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Wednesday, May 5, 2010

Some Shortcomings of Austrian Economists

As promised, this post is devoted to what I perceive to be some of the shortcomings of the Austrian School’s analysis of economic phenomena.

1. They Don’t take Market Failure Seriously Enough

Austrians like von Mises and Hayek (pictured) hate – hate – labour unions, and for the most part I’m in complete agreement with them. Labour unions work by coercion. They coerce employers, but what’s more reprehensible, they coerce other labourers, union members and non-members alike. They prevent those workers who would be willing to work for a lower wage from making a living, however meager that living may be, thereby contributing to higher unemployment. They prefer to keep their own wages artificially high, even if it means other workers must starve. The truly terrible thing is, all this is done in the name of “protecting working people”. And insofar as government permits coercive and antisocial union activity to continue, they are in dereliction of their duty to uphold the rule of law.

On the other hand, I do not believe that the blame for unemployment can be laid entirely at the feet of union thuggery and government incompetence. I believe that market failures, perhaps the most important example of which is unemployment, are real phenomena that cannot always be conveniently explained away.

As I’ve noted before in this blog (“A Tiger by the Tail,” March 8, 2009), when discussing workers and unemployment, the paradigm example Austrians seem to have in mind is the low-skilled wage worker. Such workers have transferable skills because they effectively have no skills. Thus, if they are let go during a recession, they can find another position at a similar rate of pay relatively quickly once the economy picks up again (an exception to this being auto workers whose inflated wages were the product of union extortion). Though the unskilled are more likely to lose a job, they are also likely to spend less time between jobs.

In a knowledge economy, which is dependent on more highly skilled labour, workers cannot so easily shift around from job to job. For one thing, there is a sunk-cost effect: it takes time and money to acquire skills, and the more highly skilled you are, the more time and money you’ve likely spent acquiring those skills, which means that the loss of opportunity to exercise those skills is that much more costly. And then there’s the fact that highly-skilled positions are precisely the ones most likely to change over time. They tend to require continuous upgrading of skills and knowledge, and are more subject to economic obsolescence. Not plying one’s trade for too long a time due to unemployment can effectively make one unemployable in such a field ― either the field itself disappears, or the worker is no longer qualified to work in it.

I have an armchair theory (one which I’ll leave to professional economists to demonstrate empirically). The more an economy depends on highly skilled labour, the more downwardly rigid its unemployment rate becomes and the less responsive that rate becomes to upturns in the business cycle. In a downturn, many lose jobs, but in the upturn that follows, many of these same people will not find new work, or will only find it at a lower skill and pay level and after much time spent re-training. My theory makes the following testable prediction: as an economy develops upward along a skills gradient, it will take longer and longer for employment to rebound after each recession ― if it rebounds at all. The long-term result of this will be a growing army of educated, highly-skilled unemployed. I leave it to you to imagine the negative social and political implications.

(Interestingly, in his The Road to Serfdom (1944), Hayek pegged unemployment among the skilled and educated middle class as a main contributing factor in the rise of Nazism in Germany. However, he characteristically – and rather spuriously – blamed such unemployment on meddling with the economy by government and unions.)

For advocates of the free market like me, this is a rather pessimistic and Marxian spectre. But burying our heads in the sand won’t do capitalism any favours. In short, while Keynesians may be accused of taking unemployment too seriously, Austrians can be accused of not taking it seriously enough.

2. They Don’t Take Morality Seriously Enough

Austrians are not alone among economists in their desire for economics to be a value-free science, along the lines of physics or chemistry. Theirs is not to tell us what we ought to do, but merely to describe the economic consequences of our choices. But policy must be made, and many economists make their livings by advising those who make policy.

However, policy (or at least good policy) must be made with a view to the values of people, and many of these values are not reducible to economic calculation. Many of our values cost us money, and in most cases, these are costs we are collectively willing to bear, much as, at the level of the household, one might deem the purchase of a large screen television a worthwhile cost. Strictly speaking, buying a television is not efficient economic behaviour. After all, if you could only exercise some restraint, that money could be invested at a rate of return that would eventually allow you to buy a television and, say, a new stereo. The point is, we don’t expect to make a profit from the television; we merely wish to make our lives more fulfilling somehow, and we cannot do this by perpetually foregoing consumption. Sooner or later, money must be spent.

With respect to morality, we could, if we wish, put this in the crassest economic terms. We might say that moral values are items of consumption. But as an item of consumption, values have certain important characteristics that televisions lack. They are goods that are (i) in near-universal demand, (ii) can be extremely expensive, and (iii) the demand for them is extremely inelastic. This inelasticity is shown by the fact that so many people are willing, under the right circumstances , to die for such values, which, in economic terms, seems to indicate that there is no other good that they would accept in exchange for them.

(The other unique and rather queer characteristic of fundamental values as an item of consumption is that (iv) not only do we desire to consume them, but we demand that everyone else consume them too. This is why it is not seen as problematic, except among philosophers, sociopaths, and more muddle-headed liberals, that the state has the general right – nay, duty – to enforce fundamental values on all citizens. Collectively, we go through an incredible amount of trouble to ensure that this strange economic good is provided to everyone, at vast public expense, whether they want it or not. It’s a rather strange form of welfare state. But consideration of this takes us too far from our topic.)

Many of our fundamental values are for most of us effectively outside the realm of economic calculation. The demand for them is – or is nearly – absolutely inelastic. If economists were to tell us that it no longer makes economic sense to enforce laws prohibiting murder (which, for all I know, might very well be the case), would we scrap those laws? I doubt it, because sometimes morality trumps economic calculation. The values underlying those laws are so important to us that money is no object when considering their utility. This is where the whole “law and economics movement”, which draws much of its inspiration from the Austrians, goes off the rails.

Turning to the Austrians themselves, their treatments of morality are mostly either dismissive, or at the opposite extreme, reactionary. An example of the former is von Mises, who, when he discusses morality at all, describes it as an atavism, something which comes from a primitive stage in human development and which now mostly interferes with economic prosperity and the efficient working of the market order.

At the other extreme there is Hayek, who, especially in his later writings, claims that our morality is the result of a sort of process of natural selection at the level of rules and institutions. The rules of morality, he says, were not consciously designed, but our subordination to them has allowed us to flourish. Therefore, we toy with them at our peril. Thus, where von Mises doesn’t take morality seriously enough, Hayek can be accused of taking it too seriously, listing dangerously in the direction of a mindless conservatism that sits in great tension with his overall libertarianism. What to me is worse, he seems to perpetuate the hoary old fallacy that Plato decisively refuted 2400 years ago, namely that there is some necessary connection between religion and morality. There simply isn’t.

At the same time, Hayek betrays a breathtaking ignorance of the historical development of morality, a development which seems to give the lie to his moral conservatism. At various points in history morality has changed drastically and rapidly, and often as the result of reasoned deliberation. And many of these changes were indisputably for the better. It’s doubtful whether Hayek’s precious capitalism would ever have arisen if it weren’t for precisely such revolutions in moral values.

3. They Don’t Take Inequality Seriously Enough

I am in agreement with the Austrians that in our imperfect post-Edenic world, all things considered, the market order is the best social order yet developed. Given this assumption, we must be prepared to live with the fact that a certain level of economic inequality is inevitable. Indeed, the Austrians claimed that the lot of the worst-off in society would be even worse under a strictly egalitarian system like socialism. (And of course, because we’d all be equal in such a society, we’d all be among the worst-off.)

However, there can be no doubt that too great a degree of inequality cannot be good. Hayek admitted that there should be some kind of a guaranteed minimum income to keep body and soul together for those unable to work. Allowing people to be seen starving in the streets would ultimately be bad PR for capitalism. Of course, he intended this income to be very minimal, and he envisioned that in a proper market order there would be very few indeed who would require it.

In part this attitude stems from the Austrians’ seeming inability to take market failure seriously, which we’ve already noted. But beyond that, and beyond the poor optics of allowing people to starve in the streets, there are at least a couple of other reasons why we should not allow the gap between rich and poor to yawn too widely.

First, great inequality eats society away from the bottom up. It breeds envy among the worse-off, and although envy should never be made the sole basis for redistributive schemes, nevertheless, human nature being what it is, envy is a predictable consequence of great inequality, one which policymakers (and the rich themselves) ignore at their peril. It’s no new observation that people who feel they have no economic stake in society will have less respect for the property and persons of those who do. History shows that they are too apt to fall into the embraces of demagogues who offer to enrich them at the expense of those who are better off.

Second, great inequality eats society away from the top down. Money often begets money, and the rich, as the saying goes, tend to get richer. This is not necessarily the fault of the rich. After all, they don’t behave any differently than would the rest of us if we were in their shoes. And let us not forget that many of the poor hope for nothing less than to become rich themselves. Nor is it right to say that the rich get rich at the expense of the poor, and in those cases where they do, it’s rarely intentional. But as wealth has a tendency to concentrate, and as there is a close relationship between wealth and power, power too will have a tendency to concentrate. The effects of this syllogism on a free society are many and they collectively point to the decay of democratic institutions. The result is corruption, rent-seeking, cronyism, unionism, and other termite-like behaviour. These latter are examples of activities where participants do indeed enrich themselves at the expense of others.

Allowed to progress beyond a certain point, great concentration of wealth is inimical to the political order of a free people. Under such conditions, both the poor and the rich will undermine the basis of their own security and prosperity in the blind service of their short term interests.

4. They Don’t Take Environmental Issues Seriously Enough

The Austrians have almost nothing worthwhile to say about environmental degradation and resource depletion. They had little inkling that a day would come when the oil that subsidizes the economic system they venerated would begin to run dry. All of their economic theorizing was predicated on the assumption that there would always be a limitless supply of cheap energy to underwrite the constant growth their system requires. We may disagree over the exact timeline, but no sane person can doubt that oil is a finite resource whose supply dwindles while its demand increases. The only question is exactly how much oil lies unexploited. I’m a pessimist in this regard, but even an optimist must plan for the evil day when it’s gone.

Of course the Austrians are always ready to counter that, so long as liberty is maintained, the free play of minds and markets will find solutions to things like resource depletion, either in the form of substitutes or in means of exploiting those supplies that it is not currently economically viable to extract. However, this claim does not constitute a solution to the problem. It is merely the chanting of an article of faith, no different in form than appeals to the providential hand of the Almighty. The history of the world is littered with civilizations that failed to come up with answers to such challenges. Humanity’s track record does not warrant so much faith.

Whenever Austrians deign to discuss depletion of natural resources, their basic solution is free markets and well-defined property rights. People, they claim, will be better stewards of resources if they own them, and they are implacably opposed to the idea of common ownership of anything. Unfortunately, I have seen little empirical evidence that they are correct. This is not to say that the track record of government management of resources is any better. Although I do not have the space to explore the issue in any detail, I find the Austrian attitude to environmental issues cavalier and their “solutions” facile.

Part of the problem lies in their refusal to recognize the possibility of market failure (see above). For them, freely operating markets are self-regulating and always converge on optimal outcomes. If clear-cut forests, collapsed fisheries, and poisoned lakes are optimal outcomes, then maybe they’re right.

Austrians are on safer ground when they discuss overpopulation, as both Hayek and von Mises have done. For them the population explosion is a temporary historical blip, caused, somewhat ironically, by the very prosperity which capitalism brings. It is the result of more babies surviving infancy, and more people living longer lives. Old reproductive habits have lagged behind new material realities. It no longer makes so much sense to have more children, in the hopes that at least one or two will survive long enough to look after their parents in their old age. Eventually people will adapt to their newfound prosperity. Early statistical indications are that world population growth is beginning to level off. Of course, it will take some time for this to be reflected in total population figures, but given current trends, at some point population will level off and perhaps decline. Whether this will happen in time to avert environmental (and civilizational) catastrophe is an open question.

Also an open question is the degree to which free societies can find solutions to the problems posed by environmental degradation without sacrificing that very freedom. For example, will successful (and meaningful) reductions in carbon emissions require the assumption of central coordination – or outright control – of economic activity by governments? It’s too bad that the Austrian School, prophets of liberty that they were, systematically failed to take seriously what will turn out to be liberty’s biggest challenge.

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