catallaxy files

catallaxy in technical exile

The battle of the schools

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The Are you an Austrian? quiz on the Mises website may strikes outsiders as an exercise in vetting ‘thought crimes’ but I actually think it’s a reasonably good device for teaching non-economists about the differences between various Economic schools of thought.

Each of the prominent schools – Keynesian/neoclassicals (strangely bracketed together, presumably this is supposed to represent some Harvard-Galbraithian synthesis), Chicago school (whom I regard as the actual neoclassicals), Austrians and Marxists – is represented by one of the 4 answers provided in the multiple choice format for quiztakers to choose from. Notwithstanding that, no quiz is perfect and there were some questions where the answer I chose was by default because it was the ‘least worst’ one or the one closest to how I would’ve answered if I was allowed to write the response out myself. Anyway in the spirit of debate, below the fold I reproduce the quiz and the answers I chose for each question (bearing in mind my caveat above about choosing some answers by default as the ‘least worst’ alternative – presumably this is a function of the quiz designers trying to be as succinct as possible in characterising the typical approaches of the different schools while still making the differences obvious enough). Incidentally, according to my results I chose the ‘Austrian answer’ only 4 times out of 25, the remaining 21 times I chose the ‘Chicago answer’ :

What is the correct economic status of private property? 

Property is central to prosperity and economic growth. Accordingly, it is of the utmost importance that the state, or more abstractly the law, maintain and modify the bundle of property rights in such a way as to allocate transactions costs in such a way as to promote maximum growth and economic efficiency. Property does not arise naturally, but is the end product of the legal system. 


What is the proper method to conduct research in economic science? 

Like the physicist, the economist (if he wants to be scientific) should construct a precise model that yields quantitative predictions about economic variables, such as GDP and unemployment. Then the economist should test those predictions against the actual data as collected by statistical researchers. At any given time, the best explanation or “theory” of a certain economic phenomenon is that model which yields the best fit between predictions and actual data. 


What is the reason for the interest rate, and should the rate be regulated? 

Interest payments reflect the higher value of present goods over future goods. Other things equal, everyone wants to consume sooner rather than later. The current price of a computer might be $1,000, but the price of a claim to a computer delivered in one year would currently sell for less than that, say $900. An entrepreneur might invest $900 in labor and raw materials in order to sell a product next year for $1,000; his implicit interest return is due to the fact that the factors of production represent technological “claims” on future consumption goods, and thus their current price (the $900) is less than their ultimate sale price ($1,000). Obviously the government need not interfere with the market interest rate, since it merely reflects the subjective premium individuals place on a marginal present good over a marginal future good.


What is the economic impact of saving? 

Saving (which means forestalling current consumption) is essential for capital formation, but there is no socially optimal ratio of consumption to saving that should predominate in society. It all depends on the social rate of time preference, that is, the extent to which people prefer goods sooner to later. Individuals may choose consumption over investment or vice- versa. Government intervention can skew these choices, subsidizing or taxing savings or consumption or both. In order to have the mix reflect the most economical choices, government should have no policy toward saving, even in the case of saving for old age. 


What is the source of economic value? 

The value of a good is determined by the interdependence of supply and demand, or what might be called the interaction of cost and utility. In contrast to some schools of thought, which try to explain value on the basis of utility alone, the correct approach is that of Alfred Marshall, who realized that economic value is due to both subjective preferences and to objective technological conditions. To see this most clearly, consider that if the costs of production go up for a particular good, in the new equilibrium its final price must be that much higher. 


What is money and how does it originate? 

Money can emerge from barter, but private interests will probably not develop it to suit the needs of a modern economy. We need central banks to sustain the financial sector. Efforts to manipulate the economy using the money supply will at best fail, and at worst cause severe problems. Monetary authorities should not increase the money supply at their discretion. They should increase it at a steady rate, matching the long term growth rate of the economy. 


What causes the business cycle? 

Variations in the money supply cause GDP growth to deviate from its general trend. Absent these variations the economy is relatively stable. Variations in the money supply cause inflationary booms and crashes. Lags in the adjustment of wages with these cycles mean that financial booms and busts will entail significant changes in unemployment rates 


What is the right anti-recession policy? 

The Federal Reserve can stimulate the economy through low interest rates, and Congress can increase aggregate demand, even if it results in deficits. Once the economy gets back on course, the Fed can permit rates to rise and Congress can curtail spending


How viable is socialism? 

Experience has shown thus far that free enterprise has been more productive than most known socialist experiments. This may be due to the lack of incentives to produce or it could be due to the poor quality of planning under socialism. A completely unregulated market, however, has its share of failures as well, which is why it must be tempered in some respects. In any case, it is futile to search for a general theory that allows us to say, a priori, that all socialist planning fails. History shows us that some forms of central planning do work. Central bankers engage in planning, as do judges and regulators, and rather successfully so. The desirability of government intervention beyond its role as a rule maker and enforcer will depend upon the severity of market imperfections compared to governmental imperfections.


What is the proper size and scope of government? 

Markets deliver ordinary consumer and producer goods in a relatively efficient fashion. However, for various economic and political reasons, private transactions for fundamental services and institutions, like law, money, and defense, fail badly. There is no sense in even discussing markets without the prior need of a state. Government must exist to enforce the ‘rules of the game’ for society to emerge from chaos. Government must establish and enforce basic rules for society, but avoid discretionary or destabilizing intervention into markets. 


Who should regulate consumer products and how? 

Empirical studies indicate that consumer preferences do not change much in response to things like advertising. Consumers react rationally to information concerning products, so consumer safety is not necessarily a big issue. Governmental safety regulations may have perverse effects that increase harm to consumers, but government might play a positive role in providing better information to consumers, insuring that retailers and others tell the whole truth and nothing but the truth.


What are wages? 

Wages represent the discounted productivity of labor in satisfying consumer demand. Demand for consumer goods translates into demand for workers. Markets enable us to calculate the value of different types of labor, so that we can direct the use of labor to its most highly valued uses. Governmental intervention in labor markets (e.g. minimum wage laws) cause unemployment among less productive workers


What causes economic growth? 

The source of economic growth is mutually beneficial, voluntary exchange. Within the exchange economy, consumers spend part of their income on goods and services to satisfy their most immediate wants. This drives current production. Consumers save part of their income according to their less immediate wants. This drives entrepreneurial investment in future production and leads to the development of sophisticated capital markets. Private contracts, competition in markets, and private institutions that allow for capital investment and accumulation are all you need to attain optimal economic growth.


What is your view of economics and the environment? 

Most issues concerning the environment are best solved through reliance on market incentives. Courts should be attentive to the need to establish clarity concerning property lines when conflicts arise. Issues of externalities can be solved through compensation exchanges between owners, arrived at through arbitration. As for pollution, it can be minimized through a market for pollution rights, and these can be traded so that the costs of pollution are borne by the polluters. Fees for use of public lands are generally set too low so as to encourage overuse. Higher prices are the key to conservation. 


What do taxes fund? 

Since markets are imperfect, public spending could go to subsidize the provision of some of a variety of public or merit goods that the market would not otherwise provide. Taxes can also mitigate social costs and deter the consumption of goods that should not be made available through the market. Ideally, political competition between interest groups transfers income to those who value it most. It is possible that taxes are employed in uneconomical ways, but political competition will probably mitigate the worst examples of governmental waste.


What caused the Great Depression and how effective was the New Deal? 

The Great Depression began as a conventional business cycle, characterized by deflation that might have been fought through by monetary expansion. But Hoover failed to see the seriousness of the situation and permitted banks to fail rather than restore faith in the nation’s money. This led to the election of FDR, who was right to take the nation off the gold standard but wrong to institute excessive controls over the nation’s economy. It was World War II, not the New Deal, that ended the depression. With fiat money and a Fed that stands ready to intervene, the experience never needs to be repeated. 


Do markets create and sustain monopolies and what should be done about it? 

Monopoly regulation has caused more harm than good by protecting particular competitors, not competition. Some types of regulation against trusts are based on flawed models that fail to understand that some firms gain market share solely because of their products’ desirability to consumers. Most cited cases of “path dependency” turn out to be mythical. What is left for regulators to do? As Adam Smith said, they should prevent business conspiracy, blatantly predatory behavior, and otherwise assure a level playing field leading toward genuine competition. Finally, some goods lend themselves to being best provided by monopolies, e.g. courts and defense. 


What is the role of equality and inequality? 

It is a great mistake to make equality of result a policy goal, because egalitarian legislation can kill incentives to improve. Punishing the rich is self defeating, even for the poor striving to make their way. Equality of opportunity, however, is different. It is something everyone merits by their very dignity as a human being. Thus should a nation strive for quality educational institutions, institute a limited inheritance tax, and otherwise assist those who, through no fault of their own, lack the means to gain entry into the division of labor. Once these institutions are in place, we will find that the forces of market competition will achieve egalitarian goals through predominantly voluntary means.


What is your view of free trade and globalization? 

Free trade has positive effects, but requires some public support. Labor specialization and capital investment by multinationals increase productivity and raise living standards. However, we need global governance through the World Trade Organization to provide the legal and financial conditions, such as transparency laws and protection of intellectual property rights, if we are to realize the advantages of global economic cooperation. Some global public institutions are needed for International trade and globalization to work to the good of all.


What is the function of the stock market? 

The stock market helps to align incentives in production and sort out productive from unproductive companies. At any moment, the prices on the stock exchange reflect all available and relevant information, which is why forecasts are right on average and no one investor can outwit the market on average. Takeovers and mergers put pressure on CEO’s to serve the interests of investors, large and small. The system works so long as regulations mandate full transparency and no relevant knowledge is deliberately withheld. In this way, government intervention can improve the workings of stock markets. 


What are labor unions for? 

Unions are monopolistic, but may serve some positive purposes. Their historic role has been to offset the concentration of industrial power. At the same time, too much union domination may also raise wages above competitive levels and reduce employment and production. The effects of unions vary with particular circumstances, so there is no basis for forming a general opinion as to the merits of unions. It depends on circumstances of time and place. 


What are the economic implications of national defense? 

National defense is neutral to the market. On the one hand, it cost taxpayers money, but, on the other, it provides a stable environment that permits peace to flourish and rights to be protected. By its very nature, government should maintain a monopoly over the use of force, and defending the nation against external and internal foes flows from this primary obligation. Before we can even talk about economic production, government-provided security and defense must be firmly in place. Otherwise, we are back to the Hobbesian jungle


What about goods like education and roads? 

There is no reason to debate whether roads and education are essential needs, and yet the market will likely not provide them in sufficient quantity. The only real question concerns the public administration. There are good and bad ways to provide these services. Market incentives can increase their efficiency. Construction and administration can be contracted out. Traffic problems can be addressed through tolls and other forms of market rationing. Schools can be made more competitive through vouchers and innovative systems of government chartering to meet special needs. 


What are the economic implications of warfare? 

War reduces economic welfare by destroying real resources. It may benefit only a select few from military spending, but could also be important in terms of national goals. If diplomacy fails, the general welfare of society may increase as a result of attaining important national objectives via warfare. Defensive wars are always justified. Offensive wars may be good in some circumstances. 


Who serves society best? 

Entrepreneurs play an indispensable role in society. Entrepreneurs are alert to profit opportunities and make judgments concerning the future. Competition concerning these opportunities results in profit and loss statements that generate prices for labor and capital. This competition directs resources to the satisfaction of the most urgent consumer wants. Successful politicians are those who are the best at retaining and wielding political power. These are typically the most ruthless people in our society


Written by Admin

June 8, 2006 at 1:03 am

Posted in Uncategorized

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