vol. 1, no. 3 (Summer),
1987, pp. 77-89
THE KALEIDIC WORLD OF LUDWIG LACHMANN
Review Article: The Market as an Economic Process
by Ludwig M. Lachmann.
New York: Basil Blackwell, 1986, pp. xii, 173.
Ludwig M. Lachmann has been writing about markets for half a century.
Having received his formal education in Germany by the early 1930s, Lachmann
went to England where, along with fellow student G. L. S. Shackle, he studied
under Friedrich A. Hayek. After writing and lecturing for some years in
London, he settled in at the University of Witwatersrand in Johannesburg,
South Africa for several decades of continued scholarship.
Until the mid 1970s Lachmann
was known to Americans only through his writings, and his influence on
American economics was not great. But in 1974 he was one of three lecturers
featured at a conference on Austrian economics held in South Royalton,
Vermont and sponsored by the Institute for Humane Studies. Beginning in
1975 and largely as a result of the South Royalton lectures, Professor
Lachmann has taught each spring semester at New York University, returning
to Johannesburg for the remainder of the year.(1)
The Market as an Economic
Process, itself the result of a process that began several years ago,
serves as the major focus of this review. A second volume, Subjectivism,
Intelligibility, and Economic Understanding: Essays in Honor of Ludwig
M. Lachmann on his Eightieth Birthday (New York: New York University
Press, 1986), plays a minor role. Because of the diversity of the twenty
three papers that make up this birthday offering, no comprehensive account
can be undertaken. But two of those papers, one by the reviewer, will aid
in linking the arguments in Lachmann's own book to an important issue that
has captured the attention of Lachmann and his readers for the last several
years: the presence—or absence—in the market process of a tendency toward
equilibrium. But before dealing with this or any other substantive issue,
let me focus attention on Lachmann's vision (as Joseph Schumpeter used
the term) of the market economy.
Clockworks and Kaleidoscopes
Readers familiar with Lachmann's writings will not be surprised or
puzzled by his frequent allusions to the kaleidoscope. Readers not so familiar
may wonder about the recurring prepositional phrase "in a kaleidic world."
An understated passage in Chapter 3 links Lachmann's own usage of this
imagery with G. L. S. Shackle's. The society in which we live, according
to both Shackle and Lachmann, is a "kaleidic society, interspersing its
moments or intervals of order, assurance and beauty with sudden disintegration
and a cascade into a new pattern"(2) (p.
48). The underlying vision of the market economy adopted by Shackle and
Lachmann is captured by this comparison of the market process to the dynamics
of a kaleidoscope.
Many proponents of the Austrian
school forswear using the language of Newtonian mechanics, sometimes brashly
condemning altogether the use of metaphors in constructing economic theories.
While recognizing that pendulums and kaleidoscopes each have their own
internal logic, Lachmann systematically rejects Newtonian mechanics in
favor of Shackelian kaleidics as the more relevant metaphor. He makes his
preference clear in one of his chapter titles: "The Market is not a Clockwork."
Neither, as I will argue below, is it a kaleidoscope. But the kaleidoscope
does serve as a convenient peg on which to hang Lachmannian ideas: radical
subjectivism, emphasis on process, the role of asset markets, and the Keynesian
connection, to name a few. Throughout Lachmann's discussions of methodology,
knowledge, capital and money, and his comparison of equilibrium and disequilibrium
approaches to economic theorizing, the reader will want to keep one eye
on the pendulum while peering into the kaleidoscope with the other. The
contrast between these two models of the economy, the reader will discover,
is a true reflection of the contrast between Lachmannian economics and
The kaleidoscope's intricate
pattern of colored glass represents the pattern of prices that are determined
by buyers and sellers in commodity markets and by bulls and bears in asset
markets. The pattern has order and beauty, but not longevity; no given
pattern can last for long. The passage of time is necessarily marked by
the discovery of new information in the form of fulfilled or disappointed
expectations of investors. This is the nature, according to Lachmann, of
the market process. Such discoveries can change bulls into bears or bears
into bulls. The resultant shuffling about of capital assets jars the kaleidoscope.
A new pattern of prices emerges, but the particulars of the new pattern
could not have been predicted solely from the former pattern or from the
sum total of knowledge that underlay it.
The inevitable discovery
of new information as the market process unfolds has no analogue in Newtonian
mechanics. Future positions of a pendulum can be calculated from its present
position, its mass, and the forces acting upon it. The position at which
the pendulum finally comes to rest is not the result of a process—as
Lachmann uses the term. That is, the final equilibrium position is independent
of the magnitude and direction of the particular movements that delivered
the pendulum to that position.
Lachmann is a thoroughgoing subjectivist. Though influenced at an early
age by the writings of Carl Menger, he takes his methodological cue directly
from Hayek, who wrote more than forty years ago what was to become one
of the most frequently quoted statements of Austrian methodology. "It is
probably no exaggeration to say that every important advance in economic
theory during the last hundred years was a further step in the consistent
application of subjectivism." Lachmann quotes this statement from Hayek's
of Science not just once, but twice (pp. 23 and 144). Menger established
the subjectivity of value. Ludwig von Mises employed the subjective marginal
utility theory to account for the value of money. Shackle and Lachmann
have emphasized the subjectivity of knowledge and expectations.(3)
And in his concluding chapter, Lachmann makes a plea (pp. 142 and 147)
for still a further "thrust toward subjectivism."
Students of Menger's marginalism
should be the first to recognize that there can be too much of a good thing.
While we need not call Hayek's assessment into question, we may legitimately
wonder how far we can push subjectivism without losing sight of the essential
objective aspects of economic reality. Lachmann's critics who are disturbed
with the nihilistic overtones of Radical Subjectivism have argued, in effect,
that Lachmann has pushed too far.(4) Consider,
for instance, subjectivism in monetary theory, an issue that Lachmann addresses
in his Chapter 5 by chronicling what he sees as a "thrust towards subjectivism"
over the last three-quarters of a century. The reader may suspect that
Lachmann has taken Hayek too literally. Do we really want to measure progress
in economics by the extent to which the subjectivist elements are readily
Beginning his account with
the publication of Irving Fisher's Purchasing Power of Money, Lachmann
identifies the major steps, as he sees them, away from functionalism and
towards subjectivism. The success of Fisher's book is attributed to his
combining a truism (the equation of exchange: MV = PT) with an empirical
generalization (the near constancy of V, the velocity of money). From these
elements follow the proposition that PT, the number of transactions multiplied
by the average price of the goods transacted, is proportional to M, the
quantity of money in circulation.
Lachmann leaves out of account
Mises' Theory of Money and Credit because it was not published in
English. He identifies the next step in the subjectivization of monetary
theory as a 1917 article by A. C. Pigou in which both sides of the equation
of exchange are divided by V. The reciprocal of the velocity of money is
rechristened k in what was to become known as the "Cambridge equation."
The Cambridge k focused attention on the amount of money that people choose
to hold as a proportion of their incomes rather than on the rate at which
money circulates through the economy. Most historians of monetary thought
believe that the difference between the Fisher equation and the Pigou equation,
especially when judged in the light of the textual material that accompanied
each, is one of form rather than substance. The formal difference was put
in proper perspective by a quip attributed to D. H. Robertson: "k is money
sitting; V is money on the wing." But Lachmann sees significance in the
reformulation: "The introduction of k connotes the infusion of a dose of
subjectivism into a set of relationships which did not seem to offer much
scope for acts of human minds" (p. 91).
Credit for the next advancement
goes to John Maynard Keynes, who insisted upon dividing the total demand
for money into several separate demands each identified with some specific
The use of the word purpose in this context is enough to win kudos from
Lachmann (p. 92). The question of whether one of the alleged purposes,
the so-called speculative demand for money, makes sense, and the question
of whether it makes sense to treat different reasons for demanding money
as separate and additive demands for money, are downplayed. We should not
complain too loudly, the reader is led to believe, if the road to a radical
subjectivist monetary theory contain some rocky stretches.
While John R. Hicks is cited
for having given explicit and articulate expression to monetary subjectivism
(p. 94), the highwater mark in Keynesian subjectivism came in Keynes' 1937
article in which he attempted to explain what his 1936 book, The General
Theory, actually meant. Keynes explains, in effect, that the demand
for money in the present derives from the uncertainty of our knowledge
about the future. And the kind of uncertainty that Keynes is referring
to is the kind that Lachmann calls radical uncertainty and associates with
radical subjectivism. According to Keynes, as quoted by Lachmann, "We simply
do not know" (p. 99).
But as Lachmann recognizes,
the Keynesian refrain, "we simply do not know," is frequently invoked when
not knowing serves some polemical purpose (pp. 98 and 100). Keynes' views
on private spending and public spending are illustrative. We cannot leave
investment decisions to businessmen in the private sector because they
do not know enough about the future to make their "parting with liquidity"
worthwhile. By contrast, when government spending on public works is under
consideration, the debilitating uncertainty goes into remission. And the
question of whether the spending is worthwhile somehow becomes irrelevant.
More tellingly, Keynes has great confidence in his own "knowledge" that
total output in the economy will rise to a certain multiple of the initial
Finally, and with some uneasiness,
Lachmann extends subjectivist honors to Milton Friedman for his reformulation
of the quantity theory. Friedman shifted the focus of analysis from the
supply of money to the demand for money; he included an "almost embarrassing
variety of expectations" (p. 102) in his demand-for-money equation; and
he (easily) outdid Keynes by consistently accounting for the effects of
the expectational variables. Lachmann concludes his discussion of Friedman's
"thrust towards subjectivism" in puzzlement. "For reasons not for us to
fathom Professor Friedman chose to don the mantle of a subjectivist. For
reasons more readily understood he decided to borrow one from the Keynesian
wardrobe. Embarrassing as it is, we cannot fail to notice how ill the garment
fits him" (p. 104).
The reader may suspect that
Lachmann's dogged attention to subjectivist elements in monetary theory
has led him to an untenable view of Friedman's Monetarism. Friedman included
expectational variables in his demand-for-money function only to show that
when these expectations are proxied by actual values from the past and
incorporated into an appropriate lag structure, the demand for money in
the present is almost wholly accounted for. That is, the Monetarists have
sought to show that the demand for money is a stable function of a relatively
small number of current and past variables. Further, the reason that Monetarists
focus on demand and its stability properties is precisely to establish
the importance of supply: If demand is stable, then changes in the price
level—or in the rate of inflation—are to be wholly attributed to changes
in the money supply. The empirical demonstrations that "inflation is always
and everywhere a monetary phenomenon," which are based on money-supply
and price-level data from many countries over many decades, reflect little
in the way of Keynesian or Lachmannian subjectivism.
Curiously, the Austrian
monetary theorists are all but left out of account in Lachmann's chapter
on money. And except for a single hint (p. 105), there is no mention of
a central bank or recognition that bank policy may seriously impair the
private sector's ability to make monetary calculations and to equilibrate
the supply and demand for money. Lachmann simply reaffirms that the Austrian
treatment of expectations in the context of capital theory and the business
cycle has never had much plausibility to him. He references his 1943 article
in which he challenged Mises on the basis of what would now be called a
rational-expectations argument. The reader might justifiably wonder if
Lachmann hasn't taken a cue from Keynes and selectively ignored the knowledge
problem when doing so squared with his own vision of the market economy.
Investors, evidently, have no problem in anticipating the policy moves
of the central bank and offsetting the effects of those policies by appropriately
altering their own investment decisions. It is interesting to note that
a radical subjectivist anticipated by several decades the extremes of modern
formalism that now characterize the New Classicism.
The Question of Equilibrating Tendencies
Developments in economic science from Adam Smith's invisible hand to
Friedrich Hayek's spontaneous order have provided increased assurance that
market forces are equilibrating forces and therefore that there is a distinct
tendency in market economies toward the coordination of the individual
plans of market participants. But Lachmann calls into question all such
claims that a tendency toward equilibrium exists (pp. 14ff. and passim).
Because of the subjectivity of the knowledge which is acquired as the market
process unfolds, and of expectations, which are based upon but are not
uniquely determined by this changing knowledge, no tendency toward equilibrium
can be established.
The issue of the existence
or the effectiveness of equilibrating tendencies in a market economy is
complicated by the multiplicity of meanings of the term "equilibrium."
Can we count on markets to create and maintain some degree of intertemporal
coordination among the economic activities of a multitude of market participants?
This is the question that concerns Lachmann. Two particular conceptions
of equilibrium relevant to this question must be distinguished: partial
equilibrium and general equilibrium. Under normal circumstances, approximate
equality between the amount of a particular good supplied and the amount
demanded is maintained by appropriate pricing responses to incipient surpluses
and shortages. This Marshallian notion of partial equilibrium, described
by Lachmann as the result of "intra-market processes" (p. 6), is not in
But the question of a tendency
toward a general equilibrium is a different matter. The issue is
not whether the economy is actually in an equilibrium or whether it will
eventually achieve such a state. There are no economists who believe that
general equilibrium is actually realized—except for the New Classicists,
who are willing to redefine equilibrium such that it squares with any imaginable
state of affairs. Lachmann is concerned, in effect, that Marshall's partial
equilibrium may not legitimately be extended, or generalized, to apply
to the market economy as a whole. The interconnectedness of markets coupled
with other considerations warns against such an extension. Market forces
spill over from one market to another; intertemporal market forces are
weak or nonexistent; each market participant must form his own expectations
in a cloud of radical uncertainty. Lachmann finds it "hard to see why,
in a world in which thousands of markets are connected by links however
tenuous, inter-market processes should be thought necessarily to converge
on positions of equilibrium" (p. 9). This agnosticism, which permeates
much of Lachmann's writings, reinforces his preference for Shackelian kaleidics
over Newtonian mechanics. In a kaleidic world, one pattern of prices gives
way to another, but there can be no claim that a given pattern is any closer
to a general equilibrium, or represents any higher degree of coordination,
than the one that preceded it.
Most market-oriented economists,
whether Austrian or Neo-Classical, are willing to rely on the system of
profits and losses to produce a tendency toward equilibrium. Entrepreneurs
who can see most clearly through the cloud of uncertainty earn profits,
which, in turn, increase their command over productive resources; entrepreneurs
who see least clearly make losses, which decrease their command over productive
resources. These aspects of the market process are the basis of my own
contribution to Lachmann's birthday volume. As hinted in my title, "From
Lachmann to Lucas: On Institutions, Expectations, and Equilibrium tendencies,"
I positioned Lachmann the radical subjectivist and (Robert) Lucas the New
Classicist at polar extremes on a spectrum of views. I dubbed Lachmann's
position "Equilibrium Never," and Lucas' position "Equilibrium Always,"
and then I opted for the middle-ground, somewhere between clockwork and
kaleidoscope: the market exhibits "Equilibrating Tendencies." Drawing on
Mises and Hayek, I argued that entrepreneurship coupled with profits and
losses conferred by the market would anchor market activities to the "underlying
In subsequent correspondence,
Lachmann indicated, in effect, that he was not persuaded to move any distance
from his polar position. He further indicated that there can be no such
thing, in his view, as "underlying economic realities" that form a basis
for coordination—not, at least, in our world, a world of ceaseless change.
(I could almost see him shaking his kaleidoscope at me as he spoke.) But
rather than to carry on the debate in private correspondence, he referred
me to another contribution to the birthday volume, one by Jan Kregel, a
Post Keynesian who sought to put "underlying economic realities" in their
place. And as it turns out, Kregel's essay, "Conceptions of Equilibrium:
The Logic of Choice and the Logic of Production," is worthy of some attention.
Kregel discusses several
conceptions of equilibrium whose differences hinge on the different roles
played by subjective factors and objective factors. But because of the
nature of his subjective/objective distinction, his arguments invite misinterpretation.
So-called objective factors, for instance, include not only technology
but also input costs and relative rates of return. Those who have learned
their value theory from Menger and Mises will find Kregel's distinction
puzzling. It may be helpful, then, to recast his argument using the more
conventional, and more modern, Neo-Classical terminology.
Essential to standard Neo-Classical
theory is the notion that each firm in the economy maximizes its own profits
within a set of given constraints. For the economy taken as a whole, the
given constraints include consumer tastes and preferences, the distribution
of wealth, resource availabilities, and technology. These are the factors
that I referred to above as the "underlying economic realities." In Kregel's
terminology an equilibrium in which these factors form the binding constraints
is logically implicit in the constraints themselves. Such an equilibrium
is said to be based exclusively on objective data.
This objectively defined
equilibrium abstracts from any problems or frictions in the market process
that supposedly performs the equilibration. But according to Kregel and
Lachmann, subjective expectations, which are inherent in the market process,
rob the objective data of all their significance. In fact, the very existence
of the objective data is called into question. Consumer demands are governed
in part by consumer incomes, which are determined by the decisions of entrepreneurs,
which, in turn, are based upon expectations about consumer demands. The
reasoning may be circular, but it captures a critical circularity that
characterizes the market process. If the expectations of entrepreneurs
turn out to be the binding constraint, the objective data have no opportunity
to reveal themselves, and any equilibrium actually achieved is one based
exclusively on the subjective data.
The emphasis on the role
of expectations to the virtual exclusion of the more fundamental constraints
is what gives Kregel's Post Keynesianism and Lachmann's Radical Subjectivism
their kaleidic nature. Expectations can and do change in ways that we have
no way of predicting or even fully explaining. We can only watch the resulting
changes in the pattern of prices and wonder why others associate those
patterns with an "underlying economic reality." A partial explanation of
such changes, however, comes in the form of a path-dependency effect, the
qua non of Lachmann's market process.
The Significance of the Path-Dependency Effect
The dynamic properties of Lachmann's world depend in large part upon
the dominance of a certain path-dependency effect. This effect gets brief
mention in the first chapter (pp. 4-5) and underlies much of Lachmann's
theorizing. In the broadest terms, if the specifics of a general equilibrium
position depend upon the particular sequence in which the market process
eats away at disequilibrium, a path-dependency effect is said to exist.
If the path-dependency effect is sufficiently large, it may be misleading
if not meaningless to speak of an equilibrating tendency. Each step in
the market process significantly changes the equilibirum toward which the
process is supposedly tending thus guaranteeing that the next step will
be in some other direction.
In modern Neo-Classical
theory, path-dependency effects usually take the form of income or wealth
effects. Trading at disequilibrium prices can shift wealth from one market
participant to another. While the very same trading helps to bring prices
to their equilibrium levels, the equilibrium itself is determined by the
preferences of each market participant weighted by his ability to influence
market outcomes, that is, by his wealth. To avoid analytical messiness
Leon Walras, the father of modern general equilibrium theory, assumed that
there is no trading at false (i.e. disequilibrium) prices.
In Lachmann's analysis,
the path dependency takes the form of changing knowledge rather than changing
wealth. Expectations are necessarily divergent: it takes both bulls and
bears to clear the asset markets. Even if we conceive of the market process
as tending toward some equilibrium, we must recognize that as the process
begins to unfold, asset holders will acquire additional informations, which
will cause their expectations to change. In turn, the changing expectations
will have an effect, possibly a drastic effect, on the equilibrium to which
the market process is tending. Discoordination, as implied by the conflicting
views of bulls and bears, does not give way to coordination but only to
some alternate pattern of discoordination. The Lachmannian bull (as well
as the bear), we are led to believe, is a bull in a china shop.
Austrianism and Keynesianism in Perspective
"It is a fact," according to Lachmann, "that the neoclassical orthodoxy
has, to this day, failed to grasp the consequences of the volatility of
asset markets" (p. 42). Attention to path-dependency effects in the form
of highly volatile asset markets gives Lachmann's analysis a distinct and
overt Keynesian flavor. In Keynes' vision of the market process the marginal
efficiency of capital, which reflects profit expectations, shifts about
with waves of optimism and pessimism. Businessmen are moved by "animal
spirits," to use Keynes' own colorful language, to undertake investment
projects. When riled by the spirits, investors create a prosperous economy;
when the spirits are on the wane, the demand for capital assets falls,
possibly triggering an economic collapse.
Keynes goes so far as to
lament the emergence of organized capital markets. Without such markets,
changing expectations about the profitability of different capital combinations,
whether brought about by the waxing and waning of the animal spirits or
the acquisition of new information, could not disturb an otherwise orderly
market process. Keynes own grasp of the consequences of the volatility
of asset markets becomes clear when he ponders possible remedies. "The
spectacle of modern investment markets has sometimes moved me toward the
conclusion that to make the purchase of an investment indissoluble, like
marriage, except by reason of death or other grave cause, might be a useful
remedy for our contemporary evils."(5)
While Lachmann abstains
from offering such a Draconian prescription, his diagnosis of the problem
is much the same as Keynes'. The invisible hand of Adam Smith works tolerably
well in a exchange economy. With such a steady hand on the kaleidoscope,
the particular pattern of glass and prices is more interesting than the
fact that the kaleidoscope might be bumped. But with the emergence of organized
capital markets, the invisible hand becomes palsied. In Keynesian terms,
speculation dominates enterprise; in Lachmannian terms, the shaking of
the kaleidoscope renders any particular pattern of glass and of prices
Grasping what Lachmann is
saying is easier than understanding why he is saying it. It is coming to
be recognized, especially in Austrian circles, that Keynes' view of the
market process derives from the fact that Keynes had no theory of capital.
Intertemporal market forces that work to coordinate savings with investment
and to tailor the economy's production activities to match intertemporal
consumption preferences are not at work in the General Theory. The
conclusion that market economies are inherently unstable follows trivially.
But the Austrians do have
a theory of capital. In his Capital and Interest, Eugen von Böhm
Bawerk identified the critical intertemporal relationships within the economy's
structure of production; Hayek in his Pure Theory of Capital identified
the corresponding relative-price relationships and showed how the market
process could achieve intertemporal coordination. Lachmann's own Capital
and Its Structure gave us a healthy appreciation for the difficulties
involved in market directed intertemporal coordination, but it did not
reduce our confidence in the market's performance—especially when compared
to the performance of possible alternative institutions.
It is true that neither
Keynes nor Lachmann can see these market mechanisms by peering through
a kaleidoscope. But for the Austrians, this just means that the scope of
analysis is too narrow. If movements in asset prices are not understandable
within the context of a single period, we should broaden the analysis to
include a sequence of periods. Only by taking into account the intertemporal
relationships within the multi-period capital structure can we make such
price movements intelligible. We need not claim that the market process
in a highly industrialized market economy is smooth and trouble free. The
kaleidoscope does on occasion get bumped. But based on our reading of Mises
and Hayek, we can suggest that the bumping is done not by bulls and bears
but by the central bank—a factor that Lachmann now chooses to downplay.
Lachmann's readers have
long valued his early contribution to the theory of capital. His Capital
and Its Structure, published over thirty years ago, provided a satisfying
account of the heterogeneity of the economy's capital stock and of the
network of interrelationships that, taken together, govern the market value
of each of the elements that make up the capital structure. While his readers
may wonder why this thoroughly Austrian vision of the market economy did
not serve as the point of departure for his Market as an Economic Process,
they will appreciate this most recent book's demonstration—however inadvertent—of
the importance of a well developed capital theory in theorizing about the
Roger W. Garrison
Roger W. Garrison is Assistant Professor of Economics
at Auburn University, Auburn, AL 36849. He would like to thank Roger Koppl,
Sven Thommesen, and Leland Yeager for their helpful comments on an earlier
draft of this article.
1. Lachmann's South Royalton lectures,
along with the lectures of Israel M. Kirzner and Murray N. Rothbard, are
published in Edwin G. Dolan, ed., The Foundations of Modern Austrian
Economics (Kansas City: Sheed and Ward, Inc., 1976). For a more complete
biographical treatment of Lachmann's long and scholarly career, see Walter
E. Grinder's introduction, "In Pursuit of a Subjectivist Paradigm," in
Ludwig M. Lachmann, Capital, Expectations, and the Market Process
(Kansas City: Sheed, Andrews, and McMeel, Inc., 1977), pp 3-24.
2. Lachmann took the quoted passage
from G. L. S. Shackle, Epis temics and Economics (Cambridge: Cambridge
Universtiy Press, 1972), p. 76. This imagery also underlies Shackle's Keynesian
Kaleidics (Edinburgh: Edinburgh University Press, 1974).
3. See Ludwig M. Lachmann, "From Mises
to Shackle: An Essay on Austrian Economics and the Kaleidic Society," Journal
of Economic Literature, vol. 14, no. 2 (March 1976), pp. 54-62.
4. See Leland B. Yeager, "Why Subjectivism?,"
Review of Austrian Economics, vol. 1, 1987, pp. 5-31.
5. John Maynard Keynes, The General
Theory of Employment, Interest and Money (London: Macmillan, 1936),