by Richard M. Ebeling
This June marks the 45th anniversary of the revival of the Austrian School of Economics. During the week of June 15-22, 1974, the Institute for Humane Studies brought together about 50 people in South Royalton, Vermont to listen to a series of lectures by three of the leading figures of the, then, existing remnant of the Austrian School. The conference served as a catalyst for the rebirth of Austrian Economics over the following decades.
To begin with, Austrian Economics really has nothing to do with the economics of the Republic of Austria. Its name comes from the fact that several of the founding members of this approach to understanding man, society, and the economy lived in the old Habsburg Empire of Austria-Hungary in the last decades of the 19th century. Their immediate students also lived in the Austria of the early decades of the 20th century, and they, in turn, educated another generation of “Austrian” economists before the catastrophe of the 1930s and 1940s with the rise of fascism and Nazism in Europe, which resulted in the dispersion of many of the School’s members to other lands, especially to the United States.
The uniqueness of the Austrian School, it may be said, is that it refused to be hypnotized by the lure of hyper-mathematization and empiricist quantification of all things economics, in the process of which, the Austrians have often argued, some of the uniquely human and humane aspects of the study of man were “lost in translation” when reduced mostly to the measurable and the purely mathematical.
The other element central to the Austrian approach has been a focus on the market economy as a competitive process of dynamic adaptation and adjustment to change, the cumulative results of which, when markets are free and open, are in the direction of improved standards of living, greater choices and opportunities, and widened potentials for human harmonies in place of conflict and war.
Carl Menger, Founder of the Austrian School
It all began in 1871, with the publication of a book by Carl Menger (1840-1921) that when translated into English appeared with the rather simple title of Principles of Economics. In its pages was presented a clear, logical and cogent explanation of the nature of human choice and decision-making under conditions of inescapable scarcity; and how people weigh alternatives at “the margin” in the form of trade-offs of choosing preferred combinations of desired goods and services.
However, a distinct property of Menger’s exposition of this logic of the human mind was that he linked it to the reality of inherent uncertainty concerning the possibilities and outcomes of the future; the pervasiveness of the passing and use of time in all human production and consumption activities; and the need to form expectations concerning the possible shape of things to come in selecting ends and designing the use of means for trying to attain them.
Also, different from other parallel emerging schools of economics at the time that were also explaining and introducing the central idea of marginal decision-making was that Menger’s emphasis was far less on a hypothetical and transitory “equilibrium” between various market supplies and demands. Menger’s attention was centered on the nature and workings of the never-ending processes of social and market interactions that are tending the patterns of human associations in the direction of interpersonal coordination, even if some perfectly balanced end-states are never reached.
Also, more pronounced in Carl Menger’s analysis of the social world was his attention to the origins and evolutionary processes out of which emerged many of the essential institutions of human society: language, customs and traditions, the structure and content of law, the procedures for market association and interaction, and use and development of media of exchange (money). While most other approaches to economics took the institutional order as “given” and taken for granted, starting with Carl Menger, the sociology and economics of human institutions was integral to much of the “Austrian” approach to analyzing the market process. (See my article, “Carl Menger and the Foundations of Austrian Economics”.)
Menger’s Students: Böhm-Bawerk and Wieser
Menger inspired two young followers who took his writings and ended up making then internationally renowned as the economics of the Austrian School. These were Eugen von Böhm-Bawerk (1851-1914) and Friedrich von Wieser (1851-1926), who discovered Menger’s Principles of Economics while fellow students doing their graduate studies and, besides, ended up as brothers-in-law, when Böhm-Bawerk married Wieser’s sister.
Wieser developed Menger’s theory of subjective (or personal) value for explaining the logic of marginal choice, and extended it to the theory of costs. The earlier classical economists (such as Adam Smith and David Ricardo) claimed that the “cost” of goods was determined by the quantity of labor effort that had gone into their manufacture. Wieser showed that the “cost” of anything was ultimately the subjective value to an individual of the alternative end that must be given up in applying some of the available scarce means to try to attain a goal considered of greater personal value that the alternative foregone. Costs as well as benefits are evaluative estimates in the mind of the choice-making actor.
Böhm-Bawerk’s contribution was to extend Menger’s analysis of the role of time in the economic process to a more fully developed theory of capital formation, investment, a notion of the “period of production,” and of interest rates as derived from the time preferences of savers and investors trading the use of resources between the present and the future. In the middle of Böhm-Bawerk’s exposition of capital and interest, he formalized far more than Menger the logic of marginal decision-making and the process of price formation out of the rivalrous bids and offers of suppliers and demanders in the marketplace. Furthermore, building on Menger’s approach, Böhm-Bawerk formulated one of the most devastating refutations of Karl Marx’s theory of capitalist exploitation of workers. (See my articles, “Eugen von Böhm-Bawerk: Sesquicentennial Appreciation” and “The Austrian Economists Who Refuted Marx and Obama”.)
Ludwig von Mises on Money, the Business Cycle, and Socialism
But whatever the essential achievements of these founding contributors to the Austrian School, the generation between the two World Wars was equally original and insightful in the ways they developed, refined, and extended these ideas in new directions. The most profound of these interwar contributors was, without a doubt, Ludwig von Mises (1881-1973). More than other members of the Austrian School at this time, Mises ended up formulating a thorough and logically consistent system of ideas traceable from Carl Menger’s “individualist” and “subjectivist” approach.
Before the First World War, Mises had developed what became known as the Austrian theory of money and the business cycle. He synthesized Menger’s theory of money and Böhm-Bawerk’s conceptions of capital and interest with the monetary economics of the Swedish economist, Knut Wicksell. In this distinct framework, Mises demonstrated both the dynamics of how changes in the money supply may have non-neutral distorting effects on the structure of relative prices, the allocation of resources among competing uses in the economy, and they may redistribute income among individuals and groups in society. Furthermore, Mises showed how changes in the money supply introduced through the banking system has the potential to set in motion the booms and busts, the inflations and the recessions of the business cycle. (See my article, “Ludwig von Mises and the Austrian Theory of Inflations and Recessions”.)
Then, in the aftermath of the First World War, with the threatened rise of socialism to power in a number of countries in Europe, Mises challenged the very ability of a centrally planned socialist economy to effectively function. Doing away with private property, market competition, and a functioning price system eliminated the essential institutional prerequisites for rational economic calculation for guiding the socialist paradise to come. Instead, the end result, as the history of socialism-in-practice has shown, leads to a “planned chaos” of economic stagnation, mismatched supplies and demands, and wasteful use of the resources of the socialist society. (See my article, “Why Socialism is ‘Impossible’”.)
Socialist planning can never be a viable and effective alternative to a competitive marke