Mises Daily

A
A
Home | Library | Austrian Economics on the Rise

Austrian Economics on the Rise

March 22, 2010

Tags Austrian Economics OverviewPraxeology

[Libertarian Forum, October 1974]

During the week of June 15–22, 1974, the quaint and rustic Vermont village of South Royalton came alive in a way that it probably hasn't since the Revolutionary War. Under the auspices of the Institute for Humane Studies, 50 professors and students from the United States, Australia, and England gathered for a conference on Austrian economics.

Slightly over 100 years ago, the Austrian School of Economics was founded by Carl Menger. 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, Menger developed the subjective theory of value. The value of a good, Menger explained, was not determined by the input of labor into the product, but rather the labor was given value by the intensity felt for the product by the individual who would finally consume it. And since individuals valued things differently and by different scales, there was no way to objectively determine value other than relating it back to the individual valuer.

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: first, Friedrich von Wieser, who explained the theory of imputation and opportunity cost, by which is meant that supply is, in reality, indirect demand, for we value the resources necessary for making a product in relation to the forgone uses (demands) that cannot now be carried out with them; and second, Eugen von Böhm-Bawerk, who expounded on the theory of subjective value and related it to the problems of capital and interest.

In this century, the Austrian approach was extended by Ludwig von Mises. Mises applied subjective value theory to the area of money and out of this developed the Austrian (or circulation-credit) theory of the trade cycle. Government manipulation of bank credit and the money supply disturbs the rate of interest (which acts as the allocator of goods between those produced in the present and those in the future), thus creating shifts in the ratio of consumer goods vs. capital goods and, therefore, causing the business cycle.

Mises also showed that socialism, the elimination of money and private ownership of the means of production, would put insurmountable barriers in the way of rational economic calculation. And, finally, Mises developed the methodology of praxeology, the science of human action. Praxeology declares that men carry out rational action to achieve ends through chosen means. Thus, unlike the natural sciences, the social sciences have as their subject matter the purposeful action of reasoning individuals.

Further developments in Austrian theory were the product of the versatile mind of Friedrich von Hayek. Besides adding his own contributions to business-cycle theory, methodology, and capital theory, Hayek presented a radically different theory of competition. Market activity was seen, not as a disturbance to equilibrium, but, rather as a never ending discovery process for knowledge as men pursue their ends.

The Institute for Humane Studies brought to Vermont three of the leading Austrian theorists living today: Professor Murray Rothbard of the Polytechnic Institute of Brooklyn, author of Man, Economy and State, America's Great Depression, and Power and Market; Professor Israel Kirzner of New York University, author of The Economic Point of View, Market Theory and Price System, and most recently Competition and Entrepreneurship. And Professor Ludwig M. Lachmann, of the University of Witwaterstrand, South Africa, author of Capital and its Structure and Macro-economic Thinking and the Market Economy.Download PDF Also among the conference attendants were such notables as, Henry Hazlitt, W.H. Hutt, D.T. Armentano, Sudha R. Shenoy, Walter Block, Gary North, and William Peterson.

The first day was highlighted by an opening evening banquet. In the late afternoon, Milton Friedman, who resides in Vermont, arrived at the South Royalton Inn, the site of the conference. Surrounded by a multitude of people, he declared that the optimum government policy would be one to insure zero inflation. When someone asked if it wouldn't be more optimal for the money supply to be kept constant and allow prices to gently fall with greater productivity, Friedman grudgingly conceded that it probably would be the more optimal choice.

Soon afterward, Friedman led the group out to the hotel porch where he proceeded to wax eloquent over the merits of "indexing." (For a critique of indexing, see "Uncle Miltie Rides Again," Libertarian Forum, May, 1974). After listing economists from 1702 to the present who have supported an index program, someone asked if we could now see a pure application of the program in the military dictatorship of Brazil? To which Friedman conceded, yes. He was then asked if this verified what his son, David, said at a meeting of the Philadelphia Society, that he (Milton) had latent fascist tendencies. Friedman muttered that he felt that David had been unfair.

At the dinner that evening, Henry Hazlitt reminisced about how he first met Ludwig von Mises in the 1940s. W.H. Hutt talked about the contributions that Mises made to economics, and Murray Rothbard related some of the anecdotes Mises told during his graduate seminars at NYU. When Milton Friedman was asked to make a few comments, he admitted that Mises had made a few contributions, but that he was much too "extreme." And, besides which, Friedman added, there was no such thing as "Austrian economics," only good economics and bad economics. (A rather unusual statement, because just a few weeks before, he had been on public television and spent several minutes explaining the special characteristics of "Chicago Economics.")

Starting the next day, a week of rigorous and incisive lectures began dealing with every facet of "Austrian" theory. Professors Rothbard and Kirzner laid the foundation by explaining the implications of praxeology. The study, 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, 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.

The fact that action is purposeful, chosen, and subjective also means that any statistical or historical studies that attempt to measure or predict human activity must be seen as worthless. Professor 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 1 out of 10 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 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 the 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.

"Unlike the natural sciences, the social sciences have as their subject matter the purposeful action of reasoning individuals."

Professor 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 action of other men, and unexpected occurrences. But because each man's perspective and interpretation of this stream of knowledge will be different, what seems relevant to one individual will be discarded as insignificant by another.

The unknowableness 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. And 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 dovetailing of human action? 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 force. 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 in human plans.

This train of thought was continued the following day with lectures by Professors Lachmann and Kirzner on the Austrian theory of capital. Capital is the intermediate product used to produce a 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. For a good is seen as a production good only within the context of the human plan. That which is seen as a capital good in one instance may become totally worthless or shift to a consumer good, dependent upon the subjective valuation of the actor.

The elusiveness of market equilibrium often means, as well, that, as Lachmann pointed out, a tendency of structural integration of interpersonal plans may exist, but some combinations that are found not to fit within evaluated plans may result in a scrapping of certain goods and, therefore, are "not really capital," in the eyes of the valuer. Kirzner continued the discussion with an excellent critique of John Hicks's recent attempt to place all theorists either in the category of "materialists," e.g., those who measure the quantity of physical "capital" objects, or as "fundists," e.g., those who attempt to sum up market values to measure capital goods. Rather, pointed out Kirzner, capital is the complex of "half-baked cakes," the interim form the resource takes in the process of a human plan.

Professor 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.

"Milton Friedman was then asked about what his son, David, said at a meeting of the Philadelphia Society, that he (Milton) had latent fascist tendencies. Friedman muttered that he felt that David had been unfair."

Professor Lachmann finished his series of lectures with critiques of macroeconomics and the recent neo-Ricardian counterrevolution. One of the errors, Lachmann suggested, was that macroeconomics too often assumes a Walras-Paretian long-run equilibrium price structure. But, the basis of national income statistics is not long-run market outcomes but the output flows of "market-day equilibrium" prices. Prices are affected by changing streams of knowledge and data that result in constantly shifting patterns of prices and equilibriums. The attempt to find consistent aggregate macro variables is impossible.

The inability to successfully explain the workings of the economy from a macro foundation has resulted in a counterrevolution of "Ricardian" economists. A redevelopment of cost of production theories, a "methodological egalitarianism" which overlooks the entrepreneurial contribution, and an ignoring of the nature of diversity and expectations are their main contributions. But, says Lachmann, the neoclassical establishment (e.g., Samuelson, Hicks, Halm, etc.) are unable to give a satisfactory response within the macro framework.

Here is where the Austrians must step forward and present the microeconomic solution. Our methodological individualism will enable an understanding of how the economic process unfolds through human action. Lachmann offered the conference participants the slogan of calling ourselves "radical subjectivists."

On the last day of the conference, Professors 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 wertfrei, value-free, economic analysis. As an economist, the Austrian theorist does not make judgments on ends chosen. Rather, following the lead of Mises, he says, suppose someone wishes to enhance the economic welfare of the community. The economist need take no stand on the end chosen, but he can say whether the means chosen for that end will be successful. And, thus, he can make a judgment of "good" or "bad" within the context of the goal chosen by the valuer.

While admitting this, Professor Rothbard wondered if the economist could be totally value-free in all instances. What if a politician has as his end 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.

Some extremely interesting papers were delivered in informal sessions during the week by other conference participants as well. Edwin Dolan, S. Peyovich and E. Clayton discussed the changes from central planning to quasi markets in socialist countries. Roger Garrison delivered an interesting paper on "Technique Reswitching and Capital Reversing." In a very well received paper, Gerald O'Driscoll analyzed Austrian theories of competition and business cycles in a lecture on "F.A. Hayek and the Neo-Classical Synthesis." Other topics included "Empirical Testing of Austrian Models" by Art Carol, "Subjectivism, Marginal Utility and the Marginal Revolution," by M. Rizzo and H. Young, and the success of free trade in Hong Kong in a talk by Sudha R. Shenoy.

In 1892, Friedrich von Wieser stated that,

the actual calculation of the economic world constitutes an unsurpassable work of art in which nothing is isolated or unconnected, and it is not completely grasped by theory so long as anything in it seems to be without connection with other portions of the system.

It is perhaps because Austrian theorists have always taken Wieser's words to heart that while other economists were gaining notoriety with "tracts for the times," they were studiously building an edifice of economic theory to explain all human action.

While other economists were trying to find the origin of economic crises in sunspots and statistical comparisons, Austrian thinkers listened to Böhm-Bawerk that,

A theory of crises can never be an inquiry into just one single phase of economic phenomena. If it is to be more than an amateurish absurdity, such an inquiry must be the last, or the next to last, chapter of a written or unwritten economic system. In other words, it is the final fruit of knowledge of all economic events and their interconnected relationships.

The result was the building of a theory of money and credit on the foundation of subjective marginal utility by Ludwig von Mises.

In the United States, the Austrians have been in a theoretical underworld in an environment dominated by Keynesianism. But as the structure of establishment economics has fallen more and more into disrepute, individuals have discovered an alternative approach that explains more clearly the workings of reality. Building up momentum slowly, the Austrian School has silently been finding adherents around the country, as well as the world.

Sensing the rightness of the times, the conference on Austrian economics was planned as a catalyst for expanding interest in the praxeological approach. To this end, the conference must be declared a resounding success. It opened up lines of communication among individuals who were developing ideas along similar lines but did not know of each other's existence, let alone the work being done. It can probably be safely said that every participant, whether totally convinced of the Austrian method or not, went away desiring to give careful thought to this theoretical framework.

"The conference on Austrian economics was planned as a catalyst for expanding interest in the praxeological approach. To this end, the conference must be declared a resounding success."

The Keynesian macro model has lost its credibility. Socialist economics has long ago proven itself defunct. Only the market economy can offer solutions to the economic problems the world faces. But its acceptance will be dependent on the case offered for its adoption. The Austrian framework offers such a case. Starting from the foundation of economic activity, the subjective choices of acting individuals, all economic phenomena cannot only be explained but easily comprehended. For all men act, all men choose, all men plan. It is a theoretical construction self evident to all thinking men.

As a further step in developing interest and understanding of Austrian theory, Percy L. Greaves has put together a comprehensive glossary of Ludwig von Mises's Human Action, entitled Mises Made Easier. As an added treat, an appendix has been included with a never-before-in-English critique by Mises of Böhm-Bawerk's time-preference theory. The volume is scheduled to be in print this fall.

Also, Bettina Bien Greaves, a senior staff member of the Foundation for Economic Education, has recently translated three works by Mises never before available in English.

The first of these translations, entitled "Stabilization of the Monetary Unit: Considered from the Point of View of Theory," was published in 1923, shortly before the total collapse of the German currency. In this essay, Mises explains the redistributing effects of inflation to those who first receive the new money at the expense of the others who face higher prices before their incomes rise. Also, he explains the fact that as the depreciation progresses, a "flight" from money becomes so general that "the monetary units available at the moment are not sufficient to pay the prices which correspond to the anticipated future demand for, and supply of, monetary units." This "phenomena of advanced inflation … is the other side of the 'crack-up boom.'"

Mises dissects the "balance of payments" doctrine and the "inflationist argument" that it is more painless to depreciate the currency than raise taxes. Finally, Mises declares that the "first condition of any monetary reform is to halt the printing presses" and "refrain from financing government deficits by issuing notes, directly or indirectly." Inflation, Mises concludes, is always the "product of human action and man-made policy." It is a part of the total politicoeconomic and sociophilosophical ideas of our time. A sound monetary system must firmly be "grounded on a full and complete divorce of ideology from all imperialist, militarist, protectionist, statist and socialist ideas."

The second essay is his 1928 work, "Monetary Stabilization and Cyclical Policy." Mises states the problem of the day as the attempt to stabilize the value of money, the attempt to preserve the "price level." Mises explains at length that any goods that are the products of human action, like money, cannot have their value "fixed." "There is no such thing as a stable purchasing power, and never can be … only an economy in the final state of rest, where all prices remained unchanged, could have a money with fixed purchasing power." It also shows, says Mises, that measuring changes in purchasing power is impossible as well. Exchange ratios on the market are constantly subject to change, and for a measurement "we must imagine an unchanging man with never-changing values."

Mises then offers a critique of Fisher's index-number proposal for adjusting changes in purchasing power. Everything Mises says about Fisher's idea can equally be said about Friedman's indexation plan. Since purchasing power cannot be scientifically measured, points out Mises, any index program would become a political issue. Governments would be pressured to index purchasing power favorable to some groups at the expense of others.

Also, changes in money prices don't affect all commodities at the same time and to the same extent. Only gradually does the change in purchasing power work its way through the economy, and because the price changes will bring shifts in income distribution, the exchange ratios will be different from what they started. Even if the indexing attempts to be "precise" by measuring on a narrow month-to-month basis, "the step-by-step emergence of changes in purchasing power" are accruing during the month. Thus, the "adjustment calculated at that time is based on the index number of the previous month when the full extent of that month's monetary depreciation had not been felt because all prices had not yet been affected."

Mises, in the second half of this essay, develops in complete detail his famous trade-cycle theory. He explains why price stabilization results in a "destabilizing" of price ratios and brings about the imbalance of capital goods and consumer goods by credit expansion artificially lowering the rate of interest, and how the end result of such policies must be an eventual readjustment of the structure of production, representing the actual savings and consumption of market participants.

$20 $18

 

The third essay, entitled "Causes of the Economic Crisis: an Address," was delivered by Mises in 1931 and represents his analysis of the causes and prolonging of the depression. He gives an incisive critique of the mass unemployment problem, "easy money" policies, price supports, and tax policies. Mises concludes that the only lasting solution is to give "up the pursuit of policies which seek to establish interest rates, wage rates and commodity prices, different from those the market indicates."

The essays have been organized under the title Money, Inflation and the Trade Cycle: Three Theoretical Studies by Ludwig von Mises.[1] Besides being translated by Bettina Bien Greaves, they have been edited by Percy L. Greaves, and a special introduction to the volume is planned by him. Present plans are for the book to be published sometime next year.

With a conference on Austrian Economics, and with newly translated works by Ludwig von Mises soon to be available to the public, a turning point in the economics profession may be just before us.

[bio] See [AuthorName]'s [AuthorArchive].

This article originally appeared in the Libertarian Forum, October 1974, pp. 3–6.

You can subscribe to future articles by [AuthorName] via this [RSSfeed].

Notes

[1] Editor's note: In 1978, these three essays were published in On the Manipulation of Money and Credit, together with Mises's "The Current Status of Business Cycle Research" (1933), and "The Trade Cycle and Credit Expansion" (1946). LvMI has newly edited and republished this book as Causes of the Economic Crisis.


Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.

Follow Mises Institute