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Austrian school of economics

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The Austrian School, also known as the “Vienna School” or the “Psychological School”, is a school of economics that advocates adherence to strict methodological individualism. As a result exponents of the Austrian School 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. Proponents of praxeological method hold that it allows for the discovery of economic laws valid for all human action, while the interpretive approach addresses specific historical events.

While often controversial, the Austrian School has been historically influential due to 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 minarchism, strict protection of private property, and support for individualism in general, they are often cited by conservatives, 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. The Austrian School was one of three founding currents of the marginalist revolution of the 1870s, with its major contribution being the introduction of the subjectivist approach in economics.[1] Carl Menger's 1871 book, Principles of Economics was the catalyst for this development; while marginalism was generally influential, there was also a more specific school that grew up around Menger, which came to be known as the “Psychological School,” “Vienna School,” or “Austrian School.”[2] The Austrian School played a major role in the development of economic theory in the 20th century.[1]

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”.[attribution needed] However, the Austrian School, especially through the works of Friedrich Hayek, was influential in the revival of laissez-faire thought in the 1980s.[citation needed]

The school originated in Vienna. However, later adherents of the school like Murray Rothbard and others have derived the roots of the thought of the Austrian School from the Spanish Scholastics teaching at the University of Salamanca of the 15th century and the French Physiocrats of the 18th century.[3] It owes its name to members of the German 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, Aristotelian 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[citation needed]. This was part of the Austrian economists' participation in the late 19th Century Methodenstreit, during which 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. [original research?] (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.[original research?]) The Austrian economists were, nonetheless, amongst the first to clash directly with Marxism[citation needed], 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 1905–06. 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.[citation needed]

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[citation needed]. 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.[4] However, it remains a distinctly minority position, even in such areas as capital value.

Austrian economics can be broken into two general trends. One, exemplified by Friedrich A. Hayek, while distrusting most neoclassical concepts (like the entire corpus of macroeconomics), generally accepts a large part of the neoclassical methodology; the other, exemplified by Ludwig von Mises, seeks a different formalism for economics. The main area of contention between the mainstream and the Austrian school is on their view of the market system as a process, not only to be studied using equilibrium models, but to be viewed as an incessant process that only tends toward a constantly changing equilibrium, this difference is the root of the Austrian business cycle theory, the economic calculation debate, and their different views of monopoly and competition. The second 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.” This is a more philosophical problem, than one directly relevant to the understanding of the operation of the market. The third 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 at the time. Finally there are a host of questions about uncertainty raised by Mises and other Austrians, who argue for a different means of risk assessment. These questions are directly linked to the market process approach to economic theory, since the world of probabilistic uncertainty is the equilibrium world. Only immersed in a world of genuine uncertainty the market process theory is relevant.

The influence that Austrian school ideas have had on Keynesian macroeconomics is often overlooked[citation needed]. 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. [citation needed]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).[citation needed]

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.” [5] The long-time U.S. Federal Reserve Chairman said he attended a seminar hosted by Ludwig von Mises.[6]

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.[citation needed]

The Austrian method is based on the heavy use of logical deduction from self-evident, undeniable facts of existence or axioms. The primary axiom from which Austrians deduce further certain conclusions is the action axiom which holds that humans take conscious action toward chosen goals. The axiom actually affirms many other axioms such as existence, identity, consciousness, and free-will. But Austrians recognize this but focus on action and say that it is undeniable because in order to deny action, one would have to employ action in the act of denial.

This is easily one area where Austrians significantly differ from other schools of economic thought. Rival schools such as the Chicago, Keynesian, and Neoclassical focus on induction and empirical observation of exchange while Austrians reject this approach in favor of focus on deduction and logically deduced inferences. Austrians stress deduction because deduction, if performed correctly, leads to certain conclusions and inferences that must be true. Though Austrians do not discount induction, they hold that it does not assure certainty like deduction.

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 than 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.[7].

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.

Criticism

One criticism of the Austrian school is its rejection of the scientific method and empirical testing in favor of supposedly self-evident axioms and logical reasoning.[8] However, proponents of the Austrian school point out that logically correct argumentation and framework are a necessary part of any valid scientific theory, and therefore emphasis on logical consistency over attempts to create quantitative models necessary for better empirical validation is wholly justified.

Another general criticism of the School is that although it claims to highlight shortcomings in traditional methodology, it fails to provide viable alternatives for making positive contributions to economic theory.[9] This criticism is generally accepted, in the sense that the theories of Austrian economics are qualitative in nature and do not yield quantitative predictions. As an example, some[who?] Austrians propose that the net possibility of gain is a more accurate measure of the cost of an action than opportunity cost (subjectivism). However, it is ultimately difficult to measure the possibilities and risk involved. Nonetheless, this criticism also admits that these qualitative results are valid, which would reveal as erroneous the quantitative results from other schools which often directly contradict the qualitative derivations of the Austrian school's logic.

Bryan Caplan stated that Austrian economists have often misunderstood modern economics, causing them to overstate their differences with it. He argued that several of the most important Austrian claims are false or overstated. He has also criticized the school for rejecting on principle the use of mathematics or econometrics which is "more than anything else, what prevents Austrian economists from getting more publications in mainstream journals"[10] The counterpoint to this criticism is the simple observation that all econometrics is fundamentally based on mathematically and logically invalid summation and averaging of demonstrably non-additive personal utility functions, and therefore is scientifically worthless.

There are also criticisms of more specific theories.[11]

Important people

Economists affiliated with the Austrian School

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.

Critics

Seminal works

References

  1. ^ a b Keizer, Willem (1997). Austrian Economics in Debate. New York: Routledge. ISBN 9780415140546.
  2. ^ Israel M. Kirzner (1987). "Austrian School of Economics," The New Palgrave: A Dictionary of Economics, v. 1, pp. 145-51.
  3. ^ What is Austrian economics?
  4. ^ Meijer, G. (1995). New Perspectives on Austrian Economics. New York: Routledge. ISBN 9780415122832.
  5. ^ Greenspan, Alan. "Hearings before the U.S. House of Representatives' Committee on Financial Services." U.S. House of Representatives' Committee on Financial Services. Washington D.C.. 7/25/2000.
  6. ^ The Greenspan-Paul Congressional Exchanges
  7. ^ The Opportunity Cost Doctrine
  8. ^ Joe D., Why We Can't Associate Too Closely with the Austrians
  9. ^ Klein, B. 1975. "Book review: Competition and entrepreneurship". Journal of Political Economy. 83: 1305- 1306.
  10. ^ Caplan, Bryan, Why I Am Not an Austrian Economist
  11. ^ For example, see Austrian Economics, part of the "Critiques of Libertarianism" site
  12. ^ Chase Distinguished Professor of International Business and Professor of Economics
  13. ^ a b George Mason University site
  14. ^ Karel Englis, Economist, politician
  15. ^ Associate Professor of Economics

See also

Critical

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