The undervalued insights of the Austrian School of economics

Marcin Senderski

Warsaw, 7 July 2012

Agenda

1. What is the Austrian school of Economics2. Austrian school vs. neoclassical school3. Thoughts and quotations4. The Austrian school nowadays5. Conclusions

The presentation was prepared on the basis of two major sources:• Huerta de Soto, J. (2006) Money, Bank Credit, and Economic Cycles,

Auburn, Alabama: Ludwig von Mises Institute.• Huerta de Soto, J. (2008) The Austrian School: Market Order and

Entrepreneurial Creativity, Edward Elgar Publishing.

What is the Austrian School of Economics

In general• The Austrian School of economics is a school of economic thought which advocates an individualist

approach to economics called praxeologyHistory and ethymology• The Austrian School derives its name from the identity of its founders and early supporters, who were

citizens of Austria-HungaryMethodology• Whereas mainstream economists generally use economic models and statistical methods to model

economic behavior, Austrian School economists argue that they are a flawed, unreliable, and insufficient• Austrians focus on theory rather than empirics, and employ descriptive analysis, i.e. verbal formalismReception• From the middle of the 20th century onwards, the Austrians have been considered outside the mainstream • Austrian views are heterodox and mainstream economists are generally critical of its methodology• Mainstream economists generally argue that Austrian economics lacks scientific rigorWho are the scholars?• Multidisciplinary theorists and philosophers, and radical libertariansMain representatives• Friedrich Hayek (Nobel Prize 1974), Ludwig von Mises, Carl Menger, Murray N. Rothbard, Eugen von Böhm-

Bawerk, Israel Kirzner

Austrian school vs. neoclassical school (1/3)

Points of comparison Austrian paradigm Neoclassical paradigmConcept of economics (essential principle):

A theory of human action, understood as a dynamic process (praxeology).

A theory of decision: maximization subject to restrictions (narrow concept of „rationality”).

Methodological outlook: Subjectivism. Stereotype of methodologicalindividualism (objectivist).

Protagonist of social processes: Creative entrepreneur. Homo economicus.

Concept of information: Knowledge and information are subjective and dispersed, and theychange constantly. A radical distinction is drawn between scientific (objective) and practical knowledge (subjective).

Complete, objective, and constant information on ends andmeans is assumed. Practical(entrepreneurial) knowledge is notdistinguished from scientificknowledge.

Reference point: General process which tends toward coordination. No distinction between micro and macroeconomics: each problem is studied in relation to others.

Model of equilibrium (general orpartial). Separation between microand macroeconomics.

Austrian school vs. neoclassical school (2/3)

Points of comparison Austrian paradigm Neoclassical paradigmConcept of „competition”: Process of entrepreneurial rivalry. State or model of „perfect

competition.”

Concept of cost: Subjective (depends onentrepreneurial alertness and theresulting discovery of new,alternative ends).

Objective and constant (such that athird party can know and measureit).

Formalism: Verbal (abstract and formal) logicwhich introduces subjective timeand human creativity.

Mathematical formalism (symboliclanguage typical of the analysis ofatemporal and constant phenomena).

Relationship with the empiricalworld:

Aprioristic-deductive reasoning:Radical separation and simultaneous coordination between theory (science) and history (art). History cannot confirm theories.

Empirical confirmation ofhypotheses (at least rhetorically).

Austrian school vs. neoclassical school (3/3)

Points of comparison Austrian paradigm Neoclassical paradigmPossibilities of specificprediction:

Impossible, since future eventsdepend on entrepreneurialknowledge which has not yet beencreated. Only qualitative,theoretical pattern predictions about the discoordinating consequences of interventionism are possible.

Prediction is an objective which isdeliberately pursued.

Person responsible for makingpredictions:

The entrepreneur. The economic analyst (socialengineer).

Thoughts and quotations (1/2)

1. Man does not so much allocate given means to given ends, as constantly seek new ends and means, while learning from the past and using his imagination to discover and create the future (via action). Thus, for Austrians, economics forms part of a much broader and more general science, a general theory of human action (and not of human decision or choice).= PRAXEOLOGY

2. For Austrians, cost is the subjective value the actor attaches to those ends he gives up when he decides to pursue a certain course of action.= NO OBJECTIVE COSTS

3. Hayek uses the term „scientism” to refer to the unjustified application of the methodology of the natural sciences to the field of the social sciences.= NO MATHEMATICAL FORMALISM

4. It is obvious that our concept of entrepreneurship is of an essentially humanistic nature, a concept which makes economics, as it is understood and advanced by members of the Austrian school, the quintessential humanistic science.= HUMANISTIC STNDPOINT

Thoughts and quotations (2/2)

5. Those who gauge the just price of an article by the labor, costs, and risks borne by the person who deals in or produces the merchandise are seriously mistaken; for the just price springs from the abundance or lack of goods, merchants, and money, and not from costs, labor, and risks= BROAD BASE OF FACTORS INFLUENCING PRICE GENERATION

6. The equilibrium price depends on so many specific circumstances that only God can know it.= AWARENESS OF LIMITATIONS

7. All unjustified intervention in the market constitutes a violation of natural law.= LIBERTARIANISM

8. The dynamic process of entrepreneurial coordination would eventually lead toward a state of equilibrium, though this state can never be reached in real life.= DYNAMISM

9. It is never feasible for the blind to lead the sighted.= CRITIQUE OF GOVERNMENT INTERVENTION

The Austrian school nowadays

Myths regarding the Austrian school or the points of critique raised by neoclassicals:

1. The two approaches (the Austrian and the neoclassical) are not mutually exclusive, but complementary

2. Austrians should not criticize neoclassicals for employing simplified assumptions which make reality easier to understand

3. Austrians fail to formalize their theoretical proposals

4. Austrians produce very few empirical studies

5. Austrians jettison economic forecasting

6. Austrians lack empirical criteria by which to validate their theories

7. Austrians are dogmatic

Conclusions

Major „sins” of neoclassical economists that „feed” Austrian economists:1. Neoclassicals focus exclusively on equilibrium states via a maximizing model

which presupposes that the information is „given” 2. Neoclassicals often arbitrarily select variables and parameters for both the target

function and the restrictions, and in doing so, they tend to include the most obvious aspects and overlook others which, though of vital importance, are more difficult to handle empirically (moral values, habits and traditions, institutions etc.)

3. Neoclassicals concentrate on equilibrium models which treat true cause-effect relationships with mathematical formalism and thus blur them

4. Neoclassicals raise mere interpretations of historical reality to the level of theoretical conclusions, interpretations which may be significant in certain specific situations, but which cannot be considered theoretically valid on a universal scale, since they reflect only knowledge which is historically contingent

5. The insufficient attention to the role played in the market by subjective information, knowledge, and learning processes