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The Austrian Difference

December 17, 2002

Carl Menger (1840-1921)There are legitimate reasons to question the need for the Austrian paradigm as an alternative to mainstream economics. Mainstream economists understand and appreciate marginal value theory, comparative advantage, and other basic propositions that Austrian economists promote. Mainstream economists also appreciate the fact that competition in markets benefits consumers enormously. At a basic level, Austrians have little more to say that Mainstream economists are not already saying. There are, however, subtleties that escape many of those who study mainstream economics. 

As a college student, my economics instructors taught me that markets work only under ideal circumstances. With free entry and exit, perfect information, large numbers of buyers and sellers, and homogeneous products, markets will deliver efficient results. Sadly, these ideal conditions never apply to the real world, so markets fail as a means of allocating resources. Government intervention can correct these imperfections with optimal taxes, subsidies and regulations. 

I quickly identified two problems with this approach to economics. First, market imperfections need not be very large. As I would now say, competitive pressures in markets tend to minimize these problems. Second, government has its own imperfections–which one can easily argue create greater problems than market imperfections.

I was not the first one to reach these conclusions. Mises and Hayek both recognized that advocates of intervention failed to appreciate both the failings of government and the ability of markets to evolve reasonably good solutions to their own problems. Other economists did as well. Economists like Gordon Tullock, Harold Demsetz, Ronald Coase, and Armen Alchian recognized the need to avoid false comparisons between imperfect markets and idealized versions of government. However, many other economists do not see this simple point. Why?

There is a certain logic to "market failure" reasoning that some find appealing. Market failure arguments do in fact draw many into fallacious reasoning. One could argue that those who succeed in discerning such chicanery do so because they are smarter than the ones who do not. In all honesty, I must admit that my own ability to avoid falling for such arguments did not derive from my intellect. It is also the case that market failure misconceptions lead many bright people to wrongly advocate government intervention. In my case, it was extreme skepticism and intellectual alertness that made the difference.

Those who study mainstream economics need "enough" intelligence to figure out why market failure arguments are wrong. But, in order to use one's intelligence, one must have some motivation. As Mises noted, feelings of uneasiness prompt men to act. My own uneasiness with what I was taught as an undergraduate caused me to critique that which I was being taught. As Kirzner emphasizes, people act when they notice profit opportunities. In this case, I noticed some imperfections in market imperfection arguments, and sought better explanations.

The central problem with mainstream economics is that it focuses attention on states of equilibrium, and largely ignores processes of adjustment towards equilibrium. Since end states play such a prominent role in mainstream economics, students can often overlook the importance of economic processes, even if they are smart enough to know better.

At one time, Chicago and Harvard economists debated the merits of advertising. To Harvard economists and their allies, advertising was either wasteful or anticompetitive. Large businesses used advertising to push products on people, to change preferences, and to establish monopoly power. Economists at Chicago and UCLA argued against this and other such market failure arguments by pointing out that practices like advertising help to inform consumers about alternatives. Some mainstream economists look at mathematical models of market equilibrium and also see some of the processes behind them, others do not.

The reasons for this are clear, and are not a matter of intelligence. Some people are more accepting as students, and less apt to notice faults in arguments. Such persons are far more prone to accept faulty market failure arguments. Alert skeptics will avoid bad reasoning, but such persons are not common enough.

Ironically, one must practice Austrian entrepreneurship in the study of mainstream economics in order to do it well, but need not do so when studying Austrian theory. Austrian economists bring important market processes to the forefront of their analysis.

Austrian economics emphasizes the importance of the dissemination of information throughout society, so students of Austrian theory need not be particularly alert to notice the importance of practices like advertising. Mises emphasized the importance of profit and loss accounting, in the context of private property rights, as an indispensable means of calculating the value of capital goods. Mainstream economists focus more on optimality conditions for capital goods pricing, so they tend to appreciate the process of establishing such prices much less.

Austrian analysis focuses so heavily upon essential market processes, that one needs only raw intelligence to understand it, and can do without the skepticism and alertness that one needs to successfully navigate mainstream theory.

While it is possible for people to arrive at correct conclusions about the market system by studying mainstream equilibrium economics, this is not a reliable approach. The mathematical models of mainstream economics divert our attention from the processes and institutions that enable free and prosperous societies to exist and persist.

Some mainstream economists manage to bring these important factors in to their analysis, but far too many do not. When seemingly credible mainstream economists trot out their models of market failure, we all run the risk of enjoying less future prosperity and of losing more of our freedom. Since Austrian economists never lose sight of market processes, we never fail to appreciate them. Thus, Austrian analysis provides a superior basis for correctly informing the general population about why capitalist societies are the best societies.

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D.W. MacKenzie is a Ph.D. candidate and a Walter Williams fellow at George Mason University. Send him EMAIL and see his Mises.org Articles Archive.


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