I read an article on the Mises Institute’s website giving 5 reasons why Austrian economics is better than main stream economics. Each reason demonstrates that either Austrian economists do not know anything about mainstream economics or is irrelevant. In this post I will briefly discuss why each one is misses the mark.
1) Quantitative models totally miss the nature of human action:
In his first point Jonathan Newman Argues
“Unfortunately, you can’t even do basic math with people’s preferences for two reasons: preferences are subjective, and preferences are ordinal. You can’t measure or compare something you can’t observe, and you can’t do math with ordinal figures. Adding 2ndplace to 3rdplace doesn’t get you 5thplace or 1stplace. It gets you nowhere, which is exactly where mainstream macro is today.”
This is one of the biggest misunderstandings of Austrians. Quantitative models used by mainstream economists are based off of preferences. The preference relationships used by mainstream economists are ordinal. We use utility functions because we have proved theorems about what properties preference relations need in order to be represented by a utility function. If a preference relationship can be represented by a utility functions it means anything that is true for the utility function will be true for preferences. For example, if I prefer oranges to apples, then the utility function gives me higher utility for oranges. The utility function is arbitrary. All that matters is that we are representing the underlying preferences.
Another thing we don’t do is add the third best and the second best and claim that it is first best. That is a straw man. We do however, take combinations of bundles and can rank them as long as the preferences have certain properties. For example, if I prefer a bundle of oranges to a bundle of apples then I will most likely prefer a bundle of half oranges and half apples to a bundle of only apples. To argue that mainstream economists are adding ranked bundles the way he represents it shows a complete lack of understanding of mainstream economics.
2) The micro/macro separation is baseless.
Again, the claim itself shows a lack of understanding of why economists separate into micro and macro. Current macroeconomics models are based off of micro foundations. This happened in 1976 after Chicago school economist Robert Lucas published ”Econometric Policy Evaluation: A Critique”. Click here if you would like to read more on that. The reason there is separation is because there is a difference when you are studying one person and aggregating millions of them. Individuals act differently, so if one person does action X when he faces situation Y, another might choose Z. Therefore to account for this heterogeneity macro economists use different models.
He goes on to say “Mainstream economists find their way into smaller and smaller categories. Now, there is “health economics” and “development economics” and “energy economics.”… But how could we expect individuals to act differently if we are just changing our perspective? ”
Again, he is completely missing the point. Economists do not assume that people act differently because we are changing our perspective. We have different fields because they use different models. You do not model an individuals choice in education the same way you model an aggregation of individuals buying insurance. The reason there are different fields is because no one can be a master of every model.
3) Economic laws are not just empirical regularities
No economist is claiming this. No one is trying to refute the law of demand with empirical evidence and would not be published if they submitted a paper claiming to do so. However, there are ways to logically come to different conclusions. Therefore we need to look to the real world to find out which is true. Also, logic does not lead to truth. It is a way to understand and analyze arguments.
4) Austrian economics is not a collection of vague ideas
This comment by Newman shows to me that Austrians do not even understand that they are doing:
“We do not conjure up some homo economicus who behaves in some predictable way or consider human behavior as a formula with a stochastic component. We consider real humans as they really act.”
This is exactly what Austrian economists do. Why do we get the law of demand? Every single person sees diminishing marginal utility. In other words; every single person acts in a very predictable way. Why did Austrians “predict” the housing bubble? Because every single person reacts to low interest rates and government policies in a way that would lead to the crisis. In other words; every single person acts in a predictable way. Austrians try to act as if they do not assume humans act in a predictable way but yet they constantly make predictions about how humans act! Moreover, they constantly brag about being able to predict how humans will act. If humans didn’t act in a predictable way then there would be no reason to do economics. All this fourth point by Newman has demonstrated is that Austrians do not even understand their own methods, let alone mainstream economists.
5) Austrian Economists did predict the housing bubble…
The first thing I will say about this is see the paragraph above…
Second, everyone knew there was a housing bubble. Alan Greenspan and the Fed created a housing bubble on purpose. They did this because they handled the bursting of the last bubble so well that they assumed they could handle the housing bubble as well. Therefore, they thought the benefits of the bubble would outweigh the negatives. This wasn’t some secret only the Austrians had access too. Moreover, there were many people at the Fed who were predicting it to cause a recession.
If you want to see how truly poor of thinkers Austrians are just consider this thought experiment: Austrians claim that markets are perfect (not in the sense that you learn in micro 101 but that markets do not make mistakes) but yet Austrian economics has lost in the marketplace of ideas. This means one of two things, Austrian methodology is is a failed experiment (because markets do not make mistakes) or the market is imperfect which means Austrians are wrong. Either way Austrians need to move on. There have been so many advancements to mainstream economics since Human Action was written that it is embarrassing they are still clinging to it.
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