A critique of the Austrian and Chicago schools?

Over at Economist’s View there is an interesting piece from a book named “History of Economic Thought: A Critical Perspective”.

Now I don’t disagree with large parts of this. It is indeed fallacious to state that any CONCLUSION is value free – as it never is.

However, I feel that the piece mixes up its attack on the conclusions of the Austrian and Chicago school with the general neo-classical method – which is, in itself, closer to value free and objective. As the actual article says:

Their science applies everywhere because it applies nowhere. Most theorizing by these schools is purely tautological.

Now this may make the descriptions “unscientific”, but conveniently it also makes them value free.  Remember, the purpose of these “tautologies” is to create statements that we can use to show relationships between things in logical terms – they create a framework that allows us to then apply value judgments and reach conclusions.  Currently, this is one of the main roles of economists – to create a framework that can have value judgments added to it to create descriptions and predictions.  Economists often move a step further and create testable hypotheses, hypotheses that are supposed to describe, or possibly even predict what is going on.  However, another set of value judgments is then required to “prescribe” policy given these descriptions or predictions – this is a bigger step than some economists realise.

Still, for now let us take the implied “argument” that Austrian and Chicago economists are said to use in the above linked article, and see if we can adjust it to suit the way I see things 😛

So from the article we have this as the Chicago/Austrian school of thought:

  1. All human behavior involves choice.
  2. In any choice situation, whichever alternative is chosen involves gains and costs (whether explicit costs or implicit “opportunity” costs).
  3. Therefore, all human behavior involves exchange, since it involves acquiring gains in exchange for costs.
  4. All human beings choose rationally; that is, they exchange in such a manner as to maximize the excess of the utility of the gain over the disutility of the cost (or the utility forgone in the opportunity cost).
  5. Therefore, all choices are rational and represent the best possible alternatives among those available in the exchange process (the utilitarian neoclassicists have always avoided facing the issue of how capitalist society gives some individuals so many alternatives and others so few) .
  6. Since all choices, or exchanges (they amount to the same thing), are rational and maximize each chooser’s or exchanger’s utility, then total utility is always maximized .
  7. Therefore, free exchange in a capitalist society harmonizes all interests, maximizes utility, results in rational prices, results in efficient resource allocation, and, in general, automatically creates the best of all possible worlds.
  8. Furthermore, since all human activity is in reality exchange, each and every aspect of a capitalist society is rational and blissful.

This doesn’t sound to different to our initial view of neo-classical economics – except for a whole lot of extra, value-laden, terms.

The main problem here is that in this big description there is an important term missing – expected.  The word “expected” is so important because it gives us the idea that something that is “ex-ante” optimal may not provide the best outcome “ex-post”.

If we look up above and place “expected” before utility at each point, suddenly the argument makes a lot more sense, up until point 6.  Point 6 is missing true market failures, as a result we can’t say that total expected utility is maximised.  Things go even further with points 7 and 8 – which are now just conclusions stemming from the framework.

Expectations, and information issues, then cause all sorts of issues with the allocation of resources etc, and paint a whole wide role for government.

As a result, the missing expectations and information in the model is the whole reason why the description of methodological individualism painted at the Economists View Blog makes little sense.

My view is that we should take the first six bullet points, put expected before each utility, realise that there is a role for “structure” in decision theory, and leave it at that.  That is our common framework – from their our differing value judgments will lead us to different conclusions.

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  • Socal Bill

    There is no “role for structure” unless you can determine what that “role of structure” is. That’s what having choice is all about…not that it is perfect…it isn’t. The fact is nothing is perfect which means there is no such thing as a “rule for structure” because no one knows how to implement those rules so that they work just right all the time.
    All choices that we are allowed to make are assumed to be rational and are assumed to be harmonious but often times are not. That’s called learning from experience.
    The Free market is not perfect, but neither is the so called “role of structure”. We have different conclusions on these matters, but at least we have a Free Choice. That is important.

  • “because no one knows how to implement those rules so that they work just right all the time”

    I completely agree. What I was trying to state in an offhand way is that any determination of choice needs to understand how the structure of the “game” is partially determined endogenously. I am not trying to say that government mystically knows ways pareto-optimal ways of changing the structure of society – if it came off that way then that is my mistake 🙂

  • steve

    you say point 6 excludes true market failures.

    But isn’t that the whole point of the Chicago School. Most Chicago theories justify every market situation as not a market failure but in fact the optimal position. For instance the theory of contestable markets allows for natural monopolies to be maintained. Even if there is a true market failure and Chicago Economist would say the market is contestable and therefore not a market failure. Neo-classical would assume that there is a market failure and some sort of intervention would result in a higer overall total welfare.

    I may be wrong but I thought that is the fundamental difference between the two schools of thought. Other than that they are the same, but Chicago in practice denies taht market failures occur.

  • “Other than that they are the same, but Chicago in practice denies taht market failures occur”

    Indeed, the Chicago school often explicitly places a low weight on the existence of a market failure – and I agree that is a failure on their part (at least given my own value judgements 😉 )

    But as I said “I feel that the piece mixes up its attack on the conclusions of the Austrian and Chicago school with the general neo-classical method – which is, in itself, closer to value free and objective”

    The attack on Chicago seemed to branch out and attack the tautological nature of building a framework, which is a fundamental part of neo-classical economics. I felt that in this sense the attack became misguided.

    I am all for attacking the value judgments made by other economists – and I can understand the irritation associated with the fact that many economists, of any creed, will hide value judgments. But by painting the attack so broadly (instead of focusing on the value judgments where the Chicago school deviates from more general economic thought) the piece appeared to attack the entire method – something I wanted to clear up here.

  • steve

    you’re right then, it is critiquing both chicago and neo-classical. if it were a little more objective it would critique the differences and therefore even if the author is against both, the reader can see why the author prefers neo-classical over chicago.

    the only critique I have of chicago is the failure to accept that a market failure has occurred. Similarly though, neo-classical may be too quick to assume the result is because of market failure, rather than something else as proposed by chicago economists.

    A good post though, thank you for clarifying the argument.

  • “you’re right then”

    Although it is incredibly likely that I could be mis-interpreting the article – I’m willing to accept that is a possibility 🙂

    “the only critique I have of chicago is the failure to accept that a market failure has occurred. Similarly though, neo-classical may be too quick to assume the result is because of market failure, rather than something else as proposed by chicago economists.”

    I completely agree. Ultimately, each specific school invokes different value judgments which may or may not be valid in different surroundings. The good thing about the general economic framework is that it provides a setup that makes these judgments transparent.