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The Mises Review

Edited and written by David Gordon, senior fellow of the Mises Institute and author of four books and thousands of essays.

Austrian Economics, Neoclassicism, and the Market Test

Leland Yeager

1 1998
Volume 4, Number 1

The Distance from Chicago to Vienna

Spring 1998

Sherwin Rosen
Leland B. Yeager
Journal of Economic Perspectives 11, no. 4 (Fall 1997): 139-65

You can lead a neoclassical to Austrian waters, but you can't make him drink. Sherwin Rosen, a distinguished Chicago School economist, thinks that gains from trade between neoclassical and Austrian economics are possible. Though his openness to Austrian wisdom deserves our praise, he shows himself a victim of several misconceptions. For these, Leland Yeager, a self-described fellow traveler of both the Austrian and Chicago Schools (p. 153), smartly raps him on the nose.

Rosen acknowledges that "the methods of neoclassical economics mainly are concerned with the establishment of economic equilibrium under fully known . . . or given conditions of resource availability, technology, and preferences" (p. 140). But since these conditions are never in the actual world realized, is this not an admission that neoclassicism is at best of limited utility? Nor can neoclassicals escape, says Rosen, by the claim that they are not confined to the study of equilibrium. Rosen is skeptical: "There are serious questions of whether 'disequilibrium' analysis is possible in the classical scheme. In my view it isn't" (p. 140).

Of course it does not follow that if neoclassicism fails, then Austrian economics succeeds. But Rosen thinks that the main insight of the Austrians about the market is correct. In the situation that people confront, one of very limited knowledge of preferences and technology, no central authority can gather the data required adequately to coordinate the economy.

In a world of uncertainty, what is to be done? Austrians have the answer. They correctly see that only a system of competition among individuals and firms can use dispersed information effectively. Claims that central planners can mimic the market fail. "In what was perhaps their finest hour, the Austrians, led by Mises and Hayek, argued that . . . market socialism was impossible, and that it was based on a fundamentally misguided vision of markets and prices" (p. 144).

Rosen, here following Hayek, is greatly struck by parallels between market competition and biological evolution. But I fear his acquaintance with the history of biology has some missing links. He remarks "[Richard] Dawkins recasts Thomas Paley's criticism of Darwin by way of example of the construction of the human eye. How could such a complex and wonderful object be constructed other than by a supreme designer (p. 143)? Of course, Darwin criticized Paley, whose first name, incidentally, was not "Thomas" but "William."

You might think that Rosen is ready to jump ship and enlist under the banner of Mises. Not so. The Austrians, it seems, suffer from severe failings. Most particularly, Austrians reject, or at least view with misgiving, much of quantitative work. Austrians argue that "the world is changing so much that 'behavioral relationships' inherently are unstable and it is fruitless to estimate them" (p. 147).

You might expect that Rosen would endeavor to respond. But this criticism strikes too close to the neoclassical home. Rather than answer, he suggests instead that we shall not get the "realistic and useful" (p. 148) results that we want if we turn aside from the quantitative. The studies generate useful results, therefore they are sound! Behold Chicago in action.

Professor Yeager addresses this criticism with appropriate severity. "As for predictions, Austrians take another fact seriously: the economic world is an open rather than a closed system and as such has an unknowable future. . . . a numerical forecast cannot be reliable. A pretense of satisfying unsatisfiable demands for forecasts is intellectually disreputable" (p. 157).

Yeager likewise finds unimpressive Rosen's complaint that Austrians do not define entrepreneurial activity operationally. (If you don't know what an "operational" definition is, you are not missing much.)

Yeager responds: "My reply is the standard remark about keys and lampposts. Again we see the difference between narrow empiricism that looks only at numbers, and a broader empiricism that draws on direct observations" (p. 157).

But it is another part of Rosen's article that most rouses Yeager to comment. Rosen suggests that there is a "marketplace in ideas": just as bad products fall by the wayside, so does struggle for survival weed out bad theories.

Yeager will have none of this. He points out first "that the metaphorical academic market is less responsive to the wishes of whoever the ultimate consumer may be than is the actual market in goods and services" (p. 161). And there is a deeper criticism. The market produces what consumers want. It does not test for good taste or truth. In science, our goal is truth, and we have no reason to think that in this sphere God is on the side of the big battalions.

After reading Rosen and Yeager, I have no doubt that neoclassicals can gain much from Austrians. Whether Austrians can likewise benefit from trade with neoclassicals is open to question.

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