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Was Murray Rothbard a Good Economist?

Someone on Quora was wondering whether Murray Rothbard was a good economist. I obliged with an answer:

Yes. Murray Rothbard was a prolific thinker whose contributions to economics were numerous, original, and significant.

His magnum opus, Man, Economy, and State, was the first complete treatise on economics in a half century. The book was originally meant to be a textbook version of Mises’ Human Action, but Rothbard built on Mises’ work to create a more complete body of thought. He contributed his own theory of production and supply, while critiquing Mises’ theory of monopoly as a static conception that did not fit with his generally dynamic view of the economy. Rothbard argued persuasively for a return to the original definition of a monopoly as a government grant of exclusive privilege.

His work in economic history is excellent. His book, The Panic of 1819: Reactions and Policies is the definitive work on the titular panic. America’s Great Depression applied Mises’ theory of the business cycle to the Great Depression, showing how the Fed under Benjamin Strong pumped up an inflationary bubble in the 1920’s, which led to the 1929 crash. He also demonstrated that Herbert Hoover was not a laissez faire President but a big-state interventionist, in opposition to what was commonly (and wrongly) believed at the time.

An Austrian Perspective on the History of Economic Thought, Rothbard’s two-volume work on the history of thought, is by far the most exhaustive history of economic thought up to 1870 (he tragically died before he could write a third volume covering the developments after 1870). While most histories of economic thought focus on a few key figures, maybe Smith, Ricardo, John Stuart Mill, Marx, and Keynes, Rothbard covers everyone. If someone had a passing thought about economics before 1870, and it came down to us in print somehow, Rothbard probably discusses it. While most histories of economic thought will treat Adam Smith as the inventor of the discipline (maybe with a passing nod to the French Physiocrats), Rothbard spends over 500 pages discussing the economic thinkers who preceded Smith, beginning with Aristotle. It turns out that economics had a rich history before Smith, and some earlier thinkers (Turgot and Cantillon) even surpassed Smith in many respects. Even if you disagree with Rothbard on absolutely everything else, he deserves credit for being an outstanding historian of economic thought.

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Finance and the Austrian School with George Bragues

This episode of Economics Detective Radio features George Bragues, professor of business at the University of Guelph-Humber, discussing his work developing a distinctly Austrian theory of finance. While there have been forays into finance by Austrians such as Mark Skousen and Peter Boettke, Austrians have not yet fully developed a complete and distinctly Austrian theory of finance.

George names five pillars of modern finance theory: (1) The capital asset pricing model (CAPM), (2) the Black-Scholes option pricing model, (3) the efficient markets hypothesis (EMH), (4) behavioural finance, and (5) the Modigliani-Miller theorem.

CAPM is a model that derives the value of assets based on the risk-free rate and market risk, that is, risk that cannot be diversified away. The Austrian response to this model is that there is no such thing as a risk-free asset, as risk is inherent to human action. An Austrian alternative to CAPM would incorporate the Austrian theory of a natural interest rate derived from time preference.

Black-Scholes, a model for pricing options—opportunities to buy or sell at a given price at some point in the future—assumes that price movements are normally distributed. Nassim Taleb has been forceful in his critique of this assumption; in his book, The Black Swan, he argues that returns are subject to so-called Black Swan events. Statistically, this implies a fat lower tail in the distribution of returns. George holds that, given Austrians’ skepticism about mathematics, there is little hope for an Austrian option pricing model. However, pricing assets was never the role of theorists, but of entrepreneurs.

The efficient markets hypothesis, developed by Eugene Fama, holds that the market price reflects all available information. This view holds economic equilibrium to be a normal state of affairs. The Austrian view is that equilibrium is an abnormal state of affairs; the market is always tending towards equilibrium, but it rarely reaches equilibrium. Austrian theory holds that identifying misequilibriums and arbitraging them away is the role of entrepreneurs. Identifying such opportunities isn’t easy; it requires prudence, or what Mises called “understanding.” If you believe the EMH, then Warren Buffet is not an example of someone with great insight and prudence; rather, he is someone who has repeatedly won a stock-market lottery.

Behavioural finance, developed by Robert Schiller, is a theory that argues that, contra the EMH, market prices reflect psychological factors rather than the real underlying values of the assets being traded. Behavioural finance has identified so many biases that it is essentially irrefutable. For instance, the gambler’s fallacy and the clustering illusion, yield opposite predictions. If a stock price has risen repeatedly, the gambler’s fallacy would hold that it is “due” for a correction downwards, while the clustering illusion would hold that the trend must continue upwards. Behavioural economists could thus explain a movement in either direction according to their theory, making the theory untestable in principle. Austrian theory avoids such psychological theorizing. Austrians hold that you can derive sound theory from the axiom that humans act, that they use means to achieve ends. Austrians have no particular qualm with bringing psychological factors into the analysis of economic history, but they don’t see them as part of economic theory.

Modigliani-Miller is a theory of corporate finance that says that the way a firm is financed, with more debt or equity, is irrelevant to its value. M&M holds that the value of the firm is uniquely determined by its discounted stream of revenues. Austrians might contend, in contrast, that firms financed through debt are exposed to greater risk in the case that they make entrepreneurial errors.

George is working towards an “Austrian markets hypothesis,” which would hold that markets are constantly endeavoring to achieve equilibrium, but never actually succeeding. Austrians can bring a greater appreciation of understanding, prudence, practical experience, and local knowledge to finance theory. These ideas have been wrongly impugned by modern quantitative finance, which has elevated theoreticians above entrepreneurs.

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