What is So Austrian About Austrian Economics? (Advances in Austrian Economics)

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ADVANCES IN AUSTRIAN ECONOMICS Series Editors: Roger Koppl and Steve Horwitz Associate Editors: Jack Birner and Michael Wohlgemuth Recent Volumes: Volume 6:

Austrian Economics and Entrepreneurial Studies – Edited by Roger Koppl

Volume 7:

Evolutionary Psychology and Economic Theory – Edited by Roger Koppl

Volume 8:

The Dynamics of Intervention: Regulation and Redistribution in the Mixed Economy – Edited by P. Kurrild-Klitgaard

Volume 9:

The Cognitive Revolution in Economic Science – Edited by Elisabeth Krecke´, Carine Krecke´ and Roger Koppl

Volume 10:

The Evolution Of Consumption: Theories And Policy – Edited by Marina Bianchi

Volume 11: Explorations in Austrian Economics – Edited by Roger Koppl Volume 12: Unexplored Dimensions: Karl Menger on Economics and Philosophy (1923–1938) – Edited by Giandomenica Becchio Volume 13:

The Social Science of Hayeks’s ‘The Sensory Order’ – Edited by William N. Butos

ADVANCES IN AUSTRIAN ECONOMICS VOLUME 14

WHAT IS SO AUSTRIAN ABOUT AUSTRIAN ECONOMICS? EDITED BY

ROGER KOPPL Fairleigh Dickinson University, Madison, USA

STEVEN HORWITZ Department of Economics, St. Lawrence University, Canton, NY, USA

PIERRE DESROCHERS Department of Geography, University of Toronto Mississauga, Mississauga, ON, Canada

United Kingdom – North America – Japan India – Malaysia – China

LIST OF CONTRIBUTORS Thierry Aimar

University of Nancy 2, Sciences Po Paris, France

Peter J. Boettke

Department of Economics, George Mason University, Fairfax, VA, USA

Gene Callahan

School of European Studies, Cardiff University, Cardiff, Wales, UK

David Colander

Department of Economics, Middlebury College, Middlebury, VT, USA

Christopher J. Coyne

Department of Economics, George Mason University, Fairfax, VA, USA

Laurent Dobuzinskis

Department of Political Science, Simon Fraser University, Burnaby, BC, Canada

Richard M. Ebeling

Northwood University, Midland, MI, USA

Steven Horwitz

Department of Economics, St. Lawrence University, Canton, NY, USA

Roger Koppl

Department of Economics & Finance, Fairleigh Dickinson University, Madison, NJ, USA

Rachel L. Mathers

Department of Accounting, Economics, and Finance, Delaware State University, Dover, DE, USA

Jeffery S. McMullen

Kelley School of Business, Indiana University, Bloomington, IN, USA

Ryan Oprea

University of California, Santa Cruz, CA, USA

Benjamin Powell

Department of Economics, Suffolk University, Boston, MA, USA vii

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LIST OF CONTRIBUTORS

J. Barkley Rosser Jr.

Department of Economics, James Madison University, Harrisonburg, VA, USA

Emily C. Shaeffer

Department of Economics, San Jose State University, San Jose, CA, USA

Nicholas A. Snow

Department of Economics, George Mason University, Fairfax, VA, USA

Richard E. Wagner

Department of Economics, George Mason University, Fairfax, VA, USA

Alfred G. Wirth

Wirth Institute for Austrian and Central European Studies, University of Alberta, Edmonton, Alta., Canada

Emerald Group Publishing Limited Howard House, Wagon Lane, Bingley BD16 1WA, UK First edition 2010 Copyright r 2010 Emerald Group Publishing Limited Reprints and permission service Contact: [email protected] No part of this book may be reproduced, stored in a retrieval system, transmitted in any form or by any means electronic, mechanical, photocopying, recording or otherwise without either the prior written permission of the publisher or a licence permitting restricted copying issued in the UK by The Copyright Licensing Agency and in the USA by The Copyright Clearance Center. No responsibility is accepted for the accuracy of information contained in the text, illustrations or advertisements. The opinions expressed in these chapters are not necessarily those of the Editor or the publisher. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library ISBN: 978-0-85724-261-7 ISSN: 1529-2134 (Series)

Emerald Group Publishing Limited, Howard House, Environmental Management System has been certified by ISOQAR to ISO 14001:2004 standards Awarded in recognition of Emerald’s production department’s adherence to quality systems and processes when preparing scholarly journals for print

INTRODUCTION: REGRETTABLY EXCITING TIMES Roger Koppl The papers collected here were written for the second biennial Wirth conference on Austrian Economics. The Wirth Institute for Austrian and Central European Studies sponsored the conference in cooperation with the University of Toronto in Mississauga. The conference was held from 17 to 18 October 2008 in Mississauga. The Wirth Institute has a natural home in Edmonton on the campus of the University of Alberta, which is a leading center for Central European Studies. The fact that the Institute has received support not only from government of Austria, but also from the governments of the Czech Republic, Hungary, Poland, Slovakia, and Slovenia reﬂects its historically minded recognition of the unique intellectual milieu of the Habsburg Empire. This intellectual milieu lasted beyond the breakup of the empire right through to the Anschluss in 1938. It is this milieu that shaped the Austrian school of economics and helped shape the context for the conference. Our conference venue that mild and sunny weekend was an elegant inn in Mississauga whose every window gave out to rustling autumnal trees thick with gold and brown foliage. Our host, Dr. Alfred Wirth, greeted 17 scholars for over 2 days of discussion of ‘‘What is so Austrian about Austrian Economics?’’ The setting, the weather, and the company were all charming and pleasant. The recent onset of ﬁnancial crisis, however, created a more sober context for our conversations, one that had not been anticipated when it had been organized by Pierre Desrochers of the University of Toronto in What is so Austrian About Austrian Economics? Advances in Austrian Economics, Volume 14, 1–23 Copyright r 2010 by Emerald Group Publishing Limited All rights of reproduction in any form reserved ISSN: 1529-2134/doi:10.1108/S1529-2134(2010)0000014003

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Mississauga, Steven Horwitz of St. Lawrence University, Franz A.J. Szabo of the Wirth Institute and the University of Alberta, and me. Dr. Wirth’s opening remarks emphasized the ﬁnancial crisis. He noted pointedly ‘‘we live in regrettably exciting times.’’ Dr. Wirth seems to recognize that Austrian economics is practical stuff that can and should be applied to precisely the sort of problems raised by the ﬁnancial crisis. The conference question (‘‘What is so Austrian about Austrian Economics?’’) is important and serious. The Austrian intellectual tradition is distinct from that of Germany and worthy of independent study in the history of ideas, a point Johnston’s (1972) classic, the Austrian Mind helped to impress upon English-language scholarship in the history of ideas. The question of the ‘‘Austrian-ness’’ of ‘‘Austrian economics’’ always merits consideration for those of us who are immersed in the intellectual tradition of Mises’ Privatseminar, which had its existence in interwar Vienna. There in the dark autumn of the world of the Austrian mind Ludwig von Mises had gathered scholars such as Gottfried Haberler, Oskar Morgenstern, Paul RosensteinRodan, Ilse Mintz, Karl Menger (mathematician son of Carl Menger, the founder of the Austrian school), Felix Kaufmann, Alfred Schutz, Eric Voegelin, Fritz Machlup, and, of course, F. A. Hayek (M. Mises, 1984, pp. 199–210; Kirzner, 2000, pp. 460–51). They were all ‘‘Austrian’’ scholars in the best and broadest sense of the word. They were also comrades in the ﬁght to save Austrian liberalism and civilization. Their scholarship of the time was produced in the context of an impending doom that Mises above all other saw clearly and early. Hayek (1981) noted that Mises had in those days a ‘‘disconcerting habit of rightly predicting the ill consequences of current economic policy’’ (p. xxii). Mises (1933, p. 202) warned at the time that we will have ‘‘progress on the road the western civilization has taken for thousands of years, or a rapid plunge into a chaos from which there is no way out, from which no new life as we know it will ever develop’’ depending on whether the voice of the economist is heard. The urgent context of the Privatseminar helps to explain why Austrian economists consider their subject a serious one. In conversations, seminars, and public lectures, Israel Kirzner has quoted Mises saying that ‘‘economics deadly serious’’ and ‘‘a matter of life and death.’’ F. A. Hayek (1935b) spoke of ‘‘the unmitigated gloom with which the economist of to-day must look at the future of the world’’ because it seemed to him ‘‘a world bent on planning’’ (p. 242). It was no exaggeration to speak of ‘‘gloom’’ for an economist persuaded that ‘‘the impossibility of rational calculation in a completely socialized system might be serious enough to make it impossible to maintain alive the present populations of the more densely inhabited countries’’

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(Hayek, 1935a, p. 34). (Whether experience supports Hayek’s concerns will depend on whether the failures and atrocities of particular regimes such as those of Hitler, Stalin, Mao, Pol Pot, and Mugabe are attributable partly to collectivization or exclusively to idiosyncrasies of those regimes only coincidentally linked to collectivism.) When economists sit down to discuss ‘‘policy,’’ lives hang in the balance. The context of our meeting and of the current political and economic situation is not as serious as that of pre-war Europe. It is urgent nevertheless. Now as then, much hangs on whether the voice of the economist is heard, and on which voice is heard. In my view, the Austrian school brings something to the policy table that is largely missing from current macroeconomic orthodoxy, namely, its epistemic perspective. This perspective emerged from the socialist calculation debate in which Austrian economists and others argued that socialism would not produce the beneﬁts imagined by socialists (Boettke, 1998). Prychitko (in press) notes that Hyman Minsky also adopts an epistemic approach, though one that is probably not consistent with the whole of Austrian economics. Interestingly, Gerald O’Driscoll (2010) has noted a degree of convergence between Austrian and Monetarist interpretations of the Great Recession. He draws our attention to Anna Schwartz’s comment on the Great Recession that ‘‘the basic underlying propagator was too-easy monetary policy and too-low interest rates’’ (Carney, 2008). Koppl and Luther (2010) point to evidence that something like Minsky’s analysis may be entering mainstream macroeconomics. If so, then macroeconomists who dislike Minsky’s perspective may come to ﬁnd sustenance in Austrian epistemics. Our keynote speaker, David Colander, seems to share Dr. Wirth’s sense of Austrian economics as practical stuff. Austrian economists should specialize in ‘‘political economy,’’ where they have a comparative and, perhaps, absolute advantage. We should cede ‘‘economic science’’ to the mainstream. Political economy is ‘‘that branch of the ﬁeld of economics that is explicitly concerned with policy,’’ whereas economic science might be deﬁned by Robbins’ phrase ‘‘the technical apparatus of analytical Economics’’ (Robbins, 1981, p. 8 as cited by Colander). The ‘‘technical apparatus’’ of mainstream economics has grown very sophisticated indeed, as Colander notes. Colander’s argument understandably met with some resistance in Mississauga. Austrian economists have always fancied themselves scientists. Mises (1949) says, for example, ‘‘One must study the laws of human action and social cooperation as the physicist studies the laws of nature’’ (p. 2). Colander’s argument is subtle and powerful, however, and one that is deeply respectful of modern Austrian economics.

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Applying basic economic reasoning to economists, Colander reasons that the theoretical high ground is off limits to Austrians quite independently of the merits of Austrian arguments. ‘‘Modern mainstream economics protects its rents through an orthodoxy of method.’’ By thus putting the economist into his economic model, Colander follows the practice labeled ‘‘analytical egalitarianism’’ by Peart and Levy (2005). In Colander’s view, methods, not ideas decide what is in and what is out of the mainstream. This situation has the obvious disadvantage of closing off discussion; only insiders count. This disadvantage is not unique to economics among academic disciplines. ‘‘All research programs are sociologically closed as insiders develop methods to protect their rents,’’ Colander explains. In economics at this time, however, the barrier to entry restricts methods not substance. The advantage to this mode of rent seeking is that it lets a variety of substantive ideas in. The mainstream ‘‘is not closed to any ideas on ideological grounds.’’ In the situation Colander describes, it might seem that any more or less ‘‘heterodox’’ school such as Austrian economics should simply fold up its tent in defeat. This attitude correctly reﬂects Colander’s general assessment of heterodox schools of economic thought. But the Austrians get a special dispensation. Colander, who has declared neoclassical economics dead, sees heterodox schools as so many zombies (Colander, 1998, 2000, 2003). (Munz, Hudea, Imad, & Smith, 2009 analyze zombie attack dynamics.) It is a ‘‘concession,’’ Colander says, that he makes an exception for Austrian economics. Austrian economics is spared the death sentence because of its strengths in political economy. It bears notice and emphasis that Colander thinks Austrian economists can compete and perhaps win in the ‘‘domain’’ of political economy. If Austrians are indeed cast out from the Eden of economic science, they may take comfort in the knowledge that their strengths lay in the contact points between economics and policy. Austrian economics matters even if it is denied the mantle of science. Colander does note one way Austrian economists might regain admission to the Elysian Fields of ‘‘economic science.’’ He says, apparently en passant, ‘‘unless they team up with mathematicians or physicists, I see little future as a distinct entity in Austrian economic science.’’ In my view, there may be a group of mathematicians Austrians can team up with. It seems reasonable to guess that Austrian epistemics could be developed in part with the aid of the tools of computable economics (Velupillai, 2005) as Koppl and Luther (2010) suggest. Such a marriage would require a close working relationship between Austrian economists and mathematically sophisticated researchers. If Colander is right, only such a marriage could bring Austrian economics within the fold of ‘‘economic science,’’ sociologically deﬁned.

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The sharpest contrast to Colander’s views might have been offered in Richard Ebeling’s paper, which gives us ‘‘An ‘Austrian’ Interpretation of the Meaning of Austrian Economics.’’ Ebeling’s paper is a sweeping historical overview of Austrian economics that emphasizes the role of mind in the Austrian tradition. He cites Albion Small favorably. ‘‘We might reduce the contention of the Austrian School to the proposition: The phenomena of the market are at the same time phenomena of the mind, and they must be explained accordingly’’ (Small, 1924, p. 172 as cited in Ebeling, italics in the original). For Ebeling, because men are not rocks we must study them with humanistic and not scientistic methods. ‘‘Prices are not just ‘given,’ they emerge out of mental processes of evaluation, decision and action.’’ Ebeling makes much of human meanings. ‘‘When Austrians look at man they do not just see a subjectivism of tastes, but of action and meaning.’’ If I am right to hope that the tools of computable economics can be used to develop some aspects of Austrian epistemics, Ebeling shows that other vital aspects of Austrian epistemics and Austrian economics in general probably cannot be squeezed into mathematical boxes. There are probably permanent limits to the mathematization of Austrian theory. If so, then vital parts of Austrian economics will forever remain outside the domain of ‘‘economic theory’’ as identiﬁed by Colander. Until extra-mathematical methods are admitted to the inner sanctum, Austrians will have to accept that many mainstream economists will consider parts of Austrian theory be unscientiﬁc. We can hope that Austrian economists will place the search for truth above the search for scientiﬁc acceptability in spite of the strong sociological pressures to which Colander’s argument draws our attention. The question of what mathematics can and cannot do may be more delicate that most economists seem to have appreciated. Oskar Morgenstern (1963) argued for ‘‘the impossibility of stating any ‘limits’ to the use of mathematics’’ in economics (p. 458). It is impossible in part because we do not know anything about mathematics that has not yet been invented. Morgenstern said, ‘‘altogether new mathematics has to be invented in order to cope with manifold forms of economic problems’’ (p. 443). Morgenstern draws the inference that ‘‘nothing can be said about limitations’’ (p. 443). Morgenstern goes beyond this argument, however, to say, ‘‘If [economic] laws exist, they will ﬁnd mathematical formulation. Of this, there cannot be the slightest doubt’’ (p. 456). I confess that I am unable to decipher the logical foundations for Morgenstern’s apodictic certainty about the supposedly mathematical structure of economic laws. Morgenstern is right to note that we cannot predict what new branches of mathematics will be able to do. It seems reasonable to avoid therefore strong

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statements about what mathematics cannot do. But symmetry suggests similar caution regarding claims about what mathematic can do. Hayek (1952a) provides an argument for methodological dualism that resembles Georg Cantor Cantor’s ‘‘diagonal’’ arguments, in which Cantor showed ﬁrst that there are, in a well-speciﬁed mathematical sense, ‘‘more’’ real numbers than integers and second that the cardinality of any ﬁnite or inﬁnite set is less than that of its power set. Hayek (1967) later refers explicitly to Cantor in this connection (p. 61, n. 49). Hayek showed that any description of human action in a language that omits reference to human meanings (‘‘physical language’’) will exclude information contained in descriptions that do refer to human meanings. Hayek thus gave us ‘‘scientiﬁc’’ reasons to use ‘‘humanistic’’ methods. If human meanings and understanding cannot be ‘‘reduced’’ to physical language, they might also resist mathematization in ways that would limit the use of mathematics in economics. Until we have in hand mathematical tools that really help in the analysis of human meanings and the human interpretation of human meanings, we shall have to either use ‘‘humanistic’’ methods of analysis or throw away information about the human subjects of our science. To the extent that mainstream economists think ‘‘science’’ excludes the use of nonmathematical and humanistic methods of analysis, they may not understand important bits of Austrian theory. And as long as they do not understand, Austrian economists will have to restate, revise, and repeat their arguments in political economy. Austrian epistemics depend in part on a kind of ‘‘humanistic’’ reasoning that may not be considered ‘‘economic science.’’ But then many of the most characteristic elements of Austrian theory will remain somewhat fuzzy in the minds of many mainstream theorists. In particular the really deﬁning argument of modern Austrian economics is probably not fully understood by most mainstream economists, even when they sincerely express esteem for it. I refer to the Austrian ‘‘knowledge argument’’ asserting ‘‘The Impossibility of Economic Calculation Under Socialism’’ (Mises, 1949, p. 694–711). Mises ﬁrst clearly stated the calculation argument in 1920 and Hayek later joined him in developing and delivering the argument. The dispute over his claim became the socialist calculation debate of the 1930s and 1940s. Mises and Hayek did not say that socialism is impossible. They asserted instead that rational economic calculation was impossible under socialism. Hayek (1935a) acknowledges that ‘‘Mises had occasionally used the somewhat loose statement that socialism was impossible, whereas what he meant was that socialism made rational calculation impossible’’ (p. 36). Socialism ‘‘may be tried’’ of course, but if will not ‘‘lead to the expected results’’ (Hayek,

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1935a, p. 36). If mainstream economists do not recognize important aspects of this argument as ‘‘scientiﬁc,’’ they may not appreciate all aspects of it. For this reason, we must untiringly restate, revise, and repeat. Boettke, Schaeffer, and Snow, do just that. They examine Hayek’s argument for contextual knowledge in the light of the socialist calculation debate. The epistemic turn in Hayek’s thinking can be traced to his role in the socialist calculation debate. Picking up on Mises’ (1920) reference to the ‘‘intellectural division of labour’’ (p. 102), Hayek’s work on socialist calculation led him to ‘‘what is arguably his most important contribution to economics, namely, the role the price mechanism plays in capturing fractured and dispersed knowledge to efﬁciently allocate resources.’’ Hayek came to see knowledge as contextual and as dependent on the institutions of economic life. This important contribution to (dare I say it?) economic science emerged from a debate over political economy. Hayek’s ‘‘knowledge papers’’ made a contribution to economic science that would probably not be recognized as ‘‘scientiﬁc’’ if were being offered up for the ﬁrst time today. This odd fact is explained, however, by Colander’s sociological account of what mainstream economists are willing to call ‘‘science.’’ Dobuzinskis and Aimar adopt a broadly similar approach to understanding why Austrian economics has had less success in France than in the United States. Their explanation depends mostly on the network structure of the French educational system, which creates local monopolies rather than a competition of ideas. This organization might do limited harm in a ﬁeld with less ideological charge and tighter empirical control. The ‘‘compartmentalized structure’’ of the system creates the opportunity for niches to develop, but there is not much communication or competition across niches. I think we might express the problem by saying that the organizational structure of French education creates local epistemic monopolies. Dobuzinskis and Aimar’s historical analysis seems to suggest that Austrian economics does better the more open and robust the competition for ideas. Ideas compete in many dimensions, including across disciplinary boundaries. Past issues of Advances in Austrian Economics have been devoted to exchange between Austrian economics and psychology, evolutionary theory, and entrepreneurial studies (Koppl, 2003, 2004; Krecke´, Krecke´, & Koppl, 2006; Butos, 2010). Jeffery McMullen provides an unusually penetrating example of triangular exchange between psychology, entrepreneurial studies, and Austrian economics. His analysis builds from the same phenomenon that Boettke, Schaeffer, and Snow explore, namely, the epistemic turn in Austrian economics.

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McMullen takes up the ‘‘Lachmann problem,’’ which McMullen expresses in the form of two vital questions. ‘‘[I]f one’s plans are contingent upon the complicit behavior of others, whose plans are in turn based on data and preferences that change over time, and if future data and preferences cannot be known a priori, then how is socio-economic order possible? What prevents the economy from devolving into anarchy and rescues scholarly attempts to study it from being fruitless encounters with nihilism?’’ I can recall Ludwig Lachmann in seminars repeatedly insisting on the problem of expectations in economics. Hayek (1937) argued that basic economic reasoning always has an empirical component in the form of assumptions about learning. In that article Hayek seems quite sanguine about the implications for economic theory. He says, ‘‘I do not mean to suggest that there opens here and now a wide ﬁeld for empirical research’’ (p. 55). Hayek takes the epistemic turn in 1937 without seeming to recognize how radical a move he had made. Lachmann recognized clearly just how radical it was and just how great a problem it posed for the Austrian vision of economics as a science articulating law-like regularities that must be studied ‘‘as the physicist studies the laws of nature.’’ McMullen points to ‘‘perspective taking’’ to help resolve the Lachmann problem. Perspective taking is the ability to see things from another’s point of view. It is the cognitive dual to empathy. If I am good at perspective taking, I can see how things look to you. If I have empathy, I feel your pain. I need perspective taking to out-maneuver my enemy. If I feel his pain, however, I may lose my competitive edge. Thus, empathy and perspective taking are probably different things whether or not they typically go together. McMullen develops the thesis that ‘‘perspective taking disciplines the entrepreneurial imagination of active minds to offer an explanation of socio-economic order that is dynamic, yet capable of avoiding the philosophical extremes of determinism and nihilism.’’ He links perspective taking to both hermeneutics and neuroscience. Citing Foss and Garzarelli (2007), McMullen discusses the ‘‘hermeneutical twist’’ to institutional analysis. Institutions help shape our interpretations of others and of the social world in general. They constrain our interpretations. This constraint helps prevent the apparently inﬁnite variety of potential interpretations from destroying social order. An institution’s legitimacy, stability, and universality all contribute to efﬁcacy in reining in interpretational chaos and promoting social cooperation. McMullen points out, however, that we need to understand better the foundations of this coordinative function. Institutions can play this coordinative function because of our innate capacity for perspective taking. Physiologically,

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perspective taking seems to depend on ‘‘mirror neurons,’’ which facilitate ‘‘inner imitation’’ of others thereby allowing us ‘‘to apprehend directly others’ emotions from their facial expressions and to understand their bodily movements as goal-directed actions.’’ We seem to be programmed by natural selection to interpret other humans as like us and to effect such an interpretation by a kind of inner reenactment of the other’s expressions and motions, thereby generating an inner model of the other’s action and affect. McMullen’s analysis should probably be viewed in the light of the literature on ‘‘theory of mind,’’ including the important fMRI study of McCabe, Houser, Ryan, Smith, and Trouard (2001). McMullen’s penetrating and broad analysis is a signal contribution to both entrepreneurial studies and political economy. Austrian economists should welcome McMullen’s link to current research in the natural sciences. We should welcome an improved understanding of human nature. As Hayek has pointed out repeatedly, the social sciences are in a position that is almost the reverse of that of physical sciences such as chemistry or physics (Hayek, 1952b, 1935a, pp. 10–11). The physical sciences observe regularities and guess at what must be the causes below our threshold of observation. The social sciences observe human actions and actors and guess at what must be the (unintended) consequences above our threshold of observation. Economists such as Adam Smith, John Stuart Mill, and F. A. Hayek had little choice but to model the human ‘‘atoms’’ of our analysis with naı¨ ve folk psychology modiﬁed only by observation and selfreﬂection. In other words we relied on introspection. Today, however, cognitive science, evolutionary psychology, neuroscience, and the mathematical theory of computing are enabling us to edit and revise our naı¨ ve model of man with the aid of disciplined scientiﬁc and mathematical knowledge. We should embrace and welcome the trend toward more scientiﬁcally grounded models of man. This trend tends only to improve the accuracy and scientiﬁc rigor of our theories. Experimental economics is an obvious and important example of this trend, which puts old methodological verities into question. John Stuart Mill (1872) said that ‘‘we are without the means of making artiﬁcial experiments’’ in the social sciences (p. 881). Hayek echoed this opinion more than once. He says, for example, ‘‘experiment is impossible’’ in the social sciences (1935a, p. 10). Powell and Oprea note that this view has been overturned by events. What exists is possible. We do have experimental economics and we should welcome it. They ask us to love the lab and I think they are right. Powell and Oprea point out that we need not and should not think of experimental economics as attempting to test the economist’s basic logic of

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choice, which Mises called ‘‘praxeology.’’ Economists do test hypotheses in the lab, but the ‘‘vast majority’’ of such tests ‘‘lie well outside of the scope of praxeology’’ properly speaking. In ‘‘the vast majority of ‘theory tests’ in experimental economics, the theories being tested would not be classiﬁed as theory at all in praxeology.’’ From a strict Misesian perspective, experimental economics is ‘‘a controlled form of economic history.’’ Some ‘‘neoclassical’’ versions of the logic of choice have been challenged, of course, by laboratory experiments. This fact may be especially true for experiments in the tradition of Kahneman and Tversky (1979). But the theories so challenged are subject to test in a way that praxeology probably is not. Powell and Oprea discuss the experimental literature on asset price bubbles, which is relevant to the ﬁnancial crisis of 2008. The result that experimental markets generate bubbles is robust, although experienced ‘‘traders eventually learn through experience to avoid bubbles and can in fact arbitrage away bubbles formed by less experienced traders.’’ Koppl and Luther (2010) address the importance of bubbles in the context of a criticism of interventionist elements in mainstream macroeconomics. Experimental methods can help decide which institutional settings for asset markets encourage bubbles and which discourage them. Such knowledge translates rather directly to macroeconomic issues such trade cycles and ﬁnancialmarket regulation. Powell and Oprea point out that economics experiments often hinge on what people learn in different institutional settings. Thus, experiments can addresses the very empirical issue that Hayek identiﬁed in 1937 as central to our understanding of market processes. Far from being somehow alien to the Austrian economics, experimental economics can directly address central issues in modern Austrian theory. And here, perhaps, is another way for Austrian economics to enter ‘‘economic science’’ as conceived by mainstream economists. A well-designed experiment may produce facts that challenge received opinion. By creating facts for ‘‘economic science’’ to respond to, Austrians can inﬂuence ‘‘economic science’’ even without generating impressive plumes of abstruse mathematics. Colander, Holt, and Rosser (2005) have argued that complexity theory dominates the ‘‘edge of economics.’’ As Colander put it in his keynote address, the ‘‘complexity war has been won, at least on the cutting edge of economics.’’ I think mainstream macroeconomics has been an exception to this rule until recently. Although the stability of asset markets and the macroeconomy have been addressed with the tools of complexity theory (Ahmed, Koppl, Rosser, & White, 1997; Arthur, 1994; Arthur, Holland, LeBaron, Palmer, & Tayler, 1997; da Costa & Doria, 2005; Delli Gatti,

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Gallegati, & Gardini, 1994; Rosser, 2000), the nearly exclusive use of dynamic stochastic general equilibrium (DSGE) models in mainstream macroeconomics has limited the impact of the complexity revolution. The increasing importance of ‘‘animal spirits’’ in post-crisis macroeconomics probably suggests, however, that complexity models will become more important in this ﬁeld (Koppl & Luther, 2010). Colander thinks that ‘‘complexity is the central Austrian insight.’’ For, ‘‘once one accepts that the economy is a complex system, one is naturally led to the other elements of the economy that Austrians have emphasized, such as the knowledge problem, entrepreneurship, and the limits of mathematics in understanding a complex system such as the economy.’’ There is ‘‘an irony and injustice’’ in the fact that the Austrians ‘‘have won’’ the crucial point while mainstream economists do not realize they have moved strongly in an ‘‘Austrian’’ direction. Barkley Rosser adopts a more guarded position regarding Austrians as complexity theorists. Rosser recognizes that there are important ‘‘strands of Austrian economics that are consistent with complexity thought.’’ I think Rosser is right to say that ‘‘most important of these [complexity strands] are associated with the work of Friedrich A. Hayek, who was openly and actively interested in complexity ideas.’’ Rosser has noted Hayek’s interest in complexity theory before. Rosser (1999) says, ‘‘Hayek (1967) was an early and independent developer of complexity theory in something resembling its current form, albeit without computers. He had signiﬁcant communication with both Ilya Prigogine and Hermann Haken, respectively the founders of the Brussels and Stuttgart schools’’ (p. 186, n. 11). Rosser develops this Hayekian link in his contribution to this volume. But he also notes a strand of Austrian economics he considers to be inconsistent with complexity theory. The ‘‘noncomplexity tradition in Austrian economics’’ has the same source as the complexity tradition, Carl Menger. Rosser argues that Menger has both complexity and noncomplexity elements in his thinking, making him ‘‘a complicated ﬁgure in this matter, exhibiting a tendency toward complexity in his invocation of evolution and the emergence of spontaneous orders, even while he defended abstract theorizing and marginalism against the historical approach.’’ If Hayek picked up the complexity threads, Bo¨hmBawerk, Weiser, and Mises would pick up the noncomplexity threads. Bo¨hm-Bawerk especially kept ‘‘within the conﬁnes of neoclassical orthodoxy with nary a whiff of a complexity perspective.’’ Rosser sees Mises as a ﬁgure mostly in the noncomplexity tradition of Austrian economics. He recognizes, however, that Mises ‘‘was not fully

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wedded to the equilibrium approach, invoking static equilibrium as a useful concept, but ultimately emphasizing the importance of dynamic processes of entrepreneurs pursuing proﬁts and generating prices in doing so, with the system constantly changing and moving on, never settling down to any static equilibrium, a view that would strongly inﬂuence his followers, Kirzner and Lachmann.’’ Noting the ‘‘bugaboo’’ of the possible split between Hayek and Mises, Rosser adopts the view that Hayek slowly moved away from a noncomplexity view associated with Mises to a social theory more consistent with modern complexity theory. The ‘‘evolution of Hayek’s views’’ took him from ‘‘a faithful follower of von Mises to the apostate student of complexity.’’ Rosser is probably right to see both complexity and noncomplexity elements in Menger’s social theory. We could almost say the same of Walras. On the one hand, Walras himself gives no hints of complexity theory as far as I am aware. He carefully considers the problem of multiple equilibria early in the Elements, whereas assuming barter and a twocommodity world (Walras, 1954, pp. 107–114). I note in passing that Baumol and Goldfeld (1968) therefore err by claiming, ‘‘Walras proceeded on the assumption that all would be well if and only if the number of equations was equal to the number of unknowns’’ (p. 267). Later, Walras claims that if ‘‘the number of commodities in the market is very large,’’ the problem of multiple equilibria is not relevant (p. 200). ‘‘[M]ulitple current equilibrium prices y are, in general, not possible in the case of the exchange of several commodities for one another’’ (p. 200). Even without this claim, the prohibition of trading at false prices (Walras, 1954, p. 85), would seem to prevent the emergence of any phenomena characteristic of complexity theory. On the other hand, general equilibrium models raise interesting complexity questions. Already in 1932, Harold Hotelling showed that Edgeworth taxation paradoxes may arise in a general equilibrium setting. He showed that ‘‘a tax on sellers of two commodities may result in both prices being lowered even under free competition’’ (Hotelling, 1932, p. 385). Richter and Wong (1999) show that the equilibrium of an Arrow–Debreu economy may not be computable even if ‘‘all the agents’ characteristics’’ such as ‘‘utility functions and endowment vectors’’ are computable. Citing Hirsch, Papadimitriou, and Vavasis, (1989) and Papadimitriou (1994), Axtell (2005) reports that a Walrasian auctioneer faces a computational problem that is ‘‘hard’’ in a precise mathematical sense: ‘‘there are no polynomial time algorithms for the general case with nonlinear utility functions’’ (p. F196). Axtell explains, ‘‘Polynomial time algorithms y are those that can be realistically solved by computers’’ (pp. F196–F197).

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General equilibrium models raise interesting complexity questions even though the thinking of its originator, Le´on Walras, seems to have been untouched by complexity considerations. This fact suggests that modern complexity theory gives us a way of thinking. Just as there is an ‘‘economic way of thinking,’’ there is a ‘‘complexity way of thinking.’’ Modern Austrians have a comparative advantage in the complexity way of thinking in part because of their immersion in Austrian epistemic arguments that emerged from the socialist calculation debate. The famous correspondence between Walras and Menger shows that these two thinkers were very different, as Menger, if not Walras, was well aware. Richard Wagner notes this famous exchange. ‘‘When Walras asserted to Menger that both shared a common interest in changing the direction of economic scholarship, Menger responded that: ‘There is indeed a resemblance between us. There is an analogy of concepts on certain points but not on the deeper questions.’’’ Wagner shows why in spite of the great differences between Menger and Walras, we do not need to choose between them. The neo-Walrasian and neo-Mengerian research programs address separate problems and should be viewed, therefore, as complementary in much the way the physicist’s models of light as wave and particle are complementary. ‘‘The neo-Walrasian program,’’ Wagner explains, ‘‘seeks to characterize an orderly economy in terms of consistency among various postulated relationships regarding such things as consumer demands and producer technologies.’’ In an apparent allusion to Newton, Wagner says that his program gives us ‘‘a circular system of reasoning.’’ The system ‘‘stands outside of time’’ because it cannot ‘‘generate the observations to which [its] categories pertain.’’ The neo-Mengerian program, by contrast, is all about emergence. ‘‘Property, contract, legislatures, legal proceedings, and money’’ all ‘‘represent a new level of existence that arises through interaction at a lower level.’’ Neo-Mengerian theories ‘‘start from planning agents’’ whose ‘‘plans continually are being revised or abandoned.’’ They ‘‘render intelligible the on-going generation of the institutional framework that governs human action and interaction.’’ Lachmann expressed this neo-Mengerian vision when he once commented to me, ‘‘With Menger all things are ramiﬁed.’’ Wagner connects Menger to complexity theory when he says, ‘‘Menger wrote long before such techniques as agent-based computational modeling had arisen, but it’s clear that Menger’s theoretical intuitions would have supported emergent and generative styles of theorizing, much as Vriend (2002) claims for Friedrich Hayek.’’ Wagner does not explicitly refer to Neils Bohr’s complementarity principle, but seems to allude to it. Paul Samuelson’s (1947)

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complementarity principle tells us that only stable equilibria correspond to observed events (p. 7). This correspondence principle does not seem to be related that of Bohr. Bohr’s complementarity principle is given an air of mystery when it is interpreted to say that light is simultaneously both wave and particle. It is probably closer to his meaning to say that we need both models of light according to the problem we are addressing. Mehra and Rechenberg (2000, p. 193) quote notes for a lecture Bohr gave in 1927: ‘‘The complementary features of the apparent contradictory claims of individuality and superposition [ﬁnd their] explanation thereby that such agencies as free material particles and radiation in empty space are abstractions according to quantum theory. They can only be observed through their interactions.’’ If we could describe the world without observing it, paradoxes such as that of wave/particle duality might disappear. But we are in the world when we observe it and must therefore get along with incomplete and inadequate abstractions that are, as it were, activated only by our interactions with them. Wagner’s notion of the complementarity between models that are in time and models that are out of time is similar to Bohr’s original notion of complementarity. In both cases, we have logically incompatible models capturing differing aspects of a complex (and complicated) world that we can understand only imperfectly. In both cases we need both models and cannot pick one over the other without loss of valuable information. I have been repeating Dr. Wirth’s theme that Austrian economics is a practical thing. The high abstraction of Wagner’s paper would seem far from practical concerns. But he brings us back to earth with several applications including, pertinently, the trade cycle. Wagner laments that the Austrian theory of the trade cycle is often forced into a neo-Walrasian box. When the Austrian neo-Mengerian theory ‘‘is conveyed within an equilibrium framework, it verges on incoherence.’’ Callahan and Horwitz also connect relatively abstract methodological issues to the Austrian theory of the trade cycle. Callahan and Horwitz develop a point that seems to have been ﬁrst made by Alfred Schutz (1932) and Fritz Machlup (1936), whom they cite. The point is that different ideal types have different degrees of anonymity. The arguments of economists sometimes mix together ideal types of very different degrees of anonymity. This mixing of ideal types can matter. The claim that competitive farmers will have to settle for lower prices when crops are abundant is theoretically sound and quite reliable whenever the assumed conditions hold. The assumed ideal types are all highly anonymous. We cannot have as much conﬁdence in the claim that the central bank will bail

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out struggling investment banks. In the fall of 2008 Bear Stearns and Lehman Brothers were allowed to fall; Goldman Sachs was not. If a model mixes together ideal types of different degrees of anonymity, there may be some confusion about what the model says, when it applies, and what evidence counts for or against it. Callahan and Horwitz show that the Austrian theory of the business cycle mixes together ideal types of different degrees of anonymity. It has been subject to criticisms that neglect the different epistemic claims appropriate to ideal types of different degrees of anonymity. Gordon Tullock (1988), for example, criticized the theory for presuming that people never learn. We should recognize, however, that the market draws in naı¨ ve investors. Our model should include both sophisticated and naı¨ ve investors. By deﬁnition, sophisticated actors learn and naı¨ ve actors do not. It is a matter of ‘‘history,’’ not ‘‘theory,’’ to note that both types are typically present in ﬁnancial markets, especially during an unsustainable boom of the sort described in the Austrian theory. The problem of degrees of anonymity is a methodological issue facing observing economists. Callahan and Horwitz note that it is also a practical issue facing active economic agents. For both economists and the agents in economic models, predictions are more precarious when they rely on nonanonymous ideal types. This point allows Callahan and Horwitz to answer another criticism of the theory. They say, ‘‘Cowen (1998, p. 94) contends that an investor who understood that an Austrian cycle was underway could simply short medium-term bonds, not only personally proﬁting but also dampening the boom.’’ If we recognize that investors’ expectations, too, are less reliable when they must rely on nonanonymous ideal types, then we may begin to suspect that Cowen’s argument misﬁres. If a central bank is acting as a ‘‘Big Player,’’ which is likely in the context of creditinduced boom, it will be a nonanonymous ideal type, a cipher. You may know very well that that expansionist trend cannot last, but you cannot reliably guess how long the central bank will persist in its expansionism. ‘‘Therefore, shorting the trend is extremely risky.’’ The contribution of Callahan and Horwitz illustrates the claim that economic theory should include room for ‘‘humanistic’’ methods that distinguish between people and rocks. One rock may be like another, but no two named individuals are the same. When nonanonymous ideal types matter, human idiosyncrasy matters too. Callahan and Horwitz address a central issue in domestic policy. Coyne and Mathers take on foreign policy. They examine the ‘‘The Fatal Conceit of Foreign Intervention.’’ Their title is not chosen casually. The logic of Hayek’s (1988) The Fatal Conceit provides a template for their argument on foreign policy. They show Hayekian epistemics suggest limits to foreign

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intervention that may be greater than generally appreciated. Their ‘‘central argument’’ is that ‘‘the logic of the fatal conceit can be applied to foreign interventions that go beyond the limits of what can be rationally constructed through human reason.’’ Coyne and Mathers express their thesis in a prudently qualiﬁed manner. But the substance of their analysis shows that the limits of constructive rationality are more narrow than seems to be assumed by the makers of foreign policy in the United States and elsewhere. The goal of promoting liberal democracy, for example, may seem unambiguously meritorious. But concrete efforts to do so often ‘‘assume that experts can comprehend the factors underpinning sustainable democratic institutions and transport them abroad,’’ whereas ‘‘our understanding of the conditions conducive to sustainable democracy is severely limited.’’ Reform is difﬁcult in part because it must properly engage both formal and informal institutions. It can be especially difﬁcult to engage the informal institutions of a group, society, or nation. It can be difﬁcult to know what those institutions are, let alone how to adapt them. The Washington Consensus provides a speciﬁc example of the difﬁculty of foreign intervention. First articulated by John Williamson (1990) as a set of 10 policies, Coyne and Mathers explain, the Washington Consensus has been expanded to 20 policies that are ‘‘meant to represent the agreement among the development community regarding reform in developing countries.’’ They include ‘‘privatization,’’ ‘‘trade liberalization,’’ and ‘‘anticorruption.’’ The Washington Consensus seems to reﬂect the best of intentions. We want the people of all nations to enjoy the beneﬁts of development. Shleifer (2009) and Leeson (2010) show that those beneﬁts include not only greater income, but also lower infant mortality, longer life spans, more schooling, and greater democracy. Development efforts based on the Washington Consensus have not always succeeded, however. ‘‘Despite good intentions, many of these efforts have failed to achieve the desired outcomes.’’ An essential part of the problem is the failure to recognize the importance of informal institutions and the textured and contextual nature of the vital social knowledge they embody. Instead, Coyne and Mathers say, ‘‘The development community tends to view underdevelopment as a technological issue, where failure is due to a lack of aid, resources, and effort.’’ War is another example of the fatal conceit of foreign intervention. Coyne and Mathers criticize ‘‘calls for a new era of imperialism and colonialism.’’ They say, ‘‘For example, Ferguson (2004, p. 198) argues that the United States should embrace its role as an empire, using its military might abroad to shape global outcomes and, in some cases, colonize weak and failed

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states.’’ Such calls for imperialism reﬂect the fatal conceit Hayek attacked. Coyne and Mather note that Coyne (2007, pp. 118–136) explains why the American post-war success in Japan and West Germany is not a counterexample. In both cases the essential institutional structure was in place and only policy needed radical revision. ‘‘Where the necessary informal institutions are absent or dysfunctional, in contrast, we should expect interventions to be more likely fall prey to the fatal conceit.’’ Importantly, Coyne and Mathers’ argument does not depend on the motives behind war, imperialism, or ‘‘intervention.’’ It depends only on the gap between available and necessary knowledge. The goals may be ‘‘humanitarianism, peacekeeping, liberation, a variety of national interests, and security concerns.’’ The goals may be high or low. ‘‘Regardless of different motivations,’’ Coyne and Mathers explain, ‘‘we would expect many of these interventions, like the earlier era of colonialism, to fall outside the limits of rational constructivism and, therefore, suffer from a fatal conceit.’’ The papers by Callahan and Horwitz and by Coyne and Mathers illustrate the tight link between the Austrian economics as a theoretical enterprise turning on epistemic issues and the practical concerns of foreign and domestic policy. The ‘‘epistemic turn’’ of Austrian economics has policy implications that transcend the standard dichotomy of left and right in the politics of the United States today. Left ‘‘liberals’’ tend to think that foreign intervention is much harder than domestic intervention. Right ‘‘conservatives’’ tend to think that domestic intervention is much harder than foreign intervention. They are both right. Austrian epistemics shows that both domestic and foreign interventions are hard. Both are easily subject to a fatal conceit that may defeat even the most well-meaning government policies. I have put the words ‘‘liberal’’ and ‘‘conservative’’ in quotation marks. These terms have a ﬂuid meaning. The laissez-faire views of most Austrian economists should be considered ‘‘liberal’’ because they follow directly in the liberal tradition of David Hume and Adam Smith. Mises (1927, p. 194) seems to view Hume as the earliest of the ‘‘great English and Scotch thinkers’’ who were ‘‘the ﬁrst to formulate’’ the ideas of liberalism ‘‘into a system.’’ Calling such liberalism ‘‘true individualism,’’ Hayek (1948) said, ‘‘it is primarily a theory of society, an attempt to understand the forces which determine the social life of man’’ (p. 6, emphasis in original). It is only secondarily a theory about what is politically preferable. At least one value judgment is necessary to get from the scientiﬁc vision of liberalism to its political implications. The value of beneﬁcence toward humans is sufﬁcient to imply most liberal policies, if one also assumes the scientiﬁc correctness of liberal social theory.

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Beneﬁcence is not always a shared value. The Jewish holocaust may be the most salient example, but there are many others. Abolitionists had to ask for the slave, ‘‘Am I Not a Man and a Brother?’’ (Peart & Levy, 2005, p. 189 reproduce Josiah Wedgewood’s famous image carrying this pertinent question.) It is testament to the importance of facts and science, however, that defenders of hierarchical policies such as slavery and genocide represent those whom they would oppress as less than fully human. Hitler, for example, described ‘‘the Jew’’ as ‘‘anti-man, the creature of another god’’ (Dawidowicz, 1975, p. 27). Peart and Levy (2005) uncover British images of the ‘‘simianized’’ Irish. Many readers will have seen similarly vile images of black persons. Such images illustrate the claim that even those who repudiate beneﬁcence toward all humans assert as fact that certain others are different, inferior, and less than fully human. Such appeals to supposed facts show how nearly universal is the value of beneﬁcence toward humans. Where beneﬁcence is not openly challenged, liberalism becomes mostly a question of means and not ends (see Mises, 1949, pp. 879–881). We agree on the end of improved welfare for our fellow humanity, the problem is how to get there. For this reason Mises said, ‘‘Liberalism is distinguished from socialism, which likewise professes to strive for the good of all, not by the goal at which it aims, but by the means that it chooses to attain that goal’’ (pp. 7–8). Laissez-faire liberalism is inconsistent with traditional notions of ‘‘conservative’’ and with what is today considered ‘‘conservative’’ in the United States and at least some other rich countries. In ‘‘Why I am not a Conservative,’’ Hayek (1960) lists several differences between liberalism and conservatism. The conservative ‘‘does not object to coercion or arbitrary power so long as it is used for what he regards as the right purposes.’’ In sharp contrast with the liberal, the conservative ‘‘is less concerned with the problem of how the powers of government should be limited than with that of who wields them; and, like the socialist, he regards himself as entitled to force the value he holds on others people’’ (Hayek 1960, p. 401). Liberals distrust all forms of power and seeks legal and political mechanisms to reduce or restrain power, such as the system of checks and balances built into the United States Constitution. The distrust of power is reﬂected in Hume’s statemet, ‘‘Political writers have established it as a maxim, that, in contriving any system of government, and ﬁxing the several checks and controls of the constitution, every man ought to be supposed a knave, and to have no other end, in all his actions, than private interest. By this interest we must govern him, and, by means of it, make him, notwithstanding his insatiable avarice and ambition,

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co-operate to public good’’ (Hume, 1777). Boettke and Leeson (2004) call this maxim ‘‘robust political economy.’’ Mises published a defense of liberalism in 1927. It contains passages that could hardly be considered conservative. ‘‘All mankind’s progress has been achieved as a result of the initiative of a small minority that began to deviate from the ideas and customs of the majority until their example ﬁnally moved the others to accept the innovation themselves’’ (Mises, 1927, p. 54). This passage comes in the middle of an argument against all forms of prohibition including not only alcohol, but also ‘‘morphine, cocaine, and similar poisons’’ (p. 53). If the state can choose for us in this area, Mises argues, there can be no principle to limit state power. Even freedom of speech may be threatened. ‘‘Let no one object,’’ Mises warns, ‘‘that the struggle against morphinism and the struggle against ‘evil’ literature are two quite different things’’ (p. 54). Mises notes that ‘‘In the United States, the Methodists and Fundamentalists, right after the passage of the law prohibiting the manufacture and sale of alcoholic beverages, took up the struggle for the suppression of the theory of evolution, and they have already succeeded in ousting Darwinism from the schools in a number of states’’ (p. 54). Liberalism seeks to beneﬁt the poor. ‘‘It is precisely want and misery that liberalism seeks to abolish’’ (Mises, 1927, p. 9). Mises defends liberalism against the charge of materialism by saying, ‘‘All that social policy can do is to remove the outer causes of pain and suffering; it can further a system that feeds the hungry, clothes the naked, and houses the homeless’’ (p. 4). This gloss on liberalism reveals the sense in which both Callahan and Horwitz and Coyne and Mathers are engaged in liberal scholarship. We may presume that the true goals of policy makers are those stated. Proper social theory reveals, however, that the means chosen are ‘‘inappropriate to attain the ends aimed at’’ (Mises, 1949, p. 93). We may presume that central bank authorities wish only to produce stable prices and high employment without regard to inappropriate motives such as promoting partisan political ends or increasing bank power. We may presume that the generals want to spread democracy, peace, and good will to men. Proper social theory reveals, however, that discretionary monetary policy cannot achieve the presumed goals of such policy. Proper social theory reveals that democracy is hard to impose by force and war tends to diminish good will toward men. This mode of arguing from ends presumed has been characteristic of political economy since Quesnay at least, but the logic of such reasoning was most fully elaborated and clariﬁed by Ludwig von Mises. He said, ‘‘It is in this sense that economists criticize policies from the point of view of the ends

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aimed at. If an economists calls minimum wage rates a bad policy, what he means is that its effects are contrary to the purpose of those who recommend their application’’ (Mises, 1949, p. 879). And it is in this sense that we may see Coyne and Mathers’ argument as deeply Misesian. The charms of a sunny autumnal weekend in Mississauga were a cheery backdrop to the urbane conversations on Austrian economics by an amiable group of scholars, some identifying with the tradition and others not. Events that were very fresh that October weekend provided the sober context of regrettably exciting times. The resulting contributions to this volume reﬂect both the scholarly depths of the Austrian tradition and its applicability to practical problems. The papers are urbane, scholarly, learned. They are also aimed, directly or indirectly, at policy for regrettably exciting times. The contributors to this volume honor the Austrian tradition by combining the scholarly and the practical and by their seriousness of purpose. I felt honored to be in their company that memorable October weekend.

ACKNOWLEDGMENTS I thank Gene Callahan, Laurent Dobuzinskis, Steve Horwitz, Barkley Rosser, and Alf Wirth for helpful comments.

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Papadimitriou, C. H. (1994). On the complexity of the parity argument and other inefﬁcient proofs of existence. Journal of Computer and System Sciences, 48, 498–532. Peart, S. J., & Levy, D. M. (2005). The ‘‘vanity of the philosopher’’: From equality to hierarchy in postclassical economics. Ann Arbor, MI: The University of Michigan Press. Prychitko, D.L. (in press). Competing explanations of the Minsky moment: The ﬁnancial instability hypothesis in light of Austrian theory. Review of Austrian Economics, forthcoming. Richter, M. K., & Wong, K.-C. (1999). Non-computability of competitive equilibrium. Economic Theory, 14(1), 1–27. Robbins, L. (1981). Economics and political economy. American Economic Review, 71(1), 1–10. Rosser, J. B., Jr. (1999). On the complexities of complex economic dynamics. Journal of Economic Perspectives, 13(4), 169–192. Rosser, J. B., Jr. (2000). From catastrophe to Chaos: A general theory of economic discontinuities (2nd ed.). Dordrecht: Kluwer Academic Publishers Group. Samuelson, P. (1947). Foundations of Economic Analysis. Cambridge: Harvard University Press. Schutz, A. (1932 [1967]). The phenomenology of the social world. G. Walsh & F. Lehnert (Trans.). Evanston, IL: Northwestern University Press. Shleifer, A. (2009). The age of milton friedman. Journal of Economic Literature, 47(1), 123–135. Small, A. W. (1924). Origins of sociology. Chicago: University of Chicago Press. Tullock, G. (1988). Why the Austrians are wrong about depressions. Review of Austrian Economics, 2(1), 73–78. Velupillai, K. V. (Ed.) (2005). Computability, complexity and constructivity in economic analysis. Oxford: Blackwell. Vriend, N. J. (2002). Was Hayek an Ace? Southern Economic Journal, 68, 811–840. Walras, L. (1954). Elements of Political Economy. W. Jaffe (Trans.). Homwood, IL: Richard D. Irwin, Inc. Williamson, J. (1990). What Washington means by policy reform. In: J. Williamson (Ed.), Latin American adjustment: How much has happened? Washington, DC: Institute for International Economics.

OPENING REMARKS Alfred G. Wirth Welcome to all of you to our analyses, presentations, and discussions. I especially want to thank Franz Szabo, the Head of the Wirth Institute, and Roger Koppl, for doing all the many things required to make this conference happen. As I mentioned at the last conference, according to von Mises, the originally named ‘‘Vienna School’’ became the ‘‘Austrian School’’ not as an honor but rather as a term of opprobrium applied by Prussian historical economists who found Menger and his successors’ theories not scientiﬁc enough. The principles of our school have only rarely been applied in Austria or elsewhere, although von Boehm-Bawerk did serve twice as the Minister of Finance under Emperor Francis Josef of Austria, around 1900. Lastly, as you all know, our discipline (like most other learning) is now most thoroughly studied and developed at American universities, not in Europe. When I say that our principles have not generally been applied by governments, I mean that politicians have not understood our analysis nor felt able to follow our prescriptions. But they have certainly made the mistakes our Austrian School warns against. All governments have interfered with economies and business, most notably by artiﬁcially lowering interest rates. These unnaturally low yields have discouraged saving on the part of consumers, encouraged inappropriate entrepreneurial and investment behavior because of ultra low ﬁnancial barriers to entry, and also deferred normal bankruptcies. Had interest rates been left to ﬁnd their own market levels, they would have provided continuous adjustments as businesses fail allowing more productive use of these resources. What is so Austrian About Austrian Economics? Advances in Austrian Economics, Volume 14, 25–27 Copyright r 2010 by Emerald Group Publishing Limited All rights of reproduction in any form reserved ISSN: 1529-2134/doi:10.1108/S1529-2134(2010)0000014004

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Especially right now, we live in regrettably exciting times. All businesses in the world are trying to cope with a universal ﬁnancial crisis. After living with unnaturally low costs for money, we are experiencing a credit freeze, which has been seen world-wide only once before in the last 100 years – during the Great Depression of the 1930s. Of course much was different then, especially in Austria, which was already destitute before 1930. The new republic, formed in 1918, had much against it: (1) It had only 10% of the previous empire’s land and people. (2) There was little agriculture and industry, since these had been concentrated in other, now other new nation’s territories. (3) Per capita GDP had already fallen precipitously (1930 was 25% below its peak in 1913), and the country was charged with paying reparations for World War I. (4) Unemployment was over 20% and exports were blocked by former trading partners. So the GDP fell further (the mid-1930s per capita was 40% less than that of 1913). In fact, Austrian per capita GDP only reached 1913 levels again nearly 40 years later, in the early 1950s! Could anything have worked there during the Depression? Our current crisis has some similar characteristics: We are starting with too much low cost money which has discouraged saving and led to bank failures. But fortunately, there are differences: Unlike back then, we have relatively full employment, our monetary authorities have moved quickly to support banks, ﬁscal policy is making every effort to restore conﬁdence, and there have, at least so far, been no new national barriers to international trade. Yet all our present government bailouts will in turn move us further from free markets. The call is for more regulations! Yet regulations and big brother guidance started the present malaise: Without government acts (the Clinton ‘‘Community Reinvestment Act’’) and guarantees by FNMA (Fannie Mae), FHLMC (Freddie Mac) and GNMA (Ginnie Mae), all of which distorted the US mortgage market, institutions globally would not have bought these unworthy securities. The government-orchestrated bubble and natural entrepreneurial greed were the triggers for the stock market collapse and the global credit freeze. The Austrian School believes in competition. The free market, as if by magic, arrives at better solutions than any individual with total control, could ever plan. We all believe that problems must be solved by dealing with the underlying conditions, not just symptoms. But, regrettably, our politicians do not see themselves as having the option of waiting for the market to correct itself. So they will reﬂate, as best they can. Regrettably, nonaction is not an alternative at this time. We are facing withdrawal symptoms, just as an alcoholic is, after a bout of binge drinking.

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He must swear off alcohol, but meanwhile, he looks for a little more of the same, to make life bearable. So all central banks will (have to) provide tons of liquidity to keep things going. At some point, perhaps in a year, the challenge will be how to return to normalcy, how to mop up what will be excessive money supply chasing too few goods, and how to ‘‘re-denationalize’’ ﬁnancial institutions, and how to allow free markets to function. Subject to that practical limitation, I would ask each of you to reﬂect on the current economic and ﬁnancial problems facing our world. What do you think is appropriate now – and next year? At the end of our formal sessions, we have time to hear your analysis and your suggestions of what an appropriate Austrian School approach would be. Of course this was not on our original schedule, but then most of us did not realize that this breakdown would take place just now, nor how all-pervasive it would be. Again, welcome! We are going to hear papers on interesting topics with lively discussions over the next day and a half. I look forward to these as well as our informal discussions. And please do not forget to think about: How would you handle our current problems over the next few years?

THE DOMAIN OF AUSTRIAN ECONOMICS$ David Colander ABSTRACT Modern mainstream economics is a plurocracy in which there is no orthodoxy of ideas, only an orthodoxy of method. Given the training it provides its students, mainstream economics’ natural domain is science. With the mainstream’s acceptance of complexity views of the economy, Austrian economist’s views can now get a hearing within the mainstream. Thus, within the science of economics, there is no need for a separate Austrian economics. However, there is a need for Austrian economics in political economy, the branch of economics that takes the insights of science and relates them to policy. The paper urges Austrian economics to embrace political economy as its domain and to position its work within political economy.

When Roger asked me for a title, my natural thought was ‘‘The Death of Austrian Economics’’ – after all since I killed off neoclassical economics (Colander, 2000), was life still worth living for Austrian economics? But $

Keynote address prepared for Wirth Institute for Austrian and Central European Studies’ Biennial Workshop Conference on the Austrian School of Economics: What is so Austrian about Austrian Economics?

What is so Austrian About Austrian Economics? Advances in Austrian Economics, Volume 14, 29–41 Copyright r 2010 by Emerald Group Publishing Limited All rights of reproduction in any form reserved ISSN: 1529-2134/doi:10.1108/S1529-2134(2010)0000014005

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Austrian economic has died so many times, and has always risen again, we decided that a better title was ‘‘The Domain of Austrian economics.’’ To have a domain, you cannot be dead, so by choosing that title I am implicitly taking the position that Austrian economics should continue to exist and not be integrated into the ‘‘new mainstream plurodoxy’’ that I believe describes the methodological position of mainstream economics in the ﬁrst decade of the 21st century, as I have argued should happen to almost all other organized heterodox groups (see Colander, 2010). By plurodoxy, I mean a mainstream that has no orthodoxy, neoclassical or other. It is a mainstream composed of many different competing beliefs and research programs, including an ‘‘inside-the-mainstream’’ heterodoxy. Roger Koppl has nicely captured the many views with his BRICE paper (Koppl, 2006). I am not arguing that mainstream economics is open and that anything goes – far from it. All research programs are sociologically closed as insiders develop methods to protect their rents, but once inside, there is no orthodoxy of ideas that one has to follow. Modern mainstream economics protects its rents through an orthodoxy of method. Modern economics considers itself a science and has its version of a scientiﬁc method – you model, you quantify, and you stay in a fairly narrow set of methodological approaches. Because, in truth, modern economics often falls far short of scientiﬁc standards, it often tries to make up for that failing by focusing on work that is technically difﬁcult, even when that technical difﬁculty is not especially helpful. But all economists face the same requirement, so it is not closed to any ideas on ideological grounds.1 So my argument is that modern economics is a plurodoxy limited by method, not by ideas or views, which means that Austrian ideas can get a hearing within the mainstream.

THE PROBLEM WITH HETERODOXY CHARACTERIZATION To argue that Austrian economics has a domain, and should continue as a distinct group is a concession for me, since in my other work (Colander, 1998, 2003), I have argued against the use of classiﬁcations of subgroups of heterodox economists except as temporary crutches for incoming students and lay people who need oversimpliﬁed characterizations of views as an entre´e into the debates. Thus, I have argued that all such characterizations of subgroups of economists – Austrian, Keynesian, classical, Post-Keynesian, feminist, institutionalist, and behavioral – should be ﬂeeting. I have further argued that the characterization should change over time because the debates

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change. Often, as soon as one speciﬁes what is Austrian, Post-Keynesian, or institutionalist, about Austrian, Post-Keynesian, or institutionalist, that speciﬁcation is likely to change. The reason for this ﬂeeting nature of classiﬁcation is that the views held by economists are ﬂeeting, and have to be understood in juxtaposition to other views being expressed at the time; their views have little meaning out of context of the debates that lead to the terms in the ﬁrst place. As we argued in Colander, Holt, and Rosser (2004), the economics profession is best thought of as a complex emerging system that cannot usefully be characterized by static names and concepts. You can use classiﬁers, but as soon as people start thinking that the classiﬁer deﬁnes them, it become counterproductive. The problem with any self-characterization of a view or group is that selfcharacterizations tends to become institutionalized – it leads to separate organizations and journals that deﬁne and conﬁne the conversation of this subgroup of economists. The group members communicate among themselves, and not with other heterodox groups or with mainstream economist. The self-characterization pulls them out of the mainstream plurodoxy. Put another way, self-classiﬁcation leads people to become heterodox. The creation of such subgroups deﬁned by self-characterization is often highly satisfying for the creators of these subgroups; it creates a small pond where one can be a big ﬁsh. This happens especially when the group establishes educational institutional beachheads and begins training their own students. As X students come in and study and dissect the works of X economists, often in excruciating detail, the ﬁrst movers in X have the wonderful pleasure of having someone read and care about what they said – a result that tends to be important in an academic’s utility functions. Thus, the creation of groups leads to protected domains where ideas are not subjected to the competitive pressures that they would be subjected to in the mainstream plurodoxy. As pleasurable as it is to be a big ﬁsh in a small pond, it is not a good strategy for spreading one’s ideas. Important ideas generally take multiple generations of scholars to develop, and unless the X group can develop institutions to compete with mainstream institutions, they stop progressing and become inbred. The group’s ideas become heirloom ideas that do well in a protective heterodox bubble, but which cannot stay alive outside the bubble. Unless X group can provide an institutional structure that creates a replicator dynamics that expands the number of jobs available for its graduates, its ideas will not spread beyond the bubble. Too specialized training in a subdivision leads to graduates who can exist only at the edge of the mainstream, and in environments that have

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protective bubbles. Because their training is different, they ﬁnd that their learning is of little interest to mainstream economists; they lack the ability to communicate with those mainstream economists, and hence, their views do not get a hearing. This is especially difﬁcult because the ﬁeld of economics is an evolving complex system, and what made the aging heterodox economists relevant in their youth often is of far less relevance in their middle age or old age. It is for these reasons that I argue (Colander, 2010) that heterodox organizations should be seen as incubators that give new ideas a chance to develop to the point at which they can be put out into the mainstream – to live of die. Most will die, because the competition is very strong in the mainstream, but a few may live, and those that do may well establish a foothold in the mainstream plurodoxy. What I believe must be guarded against with any self-characterized subgroup is allowing the incubator to become the environment.

IT IS TIME TO DECLARE VICTORY AND LEAVE With that introduction, let me turn to my outside view of Austrian economics, and what I see as its domain. When I was ﬁrst introduced to Austrian economics, which involved reading Lachmann, Hayek, Yeager, and Kirzner back in graduate school, I was impressed. I thought they had some neat ideas. They were certainly more insightful and thoughtful than much of the mainstream work that I was reading. I felt that clearly they were on to something that I was not getting in my classes. Thus, I was extremely sympathetic to Austrian ideas. As I came to know Austrian economists a bit better, it became clear to me that I was far too eclectic in my both policy and theoretical views to be an Austrian. I also learned that Austrians were far from homogeneous, and within the subgroup of Austrian economics there were more sub-subgroups than I could keep track of in my head. I found myself most comfortable with that subset of Austrians who saw it as necessary to separate out analytics from their pro-market ideology, which led other Austrians to question whether they were truly Austrian. I urged this group to reach out to other heterodox groups of all varieties and concentrate on analytic criticisms of economics that transcended ideology, because that was the only way that I felt that they would be taken seriously by the mainstream.2 But, as I said in the preceding text, economics is a complex emerging system, and the problem faced by Austrian economics today is different

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from the problem faced by economists of the 1970s. Today, the problem facing all heterodox groups, Austrians included, is that much of what they were ﬁghting against no longer exists, if it ever did exist. Any orthodoxy that may have existed back in the 1970s has been replaced by a mainstream plurocracy. All ideas, if expressed in an acceptable methodological form, now can get a hearing. Thus, the key analytic point that I took from Austrian economics was that any meaningful consideration of the economy must treat it for the complex system that it is.3 Today, it can be treated as such with the mainstream. That complexity war has been won, at least on the cutting edge of economics.4 Although there is likely another 20 years of mopping up to do, as the stragglers are brought in, there is today an acceptance that considering the economy as a complex system is a legitimate scientiﬁc approach. There is an irony and injustice here. Even though Austrians have won, its writings will not be given any accolades because, in the mainstream vision of the history of economic thought, the scientiﬁc war was won on the technical front – not on the conceptual front. The complexity war was won by bringing in the Calvary – ultra-mathematicians and natural philosophers who were not in the hold of any mainstream economics orthodoxy that tended to dominant the profession in the 1970s. This mathematical cavalry brought in new analytic and computing techniques. The debate about complexity has now moved on to a highly technical battleﬁeld, and the debate concerns whether any of these new analytic techniques shed sufﬁcient light on economic problems to warrant the greater technical sophistication they require, or whether the best we can hope for is an algorithmic understanding of reality (Velupillai, forthcoming). The jury is still out on that, but it is a debate that really has little to do with the Austrian economists that I know. Nonlinear dynamics, measure theory, and ultrametrics are not Austrian economist’s natural domain. Studying Hayek, Lachman, von Mises, or Rothbard is not going to prepare one for that mathematical battle. Some Austrians may well make contributions in this area, but if they do, I suspect that it will not be because of their Austrian training. For example, say I asked a graduate student at George Mason to explain to me what Lars Ljungqvist and Thomas Sargent meant in their introductory graduate macro text (ﬁrst chapter) by the ‘‘spectral density matrix and the Fourier transform of the covariogram of a covariant stationary stochastic process?’’ My suspicion is that I would get a blank stare. My point is that to take part in this mainstream scientiﬁc debate, you need to know the tools and techniques and the mainstream argument better than do the top mainstream economists. Only such people will have their

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complaints taken seriously. Barkley Rosser and Buz Brock can take part in that debate, but I, and most Austrians, cannot. The Austrian programs that I know do not provide students the technical sophistication to take a meaningful part in that debate, and their students do not have the proclivity to acquire that technical sophistication. So unless they team up with mathematicians or physicists, I see little future for as a distinct entity in Austrian economic science. It is time to leave the protective science bubble. My conclusion then is that the Austrian heterodox scientiﬁc research programs is unsustainable, and should declare victory, and essentially merge into the mainstream. It should not distinguish itself with separate graduate programs or maintain a separate conversation, trying to teach Austrian economic science.5 Science is now the mainstream’s domain, and Austrians do not have the mathematical ﬁrepower to ﬁght in that domain.6

THE MARCH OF DIMES PROBLEM My advice to most other heterodox groups has stopped there, and I have encouraged them to become an ‘‘inside the mainstream’’ gorilla economists – working within the mainstream while maintaining the ideas and beliefs. Being a gorilla economist inside the profession is a much harder life than is life in the protective bubble of heterodoxy, but my sense was that it would be more effective for the heterodox movement. That is why my ﬁrst inclination in this paper was to kill off Austrian economics – not to end their ideas, but to spread them throughout the mainstream profession, and get them out of their protective bubble. But I am not arguing that because, among all heterodox groups, Austrians have been the most institutionally successful. The success of Austrian economics leaves it with what I call the March of Dimes Problem: What do you do if you have a viable institutional organization and you win.7 One solution is to disband, but that is hard – organizations acquire a life of their own – they create rents, recognition, and power to those in the organization, and rational people work hard to maintain those rents. So the question is: what to do with these organizations if you are not disbanding them. The answer is that you get a new domain. By domain, I mean what topics it considers under its purview. Since I have already said that the science of economics should no longer be considered under the purview of Austrian economics, some of you may be thinking that I am being illogical. But I am not, because there is much more to economics than science. Speciﬁcally, there is the domain of political economy, a branch of economics that relates the insights of economic theory

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with both the normative goals of society and the real world institutions within which policy must be applied. Although science avoids normative and real world institutional issues, political economy embraces them, and guides society in implementing economic ideas. Thus, my advice to Austrian economists is to formally declare that your domain is political economy, not economic science, and that you do it with ﬂare and gusto. Be ‘‘in your face’’ with the mainstream, giving them the science domain of economics, but ﬁghting for every inch of the policy domain of economics. The reason I advise this is that political economy is a domain where Austrian economists have much greater skills than those in the mainstream. It is a domain where Austrian economists have a chance of winning.

ECONOMIC SCIENCE AND POLITICAL ECONOMY Since the term, political economy, has many different meanings, I should be a bit more explicit about what I mean. Let me start by what I do not mean. I do not mean much of the work that currently goes under the name political economy – work that adds political variables to empirical models. In my view, most of that work is at best game playing – creating arbitrarily deﬁned concepts and relating them to other concepts in ways that provide little understanding or insight. Instead, I mean by political economy is what Lionel Robbins meant – that branch of the ﬁeld of economics that is explicitly concerned with policy. Since Robbins’ views have been seriously misunderstood by the profession, let me brieﬂy explain.8 In his famous work on method (Robbins, 1932) in which he deﬁned economics, Robbins was clear that he was deﬁning economic science, not the entire ﬁeld of economics. Robbins interpreted economic science, like classical economists before him, very narrowly; it had to have no value judgments and no speculation. Before something would become part of the knowledge of economic science, it had to be indisputable by a trained economist. Since all policy was not indisputable for Robbins, economic science had essentially nothing to say about policy. He wrote ‘‘In the present state of knowledge, the man who can claim for economic science much exactitude is a quack’’ (Robbins, 1938, p. 344).9 Robbins’ methodological prescription was that value judgments (which included interpersonal welfare comparisons, but went far beyond them) had no place in economic science. That prescription has been seriously

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misunderstood by the profession, which interpreted it as meaning that value judgments had no place in economics. He speciﬁcally did not say that. All Robbins said is that economists should not use value judgments in their role as scientists. He speciﬁcally said that they should use value judgments in their role as economists. He knew that to make policy prescriptions one had to make value judgments. His point was that you do not draw policy from science – you draw it from political economy, using scientiﬁc knowledge as one input, but only one input. Thus, if you were saying anything about policy, you were not being an economic scientist, you were being a political economist. In his Ely Lecture, he is very explicit about this. He writes: My suggestion here, as in the Introduction to my Political Economy: Past and Present, is that its (political economy) use should be revived as now covering that part of our sphere of interest which essentially involves judgments of value. Political Economy, thus conceived, is quite unashamedly concerned with the assumptions of policy and the results ﬂowing from them. I may say that this is not (repeat not) a recent habit of mine. In the Preface to my Economic Planning and International Order, published in 1937, I describe it as ‘‘essentially an essay in what may be called Political economy as distinct from Economics in the stricter sense of the word. It depends upon the technical apparatus of analytical Economics; but it applies this apparatus to the examination of schemes for the realization of aims whose formulation lies outside Economics; and it does not abstain from appeal to the probabilities of political practice when such an appeal has seemed relevant. (Robbins, 1981, p. 8)

In Robbins’ time economists could reasonably focus on both political economy and economic science, but today that is harder. Technological developments have increased the need for specialization. Today good economic science requires a highly specialized technical training – a training that generally precludes training in the nuances of value judgments and sensibilities that are needed to be a good political economist. Either students learn such nuances and sensibilities on their own, or they do not learn them. This leads to over simplistic discussion of policy and all types of embarrassing pedestrian discussions of policy by top scientiﬁc economists. The problem occurs on both side of the political spectrum. For example, we have macro scientists V. V. Chari and Patrick Kehoe (2006) arguing that modern macroeconomic theory tells us that ‘‘discretionary (macro) policy making has only costs and no beneﬁts, so that if government policymakers can be made to commit to a policy rule, society should make them do so’’ (pp. 7–8). Similarly, we have economists arguing that economic theory tells us that the existence of externalities implies that we need government intervention. Both are equally wrong, and both statements make a well-trained political economist cringe. Economic theory tells us nothing about policy.

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Accepting Robbins’ distinction means that much of what currently goes under the name applied policy work combines scientiﬁc techniques with policies in unacceptable ways, by either giving too much weight to quantitative measures, without discussion, or crossing the line and seeming to provide scientiﬁc foundations for normative judgments. Trying to draw policy conclusions from scientiﬁc models reﬂects a lack of understanding of the limits of science, which Hayek (1952) nicely explained in The Sensory Order. The entire welfare economics approach of modern economics, which attempts to draw policy conclusions from deductive models is, in Robbins’s framework, misplaced. Attempts to get around Robbins’ concerns, such as the new and the new new welfare economics have made the problem worse, not better. For a true follower of Robbins, welfare economics belongs totally in the domain of political economy not economic science. Seen within the domain of political economy, welfare economics is sorely lacking. In terms of developing an analysis of policy, the true follower of Robbins was Ronald Coase, and what the economics profession sorely needs is an alternative Robbins– Coasian policy economics developed within the political economy domain, not within the science of economics domain. Austrian economists should be on the forefront of developing that alternative policy domain.

DIFFERENTIATING POLITICAL ECONOMY FROM ECONOMIC SCIENCE The reason differentiating economic science training from political economy training is important is that the methodologies for both are fundamentally different. As I discussed in Colander (2009a), the methodology for economic science is highly technical and requires what I call a producer’s knowledge of the latest developments in mathematics, along with a highly creative mind, and the latest developments in statistical techniques. Graduate schools now attempt to train students to be producers of scientiﬁc knowledge. That makes sense for training economic scientists but not for training political economists. Scientiﬁc training does not prepare economists to handle the subtleties of applying scientiﬁc knowledge to policy. That involves a quite different type of training – and it would be that different type of training that graduate schools in political economy would provide. Graduate programs in political economy would have a fundamentally different type of training than economics students currently get. They would train students to be consumers of the science of economics and in how to apply those insights to policy.

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The reason it would be a different training is that a political economist does not require a producer’s understanding of the latest developments in mathematics or statistical techniques, just a consumer’s understanding. By that I mean that it would have a Charles Kindleberger, Leland Yeager, or Charles Goodhart understanding of economic theory. They may not have produced the latest theories, but I would turn to these writers, not to most producers of modern theory, when I am trying to determine whether the scientiﬁc theories are relevant to policy. A political economist has to know how ideas developed; he or she has to know theory, but they also have to know institutions, political philosophy, and moral philosophy. A political economist would be trained in the philosophical foundations of policy – he or she would know how ethics interrelate with policy and would have a broad knowledge of both past economic literature and economic institutions. A political economist would also be trained in a different type of argumentation. That argumentation would not be scientiﬁc (proof, lemma, and theorem) but rather lawyerlike, by which I mean that the political economist would be trained to weigh the evidence, and after weighing the evidence how to develop the most persuasive case he or she can to show why a particular policy should or should not be followed. The argument would include every dimension of the problem that is important to the conclusion. In political economy, one can assume nothing away because of tractability problems. This need to include all aspects of an argument, means that the arguments a political economist makes will not be airtight arguments given wellspeciﬁed assumptions. Instead, they will be convincing arguments given the shared knowledge of people he or she is making the argument to. The output of political economy is precepts – general rules of thumb to guide policy. The outputs of economic science are empirical facts – regularities that one develops inductively – or theorems – deductive truths that follow from a wellspeciﬁed model.

CONCLUSION Let me conclude with my take-away message. The domain of Austrian economics is political economy. That domain should be embraced, and it can only be embraced by giving up the scientiﬁc domain. Doing so means changing Austrian PhD programs to speciﬁcally embrace political economy. They should be called political economy programs and they should speciﬁcally

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not try to produce economic scientists. Their training in theory should be training the producers a consumer’s knowledge, not a producer’s knowledge, of theory.10 Taking control of the political economy domain will not be easy. Mainstream economists think that they control the entire domain of economics. The entire political economy ﬁeld of economics, which was the dominant branch of classical economics, has been lost and is now occupied by economic scientists. They think they own it. One should be under no illusion that the mainstream economics will let Austrians stake out the political economy domain, because in fact, the domain of political economy is by far the larger part of the domain of the ﬁeld of economics. Were the mainstream economics to limit itself to the pure science of economics – which given its current training, it should – its size would be approximately the same size as the ﬁeld of physics, and its job opportunities would be similar. Graduates of science of economics programs would be delighted when they get a post-doc. The reason is that, in truth, there is not a whole lot of interest in the pure science of economics. Society’s interest in economics is mainly in political economy.11 My ﬁnal comment is that if Austrian economics is to establish a foothold in the domain of political economy, it will not belong to it alone. An ideological neutral political economy would be inhabited by political economists with all kinds of political and moral views, some quite anathema to Austrians. If Austrian political economy programs only present their moral views, and do not became a forum within which the best of all moral views are allowed to interact and compete, these programs will be seen as ideologically driven, and not methodologically driven. Being seen as ideologically driven will undermine even the potential for success.

NOTES 1. See Colander (2005) for a further discussion of this issue. 2. I am pleased that that group has been successful, and through the efforts of economists such a Peter Boettke and Roger Koppl, Austrian economics has played an important role in maintaining a heterodox presence in the United States, and has kept them from being seen as just pro-market ideologs. 3. The argument that complexity is the central Austrian insight is, of course, debatable. I say that because I believe that once one accepts that the economy is a complex system, one is naturally led to the other elements of the economy that Austrians have emphasized, such as the knowledge problem, entrepreneurship, and the limits of mathematics in understanding a complex system such as the economy.

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4. In ﬁghting wars, I should admit that I am from Vermont and am prone to the George Aiken ‘‘declare victory and leave’’ solution to wars. 5. The Austrian classiﬁcation here could be replaced by Institutionalist, PostKeynesian, or a variety of other heterodox classiﬁers. 6. As I suggested in the preceding text, one could argue that mathematics is not the appropriate language for science, but I believe that argument is wrong (assuming that my mathematics one means a wide range of formal logical argumentation that involves carefully speciﬁed techniques that are designed to arrive at as precise answers as one can, and not more precise) Thus, it includes work such as Velupillai (forthcoming) or Wolfram (2002). If Austrians want to argue against the use of such a broad interpretation of mathematics as the language of science, it places them in opposition to not only economics, but also the broader scientiﬁc community, which is why I consider it a loosing argument as well. 7. The March of Dimes was a charity devoted to ﬁghting polio. When polio was eradicated, it had to either go out of existence or choose a new target. It chose to ﬁght premature death, infant mortality, and birth defects, three problems that are highly unlikely to ever be solved, thereby preserving its long-term existence. 8. A more extensive discussion can be found in Colander (2009b). 9. In Robbins’ time that meant that economic science was only concerned with deductive work since the empirical tools were very rudimentary, and did not allow much testing of theories, but more recently has expanded to include empirical work. Thus, I argue that Robbins would change his deﬁnition of economics, were he around today. 10. A good pool of applicants for these political economy programs will be students at top graduate programs who have become disillusioned with the education they are getting there. Credit should be given for courses taken there, and they should be welcomed into the political economy program. Similarly, undergraduates with Austrian leanings who are interested in studying economic science should be directed to attend mainstream science programs. 11. Even if one expands the narrow interpretation of Science (large ‘‘S’’ Science) that Robbins and I use, to include an engineering branch (small ‘‘s’’ science) as well as a pure science branch, while the domain expands considerable, that domain of the engineering branch shorn of its policy issues is limited to technical interpretation of data and pulling information from data. Relating the information to policy will remain the domain of political economy.

REFERENCES Chari, V. V., & Kehoe, P. (2006). Modern macroeconomics in practice: How theory is shaping policy. Journal of Economic Perspectives, 20(4), 3–28. Colander, D. (1998). Beyond new Keynesian economics: Post Walrasian economics. In: E. Roy Rotheim (Ed.), New Keynesian economics Post Keynesian alternatives. Cheltenham, England: Edward Elgar. Colander, D. (2000). The death of neoclassical economics. Journal of the History of Economic Thought, 22(2), 127–143. Colander, D. (2003). Post walrasian macroeconomics and heterodoxy: Thinking outside the heterodox box. International Journal of Political Economy, 33(2), 68–81.

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Colander, D. (2005). Economics as an ideologically challenged science. Revue de Philosophie Economique, 1, 3–24. Colander, D. (2009a). How did macro theory get so far off track, and what can heterodox macroeconomists do to get it back on track? In: E. Hein, T. Niechoj & E. Stockhammer (Eds), Macroeconomic policies on shaky foundations – Whither mainstream economics? (pp. 55–73). Marburg: Metropolis. Colander, D. (2009b). What was ‘‘it’’ that Robbins was deﬁning? Journal of the History of Economic Thought, 31(4), 437–448. Colander, D. (2010). Moving beyond the rhetoric of pluralism: Suggestions for an ‘‘inside-themainstream’’ heterodoxy. In: W. Garnett, E. Olsen & M. Starr (Eds), Economics and pluralism (pp. 36–47). Routledge. Colander, D., Holt, R., & Rosser, B., Jr. (2004). The changing face of economics: Conversations with cutting edge economists. Ann Arbor, MI: University of Michigan Press. Hayek, F. (1952). The sensory order. Chicago, IL: University of Chicago Press. Koppl, R. (2006). Austrian economics at the cutting edge. The Review of Austrian Economics, 19(4), 231–241. Robbins, L. (1932). An essay on the nature and signiﬁcance of economic science. London: Macmillan. Robbins, L. (1938). Live and dead issues in the methodology of economics. Economica, 5(August), 42–352. Robbins, L. (1981). Economics and political economy. American Economic Review, 71(May), 1–10. Velupillai, K. V. (forthcoming). Taming the incomputable, reconstructing the nonconstructive and deciding the undecidable in mathematical economics. New Mathematics and Natural Computation. Wolfram, S. (2002). A new kind of science. Champaign, IL: Wolfram Media.

AN ‘‘AUSTRIAN’’ INTERPRETATION OF THE MEANING OF AUSTRIAN ECONOMICS: HISTORY, METHODOLOGY, AND THEORY$ Richard M. Ebeling THE USE OF THE NAME ‘‘AUSTRIAN,’’ AND HOW THE AUSTRIANS AND OTHERS THOUGHT ABOUT IT In general, the term ‘‘Austrian Economics’’ has been used both descriptively and normatively. It has either designated a set of ideas about the fundamental nature of economic theory and its logical implications or it has been viewed as a conception of society and the market with certain policy implications concerning the limits to and dangers from government intervention and control. The terms ‘‘Austrian,’’ ‘‘Austrian School,’’ and ‘‘Austrian Economics’’ were not used by Carl Menger, the School’s founder, in his own early $

Presented at the Wirth Institute Workshop on Austrian Economics in Mississauga, Ontario, Canada, October 17 and 18, 2008.

What is so Austrian About Austrian Economics? Advances in Austrian Economics, Volume 14, 43–68 Copyright r 2010 by Emerald Group Publishing Limited All rights of reproduction in any form reserved ISSN: 1529-2134/doi:10.1108/S1529-2134(2010)0000014006

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writings, neither in his Principles of Economics (Menger, 1871) nor in his Investigations into the Method of the Social Sciences with Special Reference to Economics (Menger, 1883). His points of attack were what he considered to be the faulty foundations of the existing (classical) theory of value for explaining human decision-making and market phenomena, and his highly critical analysis of the German Historical School for its emphasis on periodspeciﬁc fact and data mining in an attempt to inductively derive economic theories to explain social and market phenomena in particular historical epochs. It is sometimes difﬁcult to appreciate today the full ﬂavor of the ideas of these German historicists. The entire trend of thinking in Germany for most of the 19th century had been in a direction totally anathema to what became the ideas of the Austrian School. Following the defeat of Napoleon, the antiliberal spirit (in the broadest sense) had been strongest and most successful in the German states. German romanticism had started as a literary and poetic movement extolling the ‘‘spirit’’ over the intellect and the connectedness of man to nature. But in the hands of a growing number of German thinkers, it was turned into a revolt against the enlightenment, reason, liberalism, and free trade (Kohn, 1950). It was not only that the German historicists rejected much of economic theory as it had developed from the time of Adam Smith and David Ricardo, including the ideas that emerged out of the ‘‘marginalist’’ revolution of the late 19th century. Nor that they insisted on and erroneously believed that they were actually following a ‘‘theory-free’’ approach to historical and statistical investigations in trying to unearth period-speciﬁc ‘‘laws’’ of economics. It was also, and crucially, their philosophical and ideological collectivism that rejected methodological, epistemological, and ethical individualism. Social analysis did not begin with the individual, but with the collective whole. What deﬁned the collective were such things as nation, race, genetics, and intuitive insight belonging to a select and chosen few who ‘‘understood’’ the true meaning and real interests of the German people, the Volk. In their view, the role of all economic policy was to help prepare the nation for war and conquest as the path to ‘‘national greatness.’’1 Menger’s Investigations into the Method of the Social Sciences was a frontal assault against the very foundations of the Historical School. He insisted that the purpose of social science was to develop ‘‘exact laws’’ that would be derived from an analysis of the universal and unchanging elements ever present in the individual human condition. These exact laws would enable the social analyst to deduce the origin of economic value under

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conditions of inescapable scarcity, and to show the logical process by which men evaluate goods at ‘‘the margin,’’ (though Menger never gave a name to this concept in his Principles) in a world of time, uncertainty, and causality. From these ‘‘exact laws,’’ the social analyst would deduce the ‘‘laws’’ of price formation and the ranges within which market prices must settle, given conditions of either monopoly or emerging competition. It was these exact laws that would enable the social scientist to then give intelligibility and interpretation to the evolutionary processes of human society, of which the institutions of the market were one subset. Contrary to the German historicists, who looked to conscious laws and political powers to understand the evolution of society and its institutions, Menger insisted that many, if not most, human institutions were results of spontaneous social interactions among multitudes of human actors, the outcomes of which often led to consequences far superior to the planned actions of governments. Menger admitted that many aspects of the social order were the result of conscious intention through political and legal decision making. But he emphasized that those spontaneous institutions – language, manners, customs, traditions, much of the law itself, as well as money and commercial rules and procedures – grew in ways outside of intentional designs with numerous positive effects for humanity (Menger, 1883, pp. 139–159).2 Menger also believed that the social sciences should not be turned into a handmaiden to political power and national ambition. Economics should be viewed and practiced as a ‘‘value-free’’ discipline. As Menger expressed it a few years later: ‘‘It is the task of science to be concerned solely with fact and not with value. Science has to teach us what has been, what is, and how what is has come to be; but not what ought to be’’ (1889, p. 20). Any real assistance that economic theory can provide for informed and intelligent pursuit of economic policy would, in fact, be undermined by reducing all of economics to the status of an ‘‘applied science’’ concerned with and indistinguishable from normative perspectives. This, of course, completely ran counter to the German historicist conception of the nature and role of economics.3 Menger’s 1883 treatise on methodology was rudely, if not condescendingly, reviewed by one of the most prominent leaders of the German historicists, Gustav von Schmoller (1883).4 Menger replied in a monograph, The Errors of the German Historical School, written in the form of 16 letters to a friend, in which he again completely challenged the methodological, historical, and ideological assumptions underlying Schmoller’s writings (Menger, 1884). The contempt that Menger clearly had for Schmoller

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and his method can be seen in the following passages from Menger’s monograph: I am aware, my friend, that it is a grievous sin to ridicule the ridiculous. Moreover, it is so hard not to fall into the tone of contempt toward an insolent opponent. But what other tone is appropriate toward the utterances of a man who, without the slightest substantial orientation in the questions of scientiﬁc methodology, carries himself like an authoritative judge of the value or non-value of the results of methodological investigation? y Discuss in serious fashion the most difﬁcult questions of epistemology with a man in whose mind every effort for reform of theoretical [economics], indeed every cultivation of the same, is pictured as Manchesterism! Discuss, without dropping into a bantering tone, questions with a scholar whose entire stock of somewhat original knowledge in the ﬁeld of theoretical [economics] consists of a primordial ooze of historico-statistical material; with a scholar who incessantly confounds with one another the most simple concepts of the theory of knowledge! And such a quarrel as that should afford me satisfaction? y The most difﬁcult and uninspiring experience in the ﬁeld of science is always critical contact with one-sided representatives of practical partisanship; with men who carry over their one-sidedness and bad habits of party conﬂict into scientiﬁc discussion. How much more unedifying when such opponents pose as of superior scientiﬁc rank! y If anyone gropes in such complete darkness with reference to the aims of research in the ﬁeld of [economics], as does the editor of the Berlin Jarhbuch, his ideas about the processes of knowledge in the ﬁeld of our science will be insured against early attack.5

(For his 70th birthday in 1910, Menger asked that every economist in the world send him his photograph. He seems to have been surprised that Schmoller was virtually the only one who declined his request!)6 It was after these exchanges between Menger and Schmoller, and then the publications by others who adopted Menger’s approach and method in their own writings – especially Friedrich von Wieser and Eugen von Bo¨hmBawerk, Emil Sax, and Robert Zuckerkindl beginning in the middle of the 1880s – that the name ‘‘Austrian School’’ began to be widely applied to describe their particular set of ideas. But the name was given to them by their opponents in the German Historical School as an expression of distain.7 Schmoller insisted that those who propounded the ‘‘abstract ideas’’ of the Austrian School8 were not ﬁt for appointments at German universities, which created an almost insurmountable barrier to any of Menger’s followers ﬁnding professorships in Germany (Seligman, 1962, p. 274).9 In the German-speaking world, the relationship between the Austrians and the Historical School remained as antagonistic into the 20th century as when Menger and Schmoller originally crossed swords in the 1880s. In the years before the First World War, Ludwig von Mises confronted these ideas as a young member of the Austrian School of Economics attending the + Sozialpolitik [Society of Social Policy], the annual meetings of the Verein fur

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leading association of academics and scholars in the German-speaking world. Forty years after the First World War, Mises recollected the mentality of the German historicists he met at these meetings and their attitude toward ideas of the Austrian School and economic theory in general: Bo¨hm-Bawerk, my conversation partners remarked, is without doubt an honorable seeker of truth. Nevertheless, his deplorable errors resulted in an unacceptable justiﬁcation of the worst form of unearned income – interest on capital. According to them, it was required of a moral State to use governmental measures to lower high market rates of interest. The most absurd book in economic literature is, they said, Bentham’s Defense of Usury y They charged that Bo¨hm-Bawerk’s allegations against the Marxian exploitation theory were foolish. No matter how much Marx may have been mistaken in his criticism of modern society, he nevertheless had the merit of having revealed the motives of British economists. Compared with the contributions of the German Historical School, Bo¨hmBawerk was a stubborn reactionary y The same thing was allegedly true about my theory of money. The periodic reoccurrence of economic crises was a phenomenon inherent in the nature of capitalism, they said y Strict supervision and skillful regulation of market activities by a super-party government would free the economy of economic crises. It was pointless, they thought, to try to explain economic ﬂuctuations on the basis of monetary and credit policies. The real causes must be sought at a deeper level, they said y The monetary system, they said, is not an end in itself. Its purpose is to serve the state and the people. Financial preparations for war must continue to be the ultimate and highest goal of monetary policy, as of all policy. How could the state conduct war, after all, if every self-interested citizen retained the right to demand redemption of bank notes in gold? It would be blindness not to recognize that only full preparedness for war – not only in the military sense but also with regard to the economy – could ensure the maintenance of peace. It was admitted that the Historical School has long neglected the treatment of monetary problems. Yet, with Knapp’s State Theory of Money, they said, the German spirit has ﬁnally rejected the destructive theories of the English economists y There could be only one excuse for my errors, namely, that they were the logical results of the subversive ideas that the ‘‘Austrian School’’ had taken over from the doctrines of the Manchester men. Thinking in a vacuum was characteristic of Menger, Wieser, and Bo¨hm-Bawerk, and was my error too. What would the monetary system be like if the State did not stand behind it with all its power? It was fortunate, they alleged, that even in Austria only a small group of naı¨ ve authors shared the views of the ‘‘Austrian School’’ y They were ready to grant me that I wrote in good faith. But they were convinced that my book only served the interests of unpatriotic and subversive speculators. They never entered into any kind of process of theoretical thinking. The quantity theory of money and the theories of the Currency School were, in their eyes, nothing but curiosities in the

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RICHARD M. EBELING historical literature. One of these gentlemen remarked that a colleague of his had asked whether I was not also an adherent of the phlogiston theory. Another gentleman suggested that he considered my ‘‘Austrianness’’ to be a mitigating circumstance; with a citizen of Germany he wouldn’t even discuss such questions y Such were the opinions of my interlocutors during the last ﬁve years before the First World War (Mises, 1959, pp. 54–58).10

In the English-speaking world, the name ‘‘Austrian’’ came to designate the ideas of Menger and his followers not only in terms of their distinction from the German Historical School, but from both the older classical economists and the other marginal utility theorists, such as William Stanley Jevons and Leon Walras and their respective followers. James Bonar presented the ﬁrst detailed exposition of their ideas to appear in English in his article, ‘‘The Austrian Economists and Their View of Value’’ (1888). It was soon followed by William Smart’s short book, An Introduction to the + Theory of Value, on the Lines of Menger, Wieser and Bohm-Bawerk (1891). In the early 1890s, the writings of some of the Austrian economists began to appear in English. William Smart undertook the meritorious and demanding task of translating Bo¨hm-Bawerk’s two volumes, Capital and Interest (1890[1884]) and The Positive Theory of Capital (1889). And shortly after their appearance, Smart also edited the translation of Wieser’s Natural Value (1889). Bo¨hm-Bawerk (1890, 1891, 1894) and Wieser (1891, 1892) also wrote articles for English language journals in both America and Great Britain in which they explained the core ideas of the Austrian School.11 For economists and many other social scientists outside the Germanspeaking world ‘‘Austrian Economics’’ connoted a group of thinkers attempting to radically reconstruct economic theory along lines that were parallel to similar trends found in the writings of Jevons and Walras. But Bo¨hm-Bawerk and Wieser also emphasized what they considered to be different or distinct in the Austrian approach. As Bo¨hm-Bawerk expressed it, ‘‘But the direction in which I believe the Austrians have outstripped their rivals, is the use they have made of the fundamental idea [of marginal utility] in the subsequent construction of economic theory. The idea of ﬁnal [i.e., marginal] utility is to the expert the open sesame, as it were, by which he unlocks the most complicated phenomena of economic life and solves the hardest problems of the science. In this art of explication lies, as it seems to me, the peculiar strength and the characteristic signiﬁcance of the Austrian school’’ (1891, p. 365). However, many of the distinctions that the Austrians attempted at the time to draw between themselves and other ‘‘marginalist’’ thinkers were not

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often understood or clearly expressed.12 The ambiguities were sometimes due to the fact that the Austrians found themselves facing two fronts at more or less the same time: Sometimes they were in alignment with other marginalist schools against the antieconomic arguments of the German historicists; at other times they were trying to show what separated them from the Jevons–Walras traditions. By the end of the ﬁrst decade of the 20th century, therefore, it seemed to many that the core ideas of the Austrian School had been absorbed by the majority of ‘‘modern’’ economists around the world. Most economists (especially outside of Germany) accepted and utilized the theory of marginal utility, employed Wieser’s notion of ‘‘cost’’ as forgone alternative product, often used Bo¨hm-Bawerk’s formulation of the ‘‘marginal pairs’’ to explain the determination of market prices, and at least debated and took seriously the Austrian (i.e., Bo¨hm-Bawerk’s) theory of capital and interest. In this early period of the 20th century, the prominent Austrian Economists of the time did not see or fully understand many of the implications of their own ideas that only became clearer to the interwar generation of the School – most especially by Ludwig von Mises and Friedrich A. Hayek. Only when they were confronted with challenges from the mainstream of the economics profession during the 1920s and 1930s did they more clearly began to realize that they often meant different things than many of their marginalist ‘‘cousins,’’ even when they used the same words or phrases (Ebeling, 2003, pp. 1–9, 34–60). But at the time, it appeared to many of them that much of ‘‘Austrian’’ economics was now more or less an integral part of contemporary economics. Or, apparently, so it seemed to Carl Menger 30 years after he ﬁrst presented his theory of subjective value and marginal utility in 1871. In 1903, he told an American scholar visiting him in Vienna, ‘‘It is entirely indifferent to me whether the name Austrian School be preserved. The important thing is that every economist worthy of the name has now virtually adopted every essential thing that I stood for.’’13 Many decades later, Ludwig von Mises, reﬂecting on the origin and contributions of the Austrian School after having lived through and participated in its development through a majority of the decades of the 20th century, said the same thing about that period: ‘‘But after some years all the essential ideas of the Austrian School were by and large accepted as an integral part of economic theory. About the time of Menger’s demise (1921), one no longer distinguished between an Austrian School and other economics. The appellation ‘Austrian School’ became the name given to an important chapter of the history of economic thought; it was no longer the

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name of a speciﬁc sect with doctrines different from those held by other economists’’ (Mises, 1969, p. 19).

SUBJECTIVISM AND ACTION IN THE AUSTRIAN CONCEPTIONS OF THE MARKET PROCESS In the late 1960s, when the only references to the Austrian School in the works of most economists were in the context of the history of economic thought, Ludwig M. Lachmann observed, ‘‘Unfortunately, they [the Austrians] never were able to show with the cogency their case required the incompatibility between the idea of planned action, the very core of Austrian economic thought, and an analytical model which knows no action, but only reaction’’ (1969, p. 164). It was all so clear, yet so confusing almost from the start. All the new marginalist thinkers were interested in explaining why ‘‘value’’ was not inherent in a good, as the labor theory of value seemed to imply. They wanted to demonstrate that whether something possessed value depended on a certain relation: the quantity of a good relative to the demand for it. And demand, they all said, was based on the ‘‘usefulness’’ or ‘‘utility’’ of a good for a user. Furthermore, people not only distinguished between different types of goods (water vs. diamonds), but they evaluated units of the same good in different ways – based on the marginal signiﬁcance of the last unit of a supply of good that has had been or could be applied. This analysis introduced a distinct ‘‘subjective’’ element – the personal judgment of the individual user about the ‘‘utility’’ or ‘‘pleasure’’ or ‘‘usefulness’’ that a unit of the good might have for him. Hence, tastes and the evaluation of goods (at the margin) were subjective, being known and weighed only by the user. Already there were differences, however, but only understood through a glass darkly. For Jevons and Walras, ‘‘utility’’ was a magnitude of pleasure from the consumption of goods, the ratios of which could be compared to the ‘‘objective’’ prices of the market to determine whether or not there might be additional gains from acquiring more of one good relative to another. Francis Edgeworth, in his Mathematical Psychics, even looked forward to the day when man would have it in his power to devise a ‘‘hedonometer’’ that could be put on people’s heads to measure the amount of pleasure provided by the consumption of goods, for above all Edgeworth’s was ‘‘the concept of man as a pleasure machine’’ (1967 [1881],

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p. 15).14 Here, ﬁnally, would be a truly quantitative economics that would equal the methods and power of the natural sciences. Edgeworth’s indifference curves were meant to be quantitative totals of utility received from consuming various combinations of goods (p. 24). Pareto’s ‘‘hills of ophelimity’’ may have been claimed by him to be a way to get around the problem of measuring utility by ‘‘merely’’ determining the individual’s preference between combinations of goods that were more, less, or equally preferred. But this was only a sleight-of-hand to be capable of maintaining the use of the powerful tools of the calculus for determining optimal combinations of goods relative to individuals’ budget constraints and the relative prices of goods (Pareto, 1927, pp. 113, 120). Once we had these indifference curves, Pareto said, ‘‘The individual can disappear, provided he leaves us this photograph of his tastes’’ (1927, p. 120). The human actor no longer had a purpose or function in the economist’s analysis. He was merely one of the ‘‘variables,’’ the interaction between which determined equilibrium states. Pareto, here, was only following in the steps laid out earlier by Jevons and Walras. Jevons created his demand curves by assuming that the individual decides what quantities of goods he might be interested in buying when he is confronted with alternative prices in ‘‘perfect markets,’’ with all the participants already knowing the equilibrium ratios of exchange (Jevons, 1879, pp. 87–90). Walras conjured up an auction in which the auctioneer cries out prices to the respective demanders and suppliers; from the individual demanders and suppliers he then adds up the market demands and supplies, juxtapositions them, and derives his ‘‘simultaneous solutions’’ for a general equilibrium state (Walras, 1874, pp. 93, 122, and 143).15 In their analyses, the actor was a passive agent, who merely ‘‘reacted’ to the constraints and data with which he was confronted to derive the necessary utility or demand or supply curves that the economist needed to close the circle of his equilibrium theory. This came close to Veblen’s caricature of economic man as a mere ‘‘globule of desire’’ with little thought or action other than as a gluttonous consumer of quantities of ‘‘stuff ’’ offered to him at ‘‘given’’ prices (Diggins, 1999, p. 50). In addition, what place or role could time, uncertainty, or expectations play in these versions of the marginalist approach? In his conception of a ‘‘perfect market,’’ Jevons assumed that each individual entered the market knowing his own tastes and endowments of goods, as well as knowing the same about everyone else. This assured that no errors could occur and all trades took place at equilibrium prices. Walras paternalistically took care of

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the problem for the suppliers and demanders by generously supplying them with that auctioneer who gathered all the necessary data before any trades were consummated at equilibrium prices. Pareto distinguished between ‘‘logical’’ and ‘‘nonlogical’’ action, with the economist only concerned with ‘‘logical’’ action under which repeated trades and accumulated information from past transactions assured that everyone in the market knew the ‘‘objectively’’ correct means and ends, and the right equilibrium terms of trade at which to buy and sell. Sociologists (and Pareto was a profound and insightful sociologist as well) were left to deal with those more complex and indeterminate situations resulting from imperfect knowledge, psychological and ideological biases and prejudices, and institutional uncertainty that he encompassed under the heading of the ﬁeld of ‘‘nonlogical’’ action (Pareto, 1927, pp. 30–32; 1966, pp. 124–125, 193–195). How different was the Austrian view of these things from the economists who were the precursors of what has become known as the neoclassical, or mainstream, tradition in economics!

Carl Menger Menger began his analysis with the reminder that all things are subject to the laws of cause and effect. The task of man was to discover those causalities that would assist him in ﬁnding and applying the appropriate means to his desired ends. To speak of causality was to refer to time: a before and an after; a becoming and a became. But time also introduced the element of uncertainty – the uncertainty over whether what one wants today will still be what is wanted when actions over time have produced a particular outcome tomorrow; and whether the means thought to be available will turn out to be actually there when one needs them at some later stage in the production process that transforms ‘‘higher order’’ producer goods into ‘‘lower order’’ consumer goods. There were also the uncertainties about the actions of others, whose decisions inﬂuenced the possible outcomes of one’s own plans (Menger, 1871, pp. 67–68, 80–81, 148–150). When Menger turned to the process by which prices were formed on the market, he did not simply assume competitive conditions of equilibrium or an artiﬁcial auctioneer. No, he explained that trade normally would begin with various traders having a monopoly position, arising from particular individuals being the ﬁrst to offer a product or chose some specialization in the division of labor. Only later as others observed the monopolist’s trading

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successes would competition emerge as those others entered the market as his rivals. From a wide range within which price could fall in a bilateral monopoly situation, the arrival of more suppliers and demanders would slowly narrow the range within which price would be formed and determined (Menger, 1871, pp. 180, 190–195). In Menger’s world, as we have seen, social institutions were not taken as given. One of the central tasks of economic analysis is to show how the social order emerges, develops, takes shape, and evolves over time. Man’s uncertainty about the future and the processes of time result much in the social world being the unintended result of men’s actions, and often with good effects for the betterment of mankind.16 Eugen von Bo¨hm-Bawerk If Menger was content to merely explain the ranges within which prices had to fall due to the marginal evaluations of demanders and suppliers, Bo¨hmBawerk was interested in trying to explain exactly how market prices arise from the subjective evaluations of traders (Bo¨hm-Bawerk, 1959, pp. 203– 222).17 Each man enters the market, he said, with an understanding of the quantity of the goods he has available to sell for what whatever it is that he wishes to buy. But he usually only has a clouded conception about what his maximum demand bids and minimum sell offers might be. Indeed, he argued that all resulting market actions were grounded in people’s expectations – expectations about the degree to which the good that might be bought was important to the actor’s future well-being, and therefore the intensity of marginal signiﬁcance that good possessed for him. This would begin to set in the actor’s mind the maximum bid that he might be willing to make to acquire it; and as he starts to interact with others in the market, he would form an expectation of what minimum price he would have to bid to successfully beat his closest rival in the contest of purchasing the good. Similar expectations would be at work in the minds of those on the supply-side about the minimum price they would accept for the good, if necessary, and what maximum price they could ask for, without running the risk of losing the sale to a more eager competitor anxious to make a sale (pp. 240–243). It is only in the interactions of the market that men discover actually how much they value what they could buy and how little they value what they can sell. In Bo¨hm-Bawerk’s world, the traders initiate the bids and offers. They decide whether they value a good more than they originally thought, so as not to lose out to the next most interested buyer who also wants to purchase

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that desired commodity. Up goes the price, with each transactor deciding if the latest bid by one of his demand-side rivals has pushed the price up to the maximum threshold point at which he chooses to bow out, due to the price now being greater than what he thinks the good to be worth at the margin. The same process plays itself out on the supply-side with suppliers eager to not miss out on a proﬁtable sale by allowing one of their rivals to underbid him. Each weighs whether or not the price has reached a minimum below which it is not worth selling and better to hold on to the good. The two-sided competition continues until a price range has been reached within which all willing buyers on the demand-side are successfully matched with willing sellers on the supply-side. Bo¨hm-Bawerk’s market may also be an auction, but it is one in which the actors make the bids and offers; they initiate the actions that form the prices that ﬁnally bring the arena of exchange into balance. And behind it all, Bo¨hm-Bawerk insisted, was the fact that ‘‘price is, from beginning to end the product of subjective valuation’’ (p. 225). But, clearly, in Bo¨hm-Bawerk’s meaning subjective valuation was something more than merely ‘‘tastes and preferences.’’ His actors have reﬂective minds, they evaluate what things might be worth to them, what they might have to bid or offer to get it, and how far it was worth going in the actual interchange and process of market competition before deciding to fall by the wayside under the pressure of some rival with a demand to buy or a willingness to sell more intense than his own.

Friedrich von Wieser Part of Wieser’s analysis of subjective valuation and marginal decisionmaking was in direct contradiction to the manner in which the Jevons/ Walras traditions developed the marginalist idea. He did not look for ways to apply the calculus by assuming inﬁnitely small variations in the amounts of goods; he did not think that the logic of understanding the agent’s decisions about choosing among goods required the mathematical nicety of the equimarginal principle. It would, however, be a mistake to believe – as almost every writer who has occupied himself with this question had done, Jevons more than any other – that it is necessary to keep strictly in every branch of expenditure to the same degree of satisfaction, the same level, the same marginal utility. This is quite against the nature of wants, for wants have not each an equal but a peculiar satiation scale. Were the ‘‘level of household expenditure’’ be understood in this way, every addition to income would require to be laid out equally in corresponding enlargement of every branch of expenditure. As a

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matter of fact it is usually spent on a few branches, while others remain as they are; or, if the additional income be so great as to allow of an improved condition of things all round, the extra expenditure is distributed in the most irregular manner. The satiation scales of wants are very diverse, the receptive power of one want is great, that of another comparatively small; that is to say one is susceptible of a degree of intensity which another does not reach, or which it oversteps. (Wieser, 1889, p. 15)

Wieser’s emphasis, then, was on the reality of wants and the choice process. Goods are discrete; the scale of wants is discontinuous in its makeup with some wants reaching levels of satisfaction before others, with some dropping out of the realm of future desirability (at least for the time being), and being replaced by other wants previously unsatisﬁed at all; or when allround additions to the satisfaction of wants is possible, they are frequently enlarged in a nonproportional fashion. ‘‘Rather than to economic equilibrium’’ Wieser said, ‘‘theory should turn to margins of use’’ (Wieser, 1914, p. 52). Wieser’s subjectivist realism, in other words, called for economic theory not to be designed to ﬁt a preconceived notion of mathematical conformity of the data to ﬁt the method. Instead, a ‘‘subjectivist’’ approach required asking, how do men actually evaluate goods? What is the way they really order and arrange their preferences given the concrete discreteness of desirable commodities? And in what way are their wants actually satisﬁed at the margin in comparison to others? The method should follow the nature of the subject matter being studied. The subject matter should not be remolded into a shape merely to ﬁt a preconceived idea of what is the appropriate method of ‘‘science.’’ Subjective margins of use, not ratios of marginal quantities of utility, should be the way to study men’s choices concerning goods.

Philip Wicksteed As Bo¨hm-Bawerk pointed out, not all economists in Austria were ‘‘Austrians,’’ and not all ‘‘Austrians’’ were from Austria.18 As the Austrian Economists became better known and read in different languages, a growing number of economists adopted the ‘‘Austrian’’ conceptions of the nature of economics. One of them was British economist, Philip Wicksteed. He is usually considered a follower of Jevons who attempted to synthesize Jevons’ ideas with those of the Austrians (Schumpeter, 1954, p. 832; Robbins, 1970, pp. 202–205). And there is some truth in this. But if we understand the wider Austrian idea of subjectivism beyond mere given tastes and preferences, Wicksteed is far more ‘‘Austrian’’ than ‘‘Jevonian.’’

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He was a major contributor to the concept of economics as a logic of choice. Economics is not a study of one particular side or aspect of human life – the pursuit of material wealth, as many of the classical economists presumed – but the study of an inescapable relationship between any and all human ends in comparison to any and all means for their fulﬁllment. Whenever means are insufﬁcient to serve human ends, then that relationship has a particular economic aspect to it: the necessity to rank ends in order of importance and allocate the available means in a manner consistent with those preferences (Wicksteed, 1910, pp. 20–30). Thus, he said, ‘‘from ﬁrst to last y the laws of Economics are the laws of life’’ (p. 404). He also developed a subjectivist notion of cost, demonstrating that all costs are themselves subjective evaluations concerning the use of means in alternative directions having nothing to do merely with the expenditure of labor effort or the physical use of factors of production. This lead him to argue that there is no such thing as a supply curve, since any supply of a good is merely the mirror reﬂection of its (marginal) reservation demand in other uses in the eyes of its current possessor (p. 785). But what has been given less attention in the context of the themes we are discussing is Wicksteed’s development of a theory of price formation and price change on the basis of entrepreneurial expectations and experience. Everyday experience tells us that prices are not normally formed through auction processes, whether of the type presented by Walras with an imaginary auctioneer, or in the form presented by Bo¨hm-Bawerk where all the buyers and sellers are actively shouting out bids or crying out offers. We enter the market and the prices are already given to us. We, as consumers, decide how much of each commodity we shall buy. The prices may be different tomorrow when we return to the market, but the buyers certainly do not directly make the prices or change them. They react to the prices that they ﬁnd in the market. So from whence come these prices, and how and who changes them? Wicksteed explains that in the division of labor, this is part of the role of the retail entrepreneur. Consumers do not all enter the market during the trading day at the same time. Rather they come in sequence, one at a time as the day progresses. They may come in a greater cluster in the morning or the afternoon. But however they may appear in the market, the total demand for the available supplies will not materialize all at once. Precisely because all demanders do not appear simultaneously, what will be the total demand by all buyers over the whole trading day is ‘‘a matter of estimate and conjecture.’’ And in Wicksteed’s view the responsibility for forming these expectations falls on the shoulders of the seller (p. 236).

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The seller could adjust the price to sell all of his available stock to buyers who, say, do their shopping early in the morning. Buyers later in the day, alas, will discover the shelves empty when they arrive. Expecting ‘‘a constant ﬂow of potential customers throughout the day,’’ Wicksteed explained, at any moment the sellers ‘‘have a reserve price, not on their own account but in anticipation of the wants of others.’’ The seller, therefore, acts as the ‘‘reader of the public mind, anticipator of future wants, or speculator as to the wants of the portion of the public not present in person.’’ As Wicksteed elaborated, ‘‘What the purchaser meets in the market is a reﬂection of her own mind and that of her compeers thrown back from the mind of the seller y It is the collective mind of the purchasers, then, as estimated by the sellers, that determine the price proclaimed by the latter.’’ Thus, the ‘‘primary function’’ of the sellers was ‘‘to represent the whole body of consumers in his dealings with each individual consumer’’ (pp. 218–219, 231–236). The price set by the seller, therefore, was meant to be one that represents the best estimate the seller could make about the total demand for the good relative to his available stock. Thus, the buyer who sees plenty of the good in the store and wonders why the seller does not lower its price to make it more attractive for him to purchase more of it right now, fails to see his invisible demand-side rivals who also want to buy some amounts of the good but are not presently in the market and who will only show up later in the trading day. Wicksteed goes on to say that the seller’s pricing policy has nothing to do with altruism. But rather is another example of the ‘‘invisible hand’’ served through the motive of self-interest. If he were to lower the price sufﬁciently to clear out his stock in the morning, say, then he will miss out on all the afternoon business that could have been his at a uniform higher price throughout the trading day. At the same time, if he over-estimates the afternoon sales and sets the price too high over the entire trading day, when the day’s business is done he will be left with undesired unsold inventory, and sales revenue will be less than it might have been. Possibility for error abounds, Wicksteed emphasized, since market conditions are constantly changing. Thus, entrepreneurial expectations of demand across time are crucial for success. Yet mistakes will be made. Inventories will be depleted too much, or will accumulate above desired levels. In the next trading day, prices will be set anew based on the reality of the day before and what that experience suggests for forming expectations today (pp. 225–226). These changes in stock will then be communicated backward up the production chain to wholesalers and to manufacturers and to the suppliers

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of the ‘‘original’’ factors of production. This will set in motion the resulting shifts in relative demand, prices and resource allocations in the ‘‘higher stages’’ of the production processes to see to it that the relative structures of production reﬂect the changing patterns of demand for the goods and services ultimately bought by the consuming public (p. 393). In Wicksteed’s world, there are no ‘‘simultaneous solutions’’ in the market. Exchanges occur in sequential patterns through time; expectations need to be formed on the part of sellers as to the volume of consumer demand for the setting of prices; errors and miscalculations result in trades at ‘‘false prices’’; corrections and revisions in sellers’ expectations send ripples of reevaluation through the production process to the factors of production, and brings about changes in the structure of relative prices based on new expectations from market experiences. As a result, any equilibrium toward which the market might be tending is ‘‘path dependent.’’ Or as Wicksteed expressed it, ‘‘any actual transactions made in consequence of a mistake in estimating the equilibrium price at any given moment will theoretically alter the equilibrium price itself,’’ through alterations in preferences, endowments, and the speciﬁc use of resources (p. 227).

Herbert Davenport In the United States, a close follower of the Austrian School was Herbert J. Davenport. He had written an entire book in the form of an imminent criticism to clarify the Austrian analysis of the relationship between value and marginal utility (Davenport, 1908). His purpose was not to deny or disprove the Austrian argument but to reﬁne it and place it on a sounder footing (Davenport, 1902). But his particular contribution to the Austrian subjectivist theory of the market process was in his later work, The Economics of Enterprise (Davenport, 1913). He reminds the reader that the market is a complex network of interdependent participants, in which any change in one corner results in ramiﬁcations and necessary adjustments in other parts of the system. But, again, interdependency did not mean simultaneity, and certainly not through any ﬁctitious auctioneers or mathematical simultaneous solutions. It was equally absurd to even speak loosely about the ‘‘society’’ solving the economic problem. There were no collective entities called ‘‘society’’ or ‘‘the market.’’ There were only individuals whose interactions generated the outcomes of the market. To understand how markets work and who does what to assure patterns of coordination, we must look at the

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actions of individuals and analyze their roles and activities in the division of labor.19 The market is ultimately driven by the demanders, Davenport argued, whose wants direct all that happens in the arena of exchange and production. But demanders do not directly guide the processes of production. This is done by the entrepreneur who stands ‘‘as the intermediary in the case, representing in his hiring and buying of productive factors, the demand of the purchasing public, and representing in his cost computations, the degree of scarcity of the production factors relative to the demand for their products.’’ It is ‘‘the competition of the entrepreneurs of each industry with the other entrepreneurs of the same industry, and of the competition of the entrepreneurs of each industry with those of other industries’’ that brings about the prices of the factors of production (p. 194). The real world of market activity, Davenport emphasized, is one of constant change, shifting demand, modiﬁed supplies, and new innovations for producing things. This meant that whatever the entrepreneurs planned today, in terms of products to be brought to the market tomorrow, is based on uncertain expectations concerning a future that was not likely to be a copy of the day before. Since it is through the prism of the entrepreneur’s expectations that decisions are made, the costs of production – in the form of the money prices that are offered and paid for the hire and use of factors of production – are reﬂections of the mental judgments of those who undertake the responsibility of ‘‘captaining’’ the society’s enterprises. All costs, therefore, are entrepreneurial costs within the ﬁrm. And it is their estimates that determine what land, labor, and capital are worth in alternative uses. Their estimates are based on what they think consumers may want and the prices they might be willing to pay. But, nonetheless, they are the subjective appraisements about a future that might be, and which is not yet realized. As Davenport expressed it, the entrepreneur’s ‘‘costs’’ of production are reducible to his individual judgments, estimates, and expectations of what he sees as the opportunities and their relative future market worth. ‘‘The cost computation must stand as a purely personal and individual computation y it must express and report his [the entrepreneur’s] method, process, and decision y The bearing of cost y is signiﬁcant only for such person’s as undertake the cost’’ (pp. 50, 70). In Davenport’s hands, the market process is an analysis in subjective relationships bound together by the gain-seeking activities of competitive entrepreneurs. The causal connections were evident to him: goods have value because they serve wants; production has a motive in the creation of

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goods to satisfy those wants; for equilibrium, the supplies of goods and the factors of production need to be so distributed so that no net advantage exists for the shifting of ‘‘supplies’’ from one alternative use to another in the service of competing demands. The critical issue is to explain how an equilibrium would tend to come into being – an explanation, Davenport argued, that would run in terms of the individual actions of personalities possessing thought, will, consciousness, and memory. Market costs, as an element in this process, are all reducible to the subjective estimates of the respective entrepreneurs whose competitive actions generate the ‘‘objective’’ factor prices.

CONCLUSION: THE MEANING OF AUSTRIAN ECONOMICS – THE HUMAN MIND BEHIND THE SUBJECTIVISM OF THE MARKET PROCESS What conclusions may we draw from this excursion into the ideas of the Austrian Economists up to the First World War? What distinguished them from other ‘‘marginalist’’ economists at that time? And what does that tell us about Austrian Economics today? In his 1915, Economic Principles, American ‘‘Austrian’’ economist, Frank A. Fetter stated that, ‘‘In truth the presence of men is always, and must always be, implied and understood in any study of the value of wealth. This means not merely that man is the evaluator, the chooser of goods, this means also that man is the doer of acts.’’ There is nothing static in the world, Fetter said. ‘‘Desire is a mental reaching out for things’’ and ‘‘the ﬁtness of things for accomplishing man’s desires is what makes them objects of choice.’’ In all of this, man ‘‘ceases to accept passively [nature’s] conditions, and to live on its grudging gifts, he becomes its fashioner, in a sense its creator. His intelligence and his wants are most important factors determining what the form of the physical world about him shall be’’ (Fetter, 1915, pp. 23, 50, 52, 171–172). This, in essence, is what did and still does distinguish the Austrians from many if not most other economists. Man is not simply a ‘‘functional form’’ in a set of simultaneous equations. His ends and goals are not merely ‘‘arguments’’ in a utility function. His conception and use of means are more than sets of ‘‘initial endowments.’’ In fact, to reduce man to this is to strip him of those qualities that, well, make him man. Jevons and Walras and most of those who have followed them have been captives of the scientistic fallacy, that is, the uncritical and misplaced

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application of one conceived method of doing science to a subject matter for which that method is inappropriate. As Hayek explained in The CounterRevolution of Science (1955), it was a hard and long struggle for the natural sciences to completely free themselves from the anthropomorphism of primitive man. A method of analysis and a set of tools were constructed that could study physical world without the presumption that forces of nature possess human-like qualities. The ‘‘scientiﬁc method’’ in the natural sciences was successful beyond belief. Its use at the applied level has helped transform the world and dramatically improve the human condition. But precisely because of its astounding achievements, other scholars in unrelated ﬁelds came to believe that reﬁnement of their own disciplines required adopting the methods of their natural science colleagues. Another way of saying this is that because the natural scientist concluded that rocks were different from men for purposes of his scientiﬁc inquiry, many social scientists decided that therefore if a ﬁeld like economics was to become a ‘‘real’’ science, men had to be studied as if they were rocks. In other words, anthropomorphism was banished from economics. The absurdity of this, of course, is that anthropomorphism is quite legitimate in a ﬁeld such as economics because the subject matter – acting men – has the same human-like qualities as the economists studying their behavior. The Austrians have been anthropomorphists. That is, they have believed that the proper study of man is man. Not man as a purely ‘‘objective object,’’ or as a mathematical function, or as a statistical magnitude, or as some invisible entity that may disappear just as long as he has left us a trace of himself in the form of a photograph of his tastes, as Pareto put it. In this sense, the Austrians have been more ‘‘empirical’’ than many mainstream economists. They have ‘‘naively’’ started by asking, what are man’s basic characteristics that come into play for understanding market phenomena? And, as we saw, man is the initiator of action; he has intentionality and purpose. He looks for causal connections between means and ends, and he weighs them at the margin. But what does ‘‘the margin’’ mean? We saw that Wieser insisted that understanding marginal decision-making requires understanding how men implicitly construct and pursue the fulﬁllment of their value scales, in a world of discrete choices and discontinuous opportunities. Usually, the mainstream critic responds to this type of Austrian argument about marginal analysis, by saying, ‘‘Well, of course, you’re correct, but these are only simplifying assumptions to make some problems more tractable without ‘really’ doing any serious injustice to the actual facts of the case.’’

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Whether this is true and useful for certain problems may be set aside. What the Austrians feel uncomfortable about is that everything is always put through this methodological sieve. The scientistic prejudice has lead mainstream economists to believe that any analysis not reduced to and made to ﬁt this methodological mold is intractable and not really ‘‘science.’’ The Austrians just refuse to be intimidated by what Axel Leijonhufvud years ago satirized as the ‘‘high priests’’ of the math-econ tribe (Leijonhufvud, 1973, pp. 347–359). When Austrians look at man they do not just see a subjectivism of tastes, but of action and meaning. It breathes on virtually every page of the early Austrian Economists that have been discussed. Prices are not just ‘‘given,’’ they emerge out of mental processes of evaluation, decision, and action. Whether in Bo¨hm-Bawerk’s horse market, Wicksteed’s entrepreneurial price setting to allocate supplies of goods through time to consumers, or Davenport’s entrepreneurs who are the initiators of production, the weighers of what resources are worth in an uncertain and changing future, and therefore the bears of cost that only impinge through the process of choosing and acting; in every instance, the analysis is alive and vibrant with images of real men as we ﬁnd them in the real world with human-like qualities and characteristics, because, after all, they are men like ourselves. We can analyze and understand them in ways different from solely the methods of the natural sciences because they are exactly like us. We can draw on that taboo source of knowledge: the introspective glance at the workings of our own mind. Listen to Wieser: The theoretical economist need never deplore a lack of the instruments which are employed in the exact natural sciences. Whatever advantages they may otherwise enjoy and great as are their achievements, they are nonetheless strangers to their object. They may never scan the innermost recesses of nature. Let their instruments be inﬁnitely reﬁned, still they must be content to describe a succession of happenings, abandoning the hope of showing how the effect springs from the cause. The group of practical sciences, of which economics theory is one, accomplishes more. The object of investigation is man in a condition of activity. Hence our mind ratiﬁes every accurate description of the processes of his consciousness by the afﬁrmative declaration that such is the case, and by the compelling feeling that it must be so y Where the natural sciences can only offer proof, the theory of economics can persuade, it can enlist the unqualiﬁed inner consent of the reader. (Wieser, 1914, pp. 8–9)

This may and does shock many economists and other social scientists. But it is nevertheless how we know a good deal about what it means to evaluate, anticipate, choose, and act. How would we even know what these concepts meant if we could not ﬁnd out their meanings by asking ourselves, ‘‘What is

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it that we do, and how do we do it, and why?’’ Lucky for us, our minds very helpfully answer back (Machlup, 1969, pp. 309–332). The meaning and essence of Austrian Economics was encapsulated by the American sociologist, Albion Small, in his exposition of the place of the Austrian School in the development of 19th century sociology: ‘‘We might reduce the contention of the Austrian School to the proposition: The phenomena of the market are at the same time phenomena of the mind, and they must be explained accordingly’’ (p. 172, italics in the original). The peculiar circumstance was that even although some people saw what Austrian Economics was all about, even when its proponents went about ‘‘doing’’ Austrian analysis in explaining marginal decision-making and the workings of the market process, they somehow failed to fully and consciously clarify both to themselves and to others how and why what they were doing was different, distinct, and uniquely insightful. So, many of the Austrians in those early years of the 20th century thought that the mainstream of the economics profession had somehow adopted all of the essentials of their teachings, when in fact many of the real essentials were missed or rejected. In spite of the reﬁnements, elaborations, and enriched developments by members of the Austrian School over the last 100 years, it is a problem that contemporary Austrian Economists are still trying to overcome.

NOTES 1. For a thoughtful discussion of the evolution of these ideas from the late 18th century through the Second World War, see Kohn (1965) and also Kohn (1945, pp. 433 and 435): ‘‘The ‘socialists of the chair’ desired a benevolent paternal socialism to strengthen Germany’s national unity. Their leaders, Adolf Wagner and Gustav von Schmoller, [Heinrich von] Treitschke’s colleagues at the University of Berlin and equally inﬂuential in molding public opinion, shared Treitschke’s faith in the German power state and its foundations. They regarded the struggle against English and French political and economic liberalism as the German mission, and wished to substitute the superior and more ethical German way for the individualistic economics of the West y In view of the apparent decay of the Western world through liberalism and individualism, only the German mind with its deeper insight and its higher morality could regenerate the world.’’ 2. See, also Wieser (1914, p. 162): ‘‘The economy is full of social institutions which serve the entire economy and are so harmonious in structure as to suggest that they are the creation of an organized social will. Actually they can only have originated in the cooperation of periodically independent persons. Such a social institution is illustrated by money, by the economic market, by the division of labor in acqisition, and ﬁnally by the national economy itself, which is the greatest of these institutions,

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and includes all the others. y Money, for example, existed before the state and as world-money, is today more extensive than the state. How could any general contractual agreement be reached as to institutions whose being is still hidden in the mists of the future, and is only conceived in an incomplete manner by a few far-seeing persons, while the great mass can never clearly appreciate the nature of such an institution until it has actually attained its full form and is generally operative? y Much more satisfactory is the explanation based on gradual historical evolution, which takes into account the powerful factor of time. As the constantly repeated impact of falling water cuts a deep course in the hardest rock by the power that is in each separate drop of water, or as the creataceous animalculae in the course of ages may tower into mountains, so the service of individual forces working together in successive generations, through centuries and millennia, toward the same end, may slowly build up great economic structures. Thus one may understand the evolution of the acquisitive process with its division of labor that has now spread to tremendous proportions and diversity y [Menger] uses the phenomenon of money as a paradigm by which he assumes to show that all social institutions of the economy are nothing more than ‘unintended social results of individual-teleological factors’.’’ 3. Menger (1889, p. 29): ‘‘The inadequacies of economic policy are but the corollary of an economic theory that leaves to the arbitrary judgment of politicians the answer to such questions as whether duties on grain raise their price on predominantly grain-importing countries, whether higher grain prices raise the price of bread, or whether duties on coffee, petroleum, and tobacco or other indirect taxes raise the price of the corresponding articles of consumption.’’ 4. See Cossa, (1893, pp. 429–430): ‘‘War was declared upon the too exclusive tendencies of the historical school when Menger published his Untersuchungen [Investigations] y Schmoller printed an acrimonious and quite ignorant review of Menger’s Untersuchungen [Investigations], only to bring down upon his head Menger’s most lively and remarkably aggressive rejoinder.’’ 5. Quoted in Small (1924, pp. 231–232). Schmoller was the long-time editor of the Jahrbuch fu¨r Gesetzebung, Verwaltung, und Volkswirthschaft im deutschen Reich. See also Bloch (1940, p. 432): ‘‘Now the ire of the quiet and distingushed Viennese was aroused, and in the [Errors of the German Historical School] he out-thundered the pompous Prussian by the brilliance and ﬁre of his style as well as by the force of his refutation. Schmoller retaliated by announcing in his journal that although Menger had sent him a copy of the Errors of the Historical School, he was unable to review it because he had returned it to the author. He reprinted the insulting letter which he returned with the returned copy.’’ 6. See Kauder (1965, p. 236): ‘‘For his seventieth birthday Carl Menger desired that each economist of the whole earth should be photographed and have their picture sent to him. Everyone except Gustav Schmoller and Lujo Brentano did so. Apparently, the leaders of the historical school could neither forgive nor forget.’’ 7. See Bo¨hm-Bawerk (1894, pp. 6–7): ‘‘This name, given to us by our opponents, includes a number of theoretic economists. Not all of those included are Austrians, nor does the group include all the Austrian economists.’’ And Bo¨hm-Bawerk, (1891, p. 363): ‘‘But although the strife of methods, perhaps more than anything else, has drawn attention to the Austrian economists, I prefer to regard it as an unimportant episode of their activity. The matter of importance to them was, and is, the reform of

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positive theory. It is only because they found themselves disturbed in their peaceful and fruitful labors by the attacks of the historical school, that they, like the farmer on the frontier who holds the plow with one hand and the sword with the other, have been constrained, almost against their will, to spend part of their time and strength in defensive polemics and the solution of the problems of method forced upon them.’’ 8. See Menger (1889) for a strong defense of ‘‘abstract theory’’ and its methodological implications against the criticisms of members of the Historical School. 9. See also Blumenthal (2008, p. 20): ‘‘In contemporary German public ﬁnance Sax’s work was recognized but rejected. In a polemic review Gustav Schmoller makes clear that he disapproves of the Mengerian abstract-deductive method applied [by Sax to the problems of tax policy and tax incidence]. Much more than a scholarly discussion, Schmoller sees the intellectual struggle as he calls Sax an ‘enemy in principle’ belonging to the Austrian School.’’ 10. The phlogiston theory originated in 1667 with Johann Joachim Becher; it posited that inside ﬂammable substances was a special element without odor, color, taste, or mass that is freed by the burning process, and is what caused the burning process. It was refuted in the 18th century through a variety of quantitative experiments. To show that that the more things change, the more they stay the same, the following comment was made by, now Nobel Prize winner, Paul Krugman, (1998): ‘‘A few weeks ago, a journalist devoted a substantial part of a proﬁle of yours truly to my failure to pay due attention to the ‘‘Austrian theory’’ of the business cycle – a theory that I regard as being about as worthy of serious study as the phlogiston theory of ﬁre.’’ 11. Menger’s own writings did not appear in English until well into the 20th century, with the exception of his article, ‘‘On the Origin of Money’’ (1892). 12. However, see Green (1895, pp. 54–55), who tried to explain the subjectivist elements that separated the Austrians from the other marginal utility theorists: ‘‘Although Jevons and the Austrians agree considering marginal utility as the basis of value, we ﬁnd an important difference in regard to the fundamental meaning of the word value y Jevons accepted y the use of the word y as expressing the ratio in which commodities in open markets are exchanged against each other y The Austrians, on the other hand, follow Menger in deﬁning value as ‘the importance that concrete goods, or quantities of goods, receive for us from the fact that we are conscious of being dependent on our disposal over them for the satisfaction of our wants.’ The difference must not be overlooked. On one side value is regarded as a ratio between commodities, on the other as importance for human well-being. One conception is objective, the other subjective. y It seems to be largely through the Austrian inﬂuence, however, that recent contributions to economic theory have generally accepted the subjective concept as the primary meaning of value y The Austrians, as Menger’s deﬁnition indicates, consider value as primarily as an individual matter.’’ From this ‘‘Austrian’’ perspective, Green (1894, pp. 225–226) deduced that from ideas such as Wieser’s ‘‘the very nature of costs’’ as ‘‘opportunitysacriﬁces’’ is that they ‘‘must always have the unreal character of might-have-beens,’’ since they are what the actor in his mind considers to have been the alternative end worth forgoing so as to be able to pursue some other. And thus the term ‘‘opportunity costs’’ entered the economics profession for the ﬁrst time, with the

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clear emphasis that ‘‘cost’’ is a mental creation of the chooser, and not something objective or measurable by an external observer or yardstick. 13. See Small (1924, p. 173), who was the American sociologist to whom Menger said this. 14. Francis Edgeworth, Mathematical Psychics (1967 [1881], pp. 12, 15): ‘‘The conception of Man as a pleasure machine may justify and facilitate the employment of mechanical terms and Mathematical reasoning in social science y ‘Mechanique Sociale’ may one day take her place along with ‘Mechanique Celeste’, enthroned upon the doublesided height of one maximum principle, the supreme pinnacle of moral as of physical science.’’ 15. In fairness to both Walras (1874, pp. 184–185) and Pareto (1927, p. 171), each stated that the mathematical constructions of equilibrium states could never be used to replace the real processes of the market through which balance between supply and demand was actually brought about. 16. Menger’s (1871) Principles was meant to be the ﬁrst of four volumes on most of the basic themes in economic theory and policy. Karl Menger, Jr., explained in the introduction to the 1923 reprint of his father’s Grundsatze der Volkswirtshaftslehre that the unpublished remaining three volumes were planned to discuss the following. Vol. II: interest, wages, rent, income, credit, and paper money; Vol. III: the theory of production and commerce; the technological requirements for production; the economic conditions for production; commerce: the theory of the techniques of commerce, speculation, and arbitrage; retail trade; Vol. IV: critique of the contemporary economy and proposals for social reform (Menger, 1923, p. vi). 17. On Bo¨hm-Bawerk’s theoretical contributions as well as his role as AustroHungarian ﬁnance minister, see Ebeling (2001). 18. See footnote 5. 19. Davenport, (1913, pp. 389–390): ‘‘In the price problem the need is to understand precisely how the particular individuals arrive at their respective demand prices. There is no one single homogeneous utility or any one single aggregate demand price. Utility, for purposes of analysis, is an individual category y So far y as we know here is no social organism in the sense of a personality fulﬁlling the requirement of market coordination.’’

REFERENCES Bloch, H.-S. (1940). Carl Menger: The founder of the Austrian school. Journal of Political Economy, 48(April), 428–433. Blumenthal, K. (2008). Emil Sax’s tax theory: A revaluation of an underestimated contribution to public ﬁnance theory. Diskussionsshriften aus dem Institut fur Finanzwissenshaft der Universitat Hamburg, no. 73. Hamburg, Germany. Bo¨hm-Bawerk, E. V. (1890). The historical vs. the deductive method in political economy. Annals of the American Academy of Political and Social Science, 1(October), 244–271. Bo¨hm-Bawerk, E. V. (1890 [1884]). Capital and interest. London: Macmillan. Bo¨hm-Bawerk, E. V. (1891). The Austrian economists. Annals of the American Academy of Political and Social Science, 1(January), 361–384. Bo¨hm-Bawerk, E. V. (1891 [1889]). The positive theory of capital. London: Macmillan.

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Bo¨hm-Bawerk, E. V. (1894). The ultimate standard of value. Annals of the American Academy of Political and Social Science, 5(September), 1–60. Bo¨hm-Bawerk, E. V. (1959). Capital and interest. The positive theory of capital (Vol. 2). South Holland: Libertarian Press. Bonar, J. (1888). The Austrian economists and their view of value. Quarterly Journal of Economics, 3(October), 1–31. Cossa, L. (1893). An introduction to the study of political economy. London: Macmillan. Davenport, H. J. (1902). Proposed modiﬁcations in Austrian theory and terminology. Quarterly Journal of Economics, 16(May), 355–384. Davenport, H. J. (1964 [1908]). Value and distribution. New York: Augustus M. Kelley. Davenport, H. J. (1968 [1913]). The economics of enterprise. New York: Augustus M. Kelley. Diggins, J. D. (1999). Thorstein Veblen: Theorists of the leisure class. Princeton, NJ: Princeton University Press. Ebeling, R. M. (2001). Eugen von Bo¨hm-Bawerk: A sesquicentennial appreciation. The Freeman: Ideas on Liberty, 51(February), 36–41. Ebeling, R. M. (2003). Austrian economics and the political economy of freedom. Northampton, UK: Edward Elgar. Edgeworth, F. (1967 [1881]). Mathematical psychics. New York: Augustus M. Kelley. Fetter, F. A. (1915). Economic principles. New York: The Century. Green, D. I. (1894). Pain-cost and opportunity-cost. Quarterly Journal of Economics, 8(January), 218–229. Green, D. I. (1895). Wieser’s natural value. American Academy of Political and Social Science, 5(January), 52–70. Hayek, F. A. (1955). The counter-revolution of science. Glencoe, IL: The Free Press. Jevons, W. S. (1965 [1879]). The theory of political economy. New York: Augustus M. Kelly. Kauder, E. (1965). A history of marginal utility theory. Princeton, NJ: Princeton University Press. Kohn, H. (1945). Treitschke: National prophet. Review of Politics, 7(October), 418–440. Kohn, H. (1950). Romanticism and the rise of German nationalism. Review of Politics, 12(October), 443–472. Kohn, H. (1965). The mind of Germany: The education of a nation. New York: Torchbooks. Krugman, P. (1998). The hangover theory: Are recessions the inevitable payback for good times. Slate, www.slate.com/id/9593 (4 December). Lachmann, L. M. (1977 [1969]). Methodological individualism and the market economy. In: W. E. Grinder (Ed.), Capital, expectations, and the market process: Essays on the theory of the market process. Kansas City, MO: Sheed Andrews and McMeel. Leijonhufvud, A. (1981 [1973]). Life among the econ. In: Information and coordination: Essays in macroeconomic theory. Oxford, UK: Oxford University Press. Machlup, F. (1981 [1969]). If matter could talk. In: Methodology of economics and other social sciences. New York: Academic Press. Menger, C. (1892). On the origin of money. Economic Journal, 2(June), 239–255. Menger, C. (1923). Grundsatze der Volkswirtschaftslehre. 2nd ed. Wien, Austria: Holder-PichlerTempsky. + Menger, C. 1935 [1884]. Die Irrthumer des Historismus in der deutschen Nationalo¨konomie. The collected works of Carl Menger (Vol. 3). London: London School of Economics. 1–98. Menger, C. (1960 [1889]). Toward a systematic classiﬁcation of the economic sciences. In: L. Sommer (Ed.), Essays in European economic thought. Princeton, NJ: D. Van Nostrand.

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Menger, C. (1981 [1871]). Principles of economics. New York: New York University Press. Menger, C. (1985 [1883]). Investigation into the method of the social sciences with special reference to economics. New York: New York University Press. Mises, L. von. (1959). Bemerkungen u¨ber die ideologischen Wurzeln der Wa¨hrungskatastrophe von 1923 [Remarks concerning the ideological roots of the monetary catastrophe of 1923]. + Albert Hahn [Homage by Friends for Albert Freundesgabe zum 12. Oktober 1959 fur Hahn on October 12, 1959]. Frankfurt am Main: Fritz Knapp. Mises, L. von. (2003 [1969]). The historical setting of the Austrian school of economics. Auburn, AL: The Ludwig von Mises Institute. Pareto, V. (1966). Vilfredo Pareto, sociological writings. In: S. E. Finer (Ed.), Oxford, UK: Blackwell. Pareto, V. (1971 [1927]). Manual of political economy. New York: Augustus M. Kelley. Robbins, L. (1970). The evolution of modern economic theory. London: Macmillan. + Schmoller, G. (1883). Zur Methodologie der Staate und Sozialwissenschaften. Jarbuch fur Gesetzgegbung, Verwaltung und Volkswirtschaft im Deutschen Reich, 974–994. Schumpeter, J. A. (1954). History of economic analysis. Oxford, UK: Oxford University Press. Seligman, B. (1962). Main currents in modern economics. New York: Free Press. Small, A. W. (1924). Origins of sociology. Chicago, IL: University of Chicago Press. Smart, W. (1891). An introduction to the theory of value, on the lines of Menger, Wieser and Bo¨hm-Bawerk. London: Macmillan. Walras, L. (1965 [1874]). Elements of pure economics. New York: Augustus M. Kelley. Wicksteed, P. (1969 [1910]). The common sense of political economy. London: Routledge. Wieser, F. von. (1891). The Austrian school and the theory of value. Economic Journal, 1(March), 108–121. Wieser, F. von. (1892). The theory of value: A reply to professor Macvane. Annals of the American Academy of Political and Social Science, 2(March), 24–52. Wieser, F. von. (1893 [1889]). Natural value. London: Macmillan. Wieser, F. von. (1967 [1914]). Social economics. New York: Augustus M. Kelly.

THE CONTEXT OF CONTEXT: THE EVOLUTION OF HAYEK’S EPISTEMIC TURN IN ECONOMICS AND POLITICS Peter J. Boettke, Emily C. Shaeffer and Nicholas A. Snow ABSTRACT F. A. Hayek’s contribution to economic science is broadly remembered as relating to the ‘‘use of knowledge in society’’ but his contribution to economics of knowledge are often summarized differently. We emphasize the contextual nature of the knowledge. Hayek says the market economy is capable of eliciting and utilizing in the process of coordinating economic activities. There is, however, a double meaning of context that we explore. Hayek developed his argument about the use of knowledge in the context of the socialist calculation debate, and the aspect of knowledge he came to focus on was the contextual nature of knowledge in human action in markets, politics, law, and society. This paper traces out the development of Hayek’s focus on the epistemic foundations of the complex coordination in an advanced market economy and shows that his critique of classical and market socialism led to a reﬁned, subtle approach to understanding spontaneous order. Furthermore, it is precisely Hayek’s focus on the role What is so Austrian About Austrian Economics? Advances in Austrian Economics, Volume 14, 69–86 Copyright r 2010 by Emerald Group Publishing Limited All rights of reproduction in any form reserved ISSN: 1529-2134/doi:10.1108/S1529-2134(2010)0000014007

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of institutions in creating the conditions for the utilization and transference of knowledge through the price system that continues to shape the progressive research programs in economic science and public policy analysis that is his legacy.

1. INTRODUCTION Possibly the most important contribution F. A. Hayek made to economics concerns his explanation of how the price mechanism captures the private and dispersed knowledge in an economy and utilizes that knowledge in such a way that leads to an efﬁcient allocation of resources in society. Hayek’s work is among the most inﬂuential in the past century.1 Myerson’s (2007) discussion of the inﬂuences of his fellow Laureate Leo Hurwicz, for example, begins with the famous quote from ‘‘The Use of Knowledge in Society’’ (1945), The economic problem of society is not merely a problem of how to allocate ‘given’ resources y It is rather a problem of how to secure the best use of resources known to any members of society, for ends whose relative importance only the individuals know y it is a problem of the utilization of knowledge not given to anyone in its totality. The character of the fundamental problem has, I am afraid, been rather obscured than illuminated by many of the recent reﬁnements of economic theory, particularly by many of the uses made of mathematics (quoted in Myerson, 2007).

From the outset of the paper, Myerson (2007) suggests that the development of Hayek’s ideas about the importance of local knowledge, while an outgrowth of the socialist calculation debates of the 1930s, led to the work on mechanism design. Generally, mainstream economists cite F. A. Hayek’s arguments concerning local knowledge and the mechanism of the price system as contributing to the development of ‘‘information economics’’. From Koopmans to Arrow, economists took up Hayek’s theoretical challenge to market socialism (Mirowski, 2002, pp. 232–308). The theory of mechanism design was one approach that explicitly tried to meet Hayek head on. Like Myerson’s account, some seem to suggest that these contributions grew out of the context of a greater debate surrounding the limitations of socialism. Others like Samuelson (2009) seem to view Hayek’s epistemic focus as a ‘‘new element’’ in the debate.2 Although Hayek’s focus on the price system as a mechanism for utilizing and communicating knowledge was an important contribution to economics, it was an idea that grew from the context in which Hayek was writing and developing his arguments: a context sharpened by the challenge put to

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traditional economics by market socialists. Hayek’s focus on the epistemic properties of the market process led him to recognize the role of the division of knowledge in promoting social order just as Smith (1776) emphasized the division of labor to promote economic prosperity. Adam Smith taught us that the great increase in the productive capacity of a people resulted from expansions in the division of labor. Hayek, similarly, taught us that a division of labor also entailed a division of knowledge in society. Both emphasized the complexity that the division of labor and division of knowledge implied and the enormity of the coordinative task that must be accomplished by the market system to realize the great beneﬁts of specialization and trade. Economic coordination requires the dovetailing of the diverse plans of individuals dispersed throughout the economic system. The production plans of some must mesh with consumption demands of others, and do so in a manner that tends to exploit the gains from trade, and realize technological efﬁciency. Minds must meet and this is accomplished through the market process of relative price adjustments and proﬁt and loss accounting. Ex ante expectations guide the decisions of individuals and are informed by the existing array of prices that decision makers confront. Ex post improvements of plans are communicated via proﬁt and loss, and serve to indicate the appropriateness of those plans in terms of the competing demands for the resources and the concurrent plans of everyone else in the economy. Learning occurs when discrepancies between ex ante expectations and ex post realizations are discovered. Individuals ﬁnd better ways to accomplish their plans. The broader social order enjoys a form of learning process as good plans displace bad plans. Successful social coordination requires that the incentives individuals face in making choices align so that each has the ability to learn what opportunities exist for mutually beneﬁcial exchange and cost saving methods of production. As this process unfolds over time, the conditions must also be such as to allow for new discoveries of previously unthinkable possibilities for gains from exchange and innovation. For Hayek, the utilization of an individual’s dispersed and incomplete knowledge was the central property of the complex social order within the system of exchange. To Hayek, the extent to which the dispersed knowledge is mobilized and transmitted among distant and diverse individuals determines the extent to which individual actions dovetail and social prosperity occurs. Thus, the market is not only a system that aligns the incentives of producers and consumers to achieve an efﬁcient allocation of scare resources, but also acts as a learning device that provides individuals with feedback for the relative efﬁciency of their plans. As mistakes are made,

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so are corrections, and frequently individuals discover previously unexploited opportunities for mutually beneﬁcial exchange. Individuals are also inclined to discover previously unrecognized opportunities for innovation. Overtime, general welfare in society increases. Thus for Hayek, institutions that uphold private property rights and provide a stable legal framework of general laws of contract are an essential condition for the exchange and transmission of knowledge. Recognizing the role institutions played in creating the context for this process, Hayek later went on to focus on analyzing legal, political, and social theory in an effort to explicate the framework for how various institutions wrestle with the problems of local knowledge aggregation and transmission. We explore how Hayek came to focus on the market as an information transmission device, bringing knowledge constraints and learning to the forefront of economic and social analysis. Our argument is that Hayek’s epistemic turn occurs through his studies within the context of the socialist calculation debate. Prior to the debate, Hayek’s work in technical economics focused on capital theory and the questions surrounding the imputation of value. All of this occurring within a broader study of monetary theory and the trade cycle. When Hayek arrived at the London School of Economics (LSE), he viewed himself as working within the established marginalist tradition of Carl Menger and Friedrich Wieser, and the monetary tradition of Ludwig von Mises and Knut Wicksell. In the 1930s and 1940s, the debates concerning market socialism took place against the backdrop of the shifting philosophical program in economics science. Both formalism and positivism gripped the imagination of economists. The combination of formalistic and positivistic philosophical justiﬁcation is what Hayek termed ‘‘scientism’’ in his resistance to this intellectual trend. In 1920, Ludwig von Mises published his critique concerning the impossibility of economic calculation under socialism. At the time Mises wrote, the main proponents of socialism were Marxists and other social democratic reformers of a historicist or institutionalist perspective. Mises’s article set off a German language debate, which had little immediate effect on the English language scientiﬁc community of economists, though Taylor (1929) and Knight (1936) did take Mises challenge. When, however, Hayek published Collectivist Economic Planning in 1935, which included the ﬁrst English translation of Mises’ article, the English language debate over the feasibility of socialism captured the imagination of new generations of economists. Rather than the Marxists, historicists, and institutionalists, it was neoclassical economists who argued for market socialism and government intervention to correct market failures of monopoly, spillovers, instability, and inequality. Although

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prior to the 1930s marginalist economics entailed a presumption in favor of market forces over activist government, by the mid 1930s that consensus was gone. During this period, the English language debate coagulated primarily around economists at the LSE. It was at the LSE where Hayek’s student Abba Lerner developed his ideas of efﬁcient socialist economic planning using the tools of neoclassical price theory, and where as student editor of Review of Economic Studies he published Oskar Lange’s neoclassical model of market socialism. In just a few years, neoclassical economists moved from dispelling the utopian prognostications of the historicists and institutionalists to propagating arguments for neoclassical market socialism in the vain of Lange (1936a, 1936b, 1936c) and Lerner (1934a, 1934b, 1936, 1937, 1938), explaining how markets were prone to failure, and calling for Keynesian style management of consumer demand. The experiences and writings within this period set Hayek on the path of reﬁning Mises’s argument about the impossibility of economic calculation under socialism and developing his ideas concerning the importance of the contextual environment within which individuals pursue their plans. The growing focus that Hayek placed on the institutional prerequisites for learning stems from the various attempts to answer the neoclassical arguments put forth by economist in favor of market socialism. Hayek learned in the process of debate that responding to the market socialist arguments by reiterating the traditional economic arguments against socialism (incentives, role of prices, economic calculation, etc.) was not enough, and instead, he had to delve deeper into the institutional context of the market process. This meant broadening the ﬁeld of political economy and the methodology of the discipline of economics.

2. HAYEK, ECONOMICS, AND PUBLIC POLICY In 1933, Hayek delivered his inaugural lecture at the LSE, ‘‘The Trend of Economic Thinking,’’ beginning with a seemly paradoxical observation regarding the economist and public policy. Of all the practicing scientists, Hayek observes, the economist is asked more often to give advice on questions of public policy and yet his advice is usually ignored almost from the moment it is uttered. The reason Hayek (1933, pp. 121–122) puts forth is that the ideas of the economist are powerful, albeit, take a long time to become absorbed into public life.

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The concept that ideas inﬂuence public policy is a powerful one, and signiﬁcant because Hayek is writing during the period immediately preceding the ‘‘Keynesian Revolution.’’ The process by which the Keynesian inﬂuence came to spread was not one that occurred overnight. It proceeded as Hayek had suggested from the ideas of the leading economists down toward policy analysts, journalists, and politicians. According to Hayek (1933), progress in economic science, however, is advancement in understanding the interdependence of economic phenomena. A deeper understanding of the complex division of labor that must be coordinated to produce even the simplest products we enjoy as Adam Smith (1976 [1776]) demonstrated with his example of the common woolen coat in the opening chapters of the Wealth of Nations. The procurement of these products, Smith explained, is so much more ‘‘miraculous’’ by the fact that they result from a process that relies on the cooperation of a multitude of anonymous actors. For scarce is the time in our lives to make a few good friends, but we depend on the activity of hundreds, perhaps thousands for our daily survival. In understanding the composition of systematic forces, which lead to the emergence of spontaneous orders, we observe in the world. Hayek’s ideas were in sharp contrast to the Keynesian paradigm that would follow in the next few years. Keynes’ suggests not only that economics is the study of the relationship between aggregate economic variables, but also that the coordinating properties of the market generally fail to allocate goods properly. At the time, Hayek had one foot in two worlds. He viewed economics as a science capable of constraining utopian ideals. Hayek viewed our ability to engage in economic debates as turning on a general agreement of ends and the application of theory to illuminate the best means to achieve those ends. In other words, the ends of the liberal economist and the socialist revolutionary were in theory quite similar – advanced material prosperity and social harmony. Through the application of the laws of economics, the power of the market propels economic growth, raising living standards and exposing the harmful effects of interventionism and planning. As Hayek’s technical work in economics evolved, he became increasingly aware of both the power and the limitations of equilibrium theorizing. At ﬁrst, it was the absence of time within the equilibrium construct that caused problems for Hayek’s theorizing on intertemporal coordination of plans within a capital structure.3 In studying the derivation in value of the various inputs with relation to the value of the output produced, Hayek became aware of the dangers equilibrium theorizing poses by distorting the essential economic problem that the equilibrium propositions were supposed to

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enlighten. Hayek was acutely aware, however, of how the heterodox traditions, of the German historical school and the American institutional school, led to an atheoretical orientation of fact collection. Somewhere between arid formalism and descriptive fact collection was the appropriate domain of theoretical social science. Hayek’s ideas posed challenges to economics, and more generally challenges to the accepted methodological techniques of the social sciences. Thus, Hayek’s insights came to hold profound implications for philosophy, public policy, and history. Hayek (1933, p. 18) thought ‘‘it is not a change in ideals nor a change in reasoning, but a change of view with regard to the applicability of such reasoning’’ that causes an economist to change his view toward questions of economic policy. In effect, Hayek’s arrival at the LSE, and his views expressed in ‘‘The Trend of Economic Thinking,’’ mark the beginning of Hayek’s shift toward an epistemic focus on social coordination and the market process. As he notes (1933, p. 132), The recognition of the existence of this organism [Society] is the recognition that there is a subject-matter for economics. It is one of the causes of the unique position of economics that the existence of a deﬁnite object of its investigation can be realized only after a prolonged study, and it is, therefore, not surprising that people who have never really studied economic theory will be doubtful of the legitimacy of its existence, as well as the appropriateness of its method. A real proof for all I have said and for all the economist contends can, therefore, be given only by means of a complete exposition of his science.

3. HAYEK’S STUDENTS AND THE TRANSFORMATION OF ECONOMICS Hayek’s critique of socialism began by following Ludwig von Mises’s (1920) argument that private property is a necessary precondition for efﬁcient coordination of economic activity. Property rights provide incentives for individuals to internalize the costs of their actions and to economize in ways they otherwise would not. Mises (1920) directed his argument at the common premise held by various socialists – the elimination of private property rights could maintain an advanced system of exchange production. Without property rights in the means of production, monetary prices in these factors of production cannot emerge (Mises, 1920). Monetary prices indicate the relative scarcities of the factors of production, without which there are no other means for determining the relative abundance or scarcity of capital resources. If monetary prices do not reﬂect these underlying relative scarcities, then individuals have no way of engaging in rational

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economic calculation. Economic calculation, which drives the efﬁcient allocation of goods and services in a market economy, is impossible without private property in the means of production. Mises (1920) provided the strongest argument against the early socialists – who argued that with the abolition of private property, there would no longer be a need for any economic analysis. Economic analysis, they asserted, is only relevant to the study of capitalist societies and would be no use under socialism. Neoclassical economists such as Pareto and Wieser had established that there was a formal similarity in the economic problem that society faced whether the system was organized as capitalistic or socialistic. Scarce resources needed to be allocated in an efﬁcient manner and waste was to be avoided to realize the goals of social harmony and material abundance. Mises’s challenge to socialism was his demonstration that socialist means were incoherent with respect to socialist ends. In his treatment of these issues, Hayek (1980 [1935a]) shows the problem that markets solve involve both technical efﬁciency and economic efﬁciency. The advocates of central planning who denied the application of economic analysis to socialism failed to see the problem of resource allocation was an economic problem. Instead, central control of production was viewed only as a problem of technological efﬁciency. Hayek argues the true problem was one of economic efﬁciency (allocating resources that have competing uses). His arguments stress the complexity of knowing the value scales for each individual within the economy. ‘‘The problem which the director of all economic activities of a community would have to face would be similar to those solved by an engineer only if the order of importance of the different needs of the community were ﬁxed in such a deﬁnite and absolute way that provision of one could always be made irrespective of cost’’ (Hayek, 1980 [1935a], p. 122). Characterizing rational central planning, however, as a technological efﬁciency problem only solves one part of the more complicated economic problem. Decisions made on the basis of given prices still have to adjust to all other prices in the market to approximate efﬁciency. Solving the problem of economic production confronts the challenges imposed by complexity. This leads Hayek to argue: ‘‘the fact that one central authority has to solve the economic problem of distributing a limited amount of resources between a practically inﬁnite number of competing purposes, that constitutes the problem of socialism as a method’’ (Hayek, 1980 [1935a], p. 131, italics added). Mises’ (1920) contribution established the foundation on which Hayek places these arguments, of technical and economic efﬁciency, by arguing that if a socialist system were to succeed, it would need to accomplish what

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capitalism achieves. It must allocate goods and services efﬁciently. Neoclassical economists of all types (Schumpeter, Walras, Pareto, Barone, Wieser, & Knight) criticized the socialists’ theory during this period for not grasping the basic point concerning optimality and efﬁciency. If centralization of production were to achieve the most efﬁcient use of resources, then socialist production would need to satisfy the optimality conditions described by marginalist principles. The economic arguments against the socialist ideas in the ﬁrst two decades of the twentieth century established the properties of an equilibrium system as the standard by which centralized production must meet if it were to claim superiority over the capitalist system.4 Mises’s (1920, 1981 [1922]) calculation critique of socialism is the starting point of Hayek’s critique. In addition to Mises’s insights on calculation, Hayek emphasized the incentive problems of socialism caused by the absence of private property. Additionally, Hayek’s (1980 [1935a], 1980 [1935b], 1940) language points to the insight about the market as a mechanism for gathering and transmitting knowledge through the emphasis on the complexity of economic coordination of inﬁnite competing orderings of ends. The knowledge inputs to economic calculation are absent when market exchange based on private property is suspended by assumption. Hayek made note that socialists of the day did not typically address the more ‘‘practical problems’’ rational calculation under common ownership entails because of the arbitrary grounds on which choices must be made in the absence of free pricing.5 But the context of the times must not be forgotten. The Great Depression resulted in widespread antimarket rhetoric and a demand among policy makers and intellectuals for government intervention in the unhampered market. The market economy was no longer seen as a source of wealth creation for all, and a system of self-correction, but a system of failure where the weak are exploited by the privileged and powerful few. Academic developments in American and British universities began emphasizing market failure by introducing micro level theories of market structure imperfections. Robinson (1933) and Chamberlin (1962 [1933]) were pioneers in this area, establishing neoclassical approaches to imperfect markets. Casual empiricism, or what Hayek viewed as a new historicism, was coming back into the fold (see Berle & Means, 1932). Both theory and empirics were undermining the efﬁciency properties of unregulated markets. For politicians and academics alike, by the mid-1930s socialism seemed possible, and even desirable, to correct the presumably chaotic market. In their attempt to meet the challenge put forth by Mises and Hayek, market socialists changed the fundamental assumption of the human

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motivation: postulating that self-interest would no longer guide the actions of men under socialism. The good of society would motivate individuals to deny their own self-interests and to economize the use of resources. This is what led Mises to emphasize the calculation argument over the classical incentive argument in his critique of socialism. To Lange (1936a, 1936b, 1936c), withal, questions of human motivation were not economic questions but psychological. In response, Hayek had essentially two choices. The ﬁrst entailed a denial of the transformation of human proclivities under collective ownership arrangements. The second being the accepting of their assumption and demonstrating that even when men are angels and sought advanced material wealth under collectivism, they would fail. Hayek (1980 [1937], 1940, 1945) developed his arguments using the latter set of assumptions, accepting a high argumentative burden in the hopes that if he succeeded in proving the impossibility of socialism in this manner, his views would have the best chance of cascading through intellectual and political arenas. When the incentive argument against socialism are de-emphasized, the question becomes one of informational requirements for economic coordination.6 Assuming individuals want to make prudent decisions even in economic environments without private property rights, the question turns to how will the actors know what actions are in fact the correct pursuits to generate economic optimality. Hayek’s (1980 [1935b]) article begins to develop the importance of local knowledge by pointing out ‘‘ y what is practically relevant here is y the nature and amount of concrete information required if a numerical solution is to be attempted’’ (Hayek, 1980 [1935b], p. 153). Hayek argued that central planners would have to account for the usefulness of ‘‘every machine, tool, or building y determined by its particular state of wear and tear, its location, etc.’’ (Hayek, 1980 [1935b], p. 154). Moreover, ‘‘two technically similar goods in different places or in different pickings or of a different age cannot possibly be treated as equal in usefulness for most purposes if even a minimum of efﬁcient use is to be secured’’ Hayek, 1980 [1935b], p. 154). Prices communicate the condensed knowledge of decisions in time and place allowing individuals to economize on the amount of information relevant to the choices they make. Monetary prices that emerge from the exchange of private property are relative prices that economize on information and facilitate individually prudent decision-making. Soon the Mises–Hayek line of argument attracted a different method of central planning that attempted to incorporate rational economic calculation.7 Lerner, one of Hayek’s students at LSE, led the way.

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Lerner was an admirer of the market system as an allocation mechanism and opposed direct government control over individuals’ lives. Lerner, moreover, was a neoclassical economist trained in the modern tradition of marginal analysis. The LSE was a bastion of Fabian socialism since its founding, but Lerner brought the modern model of market socialism and the arguments of Oskar Lange (1936a, 1936b, 1936c) to the LSE, stimulating debates and pressing Hayek to articulate his objections. To Lerner (1934a, 1934b, 1936, 1937, 1938), though Marxist theory may have provided the foundation for the analysis of capitalism, it was neoclassical economics that provided the blueprint for a working model of socialism.8 Hayek must have felt deep frustration by his student’s use of neoclassical economics to advocate central direction of resource allocation. Hayek emphasized the extent the market makes use of time- and placespeciﬁc knowledge by communicating it to individuals through prices even under local conditions that are constantly changing. Where Lerner and Lange assume ‘‘given’’ information, Hayek begins to challenge these ideas. In a centrally planned society the selection of the most appropriate among the known technical methods will be possible only if all that knowledge can be used in the calculations of the central authority. This means in practice that this knowledge will have to be concentrated in the heads of one or at best a very few people who actually formulate the equations to be worked out. It is hardly necessary to emphasize that this is an absurd idea even in so far as that knowledge is concerned which can properly be said to ‘‘exist’’ at any moment of time. But much of the knowledge that is actually utilized is by no means ‘‘in existence’’ in this ready-made form (Hayek, 1980 [1935b], p. 155).

The sharp clarity of the debate came with Lange’s (1936a) ﬁrst part of his theory of socialism in response to Mises and Hayek. Lange challenged the impossibility of economic calculation under socialism by disputing the meaning of prices. Monetary prices, Lange asserts, are a subset of all prices; more generally prices reﬂect the relevant alternatives available. Thus, Lange states that to solve the problem of choice among alternatives, three things are needed: (1) the preference scale that guides choice, (2) knowledge of the terms offered for alternatives, and (3) knowledge of the amount of resources available. Lange’s second reply (1936b) advocated market socialism by trialand-error procedures that reﬁne and solve the simultaneous equations necessary for optimal resource allocation. The Lange–Lerner argument was that rational economic planning could implement a market socialist system. This system could eliminate abuses of monopoly power and irrational production of a capitalist system. In their theory, individual freedom existed by allowing for a free market in consumer goods, which also, according to Lange, aided the planners during

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the trial-and-error process. The free market in consumer goods, they argued, could coordinate production because if the prices of consumer goods were provided, then in equilibrium the price of the producer goods employed could be determined through the process of imputation. To Hayek, this direction in economic reasoning must have been puzzling, and led him to consider two possible explanations for why his arguments failed to convince even his own students. The ﬁrst reason is a methodological trend involving the rise of positivism in economics. In short, the trend in economics toward a ‘‘blind application’’ of the methods of the natural sciences to problems of the social sciences was greatly distorting the basic economic phenomena under study. This line of Hayek’s intellectual inquiry led him toward his ‘‘Abuse of Reason’’ project – a thorough critique of formalism and ‘‘scientism’’ in the discipline of economics (Caldwell, 2004). Second, Hayek began to delve further into the shortcoming of the equilibrium theorizing about the market process. Laying out the argument in a fundamentally different fashion, Hayek emphasized the aspects of spontaneous order masked by traditional equilibrium theorizing and attempted to address the confusions he saw in the arguments of his opponents. In Economics and Knowledge (1937) and then again in the reply to Lange and Lerner (1940), Hayek pushes for the return of contextual analysis. By reiterating the difference between the meaning of equilibrium in the sense of individual action and in the sphere of an entire economy, Hayek returns to the argument only partially developed in ‘‘The State of the Debate’’ that ‘‘one person’s actions are the other person’s data’’ (Hayek, 1980 [1937], p. 38). By directly addressing the apparent disjoint between the scientiﬁc language of mathematical modeling and the realities of the central argument, Hayek clariﬁes his meaning. In the pure logic of choice, ‘‘ y ‘data’ meant those facts, and only those facts, which were present in the mind of the action person, and only those subjective interpretations of the term ‘datum’ made those propositions necessary truths’’ (Hayek, 1980 [1937], p. 39). The arguments in the socialist calculation debate served Hayek in reﬁning his arguments concerning the function and role of the market price system, and it is consequently following these papers that Hayek solidiﬁes his epistemic turn in ‘‘The use of knowledge in society’’ (1945). Hayek restates the fundamental problem as one concerning mobilization of dispersed and incomplete knowledge held by individuals throughout the economy to those who require that information to plan accurately to bring about a state of greater coordination. Hayek’s turn to what others would call a ‘‘more philosophical approach’’ to the study of the market comes by reexplaining himself in light of the

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socialist arguments made with the use of a neoclassical general equilibrium framework. The epistemic focus was an economic efﬁciency problem and not just a technical efﬁciency problem (1980 [1935a]). By 1945, Hayek returns to this concept in the ﬁrst sentence of the article by asking ‘‘What is the problem we wish to solve when we try to construct a rational economic order?’’9

4. HAYEK’S SEARCH FOR A SOLUTION INVOLVING SEARCHERS10 The economics profession had gone from a neoclassical framework that presumed the market was the primary means for the efﬁcient allocation of resources, to accepting the idea that socialism was possible. The argument of Lange and others for market socialism was one Hayek would devote the rest of his career to answering. Hayek cultivated his responses over time, beginning with his response to Lange. Hayek’s (1940) response to Lange echoed the concerns he raised in his 1937 article concerning the discipline’s preoccupation with equilibrium theorizing. The equilibrium approach often assumed what in fact had to be proven. The modeling techniques of modern economics had gone wrong; the tools did nothing to discuss how a system of acting agents adapts to changing circumstances. The issue of coordination and economic production among individuals was replaced with a simultaneous equation model. Consider the questions of imputation Lange (1936a, 1936b) raised. He argued if there were a market for consumer goods, by equilibrium construction there would be no need for a market in producer goods. The imputation of the values of the higher order would already be determined by the consumer good prices. A market in capital goods, for Lange, would be redundant at best. Lange’s approach is just one example (Schumpeter made similar arguments) of what Hayek (1945, p. 530) saw as a more general problem. The problem existed because Lange’s response was consistent given the equilibrium models. General equilibrium is a model wherein all plans are prereconciled. The Walrasian auction does not allow for error; no false trading is permitted. Hayek viewed the general equilibrium framework as completely sidestepping the problem of how imputation actually takes place within an economy of constant ﬂux. How are individuals able to act where the plans of producers are coordinated with the demands of consumers at any point in time? How does the market process – the procedure leading up to equilibrium – occur?

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Decision makers use prices as signals to determine the relative scarcities of various factors of production, and thus the relative proﬁtability of various combinations of goods to produce output. How does knowledge come to exist and how do individuals come to know how to act on such knowledge to bring about a state of affairs? Such a question is not addressed by assuming that knowledge is already fully possessed by everyone in the economy. The competitive general equilibrium framework employed by Lange and others, assumed away the problem Mises identiﬁed in 1920. The problem with competitive general equilibrium was essentially epistemic. If our tools only allow us to see a world where plans immediately dovetail, then the process that brings about that coordination of plans will remain hidden. More importantly, the conditions that facilitate the process of economic coordination are absent in the general equilibrium model. Individuals’ abilities to identify relevant data, to act on that knowledge, and to convey that knowledge to others are contingent on the context of their action. Hayek’s central point was that there are particular institutions necessary to bring about the emergence of prices to indicate relative scarcity and generate economic efﬁciency. If the institution of private property is not present, the market process will not occur. The context of exchange is crucial. If the socialists abolished private property, then some other means of allocating goods and services would have to replace the market process. The socialist alternative would not have the beneﬁt of monetary prices to indicate scarcities, and would not be able to count on individuals to calculate proﬁtable opportunities. What then would characterize the production and distribution processes in a socialist economy? Even brilliant economists such as Knight and Schumpeter dramatically misunderstood the fundamentals of market process because of the assumptions and tools of their analysis; Hayek sought to strike the root. Hayek (1937) set out to examine the role of the knowledge assumptions in traditional equilibrium analysis. The general idea developed concerns how an overall order of economic activity comes about as the result of utilizing a large amount of knowledge never given to one individual in total. In addressing the concerns of the general equilibrium model, Hayek develops three points. First, in equilibrium everyone must have correct foresight of the actions of all other agents within the system. Expectations, in equilibrium, must already account for the actions of all other economic actors.11 Individuals’ expectations concerning future conditions are subjectively formed, and thus the ‘‘data’’ are not objective phenomena. The implication is that subjectivity introduces the possibility for error.

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Second, Hayek (1937) distinguishes the differences between individual equilibrium and social equilibrium. The emphasis moves from the role of time in individual situations to subjectivity and dispersed nature of knowledge. The fact that knowledge is dispersed (as opposed to given to all) leads to the third point – different people have access to different ‘‘data’’ or knowledge. If knowledge were simply subjective, then the neoclassical tools that deal with marginalist concepts already account for subjective perceptions. It is, however, because no one person possesses the relevant data and each individual accesses knowledge only in a local (in some cases, tacit) context that the ‘‘knowledge problem’’ remains even in the equilibrium construct. The epistemological problem is a permanent problem. By 1945, Hayek clariﬁed the idea that a crucial disjunction existed between the knowledge assumed to the planner by the economist, and the nature of knowledge that is possessed by the agents within the economy. The assumptions of equilibrium theorizing had come to obscure the very problem of rational economic organization both substantively and methodologically. The ‘‘data’’ underlying the simultaneous equations can never be ‘‘given’’ to a single mind, but rather the knowledge of the particular circumstances that individuals must take account of in their actions and plans is incomplete and contextual. Reducing the fundamental problem of economics by assuming condensed and given knowledge on the part of central planners, sparked Hayek’s search for a rich understanding of spontaneous orders emerging from the interaction of individuals with fractural and dispersed knowledge.

5. CONCLUSION Within the context of the socialist calculation debate, Hayek developed what is arguably his most important contribution to economics, namely, the role the price mechanism plays in capturing fractured and dispersed knowledge to efﬁciently allocate resources. The context of the debate shaped Hayek’s arguments against the collective ownership of the means of production in a different light than previously argued. Rather than contending with Marxists, historicists, and institutionalists, market advocates had to deal with arguments rooted in a neoclassical framework. This resulted in an epistemic turn toward Hayek placing a broader importance on the role of institutions. Just as Smith (1976 [1776]) noticed the importance of the division of labor, Hayek realized the crucial role played by the division of knowledge. The market economy contained the proper institutions that

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coordinated information where individuals could efﬁciently allocate scarce resources. Hayek was able to show market socialists that in their attempts to answer Mises, they provided no answer at all. They merely assumed what they needed to prove by treating the relevant knowledge of the market as ‘‘given.’’ Instead, Hayek’s work from the mid-1930s emphasized that relevant economic knowledge is never ‘‘given.’’ The knowledge of the market is knowledge of time and place, not abstract. It must be discovered and utilized within speciﬁc economic contexts outside that context; the knowledge is not costly to obtain, it literally does not exist. What we have sought to provide in this paper is the context within which Hayek came to emphasize the contextual nature of the knowledge utilized in the market. It is this contextual knowledge that makes possible the intricate meshing of plans within a modern economy, and in turn, grants social corporation under the division of labor that wealth and prosperity depend.

NOTES 1. A recent study by David Skarbek (2009) demonstrates that among the Nobel Prize winners, Hayek ranks second to Kenneth Arrow in citation count by other Nobel Prize winners. 2. See Paul A. Samuelson (2009, p. 2). In the 1940s Friedrich Hayek in an invited Harvard lecture introduced a new dynamic element into the debate. Call it ‘‘information economics.’’ The broad competitive markets, Hayek proclaimed, were the recipients of heterogeneous idiosyncratic bits of individuals’ information. 3. Since equilibrium is a relationship between actions, and since the actions of one person must necessarily take place successively in time, it is obvious that the passage of time is essential to give the concept of equilibrium any meaning. This deserves mention, since many economists appear to have been unable to ﬁnd a place for time in equilibrium analysis and consequently have suggested that equilibrium must be conceived as timeless (Hayek, 1937). 4. As Hayek states it: ‘‘The fundamental question is whether it is possible under the complex conditions of a large modern society for such a central authority to carry out the implications of any such scale of values with a reasonable degree of accuracy, with a degree of success equaling or approaching the results of competitive capitalism, not whether any particular set of values of this sort is in any way superior to another’’ (Hayek [1935a] 1980, p. 131). See Boettke (2000) for a detailed collection of the arguments. 5. Hayek reports, those who did venture to detail what economic organization would resemble such as Kautsky and Neurath demonstrated a general lack of understanding or awareness of the problem that economists had seen. Namely, that ‘‘the task that socialists had to solve was to show how in the absence of a pricing system the value of different goods was to be determined’’ (Hayek, 1980 [1935a], p. 139).

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6. This only means that the authorities only admit the obvious difﬁculty of making people follow out the plan loyally, there can be no doubt that the more serious disappointments are really due to the inherent difﬁculties of any central planning’’ (Hayek, 1980 [1935b], p. 152). 7. The clear and distinct formulation of a problem is certainly a major contribution to science, the economist will have to join the socialists in their recognition of Professor Mises’ work on economic calculation in a socialist economy’’ (Lange, 1936a, p. 53). 8. Coase (1993, p. 39) reports that Lerner actually visited Trotsky in Mexico to tell him not to despair the revolution was still possible due to the development of marginal analysis. 9. Even on reﬂection years later, Hayek would come to mark this as the beginning of new line of inquiry into the nature of spontaneous order. ‘‘Though at one time a very pure and narrow economic theorist, I was led from technical economics into all kinds of questions usually regarded at philosophical. When I look back, it seems to have all begun, nearly thirty years ago, with an essay on ‘Economics and Knowledge’ in which I examined what seemed to me some of the central difﬁculties of pure economic theory. Its main conclusion was that the task of economic theory was to explain how an overall order of economic activity was achieved which utilized a large amount of knowledge which was not concentrated in any one mind but existed only as separate knowledge of thousands or millions of different individuals’’ (Hayek, 1967, pp. 91–92). 10. The language is a play on William Easterly’s recent contrast between planners and searchers in the context of development. See Easterly (2006). 11. Caldwell (2002) connects Hayek’s developments of this particular line of reasoning on expectations to the idea developed by Oskar Morganstern that perfect foresight and movement toward equilibrium were logically incompatible.

REFERENCES Berle, A., & Means, G. (1967 [1932]). The modern corporation and private property. New York: Harcourt, Brace and World. Boettke, P. (Ed.) (2000). Socialism and the market: The socialist calculation debate revisited (Vol. 9). London: Routledge. Caldwell, B. (2002). Weiser, Hayek and equilibrium theory. Journal des Economistes et des Etudes Humaines, 12(1), 47–66. Caldwell, B. (2004). Hayek’s challenge: An intellectual biography of F. A. Hayek. Chicago, IL: University of Chicago Press. Chamberlin, E. H. (1962 [1933]). The theory of monopolistic competition. Cambridge, USA: Harvard University Press. Coase, R. (1993). Nature of the ﬁrm: Origins. In: O. Williamson & S. Winter (Eds), The nature of the ﬁrm. Oxford, UK: Oxford University Press. Easterly, W. (2006). White man’s burden: Why the West’s efforts to aid rest have done so much ill and so little good. New York: The Penguin Press. Hayek, F. A. (1933). The trend of economic thinking. Economica, 13, 121–137. Hayek, F. A. (1940). The competitive ‘‘solution’’. Economica, 26, 125–149. Hayek, F. A. (1945). The use of knowledge in society. American Economic Review, 35(4), 519–530.

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Hayek, F. A. (1967). Studies in philosophy, politics, and economics. Chicago, IL: University of Chicago Press. Hayek, F. A. (1980 [1937]). Economics and knowledge. Reprinted in Individualism and economic order (pp. 33–56). Chicago: University of Chicago Press. Hayek, F. A. (1980 [1935a]). The present state of the debate. In: Collectivist economic planning (pp. 201–244). London: Routledge. Hayek, F. A. (1980 [1935b]). The nature and history of the problem. In: Collectivist economic planning (pp. 1–40). London: Routledge. Knight, F. H. (1936). The place of marginal economics in a collectivist system. The American Economic Review, 26(1), 255–266. Lange, O. (1936a). On the economic theory of socialism: Part one. The Review of Economic Studies, 4, 53–71. Lange, O. (1936b). On the economic theory of socialism: Part two. The Review of Economic Studies, 4, 143–144. Lange, O. (1936c). Mr. Lerner’s note on socialist economics. The Review of Economic Studies, 4, 143–144. Lerner, A. P. (1934a). Economic theory and socialist economy. The Review of Economic Studies, 2, 51–61. Lerner, A. P. (1934b). A rejoinder. The Review of Economic Studies, 2, 152–154. Lerner, A. P. (1936). A note on socialist economics. The Review of Economic Studies, 4, 72–76. Lerner, A. P. (1937). Statics and dynamics of socialist economics. The Economic Journal, 47(186), 253–270. Lerner, A. P. (1938). Theory and practice in socialist economics. The Review of Economic Studies, 6, 71–75. Mirowski, P. (2002). Machine dreams: Economics becomes a cyborg science. Cambridge, UK: Cambridge University Press. Mises, L. v. (1981 [1922]). Socialism: An economic and sociological critique. Indianapolis, IN: Liberty Fund. Mises, L. v. (1990 [1920]). Economic calculation in the socialist commonwealth. Auburn, AL: Ludwig von Mises Institute. Myerson, R. B. (2007). Fundemental theory of institutions: A lecture in honor of Leo Hurwicz. The Hurwicz Lecture presented at the North American Meetings of the Econometric Society, The University of Minnesota, June 22, 2006. Robinson, J. (1969 [1933]). The economics of imperfect competition. London: Macmillan. Samuelson, P. A. (2009). A few remembrances of Friedrich von Hayek (1899–1992). Journal of Economic Behavior & Organization, 69, 1–4. Skarbek, D. (2009). F. A. Hayek’s inﬂuence on Nobel Prize winners. The Review of Austrian Economics, 22(1), 109–112. Smith, A. (1976 [1776]). An inquiry into the nature and causes of the wealth of nations. Chicago, IL: University of Chicago Press. Taylor, F. M. (1929). The guidance of production in a socialist state. The American Economic Review, 19(1), 1–8.

HOW DID AUSTRIAN ECONOMICS THRIVE OUTSIDE OF VIENNA: THE CASE OF FRENCH POLITICAL ECONOMY Laurent Dobuzinskis and Thierry Aimar INTRODUCTION Today, there is no academic or sociocultural context in which Austrian Economics (AE) is described as being dominant. AE is and remains, for better or for worse, a heterodox current. In the United States, however, but probably nowhere else in the world, AE is heterodox without being invisible or inconsequential. American scholars for whom AE is their preferred paradigm have been able to participate actively in the sort of ‘‘discussions’’ that Arjo Klamer (2007, p. 4) wishes to encourage. They are taken seriously by fellow economists. The vitality of American AE has no equivalent in the rest of the world.1 Obvious constraints of time and space prevent us from offering supporting evidence for this sweeping statement, but in this paper we propose to take a close look at the French case. AE has made few inroads in France. There was a brief period in the 1980s when it was the object of some short-lived enthusiasm; since then interest has waned, although there are indications that the tide might yet again be turning, and in fact, as compared to many other western European countries, France may

What is so Austrian About Austrian Economics? Advances in Austrian Economics, Volume 14, 87–111 Copyright r 2010 by Emerald Group Publishing Limited All rights of reproduction in any form reserved ISSN: 1529-2134/doi:10.1108/S1529-2134(2010)0000014008

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turn out to be, all things being relative, a less infertile ground than might a priori be thought. One of the objectives of this paper is to seek some plausible explanations of this contrast. This is also an opportunity to reﬂect on the varieties of liberalism that have developed over the last two centuries, and in particular, on the parallels and differences between the French and Anglo-American liberal traditions. But beyond these historical issues, the study of the successes and failures of the grafting, as it were, of a particular paradigm such as AE onto a given cultural milieu opens up interesting perspectives on the challenges encountered by intellectual innovators or entrepreneurs in the marketplace of ideas, and the structural constraints that are at work in this rather special type of market. In other words, this paper is more concerned with the epistemological, cultural, and ideational contexts of AE than with its substantive theoretical contents, although it is not always possible to separate the foreground from the background, as it were, so that we occasionally shift from one perspective to the other when appropriate. In the next section, we sketch out the multiple currents that have been inﬂuential in the development of AE, as well as the impact that AE has had on economics in general. Although seminal ideas have circulated throughout the whole western world in ways that have both inﬂuenced AE and facilitated its outreach worldwide, we underline the extent to which not only were there some afﬁnities between the Austrian founding fathers and Anglo-American philosophy and economic theory, but this afﬁnity has also been institutionalized with the emigration of the second generation of Austrians and the subsequent rise, mostly in the United States, of succeeding generations of ‘‘Austrians.’’2 The subsequent section draws a sharp contrast between these developments and the situation in France and offers at least a partial explanation of the relative weakness of the Austrian school within French economics.

AUSTRIAN ECONOMICS AND THE WIDER WORLD In this section, we brieﬂy consider the crosscurrents that have shaped AE and facilitated or hindered its dissemination throughout the international community of economists and in America in particular. The central issue at stake is: what are the conditions that ensure the successful grafting of imported ideas onto an institutionalized discipline and research tradition? Some of these conditions are structural, others are more contingent. The former concern the philosophical and cultural traditions that inform research

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and teaching, as well as the organization of the educational system. The latter simply reﬂects the choices made by individual authors and the ways in which they took advantage of opportunities open to them. The emigration to the United States in the 1930s of almost all the Viennese economists who saw themselves as Menger’s heirs is obviously a signiﬁcant event. The Scottish Enlightenment, and the spontaneous order tradition in particular, which are today very closely associated with the Austrian paradigm, did not have as determining an inﬂuence on the founding fathers as they had on Hayek and those who followed on his footsteps. Carl Menger was not insensitive to Adam Smith’s genius, but insofar he was trying to undermine the labor theory of value and substitute for it his own subjectivist approach to pricing at the margin, he was obviously set on a course that radically diverged from that chosen by Smith, although Menger’s criticisms were directed more speciﬁcally at Ricardo. As an aside, it is worthwhile to note the close connections between Menger’s works and the French liberal school of the early 19th century. Several authors (e.g., Sanders, 1994; Salin, 2000, p. 35) have noted in passing that there are parallels between the economic ideas of the French liberals and those of the founding father of AE, but we owe to Gilles Campagnolo (2008) a very detailed and systematic analysis of the textual evidence that clearly depicts Menger as an avid reader of Jean-Baptiste Say’s writings.3 But though the ﬁrst generation of Austrian economist was not consciously aligning itself with any particular thinker or school of thought in the AngloAmerican cultural sphere, it is possible to discern more subtle parallels between the latter and the Austrian intellectual tradition. Menger was indebted to the philosopher Franz Brentano on the subject of epistemology. Menger was in fact in good company, for Brentano strongly inﬂuenced many other of his contemporaries, for example, philosophers such as Anton Marty, Alexius Meinong, Kasimir Twardowski, among others, as well as the next generation of Austrian intellectuals, including Mises (Smith, 1994). Brentano’s originality was that at a time when German philosophy was in the grip of Hegelian idealism, he returned to Aristotle and scholastic philosophy. Intentionality becomes a central concern from that angle; it demarcates the psychological from the physical world. Even though Mises did not make much explicit use of Aristotelian analysis, one can clearly perceive a direct connection between Brentano’s philosophical outlook and Mises’ praxeology. But to come back to the question of cultural similarities, the signiﬁcance of Brentano’s Aristotelian turn, which had a profound inﬂuence on his contemporaries, and on Menger in particular, is that it immunized AE social theory from the holistic paradigm that prevailed in German universities.4

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Indeed this difference was at the root of the famous Methodenstreit. It also meant that, though Brentano had his own disagreements with Locke and Hume, his philosophy was not radically at odd with the empiricist and analytic bent of Anglo-American philosophy. By contrast, in spite of exceptions like T. H. Green or T. Veblen, neither Hegelianism nor historicism progressed very far in the British or American intellectual communities during roughly the same era, and even such exceptions were less than radical: Green’s philosophical idealism was tempered by his keen interest in pragmatic social and economic reforms that forced him to incorporate liberal ideas in his thinking,5 and Veblen’s institutionalism did not posit that holistic social forces alone account for individual preferences or behaviors. If as we have suggested there were some afﬁnities, or in any event, no incompatibility between the philosophical backgrounds and ideological values of most Austrian economists and of most Anglo-American economists, these two strands ended up being closely weaved together as a result of contingent historical events. The collapse of the Austrian Empire and the subsequent emergence of a strong current of ethnic German nationalism among disoriented Austrians combined with the rise of nationalsocialism in Germany proved to be a very dangerous threat to Viennese intellectuals and artists. Evidently, the threat was most dire for those among them who, like Mises or Fritz were Jewish (or were viewed as such by the Nazis). Although ominous signs already appeared in the 1920s, the coffeehouse culture was still thriving in Vienna in these years and numerous ‘‘circles’’ fostered a rich intellectual climate (the positivist ‘‘Vienna Circle’’ is arguably the best known, but in economics the most inﬂuential ones were the Miseskreis, the Geistkreis in which Hayek played a leading role, and the meetings of the Nationalo¨konomische Gesellschaft). But by the mid-1930s, most Austrian economists, as well as many other academics (e.g., Carl Menger’s son, the mathematician Karl Menger) and artists had ﬂed the country. While Hayek had left relatively early on for London, on the invitation of Lionel Robbins,6 most liberal Austrian economists emigrated to the United States. Mises ﬁrst went to Geneva in 1934 but eventually settled in New York in 1940, Machlup resettled in Buffalo, New York (he taught for several years at the University of Buffalo and eventually was appointed to a faculty position at Columbia after the war), and Haberler went to Harvard. The immediate effect of emigration was at least a partial disintegration of the Austrian school, and this for two reasons (Klausinger, 2006). The ﬁrst was that a split occurred between the ideological positions and research goals of those Austrian economists who remained in Austria (e.g., Oskar Morgenstern) and those who chose exile. The second was that some of the

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exiled Austrians (e.g., Haberler) ended up moving closer to mainstream economics in the Anglo-American world, thereby diluting the identity of Austrian school. Coming back to the ﬁrst of these consequences, it can be said of the exiled group that they belonged to the more explicitly liberal wing of the school. Those who remained in Austria were arguably continuing more in the footsteps of Wieser than of Bo¨hm-Bawek, but since Hans Mayer who in terms of seniority would have been expected to take a leading role in that respect was rendered incapable of doing so by his neurasthenic condition, that role fell on Morgenstern who had succeeded Hayek as director of the Institute for Business Cycle Research (Institut for Konjunkturforschung). Morgenstern did not share Mises’ negative view of mathematics and differed from orthodox Austrianism in other respects. According to Klausinger (2006, p. 625): Morgenstern’s dissent from Austrian thought and the liberals’ loss did not go unnoticed on either side. Scathing criticism (in particular in private correspondence) was the rule, although typically veiled in public discussions. Morgenstern often castigated the Austrians for their inexactness. y From the liberal point of view, Hayek had early on formulated his fundamental opposition to Morgenstern’s antiliberal turn y and he recognized the declining inﬂuence of the liberals within the economic community and, in particular, within the Zeitschrift.7

This rift, however, came to an end of sort when Morgenstern himself chose to stay in the United States where he found himself in 1938 at the time of the Anschluss.8 No economists of great talent was left behind in naziﬁed Austria,9 and when after the war the Austrian academic system was reformed, economics moved in the direction of the international Keynesian mainstream, although it was also inﬂuenced by the German social-market paradigm.10 More positive developments took place in the United States. Although, as mentioned in the preceding text, neither Machlup nor Haberler was very keen on continuing to afﬁrm and ﬁght to defend the distinctiveness of the Austrian paradigm, Mises was able to ﬁnd a niche in the American academic system. This allowed him to train a new generation of convinced neoAustrians who themselves spread the message far and wide. Mises encountered many obstacles in his attempt to restart his academic career after resettling in New York but eventually with the help of the Volker Fund a way was found for him to teach at New York University’s Graduate School of Business as a Visiting Professor. Among the many students who attended his graduate seminar (not all of them convinced libertarians), one counts Richard Cornuelle, Israel Kirzner, Hans Sennholz, Louis Spadaro, and Murray Rothbard. Their students, in turn, not only perpetuated the

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Austrian tradition but also, prompted in no small measure by the norms of American academia and the opportunities offered by what had become in the second half of the 20th century the most developed and prestigious university system in the world, considerably extended its scope and reach. They have published on many subjects, created journals, founded research institutes, and so on.11 This is not to say, of course, that AE even in the United States has managed to escape from the conﬁnes of heterodox economics but it enjoys a visible place in the discipline and has built solid roots in a few departments (e.g., at George Mason University) and is institutionalized through other means (think tanks, foundations, etc.). Moreover, the almost universally shared liberal consensus (in the philosophical sense) that runs deep through American culture (Hartz, 1964) has made it possible for libertarian ideas to be discussed seriously outside of the niche built by AE, for example, by philosophers like Robert Nozick, which is not to say, of course, that libertarianism has become the new core of that liberal consensus.

THE TRAVAILS OF AUSTRIAN ECONOMISTS IN FRANCE Practically none of the conditions identiﬁed previously (i.e., philosophical predispositions and ideological climate, or institutional opportunities) that facilitated the spread of Austrian ideas in the Anglo-American world were replicated in France. To develop this idea more fully, we take a broad view of the matter by sketching out ﬁrst the historical and cultural factors at play before dealing with the challenges faced by the small cohort of French neoAustrians today. A Brief Contextual Analysis: French Economics To begin with, at the time when the ﬁrst generation of Austrian economists was in the throw of the Methodenstreit, the teaching of French economics in France had just veered in the direction of historicism. This foreclosed the possibility of the successful introduction of Austrian ideas in France at that time. This is ironic because French political economy, from the late 18th century to the 1860s had been strongly liberal; indeed it had been at the forefront of the intellectual battle for freeing markets from political interferences, although not always very successfully as far as their inﬂuence

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on French rulers is concerned.12 The names of prominent ﬁgures in the history of economic liberalism such as Jean-Baptiste Say or Fre´de´ric Bastiat immediately come to mind, but one could go back to their precursors: Condillac, Quesnay, Turgot, and so on. Nor were Say or Bastiat isolated instances in their times even if their fame far outlived that of their contemporaries and/or intellectual successors (e.g., Charles Coquelin, Michel Chevalier, Yves Guyot, and Gustave de Molinari). It is too often forgotten that Cantillon in the 18th century, Say in the early decades of the 19th century, and Augustin Cournot a little later (albeit from a different starting point) were innovators whose views on the determinants of prices were already developing along a path that led to the marginalist revolution and were thus in tune with Menger’s explorations of this idea, as we pointed out in the previous section. Murray Rothbard’s (1995) original attempt at redressing this injustice has arguably born fruit and contemporary scholarship on Say’s legacy seems to be growing (e.g., Hollander, 2005; Whatmore, 2000; Forget, 1999). In practice, however, as can be judged by a look at the pages of their journal (Le journal des e´conomistes13), the members of the French liberal school who followed in the footsteps of Say were mostly interested in the policy controversies of their days and had already lost interest in matters of fundamental theory by the time Cournot and later Le´on Walras were laying down the foundations of marginalism. In fact, they engaged in rather petty disputes with Walras; this is, in other words, the history of a missed opportunity. Moreover, they were in a way intellectual outsiders because throughout most of the 19th century there were no chairs of political economy in French universities. When the teaching of political economy was institutionalized in faculties of law in 1878,14 however, the approach adopted by the newly appointed economists was empirical, institutionalist, and historicist rather than oriented toward the discovery of universal and fundamental principles.15 To this day, the best known representative of this historicist current remains Charles Gide. It should be added that French historicism was less dogmatic than its German equivalent. In fact, Michel Auguste Landry, an early 20th century French scholar, managed to restate Bo¨hm-Bawerk’s theory of capital in one of his works16 while still maintaining his good standing within the orthodoxy of the French political economy of his era. All the same, this is more like the proverbial exception that conﬁrms the rule: had the French liberal school been able to rejuvenate and to position itself within the French University establishment, the chances of a more open embrace of Austrian ideas would have been far greater. As it turns out, not only did the period before the First World War

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witness the founding of a French historicist school, but also at the same time sociology under the prestigious leadership of Emile Durkheim became the core of what the French like to call the ‘‘human sciences.’’ Thus, the historicist approach with the ranks of economists was reinforced by an emerging current of economic sociology to which Durkheim’s nephew, Marcel Mauss gave a strong impetus with his seminal work The Gift (1925 [1923]). Two other Durkheimian scholars played important roles, namely, Franc- ois Simiand and Maurice Halbwachs (see Heilbron, 2001). As we argue in the following text, this legacy is still strong today, but curiously more within contemporary heterodox currents of French economics than within French sociology proper. Of course, the French liberal school did not disappear overnight; one of its last defenders, Chevalier’s son-in-law, Paul Leroy-Beaulieu (1834–1916), carried its banner in the years preceding the First World War. LeroyBeaulieu’s admittedly rambling book Le collectivisme (1884) is perhaps the ﬁrst thorough critique of Marx’ economics, preceding Bo¨hm-Bawerk’s Karl Marx and the Close of his System (1896) by more than 10 years; it contains many interesting gems, such as his insistence that proﬁts serve as a ‘‘compass’’ in the search for the optimal level of production and that the price system is needed for ﬁnding the proper balance between production and consumption. Leroy-Beaulieu’s attack on statism, and in particular, on the dramatic (inﬂationary) growth of parliamentary legislation in his times, in his book L’Etat moderne et ses fonctions (1900) echoes much of what Hayek wrote about decades later. Yet, even though he read German, one looks in vain for any sustained engagement with the ideas of the Austrian school in Leroy-Beaulieu’s proliﬁc writings, notwithstanding a few footnotes and brief (albeit very positive) remarks interspersed throughout his massive, four-volume treatise (Traite´ the´orique et pratique d’e´conomie politique [1914]). Throughout the interwar years, Charles Rist continued to teach economics from a recognizably liberal standpoint, albeit a less dogmatic one than Leroy-Beaulieu’s. Toward the end of the interwar period and in response to the socialist experiments undertaken by the Front populaire government of Le´on Blum (1936–1938), economic liberalism17 experienced a brief renaissance. A key moment in that respect was the holding in August 1938 of a colloquium on the occasion of the publication of the French translation of Walter Lippmann’s (1943[1937]) book Inquiry into the Principles of the Good Society. Hayek played a role in the preparation of that historic colloquium that was attended by many important thinkers, including Ludwig von Mises, and by inﬂuential people in industry and government. On the French side, there were

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representatives of two currents within liberal thought: classical liberals close to AE, notably, the economists Louis Baudin and Jacques Rueff, as well as defenders of a more reformist approach, closer to German ordoliberalism, including the philosopher Louis Rougier, the industrialist and essayist Auguste Detœuf, and the economic historian Louis Marlo.18 In the wake of that colloquium, the Centre international pour la re´novation du libe´ralisme was founded in 1939, and the economic policy of the government of Premier Daladier represented a clear shift from his more leftist predecessors. Evidently, the momentum that had just began then was interrupted by the war and the short-lived triumph of the reactionary Vichy regime.19 In the postwar years, the whole French intellectual scene was dominated by various strands of Marxism, from its more dogmatic variants to original combinations of Marxist theory with other currents of Hegelian thought, such as Jean-Paul Sartre’s synthesis of Marxian and Heideggerian concepts. Philosophical liberalism was almost obliterated (Raymond Aron standing as one of the very few intellectuals of renown, e.g., Michel Crozier or Raymond Boudon still defending its core principles) and was not to reemerge in France until the 1980s.20 Marxism had a lesser impact in Law faculties where economics was taught than in the other faculties, but it certainly did made some inroads, especially in history of economics courses, thus contributing to the almost complete disappearance of Austrian thought from the curriculum. However, various shades of Keynesianism (i.e., more or less paired with either neoclassical or social democratic approaches) displaced even the remnants of the French liberal tradition. This evolution paralleled broader societal changes that took place in the socioeconomic and politic spheres. The implementation of the Marshall Plan led to a profound process of modernization orchestrated by the state, and also accompanied by actions taken by the managers of large privately owned corporations who often had been trained in the public sector and shared may values and opinions with high ranking state ofﬁcials; it swept away much of the traditional rural bases of French society and led to accelerated economic growth and rising income levels (a period usually referred to nostalgically as les trentes glorieuses or the 30 glorious years). French economics more or less became the theoretical echo of these societal changes. France being France, however, a variety of heterodox currents competed with the more prevalent but never completely dominant Keynesian approach (e.g., Marxist economists were regrouped around the journal Economie et politique). Because of the complex – one could almost say ‘‘Byzantine’’ – structure of French higher education, however, this particular turn of events in French universities is hardly sufﬁcient to explain the development of economic

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doctrines in modern France. French universities – themselves until recently lacking any sense of identify, being merely administrative shells for the management of isolated faculties to which professors and students owe their allegiance21 – form only one facet of the whole system. Because of the parallel existence of the Centre National de la Recherche Scientiﬁque (CNRS), much of the advanced research in the social and natural sciences is conducted outside of the universities proper.22 This separation of teaching and research has not been very conducive to the building of a strong Austrian presence in French economics insofar as even if a few wellknown university professors have in recent years been active in promoting AE (described in the following text), their impact on the research community has been somewhat dampened by their choice to concentrate either on teaching or, as is not uncommon among French university professors, on publishing texts intended to be read by their students or the general public rather than by specialists at the cutting edge of the discipline. But the most signiﬁcant feature of the French higher education system, at least as far as economics is concerned, is the separation between the universities proper and the more prestigious grandes e´coles (of which the best known is probably the Ecole Polytechnique). The latter recruit a small and ﬁxed number of students through highly competitive exams; most of these schools were founded in the late 18th or early 19th centuries to train the engineers that the administration or the army needed, but in 1945 the Ecole nationale d’administration (ENA), which trains administrator in the nonscientiﬁc ﬁelds (i.e., most ministries and administrative tribunals), was added to this category. Graduate from these schools can aspire to successful careers in government, state-owned corporations, as well as in most large corporations in the private sector.23 At least as far as the engineering schools are concerned, economics is a signiﬁcant component of the curriculum.24 Indeed some of the best known and inﬂuential economists, from Jules Dupuit to Maurice Allais, were trained and often also taught at one or several of the grandes e´coles.25 It goes without saying, however, that the type of economics that is taught there is highly mathematical and is more receptive to theoretical approaches like neoclassical economics or to the applied techniques of econometric analysis than to AE (more about this in the following text). Not surprisingly, considering the peculiarities of the training of French economists, one of the focal point of economic research in France has been for years the National Institute for Statistics and Economic Studies (INSEE), which has tended to favor the development of statistical databases and econometric models to be used by state ofﬁcials.26

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But the complexity, if not oddity, of the French educational system does not end with the distinction between universities and grandes e´coles. One must also take into account the network of mostly private business schools, for example, Ecole des hautes e´tudes commerciales (HEC) and ESSEC.27 It is in these schools that, not surprisingly, one ﬁnds the most pro-market instructors and students, and indeed in recent years some of the most ardent defenders of the classical liberal paradigm have come from that sector (e.g., Philippe Nemo, Florian Aftalion, or Andre´ Fourc- ans). Yet, however, pure economic theory is not the primary interest of faculty in these institutions. A ﬁnal note on the complexity of the French system concerns the famed Colle`ge de France, a unique publicly funded institution established in 1530 where prominent thinkers, who sometimes are maverick from within or even outside of the academic establishment, teach noncredit courses in the humanities and natural sciences to an enlightened public; Leroy-Beaulieu, for instance, taught at the Colle`ge. The compartmentalized structure of the French educational system creates a somewhat paradoxical situation. On the one hand, it opens up more opportunities for creating niches within which a group of commonminded thinkers can pursue their own research priorities, and this could have beneﬁted the development of AE. As we are about to explain, something like this did occur in relatively recent years. However, the heterogeneity of French higher education and research has meant that no signiﬁcant network of communication and interaction linking commonly minded scholars has been able to spread its branches across a wide variety of institutional afﬁliations or even regional location. In other words, the institutional constraints are such that though niches can easily be created, they are more or less destined to remain exactly that.

A Brief Contextual Analysis: French Political Economy To fully appreciate the obstacles that lie in the way of a successful acclimation of AE in France, one must also consider the ambient hostility toward the market economy, which in the 20th century has been a recurrent pattern since the 1930s. The idea that capitalism – the system based on private property, initiative, and individual enterprise – is by deﬁnition immoral and contrary to the values of cooperation and honesty, seems to be deeply rooted in the French psyche (and in various ways, and depending on the circumstances, this can be more or less true of the right or of the left of the political spectrum). Although there are other roots for such prejudices

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and negative symbolism, they are often reinforced in fact by structural characteristics and behavioral tendencies inherent in the French business establishment. This is not to say that the entrepreneurial spirit is absent among the French people. Since 2002, there has been an upsurge in the creation of new enterprises: more than 1.3 million have been established, although for the ﬁrst time, in August 2008, the trend has begun to turn in the other direction as a result of the deteriorating domestic and international economic conditions. Besides, 87% of the new enterprises have no salaried employees, which reﬂects a preference for independence and individualism, although it also has something to do with the inﬂexibility of labor market regulations. Three negative factors mar this picture, however: (i) between 20% and 30% of these enterprises cease to exist after 1 year, in part because of an unfavorable administrative and institutional environment; (ii) these dispersed enterprises have only a weak ﬁnancial, social, and political inﬂuence because they are poorly represented in these arenas; and (iii) ﬁnally, small- and medium-sized enterprises, which ideally should serve as a breeding ground for an entrepreneurial culture, are engaged primarily in subcontracting work for large companies from which they become dependent. As for the latter, they are typically headed by a business elite with roots either in an old industrial aristocracy or in the higher echelons of the public service. Firms like Dassault or Lagarde`re are exemplars of the former, and 12% of French ﬁrms listed on the Paris stock exchange, but representing 65% of the market capitalization, are headed by former bureaucrats who graduated from one of the ‘‘grandes e´coles’’ mentioned in the preceding text. Thus, the business elite is made up of people who are better described as inheritors of established traditions rather than the products of a process of entrepreneurial selection. They are also tightly linked to each other by overlapping social connections that reward cultural competence and intellectual brilliance but give little regard to actual performance or entrepreneurial discovery. In other words, barriers to entry into this class are high. Shareholders are hardly able to hold managers accountable: only 25% of French households own ﬁnancial titles (in part because individually subscribed retirement plans are unknown in France), and they are too dispersed to have any power. Institutional investors, however, do not perceive their interests to be different from those of the dominant corporations. Hayek (1967, p. 301) already denounced this trend years ago but it seems to be particularly true of contemporary France for the reasons just mentioned. Thus, the frequent reporting by the media of interest collusion and rent seeking are more often than not grounded in reality but,

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unfortunately, strongly reinforce public opinion’s negative judgment of what they perceive as the perverse logic of the market system. It is not surprising then to observe the almost complete absence of institutional support in the form of think tanks or foundations that could provide support for research on, and the dissemination of ideas about entrepreneurship, competitiveness, and an Austrian understanding of the market process as ‘‘creative destruction.’’ The French intellectual liberal movement has suffered from being too closely linked to the defense of a natural law philosophy that almost completely neglects the Austrians’ insistence on competitiveness, subjectivism, and the consequences of radical ignorance in the social and economic spheres. Only such ideas could challenge the conviction of educated people in France that advocating free markets does not equate with support for the hierarchical socioeconomic structures they are familiar with.

The French Neo-Austrians During the past two decades or so, engagement with Austrian ideas has developed in several stages and mostly along two axes. As far as economics proper is concerned, a few scholars who were deeply committed not only to AE as a methodology but also to classical liberalism succeeded in adding courses on or inspired by AE in the curriculum of their respective institutions (e.g., Jacques Garello and Serge Schweitzer at Aix-en-Provence, and Pascal Salin at Paris-Dauphine).28 They have received a fair amount of (mostly critical) attention from other economists and have attempted to reach a wider public by taking a strong stance in the defence of classical liberalism, which the French simply call liberalism (e.g., Salin, 2000). Of course, this in keeping with the overall philosophical orientation of AE but for the reasons cited in the preceding text, it was probably not the best way of promoting the scientiﬁc merits of the approach and of disseminating its core principles throughout the profession. It might have been more prudent but also more effective to underline that, as Israel Kirzner remarked, ‘‘while both Mises and Hayek provocatively challenged the possibility of efﬁciency under socialism, they too emphasized the wertfrei character of their economics. Both writers would see their free market stance at the policy level as related to, but not central, to their Austrianism.’’ As these pioneers approach retirement, however, the question is who will carry their torch, as it were. One can certainly think of a few people29 but an interesting question is whether or not new intellectual directions will be explored.

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One of us (Aimar) founded the Association des Historiens de la tradition Autrichienne to promote a more positive – that is, nonnormative – approach to the study of AE. Perhaps one of the best ways of pursuing this project is to treat the knowledge problem, that is, the ways in which economic agents produce and process information, together with the constraints inherent in such activities, as the focal point of the whole tradition (Aimar, 2009a, 2009b). From such a perspective, well-known differences that have been noted among the various authors who are generally regarded as belonging to this tradition do not reach the core of the paradigm. But there might be other ways of highlighting the epistemological uniqueness of AE. The important point is that such epistemological concerns must take precedence over normative goals. In this respect, it is tempting to use an economic metaphor. As was suggested in the preceding text, the marketplace for classical liberal ideas, let libertarian ones, in France is very limited. It would seem, therefore, appropriate to turn to the economics of networks (e.g., Goyal, 2007) for inspiration on how to broaden it. One promising way to bring together all the different tendencies and constellations of interests within the French liberal camp and among those who are not too far apart from it would be to create network effects. These effects emerge when beyond a critical mass a positive feedback loop is triggered that feeds on network externalities. The result could be a signiﬁcant growth in the market for liberal ideas. A necessary condition for this process to emerge is that the leading ﬁrm accepts to share with others the responsibility for decisionmaking as well as ﬁnancial resources. In other words, it seems imperative not only to move away from sectarianism but to seek new ways of branching out by establishing connections with researchers and schools of thought focused on similar problems. Considering the recent interest shown by Austrian economists for the origin and development of institutions, as evidenced, for example, by a cursory look at the contents of the Review of Austrian Economics, and the strength of institutionalism in French economics, this might be a good place to start. In that respect, the strategy pursued in particular by Pierre Garrouste at the Centre d’Analyse The´orique des Organisations et des Marche´s (ATOM) of seeking to forge links between Austrianism and more or less orthodox or heterodox economists working in the area of ‘‘neo-institutionalism’’ is a promising one. And this for two reasons. The ﬁrst is that as far as AE in general and in an Abstract sense is concerned, there are signiﬁcant but still relatively unexplored linkages between the Austrians and institutional economics (Garrouste, 2008); this is a promising way to bring AE to the attention of more mainstream economists. But this brings me to our second

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and related reason, namely that in the French context, institutional economics arguably occupies a more central place than elsewhere; moreover, there exists within that overall category, an original and somewhat heterodox paradigm known as ‘‘l’e´conomie des conventions,’’ which has been dubbed as ‘‘the French intersubjectivist school’’ (Fullbrook, 1998). In fact, the proponents of this approach are very familiar with AE and are both attracted and repelled by it. This school of thought, whose best known members and founding fathers arguably are Andre´ Orle´an and Jean-Pierre Dupuy,30 pursues an original research program that is in some measure heterodox but, contrary to the socalled ‘‘French regulation school’’ with which it shares a few ideas; it is neither radical in its critique of capitalism31 nor very much at odds methodologically with more conventional approaches to institutional economics. One of its distinguishing characteristics is that it shares with critical realism, that is, the approach usually associated with the works of Tony Lawson or Paul Lewis, ‘‘the same social ontology’’ (Dupuy, 2004a, p. 228). Dupuy approvingly quotes Lawson to the effect that ‘‘[s]cience is primarily concerned with identifying and illuminating structures and mechanisms that underlie and govern the events of experience, but which are irreducible to them’’ (Lawson, 1995 cited in Dupuy, 2004a, p. 229). Dupuy and Orle´an part company with some critical realists, as well as with Austrians, in arguing against any disparaging of the use of mathematical instruments. But on the qualitative side, there are many avenues of dialogue, albeit not necessarily full convergence, between the French intersubjectivists and Austrians, which French Austrians like Garrouste could explore. The former, and Dupuy in particular, share with Hayek an interest in cultural theory as a path toward the discovery of these underlying structures (which Hayek prefers to call ‘‘patterns’’). Dupuy, however, is rather critical of Hayek for not having fully reﬂected on the implications of having granted to cultural imitation the central importance he claims it has for understanding the complex dynamics of the extended order. Drawing at length from the writings of the Franco-American anthropologist Rene´ Girard, Dupuy (2002, 2004a, 2004b) claims that imitation or ‘‘mimetic behavior’’ is just as likely to generate positive feedback resulting in runaway processes (e.g., speculation, panic, mob rule, and scapegoating) than in equilibrating negative feedbacks leading to some form of order, one of Hayek’s favorite terms. His point, more speciﬁcally, is that in claiming that order prevails Hayek, in spite of his (and the Austrians in general) insistence on radical uncertainty, implicitly appeals to a transcendent knowledge that he, of course, does not really posses.32

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For our purpose here, references to Dupuy’s works make it possible ‘‘to kill two birds with one stone.’’ The other bird, as it were, that we want to target is the brief period of scholarly, and in some instances effusive, interest in Hayek’s writings in the 1980s and 1990s, as part of a general rediscovery of classical liberalism. Not only economists such as Dupuy (1992), but also philosophers such as Philippe Nemo (1988) or Bernard Manin (1983), sociologist such as Raymond Boudon or Pierre Birnbaum, and political scientists such as Jacques Michel (1992) or Jean Leca discussed various aspects of Hayek’s political philosophy or epistemology and/or Hayekian themes (e.g., Birnbaum and Leca, 1990).33 In recent years, however, serious discussions of the ideas of classical liberals among French philosophers or social scientists, which often were carried out in a spirit of optimistic rediscovery, seem to have been replaced by more pessimistic assessments of the prospects for human rights (Le´vy, 2008) and laments about France’s economic decline (Baverez, 2004, 2006, 2007) on the part of right of center thinkers, and by virulent attacks on ‘‘neoliberalism’’ (more often rhetorically labeled ultra-libe´ralisme in French) and globalization on the intellectual left. One could argue that there exists an additional cause – this one having more to do with epistemology than with the sociology of economic research – for the reticence displayed in France toward the Austrian paradigm, and the Austrian’s singular emphasis on radical ignorance in particular. One should not confuse the Austrians’ understanding of ignorance with the concept of imperfect information, as proposed by George Stigler (1961) or that of asymmetric information associated with the works of George Akerlof (1970) and others (e.g., Rothschild and Stiglitz, 1976) and the varied theoretical trends that are rooted in these concepts. These notions presuppose that the agents know the nature and scope of their ignorance. By contrast, the Austrian perspective implies that the scope and character of the agents’ ignorance are unknown. Terms such as ‘‘utterly unknown’’ or ‘‘sheer’’ can be used to deﬁne Austrian ignorance (Kirzner, 2000, 5 ff.). The ignorance of the unknown results in a gap between available opportunities for exchange and the opportunities that are perceived by economic agents. It is rooted in the social division of knowledge that results in the fact that it is not possible for an actor to know a priori the preferences, the assets, the skills, or the strategies of another subjective agent, all the more so that they are continually evolving. As Mises (1933, 1962, 1966) explained in his epistemological works, each agent is necessarily unaware of the manner in which other individuals evaluate goods and services. It is, therefore, not possible to engage in economic analysis by assuming that the agents have a

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perfect and reciprocal knowledge of each other, nor is it even warranted to assume that they know enough to coordinate their activities. For Ludwig Lachmann (1986) and his followers, nothing suggests that the unfolding of the processes whereby we gain knowledge could ever reduce ignorance to being merely a residual factor. Nothing indicates that the economic implications of radical subjectivism could be systematically compensated by organizational or institutional initiatives. Others refused to go that far; Mises (1966), Kirzner (1973, 1985, 1992), and Hayek (1948, 1967, 1973) aimed at some sort of convergence between information and knowledge, and they thought about ways to move in that direction by focusing on entrepreneurship, competition, market norms, legal rules, and so on. To recap, Austrian theory has made three important contributions in this regard: (i) it has brought to light some of the psychological, organizational, and institutional constraints that bear upon the production of knowledge; (ii) it has identiﬁed the nature of the processes that allow knowledge to better reﬂect available information; and (iii) it has ranked social systems according to their capacity to reduce ignorance. A few contemporary developments fall within these parameters. The emergence of the new comparative economics (Boettke, 2005) has cast some much needed light on the problems faced by the transition economies of Central and Eastern Europe. However, many French economists associate the Austrian paradigm only with a critique of the lack of efﬁcacy of macro-economic regulatory policies without paying much attention to the reasoning on which such a critique is based (Aimar, 2009). Now, of course, that critique follows directly from the demonstration that the kind of knowledge built into economic models is inadequate for what is expected of them. Whatever their quality, such models cannot serve as practical guides for decision-makers. One must conclude, therefore, that economic theory cannot be used as a means of controlling events and must be restricted to pattern prediction. Its explanatory may be strong but its predictive power in terms of actual facts remains relatively weak. But that’s precisely where the problem lies: in France, perhaps more than anywhere, this conclusion is bound to sounds singularly unattractive to economists who are keen to prove that economics is a science comparable to the hard sciences in terms of its capacity to predict economic variables, and ultimately to inﬂuence economic growth, by applying statistical tools and econometric analysis. That these instruments might be less than perfect, can be misused, or cannot always be efﬁciently deployed by policy-makers in a globalized economy, French economists would be quite prepared to accept, but that they represent futile attempts at modeling the unknowable is harder to concede.

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Finally, we must also take a brief look at the marketplace of ideas outside of academia strictly deﬁned. This would include journals of opinion, think tanks, and of course, the Internet. Journal of opinions (revues) have always played a very important role in French intellectual life, albeit more in literary criticism and philosophy than in the social sciences or public policy. Two revues, however, have been very active in promoting liberal ideas during the last three decades, namely, Le De´bat and Commentaire; the former is somewhat left of center and the latter more right of center but both have taken a sharp departure from the ambient Marxism that was so prevalent in French intellectual circles until the 1970s. One is forced to admit though that neither AE in general nor speciﬁc thinkers that can be linked with this school have received much attention in the pages of these publications, with the exception of Hayek.34 Think tanks are not a common feature of the French intellectual landscape. Scientiﬁc research, including in economics or public policy, is normally carried out by reasonably wellfunded state institutions (e.g., the CNRS, INSEE or in past years the Commissariat du Plan), whereas there is a paucity of foundations or other potential sources of private funding. This is compounded by the fact that the French media and the public generally are more fascinated by charismatic intellectual ‘‘stars’’ than by position papers or anonymous experts. But by far the most signiﬁcant development in recent years has been the Internet. It has opened up new opportunities for classical liberal, libertarians, and economists seeking to promote economic freedom to publicize their ideas and disseminate them on a scale unimaginable just a couple of decades ago. There are indeed several sites that attempt to do just that. The following is not an exhaustive list but it includes some important new resources: l’institut Hayek (www.fahayek.org), l’institut Turgot (www.turgot.org), Catallexia (www.catallexia.org), contre-points (www.contrepoints.org), as well as countless blogs written by more or less well know defenders of liberalism (e.g., Guy Sorman’s blog). It is difﬁcult to evaluate the inﬂuence of this presence on the Internet in terms of its real impact on the informed public and policy-makers, but it certainly makes it possible for everyone interested to access a wide range of hitherto unavailable sources.

CONCLUSION The historical vicissitudes of AE and the story of its less than impressive reception in France are, of course, instructive for practitioners and fellow travelers but also open up interesting perspectives on broader issues in the

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history of ideas. The rise, decline, and rebirth of AE throws light on the structural and contingent factors that facilitate or hinder the propagation of ideas across time and place. In this paper, we have identiﬁed three such structural constraints that though do not rigidly determine social outcomes, are bound to limit the choices open to individuals pursuing their own intellectual or organizational goals. The ﬁrst consists of the prevailing philosophical beliefs, with their concomitant tendency to suggest the use of some analytical frameworks rather than others. Aristotelian philosophy and an acceptance of the basis premises of empiricism guarded Austrian economists against the idealistic and holistic views that swept German philosophical thinking. But, especially after Word War I, French philosophy moved closer and closer to such views. This was combined with the decline of liberal ideas that had played an important role in the founding of the of Third Republic (Dobuzinskis, 2008), but lost their grip on the educated French public in the wake of the economic and political upheavals of the 1930s, the defeat of 1940, and the reconstruction of the institutions and infrastructures of the country by more or less collectivist political forces after 1945. Although this did not prevent the acceptance of the mathematical tools of modern econometrics among French economists, it also meant that (a) these would be harnessed to a Keynesian and interventionist program, and (b) that heterodox reactions would gravitate toward more or less radical forms of Marxist thinking rather than libertarian critiques. Second, deeply seated historical and cultural factors serve to legitimize different views about the role and scope of markets in economic life. Although the liberal views of Austrian economists who moved to the United States fell on fertile ground, liberal economists in France have always had to confront very widespread protectionist tendencies, and more generally, a rather benign view of the role of the state in public affairs. (Ordinary French people are just as likely as anyone else to complain about the ineptitude or excess of the government in power, but they have a high regard for the state both as a symbol of national unity and as a guarantor of justice, as well as for the administrative elites that run it.) Finally, the byzantine complexity of the French educational and research establishments have had the paradoxical effect of both facilitating the emergence of small specialized niches where liberal views are nurtured and ensuring that such enclaves remain isolated and incapable of networking on a large scale. But structures never exist independently of the individuals who live within them. Had Mises decided to stay in Geneva, or had the most prominent Viennese economists moved to Britain in 1930s, the contrast between

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America and Europe in general, or France in particular, would not be what it is today.

NOTES 1. Most of the contributors to the Review of Austrian Economics are from the United States; for example, this was the case of about three-fourth of the articles in the volumes 19, 20, and 21. 2. Taking ‘‘generation’’ in a loose sense used to periodize ideas rather than actual lives, this rough chronology assumes that the ﬁrst generation included Menger, Bo¨hm-Bawerk, and Wieser; the second was illustrated by Mises and Hayek; the third by Kirzrner and Lachmann; and so on. 3. Campagnolo examined in detail the annotations that Menger wrote in the margins of his copy of the reprinted correspondence between Say and Ricardo. It is the clearest indication of his familiarity and agreement with Say’s attempt at breaking away from the objectivist labor theory of value; in his letters to Ricardo, whom he revered, Say was forced to give rather convoluted explanations of his views so as not to antagonize Ricardo too directly, but Menger, who perfectly understood what Say was trying to do, became more and more impatient with these tactics as he read through the letters. Campagnolo also provides evidence of Menger’s familiarity with other members of the French liberal school, notably, Pellegrino Rossi, Michel Chevalier, and Fre´de´ric Bastiat. 4. Admittedly, this prophylactic effect was not entirely efﬁcient in light of the fact that one of the scholars who at the end of the First World War was appointed to one of the three chairs at the University of Vienna left open by the death of Bo¨hm-Bawerk, and the retirements of Philippovich and Wieser was Othmar Spann; Spann was deeply attracted to German idealism and historicism but although he was a popular lecturer, his intellectual inﬂuence among the brightest young minds in the Vienna of his times was far more limited than Mises’, even though Mises’ seminar was only an informal gathering. [Ironically, in spite of his germanophile sentiments and occasional, albeit not consistent, antisemitic behavior, Spann was arrested by the German authorities after the Anschluss! (see Craver, 1986).] 5. On the links between Green’s positions and the ideas of John Bright and J. S. Mill, see Tyler (2003). 6. While still a student, Ludwig Lachmann also moved to the London School of Economics in 1933. 7. The Zeitschrift fu¨r Nationalo¨konomie/Journal of Economics, founded in 1929, is still a leading economic journal whose roots can be traced all the way back to the Zeitschrift fu¨r Volkwirtschaft und Sozialpolitik founded by E. Bo¨hm-Bawerk. 8. As is well known, Morgenstern went to Princeton and turned his interests toward the then new game theory developed by John von Neumann (e.g., von Neumann & Morgenstern, 1944). 9. Hans Mayer, whose career by then had long ceased to be productive, opted to collaborate fully with the new regime, and as head of the Austrian National Economic Association dismissed all its Jewish members.

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10. Karl Socher and a few of his colleagues at the University of Innsbru¨ck did their best, however, to keep the tradition alive in Austria. 11. For a more detailed account of the Austrian revival in America, see Karen Vaughn (1994, pp. 103–111). 12. Economic liberalism, however, made some considerable inroads under the reigns of Louis-Philippe (1830–1848) and Napoleon III (1851–1870). 13. A group of French economists partial to Austrian ideas recreated the Journal des e´conomistes et des e´tudes humaines in 1989; after a long hiatus (2005–2009), it was recently reborn in electronic format (available at http://www.bepress.com/jeeh/). 14. This fact contributed to the relative marginalization of economics in the French academic world insofar as economists were until relatively recently in a weaker position vis-a`-vis the jurists in their own faculties. 15. A brief look at the contents of the journal in which many of these scholars published (i.e., the Revue d’e´conomie politique) suggests that their works were concerned mainly with economic history, the role of institutions or the socioeconomic justiﬁcations and impact of current pieces of legislation, with little or no theoretical intent. 16. L’Inte´reˆt du capital (1904). 17. The liberalism of that era, however, made more concessions to the spirit of the times than its prewar version in that it was more pragmatically open to some social interventions. 18. Also attending was Raymond Aron who was then still a year away from starting his university career but who, of course, went on to carry the torch of liberal thought in French academia for much of the second half of the century; but Aron found himself in opposition to Hayek on several occasions insofar as the former was less hostile to democratic egalitarianism than the latter (Audier, 2008, pp. 239–241). 19. Rougier, however, did cooperate with the Vichy regime which severely limited his intellectual inﬂuence after the war. For a more complete analysis of the colloquium and of the ideas it generated, see Audier (2008), and for somewhat different perspectives on French liberalism in the late 1930s, see Denord (2007) and Michel (2008). One must also consider the strange case of Franc- ois Perroux – ‘‘strange’’ in the sense of being unclassiﬁable; Perroux was thoroughly familiar with AE, having studied under Schumpeter in Vienna in the mid-1930s (and he wrote a long introduction to the 1935 French translation of Schumpeter‘s Theory of Economic Development), but epistemologically he was closer to Walras than to Menger or Mises, and ideologically he was sharply critical of what he regarded as the reductionist and inhumane tendencies of markets, following in that respect the social doctrine of the Catholic church. 20. This is not to say that civil liberties and basic principles of civil law guaranteeing property and contracts were jeopardized (indeed, it is one of the paradoxes of the French political system that probably the most effective defenders of these basis liberties is the Conseil d’Etat which is not an ordinary court but a tribunal adjudicating disputes between citizens and administrative bodies). But the intellectual elites had little respect for these supposedly ‘‘formal,’’ that is, not ‘‘real’’ liberties and were not interested in exploring their meaning or in defending them. 21. The historical origin of this peculiarity can be traced back to the French revolution. The old medieval universities (e.g., the University of Paris which was

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established in 1200) were abolished in 1793, largely because they were religious institutions in an era when the Catholic church had sided with the enemies of the revolutionary government; in 1806, Napoleon instituted the ‘‘Imperial university’’ with faculties in the various regional ‘‘academies.’’ It is only later (in 1896), under the Third Republic, that these faculties were regrouped under the umbrellas of ‘‘universities,’’ and it is only very recently that these universities have been granted some measure of real managerial autonomy (notwithstanding the fact that the professorial corps has enjoyed intellectual freedom since the days of the Third Republic). 22. Although preexisting the ‘‘Liberation’’ era of 1945–1946, this organism was reorganized into what it is now by the communist scientist Fre´de´ric Joliot more or less on the model of the Soviet Academy of Science. 23. It is well known that Hayek saw in these institutions the historical roots of the twin sins of ‘‘scientism’’ and ‘‘rationalist constructivism.’’ Although there is more than a grain of truth in this judgment, Hayek sweeping generalizations on the French intellectual culture often are contradicted by schools of thought that developed in the universities, as distinct from the grandes e´coles. 24. The place of economics in the curriculum of ENA, however, is noticeable mainly by restricted scope, limited as it is to public ﬁnance. 25. Le´on Walras failed the entrance exam. 26. In the 1960s, INSEE was headed by Claude Gruson who was ﬁrmly committed to Keynesianism. 27. Before the war, one of the best known private schools was the Ecole libre des sciences politiques founded by the liberal jurist Emile Boutmy and where LeroyBeaulieu taught; renamed Institut d’Etudes Politiques and brought into the public education system after the war, it is still known as ‘‘Sciences Po and is often considered to belong to the same category of mostly private management schools I am alluding to here. Another public institution that specializes in management studies is the university Paris-Dauphine where a prominent French libertarian taught for many years, namely, Pascal Salin. 28. Other relevant players in this movement include professors Jean-Pierre Centi and Ge´rard Bramoule´, and the author Henri Lepage. 29. For example, Franc- ois Facchini and Bernard Lemennicier in Paris, or Pierre Garello at Aix-Marseilles III. On the other hand, a few more or less freshly minted PhDs from Aix or Paris who were trained in AE and could have assumed that role have instead moved to the United States (e.g., Fre´de´ric Sautet at George Mason University or Alex Padilla at Metropolitan State College, Denver). 30. Other contributors include Franc- ois Eymard-Duvernay, Olivier Favereau, and Laurent The´venot. For a comprehensive overview of the scope and methods of this school, see Eymard-Duvernay (2006). 31. As Dupuy (2004a, p. 227) wryly notes, ‘‘If there is such a thing as a French intersubjectivist school, it was born in the eyes of its foes. By this I do not mean the orthodox or mainstream economists but rather the orthodox heterodoxy, that is, the various neo-Marxist denominations that claim to exert a monopoly over the critique of neoclassical economics in the French intellectual landscape.’’ 32. ‘‘Without the intervention of a knowledge that transcends it, there is no guarantee that cultural evolution based on imitation will converge toward a satisfactory order, and even less an optimal one. It is in the name of such transcendent

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knowledge that Hayek spoke, without of course being able to ﬁnd this knowledge’’ (Dupuy, 2004b, p. 289). For a parallel analysis but reaching a less harsh verdict by a French economist more closely associated with AE, see Arena (2004). 33. This is only an eclectic survey of a vast literature. 34. A quick search of the archives of these reviews yielded the following: since it was created in 1978, Commentaire has published eight articles or book reviews bearing directly on Hayek’s ideas but none on von Mises; a search of the archives of Le De´bat indicated that numerous authors cited Hayek (but not von Mises) in their articles, albeit none was dedicated exclusively to Hayek, let alone AE; the latter review, however, published a special issue on Habermas, and one (admittedly written by non- or anti-Marxist authors) on Marx.

REFERENCES Aimar, T. (2009a). The economics of ignorance and coordination: Subjectivism and the Austrian school of economics. Cheltenham, UK: Edward Elgar. Aimar, T. (2009b). The curious destiny of a heterodoxy: The Austrian Economic Tradition. The Review of Austrian Economics, 22(3), 199–207. Akerlof, G. (1970). The market for ‘lemons’: Quality uncertainty and market mechanisms. Quarterly Journal of Economics, 84(3), 488–500. Arena, R. (2004). On the relationship between individual and collective beliefs: A comparison between Keynes and Hayek’s economic theories. In: L. R. Wray & M. Forstader (Eds), Contemporary Post Keynesian analysis. Cheltenham, UK: Elgar. Audier, S. (2008). Le colloque Lippmann: Aux origines du ne´o-libe´ralisme. Lormont, France: Editions Le Bord de l’Eau. Baverez, N. (2004). La France qui tombe. Paris: Perrin. Baverez, N. (2006). Nouveau monde, veille France. Paris: Perrin. Baverez, N. (2007). Que faire ? Paris: Perrin. Birnbaum, P., & Leca, J. (Eds). (1990). Individualism: Theories and methods. Oxford, UK: Clarendon Press. Boettke, P. (2005). The new comparative political economy. Review of Austrian Economics, 18, 281–304. Campagnolo, G. (2008). Origins of Menger’s thought in French liberal economists. Review of Austrian Economics (on-line preprints). Also available in French: La lecture des penseurs libe´raux franc- ais par Carl Menger. Revue franc- aise d’e´conomie, 22(4), 139–180. Craver, E. (1986). The emigration of Austrian economists. History of Political Economy, 18(1), 1–32. Denord, F. (2007). Ne´o-libe´ralisme, version franc- aise: Histoire d’une ide´ologie politique. Paris: Demopolis. Dobuzinskis, L. (2008). Defenders of liberal individualism, republican virtues and solidarity: The forgotten intellectual fathers of the French Third Republic. European Journal of Political Theory, 7(3), 287–307. Dupuy, J.-P. (1992). Le sacriﬁce et l’envie: Le libe´ralisme aux prises avec la justice sociale. Paris: Calmann-Le´vy.

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Dupuy, J.-P. (2002). Market, imitation and tradition. In: E. Fullbrook (Ed.), Intersubjectivity in economics: Agents and structure. London: Routledge. Dupuy, J.-P. (2004a). Economics as symptom. In: P. Lewis (Ed.), Transforming economics: Perspectives from the Critical Realist Project. London: Routledge. Dupuy, J.-P. (2004b). Intersubjectivity and embodiment. Journal of Bioeconomics, 6, 275–294. Eymard-Duvernay, F. (Ed.) (2006). L’Economie des conventions: Me´thodes et re´sultats. Paris: La De´couverte. Forget, E. L. (1999). The social economics of Jean-Baptiste Say: Markets and virtue. London: Routledge. Fullbrook, E. (1998). Shifting the mainstream: Lawson’s impetus. Atlantic Economic Journal, 26, 431–440. Garrouste, P. (2008). The Austrian roots of the economics of institutions. Review of Austrian Economics, 21(4), 251–269. Goyal, S. (2007). Connections: An introduction to the economics of networks. Princeton, NJ: Princeton University Press. Hartz, L. (1964). The founding of new societies. New York: Harcourt, Brace and World. Hayek, F. A. (1948). Individualism and economic order. Chicago, IL: University of Chicago Press. Hayek, F. A. (1967). Studies in philosophy, politics and economics. Chicago, IL: University of Chicago Press. Hayek, F. A. (1973). Law, legislation and liberty, Vol. I: Rules and order. Chicago, IL: University of Chicago Press. Heilbron, J. (2001). Economic sociology in France. European Societies, 3(1), 41–67. Hollander, S. (2005). Jean-Baptiste Say and the classical canon in economics: The British connection in French classicism. New York: Routledge. Kirzner, I. M. (1973). Competition and entrepreneurship. Chicago, IL: University of Chicago Press. Kirzner, I. M. (1985). Discovery and the capitalist process. Chicago, IL: University of Chicago Press. Kirzner, I. M. (1992). The meaning of the market process. London: Routledge. Kirzner, I. M. (2000). The driving force of the market: Essays in Austrian economics. London: Routledge. Klamer, A. (2007). Speaking of economics: How to get in the conversation. London: Routledge. Klausinger, H. (2006). ‘In the wilderness’: Emigration and the decline of the Austrian school. History of Political Economy, 38(4), 617–664. Lachmann, L. (1986). The market as an economic process. Oxford, UK: Basil Blackwell. Lawson, T. (1995). Economics and expectations. In: S. C. Dow & J. Hillard (Eds), Keynes, knowledge and uncertainty. Aldershot, UK: Edward Elgar. Le´vy, B.-H. (2008). Left in dark times: A stand agaisnt the New Barbarism (B. Moser, Trans.). New York: Random House. Lippmann, W. (1943[1937]). Inquiry into the principles of the good society. New York: Gosset & Dunlap. Manin, B. (1983). Friedrich-August Hayek et la question du libe´ralisme. Revue franc- aise de science politique, 33(1), 41–64. Michel, J. (1992). Le ne´o-libe´ralisme de Hayek: une repre´sentation proce´durale des rapports sociaux. In: J. Bidet & G. Labica (Eds), Libe´ralisme et Etat de droit. Paris: Me´ridiens Klincksieck.

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Michel, J. (2008). Peut-on parler d’un tournant ne´o-libe´al en France? Sens public. Available at http://www.sens-public.org/article.php3?id_article ¼ 577 Mises, L. von. (1962). The ultimate foundation of economic science: An essay on method. Princeton, NJ: Van Nostrand. Mises, L. von. (1966). Human action: A treatise on economics (3rd ed.). Chicago, IL: H. Regnery. Mises, L. von. (1933[1976]). Epistemological problems of economics. New York: New York University Press. Nemo, P. (1988). La socie´te´ de droit selon F.A. Hayek. Paris: PUF. Rothbard, M. (1995). Classical economics: An Austrian perspective on the history of economic thought (Vol. 2). Brookﬁeld, VT: Edward Elgar. Rothschild, M., & Stiglitz, J. E. (1976). Equity in competitive insurance markets: An essay on the economics of imperfect information. Quarterly Journal of Economics, 90, 626–649. Salin, P. (2000). Libe´ralisme. Paris: Editions Odile Jacob. Sanders, K. K. (1994). A note on Jean-Baptiste Say and Carl Menger regarding value. Review of Austrian Economics, 7(1), 141–143. Smith, B. (1994). Austrian philosophy: The legacy of Franz Brentano. Chicago, IL: Open Court. Stigler, G. (1961). The economics of information. Journal of Political Economy, 69(3), 213–225. Tyler, C. (2003). T.H. Green, advanced liberalism and the reform question 1865–1876. History of European Ideas, 29(4), 437–458. Vaughn, K. (1994). Austrian economics in America: The migration of a tradition. Cambridge, UK: Cambridge University Press. von Neumann, J., & Morgenstern, O. (1944). Theory of games and economic behavior. Princeton: Princeton University Press. Whatmore, R. (2000). Republicanism and the French revolution: An intellectual history of JeanBaptiste Say’s political economy. Oxford, UK: Oxford University Press.

PERSPECTIVE TAKING AND THE HETEROGENEITY OF THE ENTREPRENEURIAL IMAGINATION Jeffery S. McMullen Heterogeneity is fundamental to Austrian economics. As advocates of methodological individualism, Austrians have argued that decision making is inherently subjective, pointing to heterogeneity in preferences (Mises, 1949) and data (Hayek, 1937). Going a step further, radical subjectivists have proposed that heterogeneity in expectations (Shackle, 1949, 1972) and interpretations (Lachmann, 1976, 1977) must also be assumed because the human mind does not merely perceive sensory inputs; it uses these perceptions to imagine possible action-consequence scenarios from which it chooses. Because of imagination, expectations and interpretations are likely to vary even when decision makers share the same preferences and data. Thus, choice, like decision making, is a subjective phenomenon. Although radical subjectivists’ arguments have considerable face validity, they seem to contradict the market coordination that characterizes much of socio-economic life. If decision making and choice are subjective, then how does production or exchange between these islands of subjective reality take place? Drawing heavily from Shackle’s conception of choice as an act of imagination (Shackle, 1972), Lachmann (1976) suggests that economic agents

What is so Austrian About Austrian Economics? Advances in Austrian Economics, Volume 14, 113–143 Copyright r 2010 by Emerald Group Publishing Limited All rights of reproduction in any form reserved ISSN: 1529-2134/doi:10.1108/S1529-2134(2010)0000014009

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give their subjective expectations, preferences, and data coherence by forming plans about how the means at their disposal may best be organized to achieve imagined ends. Unlike Shackle, however, Lachmann moves beyond the choices of an isolated individual to examine radical subjectivism in a social world. Consequently, Lachmann must confront the fact that successful implementation of plans depends on the complicit behavior of others, each of whom has his own plans. Moreover, because Lachmann embraces Shackle’s idea that choice is among imagined ends in an unknowable future, the attempt to coordinate plans is complicated by the fact that the preferences and data that others’ will use in their decision making are likely to change between the time that the focal agent formulates and realizes his plans. Together, these challenges form the crux of what Roger Koppl (1998) has termed the ‘‘Lachmann problem’’: if one’s plans are contingent upon the complicit behavior of others, whose plans are in turn based on data and preferences that change over time, and if future data and preferences cannot be known a priori, then how is socio-economic order possible? What prevents the economy from devolving into anarchy and rescues scholarly attempts to study it from being fruitless encounters with nihilism? Confronting these questions directly, Lachmann (1971) turns to institutions as a common point of reference to which various market actors can orient their plans. Although it is unclear whether he had formal institutions, informal institutions, or both in mind, critics (Lewis & Runde, 2007) and defenders (Foss & Garzarelli, 2007) alike point out that although formal institutions, such as the law, provide an objective point of reference that exists outside the mind of any one party and to which multiple market actors may orient their plans, they are an insufﬁcient solution to the Lachmann problem unless they also possess some hermeneutic dimension in which a common understanding of their meaning is facilitated. Without this common understanding, institutions provide little guidance about the future (except to suggest that the future will resemble the past owing to path dependent behavior that is encouraged by institutionalized incentives). By imagining and choosing new previously untried courses of action, however, active minds are by deﬁnition capable of escaping the determinism of these institutional preconditions. Individuals are capable of entrepreneurial agency in which they imagine and initiate new exchanges as well as choose among existing transactions. This capacity for entrepreneurial agency suggests that, even though institutions may inﬂuence the relative appeal of new transactions, they are historical in nature and therefore predictive only to the extent that the entrepreneur’s (or others’) actions do not negate their continued inﬂuence on future actions.

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As the product of interactions, institutions, by deﬁnition, are the result of a process that had to originate, at some point in history, from some noninstitutional antecedent. Therefore, before entrepreneurs can use institutions to provide a third-person perspective that enables prediction of what the market is likely to do in the future and how the market is likely to respond to their new value proposition, there had to be a human ability that allowed individuals to escape their own subjective realities (ﬁrst-person perspectives) and take another’s viewpoint (second-person perspective) enough to communicate and cooperate. This second-person perspective not only complements the ﬁrst-person perspective of isolated individual action and the third-person perspective of the anonymous masses of the market, it supplements and links these perspectives together, potentially immunizing them from the philosophical problems that plague the Cartesian view of mind – i.e., insufﬁcient recognition of the social constitution of the mind. Moreover, it does so without requiring the theorist to subscribe to a naı¨ ve position of unqualiﬁed empathy (a point upon which I elaborate in the discussion). Despite these possible beneﬁts, the second-person perspective is conspicuously absent from the decidedly supply-sided treatment of entrepreneurial agency that characterizes radical subjectivism, ‘‘mainstream’’ Austrian economics, and much of the management research devoted to the topic of entrepreneurship. This chapter introduces the social psychological construct of perspective taking to Austrian economics as a means of operationalizing the secondperson perspective. I propose that perspective taking disciplines the entrepreneurial imagination of active minds to offer an explanation of socio-economic order that is dynamic, yet capable of avoiding the philosophical extremes of determinism and nihilism. Perspective taking is consistent with radical subjectivism in that it assumes freedom of choice – heterogeneity in interpretation and expectation – thus avoiding determinism. At the other extreme, perspective taking avoids nihilism by providing an explanation of shared expectations as intersubjective, forward-looking (but historically embedded), and ﬁnally, non-Cartesian in nature. To avoid unnecessary abstraction, I ground the proposed model in the new product development literature and examine the effect of perspective taking on various aspects of the new product design process. I then draw a number of conclusions about how entrepreneurship theorists may use perspective taking to more effectively confront the anticipated preferences associated with demand uncertainty. Finally, the chapter concludes by delineating modern conceptions of empathy (a category that includes perspective taking) from the philosophically controversial concept of inference from analogy.

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AN INTRODUCTION TO PERSPECTIVE TAKING Perspective-taking is a social competency to consider the world from other viewpoints (Galinsky, Maddux, Gilin, & White, 2008); it ‘‘allows an individual to anticipate the behavior and reactions of others’’ (Davis, 1983, p. 115) and helps to balance attention between self- and other-interests (Galinsky et al., 2008). Though often used interchangeably with the term empathy – ‘‘an other-focused emotional response that allows one person to affectively connect with another’’ (Galinsky et al., 2008, p. 378), clear evidence exists that demonstrates that the two concepts are distinct (Coke, Batson, & McDavis, 1978; Davis, 1983; Deutch & Madle, 1975; Hoffman, 1977; Oswald, 1996). Although both concepts refer to a social competency of taking another’s perspective, empathy tends to be more affective while perspective taking leans toward the cognitive (Galinsky et al., 2008). For example, perspective taking is associated with personality characteristics such as high self-esteem and low neuroticism as opposed to emotionality (Davis, 1983). Perspective-takers are more capable of stepping outside the constraints of their own immediate, biased frames of reference (Moore, 2005) to reduce egocentric perceptions of fairness in competitive contexts (without it being at the expense of their own self-interest; Epley, Caruso, & Bazerman, 2006). Perspective taking has also been shown to be a more valuable strategy than empathy in strategic interactions because it helps negotiators ﬁnd the necessary balance between competition and cooperation, between self- and other-interest (Galinsky et al., 2008). Achieving such a balance facilitates creative problem-solving (Pruitt & Rubin, 1986). For instance, in negotiation, a focus only on self-interests is associated with excessive aggression and obstinacy whereas a focus only on other-interests encourages excessive concession making to the detriment of one’s own outcomes (Galinsky et al., 2008). In contrast, perspective takers have the capacity to uncover underlying interests to generate creative solutions when an obvious deal is not possible (Galinsky et al., 2008). Consequently, the cognitive appreciation of another person’s interests is capable of facilitating economically efﬁcient outcomes by acting as a discovery heuristic that reveals hidden problems or solutions and as a tool that enables individuals to capture more value for themselves (Galinsky et al., 2008). Davis (2005) deconstructs perspective-taking attempts into four components: purpose, sources of information used, processes employed, and results. Perspective taking is employed in the effort to understand a target’s perceptual point of view. Because observers cannot see the targets’ thoughts, intentions, or goals, they must infer them using the information available,

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relying on the target, the environment, or themselves. Through facial expressions, posture, voice, statements, actions, etc., targets often provide the richest source of information. This is complemented by the physical and social environment in which a target exists. Finally, the observer may draw from prior experience with the target, similar situations, or similar cognitive and emotional states, as well as from knowledge about social categories to which the target belongs. The processes employed during the perspective-taking attempt range in nature from unconscious to automatic to deliberate. For instance, physically mimicking others’ facial expressions can be involuntary whereas projecting one’s own states or traits onto another may be automatic, but it is controlled processes that are particularly salient to the entrepreneurial process. These controlled mechanisms include logical inference, simulation, and imaginative processes in which observers ‘‘deliberatively attempt to construct in their own minds what the experience of the other is like’’ (Davis, 2005, p. 47). The fourth and ﬁnal constituent of perspective taking is its outcome. These can be cognitive, motivational, or behavioral. Greater accuracy in judging the target (Bernstein & Davis, 1982; Ickes, 1997), increased value on the target’s welfare (Batson, Turk, Shaw, & Klein, 1995), and improved social effectiveness resulting from successful anticipation of others’ reactions (Davis & Kraus, 1991) are cognitive, motivational, and behavioral outcomes, respectively, that would appear to be highly relevant to successful entrepreneurial action. Despite the many studies examining perspective taking, there is much research to be done, especially regarding ways in which the phenomenon relates to novel transactions. For instance, existing studies tend to provide the observers with an aim and to induce perspective taking by instructing observers to imagine the target’s thoughts, emotions, or both (Davis, Conklin, Smith, & Luce, 1996; Stotland, 1969; Galinsky et al., 2008). Entrepreneurs, however, not only have to take the perspective of others, they must identify who these others should be. In the case of technological entrepreneurship, for example, customers may not even exist yet, requiring entrepreneurs to conﬁgure the target from a number of interests that they believe will be advanced by the product they plan to introduce (Chiles, Tuggle, McMullen, Greening, & Bierman, 2010). To date, there are few studies that examine encounters with such novel targets. An exception is Davis et al. (1996), who examined the degree to which perspective takers will attribute self-descriptive traits to novel targets. They note that at least some of the information that is used in the perspective taking attempt (knowledge about others’ self-traits) resides wholly within the observer. Even sparser is

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the systematic study of how observers use environmental information to discern another’s internal state. For example, physical features of the environment, such as temperature, humidity, or the presence of obvious threats are likely to inﬂuence a potential investor’s response to an elevator pitch. Similarly, social features of the environment are likely to affect accurate prediction of a target’s thoughts or feelings (Ickes, 1997), but they too are often neglected. Advocating a process of ‘‘quizzing’’ in which the entrepreneur seeks to imagine who the customer is with, what they are doing, etc., during the purchase decision, McGrath and MacMillan (2000) are a rare exception. Although the new value propositions that entrepreneurs introduce to others may manifest as different artifacts, such as goods, services, plans, organizations, networks, etc., they are perhaps most commonly conceived of and studied in terms of new products. Thus, in an attempt to avoid being overly abstract – a common accusation faced by Austrian economists and entrepreneurship researchers – I begin my analysis by examining the effect of perspective taking on the heterogeneity of the entrepreneurial imagination as it relates to the more concrete task of new product development.

THE ROLE OF PERSPECTIVE TAKING IN NEW PRODUCT DESIGN New product development is a term used to describe the complete process of bringing a new product or service to market (Thomke & Fujimoto, 2000). However, I limit discussion to the early phases of the innovation process or ‘‘fuzzy front end’’ in which the product concept is developed and a decision is made about whether to invest resources in its development (Smith & Reinertsen, 1997; Koen et al., 2001). Unlike subsequent phases which tend to be structured, predictable, and formal, the front end of innovation is often chaotic, unpredictable, and unstructured (Koen et al., 2001). This predevelopment period culminates in a go/no go development decision and includes activities, such as (1) preliminary market assessment, (2) technical assessment, (3) source-of-supply assessment: suppliers and partners or alliances, (4) market research: market size and segmentation analysis, VoC (voice of customer) research, (5) product concept testing, (6) value-to-the customer assessment, (7) product deﬁnition, and (8) business and ﬁnancial analysis (Cooper & Edgett, 2008). Below, I examine the inﬂuence of perspective taking on ﬁve aspects of the new product pre-development

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process, which appear to be particularly dependent on the entrepreneurial imagination: (a) detecting market problems, (b) generating new product ideas, (c) deﬁning the target market, (d) identifying stakeholders, and (e) adapting to anticipated feedback.

Detecting Market Problems If the adopter of an innovation is faced with a high degree of uncertainty, the inventor-developer of a new idea must understand not just his or her own problems but also anticipate the problems of various other individuals and organizations who will be the ultimate adopters of the innovation. (Rogers, 1995, pp. 137–138) Grounded in a ‘‘rather thin research base’’ (Rogers, 1995, p. 157), research on the innovation-development process has traditionally focused more on existing organizations than entrepreneurial ﬁrms. Thus, Rogers (1995, p. 157) suggests that two of the many questions that should be studied in the future are: (1) how are users’ needs and problems communicated to R&D workers and, (2) what role does a change agency play in translating users’ needs into R&D projects? As change agents, entrepreneurs must translate users’ needs into new product ideas that can be communicated to investors, employees, and other stakeholders (Akrich, 1995; Clarke & Montini, 1993; Oudshoorn, 1999; Woolgar, 1991). Before such translation can occur, however, the entrepreneur must become aware that a need or problem exists (Rogers, 1995). As Loasby (2001, p. 18) notes, ‘‘People do not buy goods, or even bundles of objectively deﬁned characteristics; they construct solutions to problems.’’ But because customers and their suppliers usually think about problems differently, Drucker (1964, p. 87) suggests, ‘‘the customer rarely buys what the business thinks it sells’’ (cited in Loasby, 2001, p. 18). Therein lies the challenge of introducing new products: the entrepreneur needs to know what other people need and what obstacles are currently preventing those needs from being met as well as they could be. Though they may rely on ‘‘expert visions’’ (Akrich, 1995), entrepreneurs often tend to be end-users themselves (Shah & Tripsas, 2007). Personal need can alert entrepreneurs to a broader market problem, assuming that these unmet personal interests are representative of similar frustrations to be experienced by future users. This is known as the I-methodology – ‘‘personal experience, whereby the designer replaces his professional hat by that of the layman’’ (Akrich, 1995, p. x). Often the I-methodology can be an

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unconscious process because the designer is not aware of the fact that the user representation she is using resembles herself (Oudshoorn, Rommes, & Stienstra, 2004). Implicit methods are often more powerful than explicit methods in shaping the design (Akrich, 1995). Thus, accurately or inaccurately, designers make numerous design choices by assuming that their own preferences and skills are representative of those of the user. Being an end-user can have its advantages, but it also poses a number of signiﬁcant disadvantages. Markets can evolve away from the interests of the entrepreneur, diminishing the representativeness of her preferences to those of the market (Oudshoorn et al., 2004). If prior overlap was more accidental than purposive, entrepreneurs may become overly reliant on using their own preferences to infer what the preferences of future customers will be (Chiles et al., 2010). Such inference is based on projection instead of deliberate perspective taking and is susceptible to two primary weaknesses. First, it is unlikely that the idiosyncratic preferences of one person will always align with the market. Thus, over-reliance on projection may desensitize the entrepreneur to the need to anticipate or incorporate market feedback. Compared to perspective taking, this would presumably make projection less adaptive and responsive to environmental changes, such as changing consumer preferences. Second, the ego-centric nature of projection is also likely to diminish the number of market problems that an entrepreneur notices. By taking the perspective of others, entrepreneurs can experience numerous others’ irritations, annoyances, and frustrations with various products and services, increasing the likelihood of discovering a problem that the entrepreneur is uniquely equipped to solve. In much the same way that reading ﬁction or autobiographies allows one to experience the lives of others without actually having to live them, perspective taking multiplies the user experiences to which an entrepreneur is privy. Thus, Proposition 1. Greater emphasis on perspective taking will have a positive effect on the entrepreneur’s ability to detect market problems – i.e., inadequacies of existing goods and services.

Generating Ideas for New Products Discovering market problems is of little use to entrepreneurs if they cannot generate superior solutions to those problems. Fortunately for prospective entrepreneurs, problems are never being solved as well as they

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could be, and there is always a better way (Foster, 2007). This suggests that creativity is indeed essential to the entrepreneurial process (Amabile, 1997), but it is the everyday creativity of an active mind that every human being possesses in abundance (Shackle, 1979). By taking the perspective of various stakeholders – real or imagined, entrepreneurs confront different obstacles and/or constraints that must be overcome to provide a product that is attractive to the customer, superior to alternatives, and proﬁtable enough to be worthy of investment (Zirger & Maidique, 1990). Such perspective taking requires entrepreneurs to consider important nuances which not only inspire new ideas but also trigger the realization that ‘‘old elements’’ are relevant to the task at hand. Thus, imagined evaluations of end-users require the designer to consider the problem constraints more closely (Veryzer, 2003). These obstacles provide different objects of analysis upon which the imagination can focus, stoking the ﬁres of creativity, and expanding the imagination itself. As the advertising adage goes, ‘‘The best way to get an idea is to get an idea,’’ meaning that one idea tends to spawn another. Moreover, if an idea is nothing more nor less than a new combination of old elements (Foster, 2007), then it stands to reason that a person who considers more old elements is more likely to come up with a new idea than a person who considers fewer old elements (Koestler, 1964; Smith & DiGregorio, 2002). Thus, perspective taking stokes the entrepreneurial imagination by contemplating more obstacles and calling upon information that may be capable of overcoming them to provide an overall solution. Ironically, the stimulus responsible for stoking the imagination is also responsible for preventing a perpetual increase in heterogeneity. That is, perspective taking binds as well as prompts the imagination by testing solutions against the backdrop of stakeholder acceptance (Seely Brown & Duguid, 1992). ‘‘Would this solution appeal to the user? No, it is socially inappropriate, it is too expensive, too cumbersome, too ugly, etc. What changes in design might overcome these objections?’’ ‘‘Would this solution appeal to investors? No, the target market is too small, it is too costly, too risky, etc. What changes in design might overcome these objections?’’ Such internal dialogue allows the imagination to create novelty without deteriorating into unfocused fancy (Chiles et al., 2010). Thus, perspectivetaking contributes to the generation of new product ideas by disciplining the imagination. It pushes the entrepreneur to consider different dimensions of the problem space, and to create solutions to each of those dimensions while simultaneously continuing to satisfy the varied interests of relevant stakeholders. Thus,

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Proposition 2. Greater emphasis on perspective taking will have a positive effect on the entrepreneur’s ability to generate new product ideas. Deﬁning the Target Market Identiﬁcation of a problem and generation of a possible solution does not necessarily imply that one has identiﬁed whether a market exists for that solution. Assuming that entrepreneurs solve problems for proﬁt, the question emerges: whose problems are these entrepreneurs solving? For a market to exist, the answer has to be: someone else’s – and typically several ‘‘someones’’ at that. Others, however, may not ﬁnd the problem to be compelling; or they may consider the problem to be important, but ﬁnd the solution unappealing, or they may even consider the innovation to be valuable, but consume it without compensating its creator (owing to weak institutions such as failure to enforce property rights) (North, 1990; Shocker & Srinivasan, 1979). Thus, regardless of whether a new product idea emerges as a means of solving one’s own problem or someone else’s, an inferential leap must be made to determine whether others suffer from the same problem and whether they will be willing to pay for a solution to it. How many others? Who are these others? Thus, the target market must be deﬁned (Cooper, 2001). Numerous bases for market segmentation exist, such as demographic, attitudinal, lifestyle, etc., but each requires the entrepreneur to engage in some form of perspective taking to answer the questions: why will others use the product, how will others use the product, where and when will others use the product, etc. Determining that members of Group X will like the new product because it offers beneﬁts a, b, and c or that Group Y will like the new product because it is less expensive than competing products d and e, requires that the entrepreneur (consciously or unconsciously) simulate the decision making of another, imagining what that target believes and desires (Webb, 1996). Being mindful that one is engaging in simulation can prevent unstated assumptions from unknowingly inﬂuencing the design process. Accordingly, entrepreneurs can harness the predictive power of group afﬁliation, stereotypes, and other marketing categorization schemas while recognizing the blind spots that accompany such assumptions. Thus, Proposition 3. Greater emphasis on perspective taking will have a positive effect on the entrepreneur’s ability to deﬁne the target market for the new product.

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Identifying Relevant Stakeholders Successful adoption and diffusion of an innovation requires the acceptance of a host of relevant stakeholders, be they customers (decision makers who may not be the end consumer), suppliers, competitors, employees, investors, creditors, members of the community, etc. (Oudshoorn et al., 2004). Knowing this, entrepreneurs may seek to improve the likely efﬁcacy of their change effort by imagining each and every group that is likely to be impacted by the introduction of the entrepreneur’s new value proposition. If competition is inherently evolutionary in nature, destroying as well as creating (Schumpeter, 1942), then the successful introduction of a new value proposition, whether in the form of a new product, organization, network, or other artifact, is likely to meet resistance by various individuals and/or stakeholder groups (Rogers, 1995). Taking others’ perspective should enable entrepreneurs to anticipate whose interests are likely to be facilitated or encumbered, and how and why this is likely to be the case, thereby helping entrepreneurs to identify who the relevant stakeholders are. Thus, Proposition 4. Greater emphasis on perspective taking will have a positive effect on the entrepreneur’s ability to identify stakeholders likely to be affected by introduction of the new product.

Adapting to Anticipated Feedback Finally, by considering the interests of these various groups, entrepreneurs can tailor the design of their new product and the rhetoric used to communicate it in ways that encourage complicit behavior by members of these various constituencies (Seely Brown & Duguid, 1992). This may involve neutralizing competitive threats. For example, entrepreneurs may seek to downplay the threat they pose incumbents by using rhetoric that suggests that their intention is to focus on a niche target market, a ploy modeled by Bill Gates in Microsoft’s early days. Entrepreneurs may also employ product designs or business metaphors that provide analogies that facilitate understanding of their business vision (Bhide, 2000). These may vary depending on the interests of the parties involved. For instance, successful introduction of an innovation serves different purposes for suppliers, employees, or investors (Rogers, 1995). Knowing this, savvy entrepreneurs will tailor their message accordingly. But taking the perspective of members of these various stakeholder groups does more

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than enhance the persuasiveness of entrepreneurs. It goes beyond equipping entrepreneurs with the ability to explain to stakeholders how their complicit behavior is instrumental in furthering their ends. Because the feedback of these stakeholders is anticipated during the product pre-development process, this imagined feedback can help to shape the product into one that is even more desirable to the consumer, less threatening to the competitor, easier to manufacture or supply, less damaging to the environment, etc. (Seely Brown & Duguid, 1992). That is, perspectivetaking goes beyond facilitating salesmanship; it can help to shape the nature of the product itself so that it is more appealing to proponents and less offensive to antagonists (Thomke & Fujimoto, 2000). It can ease the introduction of a product by ensuring that an important problem is addressed, that the design is optimal, and that thought has gone into why stakeholders should adopt it. Thus, Proposition 5. Greater emphasis on perspective taking will have a positive effect on the entrepreneur’s ability to encourage the complicit behavior of stakeholders by inﬂuencing (a) the importance of the problem for which the new product is offering a solution, (b) the appeal of the new product’s design, and (c) the rhetoric used to describe its beneﬁts.

DISCUSSION AND IMPLICATIONS The above propositions explore the effect that perspective taking is likely to have on ﬁve aspects of new product design, but new products are but one of several different types of new value propositions that entrepreneurs introduce to society. The relationships speciﬁed in the model should, therefore, shed light or more abstract conceptualizations of new value propositions as well. Accordingly, I turn now to discussion of the proposed model’s potential contribution not only to the literature on new product development, but also to entrepreneurship theory and Austrian economics.

Contributions to New Product Development After experiencing the beneﬁts of user-oriented design, practitioners and researchers have called for its application earlier and earlier in the new product development process (Thomke & Fujimoto, 2000; Vredenburg, Isensee, & Righi, 2002). This swim upstream has culminated in an attempt

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to apply design concepts to the pre-development of new products for new as well as existing markets (Cooper & Edgett, 2008). However, customer feedback has its limitations and, in some instances, can even prevent development of a more appealing product (Woolgar, 1994; Webb, 1996). Therefore, although keeping the consumer foremost in one’s mind during the design process is desirable, the challenge of articulating intuition and intention in the creative process suggests that, in some instances, it may be better for this consumer representation to be more imagined than real (Bacon, Beckman, Mowery, & Wilson, 1994; Iansiti, 1995; Bhattacharya, Krishnan, & Mahajan, 1998). Designers of new products of new markets need a consumer representation upon which to rely that is not necessarily provided by feedback from an actual consumer, yet not simply a projection of the entrepreneur’s own preferences either. Perspective taking ﬁlls this void by providing the sociocognitive capability that entrepreneurs need to consider other’s interests without losing sight of their own. In doing so, it provides a bridge between creative supply – i.e., the intentions and capabilities of the entrepreneur in the present – and imagined demand – the anticipated desires and beliefs of a user/ stakeholder in the future. As such, it supplements the new product development process which seeks to bridge supply and demand by integrating technical and commercial segments through industrial design (Borja de Mozota, 2002; Hollins & Pugh, 1990; Marsh & Stock, 2003; Veryzer & Borja de Mozota, 2005). Unlike observers in much of the perspective taking research, however, designers of new products for new markets must not only imagine a target’s reaction, they must also imagine who this target will be. Because the enduser does not yet exist, a representation must be conﬁgured based on the entrepreneur’s beliefs of the type of person who would be likely to adopt the innovation to be developed. Perspective taking allows individuals to read others’ minds well enough to navigate the social world of everyday life and enables entrepreneurs to imagine what future users will think and feel, but to the extent that it is conceived exclusively in terms of simulation of an actual target’s thought process, it incompletely addresses the new product predevelopment process. Thus, it would seem that designers of new products for new markets must ﬁrst determine the types of desires – be they goals, intentions, interests, motives, etc. – that would be facilitated or frustrated by the introduction of a new product and who is likely to have these desires. This proﬁle would then serve as a user representation to imagine how they might design the new product to moderate fulﬁllment of others’ desires. This extra step, in which perspective taking is used to identify the target to whom

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perspective taking is then applied, appears to be absent from the social psychology and marketing literatures. Thus, future research may wish to examine in greater detail how entrepreneurs conﬁgure user representations for new products in new markets as well as how perspective taking affects the successful ideation and implementation of innovations once this target is deﬁned. Contributions to Entrepreneurship Theory To design a new value proposition, entrepreneurs must anticipate the needs of others and seek to supply those needs with goods and services. As the propositions highlight, this requires consideration of others’ preferences when evaluating whether and how to act. Thus, entrepreneurs initiate novel transactions by considering others’ preferences in light of their own preferences. How do entrepreneurs anticipate others’ needs and determine whether those others will pay to have their needs alleviated, especially in new markets where customers do not yet exist? In these instances, how do entrepreneurs determine who to target and how these targets will respond? Demand Uncertainty Creates the Need for Perspective Taking Numerous attempts to answer these questions have been made by entrepreneurship theorists in economics and management, who have conceived of entrepreneurship as an act of opportunity recognition, discovery, innovation, learning, inquiry, negotiation, or imagination. Each of these views conceives of entrepreneurship as a form of economic agency, but they vary according to how uncertain they treat the demand for entrepreneurial action. Conceiving entrepreneurship as opportunity recognition, for instance, Kirzner (1973) objectiﬁes the needs of future customers by examining arbitrage opportunities. As arbitrage opportunities, no doubt exists about whether there is demand or supply for the good or service. Thus, the needs of the individuals comprising the market have already been identiﬁed and deﬁned by others in prior market transactions. Because of this, Kirzner is able to emphasize discovery of information about relative improvements in supply without having to pay attention to how entrepreneurs determine what others need. Along similar lines, Schumpeter (1934) focuses on entrepreneurship as a recombination of existing inputs in something akin to innovation. Demand-side uncertainty is assumed away through marketing (Schumpeter, 1934, p. 65). ‘‘Needs,’’ says Schumpeter (1939, p. 1035), ‘‘whatever they may be, are never more than conditioning

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factors, and in many cases mere products of entrepreneurial action.’’ Thus, Schumpeter proposes that the purpose of business is to create, rather than to serve, and that the former implies the latter. In the rare instances in which demand uncertainty has been addressed, theorists have preferred to discuss opportunity in evolutionary fashion, emphasizing revealed preferences over the difﬁcult subject of anticipated preferences (Hayek, 1945). In these evolutionary instances, novelty resembles random variation that is retained only after selected by the market. This perspective is extremely useful in explaining entrepreneurial response to market demand once a product is introduced, but it is less helpful in explaining how entrepreneurs decide to create new markets. That is, feedback only comes after a decision has already been made and action has taken place. Thus, the entrepreneur is a producer who makes irreversible commitments that prove to be either wise or foolish, but no one knows which until market feedback is provided. If wise, Austrians argue that this is evidence of good judgment, and if foolish, they suggest that this is evidence of poor judgment (e.g., Casson & Wadeson, 2007). For Hayek, the quality of this judgment comes from having local knowledge of time and place. Dispersion of this knowledge accounts for why decentralized decision making is more adaptive and therefore more efﬁcient than command and control economic structures (Hayek, 1945). If entrepreneurship theory is to explain the creation of new markets and incorporation of new technical knowledge, not just the reallocation of goods and services under an existing technological regime, then the data disparities of local knowledge serve as an insufﬁcient explanation of how entrepreneurs create markets. Can judgment provide foresight into the abyss of Knightian (1921) uncertainty or what Shackle (1972) labels ‘‘unknowledge’’ – the unknown and unknowable future? Is there any plausible explanation for why some people would have superior judgment regarding market needs that have yet to be articulated as ‘‘demand’’ or is proﬁt merely retention of random variation that is introduced by the entrepreneur and selected by the market? Taking demand uncertainty as a given, some researchers have sought to use inquiry and negotiation to deﬁne target markets and articulate customer needs and wants before engaging in expensive irreversible behaviors such as production. Inquiry seeks either to ask prospective customers what they want or to observe them in their ‘‘natural habitat’’ to determine what they want, but do not yet know they want (Cagan & Vogel, 2002; Mullins, 2006). These traditional marketing approaches rely on surveys, focus groups, or ethnographic methods which are less expensive (but less reliable)

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alternatives to Hayek’s learning model. Thus, to avoid purely speculative production, entrepreneurs ask or observe customers to determine what they want. Effectuation theory (Sarasvathy, 2001) takes this process a step further and involves stakeholders in the co-creation of the new product. The entrepreneur engages potential customers and modiﬁes the proposed offering in ways that encourage their participation and investment. The entrepreneur invests only what she is willing and able to lose in the hope of attaining the desired effect. Thus, effectuation seeks to engage other stakeholders, especially potential customers, but these customers tend to be speciﬁc agents as opposed to some anonymous notion of market demand. This brings us back to radical subjectivism (RS). With its focus on imagination and concepts such as heterogeneous expectations, RS is highly cognitive and anticipatory in nature. It even shares effectuation researchers’ disdain for the economic inevitabilities implied by functionalism. Although it may be complimentary to effectuation in some ways, RS is not simply the next stage of evolution in the theoretical attempt to explain how entrepreneurs design new value propositions under conditions of uncertain demand. Although RS embraces the notion of imagination, it tends (1) to ignore the social embeddedness of economic agency by focusing on an isolated individual (cf., Lachmann, 1977) or (2) to discuss imagination solely as a source of increasing heterogeneity within the economy (Chiles et al., 2010). In other words, failure to recognize that entrepreneurship involves a transaction that depends largely on the complicit behavior of others not only causes RS to resemble the exclusively supply-sided conceptions of entrepreneurship presented by Kirzner (1973) and Schumpeter (1934), but also leaves the entrepreneurial imagination unbounded (Chiles et al., 2010). Without a target upon which to focus one’s imagination, RS runs the risk of claiming that the entrepreneur must either (1) divine the future – perfectly anticipating everyone else’s preferences to execute successfully his own plans (cf., Sarasvathy & Dew, in press; Selgin, 1988) – or (2) imagine a future that he is capable of imposing on others, such that they must adjust their plans to accommodate his (Schumpeter, 1934). To avoid these extremes, entrepreneurship theory could beneﬁt by integrating RS and effectuation. Effectuation seeks to avoid these extremes by taking a nonteleological stance, suggesting that it is preferences, not goals, that people seek to fulﬁll. If values are shared, then goals can be ﬂexible and attempts to satisfy consensual preferences can manifest as various actions (Sarasvathy, Dew, Velamuri, & Venkataraman, 2003). ‘‘Nonteleological’’ should not be interpreted to mean illogical or nonanticipatory. To generate an idea and to target stakeholders who will be interested, the entrepreneur must employ

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some element of imaginative anticipation. In other words, potential collaborators are not randomly selected. Instead, some idea of who will be interested and how to approach them is likely to precede the social negotiation of the effectual process. Thus, radical subjectivism’s notion of imagination plays a role in an effectual process. The purpose of effectuation may not be to achieve a goal, but that does not mean that entrepreneurial action is random. People have reasons for actions – reasons that consist of beliefs and desires. Even in effectuation, an entrepreneur will not initiate a novel transaction unless he believes the other party is likely to have some stake in the outcome of the proposed endeavor. Thus, before approaching potential customers or investors, entrepreneurs must choose one target over another based on their own belief that the target will agree that the new value proposition has some impact on his or her desires. This requires the entrepreneur to imagine who in the future might be impacted by the innovation and how they might be impacted were the innovation to be introduced successfully to the market. The social competency of perspective taking facilitates this predictive process, whereas accuracy in this empathic effort is likely to encourage the complicit behavior of stakeholders. Thus, few if any agents are likely to develop new products for new markets without some reason for suspecting that customers will buy them. Moreover, many if not all of these agents must communicate their reasons to investors or distributors before expending the resources needed to test their new product in the marketplace. Thus, it seems unlikely that the variation represented by the introduction of a new product is random, haphazard, or blind and more likely that it is speculative in nature and informed to a greater or lesser extent by the entrepreneur’s ability to take the perspective of various stakeholders. Determining Who the Target is Not Just What the Target Wants Perspective taking provides a mechanism that facilitates the entrepreneur’s reasoning and communication, but revenue from new products still depends partially on the degree to which the imagined end-user representation is not only accurate but also representative of a larger population. For example, using a mental picture of Bill Gates to represent the imagined end-user of a new software product may allow a designer to create a product that is indeed superior to competitors’ offerings for anyone matching the representation used, but it does not speak to the issue of how many others do indeed match that user representation. If the user representation used is too speciﬁc (Bill Gates, the individual, as opposed to Bill Gates, representative of some stereotypical end-user proﬁle), then the preferences attributed to the

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representation may fail to generalize to a market that is sufﬁciently large enough to generate proﬁt. If the user representation is too vague (e.g., designing a restaurant for anyone who eats), then the product may fail to satisfy anyone owing to the consumer’s inability to categorize it and determine its relative beneﬁts vis-a´-vis the competition. Finally, there is the potential to misunderstand why users believe a new product is fulﬁlling their desires. For example, an entrepreneur could strive to create a hamburger franchise that offers healthier alternatives than competitors and achieve that goal only to ﬁnd that the market does not value that product beneﬁt. Though researchers in marketing have confronted segmentation of the market and demand uncertainty more directly than their counterparts in management or Austrian economics, they have tended to focus on feedback from existing customers. As pointed out by the new product development literature, however, such feedback is difﬁcult to obtain for innovative products (Woolgar, 1994), occasionally misleading (Bacon et al., 1994; Iansiti, 1995) and potentially damaging to creativity (Webb, 1996). Moreover, marketing research has focused almost exclusively on consumer behavior and new product development within existing ﬁrms as opposed to stakeholder behavior in general and the fuzzy front end of new product predevelopment within emerging ﬁrms. A closer look at the fuzzy front end (within new or existing ﬁrms) suggests that the success of entrepreneurial efforts is likely to be contingent on an adequate consideration of the desires of all stakeholders, not just consumers. Just as designers often had to conﬁgure representations of imaginary users for whom to design their products, entrepreneurs are likely to have to engage in a similar process for each and every stakeholder group. This observation paints a less linear picture of the entrepreneurial process in which the entrepreneur discovers an opportunity, produces a product, and then adapts the product to consumer feedback. Instead, entrepreneurs must confront uncertainty on the demand and supply sides concurrently, constructing much of the entrepreneurial opportunity in various and sundry ways to appeal to and appease simultaneously all the stakeholders involved. Thus, although entrepreneurs can discover the fact that consumers are experiencing problems that they would like alleviated and they can discover the fact that resources may already exist to solve those problems, substantial uncertainty remains regarding how exactly these elements of discovery should be best integrated and communicated if a new product is to be adopted by various stakeholder groups and alter the socio-economic structure of the market. Taking the perspective of both imagined stakeholders (during the pre-development process) and actual stakeholders (during the development and market

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introduction processes) would appear to be integral in navigating the creative choices that characterize the entrepreneurial process.

Contributions to Austrian Economics The heterogeneous imagination of active minds is constantly giving coherence to new streams of data about material resources and others’ preferences and seeking to use this data to inform the problems that characterize human existence. These problems may be discovered through personal experience or by others. Either way, perspective taking enables the entrepreneur to understand another’s frustration enough to generate possible solutions from heterogeneous data and distributed material resources. Thus, the assumption that reality is subjectively experienced does not necessarily require that theorists conceptualize opportunities as objective in nature (as Kirzner (1979) intimates) nor does it necessarily require that formal institutions exist to enable coordination among the plans arising from these subjective realities (as Lachmann (1971) suggests) – though such institutions are likely to help. Instead, it is because entrepreneurship, by deﬁnition, involves a transaction that theorists can allow for demand uncertainty and, yet, still have some semblance of market coordination, even despite the subjectivity inherent to a world in which the heterogeneity of the entrepreneurial imagination is acknowledged. In an effort to offer a more ‘‘forward-looking’’ approach to choice, radical subjectivists like Lachmann acknowledge the heterogeneity of the entrepreneurial imagination and the so-called Lachmann problem that is introduced by doing so (Koppl, 1998). The ‘‘Lachmann problem’’ refers to the difﬁculty of reconciling two aspects of human agency – (1) the subjectivity of individual decision making and (2) the freedom of individual choice – with the existence of socio-economic order. That is, it becomes necessary to explain ‘‘how individual actors’ actions and interactions, given that these issue from choices based on often very different perceptions, interpretations and expectations, nevertheless somehow seem to achieve the quite remarkable levels of coordination regularly witnessed in many spheres of socio-economic life’’ (Lewis & Runde, 2007, pp. 167–168). Lachmann confronts the difﬁcult challenge of recognizing heterogeneity in choice (expectations and interpretations) as well as decision making (preferences and data), but he remains relatively silent on the topic of innovation. Instead, Lachmann focuses almost exclusively on how institutions enable multiple actors, each of whom possesses his or her own subjective plans, to achieve market coordination.

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The Institutional Solution to the Lachmann Problem In an insightful critique of Lachmann’s work, Csontos (1998) notes that Lachmann’s views reﬂect methodological solipsism, an ontological doctrine reconstructed from scattered remarks in the works of Hayek, Mises, Lachmann, and others. Csontos (1998, p. 81) explicates, The world, more precisely the world of human action is, according to these authors, unimaginably complex, involved and multifaceted (see Hayek, 1952a; Mises, 1940). Its elements are constantly changing (Lachmann, 1976) and its phenomena are inﬁnitely diverse (Hayek, 1952b, 1964). These complex phenomena and states of affairs are produced by the interplay of an endless number of individual circumstances and qualitatively different causal sequences; and they are always given to us as a tangled web of countless individual causes and effects (Mises, 1940, p. 45).

Csontos adds (1998, p. 83), If this is what social reality looks like, that is, enigmatic, incomprehensible, although everything hangs together with everything else, then how do methodological solipsists describe social relations and how do they explain the emergence of society? In their view, society is made up of independent and isolated individuals (Hayek, 1952b, p. 5-1) who not only lack a common social knowledge of common experiences but who are made even more isolated by their existing knowledge because the latter is scattered, imperfect, speciﬁc knowledge based on familiarity with particular circumstances (Hayek, 1952b, pp. 29–30).

Although Csontos’ (1998) concerns regarding methodological solipsism and the epistemological isolationism it implies may be well founded, some have argued that critiques of Lachmann’s work are ‘‘valid if and only if one does not read Lachmann on his own terms’’ (Foss & Garzarelli, 2007, p. 801). Foss and Garzarelli (2007) point out that Lachmann’s observation that future knowledge is unpredictable and that no two minds will interpret and process information in identical fashion does not necessarily destroy economic theory or social science. If one allows for common points of reference that exist outside the minds of individuals and upon which to anchor expectations of the future, then coordination is possible. For Hayek these common points of reference were price signals to which the law of supply and demand had determined and agents had learned to respond. Thus, Hayek equates expectations to dispositions to act in a particular manner – i.e., learned behavior (Koppl, 1998). Lachmann, by contrast, sought to offer an explanation of expectations as psychological or phenomenological states (Koppl, 1998). In this spirit, he chose to focus his explanation on institutions. ‘‘An institution’’ according to

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Lachmann, ‘‘provides means of orientation of a large number of actors.’’ Lachmann (1971, pp. 49–50) adds It enables them to co-ordinate their actions by means of orientations to a common signpost. If the plan is a mental scheme in which the conditions of action are coordinated, we may regard institutions, as it were, as orientation schemes of the second order, to which planners orient their plans as actors orient their actions to a plan y The existence of such institutions is fundamental to a civilized society. They enable each of us to rely on the actions of thousands of anonymous others about whose individual purposes and plans we can know nothing. They are nodal points of society, co-ordinating the actions of millions whom they relieve of the need to acquire and digest detailed knowledge about others and form detailed expectations about their future action.

Inspired by Weber’s (1978) ideal types and Schutz’s (1932, 1951) stereotypes, Lachmann’s use of institutions offers a common nonhistorical stimulus on which individuals can anchor their expectations. This anchoring goes beyond using institutions as means of predicting what others will do and is therefore different from the rational, discursive reasoning that Mises labels conception. Instead, Lachmann sees institutions as facilitating understanding. Such understanding seeks the meaning of action in empathic institutions that not only facilitate market coordination by making others’ actions and plans more predictable but also provide a hermeneutic escape from epistemological solipsism by allowing people to understand each other’s actions. Thus, Foss and Garzarelli (2007) note that the hermeneutic dimension of Lachmann’s institutional arguments immunize him against charges of nihilism. They note: Institutions ‘prescribe certain forms of conduct and discourage others. It is clear that those persons who conduct themselves in conformity with them must attribute some meaning to them.’ Thus, a ‘more satisfactory treatment of institutions in economics y will call for the infusion of a sizeable dose of the hermeneutic spirit’ (Lachmann, 1991, p. 282). This quotation synthesizes the Lachmannian stance that avoids complete lack of order. That is, it epitomizes what we believe to be the genuine Lachmann stance, which is not nihilistic.

Institutions are relatively slow changing residuals of inter-subjectively held beliefs whose resiliency lies in the number of people who believe in their legitimacy, the conviction those people have in that belief, and the diversity of the individuals who believe in any one particular institution. It is the last of these criteria that ensures the atomistic assumption of individual agency that is needed for dynamic institutional stability to occur.1 Foss and Garzarelli (2007, p. 801) note: Lachmann often writes that coordination has two levels: individual (plans) and social (e.g., institutions, such as laws, markets, norms, etc.). The two levels are complementary.

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The social-level recurrent patterns of conduct are instrumental in realizing individual plans in that they reduce the volatility in the plans of other agents. At the same time, the plans can contribute to changing social institutions. Consequently, the two coordination levels solve the radical uncertainty problem that Lachmann places at centre stage.

Such arguments are reminiscent of the quantum physics argument in which a cup is said not to jump off a table despite the fact that all its constituent molecules are in motion because all of these molecules never move in the same direction simultaneously. Similarly, Foss and Garzarelli see multiple institutions as simultaneously in motion, but not all in the same direction at the same time. As a result, individuals can attempt to inﬂuence one institution while assuming that the others will remain at some constant speed and direction of change, effectively keeping the cup on the table. Foss and Garzarelli (2007, p. 802) add: Lachmann informs us that agents ascertain the meaning of social institutions, that is, that they hold (sometimes even unconsciously) an understanding about institutions themselves and that these understandings of the roles of different institutions can be intersubjectively and intertemporally shared. Rational individuals understand the role of laws, ﬁrms, contracts, and the like. Moreover, most individuals are able to understand the ‘efﬁciency’ or ‘inefﬁciency’ of a particular institution (e.g., most workers understand the pliability of their labour market). If this essential hermeneutical twist to institutional analysis were missing, we should not, according to Lachmann, be able fully to understand the coordinating role of institutions.

But what is the source of this ‘‘hermeneutical twist to institutional analysis’’ and how would a better understanding of it explain how entrepreneurs imagine and implement the new value propositions that are responsible for transforming these institutions? Sources of the ‘‘Hermeneutical Twist to Institutional Analysis’’ Clearly, institutions act as system constraints that entrepreneurs take into consideration, but assuming active minds of seemingly inﬁnite creative potential, how causally efﬁcacious can institutions possibly be in determining the plans and actions of any individual, especially when those plans involve introducing innovations that are capable of redeﬁning the rules of the game? If, however, these institutions possess a hermeneutic dimension, and the valuation of a choice is necessarily contingent on the complicit behavior of another individual, then arguably the potential for institutions to both inﬂuence choice and facilitate coordination improves dramatically. No longer would these institutions serve simply as functional antecedents, channeling behavior as levies do the ﬂow of water (McMullen, Bagby,

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& Palich, 2008). Instead, they would also serve as guidelines for decision making by providing theories of human behavior by which focal actors predict who relevant stakeholders are likely to be and what these stakeholders are likely to do in response to a novel stimulus such as an entrepreneur’s new value proposition. Methodological solipsists suggest that ‘‘isolated individuals organize into societies as a result of utilitarian considerations’’ and that ‘‘the exchange relationship is the social relation par excellence, and the cement that holds society together is a general normative consensus (Mises, 1940, pp. 125, 128, 167, 180–181)’’ (Csontos, 1998, p. 83). This, however, begs the question of how these individuals understand the meanings and sense of the words, gestures, and actions of other human beings, especially if one assumes, as methodological solipsists do, that the ‘‘dispersion and imperfection of all knowledge is one of the basic facts from which the social sciences have to start’’ (Hayek, 1964, p. 30). To answer this question some have suggested that foresight regarding others’ plans and actions comes from personal insight into the human condition. That is, people assume that the structure of human thinking is constant (Hayek, 1964, pp. 23–24, 33–34, 1952b, pp. 77–78, 102; Mises, 1933, p. 126) such that others are believed to share a similar mental outﬁt. Using introspection, the focal actor ascribes the logic of her thought and action to the human condition, thereby assuming that other humans will also think and act logically. Csontos (1998, p. 86) notes introspectively gained self-knowledge, as a result of the basic similarity of the human mind and the commonalities of our mental structures, gives us direct access to those thoughts, concepts, and objectives with the help of which we can understand individual and collective attitudes and actions observable in the world around us. In the view of the advocates of methodological solipsism, this introspective knowledge is not only the methodological starting point for the social sciences, but in its subjective nature lies the ultimate explanation for the systematic subjectivism of these sciences (Hayek, 1952a, pp. 192–193, 1964, p. 50).

Csontos’ observations suggest that methodological solipsists employ what John Stuart Mill called ‘‘inference from analogy.’’ Through inference from analogy, focal actors are believed to attribute mental states to others based on observation of the physical behavior of these others in conjunction with their own direct experiences of mental states from the ﬁrst person perspective. Stueber (2008) illustrates: (i) another person X manifests behavior of type B, (ii) in my own case, behavior of type B is caused by mental state of type M, (iii) because my and X’s outward behavior of type B is similar, it has to have similar mental causes. (It is thus assumed that I and

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the other person are psychologically similar in the relevant sense. Therefore, X’s behavior is caused by a mental state of type M). Because it employs a Cartesian conception of the mind according to which access to one’s own mind is direct and infallible, whereas knowledge of other minds is indirect, inferential, and fallible, inference from analogy can never provide evidence for the claim that other people have similar states as we do (Lipps, 1907). Crediting Wittgenstein with articulation of this insight, Stueber (2008) describes the Cartesian dilemma as it applies to inference from analogy as follows: If my grasp of a mental concept is exclusively constituted by me experiencing something in a certain way, then it is impossible for me to conceive of how that very same concept can be applied to somebody else, given that I cannot experience somebody else’s mental states. I therefore cannot conceive of how another person can be in the same mental state as I am because that would require that I can conceive of my mental state as something, which I do not experience. But according to the Cartesian conception this seems to be a conceptually impossible task.

The fundamental mistake of the debate about the apprehension of other minds consists in the fact that it does not take seriously certain phenomenological facts (Scheler, 1954). That is, people do not encounter merely the bodily movements of another person. Instead, they directly recognize speciﬁc mental states because they are characteristically expressed in states of the human body; in facial expressions, in gestures, in the tone of voice, etc. Nevertheless, ‘‘philosophers in the phenomenological tradition never provided a philosophically comprehensive account of mental concepts that would allow us to see them as part of an intersubjectively accessible practice in which we interpret, predict, and explain the behavior of other agents’’ (Stueber, 2008). Consequently, Stueber suggests that the lack of a comprehensive account of mental concepts is responsible for the concept of empathy not being taken seriously in the analytic tradition of philosophy until very recently. Though institutions are important, they are maintained or transformed by intersubjective beliefs made biologically possible by basic empathy and psychologically possible by re-enactive empathy. Basic empathy refers to a phenomenon of inner imitation in which one’s mind mirrors the mental activities or experiences of another person based on the observation of his bodily activities or facial expressions (Lipps, 1906), but it is not limited to such cases. Indeed, Lipps (1903, 1905) regards our recognition of all mental activities – insofar as they are activities requiring human effort – as being

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based on inner imitation. This inner imitation is facilitated neurobiologically by mirror neurons that allow us to apprehend directly others’ emotions from their facial expressions and to understand their bodily movements as goaldirected actions. Building on this foundation, Stueber (2006, p. 21) suggests that, although basic empathy ‘‘allows us to recognize, for example, that another person is angry, or that he intends to grasp a cup,’’ it must be complemented with a higher-level of empathy, or re-enactive empathy, to understand why a person is angry, or why he responded to a particular situation in a certain manner. Re-enactive empathy refers to the human ability to use our cognitive and deliberative capacities to re-enact or imitate in our own mind the thought processes of the other person (Stueber, 2006). As such, the philosophical concept of re-enactive empathy is equivalent to the perspective-taking dimension of social psychology’s conception of empathy. According to social psychologists, empathy consists of ‘‘a set of constructs that connects the responses of one individual to the experiences of another. These constructs speciﬁcally include both the processes taking place within the observer and the affective and nonaffective outcomes that result from those processes’’ (Davis, 2006, p. 443). Primary among these processes is perspective-taking, which has been deﬁned as ‘‘the deliberate attempt to imagine the internal state of another person’’ (Davis, 2006, p. 450). Through perspective-taking, re-enactive empathy provides a bridge between islands of subjective reality, allowing people to escape their solipsistic isolationism enough to understand others from a ﬁrst-person perspective and, thus, to anticipate what some target – be it a speciﬁc individual or a stereotype – is likely to think, feel, and do in response to the new value proposition that the entrepreneur is designing. Therefore, the biological basis of basic empathy enables individuals to experience a second-person perspective – i.e., I think or feel what you are thinking or feeling based on mirror neurons reacting to your expressions, body language, etc. This general ability then equips the more deliberative form of re-enactive empathy – i.e., I imagine what you might be thinking or feeling given your circumstances and goals. Finally, this re-enactive empathy also allows observers to understand more abstract targets – i.e., I imagine what anyone who is in a particular set of circumstances and who possesses a particular goal might be thinking or feeling. Though terms are often imprecisely used in the rapidly growing volumes of research on empathy, research has shown that distinction between cognitive and affective dimensions of the construct are fruitful. Thus, perspective-taking appears

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to be the cognitive dimension of re-enactive empathy whereas empathy is the affective dimension of re-enactive empathy. Thus, empathy offers a foundation for a socio-cognitive view of entrepreneurial agency that is consistent with institutional explanations of market coordination but independent of them. That is, it gives institutions their ‘‘hermeneutic twist,’’ but it is a precursor of institutional development, a human capability that enables their existence, not a consequence of them. Therefore, through perspective taking, re-enactive empathy provides a theoretical mechanism that is capable of explaining the emergence and entrepreneurial transformation of institutions. As a result, it offers an alternative explanation for the market coordinating properties of institutions while preventing forced subscription to a realist ontology which some scholars would consider inconsistent with the subjectivism of methodological individualism (Addleson, 1995; Lewis & Runde, 2007; McMullen & Shepherd, 2006). Finally, because it is capable of explaining variance in the quality of entrepreneurial judgment and prediction (as a function of empathic accuracy) without resorting to clairvoyance, chance, or historical precedent, re-enactive empathy may even appeal to Austrians of a praxeological bent.2

CONCLUSION Heterogeneity is fundamental to Austrian economics, but a reluctance to embrace the heterogeneity of the entrepreneurial imagination for fear of nihilism has prevented many Austrians from embracing the insights provided by radical subjectivists, such as Shackle or Lachmann. Though recognition of the role that institutions play in facilitating market coordination is helpful, it still relies on an empathic element or ‘‘hermeneutic twist’’ to provide social order in the face of radical uncertainty. Basic empathy provides a foundation for intersubjective understanding and the emergence of the more deliberative psychological process of re-enactive empathy. Inclusive of both affective and cognitive dimensions, researchers have demonstrated that the more cognitive dimension of empathy known as perspective taking may be essential in discovering shared interests and imagining innovative solutions to problems that are capable of advancing the interests of multiple parties. Thus, I hope to have shed some light on how and why acknowledging the socio-cognitive human capacity for perspective taking and the fact that entrepreneurship involves a novel transaction can facilitate research in new product development, entrepreneurship theory, and Austrian economics.

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NOTES 1. In a similar vein, ‘‘Big Players Theory’’ (Koppl & Yeager, 1996; Butos & Koppl, 1993) has suggested that nonatomistic agents are likely to undermine the efﬁcacy of the institution of competitive markets. By having the power to inﬂuence the market while simultaneously remaining immune to its discipline, big players encourage other market agents to rely on psychological expectations reminiscent of Keynes’ animal spirits rather than dispositional expectations grounded in the tight system constraints of an evolutionary market process – the position favored by Hayek. 2. According to praxeologists (e.g., Selgin, 1988), equilibrium and coordination are not synonymous concepts. Although the former is apodictic, the latter depends on empirical or psychological science. For instance, when people imagine some future state that promises less discomfort than their current state, they are no longer in equilibrium until they act on this opportunity. Thus, for praxeologists, judgment simply refers to the assessment derived in acts of valuation and choice. Concerns about the post hoc accuracy of ex ante judgment require content and experience and are therefore beyond the scope of praxeology. Thus, to the extent that the act of empathizing can be separated from its content, it may represent an abstract theoretical mechanism that could be treated like judgment by praxeologists.

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WHY AUSTRIANS SHOULD QUIT WORRYING AND LEARN TO LOVE THE LAB Ryan Oprea and Benjamin Powell ABSTRACT Experimental economics has been treated with skepticism by some Austrian economists. We argue that experimental methods are consistent with strong versions of praxeology, and are therefore not methodologically problematic for Austrians. We further argue that experimental research methods have illustrated many uniquely Austrian themes and provide a fruitful method for future Austrian-inspired research.

1. INTRODUCTION Both Ludwig Von Mises and Frederick Hayek wrote critical assessments about the use of experimental methods in economic research. Some modernday Austrian economists remain critical of experimental methods. Yet, Vernon Smith, who won the Nobel prize in 2002 for his work in founding experimental economics, considers much of his research as a demonstration of some key Austrian ideas (Smith, 1999, 2005). Our purpose in this chapter is twofold. First we argue that experimental economics is perfectly consistent with Austrian methodology. Second, we What is so Austrian About Austrian Economics? Advances in Austrian Economics, Volume 14, 145–163 Copyright r 2010 by Emerald Group Publishing Limited All rights of reproduction in any form reserved ISSN: 1529-2134/doi:10.1108/S1529-2134(2010)0000014010

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argue that experiments can be fruitfully used by Austrians to advance their research. Experimental economics provides a powerful forum for evaluating and critiquing neoclassical ideas. It is also a particularly useful tool for exploring and developing uniquely Austrian alternatives. Our chapter proceeds by ﬁrst brieﬂy outlining the method of experimental economics. In Section 3 we consider Austrian objections to experimental methods and explain where experimental methodology ﬁts in the Austrian paradigm. Section 4 surveys experimental studies that draw on and contribute to Austrian insights and suggests future avenues of Austrian experimental research. The ﬁnal section concludes.

2. THE EXPERIMENTAL METHOD Experimental economics is the application of laboratory methods to questions regarding economic behavior and the welfare implications of economic institutions. Typically, undergraduate students are recruited for participation and are paid in cash based on the decisions they make in the experiment. Experiments rely on a methodological tool called induced value theory (Smith, 1976). Subjects are given reservation values (or costs) over outcomes of the experiment, and their payments are related monotonically to these payoffs. Experimenters additionally impose rules regarding what sorts of decisions are available to subjects, what information subjects have access to and how subjects’ decisions impact one another’s payoffs. These rules collectively constitute an experimental design. Most modern experiments are run using networked software that allows experimenters to study extremely complicated environments and interactive institutions. Typically, experiments begin with hypotheses drawn from neoclassical theory (NCT) and are designed to examine the degree to which these hypotheses describe behavior. In multisubject experiments, these hypotheses are equilibrium predictions. In single subject experiments they are behavioral predictions made based on NCT heuristics (e.g. optimization, Bayesian learning, etc.). Typical experimental designs have subjects repeatedly making similar decisions to focus attention on the evolution of behavior over time. Most experiments therefore produce data on how well subjects come to learn optimal behavior or consistency after processes of mistake making. Thus, even when studying neoclassical models, experiments frequently incorporate Austrian concerns with feedback, learning, and correction. Experimental designs generally include multiple versions of the sets of rules or the environment. Often these treatments are inspired by the fact that

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such changes in treatment variables alter NCT equilibrium predictions. By studying multiple treatments, the experimenter can study not only the precise predictions of the theory but also the degree to which predicted qualitative changes in behavior are borne out in the lab. Experimenters therefore frequently use NCT not merely as a tool for predicting precise outcomes but rather as a tool for predicting qualitative patterns. Experimenters also often design treatments that vary facts about the environment or institution that NCT does not predict should affect equilibrium behavior. These treatments are typically designed either to examine the behavioral effects of distinctions NCT considers irrelevant or to examine factors that NCT tools are incapable of analyzing. Therefore while experimental design interfaces strongly with NCT, it is not necessarily bound by its assumptions. Indeed, in extreme cases, experimenters design experiments over which NCT can make few or no predictions at all. Typically, economics experiments include multiple replications of each treatment, each with different cohorts of subjects, to look for regularities in behavior across instances. Sometimes this results in the observation of welldeﬁned patterns of predictable behavior that are robust to replication. Other times replication reveals strong heterogeneity across subjects and cohorts, revealing a sort of indeterminacy of outcomes. In either case, the important methodological feature of economic experiments is that the faculties of subjects – for instance their rationality, foresight or learning heuristics – are not imposed (as they are in neoclassical theory) but observed. In many cases the experimental method uses equilibrium constructs as potentialities induced by the environment and institutions rather than inevitabilities. It is therefore essentially a method for relaxing the behavioral determinism required of some neoclassical theorizing while organizing inquiry around well-deﬁned equilibrium states. For this reason non (or out of) equilibrium behavior lies at the center of much of experimental economics. For an excellent survey of the ﬁeld, the reader is referred to Plott and Smith (2008), which provides a fairly comprehensive overview of what we have learned from laboratory research in economics.

3. EXPERIMENTAL ECONOMICS IN AUSTRIAN METHODOLOGY Austrian reluctance to incorporate experimental methodology stems from their objection to scientism – inappropriate applications of the methods of the physical sciences to the social sciences. In this section we attempt to

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show that experimental methods are perfectly consistent with Misesian praxeology, arguably the strictest variety of Austrian methodology. To the extent that we are able to show experimental methods are consistent with Mises’ praxeology we believe that it is also compatible with other less restrictive Austrian methodologies. In the taxonomy suggested by praxeology, economic theory consists only of propositions that are true a priori and not subject to empirical testing. All economic theory is deduced from the action axiom and a few subsidiary assumptions (such as the disutility of labor). Economic theory either applies or does not apply to a given situation in the naturally occurring world depending on whether the subsidiary assumptions used to derive the theory are present. No empirical occurrence in the real world can prove or disprove economic theory, by the deﬁnition of economic theory under praxeology. By this deﬁnition, economic theory is disproved only by showing a ﬂaw in the chain of logical deductions from the action axiom and the subsidiary assumptions. An important implication of this taxonomy is that the vast majority of conjectures made in neoclassical theory are not theory in the sense of praxeology but are rather empirical conjectures. For praxeologists there is a sharp distinction then between economic theory and what Mises called ‘‘history’’ or other economists might refer to as applied economics. Mises (1949) wrote, There is economics and there is economic history. The two must never be confused. All theorems of economics are necessarily valid in every instance in which all the assumptions presupposed are given. Of course, they have no practical signiﬁcance in situations where these conditions are not established (p. 66).

Economic history, in this schema, involves establishing whether all the assumptions of a theory are present and then using the theory to describe the particulars of the unique event being investigated. Economic history also involves nonaprioristic interpretation of the relative magnitude and importance of various factors present in any given situation. Applied economic history thus involves a priori theory and non a priori judgments of magnitudes and importance. When Austrians object to experimental methodology it is on the grounds that they believe experimental economics is being used to ‘‘test’’ a priori theory. Mises raised this objection before experimental economics was even practiced. Mises (1949) wrote, History can neither prove nor disprove any general statement in the manner in which the natural sciences accept or reject a hypothesis on the grounds of laboratory experiments.

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Neither experimental veriﬁcation nor experimental falsiﬁcation of a general proposition are possible in this ﬁeld (p. 31).

The same objection was raised by some Austrians in 2002 after Vernon Smith won the Nobel Prize for his work on the development of experimental economics. Anderson (2002) complained that ‘‘As one can imagine, Austrians are not exactly enthralled with ‘Experimental Economics,’ as they think the whole thing to be rather silly.’’ He then described some of the work Smith has done in illustrating the efﬁciency of the market but concluded, All of this is well and good, of course, but it does not ‘‘prove’’ that free markets are best for society at large. That is not because Smith’s work is slipshod or biased, but rather because it violates a central premise of Austrian methodology, that laws of human action cannot be ‘‘tested’’ for falsiﬁcation.

Shostak (2002) made the same methodological critique, Various conclusions that are derived from this knowledge of purposeful action are valid as well, implying that there is no need to subject them to various laboratory tests as is done in the natural sciences. For something that is certain knowledge, there is no requirement for any empirical testing.

going so far as to claim, ‘‘While a laboratory is a valid way of doing things in the natural sciences, it is not so in economics. If anything, the introduction of a laboratory in economics only stiﬂes our understanding.’’ However, an Austrian economist need not interpret any experimental result as ‘‘testing’’ praxeological theory. Experimental economics investigates concrete cases of human action much like economic history does. Austrian economics does not reject historical, ethnographic, or econometric ﬁndings per se. It rejects their capacity to test praxeological theory. So should be the case with experimental economics. Even if one holds that propositions in economic theory are beyond testing, experimental results can at least illustrate them. Moreover, much confusion stems from the fact that neoclassical economists and praxeologists use the word theory in very different ways. The vast majority of theories economists do test in the lab are theories that lie well outside of the scope of praxeology (i.e., are propositions that the Misesian taxonomy would not classify as theory). Most experimental theory tests, for example, concern the predictive power of game theory in strategic settings. The various forms of Nash equilibrium tested for in these experiments would certainly not be held as a prioristically true by most Austrians. Other classes of experiments test behavioral conjectures common in neoclassical economics such as Bayesian learning, altruism and consistency

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axioms over preferences and beliefs. Austrians would classify these theories as psychological rather than praxeological. Finally, the study of market experiments often focuses on speciﬁc patterns of out-of-equilibrium behavior (e.g., tattonement dynamics or Edgeworth cycles), testing neoclassical conjectures that make far ﬁner (though, a priori, perhaps less reliable) predictions than the core conclusions of praxeological theory. In each of these cases, covering the vast majority of ‘‘theory tests’’ in experimental economics, the theories being tested would not be classiﬁed as theory at all in praxeology. Instead they would be classiﬁed as empirical (or historical or psychological) conjectures. The mathematical predictions made in neoclassical economics are, in fact, often regarded with no small amount of skepticism by many Austrians. If these theories have no predictive power, they should certainly lack predictive power in the lab. Thus, experimental economics, as a controlled form of economic history, can help economists weed out the useful extra-praxeological neoclassical conjectures from the unuseful ones. Moreover, Austrians can use experimental methods to challenge neoclassical claims that run counter to praxeological ones. Indeed a number of bad ideas in mainstream economics have been discredited using laboratory tests. Both Mises and Hayek were skeptical, however, of the value that experimental economics could add. Mises (1949) wrote, The experience to which the natural sciences owe all their success is the experience of the experiment in which the individual elements of change can be observed in isolation. y The experience with which the sciences of human action have to deal is always an experience of complex phenomena. No laboratory experiments can be performed with regard to human action. We are never in a position to observe the change in one element only, all other conditions of the event being equal to a case in which the element concerned did not change. Historical experience as an experience of complex phenomena does not provide us with facts in the sense in which the natural sciences employ this term to signify isolated events tested in experiments (p. 31).

Hayek (1935), also writing before the emergence of experimental economics, was equally skeptical, In all sciences except those which deal with social phenomena all that experience shows us is the result of processes which we cannot directly observe and which it is our task to reconstruct. All our conclusions concerning the nature of these processes are of necessity hypothetical, and the only test of validity of these hypotheses is that they prove equally applicable to the explanation of other phenomena. What enables us to arrive by this process of induction at the formulation of general laws or hypothesis regarding the process of causation is the fact that the possibility of experimenting, of observing the repetition of the same phenomena under identical condition, shows the existence of deﬁnite regularities in the observed phenomena.

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In the social sciences, however, the situation is the exact reverse. On the one hand, experiment is impossible, and we have therefore no knowledge of deﬁnite regularities in the complex phenomena in the same sense as we have in the natural sciences (p. 126)

What Mises and Hayek, writing before the advent of experimental economics, claim is impossible – experimenting on subjects while changing only one element of the environment – is precisely what many experiments do. They keep the same subjects and constraints and vary only one aspect of the environment at a time and observe the change in outcomes. Smith (1999, p. 197) speculates that the reason no one believed that experiments could be used in economics by the time Human Action was published was ‘‘simply that almost no one tried or cared.’’ The fact that experiments can be run varying only one (or a few) aspects of the environment at a time need not change the status of praxeological laws. It is perfectly possible to hold certain propositions as a prioristic truths while using laboratory examination to demonstrate the working of these laws. In fact, as Smith concludes in 1999, Experimental economics, created in the 50 years since Human Action, is kind to the Austrians in enabling us to demonstrate that the spontaneous order, operating through property right institutions, exhibits the desirable characteristics that the Austrians claimed for it. This power of demonstration is for me far more compelling than the appeal to reason, especially by Mises (emphasis ours: 208).

Although many Austrians, no doubt, will ﬁnd a priori deduction more convincing than the demonstration of praxeological claims through either traditional applied history or experiment, it is no doubt the case that many people, like Smith, ﬁnd illustrations of the theory more persuasive. So far we have argued that (1) Austrians can consistently classify experiments as a part of economic ‘‘history,’’ (2) experimental ‘‘theory’’ tests are typically tests of conjectures that would not count as theory to a praxeologist, and (3) contra claims by Mises and Hayek, experiments are possible. We believe work in experimental history also offers Austrians promising avenues of research that traditional empirical (or economic history) methods do not offer. First, experiments can illustrate the working of the market process in ways that naturally occurring data cannot. Hayek (1968) famously wrote, The reason we use competition is that in those cases in which it might be interesting, the validity of the theory can never be tested empirically. We can test it on conceptual models, and we might conceivably test it in artiﬁcially created situations, where the facts which competition is intended to discover are already known to the observer. But in such cases, it is of no practical value, so that to carry out the experiment would hardly be worth the expense.

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Unlike Hayek, we believe that these illustrations do create value far over their expense. Austrians can theorize how the market process of competition discovers what is unknown but in using naturally occurring data, the counterfactual, what could have been discovered but was not, is never known and available to illustrate the theory. In constructing laboratory environments, the experimenters are able to know what subjects could discover through competition. The repeated success of subjects in discovering this knowledge provides an illustration of the discovery process succeeding in a way that could not be done in the naturally occurring world since the point of the discovery procedure is precisely to discover what is unknown. Contra Hayek, the aim of experimental study is not to facilitate discovery but to study it. An experimentalist can examine the degree to which institutional facts (in this case the degree to which competitive forces are allowed) map into possibly unintended achievement of optimal states. To the degree that we want to compare how rules, laws, and institutions impact the discovery process, experiments can be of a great deal of practical value. Koppl, Kurzban, and Kobilinsky (2008, p. 155) summarize the value of experiments in studying the epistemic discovery process of different institutional environments nicely: We construct the truth, the preferences, and the institutional environment of choice. We construct y the world in which we place our subjects. From this godlike perspective we are in a position to compare the epistemic properties of different institutional arrangements. When we return from our constructed world to the real world, we lose our privileged access to the truth and return to the normal uncertainty common to all. But we carry with us a knowledge of which institutional structures promote the discovery and elimination of error and which institutional structures promote error and ignorance. This knowledge can be carried from the constructed world of the laboratory to the natural world of social life because of the common element in both worlds, namely, the human mind. The one vital element of the experimental world that is not constructed is the human mind, which makes choices within the institutional context of the laboratory experiment (emphasis original).

This brings us to another important value that experiments add – replicability. As Austrians often stress, each naturally occurring historical event is a unique complex phenomenon. Although praxeological theory is prioristic, it does not tell us empirical magnitudes and is sometimes silent on the role of institutional details (e.g., the relative effectiveness of one set of auction rules versus another). These are empirical facts, left for the applied economist/economic historian to sort out. However, it is hard to make historical generalizations about the magnitude of any theoretical law because of the uniqueness of each individual historical occurrence. Experiments enable us to better control for all of the unique factors and vary the fewer

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factors of interest repeatedly so that we can make better generalizations from the work we do in economic history. This replicability gives experimental methods a unique place in the practice of economic history and opens up new avenues for demonstrating and reﬁning various Austrian insights. A further relevant question is the degree to which the results from experiments can be used to judge and predict naturally occurring circumstances. Sometimes experimental methods are criticized for putting people in ‘‘unrealistic’’ situations. Smith (2005) quotes Hayek from Law, Legislation and Liberty saying ‘‘fruitful social science must be very largely a study of what is not.’’ He claims that this is exactly what he does in his lab. ‘‘Of course it’s not realistic, and that is why we do it! Because we want to learn two things: we want to better understand what is; why the rules are what they are!yThe second reason why we study what is not is that we want to study social change’’ (emphasis original: 140–141). It is important to realize that in most cases, experimental work is much more concerned with characteristics of economic processes and behaviors under comparative circumstances than with making precise forecasts. Experimental economics can be understood as an empirical method for developing pattern predictions of the sort suggested by Hayek. Results of experiments often suggest tendencies and distributions of outcomes rather than hard and fast rules. We can, moreover, use experiments to make predictions about outcomes of complex social processes that are difﬁcult to make using a prioristic reasoning alone. Reﬁnements of our understanding of these tendencies can generally be best achieved by further experimentation rather than extrapolation of results into law-like predictions. Indeed there is a relatively strong culture in experimental economics of replication and iteration of designs to challenge past results or discover their robustness to institutional and environmental idiosyncrasies. To sum up, Austrians need not interpret experiments as tests of praxeological theory. They should instead view them as a new way of doing economic history. However, because of their controlled and replicable nature they open up new avenues for Austrian empirical/historical work that were previously underexploited. We now examine some of these themes in experimental research.

4. EXPERIMENTAL ILLUSTRATIONS OF AUSTRIAN ECONOMICS Austrian economists have long emphasized the vital role of property rights, the informational role of prices, and the market’s competitive discovery

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process. These topics have been of direct interest to experimental economists since the ﬁeld was founded. The earliest two-sided market experiments were multilateral bargaining markets conducted by Edward Chamberlain in the 1940s and 1950s. A subset of agents were given values over ﬁctitious units and thereby provided incentives to buy units. A second subset was given costs for producing and had incentives to sell units. These values and costs were heterogeneous across units, so that in aggregate they formed supply and demand curves and a corresponding equilibrium price and quantity. Two features of mainstream competitive equilibrium theory were violated in setting up this experiment. First, there were relatively few buyers or sellers instead of the unboundedly large market imagined by Marshall. Second, subjects were given no information about the supply and demand environment other than their own private value or cost. Subjects were then allowed to walk around the room and negotiate sales and purchases. Chamberlain found a marked failure of competitive equilibrium theory to predict prices and, as a result, observed deadweight loss in these markets. Vernon Smith conjectured that the results of such an experiment would be highly sensitive to the institutions governing trade. Smith conducted a similar experiment using the double-auction, an institution frequently used in asset trading exchanges (Smith 1962). In the double auction, buyers and sellers submit public bids and asks for units, and are allowed to increment offers until a price is agreed upon. What Smith found in these initial experiments was a reversal of Chamberlain’s results. Prices quickly converge to competitive equilibrium levels and markets attain striking efﬁciency – deadweight losses often disappear altogether. This experiment has been replicated thousands of times, with many different supply/demand environments, cohort sizes, and demographics. The results are strikingly robust: The double auction institution leads to nearly perfectly efﬁcient equilibrium outcomes in virtually all cases. This discovery marked the birth of modern experimental economics. These results have obvious relevance to Austrian market process theory and reﬂect many conjectures made in that literature. Subjects in these experiments know only their own particular circumstances and through a process of learning and adjustment quite literally discover adaptively what the experimenter would recognize as the equilibrium price. The market price and the corresponding efﬁciency of markets in this case is a spontaneous order, generated unintentionally by agents making use of market-grown information. Experimentalists call the idea that markets can economize on scarce information in this way the ‘‘Hayek hypothesis’’ and have found a great deal of evidence in support of this hypothesis in the past 40 years.

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Although the literature on experimental markets is vast, we would like to focus on only two further applications. First, the double auction experiment has been extended to general equilibrium settings in which many interlinked markets exist simultaneously. In these incredibly complex multimarket settings, experimentalists frequently observe price discovery converging on the competitive equilibrium. This occurs via dynamics similar to those in single market experiments; subjects adjust and learn from prices simultaneously, eventually unintentionally arriving at highly efﬁcient outcomes (Williams, Smith, Ledyard, & Gjerstad, 2000). Second, a great deal of experimental work has focused on ﬁnancial markets. In these experiments, subjects hold assets with an unknown value. Typically, subjects are given probabilistic (risk) information about the potential value of the asset. A number of information aggregation experiments have been conducted in which individual subjects are given private information about the value of a good and then are allowed to trade assets in a double auction. The efﬁcient market hypothesis and the idea of rational expectations equilibrium imply that prices should converge to a level that acts as a sufﬁcient statistic for underlying information. That is, as Hayek conjectures, prices should summarize information held by individual participants. Convergence in these markets depend on agents taking account of information gathered in the price as they trade, continuously learning and updating their beliefs over time. Multiple studies have demonstrated a great deal of information aggregation in prices in these markets and have studied factors contributing to or detracting from these aggregative properties (Plott & Sunder, 1988). Another important strand of literature on ﬁnancial markets examines the formation of expectations driven bubbles in asset markets (Smith, Suchanek, & Williams, 1988). In these studies, subjects are given identical information and are allowed to trade an asset that returns dividends in each of (typically) 15 periods. At the end of the ﬁnal period, assets lose their value altogether. Intuitively, the asset’s value decreases over time, becoming worthless by the end. Agents trading based on fundamentals should therefore trade the asset (if at all) at the expected value in each period. However, the price agents are willing to trade at, in fact, depends on endogenously formed expectations about the future price other agents will be willing to purchase at. Because experiments do not restrict such expectations, experimentalists can actually observe the subjective evaluations of agents in ﬁnancial markets proxied through the market price. In many (though not all) of these markets, agents form expectations that other agents will buy at higher prices, and bubbles form, with prices rising above

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expected value, sustained by a complex set of self-reinforcing expectations. Eventually these expectations collapse, causing crashes in the price. One interesting ﬁnding from extensions of this research is that traders eventually learn through experience to avoid bubbles and can in fact arbitrage away bubbles formed by less experienced traders. Other experimental research has relevance for Austrian studies of entrepreneurship. Individual decision experiments have studied ambiguity (often called Knightian uncertainty). Under ambiguity, agents know what outcomes are possible but do not have any good reason to place probabilities over particular outcomes. A component of neoclassical theory known as subjective expected utility theory argues that agents place subjective probability judgments on these possibilities and then treat their decision as if it were a response to any other risky proposition. Careful experiments show that a large proportion of (though not all) agents make decisions that are inconsistent with SEU theory and in fact show a positive aversion to ambiguity (e.g. a preference for risk over Knightian uncertainty). Most agents will avoid ambiguity even at relatively great expense to themselves. This ﬁnding, and the fact that it is only descriptive of a portion of the population, might be a clue to the entrepreneurial function and therefore may be an important piece of market process theory. Perhaps entrepreneurs are not only agents who are particularly alert, as Kirzner argues, but also particularly tolerant of ambiguity. In the past 20 years, neoclassical economists have been particularly interested in economic problems in which agents’ actions strongly inﬂuence one another’s welfare. Game theory provides a method for classifying sets of mutually consistent strategies (or in Austrian terms, mutually consistent plans) in these types of settings. Experimental economists have conducted hundreds of experiments studying how real human subjects make inconsistent plans and learn how to reconcile these plans in equilibria (Camerer, 2003). This area, often called behavioral game theory, attempts to use experiments to create psychologically rich models of decision making and expectations in strategic settings. One often-used model, the Quantal Response Equilibrium (McKelvey & Palfrey, 1995), is based on the idea that agents make mistakes more frequently when the mistakes are relatively less costly. That is, the discovery of a best strategy is more likely when the relative returns from such a discovery are higher. The idea that both agents react this way simultaneously generates predictions about the pattern of coordination that will be observed across pairs of agents. The QRE model, as it turns out, does a good job of rationalizing behavior in a wide variety of games.1 In fact, beyond the QRE, the correspondence between the size of

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payoffs and the reliability of rational action is a robust ﬁnding in experimental economics. We see in this a family resemblance to the conjecture, often made in market process theories, that entrepreneurial alertness may be stimulated by proﬁt motives (Kirzner, 1973). In both game-theoretic and market settings, experimentalists are frequently interested in the convergence of behavior over time. Out-of-equilibrium behavior and learning are the major focus of a great deal of work in this literature. Neoclassical equilibrium constructs take on a new life in the laboratory, where they are understood as descriptive benchmarks for convergence rather than expressions of individual rationality. Neoclassical theories of equilibrium become taxonomies of states of rest. In the lab, the focus returns to the processes of mistake-making, learning, and mutual understanding that lead toward or away from equilibrium and the institutional details that shape these processes. Laboratory experiments have in turn stimulated a great deal of interesting neoclassical theoretical work striving for deeper characterizations of out-of-equilibrium behavior. The parallels between this approach and traditional Austrian critiques of the place of equilibrium in neoclassical theory should be obvious. Experimental economics naturally incorporates these critiques and in the process serves as a method for learning about the character of disequilibrium processes and the realism (or in some cases unrealism) of neoclassical notions of equilibrium. We have tried to make the case that insights and evidence relevant to market process theory and consistent with praxeology can be found throughout the experimental literature. Although we are convinced that Austrian economics can proﬁt from consumption of experimental research, we suspect Austrian economics may gain more by becoming producers of experimental research. Experimental economics provides a forum for Austrian economists to evaluate and critique neoclassical theory. The lab allows for a unique intersection between NCT notions of equilibrium rationality and Austrian notions of subjective human action. Using it, NCT predictions can be, and frequently are, meaningfully reinterpreted as potential eventual achievements of agents learning through time. NCT models, in this light, become useful tools for identifying plan consistencies, with experimental work ﬁlling in the institutional and behavior factors governing the market process in relation to equilibrium. In circumstances where tractability concerns motivate NCT to impose toostringent restrictions on the problems being modeled, Austrian practitioners can adjust experimental designs to reﬂect their critiques. Smith’s original double auction experiment is an ideal example. Although competitive theory

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demands that agents have perfect knowledge of the economic environment, Smith implemented a competitive market in which this perfect knowledge assumption was done away with. His ﬁnding was that competitive equilibria were robust to the tractability assumptions placed on the neoclassical model. An ideal method for critiquing unrealistic features in the modeling of problems is to simply implement experiments in which these features are relaxed. As historic critics of NCT’s theoretical assumptions, Austrian economists might have a comparative advantage formulating and experimentally illustrating hypotheses about the importance of these assumptions. To close our review of experimental literature, we want to mention a few recent pieces of experimental research that have been conducted by selfidentiﬁed Austrian economists or that have focused explicitly on entrepreneurial discovery. Two recent experiments have focused on entrepreneurial discovery. First, Demmert and Klein (2003) conducted an interesting, though imperfectly executed, experiment explicitly studying whether proﬁts caused subjects to discover a counterintuitive method for accomplishing a task (involving moving water from one point to another in a ﬁeld). The study aimed to examine whether proﬁt motivation causes agents, as Kirzner conjectures, to unintentionally (i.e. nondeliberately) discover a superior method for accomplishing their task. The study concluded (based on questionnaires) that agents who discovered the counterintuitive method for solving the task were in fact engaging in deliberate search and that, as a result, the study failed to illustrate Kirznerian discovery. A second, and more successful, attempt to examine entrepreneurial discovery was made by Crockett, Smith, and Wilson (2009). Subjects interacted in a ‘‘virtual village’’ consisting of plots of land and houses. Each subject was given a plot of land where goods were produced and houses where goods were consumed. Subjects were able to choose to allocate their resources to produce two goods. After producing goods, subjects were allowed to drag goods from their land to their house and thereby consume the good. Subjects were given nonseparable preferences over consumption – that is they needed to ‘‘consume’’ both goods to make money. In addition to producing, subjects were allowed to communicate with one another via a chat room. Subjects were not told that the computer program assigned them different abilities to produce different goods and that there were therefore gains from specialization. Subjects were also unaware that, instead of dragging goods to their houses, they could drag their goods to the houses of other players. Therefore subjects could not discover how to specialize without discovering that they could trade. The institution of exchange itself had to be discovered

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and only by being discovered could subjects learn how to trade. In contrast to Demmert and Klein (2003), subjects had no reason to treat the experiment as a search task because the experimenters never implied the possibility that there was something to be discovered other than the best way to allocate productive energies. Crockett et al. (2009) found that agents frequently discovered exchange and in many cases learned to fully specialize. These discoveries often (though not always) were contagious, leading to exchange and specialization elsewhere in the virtual village. The authors subsequently engaged in research trying to understand factors that lead to the discovery of more complicated exchange institutions with the hope of eventually observing the endogenous development of complex markets. We discussed using experiments to learn about the process of discovery and the price system as suggested by Hayek earlier. Koppl et al. (2008) investigate the epistemic properties of forensic science discovery procedures. When courts rely on the opinion of a single expert (or lab) that may have their own bias, the court will be prone to making the wrong decisions by either under- or over-valuing the expert’s opinion. Koppl et al. create an experiment where there are senders of information, like forensic experts, and receivers who are like the courts. Receivers earn money by coming to the correct conclusion of the truth (in this case, one of three shapes). Senders earn money by either the receiver choosing the truth or by the receiver choosing the object that the sender has an induced bias toward. The experiment varies the returns to truth and bias for senders and also varies the number of senders for any one receiver. Koppl et al. unsurprisingly ﬁnd that when the returns to bias are higher, more false information is sent and more incorrect verdicts are made by receivers. Interestingly, they ﬁnd that by adding more senders it can result in senders sometimes sending even more false information, however, because of the greater information received by receivers they more often choose the truth. In studying the epistemic features of these various institutional arrangements Koppl et al. ﬁnd that although their laboratory study does not inform us of which particular expert judgments are correct and incorrect it can ‘‘tell us that the monopoly structure of forensics today produces a needlessly high error rate’’ (p. 155). This experiment illustrates how studying the discovery procedure in the laboratory can lead directly to recommendations for improving institutional arrangements in the real world to better facilitate discovery. Rothbard (1970) is one of the earliest examples of Austrian economists interested in the study of anarchism. Since his pioneering work, many other Austrians have taken up this research program studying both theoretic

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mechanisms for coordination without a state and historical work to document the voluntary institutions anarchic societies have used.2 Buchanan (1975) is critical of anarchy and assumes that in an institutionless state of nature there would be a Hobbesian war of all against all where life would be ‘‘nasty, brutish, and short.’’ However, humans have always had institutions for coordination even in anarchic situations. So there is no naturally occurring data to evaluate Buchanan’s predictions against. Powell and Wilson (2008) use the laboratory to create a real time Hobbesian jungle to measure the deadweight cost of predation and evaluate Buchanan’s claims. In their laboratory societies, each of the six individuals can choose how much, if any, of their productive endowment to invest in offense and/or defense. The subjects are not compartmentalized, exogenously or endogenously, as either pure producers or pure plunderers; they can choose the degree to which they wish to allocate productive units to offense and defense and can change these allocations throughout the experiment. Moreover, the experiment is conducted in continuous time (i.e., defensive decisions do not necessarily precede offensive ones, and offensive choices do not necessarily follow defensive decisions). There are no rounds in which subjects repeatedly face the same decisions. Actions can occur at any time. Each subject also has just one shot with their ‘‘life.’’ Since productive assets earn subjects money whereas offensive and defensive units do not, Powell and Wilson are able to examine the inefﬁciency of a Hobbesian jungle without external enforcement. Their laboratory jungles were neither utopian nor particularly brutish, and were 42.9 percent efﬁcient on average. Powell and Wilson’s experiment illustrates how ‘‘history’’ can be done in the lab to critique assumptions made by neoclassical theorists when there are no naturally occurring data to evaluate their claims against.

5. CONCLUSION There is no inherent methodological divide between experimental and Austrian economics and there are many potential gains from exchange. Experimental work is nothing else but controlled empirical analysis and for a praxeologist can easily take a place beside traditional empirics as a part of economic history. Even if one holds that certain conjectures about economic behavior lie beyond empirical veriﬁcation, experimental work can provide powerful, complementary empirical demonstrations of these conjectures. Moreover laboratory experiments can serve as an arena to study magnitudes, strategic problems and speciﬁc patterns of learning under

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various institutions, allowing Austrians and other economists to ask questions about economic life that lie outside of the scope of a prioristic theory. Experiments differ from traditional history work in at least three important ways. The ﬁrst and most obvious is that the institutional setting is not naturally occurring but is designed by the investigator. For experiments to have relevance for the naturally occurring world experimental institutional environments cannot abstract from factors that are important for subjects in the naturally occurring world. Second, investigators have more control and knowledge of important parameters and counterfactuals to evaluate experimental results against so they can better understand how economic behavior and discovery processes work. Finally, because of the prior two features, experiments are replicable, unlike historic moments in the naturally occurring world. This allows experimentalists to more directly investigate the robustness of their ﬁndings. Although we believe experimental economics falls in the realm of what praxeologists call history, we do not believe that it is simply ‘‘a history of lab results.’’ We believe that in many cases these lab results have direct relevance for our understanding of the naturally occurring world. The strong and rapid tendency toward a known equilibrium in experimental settings should strengthen conﬁdence in the market’s ability to discover the unknown efﬁciently and give us a more subtle understanding of the countervailing forces that impede such discovery. The same is true for other experimental results. In short, we learn from experimental history in the same manner as we learn from naturally occurring history. Which form of history is most appropriate to use will depend on the topic being investigated but Austrians should not be biased against experimental methods. Our aim in this chapter is not to convince Austrians to abandon their interest in a prioristic theory, but rather to convince them that experimental economics is a useful branch of empirics. Experimental economics is a tool by which praxeologists can ask detailed questions about the nature of market processes that are inaccessible to deductive reasoning alone. As such we believe that experimental economics has a place for Austrians alongside the traditional practice of economic history.

NOTES 1. As a reviewer noted, QRE models provide an interesting and consistent ex post explanation for deviations from Nash play but do not, in and of themselves, offer proof of the source of deviations from Nash equilibrium.

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2. See Powell and Stringham (2009) for a survey of the vast economics literature on anarchism. Although they focus on how anarchism ﬁts into the public choice research program, the survey summarizes much work done by Austrian economists.

ACKNOWLEDGMENT We thank Jonathan Haughton, an anonymous referee and the participants at the Wirth Institute conference on ‘‘What is so Austrian about Austrian Economics’’ in Toronto for helpful comments on an earlier version of this chapter.

REFERENCES Anderson, W. (2002). Two cheers for the 2002 nobel laureates. Available at http://mises.org/ story/1067. Retrieved on October 10. Buchanan, J. (1975). The limits of liberty: Between Anarchy and Leviathan. Chicago: University of Chicago Press. Camerer, C. (2003). Behavioral game theory: Experiments in strategic interaction. Princeton, NJ: Princeton University Press. Crockett, S., Smith, V. L., & Wilson, B. J. (2009). Exchange and specialisation as a discovery process. Economic Journal, 119, 1162–1188. Demmert, H., & Klein, D. (2003). Experiment on entrepreneurial discovery: An attempt to demonstrate the conjecture of Hayek and Kirzner. Journal of Economic Behavior and Organization, 50, 295–310. Hayek, F. A. (1935 [1948]). Socialist calculation I: The nature and history of the problem. Reprinted in Hayek, Individualism and Economic Order. Chicago, IL: University of Chicago Press. Hayek, F. A. (1968). Competition as a discovery procedure. In: F. A. Hayek (Ed.), New studies in philosophy, politics, economics and the history of ideas (pp. 179–190). Chicago, IL: University of Chicago Press. Kirzner, I. (1973). Competition and entrepreneurship. Chicago, IL: University of Chicago Press. Koppl, R., Kurzban, R., & Kobilinsky, L. (2008). Epistemics for forensics. Journal of Social Epistemology, 5(2), 141–159. McKelvey, R., & Palfrey, T. (1995). Quantal response equilibria for normal form games. Games and Economic Behavior, 7, 6–38. Mises, L. Von. (1949 [1998]). Human action. Auburn, AL: Ludwig Von Mises Institute. Plott, C., & Smith, V. (2008). The handbook of experimental economics results. New York: Elsevier Press. Plott, C., & Sunder, S. (1988). Rational expectations and the aggregation of diverse information in laboratory security markets. Econometrica, 56, 1085–1118. Powell, B., & Stringham, E. (2009). Anarchism as a public choice research program: A survey. Public Choice, 140(3–4), 503–538. Powell, B., & Wilson, B. (2008). An experimental investigation of Hobbesian jungles. Journal of Economic Behavior and Organization, 66(3–4), 669–686.

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Rothbard, M. (1970, 1977). Power and market. Kansas City: Sheed Andrews and McMeel. Shostak, F. (2002). Behavioral, experimental, and Austrian economics. Available at http:// mises.org/story/1082. Retrieved on October 27. Smith, V. (1962). An experimental study of competitive market behavior. Journal of Political Economy, 70, 111–137. Smith, V. (1976). Experimental economics: Induced value theory. American Economic Review, 66, 274–279. Smith, V. (1999). Reﬂections on human action after 50 years. Cato Journal, 9(2), 195–209. Smith, V. (2005). Hayek and experimental economics. Review of Austrian Economics, 18(2), 135–144. Smith, V., Suchanek, G., & Williams, A. (1988). Bubbles, crashes and endogenous expectations in experimental spot asset markets. Econometrica, 56, 1119–1151. Williams, A., Smith, V., Ledyard, J., & Gjerstad, S. (2000). Concurrent trading in two experimental markets with demand interdependence. Economic Theory, 16, 511–528.

HOW COMPLEX ARE THE AUSTRIANS? J. Barkley Rosser Jr. INTRODUCTION Roger Koppl (2009, p. 1) argues that ‘‘Austrian economics is a school of thought within the broader complexity movement in economics.’’ Is he correct? Although there are many who have argued for some overlapping between the two, I shall argue that this is probably an overly strong statement. The main reason is that there are substantial elements and strands within Austrian economics that do not ﬁt in with any of the multiple varieties of complexity theory, even though there are some that clearly do. Although I have some disagreements with Koppl’s argument, I think that he does a good job of identifying some of the main strands of Austrian economics that are consistent with complexity thought. The most important of these are associated with the work of Friedrich A. Hayek, who was openly and actively interested in complexity ideas, especially later in his career as documented by Bruce Caldwell (2004, Chap. 14) as well as by others (Lavoie, 1989; Vaughn, 1999; Rosser, 1999; Koppl, 2000; Vriend, 2002; Gaus, 2006), with Hayek actually authoring an essay entitled ‘‘The theory of complex phenomena’’ (Hayek, 1967a). In addition to Hayek, Koppl also sees Carl Menger (1981 [1871]) as a predecessor of the spontaneous order idea that he and others identify as being in accord with complexity ideas. Koppl (2006, 2009) also identiﬁes as consistent with both Austrian economics and

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complexity, ‘‘BRICE,’’ that is, bounded rationality, rule following, institutionalism, cognition, and evolution, a list I discussed further below. I make two broad arguments regarding Koppl’s thesis. On the one hand, he ignores the substantial vein of Austrian thought that is not consistent with complexity. The central idea of this vein is acceptance of the equilibrium approach, and it must be kept in mind that for most of his career, even Hayek remained loyal to this approach, although he would deviate from it at very end of his life, supporting Caldwell’s argument regarding the ultimate direction of ‘‘Hayek’s journey’’ (Hayek, 1981a; Witt, 1999).1 This ﬁts in with the idea sometimes argued that Hayek made a ‘‘U-turn’’ in his thinking in the mid-1930s. I do not wish to weigh in independently on this subject, but defer to Caldwell who seems to lean more to the view that while there was clearly a change in Hayek’s views over time, it was probably more gradual than some have argued.2 In any case, Hayek (1952) certainly was more conventional and less ‘‘complex’’ in his earlier economics writings, although his parallel thoughts on psychology dating from his experiences in World War I already bore the seeds of his later complexity views, with his The Sensory Order laying these ideas out more fully. On the other hand, while Koppl ignores this noncomplex vein very visible in much of Austrian thought, if becoming less popular within it over time, he also curiously ignores another strand of Austrian thought that can be argued to ﬁt in with the complexity perspective, namely awareness of the deeply rooted presence of fundamental uncertainty in economics. Admittedly this strand comes from ﬁgures somewhat more on the fringes of Austrian economics, notably G.L.S. Shackle (1973) and Ludwig Lachmann (1976). This idea clearly overlaps with Post Keynesian ideas (Rosser, 2006), and it is a bit surprising that Koppl does not recognize this strand in Austrian economics, given that in regard to the concept of computational complexity that he sees inhering in Hayek’s work he has been willing to see links with ideas in the Post Keynesian tradition as well (Koppl & Rosser, 2002).

VARIETIES OF COMPLEXITY This is a well-worn topic, nevertheless a brief excursus will be useful for categorizing the various ways in which Austrian economics overlaps with the idea of complexity, given that Seth Lloyd has listed as many as 45 different varieties of complexity (Horgan, 1997, p. 303). Rosser (2009a) provides a current classiﬁcation based on Lloyd’s and others’ views on the matter. At the most precise level we can identify what could be labeled ‘‘Santa Fe

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complexity,’’ or what Rosser (1999) labeled ‘‘small tent [dynamic] complexity.’’ This is called by others agent-based or heterogeneous interacting agents complexity, and models the economy, usually using computer simulations, as a system of locally interacting agents with no central controller, little tendency to global equilibrium, and continually evolving dynamics.3 Many phenomena such as spontaneous order and emergence can be observed with this form of complexity. Among the earliest examples of a model exhibiting this sort of complexity was that of urban segregation due to Schelling (1971), who studied this model by playing on a chess board, without any computers involved. He showed that in an initially integrated city with agents paying attention to their neighbors, introducing only the slightest preferences for one kind of neighbor over another would over time lead to a racially segregated city, a result viewed as one of emergence or spontaneous order. One level up is dynamic complexity, which Rosser (1999) deﬁnes, following Richard Day (1994), as a system that does not endogenously converge on a point, a limit cycle, or a smooth explosion or implosion. This ‘‘broad tent [dynamic] complexity’’ includes the one just described along with its earlier fellow ‘‘4C’s,’’ as mockingly labeled by Horgan (1997). The others are cybernetics, catastrophe theory, and chaos theory. Although the latter two4 have had little link with most of Austrian economics (aside from Lavoie using ‘‘chaos’’ in the title of his 1989 paper),5 much of Hayek’s investigations of complexity involved cybernetics (Wiener, 1948) and its close relative, general systems theory (von Bertalanffy, 1962), with a strong inﬂuence from Warren Weaver (1948) as well. Broadly speaking, the source of the endogenous irregularities in these sorts of mathematical models that lead to dynamically complex irregularities depend on nonlinear dynamics within these systems. Not all nonlinear systems are complex, but when nonlinear effects become sufﬁciently great, then such dynamics can occur, often associated with some destabilization of a previously existing equilibrium state. Thus, cybernetics focuses on the nature of feedbacks in systems. When these are negative, then systems tend to be stable, to return to a previous state after an exogenous shock. However, when feedbacks are positive, then a system tends to move even further away from its initial state after the feedbacks add to the shock, and if these are sufﬁciently strong, the system can destabilize entirely. Within economics, increasing returns have long been known to be a source of such potentially destabilizing positive feedback effects (Arthur, 1994). Finally, we have the broadest category, meta-complexity, which includes the full array of deﬁnitions provided by Lloyd, as well as others provided by

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other people. Probably most important among these in terms of links to Hayek’s work, at least in the eyes of Koppl (2008, 2009), is computational complexity, with deep development of this idea due to Velupillai (2005).6 Although there are great debates over which of these various views and deﬁnitions are most useful or most legitimate, we shall not concern ourselves further with such matters, conﬁning ourselves to how they relate to various parts of Austrian economics. Regarding where Hayek would ﬁt in with this taxonomy of complexities, it would appear that actually he has at least a potential presence at all of these levels. Thus, his emphasis on the dispersed nature of tacit economic knowledge and the self-organizing nature of markets through localized interactions of economic agents is very consistent with the lowest level, the agent-based modeling level. His long interest in and afﬁliation with cybernetics puts him into the second level. Finally, his understanding of how the limits of human awareness and consciousness have links with Go¨del incompleteness through diagonal proofs ties him up with the problems studied in computational complexity and halting problems and the limits of computability (Koppl & Rosser, 2002).

AUSTRIAN COMPLEXITY ACCORDING TO KOPPL Koppl (2009) presents a set of ways in which he sees complexity ideas appearing in Austrian economics. The earliest, and possibly the most widely recognized and important, is the question of the spontaneous emergence of order. He sees this as appearing initially in Menger’s work, with Menger in this regard ultimately inspired by the Scottish Enlightenment of David Hume and Adam Smith. There is no central controller in the economy bringing about its order, but rather the working of the invisible hand. A more speciﬁc example of this in Menger (1892) is his discussion of the spontaneous historical emergence in ancient societies of money for transactions purposes. Hayek (1948a) stressed this precise argument, although it appears in an earlier form in his work that some see as the key to his supposed ‘‘U-turn,’’ his ‘‘Economics and knowledge’’ (Hayek, 1948b), originally written in 1937. In this work, inspired by the socialist calculation debate, Hayek stressed the reality of how knowledge is dispersed among agents in the economy, and how, nevertheless, market order emerges from the interaction of these agents in this dispersed system. Both Lavoie (1989) and Vriend (2002) emphasize this issue as central to Hayek’s complexity viewpoint, as do Caldwell (2004)

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and Gaus (2006). Although Hayek basically developed this idea with little direct input from complexity theorists, it would appear that this idea was what most strongly motivated his study of cybernetics and general systems theory, which provided models of autopoetically self-sustaining systems and anagenetic emergence of order. In a famous passage in ‘‘The theory of complex phenomena’’ Hayek (1967a, p. 26) directly poses the idea of the emergence of new patterns. The ‘emergence’ of ‘new’ patterns as a result of the increase in the number of elements between which simple relations exist, means that this larger structure as a whole will possess certain general or abstract features which will recur independently of the particular values of the individual data, so long as the general structure (e.g., by an algebraic equation) is preserved.7

Another argument stressed by Koppl, but by few other Austrians, involves the idea of computational limits to knowledge, implying bounds to rationality and the need for policy makers to be humble and proceed with caution. This idea links to ideas of computational complexity, and Koppl (2008, 2009), along with Koppl and Rosser (2002) see this ultimately inspired by his work on psychology (Hayek, 1952, pp. 185–190), and expressed again strongly in his essay on complex phenomena (1964). The mind operates as a rule-following classiﬁer system. However, as such it is subject to the laws of logic, and among those laws are the theorems of Kurt Go¨del that imply incompleteness of logical systems. This incompleteness is deeply tied to selfreferencing by systems, and Hayek in particular cited the diagonal proof method to argue that the mind cannot know itself, which can be extended to the idea that no agent or model of the economy can fully know the economy (Koppl & Rosser, 2002). This then provides a computational foundation for bounds on rationality. As Hayek put it in The Sensory Order (1952, pp. 188–189, 8.80). Applying the same general principles to the human brain as an apparatus of classiﬁcation it would appear to mean that, even though we may understand its modus operandi in general terms, or, in other words, possess an explanation of the principle on which it operates, we shall never, by any means of the same brain, be able to arrive at a detailed explanation of its working in particular circumstances, or be able to predict what the results of its operations will be. To achieve this would be to require a brain of a higher order of complexity, though it might be built on the same general principles. Such a brain might be able to explain what happens in our brain, but it would in turn be unable fully to explain its own operations, and so on.

Drawing also on ideas expressed in The Sensory Order (p. 192), Koppl also argues that Hayek advocated the importance of verstehende psychology, with this implying the superiority of a moderately hermeneutic

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approach to economic analysis (Koppl & Whitman, 2004). He further argues that this is linked to complexity, as well as to views of Lachmann, although I confess that I am not sure which of the many views of complexity this view links to precisely, although asking precision of hermeneutics may be an unfair demand. Koppl (2006, 2009) summarizes his view of complexity and Austrian economics with his BRICE acronym: bounded rationality, rule following, institutions, cognition, and evolution, seeing essentially all of these as implied by Hayek’s work in particular. Thus, as already discussed, bounded rationality is implied by the limits of knowledge due to logical and computational limits to self-awareness both in individuals and in the broader economy. Rule following is how Hayek sees our minds operating and agents operating in the economy. In my view this is perhaps the weakest of these ﬁve elements in terms of its ability to generate complexity. Certainly there are plenty of systems that are based on rule-following that are not particularly complex by any deﬁnition. But if the rules connect up with generating positive feedback loops or enhance local interactions in a heterogenous agent-based systems, they may lead to complex outcomes. Certainly for Hayek the rules that drive thought can lead to complexities. Vernon Smith (2010) has argued that for Adam Smith, the fundamental deﬁnition of fairness depended on rules, and that these rules could lead to the spontaneous emergence of order in markets. Institutions are seen as key, again in Hayek, with his later emphasis on evolution of institutions central. Although this is correct, it must be kept in mind that more generally there was a historical conﬂict between institutionalism and Austrian economics, going back to that between Menger and the predecessors of the institutionalists in the German Historical School, led by Gustav von Schmoller in the Methodenstreit (Caldwell, 2004, Chap. 3). Even though Hayek studied brieﬂy with Wesley Clair Mitchell, most American institutionalists of the 20th century were not very sympathetic to Austrian economics. Cognition clearly relates again to Hayek’s views of pattern formation in the mind in his psychological theory. Such pattern formation out of perceptions can be seen as another example of the spontaneous emergence of order in the complex system of the mind, although it is less clear how this relates to economics except perhaps through bounded rationality. Indeed, to the extent that such perceived patterns represent ‘‘real truth’’ (as a subjectivist approach would assert), this may offer a way around the

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bounds on rationality. Of course, from a perspective that is not purely subjectivist, the patterns remain bounded in terms of knowledge of certain aspects of objective reality, such as of the future. Finally there is the matter of evolution, with Koppl mostly stressing how in his later years Hayek deeply studied the evolution of institutions. It is unequivocal that Hayek saw evolution as deeply linked to complexity, as this quotation from ‘‘The theory of complex phenomena’’ indicates (1967a, p. 31): Probably the best illustration of a theory of complex phenomena which is of great value, although it describes merely a general pattern whose detail we can never ﬁll in, is the Darwinian theory of evolution by natural selection.

Caldwell (2004, chap. 16) notes the peculiar paradox that eventually appeared as Hayek would come to advocate group selection of institutions over time, which contrasts with his usual assertion of methodological individualism, although Caldwell argues that throughout his career Hayek was never as wedded to this idea as many think. A curious aspect arises here in that at the end Koppl mentions brieﬂy Israel Kirzner (1973) and his arguments, drawing on work of Ludwig von Mises (1966), for the important role of entrepreneurs in driving the evolutionary process of the economy, including the process of technological change, an idea traceable back to Friedrich von Wieser (1884). Complexity can arise in many ways in this process, including through such phenomena as path dependence and technological lock-in as argued by Arthur (1989). Although Koppl did not develop it much, many (Hodgson, 2006) argue that evolution is the centerpiece of the complexity view, in this not too far off from Hayek’s view. A loose end here that potentially links to Post Keynesian economics and complexity is the idea of radical uncertainty (Rosser, 2006), which was stressed by both Shackle (1973) and Lachmann (1976). Both dynamic and computational complexity imply such ultimate uncertainty, although few Austrians play this idea up as much as do some of the Post Keynesians (Davidson, 1994). There may also ultimately be differences in the source of such uncertainty between the two schools, with most Austrians relying on the same sort of computational arguments that underlie their view of the limits of knowledge and rationality, whereas Davidson at least argues that such uncertainty is more profoundly ontological and axiomatic, arguing that this was Keynes’ view.

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THE NONCOMPLEXITY TRADITION IN AUSTRIAN ECONOMICS We have seen so far that even if it was not always well-deﬁned or focused, there have been elements and followers of the Austrian School whose work can be viewed as being consistent with a complexity perspective, especially Hayek in his later years, who followed to some degree the School’s founder, Carl Menger. But what then of the other members of the School, and was there (is there) a noncomplexity tradition among Austrian economists? The answer is certainly yes. The theme in Austrian economics that most clearly stands against this complexity perspective is the emphasis on marginalism and equilibrium. Thus, it must be remembered that in the Methodenstreit, it was the Austrians who upheld the nascent neoclassical orthodoxy of marginalist equilibrium theory against the proto-institutionalism and opposition to abstract theory articulated by von Schmoller (1978 [1900–1904]) and the followers of the German Historical School.8 Menger himself is generally listed with Jevons and Walras as the German-speaking of the three putative discoverers of marginal utility and how it can be used to solve the paradox of value, although Menger was somewhat different from the other two in his relative dislike of mathematics and was arguably closer in approach in some ways to von Schmoller than to Jevons or Walras.9 Thus, Menger was a complicated ﬁgure in this matter, exhibiting a tendency toward complexity in his invocation of evolution and the emergence of spontaneous orders, even while he defended abstract theorizing and marginalism against the historical approach. This more orthodox strand would be further emphasized by his immediate followers, the second wave of Austrian economists: Eugen von Bo¨hm-Bawerk and Friedrich von Wieser. Although as noted, Wieser would to some extent favor a dynamic approach in his view of entrepreneurs and technological change, both of these ﬁgures would more clearly stress the importance of marginalism, even if with an emphasis on subjective marginal utility over supply-side aspects such as marginal cost, and more importantly the idea of economic equilibrium and its link to determining value in conjunction with marginalism (von Bo¨hm-Bawerk, 1891; von Wieser, 1893), in short, an even more strongly orthodox neoclassicism than exhibited by Menger. The more famous of the two, Bo¨hm-Bawerk, would particularly support a very orthodox approach with essentially no hint of complexity, arguably the extreme opposite of Hayek in this regard, within the Austrian tradition. He would develop the idea of the average period of production as the independent measure of the value of capital, which he then used along with

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the subjectivist view of marginal utility as a battering ram to criticize the Marxian model (von Bo¨hm-Bawerk, 1975 [1898]), thus establishing this theme in Austrian economics that would be taken up later by von Mises and Hayek in the socialist calculation debate. But in contrast to them, especially Hayek, he did so essentially from within the conﬁnes of neoclassical orthodoxy with nary a whiff of a complexity perspective, Marx being the anti-equilibrium, complexity economist by contrast with Bo¨hm-Bawerk, who was also much more famous in his day than either Menger or Wieser. It would take a long time and a lot of effort to overcome this deeply rooted neoclassicism emphasized and enforced by Bo¨hm-Bawerk. Of the ideas involved here, probably adherence to the equilibrium approach was the greater obstacle to adopting a complexity perspective than was the subjectivist emphasis on the importance of marginal utility, although for von Mises the subjectivism of this would become tied up with a rationalistic a priorism that also inhibited a more dynamic approach compatible with the complexity perspective. von Mises emphasized the equilibrium approach, which would also have this rationalistic foundation. Thus, in the socialist calculation debate he strongly emphasized the inability of the socialist planner to calculate prices that would reﬂect the rationality of a market equilibrium, determined by the actions of proﬁt-seeking owners of factors of production such as land and capital (von Mises, 1981, chap. 6). Although Hayek would agree with this, he would emphasize more the problem of dispersed information, which, as we have seen argued earlier would lead him away from the more orthodox position on to his journey toward complexity. Nevertheless, von Mises was not fully wedded to the equilibrium approach, invoking static equilibrium as a useful concept, but ultimately emphasizing the importance of dynamic processes of entrepreneurs pursuing proﬁts and generating prices in doing so, with the system constantly changing and moving on, never settling down to any static equilibrium, a view that would strongly inﬂuence his followers, Kirzner and Lachmann. Thus he declares that To assume stationary economic conditions is a theoretical expedient and not an attempt to describe reality. (von Mises, 1981, p. 142)10

He goes on to declare that capitalist market processes involve a constant dynamic, and that it is socialism that seeks a stationary state, which is part of the fundamental problem with it as a system. Indeed, arguably the ultimate source of economic stagnation in actually existing command planned socialist economies was not their static microeconomic inefﬁciency, but the lack of technological dynamism and tendency to adhere to a

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stationary condition. von Mises repeatedly emphasizes the uncertain nature of the future and necessity for dynamic ‘‘speculators’’ to constantly bring forth new innovations to keep the economy moving and evolving. In this regard, as von Mises emphasizes the dynamic over the static, he becomes more of a complexity economist. We are now at the point of confronting that old bugaboo among Austrian economists of the split between von Mises and his follower, Hayek, which is tied up with this matter of Hayek moving away from a more conventional, noncomplexity approach toward the complexity perspective. We have noted earlier that according to Caldwell, it was Hayek’s essay ﬁrst written in 1937 on ‘‘Economics and knowledge’’ that ﬁrst moved him away from the conventional view, even though his psychology side had harbored some of these thoughts for nearly 20 years.11 Caldwell (2004, chap. 10) goes further to argue that this essay was speciﬁcally written as a criticism of the a priorism of von Mises, although it was so mutedly so that few observers realized this, and that Hayek covered this aspect over by his maintaining a personally diplomatic relationship with von Mises as long as the latter was alive. It would only be after von Mises’ death in writing the Foreword to the 1981 edition of von Mises’ Socialism that Hayek would more openly express his criticism in a famous passage (Hayek, 1981b, pp. xxiii–xxiv). I had always felt a little uneasy about that statement of his basic philosophy, but only now can I articulate why I was uncomfortable with it. Mises asserts in this passage that liberalism ‘‘regards all social cooperation as an emanation of rationally recognized utility, in which all power is based on public opinion, and can undertake no course of action that would hinder the free decision of thinking men.’’ [p. 418 of von Mises, 1981] It is the ﬁrst part of this statement only which I now think is wrong. The extreme rationalism of this passage, which as a child of his time he could not escape from, and which he perhaps never fully abandoned, now seems to me factually mistaken. It certainly was not rational insight into its general beneﬁts that led to spreading of the market economy.

This throws us back to the question of the evolution of Hayek’s views from being a faithful follower of von Mises to the apostate student of complexity. In his early economic writings such as Prices and Production (1967b [1935]), Hayek clearly followed in the mold of not only von Mises, but his predecessor, Bo¨hm-Bawerk, as well. Analysis focuses on static equilibrium states, even if intertemporal equilibria are allowed. The value of capital is given by average period of production, and indeed Hayek’s macroeconomic theory that was posed against the Keynesian model emphasized deviations from the natural rate of interest associated with the equilibrium average period of production as the source of business cycle ﬂuctuations.

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However, starting with ‘‘Economics and knowledge,’’ Hayek became aware that in a world of dispersed information there may be an aggregation problem. He continued to accept the idea of equilibrium for the individual, but came to feel that this did not necessarily imply or correspond with equilibrium in the aggregate. This would set him off on his most frustrating project, and would lead to his least-read book by his fellow Austrian economists, The Pure Theory of Capital (1941). Although in effect struggling to reconcile micro with macro equilibrium in a world of heterogeneous capital he would give up the doctrine of the average period of production as the measure of the value of capital, recognizing in effect some of the problems later raised in the Cambridge controversies in the theory of capital. The book’s frustrating conclusions reﬂect the mire Hayek felt himself in as his older, more conventional view clashed unresolvedly with his newer, more complexity-oriented view. Nevertheless, Hayek held on to the idea of equilibrium for most of his life and career, only ﬁnally abandoning it in 1981 in his not widely known essay on ‘‘The ﬂow of goods and services’’ (Hayek, 1981a, p. 8). It is tempting to describe as an ‘equilibrium’ an ideal state of affairs in which the intentions of all participants precisely match and each will ﬁnd a partner willing to enter into the intended transaction. But because for all capitalistic production there must exist a considerable interval of time between the beginning of a process and its various later stages, the achievement of an equilibrium is strictly impossible. Indeed, in the literal sense, a stream can never be in equilibrium, because it is disequilibrium which keeps it ﬂowing and determining its directions. Even an apparent momentary state of balance in which everybody succeeds in selling or buying what he intended may be inherently unrepeatable, irrespective of any change in the external data, because some of the constituents of the stream will be the results of past conditions which have changed long ago.

Ironically, in the end, it may well have been that Hayek was the deeper believer in equilibrium than was von Mises, holding on to the notion until very late in life, whereas von Mises in many ways abandoned it for his more dynamic and process-oriented approach, although it continued to haunt the a prioristic part of his weltanschauung.

CONCLUSION In the end we must conclude that Austrian economics is only partly compatible with the complexity perspective. Deep roots, perhaps most ﬁrmly associated with Bo¨hm-Bawerk, are essentially fully conventionally neoclassical, albeit more strongly oriented toward a subjectivist perspective. However, the subjectivist perspective is not inherently a complexity perspective, even if it

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can be compatible with it. This tradition, especially that part emphasizing the equilibrium approach, is not part of the complexity perspective. However, there has also been from its beginnings with Carl Menger, a vein within Austrian economics that has emphasized the spontaneous emergence of social orders out of dispersed processes. This view would culminate in the work of Hayek, who began with the more conventional approach, but inﬂuenced strongly by his studies of psychology and his consideration of the problems of dispersed knowledge, would move toward a complexity approach and would consciously pursue this perspective, including actively contacting many important individuals involved in its early development. Owing largely to his inﬂuence, today, Austrian economics is much more oriented toward a complexity approach.

NOTES 1. Hayek’s 1981 address in English would be published in 1984 in German. 2. At opposite extremes are Hutchison (1992) who argues for an abrupt change in Hayek’s views in the 1930s versus Birner (1994) who sees full continuity of Hayek’s views throughout his career, with Caldwell somewhere between their positions. 3. This is precisely the form of complexity that Vriend (2002) is thinking of when he discusses Hayek. 4. See Rosser (2000, chap. 2) for a more thorough discussion of the mathematics of catastrophe theory and chaos theory. 5. The situation is a bit more complicated in that as reported by Rosser (1999), based on discussions with Peter M. Allen and Hermann Haken, Hayek was in communication at various periods of time with the researchers in the Prigogine group at the Free University of Brussels as well as those at the Stuttgart Institute of Theoretical Physics. Researchers in both of these groups arguably span all four of the C’s from cybernetics/general systems theory up to agent-based models, and including the intermediate catastrophe and chaos theories, although it remains the case that Hayek seems to have not been much interested in those intermediate forms of dynamic complexity. (The conversation with Allen occurred in Beijing, China in October, 1994, and the one with Haken in Beer-Sheva, Israel, October, 1997.) 6. Rosser (2009b) provides an overview of the debate between these competing views of complexity. 7. Curiously this much-quoted passage is footnoted to a brief discussion of the British school of ‘‘emergentism,’’ associated with C. Lloyd Morgan (1933), which would later be denounced by reductionist scientists. The emergentists saw the basis of their ideas in the ‘‘heteropathic laws’’ posited originally by John Stuart Mill (1843), also cited by Hayek at this point. It can be argued that this emergentist view was consistent with the organicism opposed by Menger in favor of atomistic individualism. 8. Caldwell (2004, p. 80) argues that the term ‘‘Austrian economics’’ was originally a term of derision applied by members of the German Historical School to the Austrians during the Methodenstreit.

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9. Streissler (2001) has argued that rather than being a founder of marginalism, Menger was actually the culmination of a proto-neoclassical school that had been operating in Germany since the late 1830s, and had incorporated marginal utility and even had innovated the use of supply and demand curves with price on the vertical axis as early as 1841 by Karl Heinrich Rau, with Marshall later taking this idea from them. This school was a product of the period in Germany before the Bismarckian uniﬁcation in 1871, when these ﬁgures would be identiﬁed with small regions in Germany, only to be swept away and dominated by the German Historical School approach coming out of Berlin that was identiﬁed with the newly uniﬁed Germany. In that regard, the epithet of ‘‘Austrian’’ applied to them by the Germans had a political aspect of their being outside the political jurisdiction and control by von Schmoller and his allies. Menger was especially inﬂuenced by Roscher from this group, to whom he dedicated his Principles book. 10. I thank an anonymous referee for pointing out this quote and the related argument. 11. Caldwell (2004, pp. 138–139) reports that Hayek nearly majored in psychology rather than economics, his interest in the two being so even, with the better prospect for employment in economics being the ultimate deciding factor in his decision to pursue economics primarily.

ACKNOWLEDGMENTS I thank Angelina Christie and Robert Subrick for providing useful materials and Bruce Caldwell, Roger Koppl, and participants in the conference on ‘‘How Austrian are the Austrian Economists?’’ held at the University of Toronto, October 17–18, 2008, as well as an anonymous referee for useful discussions. The usual caveat holds.

REFERENCES Arthur, W. B. (1989). Competing technologies, increasing returns, and lock-in by historical events. Economic Journal, 99, 116–131. Arthur, W. B. (1994). Increasing returns and path dependence in the economy. Ann Arbor, MI: University of Michigan Press. Birner, J. (1994). Introduction: Hayek’s grand research programme. In: J. Birner & R. van Zijp (Eds), Hayek, coordination, and evolution: His legacy in philosophy, politics, economics, and the history of ideas (pp. 1–21). London: Routledge. Caldwell, B. (2004). Hayek’s challenge: An intellectual biography of F.A. Hayek. Chicago: University of Chicago Press. Davidson, P. (1994). Post Keynesian macroeconomic theory. Aldershot: Edward Elgar. Day, R. H. (1994). Complex economic dynamics, Volume I: An introduction to dynamical systems and market mechanisms. Cambridge: MIT Press.

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Gaus, G. F. (2006). Hayek on the evolution of society and mind. In: E. Feser (Ed.), The Cambridge companion to Hayek (pp. 232–258). Cambridge: Cambridge University Press. Hayek, F. A. (1941). The pure theory of capital. Chicago: University of Chicago Press. Hayek, F. A. (1948a). Individualism and economic order. Chicago: University of Chicago Press. Hayek, F. A. (1948b [1937]). Economics and knowledge. In: Individualism and economic order (pp. 33–56). Chicago: University of Chicago Press. Hayek, F. A. (1952). The sensory order: An inquiry into the foundations of theoretical psychology. Chicago: University of Chicago Press. Hayek, F. A. (1967a). The theory of complex phenomena. In: Studies in philosophy, politics, and economics (pp. 22–42). Chicago: University of Chicago Press (original shorter version published in 1964). Hayek, F. A. (1967b [1935]). Prices and production (2nd edn). New York: Kelley. Hayek, F. A. (1981a). The ﬂow of goods and services. Address to the London School of Economics, January 27 (published in German, 1984, ‘‘Der strom und der gu¨ter und leistungen.’’ Tu¨bingen: Mohr (Siebeck)). Hayek, F. A. (1981b). ‘‘Foreword’’ to Socialism by Ludwig von Mises. Indianapolis: Liberty Fund. Hodgson, G. M. (2006). Essays in the shadows of Darwin and Marx: Notes on institutional and evolutionary themes. Cheltenham: Edward Elgar. Horgan, J. (1997). The end of science: Facing the limits of knowledge in the twilight of the scientiﬁc age (Paperback edition). New York: Broadway Books. Hutchison, T. W. (1992). Hayek and ‘modern Austrian’ methodology: Comment on a nonrefuting refutation. Research in the History of Economic Thought and Methodology, 10, 17–32. Kirzner, I. M. (1973). Competition and entrepreneurship. Chicago: University of Chicago Press. Koppl, R. (2000). Policy implications of complexity: An Austrian perspective. In: D. Colander (Ed.), The complexity vision and the teaching of economics (pp. 97–117). Cheltenham: Edward Elgar. Koppl, R. (2006). Austrian economics at the cutting edge. Review of Austrian Economics, 19, 231–241. Koppl, R. (2008). Thinking impossible things: A review essay. Journal of Economic Behavior and Organization, 66, 837–847. Koppl, R. (2009). Complexity and Austrian economics. In: J. B. Rosser, Jr. (Ed.), Handbook of complexity research. Cheltenham: Edward Elgar. Koppl, R., & Rosser, J. B., Jr. (2002). All that I have to say has already crossed your mind. Metroeconomica, 53, 339–360. Koppl, R., & Whitman, D. G. (2004). Rational choice hermeneutics. Journal of Economic Behavior and Organization, 55, 295–317. Lachmann, L. (1976). From Mises to shackle: An essay on Austrian economics and the kaleidic society. Journal of Economic Literature, 14, 54–62. Lavoie, D. (1989). Economic chaos or spontaneous order: Implications for political economy of the new view of science. Cato Journal, 8, 613–635. Lloyd Morgan, C. (1933). The emergence of novelty. London: Williams and Norgate. Menger, C. (1892). On the origin of money. Economic Journal, 2, 239–255. Menger, C. (1981 [1871]). Principles of economics. J. Dingwell & B. F. Hoselitz (Trans.). New York: New York University Press. Mill, J. S. (1843). A system of logic: Ratiocinative and inductive. London: Longmans Green.

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Rosser, J. B., Jr. (1999). On the complexities of complex economic dynamics. Journal of Economic Perspectives, 13(4), 169–192. Rosser, J. B., Jr. (2000). From catastrophe to chaos: A general theory of economic discontinuities, Vol. I: Mathematics, Microeconomics, Macroeconomics, and Finance (2nd ed.). Boston: Kluwer. Rosser, J. B., Jr. (2006). Complex dynamics and post Keynesian economics. In: M. Setterﬁeld (Ed.), Complexity, endogenous money and macroeconomics: Essays in honour of Basil J. Moore (pp. 74–98). Cheltenham: Edward Elgar. Rosser, J. B., Jr. (2009a). Introduction. In: J. B. Rosser, Jr. (Ed.), Handbook of research on complexity (pp. 3–11). Cheltenham: Edward Elgar. Rosser, J. B., Jr. (2009b). Computational and dynamic complexity in economics. In: J. B. Rosser, Jr. (Ed.), Handbook of research on complexity (pp. 22–35). Cheltenham: Edward Elgar. Schelling, T. C. (1971). Dynamic models of segregation. Journal of Mathematical Sociology, 1, 143–186. Shackle, G. L. S. (1973). Epistemics and economics: A critique of economic doctrines. Cambridge: Cambridge University Press. Smith, V. L. (2010). What would Adam Smith think? Journal of Economic Behavior and Organization, 74, 83–86. Streissler, E. W. (2001). Rau, Hermann and Roscher: Contributions of German economics around the middle of the nineteenth century. European Journal of the History of Economic Thought, 8, 311–331. Vaughn, K. (1999). Hayek’s theory of the market order as an instance of the theory of complex adaptive systems. Journal des Economists et des e´tudes Humaines, 9, 241–256. Vela Velupillai, K. (Ed.) (2005). Computability, complexity and constructivity in economic analysis. Oxford: Blackwell. Vriend, N. J. (2002). Was Hayek an Ace? Southern Economic Journal, 68, 811–840. Weaver, W. (1948). Science and complexity. American Scientist, 36, 536–544. Wiener, N. (1948). Cybernetics: Or control and communication in the animal and the machine (2nd ed., 1961, same publisher). Cambridge: MIT Press. von Bertalanffy, L. (1962). General systems theory. New York: Braziller. von Bo¨hm-Bawerk, E. (1975 [1898]). Karl Marx and the close of his system. In: P. Sweezy (Ed.), Karl Marx and the close of his system and Bo¨hm-Bawerk’s criticism of Marx (pp. 3–118). Clifton: Kelley. von Bo¨hm-Bawerk, E. (1891). The Austrian economists. H. Leonard (Trans.). Annals of the American Academy of Political and Social Sciences, 1, 244–271. von Mises, L. (1981 [1922]). Socialism: An economic and sociological analysis (J. Kahane (Trans.). 3rd ed.). Indianapolis: Liberty Fund. von Mises, L. (1966). Human action: A treatise on economics (3rd ed.). Chicago: Henry Regnery. von Schmoller, G. (1978 [1900–1904]). Grundriss der allgemeinen Volkswirtschaftslehre (Vols I and II). Berlin: Duncker & Humblot. von Wieser, F. (1884). U¨ber den Ursprung und die Hauptgesetze des wirtschaftlichen Werthes. Vienna: Ho¨lder. von Wieser, F. (1893). Natural value. W. Smart (Ed.) and C. Malloch (Trans.). London: Macmillan. Witt, U. (1999). Hayekian macroeconomics. Paper presented at the Liberty Fund Conference, ‘‘The Legacy of F.A. Hayek,’’ Bleibach, Germany, May.

CHANGE WITHIN PERMANENCE: TIME AND THE BIVALENT LOGIC OF ECONOMIC ANALYSIS Richard E. Wagner ABSTRACT The logic of economic inquiry requires two distinct research programs. One program treats economic life in terms of invariant formal categories across time and place. The other program treats the continual generation of novelty and turbulence through time and human interaction. These programs are not commensurable: one cannot be reduced to the other. The former program must be conveyed by a theory of equilibrium; the latter program requires a process-based theory of emergent phenomena. Roy Weintraub articulated a neo-Walrasian research program in his General Equilibrium Analysis, and here I sketch a complementary neoMengerian program. In presenting this sketch, I also explain that needless analytical confusion and antagonism can result from a failure to recognize that economic analysis requires two distinct research programs. As a historical side-bar, Carl Menger probably recognized this situation, as evidenced by his correspondence with Le´on Walras.

This paper seeks to explain why the logic of economic inquiry requires two distinct and noncommensurable types of research program. One type What is so Austrian About Austrian Economics? Advances in Austrian Economics, Volume 14, 181–203 Copyright r 2010 by Emerald Group Publishing Limited All rights of reproduction in any form reserved ISSN: 1529-2134/doi:10.1108/S1529-2134(2010)0000014012

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explores eternal phenomena; the other type explores temporal phenomena. The former type of program explores those phenomena that are independent of time and place. What arises out of this program is an understanding of invariant patterns of social reality, eternal verities if you will. The other type of program explores the generation of the particular patterns that constitute social reality in particular times and places. This latter program seeks to explore how the universal qualities of economic order are transformed in their particular features through time, as illustrated by Richard Wagner (2010). The continual operation of these processes of internally generated transformation must be conveyed by a process-based theory of emergent phenomena. The former program stands with Ecclesiastes in afﬁrming that there is nothing new under the sun; the latter program stands with Heraclites in asserting that it is not even possible to step twice into the same river. A distinct research program can be developed around each orientation and with both programs being valid explorations of their domains of inquiry. These alternative programs, however, are not competitive with one another; rather they are noncommensurable. The two programs do not represent contestation over the same territory but cover distinct but tangential aspects of social life, much as illustrated by the two parabolas X2 and X2, sharing a common origin but pointing in opposite directions. I designate these research programs as neo-Walrasian and neo-Mengerian because the terms are in common use and map into the common distinction between neo-classical and Austrian economics, though I am not fully comfortable with this nomenclature for reasons that are noted in the following text. Roy Weintraub (1993) articulates a neo-Walrasian research program, noting that this program was not created by Le´on Walras but rather emerged through scholarly interaction among economists, many of them Austrian, who sought to pursue the program of general interdependence that Walras (1874 [1954]) sketched. The neo-Walrasian program seeks to advance claims that are valid independently of any particularities of time and place. We can all recognize the truth that there is nothing new under the sun. But we can also recognize the truth of the claim that we cannot even step twice into the same river. The alternative, neo-Mengerian research program seeks to articulate how the temporal experience of life varies with time and place through interaction among economizing people. Among other things, much needless analytical confusion and antagonism has resulted from the failure to recognize that logic of economic theory requires two distinct but noncommensurable research programs. As a historical sidebar, it is worth noting that Carl Menger (1871 [1981], 1883 [1985]) probably recognized this bivalent setting for economic theory, as evidenced by his

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correspondence with Walras. When Walras asserted to Menger that both shared a common interest in changing the direction of economic scholarship, Menger responded that ‘‘There is indeed a resemblance between us. There is an analogy of concepts on certain points but not on the deeper questions.’’1 I start by sketching the neo-Walrasian and neo-Mengerian research programs to illustrate their complementary but noncommensurable character. Next, I explore how needless controversy can arise when phenomena suitable to one program are examined within the other program, for a focus on the dynamics of temporal processes cannot be merged with a focus on the statics of eternal verities. In other words, epistemological concerns must be addressed in the aftermath of appropriate ontological identiﬁcation. The remainder of the paper provides two illustrations of the different orientations provided by the two research programs, one micro in character and the other macro, showing in the process both the complementary and the noncommensurable character of the two programs.

ALTERNATIVE RESEARCH PROGRAMS FOR ECONOMIC THEORY A focus on eternal validity independent of time and place generates a distinct research program from a focus on the emergence of particular societal conﬁgurations at particular times and places. I describe these alternative research programs as neo-Walrasian and neo-Mengerian. To be sure, the dichotomy I have in mind extends beyond those Le´on Walras (1874 [1954]) and Carl Menger (1871 [1981], 1883 [1985]) and the traditions they represent. For instance, the neo-Mengerian program was present in the theories of spontaneous order we associate with the Scottish Enlightenment (Daiches, Jones, & Jones, 1986). Similarly, the neo-Walrasian program was present in much preceding theologically oriented scholarship that sought to articulate the order of creation (Viner 1972). Where the scholars of the Scottish Enlightenment and Carl Menger sought to theorize about ongoing processes of development, the natural law theoreticians and Le´on Walras sought to articulate the eternal logic of relationships outside of time.2 The distinction between the neo-Walrasian and the neo-Mengerian research programs should not be assimilated directly and immediately to some dichotomy between neoclassical and Austrian economics that is often given play (compare, for instance Rosen, 1997 and Yeager, 1997). The intellectual genealogy is more complex than that. The philosophers of the

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Scottish enlightenment could hardly be called Austrians; moreover, a good deal of Austrian-inspired scholarship after Menger largely embraced the Walrasian orientation, as Gloria-Palermo (1999) explains. Both the neoWalrasian and the neo-Mengerian programs are reasonable objects of scholarly inquiry, but they are different, noncommensurable programs. Although they share a common origin in generalized interdependence among economic phenomena, they point in opposing analytical directions: one toward phenomena that are independent of time and the other toward the generation of phenomena that emerge through time and so vary across place.

The Neo-Walrasian Program The neo-Walrasian research program construes an economy as an equilibrated system of fully connected markets that can be separated into product markets where goods and services are exchanged, and factor markets where inputs are obtained and incomes earned. A disturbance in the market for one product will also affect the market for other products, as well as the market for inputs used in the production of products. This framework provides a sharp sketch of the interrelated character of economic activity within a society; it shows crisply how changes at one point in the nexus of economic relationships will induce changes elsewhere in that nexus. During his thorough examination of what has emerged as the neoWalrasian research program, Roy Weintraub (1993) summarizes the hard core of that program in terms of six presumptions that themselves are not open to empirical examination, but which provide the grammatical or metaphysical framework for constructing theories. Table 1 presents Weintraub’s list; momentarily, I present a similar list for what I perceive Table 1. 1 2 3 4 5 6

Hard Core of neo-Walrasian Research Program.

There exist economic agents Agents have preferences over outcomes Agents independently optimize subject to constraints Choices are made in interrelated markets Agents have full relevant knowledge Observable outcomes are coordinated, so they must be discussed with reference to equilibrium states

Source: Weintraub (1993, p. 109)

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to be a neo-Mengerian research program. To be sure, there is surely some scope for the development of other lists of the neo-Walrasian hard core because there is no formal convention that ratiﬁes or adjudicates this list. The list is rather an articulation of what seem to be the bedrock presumptions held in common by a large body of economists who produce scholarly works within a neo-Walrasian motif. The central point, in any case, is that any scholarly work will have some such accepted hard core that provides the point of departure for that work; any system of thought must contain exogenous variables. Scientiﬁc research programs also operate with both positive and negative heuristics. The positive heuristics provide guidance for the construction of theories; those heuristics promote the construction of theories that are consistent with the metaphysical hard core of the research program. In his presentation of the neo-Walrasian program, Weintraub (1993) presents two positive heuristics: (1) theories should contain agents who optimize and (2) theories should make predictions about changes in equilibrium states in response to speciﬁed exogenous changes in parameters. A similar articulation of a positive heuristic was articulated by Reder (1982), who argued that economic models should be based on two presumptions: (1) agents maximize and (2) markets clear. The methodology of scientiﬁc research program also includes negative heuristics about what to avoid in the construction of theories. The real work, though, is done through the positive heuristics, for it is in light of the positive heuristics that the scholarly work of constructing economic theories is accomplished. In contrast, the negative heuristics just tell someone what not to do and what to dispute about someone else’s work. Negative heuristics counsel researchers on how to avoid entering what the hard core would reveal as intellectual swamps. Weintraub (1993) lists three such negative heuristics for the neo-Walrasian program: (1) do not allow irrational behavior, (2) do not work without a meaningful equilibrium, and (3) do not think about testing empirically the hard core propositions. The neo-Walrasian program seeks to characterize an orderly economy in terms of consistency among various postulated relationships regarding such things as consumer demands and producer technologies. What consumers will demand depends on their incomes; those incomes depend on the prices paid for productive inputs; the value of productive inputs to producers depends on the desires of consumers to buy those products. What results is a circular system of reasoning that reﬂects its logical consistency but which cannot be used to generate those relationships in the ﬁrst place. This system stands outside of time and is incapable of being relocated inside of time

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because its conceptual categories are incapable of being used to generate the observations to which those categories pertain; the analytical forcus is on what Bo¨hm (1992) describes as logical causality, in contrast to generative causality.

The Neo-Mengerian Program In contrast to Walras, Menger’s analytical vision suggested a generative or emergent orientation toward economic phenomena, wherein complex macro formations emerge out of interaction among simpler micro units.3 Menger was an incipient theorist of emergent complexity for whom the move from the individual or micro level to the societal or macro level was an elevation in analytical level, with macro phenomena emerging out of interaction among micro units. In this respect, the neo-Mengerian program is the antithesis of the neo-Walrasian program. Menger wrote long before such techniques as agent-based computational modeling had arisen, but it is clear that Menger’s theoretical intuitions would have supported emergent and generative styles of theorizing, much as Vriend (2002) claims for Friedrich Hayek. This reduction of societal phenomena to objects of individual choice is antithetical to the Mengerian vision. When many Crusoes interact, patterns emerge that would never have occurred through isolated individual action. Property, contract, legislatures, legal proceedings, and money are all phenomena of interaction and not of choice. Institutional arrangements are a macro and not a micro level phenomenon. These phenomena represent a new level of existence that arises through interaction at a lower level. Accordingly, variation through time in some aggregate measure of activity is not to be explained in the same way as one would explain variation in a single person’s pattern of activity. There is a parallel in this respect with object-oriented programming, as explained by Mitchel Resnick (1994). Imagine trafﬁc ﬂowing down a highway, with the drivers following the simple rule of driving as fast as possible until they reach some stipulated distance behind the preceding car, then keeping that distance. If one car suddenly slows down, a trafﬁc jam forms as drivers reduce their speed. A time-lapse photograph of the trafﬁc jam will show it moving backwards. Yet each car continues to move forward. It makes no sense to speak of the trafﬁc jam as a gigantic car moving backwards. The jam is comprised of individual cars each moving forward, but interaction among those cars creates a higher level phenomenon that has different properties than that possessed by any of

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Table 2. Hard Core of neo-Mengerian Research Program. 1 2 3 4 5 6

There exist both economic agents and social structure Agent preferences have both genetic and societal sources Agents choose ends as well as economize on means Choices are made in interrelated markets Agent knowledge is partial and is distributed among agents Observable outcomes are just one frame of a motion picture

the individual cars. There is no gigantic car, and no individual car is moving backwards. In the spirit of Weintraub (1993), Table 2 sets forth my version of a neoMengerian hard core. Since the neo-Mengerian framework is concerned with theorizing about the emergent properties of action over some duration of time, whereas the neo-Walrasian framework seeks to give an account of eternally valid observations, there is no good reason to expect a statement of their hard cores to have the same structure. Nonetheless, I have constructed this listing of a neo-Mengerian hard core to look the same as Weintraub’s listing so as to facilitate comparison between the programs. This type of enforced comparability might not be the best way to articulate a neoMengerian research program because it applies a neo-Walrasian grammar to the neo-Mengerian program; nonetheless I can see pedagogical value in proceeding this way because of the familiarity of the neo-Walrasian grammar. The only hard core element common to both programs is #4, about the interrelated quality of markets: this element mirrors the common origin of the two parabolas X2 and X2. The other ﬁve elements differ between the research programs, as beﬁts their respective orientations toward temporality and eternity. Among those elements, differences in the ﬁrst three are perhaps less signiﬁcant than differences in the ﬁnal two. Where element #1 postulates only the existence of economic agents for the neo-Walrasian program, it also postulates the existence of social structure for the neo-Mengerian program. As Jason Potts (2000) explains, the neo-Walrasian program conceptualizes society as a ﬁeld. In contrast, the neo-Mengerian program conceptualizes it as a network; the properties of a network, in contrast to those of a ﬁeld, vary with its constitutive structure. Where element #2 in the neo-Walrasian program postulates that agents operate with given preferences, its counterpart in the neo-Mengerian program postulates that some preferences arise through particular patterns of social relationships, while also recognizing that some preferences arise from genetic endowments. Element #3 in the neo-Walrasian program postulates that agents act independently of one

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another in pursuing given ends; its counterpart in the neo-Mengerian program holds that agents choose ends as well as employ means, and with the choice of ends also entailing a societal component. It is with the ﬁnal two elements that the largest differences seem to appear. Element #5 of the neo-Walrasian hard core holds that agents have all the necessary knowledge necessary to solve their optimization problems, whereas for the neo-Mengerian program knowledge is incomplete within any single agent and is distributed among agents. This element prevents any reduction of society to a representative agent, for the way that knowledge is used depends on the particular networked structure of society that is in place. Element #6 of the neo-Walrasian program claims that observations are of coordinated equilibria, so that meaning can be derived from a snapshot. In contrast, the comparable element #6 of the neo-Mengerian program claims that observations at some instant are but slices of some unfolding process, so that meaning is derived not from observation but from interpretation of actions and plans. This element embraces temporality to accommodate the internal generation of societal transformation, not as equilibrated responses to postulated exogenous shocks but as intelligible facets of economizing action. With respect to Weintraub’s two positive heuristics for the neo-Walrasian program, the neo-Mengerian program seems similar on the ﬁrst heuristic and divergent on the second. Where the neo-Walrasian program theorizes in terms of agents optimizing over known options, the neo-Mengerian program theorizes about agents acting to implement plans that can be only incompletely articulated because the effect of any plan will depend on the future circumstances that will be inﬂuenced by future knowledge, which, in turn, will change through continuing human action as time passes. This alternative formulation is necessary to accommodate the internal generation of societal change. It is the second positive heuristic where the more signiﬁcant difference would seem to appear between the two programs. The neo-Walrasian program holds that theoretical statements should refer to changes in equilibrium states. This follows from the sixth hard core proposition that all observations are of equilibrium states. Distinct observations refer to distinct equilibrium states, and this presumption advises use of the positive heuristic to make predictions about the effect of changes in exogenous variables on equilibrium states. In contrast, the neo-Mengerian program does not postulate that observations are of equilibrium states, but rather are blips on a screen whose pattern can be discerned only with the passing of time. Theories start from planning agents, as illustrated by the ﬁrst positive

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heuristic, but the entire set of agents is never fully coordinated. To the contrary, plans continually are being revised or abandoned. Among other things, institutional arrangements arise to facilitate the revision and abandonment of plans (Lachmann 1971), and the neo-Mengerian counterpart to the second positive heuristic would counsel the construction of theories that, while consistent with agent planning, render intelligible the ongoing generation of the institutional framework that governs human action and interaction (Mises 1957).

ONTOLOGY, EPISTEMOLOGY, AND SOCIAL-ECONOMIC THEORY Both the neo-Walrasian and the neo-Mengerian programs theorize about generally orderly patterns of human activity. The objects of theorizing, however, differ between the programs, with one focusing on eternity and the other on temporality. Needless controversy and confusion can arise when there is incongruity between a program and the object of examination, as when a framework suitable to invariance across time and place is used to explore variability across time and place. Before exploring this point for two concrete economic situations, I use a different setting to frame the priority of ontology over epistemology with respect to social theory. To be sure, a purely instrumentalist view of science would seem to elevate epistemology over ontology: the degree of congruity between a theory and its object, which is a matter of ontology, is irrelevant because what matters is the degree of congruity between theoretical prediction and observed experience, which is a matter of epistemology.4 Any analytical framework that distinguishes between universal principles and particular instances of those principles that can take on multiple guises is one that will involve both process and structure. Structure speaks to the universally recognizable features of the actions, both inventive and repetitive, that occur within society. It is possible simultaneously to embrace the recognition in Ecclesiastes that there is nothing new under the sun and the assertion of Heraclites that a person cannot step twice into the same river. Both process and structure provide useful analytical orientation, but there is a question of which occupies the foreground. In a neo-Mengerian program, the foreground is occupied by process. Consider two orderly social conﬁgurations, one is a parade and the other is a crowd of spectators leaving a stadium (to aid the comparison the parade should be large and take place on a wide boulevard). Further suppose that

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the two conﬁgurations are viewed from 5,000 ft, perhaps while standing in a hot-air balloon. Both would show long and wide movements of people in one direction, and with both conﬁgurations eventually breaking up and dissipating. Perhaps the main difference between the two conﬁgurations would be that the parade appears more orderly than the spectators. The parade would appear to be perfectly coordinated, or nearly so; the spectators would appear to be only imperfectly coordinated. The neo-Walrasian program must construe society as a parade, in which case the crowd would be construed as an imperfect parade. In principle, it would be possible to develop some measure of the degree to which the crowd resembles the parade, and with this measure denoting a measure of imperfection when measured against the model of the perfectly coordinated parade. What is present here is confusion between ontology and epistemology with respect to different social conﬁgurations. The parade is constituted as an organization; the spectators are constituted as an order. Each conﬁguration can differ in the degree of coordination it exhibits. In some parades, all participants might march in step and play in tune and on key, whereas other parades might display various degrees of cacophony. On some occasions, the crowd of spectators might dissipate relatively quickly with everyone reaching their desired destinations pretty much as they had hoped, whereas other occasions might involve shoving, scufﬂes, and numerous cases of missed rides and late arrivals. A theorist who was asked to explain the variation in coordination among parades would surely take resort to such considerations as the musical and marching abilities of the members, the instructional talents of the conductor, and the amount of effort given to rehearsal. Such categories as these, however, are irrelevant to explaining the degree of coordination among spectators. Explanation of this alternative type of coordination would involve such things as conventions, customs, and moral character. Epistemological questions can be addressed both to organizations and to orders, but the character of those questions depends on which type of object is being examined. Both the parade and the crowd of spectators contain structure and can be described as an arrangement of nodes and connections among nodes. Those structures would be constituted differently, however, and those differences refer to processes by which those conﬁgurations are constituted. The parade is constituted through plans of a conductor or marshal. The crowd of spectators is constituted through each member’s seeking to secure timely arrival at some destination while mostly conforming reasonably well to the similar actions of the other members of the crowd.

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The neo-Mengerian program seeks to explore the ongoing emergence of those social conﬁgurations that conform to the template offered by the image of crowds of spectators. In contrast, the neo-Walrasian program holds that there are certain eternal features that pertain to all crowds. After all, at 5,000 ft, crowds of spectators bear family resemblances to parades. Yet those crowds also vary across time and place, and the neo-Mengerian program seeks to give an account of the internal generation of such variability, even while recognizing that there is a surface-level resemblance between the two social conﬁgurations, as denoted by fourth element of the two hard cores held in common. For instance, it is impossible to work with a formulation wherein people generate and reform continually the world they experience and at the same time work with a model of competitive equilibrium where everyone is a price taker. These alternative analytical windows are not so much antagonistic as they are noncommensurable. The existence of prices is a universal feature of social life, as are differences in prices among objects of trade. It is also true that there is immense variability in the objects of trade across time and place, as conveyed brilliantly by Georg Simmel’s (1900 [1978]) treatment of the changing sphere of alienability in property-governed relationships, the understanding of which requires employment of emergence-based concepts and categories. In the remainder of this paper, I offer two brief comparisons that highlight the noncommensurable character of the research programs, one of which is a standard topic from micro theory and the other from macro theory.

COMPARISON #1: STATICS, DYNAMICS, AND MARKET THEORY Such concepts as preference, choice, and cost can be used to explain characteristic patterns of economic activity that are independent of time and place. Fig. 1 presents a common illustration of this point, and at the same time can also be used to illustrate the noncommensurability of the neoWalrasian and the neo-Mengerian programs. Within a neo-Walrasian framework, Fig. 1 illustrates the standard comparative statics of alternative equilibrium states in light of differences in given data. As compared with point a in the two panels, point b pertains to a stronger preference to X relative to Y. In Panel A, this appears as a stronger demand for X; in Panel B, it appears as an alternative position on the production-possibility frontier. Fig. 1 illustrates a response to a ‘‘what if ’’ type of question. It answers that the structure of production would differ if preferences were

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P S β

Y1

α

α β

Y2

D2 D1 X1

X

X2

X1

A: Single Market

Fig. 1.

X X2

B: Multi-Market

Statics, Dynamics, and Market Theory.

those described by a than if they were those described by b. In other words, Fig. 1 pertains to the timeless world of logic and asserts that different patterns of production will correspond to different patterns of preference. To be sure, it is possible to use interpretative language to give the appearance of dynamic or historical relevance, as illustrated by Samuelson’s (1947) use of a correspondence principle to connect statics and dynamics. For example, a and b can be interpreted as corresponding to a change in preferences within a society over some interval of time. Alternative equilibrium allocations are interpreted as corresponding to differences or changes in postulated initial conditions. The object of theorization is the equilibrium allocation that is implied by the postulated initial conditions, with changes in those conditions being assimilated to exogenous shocks. Samuelson’s notion of dynamics is purely notional and does not deal genuinely with action through time. In no way is the object of theorization the generation of a new social conﬁguration out of a previous one. Questions of generation or transformation are simply outside the purview of the neo-Walrasian program, because these are phenomena that operate through time and so are not capable of being rendered intelligible by a framework that is invariant to time and place. A focus on action through time must bring into the analytical foreground such phenomena as creativity, exploration, and learning. Such activities bring into play both the creation of new enterprises and revisions to the operation of old enterprises. They also bring changes in consumer valuations as people gain new insight into the relation between means and ends, as well as perhaps new insight into their ends. When time is allowed to pass, it is impossible for such points as a and b in Fig. 1 to refer to anything

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other than the logic of relationships outside of time. If time is allowed to pass, knowledge must be allowed to change, and once this happens the standard ‘‘given’’ conditions of comparative statics cannot be taken as given for genuine historical dynamics, as contrasted with the notional dynamics of comparative statics. It is no wonder that the passing of time has caused such consternation for economic theorists as to lead them to write such works as Economics and the Antagonism of Time (Vickers, 1994) and Wrestling with Time (Currie and Steedman, 1990). However, antagonistic time might appear to theoretical efforts and no matter how much wrestling it might provoke, a neo-Mengerian research program is centrally concerned with phenomena that emerge through interaction over time among economizing individuals. To do this requires something like O’Driscoll and Rizzo’s (1985) distinction between Newtonian time and real time, recognizing that the correspondence principle is an exercise performed in Newtonian time. Within the domain of real time, Fig. 1 can serve a summarization of some stylized facts that pertain to distinct points in time. In this alternative, historical setting, the comparative output vectors (X1, Y1) and (X2, Y2) would be directly observable, and with the shift in preferences and demands denoted by D1-D2 being an interpretative hypothesis to help give an account of the historical observation. Where Fig. 1 denotes sufﬁcient information to give an account of the comparative statics, it is not sufﬁcient to relate the historical dynamics by which the market conﬁguration was transformed over the time period being considered. Comparative statics speaks to structure; historical dynamics speaks to process. The comparative statics of Fig. 1 would assert that if all ﬁrms face identical U-shaped cost functions, the increased production of X would be provided wholly by new ﬁrms in the alternate equilibrium. This condition is necessitated by the logic of the problem setting. This logic of comparative statics does not, however, convey adequately the process by which A-B. Most signiﬁcantly, there is nothing corresponding to any announcement of an increase in demand for X. Such an announcement corresponds to a theoretical, what-if logic, but it does not correspond to any logic of practical action. Absent some articulation of new demand conditions prior to any action to engage in production, production decisions are made by entrepreneurs who act on beliefs about future market opportunities within their ﬁeld of vision and who act now to capture those opportunities when they arrive, if, indeed, they do arrive (Kirzner, 1973, 1985). Furthermore, there is no process of assignment that assures that just the right capacity will be added. Fig. 1 might correspond to ﬁve additional ﬁrms producing X. But 10 ﬁrms might

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seek to enter the market, in which case some entrepreneurial plans will fail and will be revised or even abandoned. Among other things, this means that conﬂicts will arise among ﬁrms, and also that social processes and procedures will emerge to settle such conﬂicts as those that arise through bankruptcy and insolvency (Wagner, 2007). Within the neo-Mengerian orientation, the generation of such market formations would occupy the foreground of analytical attention. Those formations, moreover, are largely emergent products of interaction and not direct objects of choice – and most certainly are not taken as given data. Stated differently, the neo-Walrasian program cannot accommodate a genuine theory of markets, as distinct from a theory of exchange. The principles of exchange are timeless, so the articulation of those principles ﬁts nicely into the neo-Walrasian program. In contrast, markets are particular objects that evolve through time as people interact on the open-access commons created by the rules of property and contract. What is surely most notable about the buying and selling of used cars is not the presence of ‘‘lemons’’ (Akerlof, 1970), but rather is the dramatic transformation in the character of the market for used cars over the past half-century. Cars of all kinds are far more reliable now. This greater reliability is a product of interaction among many people seeking to expand their custom, and expanding the extent of the market as a by-product of those efforts. A good part of this expansion entails the formation of new organizational arrangements and contractual forms. Advances in technology also contribute to market transformation, as illustrated by the development of diagnostic technology that contributes to the creation of new organizations and contractual forms. In this history of market generation through time, there is an invariant search for gain among the participants. That search, however, involves interaction among those participants that leads to the emergence of market conﬁgurations that can be rendered intelligible ex post but could not have been created ex ante through choice, as one more implication of the impossibility of calculation without prices (Boettke, 1998). To be sure, there is no guarantee that a historical period will be dominated by market expansion, for contraction is also possible. Expansion results from the efforts of people to capture what they sense to be unrealized proﬁt opportunities; contraction results from the efforts of people to avoid being on the losing end of such efforts. In any case, there are multiple stories of market generation that can be examined within a neo-Mengerian program, each of which could conform ex post to the neo-Walrasian articulation conveyed by Fig. 1.

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COMPARISON #2: AUSTRIAN-STYLE MACRO THEORY Austrian cycle theory (ACT) has been nearly invisible within macrotheoretic discourse since the 1930s. This invisibility does not reﬂect empirical weakness but rather illustrates the noncommensurability of the neoMengerian and neo-Walrasian research programs. ACT is commonly expressed within a neo-Walrasian framework, with an initial equilibrium being disturbed by a credit expansion that drives the market rate of interest below the natural rate. What results is a two-stage form of comparative statics, wherein an initial boom in the capital-goods industries turns into a bust because consumers have not reduced their desire to buy consumer goods (Garrison, 2001). Robert Lucas’ (1975) model of the islands was actually a variation of ACT, and Lucas abandoned his support for this construction once he realized it did not ﬁt within the neo-Walrasian program that he embraced. The problem with ACT is not that it is wrong but that it has been conveyed with intellectual vehicles that are not suited to the task (Wagner, 1999). It is unfortunate in this respect that ACT has often been conveyed in comparative static fashion, for this treatment invited its assimilation to the neo-Walrasian program where it has no room to work. Comparative statics is independent of time. In contrast, any sequential analysis that is real and not merely notional must incorporate pertinent phenomena that are associated with the passing of time. ACT has always been conveyed in sequential fashion, but the neo-Walrasian orientation reduces that sequence to something purely notional. Fig. 2 illustrates this point about ACT. Within a neo-Walrasian framework, the function f(c) describes a pattern of declining marginal returns to capital projects or enterprises in light of the given initial conditions. Suppose current time preferences support the interest rate r1 that in turn supports the capital structure denoted by c1. The standard Austrian formulation distinguishes between two sources of a fall in the rate of interest to r2: a fall in time preference and an increase in bank credit without the increase in saving that accompanies the fall in time preference. The fall in time preference simply leads to a lengthening of the structure of production. The credit expansion starts the same way but then reverses direction because consumer preferences will not support the alternative structure of production. When this ACT analysis is conveyed within an equilibrium framework, it verges on incoherence. Suppose the capital-axis in Fig. 2 maps into the number of enterprises. The increase in bank credit is claimed to lead

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r1

r2 R = f(c)

Capital c1

Fig. 2.

c2

Credit Expansion and Structure of Production.

entrepreneurs denoted by c2 c1 to create new enterprises. Yet the given conditions for equilibrium support only c1 enterprises. Thus, those new enterprises are destined to fail because their value added is not worthwhile in light of prevailing time preferences. In the absence of monetary surprises and with no reason to postulate some alternative equilibrium conﬁguration, the same c2 c1 ﬁrms that are born with be the ones that will die. Being rational and knowing their fate, those owners and investors will forsake such illusory prospects. The expansion will never happen because it violates the initial equilibrium conditions in conjunction with the presumption of full knowledge of those conditions and of the credit injection. ACT can be rendered sensible only by working within a neo-Mengerian framework denoted by an evolving ecology of plans. A plan can be portrayed as a directed graph extending into the future from some point of origin. Fig. 3 illustrates what I have in mind. The line designated ‘‘Actor’s Plan’’ shows four nodes connected by intervals. This description in terms of nodes and intervals is intended to represent several relevant features concerning plans and their execution. One is that they extend from the present into the future. Hence, entrepreneurial action involves a projection from present onto future, as illustrated by Butos and Koppl (1993). Another feature is a distinction between plans and the execution of plans. Plans have a point of initial formulation, and can also be subject to amendment or revision. Amendment, however, is not something continuous. It is discrete. The ﬁrst node in the actor’s plan portrayed by Fig. 3 denotes the initial

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Actor’s Plan

Complementary Plans

Present

Fig. 3.

Future

Entrepreneurial Plans as Directed Graphs.

formulation. The ﬁrst interval denotes a period of subsequent execution in light of the original plan. The second node denotes a point of revision based on knowledge acquired since the initial formulation. The second interval denotes the enterprise’s execution after revision, and with the third node denoting another point of revision. Also denoted in Fig. 3 is the insertion of substitute and complementary plans into the society’s ecology of plans, and with these appearing at various times after the actor’s plan has been created or revised (recall that the neoMengerian program works with motion pictures and not snapshots). Substitute plans are those that would reduce the value of the actor’s plan, whereas complementary plans would increase that value. There is no precoordination among plans. It is the insertion of other plans that leads possibly to revision of the original plan. It is also, of course, recognition of the possibility of such insertions that leads to ﬂexibility, assessment, and revision being part of any plan. In the temporal sense depicted in Fig. 3, the line segments between nodes constitute a type of short run where a plan is operated on a type of automatic pilot, so to speak, until judgments have been made to revise the plan. The long run in this conceptualization constitutes some planning horizon that provides navigational guidance, as represented by that ﬁnal node in Fig. 3. A distinction between short run and long run is a staple distinction in economic analysis. At the micro level, we distinguish between a short run where ﬁrms can vary their mix of inputs but not their scale of output and a long run where everything is variable. At the macro level, such a distinction ﬁnds expression in such notions as that a Phillips curve might exist in the short run due to monetary surprises, but in the long run it cannot exist

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because the one-time surprise will have become common knowledge. This distinction between short run and long run is a sensible feature of the neoWalrasian program because it treats observations as equilibrated snapshots under different postulated conditions. Each such snapshot corresponds to sets of given data that are assumed to undergird the particular equilibrium snapshot that is being viewed. In contrast, no such distinction is coherent at the societal level within the neo-Mengerian program, even though it is sensible at the individual level. The distinction between short run and long run has no referent when it is applied to society because there is no sentient creature who acts by creating and revising plans. At any date on a calendar, there will be some entrepreneurs who are initiating plans, there will be other entrepreneurs who are letting their plans operate, and there will be yet other entrepreneurs who are revising and even abandoning plans. At any particular moment we would expect the preponderance of enterprises to the operating somewhere along the execution interval of their plans. For instance, suppose that 95% of enterprises are operating within their execution phases, leaving 5% of enterprises at nodal positions where they are either creating or revising plans. This kind of situation would generate observations that would ﬁt with the reasonably predictive properties of models of static equilibrium, as most enterprises would appear to be ﬂying on automatic pilot. The hypothesis that observations pertained to a stationary state would pass an ordinary signiﬁcance test, even though the process that generated that observation was one of emergent dynamics. Those 95% of ﬁrms that at any instant are operating within their execution phases would appear to be acting consistently with a model of static equilibrium. The empirical success of static equilibrium modeling surely ﬁts this situation. A scientiﬁc procedure that considers explanatory success in terms of averages, moreover, will be forced into making such a conclusion. To avoid such a conclusion, it is necessary to consider the entire population of enterprises and plans, and with especial attention given to outliers, and outliers of two forms. One form is the incipient enterprise that is just entering the enterprise ecology. The other form is the presence of creativity and plan revision within established enterprises, for we should never think that creativity comes only from new enterprises. The point is rather that in terms of a dichotomy between creative and routine, the preponderance of activity is routine and not creative. Indeed, the very notion of a plan as involving some duration of time between initiation and completion requires such preponderance. Furthermore, the observation that the world confronts us mostly as familiar from day to day is congruent with

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this preponderance as well. Yet there is surely a link between incipient creativity and static continuation, in that those static enterprises that do not respond to relevant developments within the nexus will lose standing and become candidates for death, whether through dissolution or takeover. What this suggests is that the appropriate grammar to apply to the nexus is the grammar that is appropriate to incipient enterprises (including the creative margins of established enterprises). At any instant within the ecology of enterprises, there are some ﬁrms that are on their death beds, whereas there are other ﬁrms that are in the throes of birth. Credit injection, moreover, does not operate as some uniformly-spread liquid, but comes in lumps to particular enterprises (Horwitz, 2000). Within this alternative frame of reference, a credit expansion may well facilitate some ﬁrms that prove to be successful, as well as exerting subsequent negative consequences. The overall impact, thus, cannot be captured only by some time series of aggregate measures, for those aggregates are composed of structural elements whose components are subject to variation. The truly central feature of ACT is cousin to claims about the impossibility of collective planning. Idealize for a moment a catallaxy that is fully privately ordered. In standard equilibrium thinking, any aggregate measure of activity would show a ﬂat line to indicate the steady state quality of the model. Catallaxy modeled in nonequilibrium fashion would not give any ﬂat-line portrayal in the aggregate. Enterprises do not die instantly, to be replaced by new ones, again instantly. Not all plans mesh fully. Sometimes they collide, with debris scattered about. We speak of a construction industry, but a good chunk of that activity is devoted to remodeling and renovation, which in turn are activities that make sense only in the presence of failed plans that require reformation and revision. Some degree of variability is surely to be expected as a normal feature of a wellordered catallaxy – although it is not at all clear what kind of aggregate indicator could be used to express this idea, since the customary aggregates are sensible only in light of a presumption of equilibrium (similar to any comparison between parades and crowds of spectators). In neo-Walrasian theorizing, much is made about the presumption that the mean forecast error is zero. This means that people are not systematically wrong, so that the claim of equilibrium appears to be sensible. Such an argument could be used to claim that it does not matter if particular entrepreneurs judge wrongly so long as the mean error is zero. This widespread claim is one more illustration of how a presumption of equilibrium neuters structure. The situation would be examined differently from within a neo-Mengerian framework because structure matters and

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does important work (or at least reﬂects important work). Most signiﬁcantly, it means that a mean forecast error of zero means nothing. If there is any work to be done by such a statistic, it is to be done by the variance and not the mean, and it does so because the variance points to structure. An increase in error means an increased volume of particular lines of subsequently ill-fated commercial activity. These failed lines of activity have particular shape: people acquire special skills and fabricate particular tools and equipment. While these can always be redeployed, typically this will be only at some loss as compared with what would have been the case had the original plans worked out successfully.

A CONCLUDING OBSERVATION One long-standing aphorism goes ‘‘the more things change the more they stay the same.’’ There is much wisdom in this conjunction of Heraclites and Ecclesiastes. There are principles that govern the permanent things of social life, and the neo-Walrasian research program is suitable for illuminating some of those invariant features of social life, showing us again and again that no matter how much things change they do yet remain the same. And yet they do also change, and they change not because of exogenous shocks but because people continually generate change through interaction in their pursuit of plans. Plans reside in the world of intentional action, and intentional action is possible because the world is reasonably intelligible, perhaps reaching in the limit a neo-Walrasian equilibrium. But this limit speaks to eternity and we are caught in temporality, and thereby are mutually engaged in a process of generating through interaction the world we are about to experience. The neo-Mengerian program is the research program that is suitable for addressing the spontaneously generated patterns of order that emerge through interaction among myriad intentionalities that inhabit the ecology of plans that constitutes a society. Economic research has room for both types of research program, but it is also necessary that the phenomena studied be matched suitably to the appropriate research program; otherwise, weird claims can arise, as illustrated by suggestions that ‘‘lemons’’ will destroy the market for used cars when we know differently. The experience of obtaining lemons will do no such thing, and rather will elicit a stream of efforts to create such things as new organizational and contractual forms that will expand the extent of the market. It is the neo-Mengerian program that is the suitable framework for exploring the continual insertion of novelty into society, even though the

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future societal patterns that emerge can always be rendered intelligible in terms of the neo-Walrasian categories.

NOTES 1. This quotation appears in Sandye Gloria-Palermo (1999, p. 20) and was taken from the correspondence of Walras collected in Jaffe´ (1965). Further discussion on the divergence between Menger and Walras is presented in Jaffe´ (1976). See also Nigishi (1985), who explains that the differences between Menger and Walras far exceed the similarities. 2. This dichotomy was also at work in fueling the debate between Johan Akerman and Ragnar Frish over business cycles, with Akerman thinking in terms of process and Frish in terms of equilibrium states, as explained by Boianovsky and Trautwein (2007). 3. For a lucid statement of the principle that models in the social sciences should aim to generate their relationships and not just postulate them, see the essays in Epstein (Ed.) (2006). Similarly, Erik Lindahl’s (1919 [1939]) articulation of the distinction between micro and macro likewise reﬂects a neo-Mengerian orientation, in contrast to the neo-Walrasian orientation of the orthodox distinction between micro and macro. For Lindahl, micro theory pertained to individual action, the domain of praxeology; macro theory pertained to interaction among people, the domain of catallaxy, and with that domain incorporating the various institutional arrangements that are generated through interaction. 4. The primacy of the epistemological in economic discourse is given its classic statement in Friedman (1953). For recognition of the primacy of ontological presumptions, see Lawson (1997, 2003) and Lewis (2004).

ACKNOWLEDGMENTS I am grateful to several of the participants at the Wirth Institute conference for helpful comments and insights, and especially Roger Koppl and Stephan Bo¨hm, as well as an anonymous referee, for post-conference suggestions.

REFERENCES Akerlof, G. (1970). The market for ‘lemons’: Quality, uncertainty, and the market mechanism. Quarterly Journal of Economics, 84, 488–500. Boettke, P. J. (1998). Economic calculation: The Austrian contribution to political economy. Advances in Austrian Economics, 5, 131–158. Bo¨hm, S. (1992). Austrian economics between the wars: Some historiographical problems. In: B. J. Caldwell & S. Bo¨hm (Eds), Austrian economics: Tensions and new directions (pp. 1–30). Boston, MA: Kluwer.

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Boianovsky, M., & Trautwein, H.-M. (2007). Johan Akerman vs. Ragnar Frisch on quantitative business cycle analysis. European Journal of the History of Economic Thought, 14, 487–517. Butos, W. N., & Koppl, R. G. (1993). Hayekian expectations: Theory and empirical applications. Constitutional Political Economy, 4, 303–329. Currie, M., & Steedman, I. (1990). Wrestling with time. Ann Arbor, MI: University of Michigan Press. Daiches, D., Jones, P., & Jones, J. (1986). A hotbed of genius: The Scottish Enlightenment, 1730– 1790. Edinburgh, UK: Edinburgh University Press. Epstein, J. M. (Ed.) (2006). Generative social science: Studies in agent-based computational modeling. Princeton, NJ: Princeton University Press. Friedman, M. (1953). The methodology of positive economics. In: Essays in positive economics (pp. 3–46). Chicago, IL: University of Chicago Press. (Idem). Garrison, R. W. (2001). Time and money: The macroeconomics of capital structure. London: Routledge. Gloria-Palermo, S. (1999). The evolution of Austrian economics: From Menger to Lachmann. London: Routledge. Horwitz, S. (2000). Microfoundations and macroeconomics: An Austrian perspective. London: Routledge. Jaffe´, W. (1965). Correspondence of Le´on Walras and related papers. Amsterdam, The Netherlands: North-Holland. Jaffe´, W. (1976). Menger, Jevons, and Walras de-homogenized. Economic Inquiry, 14, 511–524. Kirzner, I. M. (1973). Competition and entrepreneurship. Chicago, IL: University of Chicago Press. Kirzner, I. M. (1985). Discovery and the capitalist process. Chicago, IL: University of Chicago Press. Lachmann, L. (1971). The legacy of Max Weber. Berkely, CA: Glendessary Press. Lawson, T. (1997). Economics and reality. London: Routledge. Lawson, T. (2003). Reorienting economics. London: Routledge. Lewis, P. (Ed.) (2004). Transforming economics: Perspectives on the critical realist project. London: Routledge. Lindahl, E. (1919 [1939]). Studies in the theory of money and credit. London: Allen & Unwin. Lucas, R. E., Jr. (1975). An equilibrium model of the business cycle. Journal of Political Economy, 83, 1113–1144. Menger, C. (1871 [1981]). Principles of economics. New York: New York University Press. Menger, C. (1883 [1985]). Investigations into the method of the social sciences. New York: New York University Press. Mises, L. (1957). Theory and history. New Haven, CT: Yale University Press. Nigishi, T. (1985). Economic theories in a non-Walrasian tradition. Cambridge, UK: Cambridge University Press. O’Driscoll, G. P., & Rizzo, M. J. (1985). The economics of time and ignorance. Oxford, UK: Basil Blackwell. Potts, J. (2000). The new evolutionary microeconomics: Complexity, competence, and adaptive behaviour. Cheltenham, UK: Edward Elgar. Reder, M. W. (1982). Chicago economics: Permanence and change. Journal of Economic Literature, 20, 1–38. Resnick, M. (1994). Turtles, termites, and trafﬁc jams: Explorations in massively parallel microworlds. Cambridge, USA: MIT Press.

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Rosen, S. (1997). Austrian and neoclassical economics: Any gains from trade? Journal of Economic Perspectives, 11, 139–152. Samuelson, P. A. (1947). The foundations of economic analysis. Cambridge, MA: Harvard University Press. Simmel, G. (1900 [1978]). The philosophy of money. London: Routledge. Vickers, D. (1994). Economics and the antagonism of time. Ann Arbor, MI: University of Michigan Press. Viner, J. (1972). The role of providence in the social order. Princeton, NJ: Princeton University Press. Vriend, N. J. (2002). Was Hayek an Ace? Southern Economic Journal, 68, 811–840. Wagner, R. E. (1999). Austrian cycle theory: Saving the wheat while discarding the chaff. Review of Austrian Economics, 12, 65–80. Wagner, R. E. (2007). Fiscal sociology and the theory of public ﬁnance. Cheltenham, UK: Edward Elgar. Wagner, R. E. (2010). Mind, society, and human action: Time and knowledge in a theory of social economy. London: Routledge. Walras, L. (1874 [1954]). Elements of pure economics. Homewood, IL: Richard D. Irwin. Weintraub, E. R. (1993). General equilibrium analysis: Studies in appraisal. Ann Arbor, IL: University of Michigan Press. Yeager, L. B. (1997). Austrian economics, neoclassicism, and the market test. Journal of Economic Perspectives, 11, 153–165.

THE ROLE OF IDEAL TYPES IN AUSTRIAN BUSINESS CYCLE THEORY$ Gene Callahan and Steven Horwitz 1. INTRODUCTION The Austrian theory of the business cycle (henceforth ABC) frequently has been a target for critics of Austrian economics. In particular, a number of economists who are generally appreciative of other Austrian themes have singled out ABC as being, in one such critic’s words, an ‘‘embarrassing excrescence’’ marring the otherwise generally sound body of modern Austrian thought.1 Despite such criticisms, many Austrian economists persist in forwarding ABC as the best available, or perhaps even the only valid, explanation for the cycles of boom and bust regularly occurring in most modern, national economies. This sharp divergence of evaluations of ABC existing among a group of economists that, from the vantage of the economic profession as a whole, are largely in the same camp, suggests that the source of the disagreement may be some ambiguity in the most common expositions of the theory. In this chapter we argue for this view and claim that the chief culprit at work is the failure, on the part of both supporters and critics of ABC, to recognize

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that the theory is constructed using a variety of ideal types and that, crucially for our thesis, the ideal types from which ABC is built vary signiﬁcantly in terms of the contingency of their applicability.2 We will discover that although some of the underpinnings of ABC are universally true of all human action,3 other conditions that it assumes arise only in particular institutional settings, which may or may not be present at any time or place. In turn, the scope of the theory then becomes clear: an Austrian-type business cycle is neither the only plausible explanation for every macroeconomic downturn, nor even the necessary outcome of every central bank credit expansion. Rather, ABC provides a possible account of speciﬁc historical episodes, albeit one that is, in the typical circumstances found in many recent, industrialized nations, quite widely applicable.4 The amount of illumination that ABC can cast on any particular historical happening varies directly with how nearly the speciﬁc circumstances of the time in question approach the idealized state of affairs assumed in constructing the various ideal types it incorporates. Only a theory constructed with completely general ideal types could apply in every single historical instance. Since several of the building blocks essential to ABC are not completely general constructs, it follows that there may be economic downturns for which some other theory provides a better explanation, and that there can be instances of a central bank credit expansion that will not produce an Austrian-type cycle. Nevertheless, because ﬁnancial institutions and policies in the most developed countries since the 19th century have largely matched the contingent idealizations employed in the Austrian theory, we believe that ABC is crucial in understanding many, or even most, of the modern cycles in the modern, industrialized world. We hope to demonstrate that clarifying the various degrees of generality characterizing the ideal types from which ABC is constructed adequately fortiﬁes the theory against much of the criticism to which it has been subjected. Additionally, we will attempt to show that the ﬁrst proponent of Austrian Business Cycle theory, Ludwig von Mises, himself understood that the relevance of his theory to speciﬁc historical episodes depended on how closely the circumstances from which they arose, and the behavior of the actors in those circumstances, mirrored the abstract conditions underlying the conception of the various nonpraxeological ideal types embedded in the theory, even though he never explicitly stated as much. Our discussion here owes much to Machlup (1978 [1936]), a paper that, if it only had been read more widely by the participants in this debate, might have resolved it long ago. Machlup explicitly shows how the degree of anonymity of an ideal type employed in some economic prediction correlates

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with the reliability of the prediction. He asks us to consider three statements by an economist: Statement (1): ‘‘If, because of an abundant crop, the output of wheat is much increased, the price of wheat will fall.’’ Statement (2): ‘‘If, because of increased wage rates and decreased interest rates, capital becomes relatively cheaper than labor, new labor-saving devices will be invented.’’ Statement (3): ‘‘If, because of heavy withdrawals of foreign deposits, the banks are in danger of insolvency, the Central Bank Authorities will extend the necessary credit.’’ (Machlup, 1978 [1936], p. 64) As we move from statement (1) to statement (3), the reliability of the statements declines, because: [T]he causal relations such as stated in (2) and (3) are derived from types of human conduct of a lesser generality or anonymity. To make a statement about the actions of bank authorities (such as (3)) calls for reasoning in a stratum of behavior conceptions of much less anonymous types of actors. We have to know or imagine the acting persons much more intimately. – Machlup (1978 [1936], p. 68)

It is this exact mixing of degrees of anonymity in ideal types that we assign the chief blame in the confusion over the status of ABC; indeed, Machlup warned of this problem: ‘‘The mingling of assumptions of different degrees of validity y is acceptable only if the assumptions are fully stated’’ (1978 [1936], p. 68). This essay will, in essence, represent an elaboration of how Machlup’s sketch applies to ABC.

2. JUSTIFYING THE USE OF AN IDEAL TYPE If we are not involved in the theoretical analysis of action per se, but instead are attempting to explain particular past events, then we must justify the application of any particular ideal type to those episodes. What, then, sanctions the use of an ideal type as an explanatory device with which to comprehend certain events? Weber holds that ideal types ought to have two sorts of adequacy: explanatory adequacy (or, as Weber put it, adequacy on the level of meaning [Schutz, 1967 (1932), p. 225]) and causal adequacy. Explanatory adequacy means that we can comprehend why, if an actor or an action closely conforms to the ideal type in question, the phenomenon we actually observe is a comprehensible result of the ‘‘machinery’’ of that type.

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Causal adequacy means that we can ﬁnd cases in the real world that proceed roughly as our ideal type says they should; in other words, our type is not only plausible, but it also helps describe various actual social goings-on. Demonstrating causal adequacy might involve the use of historical narrative, statistical studies, and other empirical work. We can classify critics of ABC by employing Weber’s two types of adequacy. The ﬁrst group would contain those who say ABC is theoretically unsound, i.e., that it lacks explanatory adequacy. For example, such a critic might contend, ‘‘No real businessman would act as Austrian Business Cycle Theory contends he would.’’ The second category would include those who claim that ABC is, empirically speaking, irrelevant, because it lacks causal adequacy. The second type of critic might say, ‘‘I grant that Austrian Business Cycle Theory is logically sound, but we never see any real cycles that are explained by it.’’ In this chapter, we will address primarily the ﬁrst group of critics, who claim that ABC is not a plausible theory of market participants’ actions, so that as an ideal type it lacks explanatory adequacy. Callahan and Garrison (2003) attempts to deal with the second group of critics, at least to some extent, by demonstrating that the boom-and-bust cycle of the late 1990s was very much an Austrian-type cycle. (We say ‘‘to some extent’’ because showing that ABC helps explain a single cycle does not, of course, defend it against charges that it is not broadly relevant.) Others have made similar efforts for other business cycles, for example, Rothbard (2000 [1963]).

3. IDEAL TYPES EMPLOYED IN THE CONSTRUCTION OF THE AUSTRIAN BUSINESS CYCLE ABC, as we understand it, relies on several praxeological ideal types, including: All action is spurred on by a desire to bring about future conditions that seem pleasing and to avoid those that do not. Interest is, ﬁrst and foremost, a manifestation of time preference, i.e., actors, all other things being equal, prefer a satisfaction sooner rather than later. Economic goods can be divided into consumption, or ﬁrst-order goods, and higher-order goods. Value ﬂows from consumption goods to the higher-order goods that produce them. Another way to look at this is that something is a

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higher-order good if and only if it is a part of someone’s plan to produce a consumption good. One higher-order good can be a complement for another, so that each of them must be available for certain production plans to proceed as envisioned. Capital goods are heterogeneous, meaning that various capital goods are not perfect substitutes for each other, and such more-or-less speciﬁc goods require time both to create and to redeploy. Such types, unless their very construction is plagued by errors in praxeological reasoning, are always adequate both explanatorily and causally, because they operate at the very high level of abstraction of homo agens or at least the ‘‘money user’’ of catallactics. If our reasoning is sound, the type we postulate will necessarily lead to the sorts of actions it hopes to explain.5 And because praxeological types are based on the postulates that create the practical world of action, they will be empirically applicable to any events in which human action is present. However, as soon as we consider ideal types on lower levels of abstraction than that of pure praxeological types, we ﬁnd that we can conceive of types that are explanatorily sound, but that have no applicability to the world in which we live. For instance, Mises 1996 [1966] brieﬂy explored the nature of an economy in which the disutility of labor was absent (p. 131) Such a construct, while possessing explanatory adequacy, lacks causal adequacy, because it has no applicability to the world in which we actually live. (Mises recognized this: he examined a catallaxy without disutility of labor only to demonstrate that praxeology can explore modes of action that are purely theoretical.) Whenever we descend in degree of abstraction from praxeological types into more concrete types, the question of causal adequacy will arise, and should be addressed by the theorist employing the type(s) in question. We will not venture, in any depth, into ABC’s employment of purely praxeological types, since the reliance of ABC on such types has been adequately explored in the foundational work by Mises and Hayek. However, we suggest that ABC, besides being constructed from these highly abstract praxeological types, is also built from ideal types of lower levels of abstraction, whose use has been overlooked by many advocates and critics of the theory. Among such types are: The creation of a Ponzi scheme. A ‘‘mania’’ in some particular market. A central bank credit expansion mainly ﬂowing into capital markets.

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Savvy investors. Naı¨ ve investors. The Prisoner’s Dilemma. The presence of a Big Player in the interest rate market.

The above types, unlike praxeological ones, are not universal. We can conceive of human action taking place without the existence of any individuals or individual actions conforming to them. And yet, if they are often present in the social world in which we actually live, ABC will have broad, even if not universal, applicability. A brief outline of Austrian Business Cycle Theory runs as follows. The central bank can temporarily create an investment boom by forcing interest rates down below the rate that reﬂects the underlying time preferences of savers and borrowers. It ‘‘papers over’’ the shortage of loanable funds that would otherwise emerge due to the nonmarket interest rate by creating money through open market operations. In the canonical version of the ABC, the newly created money ﬂows ﬁrst into capital markets because it is assumed that the actors selling bonds to the central banks are active players in those markets. When the new funds make their way into the hands of those desiring to increase their level of investment beyond what it had been before the credit expansion, it therefore increases their demand for capital goods. An increase in the quantity of money in an economy does not increase that economy’s productive capacity. The excess supply of money does not call new goods into existence from nothing. Any increase it prompts in the production of some goods must eventually come at the expense of the production of others. More speciﬁcally, if in an Austrian cycle more capital goods are produced in certain industries as an initial response to the credit expansion, then that increase must come at the expense of a decrease in the production of either consumer goods, other capital goods, or both. Unlike Keynesian and other models where consumption and investment are assumed to move together, the key insight in the ABC is that they are in competition for resources. Inﬂation can, as Garrison (2001) argues, enable both to expand at the same time for the very short run of the start of the business cycle, but the fact that consumption and investment compete with each other over time is part of the process that turns the inﬂation-generated boom into the bust. The central bank may be able to initially direct the new money toward capital markets, but in a market economy there is no way it can prevent that money, over time, from ﬂowing into the hands of those who wish to demand

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more consumer goods. Sooner or later, the demands for the complementary investment goods needed to complete projects initiated during the credit expansion, and for additional consumer goods demanded by consumptionoriented actors, tug at the structure of production from opposite ends (Garrison, 2001). With the same resources to go around, attempting to expand both consumption and investment is unsustainable. Like overstretched taffy, the structure comes to contain gaps, places where certain capital goods were expected to be available, but in fact are not, at least not at the price at which businesses had planned to acquire them.6 Entrepreneurs ﬁnd that they are not able to complete all of the production plans they had launched subsequent to the inﬂux of new money, since some capital goods necessary to the completion of their plans either do not exist or are more scarce (and therefore more expensive) than their initial plans had envisioned. To see the relevance of the particular ideal types the theory makes use of, suppose that instead of the excess supply of money ﬁrst ﬁnding its way into the hands of producers, it ﬂowed ﬁrst to consumers. Rather than a story that starts with increased expenditures on higher-order goods and the resulting failure of the plans based on them due to the scarcity of complementary investment goods, we would tell a story that begins with an increase in consumer spending, leading to a sequence of events different from an Austrian cycle. Roger Garrison (2001, pp. 75–76) brieﬂy explores this alternative scenario where the excess money supply ‘‘makes its initial appearance as transfer payments to consumers.’’ The result would be an expansion of investment goods closer to consumption, setting off a cyclical process with some interesting variations from the traditional Austrian cycle. Garrison justiﬁes the traditional version by arguing that ‘‘lending money into existence y accords with much historical experience.’’ We might also note that the ideal type of a credit-based inﬂux of new funds meets Weber’s notion of ‘‘explanatory adequacy’’ in that there is interest to be earned from such lending, and not from pure transfer payments. It seems understandable that both central banks and ﬁnancial intermediaries would prefer the former to the latter. It is clear that the adequacy of the ideal types embedded in the theory is a crucial question to be addressed. In the sections to follow, we address the role played by several of the speciﬁc nonpraxeological ideal types in the Austrian Business Cycle Theory. We attempt to show how each has been misunderstood by critics and how clarifying the nature of the ideal-typical construct can serve to clear up that confusion.

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4. RATIONAL EXPECTATIONS AND AUSTRIAN BUSINESS CYCLE THEORY The importance of the adequacy of ABC’s ideal types becomes clear in reading criticisms of the theory. As we read those critics of ABC who seem to understand the theory well, their primary theoretical complaint is that it is unrealistic to expect that entrepreneurs will increase capital spending in response to a reduction of interest rates by the central bank.7 Most entrepreneurs are not fools, such critics note. Soon enough, entrepreneurs will learn that additional capital expenditures undertaken because of a central bank credit expansion will not be proﬁtable in the long run. As Tullock (1988) puts it: The second nit has to do with Rothbard’s8 apparent belief that business people never learn. One would think that business people might be misled in the ﬁrst couple of runs of the Rothbard [Austrian] cycle and not anticipate that the low interest rate will later be raised. That they would continue unable to ﬁgure this out, however, seems unlikely.

We will attempt to demonstrate that once the various ideal types employed in constructing ABC are made explicit and carefully analyzed, then criticism such as Tullock’s will prove to be unfounded. In particular, we can clarify some of this misunderstanding by contrasting the ABC with standard rational expectations approaches. As Tyler Cowen notes in his examination of ABC: ‘‘The older Austrian theories never explicitly spell out their expectational assumptions, and for this reason these theories are hard to evaluate’’ (2000, p. 91). That is not true of the rational expectations school of macroeconomics, whose adherents certainly have explicitly spelled out their expectational assumptions; however, those expectations strike us as highly unrealistic, and, moreover, unrealistic in a way that vitiates their analysis. Per rational expectations theorists, ABC can be dismissed because it violates their central tenet, which is that economic actors have expectations that are ‘‘rational.’’ This means that actors’ expectations are the best possible forecast of the future state of the economy, given the knowledge they have and the cost of acquiring better information. Their expectations may prove to be entirely unfounded, as events play out in ways that differ from their ‘‘best possible forecast.’’ The rational expectations hypothesis only holds that no one could have predicted those events more accurately, except by pure chance. Although he is not offering a full-blown rational expectations alternative, Tullock’s critique of ABC is typical of this approach. Within the traditional rational-expectations model, it is hard to imagine why investors would

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choose to bid up asset prices, in response to easy credit, if it is clear that many assets will later decline in price. Such models generally posit a single set of expectations prevailing throughout an economy. The model of island economies and inﬂation (Lucas, 1972) is not really an exception here, because the actors it describes differ only in that their knowledge of the macroeconomy is limited by their locale, and other than their geographical location they are all identical. There is just one economic actor in such models, cloned as many times as is necessary to fully populate it. All producers and all consumers must respond in the same way to a credit expansion, since they all share the same expectations. Once we alter that assumption, a different picture emerges. Consistent with an Austrian emphasis on the fact that different people know different things and thus form their expectations differently (Hayek, 1937), the ABC can be understood as assuming that actors have expectations that are to some degree heterogenous. The ABC can be understood as populated by two types of investors, the savvy investors and the naı¨ve investors. Although such a picture still represents a gross simpliﬁcation of the real world – investors actually exhibit a broad spectrum of naı¨ vete´ and savvy – it sufﬁces for our purposes and it signiﬁcantly alters the outcome predicted in rational expectation models. As a ﬁrst-cut at deﬁning the two types, we could say that the savvy investor buys an asset when he has reason to believe that its price will increase, based on his estimate of the future state of the market. The naı¨ ve investor buys an asset when he sees that its price has increased. Of course, even on the part of the naı¨ ve investor, there is an expectation of future gains. However, his expectation is founded on the mere fact that the price of the asset in question recently has gone up, and his belief that whatever happened in the immediate past will continue happening indeﬁnitely into the future. The idea that the form of past events will emerge, unaltered, again and again in the future has been very useful to the physical sciences. Although not as successful in gauging the future course of customs, traditions, and moral practices as it is of purely physical happenings, it is still a good ﬁrst hypothesis, to be abandoned only when events demonstrate that a period of cultural transformation is underway. But believing that recent trends in ﬁnancial markets are a reliable indicator of future events is far more dubious, and more dangerous to the believer. Shiller (2003, pp. 96–97) presents the same basic division of investors as does this chapter, although he refers to the two types as ‘‘smart money’’ and ‘‘ordinary investors.’’ (He also refers to the latter as ‘‘feedback traders.’’) He points out that mainstream theoretical work offers models where the savvy investors actually amplify trends begun by feedback traders, ‘‘in

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anticipation of the price increases they will cause.’’ And he cites recent research presenting strong empirical evidence that the two types of investors that we posit correspond at least roughly to reality. In a situation where savvy investors believe that they can proﬁt for a time from naı¨ ve investors’ enthusiasm for some price trend, another ideal type may come into play, one which we will call the Ponzi scheme. In everyday usage, a Ponzi scheme is a scam, one where funds from later investors are funneled straight to earlier ones, creating the appearance that the scheme is highly proﬁtable. Of course, as the scheme is bound to run out of investors at some point, it is inevitable both that it will crash, and that there will be more losers than winners when it does. We suggest that particular asset markets sometimes are closely analogous to a Ponzi scheme. Savvy investors recognize that some upward price trend for some asset cannot continue very far into the future. However, they believe the asset’s price will keep rising in the near term, because it has captured the interest of naı¨ ve investors. They may be able to proﬁt from the price rise, if they are able to sell before the bubble bursts. Meanwhile, naı¨ ve investors, entranced by the recent price rise of the asset in question, give little consideration to the long-term sustainability of such increases. Instead, noting that others have made proﬁts by investing in the asset, they believe that such proﬁts will continue indeﬁnitely. They pay no heed to how many potential investors remain who have not yet invested in the trend, or to whether the productive activity standing behind the asset better meets some consumer demand than do alternative investments. Naı¨ ve investors pour money into the scheme based on the fact that others previously have done well by participating in it. As Shiller (2003, p. 94) says: ‘‘Real world stock-market speculative bubbles y resemble Ponzi schemes in the sense that some ‘new era’ story becomes attached to the bubble and acquires increasing plausibility and investor enthusiasm as the market continues to achieve high returns.’’ As the term is typically used, one or more people deliberately create a Ponzi scheme, planning to ensnare naı¨ ve investors. But in our use of the Ponzi scheme as an ideal type, it is not necessary that anyone willfully initiate it. It is sufﬁcient that a group of savvy investors recognizes that an unsustainable, rising trend in the price of some asset (or class of assets) is underway, and that they decide to participate in the bubble in the hopes of selling before naı¨ ve investors realize that it will burst. Whether or not a particular bubble was deliberately inﬂated is a question to be answered by historians investigating the events around its inception. The applicability of the above ideal types – the naı¨ ve investor, the savvy investor, and the Ponzi scheme – is well documented in

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the literature on the history of ﬁnance. When all are present, they compose the ideal type ‘‘ﬁnancial market mania,’’ employed frequently to explain booms and subsequent busts in particular asset or types of assets, since at least the 19th century publication of Mackay’s Extraordinary Popular Delusions & the Madness of Crowds. Shiller (2000) is a prominent, recent advocate of mania theory, using it to explain the Internet boom of the late 1990s. Mackay (1980 [1841]) relates that many early investors in both the Mississippi Scheme and the South-Sea Bubble sold their shares near the height of the market. Meanwhile, it was often the people who were not normally speculators, but who, inspired by the mania surrounding these schemes, had scraped together their entire savings to invest in them, who bought as the bubble neared its height, and were ruined by the subsequent collapse. Financial writer Andrew Tobias (1987, p. 87) reports: ‘‘A Washington D.C. investment club purchased 200 shares of stock at 18. ‘Club sold all holdings at 12½ y due to decline in price; it intends to reinvest when price moves up.’’’ As Tobias pointedly asks, ‘‘What kind of investment strategy is that?’’ (All italics in original.) A similar sort of ‘‘strategy’’ can be seen at work when many mutual fund investors buy the fund that went up the most the previous year. Tobias (in Mackay, 1980 [1841], pp. xii–xiii) describes the ‘‘send-a-dime’’ chain letter that originated in Denver in 1935. During the course of this Ponzi scheme, ‘‘in Denver alone, postal volume swelled by some 160,000 pieces of mail a day. The craze spread across the country (and across the Atlantic), jumping in many places from a dime to ﬁve dollars and more.’’ But soon enough, the ‘‘AP reported ‘sad-faced men and women walked around in a daze y seeking vainly for someone to buy their chain letters.’ Everybody now had a letter to sell; no one was left to buy.’’ As Tobias notes, the ‘‘send-a-dime’’ chain letter was not a unique event: ‘‘Chain letters appear periodically. Just last year one rose to prominence – only this time at $100 a crack. y Virtually everyone lost his money.’’ Shiller (2003, p. 94) notes: ‘‘A number of Ponzi schemes in Albania 1996–1997 were so large that total liabilities reached half a year’s GDP; their collapse brought on a period of anarchy and civil war in which 2000 people were killed y’’ A thorough examination of the psychological basis of mania theory is beyond both the scope of this chapter and our expertise. Nevertheless, the type seems plausible in its construction. The fact that manias occur in areas of social life besides ﬁnancial markets, such as the witch mania during the 16th and 17th centuries (Mackay, 1980 [1841]), 20th-century teen frenzies

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over Frank Sinatra, Elvis Presley, and the Beatles, the enthusiasm during the 1960s for hoola-hoops, the 1970s fad for pet rocks, and numerous other examples that the reader no doubt can supply, suggests that, indeed, people may become caught up in a trend simply because other people also are caught up in it. Shiller (2003, pp. 93–94) presents recent empirical work showing that the view of investor behavior relied on in mania theory, or what he refers to as ‘‘feedback models,’’ is realistic. If the traditional rational expectations model were a close ﬁt to reality, Ponzi schemes and manias would be extremely rare or nonexistent. The fact that they have occurred frequently through history is evidence that, however useful the idea of rational expectations may be as a theoretical limiting case, it does not describe most real market participants particularly well. It is worth noting, at this point, that there is now a large literature, positing the existence of ‘‘rational bubbles.’’ Such bubbles do not require that agents act irrationally; in fact, such models assume rational expectations but posit endogenous mechanisms by which even under those circumstances asset values can become unhinged from fundamentals. The problem with such models is twofold. First, they simply demonstrate the mathematical possibility of a bubble even with rational expectations. What they do not do, in and of themselves, is to provide any reason to think such bubbles are an economic possibility. The models’ claim that asset prices become disconnected from fundamentals is paralleled by the models’ structure in which the mathematical system becomes disconnected from economic reality, e.g., the unreality of the standard assumptions of rational expectations models. Second, and more important in our view, is that our reading of the historical record is that virtually every notable ‘‘bubble’’ has been the result of ‘‘reasonably rational’’ actors responding to the irrational signals generated by various Big Players as discussed in Section 7. The presence of Big Players can distort the price signals that guide rational actors and thereby lead to irrational results like bubbles. We simply do not have any real historical examples of bubbles arising without such exogenous factors. Viewing the Austrian theory as an instance of such ‘‘rational’’ responses to irrational signals generated by the central bank helps to clarify why pure ‘‘rational bubble’’ models are insufﬁcient. Historically, one needs exogenous forces that undermine the feedback mechanism of the price system to generate bubbles. This is the missing piece from ‘‘rational bubble’’ models and that lack of historical support makes their relevance highly suspect. When rational expectations theorists ask proponents of Austrian Business Cycle Theory, ‘‘What about expectations?’’ they mean the single set of

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expectations that their models posit to be uniformly held by everyone involved in a market, including potential investors who might enter it. Once we allow expectations to differ among investors, even in as simple a way as our dichotomy of savvy and naı¨ ve investors, the rational expectations objection to ABC evaporates. As long as the savvy investors feel they have a good chance of being able to sell to the naı¨ ve investors before the bubble bursts, it is rational, in the sense of being ﬁnancially beneﬁcial, for them to participate in its expansion. And the naı¨ ve investors, by the very deﬁnition of the type, have naı¨ ve rather than rational expectations about the future state of the bubble. If a rational expectations critic of ABC wishes to contend that the ideal type of the naı¨ ve investor has no applicability to our actual world, then he must explain the continuing occurrence of chain letters, Ponzi schemes, multilevel marketing plans, and state lotteries. In other words, is the ideal type of ‘‘the rationally expecting economic actor’’ causally adequate?

5. HOW AUSTRIAN BUSINESS CYCLE THEORY COMPLEMENTS PONZI SCHEME AND MANIA THEORIES However, the type ‘‘ﬁnancial market mania’’ does not explain, by itself, why ﬁnancial manias occur at certain times and places, but not at others. No one, to our knowledge, has presented convincing evidence that particular eras or regions have had especially high concentrations of greedy people willing to take advantage of others or gullible folks ready to be taken advantage of. If mania theory is to stand on its own as a complete explanation of booms, then, since manias occurred in the United States in the 1920s, the 1960s, and the 1990s, but not during other recent decades, we would have to be convinced that the mania decades were characterized by peaks of greed and gullibility that subsided during other times. The positing of differences in expectations that might make manias possible is only a necessary condition for manias; it is not a sufﬁcient one. It seems more realistic to assume that at any moment there are many more or less savvy investors and many more or less naı¨ ve investors in most markets. If mania theory were a complete explanation for booms, it would seem that asset bubbles should be more frequent than they are given the omnipresence of the two types. Here, the ideal type ‘‘central bank credit expansion’’ supplies a triggering mechanism that explains why manias occur when they do. The promoters realize that during a credit expansion, the new

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money ﬂowing into the economy creates a temporary sense of increased wealth. They can capitalize on that illusion to generate enthusiasm for the class of assets they wish to promote. And we will note that the asset class that winds up being hyped often is, in fact, a truly breakthrough area in the economy. Although the dot com boom was an example of an Austrian-type cycle generated by central bank activity, the advent of the Internet itself was a change of major economic importance; it has altered dramatically the face of the world economy in a way that few, if any, envisioned just a decade ago. The ‘‘hype’’ is not in the notion that the ‘‘new thing’’ is important, for it often is. Rather, it is the suggestion that every single company entering the new ﬁeld will turn out to be a source of endless riches. The housing market boom and bust of the 2000s, fueled by overly expansionary monetary policy starting in 2001, is yet another example of this pattern. More generally, any true mania will have to have a source of funds that enables asset prices to diverge from fundamentals for an extended period of time. Even a Ponzi scheme can only last for so long or spread to a limited number of people before being revealed, unless there is a source of funds outside of the scheme itself that allows it to grow. The same is true of other kinds of asset bubbles and manias. The source of those funds is often central bank expansion directly, but can also be other, regulatory, manipulations of the banking system or interest rates. The ABC illustrates that typical manias and cycles require both the ideal types of investors with different expectations and the catalytic role of extra-market sources of funds. Without the ideal type contstructs in question, theories of manias and cycles will be insufﬁcient. And, to return to our central argument, evaluating the ABC requires that one understand the role played by these ideal types.

6. THE ACTIONS OF THE BUSINESSMAN DURING AN AUSTRIAN BUSINESS CYCLE The types naı¨ ve investor and savvy investor can help to explain the actions of ﬁnancial market participants during a credit expansion. But would the people who actually are managing businesses expand their operations during the boom? Surely, a critic of ABC might claim, enough of them are savvy investors, as demonstrated by their successfully maintaining a business, that we should not see widespread malinvestment by ﬁrms during a credit expansion. Here, the ideal type of the Prisoner’s Dilemma is useful in

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answering such a complaint. Mises (1996 [1966]) himself anticipated this application of the Prisoner’s Dilemma to support ABC: Of course, in order to continue production on the enlarged scale brought about by the expansion of credit, all entrepreneurs, those who did expand their activities no less than those who produce only within the limits in which they produced previously, need additional funds as the costs of production are now higher. (pp. 553–554)

Carilli and Dempster (2001) formalize Mises’ insight by explicitly using the Prisoner’s Dilemma to explain why rational entrepreneurs might participate in a credit expansion. In the standard Prisoner’s Dilemma story, two people are accused of committing a crime and imprisoned in separate cells. They are given the choice of confessing or not confessing. If neither confesses, both get relative light sentences because the evidence against them is weak. If one confesses and provides evidence on the other, that person gets a very light sentences (less than if neither confessed) while the other gets a very stiff sentence. If both confess, they get moderately stiff sentences, worse than if neither confess, but not as bad as being ratted out by the other. The ‘‘best’’ collective outcome is for neither to confess, but each individual prisoner sees it in his interest to confess no matter what the other one does. If the other confesses, the one in question is better off confessing and avoiding the really stiff sentence. If the other one does not confess, the better option is to confess and get the very light sentence. Each individual acting in his self-interest produces an outcome that is less than socially optimal. In Carilli and Dempster’s paper, the central bank plays the role of the ‘‘prison authorities.’’ The ‘‘prisoners’’ are the entrepreneurs. The best net result for entrepreneurs considered as a whole indeed occurs, as rationalexpectation theorists would have it, when none of them take advantage of the artiﬁcially low interest rates brought about by the credit expansion, the equivalent of both prisoners not confessing. But for any individual entrepreneur, the worst result is when he fails to take advantage of the low rate while one or more of his competitors do take advantage of it. (This is equivalent to the box where one of the prisoners does not confess but his cohort does.) And the best result for each individual player is when he does take advantage of the credit expansion while his competitors do not. (The box where the prisoner does confess but his cohort does not.) Since no entrepreneur can count on all of his competitors to abstain from using the easy credit, his rational choice is to confess, in other words, to jump into the boom as quickly as possible. Putting Carilli and Dempster’s argument in our terminology, the ‘‘irrational’’ behavior that the ABC seems to rest on is instead an assumption about the relevant ideal typical behavior that is in

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play. Viewing entrepreneurs as participants in a Prisoner’s Dilemma game helps to provide the necessary explanatory adequacy.

7. THE BIG PLAYER AND THE AUSTRIAN BUSINESS CYCLE Another ideal type we suggest is important to the construction of ABC is that of the Big Player, as developed by Koppl, Yeager, and Butos (see especially Koppl, 2002, but also Koppl & Mramor, 2003; Koppl & Yeager 1996; Butos & McQuade, 2006). The Big Player is a single actor who can exert a major inﬂuence on the course of the economy, at least in the short term and who is immune to the forces of proﬁt and loss. As Koppl and Yeager (1996) puts it, ‘‘A Big Player is anyone who habitually exercises discretionary power to inﬂuence the market while himself remaining wholly or largely immune from the discipline of proﬁt and loss’’ (p. 368). Most often, but not necessarily, the Big Player will be a government ofﬁcial. It is also possible to envision, for instance, the manager of a very large investment fund fulﬁlling the type. The signiﬁcance of the Big Player is that other economic actors, when active in the area where the Big Player exerts his inﬂuence, must orient their actions to the personal psychology of the Big Player. In markets without a Big Player, actors can use highly general ideal types in making their plans. They merely need to assume, for instance, that ‘‘wheat buyers’’ will purchase more wheat if the price drops. They need not consider the buyers on any level more concrete than as agents who wish to purchase a commodity as cheaply as possible. They do not concern themselves with the individual personality of wheat buyers, but only with their behavior in their functional role as purchasers of wheat. But when a Big Player is active in a market, other participants must take into consideration his personality and his particular thoughts. They cannot treat him as a somewhat abstract ideal type, such as ‘‘a wheat buyer,’’ but must attempt to understand him as an individual, albeit an individual ideal type. The problem Big Players create is that they increase the ‘‘epistemic burden’’ on market participants. In the world of the market, people already have to form expectations about the behavior of anonymous others, understand any natural processes that might be relevant, learn about competing products, etc. The acts of interpretation and appraisement that markets involve already require signiﬁcant knowledge. When a Big Player enters, that process becomes even more burdensome to the actor. The result will be resources devoted to ﬁguring out the behavior of

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the Big Player that could better be used producing the product in question, as well as a greater likelihood of error given the difﬁculties in getting the Big Player right. In the context of ABC, the Big Player is generally the head of the central bank of the country undergoing an Austrian cycle. If the central bank pursues a discretionary, rather than a rule-oriented, monetary policy, then the particular ideas of the chief central banker (and perhaps of other key central bank actors) must be taken into account by participants in the markets affected by central bank policy. As there are few, if any, ﬁnancial markets not affected by central bank policy, this fact renders ﬁnancial markets less predictable than they would be absent a Big Player. Thus, we see a mini-industry has developed that is devoted to divining what the current head of the American Federal Reserve is thinking about the economy, and we ﬁnd actors in the ﬁnancial markets awaiting his public pronouncements with bated breath. Trading volume will generally drop off considerably immediately before a speech by the chairman of the Fed, then surge as his opinion becomes known. Cowen (1998, p. 94) contends that an investor who understood that an Austrian cycle was underway could simply short medium-term bonds, not only personally proﬁting but also dampening the boom. His criticism fails in two respects. First of all, an investor must be extremely cautious when taking part in any market where a Big Player is active. He may realize that the Big Player is starting a trend that cannot be continued indeﬁnitely. However, he does not know how long the Big Player will attempt to continue his policy, nor how much capital he is willing to devote to it. And central bankers, with the power to create new money, have an almost unlimited power to commit resources to a policy goal. The fact that by doing so they drain value from the holdings of others, for instance from savings accounts or ﬁxed annuities, the value of which declines due to inﬂation, does not alter this fact. Therefore, shorting the trend is extremely risky. One can be entirely correct in one’s belief that an unsustainable boom is underway, but go broke by misestimating how long that boom will continue. However, even if we grant an investor extremely accurate insight into the future actions of the Big Player, he still would not be likely to act as Cowen says he would. Instead, he would attempt to proﬁt from the boom so long as his insight told him the Big Player would act to sustain it – thereby contributing to the bubble. Only at the point where his insight indicated that the Big Player was prepared to reverse course and deﬂate the bubble would he short bonds. After all, if his insight into the behavior of the Big Player really is accurate, there is no reason for him to proﬁt from it only when the

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bubble pops. He might as well proﬁt as it is inﬂated as well. In fact, we believe that this is a good approximation of the behavior of the savvy investor during an Austrian-type cycle.

8. CONCLUSION This chapter has forwarded the notion that Austrian Business Cycle Theory is a complex ideal type constructed from a number of other ideal types of varying degrees of abstraction. Once the types employed are made explicit and fully understood, we contend that a number of the controversies about the theory are largely dispelled. Furthermore, in the understanding of ABC presented here, ABC is an alternative to, rather than a contradiction of, other possible explanations of downturns. For instance, real business cycle theory, which models downturns as resulting from ‘‘external shocks,’’ seems a quite plausible account of the long decline occurring in the Western European economy between roughly 200 and 700 CE, as ﬁrst the invasion of the plague severely reduced the population of the region, after which the rise of Islam cut off trade routes to the East. Therefore, in the view of ABC outlined in this chapter, those who wish to contend that ABC explains a particular downturn, or who wish to contend that it applies to most downturns in recent economic history, still have a signiﬁcant task before them: they must demonstrate that, for any particular downturn, the ideal types composing ABC are applicable. But it is only our historical understanding of the events in question that can guide us in applying ABC. As Mises (1996 [1966]) put it: Whether or not the employment of a deﬁnite ideal type is expedient and conducive to an adequate grasp of phenomena can only be decided by understanding. It is not the ideal type that determines the mode of understanding; it is the mode of understanding that requires the construction and use of corresponding ideal types. (pp. 60–61)

Critics of ABC face the same task. They must show that the particular ideal types that the theory deploys are not relevant for the speciﬁc instances the theory purports to explain. Doing so ﬁrst requires that the critics understand both that the theory is built on such ideal types and the role that these ideal types play in applying theory in general. These last two points have been missed in many critical discussions of ABC. We see this chapter as a ﬁrst step in ﬁlling that gap and we hope it prompts other proponents of ABC to frame the theory in these terms.

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NOTES 1. This particularly colorful characterization of ABC is from Yeager (1986, p. 378). For similar views by ‘‘Austrian friendly’’ economists, see, e.g., Cowen (1998) and Tullock (1988). Other critics include Lucas (1981) and Krugman (1998). 2. We are deeply indebted to Alfred Schutz’s explication of the theory of ideal types in our work here. See Schutz (1967 [1932]). 3. Upon encountering the above framework for examining ABC, some Austrians may immediately object that it is a serious error to employ the method of ideal type analysis to the theories of praxeological economics. What’s more, they can cite the originator of ABC, Mises himself, in defense of their position: Ideal types are speciﬁc notions employed in historical research and in the representation of its results. They are concepts of understanding. As such they are entirely different from praxeological categories and concepts and from the concepts of the natural sciences. y (1996, pp. 59–60)

Mises was on ﬁrm ground in rejecting the classiﬁcation of praxeological categories and concepts as particular species within the genus ‘‘‘ideal types’’’ if that genus is deﬁned as it was when ideal type theory initially was presented by Max Weber. However, Alfred Schutz, a disciple of both Weber and Mises, articulated a more reﬁned version of Weber’s ideas that he regarded as addressing Mises’ objection to including praxeological constructs among the examples of ideal types. But in Weber’s later thought, ‘‘ideal types are constructed by postulating certain motives as ﬁxed and invariant within the range of variation of the actual selfinterpretation in which the Ego interprets its own acts. y Both empirical and eidetic ideal types may be constructed. By empirical, we mean ‘derived from the senses,’ and by eidetic we mean ‘derived from essential insight’’’ (Schutz, 1967 [1932], pp. 243–245). Schutz contends that the theorems of praxeology (eidetic types in his terminology) are universal in that they operate at the highest possible level of abstraction available to the social theorist, that of homo agens. 4. Horwitz (2000, p. 121) makes a similar point in his discussion of inﬂation: ‘‘Rather than seeing the traditional Austrian [business cycle] story as a necessary consequence of inﬂation, or indeed the only sort of systematic set of consequences that will follow inﬂation, we can see it as one, perhaps the most likely, of a number of kinds of intertemporal discoordination that are induced by inﬂation.’’ 5. We mean this very broadly. For example, a perceived beneﬁt to be gained by greater availability of water in a community will, all other considerations set aside, lead to some sort of effort to increase its availability. This does not imply praxeology has any power to predict what form those efforts will take, other than that they will be the ones that appear to offer the greatest beneﬁt at the least cost. 6. See Callahan and Garrison (2003) for a description of how such gaps occurred during an actual cycle. 7. There is also a history of ABC criticism on the part of those who clearly do not understand it. Those, for example, who view it as a theory of systemic overinvestment, rather than as a theory of widespread malinvestment, but we will not address such obviously misguided criticism here.

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8. Tullock decided to take a pamphlet of Murray Rothbard’s as the canonical version of Austrian theory.

REFERENCES Butos, W., & McQuade, T. (2006). Government and science: A dangerious liaison? The Independent Review, 11(2), 177–208. Callahan, G., & Garrison, R. (2003). Does Austrian business cycle theory help explain the dotcom boom and bust? Quarterly Journal of Austrian Economics, 6(2), 67–98. Carilli, A. M., & Dempster, G. M. (2001). Expectations in Austrian business cycle theory: An application of the prisoner’s dilemma. Review of Austrian Economics, 14(4), 319–330. Cowen, T. (1998). Risk and business cycles: New and old Austrian perspectives. London: Routledge Press. Cowen, T. (2000). Risk and business cycles: Reply to Rosser. Critical Review, 14(1), 89–94. Garrison, R. W. (2001). Time and money: The macroeconomics of capital structure. London: Routledge. Hayek, F. A. (1937). Economics and knowledge (1948). reprinted in Individualism and Economic Order. Chicago: The University of Chicago Press. Horwitz, S. (2000). Microfoundations and macroeconomics: An Austrian perspective. London: Routledge. Koppl, R. (2002). Big players and the economic theory of expectations. London and New York: Palgrave Macmillan. Koppl, R., & Mramor, D. (2003). Big players in Slovenia. Review of Austrian Economics, 16(2/3), 253–269. Koppl, R., & Yeager, L. B. (1996). Big players and herding in asset markets: The case of the Russian ruble. Explorations in Economic History, 33(3), 367–383. Krugman, P. (1998). The Hangover Theory. Slate, December 4, Available at http://www. slate.com/id/9593. Retrieved on September 22, 2008. Lucas, R. E., Jr. (1972). Expectations and the neutrality of money. Journal of Economic Theory, 4, 103–124. Lucas, R. E., Jr. (1981). Studies in business cycle theory. Cambridge, MA: MIT Press. Machlup, F. (1978 [1936]). Why bother with methodology? In: Methodology of economics and other social sciences: Economic theory, econometrics, and mathematical economics (pp. 63–70). New York: Academic Press, Inc. Mackay, C. (1980 [1841]). Extraordinary popular delusions and the madness of crowds, foreword A. Tobias. New York: Random House, Inc. Mises, L. von. (1996 [1966]). Human action. Irvington, NY: Foundation for Economic Education. Rothbard, M. (2000 [1963]). America’s great depression. Auburn, Alabama: Ludiwg von Mises Institute. Schutz, A. (1967 [1932]). The phenomenology of the social world. translated by George Walsh and Frederick Lehnert. Evanston, IL: Northwestern University Press. Shiller, R. J. (2000). Irrational exuberance. New York: Broadway Books. Shiller, R. J. (2003). From efﬁcient markets theory to behavioral ﬁnance. Journal of Economic Perspectives, 17(1), 83–104. Tobias, A. (1987). Still the only investment guide you’ll ever need. New York: Bantam Books. Tullock, G. (1988). Why the Austrians are wrong about depressions. Review of Austrian Economics, 2(1), 73–78. Yeager, L. B. (1986). The signiﬁcance of monetary disequilibrium. Cato Journal, 6(2), 369–399.

THE FATAL CONCEIT OF FOREIGN INTERVENTION Christopher J. Coyne and Rachel L. Mathers ABSTRACT The fatal conceit is the assumption that the world can be shaped according to human desires. This chapter argues that the logic of the fatal conceit can be applied to foreign interventions which go beyond the limits of what can be rationally constructed by reason alone. In suffering from the fatal conceit, these interventions are characterized by: (1) the realization that intentions do not equal results, (2) a reliance on top-down planning, (3) the view of development as a technological issue, (4) a reliance on bureaucracy over markets, and (5) the primacy of collectivism over individualism. These characteristics explain why interventions extending beyond the limits of what can be rationally constructed tend to fail. The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design. – F.A. Hayek (1988, p. 76)

1. INTRODUCTION In his last book, F.A. Hayek (1988) analyzed the ‘‘fatal conceit,’’ which is the presumption that ‘‘man is able to shape the world around him according What is so Austrian About Austrian Economics? Advances in Austrian Economics, Volume 14, 225–250 Copyright r 2010 by Emerald Group Publishing Limited All rights of reproduction in any form reserved ISSN: 1529-2134/doi:10.1108/S1529-2134(2010)0000014014

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to his wishes’’ (p. 27). The fatal conceit assumes that because rules that facilitate coordination emerged through human action, it is possible for planners to design a set of rules that will generate a preferable outcome. Hayek argued that socialism suffered from a fatal conceit because it assumed knowledge on the part of planners that they could not possibly possess. Further, it overlooked the fact that many of the rules facilitating cooperation were spontaneous orders, which arose through purposeful human action, but not through human design. These emergent rules allowed for what Hayek called the ‘‘extended order,’’ but they were not the result of a grand plan or of human design. The central argument of this chapter is that the logic of the fatal conceit can be applied to foreign interventions that go beyond the limits of what can be rationally constructed through human reason. Foreign intervention, which can take a variety of forms, refers to the use of the discretionary power of one government to address perceived problems in foreign societies. In addressing these problems, foreign interventions aim to construct a preferable state of affairs from the standpoint of those intervening. Our argument is not that foreign interventions can never succeed. Indeed, Hayek (1988, p. 37) was clear to note that rationally designed rules and institutions played an important role in the operation of all societies. At the same time, Hayek (1973, 1988, p. 22) was careful to note that rational constructivism was constrained by deﬁnite limits. In other words, man is limited in his ability to consciously construct social rules and institutions through the use of reason. This implies that foreign interventions will be more likely to fail when they go beyond the limits of what can be rationally constructed. We focus on two forms of intervention – foreign aid and military intervention – which often involve complex plans to rationally design a variety of rules and institutions and, hence, push the limits of designed orders. We realize that the limits of constructivism are often blurry and are not always easily deﬁnable. Nonetheless, appreciating the constraints of the rational design of a society’s institutions is important for understanding what interventions can effectively achieve and the damages they can potentially cause. Within this context, we explore the parallels between the fatal conceit of socialism as developed by Hayek (1988) and the fatal conceit of foreign interventions, which can be summarized as follows: 1. Good intentions do not necessarily lead to good results – Hayek (1988) noted that although socialism was driven by good intentions it endangered standards of living for a signiﬁcant portion of the population. Similar to socialism, foreign interventions are often driven by benevolent

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intentions. For example, foreign interventions often aim to help the poorest societies in the world or seek to address humanitarian concerns. However, many foreign interventions have failed to generate the desired results and in many cases have caused more harm than good in the form of negative unintended consequences. Reliance on top-down planning – Like socialism, many foreign interventions are grounded in central plans designed by the intelligentsia. In the context of foreign interventions, the intelligentsia consists of an array of ‘experts’ in the international development community and developed countries. Under both forms of planning, emergent institutions are neglected or viewed as secondary to the grand plan developed by experts. The view of development as a technological issue – Both socialism and many foreign interventions are grounded in the view that development is a ‘‘problem,’’ which can be solved through central planning. From this standpoint, success is mainly a technological matter, directly dependent on the amount of effort and resources invested in planning as well as on the execution of the plan. In both cases the underlying assumption is that intelligent and benevolent planners can design a plan that, if implemented properly, will yield an outcome preferable to the status quo. Reliance on bureaucracy over markets – Socialism was reliant on a massive bureaucratic apparatus to implement the dictates of central planners. Similarly, many foreign interventions take place through a large bureaucratic system which attempts to implement the central plan designed by the aforementioned experts. The primacy of collectivism over individualism – Mirroring socialism, many foreign interventions place collective goals over individual goals. Under socialism, individual freedoms and initiative were sacriﬁced for the good of the collective. Many foreign interventions, although often couched in the rhetoric of freedom, liberation, and self-determination, sacriﬁce individual autonomy for the achievement of global goals. Instead of allowing individuals to engage in self-determination and the process of individual experimentation and learning, foreign interventions rely on the plans of outside experts to maximize the global good.

These parallels provide insight into why interventions tend to fail when they extend beyond the limits of what can be rationally constructed. We proceed as follows. Section 2 clariﬁes what is meant by foreign intervention and discusses the extent of rational constructivism. Section 3 elaborates on the ﬁve parallels between the fatal conceit of socialism and the fatal conceit of foreign interventions. The following sections extend these

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parallels to two cases of foreign intervention which often suffer from a fatal conceit. Section 4 offers a history of development economics and foreign aid, providing a ﬁrm intellectual foundation for a wide array of foreign interventions in the form of aid and assistance. Section 5 discusses the use of military interventions to shape outcomes in foreign societies and explores how many of these interventions fall prey to the logic of the fatal conceit. Section 6 then concludes.

2. FOREIGN INTERVENTION AND THE LIMITS OF CONSTRUCTIVISM 2.1. What is Foreign Intervention? We envision foreign interventions as lying along a continuum of different methods and strategies. The two ends of the continuum reﬂect Nye’s (2004) distinction between ‘soft’ and ‘hard’ power. Soft power refers to getting the desired outcome through persuasion, whereas hard power refers to the use of coercion to achieve the desired end. At one end of the continuum are ‘softer’ interventions such as the control and dissemination of information and cultural products. As one moves along the continuum, interventions become ‘harder’ and may involve mediation, public denunciation, travel bans, the freezing of assets, embargos, sanctions, and peacekeeping and military activities, among other activities. The continuum of foreign interventions highlights several important points. First, whether a foreign intervention falls under the category of softor hard power is not always clear cut and is a matter of degree. Second, while strategies and methods within each general category of intervention vary in their complexity, as one moves from the ‘softer’ end of the continuum to the ‘harder’ end of the continuum, the associated interventions are more comprehensive and, hence, rely increasingly on rational constructivism. Because they push the boundaries of what can be rationally designed, interventions further along the continuum are more likely to suffer from a fatal conceit. To provide a concrete example, consider that releasing or controlling certain information (an intervention toward the softer end of the continuum) relies less on constructivism as compared to military occupation and the construction of a country’s economic, legal, political, and social institutions (an intervention toward the harder end of the continuum). Likewise, the delivery of targeted humanitarian aid is a less comprehensive

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intervention as compared to large-scale foreign aid projects which aim at society-wide reforms and fundamental changes to institutions. As such, the latter intervention is more likely to fall prey to the fatal conceit of foreign interventions. We are cognizant of the fact that the scale and scope of interventions varies greatly and that interventions may not ﬁt neatly into the categories listed earlier. Further, in some cases interventions may span several categories across the continuum. In general, as interventions increasingly rely on rational constructivism, they are more likely to suffer from a fatal conceit and, as a result, fail to achieve the desired end. Although the speciﬁc limits of constructivism can be blurry, the next subsection provides some insights into the outer boundaries of the ability of planners to rationally design a society’s institutions.

2.2. The Limits of Rational Constructivism Economic, political, and social outcomes are a function of formal and informal institutions (North, 1990, 1991). As the ‘rules of the game,’ institutions provide incentives which guide behaviors for better or worse. The central issue is how the institutional rules emerge and sustain over time. North (2005) and Boettke, Coyne, and Leeson (2008) conclude that the effectiveness of formal institutions requires certain informal institutions to serve as a foundation. Absent the proper informal institutions, formal institutions will either collapse or be dysfunctional. This realization begs the question of whether people can rationally design and shape the array of formal and informal institutions necessary for a workable society. In discussing the ‘extended order’ of a society’s institutions, Hayek emphasized the importance of emergent orders that were not the product of human plan and design. At the same time, he also recognized the role played by designed organizations in all societies. Hayek wrote that ‘‘among the rules of conduct that make it possible for extensive spontaneous orders to be formed, some will also facilitate deliberate organizations suited to operate within the larger system’’ (Hayek, 1988, p. 37). Although recognizing the importance of designed orders for the functioning of society, Hayek (1988) also pointed out their limits when he noted that ‘‘many of these various types of more comprehensive deliberate organsations actually have a place only within an even more comprehensive spontaneous order, and would be inappropriate within an overall order that was itself deliberately organised’’ (p. 37).

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Table 1.

Components of Institutional Capacity.

Component Organizational design and management Institutional design Basis of legitimization Social and cultural factors

Transferability High Medium Medium to low Low

Source: Fukuyama (2004, p. 31).

Further clarity to the limits of what can be rationally constructed is provided by Fukuyama (2004, pp. 31–32), who focuses on the ‘‘components of institutional capacity’’ and the transferability of knowledge associated with each component (summarized in Table 1). Within Fukuyama’s schemata, the transferability of institutional capacity is a function of the ability to formalize the knowledge associated with the institutional component. The formalization of knowledge is important for its communication in different contexts. Where knowledge cannot be formalized, it becomes difﬁcult, if not impossible, to transfer. The extreme case of this is Hayek’s (1945) notion of context-speciﬁc knowledge of ‘‘time and place’’ which cannot be formalized let alone transferred to different contexts. Given this, the knowledge associated with the ﬁrst component, organizational theory, is typically the most formalized and, hence, the most transferable across societies. As one moves down the list of institutional components, it becomes increasingly difﬁcult to transfer knowledge because the nuances of the component are more difﬁcult to formalize in any meaningful way. The implications are as follows. Foreign interventions which aim to inﬂuence the organizational design and management of institutions are the most likely to succeed because they remain within the boundaries of what can be rationally designed and transferred across contexts. In contrast, interventions aimed at inﬂuencing embedded social and cultural factors are the least likely to succeed because they tend to be beyond the limits of what can be rationally constructed. Given this, interventions aimed at changing the organizational design in countries where the existing social and cultural norms are at odds with these changes will tend to fail. However, in light of the difﬁculty of altering embedded social norms, even intervention efforts beginning with attempts to change these informal institutions are likely to be unsuccessful.

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3. FIVE PARALLELS BETWEEN THE FATAL CONCEIT OF SOCIALISM AND THE FATAL CONCEIT OF FOREIGN INTERVENTION This section develops the parallels between the fatal conceit of socialism formulated by Hayek and the fatal conceit of foreign interventions. These parallels are as follows: (1) intentions do not equal results, (2) reliance on top-down planning, (3) the view of development as a technological issue, (4) reliance on bureaucracy over markets, and (5) the primacy of collectivism over individualism. These ﬁve parallels provide insights into the frequent failure of interventions that go beyond the limits of what can be rationally constructed. Hayek (1988, p. 9) noted that despite the fact that socialism was inspired by the best of intentions, it ‘‘endangered the standard of living and the life itself of a large proportion of our existing population.’’ Like socialism, foreign interventions are typically driven by the best of intentions. For example, the goal of the provision of much foreign aid is to address the pressing issues of extreme poverty and reform in a variety of institutions. Likewise, the goal of many foreign military interventions is to resolve conﬂict, liberate the oppressed, and rebuild free societies. Despite these good intentions, foreign interventions have often failed to have the desired impact (see Easterly, 2001, 2006; Payne, 2006; Coyne, 2007). Further, in many cases, intentions to do good have caused harm and exacerbated already bad situations. One reason for the failure of many foreign interventions, despite being motivated by the best of intentions, is the reliance on top-down central planning, which suffers from the dual issues of incentives and knowledge. No matter what the type of foreign intervention, those involved must have the incentive to undertake actions conducive in achieving the desired end goal. However, the existing incentives often create perverse outcomes which run counter to the desired ends of the initial intervention. For example, in the case of foreign aid, Easterly (2001, 2006) and Easterly and Pfutze (2008) highlight how the incentives facing donors and aid recipients are often at odds with the stated goals of aid. Donors are often inﬂuenced by special interests and have the incentive to continue to provide aid to corrupt or ineffective governments to exhaust their aid budgets. Recipients often have an incentive to allocate aid to close friends and cronies to maintain or strengthen domestic political support. Many recipient governments also seek to limit the beneﬁcial effects of aid to

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remain a recipient in subsequent periods. The main point is that foreign aid changes endowments, but it also changes incentives. In order to understand the full impact of foreign aid, it is critical to consider the impact of that aid on the incentives of all involved. As an example of this point, consider Coyne’s (2007) exploration of the array of incentives facing policymakers, occupiers, and citizens in the occupied country, in which he concludes that their incentives are a key reason why foreign military interventions fail. The perverse incentives created by the interplay between special interests, bureaucracy, and the time horizons of elected ofﬁcials, among other factors, inﬂuence policies associated with these interventions. In addition to the issue of incentives, there is a fundamental knowledge problem associated with foreign interventions. For example, in the context of foreign aid provision, a central issue is how assistance is allocated. Decisions must be made regarding the allocation of aid, but absent feedback mechanisms such as proﬁt and loss, there is no effective means for engaging in rational economic calculation. In the absence of appropriate market feedback, allocation decisions must be based on other factors such as political inﬂuence and social connections. Similarly, where foreign military interventions attempt to reshape countries to mirror Western political and economic systems, policymakers face a knowledge problem regarding the complex array of informal institutions – belief systems, norms, values, etc. – that underpin formal institutions (Coyne, 2007). To illuminate this point, consider efforts to promote liberal democracy, a signiﬁcant motivation behind numerous interventions on the part of the development community and developed Western countries (see Meernik, 1996). These efforts assume that experts can comprehend the factors underpinning sustainable democratic institutions and transport them abroad. This neglects the fact that there is ongoing debate regarding the factors necessary for sustainable democracy. Consider, for instance, the following list of propositions put forth by Shin (1994) regarding the ‘‘third wave’’ of democracy (p. 151): (1) There are few preconditions for the emergence of democracy. (2) No single factor is sufﬁcient or necessary to the emergence of democracy. (3) The emergence of democracy in a country is the result of a combination of causes. (4) The causes responsible for the emergence of democracy are not the same as those promoting its consolidation.

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(5) The combination of causes promoting democratic transition and consolidation varies from country to country. (6) The combination of causes generally responsible for one wave of democratization differs from those responsible for other waves. As this list indicates, our understanding of the conditions conducive to sustainable democracy is severely limited. What is known is that success in foreign interventions is not simply a matter of taking the rules that work in one society and implementing or imposing them in another society. The ability to transport rules between societies is constrained by the fact that belief systems differ across societies (North, 2005). Ultimately, formal institutions are effective to the extent that they reﬂect the underlying belief systems of the societies in which they exist. Along these lines, Hayek (1973) highlighted the importance of traditions, including beliefs, ‘‘which in more fortunate countries have made constitutions work which did not explicitly state all that they presupposed, or which did not even exist in written form’’ (pp. 107–108). In short, effective formal institutions, such as constitutions, are codiﬁcations of complex underlying informal belief systems which are beyond the knowledge of any single mind or group of minds. As Hayek (1988) indicates, ‘‘our values and institutions are determined not simply by preceding causes but as part of a process of unconscious self-organisation of a structure or pattern’’ (p. 9). Foreign interventions relying on top-down, comprehensive plans must abstract from the reality of context-speciﬁc knowledge because interveners cannot possibly possess this local knowledge. The end result is one-size-ﬁts-all plans that tend to be general and nonspeciﬁc. The Washington Consensus, discussed in more detail in Section 4, is one example of this logic. The Washington Consensus provides a comprehensive checklist of reforms based on general principles which abstract from the local context where reforms will actually take place. At best this is a broad guide that adds little value to actual reforms, since it abstracts from the speciﬁcs of existing realities. Yet another shared characteristic of socialism and many foreign interventions is that both are grounded in the view of economic development as a purely technological problem. Socialism viewed the economic allocation of resources as a problem that could be solved through a central planning board. Many foreign interventions take this logic a step further by assuming that the numerous (e.g., economic, legal, political, and social) problems of foreign societies can be solved through comprehensive plans for reform and change. Given the assumption that the development intelligentsia can design a preferable state of affairs, the main issue becomes

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one of determining the right plan and calculating the required resources to achieve that plan. In this context, success is purely a matter of effort and not an issue of constrained or limited knowledge of how to go about achieving the desired ends. To illuminate this point, consider the work of Jeffrey Sachs (2005), a leading development economist and former director of the UN Millennium Project, which focuses on designing and implementing the organizational priorities and ﬁnancing necessary to achieve the Millennium Development Goals (MDGs). Sachs (2005) recognizes the numerous failures of previous foreign interventions and is cognizant of the fact that the MDGs include ‘‘long-held commitments of the international community that had not been fulﬁlled in the past’’ (p. 213). However, Sachs attributes this failure to a lack of will, effort, and resources instead of the constraints on the knowledge of development experts. From Sachs’ standpoint, development is a purely technical problem that can be solved purely through harder work and more resources. However, Hayek’s point in developing the logic of the fatal conceit was that wishing something so does not make it so. In other words, viewing development as a lack of will and effort implies that failure is a lack of work ethic and resources. This neglects the aforementioned issues of incentives and knowledge which constrain the effectiveness of foreign interventions. Reliance on bureaucracy is yet another similarity between socialism and many foreign interventions that rely on a vast network of bureaucracies to implement the plans designed by experts. The reliance on bureaucracy magniﬁes the problems of incentives and knowledge. There is a large literature exploring the political economy of bureaucracies. For example, Tullock (1965 [2005]) and Niskanen (1971) emphasize the incentive issues facing bureaucrats as well as problems in the transfer of information. First, as bureaucracies grow in size, the transfer of information becomes increasingly difﬁcult because of the ‘noise’ introduced due to the chain of transmission. One way around this is to decentralize decision making. However, this solution leads to an incentive issue because it must be ensured that incentives exist for all of the decentralized decision nodes to undertake actions that contribute to the common goal of the broader bureau. For obvious reasons, ﬁnding the appropriate balance between decentralization and incentive alignment can be a difﬁcult task. Mises (1944 [1983]) emphasized that bureaucracies have no means of engaging in rational economic calculation and, hence, no means of efﬁciently allocating resources. The result is waste due to a misallocation of resources that fails to achieve the desired end from the standpoint of those undertaking the

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action. These issues of bureaucracy have been documented as perversely impacting the delivery of foreign aid (Easterly, 2003) and the carrying out of foreign military interventions (Coyne, 2008). A ﬁnal parallel between socialism and various types of foreign interventions is the emphasis on collective goals over individual goals. Under socialism, the goals of the collective were given priority over the goals of the individual. A similar logic is at play in the context of foreign interventions, where development intelligentsia provide ‘‘collective goals such as national poverty reduction, national economic growth and the global Millennium Development Goals, over the aspirations of the individual’’ (Easterly, 2007, p. 32). These collective goals are given priority over the freedom and autonomy of the individual. As noted, the means to achieve these goals are top-down interventions through various bureaucracies. As such, emphasis on individual ambition, entrepreneurship, and the process of individual learning and experimentation are pushed aside in the name of accomplishing collective ends through top-down means.

4. THE FATAL CONCEIT OF FOREIGN AID There are various forms of aid and assistance. As its name implies, humanitarian aid is intended to help the victims of crises and calamities. Another form of aid is provided by charitable organizations and nongovernment organizations (NGOs). Systematic aid includes bilateral aid (government-to-government transfers) or multilateral aid (aid dispersed through international organizations such as the World Bank or International Monetary Fund, IMF). Systematic aid, coupled with technical assistance and advice, has been a dominant form of aid to underdeveloped countries. Aid is a type of foreign intervention in that it attempts to change the existing situation in the recipient country through external inﬂuence. In some cases, aid can be effective in achieving the desired ends of the donors. However, many interventions aimed at promoting development through foreign aid suffer from a fatal conceit. The efforts that fail tend to rely on large-scale, comprehensive plans to change the trajectory of underdeveloped countries (see Easterly, 2006). As such, these interventions go beyond the limits of what can be rationally designed through the use of reason. In order to comprehend the origins of the fatal conceit of the foreign aid, it is important to understand the evolution of development economics which provides a theoretical foundation for many of these large-scale interventions.

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In the broadest sense, development economics focuses on understanding the causes for the economic progress or stagnation of societies.1 Issues of economic development can be traced back to the earliest writings in economics, as indicated by the title of Adam Smith’s (1776 [1965]) classic, An Inquiry into the Nature and Causes of the Wealth of Nations. However, the modern development subﬁeld that exists today did not emerge until the 1930s (see Arndt, 1981; Bell, 1987). The rise of modern development economics was due to several factors and events.2 The increased availability of statistics and data, which allowed for crosscountry comparisons of standards of living, was a major factor in the rise of modern development economics. For example, Clark (1939) collected detailed data on the income accounts for the United Kingdom and is widely known for his work on national income estimation.3 The use of this aggregate data, which was part of the broader Keynesian revolution, provided a means of comparing the wealth of nations and economic development. Comparisons of income and other measures of progress made differences in development clear and highlighted the failure of certain societies to develop and progress. As such, these data were used to identify the countries in need of assistance and aid, providing justiﬁcation for comprehensive interventions to remedy the existing development gap. Global economic events starting in the late 1920s were yet another inﬂuence on the rise of modern development economics. The Great Depression in the United States led to questions regarding the stability of capitalism. These questions were further fueled by the industrialization of the Soviet Union through forced investment and saving. This supported the existing belief that widespread state planning was a critical element of the development process (see, for instance, Myrdal, 1956). In reviewing the early writing in development economics, Bell emphasizes that ‘‘if they shared anything in common, it is a distrust of the proposition that matters [of development] can be left to the market’’ (p. 825). The prevalence of the perceived need of large-scale state planning for development illustrates the essence of Hayek’s fatal conceit logic, where central planning replaced markets and emergent orders as a means of economic coordination. Yet another global event at this time was the newfound independence of former colonies, which led to numerous countries and societies with varying levels of development and institutional quality. These events led economists to focus on issues surrounding comparative economic systems and to further understand the factors contributing to development across societies. A ﬁnal inﬂuence was the 1940s rise of what today is known as the ‘‘international development community.’’ This community includes

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international organizations which attempt to facilitate economic, legal, political, and social stability and development around the world. The United Nations (UN) was founded in 1945 to uphold international law, to facilitate international peace and security, and to promote economic and social development. The World Bank and the IMF also emerged from the Bretton Woods Agreement as agencies of the UN. Several organizations within the World Bank are focused on economic development issues, whereas the IMF is closely involved in the global ﬁnancial system and the global macroeconomy.4 The creation of these organizations provided a centralized apparatus to carry out research regarding economic development across countries and to implement global programs and projects aimed at fostering economic development. Since the creation of its various elements in the 1940s, the development community has been a driving force behind global foreign interventions and has served as a centralized means of designing and carrying out comprehensive development plans. Development economics has always had an interesting relationship with the mainstream of the economics profession. The ﬁeld has historically drawn on concepts and techniques from both micro- and macroeconomics. Although development economists have embraced many aspects of the mainstream, they have been critical of others. Along these lines, much of the early development literature took issue with the orthodox reliance on perfect information and competition, constant returns to scale, the absence of transaction costs, and the assumption of market clearing (see Bardhan, 1993, p. 130). At the same time, the evolution of development economics was closely connected to work in mainstream macroeconomics. As an example of this latter point, consider that in the 1930s and 1940s, Harrod (1939) and Domar (1946) would independently develop what would become known as the Harrod–Domar model. Although the model was originally developed to analyze business cycles, it was extended to analyze economic growth.5 At the core of the model is the assumption that growth in output is driven by investment in capital, which is a function of savings. Given this, the model explains growth through levels of saving and the productivity of capital: g¼

s v

d

(1)

where g is the growth rate, s the savings, v the productivity of capital, and d the depreciation rate of capital.

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The prediction of the Harrod–Domar model is that growth is the result of increased savings and productive investments. The model was, and still is, attractive to many involved in economic development because it allows for either predictions of growth or for the calculation of the savings needed to yield a certain level of growth. The Harrod–Domar model was the impetus for two interrelated policies toward economic growth that became dominant in the development community. Both policies, discussed later, suffer from the fatal conceit. The ﬁrst was the ‘‘investment gap theory’’ of development. As per the Harrod–Domar model, the lack of growth in underdeveloped countries was attributed to a lack of saving and a lack of productive capital investments. Signiﬁcant aid from governments and the international development community were seen as the remedy to both of these problems.6 Analysts used the Harrod–Domar model to calculate the level of savings needed to achieve certain rates of growth in underdeveloped countries. This investment gap could then be ﬁlled by wealthy countries and the development community, who would provide aid to the governments of underdeveloped countries. In other words, developed countries could devise a comprehensive aid plan, which, if implemented, would overcome the lack of investment in poor countries. Second, the problem of making productive capital investments could be solved by a ‘big push’ through government-coordinated investments of foreign aid in a number of sectors and industries.7 This central planning through big push-style industrialization was often combined with mercantilist policies such as ‘import-substitution,’ whereby underdeveloped countries would rely on domestic substitutes for goods they would usually import.8 The idea was that developing countries should promote the development of domestic industries, which are typically underdeveloped or in their infancy. The means of promoting domestic industries was a comprehensive central plan by the governments of developing countries, aided by foreign governments, to pick winner industries and manipulate international trade to foster development. The use of the Harrod–Domar model and the associated investment gap and big push policies continue to be mainstays in the development community (see Easterly, 1997, 2001, pp. 35–37).9 Advocates of increased aid rely on the investment gap logic as evidenced by Sachs (2005), who attributes ongoing underdevelopment in the poorest countries in the world to the poverty trap (pp. 56–57). The central idea behind the poverty trap is that the income of citizens in these countries is so low that it barely covers the basic necessities required for survival. As such, they are unable to save

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for investment. The overall impact is that these societies are unable to accumulate the savings necessary to make capital investments to break out of the poverty trap. As a result, Sachs and others who rely on the poverty trap logic call for increased foreign aid from developed countries to ﬁll the investment gap and assist poor countries in breaking out of the poverty trap.10 The underlying assumption behind these calls for increased aid is that experts can not only determine the amount of aid needed for development, but also centrally determine the allocation of aid so that it has the desired impact. Given the magnitude of this task (i.e., economy-wide investments), one would expect it to push the limits of what can be rationally designed through reason. Starting in the 1980s, the development community began to expand its focus regarding the investment gap in developing countries. Before this broadening, the focus was on the lack of investment in physical capital. However, with the limited success of such investments, the development community began initiatives for increased investment in human capital as well as continued investments in physical capital. The underlying idea was that an educated populace was required to increase productivity and, hence, growth. As a report from the UNESCO Commission on Education for the twenty-ﬁrst century (Delors et al., 1996) noted, education is ‘‘one of the principal means available to foster a deeper and more harmonious form of human development and thereby to reduce poverty, exclusion, ignorance, oppression and war’’ (p. 13). However, as Easterly (2001, pp. 71–84) has documented, the massive investments in education over the past several decades have largely failed to achieve the desired outcomes. The reason is twofold. The ﬁrst is that dysfunctional institutions in many of the world’s poorest countries fail to generate an environment where citizens can utilize their education in a productive manner. With a low return on human capital investment, citizens responded by either not taking full advantage of educational opportunities or by leaving their home country after obtaining an education. In short, human capital matters, but only when there is a relatively high return on the initial investment. Second, efforts to centrally plan education investments, like all other aid efforts, neglect the difﬁculties associated with allocating aid to achieve the desired ends. The addition of aid for human capital to the already existing aid for physical capital increased the scope and scale of foreign interventions, making it more likely that these interventions would suffer from a fatal conceit. At the same time as the emphasis on education was increasing among the development community, a consensus around development policies, which

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Table 2.

The Original and Augmented Washington Consensus.

Original Washington Consensus 1. 2. 3. 4. 5.

Augmented Washington Consensus 11. 12. 13. 14. 15.

6. 7.

Fiscal discipline Reorientation of public expenditures Tax reform Interest rate liberalization Uniﬁed and competitive exchange rates Trade liberalization Openness to foreign direct investment

8.

Privatization

18.

9. 10.

Deregulation Secure property rights

19. 20.

16. 17.

Corporate governance Anticorruption Flexible labor markets Adherence to WTO disciplines Adherence to international ﬁnancial codes and standards ‘‘Prudent’’ capital-account opening Non-intermediate exchange rate regimes Independent central banks/inﬂation targeting Social safety nets Target poverty reduction

Source: Rodrik (2007, p. 17).

became known as the ‘‘Washington Consensus,’’ emerged. The Washington Consensus is a list of 10 policies, ﬁrst presented by John Williamson (1990), which were meant to represent the agreement among the development community regarding reform in developing countries. Williamson’s original list was expanded over the course of the 1990s to address issues associated with governance and institutional reform. The original and augmented Washington Consensus is summarized in Table 2. The augmentation of the Washington Consensus reﬂected a broader trend in development economics – the emphasis on the importance of institutions. On the academic front, the renewed focus on institutions was driven by the work of Douglas North (1990, 1991), who reminded the economics profession that ‘institutions matter’ for economic outcomes.11 Within the development community, the focus on institutions emerged from the realization that, in many cases, the implementation of policies associated with the original Washington consensus required fundamental institutional changes. The new Washington Consensus aims to prescribe best practice guidelines for institutional changes required for the effective functioning of the policies listed under the original Washington Consensus. The guidelines are typically used by the development community to develop comprehensive plans intended to carry out the desired change and reform in policies and institutions. However, given the sheer magnitude of the task, one would expect many of the associated interventions to be beyond the limits of what can be rationally constructed based on reason.

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In sum, the theories emerging from modern development economics have provided a foundation for a variety of foreign interventions in the form of aid and assistance. Many of these interventions are driven by the noble intention of helping the world’s poorest people. Despite good intentions, many of these efforts have failed to achieve the desired outcomes. The logic of the fatal conceit, discussed in the previous section, offers an explanation. The development community tends to view underdevelopment as a technological issue, where failure is due to a lack of aid, resources, and effort. Further, as noted earlier in this section, aid is often linked to large-scale central plans (e.g., a big push) intended to generate signiﬁcant society-wide changes and reforms through intervention. Given the magnitude of this task, it is not hard to see how these interventions are beyond the boundaries of what can be rationally designed through human reason. Further, comprehensive aid plans are typically implemented through a large bureaucratic apparatus which suffers from the dual problems of incentives and knowledge discussed in the previous section. At the same time, the focus on collective solutions to development downplays and discourages the importance of individual experimentation with alternative institutional and organizational arrangements to discover what works to facilitate coordination. The combination of these factors explains the disconnect between the intended and actual outcomes of foreign aid and assistance. To reiterate, the argument being put forth is not that foreign aid can never achieve the desired goals. The central issue is the presence, or absence, of feedback loops to correct allocation errors. As noted in Section 2.2, the more comprehensive interventions become, the more likely they are to push beyond the limits of rational constructivism and, hence, the more likely they are to fail. This means that interventions that are smaller in scope and scale are more likely, although by no means guaranteed, to succeed relative to more far-reaching interventions, which are more likely to suffer from a fatal conceit.

5. THE FATAL CONCEIT OF FOREIGN MILITARY INTERVENTION The use of military interventions to shape global outcomes has a long history. Perhaps the most evident, although not the earliest, example of this is the ‘colonial era,’ which typically refers to the period between the 15th and 20th centuries when European countries set up governments in Africa, the

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Americas, and Oceania. Although colonization did generate beneﬁts in terms of improved infrastructure, the overall beneﬁts are questionable. In a comparison of former colonies and noncolonies, Easterly (2006, p. 284) ﬁnds that the noncolonies had high levels of growth, income, and secondary education.12 In addition to the questionable impact on development, colonization produced many perverse and negative outcomes, including establishing and strengthening autocrats and contributing to conﬂict. Other negative effects emerged from the process of decolonization, which included the creation of nation states through the demarcation of borders by central planning. The creation of borders failed to appreciate the various ethnic, religious, and nationalist factors at work, resulting in a variety of ongoing conﬂicts, some of which continue to this day. Although recognizing the beneﬁts generated by colonization, it is not difﬁcult to see how most of these efforts suffered from a fatal conceit. Colonization was grounded in comprehensive central plans and top-down implementation through government bureaucracies. In attempting to design entire societies and nations, these efforts went beyond the limits of what can be rationally constructed through reason alone. Despite the fact that many colonization efforts suffered from a fatal conceit, a growing academic literature calls for a new era of imperialism and colonialism. For example, Ferguson (2004, p. 198) argues that the United States should embrace its role as an empire, using its military might abroad to shape global outcomes and, in some cases, colonize weak and failed states. Krasner (2009, p. 233) sums up the neo-colonial argument: Left to their own devices, collapsed and badly governed states will not ﬁx themselves because they have limited administrative capacity, not least with regard to maintaining internal security. Occupying powers cannot escape choices about what new governance structures will be created and sustained. To reduce international threats and improve the prospects for individuals in such polities, alternative institutional arrangements supported by external actors, such as de facto trusteeship and shared sovereignty should be added to the list of policy options.

The underlying assumption of these calls for modern colonialism is that comprehensive interventions can be designed to achieve the desired end. However, the logic of the fatal conceit indicates that there are real limits on what can be achieved, especially when interventions attempt to reshape and rebuild entire societies. The failures and difﬁculties of past large-scale military interventions have not stopped the development community and the governments of developed countries from continuing to use similar interventions to shape global

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outcomes. The motivations behind these interventions have varied greatly and include humanitarianism, peacekeeping, liberation, a variety of national interests, and security concerns. Regardless of different motivations, the purpose of these military interventions has been to inﬂuence and shape the state of affairs in foreign societies according to the plans of the interveners. Although the complexity of military interventions vary, they tend to be situated in the ‘harder’ end of the intervention continuum discussed in Section 2.1. As such, we would expect many of these interventions, like the earlier era of colonialism, to fall outside the limits of rational constructivism and, therefore, suffer from a fatal conceit. Along these lines, Easterly (2006, p. 10) writes, ‘‘Military intervention and occupation show a classic Planner’s mentality: applying a simplistic external answer from the West to a complex internal problem in the Rest.’’ This does not mean that all military interventions will fail. The U.S. post– World War II interventions in West Germany and Japan are typically cited as two cases of successful military occupation and reconstruction. Coyne (2007, pp. 118–136) provides insight into why this was the case, arguing that the foundations for reconstructed institutions were in place before military occupation. Given this, these cases of reconstruction efforts required marginal changes to existing institutions as compared to the wholesale creation of institutions from scratch. Thus, these interventions did not require rational planning of the complex array of underlying institutions supporting formally reconstructed institutions. Where the necessary informal institutions are absent or dysfunctional, in contrast, we should expect interventions to be more likely fall prey to the fatal conceit. This is typically the case in ‘weak’ and ‘failed’ states where institutions are either lacking or severely dysfunctional. In the modern era, the 1945 creation of the UN made the use of military intervention by the international community a viable alternative. The UN charter (Chapters VI and VII) provides the UN Security Council with the ability to take action to establish or maintain international peace.13 The UN does not maintain a standing army, so member countries voluntarily allocate military resources to UN efforts. Military efforts are then carried out under UN direction, but the members of the military intervention still remain part of their home armed forces. Costs of UN missions are spread among member nations according to a predetermined formula. UN military interventions tend to employ a variety of methods and strategies. Ghani and Lockhart (2008, p. 106) divide the process of conﬂict resolution into three parts – humanitarian, reconstruction, and

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development. The UN has historically been involved in each of these aspects. The humanitarian aspect deals with the delivery of food and health supplies to conﬂict-torn areas as well as efforts to ensure the protection of human rights. Reconstruction involves rebuilding and constructing physical infrastructure as well as building economic, legal, political, and social institutions. The developmental part of the UN’s mission reinforces reconstruction efforts and involves the continued delivery of aid and assistance. From this standpoint, the UN utilizes both forms of foreign intervention discussed here – foreign aid and foreign military intervention – as complements in achieving the desired state of affairs. The end of the Cold War led to an increase in UN humanitarian activities, as well as renewed debate in the international community about the scope and scale of humanitarian efforts. One outcome of this renewed debate was the emergence of the ‘‘Responsibility to Protect’’ (R2P) doctrine, ﬁrst developed in 2001 by the International Commission on Intervention and State Sovereignty and later endorsed at the 2005 World Summit as well as by the UN in 2006. The purpose of the R2P doctrine was to provide a legal and ethical foundation for interventions to resolve humanitarian crises. The doctrine speciﬁes a state’s responsibility toward its citizens and provides guidance regarding the international community’s responsibility to intervene when states fail to live up to their responsibilities. The scope of humanitarian interventions varies greatly, and the record of past interventions is mixed at best. Rieff (2003) has documented many of the failures and negative unintended consequences of humanitarian interventions. In the context of the logic of the fatal conceit, humanitarian interventions that remain limited in scope and scale are more likely to succeed as compared to those that require comprehensive planning and social engineering and, therefore, extend beyond the boundaries of what can be rationally designed. However, there is also evidence that even in cases where foreign interventions start out with a limited scope, they can become politicized, leading to an increase in scope due to ‘mission creep’ (see Coyne, 2007, p. 180; Foley, 2008). In addition to UN-led interventions, the governments of developed countries have also been heavily involved in foreign military interventions to inﬂuence global outcomes. Some of these interventions have been joint efforts with the UN, and others have been undertaken unilaterally. For example, the United States, with assistance from the United Kingdom, Australia, Spain, Poland, and Denmark, intervened in Iraq in 2003 to overthrow Saddam Hussein without the support of the UN Security

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Council. In 2003, France intervened in its former colony, Cote d’Ivoire, to end a civil war and provide peacekeeping forces. This was initially a unilateral intervention but was later supported by a UN peacekeeping force. These are two examples of how the governments of developed countries have used military intervention to shape foreign affairs. As part of these efforts, the governments of some developed countries have established separate bureaucracies to focus speciﬁcally on foreign military interventions. For example, in 2004 the United States created the Ofﬁce of the Coordinator for Reconstruction and Stabilization to ‘‘lead, coordinate and institutionalize U.S. Government civilian capacity to prevent or prepare for post-conﬂict situations, and to help stabilize and reconstruct societies in transition from conﬂict or civil strife, so they can reach a sustainable path toward peace, democracy and a market economy.’’14 As the name implies, the purpose of this ofﬁce is to oversee foreign interventions through increased coordination. However, to the extent that these interventions suffer from the fatal conceit, they are likely to fail in achieving the desired outcomes. It is possible for military intervention to work when it remains within the boundaries of what can be rationally designed. However, when military interventions go beyond these boundaries, they are likely to fail according to the logic of the fatal conceit. Unfortunately, many foreign military interventions serve as perfect illustrations of Hayek’s fatal conceit argument. These interventions are typically motivated by noble intentions, yet they fail to achieve the desired outcomes. They rely on comprehensive top-down plans developed by an array of ‘experts’ and implemented through large bureaucracies, which suffer from the aforementioned incentive and knowledge problems. Further, instead of focusing on the limits of intervention and what can be realistically achieved, military interventions tend to focus purely on technological issues – troop levels, the level of monetary and humanitarian aid, exit strategy, the timing of elections, etc. Finally, these interventions tend to focus on collective goals over individual discovery and experimentation. The idea of a ‘citizen-based’ approach to development has become increasingly popular over the past several years (see, for example, Ghani & Lockhart, 2008). Despite the rhetoric, supposed citizen-based approaches are typically part of a broader, comprehensive top-down plan. The irony is that a true citizen-based approach, which truly appreciates individual experimentation and discovery, cannot be centrally planned. Top-down central planning by development experts is the antithesis of a citizen-based approach to change and development.

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6. CONCLUDING REMARKS F.A. Hayek wrote The Fatal Conceit to explore the errors of socialism. Our main contribution has been to highlight that the logic of the fatal conceit is relevant beyond the analysis of socialism. We focused on foreign interventions because these efforts often fall prey to the fatal conceit for the reasons discussed in previous sections. It should be noted, however, that despite our focus on foreign interventions, the parallels with Hayek’s fatal conceit can be applied to a variety of other topics and interventions. Our analysis also contributes to an understanding of interventionism. An existing literature explores how the ‘dynamics of interventionism’ can lead to perverse outcomes (Mises, 1929 [1977]; Rothbard, 1977; Ikeda, 1997, 2005). Currently lacking in this literature is a discussion of the conditions under which interventions will tend to succeed or fail in achieving their desired outcomes. We begin to ﬁll this gap by employing the logic of the fatal conceit. The main implication is that interventions will fail when they extend beyond the limits of what can be rationally constructed through reason. Although the exact limits of reason are not always clear, as a general rule, the more comprehensive and complex interventions become, the more likely they are to suffer from the fatal conceit. Likewise, interventions that start well within the boundaries of rational construction can later expand beyond these limits due to ‘mission creep,’ where interventions extend beyond their initial purpose or design. Thus, an initially achievable goal has the potential to expand into a more comprehensive intervention, falling prey to the fatal conceit. Finally, our analysis has implications for the study of entrepreneurship, a hallmark of Austrian economics (see Kirzner, 1973). We noted that one of the characteristics of many foreign interventions is that they emphasize collective goals over the initiative and ambition of individuals. This is undesirable because it stiﬂes individual discovery and experimentation with alternative institutions and organizational forms to determine what works to enhance coordination. The existing literature typically focuses on entrepreneurship as a means of allocating (or reallocating) resources to increase economic efﬁciency. Our analysis highlights that it is important to consider entrepreneurship not only in the allocative sense, but also in the dynamic sense of discovering ways of facilitating interaction and cooperation. These issues are at the core of economic development and, as such, play an inﬂuential role in the success or failure of intervention efforts.

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NOTES 1. This includes economic growth in terms of per capita income, the evolution of the structure (i.e., industrial composition, etc.) of an economy and the factors inﬂuencing the sustainability of economic growth (e.g., human capital, human capabilities, infrastructure, etc.). For a detailed survey of the ﬁeld see Stern (1989). 2. For a discussion of some of the important early literature in development economics, see Bardhan (1993). 3. For a history of national income accounting, as well as problems with the method, see Holcombe (2004, pp. 390–394). 4. The World Bank Group consists of ﬁve international organizations: International Bank for Reconstruction and Development (IBRD), International Development Association (IDA), International Finance Corporation (IFC), Multilateral Investment Guarantee Agency (MIGA), and International Centre for Settlement of Investment Disputes (ICSID). Although the World Bank Group was created as part of the United Nations system, each of the above agencies is governed by its member countries. Discussion of the World Bank and economic development typically focus on the IBRD and the IDA, since those agencies focus on issues of economic development. 5. Domar would later say that his model was meant to contribute to an ongoing debate about business cycles, not to generate ‘‘an empirically meaningful growth rate’’ (quoted in Easterly, 1997). 6. Also inﬂuential at this time was Rostow’s (1960) book which argued that all countries passed through certain stages of development. Given this framework, it was thought that the development community could push underdeveloped countries to a later stage of development through intervention. 7. The idea ‘‘big push’’ theory of development was put forth by Rosenstein-Rodan (1943) in one of the most inﬂuential papers in development economics. 8. Note that the growth rate predicted by the Harrod–Domar model for a given level of savings assumes productive investments in one sector economy. Assumed away is the decision process through which such investment decisions are made as well as the allocation of investments across sectors. 9. Other classic theories of economic development include structural change models, international dependence models, and the Solow model. This was followed by the emergence of ‘‘the new growth theory’’ in the 1980s which focused on theories of endogenous growth. In these models, focus is place on the returns to scale and spillovers associated with technology and human capital. For an overview of these various models, see Todaro and Smith (2006, pp. 102–173). 10. For critiques of the poverty trap argument, see Bauer (2000) and Easterly (2006). 11. It is important to note that those writing in the Austrian tradition have been emphasizing the importance of institutions for economic outcomes for over a century. Menger (1883 [1985]) indicated that a central question in the social sciences is: ‘‘How can it be that institutions that serve the common welfare and are extremely signiﬁcant for its development come into being without a common will directed toward establishing them?’’ (p. 146; see also Garrouste, 2008). 12. This does not indicate that being a noncolony guaranteed better outcomes as illustrated by Ethiopia and Nepal, but rather to indicate that noncolonies have performed better than colonies on average.

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13. Peacekeeping is not explicitly stated in the UN charter. According to the UN website, ‘‘Dag Hammarskjo¨ld, the second UN Secretary-General, referred to it [peacekeeping] as belonging to ‘Chapter Six and a Half ’ of the Charter, placing it between traditional methods of resolving disputes peacefully, such as negotiation and mediation under Chapter VI, and more forceful action as authorized under Chapter VII’’ (http://www.un.org/Depts/dpko/dpko/index.asp). 14. Source: Ofﬁce of the Coordinator for Reconstruction and Stabilization website http://www.state.gov/s/crs/c12936.htm.

ACKNOWLEDGMENT Coyne gratefully acknowledges the support of the STICERD Centre at the LSE.

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