The Long FAQ on Liberalism
A Critique of the Austrian School of Economics:

HISTORY OF THE AUSTRIAN SCHOOL


A frequent Austrian boast is that Hayek accurately predicted the Great Depression. Given the Austrian's usual disdain for empirical verification, however, it is difficult to know what to make of this claim.

Actually, this prediction was a no-brainer, since the U.S. had experienced at least five depressions before the Great One, and the recurring pattern of the business cycle had long ago been recognized. It therefore took no acumen whatsoever to predict an economic downturn. What is more striking is what Hayek didn't predict: that depressions would disappear worldwide in all countries that adopted Keynesian monetary policies. Now that might have been slightly more impressive.

Another Austrian boast is that in the 1920s, their economists were involved in some famous debates with the world's top economists, during which they tore down the intellectual pillars of both socialism and Keynesianism. Of course, this boast is always accompanied by the rueful admission that Mises and Hayek didn't convince anybody in academia, and, in fact, were subject to widespread ridicule. Mises couldn't even find a university job afterwards, and Hayek abandoned his work in technical economics, turning his attention to other political and philosophical pursuits instead.

These debates began in 1920, when Mises published a ground-breaking article called "Economic Calculation in the Socialist Commonwealth," followed by his book, Socialism. In these works, Mises argued that socialism had to fail, because it had no way of knowing whether it was allocating resources efficiently or not. In market economies, prices help people make economic calculations; profits and losses allow them to know whether they are pursuing the right economic plan. In a centrally planned economy, there is no way for the planners to know. And if they attempted to know, they would become overwhelmed by all the prices, profits and loss statements required to know. Mises and Hayek also argued that any central planning committees entrusted to run the economy would become corrupt.

This is the economic version of an old argument, that dictatorships deal in corruption and insufficient information. This argument, without doubt, is true. That the Soviet Union was a dictatorship is also true. What is false is the assertion (made by the Soviet Union itself) that the country was socialist. Socialism means that workers own the means of production, not private individuals or an elite group. Socialism has been proposed in many forms, ranging from social democracy to anarcho-socialism. In the latter, workers would own companies that would compete on the free market, absent any government at all. As you can see, socialism is hardly synonymous with a central planning committee. But one thing socialism cannot be is a dictatorship -- worker's do not own anything if a totalitarian government tells them what to do. Mises and Hayek may have refuted the principle of economic totalitarianism, but they didn't come close to refuting socialism. This is one reason why academia didn't view their arguments against socialism as conclusive.

About the same time, Hayek became involved in a famous dispute with John Maynard Keynes. Austrian economist Peter Boettke provides the following account:

"The Hayek-Keynes debate was perhaps the most fundamental debate in monetary economics in the 20th century. Beginning with his essay, "The End of Laissez Faire" (1926), Keynes presented his interventionist pleas in the language of pragmatic classical liberalism. As a result, Keynes was heralded as the "savior of capitalism," rather than being recognized as the advocate of inflation and government intervention that he was.

"Hayek pinpointed the fundamental problem with Keynes's economics -- his failure to understand the role that interest rates and capital structure play in a market economy. Because of Keynes's unfortunate habit of using aggregate (collective) concepts, he failed to address these issues adequately in A Treatise on Money (1930). Hayek pointed out that Keynes's aggregation tended to redirect the analytical focus of the economist away from examining how the industrial structure of the economy emerged from the economic choices of individuals.

"Keynes did not take kindly to Hayek's criticism. He responded at first by attacking Hayek's Prices and Production. Then Keynes claimed that he no longer believed what he had written in A Treatise on Money, and turned his attention to writing another book, The General Theory of Employment, Interest, and Money (1936), which in time became the most influential book on economic policy in the 20th century.

"Rather than attempting to criticize directly what Keynes presented in his General Theory, Hayek turned his considerable talents to refining capital theory. Hayek was convinced that the essential point to convey to Keynes and the rest of the economics profession concerning monetary policy lay in capital theory. Thus Hayek proceeded to set forth his thesis in The Pure Theory of Capital (1941). However correct his assessment may have been, this book, Hayek's most technical, was his least influential. By the end of the 1930s, Keynes's brand of economics was on the rise. In the eyes of the public Keynes had defeated Hayek. Hayek lost standing in the profession and with students." (1)

This rather accurate account bears only a few additional comments. Blaming the failure of Hayek's book on the fact that it was his "most technical" doesn't wash in economics, where technicality is seen as a strength, not a weakness. One could hardly imagine a more technical and confusing book than Keynes' General Theory. Nobel economist Paul Samuelson would describe Keynes' book thus:

"It is a badly written book, poorly organized… it is arrogant, bad-tempered, polemical… it abounds in mare's nests and confusions: involuntary unemployment, wage units, the equality of savings and investments, the timing of the multiplier, interactions of marginal efficiency upon the rate of interest and many others… flashes of insight and intuition intersperse tedious algebra. An awkward definition suddenly gives way to unforgettable cadenza. When it is finally mastered, we find its analysis to be obvious and at the same time new. In short, it is a work of genius." (2)

No, economists the world over assessed Keynes' and Hayek's books for their ideas, and the fact that they found Keynes' work to be far and away the most convincing has left Austrians groping for scapegoats like "technicality" ever since. Rockwell even seems to go so far as to suggest academic corruption:

"The Mises-Hayek theory was dominant in Europe until Keynes won the day by arguing that the market itself is responsible for the business cycle. It didn't hurt that Keynes's theory advocating more spending, inflation, and deficits was already being practiced by governments around the world." (3)

Yet another boast of the Austrian School is that Hayek was awarded the Nobel Prize in economics. This is indeed an honor, but one should keep in mind the purpose of the Nobel. It is intended to reward individuals for specific contributions, not their entire lifetime of work or the school of thought from which they hail. This policy has led to many ironic awards, such as the Nobel peace prize to PLO terrorist Yasser Arafat. In Hayek's case, the award was shared by Gunnar Myrdal, "for their pioneering work in the theory of money and economic fluctuations and for their penetrating analysis of the interdependence of economic, social and institutional phenomena." Myrdal was a Swedish economist on the far left, whose Keynesian-like policies brought Sweden out of the Great Depression in 1932, the first nation to do so. In honoring both economists, the Nobel committee could have hardly been validating their very different schools of thought simultaneously.

Furthermore, the Nobel committee has established a well-known reputation for unorthodoxy: it has awarded the prize to such fringe economists as James Buchanan, Herbert Simon, Ronald Coase, Douglass North, and both Hayek and Myrdal themselves. In his acceptance speech, Hayek expressed surprise that the committee would honor someone whose ideas were "as unpopular as mine are." Furthermore, the committee has sometimes honored economists whose theories once dominated academia but have since fallen out of favor, such as Robert Lucas' Rational Expections. (Amusingly, the committee admitted that Lucas' Nobel would be controversial and was defending it even as they awarded it to him.) The selection of so many prize-winners on the far right appears to be the result of Assar Lindbeck, the right-wing Swedish economist who heads the six-man economics prize committee.

Finally, Austrians claim that "The Nobel Prize that Hayek received in 1974… caused an explosion of academic interest in the Austrian School and free-market economics in general." (4) A more careful reading of Austrian propaganda tracts reveals that this "explosion" is the result of wealthy business donors buying the movement's way into academia and the media. It does not exist on its own scholarly merits. After Hayek won the Nobel, academia reviewed Austrian theory and promptly rejected it. Even with far-right businessmen pumping millions of dollars into the movement, it has grown to no more than 75 professional faculty members worldwide. (5) One might presume that if the Austrians were to actually capture an Ivy League department, their "explosion of interest" would be upgraded to "Christ's Second Coming."

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Endnotes:

1. Peter J. Boettke, "Friedrich A. Hayek (1899-1992)," http://www.econ.nyu.edu/user/boettke/hayek.htm.

2. Quoted in Peter Pugh and Chris Garratt, Introducing Keynes (Cambridge, England: Totem Books, 1994), p. 64.

3. Llewellyn H. Rockwell, Jr. (president and founder of the Ludwig von Mises Institute), "Why Austrian Economics Matters," http://www.mises.org/why_ae.html.

4. Rockwell.

5. "About the Ludwig von Mises Institute," http://www.mises.org/book_catalog/about.html.