Austrian school of economics

The Austrian School, also known as “the Vienna School” and as “the Psychological School,” is a school of economic thought that advocates adherence to strict methodological individualism. As a result Austrians hold that the only valid economic theory is logically derived from basic principles of human action. Alongside the formal approach to theory, often called praxeology, the school has traditionally advocated an interpretive approach to history. The praxeological method allows for the discovery of economic laws valid for all human action, while the interpretive approach addresses specific historical events.

This Aristotelian/rationalist approach differs both from the currently dominant Platonic/positivist approach of contemporary neo-classical economics and the once dominant historical approach of the German historical school and the American institutionalists. While the praxeological method differs from the current method advocated by the majority of contemporary economists, the Austrian method is essentially identical with the traditional approach to economics used by the British classical economists, the early continental economists, and the Late Scholastics. The Austrian methodology is, therefore, a continuation of a long line of economic thought stretching from the 15th century to the modern era and including such major economists as Richard Cantillon, David Hume, A.R.J. Turgot, Adam Smith, Jean-Baptiste Say, David Ricardo, Nassau Senior, John Elliott Cairnes, and Claude Frédéric Bastiat.

The most famous Austrian adherents are Carl Menger, Eugen von Böhm-Bawerk, Friedrich von Wieser, Ludwig von Mises, Friedrich Hayek, Joseph Schumpeter, Gottfried von Haberler, Murray Rothbard, Israel Kirzner, George Reisman, Henry Hazlitt, and Hans-Hermann Hoppe. While often controversial, and standing to some extent outside of the mainstream of neoclassical theory — as well as being staunchly opposed to much of Keynes' theory and its results — the Austrian School has been widely influential because of its emphasis on the creative phase (i.e. the time element) of economic productivity and its questioning of the basis of the behavioral theory underlying neoclassical economics.

Because many of the policy recommendations of Austrian theorists call for small government, strict protection of private property, and support for individualism in general, they are often cited by laissez-faire liberal, libertarian, and Objectivist groups for support, although Austrian School economists, like Ludwig von Mises, insist that praxeology must be value-free. They do not answer the question "should this policy be implemented?," but rather "if this policy is implemented, will it have the effects you intend?."

History

Classical economics focused on the exchange theory of value. In the late 19th century, however, attention was focused on the concepts of “marginal” cost and value (see Marginalism). Carl Menger's 1871 book, Principles of Economics, is considered one of the crucial works that began the period known as neoclassical economics. While marginalism was generally influential, there was also a more specific school that grew up around Menger, which came to be known as the “Vienna School,” “Austrian School,” or “Psychological School.”

Austrian economics is currently closely associated with the advocacy of laissez-faire views. Earlier Austrian economists were more skeptical compared to later economists such as Ludwig von Mises and Karel Engliš, with Eugen von Böhm-Bawerk saying that he feared unbridled competition would lead to “anarchism in production and consumption.” However, the Austrian School, especially through the works of Friedrich Hayek, would be influential in the revival of laissez-faire thought in the 1980s.

The school originated in Vienna and owes its name to members of the Historical School of economics, who argued against the Austrians during the Methodenstreit, in which the Austrians defended the reliance that classical economists placed upon deductive logic. Their Prussian opponents derisively named them the “Austrian School” to emphasize a departure from mainstream German thought and to suggest a provincial approach. (The name “Psychological School” derived from the effort to found marginalism upon prior considerations, largely psychological.)

Menger was closely followed by Eugen von Böhm-Bawerk and Friedrich von Wieser. Austrian economists developed a sense of themselves as a school distinct from neoclassical economics during the economic calculation debate, with Ludwig von Mises and Friedrich von Hayek representing the Austrian position, where they contended that without monetary prices and private property, meaningful economic calculation is impossible.

The Austrian economists were the first liberal economists to systematically challenge the Marxist school. This was partly a reaction to the Methodenstreit when they attacked the Hegelian doctrines of the Historical School. Though many Marxist authors have attempted to portray the Austrian school as a bourgeois reaction to Marx, such an interpretation is implausible: Menger wrote his Principles of Economics at almost the same time as Marx was working upon Das Kapital, whose second and third volumes were published more than ten and twenty years, respectively, after Principles. (However, this does not refute the weaker claim that marginalism received the attention it did in the 1880s, and not earlier, in part because it was seen as an answer to Marx.) The Austrian economists were, nonetheless, amongst the first to clash directly with Marxism, since both dealt with such subjects as money, capital, business cycles, and economic processes. Böhm-Bawerk wrote extensive critiques of Marx in the 1880s and 1890s, and several prominent Marxists — including Rudolf Hilferding — attended his seminar in 1905–6. In contrast, the classical economists had shown little interest in such topics, and many of them did not even gain familiarity with Marx's ideas until well into the twentieth century.

The school was no longer centered in Austria after Hitler came to power. Austrian economics was ill-thought of by most economists after World War II because it rejected observational methods. Its reputation has lately risen with work by students of Israel Kirzner and Ludwig Lachmann, as well as a renewed interest in Hayek after he won the Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel. However, it remains a distinctly minority position, even in such areas as capital value.^{[citation needed]}

Austrian economics can be broken into two general trends. One, exemplified by Hayek, while distrusting many neoclassical concepts, generally accepts the neoclassical formulations; the other, exemplified by the Ludwig von Mises Institute, seeks a different formalism for economics. The first primary area of contention between neoclassical theory and the Austrian school is over the possibility of consumer indifference — neoclassical theory says it is possible, whereas Mises rejected it as being “impossible to observe in practice.” The second major dispute arose when Mises and his students argued that utility functions are ordinal, and not cardinal; that is, the Austrians contend that one can only rank preferences and cannot measure their intensity, in direct opposition to the neoclassical view. Finally there are a host of questions about uncertainty raised by Mises and other Austrians, who argue for a different means of risk assessment.

The influence that Austrian school ideas have had on Keynesian macroeconomics is often overlooked. Keynes himself acknowledged being exposed to the Misesian notion that “nominal” values could have “real” effects. A further source of this influence is the period of time when the London School of Economics brought in Hayek and other “continental” economists. While their students, though initially receptive, ultimately were drawn to the new Keynesian doctrines, many of the Hayekian concepts, particularly those relating time to the value of capital and its importance, would find their way into the work of Keynesians, especially by way of John Hicks (who, while distancing himself from Keynesianism, nonetheless made the most influential attempt to formalize it).

Alan Greenspan, speaking of the originators of the School, said in 2000, “the Austrian school have reached far into the future from when most of them practiced and have had a profound and, in my judgment, probably an irreversible effect on how most mainstream economists think in this country.” The long-time U.S. Federal Reserve Chairman said he attended a seminar hosted by Ludwig von Mises.[1]

Analytical framework

Austrian economists reject statistical methods and artificially constructed experiments as tools applicable to economics, saying that while it is appropriate in the natural sciences where factors can be isolated in laboratory conditions, acting human beings are too complex for this treatment. Instead one should isolate the logical processes of human action - a discipline named "praxeology" by Alfred Espinas.

Austrians view entrepreneurship as the driving force in economic development, see private property as essential to the efficient use of resources, and usually (if not always) see government interference in market processes as counterproductive.

As with neoclassical economists, Austrians reject classical cost of production theories, most famously the labor theory of value. Instead they explain value by reference to the subjective preferences of individuals. This psychological aspect to Menger's economics has been attributed to the school's birth in turn of the century Vienna. Supply and demand are explained by aggregating over the decisions of individuals, following the precepts of methodological individualism, which asserts that only individuals and not collectives make decisions, and marginalist arguments, which compare the costs and benefits for incremental changes.

Contemporary neo-Austrian economists claim to adopt economic subjectivism more consistently than any other school of economics and reject many neoclassical formalisms. For example, while neoclassical economics formalizes the economy as an equilibrium system with supply and demand in balance, Austrian economists emphasize its dynamic, perpetually dis-equilibrated nature.

The core of the Austrian framework can be summarized as taking a subjectivist approach to marginal economics, and a focus on the idea that logical consistency of a theory is more important that any interpretation of empirical observations. Austrians focus completely on the opportunity cost of goods, as opposed to balancing downside or disutility costs. It is an Austrian assertion that everyone is better off in a mutually voluntary exchange, or they would not have carried it out. A fuller explanation of this in more exact terms is available at the New School's economic pages.

This focus on opportunity cost alone means that their interpretation of the time value of a good has a strict relationship: since goods will be as restricted by scarcity at a later point in time as they are now, the strict relationship between investment and time must also hold. A factory making goods next year is worth as much less as the goods it is making next year are worth. This means that the business cycle is driven by miscoordination between sectors of the same economy, caused by money not carrying incentive information correct about present choices, rather than within a single economy where money causes people to make bad decisions about how to spend their time.

Contributions

Some contributions of Austrian economists:

• A theory of distribution in which factor prices result from the imputation of prices of consumer goods to goods of "higher order," that is goods used in the production of consumer goods (goods of the first order).
• An emphasis on the forward-looking nature of choice, seeing time as the root of uncertainty within economics (see also time preference).
• A fundamental rejection of mathematical methods in economics seeing the function of economics as investigating the essences rather than the specific quantities of economic phenomena. This was seen as an evolutionary, or "genetic-causal," approach against the stresses of equilibrium and perfect competition found in mainstream Neoclassical economics (see also praxeology).
• Eugen von Böhm-Bawerk's critique of Marx centered around the untenability of the labor theory of value in the light of the transformation problem. There was also the connected argument that capitalists do not exploit workers; they accommodate workers by providing them with income well in advance of the revenue from the output they helped to produce.
• Eugen von Böhm-Bawerk's capital theory, which equates capital intensity with the degree of roundaboutness of production processes.
• Eugen von Böhm-Bawerk's demonstration that the law of marginal utility, as formulated by Menger necessarily implies the classical law of costs and hence the vast majority of the conclusions of the British classical economists. This discovery was later fully developed and its implications traced by a student of von Mises, George Reisman, in his book, Capitalism.
• An emphasis on opportunity cost and reservation demand in defining value, and a refusal to consider supply as an otherwise independent cause of value. (The British economist Philip Wicksteed adopted this perspective.)
• The Mises-Hayek business cycle theory, which explains depression as a reaction to an intertemporal production structure fostered by monetary policy setting interest rates inconsistent with individual time preferences.
• Hayek's concept of intertemporal equilibrium. (John Hicks took over this theory in his discussion of temporary equilibrium in Value and Capital, a book very influential on the development of neoclassical economics after World War II.)
• Mises and Hayek's view of prices as permitting agents to make use of dispersed tacit knowledge.
• The time preference theory of interest, which explains interest rates through intertemporal choice - the different time preferences of the borrower or lender - rather than as a price paid for a factor of production.
• Stressing uncertainty in the making of economic decisions, rather than relying on "Homo economicus" or the rational man who was fully informed of all circumstances impinging on his decisions. The fact that perfect knowledge never exists, means that all economic activity implies risk.
• Seeing the entrepreneurs' role as collecting and evaluating information and acting on risks.
• The economic calculation debate between Austrian and Marxist economists, with the Austrians claiming that Marxism is flawed because prices could not be set to recognize opportunity costs of factors of production, and so socialism could not make rational decisions.

Economists affiliated with the Austrian School

Benjamin Anderson William Barnett II Gérard Bramoullé Walter Block Peter Boettke Eugen von Böhm-Bawerk Gene Callahan Tony Carilli Jean-Pierre Centi Christopher Coyne Gregory Dempster Thomas DiLorenzo Richard Ebeling Karel Engliš

Frank Fetter Jacques Garello Roger Garrison David Gordon Friedrich Hayek Henry Hazlitt Gottfried Haberler Hans-Hermann Hoppe Steven Horwitz Jörg Guido Hülsmann William Harold Hutt Israel Kirzner Ludwig Lachmann Don Lavoie

Peter T. Leeson Henri Lepage Peter Lewin Juan De Mariana Ludwig von Mises Margit von Mises Oskar Morgenstern Fritz Machlup Carl Menger Gerald O'Driscoll Ernest C. Pasour Ralph Raico George Reisman

Dr. Kurt Richebächer Mario Rizzo Llewellyn Rockwell Paul Rosenstein-Rodan Murray Rothbard Mark Thornton Joseph Salerno Pascal Salin Josef Síma Mark Skousen Jesus Huerta de Soto Richard von Strigl Philip Henry Wicksteed Friedrich von Wieser

Note that the economists aligned with the Austrian School are sometimes colloquially called "the Austrians" even though not all held Austrian citizenship, and not all economists from Austria subscribe to the ideas of the Austrian School.

Other related economists

• Richard Cantillon
• Frédéric Bastiat (precursor)
• Henry Hazlitt (introduced the Austrian School to the USA)
• School of Salamanca (Renaissance precursors)
• Étienne Bonnot de Condillac
• Louis Say
• Jean-Baptiste Say
• Léon Walras
• Jules Dupuit
• Lionel Robbins
• Wilhelm Röpke
• Joseph Schumpeter
• A.R.J. Turgot
• Knut Wicksell

Critics

• Bryan Caplan
• David D. Friedman
• Tyler Cowen

Seminal works

• Principles of Economics by Carl Menger
• Capital and Interest by Eugen von Böhm-Bawerk
• Human Action by Ludwig von Mises
• Individualism and Economic Order by Friedrich Hayek
• Man, Economy, and State by Murray N. Rothbard
• Competition and Entrepreneurship by Israel M. Kirzner

External links

• What is Austrian Economics? Austrian School as defined by the Ludwig von Mises Institute.
• The Mises Institute - A large selection of online books, video/audio, journal archives, and research on Austrian economics
• Society for the Development of Austrian Economics Largest professional organization of Austrian economists
• Austrian Economics Concise encyclopedia of economics on Econlib
• Austrian School on newschool.edu – compare Austrian versus other Schools
• The Austrian Economists by Eugen von Böhm-Bawerk 1891
• A Great Revolution in Economics - Vienna 1871 and after by Houmanidis and Leen
• The Mont Pelerin Society
• Austrian School Economists from Mark Valenti's Liberty Page
• The Origins of the Austrian School of Economics by John Moser
• {{{2}}} at the Open Directory Project
• Austrian Economics Forum Discussion message board concerning Austrian economic theory
• The Austrian Economists
• Austrian Addiction
• Lew Rockwell
• The Pure Logic of Choice

Critical

• A list of academic critiques of Austrian economics
• Why I Am Not An Austrian Economist
• Austrian Economics

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