcity of resources and their single, optimal allocation which has been the emphasis of positivist economics. Agents act in historical time where their actions and the effects of those actions are irreversible. It emphasizes scarcity of knowledge. It must ask, “what are the principles of choice that allow the continual growth of knowledge (Potts 2000, 114)?” This author might add also, “what are the principles that allow the continual growth in the employment of knowledge toward desired ends by a multitude of agents?”

To confront this question, we must consider what constraints limit gathering, interpretation, and creation of new information. While some individuals might be privy to high level interpretation of statistics, most individuals do not have access to such knowledge and most data in the real world does not lend itself to such interpretations. Even if all actors did have access to these methods and all data corresponded to them, it is impossible ex ante for them to know to what degree the model of choice applies to the data in question. A more reasonable scenario is one where individuals rely on heuristics to make economic decisions. From this view, rationality and efficiency lack a clear standard outside duplicability of the action in question. No other standard need be posited and none need act as a teleological compass to guide the construction and results of a model. Such a paradigm does not seek to predict. It seeks to understand and model complexity within the economy and society.

[1] “The ultimate goal of a positive science is the development of a ‘theory’ or, ‘hypothesis’ that yields valid and meaningful (i.e., not truistic) predictions about phenomena not yet observed.”
[2] Acknowledging the reach of the positivistic paradigm also clarifies the tension existent in Muth (1961) as he claims that his theory does not “state that predictions of entrepreneurs are perfect or that their expectations are all the same (317).”

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