1 Introduction

Ludwig Lachmann was one of the leading economists of the Austrian tradition in the twentieth century.Footnote 1 Together with Kirzner and Rothbard, he played a central role in the revitalization of the Austrian School in the 1970s. In his works, Lachmann developed Hayek’s ideas on capital and cycles and deepened the Misesian conception regarding the implications of methodological subjectivism for economic analysis. These developments culminated in his peculiar version of the Austrian theory of the market process. As is well known, his intellectual trajectory is characterized by progressive emphasis on the creative aspect of human action and growing skepticism about the utility of the concept of equilibrium. The preponderance of methodological subjectivism in his mature work led him to defend a quasi-historicist stance on economic theory.

The purpose of this article is to provide an interpretation of the evolution of this aspect of Lachmann’s thought.Footnote 2 This interpretation is constructed in terms of the compatibility between his economic ideas and Popperian philosophy of science, as portrayed by evolutionary epistemology. Specifically, we will argue that the author’s change of opinion about the preponderance of equilibrating or disequilibarating forces in market process theory is strongly associated with the adoption of a philosophical conception criticized by the Popperian tradition; namely, justificationism, which identifies rationalism with the capacity to obtain proven knowledge.

We consider that in order to properly interpret the evolution of Lachmann’s ideas, it is necessary to consider Popper’s philosophy, just as that philosophy was necessary to interpret the evolution of hayekian thought. Hutchison (1981) divided the works of the latter in two phases, the second being marked by the acceptance of Popper’s methodology from Economics and Knowledge. Reversing this procedure and shifting the focus from falsificationism to fallibilism, we postulate the existence of a Lachmann I, whose work is compatible with evolutionary epistemology and a Lachmann II, characterized by the indirect adoption of a justificationist epistemology. Lachmann I is characterized by his works in capital theory and Lachmann II by the emphasis on the so-called radical subjectivism applied to the Austrian theory on the market process. Although all his texts are marked by the coherent application of the Austrian principle of methodological subjectivism, there is nevertheless a clear shift of emphasis throughout the author’s career. Lachmann I states that in the market process, forces leading to equilibrium predominate, while Lachmann II emphasizes the disequilibrating forces. The question of what kind of force predominates, in turn, is related to a change of interpretation about the meaning of equilibrium and its role in economic theory. Studying this same issue with regard to Hayek, Caldwell (1988) describes a “Hayek’s transformation” into a skeptical author about the utility of the concept of equilibrium, something that would have happened from the same article mentioned above. In Lachmann’s case we believe that a similar change exist that can be explained in Popperian terms, which allows us to speak of a Lachmann’s transformation.

In order to escape a mechanistic conception of learning, Lachmann shows that knowledge about the future cannot be established or proven with certainty. The use of the unattainable goal of certainty as a standard, however, hinders the appreciation of the effectiveness of learning through trial and error, which in fact does not suppose that what survives in evolutionary processes is proven truth. Lachmann I, working initially on the Hayekian framework, describes learning processes of an evolutionary nature, compatible with the fallibilist perspective on the growth of knowledge. Lachmann II, on the other hand, insisting on the inability to obtain proven knowledge, becomes skeptical about the effectiveness of error correction mechanisms and thereby abandons his initial interest in the theoretical description of these mechanisms in favor of a quasi-historical description of market processes.

This thesis does not imply that the author has been guided in his career by methodological precepts. On the contrary, we believe that the study of the theoretical problems faced by economists is a better source of interpretation of changes in ideas than the alleged adherence to methodological principles. Lachmann’s transformation can in fact be explained by the context of theoretical issues that preoccupied the author. But, if we consider the Austrian research program, economic theory and philosophy of science cannot be dissociated, dealing with the acquisition of knowledge or learning. Lachmann’s rejection of the notion of equilibrium, in fact, explicitly makes use of the philosophical argument we will discuss throughout this paper. And ideas, like action, also have unintended consequences. Thus, we will show that the Hayekian research program that informs Lachmann’s initial work is compatible with evolutionary epistemology, while the methodological beliefs defended in his later work contradict it. The contrast between these two philosophical perspectives, therefore, is also manifested in Lachmann’s views on economic issues. But, before visiting his writings in order to corroborate our interpretation, it is necessary to make explicit the philosophical beliefs that we will use.

2 Evolutionary epistemology

At first it would not be necessary to expose once again the set of basic ideas associated with Karl Popper’s philosophy. However, this is necessary to the extent that what that author himself considers its main point is rarely portrayed in the secondary literature and that point is precisely what we need in our discussion.Footnote 3 In particular, too much emphasis is given to the discussion of some version of falsificationism, to the detriment of the examination of the importance and consequences of Popperian fallibilism.Footnote 4 Falsificationism is a methodological thesis that proposes a demarcation criterion between science and other types of beliefs. According to this thesis, scientific theories contain potentially falsifiable propositions, that is, statements that are logically inconsistent with possible empirical propositions, so as to prohibit the occurrence of events that, if they do occur, would reveal problems with the considered hypothesis. Fallibilism, in turn, is the epistemological thesis that states that it is not possible to conclusively establish whether a thesis is true. For this doctrine, the rational character of science does not depend on the ability to prove or justify knowledge, but on establishing favorable conditions for detect and correct errors.

Among Austrian economists, Popper’s ideas are viewed with little sympathy, largely in reaction to the acceptance of falsificationism by the mainstream of the profession, whose members frequently also espouse variations of positivist philosophy. Instead, Austrians tend to adopt the original Misesian apriorism or some subjectivist philosophy, such as those associated with M. Polanyi or hermeneutics.

On the other hand, few Austrian authors welcome the modified Popperianism proposed by Hayek (1967). The latter accepts Popper’s theses on science, but adds that, in addition to the lack of commitment to criticism manifested by the addition of ad hoc hypotheses whose purpose is to protect theories from criticism, as pointed out by Popper, the increase in the complexity of the phenomenon studied also results in reductions of the empirical content of theories and this second factor necessarily accompanies the phenomena studied by social sciences.

In addition to the acceptance of Popperian ideas at the methodological level, Hayek’s conception of the market process resembles Popper’s views about the growth of scientific knowledge. Due to the various similarities between their ideas, they can both be classified as representatives of evolutionary epistemology.Footnote 5 This latter discipline represents phenomena in various fields as learning processes that exhibit the fundamental elements of the Darwinian explanation of the evolution of living beings. The struggle for the survival of organisms, the competition in markets or the growth of scientific knowledge are all seen as different manifestations of processes of learning (or problem solving) by variation and selection. In Popperian philosophy, the growth of scientific knowledge occurs by conjectures and refutations. Likewise, in Hayekian economics, the growth of the knowledge of economic agents depends on freedom and the existence of the mechanism of error correction provided by the price system.

The appeal to the common evolutionary scheme is not merely metaphorical: the growth of knowledge requires both freedom to try different solutions to problems and the existence of decentralized mechanisms of error elimination, in scenarios in which the problems faced are complex and the cognitive capacity of individuals limited. In this way, fallibilism is the core of Popperian philosophy: recognition of the inability to establish final truths demands freedom and criticism in order to stimulate progress. Likewise, we can say that all Hayek theories, from his conception of the functioning of markets to his theses on the evolution of institutions, explore the relation between the limits of knowledge and freedom as a necessary condition for learning. As summarized by Hayek (1979a, p. 29) himself: "It is that the case for individual freedom rests chiefly on the recognition of the inevitable ignorance of all of us concerning a great many of the factors on which the achievements of our ends and welfare depends".

A key feature of Popperian philosophy, Bartley (1964) notes, is the suggestion of a non-justificationist theory of rationality. Previous philosophies of science commonly identify the rationalism of science with the capacity to generate proven knowledge, in contrast to mere opinion, not justified by reason or established facts. Even post-Popperian nihilism, in rejecting normative philosophy of science in favor of descriptive and “naturalized” approaches, identifies rationality with justification when it argues for the impossibility of the latter. Popper (1979), in contrast, develops a non-justificationist theory of rationality: all knowledge, including criticism, is provisional. A mistaken refutation requires more criticism, not less. The concern that a correct theory will be prematurely discarded by criticism would only be justified in environments with a central committee for the judgment of controversies and with no memory of the criticized hypotheses. In decentralized learning environments, in contrast, due to the diversity of opinions, criticized hypotheses survive in smaller niches.

Critical rationalism, of course, frustrates justificationist hopes about the usefulness of the philosophy of science. But, just as it would be foolish to demand from the theory of perfect competition practical recipes on how to obtain profit, it does not make sense to demand from the philosophy of science an algorithm for theory choice. Both Popper and Hayek offer instead institutional theories about the growth of knowledge: rules that foster competition between ideas or business plans lead to greater coordination and growth than rules that promote monopolies of ideas or services. The justificationist point of view, however, rejects this alternative which refuses to try to establish the veracity of particular propositions: just as the theory of evolution has often been criticized for its supposedly circular character, Hayek’s conception of competition as a mechanism of discovery has been criticized for logically precluding ex ante evaluations of the efficacy of competition, since it is not possible to know in advance what will be discovered.Footnote 6

Evolutionary epistemology, as an institutional theory of the growth of knowledge, is interested in describing environments that promote competition between ideas. Hence the preference on the part of Popper for the treatment of hypotheses as autonomous, objective entities, which in a certain sense must be separated from their formulators, so that their logical and empirical consequences are best explored in the marketplace of ideas. Each theory, seen as an autonomous entity, possesses an infinite number of logical consequences and presents also infinite propositions that contradict it. In this sense, knowledge is unfathomable (Bartley, 1990): no one, including its creators, can fully imagine its implications and meaning. Thus, with the fallibilism amplified by the recognition of the unfathomable character of knowledge, the need for a decentralized learning mechanism by trials and errors is reinforced. The growth of scientific knowledge requires division of labor, competition and criticism. On the other hand, subjectivist epistemologies, by associating the meaning of a proposition with its historical, sociological, psychological or linguistic context of its formulation, tend to ignore the comparison between institutions in terms of their capacity to promote growth. Or, as BartleyFootnote 7 put the question, this growth should be analyzed by an economics of knowledge instead of the usual sociology of knowledge.

Realism is the last aspect of Popperian philosophy that we must consider before applying evolutionary epistemology to our examination of the evolution of Lachmann’s ideas. For our purposes, we must emphasize that Popper’s philosophy combines the recognition that theories are creations of human mind with the belief in the existence of an independent external world. In fact, Popper’s philosophy emphasizes that science stems from problems rather than from observation, that there is no such thing as observation independent of prior theoretical conceptions and also that theories are partial and imperfect representations of the external world, not direct representations of it. Although theories do not mirror reality, the latter restricts what can be imagined, through the process of critical elimination of hypotheses that are farther from the reality. In the Popperian conception of science and in Hayekian economic theories, both a subjective element, represented by the creative knowledge of individuals, and an objective one, the external word with which that knowledge interacts, simultaneously coexist in theories of learning made possible simultaneously by diversity and criticism.

Armed with these methodological clarifications, we are now able to explain Lachmann’s transformation in terms of a renunciation of the Hayekian theoretical framework compatible with evolutionary epistemology in favor of a justificationist conception of scientific knowledge.

This article chronologically follows the transformation, although some sets of texts from different periods are grouped when the subject so requires. We will start from Lachmann analysis of the market process in the context of capital theory (Lachmann, 1978 [1956]). This environment is conducive to the development of recurrent themes in his work, such as the study of the role of time, expectations, indeterminism and complexity in economics. These topics are discussed next. Then we will see that a fruit of these developments—radical subjectivism—shapes the author’s theoretical efforts in his later work on the theory of institutions (Lachmann, 1971b) and his view on the market process (Lachmann, 1986). After the description of the transformation and shift towards justificationism, we conclude the article with an interpretation of this evolution in terms of the problems the author dealt with in the context of Austrian market process theory.

3 Lachmann I

Lachmann’s first contributions to economics lie in the area of Austrian capital theory. This theory is characterized by the emphasis on the temporal dimension of production. Each capital good fits into a temporal structure whose shape and complexity change as the economy grows. Economic cycles, for the Austrians, are then explained by distortions in this structure engendered by credit expansion. Austrian cycle theory profitably uses simplified representations of the capital structure in equilibrium. The discoordination of plans caused by the expansion of credit, however, requires examination of action in disequilibrium.Footnote 8 Lachmann then intends to find a manner to represent the structure of capital and how entrepreneurial plans modify this structure, considering that both its elements and the relationships between them are continually changing.

Lachmann’s contributions to the theory of capital define the first phase of his career, marked by a belief in the preponderance of the equilibrating forces.Footnote 9 Since the author works on the Hayekian research program, it is not surprising that, at this stage in his career, Lachmann describes learning processes that bring the knowledge of agents closer to the fundamentals of the economy.Footnote 10 In fact, we can find in Lachmann the main elements of a learning mechanism that we associated with evolutionary epistemology in the previous section of this article. Here, we will highlight three elements of this mechanism: complexity, limited knowledge and learning by trial and error.

Let us first consider the complexity of external reality to which agents must adapt, manifest as the need to considerer the structure of capital and not its aggregate value. Lachmann emphasizes throughout his book that if there is rigidity in production, that is, if capital goods are specific in their use to some degree, then the intertemporal compatibilization of production plans in a scenario of unexpected changes requires that we exam the structure of capital: “… we must regard the ‘stock of capital’ not as a homogeneous aggregate but as a structural pattern. The Theory of Capital is, in last resort, the morphology of the forms which this pattern assumes in a changing world”. (Lachmann, 1978: 4).

As circumstances change, not only are capital goods reallocated by agents according to their individual plans, but it is also necessary to have a certain degree of compatibility between the elements of the structure as a whole. Those capital goods that no longer fit into a plan should be grouped with complementary elements in an alternate use or turned into scrap. Regrouped capital goods, for Lachmann (1978: 3 and 38), are like “fossils” from earlier plans: palaces of merchants were turned into hotels and theaters into cinemas. The theory of capital must study the forces that lead to the integration of the structure of capital, as well as the forces that cause disturbances in this structure.

Capital as a structure resembles modern studies of complexity and self-organization. In fact, Lachmann (1956: 4) seeks to describe the emergence of an order composed of changing and interconnected elements: “The stock of capital does not present a picture of chaos; its arrangement is not arbitrary; there is some order in it. As we saw, capital resources cannot be combined in an arbitrary fashion. Only some modes of complementarity are economically significant. These form the basis of capital order.”

To describe this emergent order, the author proposes a static and a dynamic definition of the structure of capital. The former is defined negatively as the absence of regrouping. A capital structure is composed of interrelated units of capital that do not change. The dynamic definition parallels Hayek’s definition of equilibrium in terms of coordination of plans and is compatible with a growth situation. It is defined in terms of the agents’ correct prediction about changes in the actions of the other agents and in the elements of the structure. To this end, Lachmann distinguishes between consistent and inconsistent capital shifts, whether predicted or not. Inconsistent changes are called structural maladjustments. In addition to adaptation to changes, the capital structure undergoes a process of increasing its complexity, which, although it cannot be measured by a scalar, such as the notion of average period of production, is related to quantities of productive stages and number of connections between them. Just as the division of labor is important to Smith, the “division of capital” is important for Austrians.

The increasing complexity of the capital structure described by Lachmann brings us to the second element of our evolutionary model of learning: the recognition of the importance of the limitations of human knowledge. Since the number of conceivable capital combinations expands, it became increasingly difficult to a single mind to identify them. The comparison of alternatives makes inevitable the consideration of the Hayekian knowledge problem.

Following the Austrian tradition, Lachmann’s treatment of capital has a strong “subjectivist” component. For Lachmann (1978: vii), the concept of capital is not purely material and cannot be dissociated from the plans of entrepreneurs: “The generic concept of capital… has no measurable counterpart among material objects; it reflects the entrepreneurial appraisal of such objects. Beer barrels and blast furnaces, harbor installations and hotel room furniture are capital not by virtue of their physical properties but by virtue of their economic functions”.

Entrepreneurial plans influence the shape of the production structure. Such plans are guidelines for human action and should be revised as unexpected changes take place in the economy. Like Hayek, Lachmann believes that the revision of plans must not be modeled mechanically but studied according to the evolution of the agents’ knowledge. However, the growth of knowledge concerning the formulation and revision of the plans does not follow any known pattern. That occurs because one cannot predict future states of knowledge; and expectations, molded by the knowledge of the agents, are not determined by the “data” of the problem.Footnote 11

For Lachmann (1978: 22), the subjectivism of expectations is different from the subjectivism of preferences. The latter can in a sense be considered “given”, while expectations involve interpretation of reality and this interpretation is always problematic. In the face of continual change, prices “are no longer a safe guide to action”. They transmit information only imperfectly, requiring interpretation: there may be delays, interferences, changes in the opposite direction occurring at the same time and the same signals can be interpreted differently.

A theory of expectations must deal with the learning process arising from the interpretation of signals generated by the market. Consistent with the research program of evolutionary epistemology, Lachmann draws a parallel between business and scientific learning:

The business man who forms an expectation is doing precisely what a scientist does when he formulates a working hypothesis. Both, business expectation and scientific hypothesis serve the same purpose; both reflect an attempt at cognition and orientation in an imperfectly known world, both embody imperfect knowledge to be tested and improved by later experience. (1978:23).

Translating these observations into a Popperian framework, does the fallible nature of human knowledge recognized by Lachmann make learning impossible in intertemporal markets? With this question we arrive at the last and third element of evolutionary epistemology, learning by trial and error.

For Lachmann, at this early stage in his career, the market process indeed transmits knowledge through learning by trial and error, which leads to the compatibility of the elements of the capital structure. For him, capital losses and gains, through revaluation of capital or changes in the monetary reserves of companies, constitute a selection mechanism that tends to integrate the structure of capital.

In his book on the structure of capital, Lachmann tell us that agents test their expectations in the market, resulting in revisions of these expectations and learning from experience. Different people have different expectations (facing the same objective reality). Hypotheses that survive the market test tend to reflect more accurately the underlying realities or fundamentals of the economy. The market process leads to the adjustment of the production plans in order to bring them in line with the reality of the plans of other producers and consumers. We can say that Lachmann I (1978: 62) believes that the equilibrating forces are greater than the disequilibrating forces with respect to the market process situated in the context studied by the theory of capital: "We may thus conclude that via knowledge transmitted through the price system economic change tends, in general, to give rise to expectations consistent with itself.” At his point in his career, Lachmann believes in the corrective properties of the price system, in spite of the awareness that factors such as information delays or price rigidities could distort the structure of production.

Although somewhat summarized and fragmented, the exposition of Lachmann’s theory around three elements—the increasing complexity of the problem of coordination of intertemporal production plans, the dispersed and fallible knowledge of the agents, and the market mechanism of error correction illustrate the Hayekian origin of Lachmann’s contribution and consequently its compatibility with evolutionary epistemology. Lachmann’s uses of his theory, moreover, fit perfectly into the methodological framework proposed by Hayek (1967): the study of complex phenomena allows us to make only pattern predictions. These predictions are usually associated with the limitations imposed by the external world on what agents can plan and do. Complexity and subjectivism, on the other hand, leave little space for precise predictions about what agents will actually do, as Lachmann II’s methodological program will latter emphasize.

4 The transformation

Let us now see how Lachmann’s transformation occurred. In a nutshell, his reaction against mainstream economics, which disregards subjectivism, led him to adopt a set of methodological beliefs indirectly incompatible with part of the Austrian research program that informs his work on capital. In criticizing the denial of the autonomy of the human mind commonly associated with formalism in economic theory, Lachmann rejects the study of the limits to human creativity imposed by non-subjective factors that characterizes Austrian use of the concept of equilibrium. But, as we will show in our critique, an adequate interpretation of this concept does not imply a denial of the autonomy of the human mind. Exposing our argument in terms of evolutionary epistemology, we can say that the use of theories of learning does not require that we know how to establish the veracity of specific propositions. To document the transformation, our analysis will address three aspects of Lachmann’s work present in several articles written throughout his career: subjectivism, expectations, and equilibrating forces.

4.1 Subjectivism

Lachmann develops the implications of subjectivismFootnote 12 in his criticisms of the economic theories of his time, which made our author increasingly skeptical about the preponderance of equilibrating forces in the market and the utility of equilibrium theory. The emphasis on subjectivism led Lachmann to develop, together with his friend G.L.S. Shackle, a point of view known as "radical subjectivism", which will be consistently applied in his later theoretical formulation, resulting in a conception of the theory of the market process somewhat different from what we have discussed in the previous section. The examination of his writings on these subjects, however, allows us to identify a transition phase, in which the transformation is not yet complete.

Throughout his career Lachmann wages a battle against the neglect of subjectivism. His work is a long journey of struggle against what he calls the Ricardian counterrevolution (Lachmann, 1976). Lachmann does not focus only on neoricardianism itself, but also on neoclassical microeconomic theory, which, because of the exclusive focus on equilibrium situations, tends to disregard other subjective dimensions of economic phenomena besides preference ordering.

In his writings on the history of economic thought, Lachmann evaluate the evolution of economic theory in terms of adherence to subjectivism. In fact, Lachmann frequently quotes Hayek (1979b: 52) on this matter: “And 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 (1990) elaborate this idea devising a historical progression according to which economic theories incorporates successively the subjective notions of preferences, plans and expectations. This last advance, for the author, must lead us to emphasize the autonomy of the human mind (choices are not determined by external variables): since ends are in the future, they are not given, as static preferences supposedly are, but must be actively imagined.

Parallel to these advances, Lachmann (1994) reports the “vicissitudes of subjectivism” in the twentieth century: both in micro and macroeconomics,Footnote 13 the subjectivist interpretation was lost in the formalization of theories. In microeconomics, Lachmann points out several problems arising from the neglect of subjectivism. In particular, one may criticize the practice of considering the fundamentals of the economies as exogenous, independent of considerations about the active mind and the pursuit of ends. For Lachmann (1991: 289), however, choice is an active operation of the mind:

The fundamental flaw of neoclassical methodology lies in the confusion of action with reaction. Man in action is seen as a bundle of dispositions and not a bearer of thought. What difference does it make if we observe rather than ignore these distinctions? In action we reflect on means and ends, trying to fit the former to the latter, make plans and carry them out. As our ends lie in the unknowable (albeit not unimaginable) future, we have to exercise our imagination in reflecting upon them, and such exercise is incompatible with mere ‘response to stimulus’ or even the ‘decoding of signals’.

This criticism of the neglect of subjectivism has macroeconomic implications. In an article from intermediary period of his career, Lachmann (1966a) criticizes mid-twentieth century macro modeling for systematically excluding human action and individual plans from analysis. Criticism is directed, in this article, specifically to the abuse of the notion of equilibrium. Echoing Hayek, Lachmann notes that this concept, by limiting analysis to situations of prior reconciliation of individual plans, disregard any mental activity that would be necessary to explain the emergence of that state. Lachmann defines formalismFootnote 14 as this disregard of subjectivism.

But what does Lachmann offer instead? In this same article, Lachmann still presents an evolutionary theory of market process, consistent with his previous work on capital. The theory must study the inevitable incompatibility of plans, which result in malinvestments that requires revision of plans. The theory should study the selection mechanism imposed by the market and how this selective process leads to the review of plans. The selective mechanism is provided by capital gains and losses. In the analysis of this process, the author recognizes two aspects: innovation and imitation. At this point of Lachmann’s intellectual trajectory, we can thus recognize the elements of an evolutionary theory of learning: variation and error elimination. The emphasis on variation, at this point, does not yet diminish the importance of selection.

4.2 Time and knowledge: the role of expectations

We encounter another picture of the market process, however, when we contemplate the problem of knowledge about the future. By emphasizing the uncertainty of expectations, Lachmann denies the possibility of learning and equilibrium. The emphasis on uncertain and subjective knowledge brings the author closer to the ideas of Shackle. In fact, both develop this theme in similar fashion.Footnote 15 We will see in this subsection that they share with Hayek the idea of the central importance of the knowledge of the agents, differing from him, however, in the solution given to the problem.

Lachmann (1943) learns from Hayek that economic reality requires interpretation on the part of agents. Again, with Hayek, Lachmann I believes in a selection mechanism that can results in the convergence of expectations to the underlying realities.Footnote 16 But later, along with Shackle, Lachmann II studies the relationship between time and knowledge, which leads him to the concept of divergent expectations and the abandonment of the belief in the preponderance of the equilibrating forces of the market. At his point the justificationist assumptions of his analysis are manifest, as we shall see now.

Economic activity is characterized by choices. However, as noted by Shackle (1976), it is already too late to choose for the present: choices refer to alternatives that lie in the future. However, the future is not determined by the objective data of the problem. In a world of unexpected changes, the future is uncertain and must be imagined. In this sense, choice is original (Lachmann, 1994: 247). Because different individuals have different worldviews, different expectations will emerge. Hence, he uses the expression “divergent expectations”, which will characterize markets in Lachmann’s view, with little use left for the notion of equilibrium. From this point on Lachmann replaces in his writings the expression “in a world of continuous changes” by the shacklean metaphor of the kaleidoscope, according to which the market abruptly moves from one complex configuration to another.

For Lachmann,Footnote 17 however, futures markets and stock exchanges still have a positive role to play, that is, to coordinate these diverging expectations. Different agents do not have to agree on the future, but their actions can be coordinated in the market. Expectations never converge; even a perfect future market would not escape the problem of the divergence of expectations. For Lachmann (1994 [1976]: 236), those different worldviews clash in markets:

The future is unknowable, though not unimaginable. Future knowledge cannot be had now, but it can cast its shadow ahead. In each mind, however, the shadow assumes a different shape, hence the divergence of expectations. The formation of expectation is an act of our mind by means of which we try to catch a glimpse of the unknown. Each one of us catches a different glimpse. The wider the range of divergence the greater the possibility that somebody’s expectations will turn to be right. [...]

The market, of course, cannot diffuse “superior expectations” in the sense in which it diffuses superior knowledge because ex ante no criterion of success can exist. It cannot make bulls and bears change their expectations but it nevertheless can co-ordinate these.

This fragment reveals some fundamental points. In the first paragraph, Lachmann recognizes the importance of diversity to increase the likelihood of one of the possibilities being correct. As he pointed out in his previous work, this could be followed by imitation of that better alternative, resulting in an equilibrating process. In evolutionary epistemology in general and in the Hayekian tradition in particular, the existence of opposing points of view is vital for learning to take place. But, probing the nature of expectations, Lachmann concludes that learning would not be possible. In the same text, Lachmann states that the treatment of expectations by Shackle poses a challenge to the Austrian economy advocated by Mises, Hayek and Kirzner, since there would be no diffusion of expectations similar to the diffusion of knowledge: since there is no ex ante criterion of success, there is no transmission of correct expectations. Thus, Lachmann reaches a position known as radical subjectivism, which denies not only the neoclassical concept of equilibrium, but also the use of this concept in the Austrian tradition itself. This marks the transformation of Lachmann I into Lachmann II. Later, Lachmann (1988) would deny that speculative markets can be described as a Hayekian discovery process.

The reasoning outlined above reveals in Lachmann and Shackle the presence of a justificationist perspective. Both authors clearly distinguish the nature of knowledge of present and future facts. The former, according to both authors, is valid, justified knowledge, while the latter are uncertain, therefore not proved or justified. This, as we have seen, contrasts with Popper, for whom all knowledge are hypothetical. Likewise, in the context of the market process, the knowledge of the agents, in Hayek’s opinion, is also fallible. For Lachmann and Shackle, however, the absence of proven knowledge in the market frustrates and renders illegitimate any attempt to theoretically address learning. As our analysis of evolutionary epistemology shows, this retreat to a subjectivist epistemology blocks the ways for an effective institutional analysis on the environments conducive to the growth of knowledge.

For both authors, what confers the unproved character of expectations is their relation with time. For Shackle (1976: 49), “Time is the denial of the omnipotence of reason. Time divides the totality of things in that part to which we can reason about and that part which we cannot do it. For we can only reason about those things that are complete; and in a world in which time exists, never anything is complete.”Footnote 18Epistemics and Economics can be summarized as the development of the implications of the fact that the passage of time makes the knowledge of economic agents uncertain. Practically in all chapters of this book we can find sentences distinguishing knowledge and expectations in terms of valid knowledge. The same justificationist notion is also found in Lachmann (, emphasis added) with some frequencyFootnote 19: “what criteria of valid knowledge are at his [the agent] disposal?”.

For Lachmann, the impossibility of certain knowledge robs the concept of equilibrium of its usefulness. Revisiting capital theory, Lachmann (1994 [1975]), rejects equilibrium even as a first step in the analysis, and considers that notion as incompatible with market process theory. This does not necessarily mean that the author denies the existence of the limits to human action. In the same article, Lachmann speaks of action guided by constraints and even writes that, in the theory of capital, the equilibrating forces outweigh the disequilibrating ones (1994 [1975]: 208). But for him, as the idea of equilibrium is hopelessly associated with determinism and denial of subjectivism, it cannot be used to point out the limits to action recognized by him.

4.3 Equilibrating and disequilibrating forces

In the previous subsection we show how the impossibility of justifying knowledge about the future is associated with the divergence of expectations in a kaleidic world. Let us now see the implications of this for Lachmann’s view about the market process. For him, the relative strength of equilibrating and disequilibrating forces depends on the characteristics of each market. We could face different configurations of the resultant vector of opposing forces. For the relevant cases, however, the disequilibrium forces would prevail:

If, with Mises, we reject the notion of general equilibrium, but, on the other hand, do not deny the operation of equilibrating forces in markets and between markets, we naturally have to account for those disequilibrating forces which prevent equilibrium from being reached. In other words, to explain the continuous nature of the market process is the same thing as to explain the superior strength of the forces of disequilibrium (Lachmann, 1971a: 190).

In the same article, Lachmann discusses the speeds of adjustment and diffusion of knowledge, which will influence the chances that the equilibrating forces carry out their work before further disruptive changes. Delays in diffusion can make information irrelevant the instant they reach its destiny and agents could make decisions before that moment.

The divergence of expectations resulting from the inability to justify expectations and the rigidities in capital structure both collaborate to represent the market process as a continuous flow of novelties, not as an adaptive system for error correction:

In a kaleidic society the equilibrating forces, operating slowly, especially where much of the capital equipment is durable and specific, are always overtaken by unexpected change before they have done their work, and the results of their operation disrupted before they can bear fruit. Restless asset markets, redistributing wealth every day by engendering capital gains and losses, are just one instance, though in a market economy an important one, of the forces of change thwarting true equilibrating forces....What emerges from our reflections is an image of the market as a particular kind of process, a continuous process without beginning or end, propelled by the interaction between the forces of equilibrium and the forces of change. (Lachmann, 1976: 239)

We must now make some comments on Lachmann’s conception of markets. All Austrians would agree with the representation of markets stated above: the continuous flow of changes means that in the real world the markets never really reach equilibrium, understood as a state of perfect coordination. Nor Lachmann deny the existence of equilibrating forces. The concept of equilibrium, moreover, if misinterpreted, can generate a transfer of simplicity from the model to the complex reality it intends to portray. Lachmann emphasizes this danger in his criticism of the neglect of subjectivism. The point under dispute, however, concerns the rejection of the concept of equilibrium.

In the Austrian tradition, this concept has no purely instrumental or realistic interpretation and must be understood on an abstract level. It is not a pure instrument, because Austrian economists believe in the existence of real plan coordination at certain degree. Nor is it a literal description of reality, because the variables change continuously. The concept, however, is crucial for an explanation of the emergence of order in markets. At the abstract level in which it operates, an explanation of this emergence is not intended to positively identify what concrete decisions will be made in the markets, but to point out patterns on how different aspects of economic reality affect those decisions. This is done through the description of an error-correcting mechanism, in which the concept of equilibrium merely indicates the direction of the necessary adjustments.

Since it deals with complex phenomena, the explanation of the emergence of order through a mechanism of error correction involves only pattern predictions (Hayek, 1967). The analyst could never anticipate how an entrepreneur would meet a specific demand in the market, but he could describe patterns of changes in prices and profits that would occur if inputs became scarcer or if the government restricted trade or controlled prices. The discussion of the effectiveness of this mechanism does not, therefore, require that we be able to prove that entrepreneurial hypotheses or expectations are correct and represent the best alternative available. We are not interested in the hypotheses created, but in the ways in which those most incompatible with reality are discarded. Likewise, in evolutionary epistemology, the occurrence of learning does not depend on the infallibility of criticism. In its place, we have an institutional theory of learning, which describes environments favorable or hostile to the free market of ideas.

By adopting a justificationist perspective on knowledge based on the fact that expectations cannot be proven, Lachmann progressively moves away from this interpretation of markets as an error correction mechanism. In its place, he emphasizes the autonomy of the human mind. Economic phenomena are not determined by material forces but are the fruit of inventive action. But if the notion of equilibrium necessarily denies the autonomy of the human mind, what would be the role of economic theory if exact predictions are impossible? Rejecting the possibility of pattern predictions, it appears naturally for him that the positive tasks left to Economics would be, first, to understand the intentions that shaped economic decisions in the past and, second, to study institutions as guides to action. Our author, now transformed into Lachmann II, consistently follows this program and this will significantly affect his mature view on market process theory.

5 Lachmann II

We will study now the ideas developed by Lachmann after his commitment to radical subjectivism. First, we will visit his defense of a hermeneutical methodology and how this is applied in the theory of institutions. Chronologically, these developments occur simultaneously with the transformation we described in the previous section. We will next exam the application of these methodological ideas to the study of the market process that we find in his last book. The result of this exercise, as we shall see, resulted in a different account on the subject.

5.1 Method and the theory of institutions

So far, we have studied Lachmann’s subjectivism applied to capital and expectations. We shall now turn to writings in which Lachmann explicitly exposes his ideas on the methodological consequences of subjectivism. The first essay of his book on the legacy of Max Weber deals with the method of the social sciences, while the second addresses the theory of institutions. The ideas contained in these two essays will inform the particular method that the author will apply in his last book to the study the market process.

Lachmann derives his ideas of methodology from a source that we have not addressed so far: Max Weber. Our author will adapt the historical method of interpretation (verstehen) as the appropriate hermeneutic method for economics. Hermeneutics is originally the science of interpreting the meaning of a text (Lachmann, 1991: 280, 1971b: 18). Lachmann believes that this method can be adapted to economics. Following this method, the economist should interpret the meaning of action through the study of plans. The task of economics would be to study common elements in plans, including norms, institutions, and institutionalized behavior, such as profit maximization. Lachmann’s proposal in the first essay of his book on Weber is to replace the concept of ideal type with the concept of plan.

Faced with the impossibility of strict predictions in economics, due to the impossibility of accessing the knowledge of agents, the analyst faces two possibilities. We can study the consequences of those limitations to human action or we may seek the explanation of phenomena in the understanding of individual plans. Lachmann (1971b: 37) emphasizes this second option:

Causal explanation in the field of action cannot hope to attain determinateness, but this does not mean that we must give up all hope of explanation. What we may hope to accomplish here is to be able to show to what ends, means, and obstacles human action is oriented. Orientation thus emerges as a concept as fundamental to praxeological study as determinateness is to natural science.

Although we do not have access to the minds of individuals to predict their future actions, we can observe their past actions and, by the hermeneutic method, try to understand the intentions responsible for those actions. Economics should then identify what happened in the past and list what might happen in the future. Commenting on the alternative, the study of limitations to action, and specifically on pattern predictions, Lachmann simply observes that the study of the unintended consequences of human action say nothing against the correspondence between action and plans (1971b: 31 and 46) and that the study of this correspondence would be more fundamental to economics than patter predictions.

This option places Lachmann close to a historicist stance. It is interesting to note that the Austrian School, which fought historicism in its earliest years, ends up adopting a historicist position if the path Lachmann suggests is taken. In any case, given this methodological program, the next step to be followed is the development of a theory of institutions, because rules offer points of orientation for the study of plans.

Lachmann’s contribution to the theory of institutions involves elements drawn from the works of Menger, Weber, Hayek, and his own contribution to the Austrian theory of capital. This last element forms the core of his theory. The set of institutions is seen as a structure composed of interconnected elements. These heterogeneous elements can be seen as complements or substitutes. Each new law or custom does not simply replace another, but fills an empty space in the institutional matrix, providing rules that guide action in new contexts. This representation of the evolution of the matrix, in turn, invites the examination of the mechanisms that generate cohesion among its elements.

Although motivated by the research program proposed by Lachmann II, it is interesting to note that, regarding the content of the theory, we are faced not with a product of radical subjectivism, but with tools developed by Lachmann I. Besides the subjective dimensions, we encounter evolutionary explanations, learning processes and pattern predictions. Just as a purely subjective analysis inhibits the development of an institutional theory of the growth of knowledge, an economic theory centered on intentions and not on unintended consequences offers little besides the construction of typologies. In fact, a descriptive or historical approach will characterize the analysis of the market process undertaken by Lachmann II.

5.2 Market processes

We will now see how in his last book Lachmann (1986) applies the hermeneutical methodological precepts developed in the previous subsection to the study of market process. As the book systematically exposes Lachmann's mature views on the market process, we can use it to substantiate our interpretation of the author's transformation. We may attribute certain contradictory or ambiguous ideas in previous works to a transitional phase. In this last book, however, Lachmann will unequivocally defend a historicist methodology and reject the view that the task of economics is to trace the unintended consequences of human action. In this book, Lachmann’s version of historicism, which sees the task of economics as centered on the positive understanding (description) of individual plans guided by institutions, will clearly shape a new way of dealing with market process theory. In this work, the author identifies several ideal types of market and agents. The peculiarities of these markets and agents will then determine the different forms that market processes will take.

We will not deal with the way in which the author organizes the ideas we have already seen. Our exposition will rather stress two points: first we will document the historicist turn; then we will see how Lachmann II applies this method to the study of the market process.

In his book, Lachmann repeats the opinion that the subjective nature of knowledge prevents empirical generalizations, which forces the analyst to seek other ways that could be found, one can infer, in history. Lachmann (1986: 30) states, for example, that one should abandon the search for a theory of business cycles in favor of a historical analysis, in which the study of agents’ knowledge plays an important role. On the following page, we are told that we should focus analysis on economic history, since past knowledge is knowable, in contrast to predictions that would require information about future knowledge:

Our conclusion that economists must confine their generalizations to the knowable past will be deplored by all those who see the main task of economics is the making and testing of predictions. Our answer has to be that the social world, unlike the solar system, is impelled by forces as mutable as thoughts and that no Newtonian model fits it. (Lachmann, 1986: 32).

The preference for a historical point of view is manifested in several other points. He suggests that we should move away from determinism toward something descriptive (p. 112) and states that the object of economics is to describe the intentional conduct of agents in uncertain environments (p. 139).

On the other hand, the task proposed by Hayek—tracing the unintended consequences of human action through pattern predictions—is explicitly rejected in this book. We have seen that Lachmann did not deny such a possibility in previous works, even considering it as the most interesting one, after the task of understanding intentional action. Now (pp. 32–33, 115) this is considered impossible, since, according to the author, it could only be done under restrictive coeteris paribus conditions, especially with respect to expectations.

However, what is the difference between theory and history, according to him? Lachmann criticizes the Misesian definition based on the distinction between typical and unique events and offers a response echoing his book on Weber’s legacy: the economist must deal with conceptual schemes in the form of ideal types—economist creates and historian uses them (p. 34).

How does Lachmann apply this methodology in the study of the market process? For him, different markets are characterized by the interaction of different classes of agents, with different interests and acting under different constraints. A diverse range of market processes thus arise. Therefore, for him, there is not such a thing as a model of “the” market process: by constructing several ideal types, each one representing different kinds of agents, we should speak in market processes, in plural. This results in the construction of a taxonomy of agents and market processes. Lachmann distinguishes between intramarket, intermarket and macroeconomic processes; between economies of production and exchange; between cooperative and entrepreneurial economies, and between rigid and flexible prices economies. As for the agents, the author distinguishes the arbitrator, the speculator and the innovator.

The main conclusion extracted from all these distinctions is to point to the diversity of market processes, implying an equivalent variability of results. Lachmann seeks to describe the characteristics of each market process identified in the taxonomy listed above. For each combination, the question of what forces prevail—those of equilibrium or those of disequilibrium—must be done on a case-by-case basis: the more expectations diverge, the greater the preponderance of disequilibrating forces. Expectations, in turn, differ to a greater or lesser extent depending on the complexity of the market and the type of institutions that emerge in that market.

In his work, the hermeneutical methodological prescription, the theory of institutions and the study of market processes are closely linked, forming part of a coherent research strategy. The result, a series of classifications of market types and ideal types of agents is a coherent application of the methodological path that the author has chosen, resulting in a positive description of forms that a market process can assume. We no longer speak of the process of the market in general, but of several processes that differ from each other in different institutional environments.

We cannot fail to note at this point the lack of further theoretical results that follow this taxonomic effort, something common to all variants of historicist thought in economics. In the case in question, this phenomenon is explained here with the aid of evolutionary epistemology. The unattainable demand for proven knowledge implies the rejection of a “merely” institutional theory of the growth of knowledge, which only compares environments in terms of their capacity to foster progress, rather than provide an unequivocal algorithm of choice. The justificationist point of view leaves as an alternative only the description of particular concrete phenomena, providing no guide of navigation in the midst of the complexity of the phenomena studied.

We could, however, still accommodate in economics the awareness of the creative character of entrepreneurial activity and the existence of different types of market processes without abandoning theoretical representations. In an evolutionary model, different rates of mutations and recombination, or speeds at which the environment changes or yet the rigor of the selection mechanism result in the same diversity of results described by Lachmann. In an evolutionary perspective, the recognition of the creative aspect of the subjective element does not imply the rejection of the study on how the external world changes individual plans and produce unintended consequences.

6 Conclusion

We must now summarize our assessment of Lachmann's thought by asking three questions. What did he intended to show? Next, what were the unintended consequences of the author’s theoretical choices? Finally, is there an alternative to the problems inherent in this choice?

The answer to the first question is not trivial. Lewin (1996), for example, considers that Lachmann sounds more radical than necessary: when he states that prediction in Economics is impossible, in fact he meant that perfect prediction is impossible, agreeing that there might be less rigorous kinds of prediction. For Rizzo (1996), Lachmann’s work deals with the balance between equilibrating and disequilibrating forces. He considers that the subsequent emphasis on the latter kind of forces reflects the audience to which the author addressed: in speaking to a neoclassical audience, one must emphasize disequilibrating forces.

We believe that the main message conveyed by Lachmann can be illustrated by the title of the appendix of his latest book: "The Market is not a Clockwork". In this appendix, Lachmann (1986: 159) states that “[t[he neoclassical paradigm, in part, rests on an astonishing lack of ability on the part of many of its adherents to realize the limits of determinist as a form of economic thought.” Economic theory should deal with human action, not reaction. Lachmann’s work can be seen as a battle against the determinism and mechanicism of economic theory, both in its classical and neoclassical forms. His criticism is directed against plutology and neoricardianism, perspectives that perceive wealth as an autonomous entity, independent of continuous entrepreneurial evaluation. In this combat, the weapons used were two, available in the core of the Austrian research program: the complexity of the economic problem and the subjective variables that underlie every economic phenomenon.

The emphasis on the complexity of capital, with its changing pattern of structural relations, the focus on the complexity of the market process in general, with its chains of actions and interactions that creates many path dependent phenomena and finally the idea of treating economic agents as scientists who formulate hypotheses about such complexities, promise to constitute the most important elements of the legacy left by Lachmann.

To emphasize the importance of subjectivism is a very important task to correct most of the deficiencies found in modern theories. The overemphasis on this task—radical subjectivism—nevertheless presents unwanted unintended consequences, the object of our second question. By emphasizing subjectivism, one runs the risk of denying the realities underlying the market process. Lachmann does not intend to deny such realities, but the direction of his thinking leads in practice to such denial. This negation takes the form, for example, in the disregard of the error in economics:

For the new view the objects of action lie in the future. ‘Choice is made amongst the invented, subjective creations of thought’ and thus provides no criteria of error or truth. In the older view men, impelled by tastes and constrained by obstacles, make choices which are the outcome of the interaction of these forces. Choice is the result of the impact of constraints on human dispositions. In the new view, choice is not a result of anything, but a creative act. (Lachmann, 1986: 55)

The theory of equilibrium is thus viewed as a threat to the autonomy of the human mind. This only occurs, however, when we interpret this theory from a methodological point of view which does not allow the possibility of pattern predictions and uses the notion of equilibrium accordingly. In a theoretical framework compatible with evolutionary epistemology, such as the Hayekian research program, actions are both creative and limited. Lachmann II, as we have seen, does not accept this possibility. This led the author to consider equilibrium theory only in a sense—to predict quantities and equilibrium prices—disregarding the other possibility—to show the limitations of human action imposed by scarcity and other constraints. It follows that economic science should proceed in the sense of describing what agents actually do and think. We thus have the historicism that marks the work of Lachmann II, which results in the author’s view of the market process.

Regarding our third and final question, the development of the Austrian theory of the market process involves, in our opinion, the substitution of subjectivist conceptions about knowledge by evolutionary epistemology, already present, although implicitly, in Hayek’s work. The exploration of this Popperian legacy opens the way for the construction of an institutional theory on the growth of knowledge. This allows us to escape the false dilemma between mechanicism and historicism.