Action, Time & Knowledge - Ubiratan Iorio

7/31/2019 Action, Time & Knowledge - Ubiratan Iorio

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Action, Time and Knowledge: the Austrian School of Economics

Ubiratan J. Iorio1,2

I. Introduction

My purpose today is to present a summary of my bookAction, Time and Knowledge: the

Austrian School of Economics, published in 2011 by Mises Institute Brasil.Due to limitedtime and keeping in mind that time is a means of production to the Austrians, I shall limit my

presentation to just a few points of the book.

The tradition initiated by Carl Menger with the publication in 1871 of his Principles of

Economics is a vast, fascinating and formidable field of human knowledge that transcends

economics by reaching the broader spectrum of the social sciences. It has been continuously

nourished with philosophical debate and has permeated humanist culture permanently.

Hayek was precise when he affirmed that an economist who thinks only within the strict

limits of economic theory would never be a complete economist, even if he or she possesses

technical expertise.

Indeed, for the Austrian tradition asks one not only to reach the state of the art in the science,

but also to go further and try to become a humanist. However, even when dealing with a

very broad field of human knowledge, the Austrian school holds a remarkable simplicity,

which is explained by the irreproachable logic of its propositions and postulates. As Mises

wrote, "good economics is basic economics"!

The great Austrian economists of the twentieth century - especially Mises and Hayek - were

paragons of boldness. In a time when colleagues were driven to specialization in more

restricted areas of economics, they refused to compromise and remained generalists, not with

the connotation used lately, but one that denotes vast culture and humanism.

Since the second half of the nineteenth century, economists regrettably abandoned the

humanist tradition and progressively concentrated on more specific technical knowledge,thereby becoming less knowledgeable. Today, few economists are scholarly enough to

master skills that exceed those contained in micro and macroeconomics textbooks. Many,

unfortunately, disdain other social sciences, because, on their journey towards obscure

knowledge, they have been taught that those are "unscientific."

These observations neither mean that the conventional theory must be discarded nor that the

homo economicus needs to be rejected. They only mean that the human aspects of the


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economy cannot be left out, as if they were unimportant or "unscientific", or as if they were

no more than mere nostalgic evocations of a past of melancholy from the heyday of the

Austro-Hungarian time of Menger, and Wieser, Bhm-Bawerk, Mises, Hayek and others. In

fact, humanism in economics is much older than Menger: it goes back to St. Thomas

Aquinas and the Late Scholastics and continues with David Hume, Richard Cantillon and

Adam Smith. Humanism was only "dismissed" from the twentieth century on, with the

advance of positivist ideas. However, for Austrians, both in everyday life and in the world of

science, what matters is not homo economicus, but homo agens.

II. The basic triad or fundamental core

The Austrian School is founded on a concurrent and complementary triad, formed by the

concepts of a) human action, b) dynamic time, and c) the hypothesis about the limitations of

human knowledge. These three concepts form the cornerstone of the monumental Austrian

School of Economics theoretical edifice. By analogy with biology, the triad represents the

essential elements necessary for the development and maintenance of the organism, i.e., it

represents both the macro and micronutrients of the system.

Certain elements emanate from the triad. They are: i) marginal utility, ii) subjectivism, and

iii) spontaneous orders. From thesepropagation elements, every proposal of a practical

nature may be logically deducted. I refer to these aspropagation elements for they bring

implications for various fields of human knowledge, such as political philosophy,

epistemology and economics proper.

(a) action

Action, for the Austrian School, means any voluntary act, any choice made intentionally to

move from a less satisfactory state to another considered more satisfying, at the moment of

choice. Praxeology (frompraxis) is the general science dedicated to the study of human

action, considering all its formal implications. Every economic act, without exception, can

be reduced to choices made in accordance with the seminal concept of human action. Andthe basic proposition, the first axiom of praxeology, is that the motivation for any action is

dissatisfaction, since nobody acts unless one feels some dissatisfaction and considers that a

particular action will improve satisfaction, comfort, joy or feeling of accomplishment, thus

decreasing discomfort, frustration or dissatisfaction.

This axiom is universal: wherever there are people, there are actions. Therefore, that

economics which is built on praxeology is, by corollary, universal. There cannot be specific


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or particular economic theories valid only for certain country or regions, but only an

epistemologically correct economic theory valid everywhere, assembled piece by piece from

observation and the systematic study of the action. Mises called the concept of human action

thepraxeological axiom number one, in the sense that the main laws governing economics

proper may be deduced from it.

(b) the dynamic conception of time

The second component of the triad is the dynamic conception of time or subjective time, or

even real time, in which time ceases to be a static category described by a single horizontal

axis, to be redefined as the continuous flow of new experiences, which is not in time, as in

the static or Newtonian concept, but becomes time proper. When we consider dynamic time,

we are implicitly accepting that something new is continuously occurring. We also mustrecognize dynamic times three characteristics: dynamic continuity, heterogeneity and causal

efficacy, as pointed by Mario Rizzo and Gerald O Driscoll, in their interesting book The

Economics of Time and Ignorance.

The real-time dynamic is irreversible and leads to a creative evolution process, which

implies unpredictable changes. The concept of real time is essential to the understanding of

human action: acting individuals continuously accumulate new experiences, which generate

new knowledge, which, in turn, often leads them to change their plans and actions.

c) limitation of knowledge

The third element of the triad is the epistemological treatment of the undeniable fact that

human knowledge always contains components of uncertainty and unpredictability, which

confer to every human action unintended effects that cannot be a priori calculated. There

are, for the Austrians, limits to the ability of the human mind to fully fathom the complexity

of social and economic phenomena. Formal systems possess certain operating rules that

cannot be predetermined. As Jos Ortega y Gasset affirms: "The eye does not see itself."

As it is not possible to quantify all our knowledge, the Austrian School does not analyze the

markets as equilibrium states, but as processes of discovery and articulation of knowledge.

Usually in the real world economy these forces remain quiet, silent, hidden, scattered and

disconnected, waiting for the subjective human intelligence to wake, display, organize and


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articulate them. This third nucleic hypothesis of the Austrian School, for many scholars of

epistemology, is the most important. However, I prefer to consider it on equal footing with

the first two, believing that by doing so it is easier to highlight the interactions and

interdependence among the three.

III. The propagation elements

(i) marginal utility

The first propagation element of the Austrian School is not unique to it. This is the conceptof marginal utility. As we know, it was the answer proposed in 1871 to the so-called

question of value, which was challenging scholars from St. Thomas Aquinas in the thirteenth

century. About six hundred years after the Summa, Carl Menger, Leon Walras and William

Stanley Jevons, respectively in Vienna, Lausanne and London, realized that the value of a

good or service is determined by its marginal utility at each moment in time, i.e., value

depends on a simultaneous combination of scarcity and utility.

Although the concept was introduced by these three economists, each one worked

independently: Menger adopted a subjective approach, while Walras (the forerunner of so-

called school of general equilibrium) and Jevons (who influenced Marshall, the father of theschool of partial equilibrium) adopted a mathematical treatment, since the concept of

marginal or additional units of goods and services fit in perfectly with the apparatus of

differential calculus. To the Austrian scholar, the principles of marginal utility, action,

dynamic time, and subjectivity are inseparable.

(ii) subjectivism

The subjectivism of the Austrian School is not limited to the subjective theory of value or to

the perception that theories dealing with humans are personal and therefore not subject to

testing. It refers to a basic assumption: that the content of the human mind - and therefore the

decision-making processes that characterize our choices and actions - is not rigidly

determined by external events.

Thus, subjectivism emphasizes creativity and autonomy of individual choices and, for that

reason, shall be subject to methodological individualism, the notion that market outcomes


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may be explained in terms of individual acts of choice. For the Austrian scholar, economic

theory should consider primarily the web of factors that explain choices and not be limited to

simple interactions among objective variables.

Subjectivism then presupposes that action always takes place under conditions of

immeasurable and genuine uncertainty, and also that it occurs over dynamic time. When anagent chooses a course of action, the results of his choice will depend on the courses of

action taken and to be potentially performed by other individuals. Autonomy prevails in

individual decisions, hence the future cannot be known and cannot be learned.

(iii) spontaneous orders

Spontaneous orders are intermediate classes of phenomena that are specific to the science of

human action or praxeology. They are institutions that fall between instinct and reason, as a

result of human action but not the execution of human design or planning. Indeed, for the

philosophers of ancient Greece, there were two types of phenomena, corresponding to the

terms - introduced by the Sophists of the fifth century Physei, which means "by nature" and

Thesis, which means "by deliberate decision."

For Austrians, however, this dichotomy is not consistent with the social sciences. In the

words of Hayek in The Counter-Revolution of Science: Studies on the Abuse of Reason

(Collier-Macmillan, New York-London, 1964, p. 39): "some kind of order appears as a

result of individual action, but without being intended for any individual". Typical examples

of these orders are the monetary system, markets, cultural events and language.

As pointed out by the Portuguese Professor Jos Manoel Moreira (University of Aveiro) in

his doctoral thesis presented at the Universidad Pontificia Camillas (Madrid), published in a

revised edition by the University of Porto in 1994, "the contrast is between a spontaneous

order, i.e., self -generated or endogenous, and exogenous order, i.e., designed or artificial

order, or even an organization, as in the case of a managed social organization"

(Philosophy and Methodology of Economics in FA Hayek, p. 187). Prof. Moreira continues,

"Hayek, despite the authoritarian connotation the term ordercarries for people who refuse

to admit an order not deliberately created by man, insists on keeping it, or rather uses

"spontaneous order" or "cosmos" to define () structures that arise from the action of many

men, although not of human design."In fact the real world economy, ever since man

discovered the benefits of the exchange process to the present day, is a great spontaneous

order, similar to the universe, in which things are continually in expansion and contraction.


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IV. Combining the elements of the Austrian School

The attached PowerPoint presentation is an attempt to present a general view of the

extraordinary complexity that is the Austrian School of Economics. Of course, this is a

simplified attempt to show its component parts, the respective role each one plays, and how

they fit together. The great task of economists is to build theoretical models that can

reasonably explain the reality of the economy, formed by the action over time of billions of

human beings of flesh and blood, with all their characteristic desires, aspirations,

motivations, strengths and weaknesses.

It is not my purpose here to discuss the implications of the core and propagation elements in

the fields of epistemology and political philosophy. I will just mention briefly that, in the

epistemological field, the implications should be:

(a) methodological individualism;

(b) the differences between models and facts in the social sciences;

(c) the recognition that the social sciences have their own characteristics, which

differentiate them from the natural sciences, and

(d) the rejection of forecasting methods in social sciences.

And, with regard to political philosophy, the implications should be:

(a) criticism of the mixed systems;

(b) evolution in the social sciences;

(c) democracy and separation of powers;

(d) limitations to power, and

(e) rejection of constructivism in the social sciences.

V. Economics

My concern here is about the importance of the concepts of action, time and knowledge, as

well as the marginal utility, subjectivism and spontaneous orders in the theory of the


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Austrian School. In fact, the economics of the Austrian School, as well as epistemology and

political philosophy, also derives from those we call the basic triad - action, time and

knowledge - and spreads through the concepts of marginal utility, subjectivism and

spontaneous orders, their elements of propagation.

Based on these core elements and seminal propagators, the Austrian economists, from

Menger, erected a remarkable and rich structure from the scientific point of view. It works

perfectly, at least as perfect as one can to explain the real world in the social sciences.

Let me briefly expose each of the six fields of economic theory that I believe are essential to

the understanding of the Austrian thought.

1. The market process.

Unlike mainstream economics, the Austrian School does not study markets in equilibrium.

Neither does it adopt the famous classification of markets according to its "form" (perfect

competition, oligopoly, monopolistic competition and monopoly). It assumes instead that

markets are processes that tend towards equilibrium processes (because agents are rational

and learn from mistakes), but that, at each instant of dynamic time have not reached their

equilibrium positions.

To understand this, is suffices to mention the main elements of the theory. First, markets are

moved by the actions of its participants, both on the demand and the supply sides. Second,

human action takes place over dynamic time, where each moment is a learning opportunity.

Third, market transactions are carried out under conditions of limitation and dispersion of

knowledge. Fourth, markets are spontaneous orders, subject, therefore, to permanent

changes. Fifth, human action is subjective.

How can it be expected, therefore, that real world markets be at "equilibrium" at a given

point in time? This is one of the central tenets of the Austrian theory. Markets are reflections

of trials and errors, in a permanent process for finding new opportunities, and whose

dynamism does not provide room for balance or equilibrium.

Consequently, markets tend to cushion against uncertainty and to systematically coordinate

the plans formulated by economic agents.

As the various circumstances surrounding human action are continually evolving, it follows

that the state of full coordination is never fully achieved, even as markets tend towards it.


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2. The role of the entrepreneur and its function in the markets

Entrepreneurship is the subjective individual ability to perceive the possibilities of gains on

the markets. Therefore, it is nothing more than a category of action. Thus, human action can

be considered a business phenomenon, specifically one based on the capabilities of

perception, coordination and creativity of the acting individual.

As with any human action, entrepreneurship occurs under genuine uncertainty, given the

limitations of our knowledge. It requires, in turn, creativity, since the future is uncertain and

an entrepreneurial action can deliver either good or bad results. The entrepreneur undergoes

a set of choices over time and, as such, it also involves a number of alternative scenarios to

which it must necessarily forgo, the subjective value of which we denominate cost.

As means are always limited, agents seek first the ends they consider most valuable and only

then they go after other relatively less valuable ends. Every action is motivated by the

subjective belief that the chosen ends have a value greater than the value of their costs. The

difference between them is theprofit, the element that explains the action.

In addition, to economists of the Austrian tradition, each action embeds a pure and creative

entrepreneurial component that does not require any cost. This pure entrepreneurial

component provides for the convergence of the concepts ofaction and entrepreneurship.

3. The debate about the impossibility of economic calculation in socialist economies

Mises, even in the 1920s, saw clearly that in a socialist economic system calculation is

impossible. His argument was simple: economic calculation requires planners to know the

prices, and these, in turn, to be considered prices as such (and not pseudo-prices) presuppose

both: a) the existence of the market process, in which actions of bidders and sellers flownormally, and b) private property, a prerequisite of markets. Socialism, however, does not

admit private property, so it makes no sense to speak about markets in a socialist system if

there are no functioning markets, and therefore no prices. However, if there are no prices,

economic calculation is impossible. For this reason, Mises stated categorically in the debate

with socialist economists that the socialist system was based on a blind process, and was


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therefore doomed to result in social and economic chaos. History has proven - and is still

proving - Mises correct.

The central agencies of these systems are formed by people, and it is unreasonable to assume

that their "pure" intentions possess the gift of omniscience which would enable them to grasp

and interpret numerous and scattered sets of information which are continually changing.

Planners cannot even determine their degree of ignorance about the information required for

the calculation and subsequent coordination thereof. In addition, the greater the degree of

coercion imposed, the lower the chances of achieving the plans, because intervention tends

to decrease coordination, resulting in increasing distortions over time.

4. The monetary theory

There are five main points about the Austrian School monetary theory. Firstly, variations in

the stock of money have un unequal effect on relative prices, capital structure, and patterns

of production in the economy, and in addition they change the employment levels of the

factors of production. As early as 1912, in his monumental Theory of Money and Credit,

Mises stated that increases in money supply do not produce benefits for society, because

they do not improve the benefits provided by currency exchange; they merely reduce the

purchasing power of each monetary unit.

In fact, money cannot be "neutral", because Friedman's helicopter does not enter theeconomy uniformly, but at specific points in the structure of production.

Secondly, business cycles are phenomena, which, though manifesting themselves in the so-

called real sector, have only monetary causes.

Thirdly, money, like any other good, has its value established by the principle of marginal

utility, as Mises showed by solving the problem of Austrian circularity, with his famous

regression theorem.

The fourth point is that Austrians scholars do not define inflation as "continuous andwidespread increase in prices", because that is actually a mere symptom of inflation. They

define it as a permanent decline in the purchasing power of money, caused ultimately by the

issuing of currency with a consequent decrease in its marginal utility.

Lastly, money, that is, the monetary system, is a spontaneous order, a phenomenon that is

constantly changing as the result of human action, though not of planning.


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5. The capital theory

The Austrian capital theory, no doubt, is an element that differentiates the Austrian School

of thought from all others, simply because they do not have anything resembles a theory of

capital.

Bhm-Bawerk, who followed the tradition started by Menger, was without doubt the main

contributor to capital theory. Mises, Hayek and other Austrians have also made important

contributions to its development.

Its central tenet is the concept ofcapital structure or the structure of production, which

describes a good that passes through various stages in the production process. These various

stages correspond to the capital structure of the economy. Therefore, capital is not

homogeneous and constant, as the macroeconomic models consider. It is essentially

heterogeneous and varies with other factors of production over time.

The heterogeneity of capital goods and the fact that economies have capital structures have

leadamong other hypotheses, such as the methodological individualism, Austrian

economists to reject macroeconomic analysis.

6. The Austrian Business Cycle Theory (ABCT)

The ABCT was conceived by Mises in his 1912 treatise, was further developed by Hayek in

the 1930s, and was later improved by other economists in the tradition of Menger.

It is simultaneously a theory of money, of capital and of business cycles. It shows how the

issue of money and credit, in excess of the corresponding amount of savings, has the effect

of reducing interest rates, which initially fool agents into believing that this reduction is the

result of higher savings. Consequently agents embark on longer maturity investments,

thereby stretching the structure of production of the economy. Later, when agents discover

that the increased investment was not due to higher savings, but to money disguisedas

savings, interest rate rise and lead to a shrinkage in the structure of production. This

stretching and contraction (known as the concertina effect) produces unemployment, notably

in the segments of production most distant from final goods production, precisely those

which initially benefited from monetary expansion.


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Thus, inflationthat additional money introduced into the economy without corresponding

savingswill eventually cause the unemployment of factors of production. As Hayek said,

there is no choice between eating too much (issuing unbacked currency) and having

indigestion (recession). Those are inseparable, the first leading to the second. The Keynesian

analysis (which came to be known as the Phillips curve) which postulated the existence of a

trade-off between inflation and unemployment, so that if the government wanted to fight

inflation, it would have to accept a higher unemployment rate, or alternatively if it wanted to

reduce unemployment, it would be forced to accept a higher inflation rate, is therefore

wrong.

As Mises stated a hundred years ago, originary interest is not the price paid for the services

of capital.. It is, on the contrary, the phenomenon of originary interest that explains why

less time-consuming methods of production are resorted to in spite of more time-consuming

methods that could render a higher output per unit of input.

Or, in the words of Hayek in his Prices and Production,

There is, however, another and far more important difference which will become

apparent only with the lapse of time. When a change in the structure of

production was brought about by saving, we were justified in assuming that the

changed distribution of demand between consumersgoods and producersgoods

would remain permanent, since it was the effect of voluntary decisions on the part

of individuals. Only because a number of individuals had decided to spend a

smaller share of their total money receipts on consumption and a larger share on

production was there any change in the structure of production. And since, after

the change had been completed, these persons would get a greater proportion ofthe increased total real income, they would have no reason again to increase the

proportion of their money receipts spent for consumption. There would

accordingly exist no inherent cause for a return to the old proportions.

In other words, for Keynes, depression is a problem of excess savings over investment and

for the monetarists it is a shortage of currency. For the Austrians, an excess of bad

investments over real savings cause depressions.

From that time on, the academic mainstream has misunderstood the depth of the Austrian

analysis and unfortunately Keynes won the debate, because his recommendations forgovernments to save the economy from the Great Depression were far more politically

palatable.

As Ron Paul wrote in his bookEnd the Fed, If there is a book that the Washington

establishment should read immediately, this book is America's Great Depression by

Rothbard. In this book he demonstrates that the Fed created the economic boom of the late


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of 1920 that led to the crisis, and that the interventions of Hoover prolonged the Great

Depression. (chap. 3).

VI. Concluding remarks

A natural consequence of the economic theory of the Austrian School is the question of

monopoly of money by governments. Why should governments alone print money through

central banking? Why should central banks alone control the credit? Why is the instability of

fractional reserve system not questioned? Why should central banks exist, given their history

of failures? Why are people generally against monopolies, but when we discussing the most

nefarious of all, the monopoly on money, only Austrians suggest its elimination?

The current crisis represents a great opportunity for the advancement of Austrian theory and

the abandonment of the wrong approaches of mainstream economics, such as the various

forms of keynesianism and monetarism. Keynesianism is an error, neokeysianism, the

insistence on error, and new keynesianism the persistence in error.And monetarism isnothing more than keynesianism with flexible prices and stability of the demand for money.

When we look at the six elements of the Austrian theory, we realize how much the

mainstream economics got wrong. Definitely, the economic theory that has been taught in

universities for decades is wrong. I hope the world learns the truth.

I have prepared this speech to sum up the themes that I described in my bookAction, Time

and Knowledge: the Austrian School of Economics. I emphasize the multiplicity of factors

that altogether constitute the Austrian School of Economics, stressing the importance of each

in the development of the school and also how they fit together.

To the core triad, formed by the concepts ofhuman action, dynamic conception of time and

the recognition that knowledge has limitations, we have added what we callpropagation

elements, namely, the doctrine ofmarginal utility, subjectivism and the concept of

spontaneous orders. I advise the reader to pause at this point and question whether each of

the propagation elements actually follow the core triad, and to which degree.

Armed with this apparatus, in the book I attempt to describe the implications of the triad and

propagation elements to the fields of political philosophy, epistemology, and the economy.


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Finally, it should be mentioned that the Austrian school has proven far superior to the

different branches of mainstream economics. Clear evidence of this statement are the crises

and bubbles, starting from 1920-21, continuing with the Great Depression of the 1930s, and

extending to the current crisis.

The first ended without government intervention; the second, whose "solution" to this day is

attributed to the application of Keynes ideas, was ending by itself, with the econom y giving

clear signs of recovery before the New Deal.

As far as the current crisis, we have been once again in a bubble process since 2008

precisely because central banks issued currency and credit in the absence of changes in

temporal preferences, and because governments have behaved as doctors who prescribe

sugar to someone who suffers from diabetes.

Action, time and knowledge: this is the fascinating universe of the Austrian School of

Economics!

1 Ubiratan Jorge Iorio - Ph.D. in Economics from Fundacao Getulio Vargas, Professor of Economics at the

State University of Rio de Janeiro - UERJ (Brazil) and Academic Director of the Mises Institute Brazil.

2 The author is grateful to Helio Beltrao and Valeria Pugliesi-Washington for their helpful suggestions and

criticisms, as well as for grammar review. And, of course, assumes responsibility for any remaining errors.

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Action, Time & Knowledge - Ubiratan Iorio