On top of being a great political philosopher and revolutionary, John Locke paved the way for compassionate libertarian economics, drawing upon property rights, natural moral law, and reason.
The Austrian School: Its History and Relevance in Modern Economics
The Austrian School of Economics was born, as the name suggests, in Austria, in the late 1800s. It grew out of the so-called "Methodenstreit," a dispute over empirical methodology. Whereas the German Historical School held that economics could only be understood through the study of economic history of specific places and times, the Austrians believed that universal economic principles could be deduced from theoretical analysis.
These principles, the Austrians thought, beginning with Carl Menger (1840-1921), could remedy some of the problems in classical economics. In his 1871 work Principles of Economics, Menger tackled one of the most vexing of those shortcomings, the theory of value. Classical economics had proposed that the economic value of a good or service could be objectively measured, namely through determining the cost of its production (specifically by the quantity of labor hours embodied in it). Menger articulated a subjective theory of value, according to which economic goods are valued in terms of the satisfaction the individual expects to derive from them. Moreover, this value is not determined by comparing the value of all units of a good or service to that of another, but by making evaluations on the margin, based on our current needs. Menger illustrates this point using an example:
"The value of goods arises from their relationship to our needs, and is not inherent in the goods themselves. With changes in this relationship, value arises and disappears. For the inhabitants of an oasis, who have command of a spring that abundantly meets their requirements for water, a certain quantity of water at the spring itself will have no value. But if the spring, as the result of an earthquake, should suddenly decrease its yield of water to such an extent that the satisfaction of the needs of the inhabitants of the oasis would no longer be fully provided for, each of their concrete needs for water would become dependent upon the availability of a definite quantity of it, and such a quantity would immediately attain value for each inhabitant. This value would, however, suddenly disappear if the old relationship were reestablished and the spring regained its former yield of water. A similar result would ensue if the population of the oasis should increase to such an extent that the water of the spring would no longer suffice for the satisfaction of all needs. Such a change, due to the increase of consumers, might even take place with a certain regularity at such times as the oasis was visited by numerous caravans."
This subjective theory of value allows Austrians to claim that economics is not really a quantitative subject, since value cannot really be measured. Rather, economic events are the result of individuals' values, circumstances and actions.
Two of Menger's disciples, Eugen von Böhm-Bawerk (1851-1914) and Friedrich von Wieser (1851-1926) elaborated on Menger's theory of subjective value and marginal utility. Böhm-Bawerk applied it to interest and capital theory, developing a concept known as "time preference." People often value having things now rather than later, and if they are willing to borrow money to get a certain good or service, the interest they pay is the lender's compensation for his capital being tied up for the borrower's use rather than his own.
Wieser took Menger's insights into the areas of cost and production. His "law of costs" held that "[t]o say that any kind of production involves cost, simply implies that the economic means of production, which could doubtless have been usefully employed in other directions, are either used up in it, or are suspended during it. Costs are production goods when these are devoted to one individual employment, and, on account of their capacity of being otherwise employed, take the shape of outlay, expenditure. The measure for estimating costs is always the productive marginal utility, as it is found on consideration of all the employments economically permissible."
Menger, Böhm-Bawerk, and Wieser, the founding principals and "first wave" of the Austrian school, are lesser known than those of the "second wave", Ludwig von Mises (1881-1973) and Friedrich August von Hayek (1899-1992).
Mises applied marginal utility theory to money, arguing that money originates as a market commodity and hence that the value of money is also determined by supply and demand. The difference between money and other goods is that money is only a means of exchange. Therefore, any increases in the money supply dilute the purchasing power of each existing unit.
Mises' insights on money and credit fed into the theory of business cycles—of boom and busts in the economy—which he developed together with Hayek. In brief, booms occur due to artificial, often government-induced increases in the supply of money and credit. As a result, important market signals, such as interest rates, prices, profits and loss, are distorted, leading to malinvestments. Once the boom has died off, a recession, Austrians argue, albeit painful, is necessary to eliminate the unsound investments and put resource use back on the right path. In fact, they argue government interfering with a recession can prolong it and make it permanent.
Both Mises and Hayek also fought against the rise of socialism, central planning, and advocates of government intervention into the market, such as John Maynard Keynes. Mises pointed out that since market signals are an indicator of how much resources are valued and how they can be distributed in the most efficient manner, socialism's attempt to eliminate and function without market prices is unworkable. Mises' theory of human action subsequently provided a more comprehensive philosophical basis for a defense of liberalism.
Hayek supplemented this point with the "knowledge problem." This is the idea that the market cannot be centrally planned, because the necessary knowledge and consequent actions are widely dispersed and coordinated among individuals in society. The spontaneous order that emerges as a result cannot be recreated or directed by any bureaucrat or expert. Any attempts to do so could lead a society down the "Road to Serfdom." Hayek devoted the last part of his life to working out the political and constitutional implications of the knowledge problem.
A "third wave" of Austrian economists—among them Murray Rothbard and Israel Kirzner—elaborated on the ideas of their predecessors. Rothbard is probably most known for his critique of the state and defense of anarchism. Kirzner explained the crucial role of entrepreneurship in the economy. Other contemporary Austrians have focused on alternatives to government intervention, such as central banking and environmental regulation. Indeed, Austrian economics today has become one of the most forceful and popular libertarian defenses of free market economics and limited government, with notable politicians like Ron Paul endorsing it.
Yet, even though Hayek received the Nobel Prize in Economics in 1974, and even though prominent economists, including several other Nobel Prize winners, accept and have built upon some of the Austrian School's ideas, more often than not Austrian economics is dismissed as a fringe within the mainstream. Many college textbooks do not even mention it.
Hence, this topic-page will provide you with an overview of the historical development and present-day approach of Austrian Economics. It includes, among other things, materials on the Austrian view of value theory and human action, the importance of entrepreneurship, the role of money, credit and business cycles in the economy, and the effects of government regulation and intervention. The topic also covers criticisms of Austrian views from both the free market and Leftist/Progressive perspectives.
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