Understanding Differences and the War on Austrian Economics
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Understanding Differences and the War on Austrian Economics
“Ask five economists and you'll get five different answers - six if one went to Harvard.” - Edgar Fiedler
If you ended up taking an Economics course while in college in the U.S., chances are you would have learned two approaches or schools’ of thought on how economists view problems and where these solutions stem from.
The two: 1) Britain’s Classical Economics and the evolution into 2) Keynesian Economics
Yet, we are rarely exposed to other systems of thought.
It is ironic that in the ‘Land of the Free, Home of the Brave’ we are not taught more ideas on how free-market economics and its branches of thought can operate. After all, is economics not a social science? Is it not a collection of production and consumption processes all culminating in an attempt to solve the central economic problem of how we utilize finite goods with an infinite appetite for consumption?
This is the foundation of economics: every study, paper, theory, economic policy, or experiment is ultimately an attempt to find a solution to a problem, that by its very nature, has no single best solution.
So let this be a call to continue diversifying thought and open up exposure to other ideas on how to approach this central allocation problem that unifies all economic theories.
Now, the first thing to know about all of these schools of thought is that they all agree with one another on most issues. For example, the concept of opportunity costs: the forgone benefits that would have been derived from an option not chosen. But economists can differ on the concept of taxation of businesses and how to approach taxation. Going back to the idea of economics as a social science, there is a certain element of philosophy and morality that influences every economic decision, no matter how much economists attempt to wash it away with mathematics.
To make matters even tougher, the only real way to apply a new theory come is to study the results, which means phasing out current policy and bringing in a proposed untested new policy. This is difficult to implement because the stakes are so high; should a policy shift go unexpectedly wrong, it would have an impact on thousands if not millions of lives.
Furthermore, I have a gut feeling that most economists deep down have questioned the very models they use today for their forecasting ability (ahem, U.S. Federal Reserve). So I do believe there are plenty of economists that agree with some of the principles of one school of thought and then disagree wildly on some other areas. This is actually a good thing.
To make sense of things I want to look at the two school’s of thought I presented at the start, and a third one: 3) Austrian Economics.
1) Britain’s Classical Economics
This is the big boy, the elephant in the room that will probably never go away, and it shouldn’t. For all the flaws that Adam Smith brought forward with his monumental book, “The Wealth of Nations," released in 1776, his adamant support for further Division of Labor among manufacturing lines, compounded by Immanuel Kant’s own book, “The Groundwork and Metaphysics of Morals,” in 1785 have since led us to realize advancements in productivity that for some seemed unfathomable. Kant stated:
“All crafts, trades and arts have profited from the division of labour; for when each worker sticks to one particular kind of work that needs to be handled differently from all the others, he can do it better and more easily than when one person does everything. Where work is not thus differentiated and divided, where everyone is a jack-of-all-trades, the crafts remain at an utterly primitive level.”
As suggestions of how to build a better world, these were the prescriptions of these early economists when economists weren’t even a thing.
Markets should be free because the more that people are allowed to trade freely with one another, the more they can specialize and count on others to specialize to deliver all of the goods that they need.
Nations have also done the same thing; they stopped trying to hoard gold as would be suggested by mercantilist philosophies and instead realized who does what well. Once this is known, trade amongst other nations increased wealth and allowed countries too, to specialize.
Government intervention in free markets should be limited exclusively to making sure that contracts are upheld and fraud is not allowed to take place. This gave us an economic incentive to have a government and create laws and next thing you know, you have a society that through classical economics, is assumed that everybody buying, selling, and working is perfectly rational and will always make the most logical decision possible to forward their own selfish interests.
More or less, classical economics argues that we can all work together to make the world a better place by being selfish. It certainly helped accelerate us into this high-tech world.
2) Keynesian Economics
Prior to Mark Zuckerberg making a dating app on a college campus, and before the forewarnings of Nero and the Matrix, came along John Maynard Keynes. He would advocate for stronger government intervention through further regulation of central banks. So putting Bretton Woods aside, what did Keynes bring forward?
If a regular person has heard of any economists, it would be Keynes. He is touted as the most influential economist of the 20th century and he defined the way that almost all governments around the world manage their economic affairs as the rollout of new technologies bolstered by global wars changed the economic landscape.
Factories, markets, advanced financial systems, consumer debt, and public corporations were all commonplace during Keynes’ time, and the ebbs and flows of national prosperity were no longer determined by the harvest but rather by the business cycle. Around this time, economies started experiencing ups and downs that could not be explained exclusively by outside forces, but rather by the sentiment of the people within the nation. Since consumers were the center of modern economies, their changing preferences, expectations, and feelings of optimism, fear, or doubt impacted the economy. This led to the widely-accepted realization of business cycles and boy did Keynes have a solution for us.
The solution was to try and smooth out this business cycle by artificially influencing the spending of consumers. And who better to do this than our own governments? Nations would do this through fiscal policy, which called for taxing people more and spending less government money during economic booms, and then taxing less and spending more during an economic downturn. It would also be influenced by monetary policy set by a nation’s central bank, which really is just a doorway for political and financial entities to comingle, kind of like Paul and Nancy Pelosi.
As it sounds, Keynesian Economics advocated for more intervention from regulators of power, which is why I have a deep suspicion Austrian Economics was never to really take off across these major groups of power.
3) Austrian Economics
The Austrian school hated the idea of Keynesian Economics because it was tampering with the free market, which would limit efficiency and cause a whole host of other, unintended problems.
It was dubbed Austrian Economics because of its birthplace in Vienna (although founded by a Polish man).
The Austrian school shares a lot of similarities with classical economics and most of the economists that have now gone on to define this field didn’t even know that they were creating an academic discipline of economics, in the same way that Adam Smith didn’t know he was creating economics as we know it. What this school of thought did was refocus the power and interests on the consumer, the individual.
With this, these scholars started adding in more allowances for how individuals acted, and specifically how they valued things. Carl Menger was the father of the Austrian School of Economics and is credited with contributing to the theory of Marginal Utility alongside his student Friedrich von Vieser. The theory of marginal utility was an extremely important contribution to economics as a whole. It argued that goods provide a utility, but their utility is decreased for every extra unit of that good there is.
This ran contrary to the classical school of economics which simply advocated for making as much stuff as possible and then letting the free market decide what went where. Now again this might sounds obvious to us now, but you have to remember some important things.
This was the first inkling of economic theory adapting to a world of genuine sustained growth. Before the 1800’s, the idea that anybody could have too much of something was pretty bizarre, but with factories all across Europe working day and night to produce all manner of everything, the decisions everybody were making were starting to shift from, “can I afford this?” to “would I rather have this or that?” This deeper understanding in a world that was becoming more and more plentiful eventually culminated in the Subjective Theory of Value.
This theory argues that an item is not worth the sum of the materials and labor that go into making it, but rather it is worth a function of how important it is. For example, this would explain why diamonds are worth more than water if the latter is needed to survive and the former is not.
However today, Austrian economics is today seen by most conventional economists as a very fringe ideology for its reliance on conjecture rather than rigorous mathematics and statistics.
This makes a lot of their theories non-falsifiable, which in plain English means they are impossible to prove wrong, which sounds great, but in reality it just means that because there are no rigorous models drawn or prescriptions set, it’s very hard to contradict the theories. And like I said earlier, economics is not usually the place you want to ‘test’ your ideas out, given the risks of a major economic collapse.
My point is there is no ‘right’ framework for an economy to operate in; it will always be messy somehow and maybe that is the beauty of it all along. But that also does not mean that we try to fix a problem with solutions that continue to put Blu Tack on the cracks of the Hoover dam. We need greater diversity of thought and to solve 21st century problems, we require 21st century solutions.
So, maybe we all just need to stop and look around.
“Life moves pretty fast. If you don't stop and look around once in a while, you could miss it.” - Ferris Bueller