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


Austrians and mainstream economists also differ completely on what starting assumptions to use. When mainstream economists build a theoretical model to understand an economic activity, they often -- but hardly always -- make assumptions of perfect conditions. For example, they will assume that consumers have perfect information about the market, that market competition is perfect, that all products are perfectly homogenous, or that there are zero costs to firms entering the market. Austrians point out, however, that these conditions do not exist in the real world, so the results of these models' calculations are worthless. It is even more short-sighted to use these unrealistic results to guide national economic policy. There is a mainstream rebuttal to this argument, but for the moment, let's continue.

Austrians call for economic assumptions to reflect the real world -- warts and all. True, this would make the market imperfect as well, but Austrians argue that human economic activity is continually striving to overcome these imperfections, and the market is far better suited than the government to do so. The model that Austrians actually use is the theory of market process. It starts by assuming that individuals have limited and imperfect information. But probably the most important information that a person can learn is the supply and demand for any given product, which is encoded in its price. Through trading on the market, individuals learn new information, and revise and improve their goals and methods accordingly. New ways of competing for customers are found, and this competition results in steadily falling prices. This constant market process results in an ever-more efficient allocation of limited resources.

All this sounds admirably realistic -- until you get to the fine print. Austrians commit the very same sin they accuse mainstream economists of doing, by calling for utopian starting conditions before their model will work as advertised. Here is Gaillot describing their own model: This remarkable paragraph essentially calls for the utopian perfection of the human race before the Austrian model can be applied or even criticized! All market failures today can be blamed on the fact that we have a government, regardless of the actual level of government involvement in the failure. But what if the U.S. decided to become libertarian, and adopt an Austrian economic policy? Then they would still be protected from accusations of failure, because they can always blame criminals for wrecking the market process. This theory therefore serves to justify a heightened War on Crime. Considering the economic and demographic groups popularly associated with crime, one can easily see the possibilities for demagoguery and scapegoating in the event the new economic system turned out to be inherently flawed.

Liberals can point out an even more basic flaw in the "absence of force" requirement. And that is that all property rights are maintained and defended by force, or the credible threat of force. All property is protected by police and military forces, and violations of property rights result in the appropriate forceful response. Therefore, the idea that a land of perfect property rights can exist force-free is either a giant self-contradiction or hopelessly utopian.

Austrian hypocrisy aside, why do mainstream economists themselves use perfect starting assumptions? First, we should note that economists are primarily concerned with how the real world can be modeled, and the accuracy of their models is continually improving. Studying how assumptions are violated is a major part of economics. For example, William Vickrey and James Mirrlees won the 1996 Nobel Prize for their theories of asymmetric information (unequal information between buyers and sellers). The rise of New Keynesianism in the last 10 years has been based on George Akerlof's fundamental point that human beings are not perfectly rational, but nearly rational. Another liberal school of economics, institutionalism, doesn't even subscribe to static equilibrium models at all, but agree (ironically) with Austrians that the economy is one of constant change. It is really the neoclassical (conservative) economists who rely so heavily on perfect starting assumptions. If Austrians want to criticize their allies, then liberal economists are perfectly happy to let them.

A neoclassical defense for using perfect assumptions is that countless factors affect activities taking place in the real world, so economists must simplify their starting assumptions if they are to quantify the economy at all. Even so, economists have numerous tools to get around this problem, tools that have been improving with time. They can start by isolating the most important factors. They can also focus the model on a highly specific industry, product or individual, which greatly reduces the complicating factors. Another method is to establish broad groupings or taxonomies with similar characteristics that yield variables that can be applied to smaller categories. The claim that these models do not have applications for the real world betrays the Austrian's own unfamiliarity with statistics.

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1. Ken Gaillot, Jr., "The Theory of Market Process,"