© Dr Alexander Moseley
December 2007

While Ron Paul’s US Presidential campaign is finally and justifiably beginning to attract mainstream press coverage on both sides of the Atlantic, his espousal of Austrian economics is often noted with inverted commas, which can imply a lack of knowledge or a patronising dismissal of something allegedly unorthodox. Of course, the motivation for deploying speech marks can be analysed for any subject when such targets are not part of mainstream parlance, and it is rare in economics classes to hear the term Austrian Economics or the thinkers of the Austrian tradition – instead, orthodox economics prefers to present a contrived debate between classical and Keynesian economics (or now, the neo- versions of both). For a justifiable clarification and for the removal of those speech marks let us take a look at the Austrian economic tradition.

In a nutshell, Austrian economists support the free market, minimal government, and the abandonment of central banking. They reject quantitative methods in economics in favour of exploring the logic of action and interaction and their resulting divergent, voluntary and spontaneous forms notably – but not exhaustively – in the market place. Austrian thinkers tend to reject government intervention both domestically and internationally in favour of free trade and peace.
Historically, the tradition emerges out of Vienna with the work of Carl Menger (1840-1921), who gets a recognition in textbooks as one of the co-founders of the marginal revolution that took place in economics in the 1870s. However, Menger’s insights are not analogous to the independent development of calculus by Newton and Leibniz, whose followers quibbled on terminology, for Menger’s work pursued a different methodology from that of the Englishman William Stanley Jevons and the Frenchman Léon Walras. The marginal revolution overthrew an ancient theory of value that had beset economic thinkers for centuries (including Ricardo, Smith, Marx and J.S. Mill) – the idea that things possess an innate, objective, or divinely ordained Value, to which markets should converge (and woe betide them should they not!). Instead, the marginalists asserted the primacy of subjective value: I place value on this amount of time (or money, or goods and services) and I relate that value to other uses of my time and energy. You may have different preferences, so we may trade. Once it is admitted that all value is subjective (although there are Austrian influenced economists such as George Reisman who reject the subjectivism), then market and price analysis becomes a matter of unfolding the logic of personal and interpersonal choices concerning action to explain how prices and markets work.

At this junction, Jevons and Walras proceed mathematically – and today when we study mainstream microeconomics, we are taught to deploy calculus for economic models. Yet in many respects, it is the mathematical tradition that attracts most criticism from non-economists on the political left: the concept of homo oeconomicus, who acts like Star Trek’s Mr Spock rationally and precisely in all of his doings and who is derided (justifiably from the Austrian perspective) as inhuman. Thinkers such as Noam Chomsky therefore conclude the market system cannot work, which is akin to rejecting all mathematics because of the abstract leanings of pure mathematics. The Austrian tradition, however, provides an alternative and more robust method, for, while siding with the contemporary insights and excitement generated by Jevons and Walras, Menger proceeded non-mathematically. Instead, he developed the logic of human action: indeed, economics can be understood and followed very well without any recourse to diagrams or mathematics. In rejecting maths, one does not thereby reject logic, and Menger’s students and followers developed and continue to develop his methodology. Notably, Ludwig Mises (1881-1973) expanded the philosophical justification of the subjectivist and non-mathematical approach to economics in a series of books from 1912 to 1940. This included a dissection of socialism that explained the illogicality and hence expected consequences of any form of central planning based on quantitative assessments. Socialist economist Oskar Lange admitted that socialists should be grateful to Mises for his criticisms, but no cogent rejoinder to Mises’s Socialism has been made: Mises took the simple line that central planning cannot occur without knowing prices – i.e., marginal values – and these cannot be created out of thin air: prices only emerge with markets (and private property behind them), so if one abolishes markets (or private property) the lack of knowledge on the part of producers and consumers will mean waste in the forms of overproduction and underproduction. No amount of spreadsheet work could ever capture the dynamic processes and nuances that are subsumed in market activity.

In an earlier work, Mises explained the workings of the business cycle. He drew on the work of Menger and Eugen von Böhm-Bawerk (1851-1914), but also the Swedish economist Knut Wicksell (1851-1926) and upon a quiet monetarist tradition found in the writings of Richard Cantillon (1690-1734) and David Hume (1711-1776). Monetarism was a buzz word in the Thatcher era: it entails that an expansion of the money supply will affect prices and so the central bank must keep monetary growth and/or prices under scrutiny. As a starter, this is readily understandable: doubling the money supply implies a halving of its value, which is the same as saying that prices have doubled). But Mises explained that printing money causes some prices to go up initially as the new money enters those sectors – that is, not all of the new money finds its way into our pockets simultaneously. Typically, the initial sector may be the public sector (when politicians say they will increase spending on the military without raising taxes, they imply that they will print money); or, and more importantly, it may be the banking sector. When a central bank lowers its interest rate, expanding credit to other banks, it creates an enormously distorting effect that runs through the economy: banks work on fractional reserves, which means that when I place £10 into a current account, the banking sector as a whole can expand loans to value of £100 or more (depending on legal reserve requirements). There is no other business that can try this sort of scam (Enron attempted it!), for it is backed by legislation designed to protect banks should they suffer a run on their relatively small reserves.

As credit expands, the Austrians noted, it tends to be taken up by producers in highly interest-rate sensitive markets such as those in relatively more capital-intensive industries. Mises and Friedrich Hayek (1899-1992) developed these insights to explain why we see a stock market boom during periods of expansion and why certain sectors of the economy (including the house market) experience contrived growth. Once the credit expansion stops, those sectors are particularly vulnerable to rising interest rates and hence enter recession. The monetarist theory, they asserted, is too simplistic and can lead to what have become popular conclusions concerning inflation, for instance: if prices are not rising, there can be no inflation; or an economy needs a small dose of inflation to “oil its wheels”. Austrians dismiss both as fallacious. They define inflation simply as an increase in the money supply: whether that leads to individual or index price rises depends on other factors such as the demand for money by people, as well as the demand and supply of actual goods and services across the economy. This means that if an economy is actually growing, a monetary inflation can be masked: prices may fall or not rise as much as they would otherwise do. Nonetheless, the detrimental effects of distorting capital markets and producing an artificial boom do not disappear just because the RPI is not indicating a statistical rise.

Historically, the Austrian economists’ insights were literally sidelined by the rise of Nazism and the dispersal of its adherents, who vehemently opposed totalitarianism, socialism, and militarism. The Viennese economists became political and intellectual refugees, often finding their new host nations’ universities were none too sympathetic to their free market ideology. The initial epoch of the school’s influence had been in the 1920s but vying for intellectual attention were socialism and a new form of liberalism, one that rejected its libertarian tradition of individualism and minimal government in favour of democratic socialism, welfarism and intervention both home and abroad. As the fledgling economics profession became institutionalised and increasingly state funded, it is not surprising to uncover a sea change in opinion away from free market traditions and towards state intervention: Keynesian economics offered the social-engineering minded a justification to tamper with the economy through fiscal and monetary policy, and many jumped ship or did not question too closely the new logic in favour of being given a chance to manage an economy.

Keynes’s logic was questioned by the new supporters of Menger’s legacy, notably in America by those who acted to support Mises who emigrated to New York. Journalist Henry Hazlitt wrote an damning assessment of the Keynes’s General Theory in his Failure of the New Economics exploring and demolishing Keynes’s economic theories line-by-line. Soon, Hazlitt and Mises began to attract a new generation of Austrian influenced economists, notably Israel Kirzner (1930-), whose work on the role of the entrepreneur has trickled down to mainstream textbooks, and Murray Rothbard (1926-1995), who wrote volumes on politics, economics, and philosophy. Rothbard’s writings are iconoclastic, entertaining, and provocative; he pursued the anarchistic leanings implicit in the Austrian tradition to argue for anarcho-capitalism and with a growing body of Austrian supporters, including Lew Rockwell (1944-), helped to develop the Mises Institute, in Auburn, Alabama.

The Austrian tradition is now quietly global – good economics does not stop at borders, and its supporters are slowly getting recognition for the cogency of its methods and theories, notably on the business cycle. Ron Paul’s candidacy is raising the school’s profile and the internet based ground swell of support that he is attaining will indubitably be attracted to learn more about the Austrian economics he espouses.