Lesser Known Economists Editorial Opinion

New Science Validates Laissez-Faire
And Draws Attention To
Little Known School of Economic Thought

by Carole E. Scott

Dr. Carole E. Scott is a Professor of Economics at the State University of West Georgia and Editor of Business Quest.

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"Conventional thinking passes on the notion of ideal states, static equilibrium systems, and linear dynamics and continuous functions as if everything worth knowing about science had been discovered. The implication is that if students learn this catechism, then real cases can be addressed by approximation to the ideal. The fact is, of course, that physical systems are real, not ideal, and many of the most interesting systems are discontinuous rather than continuous, nonlinear, rather than linear, and dynamic as well as static. In addition, the maxim that reality is only a mild departure from the ideal isn't the case. As best-selling author James Gleick said, Relativity eliminated the Newtonian illusion of absolute space and time; quantum theory eliminated the Newtonian dream of a controllable measurement process; and chaos eliminates the Laplacian fantasy of deterministic predictability.' The great discoveries of the past should be accorded their well-earned due, but it is time to move on to what has been characterized as the science of the 21st century." [Hutchison, 70]

It was long thought that such events as water dripping from a faucet and the fibrillation of the heart were random and unpredictable events. These and similar events can be modeled mathematically via non-linear equations, but before the introduction of high speed computers solving these equations was not feasible because of the enormous number of calculations that were necessary. Once computers were used to model these events, it was learned that some contain patterns. Out of this work arose a new theory, chaos theory and a new geometry, fractal, a geometry of algorithms, rather than the lines and circles of Euclidean geometry.

Economists became interested in chaos theory when Benoit Mandlebrot, a French mathematician, applied fractal analysis to seemingly random, historical cotton prices and found clear evidence of similar patterns in daily, weekly, and monthly cotton price changes. Subsequently this analysis was applied to exchange rates and other economic events. In Chaos and Order in Capital Markets, Edgar Peters contends that chaos theory is a far superior framework for examining the stock and bond markets than the efficient markets hypothesis. Some, however, take issue with Peters.

"Many have now concluded that formal chaos theory has nothing practical to offer. As Ron Liesching, head of research at Pareto Partners, a quantitative fund-management firm, jokes: The best way to make money out of deterministic chaos is to write about it.' Other American fund-management firms, such as Renaissance and the Prediction Company, which enthusiastically embraced chaos in the 1980s, have mostly abandoned it in favor of other techniques." [Anonymous, "Finance," 69]
Among the economists today seeking to use a related theory, complexity theory, to explain stock market price movements is an Irish-American economist named Brian Arthur. His introduction to the application of chaos and complexity theory to economics is described in Complexity, The Emerging Science at the Edge of Order and Chaos by M. Mitchell Waldrop.

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Arthur was well versed in mathematics and close to obtaining a doctorate in operations research when he decided to change fields and get a doctorate in economics. He hoped and expected to find historical drama in his economics classes, but he was disappointed, as it was absent from the courses he took at Berkeley.

Economics, he concluded, has become a "...branch of applied mathematics; an ersatz physics whose theories have been leached of all human frailty and passion." [Waldrop, 22] (It may also be the case that the quantification of economics has led to the leaching of a lot of principles of economics from doctoral programs in economics).

The Neoclassical theory that underlies mainstream economics in America today, he believes, "...has reduced the rich complexity of the world to a narrow set of abstract principles that can be written on a few pages, and whole textbooks are...practically solid with equations." [Waldrop, 23]

The brightest young economists, he says, are "... devoting their careers to proving theorem after theorem--whether or not those theorems" have much to do with the real world." To Arthur, coming as he was "....from applied mathematics, a theorem was a statement about an everlasting mathematical truth--not the dressing up of a trivial observation in a lot of formalism." [Waldrop, 22]

Arthur was frustrated by his inability to get his ideas published in an established journal because an idea not published in one of these doesn't officially exist. [Waldrop, 19] Then he got a break. He was invited to join a multi-disciplinary group of scientists at the Santa Fe Institute. These scientists were seeking to explain complexity, that is, how systems that are open to sources of energy are able to raise themselves to higher levels of self-organization. (According to the second law of thermodynamics, closed systems will inevitably become random, that is, chaotic.)

Chaos theory does not explain the structure, coherence, self-organizing cohesiveness of complex systems. The complexity theory the scientists at the Santa Fe Institute work with is related to chaos theory in that it explores the behavior of a system at the edge of chaos (a point) "...where the components of a system never quite lock into place, and yet never quite dissolve into turbulence either." [Waldrop, 12] Complexity is zone which lies between stability and predictability on one side and chaos and unpredictability on the other. The Santa Fe scientists believe that complexity theory is broadly applicable across the natural and social sciences.

Physicists at the Institute were amazed, Arthur relates, to learn how seldom economists pay any attention to the admittedly lesser amount of data available to them than physicists, and their failure to consider the unquantifiable impact of non-economic influences such as political motives and mass psychology. Perfect rationality, economists' method of dealing with the fact that their "particles," people, have a past, goals, experience, and expectations drove the physicists nuts. [Waldrop, 141]

According to the theory of perfect rationality, he told them, economic actors know everything that can be known about the choices they will face infinitely far into the future, and they use flawless reasoning to foresee all the possible implications of their actions. An obviously relevant question is: how can this be, when it is not even possible for anyone to consider and evaluate all the possible moves which can be made in a chess game?

For many people, the complexity theory developed at the Santa Fe Institute goes against the grain, because they are "...strongly conditioned to attribute complex phenomena to some kind of controlling agency. We commonly assume, for example, that the frontmost bird in a V-shaped flock is the one in charge and the others are playing follow-the-leader. Not so. The orderly formation is the result of a highly responsive collection of processors behaving individually and following simple harmonious rules without a conductor." [Negroponte, 157] Some believe this is a very advantageous method of organization, because "....a highly intercommunicating decentralized structure shows far more resilience and likelihood of survival," and it is increasingly being seen as a viable way to manage organizations and government. "It is certainly more sustainable and likely to evolve over time." [Negroponte, 158]

Arthur and other social scientists were recruited by the Santa Fe Institute because complexity research quickly spread from the natural to the social sciences. The methods of computer science are appropriate for the social sciences because they are concerned with the world of information and intellectual processes that are not directly governed by physical laws.

Of particular interest to economists was the work of mathematician John Holland. In seeking a way to model the human brain, he learned that efforts at MIT to create a "command-and-control" model had failed. "So he solved the problem by making each digital 'synapse' into an economic unit. Individual synapses were paid off for solving problems, with a 'bucket brigade' to distribute the rewards to participating units." [Tucker, 37] Thus did complexity theorists confirm that Adam Smith was right. The profit motive is an enormously powerful organizing force.

In 1988, computer experts at the Palo Alto Research Center also discovered this principle when Xerox tried setting up a system to maximize the use of its computers. "Engineers had tried a 'command-and-control' system, but found it unworkable. The information needed to coordinate decisions quickly overwhelmed the central processor. So Xerox researchers invented SPAWN, a system in which individual computers are given 'money' and instructed to maximize their bank accounts by taking on tasks and trading computer downtime among themselves. Without any external direction or control, the computers quickly optimize their own use by trading on this internally created market." [Tucker, 37]

The spontaneous order that the interdisciplinary team at the Santa Fe Institute demonstrated mathematically validated the work of Austrian economist Friedrich A. Hayek. In his 1960 book, The Constitution of Liberty, Hayek coined the term "spontaneous order" to describe a market economy left to itself, because he believed that it will "...spontaneously optimize the wishes and desires of its participants--even though all are only pursuing their own self-interest." [Tucker, 37]

"Right after we published our first findings," Arthur recalls, "we started getting letters from all over the country saying, 'You know, all you guys have done is rediscover Austrian economics....I admit I wasn't familiar with Hayek and von Mises at the time. But now that I've read them, I can see that this is essentially true." [Tucker, 38]

Although the Santa Fe Institute's computer-assisted discovery of spontaneous order appears to vindicate the Austrian School of Economics' faith in free markets, Arthur, nonetheless, advocates government intervention in the marketplace. This is because he believes that, markets sometimes lock in an inferior technology, such as the VHS, and he thinks the government should intervene to prevent this. Neoclassical theory, he falsely claims "...would have us believe that a free market will always winnow out the best and most efficient technologies." [Waldrop, 34])

The only thing "Austrian" about Austrian economics is its place of origin and the nationality of Ludwig von Mises, the immigrant who brought this school of economic thought to America. Most assuredly, it is not the dominant "brand" of economics in today's socialist Austria. Only in recent years has it begun to regain a place in European thinking. It is, however, a school of thought of growing importance in the United States, where the great majority of its adherents live.

Because Ludwig von Mises was the most prominent of the few economists who claimed that socialist economies would collapse because they cannot rationally allocate resources, the collapse of the Soviet Union and the introduction of market-based economic reforms in China has raised this school of economic thought from an obscurity so great that formerly a great many economists had never heard of, and the few who had usually knew very little about it. The awarding of the Nobel prize in economics several years ago to an Austrian, the now deceased Friedrich von Hayek, also added greatly to Austrian economics' stature. Hayek was the author of many thoughtful books, one of which, The Road to Serfdom, marked the revival of classical liberalism and gained a substantial non-academic audience. (It was condensed by Readers' Digest and featured by the Book of the Month Club.) In it, he warned that Great Britain was making a terrible mistake by turning to socialism after World War Two.

That mathematics would be used to prove von Mises right is ironic in light of his views regarding mathematical economics:

"The mathematical economists...formulate equations and draw curves which are supposed to describe reality. In fact they describe only a hypothetical and unrealizable state of affairs, in no way similar to the catallactic problems in question. They substitute algebraic symbols for the determinate terms of money as used in economic calculation and believe that this procedure renders their reasoning more scientific....

In the imaginary construction of the evenly rotating economy all factors of production are employed in such a way that each of them renders the most valuable service....It is, of course, possible to describe this imaginary state of the allocation of resources in differential equations and to visualize it graphically in curves. But such devices do not assert anything about the market process. They merely mark out an imaginary situation in which the market process would cease to operate....

Both the logical and the mathematical economists assert that human action ultimately aims at the establishment of such a state of equilibrium and would reach it if all further changes in data were to cease. But the logical economist knows much more than that. He shows how the activities of enterprising men, the promoters and speculators, eager to profit from discrepancies in the price structure, tend toward eradicating such discrepancies and thereby also toward blotting out the sources of entrepreneurial profit and loss....The mathematical description of various states of equilibrium is mere play. The problem is the analysis of the market process....

The problem of process analysis, i.e., the only economic problems that matter, defy any mathematical approach."[von Mises, Human Action, 353-536]

During von Mises' lifetime, of course, mathematicians lacked the ability to deal with a system without an equilibrium. In his day, mathematical economists worked with what is called Walrasian general equilibrium. This is a system of linear equations which model a changeless economy characterized by perfect knowledge. This model, contended von Mises and his fellow Austrian economists, has no relevance in the real world, which is characterized by uncertainty, continuing change, and scattered knowledge.

If complexity theory is capable of doing what its proponents claim, today it is possible to mathematically model reality as the Austrians describe it.


Complexity Theory

The new science is complexity theory. "Complexity theory explores how systems that are open to sources of energy are able to raise themselves to higher levels of self-organization." [Tucker, 34] Complex systems, it has been discovered, are capable of making unexpectedly large leaps in self-organization that allow them to maintain a precarious non-equilibrium; thus defying entropy. (Entropy refers to an inexorable tendency of things to run down, that is, become random or chaotic.)

Some economists believe this theory provides a way to demonstrate how free markets work, that is, how it is possible for "...a group of individual agents, each pursuing his self-interest, [to lead]...to order rather than chaos." [Vriend, 2] "A decentralized economy, consisting as it does of a large number of locally interconnected and interacting rational agents who are all continually pursuing advantageous opportunities, is... an example of a complex adaptive system." [Vriend, 3] Instead of physics, they contend, economists should look to fields like biology for models useful in understanding how the economy works.

Examples of non-economic, self-organizing systems include hurricanes, air traffic control systems, and the Internet. An advantage to self-organizing systems like free markets and coral reefs are their flexibility, because this enables them to quickly adapt to change. Although such systems never settle down to an equilibrium, they may, it is claimed, temporarily lock in around bad outcomes such as stagflation.

Complexity theorists believe it may be possible to predict future events. Through dynamic modeling they believe people in the soft sciences can clarify their assumptions and discover their consequences. They are not the first to postulate a natural, increasing order. Herbert Spencer, a 19th century English sociologist, claimed that the evolutionary process tends toward increasing order.

Austrian Economics

Austrian economists' basic beliefs can be summarized as: property should be private, trade should be free, and government should be limited and close to the people. They abhor collectivism.

Founded by academicians in Vienna who in the late 1800s originated marginal analysis--a mainstay of microeconomic theory ever since--Austrians' policy prescriptions are well to the right of the mainstream. In an age in which the work of most other economists and a great many of those in the other social sciences has become highly quantified in order to mimic "real" sciences like physics, Austrian economics stands out because of its meager use of mathematics.

As a result of their avoidance of esoteric mathematics, the works of Austrian economists are far more accessible to non-academicians than are those of mainstream economists, whose works often must be extensively revised and reworded before the non-economist can gain even a superficial understanding of them. (Today is often difficult even for professional economists to glean much from mainstream articles written by their peers who specialize in a different branch of economics.)

"Austrians," claims a financial writer for the Financial Times of London, "have remained realistic because they have never suffered from what has been called 'physics envy.' Mainstream economists adopted the methods of the natural sciences in the hope of gaining greater prestige." [Prowse, 3] Unfortunately, the model they chose to copy is classical mechanics circa 1850.

"Mainstream theorists fail to grasp," he believes, "that the subject matter of economics is very different from that of natural science. Science deals with an objective realm of inanimate objects; economics with the subjective thoughts and feelings of human beings. It is surely ridiculous to imagine that similar mathematical techniques would apply in such different realms." [Prowse, 3]

Considered by mainstream economists to be radical, methodological outcasts, the Austrians, who claim, politically, to be Jeffersonians, had no opportunity to have any influence within the Washington beltway until Ronald Reagan became president. President Reagan's attitude towards Austrian economics was friendly because of its similarity to Reaganomics. Austrian economics also has much in common with the economic philosophy of Libertarians.

"What atoms are to physics, individuals are to Austrian economics. Unlike atoms governed by natural law, individuals use their will and powers of reason to guide their brute physical behavior toward their own ends and goals. The Keynesian-neoclassical orthodoxy is 'economics betrayed,' or indeed 'human action betrayed,' in that Keynesians focus, not on individual will and reason, but on forces beyond the individual's control....Keynesians ignore individual choice.

Like the Keynesians, the neoclassicals have displaced the real agent of economic (and all other) activity--the individual will. Where there is will, according to the neo-Austrians, there are ways; where will does not exist, there is only sterile neoclassical equilibrium." [Canterbery, 261] "The radicalness of Austrianism stems from the role of the consumer as the ultimate arbiter of value combined with the entrepreneur's role as the sole creator of value." [Canterbery, 264]

Austrian economists view the entrepreneur as the central actor in the economy. Disequilibra, say the Austrians, lead entrepreneurs--those perceptive enough to recognize it and willing to take advantage of the opportunity to earn profits--to unwittingly serving society. Creating the disequilibra which activates entrepreneurs is the public wanting and being willing to pay for more of something than is currently being provided.

Although, like the Austrians, Neoclassical economists believe in a limited state, the constitutional order Austrians desire is not considered by them to be a necessity. The Austrians want a Lockian-style social contract which will maximize individual freedom. Spearheading the propagation of Austrian economic theory is the Ludwig von Mises Institute. Named for the founder of Austrian economics in the United States, this institute is located at Auburn University. The principles of Austrian economics are also promoted by the Mount Pelerin Society.

It was the Mount Perelin Society which caused Nobel-prize-winning Monetarist economist Milton Friedman to begin writing about policy, as it was at a Mount Perelin Society meeting, says Friedman, "...that I first came into contact with people like Hayek, Lionel Robbins, and the European contingent of that time. That widened my perspective about issues and policy." [Doherty, 34]

Brian Arthur's Views
Equilibrium obsessed neoclassical theory simply does not, Arthur believes, describe the messiness and the irrationality of the real world. [Waldrop, 23]

If taken seriously, neoclassical theory means that history--empirical studies of such things as the history of technology and industries--is irrelevant, because an economy in perfect equilibrium exists outside history. [Waldrop, 50] This explains why so many colleges and universities have dropped their courses in economic history, which he thinks this is a mistake because, like biological ecosystems, the economy undergoes "bursts of evolutionary creativity and massive extinction events." [Waldrop, 119]

Arthur is intrigued by how new technology like "...the automobile comes in and replaces an older technology, the horse. Along with the horse go the smithy, the pony express, the watering troughs, the stables, the people who curried horses, and so on. The whole subnetwork of technologies that depended upon the horse suddenly collapses in what Austrian economist Joseph Schumpeter once called 'a gale of destruction.' But along with the car came paved roads, gas stations, fast-food restaurants, motels, traffic courts and traffic cops, and traffic lights. A whole new network of goods and services begins to grow, each one filling a niche opened up by the goods and services that came before it. [Waldrop, 119] Arthur considers this process to be an example of increasing returns.

...Complex adaptive systems typically have many niches," he observes, "each one of which can be exploited by an agent adapted to fill that niche. Thus, the economic world has a place for computer programmers, plumbers, steel mills, and pet stores, just as the rain forest has a place for tree sloths and butterflies. Moreover, the very act of tilling one niche opens up more niches--for new parasites, for new predators and prey, for new symbiotic partners. So new opportunities are always being created by the system. And that, in turn, means that it's essentially meaningless to talk about a complex adaptive system being in equilibrium: the system can never get there."[Waldrop, 147]

Development economists long ago took note of the phenomena Arthur mislabels as increasing returns. Several decades ago Albert O. Hirshman developed the concept of linkages. This term refers "...to the economic connection between a firm's operations and other sectors of the economy. The connection might be a product linkage, which in turn might be forward or backward. It is called forward when a firm's output is much used as an input by other firms and encourages investment by these subsequent users....It is a backward linkage when a firm's output requires inputs from earlier stages of production and thus encourages investment in these earlier stages." [Hogendorn, 404]

The construction of paved roads is an example of a backward linkage of the automobile industry, while the construction of motels is an example of a forward linkage. Other linkages, such as a trained workforce established by an existing firm attracting competing firms to an area, have also been remarked upon.

Arthur believes that many consumer choices are random events which become locked in due to economies of scale, which in high technology industries may be very substantial. The cost of running a computer network, for example, rises very little when a customer is added. Consumers' initial choices of which network to join is random. Since a customer benefits more from joining a larger network than a smaller one, claims Arthur, the largest network will eventually become a monopoly even though, technologically, it may be inferior to one of the other, unlucky, networks. Therefore, society has taken an inferior path, and producers are enjoying unjustifiably high profits. Arthur's solution is for the government to make these choices. This line of reasoning has been rather effectively countered by Stan Liebowitz of the University of Texas and Stephen E. Margolis of North Carolina State University.


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Biography of Computational Economics


An algorithm is a particular procedure for solving a certain type of problem.

According to the efficient markets hypothesis, a capital market reflects all information relevant to pricing securities. In its weak form it is asserted that prices fully reflect the information contained in historical prices. In its semi-strong form it is asserted that, in addition, all relevant public information about a securities-issuing firm is incorporated into its securities' prices. In its strong form, it is asserted that all relevant information known to any market participant about a securities-issuing firm is fully reflected by its securities' prices.

In light of Austrian economists' aversion to the type of forecasting (econometric) engaged in by mainstream economists, it is ironic that a major reason for Austrian economics' higher profile is due to Ludwig von Mises long ago taking the lonesome position of forecasting that a communist (totally socialized) economic system is doomed to collapse. It must collapse, he believed, because, in the absence of free markets, costs and prices do not reflect society's valuations of either the inputs (resources) or the outputs (goods and services) of the production process. Therefore, it is impossible for a communist economy to calculate whether the production of anything increases or reduces society's over all well being.

Socialist economists lack the knowledge, claim the Austrians, of consumer preferences necessary in order to provide a rational answer to questions like whether, say, additional wire is the best use of the existing stock of copper. In a market economy, on the other hand, where prices are determined by supply and demand, if the public does not value very highly additional copper wire, then the price that copper wire can be sold for will not cover the cost of producing it, because the higher demand for other copper products will cause the price of copper to be too high to make it profitable to use it for wire.

"How might a definite plot of city land be used most advantageously--as a wheat field, a parking lot, a site for a swimming pool or hotel or office or apartment building, or what? By the logic of the price system, this resource goes under the control of whoever will pay the most. In bidding for its use, business firms estimate how much it can contribute, however indirectly, to producing goods and services that consumers want and will pay for. How much value it can contribute depends not only on physical facts of production but also on the selling price of each of the possible final products, and this price depends in turn partly on opportunities to produce the product in other ways. Wheat grown on cheaper land elsewhere would keep anyone who wanted to use city land to grow wheat from affording to bid highest for it. Not only natural resources but also capital, labor and entrepreneurial ability thus move into lines of production where they contribute most to satisfying consumer needs and wants, satisfactions being measured by what consumers will pay for them." [Yeager, 95]

In a communist nation, in order to placate consumers and farmers, the government may set a price so low for bread and so high for wheat that it is cheaper to feed animals bread, rather than wheat. [This has actually happened.] As a result, much of the effort of bakers is wasted and, the public, therefore, is less well off than it could be. Even if a communist government wants to set prices on an economic, rather than a political basis, it is impossible for it to do so, because in the absence of free markets, there is no way to determine the public's relative valuations of either the various goods and services which can be produced or of the resources needed to produce them.

In the socialist economy the only way to measure efficiency is on a quantitative (engineering) basis. Because, per pound, coal is a more efficient producer of heat than wood, on an engineering basis, it is the superior fuel. Yet, so long as there was plenty of wood located near railroad tracks and river banks in this country, it was cheaper, and, therefore, better for society, for trains and steamboats to use wood, because coal had to be mined via underground shafts dug through narrow seams of coal and transported over vastly longer distances to the places where it would be used.

By supposedly achieving efficiency through reducing waste by maximizing the ratio of the weight of output to the weight of inputs, in the Soviet Union they produced chandeliers so heavy no ceiling could support them! Reducing waste by using as much of a bolt of cloth as was possible resulted in clothes so unattractive people would not buy them. Unsold merchandise piled up because under central planning retailers lacked both any incentive or the authority to lower price until it could be sold. Assigned certain suppliers by central planners, retailers lacked the leverage necessary to force their suppliers to provide salable merchandise.

Friedrich Hayek in April 1947 invited a number of then isolated libertarians to meet in the Swiss village of Mount Pelerin. Included in this group was Leonard Read, founder of the Foundation for Economic Education (FEE), and Henry Hazlitt, who wrote for The Wall Street Journal, Newsweek, and FEE's publication, The Freeman. In 1944, when Reed was general manager of the Chamber of Commerce in Los Angeles, he invited Ludwig von Mises to give lectures there. Two years later von Mises became a staff member of FEE.

Both Neoclassical and Austrian schools of economics are supporters of free enterprise, but the mainstream Neoclassical economists very rarely mention the Austrians.

Austrians differ significantly from Neoclassicals in regard to the appropriate use of quantification in economics in part because, while the Neoclassical economists are willing to lump everybody consuming, say, automobiles together, the Austrians are not. This is because people often have different motives for buying the same product.

"Austrian economists...view the world as an emerging and constantly evolving process by which people act and react in pursuit of their individually established interests." [McKenzie, 5] Austrians believe that mathematics is useful only in understanding patterns, while Neoclassical economists believe in using mathematics to make predictions. This is because Austrians view markets as "...a spontaneous order that emerges as people, attempting to pursue their own interest, adjust and readjust their own actions to the actions of others. Because of the learning that occurs as people interact with one another, complex reality is never quite the same and cannot, therefore, be predicted on the basis of past regularities.....To [Milton] Friedman and other neoclassicals, a theory is merely a convenient fiction, a rule of thumb, which is capable of generating predictions that are more often correct than are generated by other convenient fictions." [McKenzie, 7]

Like those normally classified as Neoclassical economists, Friedman, who is normally classified as a Monetarist economist, believes that it is O.K. to assume people are rational and markets are perfectly competitive even if this is not true, if these assumptions result in correct predictions. Austrians believe assumptions must be realistic, and they will only predict a pattern or range of outcomes.

Both the Monetarists and the Austrians have strong, non-mainstream views on money. The Austrians' views are much further from the mainstream than the Monetarists'. The Austrians wish to abolish the Federal Reserve System (Fed) and fractional reserve banking and return to the gold standard. Until and unless this is done, they say, inflation will continue to be a problem. Monetarists, on the other hand, simply want the increase the money supply by a fixed percent annually adequate to accommodate the growth of output, i.e., prevent the growth of output from forcing down the price level. Unlike the Monetarists, the Austrians are concerned over the redistribution of income brought about by excessive money creation. Income is redistributed because the initial recipients of new money spend it before it causes prices to rise.

Milton Friedman a well known, retired professor of Economics at the University of Chicago now with the Hoover Institute, is a leading proponent of a libertarian brand of laissez-faire. A popular educational TV series was based on a book, Free to Choose, he co-authored with his wife, who is also an economist. He writes for Newsweek and Reason: Free Minds and Free Markets.

A proponent of a modern version of the quantity theory of money, his most important academic work is Studies in the Quantity Theory of Money, which was co-authored by Anna Schwartz. During the 1964 presidential campaign, Friedman was Senator Barry Goldwater's chief economic advisor.

Friedman is concerned by the fact that many of the economists whose views the public hears are employed by people whose objective is to promote certain economic policies and theories. These economists' views should be as critically examined as you would what a defense lawyer or expert witness says in court A good example of why you should be skeptical took place recently when an economist employed by President Clinton signed a newspaper advertisement which claimed that an increase in the minimum wage would not cost jobs. Yet, in a textbook published in 1993, he wrote: "How much unemployment does the minimum wage create? That depends on the level at which the minimum wage is set and on the elasticity of demand and supply for labor." [Stiglitz, 131]

Friedman advises young economists to make policy issues an avocation, rather than a vocation. "Get a job," he advises. "Get a secure base of income. Otherwise, you're going to get corrupted and destroyed. How are you going to get support? You're only going to get support from people who are ideologically motivated. And you're not going to be as free as you think you're going to be.

One of the most important things in my career," he says, "is that I always had a major vocation which was not policy....By having a good firm position in the academic world, I was perfectly free to be my own person in the world of policy." [Doherty, 34]

The great English economist of the 19th century, Alfred Marshall, wrote a student that in economics mathematics should be used in the following manner: "

Adam Smith (1723-1790), a Scotsman who advocated an economic policy of laissez faire, is the most prominent figure among those considered to be the first economists. (Interest in and writings about various aspects of the field of economics long predated the birth of economics as a discipline in the late eighteenth century.) Smith's very influential book on economics, An Inquiry into the Nature and Causes of the Wealth of Nations was published in 1776. In it, he referred to an invisible hand. A professor of moral philosophy at Glasgow University, Smith first referred to the invisible hand in an earlier book, The Theory of Moral Sentiments.

The analogy of an invisible hand guiding producers is used to describe how a market system works: the interaction of suppliers seeking to maximize their profits and consumers seeking to maximize their utility (benefits from consumption) "guides" them to a socially optimal solution to the economic problem: what to produce, how to produce it, and who will consume it, because profits are maximized by producing what consumers most want in the most efficient (least resource using) manner.

Smith advocated laissez faire, that is, an economic system characterized a minimum of government control of the economy. Smith's objective in writing The Wealth of Nations was to point out the superiority of laissez faire to the then dominant economic philosophy of mercantilism. Karl Marx's objective in writing a later book, Das Kapital, was to demonstrate the superiority of communism to laissez faire. The free market system Smith advocated requires the private property that Marx abhorred, viewing it as the cause of as the exploitation of the many by the few. Rather than an invisible hand, Marx's ideal economic system is guided by a very visible hand of government.

Alfred Marshall's theory was concerned with partial equilibrium. For example, he would consider this kind of situation: everything else remaining the same, a reduction in the supply of beef will cause its price to rise. This is not, however, all that would happen. Like throwing a rock in a pond, a change in one market will cause changes in other markets. Because beef is more expensive, some people will replace it with other meat. This increase in the demand for other meats will cause their prices to rise. This, in turn, will raise the price of what pigs, chickens, and cattle eat. Because fish can be sold for a higher price once the price of beef rises, the demand for fisherman will rise, and so on, and so on. What is called general equilibrium analysis takes into account the impact on price and quantity in every market of a change in any one of them.

The Austrians are not the only school of economic thought which scorns the equilibrium analysis:

Institutionalist and Austrian economists have long been interested in institutions. This interest is now being shared by a growing number of neoclassical economists who recognize the inherent limitations in the equilibrium method of analysis--specifically, its lack of context. As expected, neoclassical economists are more likely to follow the Austrian approach to institutions since they already share much with the Austrians...The Austrians view institutions only as effects--as the results of individual actions. Institutionalists view institutions as both cause and effect, as socializing devices, and as the expression and result of individual actions." [Clark, 373]

Joseph A. Schumpeter differed with his fellow Austrian economists in that, like Marx, but for different reasons, he believed capitalism was doomed. Like the other Austrians, he viewed the entrepreneur as playing the central role in the economy. (Even John Maynard Keynes gave the entrepreneur a central role, but he focused on their failure in the absence of profitable investment opportunities to invest as much as the public wishes to save, and how this brings about a depression. )

According to Schumpeter, successful entrepreneurs would finance educations for their children which would turn them into intellectuals scornful of their parents and opposed to capitalism because capitalism does not provide them with the power and rewards they believe they deserve. Therefore, they would bring capitalism down; hoping to establish themselves as socialist planners who will right all the injustices they see in capitalist society.

The logical way to make an expenditure decision is on a marginal basis: what will be the amount of additional revenues generated by the expenditure of additional funds? In short, in making decisions funds already spent (sunk costs) should be ignored. A project is potentially acceptable if it adds to profits, that is, additional revenues exceed additional costs. (It is not acceptable if an alternative use of funds will provide a higher rate of return.)

An atypical, recent application of marginal analysis which is supportive of those who advocate reducing the size of government was reported on in the 6 April 1996 issue of The Economist. In an International Monetary Fund (IMF) paper, V. Tanzi and L. Schuknecht concluded that, while before 1960 additional government spending was associated with considerable improvements in social welfare, subsequent increases in total government spending have provided only modest social gains, and those countries where spending has risen the most, have done no better in either social or economic terms than have those at the other end of the spectrum.

Brian Arthur, does not define increasing returns the way introductory economics textbooks do. In them this term refers to the fact that as a fixed facility, such as a given factory, is operated at ever higher levels of output, until the level of output reaches the level the it was designed to most efficiently produce, increasing returns will be experienced. That is, as variable inputs, such as labor, are increased so that more can be produced by a factory of fixed size, output gains per unit of additional input will rise for a while. (See Nemmers, 214.)

According to Brian Arthur, economists are interested in complexity theory because it deals with non-linearities and adaptive elements. Entrepreneurs who dream up new things are, he says, the analog of reactive elements in chemistry. He calls positive feedback increasing returns, giving as an example an enhanced knowledge base speeding up economic growth. Increasing returns may lead to what he calls lock in. Lock in, he says, may not be optimal, and this, he contends, means there is a role for policy makers. Complexity theory, he says, emphasizes the importance of history because the economy is more path dependent and history dependent than earlier economists thought.

Over time and between schools of economic thought there has been disagreement over the nature of the economy. Is it more like an organism, a machine, or an evolutionary process? Mainstream economists in recent decades have looked at it as a machine. Complexity theorists view it as being like an organism. Institutionalists view it as an evolutionary process.

The theories of English economist John Maynard Keynes dominated the economics profession for several decades after World War Two. One of his most important disagreements with Classical theory was his denial of the validity of what is called Say's Law. This theory asserts that supply creates its own demand, that is, what is produced will be salable because its production provides the income needed to purchase it. The Great Depression of the 1930s, Keynes believed, proved this was not true, at least in the short run, and, he said, in the long run we are all dead. (Marx also claimed that capitalist societies suffer from and will be brought down by gluts, that is, more output than can be sold.)

Keynes believed that modern, not very competitive capitalism is so unstable that it will ultimately collapse as a result of the hardship imposed on the public by periodic depressions. Unlike Marx, he did not welcome this; so he advocated it be avoided by the government preventing the level of aggregate spending from falling by running deficits, that is, through borrowing, the government spending more than it collects through taxation.

Libertarians like the recently deceased Austrian economist Murray Rothbard should not be confused with conservatives, because conservatives want to return to a pre-New-Deal America characterized by laissez-faire that the Austrians deny existed.

The origins of today's state capitalism, claim the Austrians, trace back to the reforms of the Progressive Era. These reforms were "...pushed through by big business interests, such as J. P. Morgan and his heirs, who 'realized that monopoly privilege can be created only by the State and not as a result of free-market operations.' Big business hailed [President Woodrow] Wilson's war collectivism, and welcomed the Interstate Commerce Commission [ICC], the Federal Trade Commission [FTC], the Federal Reserve and agricultural subsidies with open arms. They didn't want free competition in free markets, but privileges doled out by an all-powerful state, in which hierarchy and monopoly would stifle all challenges to their dominance. These were the real roots of the problem, a web of controls and government-business 'partnership' that would blossom into the New Deal." [Raimondo, 210-211]

In the Progressive period, both Democrats and Republicans thought big government and national planning were needed. It is not surprising that before Herbert Hoover became president, Franklin D. Roosevelt thought he would make a good president because, as a Cabinet member overseeing the new radio industry, Hoover played a role in establishing a company, the Radio Corporation of America (RCA), that was supposed to monopolize international radio communications in the Western Hemisphere; this being made possible through an agreement with Great Britain and Germany, who were allocated the rest of the world. (Effective domestic competition for RCA was eliminated when the government forced the British Marconi Company to sell its American assets to the new American company (RCA), whose board of directors initially included a government representative.)

According to Austrian economist Murray A. Rothbard:

"The Progressive Era was essentially put through by the Morgans and their allies in order to cartelize American business and industry, to take up more effectively where the cartel and merger movements had left off. It should be clear that the Federal Reserve System, established in 1913, was part and parcel of that Progressive movement; just as the large meat packers managed to put through costly federal inspection of meat in 1906, in order to place crippling, high costs on competing small meat packers, so the big bankers cartelized banking through the Federal Reserve System seven years later. [Rothbard, 86]. ...Since the importance of political parties dwindled after 1900, and ideological laissez-faire restraints on government intervention were gravely weakened, the power of financiers in government increased markedly. Furthermore, Congress--the arena of political parties--became less important. A power vacuum developed for the intellectuals and technocratic experts to fill the executive bureaucracy, and to run and plan national economic life relatively unchecked." [Rothbard, 91]

There is a problem with Brian Arthur's claim that "...pure neoclassical theory tells us that high-tech firms will tend to distribute themselves evenly across the landscape: there's no reason for any of them to prefer one location to another." [Waldrop, 36]

David Ricardo (1771-1823) developed a theory of comparative cost included in all introductory economics textbooks which demonstrates that, due to differences from place to place in where comparative advantage lies, each type of industry will not be evenly distributed across the landscape. His theory of comparative advantage explains why, for example, in the nineteenth century the Southern States grew cotton, the great majority of which was made into thread and cloth in England and New England. It explains, too, the subsequent, westward shift of cotton cultivation and the shift of the cotton textile industry, first to the South, and then abroad.

Ricardo demonstrated that individuals and firms and regions and nations will be better off if they specialize in what they have a comparative advantage in. In Ricardo's well known example, he advised England to produce cloth and Portugal wine, because the former had a comparative advantage in cloth; while the former had a comparative advantage in wine. Because specialization will increase productivity in both nations, both could consume more of these products if they thus specialized in the one they had a comparative advantage in and traded it for the other one. Mainstream economists' view is that free trade will force people to specialize on the basis of comparative advantage.

Early in this century the work of Ohlin suggested that increases in market size increases the geographic concentration of economic activity because, with increased size, there is more to be gained by a fuller exploitation of economies of scale through a higher concentration of economic activity than is lost due to resulting higher transportation costs.

Economies of scale refers to the fact that up to some point, increasing a productive facility's size will reduce average cost per unit. That is, while a small-scale plant will produce a relatively low level of output at a the lowest cost per unit possible, a larger-scale plant will produce a greater level of output at an even lower cost per unit. Economies of scale differ from economies to scale, which refers to the fact that the average cost per unit of output produced in a given facility varies. Up to the level of output the facility was designed to produce with maximum efficiency, cost per unit declines (increasing returns). Thereafter, it rises (diminishing returns).

Institutionalists focus on society's laws, ethos, and institutions. The most prominent members of this school of economic thought may be further to the left of and more critical of the mainstream than the Austrians are on the right. (This school of economic thought began in the United States with the work of Thorstein Veblen.)

The flight of a flock of birds can be simulated on a computer by programming "birds" to follow three rules: (1) follow the leader; (2) move towards the center; and (3) do not get nearer to another "bird" than a given distance.

According to an article which appeared in the Economist, there are big problems involved in applying chaos theory to financial markets. Even if stock and bond prices are determined by a chaotic system, it would be risky to make long-range forecasts on the basis of it because even a minute error made at the outset would expand exponentially over time. A more serious problem is that because there are so many poorly understood variables which influence market prices, there's little chance of proving the existence of deterministic chaos. In addition, the amount of historical data is not available in the necessary quantity, quality, or consistency. "But perhaps the most damning problem is that it is difficult to reconcile chaos theory with the constant changes in financial markets. It is, to put it mildly, not obvious that financial prices are determined by the same factors today as they were two decades ago" [Anonymous, "Finance," 70]

According to complexity theorists, particularly complex dynamic systems can display the characteristic of "lock in." This takes place when a minimally perturbed system proceeds to a new equilibrium state with profound stability.

Examples cited by Arthur make it clear engineering criteria determines which technology he considers to be the best. The QWERTY keyboard is inferior, he says, because it was designed to slow typists down because early typewriters would jam if a typist was too fast. [Waldrop, 35] (It may be more correct to say that the letters which the striking of the keys caused to strike a ribbon and print themselves on a sheet of paper were rearranged--putting certain of them on the opposite side of the "basket" in which they located on a manual typewriter--so that fast typists would not jam them.) "...The VHS videotape format," he observes, "was well on its way to cornering the market, despite the fact that many experts had originally rated it slightly inferior to Beta technologically." [Waldrop, 35, 36]

How is the government to decide when to intervene because an inferior technology has been locked-in? Certainly, for example, government action is not called for because the market has locked in inferior--because they are less accurate--non-atomic clocks.

Is there any justification for believing government direction of technological change is any better than market direction? The Japanese government sank a huge amount of public funds in developing analog HDTV. This was a mistake, because HDTV is going to be digital.

Something government cannot do, but markets can, is weigh the relative valuations consumers place on the various features of different technologies. Would people rather have a very high quality picture, or would they prefer a good, but lesser quality picture and far more programs to choose between? (An analog TV signal takes up far more bandwidth than does a digital signal.)

Mainstream economic theory in the United States has always assumed that consumers make economically rational choices. Therefore, it has never been asserted that consumers will always choose the product with the highest engineering efficiency. Computer A, for example, may be faster than computer B, but since the consumer's objective in buying a computer is to get certain jobs done, the lack of the software needed to do these jobs which can be run on computer A makes its speed advantage meaningless.

Is VHS any more locked in than were eight-track tapes, which disappeared within only a few years? Are there really costs imposed on society by random consumer choices which lock us into inferior technologies great enough to justify establishing a government technology vetting bureaucracy? Some powerfully question this. very powerfully question this. Neither QWERTY or VHS are, as Arthur claims, say two critics examples of the locking in of inferior technologies.

Stan Liebowitz and Stephen E. Margolis have tracked down the Navy study of the QWERTY keyboard which Arthur and others sharing his views heavily rely upon--apparently without having seen it--as proof that the QWERTY keyboard is inferior to the Dvorak keyboard. The Navy study, which was done by the man who designed the Dvorak keyboard (!), was conducted in a non-scientific manner in a Dvorak-favoring way. Several other studies of these keyboards that appear to have been conducted in a more scientific manner by unbiased researchers came up with very different results.

Liebowitz and Margolis observe that "theories of path dependence and their supporting mythology have begun to exert an influence on policy. Last summer, an amicus brief on the Microsoft consent decree used lock-in arguments, including the QWERTY story, and apparently prompted Judge Stanley Sporkin to refuse to ratify the decree. (He was later overturned.) [Liebowitz and Margolis, "Typing Errors," 31]

In 1884, a vice president of the Pennsylvania Railroad said that, "...a large majority of the railroads in the Unites States would be delighted if a railroad commission or any other power could make rates upon their traffic which would insure them six per cent dividends, and I have no doubt, with such a guarantee, they would be very glad to come under the direct supervision and operation of the National government." [Gordon, 24] "Even when the law was much strengthened in the Theodore Roosevelt administration and the ICC given the power to set rates, the railroads quickly learned how to manipulate it in their own interests, just as they had the old state commissions." [Gordon, 24]

Hypertext makes it possible to write truly multi-dimensional articles. Articles on paper are pretty much limited to one dimension. Through explanatory footnotes, the readership of an article on paper can be expanded by providing explanations and definitions needed by readers not very familiar with the subject of the article. Readership can also be expanded to meet the interests of those more familiar with the subject matter through footnotes which delve into complexities not considered within the body of the article. However, it is not feasible in an article published on paper to expand very much in either direction. With an article published on the Web, hypertext makes it possible to present a subject in depth on several levels, which is what this article does.