POLITICAL OPINIONS#58: KEYNESIAN ECONOMICS AND THE AUSTRIAN SCHOOL

INTRODUCTION:

When it comes to the economic schools of philosophy and application there are two that come to mind. The two schools being Keynesian and Austrian school.  The significantly more prevalent of the two, the  Keynesian school is regarded as being the universally accepted form of economics.  It is championed and utilized by both mainstream Conservative and Liberal economists. Considering the relative obscurity of the Austrian school of economics is seldom discussed as a viable alternative economic philosophy.  In the vast majority of undergraduate economics courses it may only mentioned in brief passing. Potentially noted with a hint of parenthetical derision and ridicule.  With no serious consideration of the Austrian school it is viewed as more of a theoretical footnote. It can be argued that the Austrian school has been periodically maligned unfairly considering the Resistance to actively apply it.

 

However, while the Austrian school as been marred as a punchline to many economists it has been undergoing a reemergence. In the ravages of the 2007 and 2008 economic crisis which was punctuated by the integral contribution of the “housing-bubble”, more Americans grew incredulous of  our economic policies. The mounting evidence of the failure of the status quo economic policies, methods, and philosophies brought forth the opportunity for alternatives. The Austrian school would begin to as it continues to reach a broader audience.  No longer being confined to the circle and associations of libertarians and fringe economists. The major impetus for the increase in  mainstream exposure being the Presidential campaign of then Texas senator Dr. Ron Paul. His 2008 campaign coincided with the economic turmoil of the recession and provided ample opportunity to present suggestions to remedy the carnage. Dr. Paul having longstanding ties to organizations such as the Mises Institute which have been enduring proponents of Austrian economics. The organization taking it’s name from Austrian economist Ludwig  Von Mises. Paul utilized his platform the become one of the most vociferous allies of Austrian economics in mainstream politics.  It spoke of the kind of fiscal conservatism that appealed to those rattled by the volatility of the contemporary economic market.

 

The whole point of this blog entry is not to be a slanted and partisan indictment of Keynesian economic theory. This entry will be more of a side by side comparison and introduction to the two theories. The two paragraph preamble above is merely there to demonstrate how Austrian economics has been ostracized by the majority of economists. Which is more so why it is important for me to include in equal consideration of that of Keynesian theory. If we do not contemplate the potentials of both theories we are falling short of intellectual honest and otherwise just passively capitulate to conventional wisdom. To do otherwise would merely making us victim of the appeal to authority fallacy which is far from  a prudent means of arriving at the best answers. While I will not provide any direct commentary on the follies and positive attributes of either theory, I will do so in subsequent blog entries in the future.

 

BACKGROUND OF KEYNESIAN  ECONOMICS:

The roots of  Keynesian economics  stem back to the economic conceptualizations of English economist John Maynard Keynes. Keynes book General Theory of Employment, Interest and Money, published in 1936, solidified the principles of the pillars of his theory [1]. It remained unchallenged until the 1970’s when the economic principles of Monetarism became more prevalent. Right around the 1971 expiration of the Bretton Woods Agreement, that move the United States away from the gold standard [2]. Many of the sound money advocates grew silent as the 1980’s rolled on. The Keynesian system remained in favor and once again came under scrutiny  in the 2007-2008 recession. Theorists refined current methodology to adapt to the current economic climate and has been viewed as relative successful [1].

Keynesian Economics will have its   legacy encapsulated as the prevailing form of economics for the 20th century. Considering the reforms made to it back during the global fiscal crisis of 2007-2008, it has demonstrated its fungible malleability of it has a theory. While being open to adaptation and pragmatic evolution , the fundamental difference between the two schools needs to be established. That is the role of government in economic affairs. Economists of this economic paradigm tend to belief that government intervention can have positive results on employment rates and demand/ production of goods and services. Generally through manipulating “tax policies” and “government expenditures” [1].

 

CORE ASSUMPTIONS OF KEYNESIAN THEORY:

 

The Keynesian school of economics did arise from the Keynes attempts to analyze the causes of the Great Depression. The theory assumes that lowering taxes and increasing government spending mimics market demand and can counteract an economic depression. Through utilizing government intervention it can optimize economic performance and circumvent slumps. [3]Through artificially impacting aggregate demand or  “measurement of the sum of all final goods and services produced in an economy, expressed as the total amount of money exchanged for those goods and services”  [5].

The Keynesian theory of economics postulates that aggregate demand is impacted by decisions made in public and private sector. Which essentially can be distilled to the fact that decisions made in regards to momentary and fiscal policy impact aggregate demand. Keynesian theorists use to  purport that monetary policy had no impact and modern theorists have relinquished this view. Policies regarding spending, taxation, and currency all have an integral impact on this metric.[4].

 

A second talking point of Keynesian theory is that changes in aggregate demand have a short-term effect on output and employment, but not on prices. Subscribers of this theory believe that long term consequences cannot dictate short term and we live in the short term. This notion exemplified by  inflation only slightly rising when unemployment decreases. Pronounced repercussions of  monetary policy are only significant if prices are rigid and wages do not appropriately adjust. The injection of  more currency to the more supply would have a similar influence on prices. If  government spending increases and all other forms remain the same , commercial output will increase. They apply the concept of multiplier effect to explain how subsidy from the government increases output. [4].

 

 

A third core doctrine of this economic philosophy is that wages and prices are slow to respond to supply and demand resulting in surpluses and shortages. [4].

 

The fourth central component of  Keynesian economics do not find a typical arrange of unemployment to be acceptable due to it being contingent on aggregate demand and the slow rate of price adjustment. Keynesians have a proclivity to view unemployment to high and variable across the board. They view that in economically tumultuous periods “…efficient markets respond to unattractive opportunities..”. In other words, even if it is a recession, you should not stave off hiring more employees. [4].

 

The fifth notable attribute of Keynesian economics is that proponents support activist stabilization policies. Such as example would include a moderate increase to the money supply to combat a higher unemployment rate as a means of artificially re-calibrating  balance. [4].

 

The six and final characteristic of Keynesian though would be seeing more peril in unemployment than inflation. Many of this school of thought perceive the costs of inflation as being a small consequence. Which clearly demonstrates the train of logic used in their economic stabilization  theories. This acceptance and justification of aggressive government action rests on two assumptions, (1) the ebbs and flows of macroeconomics are overall detrimental and (2) the government has the capacity to remedy any issues in the free-market. [4].

 

BACKGROUND OF THE AUSTRIAN SCHOOL:

 

In a figurative sense, if  Keynesian economics had an arch nemesis it would be Austrian economics. While Keynesian school of though regard governmental adjustments  and institutional oversight, the Austrian school is its staunch reciprocal. In stead of artificial safeguards and invitations, Austrians economist would rather allow the market to operate in a natural fashion. Allowing the complex system of the economy adjust through the actions of actors in the private sector versus the parental stewardship of the public sector.

 

The genesis of Austrian economic theory can be traced back to the late-1800’s in the country of Austria. The key architect of  being  founder Carl Menger and his myriad of various followers Eugen von Böhm-Bawerk  and Friedrich von Wieser. Influence of such economic theories were continued in the twentieth century by some of the most renowned  theorists, including the likes of  Ludwig von Mises  and Friedrich August von Hayek, “who was awarded the Nobel prize in economics in 1974…” [6]

 

Menger engendered the enduring legacy of Austrian economics through the publication of his book  Principles of Economics 1871. The book fixated on historical studies of  entrepreneurship, time structure of capital goods, banking and money, business cycles,  dynamic markets, critiques of government intervention  and knowledge as decentralized [7]. Menger  postulated that the value of a commodity was  subjectively derived, however, the marginal of a commodity is its true value. The more scant a commodity is the it will be utilized in a more important manner. Single-highhandedly rectified Adam Smith’s “Diamond-water paradox” of how Diamond which are nonessential to life put cost more than water. Menger’s direct students would then advance upon these principles of marginal utility. [8].

 

His student Friedrich Von Wieser applied  marginal utility  to not value of a commodity but to the premise of consumption. The value of productive resources would be attributed to their contribution the final product. Wieser also applied the concept of opportunity costs to the costs of  production [8]. Opportunity costs being the opportunities lost in exchange for choosing one expenditure over another.[9]. Eugen Von Bohm-Bawerk  derived his theory of price from marginal utility.  However, Bohm-Bawerk’s  true contribution to economics was his research on capital and interest. Specifically concentrated how time factored into value, interest being a form of compensation to  a lender for the use of capital with no direct payoff. The percentage rate of the interest being determined by the size of labor pool, amount of capital in the local market, and ability to increase productivity. [8].

 

The contemporary legacy of Austrian economics was land-marked by the theories of  two Austrian economists that ended up stateside. The two prominent economists being the revered F.A. Hayek and Ludwig Von Mises.  In a broad sense both theorists asserted that complex economies cannot be planned due to ” true market prices being absent…” making it impossible to procure information for planning [8]. The seeds of the backbone this fiscally conservative tradition came about in 1945 when Hayek arrived to the United Stated for a lecture tour. Hayek embarked upon the tour in support of his renowned classic  The Road to Serfdom.  His book garnered much attention and landed him on the cover of Reader’s Digest. While impressive, Hayek’s connections to business man and free trade organizations is would made his career enduring.The organizations he formed and even his salary as a lecturer over at the University of Chicago can be cemented by these professional ties. [10].

 

KEY ASSUMPTIONS OF AUSTRIAN ECONOMICS:

“There, he offers 10 propositions that define Austrian economics.

  1. Only individuals choose.
  2. The study of the market order is fundamentally about exchange behavior and the institutions within which exchanges take place.
  3. The “facts” of the social sciences are what people believe and think.
  4. Utility and costs are subjective.
  5. The price system economizes on the information that people need to process in making their decisions.
  6. Private property in the means of production is a necessary condition for rational economic calculation.
  7. The competitive market is a process of entrepreneurial discovery.
  8. Money is nonneutral.
  9. The capital structure consists of heterogeneous goods that have multispecific uses that must be aligned.
  10. Social institutions often are the result of human action, but not of human design.”

[11].

 

DISCUSSION:

As is evident in the side by side juxtaposition of these two competing economic philosophies are their sharp distinctions.  It would be fair to say it is to the extent that they are nearly polar opposites. One body of theories places faith in governing institutions and the other does in the markets. Austrian economics views markets as a true complex systems analogous to an environmental ecosystem. Imposing artificial restraints merely causes destructive chaos. Impositions of regulation and misguided manipulation merely results in disruption. Similar to how eliminating a food source from an ecosystem  devolves into biological instability, relinquishment of equilibrium. Which is why Austrian economists generally favor less institutional intervention in economic matters. Setting aside any ideological biases I possess I can honestly state that it is line of logic that could be seen as rational.

 

However, the reasoning behind the core principles of Keynesian economics is not lost on me. While being a staunch reciprocal of the Austrian school it almost seems equally as cogent in a superficial sense. It easy to see the validity of the two body of theories when ideological predispositions and data are out of the equation. The  Austrian school of economics  may seem reasonable  if you have you are fiscally conservative or have studied biology. However, I should interject that it is counter intuitive to some extent.  The ardent emphasis on formal structure in society is so instilled in us ,even most libertarians have difficult side-stepping these tendencies. Maybe not in terms of policy, but in terms of personal judgement. From the time that we are children are constantly bombarded with  rules that shape our behavior and help us conform ideas and forms of conduct. Even examples as trivial as the rules of a board game such as Candy Land align for this cognitive bias for formal structure. I am not judging it so much as this is merely an observation.

 

The trepidation and fear of allowing economic transactions to exist without an abundance of regulation has its origins in our conditioning towards formal structure. While it denying the stability of naturally occurring equilibrium, it is not an outlandish notion. Humans are wired for self-preservation, part of the evolutionary mechanisms behind this is to address the most base and repugnant motives of human nature.  Many individuals see it as whenever there is an opportunity to capitalize, someone is getting victimized. The question becomes are the regulations truly an objective force of  moral good if they are the invention of man?  State sanctioned laws are merely  constructs, the conceptual by product of human though. The have the potential to reflect aspects of moral truth, however, they also can be slanted to favor certain individuals.  The agenda behind the lawmakers thought process are just as suspect as the motives of  your neighbor selling  his 1969 Mustang car. The key difference being your neighbor has quite a bit to lose in reputation when compared by the senator who chooses to vote for oppressive regulations. The senator can hide in obscurity, while your neighbor will likely not do so well in future transactions, having violated the variable of trust. Trust a key component of reducing transactions costs.

 

While economic regulations in theory could be well-intentioned, they are certainly open to scrutiny.  Few metrics can really examine with regulations are effective especially when dealing with a dynamic complex system such as economy. Where you are dealing with a Wealth of Nations style  free-market  or a heavily regulated market, the foreboding peril of human nature is always present.  If the inherent risk is always omnipresent, would you rather live by your own will or the will of others?  This open rhetorical question is not an attribution of judgement , but  rather food for thought.

 

 

FOOTNOTES:

[1]. https://www.britannica.com/topic/Keynesian-economics

[2]. https://www.federalreservehistory.org/essays/bretton_woods_created

[3]. https://www.investopedia.com/terms/k/keynesianeconomics.asp

[4]. https://www.econlib.org/library/Enc/KeynesianEconomics.html

[5]. https://www.investopedia.com/terms/a/aggregatedemand.asp

[6]. http://austrian-institute.org/en/the-austrian-school-of-economics/

[7]. https://www.progress.org/articles/austrian-economics-explained

[8]. https://www.britannica.com/topic/Austrian-school-of-economics

[9] https://www.britannica.com/topic/opportunity-cost

[10] https://historynewsnetwork.org/article/159020

[11]. http://www.coordinationproblem.org/2010/11/what-austrian-economics-is-and-what-austrian-economics-is-not.html

 

Advertisements

Author: invertedlogicblog

I am an armchair philosopher,libertarian,an other gear in the machine, a truth seeker and skeptic.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s