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Action, Time and Knowledge: the Austrian School of Economics


Action, Time and Knowledge: the Austrian School of Economics

[This is a transcript of a lecture given at the Austrian Scholars Conference, March 10, 2012]

I. Introduction

My purpose today is to present a summary of my book Action, Time and Knowledge: the Austrian School of Economics, published in 2011 by Mises Institute Brasil. Due to limited time and keeping in mind that time is a means of production to the Austrians, I shall limit my presentation to just a few points of the book.

The tradition initiated by Carl Menger with the publication in 1871 of his Principles of Economics is a vast, fascinating and formidable field of human knowledge that transcends economics by reaching the broader spectrum of the social sciences.  It has been continuously nourished with philosophical debate and has permeated humanist culture permanently. Hayek was precise when he affirmed that an economist who thinks only within the strict limits of economic theory would never be a complete economist, even if he or she possesses technical expertise.

Indeed, for the Austrian tradition asks one not only to reach the state of the art in the science, but also to go further and try to become a humanist. However, even when dealing with a very broad field of human knowledge, the Austrian school holds a remarkable simplicity, which is explained by the irreproachable logic of its propositions and postulates. As Mises wrote, "good economics is basic economics"!

The great Austrian economists of the twentieth century - especially Mises and Hayek - were paragons of boldness. In a time when colleagues were driven to specialization in more restricted areas of economics, they refused to compromise and remained generalists, not with the connotation used lately, but one that denotes vast culture and humanism.

Since the second half of the nineteenth century, economists regrettably abandoned the humanist tradition and progressively concentrated on more specific technical knowledge, thereby becoming less knowledgeable. Today, few economists are scholarly enough to master skills that exceed those contained in micro and macroeconomics textbooks. Many, unfortunately, disdain other social sciences, because, on their journey towards obscure knowledge, they have been taught that those are "unscientific."

These observations neither mean that the conventional theory must be discarded nor that the homo economicus needs to be rejected. They only mean that the human aspects of the economy cannot be left out, as if they were unimportant or "unscientific", or as if they were no more than mere nostalgic evocations of a past of melancholy from the heyday of the Austro-Hungarian time of Menger, and Wieser, Böhm-Bawerk, Mises, Hayek and others. In fact, humanism in economics is much older than Menger: it goes back to St. Thomas Aquinas and the Late Scholastics and continues with David Hume, Richard Cantillon and Adam Smith. Humanism was only "dismissed" from the twentieth century on, with the advance of positivist ideas. However, for Austrians, both in everyday life and in the world of science, what matters is not homo economicus, but homo agens.

II. The basic triad or fundamental core

The Austrian School is founded on a concurrent and complementary triad, formed by the concepts of a) human action, b) dynamic time, and c) the hypothesis about the limitations of human knowledge. These three concepts form the cornerstone of the monumental Austrian School of Economics' theoretical edifice. By analogy with biology, the triad represents the essential elements necessary for the development and maintenance of the organism, i.e., it represents both the macro and micronutrients of the system.

Certain elements emanate from the triad.  They are: i) marginal utility, ii) subjectivism, and iii) spontaneous orders.  From these propagation elements, every proposal of a practical nature may be logically deducted.  I refer to these as propagation elements for they bring implications for various fields of human knowledge, such as political philosophy, epistemology and economics proper.

(a) action

Action, for the Austrian School, means any voluntary act, any choice made intentionally to move from a less satisfactory state to another considered more satisfying, at the moment of choice. Praxeology (from praxis) is the general science dedicated to the study of human action, considering all its formal implications. Every economic act, without exception, can be reduced to choices made in accordance with the seminal concept of human action. And the basic proposition, the first axiom of praxeology, is that the motivation for any action is dissatisfaction, since nobody acts unless one feels some dissatisfaction and considers that a particular action will improve satisfaction, comfort, joy or feeling of accomplishment, thus decreasing discomfort, frustration or dissatisfaction.

This axiom is universal: wherever there are people, there are actions. Therefore, that economics which is built on praxeology is, by corollary, universal. There cannot be specific or particular economic theories valid only for certain country or regions, but only an epistemologically correct economic theory valid everywhere, assembled piece by piece from observation and the systematic study of the action. Mises called the concept of human action the praxeological axiom number one, in the sense that the main laws governing economics proper may be deduced from it.

(b) the dynamic conception of time

The second component of the triad is the dynamic conception of time or subjective time, or even real time, in which time ceases to be a static category described by a single horizontal axis, to be redefined as the continuous flow of new experiences, which is not in time, as in the static or Newtonian concept, but becomes time proper. When we consider dynamic time, we are implicitly accepting that something new is continuously occurring. We also must recognize dynamic time's three characteristics: dynamic continuity, heterogeneity and causal efficacy, as pointed by Mario Rizzo and Gerald 'O Driscoll, in their interesting book The Economics of Time and Ignorance.

The real-time dynamic is irreversible and leads to a creative evolution process, which implies unpredictable changes. The concept of real time is essential to the understanding of human action: acting individuals continuously accumulate new experiences, which generate new knowledge, which, in turn, often leads them to change their plans and actions.

c) limitation of knowledge

The third element of the triad is the epistemological treatment of the undeniable fact that human knowledge always contains components of uncertainty and unpredictability, which confer to every human action unintended effects that cannot be a priori calculated. There are, for the Austrians, limits to the ability of the human mind to fully fathom the complexity of social and economic phenomena. Formal systems possess certain operating rules that cannot be predetermined. As José Ortega y Gasset affirms: "The eye does not see itself."

As it is not possible to quantify all our knowledge, the Austrian School does not analyze the markets as equilibrium states, but as processes of discovery and articulation of knowledge. Usually in the real world economy these forces remain quiet, silent, hidden, scattered and disconnected, waiting for the subjective human intelligence to wake, display, organize and articulate them. This third nucleic hypothesis of the Austrian School, for many scholars of epistemology, is the most important. However, I prefer to consider it on equal footing with the first two, believing that by doing so it is easier to highlight the interactions and interdependence among the three.

III. The propagation elements

(i) marginal utility

The first propagation element of the Austrian School is not unique to it. This is the concept of marginal utility. As we know, it was the answer proposed in 1871 to the so-called question of value, which was challenging scholars from St. Thomas Aquinas in the thirteenth century. About six hundred years after the Summa, Carl Menger, Leon Walras and William Stanley Jevons, respectively in Vienna, Lausanne and London, realized that the value of a good or service is determined by its marginal utility at each moment in time, i.e., value depends on a simultaneous combination of scarcity and utility.

Although the concept was introduced by these three economists, each one worked independently: Menger adopted a subjective approach, while Walras (the forerunner of so-called school of general equilibrium) and Jevons (who influenced Marshall, the father of the school of partial equilibrium) adopted a mathematical treatment, since the concept of marginal or additional units of goods and services fit in perfectly with the apparatus of differential calculus. To the Austrian scholar, the principles of marginal utility, action, dynamic time, and subjectivity are inseparable.

(ii) subjectivism

The subjectivism of the Austrian School is not limited to the subjective theory of value or to the perception that theories dealing with humans are personal and therefore not subject to testing. It refers to a basic assumption: that the content of the human mind - and therefore the decision-making processes that characterize our choices and actions - is not rigidly determined by external events.

Thus, subjectivism emphasizes creativity and autonomy of individual choices and, for that reason, shall be subject to methodological individualism, the notion that market outcomes may be explained in terms of individual acts of choice. For the Austrian scholar, economic theory should consider primarily the web of factors that explain choices and not be limited to simple interactions among objective variables.

Subjectivism then presupposes that action always takes place under conditions of immeasurable and genuine uncertainty, and also that it occurs over dynamic time. When an agent chooses a course of action, the results of his choice will depend on the courses of action taken and to be potentially performed by other individuals. Autonomy prevails in individual decisions, hence the future cannot be known and cannot be learned.

(iii) spontaneous orders

Spontaneous orders are intermediate classes of phenomena that are specific to the science of human action or praxeology. They are institutions that fall between instinct and reason, as a result of human action but not the execution of human design or planning. Indeed, for the philosophers of ancient Greece, there were two types of phenomena, corresponding to the terms - introduced by the Sophists of the fifth century Physei, which means "by nature" and Thesis, which means "by deliberate decision."

For Austrians, however, this dichotomy is not consistent with the social sciences. In the words of Hayek in The Counter-Revolution of Science: Studies on the Abuse of Reason (Collier-Macmillan, New York-London, 1964, p. 39): "some kind of order appears as a result of individual action, but without being intended for any individual". Typical examples of these orders are the monetary system, markets, cultural events and language.

As pointed out by the Portuguese Professor José Manoel Moreira (University of Aveiro) in his doctoral thesis presented at the Universidad Pontificia Camillas (Madrid), published in a revised edition by the University of Porto in 1994, "the contrast is between a spontaneous order, i.e., self -generated or endogenous, and exogenous order, i.e., designed or artificial order, or even an organization, as in the case of a managed social organization" (Philosophy and Methodology of Economics in FA Hayek, p. 187). Prof. Moreira continues, "Hayek, despite the authoritarian connotation the term 'order' carries for people who refuse to admit an order not deliberately created by man, insists on keeping it, or rather uses "spontaneous order" or "cosmos" to define (?) structures that arise from the action of many men, although not of human design." In fact the real world economy, ever since man discovered the benefits of the exchange process to the present day, is a great spontaneous order, similar to the universe, in which things are continually in expansion and contraction.

IV. Combining the elements of the Austrian School

The attached PowerPoint presentation is an attempt to present a general view of the extraordinary complexity that is the Austrian School of Economics. Of course, this is a simplified attempt to show its component parts, the respective role each one plays, and how they fit together. The great task of economists is to build theoretical models that can reasonably explain the reality of the economy, formed by the action over time of billions of human beings of flesh and blood, with all their characteristic desires, aspirations, motivations, strengths and weaknesses.

It is not my purpose here to discuss the implications of the core and propagation elements in the fields of epistemology and political philosophy. I will just mention briefly that, in the epistemological field, the implications should be:

            (a) methodological individualism;

            (b) the differences between models and facts in the social sciences;

            (c) the recognition that the social sciences have their own characteristics, which differentiate them from the natural sciences, and

            (d) the rejection of forecasting methods in social sciences.

And, with regard to political philosophy, the implications should be:

            (a) criticism of the mixed systems;

            (b) evolution in the social sciences;

            (c) democracy and separation of powers;

            (d) limitations to power, and

            (e) rejection of constructivism in the social sciences.

V. Economics

My concern here is about the importance of the concepts of action, time and knowledge, as well as the marginal utility, subjectivism and spontaneous orders in the theory of the Austrian School. In fact, the economics of the Austrian School, as well as epistemology and political philosophy, also derives from those we call the basic triad - action, time and knowledge - and spreads through the concepts of marginal utility, subjectivism and spontaneous orders, their elements of propagation.

Based on these core elements and seminal propagators, the Austrian economists, from Menger, erected a remarkable and rich structure from the scientific point of view. It works perfectly, at least as "perfect" as one can to explain the real world in the social sciences.

Let me briefly expose each of the six fields of economic theory that I believe are essential to the understanding of the Austrian thought.

1. The market process.

Unlike mainstream economics, the Austrian School does not study markets in equilibrium. Neither does it adopt the famous classification of markets according to its "form" (perfect competition, oligopoly, monopolistic competition and monopoly). It assumes instead that markets are processes that tend towards equilibrium processes (because agents are rational and learn from mistakes), but that, at each instant of dynamic time have not reached their "equilibrium positions".

To understand this, is suffices to mention the main elements of the theory. First, markets are moved by the actions of its participants, both on the demand and the supply sides. Second, human action takes place over dynamic time, where each moment is a learning opportunity. Third, market transactions are carried out under conditions of limitation and dispersion of knowledge. Fourth, markets are spontaneous orders, subject, therefore, to permanent changes. Fifth, human action is subjective.

How can it be expected, therefore, that real world markets be at "equilibrium" at a given point in time? This is one of the central tenets of the Austrian theory. Markets are reflections of trials and errors, in a permanent process for finding new opportunities, and whose dynamism does not provide room for balance or equilibrium.

Consequently, markets tend to cushion against uncertainty and to systematically coordinate the plans formulated by economic agents.

As the various circumstances surrounding human action are continually evolving, it follows that the state of full coordination is never fully achieved, even as markets tend towards it.

2.  The role of the entrepreneur and its function in the markets

Entrepreneurship is the subjective individual ability to perceive the possibilities of gains on the markets. Therefore, it is nothing more than a category of action. Thus, human action can be considered a business phenomenon, specifically one based on the capabilities of perception, coordination and creativity of the acting individual.

As with any human action, entrepreneurship occurs under genuine uncertainty, given the limitations of our knowledge. It requires, in turn, creativity, since the future is uncertain and an entrepreneurial action can deliver either good or bad results.  The entrepreneur undergoes a set of choices over time and, as such, it also involves a number of alternative scenarios to which it must necessarily forgo, the subjective value of which we denominate cost.

As means are always limited, agents seek first the ends they consider most valuable and only then they go after other relatively less valuable ends. Every action is motivated by the subjective belief that the chosen ends have a value greater than the value of their costs. The difference between them is the profit, the element that explains the action.

In addition, to economists of the Austrian tradition, each action embeds a pure and creative entrepreneurial component that does not require any cost.  This pure entrepreneurial component provides for the convergence of the concepts of action and entrepreneurship.

3. The debate about the impossibility of economic calculation in socialist economies

Mises, even in the 1920s, saw clearly that in a socialist economic system calculation is impossible. His argument was simple: economic calculation requires planners to know the prices, and these, in turn, to be considered prices as such (and not pseudo-prices) presuppose both: a) the existence of the market process, in which actions of  bidders and sellers flow normally, and b) private property, a prerequisite of markets. Socialism, however, does not admit private property, so it makes no sense to speak about markets in a socialist system if there are no functioning markets, and therefore no prices. However, if there are no prices, economic calculation is impossible. For this reason, Mises stated categorically in the debate with socialist economists that the socialist system was based on a blind process, and was therefore doomed to result in social and economic chaos. History has proven - and is still proving - Mises correct.

The central agencies of these systems are formed by people, and it is unreasonable to assume that their "pure" intentions possess the gift of omniscience which would enable them to grasp and interpret numerous and scattered sets of information which are continually changing.

Planners cannot even determine their degree of ignorance about the information required for the calculation and subsequent coordination thereof. In addition, the greater the degree of coercion imposed, the lower the chances of achieving the plans, because intervention tends to decrease coordination, resulting in increasing distortions over time.

4. The monetary theory

There are five main points about the Austrian School monetary theory. Firstly, variations in the stock of money have un unequal effect on relative prices, capital structure, and patterns of production in the economy, and in addition they change the employment levels of the factors of production. As early as 1912, in his monumental Theory of Money and Credit, Mises stated that increases in money supply do not produce benefits for society, because they do not improve the benefits provided by currency exchange; they merely reduce the purchasing power of each monetary unit.

In fact, money cannot be "neutral", because Friedman's helicopter does not enter the economy uniformly, but at specific points in the structure of production.

Secondly, business cycles are phenomena, which, though manifesting themselves in the so-called real sector, have only monetary causes.

Thirdly, money, like any other good, has its value established by the principle of marginal utility, as Mises showed by solving the problem of "Austrian circularity", with his famous regression theorem.

The fourth point is that Austrians scholars do not define inflation as "continuous and widespread increase in prices", because that is actually a mere symptom of inflation. They define it as a permanent decline in the purchasing power of money, caused ultimately by the issuing of currency with a consequent decrease in its marginal utility.

Lastly, money, that is, the monetary system, is a spontaneous order, a phenomenon that is constantly changing as the result of human action, though not of planning.

5. The capital theory

The Austrian capital theory, no doubt, is an element that differentiates the Austrian School of thought from all others, simply because they do not have anything resembles a "theory of capital".

Böhm-Bawerk, who followed the tradition started by Menger, was without doubt the main contributor to capital theory. Mises, Hayek and other Austrians have also made important contributions to its development.

Its central tenet is the concept of capital structure or the structure of production, which describes a good that passes through various stages in the production process. These various stages correspond to the capital structure of the economy. Therefore, capital is not homogeneous and constant, as the macroeconomic models consider. It is essentially heterogeneous and varies with other factors of production over time.

The heterogeneity of capital goods and the fact that economies have capital structures have lead -- among other hypotheses, such as the methodological individualism -- Austrian economists to reject macroeconomic analysis.

6. The Austrian Business Cycle Theory (ABCT)

The ABCT was conceived by Mises in his 1912 treatise, was further developed by Hayek in the 1930s, and was later improved by other economists in the tradition of Menger.

It is simultaneously a theory of money, of capital and of business cycles. It shows how the issue of money and credit, in excess of the corresponding amount of savings, has the effect of reducing interest rates, which initially fool agents into believing that this reduction is the result of higher savings. Consequently agents embark on longer maturity investments, thereby stretching the structure of production of the economy. Later, when agents discover that the increased investment was not due to higher savings, but to money disguised as savings, interest rate rise and lead to a shrinkage in the structure of production.  This stretching and contraction (known as the concertina effect) produces unemployment, notably in the segments of production most distant from final goods' production, precisely those which initially benefited from monetary expansion.

Thus, inflation -- that additional money introduced into the economy without corresponding savings -- will eventually cause the unemployment of factors of production. As Hayek said, there is no choice between eating too much (issuing unbacked currency) and having indigestion (recession). Those are inseparable, the first leading to the second. The Keynesian analysis (which came to be known as the Phillips curve) which postulated the existence of a trade-off between inflation and unemployment, so that if the government wanted to fight inflation, it would have to accept a higher unemployment rate, or alternatively if it wanted to reduce unemployment, it would be forced to accept a higher inflation rate, is therefore wrong.

As Mises stated a hundred years ago, "originary interest is not the price paid for the services of capital.". It is, on the contrary, the phenomenon of originary interest that explains why less time-consuming methods of production are resorted to in spite of more time-consuming methods that could render a higher output per unit of input".

Or, in the words of Hayek in his Prices and Production,

"There is, however, another and far more important difference which will become apparent only with the lapse of time. When a change in the structure of production was brought about by saving, we were justified in assuming that the changed distribution of demand between consumers' goods and producers' goods would remain permanent, since it was the effect of voluntary decisions on the part of individuals. Only because a number of individuals had decided to spend a smaller share of their total money receipts on consumption and a larger share on production was there any change in the structure of production. And since, after the change had been completed, these persons would get a greater proportion of the increased total real income, they would have no reason again to increase the proportion of their money receipts spent for consumption. There would accordingly exist no inherent cause for a return to the old proportions".

In other words, for Keynes, depression is a problem of excess savings over investment and for the monetarists it is a shortage of currency. For the Austrians, an excess of bad investments over real savings cause depressions.

From that time on, the academic mainstream has misunderstood the depth of the Austrian analysis and unfortunately Keynes won the debate, because his recommendations for governments to save the economy from the Great Depression were far more politically palatable.

As Ron Paul wrote in his book End the Fed, "If there is a book that the Washington establishment should read immediately, this book is America's Great Depression by Rothbard. In this book he demonstrates that the Fed created the economic boom of the late of 1920 that led to the crisis, and that the interventions of Hoover prolonged the Great Depression."  (chap. 3).

Only because a number of individuals had decided to spend a smaller share of their total money receipts on consumption and a larger share on production was there any change in the structure of production. And since, after the change had been completed, these persons would get a greater proportion of the increased total real income, they would have no reason again to increase the proportion of their money receipts spent for consumption. There would accordingly exist no inherent cause for a return to the old proportions.Only because a number of individuals had decided to spend a smaller share of their total money receipts on consumption and a larger share on production was there any change in the structure of production. And since, after the change had been completed, these persons would get a greater proportion of the increased total real income, they would have no reason again to increase the proportion of their money receipts spent for consumption. There would accordingly exist no inherent cause for a return to the old proportions.

Hayek, Prices and Productionuals. Only because a number of individuals had decided to spend a smaller share of their total money receipts on consumption and a larger share on production was there any change in the structure of production. And since, after the change had been completed, these persons would get a greater proportion of the increased total real income, they would have no reason again to increase the proportion of their money receipts spent for consumption. There would accordingly exist no inherent cause for a return to the old proportions.

VI. Concluding remarks

A natural consequence of the economic theory of the Austrian School is the question of monopoly of money by governments. Why should governments alone print money through central banking? Why should central banks alone control the credit? Why is the instability of fractional reserve system not questioned? Why should central banks exist, given their history of failures? Why are people generally against monopolies, but when we discussing the most nefarious of all, the monopoly on money, only Austrians suggest its elimination?

The current crisis represents a great opportunity for the advancement of Austrian theory and the abandonment of the wrong approaches of mainstream economics, such as the various forms of keynesianism and monetarism. Keynesianism is an error, neokeysianism, the insistence on error, and new keynesianism the persistence in error. And monetarism is nothing more than keynesianism with flexible prices and stability of the demand for money.

When we look at the six elements of the Austrian theory, we realize how much the mainstream economics got wrong. Definitely, the economic theory that has been taught in universities for decades is wrong. I hope the world learns the truth.

I have prepared this speech to sum up the themes that I described in my book Action, Time and Knowledge: the Austrian School of Economics. I emphasize the multiplicity of factors that altogether constitute the Austrian School of Economics, stressing the importance of each in the development of the school and also how they fit together.

To the core triad, formed by the concepts of human action, dynamic conception of time and the recognition that knowledge has limitations, we have added what we call propagation elements, namely, the doctrine of marginal utility, subjectivism and the concept of spontaneous orders. I advise the reader to pause at this point and question whether each of the propagation elements actually follow the core triad, and to which degree.

Armed with this apparatus, in the book I attempt to describe the implications of the triad and propagation elements to the fields of political philosophy, epistemology, and the economy.

Finally, it should be mentioned that the Austrian school has proven far superior to the different branches of mainstream economics. Clear evidence of this statement are the crises and bubbles, starting from 1920-21, continuing with the Great Depression of the 1930s, and extending to the current crisis.

The first ended without government intervention; the second, whose "solution" to this day is attributed to the application of Keynes' ideas, was ending by itself, with the economy giving clear signs of recovery before the New Deal.

As far as the current crisis, we have been once again in a bubble process since 2008 precisely because central banks issued currency and credit in the absence of changes in temporal preferences, and because governments have behaved as doctors who prescribe sugar to someone who suffers from diabetes.

Action, time and knowledge: this is the fascinating universe of the Austrian School of Economics!



[*] The author is grateful to Helio Beltrao and Valeria Pugliesi-Washington for their helpful suggestions and criticisms, as well as for grammar review. And, of course, assumes responsibility for any remaining errors.

Sobre o autor

Ubiratan Jorge Iorio

Ubiratan Jorge Iorio é economista, professor associado da Universidade do Estado do Rio de Janeiro (UERJ) e é um dos nomes mais importantes da Escola Austríaca no Brasil.

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