I’m fairly new to the Austrian School and am starting to feel confident enough in my knowledge to engage in some polite discourse with my liberal-leaning friends. However, my knowledge is still limited. Clearly, I believe the faults of Keynesianism are glaring, but I could use some help in trying to illustrate this to my friends. Some arguments I’ve gotten against the Austrian theory and free markets are: it lacks sufficient data and numerical evidence to be applicable, it makes only vague generalizations, and there is insufficient evidence that free markets actually work. I’ve been told that models are more applicable because of their ‘hard data,’ to which I responded that models, because they are based on numbers, cannot take opportunity cost into account, making them unsound. The counter reply was that guys like Krugman and Stiglitz do take opportunity cost into account. Basically, what I’m asking for is a quick rundown of Austrian vs. Keynesianism, and if the above points could be addressed, I’d be particularly appreciative. I realize that there is no ‘magic bullet’ to prove an argument, but I think some quick talking points could be helpful.
I think it all boils down to human nature - can human beings been free? Can human beings be responsible for oneselves? If it is true, then free markets really follow. Simply logically.
If human beings always need someone to rely upon, are social animals in the worst sense of the term, then clearly free markets can’t work. Because human beings require regulation (or if specifically, the economic activity of them), markets do.
I am not sure how can you convince one who believes in the latter of the truth of the first! And I am not really sure that the first is true. How can you ‘prove’ it? In what sense ‘proof’ applies here? I would love someone to prove this to me.
Humans only can truly be regulated by God (which is a fairy tale). No god, no honest and efficient regulator, that’s why all coercive regulation systems fail miserably. Free market works not only with “good” people, but with bad people too. The government corrupts any kind of people, so it’s pure utopia. Or I should say dystopia.
Those, who think that humans need regulation are either deeply religious and believe, that final regulator is God, or they just too narrow-minded and think, that giving some humans monopoly on force they magically become decent human beings (like angels) and then can regulate the rest of the society. That can not work and we see it everyday.
And by the way, the grand error many anarchists do is when they offer free market as a cure. It’s no cure and needs to be pointed out everytime, like they were talking to a drug addict. It’s an inevitable system that must be “implemented” in order for humans to survive. Human nature offers no other alternative.
I’m not entirely sure if many people around here have a full critique of of Keynesianism beyond the basic aphorism (which I consider to be partly an excuse more than anything else) “Destruction does not create” AKA the broken window fallacy. This argument is flawless in times of full growth, but it doesn’t work when the economy is working in a period of recession. At any rate.
Methodology
Originally Keynesianism was actually vaugely similar to Austrianism in terms of methodology. This is to say that both of them utilized a priori reasoning whilst incorporating a posteriori facts about the world. For instance an Austrian case of this is the fact, discovered from empirical evidence, that labor generally brings disutility. From ths fact we can tell a priori that in some cases an increase in wages can lead to a decrease in amount of labor supplied because the laborers will cease to value the increase in money recieved more than the increase in liesure time. An early, and pivotal case of a Keynesian piece of empirical evidence is that wages are sticky downward, which means that a decrease in aggregate expenditure will lead to unemployment, because if wages can’t adjust downward then firms don’t have enough to pay workers. Austrian methodology was always laid out in a slightly better manner than the Keynesian method was. It was also more individualistic and far less mathematical.
Shortly after Keynes, in the post war period Keynesians became much more a posteriori, that is based off of empirical models, and much more mathematical, than Keynes was.
Therefore modern the Keynesian method is mathematical and based off of “evidence” whilst Austrian methodology is basically entirely a priori.
Business Cycle Theories
Keynesianism is almost entirely a macroeconomic theory, that is to say it deals with the economy as a whole rather than simply what individual firms do. Indeed in many ways the Keynesian revolution signaled the division of economics into more than simply the schools that had informally litered the science since Marx, the avent of Keynesianism marked the splitting of economics into two different disciplines. In Keyensian models individual firm action has little to do with the model. Indeed I remember talking to an economics professor at the NYSEA and a brief snapshot of our conversation:
HIm: So what are you interested in? Macro or Micro?
Me: Well I’m more interested in Macro, but I believe that microeconomics logically builds up to macroeconomic theory
Him: Oh yes that’s what the Chicago School believes, but they’ve lost popularity since their models weren’t able to predict the current crisis.
What does this mean? Basically that in mainstream theory, or at least modern Keynesian theory, microeconomics, the thing which must, by definition, lead to and make up macroeconomic events, doesn’t rely upon microeconomic theory.
At any rate. The Keynesian theory goes like this:
The Boom comes from a miscalculation by firms caused usually by speculation, the whims of business, or “animal spirits”, which is inherently irrational action on the part of businesses. This leads to “bubbles” or “booms” which send business into overdrive, mass producing things and increasing wages. Eventually the bubble pops, or spenders are overly cautious, leading to massive firm failure. People start to save because of the fact that they are afraid to lose their jobs. Here we come into macroeconomic supply and demand.
This graph is confusing but it works just like a normal supply and demand graph. The amount provided is on the X axis, in this case it is GDP, the number of transactions which occur. On the Y axis there’s the price level, which is indeed the general height of prices. Then you have short run and long run aggregate supply, which is how much the economy will actually produce. Short run aggregate supply is how much the economy can be made to produce in the short run, but eventually prices of natural resources and wages rise, which brings us back to the long run, where everything has reached its real value.
Now we simply come to Aggregate demand, this is how much money people are spending at any one time. So let’s connect the two concepts!
Now when people stop spending so much and start saving more aggregate demand moves to the left, or falls. This means that less is demanded in the entire economy, GDP falls, which means the amount produced falls, and employment falls because now firms don’t have enough money to produce.
This would be fine in the Keynesian model if wages swiftly fell like other input prices are supposed to do, because let’s say that Aggregate demand falls by 20 percent, well if all prices in the economy fell by 20 percent, then presto! We’ve returned to the LAS and the same amount will be produced as before! But in Keynesian models wages are sticky, they won’t fall, people won’t accept lower wages. This means that the economy is stuck at a point where the short run aggregate supply curve is stuck, as it were, and so it will not adjust and the economy is stuck in recession.
Therefore the Keynesian prescription is to have the government come in and attempt to boost aggregate demand through stimulus spending. This returns employment to previous levels, getting people to spend, and then we’re back.
The Austrian theory of the business cycle
The boom is caused by the government lowering interest rates through inflation. This causes a general miscalculation because it causes entrepreneurs to believe that they have more money than they actually do to spend. This causes a boom in investment spending that is inherently unsustainable. Eventually entrepreneurs bid up the prices of capital goods and labor, at the same time consumer prices begin to rise as well, which causes capital to be bid back to the new inflation adjusted level, eventually it is obvious that the projects cannot be completed. Mass firm failure results.
In the Austrian theory the only way that the economy can come back to its real levels is if wages fall and the malinvestments made during the boom are liquidated, bringing the structure of production back to where real consumer demand is.
The flaws in the Keynesian system
There is no real reason given for the boom. As I one read in a book about early business cycles “bubbles are non-answers”. Keynes literally used the term “animal spirits” in his book. He didn’t really know why the boom happened, just general overoptimism. This doesn’t explain why it is that firms can generally predict the structure of production quite well, but then suddenly there is massive failure. Small bubbles make sense, but why don’t they burst quickly? It’s a non-answer. The closest reason given is by the likes of Hyman Minsky, who argue that such a long production structure is bound to lead to some sort of firm failure. This also makes sense, but why can’t firms generally predict this, liquidate losses as much as possible, and so on? No matter what the central bank lowering of interest rates through credit expansion MUST have something to do with it. The fact is that in a free market few malinvestments would be made. Small business cycles through failures of large firms might happen, but this would be to small to lead to a downwards spiral in a world where prices are flexible.
Why aren’t prices flexible? There are only three answers for this: A, labor unions, B, governments, C, sheer stuborness on the part of individiuals. The first answer is a result of labor unions setting prices of labor artificially high. This is indeed possible, but in the long run this would most likely cause labor unions to be liquidated in the long run in a free market because firms lacking unions would be at a comparative advantage. Furthermore unions could likely be forced to accept lower wages rather than seeing their membership dissipate or their firm going out of business. The government is obviously a problem with taxes, minimum wages, unemployment insurance, and propping up unions. The stubborness of individuals would probably be broken in a world without unemployment insurance, because a low paying job is better than none at all. No matter how you spin it the government harms the process of flexible wages.
There is no price level, only individual prices. Therefore you cannot tell through stimulus spending what prices will rise and fall. You might end up simply increasing prices in an industry rather than bringing forth any employment
Inflation leads to malinvestment. Simply as it is said, one of the common Keynesian prescriptions leads to malinvestment for the Austrian reason.
How much should the government spend? Keynesians have no way of calculating exactly how much spending is necessary in order to actually stimulate the economy. There’s the so called “multiplier”, but the fact is that it’s amazingly inaccurate because people are, well, different, and so you can’t tell how much each of them will spend
Regime uncertainty. In a discretionary Keynesian world it’s impossible to tell exactly the government will do or how much. This leads firms to cut back production from what they otherwise could.
Government spending stops wages from adjusting. If the government keeps hiring people, or supporting them, then why would wages fall to their desired level?
Government spending would be the cause of its own disease. Let’s say that the government drastically increases its spending. Well then according to the Keynesian model if it stops doing this then there’s suddenly a massive decrease in aggregate demand which leads to, you guessed it, a recession.
This is all assuming that the government acts perfectly, but chances are that in the real world there will be a huge amount of waste and that government spending will not decrease all that much, and that leads into the argument of how the government is not efficient and is wasteful.
If there are malinvestments then government spending will simply lead to the propping up of the malinvestments. Since the Keynesians don’t really have a theory of the boom and bust, they just assume that it happens. Therefore if there are malinvestments then they will likely continue through government spending which attempts to prop up the structure of production to what it previously was. This means no adjustment, simply a continuation of the problem at hand.
I hope that this all makes sense to you. If you have any questions feel free to ask them.
Some arguments I’ve gotten against the Austrian theory and free markets are: it lacks sufficient data and numerical evidence to be applicable,
First of all, this is a pooorly worded, because “lack of data and numerical evidence” does not show a theory is not applicale, but that it is not proven.
For example, if AE would claim 2+2=5, and did not have data and numerical evidence to show it, the equation would still be applicable to the question “If you have two apples and your friend has two apples, how many apples are there in total?” The problem is that it has not been proven [and might therefore be wrong].
OK, on to the argument. Where is the data and numerical evidence to back up AE?
The usual answer is two pronged. First, where is the data to back up Keynesianism? There is none. Of course, they have an excuse for their failures, mainly that the govt in question didn’t spend enough money, and should have spent more. Maybe, but there goes your evidence and numerical data, right? Having an excuse for lsing is not the same as winning. Having an excuse why the data doesn’t support you is not the same as having the data that proves you right.
And what about the Nixon era stagflation, that Keynesianism says cannot possible ever happen?
Bottom line, lack of data and numerical evidence is a refutation of keynesianism, not AE. Hoisted with your petard, Keynsians.
Second, such a question [where’s the data] makes two mistaken theoretical assumptions. First, that data and numerical evidence is collectible somehow to prove or disprove an economic theory. AE denies this. [Sorry, you’ll have to read up on why. The post is getting long]. Second that data ind numerical evidence is the only valid support for a scientific theory. AE claims there is something else, i.e. deductive reasoning. Here too, you’ll have to read up].
it makes only vague generalizations,
It makes generalizations, but not vague ones. Sir Isaac Newton made a generalization, F=ma. Do you see any flaw in it, just because it is a generalization? The whole aim of science is to arrive at great laws, aka generalizations, that apply in many cases. Sheesh.
and there is insufficient evidence that free markets actually work.
What about the nineteenth century? And what evidence is there that govt meddling actually works? None. Have these guys no shame?
I’ve been told that models are more applicable because of their ‘hard data,’
See above why the word “applicable” is not the right one here. But let’s look into the supposed superiority of “hard data”. To give an extrem example that brings out a point, say an economist busily collects hard data for many years. He then shows everyone irrefutable data that economic growth in Germany correlates perfectly with the number of pimples on his dog’s face, year in year out.It’s hard data, but it;s not backed up by sound theory. Which is exactly the problem with Keynesian economics, only worse. It makes no sense at all.
to which I responded that models, because they are based on numbers, cannot take opportunity cost into account, making them unsound. The counter reply was that guys like Krugman and Stiglitz do take opportunity cost into account. Basically, what I’m asking for is a quick rundown of Austrian vs. Keynesianism, and if the above points could be addressed, I’d be particularly appreciative. I realize that there is no ‘magic bullet’ to prove an argument, but I think some quick talking points could be helpful.
Talking points are good if they are the tip of an iceberg of sound knowledge. Meaning maybe you should retire from the field of argument for a while, till you have a sound understanding of AE from reading the free material here. Fear not, there will be plenty of Keynesians around when you are ready.