Michael Prowse on Austrian Economics

Spring 1996
Volume 16, Number 1

Austrian Economics and the Public Mind

by Michael Prowse

Michael Prowse, the American economics correspondent for the Financial Times of London, has been compared with Henry Hazlitt for the clarity of his thought and prose, and for his use of Austrian insights in his writing. This speech was delivered at the Mises Institute's 1996 Austrian Scholars Conference at Auburn University.

I'm delighted to be here in Auburn. And I want to say how much I've enjoyed the presentations of the past two days.

I'd like to begin by giving you an idea of the structure of my remarks. I'll start by giving you a little personal history--how I came to be interested in Austrian economics and classical liberalism. Then, as a journalist (and thus in a sense a representative of the public mind), I'll tell you what I find attractive about the Austrian approach.

Let me apologize in advance if some of what I say is not new: I'm more used to addressing audiences who believe Austrian economics has something to do with central Europe than a roomful of some of the foremost experts in the U.S. I'll then look at some of the challenges facing Austrians in the late 1990s and finish by assessing the progress Austrians are making in the battle to influence public opinion.

You'll probably not be surprised to learn that I heard nothing about Austrian economics when I attended British universities in the 1970s. When I was a graduate student at the London School of Economics, that distinguished institution was going through a Keynesian phase: Alan Walters (later an adviser to Margaret Thatcher) had already left for Johns Hopkins and had been replaced by George Akerlof from Berkeley, a quintessential American Keynesian. Friedrich Hayek might never have graced the LSE's portals.

I emerged from higher education--like most of my generation in Britain--with a strong affection for the public sector. Like so many others, I believed that you could not be a compassionate, caring person unless you believed in big government. I accepted that market forces had some uses in promoting economic efficiency. But I thought the government had to intervene in countless ways to prevent "market failure" and that it had a moral duty to redistribute resources on a massive scale to ensure "social justice."

I don't feel much need to apologize for having held these views. They were entirely natural for someone brought up in a welfare state. None of my teachers in school or university seemed to have any interest or first-hand knowledge of industry or commerce. Entrepreneurship was equated with greed. Coming from this background, it is hardly surprising that, as a young journalist in the early 1980s, I was instinctively hostile toward the Thatcher government's free-market agenda.

How and why did my opinions move in a classical liberal direction? Three sets of forces helped change my views. The first was the demise of communism in eastern Europe and the Soviet Union. It struck me as intellectually dishonest to argue that the collapse of planning on a large scale had no implications for planning on a small scale. My confidence in government intervention everywhere diminished as a result of those historic events.

The second influence was simply moving from England to the U.S. six years ago. There are, of course, plenty of supporters of big government in Washington, D.C., where I now reside. But the free market/libertarian case is presented with far greater vigor here than in the U.K. My faith in markets as a ladder of personal opportunity has been strengthened because here in the U.S. the link between wealth and social class seems less pronounced than in Europe. It is striking how often U.S. supporters of liberty and free markets come from relatively humble backgrounds.

But probably the most important influence was my own reading and study. About five years ago I took the advice in John Stuart Mill's "On Liberty" rather too seriously. "He who knows only his own side of the case knows little of that," Mill wrote. I decided I should make a better effort to understand the arguments of critics. I ended up, to my embarrassment, concluding that their arguments were better than mine.

The first Austrian book I read was Hayek's Constitution of Liberty. I then turned to The Fatal Conceit and his three volume opus Law, Legislation and Liberty. I noticed that Hayek frequently referred to a Ludwig von Mises--a name that I had never heard mentioned in the U.K. So I read Human Action from cover to cover.

Some people find this book difficult or off-putting. I found it inspiring from start to finish. In fact, in describing my reaction, I can do no better than quote from a review in The Economist magazine of December 1949. Human Action, it said, is a "magnificent book; intellectual power roars through it like a great wind; it has the impetus of first-rate polemic and the impeccable coherence of Euclid.

After Human Action turned to more recent books on Austrian theory and read works by Mises' two most prominent American students: Murray N. Rothbard and Israel M. Kirzner. At that point I began to realize that Austrian economics is very much a living tradition--at least in the U.S.

The clarity of Rothbard's writing on economics prompted me to read his political work, especially For a New Liberty, his uncompromising defense of "anarcho-capitalism." At this time I became familiar with the work of Henry Hazlitt, James Buchanan, Anthony de Jasay, and other writers in the classical liberal tradition. I'd come a long way from the British welfare state.

Over the years I've managed to publish quite a few articles and columns on Austrian and classical liberal themes in the London Financial Times. I must say this has not always been easy. In the minds of London-based editors, Austrian economics is something that should be covered, if at all, by correspondents in Europe. I'm supposed to write about America, not about the finer points of 19th-century Viennese culture. It cuts little ice to argue--in Karen Vaughn's words--that there has been a "transfer of a tradition."

So I've had to be imaginative in thinking up justifications for articles: in 1994 for example I wrote a long op-ed piece presenting Austrian theory as an "antidote" to the "economic correctness" of Clinton's Council of Economic Advisers, then headed by Laura Tyson. Last fall, I smuggled in a piece on Austrian business cycle theory in the form of an imaginary conversation on the U.S. economic outlook between Keynes and Mises. You will be pleased to hear that it ended with Keynes describing Mises as a "genius" and declaring "you never know, I might become an Austrian." Actually that is not as improbable as it sounds: Keynes was deeply impressed by Hayek's Road to Serfdom and would probably have been appalled by much of post-war "Keynesian economics."

So what, from a journalist's perspective, do I find appealing about Austrian economics? I should say that my appetite was whetted initially by the sheer implausibility of the Austrian story. The message is that the vast majority of economists--including great names such as Paul Samuelson and Milton Friedman--fundamentally misconceive the nature of economic processes. True understanding is restricted to a small band of thinkers, originating in Vienna, Austria. And the truth is kept from the public by the ignorance and mendacity of the profession at large. This is a most appealing story line.

Having become familiar with Austrian theory, I think its attractions are best summarized as "six virtues."

The first--from my perspective--is the realism of the Austrian approach. I believe Austrians analyze market capitalism as it is, not as it might be. Unlike neoclassicals, they make room for such real-world phenomena as Rupert Murdoch, the Australian media tycoon.

The Austrian vision of market competition as an endless dynamic process in which powerful companies struggle for commercial supremacy accords perfectly with the everyday experience of business people and workers. You only have to look at the telecommunications or computer industries today to grasp the realism of the Austrian "process" model of competition.

I need hardly underline the contrast between this red-blooded characterization of capitalism and the insipid general equilibrium model so beloved by mainstream theorists. For the man in the street, the perfect harmony of general equilibrium is an utter fantasy. He would never believe that perfect competition occurs only in a state of equilibrium in which all companies are passive price takers, and in which nothing changes.

Austrians, I believe, have remained realistic because they have never suffered from what has been called "physics envy." Mainstream economists adopted the methods of the natural sciences in the hope of gaining greater prestige. Unfortunately, as Murray Rothbard argued, the model they chose to emulate was classical mechanics circa 1850. Science has since moved on, but neoclassical economists remain wedded to long-outdated nostrums.

Mainstream theorists fail to grasp that the subject matter of economics is very different from that of natural science. Science deals with an objective realm of inanimate objects; economics with the subjective thoughts and feeling of human beings. It is surely ridiculous to imagine that similar mathematical techniques would apply in such different realms.

The second virtue of Austrian economics is its emphasis on the dispersal of knowledge. Hayek, as everyone here will remember, made this point with great clarity in some famous papers in the late 1930s and 1940s. As he argued, the sum total of knowledge available in an economy "never exists in concentrated or integrated form but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess." It follows that nobody--and that obviously includes the government-- is able to take a God's eye view of economic or social life.

Politicians should be humble and cautious when they attempt to make decisions on behalf of the community as a whole because they rarely, if ever, possess enough knowledge to make the right decisions. The fact that this humility is so rarely evident only shows that Hayek s arguments, although totally familiar in Austrian circles, are still not widely understood.

Indeed, they are still not understood by otherwise competent economists. What, I often wonder, do mainstream economists think they are doing when they write down utility and production functions for numerous agents in an economic model? Don t they realize that nobody in a real-world economy could possibly possess all this knowledge?

Once Hayek's point is grasped there is no alternative but to adopt an Austrian view of markets: to see competition as a process by which knowledge is discovered and efficiently shifted around an economy. Knowledge is what you get as a result of the competitive process, not something you can assume at the outset.

I regard Hayek's argument as a powerful--perhaps the most powerful--argument against nearly all forms of government intervention. And I believe it has a special resonance for journalists who see government at close quarters. They cannot help noticing that public officials frequently have very little knowledge of the issues on which they make such sweeping decisions. They also notice that different parts of the public sector possess--in Hayek's words--"bits of incomplete and frequently contradictory knowledge." Many journalists are proto-Hayekians, without knowing it.

The third virtue of Austrian economics, to my mind, is the Misesian theory of entrepreneurship. I've always found it curious that mainstream economists have so little to say about the motive force of capitalism. They write endless papers about monetary policy, fiscal policy, and other functions of government. But entrepreneurship itself gets short shrift: indeed there is no place at all for it in the most prestigious general equilibrium models.

For Mises, as you know, entrepreneurship was utterly fundamental to all economic activity--indeed to all human action, which he defined as purposeful attempts to remove feelings of uneasiness. This is because all human action occurs in conditions of radical uncertainty. We have to act, yet we cannot know the consequences of our actions. As Mises emphasized, we are thus all entrepreneurs or speculators.

When we buy a house or choose a career we must make assumptions about future real estate prices or salary trends that may or may not be justified. If we guess correctly, we prosper, but there is always a risk of disappointment. Such everyday actions are no different in their essentials from the decisions of the business tycoon who buys factors of production today in the hope of supplying a good or service at a profit in the future.

Once one understands Mises's point, one realizes that entrepreneurship is not something one can be for or against. Properly understood it is part of the human condition; it is unavoidable if we are to act purposefully in an uncertain world.

The fourth important virtue of the Austrian School is its inter-disciplinary approach and philosophical sophistication. Today, most mainstream economists appear to be technicians, happiest when surrounded by equations or working with computers. They focus on refining the mathematical properties of existing models and rarely stop to question the realism of their underlying assumptions. Their theorizing frequently takes place in an intellectual vacuum.

Austrians, by contrast, have resisted the post Second World War trend toward ever-greater specialization. They remain political economists in a sense that Adam Smith and David Hume would have understood. They tend to be well versed in related disciplines such as political science, law, philosophy, and history. This breadth of vision is common to all the great writers in the Austrian tradition. You cannot miss it in the work of Menger, Mises, and Hayek or, more recently, in that of Rothbard and Kirzner.

As a journalist and a generalist by nature, I find Austrians capacity to relate economic issues to broader political and philosophical themes tremendously appealing. I also believe that breadth of vision is essential if economics is to retain its appeal as an intellectual discipline. If mainstream theorists fail to heed this lesson, they will become increasingly sidelined in academic debate.

The fifth virtue of Austrian economics is the clarity of its policy prescriptions. Economists in general have gained a reputation for equivocation. Their advice is nearly always hedged with qualifications: on the one hand such and such would be desirable but on the other hand . . . Frustrated by these caveats, one famous politician said it was his ambition to find a "one-armed economist."

There is no denying the existence of some policy differences among Austrians. Some believe that central banks monopoly of money creation is justified while others favor free banking. Some--especially European Austrians--support aspects of the welfare state, while others would abolish it entirely. But differences between Austrians pale into insignificance when compared with differences within the profession at large.

Mainstream economists involve themselves in highly technical debates about the efficacy of numerous different kinds of government intervention. They tend to analyze each intervention separately. Austrians look at the big picture. They recognize that each separate intervention--however appealing it seems at the time--contributes to a habit of intervention that is bad for society in the longer run. They recognize that interventions usually serve the interests of special lobbies rather than the wider community. And they recognize that government legislation is very hard to repeal.

Austrians thus tend to be opposed to intervention, period. They understand that the goal of public policy should be to maintain free entry to all markets--that this is the precondition for competition to work its magic. I am certain the public would find this clear policy stance appealing--if it understood the underlying rationale.

The sixth and final virtue from my perspective is the Austrian School's "historical credibility." Journalists are not much impressed by abstract arguments. But they do respect people who call events and trends correctly. As you all know, Austrians saw the flaws in socialism sooner than anybody else. Neo-Keynesian technocrats were still defending socialist planning in the mid-1980s, 60 years after the publication of Mises's book Socialism.

Today, I suspect Mises's critique of communism will strike many readers as so obvious as to hardly require stating: of course efficient decisions will not be possible in the absence of market prices for the means of production; of course a socialist economy would have no means of adapting to the dynamic change that is inherent in all economic life.

Yet we should always remember that this was not obvious to the vast majority of the brightest intellects of this century. As late as 1938, in a review of an English language version of Socialism, Frank H. Knight, father of the Chicago School, supported Oskar Lange's criticism of Mises. Knight wrote that economic life under socialism, and I quote, "will be in general form about what it has been under capitalism." Socialism, he argued, presented a political but not an economic problem. And he accused Mises of, and I quote, "an amazing tissue of question-begging assertion and mere quibble." If this was the view of Frank Knight, you can imagine what lesser minds were saying.

Having outlined some of the principal virtues of the Austrian approach, I now want to consider challenges facing Austrians in the 1990s.

Let me start by making an heretical suggestion: the challenge is not principally intellectual. I know there are a lot of theoretical debates and disagreements. Should Austrians abandon the neoclassical concept of equilibrium altogether, as Ludwig Lachmann suggested? Or should they, following Israel Kirzner, regard market process theory as a device for shoring up neoclassical doctrines, as a device that explains why a capitalist economy, in the absence of shocks, would tend toward an equilibrium?

I think these and other arcane disagreements are generated by an unquestioned assumption: that knowledge must always advance in all academic disciplines. This is a 19th-century assumption and perhaps is true of natural science: perhaps there is always more to be learned about physical reality. But in social science and the humanities the concept of progress is more debatable. There is no reason in principle why Mises and Hayek, building on 19th-century thought, might not already have said most of what is important about the functioning of market economies.

It may be that we are in an age of seriously diminishing returns. It may be that economics as a discipline does not have much work to do, other than to educate the young. It may be that the sterility of much economic research reflects the maturity of the discipline. Indeed, I suspect that were it not for massive public subsidies, there would be far fewer academic economists and far fewer PhDs awarded. If this thesis is correct, it follows that the principal task for Austrians is not to add bells and whistles to the theories of Mises and Hayek, but to try to ensure that their ideas are more widely disseminated. The primary task facing Austrians--and this is the most important point I want to make tonight--is thus outreach, not research: it is influencing the climate of opinion, not breaking new ground. There are two ways to proceed: first, to try to convert mainstream economists to the Austrian paradigm; secondly, to bypass the profession and speak directly to the broader public.

The first route is hard, but important: the economics profession is the filter through which the media and public gain an understanding of economic processes. If most academics are neo-Keynesians, it is likely that most of the public will share their opinions.

The Keynesian revolution offers two insights into the most efficient means of achieving a paradigm shift. The first is that if you want to re-educate a profession, you have to influence students and young scholars. The Keynesian theory was victorious not because it converted mature scholars (who knew the classical counter-arguments) but because it altered the way the young were taught. Eventually the older professors died off leaving the profession in the hands of younger academics who were simply ignorant of many of the pre-Keynesian doctrines.

The second insight is that the agent of change must have mainstream credibility: Keynes's heresies were taken seriously because he had previously established his credentials in classical theory. Unless somebody like Paul Krugman experiences a sudden conversion, this suggests that Austrian infiltration of the profession will remain a slow process.

The other route--speaking directly to the public--seems more promising, thanks to the efforts of institutes such as this. I can testify from my own experience that people are surprisingly receptive to Austrian ideas. I got more enquiries in response to a column in the Financial Times last year on the Elgar Companion to Austrian Economics than to any other article I wrote, with the possible exception of a piece exploring Adam Smith's ethics.

This is encouraging since Austrian economics is often seen as too esoteric a subject for the ordinary business reader. The level of interest reflects, I believe, a deep-seated disillusionment with the scientific pretensions of mainstream economists: their comical efforts in the field of economic forecasting in particular have helped fuel popular discontent.

Austrians may not be getting many articles published in the so-called "top" academic journals, but publishers in the real world seem increasingly interested in the school. British publishers putting out Austrian texts recently include Cambridge University Press, Routledge, Edward Elgar, and Pickering and Chatto. The ready availability of Austrian books and articles is having an impact on public opinion. It is striking that in the past year, writers in the Washington Post and other popular publications have referred, without feeling the need for much explanation, to Mises and Hayek.

Let me finish by congratulating Austrians on their success in advancing the broader cause of classical liberalism. In the U.S., government expenditure accounts for about a third of national income--and this is the lowest in any large industrial country. This level of public spending is probably at least three times higher than a classical liberal would desire. So it is undeniable that "welfare liberalism" as a practical political doctrine is still in pretty good shape.

However, to illustrate the turn in the tide of ideas, I'd like to end by quoting from the introduction to Mises's Socialism, published in 1922. He wrote: "Socialism is the watchword and the catchword of our day. The socialist idea dominates the modern spirit. The masses approve of it. It expresses the thoughts and feelings of all; it has set its seal upon our time."

The fact that this is no longer the case shows how much progress has in fact occurred in the past 75 years. Indeed I believe that Mises, were he still alive, would be immensely gratified by the extent to which market capitalism has become the watchword and catchword of our day. That it has become so, of course, in large measure reflects his efforts.

Special Note: Since Mr. Prowse gave this paper, he has shifted toward a more statist position. For more on his new views and an intelligent response to them, see Thoughts on Power and Wealth.

HOW HAYEKIANS
BECAME KEYNESIANS
AND WALRASIANS
by Murray N. Rothbard

Why did so many of the rising stars of the English economic profession of the 1930s, converted by F.A. Hayek to Austrianism at the London School of Economics, flop over to Keynesianism in the last half of the decade?

Until now, most of the blame has been placed on the tidal wave of the Keynesian Revolution, which so sharply altered the fashions, as well as the tangible rewards, of the profession. I had always speculated that another reason was that Hayek had brought to these young English theorists only the monetary and business cycle theories of the Austrian School, but not its broader "micro" or methodological-praxeological perspective.

A recent stimulating discussion by E. Roy Weintraub of one of the leading Hayekians-turned-Keynesians, John R. Hicks, focuses on another, related explanation: that Hayek's version of Austrian equilibrium theory--so very different from Mises's--was precisely the sticking point that led Hicks, tragically but understandably, away from Austrianism and into the Walrasian (and Keynesian) pit. (E. Roy Weintraub, Stabilizing Dynamics [Cambridge: Cambridge University Press, 1991, pp. 30 32.])

For, as Joseph Salerno has recently brought out, Hayek (and Kirzner after him) held that general equilibrium, while not actually in existence, is virtually so, is indeed right-around-the-corner (what Salerno calls "near equilibrium"). In Hayek's version of Austrian monetary and cycle theory, the market economy would continue to luxuriate in happy and harmonious general equilibrium, provided that bank credit expansion did not disturb matters, and prevent money from remaining "neutral" to the economy. But Hicks realized that equilibrium was a condition of absence of uncertainty and hence of perfect foresight.

But if there were no uncertainty, no one would desire to hold money. Consequently, Hicks concluded that a world of equilibrium could not be one where money was neutral, or a mere veil, if indeed money could be used at all. Therefore, Hicks abandoned Hayekianism and moved toward the now all-too-familiar neoclassical bifurcation of Walrasian equilibrium without uncertainty or money, separate from a Keynesian "real" world of money and uncertainty.

Perhaps, then, if Hayek had brought to London in the early 1930s not his own concept of a virtually existing equilibrium-with-money, but the Misesian view of general equilibrium as a remote tendency for the market economy which will never and can never be reached (partly because no one would hold money in an unchanging and certain world), the Hayekians might never have defected to Keynes and Walras, and Austrianism might have become the dominant paradigm in the profession.

More and more, it appears necessary to advance the dehomogenization of Mises and Hayek, even of Hayek I, not just for the sake of the historiography of economic thought, but also to rediscover the essence of the Austrian paradigm and to set Austrianism on a sound basis for future development.