One of my research interests is the synthesis of Neoclassical and Austrian Economics. While I originally set out to execute this synthesis, I now find myself documenting the fact that such synthesis has already occurred. An individual scholar of interest in this regard is James Buchanan.
James Buchanan is a Nobel Prize winning economist and key contributor to public choice, the field of economics which applies the analytical methods of economics to analysis of the political system. You might call it an interdisciplinary field, except that economics and political science were originally one field called political economy years ago in the history of science. That’s an interesting debate for another article.
Buchanan co-founded the Thomas Jefferson Center for Studies in Political Economy at the University of Virginia in 1957. Through the work of Buchanan and others, the Virginia School of Political Economy emerged at that center. In 1983, the center had been renamed The Center for Study of Public Choice and moved to George Mason University.
Buchanan was a student of Frank Knight, one of the founders of the Chicago School of Neoclassical economics. Among Buchanan’s peers are Milton Friedman, George Stigler and Ronald Coase. Friedman, Stigler, and Coase are all well known Neoclassical economists, and perhaps right-0f-center neoclassical scholars as none of them belong to the Piguo Club.
Knight debated Piguo about social costs, arguing for private solutions to problems such as traffic congestion instead of more government regulation or Pigovian taxes. See, for example, History of Political Economy 35:1 (2003), page 62-63. Buchanan falls squarely in the club good club as Buchanan is the one who came up with Club Theory in 1965.
In addition to coming from the Neoclassical school, Coase is known as the founder of New Institutional Economics and a key contributor to Transaction Cost Economics. Both New Institutional Economics and TCE are extensions of Neoclassical economics. I will argue TCE is particularly compatible with Austrian economics, and Public Choice is in part a realization of this synthesis.
Coase wrote his well known The Problem of Social Cost while at the University of Virginia and working in the Thomas Jefferson Center for Studies in Political Economy founded by Buchanan. This provides evidence of an intellectual link between TCE and Public Choice, and I think this abstract link is consistent with the specific papers from each field.
In Austrian economics, individuals take actions in order to achieve their own ends. Austrian microeconomic process can be described as an individual-level discrete-choice approach. At any given time an individual will have various actions they can take and they prefer whichever maximizes their ability to achieve some goal. For this reason I think agent-based models are an ideal way to model Austrian economics, but I also think this approach is compatible with bounded rationality, at least the 3-factor model of bounded rationality provided by Simon (1957) which uses search, satisficing, and aspiration adaptation.
While Buchanan did not indulge much in mathematical models, his Club Good model of optimal pool congestion uses utilitarian analysis under a discrete-choice model. Likewise, discrete-structural analysis is one of Oliver Williamson’s 6 key points in TCE. Public Choice emphasizes the notion that political failure exists and therefore market failure may be preferred to political failure, so long as the market fails to a lesser degree than the political system. TCE also emphasizes this notion through the concept of remediableness. A market is considered efficient if there are no more efficient available coordination systems, even if the market produces an outcome less efficient than a competition-theoretic market would.
Austrian economics has yet to produce a unique Theory of the Firm, and they have only offered mild criticism to the TCE and NIE approaches. I would argue this is because the TCE approach does a great job of modelling the Austrian approach, with a few exceptions. For example, Langois has written as much about the Theory of the Firm from an Austrian perspective as anyone, and a current working paper of his basically approaches the Theory of the Firm from an Austrian perspective as the process of “Using Hayek to rewrite Coase.” In my view this means that Coase’s TCE forms a very acceptable base to the Austrian school, with a few things on the edges to be refactored, rather than a view which is wrong-headed in the main.
Bounded rationality search costs and other transactions costs would seem to explain firms as emergent entities formed to help individuals achieve goals, in particular through transaction cost minimization. This conclusion seems to follow from Austrian logic and ABM models as well as through simplified Knightian market-level models.
Buchanan’s process-oriented view of the individual is compatible with modern behavioral economics, which argues contra Stigler-Becker that people don’t know their own preferences perfectly or make optimal calculation even based on the set of known facts, where the set of known facts is potentially much smaller than the set of facts or information needed to make an optimal choice. At the same time, Buchanan’s process-oriented view is very much compatible with the Austrian emphasis on market as a process. Here’s a related and interesting discussion between a pro-Austrian peer of mine and a behavioral economist.
Another note in the discussion of compatibility is that Langois notes that the “Penrose’s account arguably qualifies” as an Austrian theory of the firm. This makes the Resource-Based View and perhaps some or all of its descendants arguably Austrian views.
In conclusion, Austrian economics is compatible with transaction cost economics and new institutional economics. James Buchanan has already largely synthesized these two in his contributions to Public Choice Economics and the Virginia School of Political Economy in particular which is the prominent sub-school within public choice. Buchanan’s approach includes major components of TCE including bounded rationality,
While the Virginia School emphasizes the intersection of politics and economics, I think Buchanan’s ideas can and should be expanded and applied more generally in economics.