The Beginnings of a Reborn Austrian School of Economics

by | Jan 1, 2024 | Economics

Fifty years ago, on October 10, 1973, one of the leading members of the Austrian School of Economics, Ludwig von Mises (1881–1973), passed away at the age of 92.

Fifty years ago, on October 10, 1973, one of the leading members of the Austrian School of Economics, Ludwig von Mises (1881–1973), passed away at the age of 92. There was little notice of Mises’s death in the mainstream of the economics profession, even though he had been one of the most widely recognized economists in Europe during the interwar years of the 1920s and 1930s. At the time of Mises’s passing, it was difficult to even refer to an existing Austrian School of Economics. Except for a small handful of individuals, the Austrian School, for all intents and purposes, had been relegated to being a closed chapter in the history of economic ideas.

The Keynesian Revolution in macroeconomics had swept away all the competing approaches for understanding inflations and recessions. This included the Austrian theory of money and the business cycle that had been developed by Mises before and after the First World War. It was then reformulated and given international recognition by Mises’s protégé, Friedrich A. Hayek (1899–1992) during the 1930s as part of his debates and controversies with John Maynard Keynes (1883–1946) over the causes of the Great Depression and the policies most appropriate to restore full employment and sustainable long-term growth and prosperity. As one writer suggested, the Austrian School had been swept away in the Keynesian avalanche.

In the field of microeconomics, circumstances were no better. From the founding of the Austrian School in 1871 with Carl Menger’s (1840–1921) Principles of Economics, a particular characteristic in the writings of many members of the school had been a focus on the nature and workings of the market process —the determination of prices through the competitive interactions of suppliers and demanders. This was especially the case in the contributions of Mises and Hayek in the 1930s and 1940s. The market was seen as an entrepreneurially driven, dynamic competitive process in which the decentralized and ever-changing knowledge of the interdependent market participants determined prices.

However, beginning at the same time in the 1930s and 1940s, and coming to dominate economics in the 1950s and 1960s and after, there was an increasingly arid mathematical formalism in which everything going on the market was part of a series of simultaneous mathematical equations that measured and promoted the stability of the economy’s general equilibrium among all the individual suppliers and demanders for all the goods and services and factors of production offered for purchase and sale. The origin of the general equilibrium approach began in the 1870s by a French economist, Leon Walras (1834–1910), who, like Carl Menger, had developed a version of the theory of marginal utility. But it was only in the middle decades of the twentieth century that it came to be the primary focus of those specializing in microeconomic theory.

The peculiar assumptions of perfect competition

Central to this dominant economic approach was the concept of “perfect competition,” which was intended to ensure some of the assumptions considered crucial for a unique equilibrium to exist. First, all consumers and producers are individually too small, relative to the overall market in which they participate, to influence the market price by increasing or decreasing the amount they, respectively, buy or sell. Hence, each is a “price taker,” adjusting how much they find it desirable or profitable to buy or sell at the given market price. Second, on the supply-side, every seller in their particular market offers for sale a product that is perfectly interchangeable for the product their rivals also offer for sale in that same market. Thus, no seller can or does attempt to differentiate their version of the product from that of their competitors, and as such, none of them can sell their product at a price different from what other sellers in that same market are receiving.

Finally, buyers and sellers are presumed to have perfect or sufficient knowledge of all relevant market circumstances and therefore never make the mistake of buying a product at a price higher than someone else may be offering it or selling a product at a price less than they need to. Logically, therefore, all markets meeting the conditions of perfect competition are in a perfect long-run equilibrium since all buyers and sellers know the “objective” circumstances prevailing in and across markets. Hence, they never make the mistake of missing out on a profit opportunity that could have been theirs or suffering a loss that might have been avoided if only they had known all the correct information about all market circumstances that they face.

The mathematical general equilibrium approach had already been challenged by Carl Menger in an exchange of letters he had had with Leon Walras in the 1880s. In 1932, Hans Mayer (1879–1955), a prominent member of the Austrian School who taught at the University of Vienna, published a 100-page monograph, “The Cognitive Value of Functional Theories of Price,” in which he offered a critique of several of the leading general equilibrium theorists for narrowly limiting their analysis to merely describing the conditions for and the configuration of a final economic equilibrium state. He contrasted this with what he referred to as the “causal-genetic” approach of the Austrian School that focused on the origin of market prices in the subjective valuations of individuals and the competitive process through which prices were formed and adjusted through time, leading to a possible equilibrium outcome.

Ludwig von Mises also emphasized, most especially in his treatise, Human Action (1949), the dynamic nature of the market process in which rival entrepreneurs attempt to do better than each other in anticipating and estimating the consumer demands of the future and devising ways of organizing, directing, and producing ever better new and less expensive goods to earn profits and avoid losses. Price competition and product differentiation were essential hallmarks of a vibrant, functioning, and ever-improving market economy and society. Mises insisted that the “market is a process” rather than a never-attained hypothetical final equilibrium state in which all change would come to an end.

Mises and Hayek criticized the central-planning idea

In the 1920s, Mises had challenged the socialist idea of central economic planning by arguing against its realistic workability, first in an essay on “Economic Calculation in the Socialist Commonwealth” (1920) and then in, Socialism: An Economic and Sociological Analysis (1922; revised ed., 1932). He argued that by doing away with the institutional foundations of a functioning market economy — that is, private property in the means of production; an open competitive process through which prices for consumer goods and the factors of production (land, resources, labor, capital) could be formed; and a market-based medium of exchange (money) — the socialist central planners would not be able to undertake any rational form of economic calculation for purposes of determining profitable versus loss-making lines of production in the most cost-efficient ways. He refined his critical analysis of socialism in his book Human Action in the context of his broader exposition of the entrepreneurial-guided market process for satisfaction of consumer demands.

As a professor at the London School of Economics in the 1930s and 1940s, Hayek took up Mises’s arguments in debating advocates of socialist central planning. He first offered his own critique in the opening and closing chapters of a book he edited on Collectivist Economic Planning (1935). But his own unique contribution came in three articles: “Economics and Knowledge,” (1937), “The Use of Knowledge in Society” (1945), and “The Meaning of Competition” (1946), all of which were reprinted in Hayek’s Individualism and Economic Order (1948).

The essential nature of “the economic problem,” Hayek argued, was the division of knowledge that accompanies the division of labor in society. The knowledge of the world is decentralized and dispersed in the minds of all people around the globe. The question was, how shall that knowledge, possessed and most fully appreciated only in the minds of each particular person, be effectively brought to bear in ways that benefit and improve the conditions of others, as well as the person possessing that knowledge, in the interconnected system of division of labor?

Hayek’s answer was the market system of competitively formed prices. Prices are a communication network through which consumers and producers, suppliers and demanders can inform each other about what it is they respectively want or might be able to do in the arenas of exchange, without anyone needing to know all the knowledge that, in fact, no one could ever successfully master. Prices help generate a coordinated system of mutual association and benefit encompassing, in principle, everyone in the world without any one person or few having to guide, direct, or command it. In Hayek’s view, this was a primary reason why a system of comprehensive socialist central planning was an unworkable substitute for a functioning market economy.

The importance of the competitive process

Part of the error on the part of socialists and too many economists in general when they conceived of an economic system was to do so in the context of the perfect competition model, Hayek said. It was presumed that “somehow” it was possible to have a “perfect knowledge” of market circumstances to ensure a perfect equilibrium of supply and demand. Then, when anything falls short in the real world from the benchmark of the perfect-competition assumptions, it is claimed to be an instance of “market failure.” Government regulatory and interventionist policies are called for to correct them, under the presumption that those in political power could or do know and understand enough to ensure that actors in the real world conform to the perfect competition postulates, resulting in perfect equilibrium outcomes.

Hayek insisted that the purpose and role of real competition, that is, rivalrous competition among sellers in the marketplace and competition as a dynamic process of discovery, is to find out who could do what, and how they might be able do it better than others who are attempting to market the same goods and services.

If we already knew ahead of time what people wanted, how best to produce it, and which methods of production and combinations of resources, capital, and labor that would do the job in the most cost-effective way, society would have the most economically optimal set of relationships and resource uses. The economy would be and could remain in a perfect, long-run general equilibrium. It is precisely because we do not know all these things ahead of time, however, due to the fact that people’s knowledge is imperfect and dispersed among all in society, that competition in the marketplace is socially desirable and beneficially.

It is only in the dynamic process of competition that people find out what they can do and how they might do it better compared to others in the social system of division of labor. Thus, in Hayek’s view, far too many economists used and judged the market economy by a hypothetical, perfectly planned socialist system or perfectly regulated economy by a government presumed, again, to be able to know and understand more than any of those in government can ever have the capacity to know.

Mainstream economists ignored the Austrian challenges

But rather than confront and reply to the types of arguments that Mises and Hayek had articulated in the 1930s and 1940s about the competitive market economy, or the impossibilities of central planning, or the unworkability of the regulatory interventionist state, the mainstream of the economics profession just blissfully played on with their mathematical models of general equilibrium and with how wisely introduced planning or regulation could correct all the ills in society created by the presumed market failures due to unregulated free markets in the imaginary world of the theory of perfect competition.

In other words, for the mainstream economics profession, the Austrian School was a closed chapter in the history of economic ideas. It was irrelevant to “modern” economic theory and policy considerations precisely because the “Austrians” had been of an earlier generation not educated in and wise enough to understand and appreciate the “true scientific method” of hyper-mathematization combined with aggregated statistical analysis to manage and manipulate the macroeconomics of total output, total employment, and the general price level.

After coming to America during the Second World War, Mises taught graduate seminars as a “visiting professor” at New York University until 1969, when he was almost 89 years old. Most of his more scholarly writings in the postwar period had turned to questions of the methodology of the social sciences, such as his books Theory and History (1957) and The Ultimate Foundations of Economic Science (1962). Hayek also had moved away from the narrower questions of economic theory and policy after the war. His interests turned to the social and political philosophy of the liberal free society, as reflected in his works The Constitution of Liberty (1962) and Law, Legislation, and Liberty, 3-vols. (1973–1979).

Ludwig M. Lachmann (1906–1990), who had left Germany in 1933 and earned an MA degree under Hayek’s supervision at the London School of Economics, taught for decades at the University of Witwatersrand in Johannesburg, South Africa. He wrote mostly on the Austrian Theory of Capital and Its Structure (1956) and Macroeconomic Theory and the Market Economy (1973), as well as on the methods of the social science, including The Legacy of Max Weber (1971).  In conversation in later years, he would say that in the 1950s and 1960s, he feared that he would be “the last” Austrian economist.

New beginnings of the Austrian School: Rothbard and Sennholz

But there were the seeds of a new generation of Austrian economists, mostly surrounding Ludwig von Mises at New York University. Mises seemed to have an uncanny ability and talent for attracting interested and bright students. He had done so at the University of Vienna between the two world wars, where he taught as a part-time unsalaried lecturer and as a full-time senior economic policy analyst for the Vienna Chamber of Commerce, Crafts, and Industry.

He did so again at NYU, where his two leading so-inspired students were Murray N. Rothbard (1926–1995) and Israel M. Kirzner (b. 1930). In the late 1940s, Rothbard was told that there was this economist teaching at NYU who would soon be publishing a book that was about “everything.” When recalling this, Rothbard said that he replied, “How can one book be about ‘everything?’” But when Human Action was published in September 1949 and Rothbard read it, he would then say, “It was about ‘everything!’”

While finishing his own PhD at Columbia University, Rothbard regularly attended Mises’s NYU seminar. The result of Mises’s influence on him led to the writing of Rothbard’s two-volume work, Man, Economy, and State: A Treatise on Economics (1962), followed by his “Austrian” analysis of The Great Depression (1963) and Power and Market: Government and the Economy (1974). The significance of Man, Economy, and State was that it presented a clear, logical, and comprehensive exposition of the “Austrian” view of economics from the starting elements of human action and the logic of choice to the complexities of exchange, markets and prices, the time structure of production, capital and interest, and the intricacies of money, monetary transactions, the purchasing power of money, and the political economy of the business cycle, along with a critique of socialist central planning and the contradictions of the interventionist state. It was a lucid and readable guidebook to the Austrian perspective on the nature, concepts, and theory of economics from A to Z.

In addition, Rothbard also drew around him a group of young libertarians who were introduced both to the ideas of liberty and the insightfulness of the Austrian approach for understanding the potentials of a free market for both liberty and prosperity in comparison to any form of government control and command. A good number of these young people, then in their teens or twenties, helped bring about the revival of the Austrian School during the remaining decades of the twentieth century as they followed their own careers, many of them as academic economists. .

Also attending Mises’s NYU seminar was Hans Sennholz (1922–2007), who had earned a doctorate in political science in Germany after the war and came to New York precisely to study for a PhD under Mises. Sennholz’s expertise was not only a detailed knowledge of both Austrian and mainstream economics but also a unique capacity to articulate both economic theory and policy matters with great ease and clarity for a wider popular audience through articles and the spoken word. This included a decades-long professorship in economics at Grove City College in Pennsylvania, through which he influenced a good number of students who went on to prominent academic careers in economics and the Austrian tradition.

Israel Kirzner on acting man and the market process

The other leading protégé of Ludwig von Mises at New York University was Israel M. Kirzner. Born in London, Kirzner was at New York University working on an MBA when he took Mises’s graduate seminar. The first evening of the course, Kirzner recalled, Mises began by saying that “the market is a process.” Figuring out what that fully meant became Kirzner’s lifelong intellectual pursuit. He wrote his dissertation under Mises on The Economic Point of View (1960), a doctrinal investigation on the subject matter of economics, from the classical economists to the Austrians. This was followed by Market Theory and the Price System (1963), a textbook exposition of the core concepts of microeconomics from a clearly defined market-process approach. Not meant to be as comprehensive as Rothbard’s Man, Economy, and State, Kirzner offered a theory of market adaptation to changing circumstances that included an emphasis on the role and significance of time in the processes of adjustment to conditions of market coordination.

With little doubt, Kirzner’s most important and influential work from this period was Competition and Entrepreneurship (1973), which was published a few months before the death of Ludwig von Mises. This year marked the 50th anniversary of the publication of Kirzner’s book. Kirzner blends Mises’s idea of the market as an entrepreneurial process with Hayek’s conception of competition as a discovery process that coordinates the activities of all the participants in the social order through the price system.

Kirzner’s starting point is Mises’s conception of “human action.” Man is a purposeful and active being who is open and alert to new and previously unthought of opportunities and avenues to improve his circumstances. He imagines and selects among the ends that might be desirable to attain, and he intentionally looks for means and methods to pursue them. In this sense, the individual actively chooses his ends and purposely searches for means to better his life.

This is significantly different from the mainstream microeconomic premises, Kirzner said, in which the analysis assumes from the start that each and every agent already has a clear and delineated set of “given” ends and means. The “economic problem” is merely a mathematical exercise in “constrained maximization,” that is, given his “given” and ranked ends and given the known means available, how does he logically apply those means in such a way to achieve the greatest number of his ends? Where and how the individual decides upon the ends to pursue, and where and how he discovers and decides on which things might be useful as well as useable means to pursue them, is never explained or explored.

“Austrian” man, if we may use such a phrase, creates the “given” ends and means taken for granted in the mainstream microeconomic framework. Indeed, if we do not at least attempt to understand the preceding active and alert acts by individuals in discovering ends worth pursuing and deciding upon what might be useful means to try to attain them, it becomes impossible to ever explain how and why people’s chosen ends and selected means ever change. In other words, how would today ever be different from yesterday, or tomorrow from today, if the economic agents merely keep acting within the “given” ends-means framework they begin with? The only changes would come from some change in the “objective” physical circumstances, to which individuals would merely react, given their “given” ends and known means.

Kirzner on entrepreneurial alertness and competitive discovery

In taking up Hayek’s ideas of competition as a discovery process in comparison to the assumptions of the mainstream perfect competition theory, Kirzner then asked, if sellers in the market are prohibited from offering lower prices than their rivals, and if they are not allowed to differentiate their product by innovatively devising ways to make them new, better, and improved in comparison to their competitors, how do any new and better quality products ever come on the market?

Mainstream microeconomics had constructed a theoretical edifice claiming to “explain” how markets work but that did so on a set of peculiar assumptions and premises that prevented any understanding of actual markets in a real world that is populated by real people who, in fact, are alert, purposeful human beings constantly open to and trying to find new and better ends and means.

This alertness, Kirzner said, building on Mises’s work, was the nature and essence of entrepreneurship. The entrepreneur is always looking out for and attempting to take advantage of discoverable profit opportunities. Part of Mises’s point is that, fundamentally, each and every one of us is an “entrepreneur” trying to find profitable opportunities to better our life in all that we do. An entrepreneurial element, therefore, is inseparable from human action and the human condition.

In the marketplace division of labor, there are those who specialize in this task and combine it with the decision-making of what products to produce; how, when, and where to produce them; and with what combination of inputs, based on their expectations of what products consumers may want and the prices they might be willing to pay some time in the future when the production processes have been completed. Real competition in the marketplace is a competition between rival entrepreneurial visions of the discoverable and the possible, the reality of which will be found out when their competing goods are offered to consumers and they earn either hoped-for profits or suffer unfortunate losses.

The resulting outcomes of experienced profits or losses bring about adjustments and adaptive changes that move modified productions and supplies into a more consistent coordination with consumer demands. However, in this Austrian understanding of the on-going and never-ending competitive market process, a “perfect” equilibrium is never attained because there are always new entrepreneurial discoveries, products, and price offerings before the market has fully adjusted to the earlier supply and demand conditions. There is a constant tendency toward equilibrating coordination in the marketplace, but it is a continuously “moving target.”

Kirzner on misguided government interventions

This Austrian market-process view also leads to radically different economic policy conclusions in comparison to the “perfect-competition” presumptions in mainstream microeconomics. As we saw, within the mainstream microeconomic framework, any seller’s attempt to competitively change his price to offer consumers better terms of trade than his rivals or to differentiate his product, including by offering a better or different version of it, can be considered instances of anti-competitive “market failure.” This leads to proposals for a variety of government interventions to “correct” the unregulated market.

An instance of this, which Kirzner discusses, is business advertising. From the perfect competition perspective, advertising is viewed as wasteful and undesirable since it is one competitor trying to create an impression in the minds of consumers that his product is different than his rivals. But within the Austrian market process approach, advertising is a logical and useful means by which entrepreneurs attempt to inform consumers about product opportunities they may not and often do not know about.

In fact, those entrepreneurs are creatively devising ways to make those new and better products and frequently offering them at better prices than those in the past. Only in the la-la land assumptions of perfect competition, under which every buyer and seller start with perfect or sufficient knowledge to never make a buying or selling mistake, can informing people about things they may not know about in ways that get people’s attention in a world with many distractions, can business advertising be considered a “failure” of the unregulated capitalist system.

A few years after the publication of Competition and Entrepreneurship, Kirzner delivered a lecture entitled “The Perils of Regulation: A Market-Process Approach” (1979). He reiterated and extended his critique of mainstream microeconomic policy views. He explained some of the negative effects from various forms of government intervention:

Government controls constrain and constrict; they rearrange and repattern the structure of incentives; they redistribute incomes and wealth, and sharply modify both the processes of production and the composition of consumption…. The most serious impact of government regulation on the market discovery process well might be the likelihood that regulation, in a variety of ways, may discourage, hamper, or even completely stifle the discovery process of the unregulated market…. Regulatory constraints, that is, are likely to bar the discovery of pure profit opportunities….

The beneficent aspect of competition in the sense of a rivalrous process … arises out of freedom of entry. What government regulations so often erect, are regulatory barriers to entry. Freedom of “entry,” for the Austrian approach, refers to the freedom of potential competitors to discover and to move to exploit opportunities for pure profit. If entry is blocked, such opportunities simply may never be discovered, either by existing firms in the industry, or by regulatory authorities, or for that matter by outside entrepreneurs who might have discovered such opportunities, were they allowed to be exploited when found.

This is the danger and undesirability of antitrust regulations that prevent market-based mergers and acquisitions and prevent existing firms from simply gaining larger market shares resulting from their ability to attract more customers due to better products or more attractive prices. Drug-testing regulations, Kirzner warned, “not only reduce the flow of new pharmaceutical drugs where successful research might have been more or less predictable, but also discourage the entrepreneurial discovery of wholly unknown research procedures.” As Kirzner concluded:

The basic insight underlying these conclusions, in sum, is a simple one. The competitive-entrepreneurial process, being a process of discovery of the as-yet-unknown, can hardly be predicted in any but the broadest terms. The imposition of regulatory constraints necessarily results, therefore, in a pattern of consequences different from and most plausibly, distinctly less desirable than, that which would have occurred in the unregulated market.

The year 1974 saw two momentous events for the rebirth and revival of an active and vibrant Austrian School: a conference on Austrian Economics organized by the Institute for Humane Studies, held in South Royalton, Vermont, that brought together about 40 students and young professors to hear a series of lectures by Israel Kirzner, Ludwig Lachmann, and Murray Rothbard. They were published soon after as The Modern Foundations of Austrian Economics (1976). And certainly, most unexpectedly, there was the awarding of the Nobel Prize in Economics to Friedrich A. Hayek in October of 1974.

These two events will be celebrating their 50th anniversary in 2024, and it will be a notable time to appreciate the half-century of the reborn and revitalized Austrian School that is so actively contributing to economic understanding today.

This article was originally published in the December 2023 edition of Future of Freedom. Publisher’s Note: As Professor Yaron Brook notes, though Rothbard for the most part was sound on economics, his politics (“anarcho-capitalism”) was rather abysmal.

Dr. Richard M. Ebeling is the recently appointed BB&T Distinguished Professor of Ethics and Free Enterprise Leadership at The Citadel. He was formerly professor of Economics at Northwood University, president of The Foundation for Economic Education (2003–2008), was the Ludwig von Mises Professor of Economics at Hillsdale College (1988–2003) in Hillsdale, Michigan, and served as vice president of academic affairs for The Future of Freedom Foundation (1989–2003).

The views expressed above represent those of the author and do not necessarily represent the views of the editors and publishers of Capitalism Magazine. Capitalism Magazine sometimes publishes articles we disagree with because we think the article provides information, or a contrasting point of view, that may be of value to our readers.

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