EXPECTATIONS AND THE MEANING OF INSTITUTIONS FOUNDATIONS OF THE MARKET ECONOMY SERIES Edited by Mario J.Rizzo, New York University and Lawrence H.White, University of Georgia A central theme of this series is the importance of understanding and assessing the market economy from a perspective broader than the static economics of perfect competition and Pareto optimality. Such a perspective sees markets as causal processes generated by the preferences, expectations and beliefs of economic agents. The creative acts of entrepreneurship that uncover new information about preferences, prices and technology are central to these processes with respect to their ability to promote the discovery and use of knowledge in society. The market economy consists of a set of institutions that facilitate voluntary cooperation and exchange among individuals. These institutions include the legal and ethical framework as well as more narrowly ‘economic’ patterns of social interaction. Thus the law, legal institutions and cultural or ethical norms, as well as ordinary business practices and monetary phenomena, fall within the analytical domain of the economist. Other titles in the series THE MEANING OF MARKET PROCESS Essays in the development of modern Austrian economics Israel M.Kirzner PRICES AND KNOWLEDGE A market-process perspective Esteban F.Thomsen KEYNES’ GENERAL THEORY OF INTEREST A reconsideration Fiona C.Maclachlan LAISSEZ-FAIRE BANKING Kevin Dowd EXPECTATIONS AND THE MEANING OF INSTITUTIONS Essays in economics by Ludwig Lachmann Edited by Don Lavoie London and New York First published 1994 by Routledge 11 New Fetter Lane London EC4P 4EE This edition published in the Taylor & Francis e-Library, 2005. “To purchase your own copy of this or any of Taylor & Francis or Routledge’s collection of thousands of eBooks please go to www.eBookstore.tandf.co.uk.” Simultaneously published in the USA and Canada by Routledge 29 West 35th Street, New York NY 10001 © 1994 Don Lavoie All rights reserved. No part of this book may be reprinted or reproduced or utilized in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library. Library of Congress Cataloging in Publication Data Expectations and the meaning of institutions : essays in economics by Ludwig Lachmann / edited by Don Lavoie. p. cm. Includes bibliographical references and index. 1. Economics 2. Rational expectations (Economic theory) 3. Financial institutions. I. Lachmann, Ludwig M. II. Lavoie, Don, 1951 HB34.E84 1994 93–29051 CIP ISBN 0-203-97655-X Master e-book ISBN ISBN 0-415-10712-1 (hbk) This book has been sponsored in part by the Austrian Economics Program at New York University. CONTENTS Editor’s note vii Acknowledgements viii INTRODUCTION: EXPECTATIONS AND THE 1 MEANING OF INSTITUTIONS Don Lavoie Part I Uncertainty, investment and economic crises 1 COMMODITY STOCKS AND EQUILIBRIUM 23 [1936] 2 UNCERTAINTY AND LIQUIDITY- 29 PREFERENCE [1937] 3 INVESTMENT AND COSTS OF PRODUCTION 41 [1938] 4 COMMODITY STOCKS IN THE TRADE 55 CYCLE [1938] (with F.Snapper) 5 ON CRISIS AND ADJUSTMENT [1939] 73 Part II Capital and investment repercussions 6 ON THE MEASUREMENT OF CAPITAL [1941] 87 7 FINANCE CAPITALISM? [1944] 103 8 A NOTE ON THE ELASTICITY OF 119 EXPECTATIONS [1945] 9 INVESTMENT REPERCUSSIONS [1948] 125 Part III Diagnosing the Austrian School’s ‘great depression’ 10 AUSTRIAN ECONOMICS UNDER FIRE: THE 141 HAYEK-SRAFFA DUEL IN RETROSPECT [1986] vi 11 THE SALVAGE OF IDEAS: PROBLEMS OF 159 THE REVIVAL OF AUSTRIAN ECONOMIC THOUGHT [1982] 12 JOHN MAYNARD KEYNES: A VIEW FROM 179 AN AUSTRIAN WINDOW [1983] 13 REFLECTIONS ON HAYEKIAN CAPITAL 193 THEORY [1975] Part IV Subjectivism and the interpretation of institutions 14 CARL MENGER AND THE INCOMPLETE 207 REVOLUTION OF SUBJECTIVISM [1978] 15 VICISSITUDES OF SUBJECTIVISM AND THE 213 DILEMMA OF THE THEORY OF CHOICE [1978] 16 FROM MISES TO SHACKLE: AN ESSAY ON 223 AUSTRIAN ECONOMICS AND THE KALEIDIC SOCIETY [1976] 17 G.L.S.SHACKLE’S PLACE IN THE HISTORY 235 OF SUBJECTIVIST THOUGHT [1990] 18 THE FLOW OF LEGISLATION AND THE 243 PERMANENCE OF THE LEGAL ORDER [1979] 19 THE MONETARY SYSTEM OF A MARKET 255 ECONOMY [1986] 20 SPECULATIVE MARKETS AND ECONOMIC 263 COMPLEXITY [1988] 21 AUSTRIAN ECONOMICS: A HERMENEUTIC 269 APPROACH [1991] APPENDIX: BIBLIOGRAPHY OF WORKS BY 285 LUDWIG M.LACHMANN Notes 291 References 313 Index 321 EDITOR’S NOTE This selection of essays by Ludwig Lachmann (1906–90) includes the most important of his works in English which were previously published only in scattered places, and not included in his own books. An excellent collection of many of his essays was put together by Walter Grinder in 1977, but there are many significant works that did not fit in that collection, and several others which have only appeared since 1977. In particular, the collection featured heavily what could be called Lachmann’s middle period, that is the 1950s and 1960s, but included no essays from the 1930s and only three from the 1940s. This collection then fills in the gaps, including nine essay from the early period, spanning from 1936 to 1948, and twelve from the later period, from 1975 to 1991. Two of the essays, ‘Reflections on Austrian capital theory’ and ‘Vicissitudes of subjectivism and the dilemma of theory of choice’, have not been previously published. The essays have been reproduced with no editorial alterations to the content, except for the insertion of some section headings to improve consistency. ACKNOWLEDGEMENTS I would like to thank Bill Tulloh, whose work in gathering together the bibliography, and talking with me at length about the meaning of Lachmann’s work, was instrumental in moving this project forward. It was gratifying to see most of our entries verified in the bibliography that was separately collected by C.S.W.Torr, S.Böhm, and K.H.M.Mittermaier for the South African Journal of Economics, but there were a few items they found that we had missed, and we thank them for this help. Robert Baldini helped with the proofreading. Alan Jarvis of Routledge encouraged me in the idea of this book from the beginning, and never lost patience with my plodding efforts. INTRODUCTION Expectations and the meaning of institutions Don Lavoie The main social function of the economist is to provide the historian and the student of contemporary events with an arsenal of schemes of interpretation. Ludwig M.Lachmann1 Professor Lachmann’s contributions to economics, spanning six decades, and addressing issues in microeconomics, macroeconomics, methodology and the history of thought, are a treasure chest. His essays are consistently well written and extraordinarily insightful, yet his message has not yet been adequately appreciated, even by those who know some of his major works. As a dissident member of a dissident school of thought, the Austrian school, his work is not well known in the economics profession at large. Yet as these essays show, Lachmann’s challenges to mainstream economics in general, and to mainstream Austrian economics, even those he penned a half century ago, strike at the very heart of what has gone wrong with ‘the dismal science’. Lachmann lived through dramatic changes in the status of the Austrian school during his long career. He began his academic life when the school was at its peak, witnessed its rapid decline throughout the 1930s, survived its dark ages during the next three decades, and then contributed to its resurgence during the 1970s and 1980s.2 His work is now the inspiration of a growing group of Austrian-oriented critics of mainstream economics who are trying to recover what might be called its interpretive dimension.3 Among Austrian economists he is best known as the leading representative of the ‘radical subjectivist’ wing of the school. His allies understand this to be an honourable position and his critics understand it to be a serious danger: too much subjectivism, say the critics, 2 INTRODUCTION undermines the ability of economics to describe market processes as systematic in any sense. The critics’ concerns that Lachmann’s work leads to nihilism have, I think, been misplaced. They have distorted the main thrust of Lachmann’s work, by making it seem as though the issue his work is raising is some kind of metaphysical doubt about whether economic reality might be beyond any systematic understanding because it is completely chaotic, or even whether the real world exists at all. This is especially unjust in that Lachmann was in fact far more oriented to the real world of the economy than the vast majority of his professional colleagues. To treat this economist—who was as much at home discussing the latest news from the financial press or the intricate details of stock market options as he was discussing economic theory— as if he entertained doubts about whether there is a real world out there, is utterly absurd. The essays collected in this book make clear that on the contrary Lachmann’s contributions are precisely aimed at helping us to understand the systematic order and empirical complexity of real world market processes. Lachmann’s message does, to be sure, identify a conflict between neoclassical economics and the real world, but it is not the real world that he is saying needs to go. His work is as uncompromising a challenge to mainstream economics as can be found anywhere. It resembles in this respect, the work of his good friend George Shackle. But in one important respect he differs from Shackle. Lachmann saw his work not only as a criticism of mainstream economics, but as a constructive effort in building an alternative sort of economics, an alternative he thought could be put together primarily from the resources of the Austrian school, although freely borrowing from other sources.