Austrian economics — a methodological critique

29 Jul, 2014 at 17:04 | Posted in Theory of Science & Methodology | 5 Comments

[h/t Jan Milch]

This is a fair presentation and critique of Austrian methodology. But beware! In theoretical and methodological questions it’s not always either-or. We have to be open-minded and pluralistic enough not to throw out the baby with the bath water — and fail to secure insights like this:

What is the problem we wish to solve when we try to construct a rational economic order? … If we possess all the relevant information, if we can start out from a given system of preferences, and if we command complete knowledge of available means, the problem which remains is purely one of logic …

The-Use-of-Knowledge-in-Society_800x600-05_2014-172x230This, however, is emphatically not the economic problem which society faces … The peculiar character of the problem of a rational economic order is determined precisely by the fact that the knowledge of the circumstances of which we must make use never exists in concentrated or integrated form but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess. The economic problem of society is … a problem of the utilization of knowledge which is not given to anyone in its totality.

This character of the fundamental problem has, I am afraid, been obscured rather than illuminated by many of the recent refinements of economic theory … Many of the current disputes with regard to both economic theory and economic policy have their common origin in a misconception about the nature of the economic problem of society. This misconception in turn is due to an erroneous transfer to social phenomena of the habits of thought we have developed in dealing with the phenomena of nature …

To assume all the knowledge to be given to a single mind in the same manner in which we assume it to be given to us as the explaining economists is to assume the problem away and to disregard everything that is important and significant in the real world.

Compare this relevant and realist wisdom with the rational expectations hypothesis (REH) used by almost all mainstream macroeconomists today. REH presupposes – basically for reasons of consistency – that agents have complete knowledge of all of the relevant probability distribution functions. And when trying to incorporate learning in these models – trying to take the heat of some of the criticism launched against it up to date – it is always a very restricted kind of learning that is considered. A learning where truly unanticipated, surprising, new things never take place, but only rather mechanical updatings – increasing the precision of already existing information sets – of existing probability functions.

Nothing really new happens in these ergodic models, where the statistical representation of learning and information is nothing more than a caricature of what takes place in the real world target system. This follows from taking for granted that people’s decisions can be portrayed as based on an existing probability distribution, which by definition implies the knowledge of every possible event (otherwise it is in a strict mathematical-statistically sense not really a probability distribution) that can be thought of taking place.

The rational expectations hypothesis presumes consistent behaviour, where expectations do not display any persistent errors. In the world of rational expectations we are always, on average, hitting the bull’s eye. In the more realistic, open systems view, there is always the possibility (danger) of making mistakes that may turn out to be systematic. It is because of this, presumably, that we put so much emphasis on learning in our modern knowledge societies.

As Hayek wrote:

When it comes to the point where [equilibrium analysis] misleads some of our leading thinkers into believing that the situation which it describes has direct relevance to the solution of practical problems, it is high time that we remember that it does not deal with the social process at all and that it is no more than a useful preliminary to the study of the main problem.


  1. Hayak , like Knight, believes uncertainty is epistemological– not ontological.

    With the growth of electronic computer systems since Hayek’s and Knight’s time, and the growth of economic data collection, it might be possible for modern computers to solve the epistemological problem that Hayek and Knight believed was not possible by human collection of such disperse data and human computing capacity to analyze such data.

    There is no good Hayek!

    Only Keynes argued that the uncertainty of economic processes was an ontological problem — and hence no matter how sophisticated computer systyems and data collection becomes, uncertainty about future outcomes will stil haunt us!.

    • Paul, although I agree with you to a large extent — see e. g. here — and certainly on the primacy of ontological over epistemological uncertainty, I don’t want to go as far as you and say that people like Hayek and Knight have nothing interesting to come up with re uncertainty. That’s to outré for my taste.

      • Syll:

        It has nothing to do with taste! It has to do with knowing what economics is all about.

        If the system is ontological then one can explain the use of money contracts to “assure” cash inflows and cash outflows over time –as the only means of individual’s getting control of their cash flow economic future — because bankruptcy is like a walk to the gallows.

        If uncertainty was merely epistemological then this will set decision makers to make more educated “guesses” about the real economic future — a futile excursion if the system is ontological — but not if the system is epistemological.

        So Keynes analysis is useful for understanding why a market , entrepreneurial system uses money contracts to organize all market production and exchange transactions.
        Hayek’s analysis is useless in trying to explain the use of money– not real –contracts.

        So lets get with it — and put the Austrians back with the rational expectations people except the RE people believe modern computers can solve the epistemological problem.

        • Paul: I, again, agree on the essentials (myself being a critical realist, it comes as a surprise for no one, I guess) — but I think you throw out the baby with the bath water. I still think I can learn one or two things from reading people like Hayek, Knight and Shackle, although I — like you — vastly prefer Keynes. Even when it comes to knowledge and uncertainty in economics it’s not, as I wrote, always a question of a digital 0-1. Economics as a science would be very much more a monologue if we only think we can learn from people thinking EXACTLY as we do ourselves.

  2. […] rest here (and be sure to check out the comments made by Paul […]

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