A “Kleinian” Version of Austrian Business Cycle Theory

by Gene Callahan

The next phase in my (now our, as I’ve taken on a colleague) project of thinking through Dan Klein’s Knowledge and Coordination is to see how his ideas might be used to help describe business cycle theories and demonstrate commonalities they share. Note: the point of the present exercise is simply to try to describe an existing business cycle theory in Kleinian terms, not to improve upon it or argue for its accuracy.

We will begin with the Austrian Theory of the Business Cycle:

The Great Ideas of the Social Sciences

by Gene Callahan

Let’s take social science broadly, in the sense of German wissenschaft, so that The Republic and Politics and The Social Contract are social science. (I would contend that they are, in fact, often much more scientific than the latest regression study of how detergent use correlates with the suicide rate.)

So what, then, are the most important ideas ever put forward in social science? I’m not asking what are the best ideas, so the truth of them is only obliquely relevant: a very important idea may be largely false. (I think it still must contain some germ of truth, or it would have no plausibility.) Think of it this way: if you were teaching a course called “The Great Ideas of the Social Sciences,” what would you want to make sure you included?

Here’s my preliminary list. What have I left off? What have I mistakenly included?

Fads as Social Cycles

We don’t follow fashion
That would be a joke
You know we’re going to set them set them
So everyone can take note take note — Adam Ant and Marco Pirroni

by Gene Callahan*

In his book Knowledge and Coordination, Daniel Klein distinguishes between mutual coordination and concatenate coordination. Mutual coordination is coordination which people intend: you and I plan to meet for lunch, or several con artists devise a scheme to defraud an elderly widow of her fortune. Concatenate coordination is coordination that is pleasing to an impartial observer: one of Klein’s examples is a room designed with a harmonious combination of colors, shapes, and so on.

It is important to note that successful mutual coordination does not imply concatenate coordination. If the con artists pull off their scheme to defraud the widow, they will have achieved mutual coordinaiton that is not concatenate coordination. (I really cannot do this schema full justice here; I am just introducing it to make sense of the rest of this post, and you really must read the book to fully grasp it.)

Let us analyze fads using Klein’s terms.

Ban the Traffic Light?

by Gene Callahan

Joseph Fetz’s blog alerted me to an interesting video comparing the same intersection in New Zealand on a day when its traffic light was out versus the next day with the light back in operation. The video certainly illustrates the fact that people’s ability to achieve spontaneous order can be greater than one might suspect at first: many people would guess that the day without the light would be chaotic by comparison to the one with it, but traffic actually seems to flow better with the light off.

The Limits of Bayesian Inference

by Gene Callahan

Dan Klein’s Knowledge and Coordination has something interesting to say about Bayesian inference, although he never explicitly addresses that topic. Consider the following:

Here, we have the distinction between responding to the realization of events within a framework of recognized variables and relationships and the discovery of a fresh opportunity to embrace a new and better framework or interpretation. This element of epiphany, of finding fortune by interpreting the world differently, is the subtle and vital element in human decision making. Yet, it is absent from equilibrium model building. In equilibrium stories, agents never have a “light bulb” moment… (p. 13)

Kirzner’s alertness is the individual’s re-interpretation of that world [of a world of already-interpreted “facts”]. (p. 14)

“Equilibrium” is meaningful only in reference to a specified model… (p. 28)

Bayesian inference, similar to equilibrium theorizing, works within a fixed frame of interpretation: it “is meaningful only in reference to a specified model.” It cannot extend across instances when a new interpretive framework takes the place of the old.

Spontaneous or Planned: A Sharp Dichotomy, or a Gradient?

by Gene Callahan

I am writing a solicited comment for Dan Klein’s new book, Knowledge and Coordination: A Liberal Interpretation, for the journal Studies in Emergent Order. This is an especially interesting task for me, as Klein’s topic is obviously vital to my preliminary work on social cycles. And Dan is always an intelligent and engaging writer, so this should be a fun project. I find it helpful, in the interest of getting a paper done, to blog my thoughts as I go along, so here we go:

The first thing of importance I have noted is Klein, at least in the opening chapter, seems to posit a sharp dichotomy between spontaneous orders and planned orders. He uses the example of roller skaters in a rink: either they are each skating purely as they wish, or their movements are entirely planned by a “wise” planner. (This may well be modified by Klein later, but even if so, I have seen others treat this topic as if this was a simple dichotomy, so my remarks are, I think, worth making anyway.)

But real social orders are rarely (ever?) of either extreme. The extremes are ideal types, and real orders more or less instantiate the types.

Using Sortition to Achieve Campaign Finance Reform

by Gene Callahan

I was sitting in a session of the British Political Studies Association Conference today, listening to several speakers talk about sortition (using random selection in the political process) when I was struck by a way to employ it to achieve campaign finance reform without any restriction on donations or campaign length. So, I share:

We have a problem with money corrupting the political process, and part of that problem is how long our campaigns run. How can sortition ameliorate the problem?

Social Cycles: An Example

by Gene Callahan

Earlier, I posted some preliminary thoughts on the idea of a general theory of social cycles. Today, I’d like to expand upon one of my examples a bit.

If you recall, I mentioned merging onto a highway as an illustration of adjustments and displacements — which I will henceforth call “disruptions,” by the way, since I think that is a better term.

Let us now imagine a busy highway with entrances and exits every mile. The entrances are not well-designed: there is no lane for smoothly merging into traffic while getting up to speed, but a stop sign at the end of the entrance ramp. (This, in fact, is pretty much a description of the Merritt Parkway in Connecticut as of 30 years ago.) What this means is that every time traffic nears an entrance, there occurs a cluster of disruptions, as people enter traffic at a slow speed.

These disruptions will produce a cascade of further disruptions, as the adjustments made by drivers breaking for merging automobiles thwarts the plans of other drivers who wish to continue at a steady speed. Thus we get a logjam around the entrance ramp. This is the “bust” phase of our cycle. (We need a better, more general term here. Any ideas?)

Notes on a General Theory of the Social Cycle

by Gene Callahan

Monday past at our colloquium Andreas Hoffman presented a fascinating paper attempting to depict Austrian Business Cycle Theory as a special case of a more general business cycle theory based upon Hayek’s later work on spontaneous orders. Hoffman’s general idea (I won’t do it justice in this brief summary, so please have a look at the paper) is that business cycles occur when a “displacement” creates a situation in which people are uncertain how to make “adjustments” to move back closer to equilibrium. The period during which people are groping about for what to do creates the slump, and the upturn comes, of course, once they have gotten the hang of the new situation.

A lively discussion followed, during which Israel Kirzner, Mario Rizzo, and others pressured Hoffman on just what he meant by an “adjustment,” a “displacement,” and why these things would create a cycle, rather than merely ongoing “churning,” to use Kirzner’s word. (He also mentioned Lachmann’s notion of the “kaleidic society” in this context.)

Riding home on the subway afterwards, what struck me was that we lacked a general framework of accepted definitions for talking about things like adjustments, displacements, and social cycles. (I will justify the use of “social” later.) As soon as I noticed this, the following thoughts entered my mind, essentially all at once. Some of them were drawn directly from the discussion. And they are all very preliminary: but that is one thing that blogs are for, is it not? In any case, feedback on these presently sketchy ideas is welcomed.

O’Driscoll and Rizzo Got There First

by Gene Callahan

I had believed that Tony Carilli and Greg Dempster (“Expectations in Austrian Business Cycle Theory: An Application of the Prisoner’s Dilemma,” The Review of Austrian Economics, 2001) made a major advance in Austrian Business Cycle Theory by hitting upon the correct solution to the challenge presented by, for instance, Gordon Tullock, who once wrote:

“The second nit has to do with Rothbard’s apparent belief that business people never learn. One would think that business people might be misled in the first couple of runs of the [Austrian] cycle and not anticipate that the low interest rate will later be raised. That they would continue unable to figure this out, however, seems unlikely.” (“Why the Austrians Are Wrong about Depressions”)

By posing the situation as a prisoner’s dilemma, where businessmen are rational to exploit the short-term profit opportunities offered by the boom phase (since if they don’t their competitors will) Carilli and Dempster adequately answered Tullock’s complaint. (I especially liked their solution because I independently had hit upon the same idea, which I was working out while writing my book, Economics for Real People. Well, I wasn’t the first to print, but at least I was the first to reference their paper!)

But yesterday, while editing someone else’s work, I discovered that Gerald O’Driscoll and Mario beat us to the basic insight by several decades, although they did not give it a game-theoretical formulation:

“[T]here are profits to be made from exploiting temporary situations. . . . Though entrepreneurs understand [the macro-aspects of a cycle] they cannot predict the exact features of the next cyclical expansion and contraction. . . . They lack the ability to make micro-predictions, even though they can predict the general sequence of events that will occur. These entrepreneurs have no reason to foreswear the temporary profits to be garnered in an inflationary episode. . . . From an individual perspective, then, an entrepreneur fully informed of the Austrian theory of economic cycles will face essentially the same uncertain world he always faced. Not theoretical or abstract knowledge, but knowledge of the circumstances of time and place is the source of profits.” O’Driscoll and Rizzo, The Economics of Time and Ignorance

Note: I still think what Carilli and Dempster did, in giving this a game-theoretic formulation, is great work. I just see it is not quite as original as I had thought.

Of Interest to All Market Process Economists

by Gene Callahan

Dan Klein responds, on the meaning of economic coordination, mostly to Israel Kirzner, and secondarily to several others, including me. Here is Klein’s abstract:

The Fall 2010 issue of the Journal of Private Enterprise featured a complicated set of papers. The lead article was a long paper by Jason Briggeman and me, on Israel Kirzner’s work on coordination and discovery. The thrust of our paper was an affirmation of Kirzner’s central claims, but with two alterations. First, we propose that the coordination that figures into the central issues ought to be understood as what we call concatenate coordination. Second, the central statements at issue ought not be asserted as holding 100 percent of the time, but rather should be by-and-large statements, making for a strong presumption, not a categorical result. Israel Kirzner then replied to our paper. The pair of papers was then the object of commentary by Peter Boettke and Daniel D’Amico, Steven Horwitz, Gene Callahan, and Martin Ricketts. Here, I respond to Kirzner, and, in an appendix, more briefly to the others.

Interpreting Statistics

by Gene Callahan

There is always a temptation to think of a statistic as a simple, straight-forward fact: Numbers don’t lie. Consider this statement from Newsweek from an article on structural unemployment in the US:

‘Another theory is that Americans are less willing to move to take jobs. The McKinsey study reports that, in the 1950s, one in five Americans moved every year; now it’s one in 10. “Work is more mobile than workers,” says Camden.’

What could be clearer? Workers are less willing to move. Just look at the numbers!

But let me suggest that things are not so simple as they appear.

How to Teach the History of Economic Thought

by Gene Callahan

I was recently asked about a good textbook to use in teaching the history of economic thought. Well, last year I had used William Barber’s book, and found it wholly adequate. But as I was teaching the course, I became somewhat uneasy about the textbook approach. I started to feel I was giving what Michael Oakeshott referred to as a “museum tour” of that history: “Over there, on your left, is Aristotle… he held exchange should take place when values exchanged are equal. There, on the right, is Adam Smith. Do you see the extensive division of labor in his diorama? Just past him is David Ricardo…”

Generalizations in the Social Sciences

by Gene Callahan

On his blog, Daniel Kuehn notes that “relations in economies are not stable.” In fact, we can go further:  Relations in the social sciences are not stable. As an illustration, consider Zipf’s Law as applied to city size.

In 1700, London had about 575,000 people. According to Zipf’s Law, the next-sized city should have had about 280,000 or 290,000 thousand. What was the actual size of the second largest city? As far as I can determine, it was Norwich, with a population of about 30,000. (My source for the population figures is 1688: The First Modern Revolution.) Zipf’s “Law” is off by a factor of about ten in this instance.

What I suspect is that there is some historical circumstance that leads to Zipf’s Law applying to city size in recent centuries, which was not present in 1700. As political scientist Terry Nardin put it: “Generalizations about how people usually behave are not scientific generalizations about a truly time-independent class of phenomena; they are more or less well-disguised descriptions of customs specific to a particular historical situation.”

The Genius of Weber

by Gene Callahan

This semester, I am having the pleasure of teaching Max Weber‘s The Protestant Ethic and the Spirit of Capitalism for the second time. Doing so is renewing my appreciation for one of the great works of social science.

Weber’s historical thesis is fascinating in itself, but what really makes the work is that it is a mini-study in how to historically investigate a social-science proposition, complete with asides on method were Weber explains what he is doing. He takes two situations that are in most respects the same (that of German Catholics and that of German Protestants) and notes a crucial difference (besides religion): the two populations have significantly different degrees of participation in the capitalist mode of economic organization (as of 1905).

Attributing Agency

by Gene Callahan

In C. Mantzavinos’s Philosophy of the Social Sciences there is a paper by Philip Pettit entitled “The Reality of Group Agents.” (He decides, by the way, that sometimes it makes perfect sense to attribute agency to a group, but that’s a topic for a different day.) What I wish to talk about today is the following passage, a preliminary to the issue of group agency, which discusses when it is sensible to posit agency for an individual creature such as, say, a wasp:

Why Are Medical Offices in the IT Paleolithic?

by Gene Callahan

As a social theorist, I find it always interesting, and a useful exercise, to try to arrive at a good explanation for some social anomaly. But sometimes I find myself at a loss, and here is such an instance: Why, oh why, when we go to a medical office, do we write the exact same info on three of four different pieces of paper? Why are we even writing on paper? I mean, if there is one thing that computers have unambiguously improved, isn’t it the storage of routine information like this? Why can tiny St. Francis College, where I teach, in about one minute set me up so that I am receiving

Minimax It

by Gene Callahan

I’m always shocked by the idea that “the star has to take the final shot” in basketball. I just watched UConn, down one point with eight seconds left against Louisville, force the ball to Kemba Walker for what must have been about a thirty-foot shot. They had the ball in the hands of Shabazz Napier, a dynamic, fast point guard, who can drive, and they only needed two to win. When Napier saw Louisville was focused on Walker, why in the world wasn’t he given the green light to go to the basket?

Keynes Versus Hayek: An Empirical Matter

by Gene Callahan

Imagine that you saunter to the faculty cafeteria one day and sit down at a table already occupied by two theoretical physicists. You discover them deep in a debate. One says he has developed the wind-driven theory of leaf fall that portrays the path of a leaf, once it has left its parent tree, to be determined almost entirely by the wind. The other fellow has a gravity-driven model of leaf fall, which has it that it is gravity controlling the show. You are somewhat amazed by the fierceness of their debate, and by the fact that they just keep going on at the level of theory. Finally, exasperated, you ask, “Has it ever occurred to either of you that you are both right?

Phil the Economic Literacy Turtle

by Gene Callahan

My family recently acquired “Phil the High-Yield Turtle.” This came about because a friend of my wife, whom we will call Bill and who happens to trade high-yield bonds, saw Phil being sold on the street, presented in rather bad circumstances by his owner, and felt sorry for him. Bill took Phil and kept him (in much better conditions) in his office for several months before realizing that Phil was running out of space and needed a new home — at which point my wife volunteered to adopt him and… now we are Phil’s caretakers!

Well, Bill’s motives were certainly admirable: he wanted to help an animal he thought was in distress. Unfortunately, Bil”s attempt is likely to have the opposite effect to that he desired, since, by newly entering the market for turtles, Bill shifted the demand curve to the right. And that will increase the quantity supplied. In short, even if Bill had been moved enough and generous enough to buy every single abused turtle on the market, he simply would motivate the sellers to immediately replenish the supply. (Do you recall Milo Minderbinder trying to corner the Egyptian cotton market in Catch-22?)

In fact, the horrible thought came to me that this market could be largely driven by mercy purchases. And furthermore, such purchasers give the vendors a motive to make the conditions in which the animals they are selling are kept as bad-looking as possible!

Kirznerian Baseball

by Gene Callahan

The Mets recently hired Paul DePodesta, one of the key developer’s of the “Moneyball” approach to finding and hiring baseball talent in Oakland. DePodesta describes what Moneyball really is here:

DePodesta, who left Oakland to serve as the Los Angeles Dodgers’ general manager for two seasons before becoming an executive with the San Diego Padres, said that Lewis’s 2003 book — which remains a bible for statistics-minded fans — was a caricature. Statistics are important, he said, but the Moneyball philosophy is more an approach to evaluating talent, not a constrictive road map.

“In my mind, Moneyball really has absolutely nothing to do with on-base percentage; for that matter, it doesn’t really have anything to do with statistics,” he said Tuesday on a conference call with reporters. “Rather, Moneyball is really about a constant investigation of stagnant systems to see if you can find value where it isn’t readily apparent.”

Scientism in the Way of Science

by Gene Callahan

I repeatedly find attacks on positions in the social sciences made based on extremely limited and, frankly, antiquated views of how the physical sciences proceed. I will give one example from a rightist criticism of a leftist view, and one that is a leftist criticism of a rightist view, to illustrate that my point has nothing to do with ideology — or perhaps, that it has to do with the way ideology can lead one to embrace flimsy criticisms of other’s positions.

The first excerpt is from Hunter Lewis’s book, Where Keynes Went Wrong:

“In chapter 15, we saw how Keynes wrote N = F(D), which means that employment, denoted N, is a function of demand. Demand however is defined as expected sales, not actual sales. We noted that expectations are not a measurable quantity and thus do not belong in an equation.”

Well, one way to measure these expectations would be to walk around and ask the entrepreneurs “How much do you expect to sell this year?” then total up those amounts. Why in the world this would not be a fine measurable quantity is unclear.

When Good Historians Go Bad

by Gene Callahan

I had posted about something that Thomas Sowell wrote on the history of economic thought over at my other blog, and received a comment to the effect that, “You can’t trust Sowell on history: he thinks that England conquered Scotland!” (Rather than the two nations having joined together in a union.)

This comment both illustrates an important misconception as well as highlights an important distinction. The misconception is that someone is a good historian if they know lots of “facts” about history, and rarely get anything wrong.

Krugman Mangles Smith

by Gene Callahan

Here’s Paul Krugman, explaining the meaning of Adam Smith’s pin factory, and why it opposes Smith’s invisible hand metaphor:

“What may not be obvious is the way these two concepts [pin factory and invisible hand] stand in opposition to each other. The parable of the pin factory says that there are increasing returns to scale — the bigger the pin factory, the more specialized its workers can be, and therefore the more pins the factory can produce per worker. But increasing returns create a natural tendency toward monopoly, because a large business can achieve larger scale and hence lower costs than a small business. So in a world of increasing returns, bigger firms tend to drive smaller firms out of business, until each industry is dominated by just a few players.”

And, of course, this monopolistic competition wrecks the operation of the invisible hand, per Krugman.

The Method of History

by Gene Callahan

I’m currently reading Bryan Sykes excellent book, The Seven Daughters of Eve. Well, excellently written, and, I have to assume, excellent on the genetics. But there are a couple of fundamental misunderstandings of history present in the book, that I think are worth noting, because of the frequency with which people believe them.

The first such error is that Sykes keeps referring to “prehistory,” “recorded history,” “the beginnings of history,” and so forth. These phrases are symptomatic of the error, exploded decades ago by Collingwood, that there is something especially “historical” about written records, that they represent the “recording” of history by those “witnessing” it, and that, in their absence, we only have some fuzzy “prehistory” with which to deal.