David Friedman On The Austrian Test

The Ludwig von Mises Institute just published an economics quiz designed to determine how compatible one’s views are with Austrian economics. (I note that the quiz was prepared with the assistance of No Treason contributor Bob Murphy.) As soon as I saw the quiz I had two thoughts: (1) Tests of this sort are very often skewed in favor of a desired result. (2) In general I have not been impressed when writers form the Mises Institute have offered their representations of the positions of other schools, especially those of neo-classical economics and the “Chicago” school.

I asked David Friedman what he thought of the quiz and he kindly gave me permission to post his observations. I present them here and I’ve inserted the quiz answers representing the positions of the Austrian and Chicago schools.

The Ludwig von Mises Institute just published an economics quiz designed to determine how compatible one’s views are with Austrian economics. (I note that the quiz was prepared with the assistance of No Treason contributor Bob Murphy.) As soon as I saw the quiz I had two thoughts: (1) Tests of this sort are very often skewed in favor of a desired result. (2) In general I have not been impressed when writers form the Mises Institute have offered their representations of the positions of other schools, especially those of neo-classical economics and the “Chicago” school.

I asked David Friedman what he thought of the quiz and he kindly gave me permission to post his observations. I present them here and I’ve inserted the quiz answers representing the positions of the Austrian and Chicago schools.

Friedman:

I’m looking at the ten question version:

1. c is a little closer to my view than b, but neither accurately represents my position or, I think, that of other Chicago school people. In particular, I would reject the final sentence in c–Property does not arise naturally, but is the end product of the legal system. On the other hand, b’s “any encroachment on property” makes it sound as though there is only one way in which property rights can be defined–which is inconsistent with observations of the primitive societies that presumably give us our best picture of what “naturally arises.”[quote]Answers:

B. Property is a naturally arising relationship between human beings and material things. Property and enforceable property rights make possible economic calculation, a wider and more productive division of labor, and therefore increasing levels of prosperity. Indeed, civilization itself is inconceivable in absence of private property. Any encroachment on property results in loss of freedom and prosperity. The Austrian answer.

C. Property is central to prosperity and economic growth. Accordingly, it is of the utmost importance that the state, or more abstractly the law, maintain and modify the bundle of property rights in such a way as to allocate transactions costs in such a way as to promote maximum growth and economic efficiency. Property does not arise naturally, but is the end product of the legal system. Chicago answer.

Friedman:

2. B. does not represent my view nor, I think, that of other Chicago school economists.

Answers:

A. The economist should not mimic the behavior of the natural scientists, because the social sciences involve human beings. Human action is characterized by intentional behavior, which involves the rational use of means to achieve desired ends. The very subject matter of economics—capital goods, money, wage rates, etc.—are not defined by physical or chemical properties, but instead by the mental or subjective attitudes that human minds take toward these things. Consequently, the proper method for an economist is to start with self-evident axioms—such as that people try to achieve the highest utility at the lowest cost—and logically deduce conclusions from them. The Austrian answer.

B. Like the physicist, the economist (if he wants to be scientific) should construct a precise model that yields quantitative predictions about economic variables, such as GDP and unemployment. Then the economist should test those predictions against the actual data as collected by statistical researchers. At any given time, the best explanation or “theory” of a certain economic phenomenon is that model which yields the best fit between predictions and actual data. The Chicago answer

Friedman:

3. B is closest to my view and reasonably accurate–I’m guessing it is supposed to be the Chicago view.

Answers:

B. Interest payments are a return on capital, and the interest rate in equilibrium equals the marginal product of capital. The situation is perfectly analogous to labor, where the wage rate equals the marginal product of labor. There are various technological recipes yielding output at various future dates, and consumers have preferences for consumption at various future dates. On the margin, present consumption will be preferred to future consumption, and an extra unit of capital invested will yield an increment in output (available in the future) that just makes the consumer indifferent between consuming now or waiting an additional unit of time and consuming the higher yield made possible by the productivity of capital. The government should not meddle with interest rates, for the same reasons that the government should not meddle with wage rates. Chicago answer

D. Interest payments reflect the higher value of present goods over future goods. Other things equal, everyone wants to consume sooner rather than later. The current price of a computer might be $1,000, but the price of a claim to a computer delivered in one year would currently sell for less than that, say $900. An entrepreneur might invest $900 in labor and raw materials in order to sell a product next year for $1,000; his implicit interest return is due to the fact that the factors of production represent technological “claims” on future consumption goods, and thus their current price (the $900) is less than their ultimate sale price ($1,000). Obviously the government need not interfere with the market interest rate, since it merely reflects the subjective premium individuals place on a marginal present good over a marginal future good. The Austrian answer.

Friedman:

4. C would be my position, and I think that of other Chicago people, not D, which I presume is supposed to be.

Answers:

C. Saving (which means forestalling current consumption) is essential for capital formation, but there is no socially optimal ratio of consumption to saving that should predominate in society. It all depends on the social rate of time preference, that is, the extent to which people prefer goods sooner to later. Individuals may choose consumption over investment or visa versa. Government intervention can skew these choices, subsidizing or taxing savings or consumption or both. In order to have the mix reflect the most economical choices, government should have no policy toward saving, even in the case of saving for old age. The Austrian answer.

D. There is no investment, and hence no economic growth, without saving. For this reason, the encouragement of saving should be an economic priority. Inflation discourages savings, which is a major reason why a policy of stable money should be the central-banking policy. Empirical studies show that saving takes place over the life-cycle of individuals. Miscalculations can occur, which is why the government might need to encourage private retirement accounts, a system that is more efficient than Social Security because it yields higher returns. The Chicago answer.

Friedman:

5. A would be closest, although not very good. C looks as though it was written by someone who either doesn’t understand Marshall or can’t explain the ideas very well.

Answers:

A. Physical objects such as a banana or an automobile do not possess intrinsic economic value. On the contrary, only a human mind can attribute value to such items, and only then do economists classify them as goods. An object is valuable only because there is at least one human being who believes that this object can help satisfy his or her subjective desires. For example, even if a particular root cures cancer, if no one knows this fact, then the root has no economic value, and people will not trade money for it. Consequently, value is caused by an individual’s subjective desires and his or her beliefs about the causal properties of a particular item. The Austrian answer.

C. The value of a good is determined by the interdependence of supply and demand, or what might be called the interaction of cost and utility. In contrast to some schools of thought, which try to explain value on the basis of utility alone, the correct approach is that of Alfred Marshall, who realized that economic value is due to both subjective preferences and to objective technological conditions. To see this most clearly, consider that if the costs of production go up for a particular good, in the new equilibrium its final price must be that much higher. Chicago answer

Friedman:

6. C is closest to my position and, I would think, that of many other Chicago people. Presumably A is supposed to be.

Answers:

A. Money can emerge from barter, but private interests will probably not develop it to suit the needs of a modern economy. We need central banks to sustain the financial sector. Efforts to manipulate the economy using the money supply will at best fail, and at worst cause severe problems. Monetary authorities should not increase the money supply at their discretion. They should increase it at a steady rate, matching the long term growth rate of the economy. Chicago answer.

C. Money always emerges out of barter. The difficulties of finding trading partners under barter systems results in the emergence of commodity monies. Durable, portable, and divisible commodities, like gold and silver, typically fit the bill as money best. Money and related institutions emerge as an unintended consequence of self interested trading. The evolution of such institutions is best left to the competitive market forces that created them in the first place, as governmental intervention will result in inflation and other distortions. Austrian answer.

Friedman:

7. I don’t like any answer, in part because I’m not sure I know what causes business cycles. A, which is probably supposed to be the Chicago answer, is at least better than the others.

Answers:

A. Variations in the money supply cause GDP growth to deviate from its general trend. Absent these variations the economy is relatively stable. Variations in the money supply cause inflationary booms and crashes. Lags in the adjustment of wages with these cycles mean that financial booms and busts will entail significant changes in unemployment rates. Chicago answer

C. Expansion of the money supply artificially reduces interest rates. This causes a boom in consumer and investor spending. With businesses thinking longer term, and consumer thinking shorter term, a discoordination emerges in the economy. The time relationship between saving and investment, production and consumer, is disrupted. Market processes reveal that many investments are not really profitable but instead are clusters of errors. Businesses then liquidate these investments, causing a recession. Austrian answer.

Friedman:

8. The only answer that seems to me to make sense for either Chicago or Austrian is D, which presumably is not what the test intends.

Answers:

A. A balanced relationship between aggregate demand and aggregate supply is the leading determinant of economic growth. Because private markets cannot always provide this, stable institutional environments are necessary. The public sector plays a vital role in securing economic growth by providing a framework of legal and financial institutions. A variety of public-sector efforts such as low-interest rates and subsidies may also play a positive role. A limited amount of regulation is necessary, but this is not necessarily true. Chicago answer

D. The source of economic growth is mutually beneficial, voluntary exchange. Within the exchange economy, consumers spend part of their income on goods and services to satisfy their most immediate wants. This drives current production. Consumers save part of their income according to their less immediate wants. This drives entrepreneurial investment in future production and leads to the development of sophisticated capital markets. Private contracts, competition in markets, and private institutions that allow for capital investment and accumulation are all you need to attain optimal economic growth. Austrian answer.

Friedman:

9. D is the closest to the Chicago position.

Answers:

C. Economists of the classical school were right to define a monopoly as a government-grant privilege, for gaining legal rights to be a preferred producer is the only way to maintain a monopoly in a market setting. Predatory pricing cannot be sustained over the long haul, and not even the attempt should be regretted since it is a great benefit to consumers. Attempted cartel-type behavior typically collapses, and where it does not, it serves a market function. The term “monopoly price” has no effective meaning in real market settings, which are not snapshots in time but processes of change. A market society needs no antitrust policy at all; indeed, the state is the very source of the remaining monopolies we see in education, law, courts, and other areas. Austrian answer.

D. Monopoly regulation has caused more harm than good by protecting particular competitors, not competition. Some types of regulation against trusts are based on flawed models that fail to understand that some firms gain market share solely because of their products’ desirability to consumers. Most cited cases of “path dependency” turn out to be mythical. What is left for regulators to do? As Adam Smith said, they should prevent business conspiracy, blatantly predatory behavior, and otherwise assure a level playing field leading toward genuine competition. Finally, some goods lend themselves to being best provided by monopolies, e.g. courts and defense. Chicago answer.

Friedman:

10. A is the closest to the Chicago position, although not very close. Presumably B is supposed to be.

Answers:

A. Equality is a term that properly relates to mathematics but not to social science. Human beings are unequal in their endowments, opportunities, and will to achieve. Unequal does not mean inferior or superior; it merely means different. Differences are the very source of the division of labor, and, within a market setting, lead not to conflict but cooperation. While differences should be celebrated, property owners have every right to treat people unequally because it is owners that bear responsibility. Legislators, however, should not have any concern for bringing about equality of result or opportunity, either between individuals or groups of individuals classified according to any criterion. The only place for equality concerns the law, which should treat all individuals the same without regard to their station in life. Austrian answer.

B. It is a great mistake to make equality of result a policy goal, because egalitarian legislation can kill incentives to improve. Punishing the rich is self defeating, even for the poor striving to make their way. Equality of opportunity, however, is something different. It something everyone merits by their very dignity as a human being. Thus should a nation strive for quality educational institutions, institute a limited inheritance tax, and otherwise assist those who, through no fault of their own, lack the means to gain entry into the division of labor. Once these institutions are in place, we will find that the forces of market competition will achieve egalitarian goals through predominately voluntary means. Chicago answer.

Friedman:

In summary, the test does a very poor job of representing the Chicago position, I think for two reasons.

1. Its author doesn’t understand other people’s ideas very well.

2. It’s author want to link Austrian economics with libertarianism to a degree that is historically unjustified.

David Friedman
Professor of Law
Santa Clara University
http://www.daviddfriedman.com/
[/quote]Depending on what he chose for the second question I think Friedman would get a score between 70 and 80. I think the designers would expect him to get a 50. He identified the supposed Chicago positions with high accuracy but he rejected most of those representations as unsatisfactory.

I don’t think the test is very good.

13 thoughts on “David Friedman On The Austrian Test”

  1. I scored a 95, making me marginally more compatible with the Austrian answers than Friedman was. On nine of the questions I could immediately tell which answer was supposed to represent which school. In many cases I was unhappy with the answer I chose feeling that it was partly wrong even though it was closest to my view.

  2. I finsihed with a 95, which surprised me, as I wasn’t aware as I was taking the test that I was so consistently choosing the Austrian over the Chicago answers.

    Many of Friendman’s observations, especially about questions 1 and 7 were pretty much exactly mine. The malinvestment theory of business cycles still “speaks to me” more that the alternatives, but I don’t really think I know what causes business cycles, either. (I did think that the Austrian answer to number 5 was reasonably good, though).

    I disagree about the criticism of the test in one way, though. I thought the questions and answers were much better and well thought out that any other “position” quiz on the web that I’ve seen.

  3. I got 98 out of 100 points on the 25 question version, but that’s probably just because I picked the answers that seemed most libertarian. Many of the non-Austrian posititions were strawmen. The most pathetic mischaracterization of non-Austrian views was the labeling of the Keynesian/neoclassical answers, as if the neoclassical economists and the Keynesians were one and the same school of thought!!

  4. David Friedman says that 2B “does not represent my view nor, I think, that of other Chicago school economists.” Come on! Didn’t he read his own father’s books?????? It certainly is!!!! Check out “Essays in positive economics” 1C is good – check out Coase’s work. 6A is also good. Again! Check Prof. Milton’s work. Chicago is in favour of a central banking system to “stabilize price level”. 8A check out what are Chicago economists talking about Great Depression. See Simons, Knight, Fisher etc. See also Friedman on money. 10B is an utilitarian answer, compatible with Chicago guys.

  5. Hmmmm. I scored 67, but didn’t feel like my views mapped onto the questions very well.

    I didn’t find it difficult to identify the Marxist selections, but felt that they were set up as “straw men” to throw the other options into relief. I found myself doing a “2/3 A and 1/3 B” in my mind quite often.

    I found many of the “Chicago” answers were plausible, but not necessarily in the way intended. My own personal philosophy is based on: “Each person needs to assume personal responsibility for their own economic choices. The more successful members of society, however, may advocate wealth-sharing, education, charity, public works, and incentivization plans to help the less-fortunate — because social problems of disaffected groups can easily become personal problems of more successful people.

    The pigeonholing of answers as “Chicago” seemed to come from the notion that these actions could only spring from pure altruism.

    As an aside to JTK — funny, I use my middle initial everywhere, too….JHK.

  6. Regarding the comments on some of the answers being “strawmen”, I think a test like this simplifies all answers to the point where even the Austrian answers look like strawmen. And besides, I prefer Chicago economics or Austrian economics over J.M.K.’s ideas anyday. (I won’t even mention the socialist theory)

  7. Until I saw this quiz, I didn’t realize that Austrian economics specifically implied anarchism (and I’m being sarcastic, because I still don’t think it really does). Does the author of the quiz really mean to imply that you aren’t a true Austrian if you aren’t an ancap? Mises, after all, was no anarchist.

  8. Many Austrian economists are anarcho-capitalists. Many anarcho-capitalists are Austrian economists. However, not all Austrian economists are anarcho-capitalists (Mises, Hayek, Rand [if you can call her an economist]). Hell, if we consider Allan Greenspan an Austrian economist (despite all his hocus pocus now as the chairman, if you look back in his history, he made Austrian remarks), you realize that Austrian economists can even be Statists. Furthermore, not all anarcho-capitalists are Austrian economists (e.g., Bryan Caplan, David Friedman).

    Though I greatly appreciate and highly agree with the Austrian school, with a few exceptions (e.g., Mises), I’d rather have someone who’s a non-Austrian anarcho-capitalist, than someone who’s a non-anarcho-capitalist Austrian economist. Despite the numerous disagreements between Friedman/Caplan and Rothbard/Hoppe on economists, all of them (as far as I can tell) want the same thing: a completely stateless society. Those who would alienate Caplan and Friedman because they aren’t Austrian economists baffle me. If someone is aiming for essentially the same goal as you, what does it matter why they’re aiming for that goal, or what reasons they use to justify it?

    I looked at this quiz, but never completed it. It was very long, and I’m pretty sure I’d have almost completely identical positions to the Austrians anyways (though D. Friedman can question how well the Austrians represent other schools, I doubt he would claim they don’t represent themselves properly). The problem with representing other schools is that eveyrone has a different opinion on what the school represents. Maybe a better thing to do would be to submit the questions to prominent members of the various schools, and have them send back answers. I’m uncertain of D. Friedman’s economics, however, I know Milton Friedman is the foremost representative of the Chicago school. Ask him for the “Chicago” answer. Ask someone like Paul Craig Roberts for the “Keynesian” answer. And so-on and so-forth.

    However, even that isn’t going to solve the problem that this is a multiple choice quiz, and thus has all the problems that any multiple choice quiz has. You can’t possibly represent all answers, for example.

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