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Home | Mises Library | Why Austrians Are Not Neoliberals

Why Austrians Are Not Neoliberals

  • Why Austrians Are Not Neoliberals
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Tags History of the Austrian School of EconomicsMonetary TheoryOther Schools of ThoughtValue and Exchange

01/04/2016Philipp Bagus

Philip Mirowski, known for his book More Heat than Light: Economics as Social Physics, Physics as Nature’s Economics in which he criticizes neoclassical economics for adopting methods from the natural sciences, recently published a book on neoliberalism and the economics profession during the financial crisis. In Never Let a Serious Crisis Go to Waste: How Neoliberalism Survived the Financial Meltdown, his main thesis is that the economics profession utterly failed in predicting and explaining the financial crisis. Nevertheless mainstream economists did not suffer any negative consequences but continue with business as usual.

In Mirowski’s view, neoclassical economics, neoliberalism, and the political right came out of the crisis stronger thanks to a complicated propaganda effort and an intricate lobbying machine headed by the Mont Pelerin Society (MPS). According to Mirowski, the Mont Pelerin Society functions at the heart of a complex web of conservative and free-market think tanks and the neoliberal academics that controls politics.

Mirowski’s analysis is interesting even though it comes from a far left and egalitarian perspective. Especially pertinent is his analysis and critique of neoclassical economics.

The Lamentable State of the Mainstream Economics Profession

The neoclassical mainstream profession was unable to predict the Great Recession. As neoclassical economists believed in a new age of macroeconomic stability, dubbed the Great Moderation, in which central banks had basically abolished harsh recessions, they were taken by surprise by the immense problems the financial system and the world economy started to experience in 2008.

Mirowski explains this failure as the result of a methodological dead end. The neoclassical profession was unable to predict the Great Recession with their methodological instruments such as the infamous dynamic stochastic equilibrium models (DSGE). Since in the DSGE there is basically no room for crises, neoclassical economists were not only unable to predict the financial crisis, they are also unable to explain it in retrospect.

Mirowski diagnoses a cognitive dissonance in the neoclassical camp. As neoclassical theories are unable to explain the financial crisis, there is a gap between the accepted theory and reality. To bridge this gap neoclassicals have, according to Mirowski, reacted in accommodating (or distorting) the empirical evidence to fit their theories somewhat. Instead of recognizing that a paradigmatic change is necessary in mainstream economics, the economics profession stubbornly sticks to their mathematical models.

Mirowski describes accurately the inertia of mainstream orthodoxy. Sunk costs of intellectual capital investments for neoclassical economists are enormous. The profession remains without orientation and vision, stumbles, and stagnates in mediocrity. Indoctrination propagates the orthodoxy. Students are socialized with economics textbooks using an incoherent potpourri of theories. They are made to read short-lived articles published in highly ranked journals using mainstream methodology. In this context, Mirowski points to the fact that journals in general have stopped publishing articles on methodology and economic history in favor of mathematical and statistical articles. Mirowski correctly connects the mathematization with the incorporation of natural scientists into economics and regards this development as one reason for the financial crisis.

The Methodology Problem

Mirowski criticizes neoclassical methodology arguing that economists envy the physical sciences. Due to this envy, economists started to imitate the method and models of physics. It was the mathematical approach used in physics that made neoclassical economists unable to foresee the crisis. Mirowski’s critique does not shy away from leftist neoclassical economists. Consistent in his approach he not only chides Greenspan and Bernanke, but also Stiglitz and Krugman. While there may be ideological differences between them, they all employ DSGE models in which a representative agent maximizes utility functions.

According to Mirowski it was the DSGE model that allowed for the unification of economics again after microeconomics had been separated from macroeconomics due to the Keynesian revolution. DSGE models allowed employing the mathematical approach of microeconomics in the macrosphere by introducing utility maximizing agents and high aggregation. Mirowski goes so far as to say that without DSGE, neoclassical economics disappears.

While Mirowski calls for a reset of economics and the end of the neoclassical paradigm, he fails to provide an alternative, and he does not seem to be aware of the praxeological approach of the Austrian school. The realistic alternative Mirowski calls for already exists. He is also unaware that due to their realistic approach, Austrian economists were not surprised at all by the financial crisis, which was predicted by some of them. Unfortunately, the ignorance of Mirowski concerning the Austrian school is immense as we will see in his interpretation of Hayek and his complete neglect of the works of Ludwig von Mises and Murray Rothbard; not to speak of his neglect of contemporary Austrians.

Mirowski’s Confusion About Schools of Thought

The main problem of Mirowski is his confusion when it comes to the Austrian school and libertarianism. Mirowski regards most neoclassical economists as neoliberals (with some exceptions on the left such as Stiglitz or Krugman). Implicitly he also incorporates the Austrian school in the neoliberal camp. He even writes about “Hayekian neoliberals.” Yet, Austrians are neither neoclassical nor can many be considered to be neoliberal.

It is true that in some parts of his book Mirowski distinguishes between neoliberal versus libertarian, and neoclassical versus Austrian, but he does not apply this distinction consistently. This lack of consistency produces curious results.

For instance, he argues that Chicago’s efficient market hypothesis (EMH) formalizes Hayek’s theory of knowledge. This seems to imply that Hayek, or other Austrians, share the method of neoclassical economists, and belong to one and the same neoliberal camp.

Nothing could be further from the truth. Hayek’s theory of subjective knowledge treats knowledge as being tacit, private, subjective, and decentralized. Hayek’s treatment of subjective knowledge is fundamentally opposed to any mathematical or formalized treatment of information. More specifically, the creative nature of entrepreneurial knowledge in the Austrian tradition contrasts with the objective and given type of information of the EMH.

The EMH states that market prices are efficient as they incorporate all relevant information and assumes an objective kind of information that can be bought and sold on the market place. Yet, what is important is not the objective and given information, but rather the subjective interpretation thereof and the creation of new entrepreneurial knowledge in a dynamic process. Past prices are just historical exchange relationships that serve market participants to create new information. Mirowski distorts Hayek by stating that according to Hayek the market transmits the knowledge of what we need to know. Instead Hayek pointed out that market prices allow us to use the subjective knowledge of other market participants. The market does not automatically transmit the knowledge that we need to know, rather market participants need to discover and create what they need to achieve their ends.

There are additional problems with Mirowski’s mixing of subjectivism and Hayek’s theory of knowledge with EMH, CAPM, and the Black-Scholes model. There is nothing subjectivist in an equilibrium construct such as the EMH, the CAPM; or Black-Scholes. In all these mathematical models all relevant information is already given. They are static. Mirowski simply misses Hayek’s main point that entrepreneurs in a competitive market process discover new information. As the market is a process, the market is never perfect. Market participants may err or fall prey to illusion; Mirowski’s whole book is a prime example for that.

Another curious result from Mirowski’s failure to distinguish clearly between the Austrian school and neoliberals comes when he deals with constructivism. Mirowski regards neoliberals as constructivist. At the same time Mirowski includes Hayek in the group of neoliberals (and one might wonder the whole Austrian school) and tries to reconcile Hayek’s criticism of constructivism with neoliberalism. But how can Hayek, who has fought most vigorously against scientism and constructivism in the twentieth century, be a constructivist?

Austrians vs. Chicagoans

The implicit mixing of the Austrian and Chicago schools is especially problematic. Mirowski claims that neoliberals subscribe to the concept of the spontaneous order. Yet, the spontaneous order is a concept employed mainly by Hayek and other Austrians. In contrast, neoliberals of the Chicago school use the equilibrium construct as an analytical tool. Yet, equilibrium analysis is fundamentally opposed to the Austrian school’s analysis of the dynamic market process. In short, neoliberals of the Chicago school do not employ the concept of spontaneous order consistently.

Writers such as Mark Skousen (2006) have tried to bridge the gap between the Chicago school and the Austrian school. Yet, this endeavor is an impossible undertaking. The main and fundamental difference between the two schools of thought is their methodological approach. Austrians in the Misesian tradition logically derive a priori economic laws from the axiom of human action with the help of some general presuppositions. Instead of making experiments and looking into the outside world, they look inside using introspection to find truth.

In contrast, Chicago school economists following Milton Friedman (1953) employ a positivist methodology. While Austrians maintain that one needs a theory first in order to understand history, followers of the Chicago school try to derive economic laws from history; sometimes applying econometric analysis. While scholars in the tradition of the Austrian school view reality as a dynamic process of human interaction, Chicago scholars employ equilibrium models, in which entrepreneurship and creativity are absent by definition and the dynamic market process is frozen. While Austrian economists regard the aim of an economist to understand and to explain the laws that govern the dynamic market process, Friedman’s aim is to make correct predictions. While Austrian economists aim at a realistic explanation of the market process, for Friedman realism of the assumptions is irrelevant. Only the predictive power of a theory counts.

In his book, Mirowski criticizes Friedman’s approach stating that model building for predictions has been a disastrous failure, an assessment many Austrians would share. Unfortunately, Mirowski fails to mention Austrian methodology in his book and seems to be unaware of this alternative defended by many members of the “neoliberal” MPS.

Directly related to these methodological differences between Vienna and Chicago is the opposed view on competition. While Chicago scholars tend to support and devise antitrust laws in order to bring reality closer to their model of perfect competition, Austrian scholars oppose the intervention of the government into the dynamic market process in the form of antitrust laws.

The high aggregation required by model building and mathematization has also lead to directly opposed views on capital by both schools. Capital, which is presented by the letter “K” in Chicagoite models, is viewed as a homogenous, permanent fund that synchronously and automatically produces income. The view of capital as a homogenous fund and production as instantaneous is a direct consequence of the mathematization and formalization of the Chicago school.

The Austrian view on capital is fundamentally opposed to the neoclassical one. Indeed, there was an intense debate between Chicago and Vienna on the concept of capital. Friedrich Hayek (1936) and Fritz Machlup (1935) criticized Frank Knight for the meaningless concept of capital as a homogenous, automatically self-maintaining fund. Austrian capital theory and the view of production as a time consuming process allowed Austrian economists to develop a theory of intertemporal distortions in the structure of production induced by credit expansion unbacked by real savings. Austrian business cycle theory is commonly not understood by the Chicago school as neoclassical economists lack the necessary theoretical instruments; instruments they are unable to develop with their methodological approach.

Explaining Booms and Busts

Consequently, the interpretations of the Great Depression (and the Great Recession) by Austrians and Chicagoites differ widely. The Chicago school, following Milton Friedman and Ana J. Schwartz, maintains that the severity of the Great Depression was due to errors committed by the Federal Reserve. More precisely, the Federal Reserve according to Friedman and Schwartz did not expand the monetary base fast enough during the early 1930s. Following the Chicago interpretation, Ben Bernanke (2002) promised Milton Friedman not to commit the same mistake again, which explains the Federal Reserve’s reaction to the Great Recession in the form of Quantitative Easing.

In contrast, Austrian business cycle theory explains the Great Depression by the extraordinary credit expansion of the 1920s. Reinflating the money supply, in the Austrian view, disturbs the necessary readjustment as it stabilizes artificially old malinvestments and stimulates additional ones. Austrians explain the severity of the Great Depression by the size of the credit expansion in the 1920s and the concomitant malinvestments as well as the government interventions introduced in the 1930s such as the Smoot-Hawley Tariff Act or the New Deal in general.

Austrian economists were not blinded by the apparent price stability in the early 2000s. In fact, Mises and Hayek warned against policies of general price level stabilization hailed by Fisher and other monetarists. In times of economic growth such policies require the continuous injection of new money which is the source of intertemporal distortions. Due to their business cycle theory, Austrians were not taken by surprise by the financial crisis in contrast to Chicago economists. The same is true for the years leading to the Great Recession. Thus, Mirowski is just plain wrong with his sweeping statement that the (whole) economics profession did not foresee the financial crisis. It is true that neoclassical economists due to their methodological approach could not develop the theoretical tools necessary to understand the problems of the ongoing credit expansion of the early 2000s. In contrast, Austrian economists had those tools.

Unsurprisingly, another main area of disagreement between Chicago and Vienna, which Mirowski does not explain, is on monetary policy. Most Austrians favor the abolition of central banks and the introduction of a free market money, such as a 100 percent gold standard. Chicago school economists generally do not want to entrust the money supply to the market but are in favor of a central bank issuing fiat money. Central planning in money is not seen as a problem, but as a solution to crisis in the banking sector by defenders of the Chicago school.

Mirowski does not touch upon all these fundamental differences. He is correct, when he points to the central bank correctly as a neoliberal institution. Yet, he also claims that the Tea Party in the US is basically a neoliberal group. Later in the book he states that Ron Paul wants to abolish the Federal Reserve. Mirowski also mentions that Ron Paul is in the tradition of Hayek who is in favor of free banking. However, Ron Paul is regarded to be close to the Tea Party. The reader remains confused. Why would a hero (Ron Paul) of a neoliberal group (Tea Party) want to abolish a neoliberal institution (Federal Reserve)?

We are faced with another apparent contradiction caused by not distinguishing clearly between Austrians and Chicagoites or neoliberals and libertarians. If Mirowski had explained that Ron Paul is a follower of the Austrian school, it would have been no surprise to the reader that he opposed the Federal Reserve. But Mirowski just states that Bernanke sides with the neoliberal position of Milton Friedman. He simply fails to understand that Chicagoites and Austrians are diametrically opposed on fundamental questions and that it is a fallacy to consider them as ideologically and methodologically close.

The Origins of Mirowski’s Confusion

Where does Mirowski’s confusion stem from? Why does he not clearly differentiate between the Chicago and the Austrian school?

There are basically three reasons that may have contributed to this confusion. First, the Austrian school and the Chicago school share many free market ideas. Members of both schools generally oppose price controls, product regulation, and the public provision of education services. Yet, as we have pointed out above, differences abound. The Chicago school supports central banking and antitrust, while the Austrian school does not. If Mirowski had looked into the libertarian positions many Austrians hold, he would have recognized that most Austrians are wide apart from the neoliberal positions of Chicago.

Second, Hayek became a professor at the Univeristy of Chicago in 1950. Yet, the location of Hayek at Chicago does not imply that he was close to Chicago school ideas. In fact, Hayek became professor at the Committee of Social Thought in Chicago, because Chicago economists had opposed his appointment at the economics department. This is understandable as Hayek was very critical of the positivistic approach that Chicago economists followed.

Third, the most likely cause of confusion stems from Mirowski’s treatment of the Mont Pelerin Society where Austrians and Chicagoites often meet together. From the very beginning, starting with the 1947 founding meeting of the Mont Pelerin Society, there were three main schools of thought that were represented: the Austrian school, the Ordoliberalism, and the Chicago school. Mises and Hayek from the Austrian school, Walter Eucken and Wilhelm Röpke were Ordoliberals, and George Stigler, Frank Knight, and Milton Friedman from the Chicago school.

Both the Chicago school and the Ordoliberal school can be classified as neoliberal. They oppose socialism, but also Manchesterism, i.e., they oppose the laissez-faire approach of classical liberalism. Both Ordoliberals, mainly located in German speaking countries, and the Chicago school favor a strong state to set the framework for the market and direct economic life in certain directions. They also want the state to provide some social security.

There has been tension from almost the very beginning between Austrians and neoliberals within the Mont Pelerin Society. As Mises wrote in the 1950s: “I have more and more doubts whether it is possible to cooperate with Ordo-interventionism in the Mont Pelerin Society.”

In retrospect and from the point of view of the Austrian school, it may be regarded indeed as a strategic error to found an alliance with the Chicago school and other neoliberals within the Mont Pelerin Society. As Austrians and neoliberals are united in the Mont Pelerin Society, authors like Mirowski tend to conflate neoliberalism with libertarianism and Chicago positions with Austrian ones. Instead of treating neoliberals as friends with a common cause, Austrians could have fared better by regarding neoliberals as enemies of their enemies; namely of full-blown socialism. Austrians could have made their ideological and methodological differences much clearer in a Mont Pelerin Society dominated by themselves and excluding Chicagoites and other neoliberals. Most of the attacks from Mirowski against the economics profession per se or against liberalism would have lost credibility. Then Mirowski would have had to direct his criticism only against the Chicago school and neoliberals.

This article was adapted from Philipp Bagus’s article “Why Mirowski Is Wrong About Neoliberlaism and the Austrian School.”

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