Schumpeter and the Financial Instability Hypothesis 

"Economic progress, in capitalist society, means turmoil." ~ Joseph Alois Schumpeter

    While Schumpeter is most widely known for his contributions to economics through his theory of entrepreneurship, i.e., creative destruction, Schumpeter was much more than this whilst theorizing. Having multiple exceptional treatises on Economic History, Business Cycles, and Finance’s role in the real economy, Schumpeter’s economic tradition spanned multiple vibrant traditions that he does not get enough respect for. To Schumpeter, the economy was constantly in disequilibrating flux, constantly changing as all dynamic capitalist economics, making the use of equilibrium theory almost obsolete. Despite the few lapses in Walrasian General-Equilibrium theory for business cycle theories, Schumpeter remained true to this thesis of market economy dynamicity, a disequilibrating and explosive process that pushes the economy to more welfare-enhancing combinations through “Creative Destruction”; a conception that was in fact originally Marxist!1 Another tradition putting the dynamicity of the Capitalist economy at the forefront of its theory during a time of exceptional Physicist delusion was the Post-Keynesians, in particular, Hyman Minsky, the creator of the first formalized version of the Financial Instability Hypothesis. The FIH (Financial Instability Hypothesis) has recently gained increased traction since the 2008-2012 Economic recession, outlining the flaws of the mainstream Walrasians who were predicting times of exceptional progress and almost no possible recessions in the immediate future! This however, was demonstrated to be utterly deluded with the following financial crash in 2008 and the consequent shocks throughout the real sectors, pushing the economy in a recession that has not been seen in terms of severity since the original 1929-1939 Great Depression.

     The financial instability hypothesis brought something almost completely unknown to the Mainstream of economics since the 1930s, an endogenous theory of the business cycle. Hyman Minsky, defying the standard Walrasian conceptions of the business cycle, boldly claimed that the cause for instability was in fact stability, the paradox of tranquility! In times of stability, the economy’s particularly unstable financial sector undertook incredibly risky investments due to radical uncertainty and the illusion of forever economic progress, leading to investments that were incapable of being fully seen through and consequently forced liquidation. The original stable “hedge finance” units in an unregulated laissez faire economy turned into “Ponzi finance” units, unstable financial units consequently leading to unwise investments and forced partial or complete-liquidation when losses are finally realized. Only with proper regulatory oversight would the financial sector remain primarily composed of “hedge finance” units, rather than “Ponzi finance” units that characterize laissez faire economies during times of stability. 

Unfortunately Hyman Minsky’s theory of the business cycle is simply inadequate for a theory of the business cycle which encompasses the real sector, the financial instability hypothesis solely addressed the financial sector and presupposes a domino effect moving throughout the entire economy; decline of finance leading to decline of all other sectors. This theory however, cannot describe what exactly happens in a capitalist economy when this phenomenon of financial decline occurs, it cannot describe what factors are at work to lead to complete economic decline, why the entire economic system must collapse. However, a group of vibrant (primarily) German scholars have undertook a task of creating a new paradigm in economics, Neo-Schumpeterian Economics. 

    Neo-Schumpeterian economics (NSE) is a recently founded school of economics by economists such as Horst Hanusch seeking to revive Schumpeter’s theory of the dynamic market process and repurpose it for the entire economy, not simply a theory of entrepreneurship. These economists emphasize, similarly to the Post-Keynesians, radical uncertainty, and the endogenous nature of credit in the economy, as the Monetary-Circuitists in the Post-Keynesian tradition tend to do. Rather than being exogenously dropped from a helicopter as the New-Monetarists of the Mainstream tend to emphasize, credit & money in a modern capitalist economy is largely endogenous, and consequently leading to problems for standard policy measures advocated by the New and Neo’s of the mainstream along with multiple problems being posed with the standard loanable funds picture of the market economy, in which the mythical natural rate of interest equilibrates investment and savings. Endogenous money essentially reverses the causation between savings and investment, savings do not create investments, investments create savings through a conception of monetary circuits! Due to the fact this is a very complex topic, this topic will be left for another time to dive into the problems with exogenous money and the policy measures derived from endogenous monetary theories.

    The understanding of the Neo-Schumpeterians of the endogenous nature of money consequently leads to a much richer comprehension of money in the economy, it is not simply a deus ex machina created by market participants and is merely a veil, money and credit are created by private banks to finance entrepreneurial investments, which deliver themselves through the wage system and consequently deposits in private banks, a system of “circuits” in the modern market economy. For the Neo-Schumpeterians, the sole most important factor in the economy is the entrepreneur, as it is for the Post-Keynesians. The entrepreneurs in a market economy provide the crucial disequilibration functions that overthrow the previous disequilibrium regime to better satisfy consumers in the economy, through the process of seemingly paradoxical creative destruction the unemployment caused by the initial destruction is replenished by the creative aspect of creative destruction, increased employment and consequently increased consumption, a system of economic progress. The Neo-Schumpeterians compliment beautifully the Post-Keynesians in business cycle theories and Micro-MacroEconomics through providing an adequate theory of what proceeds to function in the real sectors of the economy through the boom. Looking at the boom, rather than simply ignoring it as the New-Classicals do and look directly towards the recession, the NS’s and the PK’s comprehend that the causal forces at work are always in the boom phase of the business cycle and consequently necessitates the need for an analysis of the boom during the business cycle. Taking from Schumpeter’s original business cycle theory, creative destruction, and even Hyman Minsky’s FIH (Financial Instability Hypothesis), Perez (2011) has developed a theory of the business cycle that adequately describes the working of modern capitalist economies. 

    Starting from the basic principle that business cycles are caused endogenously, as most Post-Keynesians and Neo-Schumpeterian Economists agree with, we may continue with the hypothesis of the business cycle theory. As has already been outlined, credit and money in an economy are largely endogenous rather than exogenous and dropped from a helicopter, meaning most money is created by private banks to finance entrepreneurial activity in the real sector. An often overlooked aspect of financial firms is that they do also engage in creative entrepreneurial activity, generally to loan money easier to credit worthy entrepreneurs, engaging in a similar sort of creative destruction in the economy. The only difference, however, is that financial creative destruction is quite distinct from creative destruction in a market economy’s real sector, financial creative destruction are often more disruptive than creative in such a fragile financial situation, in which those taking investment decisions in the financial sectors act as gamblers, even the slightest “destruction” could lead to increased economic fragility, soon collapsing due to the nature of the economy’s short and long run expectations, colloquially termed animal spirits. Financial creative destruction adds an important expansion to the standard Minsky-ian theory of the business cycle with sole “over-leveraging” and stability. Another route that can be taken to explain the real sector, can be taken with the same Schumpeterian principles, however. Investors in market economies often function similar to entrepreneurs in non-highly speculatory markets, always looking for profit opportunities and to satiate those they owe money to by managing to derive enough profits for both them and themselves. This consequently means there is a necessity for financial entrepreneurs to seek entrepreneurial opportunities.

     This can occur in multiple ways, the most common of which is following the recent innovations and the sectors in which creative destruction is much more prevalent, e.g., the software sector during the 1990s and Post the 2001 crash. The financial entrepreneurs often are looking to maximize the total amount of profits they can receive while maintaining less risky investments, however, in newly forming sectors that are subject to radical incalculable uncertainty, investment decisions are often subject to pure short-long run expectations rather than any basis in the past price systems. Crucial decisions, rendering the past-price system increasingly less valuable, which are often undertaken in sectors that are young and rapidly advancing further contribute to radical uncertainty. Considering the complete inability to base investment decisions from present and past prices as the Austrians seem to claim, the radical uncertainty and disequilibrium overtake said sector, e.g., a budding robotics sector. This consequently means that there are massive opportunities of immense profits for investors, but also opportunities of great loss due to the radically uncertain nature of said sectors. When entering these sectors, financiers tend to also attract a great deal of entrepreneurs in real sectors that wish to make profits. This feeds itself in a form of an investment multiplier, increased financers, increased entrepreneurs, and the circle continues to feed itself. What occurs then, happens to be a massive bubble in said sectors. To cope with the immense amount of funds being loaned out to a certain sector, an upwards pressure is put upon asset prices, continuing the bubble in the economy. The bubble in the real sector is constantly being fed upon itself, moving from the original positive boom in investment to an unstable and radically uncertain bubble in which financers and entrepreneurs feed one another through loans and returns. After a certain point, a clear phenomenon of not enough real resources existing to complete all projects occurs, along with a massive realization across the financiers that they are simply riding a bubble rather than a real economic increase in production. Realizing losses and the bubble sector, financers withdraw credit from that sector, leading to a collapse of that entire sector. This phenomenon is replicated across the entire economy that has budding sectors, along with collapses in sectors and firms which had contracts with these radically uncertain bubble markets, a phenomenon which works its way throughout the market economy, causing mayhem and a decline in investment expectations, necessitating the need for a revival in aggregate demand. To illustrate this phenomenon in a clearly understood example, let us demonstrate how this affects the economy with certain sectors: 

Let us suppose that economic actors in the economy, by being exceptionally productive with resources and satiating consumers in a radically new way, trigger the phenomena of creative destruction and immense technological progress in say, the robotics sector. The robotics sector consequently sees a massive increase in this production process’s profitability, a phenomenon that is incredibly attractive to prospective investors and financiers. This massive uptick in profits that were originally organic attract a great deal of financiers who act in an entrepreneurial manner to best satiate their own contractual arrangements, leading to creative destruction in the financial sector for the best way to provide loans and credit. The consequent phenomenon, as has been described above, is often much more destructive than creative due to the radically uncertain nature of the financial markets, and how malleable investment expectations are in a world of crucial decisions which render the past-price system a great deal more useless than before. Increasing the fragility of financial markets with the creative-destruction phenomenon, we may turn our eyes to the robotics sector, the sector that was originally in question. What occurs in that sector is an increase in prospective financiers who wish to act in an entrepreneurial manner to satiate their contractually bound arrangements and to provide for themselves.

    Entering this incredibly young and volatile robotics sector, however comes with multiple risks, e.g., Radical uncertainty which is fundamentally incalculable due the prevalent nature of Ontological Uncertainty in these sorts of investment decisions. Due to the prevalent nature of Ontological Uncertainty, investment in these sectors are incredibly uncertain and fragile. Despite the risks, prospective investors enter the market in order to satiate their profit motive, increasing the total amount of credit granted to the producers in the robotics market. This phenomenon leads to entrepreneurs in the real sector entering the markets in order to make a greater profit. The robotics sector, now, is forced to deal with an original organic phenomenon turning into a great bubble which feeds upon itself through investment multipliers due to the amount of prospective financial and real sector entrepreneurs entering this market. After a certain point, financiers are forced to confront the future, these investments were unsound and made based on radically uncertain conditions which turned out to be wrong, there were simply not enough real resources to complete these projects or carry through with loans. A massive decline in the economy consequently occurs, liquidation in the real sectors and financiers preventing themselves from loaning anytime in the near future due to pessimistic short and long run expectations, a situation that sets in as a recession. To make matters worse, are the future contracts in different sectors, e.g., a software sector that is interconnected with the robotics sector. With the now collapsed robotics sector, losses inflict themselves upon different sectors, and consequently, a multiplier effect finds itself across the entire economy due to the interconnected nature of the capitalist economy. With the increased financial instability due to the loan creative destruction and the bubbles in the real sector, what occurs is a complete decimation of the financial sector and at the same time the real sector. The entire economy is faced with immense turmoil, inability to recover without aggregate demand stimulation through fiscal policy to lead to a rebound in investment expectations and consequently investment demand & the employment effects that derive from the increase in production. 

The causal factor at the start of the bubble shares remarkable similarities with Minsky's theory of a transition from a “hedge finance” dominated financial sector to a “Ponzi finance” dominated sector. The Neo-Schumpeterian explanation provides the Minsky-ian FIH with a basis in the real sector, rather than the sole financial sector, completing the theory to make room for the entire economy without having to adopt the original equilibrium conditions that Schumpeter’s business cycle theory had adopted. Following from radical uncertainty and the consequences of stability in a laissez faire capitalist economy, the real sector also feels the consequences during the boom era, harming the entire economy due to the misdeeds of the financial sector.

References: 

1. Pettinger, T., & Langdon, M. (2018, January 22). Creative destruction. Economics Help. https://www.economicshelp.org/blog/20255/economics/creative-destruction/.

A Note on the Future of This Blog

 Minuscule Amount of Readers: 

    This is not a claim that I will end this blog. However, over the time between the last and the recent post, it has occurred to me that Austrian Economics truly is damaged to the core with false economic axioms, leading to a reversion in my thought. I now find myself interested in the Post-Walrasians, but more particularly I have decided to term this blog, rather than a Post-Austrian blog, a Post-Schumpeterian blog. The Neo-Schumpeterians and Post-Keynesians are clearly compatible, to create a superior theory of the market process, along with not inhabiting a dogmatic position that most Austrians espouse. I will still look into an Austrian-Post Keynesian synthesis on business cycles, but the Post-Schumpeterian position particularly interests me. 

    Another interesting development, a friend and I decided to set up a discord server for radical subjectivists, in the Post-Keynesian or Austrian tradition. This server has multiple source channels that I regularly update (note, 2-4 days if no one posts anything) that anyone can post in. Feel free to join:

https://discord.gg/Z2WQM8Mmjr

Keynes v. Mises: Why Should You Choose Keynes

 Keynes v. Mises: Why Should You Choose Keynes
A Review of the Mises Wire Article: For Keynesians and Austrians, "Uncertainty" Means Two Different Things

https://mises.org/wire/keynesians-and-austrians-uncertainty-means-two-different-things

    Recently, having been in multiple arguments with incredibly dogmatic Austrians, I have been confronted with a Mises Wire article that claims that the Austrians are also subjectivists compared to Keynes but are not nihilistic, my words, in the sense that the price system conveys all of the necessary information to prevent the phenomena of multiple entrepreneurs facing radical swings in investment behavior, “Animal Spirits”. Putting aside the fact this article is from a Neo-Confederate institute founded by isolationists, and that they frequently use the pejorative “Animal Spirits”; I found the article interesting enough to consider writing a post on for the sake of my own boredom. The article’s main argument is essentially that due to the price system existing, entrepreneurs cannot be mass-mislead and cause a business cycle in the form of massive “mood swings”. To begin with: 

“One such explanation inspired by the General Theory emphasizes the endemic uncertainty of the future and its implications for market stability. Championed by Paul Davidson and popularized by Robert Skidelsky, this line of thought blames the crisis and recession on the fickle expectations and “animal spirits” that guide investment in a market economy.”

    The use of animal spirits, to begin with, is problematic in the sense it was barely used by Keynes at all, a term borrowed from Descartes. Only 3 times had the term been used by Keynes, the use of animal spirits is largely a pejorative used by dogmatic Austrians to ridicule the “Keynesians”. Animal spirits, then, are not the sole reason for the radical swings in investment behavior as a hormonal teen would act, rather the problems that arise from operating in a complex economy in which immense amounts of capital are being moved around, increasing the psychological burden placed upon entrepreneurs and consequently turning investment behavior into almost gambling like mentalities. 

“Per this thesis, in an uncertain world, entrepreneurs and investors suffer from mood swings. Optimism regarding the future abruptly gives way to pessimism. Fluctuations in economic activity are the result of these variations in outlook.” 

    As I’ve stated above, these “mood swings” are much more than mood swings. These swings in investment behavior are a consequence of all investments being irrational and consequently subject to mass error due to the impossibility of knowing the future and determining what the subjective valuations of consumers will be. This phenomenon makes itself incredibly apparent in financial markets, in which the sole purpose of the markets is to bet on a future that does not exist yet. No matter the amount of studies done before making investment decisions, there is simply no way of telling us exactly what the future will be when factoring in billions of decisions on the daily changing the open ended future, the problem of finding the necessary data in a world of crucial decisions and incredibly innovation to forecast the future reliably simply is impossible, it is not a matter of complexity nor is it a phenomenon that is possible for a deus ex machina to solve, no amount of computational power can ever compute and probabilistically determine the future exactly. Fluctuations in economic activity, then, are a result of the massive amount of instability behind millions of decisions like the aforementioned being taken on the daily in financial markets, it makes perfect logical sense. 

“With its focus on uncertainty, this line of thought bears a striking resemblance to Austrian ideas. Moreover, its rejection of mathematical probability as a foundation for expectations is echoed by several prominent Austrian economists.” 

    Not necessarily incorrect, just something worth noting that Hans Hermann Hoppe, the leader of the contemporary Austrian School, accepts this probabilistic view of the future in his criticism of Lachmann. The section on Keynes’ theory of probability and uncertainty is somewhat correct, with occasional mistakes. 

“Lurking behind her animal spirits are expectations formed as the result of an attempt on her part to “conform with the behavior of the majority or the average.” A similar striving on the part of everyone else gives rise to a “conventional judgment” regarding the future, shared by the overwhelming majority of entrepreneurs and investors.” 

    In this situation, the authors seem to be claiming that “animal spirits” are formed collectively and individual expectations mold around that in Keynes’ theory. This, however, is definitely not true to any Post-Keynesian who understands uncertainty theory. The reason for the chain reaction of a decline in the financial sector and consequent collapse is due to the fact watching multiple bank failures occur shakes investing expectations in a major manner, leading to flight from the country and consequent certain attempts to hedge against an increasingly uncertain future, e.g., liquid assets, which prevents the standard Austrian story of individuals simply saving to rebuild the capital stock from being true, it fails to consider the existence of liquidity preference in their analysis involving a false theory of loanable funds. 

“Based on the flimsy foundations of the psychology of opinion and with no moorings in experience, this conventional judgment is subject to sudden and violent change. Like a school of fish, investors and entrepreneurs swim this way and that, always taking their cues on what to do from others, without recourse to any solid foundations in which to ground their expectations.”

    Again, the Austrians fail to consider the core of the Keynes-Post Keynesian theory of business cycles and investment, that is, the market is volatile and subject to massive swings due to the immense amount of decisions being taken in the financial sector in which the goal is being to accurately forecast the future, something that is impossible, regardless of the existence of a deus ex machina that the Austrians seem to find in the market system, particularly prices. This theory of a machine that can mitigate all uncertainty through spontaneous order, however, is flawed when considering that this is simply a case of epistemic uncertainty rather than Ontological Uncertainty, which is fundamentally what the market process is about. 

“Buoyed by an optimistic conventional judgment, investors, with positive animal spirits pumping through their veins, rush to produce more capital goods, lifting the fortunes of workers with them. Soon the judgment turns and pessimism sets in. Investors no longer have the urge to act. They become quiescent, and unemployment increases.” 

    This statement above misses out the majority of what Post-Keynesians use for considerations of the business cycle, i.e., the paradox of tranquility. Times of economic growth breed instability due to creating investment decisions which are based on the belief that the growth of the current will continue forever, without regard for future supply side shocks and radical changes in subjective preferences, leading to over-leveraging and consequently unsustainable investment decisions which must be liquidated eventually when real resources and financial capital do not exist in the abundance presupposed by the mislead entrepreneurs. The judgment does not occur simply because of unknown psychological forces, it is caused due to the phenomena which occur in the boom of over-leveraging, to claim otherwise is a clear strawman of Minsky, Keynes, and other Post-Keynesian boom-business cycle theorists. 

“The path to greater market stability requires heavy government intervention. It is the job of the state to counter the waxing and waning of animal spirits and help stabilize the level of investment, output and employment.” 

    This passage above isn’t necessarily what is being claimed by Post-Keynesians, a great deal recognize that certain policies can induce greater uncertainty into the market through “Regime Uncertainty”; however to mitigate the investment decisions which are unsustainable Post-Keynesians do propose certain methods such as 100% reserve banking, or at least higher bank reserves, and other regulatory mechanisms to prevent hedge finance units from becoming Ponzi finance units which dominate markets in laissez-faire markets during times of stability. 

Starting with the section on Austrian “subjectivity”: 

“Prominent Austrian economists such as Mises,5 Lachmann,6​ and Rothbard7​ agree with Keynes’s rejection of a mechanistic relationship between past and future prices.” 

    Something I find amusing, is the adoption of Ludwig M. Lachmann of all people as an appeal against the Keynesians. The same Lachmann who was ostracized by the Austrian School for being too Keynesian, the same Lachmann who was deemed an epistemological nihilist by the dogmatist Murray N. Rothbard, the same Ludwig M. Lachmann whose followers are still rejected by a majority of Austrians. The appeal to Lachmann of all people for the situation at hand is incredibly ironic. 

“This has implications for the formation of expectations. Entrepreneurs cannot study past prices, calculate the numerical probability associated with them and then simply extrapolate these numbers into the future. As a result, mathematical probability is not a suitable foundation on which to base expectations. However, this does not imply that we know nothing about the future. The past can still serve as a guide to action.”

    The final claim, that the Austrians believe that due to the past acting as a guide for action, is ignorant of the fact Post-Keynesians do also comprehend the past as an indicator for future investment decisions, however putting less emphasis due to the existence of Shackle’s crucial decisions. Crucial decisions are decisions which cannot be reverted and fundamentally change the direction of the market process, making the existence of past information before this a great deal irrelevant through the phenomena of Schumpeterian “Creative Destruction”. This appeal to past information ignores the existence of crucial decisions and Schumpeterian “Creative Destruction”. 

“Entrepreneurs can still estimate the likelihood of future events. They do so by trying to understand the motivations underlying the valuations of market participants in specific situations in the past. They must peer beneath the veil of past prices and must analyze why market participants acted the way they did under the given conditions.” 

    The attempt to understand the motivations of market participants in the past, however, is a fool’s endeavor a majority of times. It requires analysis of subjective value scales and almost omniscient knowledge of the market at that time, it simply cannot occur for a simple entrepreneur wishing to enter the market. Another thing is that this analysis of the past does not change the Post-Keynesian analysis, it still leads to decisions being made that are essentially betting on a non-existent future with limited past knowledge that cannot be fully correct due to the existence of crucial decisions. Crucial decisions essentially, through the process of creative destruction, makes a great deal of information irrelevant due to the irrelevance of the firms who produced this product in the current because of creative destruction. 

“This, as in the case of Keynes, lends them a subjective flavor. Nevertheless, the subjective expectations of entrepreneurs do not coalesce into a homogenous and ever-shifting conventional judgment regarding the future. Instead, these expectations are heterogeneous. Two entrepreneurs may come to different conclusions regarding why individuals behaved the way they did in the past. Moreover, their grounding in the past gives them a basis in reality. Thus, they are not whimsical and subject to random fluctuations.”

    Almost painfully ignorant of Keynes and the Radical Subjectivists, the authors then proceed to claim that expectations are somehow homogenous in Keynes’ theory unlike the Austrian theory which accounts for it. This is completely false, the reason for the collapse of the financial system is due to heterogeneous expectations being influenced by a collapse in major institutions, these send shockwaves throughout the market and cause investment expectations and investment demand to fall. It is not a matter of “heterogeneous” or “homogeneous ”, it’s a matter of what occurs when market institutions decline and cause economic panic. This statement is both unfounded and proves nothing.   

“This process of entrepreneurial selection allows for the coordination of the decisions of producers and consumers. It ensures that, at any given moment in time, the best appraisers of the future are in control of making the key production decisions in the economy. Thus, in the Austrian framework, uncertainty and subjective expectations are compatible with market order and stability.” 

    This view, however, is not true when considering Schumpeterian and other Post-Keynesian elements, the market is not naturally equilibrating. On this, more in depth, see my other post on Hayekian plan coordination equilibrium, but I will give a brief summary here. The concept that somehow the market tends towards increased coordination, i.e., Hayekian equilibrium, is completely false when considering heterogeneous subjective expectations which can react in any way to new information in the market, leading to discoordination on the production side due to competition and creative destruction, necessary disequilibrating processes due to the fact competition is essentially purposeful plan discoordination to control more resources and clientele than the other firm, a conquest that is disequilibrating for power. 

“The key to ensuring this is a price system that results from the voluntary decisions of market participants to engage in mutually beneficial exchange. The prices that emerge on the various factor markets must reflect the appraisements of the participating entrepreneurs. Any interference with such a system of prices can interfere with this process of coordination and the order generated by the market.” 

    The concept of spontaneous order does not hold true for a dynamic market in which Creative Destruction prevails, which is a necessary condition for all dynamic market economies. No such “order” is created in the market, it is always destroyed and overthrown without any time for readjustment due to innovation and creative destruction, causing some sort of ability to retaliate against the paradox of tranquility to simply not exist. The core is not about homogeneous expectations, it is about the way collapses of major institutions have effects on market participants and consequently abandonment of production processes, unemployment, and a fall of aggregate demand! This appeal to the price system simply does not make sense in a world that is dynamic and without an ordering axiom, it is fallacious! 

The rest of the article happens to be about the false Austrian Theory of the Trade Cycle: 

“Profits no longer reward those entrepreneurs who allocate scarce resources to the highest ranked ends of the consumers. Instead, they reward those who, misled by the artificially low interest rate, embark on production projects that are unsustainable. Those entrepreneurs who correctly perceive the underlying unsustainability now lose control of the capital at their disposal and gradually lose the ability to influence the course of affairs.” 

    This theory rests on the adoption of a more capital intensive technique that is profitable at this lower rate of interest but not at the higher rate which happens to be more natural. However due to capital reswitching, it has been demonstrated that this monotonic relationship does not exist, nor is it necessary for entrepreneurs to adopt a more profitable higher capital intensity project. Reswitching is essentially a production technique that is profitable at a high rate of interest, unprofitable at a medium rate, and profitable again at a low rate of interest. This technique which is profitable at both technique extremes, higher and lower, is less capital intensive but cost minimizing, which means the necessity of adopting a more capital intensive unsustainable project does not need to occur. For further information on this, check out Robert Vienneau’s blog, in which he demonstrates under a wide array of conditions that reswitching can occur.

    Finally, to answer the question posed at the title of the blog, why should you choose Keynes over Mises? The reason for this is quite simple, Keynes provides a full analysis of uncertainty and consequently derives truthful axioms about the economy, that it is fundamentally unstable due to a radically uncertain future! The Austrians simply pick and choose what they enjoy about uncertainty, and forget it the next! It is nonsensical then, to claim that Mises is superior to Keynes.

Are the Post-Keynesians Wrong on Uncertainty?

 Michael Brady's Criticism of Post-Keynesian Economics 

"The market can stay irrational longer than you can stay solvent." ~ John Maynard Keynes

    If you've heard about Paul Davidson, and read his work, and then attempted to read more by him utilizing the search bar, you have most likely run into M.E Brady's work on Post Keynesians and Uncertainty, primarily claiming that the Post-Keynesians aren't true successors of Keynes and a sort of nihilism. Michael Brady's work is extensive and the individual is clearly very determined, however wrong. Brady generally tends towards a laissez-faire theory of the market process and the tendency towards full employment of resources of the free market naturally, which leads to the "withering" critiques of the Post-Keynesians. However, M. Brady is generally off the spot on these critiques, primarily on degrees of uncertainty and concluding that's of nihilism. An example of his critique of the Post Keynesians is found in this quote:

“The Post Keynesian school is doomed intellectually because it does not have a solid foundation to deal with uncertainty as a range. Radical uncertainty only has import in decisions involving innovation/long-run capital investment. Any attempt to put it at the center of decision making leads to intellectual chaos.”

    This first criticism is not satisfactory. In fact, Brady admits that radical uncertainty is fundamental to the market economy through central decisions of innovation and long-run capital investment. Long-run capital investment and innovation heavily determine the entire traverse of the market process, without a satisfactory theory of it we result in a theory that is without grounding in reality and ignores the necessity of crucial decisions on a massive scale, such as the creation of the iPhone, a crucial decision by any standard. Had we followed a standard explanation of this without a long-run theory of radical uncertainty and innovation, we would somehow have to explain through mental gymnastics that the economy had this state pre-programmed into objective probability distributions, that the creation of the iPhone and the creative destruction that ensued from its creation where all apart of some theistic God’s plan for the economy which further pushed us across a linear tendency towards General Equilibrium and Full Employment of all resources, capital, and labor. 

    Had this been true, we would then be able to believe that in the market economy of ergodicity we could objectively calculate these probability distributions of the future and make decisions from it, that rational expectations could be made from it and thus deriving a theory of a linear tendency towards equilibrium and full employment of all resources. This, however, is not true for an economy such as the modern market economy, which at the center is constantly filled with crucial decisions of entrepreneurs to innovate and fundamentally change the transmutable future of the market process, it makes much more sense to describe this in an open-ended conception of the market process in which the economy isn’t tending towards a static state, the economy is unfolding throughout historical time and is constantly unfolding in different ways due to the nature of a kaleidic environment that the market process functions on. If Post-Keynesians like Davidson were to not place at the center of our analysis radical uncertainty stemming from innovation and long-run capital investment, they would end up with a similar theory to the Neoclassical which fails to comprehend the intricacies of the market process and the unfolding behavior of the market process over time, we would end up with a theory that neglected all true uncertainty for a form of epistemic uncertainty which is simply just complexity, rather than Ontological uncertainty which is true uncertainty. 

    Ontological uncertainty comprehends that the future is not set in stone, it is constantly adapting and changing, and moreover, fundamentally uncertain. The direction of the economy can never be in one direction due to its dependence on the expectations and the production processes of individuals and the consequent incompatibility between certain plans causing disequilibration, or creative destruction, in Schumpeterian lingo. None of this could exist had this theory of radical uncertainty not been at the center of the market process theory of decisions for Post-Keynesians, they would end up with a theory that can only describe an ergodic system of robotic decision-makers, such as the world of Lucas and other New-mainstream economists who favor a laissez-faire system due to their ignorance of the conditions of financial markets that stem from their lack of centrality on radical uncertainty! This is not a critique of the Post-Keynesians, it is what makes them fundamentally correct, and what makes the New-Classicals, New-Keynesians, and Neoclassicals fundamentally wrong, ignorance of the centrality of radical uncertainty leads to faulty theories! When we comprehend that the path of the economy is not fixed, i.e., it cannot be calculated probabilistically and therefore is radically uncertain, we must also comprehend that most investment is therefore irrational, betting on the future conditions of the market dependent on millions if not billions of contingent human actors, all acting in their own self-benefit based on their subjective valuations and expectations. 

    This makes the economic decision-making process incredibly volatile, which New-Classicals and New-Keynesians tend to deny, unfortunately. The reason for the volatility of the market economy is based on the problem of determining the future accurately when it is not predetermined, therefore the Mainstream of economics tends to ignore this for the sake of their dogmatic financial laissez-faire stance, which is untenable when realizing the non-ergodicity and the transmutability of the economy and the economy’s future. We cannot proceed with any satisfactory theory of the market process without a theory of how long-run capital decisions and innovation occurs under certain conditions and how it affects the rest of the economy, as the very heart of the economy’s future and economic relationships are determined by these crucial decisions and their impact on the future. To claim that Post-Keynesians do not have a solid explanation of the market process due to having radical uncertainty at its core of decision-making is completely false. The reason Post-Keynesians stand out and tend to be more correct on these issues is due to the radical subjectivism underpinning economic reality on the Post-Keynesian view of Joan Robinson, G.L.S Shackle, and Paul Davidson, and why the future is much more than uncertain, it is radically uncertain. This brings us into another criticism of Brady’s, that Post-Keynesians don’t understand that there are various degrees of uncertainty: 

“Paul Davidson assumes that Keynes’s and Shackle’s views are the same. The Post Keynesians DO NOT accept the concept of uncertainty coming in different grades or gradations. They fall back on Shackle’s own words … – Uncertainty is the opposite of certainty. … There is nothing in between certainty and uncertainty.”

    Brady’s criticism here is problematic. To begin with, multiple Post Keynesians have accepted a view of different gradations of uncertainty depending on the economic importance and other factors, acting as if Post-Keynesians follow a view of complete radical uncertainty completely ignores what a great deal of Post-Keynesians truly believe about the market process, such as Jespersen (2009). Our degrees of belief on certain decisions, or degrees of uncertainty, vary on multiple variables. Some economic decisions are much more certain than other economic decisions, the economic decision to purchase a good, say bread, today, is much more certain than the economic decision to utilize the internet for commerce and greater ease, which was radically disequilibrating on the economic system and fundamentally was a case study of radical uncertainty in action. Creating such a complex system and then using it to radically change the entire economic system to a level that was completely unforeseeable by the first of these inventors is clearly a case study of radical uncertainty. 

    Contrasting this behavior with that of the choice to purchase bread or purchase a new capital good is certainly much less uncertain, but the reason why economists such as Paul Davidson tend to employ such an analysis as the core is due to the pathbreaking nature of these decisions, they fundamentally alter the course of all sectors and radically disequilibrate and overthrow the previous equilibrium order. These decisions are incredibly complex and have massive influences on economic life. To ignore such is to completely ignore the importance of this crucial decision-making and ignore what makes the economy truly function. Ontological uncertainty’s effect on the economic environment is to turn every decision subject to uncertainty, and especially in investing, subject to radical swings due to the dependency on millions and if not billions of contingent human actors shaping the future. The Post-Keynesian radical subjectivist focus on this conception is not the reason why they err, it’s the reason why Post-Keynesians are generally much better in their analysis of economic conditions! Degrees of uncertainty, however, do not change the final analysis of radical uncertainty in the economy and consequently financial market failure and the private sector failing to provide for less than full employment. When considering that such large, economy-shaking decisions strongly affect the entire market process and subjective expectations of each individual, the economy is fundamentally radically uncertain. A choice to buy a capital good or bread does not have economy-wide impacts, however, the creation of something revolutionary is and is then consequently subject to radical uncertainty which affects all economic participants in some form, this makes the entire economy then subject to radical uncertainty. The fact that the economy has some gradation of uncertainty doesn’t change this analysis of irrational investment and radical uncertainty about the future and consequently swings in investment behavior, it merely exists to show us that a choice to produce or buy bread is less uncertain than innovation or long term capital projects. 

    Brady’s final criticism that I will go into here is that Keynes did not solely view the economy in matters of complete incalculable uncertainty. This claim, while true, isn’t something that should serve to invalidate Post-Keynesian analysis, because as Keynes himself claimed, these interval estimates are fundamentally imprecise and do not serve as completely reliable measures in a world of Ontological uncertainty. It is simply a way to mathematically express Keynes’ decision-making theory that could also be described as something subject to non-mathematical probability measures due to the sheer amount of individuals and subjective valuations and expectations at work, these interval estimates can only function as somewhat correct, never accurate enough about the future to do empirical work from. Brady’s arguments against the Post-Keynesians, that they are not the true successors of Keynes due to the differences in probability are not fully true, however, I do accept that Keynes did have an objectivist slant. Shackle’s and Davidson’ theory of the future and uncertainty, however, remains fundamentally correct to me due to the insistence on the incalculable, transmutable future, stemming from long-run capital decisions and radical innovation which cannot be ever calculated through probability in a world of non-ergodicity, the data necessary to do so is fundamentally imprecise as Keynes himself admitted. 

    

    To claim then, that market participants then are able to find objective probability distributions in an ergodic fashion and bring the economy towards full employment from intervals makes little sense, when Brady himself accepted that this theory of radical uncertainty is clearly applicable to multiple phenomena in a market economy and consequently a theory which underpins how the market grows and adapts throughout historical time, and how the market economy fails. Brady’s criticism falls on all ends when considering that his analysis’ change nothing for the Post-Keynesian view of the economy and criticism number two is something most Post-Keynesians accept, they're barely anything substantial as an argument against Post-Keynesianism. Keynes had an objectivist leaning that the "Bastard" Keynesians espouse, Post-Keynesians espouse his subjectivist leanings. The minor differences between Keynes and the Post-Keynesians are not something that destroys the Post-Keynesian analysis, it's simply something to note.