What is a Causal-Realist Approach?
[This article is based on Professor Salerno's introductory remarks for the seminar "Fundamentals of Economic Analysis: A Causal-Realist Approach," with Peter G. Klein. This introduction can be viewed in online video below. The entire series is available in the store as a DVD boxed set or CD.]
Let me say a few words about the title of the course and its significance.
The subtitle "A Causal-Realist Approach" refers to a broad movement in economic science that flourished during the period 1871–1914 that began with Carl Menger. This movement included not only Austrian economists but also British, American, Swedish, French, Italian and Dutch economists. [John Bates Clark, Frank A. Fetter and Herbert J. Davenport in the United States; Philip Wicksteed And William Smart in Great Britain; Knut Wicksell in Sweden; Augusto Graziani in Italy; and Paul Leroi-Beaulieu and Maurice Block in France.] Menger emphasized that economics was a unified science involving the search for cause-and-effect relationships or causal laws ("exact laws") that would explain the prices, wages, and interest rates actually observed in reality. Thus in the preface to his seminal book, Principles of Economics, Menger (1981, p. 49) declared:
I have devoted special attention to the investigation of the causal connections between economic phenomena involving products and the corresponding agents of production, not only for the purpose of establishing a price theory based upon reality and placing all price phenomena (including interest, wages, ground rent, etc.) together under one unified point of view, but also because of the insights we thereby gain into many other economic processes heretofore completely misunderstood. [Emphases are mine]
The search for these causal laws of reality was very much an international enterprise among economists in the last quarter of the nineteenth century and up to World War I. Unfortunately economics veered off the tracks in the interwar period as a result of a number of factors:
In 1890 Marshall introduced a disjointed "partial equilibrium" analysis, an allegedly more realistic analysis that focused on business firms in particular markets while abstracting from and ignoring the unity of all economic phenomena and downplaying demand and the role of the consumer. By the 1920s Marshallian economics had swept the English-speaking economics profession.
The shift of focus from Menger's project of explaining actual prices determined in real markets to explaining the equilibrium prices of the model of perfect competition that was implicit in Marshall's treatise was later formalized and introduced into economics by Frank Knight in the early 1920s.
By the 1930s economics had jumped the tracks. The Monopolistic Competition Revolution modified the perfect competition model to show that almost every real-world firm except a tiny farmer in Iowa charged monopolistic prices, while the Keynesian Revolution severed the connection between laws governing the micro sphere of consumers, firms and markets and propounding new and contradictory principles to explain macro phenomena like unemployment, depression, inflation, etc.
Finally, there was the rise of mathematical General Equilibrium Theory, pioneered by Léon Walras. This branch of economics previously had been pursued by a small sect centered mainly in Switzerland, France and Italy and portrayed the economy as a system amenable to analysis along the lines of classical mechanics.
By the 1950s, economics was definitely on the wrong track. This was aptly summed up by one modern price theorist who wrote:
The shades of Jevons, Menger, Edgeworth, Wicksteed, Wicksell, Clark, and Fisher may justifiably be offended by the attribution of modern price theory to two sources, Alfred Marshall and Léon Walras, but these two scholars have had far and away the most influence on twentieth century thought…. In contrast with Marshall's down-to-earth struggle with the interpretation of the detailed working of the economy stands Walras's grand construction of general equilibrium. In a typical British or American textbook on price theory nine-tenths of the contents stem from Marshall's work, general equilibrium only getting notice in a last chapter or appendix. (Townsend 1971, p. 57)
The course that we will be giving is what you would have gotten in contemporary colleges and universities had this tragic diversion not occurred:
Joseph Salerno is a senior fellow at the Mises Institute, professor of economics at Pace University, and editor of the Quarterly Journal of Austrian Economics. He has been interviewed in the Austrian Economics Newsletter and on Mises.org. Send him mail. See his archive.
Peter G. Klein teaches economics at the University of Missouri. This is his foreword to the new edition of Principles of Economics, published by the Mises Institute (2007). Klein blogs at Organizations and Markets. Send him mail. See his archive. Comment on the blog.
This article is based on Professor Salerno's introductory remarks for the seminar "Fundamentals of Economic Analysis: A Causal-Realist Approach," with Peter G. Klein. The entire series is available in the store as a DVD boxed set.