Austrian Economics: Global Influence And Practical Applications

The Austrian School of Economics, founded in 1871 by Carl Menger with his book 'Principles of Economics', is a heterodox school of economic thought that advocates strict adherence to methodological individualism, holding that economic theory should be derived from basic principles of human action. The school originated in Vienna, Austria-Hungary, and was methodologically opposed to the Historical School, in a dispute known as the 'Methodenstreit' or 'methodology quarrel'.

While the Austrian School fell out of favour in the mid-20th century due to its rejection of mathematical and statistical methods, it has since experienced a revival, with universities around the world now teaching its theories. The school's influence is particularly strong in the English-speaking world, but it is also gaining traction in Europe.

The Austrian School's origins

The Austrian School of Economics was founded in 1871 with the publication of Carl Menger's 'Principles of Economics'. Menger, along with William Stanley Jevons and Leon Walras, developed the marginalist revolution in economic analysis. Menger's work was methodologically opposed to the German Historical School, in a dispute known as the 'Methodenstreit' or methodology quarrel.

Menger's 'Principles of Economics' argued that economic analysis is universally applicable and that the appropriate unit of analysis is man and his choices. These choices, he wrote, are determined by individual subjective preferences and the margin on which decisions are made. This is known as 'marginalism'. Menger believed that the logic of choice was the essential building block to the development of a universally valid economic theory.

The Historical School, on the other hand, argued that economic science is incapable of generating universal principles and that scientific research should be focused on detailed historical examination. They believed that the English classical economists were mistaken in believing in economic laws that transcended time and national boundaries. Menger's work restated the classical political economy view of universal laws and did so using marginal analysis.

Menger's work was criticised by the leading figure in the German Historical School, William Roscher, and his students, especially Gustav Schmoller. It was the latter who gave the work of Menger and his followers, Eugen Böhm-Bawerk and Friedrich Wieser, the derogatory name 'Austrian School' because of their faculty positions at the University of Vienna. The term stuck, and the Austrian School was born.

Its key thinkers

The Austrian School of Economics was founded in 1871 with the publication of Carl Menger's 'Principles of Economics'. Menger, along with William Stanley Jevons and Leon Walras, developed the marginalist revolution in economic analysis. Menger's work was dedicated to his German colleague, William Roscher, the leading figure in the German Historical School, which dominated economic thinking in German-language countries.

Menger's 'Principles of Economics' argued that economic analysis is universally applicable and that the appropriate unit of analysis is man and his choices. These choices, he wrote, are determined by individual subjective preferences and the margin on which decisions are made. The logic of choice, he believed, is the essential building block to the development of a universally valid economic theory.

Menger's work was followed by that of Eugen Böhm-Bawerk and Friedrich von Wieser, who, along with Menger, became what is known as the "first wave" of the Austrian School.

In the 1930s and 1940s, the Austrian School moved to Britain and the United States, with scholars associated with this approach to economic science located primarily at the London School of Economics, New York University, Auburn University, and George Mason University.

Many of the ideas of the leading mid-20th-century Austrian economists, such as Ludwig von Mises and Friedrich Hayek, are rooted in the ideas of classical economists such as Adam Smith and David Hume, or early 20th-century figures such as Knut Wicksell.

Other important names in the Austrian School include:

• Gottfried Haberler
• Fritz Machlup
• Karl Menger (son of Carl Menger)
• Oskar Morgenstern
• Paul Rosenstein-Rodan
• Abraham Wald
• Michael A. Heilperin
• Alfred Schütz
• Israel Kirzner
• Murray Rothbard
• Leland Yeager
• Walter Block
• Hans-Hermann Hoppe
• Jesús Huerta de Soto
• Robert P. Murphy

Its core principles

The Austrian School of 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-school theorists hold that economic theory should be exclusively derived from basic principles of human action.

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 "methodology quarrel".

The Austrian School of Economics has several core principles that set it apart from other schools of economic thought. Here are some of its key ideas:

Methodological Individualism:

Austrian economics emphasizes the role of individual choices and actions in shaping social phenomena. They believe that economic theories should be based on understanding individuals' motivations and actions rather than aggregate variables or societal groups. This approach, known as methodological individualism, is a fundamental tenet of the school.

Subjectivism and A Priori Thinking:

Austrian economists use a priori thinking and logical reasoning to discover economic laws that have universal application. They argue that economic values are subjective in nature and depend on individuals' preferences and choices. This subjectivism extends to costs, which they believe are also subjective and determined by the value of alternative uses of scarce resources.

Rejection of Mathematical Models:

The Austrian School critiques mainstream economics for its reliance on complex mathematical models and data. Instead, they prefer to use "thought experiments" and verbal logic to understand economic phenomena. They argue that human behavior and complex economic systems cannot be accurately modelled using mathematical equations.

Theory of Marginal Utility:

One of the most significant contributions of the Austrian School is the development of the theory of marginal utility. This theory states that the value of a good or service to an individual decreases as the number of units they possess increases. This concept has far-reaching implications for economic analysis.

Opportunity Cost:

The Austrian School introduced the concept of opportunity cost, which is the value of the next best alternative forgone when making a choice. This concept is crucial for understanding economic decision-making and resource allocation.

Rejection of Classical and Neoclassical Views on Prices:

The Austrian School rejects the classical view that prices are determined solely by the objective costs of production. Instead, they argue that prices are influenced by subjective factors, including individual preferences and the value of alternative uses of resources. They also disagree with the neoclassical view that equilibrium prices are determined solely by the interaction of supply and demand curves.

Capital Heterogeneity:

Austrian economists argue that capital goods are heterogeneous and cannot be treated as homogeneous factors of production. They critique the Keynesian treatment of capital, which ignores this heterogeneity and can lead to economic waste and misallocation of resources.

Interest Rates and Time Preference:

The Austrian School holds that interest rates are determined by individuals' time preference, or their choice between consuming now or in the future. They argue that an increase in saving suggests individuals are postponing present consumption, leading to more resources being available in the future.

Inflation and Monetary Policy:

Austrian economists believe that increases in the money supply lead to an increase in prices, or inflation. They argue that government attempts to control money and distort interest rates can lead to economic recessions and business cycles. They generally oppose government intervention and favor free-market solutions.

Its influence today

Austrian economics is especially influential in the English-speaking world, but it is also gaining traction in Europe. The school's basic, understandable insights provide citizens with the knowledge to identify political threats to freedom and prosperity, and it motivates them to develop independent entrepreneurial initiatives.

Austrian economics is currently taught at universities across the world, including George Mason University, New York University, Grove City College, Loyola University New Orleans, Monmouth College, Auburn University, King Juan Carlos University, and Universidad Francisco Marroquín.

Austrian economic ideas are also promoted by privately funded organisations such as the Mises Institute and the Cato Institute.

The school's influence can be seen in the work of economists such as Armen Alchian, James Buchanan, Douglass North, Vernon Smith, and Oliver Williamson.

Austrian economics has also contributed to the development of modern economic theory, with concepts such as marginal analysis and opportunity cost now widely acknowledged and taught in mainstream economics.

Some modern economists may consider themselves to fall into an ideological mix of several schools of thought, and theories from the Austrian school can be useful even if an economist considers themselves a "member" of another.

How it differs from other schools of economic thought

The Austrian School of 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-school theorists hold that economic theory should be derived exclusively from basic principles of human action.

The Austrian School differs from other schools of economic thought in several key ways:

• Methodology: Austrian economists use a priori thinking and "thought experiments" to discover economic laws of universal application, rather than relying on data, mathematical models, and quantitative analysis as in mainstream schools such as neoclassical and new Keynesian economics. They emphasise verbal logic and empirical work focused on historical narratives.
• Role of the Individual: Austrian economics focuses on individual choice and subjective factors, such as preferences, expectations, and time preference, in determining economic outcomes. They reject aggregate variables and societal groups as the primary focus of economic analysis.
• Prices: The Austrian School holds that prices are determined by subjective factors like an individual's preference to buy or not buy a particular good, while the classical school emphasises objective costs of production, and the neoclassical school focuses on equilibrium between demand and supply.
• Capital: The Austrian School views capital goods as heterogeneous and multispecific, arguing that they cannot be substituted for one another perfectly. This contrasts with the Keynesian treatment of capital, which treats it as homogeneous.
• Interest Rates: The Austrian School rejects the classical view that interest rates are determined by the supply and demand for capital. Instead, they argue that interest rates are determined by the subjective decisions of individuals regarding spending, saving, and time preference.
• Inflation: The Austrian School believes that any increase in the money supply not supported by a corresponding increase in the production of goods and services leads to an increase in prices, with relative prices adjusting faster than others. This can lead to distortions in the pattern of exchange and production.
• Business Cycles: Austrian economists argue that business cycles are caused by distortions in interest rates due to government attempts to control money and intervene in the economy. They reject the idea that government intervention can effectively address economic downturns.
• Market Mechanism: The Austrian School views the market mechanism as a process that emerges from individuals' intention to better their lives, rather than as an outcome of a conscious design. They emphasise the role of entrepreneurs in discovering mutual gains and efficient resource allocation.
• Social Institutions: Austrian economics recognises that many social institutions and practices are the unintended result of human action, rather than being deliberately designed. This has implications for understanding the role of government intervention in the economy.
• Free Market: Austrian economics strongly favours unregulated free markets and opposes most forms of government intervention, aligning with libertarian political theory.

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