Liberty Matters

Demystifying Lachmann

Peter Lewin, more than anyone, has been responsible for making Lachmann's work accessible to modern scholars. As my own understanding owes much to Peter, I find myself in the difficult position of finding an area where I disagree.
Enigmatic and Controversial
When I first became aware (in the late '80s) of Lachmann's place in the Austrian revival, the message was clear: Lachmann was the "dangerous" member of the founding triumvirate. His work came with a warning: "caution, stay back" or, perhaps, "handle with care."
This view was shaken when I was tasked with compiling a collection of Lachmann's articles.[1] The picture that emerged from this effort contained greater richness, depth, and subtlety than was provided by the caricature of Lachmann as a troublemaker. Yet it was only as I dug deeper into his early work, and its context, that I began to see a coherent story.
Lachmann's concern with social economics, verstehen, and intertemporal plan coordination sprang from the same broad tradition as Menger, Weber, Mises, Schumpeter, Schutz, and Hayek. Continental scholars in Austria, Germany, Italy, Sweden, and elsewhere were engaged with questions of how best to integrate theory with history, individuals with institutions, and statics with dynamics. By the time Lachmann became a student in the late 1920s, the travel time between Berlin and Vienna had been greatly reduced.
This rich continental tradition did not survive the move to post-World War II America. The arid soil of "late classical formalism" proved inhospitable to the lush European flora. Lachmann's dubious reputation had more to do with the particulars of the revival than anything peculiar to Lachmann's approach. Lachmann's message was that we had to recover the past in order to make progress in the future.
From Expectations to Institutional Order
Peter puts expectations at the center of the Lachmann story. I see them as playing more of a supporting role.
The role of heterogeneous expectations was no doubt important to Lachmann. He never tired of pointing out their significance and was always quick to praise his friend Shackle's work in this regard. But Lachmann was more than just a cheerleader for Shackle's approach; he was also consistent in urging him to take interpretation and institutions more seriously.[2] For Lachmann, subjectivism (of the active mind) encompasses not only expectations of an unknowable future, but interpretations of past experiences: just as expectations diverge among people, so will their interpretations of the past.
Lachmann's interest in expectations grew out of his wrestling with the question of intertemporal plan coordination, stemming from the interwar debate on intertemporal equilibrium.[3] The upshot of this debate was to bring attention to the questions of knowledge, learning, and expectations. Lachmann, like Hayek, turned to institutions in search of answers.
Lachmann's work on institutions can be understood as trying to answer the questions raised by Hayek's "Economics and Knowledge." How, in a world of partial knowledge and constant change, can the separately constructed plans of individual actors lead to productive coordination? His work on expectations should be understood in this context. It was the central role of the plan, linking means to ends, that led Lachmann to look towards Mises and Weber for solutions to this problem. Lachmann did indeed consider himself a Hayekian while at LSE, but this went much deeper than just capital and business-cycle theory.
Peter dislikes "Hayek's conception of plan-equilibrium," and calls for an "institutional structure that can accommodate a huge diversity of incompatible plans." Hayek and Lachmann would agree. Hayek in 1937 speaks of mutual compatibility of plans and perfect foresight. Hayek in 1974 speaks of maximal compatibility and adaptation to the unknown.[4] He proposes the notion of abstract order based on abstract rules that consists of a system of abstract relations between elements: the elements change, but the order persists.
Lachmann addresses the same issue of coherence and change in The Legacy of Max Weber.[5] Lachmann saw institutions as providing the coherence needed for actors to coordinate their plans, while also providing the flexibility required to adapt to constant change. Lachmann's distinction between fundamental and secondary institutions has many parallels to Hayek's abstract order. Fundamental institutions represent the abstract rules, while secondary institutions embody the abstract relations.[6] Institutions, according to Lachmann, do more than just serve as "rules of the game." While fundamental institutions might fit that characterization, secondary institutions do not.
Capital: General and Specific
I am excited about the recent exploration of the "finance-view" of capital. I hope this reinvigorates Austrian capital theory and leads to a tighter integration with finance theory.
Lachmann would have approved. He emphasized capital gains and losses, futures markets, and stock exchanges as key drivers of the market process. He called for "a theory of business finance based on our knowledge of entrepreneurial action in response to change, expected and unexpected."[7] Lachmann made little progress toward this goal, and he was writing before the revolution in modern finance, so this an area ripe for further development.
However, in the process of adopting the finance view, I hope we don't lose sight of Lachmann's signature contribution. Peter notes: "At issue is the appropriate dimension for capital. Is it quantity, is it time, or is it value (money)?" Lachmann highlighted another dimension: specificity. Specificity is measured in terms of human purposes. Capital goods exist on a spectrum from general purpose money to single purpose capital goods; degrees of specificity distinguish finance capital from capital goods.
For Lachmann, this is the role of the entrepreneur – to transform general purpose money invested in the enterprise into specific capital goods, products, and services that can later be transformed back into money in the form of profits from sales. As Lachmann writes, "But the entrepreneur's function as regards capital is not exhausted by the hire of services. Here his function is to specify and make decisions on the concrete form the capital resources shall have."[8] Peter is correct in emphasizing that the entrepreneur's job is greatly aided by the ability to calculate in terms of monetary value, but this does not substitute for the act of specifying the particular ends that the enterprise decides to pursue, nor specifying the particular means by which to pursue them.
Again, it was their emphasis on purposive human action – the subjective choice of means and ends – that linked Lachmann's two great heroes -- Mises and Weber. The subjectivism of means and ends, embodied in plans that incorporate the interpretation of the past and the expectation of the future, form the common thread for Lachmann. It ties together his views on entrepreneurship, institutions, and expectations, as well as finance and capital theory.
More Relevant than Ever
The questions Lachmann posed -- on the nature of capital, the emergence of secondary institutions, and the coherence and flexibility of the institutional order – seem especially critical as we enter a new era of crypto-commerce. Blockchains promise to create new classes of digital assets that blur traditional distinctions between financial capital and capital goods.
Hernando De Soto has demonstrated the crucial link between property rights and capital formation; tokens created by public blockchains represent new types of electronic property rights that can be transferred via smart contracts.[9] But the change is not only one of new types of goods that can be electronically traded. Blockchains also make possible new types of decentralized organizations and social institutions.[10] Technical innovation has sparked rapid experiments in new types of secondary institutions, but it has also raised questions about their long-term coherence in the face of rapid change. These questions are at the heart of Lachmann's work.
Lachmann, I imagine, would welcome these developments. As he might write today: "Whether we send a text, wait for an Uber, or spend a bitcoin, our action is in each case oriented towards a complex network of human action…. The existence of such institutions is fundamental to civilized society. They enable each of us to rely on the actions of thousands of anonymous others about whose individual purposes and plans we can know nothing."[11]
[1.] Don Lavoie, ed. Expectations and the Meaning of Institutions: Essays in Economics by Ludwig Lachmann (London: Routledge, 1994).
[2.] L. M. Lachmann, Capital, Expectations, and the Market Process: Essays on the Theory of the Market Economy, ed. with an Introduction by Walter E. Grinder (Kansas City, MO: Sheed Andrews and McMeel, 1977), pp. 81-93.
[3.] L. M. Lachmann, "Preiserwartungen und intertemporales Gleichgewicht," Zeitschrift für Nationalökonomie, 8:1 (1937), 33-46.
[4.] F. A. Hayek, "Economics and Knowledge," Economica, 4:13 (1937), 33-54, and F. A. Hayek, Law, Legislation, and Liberty, v.1 Rules and Order (Chicago: University of Chicago Press, 1973).
[5.] L. M. Lachmann, The Legacy of Max Weber (London: Heinemann, 1970).
[6.] B. Tulloh, and Mark S. Miler, "Institutions as Abstraction Boundaries," Humane Economics: Essays in Honor of Don Lavoie (Cheltenham, UK: Edward Elgar Publishing, 2006), pp. 136-88.
[7.] L. M. Lachmann, Capital and Its Structure (Kansas City, MO: Sheed Andrews and McMeel, 1978), p. 89.
[8.] Ibid., p. 22.
[9.] Hernando De Soto, The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else (New York: Basic Books, 2000). See also, Mark S. Miller and Marc Stiegler, "The Digital Path: Smart Contracts and the Third World," Austrian Perspectives on the Internet Economy (London: Routledge, 2003), pp. 63-88.
[10.] S. Davidson, Primavera de Filippi, and Jason Potts, "Blockchains and the Economic Institutions of Capitalism," Journal of Institutional Economics, January 18, 2018, pp. 1-20; <>.
[11.] L. M. Lachmann, The Legacy of Max Weber, p. 50 (with modifications).