The Soundbite Straw Man
You can tell that Austrian economics is on the comeback trail by the amount of attention it has received from critics in recent years. Unfortunately most of the critiques are incredibly shallow and afford little basis for serious debate. The main failing of the critics is that they as a rule misrepresent Austrian theory due to the fact that they are evidently not overly familiar with it (or alternatively, if they are familiar with it, they have not understood it – or even worse are misrepresenting it on purpose, although that seems not very likely to us).
For instance, as Joseph Salerno remarks in a 2011 paper ('A Reformulation of Austrian Business Cycle Theory In Light of the Financial Crisis', pdf), many of the mainstream critiques of ABCT from the likes of Brad de Long or Paul Krugman betray the fact that their authors are apparently only aware of a single text describing ABCT, namely that found in the survey of business cycle theories published under the auspices of the UN in 1937 by Gottfried Haberler. Haberler was an Austrian, actually a student of von Mises who later 'recanted' and became an adherent of 'a mild Keynesianism', as Salerno puts it (Haberler in his own words described himself as close to the Chicago school and it should be noted that he never completely forgot his roots). Importantly, Haberler's break with ABCT in particular came in 1933, and his 1937 representation of it is an over-simplified, mechanistic one that describes it as a 'monetary overinvestment theory', which it plainly is not.
Now, if critics of ABCT base their critique not on the writings of von Mises, Hayek and Rothbard, then readers of these critiques who are indeed familiar with the works of these authors are often left somewhat mystified (the usual reaction is 'huh, what the hell are they talking about?'). It appears that Salerno has hit the nail on the head: all they have ever read was Haberler's 1937 compilation. This can be deduced from what precisely their critique consists of – as Salerno writes, they are expending their efforts on criticizing what is little more than a caricature of ABCT. The theory as laid out by Mises and Hayek is a theory of both malinvestment and overconsumption due to an unsustainable credit boom. Malinvestment is very distinct from 'overinvestment' and the subject of 'overconsumtpion' is completely overlooked in these mainstream critiques.
Since the critics seem as a rule not prepared to really engage with the theory, their sniping is usually confined to blogs or brief editorials, where they are – whether on purpose or inadvertently – busy knocking down straw men with the help of a few soundbites.
Recently we came across another example provided by a Bloomberg columnist, one Josh Barro, who in lauding 'born-again' Keynesian Richard Posner uses a caricature of Austrian economics to criticize the Republican party (!) of all things. It is a very short article, in keeping with the soundbite principle, so we will reproduce it in its entirety below:
“Richard Posner gave an interview to NPR this week in which he blasts current-day conservatives and says today's "goofy" Republican Party has made him less conservative. Over the last 10 years, he said, "There's been a real deterioration in conservative thinking. And that has to lead people to re-examine and modify their thinking."
Policymakers and their Advisors
The positivist approach has been practiced by the economic mainstream for decades. There hasn't been a single policymaker or advisor to policymakers that has adopted what could be termed an 'Austrian' approach to either economic analysis, forecasting or policy at any point in time since president Harding's administration in the early 1920's.
Given that these policymakers and their advisors all insist on empiricism as the be-all and end-all and have based their actions and recommendations on it for decades, why are they ignoring the by now rather glaring empirical evidence of the utter failure of these policies?How come there is an economic and financial crisis 'only rivaled by the Great Depression' as we keep hearing from Paul Krugman and many others, if the economic theories these policies were based on are really so superior?
Let us not forget, it was Über-Keynesian Paul Krugman who agreed sotto voce and in writing with Paul McCulley in 2002 that 'Greenspan needed to create a housing bubble to replace the Nasdaq bubble' (we got you fact-checked Krugman, there's no use denying it).
Krugman, who likes to back-pat himself over and over again for every 'prediction' he gets right, somehow completely failed to predict the big financial crisis, although it seems quite clear with hindsight that his policy recommendations were followed and that these policies were directly responsible for it.
Let's quickly name an Austrian economist who failed to predict the crisis … gee, we can't think of one off the cuff. Literally every single economist in the Austrian tradition was well aware that an unsustainable credit boom was underway that would end in tears and a major bust. However, we would also stress here that correct predictions of this sort are not what makes one a good economist. It is of course possible to engage in economic forecasting, but only within the praxeological constraints that such forecasting is subject to.
As an aside, there is of course a good reason why many mainstream economists like to now and then issue off-the-cuff put-downs of Austrian theory, even if they evidently haven't read or understood much of it. They probably know enough to realize that if the radical free market approach favored by Austrians were indeed adopted, there would be very little demand for the mostly mediocre intellectual output of today's 'macro-economists'. They don't want to bite the hand that feeds them. An economist who insists that the economy doesn't require interventionism or planning can not possibly hope to get paid by planners for his advice, since both his advice and the planners themselves would appear to be surplus to requirements.
Addendum: Dylan Grice and Spontaneous Order
We are big fans of Societe Generale analyst and scribe Dylan Grice. Grice regularly presents 'Austrian' ideas, without ever identifying them as such (at least we have not yet come across an outright mention of Austrian economics by Grice, although he obviously knows a thing or two about it).
A recent example was a short paper by Grice on an experiment with traffic lights in a Dutch town which we have also mentioned in these pages in the past. Here is a brief summary of Grice's paper at Alphaville.
Grice points out that ever since traffic lights and traffic signs were almost completely removed in the town of Drachten in the Netherlands (the equivalent experiment in Germany has been conducted in Bohmten), traffic accidents have fallen to a grand total of…zero. The very same experience was made in Bohmte: all traffic signs and traffic lights are gone, and ever since that time there have been no accidents. Not only that, the traffic also flows better and there are no longer any traffic jams either.
Well, what this represents is of course a slightly different application of an idea developed by both Michael Polanyi and Friedrich Hayek with regards to markets, namely the 'spontaneous order' that is generated by free markets. Grice concludes that one reason why there are no longer accidents is that 'people actually feel less safe without traffic lights'. In other words, due to the lack of central planning and regulation 'from above', many citizens feel – boohoo – that big brother is no longer looking out for their interests and hence, they believe they are 'less safe'. Obviously though, they are safer than they used to be, since accidents have undeniably simply stopped happening. This is precisely because now that they feel less safe, their behavior in traffic has become more circumspect and courteous.
Grice further concludes that the same principle can be applied to other types of regulation, including financial regulation. This is so up our alley we simply had to mention it here. Long time readers of this blog know that we have always stressed what a complete waste of time and effort it was to concoct the telephone-book sized Dodd-Frank monstrosity.
We have quite often ridiculed Ben Bernanke and others for asserting that the crisis was the result of a 'lack of regulation' when it was plain that at the center of the crisis was one of the by far most heavily regulated industries!
Bernanke of course mainly wanted to deflect attention from the Fed's culpability in setting interest rates too low for too long, but the chant 'we need more regulation' could and still can be heard from everywhere.
We are today at the point of maximum absurdity: we are fighting a crisis of regulation and easy money with even more regulation and more easy money.
Let us briefly quote Dylan Grice on the topic:
“The traffic lights and road signs are well intentioned, but by subtly encouraging us to lower our guard they subtly alter the fundamental algorithm dictating micro-level driving behaviour. This causes a perverse macro-level outcome.
Considering the sheer size of Dodd-Frank, the next crisis should be a real doozy – click chart for better resoltion.
Chart by SocGen
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