Austrian Tendencies Towards Equilibrium 

"What does not yet exist cannot now be known. The future is imagined by each man for himself and this process of the imagination is a vital part of the process of decision."~G.L.S Shackle

    

    Commonplace in most of Austrian Economics is the presupposition of the market tendency towards equilibrium, either full employment equilibrium or Hayekian plan coordination. This is the hallmark of the neoclassical influence on Austrian Economics, the textbook definition of an isolationist heterodox school of economics, an attitude prevalent throughout the Mises Institute and its online fanboys. Unfortunately, this neoclassical influence that pervades most of contemporary Austrian Economics is completely false in describing the modern market economy, whether it be through a tendency towards Hayekian plan coordination or a tendency towards full employment equilibrium. This gross error also underpins their policy proposals based on spontaneous order and their ignorance of the role of expectations as the causal factor of the business cycle, with or without credit expansion. 

    To those who follow the Neoclassical school in Austrian Economics, primarily the Kirznerians, the market is constantly tending towards an equilibrium-like state that’s defined as Hayekian plan coordination, i.e., perfect intertemporal coordination of economic production plans realized and unrealized. The market, however, never reaches this intertemporal equilibrium of perfect plan coordination, it is constantly pushed aside due to the nature of the market and exogenous “shocks”; forcing the market away from this pre-programmed equilibrium. This tendency, similar to the New-Classicals, arises from the Darwinist process of the market economy in which those with the wrong subjective probability functions are punished with losses and those with the “more-correct” subjective probability functions are rewarded with profits by the nature of the profit and loss system. The profit and loss system is seemingly the equilibrator in almost all theories of pre-programmed equilibrium in nature, tending towards a singular point due to the profit and loss system in which consumers reveal their subjective preferences and then consume based on it, the more “correct” entrepreneurs are given a reward of profits and the mistaken “incorrect” entrepreneurs are given a punishment of losses, enough losses resulting in the complete eradication of this specific individual entrepreneur in a Darwinist process of the market. The faults with this view are already apparent, primarily with the ignorance of the way the market functions on the production side, that the forces they view of equilibrating are disequilibrating on the production side, but they are also disequilibrating on the consumption side of individual consumers in the market. Some Kirznerians also adopt a conception of infinite equilibria, a slow ever-lasting march towards an ever-shifting equilibria that changes based on exogenous shocks in the economy, and is formed based on the will of the consumers, as the consumers are King and control the production process as a King would command his subjects. Finally, a theory of the market process primarily espoused by the “Misesians” and “Rothbardians” of the Austrian School of Economics is a tendency towards the ERE, an evenly rotating economy. Mises defined the ERE as:

“This hypothetical future state of equilibrium will appear when all methods of production have been adjusted to the valuations of the actors and to the state of technological knowledge. Then one will work in the most appropriate locations with the most adequate technological methods. [But, of course,] Today's economy is different."  

This state of equilibrium used by Mises for theorizing on capital and interest but also used to claim that the market economy is constantly tending towards a state of equilibrium. This state of equilibrium exists in which all productive resources, labor, and capital, are being maximized and used in a maximally useful way, a state of almost full employment of labor and capital resources. The ERE happens to be quite similar to Neoclassical constructions of General Equilibrium models, which is another data point to suggest the not-so-large chasm between the Neoclassicals and the Austrians on economic theorizing is barely as large as those at the Mises Institute or other Rothbardian institutions lead us to believe. 

    Now that it’s been discussed on the states of equilibrium in Austrian Economics, it is time to see the flaws in believing a market tendency towards these states, both Hayekian plan coordination and the ERE. The tendency towards Hayekian plan coordination presupposes that due to some notion of “spontaneous order” and the profit-loss system the market is constantly tending towards a state in which all plans are coordinated intertemporally, production and consumption. To make matters even more complex this state does also shift according to certain Kirznerians, leading to a conception that is incredibly difficult to both deal with and theorize on, to make a claim of a constantly shifting equilibrium leaves us with no reason to believe this tendency even exists. This tendency towards Hayekian plan coordination, in the real world, does not exist, and cannot exist in an economy with detailed multi-layer plans and subjective expectations. When new information enters the economy, what we necessarily end up seeing is that expectations of subjective production plans are forced to change to accommodate a new inflow of information, lest they are outcompeted for this reason, a lack of information about the state of the economy on the production and consumption side. To illustrate, in an economy such as one that is common in most occidental countries, the economy is constantly subject to massive inflows of information due to the interconnectedness of the international market and the sheer size of domestic markets, and the amount of capital being moved around in both. Let us say that a Bio-Robotics firm in Canada decides to undergo a production process in which the goal is to efficiently produce, i.e., produce something in a cost-minimizing manner with maximum quality, a new prosthetic for amputees.

    This production process takes time due to the sheer amount of resources necessary for such a project, in the sequestered stages of R&D and the actual production stages, which means that this project happens to also be risky considering the temporal horizon the amount of capital necessary to design, produce, and distribute this robotic prosthetic. Now suppose that a firm in Chicago has decided to undergo a similar production process with the sole goal of competing and gaining a larger profit and this prosthetic is already out in the market, and that Canada and the US happen to be interconnected enough for the information to reach in sufficient time for theorizing about these firms. What would end up happening is that this information would eventually reach the firm in Canada that is developing something similar, it would affect the subjective expectations of the management and the entrepreneur who started this venture. The entrepreneur who started this Canadian Bio-Robotics firm is now faced with a choice, to end the venture or continue and alter the production mechanism of the robotic prosthetic to gain both productive efficiency and increased durability. This change in subjective expectations has directly lead to a change in the production process in our two firm model. Now, consider this exact same model on a global and larger scale. This Bio-Robotics company isn’t the only developer of this concept, it has future agreements with certain hospitals and other firms when the model is finished and up for distribution, and that consumers are forced to bear with a change in the economy and consequently a change in their consumption plans. What happens now on a larger scale? What happens is these disequilibrating phenomena that have been shown above replicate themselves economy-wide, it affects the production processes of the dependents on the Canadian firms, and the firms that depend on those firms, and it continues as a change. This phenomenon is fundamentally disequilibrating, it has pushed the economy off balance and away from this equilibrium of plan coordination. Some may state that after this the market will regain its balance and continue its traverse towards an equilibrium, but this is not true either. The profit and loss system only acts as initially equilibrating, but when considering subjective expectations on profit and loss signals we must understand that different results can arise from the same data based on different people and subjective expectations.

    To illustrate yet again, let us suppose that this Canadian firm is punished, initially, with loss due to the already established Chicago player. This signals one thing for certain for efficient entrepreneurs, that the market does not like the product in its current state and therefore necessarily needs some tweaking to subjectively satisfy consumers more, on a relative scale. The only problem with the Kirznerian story from here is that due to the regrouping of resources the market then continues on its traverse towards equilibrium, however, this presupposes that the market primarily regroups resources to a state in which none of the plans and subjective expectations are ever conflicting, they regroup capital in such a precise way in which the entire economy does not end up with conflicting production processes. This, in a way, both implicitly suggests an Ordering Axiom but also that all of these entrepreneurs make rational expectations of the future to not further conflict with the other entrepreneurs. The Ordering Axiom is a theory of the New Classical economists which presupposes that all market participants “look before they leap”, i.e., consider all possible routes and then proceed on the utility-maximizing route, one which is necessarily with less conflict, which is coordination with other enterprises. Since entrepreneurs in this hypothetical world of Kirzner follow this Ordering Axiom, they can make rational expectations about the future due to the already shown utility-maximizing routes and know all of the outcomes to make these expectations which do not conflict with one another and derive a basis for “discovery” which acts as an equilibration mechanism in the market. This discovery process is somehow “equilibrating” in the real world when it truly is only equilibrating if: 

A.) The market has a finite set of outcomes. 

B.) The Ordering Axiom applies and individuals can “Look before they leap” and find utility-maximizing routes which are necessarily the least conflicting, i.e., economically coordinated.

C.) And due to the conditions of A and B, market participants can form rational expectations about the future due to the ability to determine the finite utility-maximizing processes, and consequently what the future will be.

In this manner Kirznerians are the same as New-Classicals and the Rational Expectation Theorists, their theories can only apply in a world of ergodicity and a world in which the future is set and the past perfectly determines the future, i.e., objective probability distributions of outcomes, the entrepreneur has become God! The only possible way for this process of discovery to be equilibrating is if everyone in the market knew the exact objective probability distributions of outcomes, which isn’t even Ontological Uncertainty, it is Epistemic Uncertainty, which is essentially just complexity. Furthermore, outside of complex chain reactions of expectations and production processes, the notion of compatible plans is vague considering the nature of plans in a capitalist economy. They are multileveled and operate with immense amounts of capital, meaning that isolating production processes to call them compatible is an effort that makes no sense. How do we determine what a plan is? How do we determine to what extent this plan functions? How do we determine how plan compatibility would function if we don’t know what encompasses plans?

     The question of plan compatibility is a vague notion that can only function if the world was ergodic and filled with epistemic (Epistemic uncertainty is not even uncertainty fully, rather, it’s complexity) rather than Ontological uncertainty as if the economy is predetermined and objective probability distributions can be calculated by entrepreneurs to engage in utility-maximizing behavior without conflict or “disequilibration.” The notion of Hayekian plan coordination is nonsensical, whether or not we consider it as ever-shifting or simply stationary the possibility of perfect plan coordination and equilibration through discovery is one that cannot function in a world such as ours. When we consider notions of ever-changing equilibria, infinite equilibria, the notion still does not make sense. It’s an exercise in futility to attempt to hold onto Kirzner’s belief of an equilibrating entrepreneur when we consider that ever-shifting equilibria don’t shift by the year, they shift by the day, millions of times. Whenever expectations change we see production processes consequently change too, meaning that this plan coordination state needs to then be changed. Considering the sheer amount of inflowing information in the economy and the nature of expectations in an economy of Ontological Uncertainty, this equilibria needs to constantly be switching, millions of times per day and trillions of times per year. It’s a notion that tries its best to pretend that the market process is equilibrating, but rather proves the opposite when considering the number of times it’s forced to switch, it’s an inane statement to use this as an example of an equilibrating market process. 

The other “Misesian” notion of equilibrium is the Evenly Rotating Economy (ERE) in which all resources, labor, and capital resources, are being utilized to their fullest extent. From here we can logically claim that this is a tendency towards full employment of capital and labor, a very Neoclassical notion of the market process. The problem with the hypothetical tendency towards a fixed point of full employment equilibrium is that it presupposes that the market process is stable enough to reach this point, which it is not, wages and price systems in market economies are highly inflexible, which is what the Austrian and Neoclassical theory of a tendency towards full employment equilibrium depends on, it cannot function with a rigid price and wage system. Furthermore, when the economy is subject to radical uncertainty as most modern market economies are, capitalists generally tend to invest in liquid assets and save rather than investing this money directly into their business due to uncertainty about the future. Due to this, the firms cannot continually expand to a level of full employment of labor and capital resources unless they are induced to give up liquidity for an amount of time or via demand management.

    If firms in an economy are not moving towards a full-employment equilibrium due to uncertainty about the future and the necessity to save in the light of uncertainty, rather than investing in the firm and growing the business, what is necessary is demand management by the government. When the government is given the ability to stimulate aggregate demand to manipulate the transmutable future towards a direction of full employment of capital and resources, the economy can grow. Governments spending and running deficits are equal to increased private savings and consequently the ability to grow firms and employ more capital and labor. The untamed laissez-faire economy, while efficient (Aside from the business cycle), cannot provide us full employment as demand management by the government can. This tendency towards an ERE then, cannot exist unless the economy is stimulated through government spending, the untamed laissez-faire economy has no such tendency on its own. 

The real economy, unlike what the Austrians seem to believe about the economy, has no such tendency towards equilibrium or equilibria, and the entrepreneur is fundamentally disequilibrating due to the nature of competition in an economy. The only possible way for an equilibrating entrepreneur and consequently a fully equilibrating economy is an economy that is ergodic in which entrepreneurs can calculate objective probability distributions about the future and their present decisions to form these rational, God-Like, expectations which can behave as an equilibrating force. In a world of transmutability, non-ergodicity, and open-ended market processes however, these conditions for equilibration do not exist and consequently, the Kirznerian/Misesian theory of the market process does not function adequately.