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When Austrians Came to America

Economists of the Austrian school in recent years, writes Karen Vaughn, “present no less than a fundamental challenge” to how members of their field view their work and the world around them. “At the very least,” she says, “Austrian economics is a complete reinterpretation of the methods, substance, and limitations of contemporary economics. At most, it is a radical, perhaps even revolutionary restructuring of economics.”

So she writes in the introduction to her splendid book, Austrian Economics in America: The Migration of a Tradition, the latest in a spate of books that signify the resurgence of interest in Austrian economics.

The publication of this book couldn’t be more timely. With the unparalleled collapse of socialist regimes in Eastern Europe and the former Soviet Union, the economics profession finally admits that the central argument of Ludwig von Mises and F.A. Hayek–socialism will fail–was right after all. Even Robert Heilbroner, who, in one top-selling book after another, championed an ever-expanding role for state planning and democratic socialism, now (with a humility uncommon among intellectuals of his stature) admits his previous ignorance of Austrian economics, and, with it, his profound misunderstanding of markets and planning.

Many reputable economists now believe that markets are necessary for economic growth and increasing standards of living. But that doesn’t mean they’re all Austrians now, for Austrian economics is not a set of policy prescriptions, or political beliefs, or positions on capitalism versus socialism. Austrian economics is a rather complicated challenge that strikes at the core of modern economic theory, a challenge which has evolved for over a century.

The difference between Austrian economics and mainstream economics has become clear, Vaughn argues, only within the past twenty years or so. To demonstrate it, she examines the evolution of Austrian economics, from its earliest beginnings in Vienna in the 1870s through today, in America.

In chapter two, for example, Vaughn focuses on the beginnings of Austrian economics, with the work of Carl Menger in Vienna. Although Menger is commonly interpreted as a co-creator of modern, neoclassical economics, Vaughn argues that he can also be interpreted as an iconoclastic theorist of the highest order; one who focused more on the market system as a “spontaneous order,” rather than a general equilibrium. While equilibrium-centered theory (such as that of neoclassical economics) concentrates on how the market system looks if it were to achieve a general equilibrium (answer: there would be no uncertainty, ignorance, money, profits, losses, entrepreneurs, firms, institutions!), a theory of spontaneous order attempts to explain the evolution of institutions that support the market system by examining individual human plans and actions and their unintended consequences. Thus, while neoclassical economics discusses how markets “work” if and when people enjoy full and complete information, Austrian economics tries to explain how markets work when, in fact, the important information is dispersed among millions of people throughout society.

To drive home this distinction, Vaughn reconsiders the famed socialist calculation debate (chapter three). Ludwig von Mises had argued, way back in 1920, that real-world socialism will fail because a central planning board would not be able to calculate the relative values (and costs) of scarce resources. Why? Because socialism strives to abolish private ownership of the means of production. Doing so would abolish markets for the means of production, and therefore the market pricing system and profit-loss signals. Without information transmitted through the market pricing system, socialist planners wouldn’t have the foggiest idea of the relative values of capital resources. Socialist planning tends to create ever growing shortages of useful goods, and wasteful surpluses of unwanted items. Rather than guide society to rising standards of living and steady increases in economic growth, socialism would plummet society into a downward spiral of waste, inefficiency, mass misery, and (as Hayek would add later) totalitarian dictatorship. This, in fact, did happen.

Why didn’t the rest of the profession accept the Austrian argument? The problem lies, as Vaughn sees it, with the Austrians, for not fully understanding the radical nature of their own theoretical argument–both Mises and Hayek may have harbored too much sympathy with their neoclassical allies. The “debate” resulted when socialists used neoclassical theory in the 1930s to demonstrate how socialist planning can theoretically lead to equilibrium and economic efficiency. From that point on, the Austrians were considered losers: they were interpreted, in textbook after textbook, as being defeated on their own theoretical grounds.

Austrian School Goes Underground

Combine this with the terror of Naziism that forced the Austrian School to relocate off the Continent, and you get an idea of the fate of Austrian economics in the post-war years. Hayek first fled to England, whilst Mises, Haberler, Machlup and others headed for America. Shaken from their institutional roots, and considered losers in the grand debate over socialism, Austrian economics became further and further removed from the burgeoning neoclassical (and Anglo-Saxon) mainstream.

Austrians such as Morgenstern and Machlup established solid careers in America by the 1950s by downplaying their Austrian heritage. Hayek would leave his position at the London School of Economics in 1950 to become a professor on the Committee on Social Thought at the University of Chicago –but this position was established outside the economics department, where his salary was paid not by the university, but through private foundations. Mises taught in the graduate school of business at New York University, beginning in 1945, but by 1949, and through his retirement in 1969, his salary, too, would be paid only through outside foundations.

In a sense, Austrian economics in America became almost subterranean: Hayek pursued research in legal and political theory (rather than economics), while Mises tried to reconcile Austrian economics with elements of the neoclassical mainstream (on policy grounds, however, he unflinchingly–and at much professional cost–continued to staunchly defend the free market system). His attempt at theoretical reconciliation bore little fruit, as Vaughn observes in chapter 4: “he tried too much to blend some fundamental Mengerian insights with the apparatus of neoclassical price theory to the detriment of both. The project was flawed, but it was at once so learned and complex that it would take decades to unravel its central contradiction. In fact, Mises’ edifice inherited a basic incompatibility between the Mengerian and the neoclassical approach that it is still a source of controversy among modern Austrian economists.”

If this first period of Austrian economics in America (roughly 1940 through the 1960s) can be interpreted as one of ever-increasing marginalization of the Austrian School, then the second period, beginning in 1974 with the Austrian “revival” (as Vaughn titles chapter 5), can be seen as an astonishing resurgence of interest in Austrian economics, with dozens of scholarly books and hundreds of articles devoted to the scope and nature of Austrian economics.

In the fall of 1974, Hayek won the Nobel Prize in economics for his early work on monetary theory and the trade cycle, suggesting that the profession started to recognize the merit of earlier Austrian economics. In addition, the Institute for Humane Studies sponsored a week-long conference on Austrian economics earlier that summer, in South Royalton, Vermont. It drew together roughly fifty economists and graduate students who, not all thoroughgoing Austrians, nevertheless shared some interest in Mises’ and Hayek’s theories. “What started out as a crusade for Austrian economics,” Vaughn observes, “turned into a deep and extensive examination of a core of ideas that began with Menger and that have been amended, enlarged, weeded out, and improved on by scores of scholars for over a century.”

The Equalibrium Debate

For example, Ludwig Lachmann, an Austrian economist who had spent his post-war years at the University of Witwatersrand in South Africa and who was unknown to most of the South Royalton crowd, argued at the conference that Austrian economics should further distance itself from the mainstream by developing a theory of the market that does not rely at all on some notion of “general equilibrium.” That is, Austrians should strive to explain how the market produces an overall order, but an order that is not tied to some timeless notion called equilibrium.

The question of equilibrium has divided the contemporary Austrian School in America ever since, which Vaughn documents in the book’s remaining chapters. What does it mean, for example, to say that the market system tends toward equilibrium? If by equilibrium we mean a perfect coordination of plans, then, as we’ve learned from neoclassical economics, a world of perfectly coordinated plans is a world where people can dispense with money, firms, institutions, and so on. Now we all clearly know the market is never in equilibrium. But to say that the market has a direction– it moves toward equilibrium–may be saying too much. How do we know that?

If it is an empirical claim, it would seem to be wrong (the evidence suggests that money, firms, institutions, etc., are not disappearing). If it is a formal or logical claim, then the question becomes: does the logic of each individual’s actions (and its unintended consequences) necessarily imply a greater coordination of plans? The “New Austrians” (as Vaughn calls the Austrians of the 1980s and ’90s influenced by Lachmann) seriously doubt both the empirical and the purely formal claims. Turned against them, the question becomes: what can replace the notion of “equilibrium”? Furthermore, can we still have a science of economics (Austrian, neoclassical, or otherwise) without referring to some notion of equilibrium? What would it look like? And where does all this leave the defense of free market policy?

At stake is nothing less than the (traditionally understood) scientific status of Austrian economics, and with it the irony that, perhaps, the tremendous resurgence of interest in Austrian economics may lead to its ultimate downfall as a scientific discipline. Many of the more traditional Austrians fear just that. Vaughn, however, is more persuaded by the New Austrians, and writes that moving beyond, if not abandoning the equilibrium concept, “does not imply that there are no longer good arguments for the value of free markets to the achievement of human plans. Indeed, I suspect a recasting of Austrian economics in light of the recognition of time and ignorance will strengthen the arguments for decentralized markets rather than centralized government in economic affairs.” “However,” she warns us, “work must be done to articulate and integrate these arguments once again.”

Long-Overdue Recognition

The New Austrian economists in America have only begun to unearth the extraordinary nature of their tradition. Whether this will be reconciled with more traditional Austrian economics, it’s hard to say. But nobody can deny that now is an exciting time to study Austrian economics, for the market system is here to stay, and the Austrian understanding of markets is finally enjoying a long-overdue recognition by other economists and social scientists.

The topics in this book are deep, the debates grand, the implications are limited only by the reader’s own imagination. And–a rarity among economists–Vaughn writes with clarity and grace. This is a history of modern economics the way it should be written. I highly recommend it to anyone interested in contemporary Austrian economics and its innovative direction of research for the next century.