Extensions and Applications in Austrian Macroeconomies (lecture 25 of 32)

August 22, 2004 6:16 PM by David J. Heinrich | Other posts by David J. Heinrich | Comments (0)

These notes are from the lecture Extensions and Applications in Austrian Macroeconomies, given at the Mises University. Any errors are mine, feel free to point them out so that I can correct them. This lecture was given by Prof. Murphy.

Rational Expecations Objections to the Austrian Business Cycle Theory (ABC)

• There are no systematic forecasting errors.

• Rational expectations does not mean perfect forecasting.

• Maybe the first time the government injects money into the economy, ABC is right; however, businessmen are not so stupid as to fall for it again and again.
  • But, in the real world, people do make mistakes, because rational expectations doesn't say that people don't make mistakes, that they're omnisicent -- just that there are no systematic errors.
  • Rational expectations says that people don't systematically under-estimate the adjustment for the actual rate of interest -- it says that half underestimate it and half overestimate it.

Austrian Resposne to Rational Expectations Objections to the ABC

1. What they are saying is that "We don't agree with ABC, because if it were true, then people would act to alleviate it, so therefore it must be false." This is nonsense on stilts.

2. We are not talking about just a one-time injections, but a daily process. It is entirely possible that businessmen act on the average to compensate, but that is not going to cancel out the malinvestments that have occured.
   • It's just malinvestments not made, which doesn't cancel out malinvestments. Utility is lower. This illustrates the danger of thinking in aggregates.
   • Given that the goverment keeps doing this, and that it's causing the boom, the goverment is getting around this.
   • The govenrment just has to inject more credit to get around the adjustments of businessmen.

3. Clearly, there are ignornat borrowers out there, such as dumb people, or people who just ahven't been burned yet. Rational expecations argues that smart people adjust, and offset the actions of stupid people, so as to overcompensate; thus, in aggregate, there is no overinvestment in capital as opposed to consumer goods.
   • The problem with this is that it is not the aggregate that matters -- aggregate thinking is a simplification.
   • You have to look at the specifics; no matter what smart people do, they can't undo the inefficient employment of resources by stupid people. Even if smart people overcompensate, that can't negate malinvestment, but is in-and-of itself a malinvestment.

4. Prisoner's dilemma answer. If you look at the incentives that businessmen face, even if they know what's going on, they can't stop it:
   • If you're a businessman, you still have to operate, and borrow money.
   • You can't prevent other people from responding to the government's changed policy.
   • All businessmen would have to agree to ignore the fact that the government did inflate the money-supply and is lowering the interest rate; if one ignores this and others don't, that person loses.
   • On the margin, it is more beneficial to borrow money at the low rate.
   • The dominant strategy is to borrow money at low interest rates; however, the pareto-optimal strategy is for no-one to borrow, because they'd all be better off.

Outsourcing

• Some poeple don't like it, because it lays off American workers. We don't discuss that anymore, since that is naive.

• Paul Craig Roberts objection to outsourcing is the best criticism of outsourcing. Roberts says that the situation has chagned, so we can't use the standard case for free trade. He is not really saying that we can' use some argument for free trade, but just that we can't use the standard argument for it (David Ricardo's classical argument).

• David Ricardo's classical case for free trade:
  • If we eliminate tarrifs, goods flow in.
  • But, we'll just speicalize in something different.
  • Aggregate consumption will go up in the US>
  • Ricardo argues that we can be richer if we specialize in that in which we have a comparative advantage:

    Comparative Advantage

    Product	US		India
    	Units	Time	Units	Time
    Televisions	10 TV's	4hrs	8 TV's	4hrs
    CD Players	50 CD players	4hrs	10 CD players	4hrs

  • Some people get poorer, but on average, people in the nation are richer.

• Roberts says that Ricardo's argument is right, but that that is not what is happening today:
  • US firms actually ship machinery over to India.
  • We were assuming that only consumption goods, not capital good, can be shipped accross the ocean.
  • As machinery is just being shifted over, there is no compensation.

• Response to Roberts:
  • Black box response:
    • Can construct a very similar scenario, and Roberts must agree that it's ok.
    • Suppose that rather than the firm transmitting information over the internet to Indian doctors, Indian doctors make black boxes that have all the medical knowledge.
    • Now, India ships black boxes to the US.
    • They put doctors out of business, but help Americans a lot by making things cheaper.
    • The difference between this case, and Robert's situation, is not the difference between the US benefitting or not benefitting
  • Heavy vs. light gift:
    • Send an under-developed economy a machine.
    • This can't hurt them, but can only help them, as they can choose to use or not use it.
    • Roberts is saying we'd better help them if we make the machine heavy so they can't ship it to India.
    • So, Roberts would have to argue that if they found a capital good and sold it to India, we wouldn't be helping them; however, this is wrong, because the person who sold it is actually getting more by shipping it to India than keeping it; the market price of the machine is higher in India than on the island.
  • Symbolic proof that free trade must help us out:
  • Lets say that capitalists/shareholders outsource jobs.
  • Obviously, capitalists/shareholders are better off.
  • The workers laid off are worse off.
  • Let:
    • W = aveage original wage of workers laid off
    • w = average wage of laid off workers in 2nd best job
    • N = number of outsourced workers
    • f = average foreign wage
  • Thus:
    • Total cost to US labor:
      (w - W)N
    • Total gain to shareholders:
      (W - f)N
    • What does the US gain overall? Capitalists only outsource if:
      (W - f)N > (W - w)N
      W - f > W - w
      -f > -w
      f < w
      This must be true, because if the 2nd best wage wasn't better than the foreign wage, companies would just offer to reduce their employees salaries.