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The Mises Review

Edited and written by David Gordon, senior fellow of the Mises Institute and author of four books and thousands of essays.

Vienna & Chicago: Friends or Foes? A Tale of Two Schools of Free-Market Economics

Mark Skousen

4 2005
Volume 11, Number 4

Lost in Vienna

Vienna& Chicago:  Friends or Foes? A Tale of Two Schools of Free-Market Economics

Mark Skousen

Capital Press, 2005

306 pgs.                   

Mark Skousen has undertaken a valuable project, but his book is not altogether a success. He compares the Austrian and Chicago Schools on several topics, including methodology, the proper monetary standard, the causes of the business cycle, and antitrust policy. Let us begin with the good news: the chapter "Macroeconomics, the Great Depression, and the Business Cycle" contains some insightful points.

The Austrian theory of the cycle depends crucially on the division of the process of production into higher and lower stages. An artificial boom results when an increase in bank credit drives the money rate of interest below the natural rate. This may result in over-expansion in the higher stages of production. Obviously, if there is no tenable distinction between the stages, the Austrian theory cannot get off the ground.

This is just what the Chicago School maintains. The patron saint of Chicago, Frank Knight, "became convinced that ‘all capital is inherently perpetual’ and ‘homogeneous’ like a ‘perpetual fund’ of synchronized consumption and production. . . . Knight, [Irving] Fisher, and [John Bates] Clark deny that capital is heterogeneous or that the production process lengthens or shortens during the business cycle" (p. 164).

Skousen aptly and succinctly expounds the Austrian refutation of this odd doctrine. "According to Hayek, Knight assumes ‘perfect foresight’ when he eliminates time altogether from the capitalistic process, and adopted a capital concept which ‘leaves us with the impression that there is a sort of substance, some fluid of definite magnitude which flows from one capital good to another’" (pp. 164–65). Skousen, like Fritz Machlup, thinks that a "return to Austrian School tenets, both in capital theory, and in monetary theory, and also in business-cycle theory, is absolutely needed" (p. 189). Skousen tells us that Sir John Hicks, in a conversation in 1988, "seemed greatly displeased by the failure of orthodox economists to teach the importance of time and the stages-of-production concept" (p. 289).

Skousen also brings to our attention a number of studies that lend support to the Austrian theory of the cycle. For example, two noted mainstream economists, Barry Eichengreen and Kris Mitchener, in a recent paper "adopt a remarkable Austrian interpretation of the 1920s and 1990s, describing both episodes as an unsustainable asset inflation in securities, property, technology, and consumer durables, caused by easy-credit policies during a period of low consumer/commodity price inflation" (p. 180).

Milton Friedman, whom Skousen asked to read this paper, is skeptical; but even this arch-monetarist has admitted "the possibility of Austrian-type distortions. . . . Friedman identifies ‘first round effects’ of monetary expansion through variations in interest rates, which may affect various asset classes differently" (p. 182). Commenting on Friedman’s argument, Roger Garrison, a leading exponent of Austrian cycle theory, remarked: "If the misallocation of capital sets the pace, as Friedman’s discussion of the lag suggests it well may, the Monetary theory of boom and bust becomes one with the Austrian theory" (p. 183).

Unfortunately, Skousen is not always so illuminating. When he writes on topics he knows, such as the stages of production, he is well worth reading; but all too often he pontificates about subjects of which he is ignorant. His understanding of praxeology is abysmal. He tells us that "Mises claimed in Human Action that the only pure economic science is radical apriorism—using pure deductive reasoning without the help of experience to establish first principles. Under the influence of German philosopher Immanuel Kant, who was convinced that reason alone, contra empiricism and historicism, could give universal knowledge, Mises built his entire system on logic and self-evident assumptions, similar to geometry" (p. 108).

Has Skousen ever so much as opened the Critique of Pure Reason? Kant’s fundamental aim was to show that reason cannot give us knowledge by itself: our concepts give us knowledge only when they are applied to experience. "Concepts without percepts are blind; percepts without concepts are empty" (Critique of Pure Reason, A51/B75). In like fashion, we know Mises’s axiom of action because we act. Mises abstracts from the contents of particular actions and endeavors to trace what is given in the form of an action. This quest does not ignore experience but rather depends on it.

Because praxeology studies the form or structure of human actions, details about the contents of particular actions are not needed to verify its results, nor can they falsify them. It hardly follows, nor is it true, that Mises held "that history does not teach us important lessons" (p. 116). History, properly interpreted, teaches us many things, and Mises never denied this; but what has this to do with the deductive structure of praxeology? Likewise irrelevant is the perfectly valid point that "history causes scholars go back to theory and discover new truths" (p. 119). How someone comes to learn something is a different matter entirely from whether what has been learned needs empirical confirmation.

Skousen incredibly thinks that when Rothbard applied Austrian business cycle theory to interpret the origins of the 1929 Great Depression, "he used the Chicago empirical method" (p. 114). Mises again and again insisted that one cannot deduce particular events from the theorems of praxeology: history, including most definitely economic history, is an empirical discipline. But this is entirely consistent with the claim that economic theory has a deductive structure. Does any use of history turn one into a Chicagoan?

Although Skousen thinks that Hayek was more flexible than Mises on methodology, he too was insufficiently empirical. Skousen claims that his "popular work The Road to Serfdom (1944) make [sic] no attempt to apply his theories to historical evidence" (p. 112). That’s odd: I thought the book had more than a few things to say about German history. Perhaps Skousen and I have read different books with the identical title. Skousen also thinks that Hayek was unduly pessimistic "about the future of the West. For example, chapter 10 of his bestseller The Road to Serfdom is entitled ‘Why the Worst Get on Top’" (p. 269). Once more, Skousen muffs it. Hayek’s argument is that under collectivism, the worst tend to assume control. Hayek does not claim that the trend to collectivism is inevitable: the point of the book was to avert this development.

Even more incredibly, Skousen thinks that "Hayek gradually shifted away from Misesian apriorism to some form of positivist empiricism" (p. 112), though the shift was of short duration. Apparently the shift is to be found in The Constitution of Liberty. Needless to say, neither in that nor any other of his books did Hayek adopt positivism, one of his chief aversions. Hayek is not the only author whom Skousen interprets strangely. He refers to John Stuart Mill’s "clarion defense of Say’s Law, hard money, and personal liberty in his classic libertarian tract On Liberty(1859)" (pp. 229–30; he makes the same claim on p. 20). On Liberty does not discuss Say’s Law or economic policy.

Skousen’s criticism of praxeology has a practical goal behind it. He thinks that Austrians have isolated themselves from the mainstream because of their insistence on esoteric doctrines and methodology: Austrians refuse to speak to the economics profession in its own language. He contrasts Austrian criticism of Keynes with that of Chicago. Rothbard and Henry Hazlitt offered detailed critiques of Keynes, but their work had no effect in weakening Keynesian hegemony. When Milton Friedman, by contrast, presented detailed statistical evidence that threw into question key tenets of Keynesian doctrine, such as the stability of the consumption function, his results could not be ignored. Skousen in essence says to Austrians: we must abandon our insistence on a rigid method that the profession rejects. Let us rather adopt the ways of Chicago and win friends and influence people!

Our author’s advice resembles John Dewey’s criticism of antiwar intellectuals such as Randolph Bourne and suffers from the same failing. Dewey maintained that principled opponents of American entry into World War I risked losing their influence over the public. Would not the aims of liberal social reformers be better served by joining the war effort? Then people would pay attention to them: should they insist on doctrinal purity, they would be ignored.

Dewey and his latter-day follower Skousen fail to ask a crucial question: why does one want influence? Is the aim to promote certain ideas, or is it, rather, to gain power over others for its own sake? If the goal is to secure acceptance of one’s views, one cannot abandon these views as the price of influence. Dewey’s counsel is to gain power by joining the other side; in like fashion, Skousen wishes to excise key Austrian doctrines in a quest for a larger public voice.

Skousen thinks that Chicago monetary theory has better "pragmatic solutions to monetary problems we currently face" even though the "Austrians have a better theoretical, historical and ethical argument in favor of the classic gold standard" (p. 156). Austrians should not be dismayed; I do not think we can put much credence in Skousen’s grasp of monetary theory. He finds heartening the rise of Internet firms that record transactions in gold, without reference to "government controlled monetary substitutes. If this new service becomes popular enough, it could provide an alternative parallel monetary system that would eventually make the current monetary system obsolete. We could witness the opposite of Graham’s Law occurring: Good money drives out bad. The Austrians may win by choice" (p. 156).

The problem of course is not the trivial slip "Graham’s Law;" he elsewhere manages to refer to the law by its correct name. Rather, Skousen has completely misapprehended Gresham’s Law. If consumers replace state-controlled money with a system they prefer, this does not violate Gresham’s Law. As Murray Rothbard long ago pointed out, the "law is merely a specific instance of the general consequence of price controls. . . . Gresham’s Law should read; ‘Money overvalued by the State will drive money undervalued by the State out of circulation’" (Rothbard, Man, Economy, and State, Scholar’s Edition, Mises Institute 2004, pp. 898–99).

This is not the only instance where Skousen could have profited from a closer study of Rothbard. He notes Rothbard’s opposition to the flat tax. He opposed eliminating loopholes: why make tax collection simpler? For Skousen, "Rothbard protests too much." He condescendingly dismisses Rothbard’s "tendency to overreact to any policy, theory, or history widely accepted among conservatives and libertarians. . . . Why didn’t he simply advocate cutting the tax rate down to one low rate, while leaving the loopholes intact?" (p. 239). Of course, Rothbard always did support reducing taxes to the greatest possible extent.

Skousen has some remarkable observations on Austrian history. A section about Maria Theresa is headed "The First Holy Roman Empress" (p. 23). She did have the title by courtesy of Empress, as the wife of Francis Stephen, who became Emperor in 1745. But she was not the first Empress; any wife of an Emperor would have the title. Skousen wrongly thinks that Maria Theresa herself headed the Holy Roman Empire, but no woman could hold this position. 1 She was indeed the only woman ever to head the Habsburg lands, but she did so as Archduchess of Austria and Queen of Hungary and Bohemia, not as Empress. Also, contrary to our author, she limited, but did not abolish, serfdom: abolition occurred during the reign of her son, Joseph II.

The Austrian School, we learn, was founded by Carl Menger, "(sometimes spelled Karl)" (p. 240). No; Karl Menger was Carl’s son. Friedrich Hayek did not "leave Vienna during the Nazi era" (p. 2); he became a professor at the London School of Economics in 1931. Writing on the socialist calculation debate, Skousen comments: "Led by Oskar Lange, Paul Samuelson, and Robert Heilbroner, among others, the economics profession scoffed at Mises, but ultimately Mises was proven correct nearly twenty years after his death" (p. 35). Neither Samuelson nor Heilbroner played a major role in the debate. He quotes a statement by E.C. Harwood as an example of Austrian criticism of Friedman’s monetary rule, but Colonel Harwood, a disciple of John Dewey and Arthur Bentley, opposed the Austrian approach as unscientific (p. 141).

Whatever his failings as an accurate historian, Skousen at any rate has a good sense of humor. In the index, this entry appears: "Gordon, David, balanced reviews by, 160, 194, 294)" (p. 298). Each of these pages is blank. At least they contain no crass mistakes.

1Incidentally, the Emperor was sometimes referred to as the "Roman Emperor" or "German Emperor" but not "Holy Roman Emperor."

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