Sorry Matt, You Don't Know What Austrian Econ Is

 LvMIC:

Keynesian blogger extraordinaire Matt Yglesias’ new Slate article is yet another attempt from a mainstream econ pundit to delegitimize the Austrian school by misrepresenting key aspects and its applicability to the crisis today.  Robert Wenzel has already done a superb job of picking out many of Yglesias’ shoddy mistakes, I wanna correct just a few more.  Let’s start with this proclamation by the popular Think Progress blogger:

As he declared quasi-victory in Iowa following a third-place finish, Ron Paul puzzled cable news watchers across the country by proudly proclaiming, “We are all Austrians now.” The average Republican presidential candidate would sooner officiate a gay marriage than praise Europe, yet here was Paul pledging allegiance to Vienna. What did he mean? Why would we all be Austrians?

Paul’s statement was crystal clear to those familiar with the internecine controversies of the libertarian movement. He was referring to so-called “Austrian economics,” an idiosyncratic passion of his and a set of beliefs that put him at odds with the vast majority of well-known economists of all ideological inclinations.

While a majority of “well-known economists” do indeed reject the praxeological deductive reasoning and business cycle theory that make up the Austrian school, such a statement is heavily critical on what passes as orthodox economics today.  Unlike the Austrians, the “vast majority of well-known economists” missed the devastating housing bubble with flying colors.  Being “at odds” with such a group actually reflects very well on Dr. Ron Paul who saw the crisis coming years in advance.  Yglesias continues:

“Austrian economics,” in this sense, goes beyond standard-issue free market thinking in a number of ways. Most notably, it seeks to build a strong ethical case for strict libertarianism without admitting that this would lead to any practical problems whatsoever.

While Murray Rothbard synthesized the benefits of unhampered capitalism and natural rights to make the ethical case for libertarianism, Ludwig von Mises wrote on economics from a “value free” and utilitarian perspective.  To paint over the whole school as one that makes a strictly ethical case like Yglesias does is another sign that he misunderstands the views of the most important Austrian economist (Mises) outside its founder Carl Menger.

Perhaps the most damning statement demonstrating Yglesias’s true ignorance on the Austrian theory lies here:

Austrians also believe that cutting taxes to boost economic activity doesn’t work either.

How in the world does Yglesias come to this conclusion?  Mises was a long time advocate of lowering taxes on real estate, corporations, and capital gains.  Here is Mises making the case that taxes should be cut in order to stir production and free up income at the onset of a downturn:

Everywhere we see government continually taking over new taxes when it is hardly able to carry out satisfactorily its previous obligations.  Everywhere, we see the bureaucracy swell in size.  As a result, taxes are rising everywhere.  At a time when the need to reduce production costs is being discussed, new taxes are being imposed on production. 

Because of tax legislation, entrepreneurs must frequently operate their businesses differently from the way reason would otherwise indicate.  As a result, productivity declines and consequently so does the provision of goods for consumption.  As might be expected, capitalists shy away from leaving capital in countries with the highest taxation and turn to lands where taxes are lower.

And here is Rothbard writing on the necessity of cutting taxes:

If we allow the government to find and exploit new sources of tax funds, it will simply use those funds to spend more and more, and aggravate the already fearsome burden of Big Government on the American economy and the American citizen. The only way to reduce Big Government is to cut its tax revenue, and to force it to stay within its more limited means. We must see to it that government has less tax funds to play with, not more.

Where Yglesias gets this idea that Austrians don’t favor cutting taxes, I have no idea.  Certainly lowering taxes alone may not bring a robust recovery without a reduction in the regulator apparatus that acts as a burden on aspiring entrepreneurs, but it should be seen as a necessary step since all taxes, no matter what size, are a burden on the private sector.

Yglesias goes on to bring up one of the most widely used criticisms of  the Austrian business cycle theory:

The way this works, according to the Austrians, is that artificially low interest rates spur “malinvestment” in unworkable enterprises that inevitably crash when the stimulus is withdrawn. This is an emotionally appealing idea, positing that the suffering of a bust is a kind of cosmic payback for the boom. But it doesn’t make much logical sense. For one thing, as George Mason University economist Bryan Caplan, who’s ideologically sympathetic to the Austrians, points out, it’s hard to understand why businesspeople would be so easily duped in this way. If Ron Paul and Ludwig von Mises know that cheap money can’t last forever, why don’t private investors? Why wouldn’t firms avoid making the supposedly dumb investments? Ironically, the Austrians have replicated an error from the crudest forms of postwar Keynesianism—the failure to consider the role of expectations feedback in macroeconomic policy.

First off, just because Caplan and Yglesias think that investors and businessmen are endowed with perfect knowledge over central banking monetary policy does not make it so.  The existence of the housing bubble and its various supporters who never saw the bust coming is a huge vindication of the theory.  In a paper serving as a reply to the detractors of the ABCT, economist Walter Block shows why such assumptions by Caplan and Yglesias are simply wrong:

Of course, these assumptions are outlandish. There is nothing like full information available in the real world. Not only has an appreciation for ABCT not taken over the business community, it has not even done so within the profession of economics.  That being the case, there should be little real fear that government cannot create an ABC.We are arguing here, on the basis of contrary to fact conditionals. The present authors maintain that ABCT is so incisive and powerful an explanation that it would operate even in this heady non-existent world. That is, even if all market participants were not only fully cognizant of ABCT, but were also fully and totally informed about the decisions of the central bankers and, in addition, all consumers and firms, ABCT would still be correct. We claim it is an underestimate of ABCT to posit that inter-temporal misallocation due to money creation and funneling through the credit market works only through lack of information.  Moreover, in reality, many businesses and industries are well aware of the “Too big to fail” syndrome.  The point is that in the real world the idea of full (or complete or perfect) information is absurd. However, sometimes decision makers do have sufficient information to know that activities they might undertake in response to a Fed engineered money/credit expansion, with consequent reductions in interest rates, will, in all likelihood, prove unprofitable if the Fed reverses itself, causing interest rates to rise, even to the point of bankrupting them. Nevertheless, they may rationally undertake such activities hoping to make big profits before the Fed changes its policy, fully expecting the Treasury to bail them out and, indirectly, also rescue their creditors, if they prove to have been mistaken. Of course, they are able to become so highly leveraged because their creditors also fully expect such bailouts. Consequently, even if they know and understand ABCT, and even if they know that, without the possibility of a bailout, they would not engage in certain activities, nevertheless they do engage in them.

Businessmen, like all men, act to achieve ends.  In most cases, those looking to gain a profit buy low and sell high to do so.  To accomplish this, such entrepreneurial activity requires forecasting without having all relevant market information.  Even in the unrealistic scenario where the investor is more than aware of how much the central bank will print, exactly how the new money will find its way through the economy, and when the cheap money will run out, he may still try allocating his resources to the effected industry to make a few (or thousand) bucks when the prospect of doing so looks favorable.  But in the affairs of human action which holds no constants, such a scenario is pure fiction.

Yglesias through and through misunderstands and misstates many of the key components of the Austrian theory.  This makes him no different from much of the economic commentariat who are blinded by Keynesian econometric modeling.  Though I tackled a few issues with Yglesias’ piece here, Wenzel does the real takedown over at EPJ which is a highly recommended read.