Liberty Matters

A Methodology for Purposes and Processes


Mario Rizzo in his characteristic style provides a carefully reasoned reply, which is fairly persuasive.  He has, after all, written some of the most thoughtful essays among contemporary Austrian economists on the meaning of equilibrium and equilibrating tendencies.  He has also written, I would argue, the most sophisticated piece on the centrality of human purposiveness in economic theory in his paper with Robin Cowan, the “Genetic-Causal Tradition and Modern Economic Theory” (1996).[17]  So my agreement with Rizzo (a consequence of Rizzo’s influence on my thinking during my years at NYU and since) is very deep, and I don’t want to give the opposite impression when I push back slightly.  I also don’t want to necessarily get into a semantic squabble about the terms framework, theory, and model. So I hope to draw attention to a substantive point about learning in the Kirznerian system as I read it. 
Rizzo concludes his comment as follows: “Kirzner indeed set up a framework that, in conjunction with Hayek’s, focuses on the issue of alertness in markets. Good. But Kirzner’s avoidance of the how of social learning leads him into substantive claims he cannot legitimately make”(emphasis added). There is no escaping the empirical element in any theory of the market process. Without an elaboration of that empirical element we do not have a “theory” as most economists use the word. We have a framework but, I fear, a framework that does not easily direct us to the key issues. In summary, he writes, “We cannot leap from the willingness or desire of agents to learn – purposefulness – to a tendency toward equilibrium.” (emphasis added)
My pushback relates exclusively to the emphasized words because I want to claim that this is the difference in Kirzner’s system between entrepreneurship – the individual characteristic that individuals will be alert to that which it is in their interest to be alert to – and the entrepreneurial market process – which is a claim about the directedness of alertness toward mutual learning within specified institutional environments.  Outside a specific institutional environment, alertness or purposiveness alone guarantees nothing except that individuals will strive to do the best they can given their situation.  Other such broad-brush claims are made by Alchian when he says “more is preferred to less” A more standard claim is made that individuals maximize utility subject to constraints, where the arguments in their utility function remain unspecified.  Again, consider Kirzner’s claim -- individuals will be alert to that which it is in their interest to be alert to.  As Kirzner put it in Discovery and the Capitalist Process (1985, emphasis in original), "Entrepreneurial alertness is not an ingredient to be deployed in decision making; it is rather something in which the decision itself is embedded and without which it would be unthinkable."[18]
Now it is important to remember here that neither Mises nor Kirzner is making any sort of claim about the competency of the decisionmaker in achieving the ends of their goal-directed behavior.  Striving is not the same as achieving.  Mises in Theory and History (Liberty Fund 2005 [1957], 178) perhaps provides, in my opinion, the best summary of the position:
To make mistakes in pursuing one’s ends is a widespread human weakness. Some err less often than others, but no mortal man is omniscient and infallible. Error, inefficiency, and failure must not be confused with irrationality. He who shoots wants, as a rule, to hit the mark. If he misses it, he is not “irrational”; he is a poor marksman. The doctor who chooses the wrong method to treat a patient is not irrational; he may be an incompetent physician. The farmer who in earlier ages tried to increase his crop by resorting to magic rites acted no less rationally than the modern farmer who applies more fertilizer. He did what according to his -- erroneous --opinion was appropriate to his purpose.[19]
Man in the Mises-Hayek-Kirzner system is fallible but capable.  There are errors of execution evident in everyday life all around us.  Yet we don’t see many efforts to build bridges out of bubblegum, or skyscrapers with paper, or even railroad tracks with platinum.  Why?  Going back to Mises’s quote, we did see doctors treating patients through blood-letting, and we did see farmers relying on magical rites.  Why don’t we see entrepreneurs in the modern economy making similarly wildly wrong “wishful conjectures,” especially, when we consider the reality and sheer magnitude of failed business ventures?  Every act of entrepreneurship is a wishful conjecture into a future that is unknown.  What else would it mean for Kirzner to stress the “agony of choice” in human decisionmaking?  But in the entrepreneurial market process, with the institutional ecology of private property and freedom of contract, and the corresponding aids to human reasoning provided by relative prices as guides, profit as inducement, and loss as discipline, the “wishful conjectures” of entrepreneurs in the system are bounded and directed.  This is where the “tendency toward equilibrium” is to be found.  It is (a) only against a background of a given set of institutions and (b) only because of relative price movements that guide decision makers and monetary calculation that this tendency occurs in appraisement of alternative projects.  The critical functional insight of Mises-Hayek-Kirzner concerning monetary calculation within a market economy, its absence within a fully socialist one, and its distortion within the interventionist system is that the market enables decision makers to sort through the array of technologically feasible projects and select only the economically viable.  Without monetary calculation, as Mises pointed out, exchange and production would be just so many steps in the dark and economic decision makers would be ensnared in the throng of possibilities, unable to figure out which way to go.  “Wishful conjectures” would be unchecked and undisciplined. Such a world would be “chaotic” in Mises’s sense of the word.
To clarify just a bit more, Mises’s never said that actors under socialism would be irrational.  But what they will not be able to do is engage in rational economic calculation.  They would be “entrepreneurial,” but they would not be able to learn within an entrepreneurial market process.  Errors would become embedded in the system and would not be rooted out.
Any theory of a tendency of the economic system must, as Rizzo points out, explain how social learning takes place.  But I am suggesting that in the Mises-Hayek-Kirzner framework/theory/model (whatever we call it) learning is a function of the epistemic properties of alternative institutional arrangements, and within a private-property order with freedom of trade, the learning mechanism is provided by relative price movements, the inducement provided by pure profit, and the discipline inflicted through losses. 
Mises-Hayek-Kirzner put the theoretical puzzle of the study of man in such a way that one is compelled to ask, as Rizzo does, how is it that we learn how to coordinate with one another to realize the gains from social cooperation.  But they did not themselves engage in the detailed empirical project of studying institutions, institutional change, and the performance of economic systems through time.  This is why there are so many great gains from intellectual exchange with scholars who did so.  One of the most insightful of these scholars was Elinor Ostrom, the Nobel Prize-winner in 2009, who in her classic work Governing the Commons (1990) states the connection between rational choice theory, institutional analysis and the complexity of social order as follows:
As an institutionalist studying empirical phenomena, I presume that individuals try to solve problems as effectively as they can. That assumption imposes a discipline on me.  Instead of presuming that some individuals are incompetent, evil, or irrational, and others are omniscient, I presume that individuals have very limited capabilities to reason and figure out the structure of complex environments.  It is my responsibility as a scientist to ascertain what problems individuals are trying to solve and what factors help or hinder them in these efforts. When the problems that I observe involve lack of predictability, information, and trust, as well as high levels of complexity and transaction difficulties, then my efforts to explain must take these problems overtly into account, rather than assuming them away.[20]
Read closely, as I have argued repeatedly -- including in my book about the Ostroms published just before she was honored with the Nobel -- this rich research program provides us with a window into the study of learning within alternative institutional environments that is consistent (though certainly not identical) with the sort of scientific research program one can derive from Mises-Hayek-Kirzner.[21]
Rationality in this program is a “thin” conception, but the institutional analysis is “thick,” and the devil is always in the details.  The way entrepreneurship is transformed into concerted action that results in the dovetailing of plans is through the entrepreneurial market process.  Without the institutions of property, contract, and consent, this market process does not work.  Kirzner, in order words, never sought to achieve a theory of market-clearing from purposiveness alone.  Instead, his contribution was to say that any theory of market-clearing had to account for purposiveness and process.  Unfortunately, in his work the process was always specified against a given set of institutions and thus the unique epistemic properties of the private-property order were not as highlighted as should have been the case. 
Context matters for Kirzner just as must as it mattered for Mises and Hayek, and more modern theorists who have emphasized the vital role of institutions in economics and political economy, such as James Buchanan, Ronald Coase, Douglass North, Vernon Smith, and Elinor Ostrom.  Kirzner’s contributions must be placed within the mainline of economic thinking from Adam Smith to today.  The rational-choice postulate, or purposeful human action, must be squared with the “invisible hand” “theorem,” or social cooperation under the division of labor, via institutional analysis.  Different institutional arrangements have different properties about how we learn and what we learn.  It is the private-property order, with its freely negotiated terms of exchange and the free decisions to buy or abstain from buying, that transforms our entrepreneurial alertness into the realization of the complex coordination of the modern economy.  Prices guide us; profits lure us; losses discipline us -- this is how we learn. This is how markets work. This is how civilization progresses. And this is based on rules of property that serve to assign accountability, limit access, and offer graduated penalties when we fail to follow the rules.  Studying the operation of alternative institutional arrangements is in a significant way an empirical project, but we cannot even get off the ground in that project unless we recognize human purposiveness and thus the entrepreneurial capacity to be alert to that which it is our interest to be alert to.
[17.] Robin Cowan and Mario Rizzo, “The Genetic-Causal Tradition and Modern Economic Theory,” Kyklos, August 1996, vol. 49, pp. 273-317.
[18.] Kirzner, Discovery and the Capitalist Process (1985), p. 22.
[19.] Mises, Theory and History (Liberty Fund 2005 [1957]), p. 178.
[20.] Elinor Ostrom, Governing the Commons (Cambridge University Press 1990), pp. 25-26.
[21.] Peter Boettke and Paul Dragos, Institutional Analysis and Development: The Bloomington School (Routledge, 2009).