Progressive Taxation for a Just Redistribution of Incomes Is the Chief Source of Irresponsibility of Democratic Action

By the tenets of post-Keynesian economics — with its ‘emancipatory’ objectives of social justice — the spontaneous order of a competitive market economy must be tempered (at least) by state coercion of the right kind. Although Austrians accept that some degree of state coercion is unavoidable, they insist that it should be ‘reduced to a minimum and made as innocuous as possible . . . [b]eing made impersonal and dependent upon general, abstract rules’ (Hayek 1960). Yet, state coercion is insidious; and so there must be safeguards and vigilance. Hayek cites the illustration provided by progressive taxation. Once the principle of progressive taxation was conceded, there were no guidelines

by which such progression can be made to correspond to a rule which may be said to be the same for all, or which would limit the degree of extra burden on the more wealthy, . . . a generally progressive taxation is in conflict with the principle of equality before the law and it was in general so regarded by liberals in the nineteenth century. (Hayek 1978)

The view that a just redistribution of incomes can be achieved through progressive taxation is condemned as ‘the chief source of irresponsibility of democratic action’ and ‘the crucial issue on which the whole character of future society will depend’ (Hayek 1960). The drive for social justice is both flawed (because it has no definitive meaning) and dangerous to the ideal of individual freedom. That drive is simply incompatible with the notion of general impartial rules — blind justice — that are integrated within the structure of a liberal market economy.

—G.R. Steele, Keynes and Hayek: The Money Economy, Foundations of the Market Economy (London: Routledge Taylor and Francis e-Library, 2002), 177.

To Mises, Mitchell's Emphasis on the “Purely Empirical” Examination of Business Cycles Smacked of Historicism

As Mitchell points out, the main purpose of Persons’ three-curve charts was to improve forecasting and aid the social control of the economy (Figure 6.1). Even if the materials were thin and somewhat arbitrarily chosen, it remained a fact that, for the 1903–1914 period, the cyclical fluctuations of business (curve B) followed those of speculation (curve A), with an average lag of eight months. Money rates (curve C) followed both business, with an average lag of four months, and speculation, with a delay of one year.

Vienna’s Mises was critical of all such work. To him, Mitchell’s emphasis on the “purely empirical” examination of business cycles, unhindered by theoretical preconceptions, smacked of historicism. Mises argued that even if no satisfactory theory of the business cycle yet existed, it was not going to emerge inductively from the consideration of masses of statistical data. He saw Mitchell’s form of Institutionalism as an American reincarnation of the German historical method, and both as species of statist apologetics.

Then there was the aim of the Harvard group to improve the predictive capacities of statistical observation: the examination of trends in certain barometers was to help predict their future path, and Bullock’s group was already selling its services to private companies. To Mises, the idea that the future path of the economy could somehow be known, and approximated through statistical measurement, was anathema. What statistics could say about the economic order was very limited indeed, and was purely historical in that it referred to the past. The conceptual order of the economy could be grasped or understood when one reflected on the motivations governing individual economic action. This, in turn, involved the formation of beliefs and expectations, which were in perpetual flux. The economy, although it could be “understood”, could be only inadequately represented by statistics and could never be predicted. More dangerous, in Mises’ view, was the short step that lay between believing that one could capture the economy through statistical representation and advocating state intervention to correct anticipated downturns. He felt institutionalist modesty concerning the possibilities of theory had given way to illusions concerning the capacities of empiricism. All of this found an echo in the young Morgenstern’s response to the business cycle literature.

—Robert Leonard, Von Neumann, Morgenstern, and the Creation of Game Theory: From Chess to Social Science, 1900-1960, Historical Perspectives on Modern Economics (New York: Cambridge University Press, 2010), 99-100.

Morgenstern Dismissed Harvard's ABC Curves Saying Economic Forecasting Is Inherently Impossible

Morgenstern used his time at Harvard to write a book-length appraisal of economic forecasting that he published in Austria in 1928 as Wirtschaftsprognose: Eine Untersuchung ihrer Voraussetzungen und Möglichkeiten (Economic Forecasting: An Investigation of Their Prerequisites and Possibilities). In it, he dismissed the Harvard Economic Service’s ABC curves on the grounds that an economy was too complex for regular patterns to be discerned, as forecasters were attempting to do. But he also offered what he later called an “epistemological” critique, writing that he found the entire enterprise of business forecasting, as currently practiced, inherently impossible. “[A]ny widely accepted forecast,” Morgenstern contended, “itself sets up reactions which doom it to failure.” To illustrate his point, Morgenstern made an analogy to the pursuit by Sherlock Holmes of the criminal mastermind Professor Moriarty in the popular series of detective novels by Arthur Conan Doyle. The narrative premise of the struggle is that both men, intellectually closely matched, attempt to guess what their rival was likely to do. “One may be easily convinced,” Morgenstern wrote, “that here lies an insoluble paradox.” The analogy, he suggested, was direct: economic forecasting was in essence little more than a futile effort on the part of one party to out-think another. “And the situation is not improved,” he continued, “but, rather, greatly aggravated if we assume [the presence of] more than two individuals,” as there necessarily would be in a real-world example. “Always, there is exhibited an endless chain of reciprocally conjectural reactions and counter-reactions.”

Morgenstern continued to pursue the line of thought raised by his criticisms of forecasting through what would become a hugely influential career. He became professor at the University of Vienna and director of the Austrian Institute for Business Cycle Research from 1931 to 1938. He returned to the Holmes-Moriarty example in a 1935 article on foresight and economic equilibrium. When the Nazis declared him “politically unbearable” and dismissed him from his posts in 1938, he accepted an offer from the Princeton Institute for Advanced Studies, where he struck up a close working relationship with the mathematician J. von Neumann, who had been pursuing related ideas in his own research since the late 1920s. Their subsequent collaboration resulted in the publication of their major work, The Theory of Games and Economic Behavior (1944). Morgenstern regarded this book—which also made use of the Holmes-Moriarty example—as a natural outgrowth of his 1928 Wirtschaftsprognose.
—Walter A. Friedman, Fortune Tellers: The Story of America's First Economic Forecasters (Princeton, NJ: Princeton University Press, 2014), 153-154.

Constructivist Rationalism Pervades Socialism and Post-Keynesian Economics and Is Denounced by Austrian Economists

It is this kind of constructivist rationalism — which pervades post-Keynesian economics in particular and socialism more generally — that is emphatically denounced by Austrian economists. It is a ‘fatal conceit’ of intellectuals that they presume to determine structures for a beneficent social order. This is found in a conclusion that is familiar across diverse post-Keynesian analysis: that, although the world is fraught with difficulties that arise from decisions that must be undertaken in the face of uncertainty, a solution is at hand. With a heart-stopping leap — made without fear, hesitation or embarrassment — the void is crossed. The future is uncertain, but it can be shaped by the guidance of theorists who have understood Keynes correctly.

—G.R. Steele, Keynes and Hayek: The Money Economy, Foundations of the Market Economy (London: Routledge Taylor and Francis e-Library, 2002), 173.

Hayek’s Thesis Is That Socialism Is a Lethal Scientific Error Resulting from Intellectual Arrogance

Since Keynes’s economic theory has been proven to be incorrect on purely scientific grounds, it is permissible to analyze the factors that made him susceptible to error. The ultimate source of Keynes’s error is captured by the title of Friedrich Hayek’s final book, The Fatal Conceit: The Errors of Socialism (1988). What exactly did Hayek mean by the expression “the fatal conceit”? Conceit is defined as an exaggerated estimate of one’s own intellectual abilities. Thus, the expression “fatal conceit” connotes deadly intellectual pride. As the book’s subtitle indicates, Hayek directs the term to the advocates of socialism. Here then is Hayek’s thesis: socialism is a lethal scientific error resulting from intellectual arrogance. Jesús Huerta de Soto, a leading Hayek scholar, explains:

In the most intimate part of our nature lies the risk of succumbing to socialism, because its ideal tempts us, because humans rebel against their own nature. To live in a world with an uncertain future disturbs us, and the possibility of controlling that future, of eradicating uncertainty, attracts us. In The Fatal Conceit, Hayek writes that socialism is actually the social, political and economic manifestation of humankind’s original sin, pride. Humankind wants to be God, that is, omniscient… . The socialist considers him- or herself as overcoming this problem of radical ignorance which fundamentally discredits his (or her) social system. Hence, socialism is always a result of the sin of intellectual pride. Within every socialist there lies a pretentious person, a prideful intellectual.

—Edward W. Fuller, “Keynes's Fatal Conceit,” Procesos de Mercado: Revista Europea de Economía Política 15, no. 2 (Autumn 2018): 15-16.

The Essential Causal Element in the Austrian School's Theory of Business Cycles Is Falsified Loan-Market Signals

While a visiting scholar at New York University in 1923–24, Friedrich A. Hayek focused his attention on the ten-year-old American central bank. He watched the early phases of the 1920’s boom and saw a connection between Federal Reserve policy and the ramped-up economic activities. The early dynamics of that decade mirrored the dynamics of an unsustainable boom as set out briefly by Ludwig von Mises in his Theory of Money and Credit. According to Hayek, the seeds of the downturn were sown in the US in the form of easy money maintained by the Federal Reserve during the 1920s, the most salient consequence of which was the accelerating — and increasingly unrealistic — stock prices. The most insidious consequences, however, stemmed from the policy-tainted loan-market signals that created conflicts within the economy’s capital structure. Falsified loan-market signals can throw early-stage production processes out of line with the temporal pattern of consumer demand. This is the essential causal element in the Austrian school’s theory of business cycles. Policy-tainted interest rates give rise to internally conflicted production activities.

Artificially low interest rates stimulate early-stage — or, more broadly, interest-rate sensitive  —production processes, creating employment opportunities in those areas and hence raising incomes earned in those early-stage undertakings. Had the low interest rates been the consequence of increased saving rather than of policy actions by the Federal Reserve, the increase in early-stage capital formation would have been accompanied by a contemporaneous reduction of consumption — and hence a reduction in late-stage inputs and outputs. Accordingly, consumable output would have been shifted to the more distant future. This is the temporal pattern that characterizes sustainable, market-directed, economic growth. By contrast, a policy-induced boom as occurred in the 1920s and especially as it intensified near the end of that decade saw an increase in both early-stage production and contemporaneous consumer demand, creating a virtual tug-of-war centered on resources usable in both early-stage and late-stage markets — and with rising prices of those resources dimming profit prospects. These are the kinds of internal dynamics within the economy’s investment sector that lead to a crisis and warrant the charge that Keynesian theory is based on an overly aggregated macroeconomic framework.

—Roger W. Garrison, “Cycles and Slumps in an Overly Aggregated Theoretical Framework,” in What's Wrong with Keynesian Economic Theory? ed. Steven Kates (Cheltenham, UK: Edward Elgar Publishing, 2016), 93-94.

How Would Professor Rothbard Respond If Asked “Which of the Factors of Production Is Truly Productive?”

Does one of the factors of production allow for an output whose value exceeds the combined values of the factors of production? If such a factor exists, it would be productive in a very special sense. This factor would produce surplus value. If the search for the source of a supposed surplus value is confined to questions concerning the nature of the individual factors of production, the possible answers are few in number. A survey of the different positions taken, however, is revealing. Without digging very deep into the history of economic thought, we can find four points of view that, collectively, exhaust the possibilities.

Francois Quesnay believed that only land was capable of producing a surplus. The inherent productive powers of the soil allow for a given quantity of corn—employed as seed and worker sustenance—to be parlayed into a greater quantity of corn. The notion of land's natural fecundity lies at the root of Physiocratic thought.

Karl Marx believed that only labor can produce surplus value. Without labor, nothing at all can be produced. This one factor, then, is the ultimate source of all value. Income received by other factors represents not the productivity of those factors but the exploitation of labor.

Frank Knight believed that there is only one factor of production and that it should be called capital. Rather than argue in terms of a factor that yields a surplus, he argued in terms of a stock that yields a flow. Capital consists of all inputs that have the dimensions of a stock (land, machines, human capital); the corresponding flow is the annual output net of maintenance costs. This net yield is a consequence of capital productivity. The net yield divided by the capital stock is the rate of interest.

Joseph Schumpeter, following Leon Walras, denied that there was any surplus to be explained. In long-run general equilibrium, the sum of the values imputed to the several factors of production must fully exhaust the value of the economy's output. Schumpeter insisted that in the long run, the interest rate must be zero; the positive rate of interest that we actually observe is to be understood as a disequilibrium phenomenon.

We can pause at this point for a midterm exam: Which of the factors of production is truly productive? (a) Land; (b) Labor; (c) Capital; (d) None of the above. Quesnay, Marx, Knight, and Schumpeter would answer (a), (b), (c), and (d), respectively. Professor Rothbard would reject the question. The notion of productivity in this sense—and hence the issue of the source of such productivity—vanishes once we take adequate account of the temporal pattern of inputs and outputs and of the effects of time preference on their relative values.

—Roger W. Garrison, “Professor Rothbard and the Theory of Interest,” in Man, Economy, and Liberty: Essays in Honor of Murray N. Rothbard, ed. Walter Block and Llewellyn H. Rockwell Jr. (Auburn, AL: Ludwig von Mises Institute, 1988), 46-47.

The “Tendency Toward Equilibrium Spectrum” Has Lachmann (“Never”), Mises-Hayek (“Sometimes”), and Lucas (“Always”)

Roger Garrison's contribution to the Festschrift, “From Lachmann to Lucas: On Institutions, Expectations, and Equilibrating Tendencies” is nothing short of magnificent. By creating a “tendency toward equilibrium spectrum” and then placing on it Lachmann (“never”), Mises-Hayek (“sometimes”), and Lucas (“always”), Professor Garrison does more to elucidate the views of the Austrian, the Rational Expectations, and the “kaleidic” schools of thought on the equilibrating tendencies in an economy than an essay of ten thousand words or more could have done. Through this astute and innovative feat, moreover, the author of this chapter is able to once again establish praxeology as the moderate and reasonable view that takes on an intermediate position between two extremist beliefs that might otherwise have appeared more attractive than they are.

Garrison uses Lachmann's concern with future expectations to cast doubt on Lucas's assertion that the economy must always and ever be in equilibrium. He mobilizes the Mises-Hayek insight that on the free market, those who are better able to anticipate consumer demands will tend to have command over more and more resources and thus will be able to cast a disproportionate impetus toward equilibrium. This undercuts the extreme Lachmannian skepticism that there can be even a tendency toward equilibration.

Further, with this spectrum device, the Auburn University professor can focus attention on the crucially important role played by institutions. The Hayekian criticism of Keynes is that there is not enough disaggregation in this system to allow for the equilibrating role of entrepreneurial success. But this can only occur, shows Garrison, in a marketplace where businessmen can reap the reward of their superior insight. Paradoxically, or perhaps not so paradoxically, Keynesian-inspired government “stabilization” measures can actually retard movements toward equilibrium. Says Garrison: “They nullify the market forces that give rise to equilibrating tendencies, thus causing the economy to perform in the very way that Keynes envisioned it.”

—Walter Block, review of Subjectivism, Intelligibility and Economic Understanding: Essays in Honor of Ludwig M. Lachmann on His Eightieth Birthday, edited by Israel M. Kirzner, Review of Austrian Economics 3, no. 1 (1990): 223-224.