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Why I am not an Austrian

Quiggin, J. (1998), ŒWhy I am not an Austrianč, New Australian Internet publication.

Date created: 20 April 1998

Last modified: 20 April 1998

Maintained by: John Quiggin

Why I am not an Austrian

There is nothing more disheartening to a writer than to be ignored, and I am therefore very pleased to note that my work has received extensive, if almost exclusively critical, attention in The New Australian. Although the immediate ground for criticism is usually the fact that I hold 'left-wing' views on economic policy, the more fundamental objection is that I derive these views from strict application of a 'neoclassical' economic framework, or, more precisely, a synthesis of neoclassical microeconomics and neo-Keynesian macroeconomics.

By contrast, most commentators on economic policy in Australia mix neoclassical arguments with a set of pro-business prejudices such as 'services like health and education are a burden on the real economy' or 'competition makes people work smarter, not harder' and so on to derive policy conclusions supporting free-market economic reform. Much of my writing consists of pointing out the intellectually incoherent nature of these arguments, with such success that, as Gerard Jackson observes, 'the Federal government has no answer to Quiggin's economic fallacies'.

Jackson's objection to my analysis rests primarily on the claim that the neoclassical economic framework is inadequate because it is an essentially static, mechanistic, economic model that fails to take account of phenomena such as entrepreneurship. Hence, he refers to my criticisms of the 'Asian economic miracle' first put forward in the 1980s (Quiggin 1987) and repeated in an article in the Australian Financial Review in December 1996, as 'Pollyanna economics'. Jackson argues that the appropriate approach to economic analysis is an Austrian approach.

I endorse the criticism that the neoclassical model is inadequate because of its static and mechanistic nature. Nevertheless, I am not attracted by the Austrian alternative and would argue that it is the Austrian approach that is really 'Pollyanna economics'. I will develop this argument and then illustrate it with reference to the Asian case.

The problems with neoclassical economics and its competitors may be illustrated by the story of the drunk looking for his keys under a lamp-post. When asked where he last had the keys he points to a dark stretch of the street, but says he is searching under the lamp-post because 'the light is better here'. Speaking more plainly, neoclassical economics provides a very good explanation of certain aspects of an economy, such as the adjustment of prices in anonymous competitive markets, at the cost of ignoring many of the most important economic phenomena including entrepreneurship, economie of scale, institutions, motivation and co-operation. Some progress has been made in some of these areas in the past twenty or years or so, but it remains very limited.

The difficulty with alternatives to the neoclassical model, such as the Austrian and institutionalist schools of economics, and the pseudo-economics of management theory is that they are typically based on fairly loose reasoning about one, or a few, of the phenomena excluded by neoclassical economics. It is easy for wishful thinking to creep into this process. In my view, Austrian economists display wishful thinking about the performance of free-markets, just as institutionalists tend to display wishful thinking about certain forms of economic planning.

This may be illustrated by the debate about the relative performance of Australia and the Asian 'tigers'. Readers will recall that, until very recently it was argued that the leading Asian economies had overtaken Australia in terms of income per capita and living standards. In the absence of radical reforms we would fall steadily further behind these economies and be overtaken in short order by the others, becoming the 'poor white trash of Asia'. Most exponents of the 'Asian miracle' supported free-market reform but a minority drew on the Korean and Japanese models to argue for an export-oriented interventionist industry policy.

Against this, I pointed out that, as shown in Dowrick and Quiggin (1993), Australian living standards are still higher than those in Japan. Furthermore, as pointed out by Krugman (1994) and earlier by Quiggin (1987), growth based on capital accumulation and technological catch-up has a natural limit, at least in neoclassical economics. An economy with high rates of investment will eventually attain a higher level of income than one with a lower rate, but the income gain is subject to diminishing returns. Furthermore, since investment involves the sacrifice of current consumption excessive levels of saving and investment reduce economic welfare.

None of these arguments led either Krugman or myself to forecast the crash that occurred in 1997. However, whenever lending and investment are based on false premises such as the 'Asian miracle', the stage is set for an unsustainable boom and slump. While it is impossible to predict the exact timing of a crash, a neoclassical analysis suggested that the boom of the 1990s was unsustainable.

Against the neoclassical analysis, Gerard Jackson argues that

'Now the law of decreasing returns is perfectly sound. What is unsound is its thoughtless application to the question of economic growth. Capital is not and never can be homogeneous. This has enormous ramifications and completely demolishes Quiggin and Krugman's views on Asian growth. In reality, capital (as the Austrians point out) is a complex structure of many stages with a time dimension. Moreover, as the structure becomes more complex by adding more roundabout stages of production an increasing division of capital occurs specialised. It this lengthening and increasing specialisaton of capital that increasing returns that defeats decreasing returns. So we see that Quiggin's conclusion that growth rates will slow with increasing capital formation to be without foundation.'

and draws the conclusion that

'If the Asian tigers maintain their levels of investment and become even more market oriented, there is no doubt that their living standards will eventually exceed those of Australia. If Quiggin really thinks otherwise, he is kidding himself and his students.'

Jackson has left himself some wiggle room with his references to the need for market-oriented policies. But there was no significant change in Asian economic policy between December 1996 and December 1997. If Jackson now wants to argue, with many other former members of the 'Asian miracle' school, that the current problems are the result of a failure to pursue free-market policies, why didn't he point out that failure in advance. As it is, Jackson and other members of the Austrian school are in much the same position as those dedicated Marxists who argue that the collapse of the Soviet Union was due to deviations from the true path of Communism.

Dowrick, S. and Quiggin, J. (1993), 'Australia, Japan and the OECD: international GDP rankings and revealed preference', Australian Economic Review (1st quarter), 21-34.

Krugman, P. (1994), 'The myth of Asia's miracle', Foreign Affairs 73(6), 62-78.

Quiggin, J. (1987), 'White trash of Asia?', Current Affairs Bulletin 64(2), 18-25.

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