I’ve been quite busy for the past weeks, but I had a slow-ish day today, so I clarified my remarks about why Johan Norberg’s book Financial Fiasco is a good read, and much better than Meltdown by Tom Woods.
*”With the YouTubes to prove it!”
Norberg and the Comparison to a Chautauqua Tent Revivalist*
3 Responses to “Norberg and the Comparison to a Chautauqua Tent Revivalist*”
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Here’s the response…
I’ve been occupied by many other projects, but I’m in Hong Kong in-between meetings and have found a few minutes to devote to this odd kerfuffle, so let me clarify a few things.
1. A number of people seemed angered by my use of the word “religion.” Let me clarify. By “religion,” I was not referring to the methods of investigation of Menger, Mises, Hayek, et al. That was certainly not my point. I used the term to refer to people whose method of investigation is to quote sacred texts as, well, sacred, without bothering to ask whether the claims quoted in fact can be checked, verified, disproven, compared with other claims as explanations of complex phenomena, etc., etc. Woods’s book qualifies. In comparison to Norberg’s (which also relies on insights from Mises and Hayek into booms induced by manipulated credit markets), it’s less serious and more an act of religion.
2. I’m not criticizing “ABCT” in general, either. I’m not committed one way or the other. I’m asking whether the theoretical account in Woods’s book (and not some other version in some other essay somewhere else) accounts for what happened. Woods himself sets a test on p. 82, after much insistence that “Austrian business cycle theory” explains what has happened in the present crisis: “If Austrian business cycle theory is correct, we should expect the most significant declines to be in the capital-intensive industries in the higher-order stages of production.” He applies that to the Japanese economy in the 1990s and cites a 2002 article by Ben Powell in the Quarterly Journal of Austrian Economics on “Explaining Japan’s Recession.” Note the words, “If Austrian business cycle theory is correct….” It suggests that if that is not what happens, Austrian business cycle theory is not correct. So, did we see “the most significant declines in the capital-intensive industries in the higher-order stages of production”? Is that what happened in the current case? Was the crisis a rippling out of the process he describes? Is it the case that the crisis was due to overinvestment in the “home construction” industry? (“Artificially low interest rates misdirected enormous resources into home construction.” P. 75) Was a collapse of the “home construction” industry the source of the problem, and not, perhaps, a financial house of cards built on a speculative bubble? Is it the case – and Woods cited it specifically on p. 82 as a test of “ABCT,” that “As the company works towards completing its projects [TGP: in this case, for Woods, it is “home construction”], it will find that the resources it needs, such as labor, materials, replacement parts – called by economists ‘complementary factors of production’ – are not available in sufficient quantities. The pool of real savings turns out to be smaller than entrepreneurs anticipated, and thus the complementary factors of production they need wind up being scarcer than they anticipated. The prices for these parts, labor, and other resources will therefore be higher than entrepreneurs expected, and business costs will rise.” Is that what happened? Did the home construction industry find that labor, parts, and other “complementary factors of production” rose higher than entrepreneurs expected, which caused them to stop building homes and lay off workers, which caused a crash? Yes, or no?
3. There has to be some way to test the account that Woods gives. There may be many ways to do so. Woods himself offers one in the case of the Japanese economy. But he doesn’t bother to apply it to the American. Why not?
4. My point about a theory being testable to be scientific is compatible with a variety of tests. But if it’s just asserted, or – and here the religion comes in – merely quoted from a text that is treated as if it were sacred, then the person doing the assertion is not engaged in a scientific enterprise. It’s a religious act, like quoting the Bible, the Qur’an, or the Book of Mormon. How could we tell which theoretical account best fitted with or explained the available evidence? Woods seems to insist on it in one case (the Japanese economy) and his formulation states quite clearly that if “the most significant declines” are not in “the capital-intensive industries in the higher-order stages of production,” then “ABCT” is not correct. (Note the syllogistic form: If A [Austrian business cycle theory is correct], then B [the most significant declines are in capital-intensive industries in the higher-order stages of production]. He states that it is the case that B. He doesn’t go so far as to say that B being the case means that A is the case, but given his formulation, it would follow that if not B; then not A. Thus, by his rather exacting standard, if it is not the case that B, then “ABCT” is not correct, i.e., “ABCT” is false. That’s his standard, not mine. If the most significant declines were not in the “capital-intensive industries in the higher-order stages of production,” then “ABCT” is false. So, is “ABCT” false by his own standards?
5. John Taylor offers a monetary-based account of the housing boom, but focuses, not on the decline in the “home construction” industry, but in the collapse of the financial system due to the excessive risk that was encouraged in the financial industry by government policy. “[R]isk in the balance sheets of financial institutions has been at the heart of the financial crisis from the beginning.” (p. 13, John Taylor, “Getting Off Track: How Government Actions and Interventions Caused, Prolonged, and Worsened the Financial Crisis” [Stanford: Hoover Institution Press, 2009]) There’s no need to invoke any significant declines in the “capital-intensive industries in the higher-order stages of production” to tell that story. It may be compatible with some other variation of “ABCT” offered in some other book, but not with the one offered by Woods in the book I cited as inferior to another book that offers a better explanation.
6. People should not read books on economics or history religiously or feel invested in the necessary truths of theoretical accounts of complex phenomena. If Hayek gave an account that explained a crisis, then we’re better off for knowing it. But it doesn’t follow that all crises must be explained by that account. And if people calling themselves “Austrians” think it does, then they will consign themselves to an odd little corner of economics, and a shrinking one, at that, despite Woods’s odd description: “The Austrians, surely the fastest-growing school of economic thought in the world.” (For “the fastest growing school,” he notes they “have been neglected long enough.” Um, right.) Economists associated with that tradition have much to say to us, but when their ideas are promoted in a truly religious manner (i.e., merely quoted, without having their theories tested or compared to the evidence or to other theories) it does far more harm than good.
7. All that said, the Woods book has a number of good quotes from the popular media documenting the disastrous interventions into the mortgage markets. It’s “ok, but it does not compare well with the much more rigorous and financially sophisticated treatment offered by Norberg.” Norberg wrote a better book. (I should point out that Taylor did, as well, but it’s not as accessible or as general in its treatment of financial markets.)
8. So if people are mad that a book was compared to another book, so be it. They should think about what that says about them and their commitment to science. Emotional attachment may a very good thing when it’s to friends, family, places, and the like. But not when it’s to a theory. And it does no service to that theory, or any of its refinements, when it’s merely quoted as dogma, without being subject to any sort of tests, especially by someone who — in another context — subjected it to a very strong falsificationist criterion, but who seems unable or unwilling to do so in the case at hand.
9. I hope that I have clarified my comments about religion, which seem to have riled up a lot of people. I hope that maybe it will induce some of them to do the research and write the studies, articles, and books that improve our understanding of the financial crisis. We need that kind of work — from scholars and scientists, not preachers…or even cartoonists.
Posted by: Tom G. Palmer | November 16, 2009 at 09:14 AM
Dear Mr. Palmer,
Inspired by your dispute with the folks from Mises Institute, I also had a similar discussion with the Russian Rothbardians.
They kept claiming that ABCT is apriori right. In other words, if the central bank expands credit, the austrian cycle necessarily follows. They claimed that ABCT is logically deduced from apriori true premises (e.g., that any human action is purposeful).
I looked into Mises’s On Human Action and found that this is exactly what Mises wanted to say. He really meant that economics done right is just deductive logical reasoning.
In response to such logic, I answered that business cysle is a complex phenomenon and cannot be deduced from apriori true statements only. ABCT makes assumptions that are not apriori true. For example, for the austrian cycle to happen, the new credit should go to entrepreneurs, because, if it goes to consumers, it will not be an austrian cycle.
Was I right in my counter-arguments?
Yes, I think that your approach is correct. I am quite happy to apply the theories of the Austrians to such matters and there are certainly some things that we can generally know about, say, expansion of the money supply. (Prices will rise, although even there there are complications, such as whether people hold on to money in the expectation that prices will fall later, or whether there are also downward pressures on prices due to increased productivity, so that nominal prices do not go up, or not as fast as would otherwise be the case.) But to think that the whole global financial meltdown we have experienced HAD to happen as an account describes it happening in other cases is simply an abdication of responsibility to find out what, in fact, happened. And if there is evidence to support the case that the meltdown was due to a collapse of the housing industry (the strongest case that they can make), I’d like to see it. The general approach of Mises and Hayek (and Schwartz and Taylor and others) to the impact of manipulation of the interest rate by the central bank is compatible with a variety of particular concatenations of events. The question is, what happened?