Uncertainty and How it Works in Economics

I question a’ mainstream Austrian thinking’ Austrian in Lord Keynes’ blog:

The commentor states:

Of course as An Austrian I hold the view that if you removed the huge tax burden on individuals and businesses (much of which is used to support a moribund bureaucracy and its bribed supporters) there would by a much bigger pool of resources available to the private sector , and that would lead to the required infrastructure investment taking place spontaneously.

In which I reply:

How do you know this? This completely ignores market instability and uncertainty, both of which are Austrian principles in themselves.

He responds:

I believe it based on theory and also think this is (to some degree) backed up by what actually happened following denationalization and deregulation in some key infrastructure industries in the 1980s and 1990s where those industries (on the whole) became more efficient and more innovative.

In which I respond:

Even if I were to take your premise as true, can’t the keynesians do the same thing: 1) claim its based on theory 2) point to some event in history where the theory may be consistent with reality (even if at some degree too)?

Thus, I come back to my initial concern, where is the uncertainty aspect in this? So far, all I know is that your theory (whatever it is) is one that ignores uncertainty.

———————–

What I have said is very important because it is clear that, at least internet Austrians, Austrians fail to apply uncertainty in their thinking. I have replied to this comment by granting what he said about deregulation in the 80s and 90s as true and asked whether keynesians can claim along the same lines, 1) believe theory 2) show historical events that seem consistent with the theory. This is hard to reply to, if one says yes, then looking at theory and events that are consistent with the theory is not sufficient to prove your case that your theory is right. Also, it is quite clear that the theories ignore the uncertainty aspect too because they view the theory has being consistent, even in a world of changing data. If one says no, then there is still trouble here because keynesians do look at their theories and look at historical events to see if the theory is consistent. And therefore, there needs to be more research on the events in question and the theories in see which theories, if any, are consistent.  They also see the same uncertainty problem here, in which the theories in question seem to only look at a world in which there is a given amount of data and thus ignore the change in data and the ‘amount’ of data at a specific time. And on a side note, I am not really questioning whether deregulation is right or whether regulation is right, I am only concerned here with how one thinks of this as right. I have said before, I am not highly concerned right now on what to think in economics, but on how to think. This concern on how to think about economics is really why the Austrian school got started in the first place. People have to keep in mind that the Austrian school was not started as a defense for free markets, it was started because they sought to challenge the current mainstream on methodological issues. Socialists and liberals did not consider Carl Menger’s lectures as mind blowing because of his liberal views, but his lectures were mind blowing because the way he thought about economics was unheard of at the time and people found it interesting, people of all political spheres.  That said, let me get back to the topic of uncertainty.

The best person in my mind to convince me wholly of uncertainty is probably Paul Davidson, a post keynesian, but regardless, what he has  to say about uncertainty should be adopted by the mainstream Austrians (see Davidson’s book John Maynard Keynes and his article Reality and Economic Theory for more info). To Davidson, there are three elements of uncertainty to question neoclassical reasoning on markets: 1) ontological uncertainty 2) transmutabilty and 3) a non- ergodic world. These are not laymen terms, so lets discuss each term to where we can get a better understanding of them.

1) Ontological uncertainty

This concept in itself, Austrians fail to understand. The Austrian explanation of uncertainty is that of complexity. This is to say, the world is complex and our knowledge is limited, thus uncertainty. And in a theoretical perspective, the increase of our knowledge and thus an increase to the knowledge of specific complexities in this world, we reduce the uncertain element. Simply put increase in knowledge = less uncertainty (if we were to stay consistent with how the Austrians view how uncertainty arises).

Radical subjectivists automatically reject this notion on how uncertainty arises for the radical subjectivist see the world as Kaleidic, that is to say, we look at the world as ontological uncertainty. This is the whole point of Lachmann’s infamous quote, “The future is unknowable, but not unimaginable.” In a world where data is constantly changing, in a world where capital X could be useful today and entirely useless tomorrow how can one know the future? Just because we gain more knowledge of this complex world does not follow that we reduce uncertainty.The future is uncertain because of constant change via human action and expectations! This is the basic concept of ontological uncertainty. We can credit the radical subjectivist for ontological uncertainty, specifically Lachmann and George Shackle. It is clear that Paul Davidson got this notion of uncertainty directly from reading George Shackle. This is also the most important of the three to grasp, for it seems that the other two are understood once ontological uncertainty is understood.

2) Transmutable Reality

Transmutability deals with the creative part of reality. We live in a world of uncertainty but also a world where actors progress through creativity. This is the second part of the Lachmann quote (The future is unknowable but not unimaginable). Not only this but this implies the expectations of actors. Keynes’ view of the transmutable reality is what made Lachmann conclude that Keynes was more subjective than the Austrians! But it is in fact this that we should be skeptical of  using historical data to come up with probabilities of what is going to happen in the future. Davidson states the following:

…[E]ven if agents have the capacity to obtain and statistically process information regarding past and current outcomes, this existing market information does not, and cannot, provide reliable data for forecasting the future. Hicks correctly concludes that stochastic methods involving ergodic systems are inapplicable in this situation. Or as Keynes (1973b, p. 114) wrote, “About these [future] matters there is no scientific basis to form any calculable probability whatever. We simply do not know.”

This is perfectly consistent to the radical subjectivist perspective in that, as Shackle states, the future remains to be written and is determined about the actions we take today and the expectations we have for the future. This is to say, ‘About these future matters… [w]e simply do not know’.

3) Nonergodic Reality

Ergodicity is another word for something being predetermined, therefore non ergodicity means that something is not predetermined, and thus, we see a world that is not predetermined. This is a unique concept in economics As Davidson states:

… [M]ost economist today, following Samuelson and Lucas, accept as a universal truth the existence of a predetermined reality that can be fully described by unchanging objective conditional probability functions.’ Reality is, therefore, immutable; the future path of the economy and the future conditional consequences of all possible choices are predetermined(i .e., programmed by natural laws). This does not preclude an economy that is moving or changing over time. It does mean that all future movements and changes are already predetermined by the fundamental real parameters of the system and cannot be changed by human action.

The bold is very important here because in accepting a predetermined reality, one admits that this objective reality cannot be changed by human action.What utter nonsense it is to say that human action has nothing to do in the overall effect of economics. Or at least it is utter nonsense from an Austrian perspective, as Davidson shows, from a Post Keynesian perspective as well.

——————————–

By applying all that has been said to economic theories and policies are key if we wish for economics, as a subject, to progress. Davidson is really spot on, on what he has to say about uncertainty and he does a very good job at explaining uncertainty in depth. Nevertheless, this puts in question all theory that asks for both positive and negative regulation. I do believe that Davidson does make a mistake for implying the following, “There is uncertainty in the markets. Markets are unstable. Therefore government intervention because government intervention reduces uncertainty.” Granted, this is a very simplified version of  what Davidson concludes but I think this is fair to say nonetheless. How can the Post Keynesians talk perfectly about uncertainty in the markets, but ‘know’ the basic things to do to combat the uncertainty? The common Post Keynesian answer is that there is a limit to where uncertainty is applied. But then what things are not uncertain in a world of transmutability, non ergodicity, and ontological uncertainty? Or this is to say, at least my interpretation of the previous question: What things are not uncertain in a world of uncertainty? As far as I can tell, the only thing that we do know is that we will always live in a world of uncertainty, so long as there is human action.

-Isaac Marmolejo

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13 responses to “Uncertainty and How it Works in Economics

      • This standard on theory though seems like an impossible standard. You imply that because of this uncertainty, there can be no certain theory. Are we supposed to put all theories of economic policies on hold because there is not a clear theory which has your standard of uncertainty?

        • This is a complete argument from ignorance idea that you just put yourself into. Just because you cannot think of a theory for economic policy which incorporates “my” standard of uncertainty does not mean that it is impossible. And no, I do not advocate putting theories on hold, instead I advocate improving theory by including uncertainty into their theories. Thats the whole point of economic theories to begin with, they are not set in stone ideas, they are ideas that generally change over time, and hopefully the change over time leads us closer to better explanations on economic issues.

          Clearly, uncertainty is a reality that we must deal with… We have been presented a pretty good explanation of uncertainty… If anything, we should not leave aside dealing with uncertainty in our theories because it seems impossible at the moment or it is too hard to theorize with. Uncertainty is a reality we must deal with, so it must be part of our theories if we wish to have theories that are realistic explanation.

          • Wasn’t this Lachmann’s point of view on econ theory, that econ theory is really incomplete without uncertainty? I think it is and it was misinterpreted as him disproving of all econ theory by the Rothbardians. This is a laughable passage by Gordon:

            “Rothbard admired Lachmann’s early work in capital theory but believed that his later thought carried to an extreme the valid Austrian point that the future is uncertain. Lachmann used this point, Rothbard contended, to eliminate economic theory altogether. He termed this deviation “Lachmannia.””

            • Yes Anon, essentially this was what Lachmann was saying and this is why the rothbardians criticize him. The fact of the matter is that he did not think of himself as an institutionalist or a person that rejected all economic theory. He thought of himself as an Austrian, trying to further the Austrian theory by making it more reality based. This is hardly nihilism.

  1. Thank you for this. I am a huge fan of Paul Davidson.

    To all you out there on the interwebs, frame and hang this fucker up!

  2. I may have a possible repsonse to this uncertainty problem. The market itself is uncertain, we both agree, but government does reduce uncertainty because it has intervening factors that we know and that said, it does not apply to the uncertain problem like that of the markets at least.

  3. Pingback: Uncertainty…Round 2 | The Radical Subjectivist

  4. I was the commentator you were engaged in that discussion with. While I have to admit I do sound a bit like an “Internet Austrian” in my initial post I don’t think I am one really – but perhaps all Internet Austrian think that.

    However I do struggle to see what uncertainty has got to do with our discussion – which was (if I recall) on the subject of whether the state or the private sector would allocate resources more efficiently. You asked me “How do you know this” and alluded to issues of market uncertainty. Given that LKs blog is more economics than epistemology – my answer that I based my views partially on theory and partially on empirical evidence stills seems reasonable to me.

    While it is often does not take center stage I believe there is a strong sense of the importance of market uncertainty in mainstream Austrianism. Economic actors have to make decisions today based upon expectations about the future – and these expectations are held with varying degrees of uncertainty. Directly relevant to the discussion on the LK blog is the fact that a whole body of Austrian literature (and its the main theme of Human Action) is on how in the face of this uncertainty free individual co-operating together to achieve mutual beneficial goals will drive better outcomes than those from central planning, or even a “mixed economy”. Of course Keynsians don’t believe this – and can up with theory and examples to back this up. But isn’t that what discourse is all about – discussing these theories and their relationship to reality with the aim of coming up with the right answers to drive good outcomes ?

    I understand you may be talking about a deeper level of uncertainty than this – but until I have read Lachman and understand “radical subjectivism” a bit better this will have to do for now.

    BTW: I’m glad I found this site – it looks interesting.

    • “Given that LKs blog is more economics than epistemology – my answer that I based my views partially on theory and partially on empirical evidence stills seems reasonable to me.”

      Well LKs blog is from a post Keynesian perspective, and in post Keynesian literature, much work is on ontological uncertainty… This is still economics (but issues like this rarely come up in the mainstream), this is how we are able to make conclusions like heterogeneous goods, immeasurable capital goods in disequilibrium, our overall distaste for equilibrium economics, importance of human action etc.

      My concerns with your comment is that claiming something on theory and on empirical evidence is not sufficient for you to conclude that the private sectors best allocates resources.

      Also I am not claiming that Austrians don’t have things to say about expectations and uncertainty. Hayek’s ‘on the maintenance of capital’ has possibly the first insight about how capital is immeasurable in disequilibrium due to expectations. Mises has good things to say in Human Action especially the emphasis of human action and how it applies in entrepreneurship. This doesn’t ignore the fact that they hold some neoclassical assumptions in their framework that quite obviously ignores expectations and action. A quite simple example is the tendency towards equilibrium and assuming loanable funds theory, even though it takes a given set of expectations to make it true.

      Also a market, especially a capitalistic one, is far more complicated than individuals and mural exchange. Markets in general are set up by institutions, both spontaneous and political, and therefore there shouldn’t be this market vs state mentality that you are implying.

      Finally, while Lachmann has played a huge impact on my views on market instability and uncertainty, I take a more ‘radical ‘ view of uncertainty, though I use the works of Lachmann , Wiseman , and Shackle to justify my position. I suggest looking at my posts on uncertainty to grasp my position on it.

      Thanks for the compliment btw

  5. Pingback: Uncertainty Part 3: A Response to Lord Keynes and Unlearningecon | The Radical Subjectivist

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