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Accountability, Money Matters, Politics

The Rebirth of Austrian Economics

Forty years ago, during the week of June 15-22, 1974, the Austrian School of Economics was reborn during a conference in the small New England town of South Royalton, Vermont. Why was this important? Because the economists of the Austrian School have developed the most persuasive understanding of why only economic freedom can give mankind both liberty and prosperity.

During the Great Depression of the 1930s, many economists and political policy-makers argued that capitalism was a “failure” and only wisely guided government intervention and regulation of the market place could bring stability and fairness to society.

The Domination of Big Government Ideas

For the next thirty years following the Second World War, Keynesian Economics dominated economic policy decision-making. Government, it was said, had to have the discretionary authority to manipulate spending and taxing as well as the monetary system to assure full employment and stable economic growth.

This was matched by a rarified mathematical formalism in the higher levels of economic theory in which the everyday individual was reduced to a mere passive variable in a series of equations, with the assistance of which it was presumed government could successfully micro-manage the market. Unless regulated and guided by the superior hands of the government policy-makers, society would fall into waste and inefficiencies due to people’s wrong choices and misplaced actions when left on their own.

The Beginning of Austrian Economics

Almost 145 years ago, Carl Menger founded the Austrian School of Economics. One of the pathfinders to break asunder the myth of the labor theory of value, which had dominated economics from the time of Adam Smith to that of Karl Marx, Menger developed the subjective theory of value. The value of a good, Menger explained, was not determined by the amount of labor devoted to making a product, but rather the labor was given value by the intensity felt for the product by the individual who would finally use or consume it. Since individuals valued things differently and by different scales of importance, there was no way to objectively determine the value any market-traded good might have other than relating it back to the personal (“subjective”) judgments of the individual valuator.

Menger was soon followed by two disciples who refined Austrian theory to such a point that it became a major force in the world of ideas. Friedrich von Wieser formulated the concept of opportunity cost, by which is meant that nothing is free. The fact that most of the means that we use to achieve our various ends are scarce (too limited in supply to enable us to attain all the goals for which those means might be used) means we always have to make trade-offs.

The cost of anything is the alternative goal, purpose or end for which some scarce means might have been used if we had not instead valued more highly some other use for which we ended up applying those limited means. The idea that government can give people a “free lunch” is fundamentally wrong; what the government gives to someone with one hand it must take from someone else by the other hand, because the available means are not enough to fully satisfy both uses at the same time.

Eugen von Böhm-Bawerk, developed Menger’s theory of subjective value and applied it to the problem of savings, investment, and the creation of capital. Everything we do involves time. Whether we are boiling an egg or constructing a tunnel through a mountain, or planting a crop for food, all of our production activities take time.

This requires that individuals must save enough to free up the resources needed to build the capital goods and cover people’s living expenses until the production processes are completed at some point in the future when more and better goods and services will be forthcoming as the benefit from having waited for them.

Government taxation and regulation can undermine if not destroy the ability and motive of people to do the savings and investing that is essential if we are all to benefit from rising standards of living in the future.

 

Ludwig von Mises and the Case for the Free Market

In the twentieth century, Ludwig von Mises extended the Austrian approach. Mises applied Menger’s subjective value theory to the area of money and developed the “Austrian” theory of the business cycle. Government manipulation of money and credit in the banking system throws savings and investment out of balance, resulting in misdirected investment projects that are eventually found to be unsustainable, at which point the economy has to rebalance itself through a period of a corrective recession.

The only wise policy for government is to leave money and the banking system to the competitive forces of a free market to eliminate the inflationary booms and recessionary busts of the business cycle, so markets can effectively keep people’s saving and investing decisions in balance for well-coordinated economic stability and growth.

Mises also demonstrated in the early 1920s why the new experiment with socialist central planning in communist Russia would eventually fail. Rational and efficient economic decision-making requires market-generated money prices to determine and calculate the relative values of the finished goods that consumers might wish to buy in comparison with the costs of using the means of production – land, labor, and capital – in one alternative production activity instead of another, on the basis of which entrepreneurs can estimate likely profits or losses from producing one product rather than some other.

Comprehensive socialism abolishes private property, bans market ownership and trading of goods and resources, and places all economic decision-making in the hands of a government central planning agency.

But without private property, there is nothing to buy and sell. With nothing to buy and sell there is no bargaining to determine possible terms-of-trade. With no agreed-upon terms-of-trade, there are no market prices.

Without market prices to tell market decision-makers the value of what consumers might want and the actual value of scarce resources in competing uses for their employment, there is no rational way for the socialist planner to efficiently and effectively know what to produce and at the lowest costs to maximize total desired production. Socialist central planning creates a society of “planned chaos.”

Based on his critique of the unworkability of socialist central planning Ludwig von Mises developed a theory of how the competitive market process works, and the important role of the entrepreneur for guiding production in the pursuit of profits and the avoidance of losses.

This also led Mises to a detailed critical analysis of how and why various forms of government regulation and intervention in the market economy can only distort and bring about imbalance in the market’s own coordination of multitudes of supplies and demands in the service of consumer desires. The only viable economic system for freedom and prosperity, Mises concluded, is laissez-faire capitalism.

F. A. Hayek and the Use of Knowledge in Society

Further developments in Austrian theory were the product of the versatile mind of Friedrich von Hayek, who won the Nobel Prize in Economics in 1974 a few months after this Austrian Economics conference in South Royalton, Vermont.

In the 1930s, Hayek refined Mises’ theory of money and the business cycle, and became the leading free market critic of John Maynard Keynes at the time when “Keynesian Economics” was just being developed. He insisted that government deficit spending and manipulation of spending in the economy would only slowdown the normal market-generated recovery from a recession, and ran the danger of creating a future inflation that would be followed by another economic downturn.

Hayek, like Mises, was a leading critic of socialism. His core argument centered on the impossibility of even the wisest and most intelligent central planners ever having the ability to master, integrate and effectively use all the needed knowledge to successful guide an entire economy from the offices of a government planning bureau.

The division of labor in society is matched by a division of knowledge in which each of us possesses only a limited and small amount of all the knowledge of the world in our individual minds. We all must admit and accept how ignorant any one of us is about all the forms of knowledge that exist in the world, and which must somehow be successful brought to bear if all of us are to benefit from what one or a few people may know that we do not.

Hayek’s answer to this problem was to explain that market-generated prices serve as the communications devise through which we can inform each other about our desires as consumers and our abilities as producers, while leaving us free to use the knowledge that each of us individually possesses as we find it most advantageous. Thus, freedom and prosperity are combined through the market system of prices and competition to find out who can do better in satisfying the wants of others in the pursuit of self-interested profit.

Austrian Voices at the South Royalton Conference

The Institute for Humane Studies (IHS) organized the South Royalton Austrian Economics conference, and brought to Vermont three of the leading Austrian economists of that time to deliver a series of unique and important lectures: Israel M. Kirzner, Ludwig M. Lachmann, and Murray N. Rothbard.

 

Israel Kirzner had studied under Mises at New York University, and in 1973 had written, “Competition and Entrepreneurship,” the first of many books explaining the importance of the alert and creative market-based entrepreneur who brings about the balance and coordination of supplies with our consumer demands through his pursuit of profit opportunities.

 

Murray Rothbard had already made an outstanding name for himself as an Austrian economist with his two-volume work, “Man, Economy and State” (1962), in which he developed the entire edifice of economic understanding following in the footsteps of Ludwig von Mises. His 1963 book, “America’s Great Depression,” demonstrated that the economic depression of the 1930s had its origin in bad Federal Reserve monetary policy in the 1920s, and made far worse than it needed to be due to the wrong-headed interventionist policies of the Hoover Administration in the early 1930s.

 

Ludwig Lachmann had studied with F. A. Hayek at the London School of Economics in the 1930s, and went on to challenge the Keynesian misconception that the economy should be viewed and treated as one single aggregate lump of economic output. He subtly showed that the market is an intricate web of multitudes of individual supplies and demands interconnected in ways that could have no harmonious order to them other than through the free competitive actions of people, themselves, in a dynamic world of unexpected change.

 

Austrian Economics as Good Economics

The first day of the conference was highlighted by an opening evening banquet. At the dinner, free market economist, Henry Hazlitt, (the author of “Economics in One Lesson”) reminisced about how he first met Ludwig von Mises in the 1940s. The noted anti-Keynesian economist, W.H. Hutt, talked about the contributions that Mises made to economics And Murray Rothbard related some of the amusing anecdotes Mises would tell during the graduate seminars that Mises taught at New York University from 1945 until his retirement in 1969 at the age of 89.

Milton Friedman, who had a summer home in Vermont and who had been invited to the dinner, was asked to make a few comments. He admitted that Mises had made a number of notable contributions to economics, but that he was much too “extreme” in his views on economics and public policy. Besides which, Friedman added, there was no such thing as “Austrian economics,” only good economics and bad economics.

Clearly Freidman considered that the attendees at that conference were on a “fool’s errand” in focusing on something called “Austrian” economics. But for those of us attending that conference that week, we considered that Austrian Economics was a good economics for understanding the nature and workings of the real world of the free market place.

Human Action and Man as Unique Chooser

Starting the next day, a week of rigorous and incisive lectures began dealing with every aspect of “Austrian” theory. Rothbard and Kirzner laid the foundation by explaining the implications of the Austrian theory of human action and choice. The study of economics, Rothbard pointed out, begins with the fundamental axiom that man acts, that conscious action is taken to achieve chosen goals. This also implies that all action is purposeful and rational from the point of view of the actor.

All action, besides which, occurs through time. Action is taken now with the expected attainment of some result in the future. It also means that man acts without omniscience, for if an individual knew what the future would be in all its rich detail, then his action to replace one state of affairs with another would be pointless. With a guaranteed and certain future, action becomes worthless, because nothing can be changed in that future and the idea of people making their free choices becomes meaningless.

The fact that action is purposeful, chosen, and personally subjective also means that any statistical or historical studies that attempt to measure or predict human activity must be seen as having limited usefulness. Kirzner used the example of a man from Mars looking down at the earth through a telescope. The Martian observes that out of a box every day comes an object that enters another rectangular box that then moves away through a maze of canals and intersections. The Martian notices that on certain days the object that comes from the first box moves rapidly to catch up to the second, rectangular box. He then draws up a statistical study showing that one out of ten times the object will move rapidly to reach the rectangular box and uses this for predictions of “earthly” activities.

What has been totally overlooked by this method is that the first box happens to be an apartment building out of which comes an individual who goes to the street corner to catch the morning bus to work. The fact that on occasion the individual in question oversleeps and has to rapidly chase after the bus, so as not to miss it, does in no way guarantee that he may not get a better alarm clock, go to sleep earlier, or in the future, oversleep even more often. Nor does one individual’s actions determine how another individual will act in the same circumstances. Thus, to base one’s understanding of man on statistics and historical studies alone is to ignore that human action is volitional, purposeful, and changeable, dependent on the goals and means of the acting individual.

The inability of the economics profession to grasp the mainsprings of human action has resulted from their adoption of economic models totally outside of reality. In the models put forth as explanations of market phenomena, equilibrium — that point at which all market activities come to rest and all market participants possess perfect knowledge with unchanging tastes and preferences — has become the cornerstone of most economic theory.

The Market Process and the Entrepreneur

Lachmann, in an illuminating lecture, explained that the market is not a series of equilibrium points on a curve, but rather, it’s a constant process kept moving because the underlying currents of human action never rest. Men, lacking omniscience, integrate within their plans the information provided by a constant stream of knowledge about changes in resource availabilities, the relevant actions of other men, and unexpected occurrences. But because each man’s perspective and interpretation of this stream of knowledge may be different from that of others, what seems relevant to one individual may be discarded as insignificant by another.

The unknowability of the future means that individuals draw conclusions based upon expectations of what will happen over time. Divergent expectations and unexpected change, therefore, results in potential inconsistency of interpersonal plans. When errors become visible to individuals, each market participant will learn different lessons from the revised, available information. And, thus, we are again faced with the possibility of inconsistency of different market plans.

But if the plans of market participants can never be expected to smoothly and automatically mesh, what forces in the market tend toward an equilibrating, or coordinating, of the actions of multitudes of human actors? At this point, Professor Kirzner’s follow-up lecture offered the clue. Acting man is not merely a blind “taker” of prices and resource offerings; rather, because of the fact that unexpected change occurs in an uncertain future, man is also “watchful.”

Alertness to previously unseen opportunities serves as the key to the equilibrating market forces. This human capacity for alertness, said Kirzner, is the entrepreneurial role. It is not merely the difficult task of knowing when to hire and where to place the worker. It’s a much more subtle and rarified knowledge; it’s the ability of knowing where to get knowledge, of picking up bits of information that others around you have passed up and seeing the value of it for bringing into consistency a human plan or plans that otherwise would have remained in disequilibrium. The chance to profit from information about market opportunities that others have failed to see acts as the incentive for people to keep their eyes open for inconsistencies and opportunities in human plans.

Production, Time and Money in the Market Process

Lachmann and Kirzner continued this train of thought the following day with lectures on the Austrian theory of capital. Capital is the intermediate product – often the tool or machine – used to produce a finished good for consumption. Yet the many attempts to measure and quantify “society’s” capital stock fall apart when we once again emphasize the nature of purposeful action. A particular good is seen as a “production good” useful for a particular purpose only within the context of a human plan. That object that may be seen as a capital good in one instance may become totally worthless or shift to a consumer good tomorrow, depending upon the changing subjective valuations and judgments of the individuals interacting in the market.

The elusiveness of market equilibrium often means, as well, that, as Lachmann pointed out, a tendency for structural integration of interpersonal plans may exist, but some combinations that are found not to fit within existing plans may result in a scrapping of some of these goods and, therefore, are not really “capital” any longer in the eyes of the valuator. Kirzner continued the discussion pointing out that capital is the complex of “half-baked cakes,” the interim form the resource takes in the process of a human plan leading to the final stage of producing a product to satisfy the wants of some consumers.

Rothbard delivered an interesting and comprehensive lecture on the Austrian theory of money. It was Ludwig von Mises, Rothbard pointed out, who first applied the principles of marginal utility to money, showing how money originated and how exchange values were established on the market. Professor Rothbard suggested three areas for possible future research: (1) how to separate the state from money; (2) the question of free banking vs. 100-percent-gold dollars; and (3) the defining of the supply of money.

He followed up with a lecture on “New Light on the Pre-History of the Austrian School,” and showed the development of marginal-utility theories through the Middle Ages in Spain and Italy.

The Central Error in Keynesian Economics

Lachmann finished his series of lectures with critiques of macroeconomics and its recent controversies.  He argued that the market is a complex and ever-changing network of multitudes of individual actions and reactions to what everyone else is attempting to do in the pursuit of their desired goals and ends.

The Keynesian attempt to reduce all the rich complexity of human activity to a few simple statistical aggregates for government manipulation and control not only misunderstand the real and true nature of a dynamic and competitive market system, but was likely to lead to government policy mishaps that would create far more instability and disorder than if the political authorities simply left the market alone.

 

Showing How Government Policy Goes Wrong

On the last day of the conference, Kirzner and Rothbard summed up the Austrian approach within a consideration of the “Philosophical and Ethical Implications of Austrian Economic Theory.” Kirzner restated the principle of “value-freedom,” in economic analysis. As an economist, the Austrian theorist does not make judgments on ends chosen by people in the market. The economist’s task is to objectively analyze whether or not the means proposed to achieve a particular goal or end are the most appropriate or efficient to that purpose. The economist on his own cannot say or judge whether the goal or end being pursued by an individual, with whatever means chosen, is in itself “good” or “bad.”

While admitting this, Rothbard wondered if the economist could be totally value-free in all instances. What if a politician has as his goal the economic impoverishment of the nation so as to use demagoguery for gaining political power? Are we to tell him that this is a “good” means to achieve his end? Thus, Rothbard concluded, it may often be necessary to have certain value-laden principles to judge ends as well as means.

Conference Life in South Royalton

The evenings during the week were partly spent with the participants discussing the topics lectured about that day. But in addition, Murray Rothbard would “hold court” every night until the wee hours of the morning. He would tell funny stories, and relate an unending stream of hilarious anecdotes about famous people alive and dead. He amused his audience with a repertoire of “left-wing” and “right-wing” political songs that he knew in several languages. And he optimistically argued for the importance of Austrian Economics and a political philosophy of liberty if the human race was to free itself from the dangers of oppressive and harmful government.

The rustic appearance and the somewhat antiquated facilities and features of the town of South Royalton led Ludwig Lachmann to observe at the end of the week that he could now say that he knew what life had been like in the nineteenth century!

The slanted floor in the room I was staying in required me to spend the night holding on to the sides of the bed so I would not slide out the window behind the low headboard. And some strange mishap seemed to have occurred to one of the female attendees while alone taking a shower that it was all too “shocking” for her to relate all the details.

Another participant, who originally came from Yugoslavia, said that some things in the town seemed so “scary” at night that he admitted the following: “I lived under Nazi occupation and I endured life under communist rule in my native Yugoslavia. But last night was the first time in my life that I slept with the light on!”

The Catalyst for Austrian Economics Reborn

The organizers at the Institute for Humane Studies had sensed the rightness of the time for arranging such a conference as a catalyst for expanding interest in the Austrian School of Economics. And with that goal in mind it can only be said, forty years later, that it was a resounding success.

Between the South Royalton conference in June of 1974 and the awarding of the Nobel Prize in Economics to F.A. Hayek in October of that same year, the Austrian School began a brilliant renaissance that has once more made it one of the most important forces for sound ideas on economics and public policy making in the world today. This was assisted at first, also, by the publication of those lectures delivered at South Royalton in book form in 1976 under the title, “The Foundations of Modern Austrian Economics.”

After near oblivion in the decades immediately after the Second World War due to the dominance of Keynesian Economics, the Austrian School has been reborn. There are universities at which undergraduate and graduate students can take courses on Austrian economics with professors knowledgeable about and dedicated to the tradition that began with Carl Menger and then grew under the ideas of Ludwig von Mises and F. A. Hayek.

There are, now, at least three scholarly journals devoted to the further development of Austrian Economic ideas, plus online websites, blogs, and printed publications explaining and applying “Austrian” ideas to the contemporary policy problems of the day. In addition, well-known and respected publishing houses print both scholarly and popular books on Austrian Economics every year.

Even some prominent political figures have publicly advocated the implementation of free market-oriented policies on the basis of Austrian economic insights – including abolishing the Federal Reserve and moving money and banking into the arena of the competitive free market.

All of this has had a good part of its beginning with that conference on Austrian Economics forty years ago in a small, out-of-the-way New England town.

 

 

 

2 COMMENTS

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  • Charles Wallman

    Gee, this is a nice summary of the Austrian approach. Really good, especially for non-economists.

    Did you and the other participants worry (or wonder) if Friedman might be right about being on a “fool’s errand?”

    Once again, great summary.

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  • Ed Dolan

    > Did you and the other participants worry (or wonder) if Friedman might be right about being on a “fool’s errand?”

    Interesting question. IMHO, Friedman did not mean that people who were interested in Austrian economics were necessarily on a fool’s errand. I think he probably had two things in mind when he made his quip. First, he did not like the portrayal of economics as a battleground of “schools.” He would have been equally quick to say “there is no such thing as the Chicago school.” Second, I think he was cautioning those interested in Austrian economics that no one tendency in economics has a monopoly on the truth. Just because a piece of research or writing cites Mises and Rothbard and proclaims adherence to Austrianism doesn’t make it “good economics.” Belonging to a “school” does not give you a free pass on critical thinking.

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