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What is Austrian Economics?

June 28, 2010

[Article on the history of the Austrian school of economics. From Mises.org.]

The Austrian School

The story of the Austrian School begins in the fifteenth century, when the followers of St. Thomas Aquinas, writing and teaching at the University of Salamanca in Spain, sought to explain the full range of human action and social organization.

These Late Scholastics observed the existence of economic law, inexorable forces of cause and effect that operate very much as other natural laws. Over the course of several generations, they discovered and explained the laws of supply and demand, the cause of inflation, the operation of foreign exchange rates, and the subjective nature of economic value–all reasons Joseph Schumpeter celebrated them as the first real economists.

The Late Scholastics were advocates of property rights and the freedom to contract and trade. They celebrated the contribution of business to society, while doggedly opposing taxes, price controls, and regulations that inhibited enterprise. As moral theologians, they urged governments to obey ethical strictures against theft and murder. And they lived up to Ludwig von Mises’s rule: the first job of an economist is to tell governments what they cannot do.

The first general treatise on economics, Essay on the Nature of Commerce, was written in 1730 by Richard Cantillon, a man schooled in the scholastic tradition. Born in Ireland, he emigrated to France. He saw economics as an independent area of investigation, and explained the formation of prices using the “thought experiment.” He understood the market as an entrepreneurial process, and held to an Austrian theory of money creation: that it enters the economy in a step-by-step fashion, disrupting prices along the way.

Cantillon was followed by Anne Robert Jacques Turgot, the pro-market French aristocrat and finance minister under the ancien regime. His economic writings were few but profound. His paper “Value and Money” spelled out the origins of money, and the nature of economic choice: that it reflects the subjective rankings of an individual’s preferences. Turgot solved the famous diamond-water paradox that baffled later classical economists, articulated the law of diminishing returns, and criticized usury laws (a sticking point with the Late Scholastics). He favored a classical liberal approach to economic policy, recommending a repeal of all special privileges granted to government-connected industries.

Turgot was the intellectual father of a long line of great French economists of the eighteenth and nineteenth century, most prominently Jean Baptiste Say and Claude-Frederic Bastiat. Say was the first economist to think deeply about economic method. He realized that economics is not about the amassing of data, but rather about the verbal elucidation of universal facts (for example, wants are unlimited, means are scarce) and their logical implications.

Say discovered the productivity theory of resource pricing, the role of capital in the division of labor, and “Say’s Law”: there can never be sustained “overproduction” or “underconsumption” on the free market if prices are allowed to adjust. He was a defender of laissez-faire and the industrial revolution, as was Bastiat. As a free-market journalist, Bastiat also argued that nonmaterial services are subject to the same economic laws as material goods. In one of his many economic allegories, Bastiat spelled out the “broken-window fallacy” later popularized by Henry Hazlitt.

Despite the theoretical sophistication of this developing pre-Austrian tradition, the British school of the late eighteenth and early nineteenth centuries won the day, mostly for political reasons. This British tradition (based on the objective-cost and labor-productivity theory of value) ultimately led to the rise of the Marxist doctrine of capitalist exploitation.

The dominant British tradition received its first serious challenge in many years when Carl Menger’s Principles of Economics was published in 1871. Menger, the founder of the Austrian School proper, resurrected the Scholastic-French approach to economics, and put it on firmer ground.

Together with the contemporaneous writings of Leon Walras and Stanley Jevons, Menger spelled out the subjective basis of economic value, and fully explained, for the first time, the theory of marginal utility (the greater the number of units of a good that an individual possesses, the less he will value any given unit). In addition, Menger showed how money originates in a free market when the most marketable commodity is desired, not for consumption, but for use in trading for other goods.

Menger’s book was a pillar of the “marginalist revolution” in the history of economic science. When Mises said it “made an economist” out of him, he was not only referring to Menger’s theory of money and prices, but also his approach to the discipline itself. Like his predecessors in the tradition, Menger was a classical liberal and methodological individualist, viewing economics as the science of individual choice. His Investigations, which came out twelve years later, battled the German Historical School, which rejected theory and saw economics as the accumulation of data in service of the state.

As professor of economics at the University of Vienna, and then tutor to the young but ill-fated Crown Prince Rudolf of the House of Habsburg, Menger restored economics as the science of human action based on deductive logic, and prepared the way for later theorists to counter the influence of socialist thought. Indeed, his student Friederich von Wieser strongly influenced Friedrich von Hayek’s later writings. Menger’s work remains an excellent introduction to the economic way of thinking. At some level, every Austrian since has seen himself as a student of Menger.

Continue reading at Mises.org.

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