Paul Davidson's Uncertainty, International Money, Employment and Theory Review

Review of Paul Davidson's Uncertainty, International Money, Employment, and Theory

Brief review of Davidson's collected essays from a Post-Austrian perspective on Uncertainty.  

    Before I proceed I'll talk a bit about the actual structure of the book itself rather than the content inside of it. Paul Davidson's collected essays are of course, collected essays, which leads to an odd format on certain topics which seem repetitive to the observe who is quite used to seeing books written in a format of entirety rather than simply collected essays considering the often used words and phrases along with tables which brings an odd feeling of repetitiveness to the reader as Paul Davidson himself points out at the start of the book, however this slight drawback does not negate the book itself considering despite the repetitive nature of the book each essay adds something interesting and new to the reader and build to a final point which leaves the reader with more knowledge, despite the shared topics and shared tables and phrases. There was certainly a great deal of precision involved by the editor to prevent such an occurrence to which I believe is under-acknowledged with most books in this specific format, which is why I felt it necessary to point out this structural outline before the book itself.

    What we see throughout the first section of the book should be of immense interest to all heterodox economists, despite the occasional mischaracterizations of certain figures, remains to be a seminal part of the book which talks about incalculable uncertainty in a manner which is both concise and easily comprehensible, even for those individuals who lack a background in mainstream Bayesian subjective probability functions and or rational expectations, which is quite great considering a multitude of Austrians in particular unfortunately forget about these aspects of mainstream thinking when learning about economics, which is not too bad considering a majority of mainstream economics are specifically tailored to a final result of pleasing political rhetoricians without any real world considerations of demand, basic price theory, etc.. To begin with is it worth understanding that the book is Post-Keynesian, which means the section on uncertainty will necessarily not result in Austrian conclusions which may turn away readers, however I would recommend against this, lest individuals overlook the gold-mine that is Davidson's section on uncertainty and risk. Davidson distinguishes between three different conceptions of the market process and probability function's roles in uncertainty:

    Group 1: The classical economists such as Ricardo who completely neglect all mention of uncertainty in economics and believe all economic actors to have equal knowledge and will not be subject to the problems of entrepreneurship in a fundamentally kaleidic environment, which Davidson classifies as Newtonian in a way, operating by certain mechanic principles with no conception of creativity or the human aspects of economics, what distinguishes it from what he on repeat deems "hard sciences"; a separation which isn't always viewed as a sound idea by multiple Austrians who are focused primarily on methodology. 

    Group 2: Group two is primarily inhabited by the New Classicals, Neoclassicals, Old Keynesians (neoclassical synthesis) and New Keynesians, i.e., a majority of what the mainstream of economics is today, along with his including of certain school such as the Austrians, which I view as an unsound idea considering the diversity between thought (which he goes on about in his third essay in this section) on Austrians, the ones that would accept this mechanicalistic, in his terms, Newtonian conception of the market process with no human aspects and bases solely on a sort of "Darwinism" of subjective v. objective probability functions. Group 2 focuses on, primarily, a tendency towards a long run equilibrium and if exogenous shocks were to cease to happen, which would be achieved, which Davidson deems to be the "immutable" school of the market process, contrasted to Keynes and Post Keynesians on a conception of incalculable uncertainty, which brings us to the final group:

    Group 3: Group three are primarily the Post-Keynesians, who, rather than viewing the economy as immutable and Newtonian, view it as an open ended process of ontological uncertainty that is transmutable rather than immutable of Group 1 and 2. The Post-Keynesians, who Davidson admits to be a very diverse group, draw this conception of transmutability to a conclusion that the State has the ability to manipulate the future and effective demand in order to achieve full employment, which the laissez faire market economy seems to have no tendency towards for reasons that will be outlined in later reviews. Davidson utilizes this conception of transmutability to a conclusion that "Reagan-esque" conceptions of "What does a congressman in Washington know about you" are false when considering the future is always subject to malleability upon the part of entrepreneurs but also the state, via uncertainty mitigation.

Davidson then goes on, throughout the section, to critique types 1 and 2 on the immutability of the market process and close ended-ness, which he deems to be false and having a process that is a form of probabalistic "Darwinism", in his words. A major conception attacked by Davidson ferociously throughout his essays is the EUT (Effective utility theorem) which underpins New Classicalism and Keynesianism that views the market process as a "Look before you leap" situation rather than a uncertain situation of "We'll get there when we get there" or "Left for later". 

    Noting that Savage himself accepts that the EUT is not a full theory of the market process, i.e., it misses out on uncertainty and other processes in the market with the "Look before you leap" conception, proceeds to tear the "ordering axiom" apart, which he demonstrates to be false in the short and the long run. The problem with Savage's theory, to Davidson, is that the entrepreneur is completely left without uncertainty, i.e., he doesn't know all of the options given to him, he is, in Savage's words in the excerpt, ignorant and is left with open options that are uncertain and not "looked at before leaping", following the metaphor given by Savage. It is utterly ridiculous, to Davidson and partially even Savage to even believe such is a possibility without complete omniscience in the market by the entrepreneur, which is impossible due to ever shifting expectations that are subjective and the impossibility of knowing whether or not present data is relevant for the future due to subjective expectations. This ordering axiom is violated always when the entrepreneurs are unable to look before they leap, unable to figure out every single possible "option" before undergoing one, it simply isn't possible which even Savage accepts, yet this notion still underpins contemporary NC and NK work which gives rise to "rational" decisions! A further concept Davidson considers is epistemological uncertainty versus ontological uncertainty, not quite related to the divine argument but something that shell be left for another time. 

    Epistemological uncertainty, starting with Keynes, is uncertainty about the future which is something observable in certain actions in the real world, e.g., a game of roulette. Granted that you've increased your total information to a point where you're practically God (Already an unrealistic assumption) and have all of the relevant information on everything necessary for a game of roulette which determines the outcome of a certain action, we can calculate objective numeric probabilities for winning at each bet, this is a case of epistemic uncertainty. What ontological uncertainty is, on the other hand, is incalculable as Mises and Keynes both point out, due to the fact the future is open-ended, no amount of computing power could ever predict future events subject to ontological uncertainty due to human actions, unknowability about the future, and subjective expectations. From here Davidson goes on about Knight, primarily on the differentiation between risk and uncertainty. To Knight, risk is something calculable and consequently insurable against, which entrepreneurs in a modern market economy do a multitude of times, however, uncertainty is something incalculable by entrepreneurs in the economy, due to the open endedness of the economy, i.e., the future is not pre-determined, and herein lies the flaws with the "subjectivist" Bayesian analysis that supposedly incorporates subjective expectations but truly does not, it only has finite outcomes which inherently makes it another immutable theory which is not true for the market economy which is transmutable. With the Post-Keynesian non-ergodic transmutable world of innovation and entrepreneurship/market destinations, from which he lays a critique of rational expectations from a Post-Keynesian non-ergodic perspective:

"As a matter of logic, rational expectations are not irrational in an ergodic world. Rational expectations are irrational only when agents 'know' that the system is not ergodic. Under non-ergodic economic conditions, therefore, it is sensible for decision-makers to make choices that would be seen as 'irrational' in an immutable system. For example, to orthodox theorists, the fact that income recipients may decide never - not even in the long run - to spend some savings from income on any current products of industry may seem 'irrational', in that this behaviour conflicts with the orthodox life-cycle hypothesis.

Empirical evidence shows, however, that 'irrational' income-recipients often purchase non-reproducible liquid assets (including money) as a pennanent hedge against a pennanently uncertain future. 17 Analysing a sample of over 9000 households, investigators from the Poverty Institute at the University of Wisconsin found that 'the elderly spend less than the nonelderly at the same level of income and the very oldest of the elderly have the lowest average propensity to consume' (Danziger et al., 1982-3, p. 224). Instead of spending as rational utility maximizers would in an immutable reality world, these investigators found that the elderly who 'face a complex problem of uncertainty about their health, life expectancy, and ability to maintain independent households . . . respond by reducing their consumption' (Danziger et al., 1982-3, p. 226). In so doing, these 'irrational' households are attempting to permanently increase their liquidity."1

    When considering that macroeconomic events are non-stationary, this essentially dispels the restrictive ergodic notion by NC and NKs that the future is predetermined by a certain objective probability functions and erroneous subjective expectations that fail to be inline with this are weeded out through a "Darwinian" process, in Davidson's words, i.e., due to many macroeconomic relationships being demonstrated to be non-stationary, we do not live in a ergodic world. From here, considering the non-ergodic world that we live in, he critiques the notion of "neutrality of money" in the long and short run. By incorporating Shackleian "crucial decisions" (which are essentially decisions that will forever alter the future of the market economy or "direction"; such as the creation of the internet), individuals in an economy effectively create the future, contrasted to the ergodic mainstream economists. Herein we see some interesting concepts related to infinite every changing equilibria that even some Kirznerians accept, but I won't go into great detail about this. Davidson, effectively, tears down every mainstream conception of an economy constantly moving to only one general equilibrium and ergodic economics, and lays the foundation for Post-Keynesian economics with transmutable reality subject to incalculable uncertainty and wild swings in investment behavior with an entrepreneur that isn't a robotic decision maker of Lucas and Sargent, and long run expectations, finding a theory true theory of the market process and the role of the State in the midst of it all.

Citations: 

Davidson, P. (2014). Uncertainty, International Money, Employment and Theory: the Collected Writings of Paul Davidson, Palgrave Macmillan. Page 14.