Austrian Economics: Does It Work In Practice?

Austrian economics is a heterodox school of economic thought that advocates strict adherence to methodological individualism, the concept that social phenomena result primarily from the motivations and actions of individuals along with their self-interest. Austrian economists believe that economic theory should be derived exclusively from basic principles of human action. Austrian economics places great stress on free markets and argues that government efforts to control the economic cycle invariably make it worse. Austrian analysis fell out of favour in the 1950s and 1960s, but a revival of the school was sparked by Friedrich Hayek being awarded the Nobel Prize in Economics in 1974.

Austrian economics places great stress on free markets

Austrian economics is underpinned by methodological individualism, which holds that economics is the study of purposeful human action in its broadest sense. Austrian economists believe that one can never know if humans have maximised benefits or minimised costs. Austrian economists emphasise the process by which market participants gain information and form their expectations to lead them to their own idea of the best solution. Austrian economists do not use mathematics in their analyses or theories because they do not think mathematics can capture the complex reality of human action. Austrian economics also emphasises methodological subjectivism, which holds that an individual's actions and choices are based upon a unique value scale known only to that individual. It is this subjective valuation of goods that creates economic value.

Austrian economics also emphasises processes over end states. An individual's action takes place through time. A person decides on a desired end, chooses a means to attain that end, and then acts to attain it. However, because all individuals act under the condition of uncertainty, especially regarding the plans and actions of other individuals, people sometimes do not achieve their desired ends. The actions of one person may interfere with the actions of another. The actual consequences of any action can be known only after the action has taken place. This does not mean that people do not include in their plans expectations regarding the plans of others. But the exact outcome of a vast number of plans being executed at the same time can never be predicted. Offering a product on the market is always a trial-and-error, never-ending process of changing one's plans to reflect new knowledge gained from day to day.

Austrian economists develop theory a priori

Austrian economics is a school of economic thought that advocates strict adherence to methodological individualism, the concept that social phenomena result primarily from the motivations and actions of individuals along with their self-interest. Austrian economists develop theory a priori, meaning explanations are derived logically from sound starting points. This means the theory is true and can therefore be used to uncover the actual causalities behind observable phenomena. Economics is, therefore, to “Austrians” a framework for understanding what we see.

The Austrian school uses the logic of a priori thinking to discover economic laws of universal application, whereas other mainstream schools of economics make use of data and mathematical models to prove their point objectively. In this respect, the Austrian school can be contrasted with the German Historical School, which rejects the universal application of any economic theorem.

The Austrian school originated in 1871 in Vienna with the work of Carl Menger, Eugen von Böhm-Bawerk, Friedrich von Wieser, and others. It was methodologically opposed to the Historical School, in a dispute known as the Methodenstreit, or methodology quarrel. The Austrian school takes a subjectivist approach, theorizing that the subjective choices of individuals, including individual knowledge, time, expectation, and other subjective factors, cause all economic phenomena. Austrians seek to understand the economy by examining the social ramifications of individual choice, an approach called methodological individualism.

The Austrian school holds that prices are determined by subjective factors like an individual's preference to buy or not to buy a particular good, whereas the classical school of economics holds that objective costs of production determine the price, and the neoclassical school holds that prices are determined by the equilibrium of demand and supply. The Austrian school rejects both the classical and neoclassical views, saying that costs of production are also determined by subjective factors based on the value of alternative uses of scarce resources, and the equilibrium of demand and supply is also determined by subjective individual preferences.

A central Austrian insight is that capital goods are not homogeneous. Hammers, nails, lumber, bricks, and machines are all different and cannot be substituted for one another perfectly. This has real implications in aggregated economic models. Capital is heterogeneous. The Keynesian treatment of capital ignores this.

The Austrian school views the market mechanism as a process and not an outcome of a design. People create markets with their intention to better their lives, not by any conscious decision. So, if you leave a bunch of amateurs on a deserted island, sooner or later their interactions would lead to the creation of a market mechanism.

The Austrian school theorizes that economic theory should be exclusively derived from basic principles of human action. Ludwig von Mises organized his version of the subjectivist approach, which he called "praxeology", in a book published in English as Human Action in 1949. In it, Mises stated that praxeology could be used to deduce a priori theoretical economic truths and that deductive economic thought experiments could yield conclusions that follow irrefutably from the underlying assumptions. He wrote that conclusions could not be inferred from empirical observation or statistical analysis and argued against the use of probabilities in economic models.

Since Mises' time, some Austrian thinkers have accepted his praxeological approach, while others have adopted alternative methodologies. For example, Fritz Machlup, Friedrich Hayek, and others did not take Mises' strong a priori approach to economics. Ludwig Lachmann, a radical subjectivist, also largely rejected Mises' formulation of Praxeology in favor of the interpretive method articulated by Max Weber.

Austrian economics is theory and deductive

Austrian economics is a scholarly tradition that consists of a body of theory that explains how an economy works. Austrian economists develop theory a priori, meaning explanations are derived logically from sound starting points. This means the theory is true and can therefore be used to uncover the actual causalities behind observable phenomena. Economics is, therefore, to “Austrians” a framework for understanding what we see.

Because Austrian economics is deductive, it can rely on its economic theory as a framework to interpret and understand what is going on in the economy. This is why Austrians can say without any doubt that, for example, credit expansion—an increase of the money in circulation—will cause market prices to increase if nothing else changes. However, Austrian economic theory cannot tell how quickly this happens or what exact prices will be affected to what extent. Only that this must be so.

Austrian theory is much narrower in scope than mainstream economics. Whereas the latter presumes to develop “theory” to explain anything that is related to the data at hand, Austrian theory is derived from basic principles of human action. Austrians cannot and do not go beyond what can be derived logically, which means economic theory remains true, but also cannot be used to explain specific phenomena in detail or predict precise outcome magnitudes. Austrians do predict, but only using established causal relationships. Austrian theory disallows predictions that are quantitative or state exact times.

Austrian economics emphasises methodological individualism

Methodological individualism is a cornerstone of Austrian economics, alongside methodological subjectivism and an emphasis on processes rather than end states. Austrian economists believe that the most important economic problem people face is how to coordinate their plans with those of others. For example, when a person goes to a store to buy an apple, how is the apple there to be bought? This meshing of individual plans in a world of uncertainty is, to Austrians, the basic economic problem.

Austrian economists do not use mathematics in their analyses or theories because they believe that mathematics cannot capture the complex reality of human action. They think that quantifiable relationships are only applicable when there is no change, and that mathematics can only capture what has already taken place, not what will take place. Austrian economists emphasise the process by which market participants gain information and form their expectations to lead them to their own idea of a best solution.

Austrian economics is a scholarly tradition that consists of a body of theory that explains how an economy works. Austrian economists develop theory a priori, meaning that explanations are derived logically from sound starting points. This means that Austrian theory is true and can be used to uncover the actual causalities behind observable phenomena. Austrian economic theory can be used as a framework to interpret and understand what is going on in the economy. For example, Austrian economists can say without doubt that credit expansion will cause market prices to increase if nothing else changes. However, Austrian economic theory cannot tell how quickly this will happen or what exact prices will be affected to what extent.

Austrian economics emphasises methodological subjectivism

The Austrian school of economics was founded in 1871 by Carl Menger, who published the book 'Principles of Economics'. Menger's work was built upon by his students, Eugen von Böhm-Bawerk and Freidrich von Wieser, who made significant contributions of their own. Wieser, for example, developed the opportunity cost doctrine, which is the idea that the cost of any activity is measured in terms of the value of the next best alternative.

Austrian economists do not attempt to measure or quantify subjective values, but instead take them as given data. They believe that economic value is created by the subjective valuation of goods by individuals, based on their unique value scales. Austrian economics also emphasises that only the individual can decide what actions are efficient or inefficient, as all costs and benefits are subjective and therefore not measurable.

The Austrian school's focus on methodological subjectivism is reflected in its approach to economic efficiency. Austrians define efficiency as the fulfilment of the purposes deemed most important to an individual, rather than the fulfilment of less important purposes. This is in contrast to the notion of an equilibrium state, which assumes that supply and demand are equal and that there is no surplus or shortage of goods. Austrians argue that equilibrium is a process of learning and changing expectations, which will itself change the equilibrium.

Methodological subjectivism is also central to the Austrian view of competition. Austrians define competition as rivalrous behaviour, and to compete is to attempt to offer a better deal than one's competitors. Competition arises when firms attempt to distinguish their products from those of other firms. Austrian economists argue that competition is a "discovery procedure", as firms do not know what a successful competitive strategy is until they try it.

In summary, Austrian economics emphasises methodological subjectivism by focusing on the subjective values and preferences of individuals, and how these shape economic phenomena. Austrians do not attempt to measure or quantify these subjective values, but instead emphasise the role of the individual in determining economic efficiency and competition.

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