The Foundations of Modern Austrian Economics

Part 4, Essay 1

Austrian Economics in the Age of the Neo-Ricardian Counterrevolution

by Ludwig M. Lachmann

Part 4

CONCLUSION

Economic theory is about the sources of individual conduct and the
consequences of its interaction. It is the intimate fusing together of the two questions, concerning the mode of choice of conduct and the outcome of the combination of many men’s choices, that constitutes economics as a distinct body of ideas and a discipline on its own.
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We cannot know whether economists in the course of time will have to shoulder tasks other than these two. However, it is characteristic of the Austrian style of thought that the backward-looking task is regarded as the more important. It is more important to make the world of action as it unfolds intelligible than it is to deduce the unintended consequences of action. This postulate entails certain limits to the degree of abstraction we may employ and to our freedom in constructing models. Abstraction is necessary, useful, even inevitable, to let our minds grasp the essentials of a situation, but we must not abstract from those acts of the mind in choice and interpretation that shape and constitute the social world. We must reject mere formal entities as elements of models. Different men finding themselves in the same situation may give it widely differing interpretations. Austrian economics is always concerned with action, never solely with reaction. It rejects as mere formalism, whether neoclassical or neo-Ricardian, all those endeavours that in a quest for “formal uniformities” are ready to assign causal roles to entities like quantities and prices, and all those models in which the economic system assumes the appearance of a “goods circus.”
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2. The human mind can grasp many forms and patterns, structures as well as uniformities of sequence in nature. Only individuals, however, have minds and therefore can make plans and act. Hence, if our main task is to understand the world of human action, we must reject any explanation of events other than in terms of plans and action. To be sure, individuals acting are oriented to their environment, natural and human. But this orientation is always a matter of subjective perspective and interpretation. Moreover, where the environment is human, problems arise of multiple perspectives and interpretations, hence the difficulties with any notion of equilibrium involving interaction of many minds, and hence the superiority of the market process as a model of interaction.

Austrian economists must disagree strongly with most of the ideas flaunted by the neo-Ricardians. Any return to the classical world of economic thought would nullify Menger’s work, as well as that of most of his successors. The strange dichotomy between cost of production determining price and demand determining quantity sold is quite untenable. In any circumstances other than those of constant cost, whatever the scale of output, demand must have some effect on price. The underlying methodological
egalitarianism—the view of competition as a state of affairs in which all producers sell identical goods, the failure to understand that the contribution of each entrepreneur is an individual contribution—is also no more attractive. To watch neo-Ricardians handle expectations is, according to taste, a sad or an amusing spectacle: they play with them like children playing with ancient coins, the value and origin of which they fail to understand. The diversity of the world is to them a closed book. As radical subjectivists Austrians must stand in the forefront of the resistance to this counterrevolution.

The list of points of disagreement between Austrian and neo-classical economics is hardly shorter. A kaleidic world can offer no congenial habitat to the neoclassical mind, to which all time sequences at once appear in the familiar form of difference equations. Will they ever understand that “frequency distributions”
e tutti quanti can have no place outside a homogeneous world, a world in which we are entitled to judge the unknown future by the standards of a known past? Or that “orthodox welfare analysis calmly assumes that the critically important social task of making all the scattered bits of information available to those making decisions has already been performed.”
*120 Without this assumption the vaunted Pareto optimum makes little sense. From time to time neoclassical economists are apt to flaunt consumers’ tastes, one of their data, as a mark of their individualism. But on closer inspection their individualism turns out to be a pseudoindividualism. The individual interests them only in his capacity as a possessor of given tastes, not as a possessor of a mind capable of probing and digesting experience, of acquiring and diffusing knowledge. Pareto saw quite clearly that real individuals, continuously having experiences bound to modify given tastes, can have no place in the neoclassical model, and that a photograph of their tastes is all that is required.
*121 It is thus only at
a point in time that we can speak of utility functions of individuals.
*122 Their unpredictable change over time forms the basis of the kaleidic society and provides the rationale for the market process.

At present a good deal of soul-searching appears to be going on in the higher ranks of the neoclassical establishment. My own impression is that little will change. The very language in which criticism of neoclassical orthodoxy is presented inspires little confidence. When Hahn, after having noticed that “the argument will here turn on the absence of futures markets and contingent futures markets,” observed that “practical men and ill-trained theorists everywhere in the world do not understand what they are claiming to be the case when they claim a beneficent and coherent role for the invisible hand,”
*123 it is painfully obvious that he has paid no attention to Austrian economics. He apparently was unable to conceive of the function of the market in terms other than those of some kind of intertemporal Pareto optimum.

Also, we hear of a “state of nature” (but no state of culture) emanating “messages” received by the individuals acting. While admittedly individuals cannot be in equilibrium while they are learning (hence no equilibrium over time?), the neo-Darwinist language in which we are told how man, as he learns about his environment, makes a better adjustment to it, sounds rather forbidding. The fundamental obstacle to any rapprochement between Austrian and neoclassical economics is the fact that the latter cannot conceive of human action, but only of reaction to given circumstances.

What of the future? Austrian economists must evidently establish themselves as a third force outside the counterrevolution and the neoclassical establishment against which it is directed. This will be no easy task. Their numbers are small, their resources slender. The big foundations are closed to them. They have no academic foothold. Their only strategy can be to impress the world by the quality of their contributions. But this will hardly be enough. In the 1930s a hopeful flowering of Austrian economics was nipped in the bud; as Hicks put it, its “voice has
been almost drowned in the fanfare of the Keynesian orchestra.”
*124 This must not happen again.

Owing to the current weakness of the Austrian position in the academic world, we must make optimal use of assets and exploit every opportunity. In this regard, I have three suggestions.

In the first place, two eminent contemporaries, Axel Leijonhufvud and Shackle, who do not, to my knowledge, regard themselves as Austrian economists, within the last six years made outstanding contributions that conform to what I have described as the main body of Austrian thought. It is for Austrian economists to make full use of the implications of their ideas.

Second, at times in the course of the counterrevolution, both sides present arguments with unmistakably Austrian implications of which their authors may be quite unaware. In such cases Austrian economists must appear on the scene at once to point them out. Otherwise the lesson will be lost. For example, when Luigi L. Pasinetti in his criticism of Robert Solow stated that “the two situations
a and
b that Solow compared differ not only by the single ‘consumption good’ he has hypothesised but also by
the whole structure of capital goods“,
*125 the Austrian implications of this notion, are obvious. But neither of the rival sides appears to have taken much interest in them. In any case they go much beyond what is provided for in Hicks’s neo-Austrian model.

The best opportunity for the rehabilitation of Austrian economics today is, I regret to say, to be sought in the permanent inflation the Western world has suffered since the Second World War. This is certainly not the fault of Austrian economists; there has been no lack of warnings from their side.

We live in a world in which prices can only rise and never fall, because the public has come to believe that a widespread fall of money wage rates in the face of a falling demand for goods and services would be intolerable. A world, however, in which all relative price adjustments have to be made against a background of continuously rising money prices and wages is one in which money is no longer a store of value: it can only depreciate, never
appreciate. The process of inflation must accelerate once everybody understands what is happening.

Second, we may have some reasonable hope that economic research and experimentation in policymaking, between them, will evolve more sophisticated means of managing the overall economy.
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Solow expressed an even more striking view: “In a monetary economy, it is natural to amend the definition of a steady state to require a constant rate of inflation; since everything else is growing exponentially, the price level ought to be no exception.”
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Neo-Ricardians have been far more cautious about inflation. Hayek and Joan Robinson not merely agreed on the substance of the matter but actually, though no doubt unwittingly, used the same metaphor: “An inflationary economy is in the situation of a man holding a tiger by the tail.”
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