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.

Apriorism Misapprehended

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."

Posner is probably the most respected judge in America who doesn't sit on the Supreme Court, and a key thinker in the law and economics movement. His alienation is a reflection of how hostile the conservative movement has become to intellectuals.

Of course, conservatives will tell you they care a lot about intellectual grounding. These days, they especially love Austrian economists, such as Friedrich Hayek and Ludwig von Mises. I have a whole bookshelf dedicated to duplicate copies of Austrian economics books that conservative and libertarian organizations have given to me for free. I have four copies of The Road to Serfdom, which is like Dianetics for libertarians.

There are two big reasons today's right loves the Austrians. One is that Austrian economists reject empirical analysis, and instead believe that you can reach conclusions about correct economic policies from a priori principles. It's philosophy dressed up as economics; with the Austrians, there is never any risk that real-world events will interfere with your ideology.

The other big advantage is that the main Austrian thinkers, Friedrich Hayek and Ludwig von Mises, are dead, so they can't argue with your interpretation of their work. This is especially important with Hayek, who got sort of squishy later in life.

And that is how so many on the right have pulled off the remarkable feat of going through the 2008 crisis and its aftermath without revisiting any of their policy views. Mine have certainly changed a lot — I have a much different outlook on monetary policy and bank regulation than I did four years ago. Posner had a big shift on fiscal policy.

But if you have Mises at your side, you "know" that empirical findings have no bearing on what policy should be. Leaning on Austrian thinkers is a great way to avoid further thinking. If Posner feels like he's no longer welcome on the right, it's probably because the right has decided it no longer needs people like Posner.”

Now, we must note here from the outset that we care neither about Richard Posner (we don't even know who he is), nor the Republican party. We care even less about Posner now that we know that he's become a Keynesian for some reason. Apparently he read the confused jumble that is the 'General Theory' and was impressed by it. We weren't. If this is what identifies him as an 'intellectual', then he has just taken two big steps backward. He may well be a legal eagle of the first order, but there really is more to economics than Keynes (since we don't know Posner, we concede he may be open to broadening his horizon; maybe he'll tell us next year that after reading 'Human Action' that he is prepared to reject Keynes again). Still, if the conservative movement is indeed hostile to this type of intellectualism, then it can't be as bad as Barro makes it out to be.

Allow us however to point out in this context that to argue that the Republicans as such have actually found their 'intellectual grounding' in Mises and Hayek strikes us as well beyond absurd.

Apparently this is a case of a 'pars pro toto' misidentification, because Ron Paul happens to be a Republican. To think that Ron Paul and the handful of others in the microscopic 'libertarian wing' of the Republican party are somehow representative of modern-day conservatism is plainly laughable.

If anything, they tend to inspire even more fear and loathing in the Republican establishment than the Democrats (as anyone who has followed the GOP primaries in the US media could easily ascertain). The only reason why people like Ron Paul are associated with the Republicans at all is because the two big establishment parties have made it all but impossible for third party competition to get on the ballots anywhere. We think that's all there is to it. If you were to ask the average Republican representative about Mises and his apriorism, he would at first blush probably assume that Mises was a fruit grower somewhere in California and you were inquiring about the apricot harvest, or more likely, apricot growing subsidies.

Calling Hayek's timeless warning against central economic planning the 'Dianetics for libertarians' may strike the author as witty, but considering the stature of Friedrich von Hayek one should probably refrain from comparing him to L. Ron Hubbard, unless of course one wants to show the world that one is not exactly above what's known as really cheap shots.

Then it becomes downright ridiculous. We are referring to this:

There are two big reasons today's right loves the Austrians. One is that Austrian economists reject empirical analysis, and instead believe that you can reach conclusions about correct economic policies from a priori principles. It's philosophy dressed up as economics; with the Austrians, there is never any risk that real-world events will interfere with your ideology.”

The other big advantage is that the main Austrian thinkers, Friedrich Hayek and Ludwig von Mises, are dead, so they can't argue with your interpretation of their work.

Allow us to point out here that while the methodological questions addressed at length by Mises are indeed considered controversial today, this has nothing to do with 'ideology'. Mises and Hayek both were always at pains to keep their economic theorizing 'wertfrei', i.e., value neutral. As Rothbard once remarked (we are paraphrasing), Mises the citizen may well be a classical liberal, but Mises the economist is entirely free of value judgments. Moreover, if the author thinks he can knock down Misesian apriorism with a two sentence aside, he merely parades his ignorance.

As to the 'other big advantage' of the main Austrian thinkers, well, Keynes has that advantage too. He is even deader than they are, as the 'long run' overtook him somewhat earlier. So what? Does this mean we can no longer critically examine what he and his followers said and are still saying? Are there no contemporary Austrians whom one might engage in debate? Are we to assume that the aforementioned Richard Posner can talk with the dead? After all, it is Posner's hasty conversion to Keynesianism after reading the 'General Theory' that apparently occasioned Barro's article!

As to Austrian apriorism, it might just as well be called 'common sense'. As both Mises and Hayek never tired to point out, it is a grave error to assume that human beings can be analyzed as though they were inanimate objects. There are undoubtedly nevertheless economic laws, but these cannot be discovered by quantitative statistical analysis or to put it in more general terms, by the study of economic history. Economic theory must precede economic history – if one wants to examine the facts of economic history in a fruitful manner, one better have a correct theory for doing so. It is actually quite amusing to see the most realistic and common-sense grounded of all economic theories to stand accused of a lack of realism.

The basis for discovering economic laws is given by the logical structure of the human mind itself. These laws can be formulated by means of deductive reasoning starting from the action axiom. The act of cognition that led Ludwig von Mises to the action axiom is of course by no means completely divorced from our experience – in fact, it is a bridge between the purely rational, idealistic aspect of apriorism and reality. Obviously, purposive human action only takes place in the real world. On the other hand, it would hardly make sense to try to prove the existence of e.g. the law of marginal utility or other basic economic laws by means of 'experimental testing'.

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.


Ludwig von Mises and Friedrich August Hayek. It seems Mises is a bit like Jesus: he may be dead, but ya can't get rid of him.

(Image via Wikimedia Commons)



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.

You might be thinking that traffic lights don't have anything to do with the markets we all work in. But I think they do. Instead of traffic lights and road signs think rating agencies; think Basel risk weights for Core 1 and Core 2 bank capital; think Solvency 2; or think of the ultimate market regulators of our currencies – the central banks – and the Greenspan/Bernanke 'put' which was once imagined to exist. Haven’t these regulators provided the same illusion of safety to financial market participants as traffic safety tools do for drivers? And hasn’t this illusion of safety been even more lethal?

The regulations which told banks that AAA-rated bonds were 'risk free' were designed to make markets safer. But they created an artificial demand for such bonds, which created an incentive for issuers to dress up bonds as 'risk free' when they were anything but. The regulations effectively incentivized ratings agencies to rate them as 'risk free' when they clearly weren't. And today, the same madness is going on in the government bond markets. It’s very difficult to see how government bonds are anything other than 'risk assets' (let's face it, all assets are). Yet insurers are buying them because they've been told to 'take less risk' (whatever that means) by the regulators. So they are taking more risk, and they will one day suffer the consequences.”

Amen brother!


Considering the sheer size of Dodd-Frank, the next crisis should be a real doozy – click chart for better resoltion.





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One Response to “Misrepresenting Austrian Theory – A New Mainstream Hobby Horse”

  • This is the key to ignorance, the part of the story you highlighted:

    “There are two big reasons today’s right loves the Austrians. One is that Austrian economists reject empirical analysis, and instead believe that you can reach conclusions about correct economic policies from a priori principles. It’s philosophy dressed up as economics; with the Austrians, there is never any risk that real-world events will interfere with your ideology.”

    For one, I have been a religious reader of the Austrian leaning Doug Noland for over 10 years. Doug saw it coming before it even started, as FNM and FRE were ballooning their balance sheets at an amazing pace in the 1990’s. Doug at least indicated the GSE’s were much of the power behind the tech bubble, providing massive cash off home equity. Their balance sheets should have never allowed their expansion to the degree they were expanded.

    Robert Prechter, who I have to believe is steeped in Austrian economic leaning, wrote in “At the Crest” that the crisis would be a crisis of credit. Though educated in finance, I had acquired a basic understanding of the real world outside of my education. Financial theory incorporates risk, but its models imply the flow of funds goes on forever. You merely raise the discount. The core idea that compound rates of return, compound increases of debt can’t go on forever is the event. Prechter mentioned that credit was based on faith, the faith of the borrower he could pay and the faith of the lender he would get paid back. That faith, or social mood, was not unshakable or even mathematically possible to continue indefinitely. It is time, rather than events, that end this Keynesian Utopia and i believe it was another Keynesian, Galbraith who said in the long run we are all dead. Thus, the real emphasis of Keynesianism and neo-classical economics isn’t to solve economic problems, but to pass the buck as far forward as possible.

    Bar a comet or a new ice age, world war (caused by excessive statism) or some other worldwide natural disaster, it is only the Austrian formula that is immune to events. If there isn’t a systematically connected structure of credit to knock over, there can’t be an event. The events they mention are merely the failures of their own solutions. Thus, Krugman’s solution is to merely find a way to go back to blowing more bubbles on credit that can’t be liquidated, consumer demand based on overfinanced bubble projects (with leveraged capital spending comes income to workers that is often leveraged as well into unsustainable consumer demand for luxury autos, granite countertops, swimming pools, fancy vactions, etc.) and projects that fail the financial test or cannot be completed. Withdraw the mal-investment bubble and the extra demand that comes with it goes away.

    This is the core of my reasoning that the Chinese economy fails. The whole game there has been built on a credit bubble at least as much as the Inland Empire of California. The piling on of concrete and iron works, the erection of cities, whether there was demand or not, the building of public works such as high speed trains and huge airports, skyscrapers and so on are much akin to the Egyptian pyramids. Where does the demand for labor go if they quit? How much larger a bomb is it if they continue? The slice of the pie is too large. But, the failure of China will be blamed on the failure of Europe, an event in Keynesian terms, while in fact it was the excesses of Europe and the US, which were unsustainable that created the bubble to start. China in itself had no real credit or funds to enact what has since been enacted. The God of bankers and statists, the Fed and ECB, created this bomb. The event is merely not mixing the concrete for a building to minimal specifications, not the collapse.

    The primary difference I believe is that under Austrian economics, the principal is that over time, people have good sense to do what is right, while under keynesian theory, the government and its bureaucrats are the ones with good sense and people in general are too stupid. Reserve, or as I prefer to call it, credit banking, could possibly exist, but couldn’t go on as it has under statist policies. in the midst of every modern widespread economic crisis I can identify, we have the institution of credit banking at front and center. Only through this system can widespread mal-investment and over consumption occur. That is, save the Keynesian solution.

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