Neoclassical vs Austrian Economics

Before I start, I want to say that I have not read Mises, Hayek or Rothbard.  I arrived at these conclusions on my own.  I also want to quote Buffett:

“It is better to be approximately right, than precisely wrong.”

Applying math to economics has been a loser.  Who has a consistently good macroeconomic model?  No one that I know.  Estimates of future GDP growth and inflation are regularly wrong, and no one calls turning points well.

Even microeconomic models are bad shape; most of the major hypotheses get rejected when doing general equilibrium tests.

Why?? Because capitalistic economies are more dynamic than mathematical models can mirror.  Live with the volatility, and don’t try to model it.  We face the same in the asset markets, behavior is not predictable.

Austrian economics understands the boom-bust cycle.  Neoclassical economics assumes we move to an equilibrium.  Have you ever lived in an equilibrium?!  There is never an equilibrium, or it is always unstable, and that is the beauty of Austrian economics.  The lack of an equilibrium means the system is always adjusting it does not rest.

Why do neoclassical economists assume equilibrium?  To make their stupid math work.  It is the same for guys in finance.  Why do they assume normality?  To make their stupid math work.  The world is complex, but the economists assume that it is not complex in order to make their models work.

Bias

There is a bias that exists below the surface of all macroeconomic commentary.  Do we look at the income statement, or do we look at the balance sheet?  Neoclassical economists mostly look at the income statement.  Austrian economists look at the balance sheet.  (Neoclassical economists are friends with growth investors, Austrians are friends of value investors.)

Think of the “brick through the window” fallacy.  On the Neoclassical version of GDP, a brick through the window raises GDP.  The Austrians are smarter, and realize that the change in aggregate net wealth is negative.

Neoclassical economics believed debt levels were neutral and were proven wrong in the recent crisis.  They did not look at the balance sheet.

Neoclassical economists, who have dominated the Fed for over 40 years, drove us into a huge inflation, which Volcker choked, and then Greenspan & Bernanke drove us into a liquidity trap by refusing to let recessions eliminate bad debt, creating the “great moderation,” which is now known as a sham.

What You Can’t Quantify Well

Quantitative economics has not improved understanding.  Ben Bernanke flies blind but claims that he sees; the Fed has been a lousy predictor of economic outcomes, despite the legion of academic economists they employ.  There are no economists that have consistently forecast the economy well.

That’s why I don’t agree with those that criticize Austrian economics for avoiding quantifying their theories.  Economics is not a science; it does not quantify well, at least in detail.

Economics should be primarily an ethical discipline.  The government is a referee rather than an overlord.  The government should assure equality of opportunity rather than equality of result.

It’s not as if the government can use its “policy levers” to create any degree of lasting prosperity.  Prosperity lies within the control of individuals who apply their acumen to the situation, and come up with creative ways of meeting human needs.

Closing

Thus, I don’t have much sympathy for those that reject Austrian economics because we don’t have a mathematical means of expressing it.  Paraphrasing the Buffett quote, “I would rather be approximately right than precisely wrong.”  There are many things that I don’t have an exact economic model for that I know a decent amount about.  Qualitative knowledge is valuable, and should not be disrespected by those that do not have a better model, such as the broken model of the neoclassical economists.

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About David Merkel 145 Articles

Affiliation: Finacorp Securities

David J. Merkel, CFA, FSA — From 2003-2007, I was a leading commentator at the excellent investment website RealMoney.com (http://www.RealMoney.com). Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and now I write for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I still contribute to RealMoney, but I have scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After one year of operation, I believe I have achieved that.

In 2008, I became the Chief Economist and Director of Research of Finacorp Securities. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm.

Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life.

I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.

Visit: The Aleph Blog

1 Comment on Neoclassical vs Austrian Economics

  1. Everything you just said is false. Classical Economics doesn’t state that people will always act predictably, it states that people will, on the aggregate, tend to act in certain ways. It isn’t precise or definite, but the tendencies are very clear. Adam Smith himself said this.

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