David Friedman On Austrian Economics

The other day David Friedman created a bit of a stir by questioning the uniqueness of Austrian economics:

Yesterday I spoke at a Students for Liberty Conference. Before the talk I had a conversation with several students who identified themselves as supporters of the Austrian school of economics. I asked them if they could explain what that meant by identifying a proposition in economics that almost all Austrian economists and almost no non-Austrian economists would agree with.

One response was along the lines of “Austrians believe that one can derive economic conclusions from convincing axioms without adding any empirical facts.” So I asked them to give me an example of such a conclusion, of a statement that one could  test, observe the truth or falsity of in reality, that could be derived in that way.

I now put the same two questions to any readers of this blog who consider themselves believers in Austrian economics. Can you state such a proposition?

In the comments he concluded:

I think the whole “Austrian” business in libertarianism is in large part a matter of product differentiation. There are differences of emphasis among people who got their ideas through different branches of the neoclassical tradition, but they become differences of kind only when one takes an extreme version of one’s own position—which I don’t think is defensible—and/or of the alternative, which I don’t think is true.

Now there is a sense in which David’s criticisms are at least partially correct. Austrians sometimes tend to think they hold insightful views that are not shared by mainstream neoclassical economists. With the lone exception of the business cycle theory, however, there are very few propositions in Austrian economics that neoclassicists wouldn’t agree with. The bigger difference is in the approach to economics. This is where I find much more value in the Austrian ‘casual realist’ approach as opposed to model driven neoclassical economics. Let me give an example of the superiority of the former:

The other day I was watching this TED talk given by behavioral economist Dan Ariely:

I have to confess I find behavioral economics extremely fascinating. I love learning about people’s behavioral quirks. Unfortunately, many leftists use these observations to make the unjustified leap to government intervention. In this video Ariely discusses his research on cheating. He starts by describing the standard neoclassical model for cheating ― people weigh the probability of getting caught and the expected punishment against the benefit from cheating. If the benefit is greater than the cost then people will cheat.

Ariely designed laboratory experiments to test this proposition. He asked people to take a 10 question test and paid them for each correct answer. On average, people answered four questions correctly. In other experiments he had people take the same test, then when it was over, he told them to rip up the test into small pieces and put them in their pocket and self-report the number of answers they got correct. Now people claimed to answer seven questions correctly. But the problem here is since the probability of getting caught cheating is zero, the neoclassical model would predict everyone would cheat and report they got all ten questions correct. Yet, this doesn’t happen.

While he doesn’t come out and say it, Ariely acts like this blows up the entire case for free markets. He contends that nearly all of economics is based on models, just like this one, that can be proven to be false.

Now since Austrians don’t feel compelled to reduce human behavior to mathematical models, they would have no problem interpreting these results. People act according to their values and strive to satisfy their highest valued ends. There’s nothing in Austrian economics that says that people can’t find value in adhering to social norms and scale back their cheating as a result.

In fairness a neoclassical would most likely respond to these results by saying, “Well, these experiments just show we need to update the model by adding another variable or two to the equation.” But how long until that model is broken? It’s precisely the fact that neoclassicals reduce human behavior to these rigid models that gives ammunition to opponents of the free market when the models don’t conform to reality.

This isn’t just a strategic point either. I genuinely believe the Austrian approach can unlock more insights about the economic world than can be had by drawing up mathematical models. That doesn’t mean theories shouldn’t be tested, but it does suggest we should recognize the limits of that approach.


4 thoughts on “David Friedman On Austrian Economics

  1. A neoclassical would point out, first, that the people might plausibly suspect that if they claimed to get ten right out of ten the experimenter wouldn’t believe them. Second, he might point out that telling the truth is part of most people’s utility function. I don’t think putting it in terms of adding a variable or two to the equation reflects the way in which (non-Austrian) neoclassicals actually think about economics.

    • Also, I have to watch the video again, but I believe Areily controlled for the possibility that people might be influenced by the thought the experimenter knew they were lying. By allowing them to take their own compensation and leave. I could be misremembering, though. But that is a valid point.

      On adding varibles to the equation, I’ve read papers where that was done after experiments (not this one) demonstrated the model is faulty. But I do agree it’s more appropriate here to talk in terms not cheating providing utility to people.

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