This recession has brought out a great deal of talk about the Austrian approach to economics, a subject I studied intensely in my student years. This post is a brief primer for the mainstream business owner or manager.
Austrian economics is not at all about Austria; it is a school of thought that originated with a few very influential Austrian economists, including Carl Menger, Ludwig von Mises and Friedrich Hayek. Austrian Economics is often considered synonymous with free market economics, but that’s an error. Milton Friedman was not an Austrian in his methodology or conclusions, though he was an ardent free market supporter.
Two aspects of Austrian Economics are particularly important for the business leader: the Austrian theory of the business cycle, and Austrian approach to information within the economy, including within the corporation.
The Austrian Theory of the Business Cycle
The recession has brought out the Austrians, who claim to have forecast the downturn well in advance. The problem here is that some were forecasting recession many years early, which is counterproductive to successful business planning. The key concept of the Austrian theory of the business cycle is that easy money causes imbalances in the economy, and recession is the process whereby the imbalances are corrected. This theory takes on overtones of morality: sinful excesses must be atoned for.
The Austrians are not alone in their monetary approach to the business cycle. The monetarist school, led by Friedman in the late 20th century, viewed changes in the money supply as a central cause of business cycles, but with a different internal logic.
After a good bit of study, I find the Austrian approach to the business cycle lacking in rigor. The key insight has validity, but has been incorporated into better economic models. The Austrians traditionally eschew econometric models, which hampers their ability to predict magnitude and timing of fluctuations.
However, I am increasingly incorporating Austrian concepts into my analysis of activities within a corporation, and in interaction among corporations.
The Austrian Theory of Information
When Socialism was all the rage, Friedrich Hayek had two key insights into why it would fail. First, Hayek said that the knowledge needed to make good economic decisions is very detailed and resides deep within the enterprise. For instance, consider a simple piece of aluminum strip that might run along the side of a product. An engineer might specify a width of 1 and 5/32 inches, because that’s the minimum size needed for structural support. But the purchasing manager may have an opinion about whether using a slightly larger but standard size would be cheaper. And a designer might have some thought about esthetic proportions, and how they would impact consumer perceptions. The shipping manager might also weigh in on weight issues. The best decision may incorporate very detailed knowledge from several people, none of whom are particularly high up in the organization. Central planners have no way of knowing this level of detail. That’s an important insight for public policy, and also for corporate strategy. If too many decisions are made at the highest levels, the detailed low-level information will not be used, resulting in poor decisions. This is one reason why smaller companies frequently grow to challenge the big boys.
Furthermore, Hayek argued, this detailed, low-level knowledge is continually changing. The standard sizes may change over time; production tolerances changes; esthetic preferences change. New materials are developed, and new ways to process old information are found. A Soviet Five Year Plan will be hopelessly out of date when finalized, as will be your corporate strategy.
* * *
Although I incorporate many Austrian insights into my work, I also use plenty of non-Austrian theories and models. It doesn’t make sense to limit one’s field of vision. In the words of Milton Friedman, “There is no Austrian economics - only good economics, and bad economics.”
Austrian economics is not at all about Austria; it is a school of thought that originated with a few very influential Austrian economists, including Carl Menger, Ludwig von Mises and Friedrich Hayek. Austrian Economics is often considered synonymous with free market economics, but that’s an error. Milton Friedman was not an Austrian in his methodology or conclusions, though he was an ardent free market supporter.
Two aspects of Austrian Economics are particularly important for the business leader: the Austrian theory of the business cycle, and Austrian approach to information within the economy, including within the corporation.
The Austrian Theory of the Business Cycle
The recession has brought out the Austrians, who claim to have forecast the downturn well in advance. The problem here is that some were forecasting recession many years early, which is counterproductive to successful business planning. The key concept of the Austrian theory of the business cycle is that easy money causes imbalances in the economy, and recession is the process whereby the imbalances are corrected. This theory takes on overtones of morality: sinful excesses must be atoned for.
The Austrians are not alone in their monetary approach to the business cycle. The monetarist school, led by Friedman in the late 20th century, viewed changes in the money supply as a central cause of business cycles, but with a different internal logic.
After a good bit of study, I find the Austrian approach to the business cycle lacking in rigor. The key insight has validity, but has been incorporated into better economic models. The Austrians traditionally eschew econometric models, which hampers their ability to predict magnitude and timing of fluctuations.
However, I am increasingly incorporating Austrian concepts into my analysis of activities within a corporation, and in interaction among corporations.
The Austrian Theory of Information
When Socialism was all the rage, Friedrich Hayek had two key insights into why it would fail. First, Hayek said that the knowledge needed to make good economic decisions is very detailed and resides deep within the enterprise. For instance, consider a simple piece of aluminum strip that might run along the side of a product. An engineer might specify a width of 1 and 5/32 inches, because that’s the minimum size needed for structural support. But the purchasing manager may have an opinion about whether using a slightly larger but standard size would be cheaper. And a designer might have some thought about esthetic proportions, and how they would impact consumer perceptions. The shipping manager might also weigh in on weight issues. The best decision may incorporate very detailed knowledge from several people, none of whom are particularly high up in the organization. Central planners have no way of knowing this level of detail. That’s an important insight for public policy, and also for corporate strategy. If too many decisions are made at the highest levels, the detailed low-level information will not be used, resulting in poor decisions. This is one reason why smaller companies frequently grow to challenge the big boys.
Furthermore, Hayek argued, this detailed, low-level knowledge is continually changing. The standard sizes may change over time; production tolerances changes; esthetic preferences change. New materials are developed, and new ways to process old information are found. A Soviet Five Year Plan will be hopelessly out of date when finalized, as will be your corporate strategy.
* * *
Although I incorporate many Austrian insights into my work, I also use plenty of non-Austrian theories and models. It doesn’t make sense to limit one’s field of vision. In the words of Milton Friedman, “There is no Austrian economics - only good economics, and bad economics.”
Hi, Bill. Every time I stop by here, I end up glad I did. You always have an interesting post. Thanks especially for your thoughts on Austrian economics. As you say, "The recession has brought out the Austrians," and I need to know more of how they think.
And I have a question. You write: "I find the Austrian approach to the business cycle lacking in rigor. The key insight has validity, but has been incorporated into better economic models."
Question is: Would you expand on that? What key insight? What better models? Sounds like you had specifics in mind. As Ross Perot said, "I'm all ears."
Posted by: The Arthurian | June 16, 2010 at 06:53 PM