Commentary on Political Economy

Friday 2 September 2011

The Austrian School - Between Equilibrium and Innovation

Another reward for our loyal friends to follow up on the pieces on "Gold And Labor Standards". This piece ties together the "empirio-criticism" of the Austrian School with the critique of Schumpeter's "Individualitat" or "Geist" at the origins of "entrepreneurial technical innovation" and, therefore, "creative destruction".

Not only was my

first technical training largely scientific in the narrow sense of the

word but also what little training I had in philosophy or scientific

method was entirely in the school of Ernst Mach and later of the logical

positivists.” (Individualism and Economic Order)

 As you know, Hayek like Schumpeter starts from this notion of "individual freedom" which he translated into the political dimension of "Liberty" and contrasted with the "collectivist Serfdom". For Hayek it is the "freedom" of the "individual" that guarantees the "free exchange" that takes place in the "market". And it follows therefore that the notion of market "equilibrium" - regardless of whether it rests on "utility" or some other inscrutable "metaphysical" element - is entirely dependent on this "free exchange" which will invariably lead to the contractual or "synallagmatic" finding of the "equilibrium price". (I drew the Hobbes-Schopenhauer-Hayek line – as opposed to Rousseau-Hegel-Marx – in the first ‘wolfexchange’.)
Given the philosophical-scientific foundation of Hayek's economic theory on "observable facts", it follows that "prices" are necessarily "equilibrium prices" and that therefore market transactions conducted "freely" are the best means of ensuring that resources are allocated optimally not in an absolute sense, but in an “empirical” sense, subject to the information available, which is itself “signalled” by market prices. For Hayek, prices fixed in "free markets" are the best source of "information" for the achievement of resource allocation  or “co-ordination” and investment and the search for these "prices" is what leads to "equilibrium". To the “division of labour”, Hayek substitutes “the division of knowledge” as the social reality that enables the market to act as “the social mind”, as it were. Optimal allocation of resources is simply “inscrutable” because all that is “visible” are prices….and prices provide the best exchange of information possible for the co-ordination of economic decisions.

In the light of our analysis of the meaning of a state of equilibrium

it should be easy to say what is the real content of the assertion that a

tendency toward equilibrium exists. It can hardly mean anything but

that, under certain conditions, the knowledge and intentions of the

different members of society are supposed to come more and more

into agreement or, to put the same thing in less general and less exact

but more concrete terms, that the expectations of the people and particularly

of the entrepreneurs will become more and more correct. In

this form the assertion of the existence of a tendency toward equilibrium

is clearly an empirical proposition, that is, an assertion about

what happens in the real world which ought, at least in principle, to

be capable of verification. (Ibid.,p.45)

Any "divergence" from "equilibrium" can only be temporary if "market agents" are allowed to fix these prices "freely" because “over time” prices will tend to adjust toward “equilibrium” – were it not for the fact that “information” changes continually. Consequently, the role of the State must be not that of a State-Plan as in Keynes but that of a "State of Law", that is a State that does not interfere or intervene in the "free market exchange" and "limits" itself to ensuring that "individuals" are "free" to fix "prices" in the market.
Both Hayek and Schumpeter understood quite clearly that "equilibrium" was only a "heuristic" or "ideal type" construction rarely occurring in reality. (Hayek uses the latter term in “Ind. And Econ.Ord”.) Hayek attacked “neoclassical equilibrium theory” for its “tautological” character, for fixing prices a priori in a “timeless” framework in which market participants have complete and simultaneous information of factors affecting prices. Hayek calls this “the Logic of Pure Choice”.

The statement that, if people know everything, they are in equilibrium

is true simply because that is how we define equilibrium.(p.46)

 For Hayek prices are determined a posteriori or ex post facto. Thus, the “equilibrium” they lead to is an “inter-temporal equilibrium”, not necessarily one of “optimal allocation” like Walrasian equilibrium because all market players do not have perfect “knowledge” or “information”. Therefore the best that can be said is that market prices offer the best “equilibrium” possible precisely because, unlike the Walrasian “stationary” equilibrium, “perfect knowledge” would imply “socialistic” or “planned” co-ordination of the allocation of resources in society.

While such a position represents in one sense a position of equilibrium,

it is clear that it is not an equilibrium in the special sense in which equilibrium is regarded as a sort of optimum position, (in “Economics and Knowledge”).

It is entirely evident from this summary that Hayek’s criticism of “tautologism” that he moved against Walrasian equilibrium is absolutely applicable to his own theory of “market prices”! Whereas neoclassical equilibrium theory starts with a “simultaneous tautology” where market prices are determined by known and unchangeable quantities of exchangeable goods in a timeless stationary framework, Hayek falls into the equivalent trap of assuming tautologically ex post facto that market prices are “equilibrium prices”….because the “free” market says so!!
And the immanent stupidity of Hayek’s theory does not stop there! Because with the sanctimony of a fastidious protestant clergyman he goes on to pontificate about how “the market” must necessarily be the best form of social organization (of course! Because the market says so!) to which the only alternative (why?) is “totalitarian dictatorship”!

Man in a

complex society can have no choice but between adj usting himself to

what to him must seem the blind forces of the social process and obeying

the orders of a superior. So long as he knows only the hard discipline

of the market, he may well think the direction by some other

intelligent human brain preferable; but, when he tries it, he soon discovers

that the former still leaves him at least some choice, while the

latter leaves him none, and that it is better to have a choice between

several unpleasant alternatives than being coerced into one.

Hayek from “Individualism and Economic Order”, p.24

(Such execrable intellectual bestiality is only pardonable in a learned man such as Hayek only because he had to endure the horrific experience of Nazi and Soviet totalitarianism. But it is hard to contain the kind of disdain for Hayek that Martin Wolf displayed in the remarks I quoted just below in this forum.)
It follows necessarily that for Hayek the role of the State must be limited to that of a “Rechtsstaat” or “State of Law” that preserves “individual property rights” and the “free exchange” of the “self-regulating market”.
By contrast, with the adventurous exuberance of a superb horseman, Schumpeter attacks the very notions of "competition" and "markets". Far from being "free", markets are in reality subject to distortions arising from the "monopolistic" advantages brought on by "innovation" and “creative destruction". Schumpeter is light years ahead of Hayek because he focuses on the historical-evolutionary aspects of capitalism in terms of its productive transformation (innovation) and institutional organisational evolution (“monopoly”).
We can see thus how far historically and "empirically" superior Schumpeter's analysis of capitalism was and why it has had so much more prominence intellectually than Hayek's analysis. We can also see how both Hayek's and Schumpeter's analyses were based on the empirical observation of actual economic facts and institutions. But whereas Hayek proceeded to impose an "ideal" model of "market equilibrium" conditional on the political guarantee of "free exchange" and "price determination", Schumpeter accepted the historical reality of the capitalist "business cycle" and of its "crises" to develop his "Theory of Economic Development" according to "entrepreneurial innovation" and "creative destruction" as the distinguishing features of capitalism.
Schumpeter insisted that “Innovation” was a process “endogenous’, “intrinsic” to capitalism because he wished to highlight the “evolutionary” and hence “scientific” nature of his analysis. But, as can easily be perceived, his “evolutionary” concepts are so “empirical” and “subjective” that they can only be “adventitious” and “accidental” in relation to capitalism itself, which explains why Schump engaged in incredible contortions to deny the “profit motive” or the “accumulation of capital” as the real forces behind “entrepreneurial innovation”.
As a result of his analytical-philosophical approach, there can be no question of Hegelian 'Aufhebung' in Schumpeter's notion of "creative destruction" and of “innovation”.  Yet, as I will try to show, a careful critical examination of these central Schumpeterian concepts reveals unmistakably that the "motivations" and the "antagonistic forces" that engender them are certainly com-prehensible broadly as 'Aufhebung'. Not "technical innovations" themselves but rather the "social relations" that they embody and that bring them into being, not the process of “creative destruction” but the forces that pro-duce it are what we must com-prehend more incisively if we wish to advance and enhance our analysis of capitalism itself. 

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