Hi,
Just got back from this event at LSE in London. I quite enjoyed his lecture despite his deficiency in English language (poor thing misspelt my name when signing his book even though I spelt out every letter :). He seems a charismatic, certainly appeared passionate about the subject of Austrian Business Cycle Theory. The theatre was packed.
He started by explaining ABCT, then emphasized the utmost impossibility of central banks to carry out monetary policy (socialist calculation - LvM), legal problem of bank deposits (mentioned Tories' initiative in UK to recognised deposits vs loans) in FRB and finished it off by proposing his "bail-out" transitional scheme from fractional reserve banking to 100% backed money with no legal tenders, final step being the complete privatisation of money. 1h40m lecture with 20m Q&A.
Audience Q&A session was a mix of "yes, get rid of FRB", "surely society needs central banks, just change the managers", "gold didn't help us in 1930s" and "you seem to forbid commercial banking and leave investment banking only". Hopefully these misinformed and mislead people will educate themselves in economics of freedom after his lecture. I've seen some people nodding at even his most radical propositions.
Overall, great to see an Austrian speaking in public about things that matter the most.
Do you have any idea if it was recorded and will be uploaded to vimeo or youtube?
I saw that they were recording it. Hopefully there will be a video published soon. Here is the link of the event:
http://www2.lse.ac.uk/publicEvents/events/2010/20101028t1830vSZT.aspx
And here is the lecture in mp3:
http://richmedia.lse.ac.uk/publicLecturesAndEvents/20101028_1830_financialCrisisAndEconomicRecession.mp3
Great. Thanks!
"If we wish to preserve a free society, it is essential that we recognize that the desirability of a particular object is not sufficient justification for the use of coercion."
Ensuric,
Why does De Soto conflate his own theories of money and banking with that of Hayek?
Does he? He doesn't appear so in his lecture, and I don't remember him attributing any of his conclusions to Hayek. Yes, he attributes many of his premises to Hayek (e.g. capital theory, Ricardo effect, et cetera), but I don't remember him going as far as to claim that his and Hayek's conclusions were identical. It is true, however, that it seems as if Huerta de Soto ignores much of Hayek's literature that argues for an elastic currency (see: Huerta de Soto [2006], pp. 723–727); i.e. Huerta de Soto is very selective of what he quotes from Hayek.
Also, it's somewhat disturbing that a well-known Austrian economist, such as De Soto, openly endorses bank bailouts and heavy financial regulations (he says that the repeal of Glass-Steagall was a "tragedy").
Out of interest, where does he endorse the bank bailouts? Regarding Glass-Steagall, I believe that the only part that de Soto really emphasizes is the seperation of commercial and investment banking.
Does he? He doesn't appear so in his lecture, and I don't remember him attributing any of his conclusions to Hayek.
Yes. He claims that the Austrian position is that business cycles are caused by fractional reserve banking, which is simply incorrect (fractional reserve banking, in itself, does not yield business cycles, which are caused by arbitrary alterations in the ratio of demand between consumption and investment (inter-temporal disequilibrium). If the banking system creates money in order to satiate the demand for money as money, or if it alters the supply of loans to consumers and producers by the same degree and in the same direction then it cannot yield business cycles). He cites a quote by Hayek where Hayek says that the only way to prevent businesses cycles is to extend the Peel's act to bank deposits, but he neglects to mention that that was merely one out of three necessary conditions (the other two conditions were: flexible prices, and correct anticipation of future price fluctuations, Prices and Production, pp. 304). He also said that such a regulation would necessarily fail because banks would innovate and find ways around it (pp., 412).
The first Austrian economist to explitly endorse 100% reserves was, to my knowledge, Murray Rothbard. Additionally, he continues to mention the "Ricardo effect" which is entirely incoherent and has been invalidated. Real wages don't rise because labor becomes relatively cheap. Real wages rise because the total supply of capital increases as a result of additional savings and investment. If his logic were correct, then we could increase total investment by arbitrarily elevating wage rates, and we could increase wage rates by destroying a significant portion of the total supply of capital.
Towards the end. He claims that his bailout solution is the most pragmatic and realistic course of action, though not the optimal route. And he literally endorses Glass-Steagall.
Esuric,
I would like to subscribe to your newsletter. Do you have a blog or something of that kind?
Esuric, I would like to subscribe to your newsletter. Do you have a blog or something of that kind?
No. I don't see the point.
Esuric:or if it alters the supply of loans to consumers and producers by the same degree and in the same direction then it cannot yield business cycles
They cannot possibly devise a method that allows them to do this which is why the modern ME theorists ignore this problem altogether. Besides, talking about altering supply of loans between consumers and producers "by the same degree and in the same direction" is still an aggregate/macro analysis, which ignores the micro-effects that are at the core basis of the Austrian Business Cycle theory. You can't possibly get the new money created via loans into precisely those hands that wish to hold it due to the nature of how the new money comes about. The idea is totally absurd.
Esuric:Additionally, he continues to mention the "Ricardo effect" which is entirely incoherent and has been invalidated. Real wages don't rise because labor becomes relatively cheap. Real wages rise because the total supply of capital increases as a result of additional savings and investment. If his logic were correct
Where do you get this from? If you read his work, he uses the "Ricardo effect" to explain how and when it becomes more (or less) profitable to employ labor saving tools/machines. This is perfectly coherent with Austrian capital theory.
Where do you get this from?
This lecture. It's a concept that Hayek introduced in the Pure Theory and it makes no sense.
Really poor sound but is de Soto commiting in that clip to an ancap society or is it just me mishearing?
http://www.youtube.com/watch?v=qk2wmYyziKo
@4.05 "... and I should tell you that I will dedicate all my effort in my life to try to dismantle and destroy the state".
Didn't listen to the thing, but yeah, I believe de Soto is an ancap.
Esuric: Where do you get this from? This lecture. It's a concept that Hayek introduced in the Pure Theory and it makes no sense.
Well then, where do you see anything that implies that real wages rise because labor becomes relatively cheap?
He's saying something totally different. real wages are rising because prices are dropping for consumers goods. This induces them to seek labor saving devices. Devices that before were less profitable then labor, now become more profitable. That's all.
The Ricardo effect was actually introduced in Profits, Interest, and Investment.
Ya, me too.
Of course, if you want, feel free to expand on why you think it's not worth doing.
@Esuric
...(fractional reserve banking, in itself, does not yield business cycles, which are caused by arbitrary alterations in the ratio of demand between consumption and investment (inter-temporal disequilibrium).
It appears that Block, Garschina, and Rothbard would disagree with you here.
see: Walter Block and Kenneth M. Garschina: "Hayek, Business Cycles, and Fractional Reserve Banking: Continuing the De-Homogenization Process" (p. 83)
In short, the Misesian view is that the banks don't have to search for the natural rate in order to avoid generating the business cycle; all they have to do is not expand credit beyond their cash holdings...The banks' insistence on expanding credit generates the business cycle. (footnote: The authors of this paper wish to thank Murray N. Rothbard for this insight)
This is my problem with the Ricardo Effect:
What you're saying is that the causal relationship is as such: (a) higher real wages --> (b) capital accumulation. But basic economic theory, including Austrian economic theory (Bohm-Bawerk) says that the causal relationship flows in the opposite direction, namely that the demand for labor and the productivity of labor, at the margin, will rise when the total supply and sophistication of capital increases. In other words, rising real wages does not cause capital accumulation; capital accumulation causes real wages to rise. If real wages rise without the introduction of additional capital, or more sophisticated capital, we get involuntary unemployment. The Ricardo effect implicitly assumes that capital and labor are for the most part substitutable factors of production rather than complimentary factors of production.
An implication of this theory is that trade unions and minimum wage laws increase capital accumulation. And finally, profit is not the result of how much labor and capital you employ, or how you organize the various factors of production into certain combinations. Profit or interest (excluding entrepreneurial profit) determines how much capital and labor you will employ, and how you organize the factors of production into certain combinations (insight from Hayek's Pure Theory).
Esuric:What you're saying is that the causal relationship is as such: (a) higher real wages --> (b) capital accumulation
Obviously, that would be absurd. I am not saying that and neither would such a prominent Austrian such as de Soto.
Esuric: But basic economic theory, including Austrian economic theory (Bohm-Bawerk) says that the causal relationship flows in the opposite direction, namely that the demand for labor and the productivity of labor, at the margin, will rise when the total supply and sophistication of capital increases.
I agree.
But here is how the Ricardo effect is not in violation with basic economic and Austrian theory. The Ricardo Effect in this context pertains to a transition state, one that affects entrepreneurial decisions, and not to an equilibrium state analysis. When consumers increase their savings by restricting their immediate consumption, it is a matter of fact that the decrease in aggregate demand for final goods mandates a reduction in their prices. So initially, real wages are increased. Again, this is a temporary phenomenon; People have already previously received their wages but then did not consume all of it. They are now able to get those same goods with less money. This is not in contrast to capital theory, quite the contrary, it is one of its predictive outcomes. This temporary rise in real wages further induces entrepreneurs to replace labor with capital goods. This is just another additional effect tending toward the lengthening of the structure of production. It is simply one more microeconomic explanation for the behavior of entrepreneurs and how they react to a rise in voluntary savings.
Obviously real wages will rise permanently due to the increase in voluntary savings and after the capital structure is readjusted.
But this is exactly what you're implying. The argument is that as total consumption falls, that savings must necessarily rise (correct), and that this would yield consumer price deflation and therefore higher real wages rates. The higher wage rates, in turn, would make capital more lucrative relative to labor, and therefore it would increase investment. Again, this argument assumes a high degree of substitutability amongst labor and capital, somewhat similar to Marxian analysis. What I'm saying, though, is that a higher rate of capital accumulation is the result of an out-ward shift in the supply of loanable funds, and therefore a lower rate of interest, and a relative elevation in the price of capital goods, which direct production towards the higher phases (this is the necessary and sufficient cause).
Again, if your position was valid (the ricardo effect), then it would be possible to increase investment, in relative terms, by arbitrarily elevating real wages and by arbitrarily causing forced deflations (contracting the total supply of money below the demand for money). Additionally, if this transition process, namely a transition to more capitalistic methods of production (lengthen the structure of production), is delayed, for whatever reason, then we should expect either (a) temporary short-term involuntary unemployment (until the structure of production begins to expand and until the higher phases of production bid away labor from the lower phases), or (b) a lower demand for labor and therefore a reduction in real wage rates back to previous conditions (towards the marginal product of labor).
If the transition is seamless, as we should expect in an undisturbed setting, then (a) and (b) won't occur (or will occur by a very limited extent). The reason why there is no "paradox of saving" is precisely due to the fact that the structure of production expands, increasing the division of labor, and because of a lower interest rate (all of which reduce the marginal cost of production and prevent a collapse in profits, and in fact increase total profits in the aggregate). Essentially:
I understand your reasoning but let me address your last 3 points in reverse:
3. There is a confusion of causality.
There is no confusion of causality. The debate is over whether the Ricardo effect can account for one (among others) microeconomic effects that occur during an increase in voluntary savings. Even if it's wrong, there is no [intentional] suggestion that causality is reversed.
2. Real wages rise in the long-run because of a lengthened structure of production (investment), i.e., a higher degree of capital per worker, and not becuase of a lower demand for final goods and services.
Yes, I said that. I clearly said that the permanent rise in real wages is only due to the above. NO disagreement here.
1. If the structure of production does not expand, and if real wages rise due to general price deflation (of consumer goods) then we should expect a lower demand for labor (reduction in real wages back to the marginal productivity of labor) and/or involuntary unemployment.
This "lower demand for labor" is exactly what the Ricardo Effect predicts but it is only due to the increase in real savings that increases the demand for capital goods in its place. The Ricardo Effect absent an increase in real savings may indeed make no sense, in which case you are correct. But the point here is that when real savings are increased, then the Ricardo Effect does make sense. It takes Austrian capital theory to demonstrate the conditions that make it valid. That's what Hayek has basically done and de Soto is simply elaborating on this point.
I understand, but I believe that the Ricardo effect conflates different phenomena (doesn't hold the ceteris paribus condition). Again, if it were true, than one could say that labor unions are actually beneficial. They would, in the short-run, cause involuntary unemployment as they increased their wages above the marginal product of labor at the expense of other laborers. But the secondary effect would be an elevated demand for investment and additional capital accumulation. This would, in turn, reemploy those laborers that initially went unemployed due to the wage rigidity, but at a new and higher real wage rate (due to the increased supply of capital).
This doesn't make sense, for the reasons I've already mentioned and which you already understand.
That's kind of a weak refutation of the Ricardo effect. Government-dictated wage hikes would not bring about the necessary allocation of resources between investment and consumption. A mandated wage hike per se is not a solution, not because the Ricardo effect is invalid, but because the mandated increase would not correspond to market preferences in any case, even if there was a tendency for investment to go up in relation to consumption as the Ricardo effect would have it.
As to the argument against FRB being the cause of the biz cycle, I agree with the earlier poster. Private banks couldn't possibly readjust their loans between investors and consumers so as to balance out investment and consumption and prevent a bubble. And the ability to expand as drastically via FRB still comes about from the central bank.
The 'bubble' happens because entrepreneurs over invest in response to artificially low interest rates, not because time preferences have changed. Why are interest rates artificially low? Because of FRB.
In short, it's not the job of FRB to bridge the divide between old and new time preferences (time preferences haven't changed)---it's the job of FRB to stop pyramiding loans and therefore causing artificually low interest rates and malinvestment in the first place.
And, I agree that in a free market FRB is prevented from causing much harm, because of competition---but we don't have a free market, because as you correctly point out, FRB banks are insured against failure by the central bank.
Any chance some one can rustle up a pdf or something of HAYEK, Friedrich A. (1978), “Three Elucidations of the Ricardo Effect” ?
I tried googling around but doesn't seem to be digitized....
Where there is no property there is no justice; a proposition as certain as any demonstration in Euclid
Fools! not to see that what they madly desire would be a calamity to them as no hands but their own could bring
They're available on jstor.
Here you go just scroll to the bottom.
re: The Ricardo effect is an economic fallacy.
I agree with Esuric. Specifically, I agree with this (except the mention of real wages):
In my opinion, real wages can't rise without an increased marginal product of labor, which in turn requires additional capital. This is because "higher real wages" just means "more stuff and more junk owed, per unit of labor". But, output of more stuff per unit of labor can only happen with more capital. For those who are curious, here's excerpts from two critiques of the Ricardo effect derived in the praxeological branch of Austrian economics:
edit: On second thought, I take that back. Starting from full employment in this scenario, and without the possibility of capital accumulation, the mechanism available for increased labor productivity would be discovery of additional natural resources. This would be an example of real wages increasing due to changes originating from within the economy---or endogenous changes. At this point says Hutt, in a completely free market economy, this increase of real incomes will effect changes in consumers' evaluations of (a) leisure preferences; (b) time preferences; and (c) liquidity preferences.
Economic theory tells us we have no way to know what these changes will be---the only thing we can know with certainty is that there will be changes. (Austrian praxeological theory, at least---I venture to guess that mainstream economics has some quantities and magnitudes for us to plug in somewhere?). So, we don't know what the net effect will be on the capital structure. Ricardo, however, says he knows the answer---and he knows it to be in the favor of an increase of savings and investment, and capital accumulation.
But, in order to stake out this position, Ricardo must presuppose to know not only the direction, but also the magnitudes of changes in consumers' (a) leisure preferences; (b) time preferences; and (c) liquidity preferences. This is the root of his fallacy. But, we have to cut Ricardo some slack here---he was without Menger's revolutionary insight of ordinal valuation according to subjective preferences, and without a host of other key economic discoveries.
On the other hand, the real wage increase Esuric refers to above is that caused by government-mandated nominal wage increases---an exogenous impetus of change. The qualitative effects are the same as in the first case, however: consumers will re-prioritize their preferences. As in the first case, we can't predict the relative magnitudes of the changes. And, again, Ricardo believes he knows the answer, but doesn't.
Mises:
Ricardo is the author of the proposition that a rise in wages will encourage capitalists to substitute machinery for labor and vice versa. Hence, conclude the union apologists, a of raising wage rates, irrespective of what thcy would have been on the unhampercd labor market, is always beneficial. It generates technological improvement and raises thc productivity of labor. Higher wages always pay for themselves. In forcing the reluctant employers to raise wage rates, the unions become the pioneers of progress and prosperity. Many economists approve of the Ricardian proposition although few of them are consistent enough to endorse the inference the union apologists draw from it. The Ricardo effect is by and large a stockin- trade of popular economics. Nonetheless, the theorem involved is one of the worst economic fallacies. The confusion starts with the misinterpretation of the statement that machinery is "substituted" for labor. What happens is that labor is rendered more efficient by the aid of machinery. The same input of labor leads to a greater quantity or a better quality of products. The employment of machinery itself does not directly result in a reduction df the number of hands employed in the production of the article...concerned. ... Ricardo's proposition and the union doctrine derived from it turn things upside down. A tendency toward higher wage rates is not the cause, but the effect, of technological improvement. Profit-seeking business is compelled to employ the most efficient methods of production. What checks a businessman's endeavors to improve the equipment of his firm is only lack of capital. If the capital required is not available, no meddling with wage rates can provide it. Human Action, Scholar's Edition, p. 767, p. 769.).
Many economists approve of the Ricardian proposition although few of them are consistent enough to endorse the inference the union apologists draw from it. The Ricardo effect is by and large a stockin- trade of popular economics. Nonetheless, the theorem involved is one of the worst economic fallacies.
The confusion starts with the misinterpretation of the statement that machinery is "substituted" for labor. What happens is that labor is rendered more efficient by the aid of machinery. The same input of labor leads to a greater quantity or a better quality of products. The employment of machinery itself does not directly result in a reduction df the number of hands employed in the production of the article...concerned.
...
Ricardo's proposition and the union doctrine derived from it turn things upside down. A tendency toward higher wage rates is not the cause, but the effect, of technological improvement. Profit-seeking business is compelled to employ the most efficient methods of production. What checks a businessman's endeavors to improve the equipment of his firm is only lack of capital. If the capital required is not available, no meddling with wage rates can provide it. Human Action, Scholar's Edition, p. 767, p. 769.).
Rothbard:
A more sophisticated variant of this thesis was advanced by Ricardo and has been revived by Hayek. This doctrine holds that union-induced higher wage rates encourage employers to substitute machinery for labor. This added machinery increases the capital per worker and raises the marginal productivity of labor, thereby paying for the higher wage rates...Capital investment is limited by saving. Union wage increases do not increase the total supply of capital available. Therefore, there can be no general rise in labor productivity. Instead, the potential supply of capital is shifted (not increased) from other industries to those industries with higher wage rates. And it is shifted to industries where it would have been less profitable under nonunion conditions. The fact that an induced higher wage rate shifts capital to the industry does not indicate economic progress, but rather an attempt, never fully successful, to offset an economic retrogression—a higher cost in the manufacture of the product. Hence, the shift is “uneconomic.” Man, Economy, & State, p. 718.