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The Austrian School, also known as the “Vienna School” or the “Psychological School”, is a heterodox[1] school of economics that advocates adherence to strict methodological individualism. Proponents of the Austrian School hold that the only valid economic theory is logically derived from basic principles of human action. Alongside the formal approach to theory, often called praxeology, the school has traditionally advocated an interpretive approach to history. Proponents of praxeological method hold that it allows for the discovery of economic laws valid for all human action, while the interpretive approach addresses specific historical events. On the other hand, critics of the Austrian school contend that its methods consists of post-hoc analysis and do not generate testable implications, and so fails falsifiability.[2][3] While often controversial, the Austrian School has been historically influential due to its emphasis on the creative phase (i.e. the time element) of economic productivity and its questioning of the basis of the behavioral theory underlying neoclassical economics.[citation needed] According to Austrian economist Joseph Salerno, what most distinctly sets the Austrian school apart from neoclassical economics is the Austrian Business Cycle Theory:[1]
Austrian School theorists, like Ludwig von Mises, insist that praxeology must be value-free. That the method does not answer the question "should this policy be implemented?", but rather "if this policy is implemented, will it have the effects you intend?" However, Austrian economists often make policy recommendations that call for the elimination of government institutions - anarcho-capitalist solutions. These recommendations are similar to, but further reaching than the minarchist ideas of Chicago School economists. Both schools advocate strict protection of private property, and support for individualism in general, and are often cited by conservatives, laissez-faire liberal, libertarian, and Objectivist groups for support,
[edit] HistoryClassical economics focused on the labour theory of value. In the late 19th century, however, attention was focused on the concepts of “marginal” cost and value. The Austrian School was one of three founding currents of the marginalist revolution of the 1870s, with its major contribution being the introduction of the subjectivist approach in economics.[4] Carl Menger's 1871 book, Principles of Economics was the catalyst for this development; while marginalism was generally influential, there was also a more specific school that grew up around Menger, which came to be known as the “Psychological School,” “Vienna School,” or “Austrian School.”[5] The Austrian School played a major role in the development of economic theory in the 20th century.[4] Austrian economics is currently closely associated with the advocacy of laissez-faire views. Earlier Austrian economists were more skeptical compared to later economists such as Ludwig von Mises and Karel Engliš, with Eugen von Böhm-Bawerk saying that he feared unbridled competition would lead to “anarchism in production and consumption”.[cite this quote] However, the Austrian School, especially through the works of Friedrich Hayek, was influential in the revival of laissez-faire thought in the 1980s.[citation needed] The school originated in Vienna. However, later adherents of the school like Murray Rothbard and others have derived the roots of the thought of the Austrian School from the Spanish Scholastics teaching at the University of Salamanca of the 15th century and the French Physiocrats of the 18th century.[6] It owes its name to members of the German Historical School of economics, who argued against the Austrians during the Methodenstreit, in which the Austrians defended the reliance that classical economists placed upon deductive logic. Their Prussian opponents derisively named them the “Austrian School” to emphasize a departure from mainstream German thought and to suggest a provincial, Aristotelian approach. (The name “Psychological School” derived from the effort to found marginalism upon prior considerations, largely psychological.) Menger was closely followed by Eugen von Böhm-Bawerk and Friedrich von Wieser. Austrian economists developed a sense of themselves as a school distinct from neoclassical economics during the economic calculation debate, with Ludwig von Mises and Friedrich von Hayek representing the Austrian position, where they contended that without monetary prices and private property, meaningful economic calculation is impossible. The Austrian economists were the first liberal economists to systematically challenge the Marxist school[citation needed]. This was part of the Austrian economists' participation in the late 19th Century Methodenstreit, during which they attacked the Hegelian doctrines of the Historical School. Though many Marxist authors have attempted to portray the Austrian school as a bourgeois reaction to Marx, such an interpretation is implausible: Menger wrote his Principles of Economics at almost the same time as Marx was working upon Das Kapital, whose second and third volumes were published more than ten and twenty years, respectively, after Principles.[original research?] (However, this does not refute the weaker claim that marginalism received the attention it did in the 1880s, and not earlier, in part because it was seen as an answer to Marx.[original research?]) The Austrian economists were, nonetheless, amongst the first to clash directly with Marxism[citation needed], since both dealt with such subjects as money, capital, business cycles, and economic processes. Böhm-Bawerk wrote extensive critiques of Marx in the 1880s and 1890s, and several prominent Marxists — including Rudolf Hilferding — attended his seminar in 1905–06. In contrast, the classical economists had shown little interest in such topics, and many of them did not even gain familiarity with Marx's ideas until well into the twentieth century.[citation needed] The school was no longer centered in Austria after Hitler came to power. Austrian economics was ill-thought of by most economists after World War II because it rejected observational methods[citation needed]. Its reputation has lately risen with work by students of Israel Kirzner and Ludwig Lachmann, as well as a renewed interest in Hayek after he won the Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel.[7] However, it remains a distinctly minority position, even in such areas as capital value. Austrian economics can be broken into two general trends. One, exemplified by Friedrich A. Hayek, while distrusting most neoclassical concepts (like the entire corpus of macroeconomics), generally accepts a large part of the neoclassical methodology; the other, exemplified by Ludwig von Mises, seeks a different formalism for economics. The main area of contention between the mainstream and the Austrian school is on their view of the market system as a process, not only to be studied using equilibrium models, but to be viewed as an incessant process that only tends toward a constantly changing equilibrium, this difference is the root of the Austrian business cycle theory, the economic calculation debate, and their different views of monopoly and competition. The second primary area of contention between neoclassical theory and the Austrian school is over the possibility of consumer indifference — neoclassical theory says it is possible, whereas Mises rejected it as being “impossible to observe in practice.” This is a more philosophical problem, than one directly relevant to the understanding of the operation of the market. The third major dispute arose when Mises and his students argued, building on Czech economist Franz Cuhel,[8] that utility functions are ordinal, and not cardinal; that is, the Austrians contend that one can only rank preferences and cannot measure their intensity, in direct opposition to the neoclassical view at the time. Finally there are a host of questions about uncertainty raised by Mises and other Austrians, who argue for a different means of risk assessment. These questions are directly linked to the market process approach to economic theory, since the world of probabilistic uncertainty is the equilibrium world. Only immersed in a world of genuine uncertainty the market process theory is relevant. The influence that Austrian school ideas have had on Keynesian macroeconomics is often overlooked[citation needed]. Keynes himself acknowledged being exposed to the Misesian notion that “nominal” values could have “real” effects. A further source of this influence is the period of time when the London School of Economics brought in Hayek and other “continental” economists.[citation needed]While their students, though initially receptive, ultimately were drawn to the new Keynesian doctrines, many of the Hayekian concepts, particularly those relating time to the value of capital and its importance, would find their way into the work of Keynesians, especially by way of John Hicks (who, while distancing himself from Keynesianism, nonetheless made the most influential attempt to formalize it).[citation needed] The former U.S. Federal Reserve Chairman, Alan Greenspan, speaking of the originators of the School, said in 2000, “the Austrian school have reached far into the future from when most of them practiced and have had a profound and, in my judgment, probably an irreversible effect on how most mainstream economists think in this country.”[9] Greenspan also said that he had attended a seminar hosted by Ludwig von Mises.[10] In more recent politics, Ron Paul, a Republican U.S. Representative who was running for the 2008 American Presidency, is a strong believer in Austrian school economics. He has authored six books on the subject, and displays pictures of classical liberal economists Friedrich Hayek, Murray Rothbard, and Ludwig von Mises (as well as of Grover Cleveland) on his office wall.[11] [edit] Analytical frameworkAustrian economists reject statistical methods and artificially constructed experiments as tools applicable to economics, saying that while it is appropriate in the natural sciences where factors can be isolated in laboratory conditions, the actions of human beings are too complex for this treatment. Instead one should isolate the logical processes of human action - a discipline named "praxeology" by Alfred Espinas.[citation needed] The Austrian method is based on the heavy use of logical deduction from self-evident axioms, undeniable facts about human existence. The primary axiom from which Austrians deduce further certain conclusions is the action axiom which holds that humans take conscious action toward chosen goals. The axiom actually affirms many other axioms such as existence, identity, consciousness, and free-will. Austrians recognize this but focus on action and say that it is undeniable because in order to deny action, one would have to employ action in the act of denial. This is the one area where Austrians differs most significantly from other schools of economic thought. Mainstream schools such as the neoclassical economists, the Chicago school, the Keynesians and New Keynesians, adopt mathematical and statistical methods, and focus on induction and empirical observation to construct and test theories; while Austrians reject this approach in favor deduction and logically deduced inferences. Austrians stress deduction because deduction, if performed correctly, leads to certain conclusions and inferences that must be true. Though Austrians do not discount induction, they hold that it does not assure certainty like deduction. Mainstream economists do not argue with this assertion, but believe the conclusions that can be reached by pure logical deduction are limited and weak.[12] Austrians view entrepreneurship as the driving force in economic development, see private property as essential to the efficient use of resources, and usually (if not always) see government interference in market processes as counterproductive. In this, their views do not far differ from those of the Chicago school. As with neoclassical economists, Austrians reject classical cost of production theories, most famously the labor theory of value. Instead they explain value by reference to the subjective preferences of individuals. This psychological aspect to Menger's economics has been attributed to the school's birth in turn of the century Vienna. Supply and demand are explained by aggregating over the decisions of individuals, following the precepts of methodological individualism, which asserts that only individuals and not collectives make decisions, and marginalist arguments, which compare the costs and benefits for incremental changes. Contemporary neo-Austrian economists claim to adopt economic subjectivism more consistently than any other school of economics and reject many neoclassical formalisms. For example, while neoclassical economics formalizes the economy as an equilibrium system with supply and demand in balance, Austrian economists emphasize its dynamic, perpetually dis-equilibrated nature. The core of the Austrian framework can be summarized as taking a subjectivist approach to marginal economics, and a focus on the idea that logical consistency of a theory is more important than any interpretation of empirical observations. Austrians focus completely on the opportunity cost of goods, as opposed to balancing downside or disutility costs. It is an Austrian assertion that everyone is better off in a mutually voluntary exchange, or they would not have carried it out.[13]. Mainstream economists point out that this is not necessarily true if there are external costs. This focus on opportunity cost alone means that their interpretation of the time value of a good has a strict relationship: since goods will be as restricted by scarcity at a later point in time as they are now, the strict relationship between investment and time must also hold. A factory making goods next year is worth as much less as the goods it is making next year are worth. This means that the business cycle is driven by miscoordination between sectors of the same economy, caused by money not carrying incentive information correct about present choices, rather than within a single economy where money causes people to make bad decisions about how to spend their time. [edit] Contributions
Some contributions of Austrian economists:
[edit] CriticismThe main criticism of modern Austrian economics is its lack of scientific precision. Austrian theories are not formulated in formal mathematical form, but using verbal logic. Mainstream economists believe that this makes Austrian theories too imprecisely defined to be clearly used to explain or predict real world events. Economist Bryan Caplan noted that, "what prevents Austrian economists from getting more publications in mainstream journals is that their papers rarely use mathematics or econometrics."[14] This criticism of the Austrian school is related to its rejection of the use of the scientific method and empirical testing in social sciences in favor of self-evident axioms and logical reasoning.[2][3] The Nobel prize winning economist Paul Samuelson wrote that, "I tremble for the reputation of my subject" after reading the "exaggerated claims that used to be made in economics for the power of deduction and a priori reasoning [the Austrian methods]."[12] Another general criticism of the School is that although it claims to highlight shortcomings in traditional methodology, it fails to provide viable alternatives for making positive contributions to economic theory.[15] This criticism is generally accepted, in the sense that the theories of Austrian economics are qualitative in nature and do not yield testable predictions. As an example, some[who?] Austrians propose that the net possibility of gain is a more accurate measure of the cost of an action than opportunity cost (subjectivism). However, it is ultimately difficult to measure the possibilities and risk involved. In his critique of Austrian economics, the libertarian economist Bryan Caplan stated that Austrian economists have often misunderstood modern economics, causing them to overstate their differences with it. He argued that several of the most important Austrian claims are false or overstated. For example, Austrian economists object to the use of cardinal utility in microeconomic theory; however, microeconomic theorists go to great pains to show that their results hold for all monotonic transformations of utility, and so are true for purely ordinal preferences.[14] He has also criticized the school for rejecting on principle the use of mathematics or econometrics. In response, Austrians claim that neoclassical economists are innumerate and do not understand the mathematics they rely on.[16] Austrians also argue that econometrics is fundamentally based on mathematically and logically invalid summation and averaging of demonstrably non-additive personal utility functions, and therefore is subjective. There are also criticisms of specific Austrian theories.[17] For example, MIT professor Paul Krugman argued that Austrian business cycle theory implies that consumption would increase during downturns, and cannot explain the empirical observation that spending in all sectors of the economy fall during a recession.[18] Economist Jeffrey Sachs pointed out that when comparing developed free-market economies, those that have high rates of taxation and high social welfare spending perform better on most measures of economic performance compared to countries with low rates of taxation and low social outlays. Poverty rates are lower, median income is higher, the budget has larger surpluses, and the trade balance is stronger. (Unemployment however, tends to be slightly higher in those countries.) He concludes that Austrian economist Friedrich von Hayek was wrong when he said that high taxation would be a threat to freedom; but rather, a generous social-welfare state leads to fairness, economic equality, international competitiveness, and strong vibrant democracies.[19]. However, Sachs supports his position with data from the Swedish experience following tax cuts and welfare reform. Hayek would have likely approved of the Swedish policies that reduced taxes and welfare abuse.[original research?] [edit] Seminal works
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