Market Process: Lecture One
INTRODUCTION AND HISTORICAL BACKGROUND OF THE AUSTRIAN SCHOOL
Major Sources: The Meaning of Market Process by Israel M. Kirzner, 15 Great Austrian Economists, edited by Randall G. Holcombe, and “Austrian School of Economics” by Peter J. Boettke in the Concise Encyclopedia of Economics.
Let’s start from the beginning:
Usually the “Austrian” school is traced back to the publication of Carl Menger’s Principles of Economics (1871). However, as we shall see, the term “Austrian economist” means someone who does economics a certain way – and therefore, there were Austrian economists before Menger. Most notably:
The Irish banker Richard Cantillon (1680 or so -1734);
The Frenchman A.R.J. Turgot (1727-1781);
The (probably) most famous French economist Jean-Baptiste Say (1767-1832);
And the great French writer and economist Frederic Bastiat (1801-1850).
These economists can all be considered “Austrian” in the way by which they went about doing economics and what they emphasized and explained.
Some also would include Adam Smith (1723-1790) and David Hume (1711-1776) as "pre-Austrian" as well, at least in some ways.
As we shall see – Austrian economists do not agree on everything! There are major disagreements within the school of thought.
So why called the “Austrian School”?
Carl Menger (1840-1921) and William Roscher of the German historical school had great differences regarding the method which economic science should use. This “debate” came to be known as the Methodenstreit. One of Roscher’s students (Gustav Schmoller) derogatorily called the work of Menger and his followers the “Austrian school” since they were teaching at the University of Vienna. And that’s where the name came from.
But the school of thought is not about a place or about certain people – it is about a way of approaching economic science. We will delve into this approach (and how it differs from much of mainstream economics) soon.
So given that, we have:
First Generation: The founder, Carl Menger (1840-1921). Menger was one of the three economists who moved economics forward great leaps and bounds with what is known as the Marginal or Subjectivist revolution in economics. The other two were Jevons and Walras. Market prices were finally explained when both subjective value and marginalism were used in the explanation (more on this later).
Second Generation: Two most famous followers of Menger were Eugen von Bohm-Bawerk (1851-1914) and Friedrich von Wieser. Bohm-Bawerk is known for his continuation of Menger’s theory regarding subjective value and also his theories regarding capital and interest. Bohm-Bawerk is also known for his criticisms of Marx. Wieser’s ideas were far less recognized.
Third Generation: Bohm-Bawerk held a seminar in the decade prior to the First World War – Ludwig von Mises (1881-1973) (and also Joseph Schumpeter) attended this seminar. Mises is often considered the “father” of Austrian economics, although not the founder. We will certainly discuss his prolific work throughout the course.
Fourth Generation: the most famous in this generation is Friedrich A. Hayek (1899-1992) – who won the Nobel Prize in Economics in 1974. Although others, such as Gottgried Haberler, Fritz Machlup, and Oscar Morgenstern – to name a few – were also famous economists in their own right.
We should also include Lionel Robbins in this crowd – at least to some degree. Robbins invited Hayek to lecture at the London School of Economics in 1931 – most especially to counter John Maynard Keynes. To a large degree – Robbins was responsible for a number of key Austrian ideas being absorbed into the mainstream literature of twentieth-century economics - via his very influential book, An Essay on the Nature and Significance of Economic Science (1932, 1935).
The main ideas:
Let’s interrupt here and talk about six ideas that expressed the Austrian approach as was understood around 1932. Then we will update and expound upon these later – so this is just a brief introduction of each.
1. Methodological individualism:
2. Methodological subjectivism:
3. Marginalism (careful – not exactly the marginalism you are used to in mainstream economics – more later):
4. The influence of utility (and diminishing marginal utility) on demand and on market prices:
5. Opportunity cost:
6. The time structure of consumption and production (expressing time preferences and the productivity of “roundaboutness”):
You might be thinking – so aren’t all of these ideas found in most mainstream textbooks? To some degree – yes (well, most but not all). But some are presented and interpreted very differently than Austrian economists interpret them.
Furthermore, “subsequent developments (after 1932) in the work of Mises and Hayek suggest that the list of six Austrian ideas was not really complete” (Kirzner, p. 65).
There were ideas that were say, implicit in the Austrian tradition, but were not necessarily articulated at this point. So it is really after the early 1930s that we see these ideas articulated and the important differences that do separate Austrian economic theory from the mainstream become more obvious. In this way, it was really Mises and Hayek that did articulate these ideas and therefore preserved “a unique Austrian ‘presence’ in the profession” (Kirzner, p. 65).
So the next generation were really influenced by Mises and Hayek:
Fifth Generation: There are many - Israel Kirzner, Murray Rothbard, Gerald P. O’Driscoll, Mario Rizzo, Don Lavoie and Roger Garrison – to name a few. We will discuss some of the work of each of these economists.
Sixth Generation and beyond: Too many to name – includes Deb Walker.
OK, so let’s talk generally about what Austrian economics is and what it is not.
What Austrian economics IS NOT:
The term Austrian economics has come to evoke a number of different connotations in contemporary discussion in the profession. Having studied Austrian economics for many (we won’t say how many) years now – I can confidentially say that some of these connotations (what people think Austrian economics is) are spoken out of ignorance and, in some cases, fear (that is my opinion). But take them as you will. I know I can be defensive here, so I apologize if that shows! After this class, you might agree or disagree with these – that is up to you to decide.
1. For some economists “Austrian economics” is strictly a historical term. In this perception the existence of the Austrian School did not extend beyond the early 1930s; it was partly absorbed into mainstream microeconomics, and partly displaced by emerging Keynesian macroeconomics.
Deb’s response as an Austrian economist: Have you read Mises and Hayek and Garrison and Rothbard and Kirzner and …… - all written during and after the 1930s? Did you miss Hayek’s Nobel Prize? Do you know what their contributions have been and how those contributions differ from the mainstream? Austrian economics is alive and well today – probably more so than in any other time in history. In some ways I view it as “cutting edge” economics – because it explains so much that mainstream does and cannot. It is not an “outdated philosophy” -- that is a statement that would be made by someone ignorant of the history of economic thought and of even modern day theory.
2. For a number of economists the adjective ‘Austrian” has come to mark a revival of interest in Bohm-Bawerkian capital and interest theory. But that’s about as far as it goes. Therefore it has little to do with the general subjectivist Mengerian tradition.
Deb’s response as an Austrian economist: Again, this view does not understand the entire contribution (and differences) of the school.
3. For other economists (and non-economists) the term ‘Austrian economics’ has come to be associated not with a unique methodology, or with specific economic doctrines (as it should be), but with libertarian ideology in political and social thought. For these people, to be an Austrian economist simply means that you favor free markets.
Deb’s response as an Austrian economist: This view again comes from being ignorant of what Austrian economics is. If you truly understand what Austrian economists are saying in terms of their theories about economic reality – then, and only then, can one understand the policy stances that most Austrians make. As Pete Boettke puts it in your reading (last sentence): “In the twentieth century, economists of the Austrian school of economics were the most uncompromising proponents of this message [that the market economy betters people’s lives], not because of a prior ideological commitment, but because of the logic of their argument.” We will discuss this in detail in this course since it is a pet peeve of mine (one of many when it comes to those who criticize something they don’t understand)!!
4. For many in the profession the term ‘Austrian economics’ has come to refer to a revival of interest in the ideas of Carl Menger and the earlier Austrian school, particularly as these ideas have been developed through the work of Mises and Hayek. This revival has particularly occurred in the United States – but has happened in many other places as well.
The thrust of the revival has been to emphasize the differences between the Austrian understanding of markets as processes and that of the equilibrium theorists whose work has dominated much of modern economic theory. As a result of this emphasis – the term has often (and only partly accurately) come to be understood as a refusal to adopt modern mathematical and econometric techniques – which standard economics adopted largely as a result of its equilibrium orientation. These are sometimes called “neo-Austrians” – they do see themselves as continuing an earlier tradition – sharing with mainstream neoclassical economics an appreciation for the systematic outcomes of markets, but differing from it in the understanding of how these outcomes are in fact achieved.
Deb’s response as an Austrian economist: This view is pretty much correct as far as it goes. Many Austrians that I know became Austrian economists out of frustration with mainstream models. Out of frustration of the models not being able to explain reality – or answer the questions that these economists think are important.
An Austrian economist is like a pesky kid that is always asking, “why” – they want to explain why an institution exists in the first place instead of just starting with its existence. As good examples: money, a business firm, a particular law, etc.
And a second frustration arose out of the harm that mainstream models do when policy recommendations are made from a completely unrealistic model. As Pete Boettke says – we, as economists, should adopt the doctors’ creed: “First, do no harm.” A lot of harm has been done.
If you want to “do economics” for the sake of simply doing economics because it is fun (which, of course, it is) – then you are not an Austrian economist.
A cultural norm among Austrian economists exists – people (individuals) are the center of our discipline – that’s why we are economists – at least that has been my experience in knowing many Austrian economists.
5. Lastly, there is also a current meaning loosely related to the preceding one. This refers to an emphasis on the radical uncertainty that surrounds economic decision making, to an extent that implies virtual rejection of much of mainstream economics.
Deb’s response as an Austrian economist: There are those writing in this tradition. And there is overlap here with post-Keynesian economics (more later). One can say that this does stem from the Austrian “tradition” in some ways but most Austrian economists would reject this extreme view.
What Austrian Economics Is:
So What Is Austrian Economics all about? I think Pete Boettke’s list of propositions is well done. We will expand upon each of these as the class unfolds. I think you will be surprised (I hope pleasantly) when you learn how these propositions translate into economic theory. But let’s make sure everyone understands the basics of each of the propositions:
Proposition One: Only individuals choose.
Proposition Two: The study of the market order is fundamentally about exchange behavior and the institutions within which exchanges take place.
Proposition Three: The “facts” of the social sciences are what people believe and think. Not the same kind of “facts” that we find in the physical sciences.
Proposition Four: Utility and costs are subjective (Alfred Marshall was wrong)!
Proposition Five: The price system economizes on the information that people need to process in making their decisions. Emphasis is on the uncertainty that we all face – not on assuming that uncertainty away so that we can “formalize” a model.
Proposition Six: Private Property in the means of production (capital goods, not just consumer goods) is a necessary condition for rational economic calculation.
Proposition Seven: The competitive market is a process of entrepreneurial discovery.
Proposition Eight: Money is non-neutral.
Proposition Nine: The capital structure consists of heterogeneous goods that have multi-specific uses that must be aligned. In other words – Output = f(K, L) doesn’t really tell us much about reality.
Proposition Ten: Social institutions often are the result of human action, but not of human design.
So we will start with propositions one, three and four – all of which have to do with the methodology of the Austrian school – our next topic.
DISCUSSION ONE