Part I. What is it and What does it Mean?

We do not simply study quantitative relationships but also the nature or essence of economic phenomena. How can we attain to the knowledge of this latter (e.g., the nature of value, rent, profit, the division of labor, bimetallism, etc.) by mathematical methods?

Carl Menger (1840-1921, Founder of the Austrian School of Economics)

The central philosophy of the Austrian School of Economics is grounded in the theory of subjective value, individual freedom, and underscores the dynamics of free markets, of private property and the Rule of Law. Thus, its approach is characterized by the methodological individualism and the principles of marginal utility and opportunity costs. The school also stands in explicit opposition to methods that justify state interventions, which are neither compatible with free markets nor with the social fabric of a society.

As all human actions imply the cost of a forgone opportunity, any individual value judgment reflects the relationship between an appraising mind and the objects considered. The aim of the Austrian School of Economics hence is to explain how and why people co-operate in spontaneously evolving markets and compete for different ends and the alternative use of scarce means.

While most current schools of economic thought strive to explain the infinite complexity of human actions or their purposes with quantitative techniques and also endorse mathematical methods or econometric models to outline their policies. Austrian Economics is not about things or tangible material objects. It is about sovereign citizens, their boundless choices and ultimate accountability.

Generally speaking, mainstream economics applies mathematical methods and mechanical images in order to specify the static conditions required for an equilibrium without the dimension of time, despite the obvious fact that an equilibrium can only be defined as a relationship between successive actions. The Austrian school on the other hand focuses on the dynamic transactions undertaken in the course of time. Because all human actions involve plans and hence require a real time dimension, equilibrium theory is meaningful only in a framework of timeless static.

This apparent dilemma cannot be resolved by splitting actions into several successive equilibriums as these render sense only if they are used for the analysis of the actions of an individual. It is therefore important to stress again that human actions can be viewed as being in equilibrium only, if they are part of a plan. And only if all these actions were to take place at the same time and under identical circumstances could we substantiate our claim about the links of which we reach a conclusion from our assumption of the knowledge and the subjective preferences of an individual’s action. The actor only subjectively knows all those data, which lead to his action, precisely because he deals not with the relations between things, but with the relations between men and things or the relations between man and man. Hence there cannot be objective facts, which are as such equally recognizable to all. For any social interaction or transfer to take place, the information on which an individual grounds his plans necessarily must represent the expectation that others are going to act in a certain way. Thus for Austrians it is a necessary precondition for the compatibility of the different plans that the planned actions of one individual contain the data for the strategy of the other.

What are the characteristics of the Austrian School of Economics? Since the term “Austrian Economics” has come to evoke a number of different connotations in contemporary academic and popular discussions, it lacks clarity. The tag has been widely associated much less with an innovative way of thinking and a unique methodology, the appellation instead is chiefly used to identify its protagonists as aggressive ideologues of free markets or worse, as members of a libertarian, anarchical sect. For a number of people the term is just a historical reference to an outdated school of thought and used to hint at some faint figures of a distant past such as Menger, Böhm-Bawerk, or Friedrich von Wieser. While Schumpeter or a few of his buzzwords are mentioned in order to demonstrate at least some knowledge, the equally important names of Mises, Hayek or Machlup and Haberler are conveniently suppressed. An increasing number of people however got the records straight and associate the term with an academic tradition that has generated a unique set of tools, which capture aspects of complex social phenomena that would remain impenetrable to mainstream economics.

Fritz Machlup, himself a prominent member of the 4th generation and Mises’ last student in Austria, listed six ideas as central to the Austrian School. A few of these tenets have become recognized by mainstream economics and have been embodied into the “general body of commonly accepted thought”. These six fundamental points are:

  • Methodological individualism
  • Methodological subjectivism
  • Marginalism
  • Opportunity cost
  • Tastes and Preferences
  • Time Structure of Production and consumption.

Although, most members of the school used different advances at different times in their analyses, they all grounded their work chiefly first on methodological individualism (a term coined by Schumpeter), and secondly on methodological subjectivism. The first underscores that the decisive building blocks of any socio-economic analysis are the manifold activities of the market participants whose unpredictable interactions generate the social realm. The second term emphasizes the fact that meaning and significance can be attached to these human actions only in terms of an understanding and interpretation of the knowledge, intentions, and of course expectations of the actors themselves.

This is the often ridiculed, yet characteristic Austrian idea of “Begreifen” (conceptualizing) and “Verstehen” (understanding) which has been mentioned earlier.

The undertakings of an unknown number of individual plans in the complex social order of a market in which each actor’s knowledge and expectation is naturally limited by her or his own scope, sets the stage for inevitable consequences that may turn out to be “the results of human action but not of human design” (Hayek). These omnipresent but unintended consequences of human action are an implication of subjectivism. As un earlier, for Austrians economics is an explanatory and not a descriptive science, the chief task of social theory is therefore to explain the development, the pattern, the growth and the change of spontaneously generated social institutions that independently coordinate all human actions. For Austrians thus economics is not about things and tangible material objects; it is about men, their meanings, and actions.

Unlike in mainstream economics, the individual here is the actor rather than the ‘homo economicus’ as a mere passive responder to given constraints of knowledge, time, and place. Suffice it to say, for Austrians social entities are not one large decision-maker, for them societies or nations for those matters are being composed of a complex collection of independently acting individuals. The central concepts of the Austrian School therefore clearly are the theory of subjective value, the subjective assessments of the individual market participants grounded on the marginal principle and its stress on the methodological foundations of the social sciences in general. Accordingly the value of a good or an action is simply put, the relationship between an appraising mind and the object appraised. Markets are therefore always dynamic processes, which may lead the participant to a unique and individually experienced equilibrium.

The scholar who has produced the most comprehensive critique of the notion that the social sciences should imitate the methods used by the exact sciences is Friedrich A. von Hayek. Hayek differentiates between scientific or theoretical knowledge and the knowledge of the particular circumstances of time and place. For the individual market participant it is not the systematically collected scientific knowledge what counts, rather it is the unorganized, widely dispersed knowledge of the particular circumstances of time and place. If we were to explain the evolving of spontaneous social orders we must track the very conditions to the individually undertaken actions that gave rise to that order. In other words, it is the concepts and the views held by the individuals which are directly known to us and which form the elements from which we must build up, as it were, the more complex phenomena of markets or of society. Our whole modern social order and well-being rest exclusively on the unfettered possibility of adapting to processes that we neither fully know nor understand. Markets are thus the result of the Logic of Choice, which alone are an empirically observable fact and therefore a priori. These powerful insights were inspired by his excursions into the manifold problems of business cycle theory, the impossibility of socialist calculation, capital theory or rent control.

It was therefore only a short theoretical step from his discovery of the knowledge utilization in the spontaneous order of markets to the interpretations of the price system as a communication network. Accordingly only the unhampered system of price signals can communicate information and thus enables men to adjust their actions spontaneously to circumstances and events of which the actors cannot have any prior knowledge. In our modern, highly diverse societies in which the knowledge of the relevant facts is so widely dispersed among any numbers of independent people, only a system of unfettered signals can enable us to adapt to circumstances of which we know nothing.

It was especially von Hayek who extended his analysis of society to an examination of the spontaneous emergence of legal and ethical rules. Here in a typical Austrian fashion he began to see that the Rule of Law, subordinating the coercive power of the government under the law was the necessary foundation for a peaceful coexistence of people with totally different value-convictions and he began to develop his specific approach. As stated above, the Rule of Law or the ‘ought’ of the law, has a normative character and is prior to the state and in tune with the priority of “Recht” and “Staat” in the term “Rechtsstaat”. In view of Hayek’s imperative of the rule of law, the legal order corresponding to the ideal of the law develops in freedom and is therefore a spontaneous order.

Man did not consciously choose the necessary structures and institutions of social life because he recognized the benefits, which their installation would bring about, but these structures have evolved because they bring benefits to those individuals or groups who adopt them. Moral behavior or the law are themselves manifestations of spontaneous orders, which evolve from the competitive process of the logic of choice. Men according to Hayek were not endowed with a mind capable of conceiving a civilization and setting out to create our culture, the law, or other social institutions at will. Man did not simply design a set of social rules and impose it upon his environment, because his mind is itself a ‘system’ that undergoes permanent changes as a result of his efforts to adapt himself to new knowledge and new situations. Our understanding about the workings of society is, therefore itself a product of current civilization and thus the result of actions of hundreds of generations. Civilization, culture, or our social institutions thus cannot be interpreted as the product of human design, nor is man aware what his working or continued existence depends upon. The assertion that we have created our ethics and morals and are therefore able to change them at wills is fatally flawed and could be justified only, if we had deliberately created them in full understanding of what we were doing.

To sum up, for most ‘Austrians’ our societies are the undesigned product of an evolution or an order which has grown spontaneously without anyone intending it. Therefore, only in unhampered competitive markets can we bring to bear the dispersed, specialized, individual knowledge and by utilizing it according to our subjective preferences we may unintended discover more of our potentialities and employ them according to the demand of other participants. All competition is “a discovery procedure”. Therefore, the task of philosophy is not the construction of metaphysical systems, but an investigation into the limits of human reason.

Kurt L. Leube

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