Austrian v/s Mainstream Economics – A Review of The State of The Art

Austrian Economics is a school of economic thought that is based on methodological individualism. It originated in late-19th and early-20th century Vienna with the work of Carl Menger, Eugen von Bohm-Bawerk, and others…

Some of the key principles of the Austrian school include but are not limited to:

1. Individualism. First and foremost, Austrians are believers in individualism, as opposed to forced government collectivism. The most efficient economies are free economies, because they tap into people’s unique, innate incentive structures. Government involvement in economies stifle individual incentive because they take capital from all and reallocate it to some, creating an inequality and inefficiency which undermines the natural free incentive structure. Individualism does not mean selfishness, it literally just means the freedom for individuals to choose for themselves. People are naturally motivated to provide for other people, including their families, communities, and causes they believe in. Rather than ‘donating’ their income to government, Austrians believe that under a truly free market economies prosper, and that greater wealth both improves general standard of living and allows privately funded charities to prosper as well.

2. Decentralization of power. Freedom and equality cannot exist when military, economic, and political power are centralized, because by its nature centralization leads to unfair advantage and ruins the market-based competitive equilibrium. Austrians typically believe in the individual’s right to bear arms as a check on military and police power. In terms of economic power, centralization of the money supply is the greatest threat. When one central bank controls the entire means of creating additional money they can print more money at will which dilutes the currency of the private market and then reallocates it outside of a fair market structure. Variations in the distribution of wealth are acceptable as a consequence of fair competition, but not as an infringement on personal property or coercion. Socially, Austrians believe government should be democratic and as localized as possible in order to capture the unique political diversity that exists in communities. Grassroots democracy to an Austrian is more efficient, more personal, and more representative because it enhances the political power of all individuals, whereas centralized government does the opposite.

3. Free Markets. Austrians believe that individual freedom cannot exist without free markets, and they are adamantly opposed to government intervention in the markets. That being said, Austrians believe in a judicial system that protects property rights, and a moderate military and police force adequate enough to protect personal property and individual rights. Centralized regulation leads to corruption, favoritism, ‘regulatory capture’ by the industry being regulated, can create a dangerous false sense of security, and operates inefficiently. Self-regulating industries are acceptable, and consumers are expected to step up their diligence on purchasing decisions. That being said, litigation is also expected to keep unsavory business practices in check.

4. Sound money. This really follows decentralization of power, but Austrians do not believe fiat currencies are sustainable, nor beneficial to an economy. A fiat currency system relies on the centralization of the money supply and relies on an exogenous power to force the use of currency that otherwise has no intrinsic value. Austrians believe currency should be a naturally accepted medium of exchange with certain ideal qualities. Namely it should be easily transportable, storable (i.e.: not perishable), uniform (e.g.: not real estate or art), have intrinsic value (i.e.: not just an otherwise worthless piece of paper), divisible, recognizable, and resistant to counterfeiting. Through history, gold and silver have satisfied all these qualities, though to an Austrian any currency is acceptable if it satisfies those characteristics.

5. Deductive reasoning. Most economic schools rely on inductive reasoning and statistics to form theories. To an Austrian, statistical models and mathematical approaches are poor substitutes for the core deductive logical principles that make up complex economies. Economies are made up of the unique decisions and motivations of many individuals, so it would be much like using statistics and mathematics to form the core theories of individual human psychology. Statistics certainly have their place in both sciences as measurement tools, but under the Austrian school they are recognized as limiting, and generally used to support theories rather than form their basis.

Austrian – Mainstream Economics Discourse

World War I and then the Great Depression knocked things into a new level of play. The influence of F.A. Hayek was immense in Britain for a while, not merely in developing the Mises theory of the business cycle and spreading it through the London School of Economics, but also with Mises’ calculation debate. In both of these cases, however, the “winners” (mostly self-declared) were the anti-Austrians (Keynes and Lange), and Hayek’s most lasting influence in Britain was to bring a form of general equilibrium analysis – Lausanne School, mainly via Pareto – into the picture, largely replacing the partial equilibrium approach of marginalizing compromiser Alfred Marshall.

With the arrival of both Mises and Hayek, the former fleeing the Nazis and the latter fleeing the Keynesians, into the U.S. started the great incubation of Austrian School economics in America, which established itself as an ultra-minority dissenting school. So, of course, the mainstream would not like that.

The mainstream of economics has been immensely confused about its own standards for a long time. The Austrians often seem “too philosophical” on the one hand and “too ideological” on the other. And yet many, many major economists have been greatly influenced by Austrians… People such as James Buchanan and Vernon Smith – to name just two important ones. Further, the success of Israel Kirzner’s “Competition and Entrepreneurship” broadened both Austrian theorizing and mainstream narrowness on an important issue.

While Mainstream economics likes to fashion itself as “Science” akin to physics or biology, whereas the Austrian school says that economics is a study of human behavior. In other words, the Austrian point-of-view implies that the Keynesians, Monetarists, etc…. are not only giving the wrong answer, they’re not even asking the right question. To accept Austrian theory would mean not only admitting “I came up with the wrong answer” but “I have completely wasted my career because my fundamental assumptions about reality were flawed.” This would be akin to a religious conversion. Such conversions are traumatic.

When the history of economics gets written a hundred years from now, I suspect that the Austrian revival will be a central part of a new mainstream.

Share your thoughts…

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Ziad Abdelnour is a political activist and is the Founder and President of the United States Committee for a Free Lebanon.