diocletian

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A Critique of the Methodology of Mises & Rothbard

I find myself in the middle of a huge blowup between Max Keiser and Tom Woods over Mises, Menger and Austrian economics and feel that this is an opportune moment to express some doubts I have regarding contemporary Austrian methodology.

I am to some extent an Austrian, on three counts.

First, I subscribe to the notion that value is subjective; that goods’ and services’ values differ according to different individuals because they serve various uses to various users, and that value is entirely in the eye of the beholder.

Second, I subscribe to the notion that free markets succeed because of the sensitive price feedback mechanism that allocates resources according to the real underlying shape of supply and demand and conversely the successful long-term allocation of labour, capital and resources by a central planner is impossible (or extremely unlikely), because of the lack of a market feedback mechanism.

Third, I subscribe to the notion that human thought is neither linear nor rational, and the sphere of human behaviour is complicated and multi-dimensional, and that attempts to model it using linear, mechanistic methods will in the long run tend to fail.

It is not, then, the overall drift of Misesean-Rothbardian economics that I find problematic — indeed, I often find myself drawing similar conclusions by different means — but rather the methodology.

I reached my views — some of which new evidence will eventually wash away — through a lot of theorising mixed with much careful observation and consideration of case studies, historical examples and all sorts of real world data. I love data; and one of the things that attracted me toward thinking and writing about economics is the beautiful superabundant growth of new data opened up to the world by computers and the internet. No, it is not universal or complete, and therefore building a perfect predictive model is not possible, but that is not the point. If I want to know how the corn price in the USA moved during the first half of the twentieth century, the data is accessible. If I want to know the rate of GDP growth in Ghana in 2009, the data is accessible. If I want to know the crime rate in France, the data is accessible.

Miseseans choose to reach their conclusions not from data, but instead from praxeology; pure deduction and logic.

This is quite unlike the early Austrians like Menger who mainly used a mixture of deductionism and data.

According to Rothbard:

Praxeology rests on the fundamental axiom that individual human beings act, that is, on the primordial fact that individuals engage in conscious actions toward chosen goals. This concept of action contrasts to purely reflexive, or knee-jerk, behavior, which is not directed toward goals. The praxeological method spins out by verbal deduction the logical implications of that primordial fact. In short, praxeological economics is the structure of logical implications of the fact that individuals act.

And Mises:

Our statements and propositions are not derived from experience. They are not subject to verification or falsification on the ground of experience and facts.

This is completely wrongheaded. All human thought and action is derived from experience; Mises’ ideas were filtered from his life, filtered from his experience. That is an empirical fact for Mises lived, Mises breathed, Mises experienced, Mises thought. Nothing Mises or his fellow praxeologists have written can be independent of that — it was all ultimately derived from human experience. And considering the Austrian focus on subjectivity it is bizarre that Mises and his followers’ economic paradigm is wrapped around the elimination of experience and subjectivity from economic thought.

If, as I often do, I produce a deductive hypothesis — for instance, that the end of Bretton Woods might produce soaring income inequality — it is essential that I refer to data to show whether or not my hypothesis is accurate. If I make a deductive prediction about the future, it is essential that I refer to data to determine whether or not my prediction has been correct.

Exposing a hypothesis to the light of evidence augments its strong parts and washes away its weaker ones. When the evidence changes, I change my opinion irrespective of what my deductions led me to believe or what axioms those deductions were based upon. Why reach the conclusion that central planning can induce civilisational failure through pure logic when the historical examples of Mao’s China and Stalin’s Russia and Diocletian’s Rome illustrate this in gory detail?

This is elementary stuff. Deduction is important — indeed, it is a critical part of forming a hypothesis — but deductions are confirmed and denied not by logic, but by the shape of the evidence. In rejecting modelling — which has produced fallacious work like DSGE and RBCT, but also some relatively successful models like those of Minsky and Keen — praxeologists have made the mistake of rejecting empiricism entirely. This has confined their methods to a grainier simulation; that of their own verbal logic.

It is not necessary to define a framework through mathematical models in order to practice empirical economics. Keynes was cited by Rothbard in support of the notion that economics should not be fixated on mathematical models:

It is a great fault of symbolic pseudo-mathematical methods of formalizing a system of economic analysis, that they expressly assume strict independence between the factors involved and lose
all their cogency and authority if this hypothesis is disallowed: whereas, in ordinary discourse, where we are not blindly manipulating but know all the time what we are doing and what the words mean, we can keep “at the back of our heads” the necessary reserves and qualifications and the adjustments which we have to make later on, in a way in which we cannot keep complicated partial differentials “at the back” of several pages of algebra which assume that they all vanish. Too large a proportion of recent “mathematical” economics are mere concoctions, as
imprecise as the initial assumptions they rest on, which allow the author to lose sight of the complexities and interdependencies of the real world in a maze of pretentious and unhelpful symbols.

And I agree. But nowhere did any of the figures cited by Rothbard; not Keynes, nor Wild, nor Frola, nor Menger endorse a wholly deductionist framework. All of these theorists wanted to work with reality, not play with logic. Create a theory; test; refine; test; refine; etc.

Praxeologists claim that praxeology does not make predictions about the future, and that any predictions made by praxeologists are not praxeological predictions, but instead are being made in a praxeologist’s capacity as an economic historian. But this is a moot point; all predictions about the future are deductive. Unless predictions are being made using an alien framework (e.g. a neoclassical or Keynesian model) what else is the praxeologist using but the verbal and deductive methodology of praxeology?

It has been the predictive success of contemporary Austrian economists — at least in identifying general trends often ignored by the mainstream — that has drawn young minds toward Misesean-Rothbardian economics.

Of those economists who predicted the 2008 crisis, a significant number were Austrians:

Yet Miseseans including Peter Schiff damaged their hard-earned credibility with a series of failed predictions of imminent interest rate spikes and hyperinflation of the dollar by 2010.

That is not to say that interest rate spikes and high inflation cannot emerge further down the line. But these predictive failures were symptomatic of deduction-oriented reasoning; Miseseans who forewarned of imminent hyperinflation over-focused on their deduction that a tripling of the monetary base would produce huge inflation, while ignoring the empirical reality of Japan, where a huge post-housing-bubble expansion of the monetary base produced no such huge inflation. Reality is often far, far, far more complex than either mathematical models or verbal logic anticipates.

Like all sciences, economics should be driven by data. For if we are not driven by data than we are just daydreaming.

As Menger — the Father of Austrianism, who favoured a mixture of deductive and empirical methods — noted:

The merits of a theory always depends on the extent to which it succeeds in determining the true factors (those that correspond to real life) constituting the economic phenomena and the laws according to which the complex phenomena of political economy result from the simple elements.

Praxeology is leading Austrian economics down a dead end.

Austrianism would do well to return to its root — Menger, not Mises.

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Krugman, Diocletian & Neofeudalism

The entire economics world is abuzz about the intriguing smackdown between Paul Krugman and Ron Paul on Bloomberg. The Guardian summarises:

  • Ron Paul said it’s pretentious for anyone to think they know what inflation should be and what the ideal level for the money supply is.
  • Paul Krugman replied that it’s not pretentious, it’s necessary. He accused Paul of living in a fantasy world, of wanting to turn back the clock 150 years. He said the advent of modern currencies and nation-states made an unmanaged economy an impracticable idea.
  • Paul accused the Fed of perpetrating “fraud,” in part by screwing with the value of the dollar, so people who save get hurt. He stopped short of calling for an immediate end to the Fed, saying that for now, competition of currencies – and banking structures – should be allowed in the US.
  • Krugman brought up Milton Friedman, who traversed the ideological spectrum to criticize the Fed for not doing enough during the Great Depression. It’s the same criticism Krugman is leveling at the Fed now. “It’s really telling that in America right now, Milton Friedman would count as being on the far left in monetary policy,” Krugman said.
  • Paul’s central point, that the Fed hurts Main Street by focusing on the welfare of Wall Street, is well taken. Krugman’s point that the Fed is needed to steer the economy and has done a better job overall than Congress, in any case, is also well taken.

I find it quite disappointing that there has not been more discussion in the media of the idea — something Ron Paul alluded to — that most of the problems we face today are extensions of the market’s failure to liquidate in 2008. Bailouts and interventionism has left the system (and many of the companies within it) a zombified wreck. Why are we talking about residual debt overhang? Most of it would have been razed in 2008 had the market been allowed to liquidate. Worse, when you bail out economic failures — and as far as I’m concerned, everyone who would have been wiped out by the shadow banking collapse is an economic failure — you obliterate the market mechanism. Should it really be any surprise that money isn’t flowing to where it’s needed?

A whole host of previously illiquid zombie banks, corporations and shadow banks are holding onto trillions of dollars as a liquidity buffer. So instead of being used to finance useful and productive endeavours, the money is just sitting there. This is reflected in the levels of excess reserves banks are holding (presently at an all-time high), as well as the velocity of money, which is at a postwar low:

Krugman’s view that introducing more money into the economy and scaring hoarders into spending more is not guaranteed to achieve any boost in productivity.

As I wrote last month:

The fundamental problem at the heart of this is that the Fed is trying to encourage risk taking by making it difficult to allow small-scale market participants from amassing the capital necessary to take risk. That’s why we’re seeing domestic equity outflows. And so the only people with the apparatus to invest and create jobs are large institutions, banks and corporations, which they are patently not doing.

Would more easing convince them to do that? Probably not. If you’re a multinational corporation with access to foreign markets where input costs are significantly cheaper, why would you invest in the expensive, over-regulated American market other than to offload the products you’ve manufactured abroad?

So will (even deeper) negative real rates cause money to start flowing? Probably — but probably mostly abroad — so probably without the benefits of domestic investment and job creation.

Nor is it guaranteed to achieve any great boost in debt relief.

As Dan Kervick wrote for Naked Capitalism last month:

Inflation only reduces debt overhang in a significant way for households who are fortunate enough to see their nominal wages rise along with the general rise in prices. In today’s economy, workers are frequently not so fortunate.

Again, I have to bring this back to why we are even talking about debt relief. The 2008 crash was a natural form of debt-relief; the 2008 bailouts, and ongoing QE and Twist programs (which contrary to Professor Krugman’s apologetics really do transfer wealth from the middle classes to Wall Street) crystallised the debt burden born from a bubble created by Greenspan’s easy money policies. There would be no need for a debt jubilee (either an absolute one, or a Krugmanite (hyper)inflationary one) if we had simply let the market do its work. A legitimate function for government would have at most been to bail out account holders, provide a welfare net for poor people (never poor corporations) and let bankruptcy courts and markets do the rest. Instead, the central planners in Washington decided they knew best.

The key moment in the debate?

I am not a defender of the economic policies of the emperor Diocletian. So let’s just make that clear.

Paul Krugman

Actually you are.

Ron Paul

Ron Paul is dead right. Krugman and the bailout-happy regime for which he stands are absolutely following in the spirit of Diocletian.

From Dennis Gartman:

Rome had its socialist interlude under Diocletian. Faced with increasing poverty and restlessness among the masses, and with the imminent danger of barbarian invasion, he issued in A.D. 301 an edictum de pretiis, which denounced monopolists for keeping goods from the market to raise prices, and set maximum prices and wages for all important articles and services. Extensive public works were undertaken to put the unemployed to work, and food was distributed gratis, or at reduced prices, to the poor. The government – which already owned most mines, quarries, and salt deposits – brought nearly all major industries and guilds under detailed control.

Diocletian explained that the barbarians were at the gate, and that individual liberty had to be shelved until collective liberty could be made secure. The socialism of Diocletian was a war economy, made possible by fear of foreign attack. Other factors equal, internal liberty varies inversely with external danger.

While Krugman does not by any means endorse the level of centralism that Diocletian introduced, his defence of bailouts, his insistence on the planning of interest rates and inflation, and (most frighteningly) his insistence that war can be an economic stimulus (in reality, war is a capital destroyer) all put him firmly in Diocletian’s economic planning camp.

So how did Diocletian’s economic program work out?

Well, I think it is fair to say even without modern data that — just as Krugman desires — Diocletian’s measures boosted aggregate demand through public works and — just as Krugman desires — it introduced inflation.

Diocletian’s mass minting of coins of low metallic value continued to increase inflation, and the maximum prices in the Edict were apparently too low.

Merchants either stopped producing goods, sold their goods illegally, or used barter. The Edict tended to disrupt trade and commerce, especially among merchants. It is safe to assume that a gray market economy evolved out of the edict at least between merchants.

And certainly Rome lived for almost 150 years after Diocletian. However the long term effects of Diocletian’s economic program were dire:

Thousands of Romans, to escape the tax gatherer, fled over the frontiers to seek refuge among the barbarians. Seeking to check this elusive mobility and to facilitate regulation and taxation, the government issued decrees binding the peasant to his field and the worker to his shop until all their debts and taxes had been paid. In this and other ways medieval serfdom began.

Have the 2008 bailouts done the same thing, cementing a new feudal aristocracy of bankers, financiers and too-big-to-fail zombies, alongside a serf class that exists to fund the excesses of the financial and corporate elite?

Only time will tell.

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Rome & Central Planning

Central planning — like war — never changes. It has always been a powerful and effective way of achieving an explicit objective (e.g. building a bridge, or a road), but one that has has always come with detrimental side-effects. And the more central planners try to minimise the side-effects, the more side-effects appear. And so the whack-a-mole goes on.

This was true in the days of Rome, too.

From Dennis Gartman:

Rome had its socialist interlude under Diocletian. Faced with increasing poverty and restlessness among the masses, and with the imminent danger of barbarian invasion, he issued in A.D. 301 an edictum de pretiis, which denounced monopolists for keeping goods from the market to raise prices, and set maximum prices and wages for all important articles and services. Extensive public works were undertaken to put the unemployed to work, and food was distributed gratis, or at reduced prices, to the poor. The government – which already owned most mines, quarries, and salt deposits – brought nearly all major industries and guilds under detailed control. “In every large town,” we are told, “the state became a powerful employer, standing head and shoulders above the private industrialists, who were in any case crushed by taxation.” When businessmen predicted ruin, Diocletian explained that the barbarians were at the gate, and that individual liberty had to be shelved until collective liberty could be made secure. The socialism of Diocletian was a war economy, made possible by fear of foreign attack. Other factors equal, internal liberty varies inversely with external danger.

The task of controlling men in economic detail proved too much for Diocletian’s expanding, expensive, and corrupt bureaucracy. To support this officialdom – the army, the courts, public works, and the dole – taxation rose to such heights that people lost the incentive to work or earn, and an erosive contest began between lawyers finding devices to evade taxes and lawyers formulating laws to prevent evasion. Thousands of Romans, to escape the tax gatherer, fled over the frontiers to seek refuge among the barbarians. Seeking to check this elusive mobility and to facilitate regulation and taxation, the government issued decrees binding the peasant to his field and the worker to his shop until all their debts and taxes had been paid. In this and other ways medieval serfdom began.

So much for the view that increasing aggregate demand is the recipe for wider prosperity; Diocletian surely raised it a lot. But that didn’t really accomplish much, either in terms of wider prosperity, or in terms of the sustainability of the Roman civilisation. Raised aggregate demand is only useful if it contributes to creating and producing things that society needs and wants. And as Hayek brutally demonstrated, central planning is notoriously useless at determining what people actually want.

Of course, no modern centralist (e.g. Krugman) explicitly endorses price controls although, I am sure some of the more Hayekian or Paulian-minded among us will point out among other things that the minimum wage and the setting of interest rates are both kinds of price control. Diocletian however, was far more expansive.

From Wiki:

The first two-thirds of the Edict doubled the value of the copper and bronze coins, and set the death penalty for profiteers and speculators, who were blamed for the inflation and who were compared to the barbarian tribes attacking the empire. Merchants were forbidden to take their goods elsewhere and charge a higher price, and transport costs could not be used as an excuse to raise prices.

The last third of the Edict, divided into 32 sections, imposed a price ceiling – a maxima – for over a thousand products. These products included various food items (beef, grain, wine, beer, sausages, etc), clothing (shoes, cloaks, etc), freight charges for sea travel, and weekly wages. The highest limit was on one pound of purple-dyed silk, which was set at 150,000 denarii (the price of a lion was set at the same price).

And how did it work out?

The Edict did not solve all of the problems in the economy. Diocletian’s mass minting of coins of low metallic value continued to increase inflation, and the maximum prices in the Edict were apparently too low.

Merchants either stopped producing goods, sold their goods illegally, or used barter. The Edict tended to disrupt trade and commerce, especially among merchants. It is safe to assume that a gray market economy evolved out of the edict at least between merchants.

Bernanke of course is much more sophisticated; he uses the facility of the primary dealer banks to hide the currency inflation necessary to monetise government debt. Central planning wins again? No; central planning always comes with unpredictable boomerang side effects.

I suppose, though, that it is comforting that history is repeating itself. After the horrors of mediaeval feudalism, we pulled ourselves up anew from the wastes of history.