Ludwig Lachmann – Radical Prophet

    

In the Fall of 1976 I left the University of Chicago to accept a postdoctoral fellowship at New York University in the new Austrian program directed by Israel Kirzner. Although I had met Ludwig Lachmann earlier, it was only at NYU that I gained a true appreciation for his intellect and his work. My education at Chicago was deep but not broad. I learned, in its heyday, Chicago "price theory" and a monetarist slant on macroeconomics.  Prior to my education at Chicago I had already studied the great Austrian writers, including Menger, Böhm-Bawerk, Kirzner, and Rothbard. But what I took away from them was primarily a static Austrian economics. This is true notwithstanding Kirzner's Competition and Entrepreneurship (1972), which at the time seemed perfectly consistent with the work that Harold Demsetz and Yale Brozen were doing on industrial concentration and profit rates. It seemed like a little dynamic spice in a basically comparative static framework.

Lachmann's contribution to my education consisted in making me aware of neoclassical economics outside of the Chicago tradition and of a more thoroughgoing subjectivist tradition finding its voice within Austrian economics and within other schools of thought as well. His plea to extend the subjectivism of preferences to the subjectivism of expectations was met with skepticism. This is because many Austrians thought this would imply the radical indeterminacy of market processes. Lachmann often argued that there was not just one Market Process but that processes differed importantly depending on the nature of the market. Asset markets were particularly volatile because here prices were a reflection of expectations. These expectations were of a radically uncertain future about which people disagreed. Asset markets are speculative markets. Their equilibrium can only be a temporary one in which divergent expectations are precariously balanced.

The economics world in which Lachmann discussed these issues was dominated by the discussion of rational expectations and efficient markets. Dissent existed but it was beaten down by a display of relatively advanced mathematics. Lachmann was ahead of his time. Behavioral economics was bringing psychology back into economics, yet its developments were too fragile and tentative at the time to have much impact. It was said that economic expectations reflected the structure of the economist's model while psychological expectations were ad hoc. The former were "rational," and the latter were arbitrary.

Today psychology has been brought back into economics but in a way Lachmann would find quite odd. Behavioral economists conceive of expectations as systematic and persistent deviations from the standard neoclassical model. But since Lachmann thought that the standard model was inapplicable in asset markets, it would be unclear what actual expectations were deviating from. An explanation in terms of "bias" implies the existence of a true value if only in stochastic terms.

Lachmann would have preferred a more direct assessment of expectations. Context would be important. Heuristics would also have had their place, especially insofar as they enable individuals to deal with situations of limited data. But the future would still be unknowable, and thus he would continue to view asset markets as fragile. This does not seem to be an inappropriate lesson to have (re)learned, especially since 2007-8.

And yet one cannot but get the sense that Lachmann went too far in the direction of "unknowability" and the instability of asset markets. People understand that the future is truly uncertain, and they adapt to that. They create structures and institutions that moderate the impact of incorrect expectations. They also can learn (hopefully) to avoid further destabilization of the system by stable macroeconomic policies. In our book, The Economics of Time and Ignorance, Jerry O'Driscoll and I distinguished between typical and unique features of future events and developed a concept of "pattern equilibrium." People do not have to predict the future precisely to implement suitably flexible plans. And the future is not completely unlike the past – since it grows out of it.

Lachmann was also not particularly happy with the standard neoclassical theory of choice. I remember his criticisms of the idea of a completely ordered preference field. Even Pareto thought that the assumption only made sense in the context of repeated and familiar options. Axiomatic choice theory exhibits the same neglect of time as a static (or rational-expectations) approach to market adjustment. I think Lachmann would have looked aghast at behavioral economists rejecting the realism of the choice axioms but then elevating them to normative standards. He knew that the axioms were properties of puppets created by economists and human beings were not – nor should they aspire to be – puppets.

On Lachmann's capital theory, Peter Lewin is the expert. Obviously capital involves expectations, change, and uncertainty. In a dynamic world this means the altering of capital combinations as some prove to be unprofitable. But once the homogeneity of capital is rejected, concepts like complementarity, multispecificity, formation, and regrouping of capital goods become critical. Analysis of these was the purpose of Lachmann's Capital and Its Structure. This analysis was taken further by Lewin in his own Capital in Disequilibrium and in later articles.

Where does Lachmann's economics take us? I think Lachmann was a subjectivist but in a different tradition from that of Mises, Rothbard, and even Kirzner. He had a lot of difficulty with apriorism. I remember him telling me that he did not know what apriorism is supposed to be if not subjectivism. We have certain categories of understanding because we are all human beings sharing the same social world. Ideas like purposes, meaning, and expectations are the stuff of social-science explanations. Some Austrians went too far in claiming what could be known about markets simply through an analysis of these formal concepts. I misspent many a year expecting to get useful knowledge directly from the initial hundred pages or so of Mises's Human Action. Clearly, Mises gets carried away with his apriorism.

On the other hand, does Lachmann's subjectivism lead to a skepticism about the equilibrating properties of markets? In one sense, yes. And that is all to the good. Neoclassical conceptions of equilibrium can be too rigid and too epistemically demanding. Even the Austrian variant as a target toward which the system moves but never reaches is inadequate. What we need is more fuzziness or imprecision in our conceptualization of the equilibrium. We can reconcile equilibrium with certain kinds of learning as in the case of a flexible or adaptable research program. This is what The Economics of Time and Ignorance is about. I never got the sense that Lachmann fully understood what O'Driscoll and I were trying to do. We wanted to extract the less-skeptical analytical core from Lachmann's work drawing on Carl Menger, Max Weber, Alfred Schutz, and others in the Austrian pantheon. We even saw merit in aspects of Keynes's subjectivism, as did Lachmann himself.

The legacy of Ludwig Lachmann for Austrian economics is to open it up to new ideas, to loosen the grip of static apriorism, to be more empirical in our study of markets, and to reject sacred cows of any kind. We used to discuss these and other matters on Friday mornings. If I had to do something else and couldn't make a meeting, he told me that I had to "make it up." I miss those meetings, and I miss him.