Austrian economics: a response to Boettke

I’ve long promised a post on Austrian economics. To organise my thoughts and minimise the risk of attacking a straw man, I’ve taken as my starting point this encylopedia article by Peter Boettke. Boettke sets out ten claims and derives some claimed conclusions. I’ve responded point by point, and then given my own summary.

As I’ve had trouble with various fringe adherents of Austrianism, I’m setting out some strict ground rules for discussion here. Comment should stick strictly to discussion of economics. Anyone making personal attacks of any kind will have their comments deleted and be barred from this thread. Avoid anything that might be seen as insulting other participants in the discussion

Boettke’s points follow, with my responses in itals

The Science of Economics

Proposition 1: Only individuals choose.

Man, with his purposes and plans, is the beginning of all economic analysis. Only individuals make choices; collective entities do not choose. 

The primary task of economic analysis is to make economic phenomena intelligible by basing it on individual purposes and plans; the secondary task of economic analysis is to trace out the unintended consequences of individual choices.

So far so good. Methodological individualism seems like a good starting point. But it’s important to remember that individual choices are very much affected (sometimes, effectively determined) by the collective entities of which they are a part. 

Proposition 2: The study of the market order is fundamentally about exchange behavior and the institutions within which exchanges take place.

The price system and the market economy are best understood as a “catallaxy,” and thus the science that studies the market order falls under the domain of “catallactics.” These terms derive from the original Greek meanings of the word “katallaxy”—exchange and bringing a stranger into friendship through exchange. Catallactics focuses analytical attention on the exchange relationships that emerge in the market, the bargaining that characterizes the exchange process, and the institutions within which exchange takes place.

Markets are places where exchange takes place, so this is more or less self-evident. But there is more to economics than markets. The extensive attention given to Robinson Crusoe in economic textbooks is evidence of this, as is the huge amount of activity that takes place within firms, households, governments and so on. The absence of any real theory of the firm, or of the household, is a major weakness of Austrian economics, partly reflecting the very limited work done in this framework in recent decades, a period which has seen huge developments in mainstream analysis of contracts, asymmetric information and so on

Proposition 3: The “facts” of the social sciences are what people believe and think.

Unlike the physical sciences, the human sciences begin with the purposes and plans of individuals. Where the purging of purposes and plans in the physical sciences led to advances by overcoming the problem of anthropomorphism, in the human sciences, the elimination of purposes and plans results in purging the science of human action of its subject matter. In the human sciences, the “facts” of the world are what the actors think and believe.

The meaning that individuals place on things, practices, places, and people determines how they will orient themselves in making decisions. The goal of the sciences of human action is intelligibility, not prediction. The human sciences can achieve this goal because we are what we study, or because we possess knowledge from within, whereas the natural sciences cannot pursue a goal of intelligibility because they rely on knowledge from without. We can understand purposes and plans of other human actors because we ourselves are human actors.

The classic thought experiment invoked to convey this essential difference between the sciences of human action and the physical sciences is a Martian observing the “data” at Grand Central Station in New York. Our Martian could observe that when the little hand on the clock points to eight, there is a bustle of movement as bodies leave these boxes, and that when the little hand hits five, there is a bustle of movement as bodies reenter the boxes and leave. The Martian may even develop a prediction about the little hand and the movement of bodies and boxes. But unless the Martian comes to understand the purposes and plans (the commuting to and from work), his “scientific” understanding of the data from Grand Central Station would be limited. The sciences of human action are different from the natural sciences, and we impoverish the human sciences when we try to force them into the philosophical/scientific mold of the natural sciences.

As an objection to naïve behaviorism this is fine. If you want to understand what people do, it’s important to understand what they think. But the facts economists try to explain are what people do.


Proposition 4: Utility and costs are subjective.

All economic phenomena are filtered through the human mind. Since the 1870s, economists have agreed that value is subjective, but, following alfred marshall, many argued that the cost side of the equation is determined by objective conditions. Marshall insisted that just as both blades of a scissors cut a piece of paper, so subjective value and objective costs determine price (see microeconomics). But Marshall failed to appreciate that costs are also subjective because they are themselves determined by the value of alternative uses of scarce resources. Both blades of the scissors do indeed cut the paper, but the blade of supply is determined by individuals’ subjective valuations.

In deciding courses of action, one must choose; that is, one must pursue one path and not others. The focus on alternatives in choices leads to one of the defining concepts of the economic way of thinking: opportunity costs. The cost of any action is the value of the highest-valued alternative forgone in taking that action. Since the forgone action is, by definition, never taken, when one decides, one weighs the expected benefits of an activity against the expected benefits of alternative activities.

This can be read in two forms. The weak form, which Peter Boettke adopts in comments relies on the opening claim that “all economic phenomena are filtered through the human mind” and are in that sense subjective. This is true of the standard neoclassical theory as presented by Marshall, and it was equally true of the older labor theory of value. The strong form is the implication that a theory of value (different in some substantive sense from the Marshallian) can be developed without reference to objective conditions of production. The strong form is important, but wrong. The weak form consists of claims that are true, as Boettke says, “by definition”, and are therefore tautological. The problem I have with this kind of thing is twofold. First, you commonly get a rhetorical two-step where the strong form of the claim is put forward, then replaced by the weak form when it is challenged. Second, it seems to be supposed that purely tautological claims of this kind justify the kind of a priorist metholodogy favored by Mises and some (but not all) other Austrians, in which economics is supposed to consist of logically self-evident truths.

Proposition 5: The price system economizes on the information that people need to process in making their decisions.

Prices summarize the terms of exchange on the market. The price system signals to market participants the relevant information, helping them realize mutual gains from exchange. In Hayek’s famous example, when people notice that the price of tin has risen, they do not need to know whether the cause was an increase in demand for tin or a decrease in supply. Either way, the increase in the price of tin leads them to economize on its use. Market prices change quickly when underlying conditions change, which leads people to adjust quickly.

True and important, but not the whole truth, as witness the fact that people (including the managers of enterprises) so frequently choose to dispense with prices and rely on direct control to get things done.

Proposition 6: Private property in the means of production is a necessary condition for rational economic calculation.

Economists and social thinkers had long recognized that private ownership provides powerful incentives for the efficient allocation of scarce resources. But those sympathetic to socialism believed that socialism could transcend these incentive problems by changing human nature. Ludwig von Mises demonstrated that even if the assumed change in human nature took place, socialism would fail because of economic planners’ inability to rationally calculate the alternative use of resources. Without private ownership in the means of production, Mises reasoned, there would be no market for the means of production, and therefore no money prices for the means of production. And without money prices reflecting the relative scarcities of the means of production, economic planners would be unable to rationally calculate the alternative use of the means of production.

As with P4, this has a strong and a weak form. The strong form suggests that rational economic calculation is impossible in enterprises where the means of production are publicly owned. This is false, unless the term ‘rational’ is stretched so as to make the claim meaningless. Publicly owned enterprises have operated successfully for decades, sometimes in competition with private firms and sometimes as monopoly providers. There’s a case to be made that, on balance, private ownership yields better performance, but even if you accept this case, this does not sustain the claim above. The weaker view, defended by Boettke in comments, is that an economy needs at least some private ownership to produce informative money prices. This obviously leaves open the question of how large the publicly-owned sector can be without inducing economic collapse. Experience here and elsewhere suggests that substantial public ownership is compatible with continued economic growth. Determining the optimal balance is a matter of empirical assessment not abstract arguments of the kind put forward by Mises.

Proposition 7: The competitive market is a process of entrepreneurial discovery.

Many economists see competition as a state of affairs. But the term “competition” invokes an activity. If competition were a state of affairs, the entrepreneur would have no role. But because competition is an activity, the entrepreneur has a huge role as the agent of change who prods and pulls markets in new directions.

The entrepreneur is alert to unrecognized opportunities for mutual gain. By recognizing opportunities, the entrepreneur earns a profit. The mutual learning from the discovery of gains from exchange moves the market system to a more efficient allocation of resources. Entrepreneurial discovery ensures that a free market moves toward the most efficient use of resources. In addition, the lure of profit continually prods entrepreneurs to seek innovations that increase productive capacity. For the entrepreneur who recognizes the opportunity, today’s imperfections represent tomorrow’s profit.1 The price system and the market economy are learning devices that guide individuals to discover mutual gains and use scarce resources efficiently.

This is probably the most distinctive and valuable point of the Austrian school. But it’s important to remember that discovery is ultimately a public good, and that markets only reward some kinds of discovery 


Proposition 8: Money is nonneutral.

Money is defined as the commonly accepted medium of exchange. If government policy distorts the monetary unit, exchange is distorted as well. The goal of monetary policy should be to minimize these distortions. Any increase in the money supply not offset by an increase in money demand will lead to an increase in prices. But prices do not adjust instantaneously throughout the economy. Some price adjustments occur faster than others, which means that relative prices change. Each of these changes exerts its influence on the pattern of exchange and production. Money, by its nature, thus cannot be neutral.

This proposition’s importance becomes evident in discussing the costs of inflation. The quantity theory of money stated, correctly, that printing money does not increase wealth. Thus, if the government doubles the money supply, money holders’ apparent gain in ability to buy goods is prevented by the doubling of prices. But while the quantity theory of money represented an important advance in economic thinking, a mechanical interpretation of the quantity theory underestimated the costs of inflationary policy. If prices simply doubled when the government doubled the money supply, then economic actors would anticipate this price adjustment by closely following money supply figures and would adjust their behavior accordingly. The cost of inflation would thus be minimal.

But inflation is socially destructive on several levels. First, even anticipated inflation breaches a basic trust between the government and its citizens because government is using inflation to confiscate people’s wealth. Second, unanticipated inflation is redistributive as debtors gain at the expense of creditors. Third, because people cannot perfectly anticipate inflation and because the money is added somewhere in the system—say, through government purchase of bonds—some prices (the price of bonds, for example) adjust before other prices, which means that inflation distorts the pattern of exchange and production.

Since money is the link for almost all transactions in a modern economy, monetary distortions affect those transactions. The goal of monetary policy, therefore, should be to minimize these monetary distortions, precisely because money is nonneutral.

With a handful of dogmatic new classicals, all economists agree that money is non-neutral. And with a similar handful of exceptions, all economists agree that inflation is undesirable (if sometimes unavoidable)

Proposition 9: The capital structure consists of heterogeneous goods that have multispecific uses that must be aligned.

Right now, people in Detroit, Stuttgart, and Tokyo City are designing cars that will not be purchased for a decade. How do they know how to allocate resources to meet that goal? Production is always for an uncertain future demand, and the production process requires different stages of investment ranging from the most remote (mining iron ore) to the most immediate (the car dealership). The values of all producer goods at every stage of production derive from the value consumers place on the product being produced. The production plan aligns various goods into a capital structure that produces the final goods in, ideally, the most efficient manner. If capital goods were homogeneous, they could be used in producing all the final products consumers desired. If mistakes were made, the resources would be reallocated quickly, and with minimal cost, toward producing the more desired final product. But capital goods are heterogeneous and multispecific; an auto plant can make cars, but not computer chips. The intricate alignment of capital to produce various consumer goods is governed by price signals and the careful economic calculations of investors. If the price system is distorted, investors will make mistakes in aligning their capital goods. Once the error is revealed, economic actors will reshuffle their investments, but in the meantime resources will be lost.3

Again, no one disagrees with this. I was waiting for a claim that capital markets always do a better job of allocating capital than any alternative, or that they would do better in the absence of government regulation, but it hasn’t been made, so I won’t impute it. I will note that the price system may be distorted by all sorts of factors, including systemic biases in capital markets. The dotcom bubble/bust is a prime example of capital market failure in the leadup to the GFC.

Proposition 10: Social institutions often are the result of human action, but not of human design.

Many of the most important institutions and practices are not the result of direct design but are the by-product of actions taken to achieve other goals. A student in the Midwest in January trying to get to class quickly while avoiding the cold may cut across the quad rather than walk the long way around. Cutting across the quad in the snow leaves footprints; as other students follow these, they make the path bigger. Although their goal is merely to get to class quickly and avoid the cold weather, in the process they create a path in the snow that actually helps students who come later to achieve this goal more easily. The “path in the snow” story is a simple example of a “product of human action, but not of human design” (Hayek 1948, p. 7).

The market economy and its price system are examples of a similar process. People do not intend to create the complex array of exchanges and price signals that constitute a market economy. Their intention is simply to improve their own lot in life, but their behavior results in the market system. Money, law, language, science, and so on are all social phenomena that can trace their origins not to human design, but rather to people striving to achieve their own betterment, and in the process producing an outcome that benefits the public.

This is true, but so is the converse: social institutions are often the result of human design.

The implications of these ten propositions are rather radical. If they hold true, economic theory would be grounded in verbal logic and empirical work focused on historical narratives. 

This is a gigantic non-sequitur, which reflects the cultural predilections of the Austrian tribe. If anything, the outline above supports an axiomatic and mathematical approach of the type favored by the neoclassical school. Prices are numbers after all, and information is a mathematically precise concept. Why would you throw all that away and stick to verbal methods, except for lack of capacity to do it right? And the claimed focus on empirical work seems to be the exact opposite of the a priori methodology espoused by Mises and supported above.

With regard to public policy, severe doubt would be raised about the ability of government officials to intervene optimally within the economic system, let alone to rationally manage the economy.

Not many people these days would claim optimality for government intervention. But there’s nothing so far to show that government intervention can’t improve outcomes in the standard cases of microeconomic market failure and macroeconomic co-ordination failures.

Perhaps economists should adopt the doctors’ creed: “First do no harm.” The market economy develops out of people’s natural inclination to better their situation and, in so doing, to discover the mutually beneficial exchanges that will accomplish that goal. Adam Smith first systematized this message in The Wealth of Nations.

The first sentence seems entirely inconsistent with the general policy stance of the Austrian school, which involves a wide range of radical policy measures, based on untested hypotheses. “First do no harm” would suggest cautious incremental changes to the existing mixed economy. It’s true that markets develop out of natural inclinations to better our situation, but then so do governments.

In the twentieth century, economists of the Austrian school of economics were the most uncompromising proponents of this message, not because of a prior ideological commitment, but because of the logic of their arguments.

Sorry, but I can’t agree. Maybe this was true at the beginning of the 20th century, but in recent decades, the Austrian school of economics has been a dogmatic sect, characterised by extreme ideological views on all subjects. About the only thing I agree with in this point is that the Austrian message is based primarily on a priori logic and not on openness to empirical evidence.

Summary. The main thing I find useful in Austrian economics is captured by Proposition 7, which encapsulates the limitations of neoclassical general equilibrium theory, where all possible states of nature are assumed known, so that discovery is not really possible. Unfortunately, this is wrapped up with both some misconceived methodological views (for example, the commitment to verbal logic) and a set of ideological blinkers which guarantee in advance that the policy conclusions will be those of laissez-faire.

Final point. Boettke doesn’t talk explicitly about Austrian Business Cycle Theory, which is obviously of some interest. I’ll treat this topic in a later post.

Update I advertised this in comments over at the Austrian Economics Blog. I got a couple of comments from Greg Ransom (thanks!), but I was hoping for a bit more of a response from serious Austrian economists, while avoiding the lunatic fringe. Is there anywhere else I should be looking?

Further update I’ve edited this a bit in response to comments from Peter Boettke. In particular, I’ve changed my treatment of Props 4 and 6. As clarified Prop 4 doesn’t reveal any substantive difference between Austrian and mainstream economics, and Prop 6 is much weaker than it appears.

164 thoughts on “Austrian economics: a response to Boettke

  1. Alice computers are just a tool. Used properly they are wonderful at enabling analysis, model building, forecasting, etc.

    But they are just as good as the programs, which are just as good as the maths.

    What worries me is misuse of packages (statistical, etc). I first saw this trend in the late 70’s, with psychologists using SPSS (on a mainframe) and presenting work with no understading of the meaning of the stats. I had an argument with a PHD in Psychology about the meaningless of an R squared of 0.11. But this was dutifully used and presented.

    There also seems to be paucity of empirical work, assumption seems to the name of the game. Once overheard an argument between two people about the risk premium of shares over bonds. it went on and on. I went to my pc, pulled up some numbers and then went back to and told them it was about x% over the last 10 years. In other words pedagogy replaced solid empirical work.

    DFA’s are another example. The amount I’ve seen where the underlying statistical distributions are assumed and the mean and std deviations are assumed. Then these are used to make capital allocation decisions? Where’s the measurement?

  2. Oldskeptic – one of the senior academics (exec) at UTS is now stating unis must take some responsibility for the mess of the GFC because of the quality of what has been pouring out of economics schools…..and the basis of teaching ie emphasis on neoclassical models I presume..
    I agree.

  3. Thanks Alice, already got it through The Automatic Earth (a great site).

    Look there is a political element to everything, the neo-liberal/neo-classical/neo-conservative movement has always had, largely incoherent I might add, a ‘game plan’.

    I have not looked at neo-classical economics as an ‘economic’ discipline for decades now, rather I see it as an ‘intellectual cover’ for neo-liberal beliefs. This crossover happened in Friedman’s time, in fact he was one of the great offfenders in merging a political structure with an economic one, to the point where you really cannot seperate them (the neo-cons came later and added the military side).

    Which is why JQ, Steve Keen, Roubini, et al (many et al) simply could not get any traction within mainstream economics over the last few decades. They were fighting the wrong game.

    Et al played the technical game, the other side was playing politics (with no interest in technicalities or reality at all). You could present all the maths and data you wanted, but since you were fighting against a political ideology it had absolutely no effect at all. Might as well argue about improving agricultural output with Stalin for all the good it would do you.

  4. Oldskeptic,

    Economics and politics are invariably attached at the hip. Do you think Rudd’s conversion to social democracy came about because he read the works of someone like JK Galbraith?

    Economics is a theory, a “social science” and to presume that there are definitive answers to every question is begging for trouble.

  5. Oldskeptic #154

    you comment

    “I have not looked at neo-classical economics as an ‘economic’ discipline for decades now, rather I see it as an ‘intellectual cover’ for neo-liberal beliefs.”

    I agree. A bit of history Oldskeptic – the free marketeers want intervention when they need it and want regulation when it suits them but there continues to this day a concerted campaign of misinformation to ensure “free market ideology” continues as some sort of bona fide justification being a genuine economic theory ‘n all (and its a nonsense).

    Free market ideologies are actively promoted by Corporations when Corporations dont want government watching them (or interfering in their activities) and free markets are the reason proffered when they ask for Government protection and intervention when they need help (like now).

    Of course (the bailout) is proceeding – to help the “free market or free enterprise system.”

    I have to laugh – Friedman won the Nobel in 1976 for …”his demonstration of the complexity of stabilization policy”.

    Yet as Galbraith incisively noted (78 – two years after, nothing much has changed really since);

    “If you believe in the market, you dont allow such things.. (referring to the growth of oligoplies and monopolies or market power) to bother you; you deny that oligopoly makes any difference. This is the position of Professor Milton Friedman and his very distinguished communicants. And on occasion they produce statistics to show that concentration and oligopoly are not getting any worse.”

    “Quite a few liberal economists accept that concentration and oligopoly undermine the neoclassical market but hold that the trend will somehow, someday, be reversed. Their faith is also in the competitive market.”

    “Where, as occasionally happens, an oligopoly has difficulty maintaining prices it comes to the government for help in doing so. And our airlines have been fighting desperately to keep government price fixing of air fares as well as control over the granting of routes. They dont want any Freddy Lakers ..getting loose in the domestic market. Government regulation of fares and route allocations, they have been arguing, is an exceptionally advanced form of free enterprise.”

    Just what we are hearing now from AIG and others (and the car manufacturers).

    Some things dont change Oldskeptic. I dont like being taken for an idiot and I dont like seeing good economists, as you mention above, swimming against a tide of mud but it happens, it keeps on happening and its probably always happened.

    Corporations etc – toying with economic ideas courtesy of “expert economists” who deliver stats on standby (starting with the Chicago School – still keeping up the fine tradition).

    There are times when I wish a hole would open up in the ground and swallow the footsoldiers of the economics disinformation campaign (but then I realise they are probably just angling for a promotion in the Financial services firm they work for or a Treasury posting – God help us all -but actually, can economic policy get any worse? I doubt it. ).

  6. “Thankyou Rafael – but you missed the irony alert.”

    Well, I knew that you do not consider the concept of efficiency relevant. But I like to explain anyway.

  7. Alice,
    Most corporations hate the free market. They would much prefer to be protected from competition and showered with goodies from governments than to compete honestly and openly. Support for this kind of nonsense comes from across the political spectrum but much more strongly from the left. In opposing corporate welfare you become, if only for a brief moment, a free market economist.

  8. Alice:

    “I agree. A bit of history Oldskeptic – the free marketeers want intervention when they need it and want regulation when it suits them but there continues to this day a concerted campaign of misinformation to ensure “free market ideology” continues as some sort of bona fide justification being a genuine economic theory ‘n all (and its a nonsense).”

    Total nonsense – no free marketer wants interventionfor his self interest, but intervention to stop his competitors using the powers of the state to ruin his business so his competitors benefit.

    An intervening free marketer is an oxymoron.

  9. 158# Joseph
    I not only oppose the huge bailouts to AIG and the rest to save them (which as you note, may for a moment, make me a free marketeer) but after that I support as much regulation as it takes to hogtie them to home (which makes me an interventionist and an anti globalisationalist with regards to finance), to prevent at every turn these firms becoming global gigantors with tentacles in every nation’s money systems, cut them up into regional small banks with functional purpose and force the execs back down to local bank manager status (no more Brioni suits – just boring old pinstripes).

  10. Alice,
    You should expand your social circle to meet more bankers. They’re really not such bad people and don’t deserve much of the venom currently being spat at them.

  11. “Prices are numbers after all, and information is a mathematically precise concept.”

    There are more information than the prices alone in the markets. And therein lies the weakness of both neoclassical and keynesian economics, this refusal to accept that human behavior is not a mathematically precise concept.

    There are no equations that can perfectly reproduce human behavior, thus models need to rely on approximate equations. This makes both neoclassical and keynesian economics scientifically invalid at the starting block.

    For complex systems such as markets or the economy, models are sensitive to imperfect equations because the systems consist of a delicate balance of opposing forces, so a slight imbalance in their representation has big effects. That is why policy prescriptions always end up in failure or with worst unintended consequences.

    I do regret that you chose this Boetkke piece for your analysis though. A serious discussion of Austrian economics requires the reading of Hayek or Mises (I prefer Hayek). I provide excerpts from Hayek about mathematics to close on the subject:

    “…it is an erroneous belief, characteristic of bad mathematicians, that mathematics is essentially quantitative and that, therefore, to build on the great achievements of the founders of mathematical economics, men like Jevons, Walras and Pareto, one has to introduce quantitative data obtained by measurements. That was certainly not the intention of the founders of mathematical economics. They understood much better than their successors that algebraic mathematical formulae are the pre-eminent method for describing abstract patterns without assuming or possessing particular information about the specific magnitudes involved (…)

    The second point which I want to make is that a particular reason which in the physical sciences make measurements of concrete magnitudes the hallmark of scientific procedure for a very definite reason do not apply to the explanation of human action (…)”

  12. As regards my choice of Boettke, I’m not in a position to arbitrate between Mises and Hayek, and I wanted to write about what (is taken to be) Austrian economics now, not in the first half of C20 when Mises and Hayek were active in economics. Most neoclassicals would argue that the mainstream has long since absorbed what was useful in the work done back then. The idea that there exists a distinct Austrian school depends on the claim that current Austrians are doing useful work.

    On your methodological points, Hayek is here praising mathematical economics at the expense of econometrics. You (like most Austrians) seem to be opposed to mathematical methods in general – certainly there is very little math in the Austrian publications I’ve seen.

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