Liberty Matters

Situating Kirzner


I am most grateful for the time and attention that Mario, Peter, and Fred paid to my essay on Israel Kirzner’s contributions.  For a medium such as Liberty Matters, and in dealing with an economist who sought consciously to avoid as much as humanly possible normative discussions of the free society as an economist, one is always in a precarious situation of steering the conversation in too esoteric a direction by stressing the scholar’s methodological and analytical contributions to a specialized scientific field of inquiry, or forcing the conversation into a social-philosophical realm in which the particular scholar was not so comfortable being placed.  But let me quote Kirzner’s own words about his teacher Mises on how these esoteric issues in the methodology of economics science and the method of economic analysis matter for the practical issues of public policy and social philosophy.  “Mises saw the denial of economics,” Kirzner wrote (1978, vii), “as an alarming threat to a free society and to Western civilization.”  It is economic theory, after all, Kirzner pointed out, that is capable of demonstrating the great benefits of social cooperation under the division of labor that the free-market economy produces.  But “the validity of these demonstrations rests heavily on precisely those insights into human action that positivistic thought treats, in effect, as meaningless nonsense.”  So Kirzner argues that what inspired Mises’s vigorous and contentious “crusade against the philosophical underpinnings of economics not founded on human purposefulness was more than the scientist’s passion for truth, it was his profound concern for the preservation of human freedom and dignity.”
Methodology matters because it determines not only what we consider to be “good answers” but also what we consider to even be “good questions” in our science.  Analytical methods matter because some tools of reasoning illuminate some aspects of the phenomena to be studied, but others actually cloud that understanding and steer our mental focus in other directions.  The world of economic scholarship that Kirzner entered in the late 1950s, and what persisted throughout his long and distinguished scientific/scholarly career, was dominated by two “philosophical” trends which put the questions he wanted to ask and the answers he provided on the defensive at best, and dismissed them as unimportant at worst – the doctrines of positivism and formalism as understood by economists.[12] The comfort level at which the post-World War II economics profession settled on a positivist and formalist rendering of the discipline was certainly not dictated by the history of the discipline, nor even by the most up-to-date reading of the literature in the philosophy of science, nor even by a correct interpretation of what the older literature was saying.  But that is a topic for another day, though critical to understanding this comfortable scientific equilibrium and the challenge it presented to someone like Kirzner, namely, the self-reinforcing alliance between scientism and statism that the broader modernist agenda of “progressivism” represented in public administration and public policy.  Economics from the 19th to 20th century was transformed from a discipline seeking philosophical understanding of the social conditions of humanity to a discipline expected to provide the tools for social control implemented by the administrative state to fight poverty, ignorance, and squalor, and to eradicate instability, inefficiency, and injustice.  Hopefully, the reader now gets a sense of the titanic struggle that scholars entering the economics profession who happened to have sympathy for classical-liberal political economy faced in their efforts to make their way in the science.
Kirzner focused almost exclusively on purely scholarly and scientific explorations of economic theory.  I say “almost” because Kirzner throughout his career also engaged in what might be termed economic educational efforts to make the ideas of his teacher – Mises, and his teacher’s star student, Hayek -- better known not only to a profession that was no longer paying attention, but also to college students, as seen say in his Market Theory and the Price System textbook (1963).  If you look at the first decade of Kirzner’s career, he published The Economic Point of View (1960), Market Theory and the Price System, and An Essay on Capital (1966), all focused scholarly monographs picking up on refined debates in the scientific literature and seeking to demonstrate how the Mises and Hayek contribution would change the nature of the discussion and the conclusions to be reached.   Critical to this exercise was for Kirzner to explain how markets work, not simply explore the optimality conditions that define the economic system while assuming that the market had done all the work.
So this brings me to the insightful set of comments from Mario, Peter, and Fred.  Mario invokes the critical debates of the 1970s concerning Kirzner and Ludwig Lachmann that focused on the equilibrating nature of the entrepreneurial market process.  As Mario highlights, Kirzner sought to derive from human purposiveness a theory of the market, but Hayek and then Lachmann forced us to consider that in addition to the theory of purposiveness, we had to empirically examine the institutional environment within which economic activity was taking place with respect to its learning properties.  The sort of mutual learning required for the achievement of equilibrium was an empirical matter and not something that could be derived from pure theory.  The pure logic of choice, in other words, may be a necessary component of a fully worked-out explanation of market clearing, but it was not sufficient.  Lachmann pressed this point over and over again in debate throughout the 1970s, and his pointed criticisms influenced an entire generation of economic thinkers such as Mario, but also Don Lavoie, Bruce Caldwell, Peter Lewin, etc.
But two points I would like to suggest might give this narrative a slightly different twist. First, the impetus for the Lachmann-Rizzo move is Hayek’s 1937 paper, “Economics and Knowledge[13], his supposedly gentle refutation of Misesian a priorism.  In a March 30, 1985, letter to Kirzner (archived in the Hoover Institution) concerning a paper Kirzner had recently sent him, Hayek wrote:
I agree with most of what you say and I believe it is important to bring these points out.  It confirms a point of which I have become increasingly unhappy about recently, namely, that the subjective character of the Austrian method dealt wholly with consumption, or tastes and neglected information (knowledge) and production.  It was curious that Mises who, as you probably know, was very sensitive to criticism, actually praised my 1937 article and seems never to have been aware that it was directed against his a priorism.  In a way of course he ought to have agreed because my stress on the diversity of individual information derives probably from his argument about the impossibility of socialist calculation, but he appears never to have quite seen the importance of the learning process which seems to me still wholly irreconcilable with his a priorism.  To me it seems that the manner in which we and other people learn about new facts is decidedly a result of observation, and that consequences we derive from this knowledge is subject in some degree to falsification. [Emphasis added.]
Hayek’s interpretation, though, leaves us with at least two hypotheses to consider: (1) Mises didn’t understand , or (2) Hayek misunderstood Mises’s commitments.  We will not settle this dispute today in this forum, but hopefully we can stimulate discussion around it.  The critical insight I would take from Hayek’s 1937 article is that the optimality conditions of the market emerge from the market process itself and are not, in Hayek's rendering, behavioral assumptions anterior to the market process as in the standard textbook model.  Rationality and optimality are system level consequences of the competitive market. Kirzner, in his essay “The Meaning of Market Process,” introduces the useful distinction between “induced” and “underlying” variables.  What he postulates is that the market process engenders mutual learning about the underlying variables (tastes, technology, and resource availability) through the ongoing adjustment of the induced variables (prices, profit, loss).  This market process, in Kirzner’s depiction, is situated in a given institutional background of property, contract, and consent. So the postulated learning properties are within that already given environment.  Any situation in which the induced variables do not align with the underlying variables will send the participants strong signals, in the form of opportunities for profit or the threat of losses, to adjust behavior as guided by relative prices to move in a direction such that the induced variables reflect more accurately the underlying variables.  Of course, tastes, technology, and resource availability are ceaselessly changing, so the perfect alignment does not occur in a realistic depiction of the competitive market. But the tendency and directions are laid out.
In many ways the Kirzner-Lachmann debate simply rehashed the discussion laid out in Hayek’s letter to Kirzner about his disagreement with Mises, but it also has the same interpretative difficulty, I would contend.  Lachmann at times seems to suggest that all we have are the induced variables and so no anchor to the underlying conditions.  Clearly in some institutional settings the learning by participants of the underlying conditions is more difficult because of confused signals and perverse incentives.  But within Kirzner’s postulated environment the idea of a groping market converging with the underlying variables is certainly not as much of a leap in logic as it is often portrayed; nor is it oblivious to the precise empirical point Hayek actually was making in 1937 and beyond.  That point was simply that alternative institutional environments have alternative epistemic properties which must be recognized and explored.  And isn’t that exactly Kirzner’s  point in say his essay “Perils of Regulation” (1979) and in his notion of “superfluous discovery”?  He postulates that learning still takes place, but it is learning that takes us away from the dovetailing of the induced and underlying variables and thus to a situation which is defined not by the coordination of production plans with consumption demands, but instead by discoordination, where mutual gains from trade go unrealized.
Rizzo raises an important question about Kirzner’s “theory” and says that we are still seeking an acceptable “theory of the market process.”  In contrast I would invoke Elinor Ostrom’s distinctions among “framework,” “theory,” and “model.”  I agree with Mario that Kirzner provides us with a framework, but I would also say he provides us with a theory.  He definitely does not provide us with a model.  And in a profession that demands models, this was a big issue in the difficulty of communication.  We have work to do, but that work can be of a methodological nature to redefine what we economists are doing, and it can be of an analytical nature to seek to develop tools that enable us to capture the ongoing dynamics of adjustment and adaptation that make up the market -- dynamics that remain outside of the analytical toolkit of conventional economics.
This raises issues that Peter Klein brings up. Peter challenges my essay on several fronts, and I want to focus on just one.[14] But first let me say I agree with him that Kirzner’s citations are primarily outside of economics proper. However, that hasn’t precluded others from being recognized by the Nobel committee -- most famously Elinor Ostrom, but also Douglass North and even my teacher James Buchanan and Klein’s teacher Oliver Williamson.  So as I said, Nobel recognition for Kirzner is improbable but not unimaginable. 
The more substantive points that Peter raises is about what exactly Kirzner achieves with his theory of the market process and about my depiction of him as solving a fundamental problem in the theory of competitive equilibrium via Mises.  Klein suggests an alternative direction.
No doubt there are many alternative analytical approaches to studying market behavior.  But why was competitive equilibrium so successful in controlling the agenda of postwar theoretical economics?  First, what did general equilibrium theory accomplish?  It gave us a depiction of the interconnectedness of economic activity.  It also provided us with a clear set of optimality conditions which would exist if an economic system was to avoid waste and utilize available resources in the most efficacious way possible.  In delivering on these, three key analytical concepts were developed: the equimarginal principle, the law of one price, and the marginal productivity theory of factor pricing.  In other words, we get interconnectivity and efficiency properties. 
But what did general equilibrium theory not accomplish?  The biggest gap for our discussion is that the theory failed to provide a theory of adjustment and adaptation to changing circumstances.  In the formalist rendering, competitive equilibrium is a static theory and as such does not do well with change; as a result it analytically pushes change agents such as the entrepreneur out of the picture.  General equilibrium theory is a theory of economic forces after they have worked and not a theory of economic forces at work.  If we want to understand how markets work, we cannot simply study the configuration that would result if they did all of the job they are asked to do.  Instead, we must study how they in fact work through time to produce such a configuration via adjustment and adaptation guided by relative prices, lured by pure profit, and disciplined by loss.  As Peter notes, Mises’s essay “Profit and Loss” (1951) provides us with an example of such an approach, as I want to contend Kirzner does.
Where I think Peter and I differ is that I emphasize Kirzner’s attempt to bring the lessons of “Profit and Loss” to the attention of practicing economists circa 1960-1990.  We are, after all, professional economists, not public intellectuals.  As Paul Samuelson stressed, we scientists work for the applause of our peers, and we don’t seek to write the laws or policies of any nation as long as we write the textbooks from which people learn economics.  Kirzner was writing to a reluctant profession in the heyday of positivism and formalism, while trying to present an alternative vision of economic science to students and would-be professional economist.  To do that, you have to begin with the existing conversation and engage in terms that your peers will understand and your students will be somewhat familiar with.  I honestly have no idea what alternative we have if we are to stay as professional economists.  Certainly there is some loss in the translation in paradigmatic clashes, but as in the debate with Lachmann and Kirzner’s response about underlying and induced variables and a given institutional background, in my discussion with Peter I want to know how do we retain the core insights about general interconnectedness and theoretical constructs such as the equimarginal principle, the law of one price, and marginal productivity theory of factor pricing, and make conversational sense with our peers in this profession, unless we are willing to discuss in part on their terms and to tackle problems that they see in their own system.  It isn’t just a strategic ploy to invoke, as I do, Arrow, Fisher, and Dixit in my original essay. It is a communication point.  Kirzner is an economic theorist – as Mises and Hayek were before him – and he is postulating an entrepreneurial solution to one of the most vexing problems in pure economic theory.  It is an answer that Mises provided to his peers in his time, and it is an answer Hayek tried to clarify for his peers in his time. It is also what Kirzner tried to do during his era.  And, I would say, it is what we must do in our era as well.  We are professional economists engaged in a highly specialized technical discussion of how to understand how economic systems function.  In our capacity as public intellectuals we can behave differently, just as Milton Friedman wrote differently in Free to Choose than in A Theory of the Consumption Function. The argumentative demands are different; the readers’ expectations are different. 
Perhaps Kirzner ultimately “failed” in his endeavor, but what other path could he have followed while achieving what he did, which was to publish his books with the University of Chicago Press, to become in the 1970s the leader of the Austrian theory of the market process in the eyes of the economics profession, and to emerge along with William Baumol as the top contemporary scholar responsible for the rediscovery of the entrepreneur in economic theory?  Clearly the alternative path that Peter suggests in his comment would not have even tried to engage in that professional endeavor.
To put this even more pointedly, Tim Harford’s recent books Adapt (2011) and Messy (2016) no doubt tell us more about real-world markets than, say, a textbook by Mas-Colell, Whinston, and Green (1995), but a professional economist wanting to nudge the conversation among professional economists would be on a fool’s errand not to start the conversationwith the commonly acknowledged shortcomings in Mas-Colell, Whinston, and Green, and move from there to discuss how to incorporate ideas from Adapt or Messy.  I hope that helps clarify the position.
I will address Fred’s comment in a follow-up post.
[12.] I put “philosophical” in quotes because most modern economists do not seek to justify their approach on any philosophy of science except pure conventionalism.  Economics is what economists do, and there is no effort to situate the discipline’s practices in the contemporary literature in the philosophy of science.  That wasn’t always the case – Milton Friedman and Paul Samuelson, and their various commentators in the 1940s and 1950s, did discuss their ideas as they related to the broader discipline of philosophy of science.  But after the last real philosophical soul-searching in the 1980s, spearheaded by Deirdre McCloskey, the economics profession pushed that conversation to the periphery of the discipline and instead just got on with the task of doing economics.  Debates certainly took place over methods of analysis and criticisms and improvements of various tools utilized by economists, but the basic nature of the scientific enterprise was assumed to be settled, and it is settled in a way that presumes the correctness of positivism (read really as empiricism) and formalism.
[13.] A presidential address to the London Economic Club, 10 November 1936, first published in Economica (February 1937). It was republished in James M. Buchanan, The L.S.E. Essays on Cost, ed. J.M. Buchanan and G.F. Thirlby (New York University Press, 1981). Online: </titles/105#lf0725_label_068>.
[14.] Klein’s additional criticism that Kirzner's idea of alertness/discovery is worthless -- redundant at best and confusing at worst -- deserves serious consideration, and I will discuss it in a follow up comment.