A Triple Whammy for Austrian Economics

By Ikeda, Sanford | Freeman, September 2009 | Go to article overview

A Triple Whammy for Austrian Economics


Ikeda, Sanford, Freeman


They say that when economic times are good businesses can get away with sloppy practices. In the intellectual world, however, it seems that sloppy thinking prevails in desperate times and important distinctions get thrown out the window.

A good example of this appeared recently in a March 4 New York Times article titled "Ivory Tower Unswayed by Crashing Economy" (www.tinyurl.com/ bnesly). Reporter Patricia Cohen suggests that in spite of the apparent failure of the free market in housing and finance in 2008, supporters of the free market have been surprisingly slow to change their minds. "Free market theory, mathematical models and hostility to government regulation still reign in most economics departments at colleges and universities around the country," the story said.

To begin with, this reveals a naive view of how intellectual paradigms shift in the academy. Does the reporter expect that professors would so quickly abandon long-cherished beliefs or that in a few short months they would be summarily replaced by professors with "better" ideas? (It may be too much to expect of someone evidently unfamiliar with university tenure to be familiar with the concepts of Thomas Kuhn.)

That aside, there were three other things that bothered me about this article because they reflect serious untruths that have been spreading into the larger public discussion in the wake of the Panic of 2008.

Blaming the Free Market: Orthogonal Mindsets

First is the all-too-common bromide that the free market is wholly or at least primarily responsible for the current economic mess. There is no need to attack this notion here, owing to the numerous articles that have already been published within the last year, including in The Freeman, thoroughly refuting this fallacy.

As I've debated the issue in various public forums over the past few months, I've realized that there are two widely held and mutually exclusive views on how the situation came about and therefore on the best way to fix the problem.

One is that to get the economy out of slump, it's necessary to understand how and why we got to where we are. Identifying the causes of the widespread poor judgment that produced this mess requires that we look for changes in the "rules of the game" that gave investors the incentive to create it. Then, having understood that, we must change the incentive structure so as not only to revive the economy in a way consistent with sound economic principles but also to ensure that we don't wind up back here ever again. (Since this has been addressed elsewhere, it is not my concern here.) Although consistent with several schools of thought, one might call this the "Austrian view."

The other perspective sees markets as dominated by the irrational drives and psychological proclivities of private investors. It's therefore a waste of valuable time during a crisis to search for the causes of perverse incentives because all incentives are in a sense perverse or at least potentially so.

One popular version of this blames the housing and financial bubbles of the recent past on an epidemic of "greed." It argues that a psychological shift occurred under the apparently more market-friendly regimes of the 1980s and 1990s that intensified investor avarice and prompted irresponsible lending and borrowing. Since private investment is the source of the problem, the solution lies in massive government spending to stimulate confidence and restart the economy. (It is not my intent to critique this view here.) I will call this the "animal spirits" view, after John Maynard Keynes, who made the expression popular.

The interesting thing is that, because each side approaches the present situation from such divergent perspectives, neither really understands the other. The approaches aren't "opposed" but "orthogonal" - the debate is really never joined, and each side simply doesn't "get" the other.

"Free-Market Economics" = Mathematical Economics? …

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