Forty years ago, during the week of June 15-22, 1974, the Austrian School of Economics was reborn during a conference in the small New England town of South Royalton, Vermont. Why was this important? Because the economists of the Austrian School have developed the most persuasive understanding of why only economic freedom can give mankind both liberty and prosperity.
During the Great Depression of the 1930s, many economists and political policy-makers argued that capitalism was a “failure” and only wisely guided government intervention and regulation of the market place could bring stability and fairness to society.
The Domination of Big Government Ideas
For the next thirty years following the Second World War, Keynesian Economics dominated economic policy decision-making. Government, it was said, had to have the discretionary authority to manipulate spending and taxing as well as the monetary system to assure full employment and stable economic growth.
This was matched by a rarified mathematical formalism in the higher levels of economic theory in which the everyday individual was reduced to a mere passive variable in a series of equations, with the assistance of which it was presumed government could successfully micro-manage the market. Unless regulated and guided by the superior hands of the government policy-makers, society would fall into waste and inefficiencies due to people’s wrong choices and misplaced actions when left on their own.
The Beginning of Austrian Economics
Almost 145 years ago, Carl Menger founded the Austrian School of Economics. One of the pathfinders to break asunder the myth of the labor theory of value, which had dominated economics from the time of Adam Smith to that of Karl Marx, Menger developed the subjective theory of value. The value of a good, Menger explained, was not determined by the amount of labor devoted to making a product, but rather the labor was given value by the intensity felt for the product by the individual who would finally use or consume it. Since individuals valued things differently and by different scales of importance, there was no way to objectively determine the value any market-traded good might have other than relating it back to the personal (“subjective”) judgments of the individual valuator.
Menger was soon followed by two disciples who refined Austrian theory to such a point that it became a major force in the world of ideas. Friedrich von Wieser formulated the concept of opportunity cost, by which is meant that nothing is free. The fact that most of the means that we use to achieve our various ends are scarce (too limited in supply to enable us to attain all the goals for which those means might be used) means we always have to make trade-offs.
The cost of anything is the alternative goal, purpose or end for which some scarce means might have been used if we had not instead valued more highly some other use for which we ended up applying those limited means. The idea that government can give people a “free lunch” is fundamentally wrong; what the government gives to someone with one hand it must take from someone else by the other hand, because the available means are not enough to fully satisfy both uses at the same time.
Eugen von Böhm-Bawerk, developed Menger’s theory of subjective value and applied it to the problem of savings, investment, and the creation of capital. Everything we do involves time. Whether we are boiling an egg or constructing a tunnel through a mountain, or planting a crop for food, all of our production activities take time.
This requires that individuals must save enough to free up the resources needed to build the capital goods and cover people’s living expenses until the production processes are completed at some point in the future when more and better goods and services will be forthcoming as the benefit from having waited for them.
Government taxation and regulation can undermine if not destroy the ability and motive of people to do the savings and investing that is essential if we are all to benefit from rising standards of living in the future.
Ludwig von Mises and the Case for the Free Market
In the twentieth century, Ludwig von Mises extended the Austrian approach. Mises applied Menger’s subjective value theory to the area of money and developed the “Austrian” theory of the business cycle. Government manipulation of money and credit in the banking system throws savings and investment out of balance, resulting in misdirected investment projects that are eventually found to be unsustainable, at which point the economy has to rebalance itself through a period of a corrective recession.
The only wise policy for government is to leave money and the banking system to the competitive forces of a free market to eliminate the inflationary booms and recessionary busts of the business cycle, so markets can effectively keep people’s saving and investing decisions in balance for well-coordinated economic stability and growth.
Mises also demonstrated in the early 1920s why the new experiment with socialist central planning in communist Russia would eventually fail. Rational and efficient economic decision-making requires market-generated money prices to determine and calculate the relative values of the finished goods that consumers might wish to buy in comparison with the costs of using the means of production – land, labor, and capital – in one alternative production activity instead of another, on the basis of which entrepreneurs can estimate likely profits or losses from producing one product rather than some other.
Comprehensive socialism abolishes private property, bans market ownership and trading of goods and resources, and places all economic decision-making in the hands of a government central planning agency.
But without private property, there is nothing to buy and sell. With nothing to buy and sell there is no bargaining to determine possible terms-of-trade. With no agreed-upon terms-of-trade, there are no market prices.
Without market prices to tell market decision-makers the value of what consumers might want and the actual value of scarce resources in competing uses for their employment, there is no rational way for the socialist planner to efficiently and effectively know what to produce and at the lowest costs to maximize total desired production. Socialist central planning creates a society of “planned chaos.”
Based on his critique of the unworkability of socialist central planning Ludwig von Mises developed a theory of how the competitive market process works, and the important role of the entrepreneur for guiding production in the pursuit of profits and the avoidance of losses.
This also led Mises to a detailed critical analysis of how and why various forms of government regulation and intervention in the market economy can only distort and bring about imbalance in the market’s own coordination of multitudes of supplies and demands in the service of consumer desires. The only viable economic system for freedom and prosperity, Mises concluded, is laissez-faire capitalism.
F. A. Hayek and the Use of Knowledge in Society
Further developments in Austrian theory were the product of the versatile mind of Friedrich von Hayek, who won the Nobel Prize in Economics in 1974 a few months after this Austrian Economics conference in South Royalton, Vermont.
In the 1930s, Hayek refined Mises’ theory of money and the business cycle, and became the leading free market critic of John Maynard Keynes at the time when “Keynesian Economics” was just being developed. He insisted that government deficit spending and manipulation of spending in the economy would only slowdown the normal market-generated recovery from a recession, and ran the danger of creating a future inflation that would be followed by another economic downturn.
Hayek, like Mises, was a leading critic of socialism. His core argument centered on the impossibility of even the wisest and most intelligent central planners ever having the ability to master, integrate and effectively use all the needed knowledge to successful guide an entire economy from the offices of a government planning bureau.
The division of labor in society is matched by a division of knowledge in which each of us possesses only a limited and small amount of all the knowledge of the world in our individual minds. We all must admit and accept how ignorant any one of us is about all the forms of knowledge that exist in the world, and which must somehow be successful brought to bear if all of us are to benefit from what one or a few people may know that we do not.
Hayek’s answer to this problem was to explain that market-generated prices serve as the communications devise through which we can inform each other about our desires as consumers and our abilities as producers, while leaving us free to use the knowledge that each of us individually possesses as we find it most advantageous. Thus, freedom and prosperity are combined through the market system of prices and competition to find out who can do