Blogger Lord Keynes (LK) responds to my post on economic calculation. Unfortunately, I feel as if he missed the essence of my point. Much of what he says, I feel, is all over the place and difficult to see the relevance of, but I will try my hardest to tie it all in. Hopefully the reader can then put the pieces together to understand the fundamental thesis I am trying to get across.

To clear up any confusion amongst third party readers, what I call the “theory of intertemporal discoordination” is Austrian business cycle theory — I prefer my term, because I think it gets across what the theory is about much better than the conventional one. Furthermore, as I posited in my original post, the new term suggests that the theory is only one facet of many within the body of theory of economic coordination (and discoordination). More accurately, it describes an artificial tendency of discoordination between investment and societal time preference (the latter dictating the aggregate stock of savings at any given point in time).

With regards to this, some of what LK writes is true. For instance, he writes that the Hayekian exposition of capital theory relies on the notion of equilibrium. He also correctly suggests that equilibrium is not something that represents reality. Much of what LK writes is untrue. That Austrians “reject Walrasian equilibrium” does not mean that some Austrians reject the use of equilibrium as an ideal type, which is how Hayek used equilibrium theory in Prices and Production. Hayek’s purpose was to show how intertemporal coordination (and discoordination) operated in a world where certain data remained constant. That Hayek used equilibrium as a pedagogical tool, though, does not suggest that this is how Hayek envisioned the capital structure in reality, although since Hayek never directly comments on this it is difficult to know for certain what his intentions were. It is for certain that he moved on to new pedagogical tools, such as dynamic equilibrium, in The Pure Theory of Capital (which forever remained incomplete, anyways). If we can, in any case, deduce one point of value from all of this is that how you interpret a pedadogical approach to capital theory and apply it to reality really reflects your own views of the economy.

Unfortunately, most of what LK writes with regards to the theory of intertemporal discoordination is besides the point. That Hayek relied on equilibrium as an ideal type has no implication on the argument I am making. Neither does any discussion on anarcho-capitalism or the role ascribed to government by theorists like Mises or Hayek. Of the three paragraph LK allots to the discussion of the theory of intertemporal coordination as it relates to my original post, only the first is useful. Unfortunately, the critique gets it all wrong.

LK disagrees that the theory of intertemporal discoordination is only a minor facet of the theory of economic calculation, because “[m]ost Western economies today are ones where the vast majority of all production is done privately and the majority of capital goods are owed privately.” “So,” he concludes, ” the ABCT must be the major Austrian theory that applies to them.”

I never argued the applicability of the theory — I believe that the theory is correct and is applicable, if the conditions for its applicability have manifested empirically, but I never meant to argue whether or not this particular aspect of the theory of economic coordination (and discoordination) is correct. My point is that LK must recognize that the theory of intertemporal discoordination is one part of the whole corpus of theory that explains economic calculation. No less, an understanding of how an economy coordinates is necessary to understand how it discoordinations given certain conditions (which is exactly why Hayek used the notion of equilibrium as an ideal type). If we accept the fact that the theory of intertemporal discoordination is only a facet of the theory of economic calculation, then we can begin to see how economic calculation encompasses a theoretical area much broader than that which LK ascribes to it (business cycle theory).

We can now see how the second part of LK’s reply is completely irrelevant to my argument. When I accuse him of not understanding what economic calculation is he balks at my claim, and in the process of defending himself actually proves my point. He begins to discuss fractional reserve banking and intertemporal discoordination (again), without realizing that all of this is really completely besides the point. Yes, some Austrians believe fractional reserve banking causes economic discoordination, and yes, we can say that certain aspects of some theories of coordination and discoordination are wrong (such as the belief that fractional reserve banking necessarily causes intertemporal discoordination — and the failure to distinguish between fractional reserve banking on the free market and a fractional reserve system cartelized by a central bank, with a monopolized currency). These are all facets of the theory of economic calculation (or coordination and discoordination).

Government imposed price floors/ceilings, subsidies, and whatnot all cause economic discoordination — they disrupt the pricing process. Entrepreneurial failure on the free market, to some degree or another, is a force of discoordination (although, to another degree, is also a force of coordination — the distribution of wealth from failing entrepreneurs to successful ones, through profit or loss, is definitely a manifestation of market coordination. There are various forces of coordination and discoordination which have nothing to do with the theory of intertemporal discoordination, or at least separate to it. To understand all of this, though, you have to acknowledge that what the concept of economic calculation really refers to is the entire process of the allocation of goods towards the pursuit of ends.

The only thing that LK’s response has really proven is that he does not understand the argument I was making, and therefore does not hold comprehensive knowledge on the Austrian theory of economic calculation. This fact is embodied in the unnatural focus he holds on the theory of intertemporal discoordination — which we would not miss if it were left out of this particular discussion altogether —, which forms only a single portion of the entire body of theory that describes the workings of a market economy (i.e. the market process, or economic calculation, or the theory of market coordination/discoordination).

Side Arguments:

Fractional Reserve Banking in Mises and Hayek

LK claims that for Mises and Hayek the business cycle was caused, to the greatest extent, by the private banking system, and thus that the business cycle is endogenous to the market. This is true of the Hayek of Monetary Theory and the Trade Cycle (1933), but I am not sure this is true of the Hayek of The Denationalisation of Money (1976). While Hayek never reached the conclusions which were ultimately brought to the science by theorists such as Lawrence White and George Selgin, it is nevertheless evident that his knowledge on the banking system matured over time. Therefore, I am not sure it is fair to characterize the (Austrian) business cycle as an endogenous calamity on the basis of what Hayek wrote during the early 1930s. (As a sidenote, that this is true does not mean that we must throw all of early Hayek out — there is no reason to throw the baby out with the bath water.)

However, LK’s argument here is not true of Mises. Both early Mises (The Theory of Credit and Money, 1912) and later Mises (Human Action, 1949) believed that a free banking system would not cause concerted fiduciary overexpansion. This is evident in Mises’ belief that fiduciary media was necessary in the market economy (even if for different, or less dramatic, reasons than Selgin/White). He saw the problem of fiduciary overextension as one of central banking and/or government, and these non-market institutions alone.

It is true that both theorists saw the private banking system as the largest exponent in fiduciary overexpansion. However, saying that it was private banks who extended the most credit is different to claiming that the business cycle is an endogenous occurrence. If private overexpension is predicated on the actions of outside, non-market forces, then fiduciary overexpansion is not an endogenous force.

Ludwig Lachmann and Equilibrium

In response to my claim that ” an Austrian will tell a Keynesian that the market does not fail at intertemporal allocation,” LK summons Ludwig Lachmann. LK, however, utterly and terribly misinterprets Lachmann’s argument regarding the nonexistence of the equilibrium state. Lachmann’s main intention was to replace the notion of equilibration with the idea of the market process (see his essays “On the Central Concept of Austrian Economics: Market Process” and “Toward a Critique of Macroeconomics,” both of which are included in Edwin G. Dolan’s (editor) The Foundation of Modern Austrian Economics (1976), pages 126–132 and 152–159, respectively).

That Lachmann did not believe equilibrium was a useful tool in economic analysis, however, says nothing with regards to his views on intertemporal coordination, however. Indeed, the theories of coordination and discoordination were embodied in his conception of the market process (for a more complete view of his ideas on the market process see Lachmann’s The Market as an Economic Process). Thus, when LK challenges my claim that Austrians believe in the theory of intertemporal coordination by pointing to Lachmann, he is pointing to a scholar who actually agrees with me. Indeed, Lachmann wrote extensively on capital theory in the Hayekian tradition, although he sought a movement away from the Böhm-Bawerkian theory of capital (which is not the same as a movement away from the general Austrian theory of capital).