The Long FAQ on Liberalism
A Critique of the Austrian School of Economics:
STARTING ASSUMPTIONS
Austrians and mainstream economists also differ completely
on what starting assumptions to use. When mainstream economists
build a theoretical model to understand an economic activity,
they often -- but hardly always -- make assumptions of perfect conditions. For example, they
will assume that consumers have perfect information about the
market, that market competition is perfect, that all products
are perfectly homogenous, or that there are zero costs to firms
entering the market. Austrians point out, however, that these
conditions do not exist in the real world, so the results of these
models' calculations are worthless. It is even more short-sighted
to use these unrealistic results to guide national economic policy.
There is a mainstream rebuttal to this argument, but for the moment,
let's continue.
Austrians call for economic assumptions to reflect the real world
-- warts and all. True, this would make the market imperfect as
well, but Austrians argue that human economic activity is continually
striving to overcome these imperfections, and the market is far
better suited than the government to do so. The model that Austrians
actually use is the theory of market process. It starts
by assuming that individuals have limited and imperfect information.
But probably the most important information that a person can
learn is the supply and demand for any given product, which is
encoded in its price. Through trading on the market, individuals
learn new information, and revise and improve their goals and
methods accordingly. New ways of competing for customers are found,
and this competition results in steadily falling prices. This
constant market process results in an ever-more efficient allocation
of limited resources.
All this sounds admirably realistic -- until you get to the fine
print. Austrians commit the very same sin they accuse mainstream
economists of doing, by calling for utopian starting conditions
before their model will work as advertised. Here is
Gaillot describing their own model:
"Market process theory assumes that there is no force and
fraud. Force includes force by individuals in the form of theft
and so forth, and force by the government in the form of taxation,
regulation, and so forth. Austrians recognize that force by both
individuals and governments exists, and that market theory does
not completely explain reality. Instead, market theory allow economists
to understand the processes at work in a market society and to
isolate the effects of force. Attempts to analyze real-world markets
must account for government and individual force. Austrian analysis
of government policies thus includes not only the direct effects
of the policies, but also the effect of the policy on the functioning
of the market process." (1)
This remarkable paragraph essentially calls for the utopian perfection of
the human race before the Austrian model can be applied or even
criticized! All market failures today can be blamed on the fact
that we have a government, regardless of the actual level of government
involvement in the failure. But what if the U.S. decided to become
libertarian, and adopt an Austrian economic policy? Then they
would still be protected from accusations of failure, because
they can always blame criminals for wrecking the market process.
This theory therefore serves to justify a heightened War on Crime.
Considering the economic and demographic groups popularly associated
with crime, one can easily see the possibilities for demagoguery
and scapegoating in the event the new economic system turned out
to be inherently flawed.
Liberals can point out an even more basic flaw in the "absence
of force" requirement. And that is that all property rights
are maintained and defended by force, or the credible threat of
force. All property is protected by police and military forces,
and violations of property rights result in the appropriate forceful
response. Therefore, the idea that a land of perfect property
rights can exist force-free is either a giant self-contradiction or
hopelessly utopian.
Austrian hypocrisy aside, why do mainstream economists themselves
use perfect starting assumptions? First, we should note that economists
are primarily concerned with how the real world can be modeled,
and the accuracy of their models is continually improving. Studying
how assumptions are violated is a major part of economics. For
example, William Vickrey and James Mirrlees won the 1996 Nobel
Prize for their theories of asymmetric information (unequal information
between buyers and sellers). The rise of New Keynesianism
in the last 10 years has been based on George Akerlof's fundamental
point that human beings are not perfectly rational, but nearly
rational. Another liberal school of economics, institutionalism,
doesn't even subscribe to static equilibrium models at all, but
agree (ironically) with Austrians that the economy is one of
constant change. It is really the neoclassical (conservative) economists who
rely so heavily on perfect starting assumptions. If Austrians want
to criticize their allies, then liberal economists are perfectly happy
to let them.
A neoclassical defense for using perfect assumptions is that countless factors
affect activities taking place in the real world, so economists
must simplify their starting assumptions if they are to quantify
the economy at all. Even so, economists have numerous tools to
get around this problem, tools that have been improving with time.
They can start by isolating the most important factors. They can
also focus the model on a highly specific industry, product or
individual, which greatly reduces the complicating factors. Another
method is to establish broad groupings or taxonomies with similar
characteristics that yield variables that can be applied to smaller
categories. The claim that these models do not have applications
for the real world betrays the Austrian's own unfamiliarity with
statistics.
Next Section: The Market Process
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Endnotes:
1. Ken Gaillot, Jr., "The Theory of Market Process,"
http://www.scimitar.com/revolution/by_topic/commerce/economic/process/process.html.