The recent financial crisis has called into question several basic tenets of mainstream macroeconomics. In the words of William White, former chief economist of the Bank for International Settlements (BIS), “the prevailing paradigm of macroeconomics allows no room for crises of the sort we are experiencing.”
White and his BIS colleagues were among the few economists within the mainstream institutional orbit who warned of the unsustainable financial imbalances building up in the United States and elsewhere in the global economy during the 2000s. Among the leading indicators of these imbalances were rapid credit growth, unsustainable debt levels, and asset prices diverging strongly from historical trends.
In addressing the shortcomings of mainstream macro, White advocates drawing upon “Austrian” insights in order to change the way economists think about real and financial imbalances in the economy.
“Austrian” economics refers to the school of thought established by the Austrian economist Carl Menger in the 1870s, and further developed by his intellectual successors Eugen von Böhm-Bawerk, Ludwig von Mises and Friedrich Hayek.
In the postwar era, this school of thought has mainly been located in the United States, centered on economists such as Murray Rothbard and Israel Kirzner. The two main centers of Austrian economics today are the economics department at George Mason University in Fairfax, Virginia (where the Austrian research program is led by economist Peter J. Boettke), and the Mises Institute in Auburn, Alabama (led by Lew Rockwell). The Foundation for Economic Education, in Irvington, New York (soon to move to Atlanta, Georgia) is another organization dedicated to disseminating Austrian economic thought.
Austrian and mainstream economics differ greatly in explaining booms and busts in the economy. Austrians emphasize monetary disequilibrium in the boom phase–a central bank keeping interest rates lower than the “natural” rate of interest that would prevail in a free financial system without central bank tinkering with money. Mainstream macroeconomists tend to focus instead on what the government should do in response to crises after they occurr. They also typically don’t see any role for monetary policy in curbing asset booms, as their models lead them to believe that the economy is on a sustainable path as long as prices are “stable”– i.e. as long as there is moderate and constant year-on-year consumer price inflation (typically 2 percent per year)–and output grows at the assumed optimal rate (a highly hypothetical construct that according to this view also implies that unemployment is at its optimal level).
An informative description and discussion of the mainstream approach can be found in a recent paper by the chief economist of the International Monetary Fund, Olivier Blanchard. Here he writes:
“[W]e thought of monetary policy as having one target, inflation, and one instrument, the policy rate. So long as inflation was stable, the output gap was likely to be small and stable and monetary policy did its job.” (Emphasis added.)
Thus, “Stable and low inflation was presented as the primary, if not exclusive, mandate of central banks.” I have previously commented upon the short-comings of this line of thought, as represented by Blanchard, one of our times leading macroeconomics textbook authors and New Keynesian economists.
Mainstream macroeconomics stands in stark contrast to the Austrian approach. As explained by White:
“In contrast to the Keynesian framework, Austrian theory assigns critical importance to how the creation of money and credit by the financial system can often lead to cumulative imbalances over time. These imbalances, which ultimately come down to investments that do not end up profitable, eventually implode in the context of an economic crisis of some sort. In today’s terms, unusually rapid monetary and credit growth over the past decade or so led to asset price increases that seemed to have little to do with fundamentals. It also led to spending much higher than historical norms.”
Austrians accuse mainstream economists of what could be called aggregate myopia, namely that they do not pay close enough attention to what is really going on in the economy at the micro level. The Austrians find that low interest rates lead to economy-wide distortions and the misallocation of resources, led on by false price signals.
Whereas mainstream economists treat financial crises as something external, shocking the otherwise assumed healthy state of the economy, Austrians look upon how monetary disequilibrium leads to real (and financial) imbalances that eventually need to be unwound in a bust phase. Thus White criticizes the mainstream for not understanding the true importance of economic imbalances:
“One tendency that must be resisted is to see this work on imbalances as related solely to ‘financial stability.’ In part, this tendency is related to the misconception that our current problems are limited to those of a financial crisis. Rather, an important aspect of the issue is how excessive credit and monetary creation can lead to imbalances outside the financial system, with significant macroeconomic implications.”
Mainstream economists, in other words, treat financial crises as some unfortunate incident that hurts the “real” economy, and that must be addressed through “counter-cyclical” policies. However, if the true problems are economy-wide imbalances built up in the boom phase, these Keynesian remedies simply won’t work. What is needed is a significant restructuring and rebalancing of the economy. Thus the Austrians also have a strongly divergent view of the bust phase, i.e. the downturn, of the business cycle.
Since resources were misplaced during the boom phase, they need to shift during the bust phase and the recession that follows. Any attempts at stopping this process from taking place by helping sectors in distress would only prolong the necessary restructuring of the economy, thus dragging out the economic woes of the country. Also, the imbalances of too high consumption, too little saving, too much debt, malinvestment, and unsustainably high asset prices need to rebalance for the economy to return to a healthy state. Government programs to prop up asset prices, such as the current Fed purchase of $1.25 trillion in mortgage-backed securities, and the administration’s mortgage-relief programs, could at best be a temporary relief, but in the end only push the necessary corrections forward in time, thus preventing the imbalances from unwinding in the short run.
The policy implications of the Austrian understanding of the boom-bust cycle has led to accusations of “liquidationism,” i.e. that Austrians think it is a good thing that many companies and investments are liquidated in an economic downturn, a view of the Austrian position popularized by economist J. Bradford DeLong (1991).
This critique, however, is based upon a wrongful understanding of what the Austrians are saying. They lament the bankruptcy of firms during the economic hard times that follow an unsustainable boom, but if a company is insolvent it should be allowed to go under (including financial firms), thus freeing up resources which can be utilized somewhere else in the economy. As explained by Austrian business cycle theorist Roger W. Garrison:
“For the Austrians, the liquidation that is essential to the economy’s recovery is the liquidation of the malinvestments. Resources need to be reallocated. Hence, any government spending program that serves to rekindle the housing boom or even to keep resources from leaving the housing industry is counterproductive. It locks in the misallocated resources.”
However, economic busts could also lead otherwise solvent companies into bankruptcy as happened in the 1930s, due to a major contraction in the circulating money supply. Hayek referred to this as a “secondary contraction.” Garrison describes such a detrimental development as “a selfreinforcing spiraling downward of economic activity that causes the recession to be deeper and/or longer-lasting than is implied by the needed liquidation of the malinvestment.”
In DeLong’s view, the Fed did nothing to stop the contraction during the early 1930s because it relied upon the “liquidationist” views of economists such as Hayek. However, this is hardly historically correct. There is no record of Fed officials referring to Hayek or any other Austrian during this period. In fact, Hayek’s first English publication on the business cycle (Prices and Production) came in 1931 and could hardly have influenced the actions of the administration or the Fed during the presidency of Herbert Hoover (who left office in early 1933) as DeLong claims. Rather, the Fed was informed by an antiquated monetary theory called the “real bills doctrine,” a current of monetary thought that the Austrians opposed.
Furthermore, Hayek, far from advocating a “do nothing” policy or “liquidation” in the face of such a contraction, actually called for the central bank to stabilize the circulating money supply, an important point discussed at length by George Mason University economist Lawrence H. White in a paper on Hayek and the Great Depression. (Unfortunately, this policy prescription was only clearly formulated later on in the 1930s, but is implied by the monetary theories of the Austrians preceding the depression.)
Though Hayek’s policy prescription would be for the Fed, or any other central bank, to stabilize the circulation of money in the face of a severe credit contraction, as the one witnessed in the 1930s and again in the late 2000s, the main message of the Austrians could be summed up in the phrase “the best way to stay out of trouble is not to get into it in the first place.” In other words, the best way to avoid a financial crisis and depression-like downturn, as the one we’re experiencing right now, is to avoid financial imbalances from building up in the boom phase. And the best way to address these imbalances is to stop manipulating interest rates below the market equilibrium rate.
This should be the main monetary lesson of the current economic calamity. There are of course other important lessons to be drawn as well, lessons to which Austrian insights turn out to be equally instructive.
The government should stop encouraging and stimulating investment in housing and housing-related securities through preferential tax treatment (interest rate deductions on mortgages and preferential treatment of capital gains from investment in housing), through government-mandated buyers of mortgages in the secondary market (Fannie Mae and Freddie Mac) and by preferential treatment of mortgage-backed securities in the regulatory standards for capital ratios (the Basel rules). The bipartisan political quest to drive up the U.S. homeownership rate only leads to misallocation of capital: too much credit flows into housing and housing-related investments.
The government, notably the central bank (Fed) and the fiscal authorities (Treasury), should stop bailing out the financial sector whenever it runs into trouble. This only creates moral hazard, systemic under-pricing of risk, and the build-up of financial fragility–eventually creating huge distortions and potential pitfalls that materialize in a credit crisis, thus amplifying the boom-bust cycle.
Austrian economists (and other free market economists) greatly emphasize the role of the market as a profit-loss system, not a “coins, we win; heads, the tax-payers lose”-system, as seems to be the characteristic of the U.S. financial sector. The economic signals of profit and loss are central to the market mechanism. Take out the loss part, and you create destructive distortions and perverse incentives.
The government should adopt a more realistic view on what can be achieved through regulation. Often regulation designed to be foolproof, turn out to create unintended consequences. The market works best if there is a certain degree of market discipline, i.e. market participants monitoring counterparties for risk and punishing imprudent players through higher risk premiums or denied access to credit. Centrally set and supervised regulation tends to replace this market discipline with a reliance on arbitrary standards (as succinctly pointed out by Jeffrey Friedman in the essay A Crisis of Politics not Economics: Complexity, Ignorance and Policy Failure, emphasizing a somewhat Hayekian theme).
A point in case is the above-mentioned international rules for capital ratios–the so-called Basel rules. These were risk-weighted in an attempt to establish a benchmark for how much capital was required for financial firms to keep different kinds of assets in their portfolios. The rules deemed that mortgage-backed securities (MBS), given an “investment-grade” by the three U.S. government mandated rating agencies, were much safer than holding the underlying mortgages. The amount of capital required for MBSs were half of the capital required to hold actual mortgages. Thus commercial banks filled their portfolios with MBSs. When the crisis hit, it turned out that risk was actually concentrated in the banking system (and not spread, as regulators and market participants originally believed). When housing prices flattened and then started to fall and foreclosure rates started to rise in 2006-2007, this led to a rapid deterioration of these banks balance sheets.
This is of course only one example of unintended consequences related to regulations and policies in the years leading up to the recent financial crisis. The story of unintended consequences should be familiar to anyone acquainted with Austrian economics. Austrians hold that society is complex, the future uncertain, and that knowledge is limited. There is thus ample room for mistakes, both amongst government regulators and policymakers as well as market participants.
There are however some pronounced differences between the political arena and the market place. The market, though never perfect, has a built-in mechanism for detecting and correcting mistakes over time, namely price signals and the signals of profit and loss. The political process lacks these signals and political actors face a different set of incentives, which means that politics often leads to outcomes which are not socially desirable.
The main strength of Austrian economics is that it adapts a more realistic understanding of how real markets work and the limitations of human knowledge. Such an understanding leads one to a more sober view of what can be achieved through politics and regulations. It also leads to a better understanding of the central importance of market signals and how they need to operate with as little distortion as possible.
Marius Gustavson is a Sound Money Fellow at the Atlas Economic Research Foundation and an Economic Policy Research Fellow at the Reason Foundation.
Related Articles – Business-Cycle Conditions, History of Economic Thought, Monetary Policy, Sound Banking, Sound Money Project
What’s Good and Bad about Automation


Currently, there is a lot of discussion about the impact of technologies such as artificial intelligence on the world of work and employment. Some of this is alarmist, and some excessively excited. There will indeed be dramatic changes, but history and economic theory both suggest that these will not radically alter the nature of the economic system.
However, while we should not fear the changes brought by widespread and extensive automation, we should be concerned about the way the process works and about its short-term and transitional aspects. Devising ways of dealing with these is a real challenge for both public policy and civil society.
In the last few years, there has been a lot of discussion about a new wave of automation that is already under way and starting to transform much of the economy. The central element in this is the combination of telecommunications with artificial intelligence (AI). This makes possible, people both hope and fear, the replacement of a great deal of human labor of many types. It is AI in particular that attracts the attention, not least because of recent dramatic breakthroughs such as the development by the Google-owned firm Deep Mind of an AI that could defeat the world’s best Go player (Go is a game played mainly in the Far East that in terms of its complexity is at least one order of magnitude higher than chess).
There have of course been many episodes of mechanization and automation before over the last 250 years. The argument made by many is that this time really is different for two reasons: AI replaces not just human labor but the human mind and judgment as well, and the automation will make market signals unnecessary because the key resource will be information, which is inherently abundant and can be reproduced at zero marginal cost.
There is a consensus that a lot of jobs or kinds of employment are going to disappear in the next two decades or so. There is disagreement over just how many will go as a proportion of currently existing employment. The OECD estimates that just under 10 percent of existing jobs are at high risk of automation. Other studies all conclude that the correct figure is somewhere in the high 40 percent range. The weight of opinion is therefore on the higher side of the two kinds of estimate.
Kinds of Jobs
There is a general agreement about the kinds of jobs that are likely to vanish. They all have certain qualities. One is that they are routine and repetitive, involving the repeated performance of standardized tasks. This includes both simple manual jobs and process-driven desk jobs. Another is that the job or role can be captured in a decision-making tree or flow diagram so that the range of decisions that have to be made is finite (it may still be large) — this means it can be done by an algorithm.
There is also general agreement about the kinds of work that are at low risk of automation. One is work requiring manual dexterity and manipulation (because of the difficulty of replicating the human hand); another is anything that requires human judgment or creativity, dealing with something that cannot be captured in an algorithm. The OECD study also argues that work involving human interaction is likely to survive simply because people crave human contact. Others are skeptical about this. Finally, there are some cases where stubborn human prejudice will keep the job in existence: it would be much safer if airplanes were entirely automated, but in polls most people would (irrationally) prefer a human pilot.
Given this, we can easily construct a list of the kinds of employment that are likely to vanish in the next decade or two. These range from jobs such as truck drivers and taxi drivers (replaced by autonomous vehicles), to a lot of logistics and warehouse work (replaced by automated handling systems), to a lot of routine work in the financial-services sector both high and low paid, to most legal work (but not trial lawyers) and most medical work, including diagnosis and prescription (but not surgery). There will thus be substantial losses of both blue collar and white collar jobs — in fact the losses of the second kind are likely to be larger.
Common Responses
Faced with this prospect of a huge upheaval in employment with many kinds of work simply vanishing, one response is to panic. The fear is that there will simply be no work available, or not enough for the people looking for and needing paid work. Others are excited and see this as a huge opportunity.
A popular reaction at the moment is to see this as the way toward a radical reconstruction of the entire economic system and a move beyond capitalism to some other kind of economic order. The idea is that the connection between work and income will be decisively severed and that we will also move into a world in which many products will be capable of being reproduced at zero marginal cost, which means they will be effectively free: in that case, the price mechanism will no longer operate.
This view has been eloquently put forth by people on the Marxist left such as Paul Mason (in Post-Capitalism) and Aaron Bastani (in Fully Automated Luxury Communism). These authors see the chance to realize the vision of the young Marx, in which the alienation of work is abolished along with the division of labor.
There are also people on the free market side who see this kind of outcome as likely, although what they envisage is a capitalist economy in which a large part of the population subsists on free stuff while not working or doing low-paid work.
New Kinds of Work
Neither panic and despair nor excitement is justified. The question to ask is not whether new technology is going to replace many jobs but whether those jobs will be replaced by new ones. There have been several episodes before where observers have expected the end of employment because of automation, and in every case the actual result has been that while many jobs do disappear, they are replaced by even more new ones.
Of course, that does not mean the same pattern is bound to happen again — to think so is to commit the fallacy of induction. It really could be different this time. However, there are theoretical reasons to doubt the more excitable predictions.
Firstly, many theoreticians of AI have a mechanistic view of human consciousness and decision making. For them, the human brain is simply a computer, only more complex and made of neurons rather than silicon. Hence the processes that create human thought are no different from the kind that take place in a computer or an AI, and any and all of them can be reproduced in a sufficiently advanced AI. This would mean that any and all human activities could be performed by an AI.
This, however, confuses intelligence and consciousness. We truly have no idea what the latter is or how it is produced, but we do know that the two are distinct (there are animals that we can show to have one but not the other). An AI or computer procedure, no matter how advanced, can only do what its programming and algorithm allow for — it cannot originate anything. This means that genuine creativity or the exercise of judgment when confronted by something novel cannot be built in. They remain human capacities.
Secondly, there is the question of knowledge. Even if most activities can be reduced to an algorithmic decision tree, the knowledge that those decisions will be made on is mostly tacit, localized, changing, and therefore incapable of being expressed in writing or numbers. This gives humans an advantage because of their greater flexibility and adaptability (AI can also learn, but this process is not as flexible as in humans). Putting the two things together means that there are many areas where humans will retain an advantage. Even if AI can also do these things, it will do so at a higher cost.
Thirdly, this misunderstands what automation does and hence its effects. What automation of any kind does is to make work more productive and hence to free up time and resources by increasing the intensity of the use of resources. Instead of using X amount of time and Y physical resources to get a given output, you use a fraction of X and Y to get the same result. This frees up the resources and human time for doing other things.
The result is fewer people doing some things and the people no longer doing them doing other things (often in different places). One challenge is that we do not know what those other things will be (although we can make informed guesses). We should not speak of a displacement of human labor but rather of its being freed up to do new things, in the way that all of the labor once needed to grow food has been released to do a myriad of other tasks. (The argument about zero-marginal-cost production misunderstands the nature of both scarcity and the price system, but that is another argument).
Genuine Challenges
So should we just chill and see what happens? Not so. There are two genuine challenges that these changes pose. The first is that the rewards from the new activity and its output will accrue to a small minority. The historical pattern is that this is what happens in the early phase of any technological transformation, due to first-mover advantage and simple good fortune.
However, as time passes and the returns to the new technologies decline as it becomes mature and widely adopted, the income and wealth gap that widened in the earlier phase starts to shrink. This is what we can observe in both the 19th and 20th centuries. However, this takes time, and in the meantime you can have serious political and social unrest, for obvious reasons. Moreover, today the high rewards to first movers are artificially heightened and prolonged by the legal system, above all the current regime of intellectual property rights.
The second challenge is that the transitional costs in human terms of rapid innovation can be very high. Outside the world of economic models, the reallocation of both capital and labor as a result of technological innovation is neither immediate nor frictionless. This is because of the heterogeneity of both labor and capital — they are not uniform.
In plain English, this means that many capital resources such as buildings and machinery will simply become useless because they are in the wrong place or cannot be readily adapted or changed to a new use. In terms of labor, a person who has a range of skills that are now redundant may find it very difficult to acquire new ones or to move physically to a different place. In human terms, this can be very painful and traumatic and very destructive of both human connections and personal happiness. This is a real challenge — you can write off capital, but writing off human beings (often in large numbers or in concentrated locations) is both wrong in itself and very dangerous.
What Should Be Done?
If that is the real challenge of AI and automation (as opposed to fantasies of automated luxury communism or panic and despondency about the replacement of humans), what then should be done? Clearly, there is a place for imaginative public policy, which should mainly take the form of institutional reform and innovation rather than paid programs (e.g., radical reform of intellectual property).
The main step though is to look to social entrepreneurialism. We need people to develop solutions to the challenge of radical change in work and employment at a local level and in a decentralized but networked way. It is mutualism and social action that we need to rediscover and employ. Fortunately, some of the results of the current wave of automation are likely to make this easier, but that is for another column.
Is it Proper for Men to Be Creative with Formal Wear?


There seems to be a fashion this season for new approaches to men’s formalwear, and I’ve been getting questions about it.
Is this proper or tacky? Exactly what are the limits here? Here is my answer.
This is probably the third round of such experimentation in my adult life. It’s as if people suddenly get bored with the traditional black tie, studded white shirt, black dinner jacket, and black trousers with a satin stripe. Hey, how come all the women at this party look amazing while every man looks the same and together the men look like they should be standing on an iceberg at the North Pole and have tiny unusable wings on their sides?
It’s a good question. The answer is as follows: the men all look the same precisely so that the women can stand out, dress up, be fancy, and display themselves in all glory. This is precisely how it is supposed to be. It’s the reverse of the animal kingdom where the male cardinal is fancy and the female is plain.
The evolutionary reason has to do with gender balance (and you are free to reject the following; don’t shoot the messenger). The explanation is that in general men have superior body strength and are hence more physically threatening by their nature and thus must affect a variety of displays of deliberate disempowerment to even out the balance in the interests of gender tranquility. This is why men open and hold doors, bow and defer, pay for meals, light cigarettes, and affect other forms of obsequious service as part of the rubric of social life. Deliberately declining to don fancy, glittery, overtly individualistic clothing at high-end socials is part of that protocol.


As with any of these rules, they only matter if they are operational in a world of prosperity and choice. If everyone is scratching around in dirt and living hand to mouth just to survive, high-end manners never become a reality to which anyone but the lord of the manner and his family must comply. The world in which manners and dressing protocols begin to matter is the second half of the 19th century.
This tradition in the modern world began in the aftermath of the Civil War at the dawn of the great enrichment in America, when the possibility of exercising clothing choice spread from the aristocratic upper classes to the newly capitalistic well-to-do. The question for men in this age in America was: how can we look amazing and keep to the protocols of what is right and not right?
In 1865, the Prince of Wales (later King Edward VII) wore the black tie and dinner jacket (instead of the more formal cutaway coat) and this was borrowed for social occasions in Tuxedo Park, New York, which had become a fashionable area for hunting and fishing clubs for the newly rich. This is why the black tie and dinner jacket in America, and only in America, is called a Tuxedo.
According to the Wall Street Journal:
The story of how the tuxedo made its initial debut in American society dates back to the Gilded Age, when the founders of the posh Tuxedo Park resort in Orange County, N.Y., are thought to have introduced the coat at their exclusive sporting club. This fall (2011), current residents of the Park, along with the local historical society and the distinguished Savile Row clothier Henry Poole & Co. plan to celebrate the legacy of the tuxedo in a manner befitting its eminent birth.
The word has always been and remains a colloquialism. The proper term is black tie. Predictably, the tux disappeared mostly during world wars one and two – no one cares about such finery when the nation is involved in a seemingly existential struggle – but returns in times of peace and prosperity.
Now to the subject at hand. To what extent can traditional wear be adjusted and remain in the realm of propriety? In the 1960s, you began to see the jackets change with new seasonal plaids. In the 1980s, red ties became popular. And now we see the sudden emergence of what was considered tacky in the 1970s reinvented into a high-end product: the velvet dinner jacket.


The look is still formal but it steps out of the bounds of what is supposed to be the canonical social requirement that men dress more or less identically in order to make room for the women to shine.
My own view on this is that while duty seems to require that men decline to be fashionable at formal events, there are times when you just have to say: hey, this is boring!
What are those occasions? Every woman knows the difference between a cocktail dress and a formal long dress, and which occasion calls for what.
I would simply suggest that the same is true of men. The traditional garb can be adjusted for cocktail parties asking for black tie. It means you can wear a white, red, pink, or Polkadot tie. You can wear a plaid or velvet dinner jacket (not just any sport coat please).


On the other hand, for a formal ball – say a benefit ball for the opera or a foundation – play it safe with the traditional garb. Thus does it depend on the occasion.
That said, there are ways to distinguish yourself even with the traditional tuxedo. You can wear a single high collar, a pocket square (white only please), double breasted, or a shawl collar. You can choose pearl shirt studs. There is an endless number of formal options for cufflinks and hence no requirement as such to stick to black.
A little bit of signature goes a long way here.
Keep in mind that there is a reason that all of this represents a modern tradition. Only modern capitalistic economies created a glorious opportunity for everyone to dress in the attire reserved for the royalty of old. We democratized formality, and there’s no better time to show precisely how this works than during the holiday season.
Women have long understood this. It’s time for men as well to step up and embrace both the rules and the proper way to break them.