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The undervalued insights of
the Austrian School of economics
                Marcin Senderski



                                   Warsaw, 7 July 2012
Agenda

1.   What is the Austrian school of Economics
2.   Austrian school vs. neoclassical school
3.   Thoughts and quotations
4.   The Austrian school nowadays
5.   Conclusions


The presentation was prepared on the basis of two major sources:
• Huerta de Soto, J. (2006) Money, Bank Credit, and Economic
  Cycles, Auburn, Alabama: Ludwig von Mises Institute.
• Huerta de Soto, J. (2008) The Austrian School: Market Order and
  Entrepreneurial Creativity, Edward Elgar Publishing.
What is the Austrian School of Economics

In general
•    The Austrian School of economics is a school of economic thought which advocates an individualist
     approach to economics called praxeology
History and ethymology
•    The Austrian School derives its name from the identity of its founders and early supporters, who were
     citizens of Austria-Hungary
Methodology
•    Whereas mainstream economists generally use economic models and statistical methods to model
     economic behavior, Austrian School economists argue that they are a flawed, unreliable, and insufficient
•    Austrians focus on theory rather than empirics, and employ descriptive analysis, i.e. verbal formalism
Reception
•    From the middle of the 20th century onwards, the Austrians have been considered outside the mainstream
•    Austrian views are heterodox and mainstream economists are generally critical of its methodology
•    Mainstream economists generally argue that Austrian economics lacks scientific rigor
Who are the scholars?
•    Multidisciplinary theorists and philosophers, and radical libertarians
Main representatives
•    Friedrich Hayek (Nobel Prize 1974), Ludwig von Mises, Carl Menger, Murray N. Rothbard, Eugen von Böhm-
     Bawerk, Israel Kirzner
Austrian school vs. neoclassical school (1/3)

Points of comparison               Austrian paradigm                      Neoclassical paradigm
Concept of economics (essential    A theory of human                      A theory of decision: maximization
principle):                        action, understood as a dynamic        subject to restrictions (narrow
                                   process (praxeology).                  concept of „rationality”).
Methodological outlook:            Subjectivism.                          Stereotype of methodological
                                                                          individualism (objectivist).
Protagonist of social processes:   Creative entrepreneur.                 Homo economicus.

Concept of information:            Knowledge and information are          Complete, objective, and constant
                                   subjective and dispersed, and they     information on ends and
                                   change constantly. A radical           means is assumed. Practical
                                   distinction is drawn between           (entrepreneurial) knowledge is not
                                   scientific (objective) and practical   distinguished from scientific
                                   knowledge (subjective).                knowledge.
Reference point:                   General process which tends            Model of equilibrium (general or
                                   toward coordination. No                partial). Separation between micro
                                   distinction between micro and          and macroeconomics.
                                   macroeconomics: each problem is
                                   studied in relation to others.
Austrian school vs. neoclassical school (2/3)

Points of comparison              Austrian paradigm                     Neoclassical paradigm
Concept of „competition”:         Process of entrepreneurial rivalry.   State or model of „perfect
                                                                        competition.”

Concept of cost:                  Subjective (depends on                Objective and constant (such that a
                                  entrepreneurial alertness and the     third party can know and measure
                                  resulting discovery of new,           it).
                                  alternative ends).
Formalism:                        Verbal (abstract and formal) logic    Mathematical formalism (symbolic
                                  which introduces subjective time      language typical of the analysis of
                                  and human creativity.                 atemporal and constant
                                                                        phenomena).
Relationship with the empirical   Aprioristic-deductive reasoning:      Empirical confirmation of
world:                            Radical separation and                hypotheses (at least rhetorically).
                                  simultaneous coordination
                                  between theory (science) and
                                  history (art). History cannot
                                  confirm theories.
Austrian school vs. neoclassical school (3/3)

Points of comparison               Austrian paradigm                  Neoclassical paradigm
Possibilities of specific          Impossible, since future events    Prediction is an objective which is
prediction:                        depend on entrepreneurial          deliberately pursued.
                                   knowledge which has not yet been
                                   created. Only qualitative,
                                   theoretical pattern predictions
                                   about the discoordinating
                                   consequences of interventionism
                                   are possible.
Person responsible for making      The entrepreneur.                  The economic analyst (social
predictions:                                                          engineer).
Thoughts and quotations (1/2)

1. Man does not so much allocate given means to given ends, as constantly seek new
   ends and means, while learning from the past and using his imagination to
   discover and create the future (via action). Thus, for Austrians, economics forms
   part of a much broader and more general science, a general theory of human
   action (and not of human decision or choice).
   = PRAXEOLOGY
2. For Austrians, cost is the subjective value the actor attaches to those ends he gives
   up when he decides to pursue a certain course of action.
   = NO OBJECTIVE COSTS
3. Hayek uses the term „scientism” to refer to the unjustified application of the
   methodology of the natural sciences to the field of the social sciences.
   = NO MATHEMATICAL FORMALISM
4. It is obvious that our concept of entrepreneurship is of an essentially humanistic
   nature, a concept which makes economics, as it is understood and advanced by
   members of the Austrian school, the quintessential humanistic science.
   = HUMANISTIC STNDPOINT
Thoughts and quotations (2/2)

5. Those who gauge the just price of an article by the labor, costs, and risks borne by
   the person who deals in or produces the merchandise are seriously mistaken; for
   the just price springs from the abundance or lack of goods, merchants, and
   money, and not from costs, labor, and risks
   = BROAD BASE OF FACTORS INFLUENCING PRICE GENERATION
6. The equilibrium price depends on so many specific circumstances that only God
   can know it.
   = AWARENESS OF LIMITATIONS
7. All unjustified intervention in the market constitutes a violation of natural law.
   = LIBERTARIANISM
8. The dynamic process of entrepreneurial coordination would eventually lead
   toward a state of equilibrium, though this state can never be reached in real life.
   = DYNAMISM
9. It is never feasible for the blind to lead the sighted.
   = CRITIQUE OF GOVERNMENT INTERVENTION
The Austrian school nowadays

Myths regarding the Austrian school or the points of critique raised by neoclassicals:
1. The two approaches (the Austrian and the neoclassical) are not mutually exclusive,
   but complementary
2. Austrians should not criticize neoclassicals for employing simplified assumptions
   which make reality easier to understand
3. Austrians fail to formalize their theoretical proposals
4. Austrians produce very few empirical studies
5. Austrians jettison economic forecasting
6. Austrians lack empirical criteria by which to validate their theories
7. Austrians are dogmatic
Conclusions

Major „sins” of neoclassical economists that „feed” Austrian economists:
1. Neoclassicals focus exclusively on equilibrium states via a maximizing model
   which presupposes that the information is „given”
2. Neoclassicals often arbitrarily select variables and parameters for both the target
   function and the restrictions, and in doing so, they tend to include the most
   obvious aspects and overlook others which, though of vital importance, are more
   difficult to handle empirically (moral values, habits and traditions, institutions etc.)
3. Neoclassicals concentrate on equilibrium models which treat true cause-effect
   relationships with mathematical formalism and thus blur them
4. Neoclassicals raise mere interpretations of historical reality to the level of
   theoretical conclusions, interpretations which may be significant in certain specific
   situations, but which cannot be considered theoretically valid on a universal
   scale, since they reflect only knowledge which is historically contingent
5. The insufficient attention to the role played in the market by subjective
   information, knowledge, and learning processes

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The undervalued insights of the Austrian School of economics

  • 1. The undervalued insights of the Austrian School of economics Marcin Senderski Warsaw, 7 July 2012
  • 2. Agenda 1. What is the Austrian school of Economics 2. Austrian school vs. neoclassical school 3. Thoughts and quotations 4. The Austrian school nowadays 5. Conclusions The presentation was prepared on the basis of two major sources: • Huerta de Soto, J. (2006) Money, Bank Credit, and Economic Cycles, Auburn, Alabama: Ludwig von Mises Institute. • Huerta de Soto, J. (2008) The Austrian School: Market Order and Entrepreneurial Creativity, Edward Elgar Publishing.
  • 3. What is the Austrian School of Economics In general • The Austrian School of economics is a school of economic thought which advocates an individualist approach to economics called praxeology History and ethymology • The Austrian School derives its name from the identity of its founders and early supporters, who were citizens of Austria-Hungary Methodology • Whereas mainstream economists generally use economic models and statistical methods to model economic behavior, Austrian School economists argue that they are a flawed, unreliable, and insufficient • Austrians focus on theory rather than empirics, and employ descriptive analysis, i.e. verbal formalism Reception • From the middle of the 20th century onwards, the Austrians have been considered outside the mainstream • Austrian views are heterodox and mainstream economists are generally critical of its methodology • Mainstream economists generally argue that Austrian economics lacks scientific rigor Who are the scholars? • Multidisciplinary theorists and philosophers, and radical libertarians Main representatives • Friedrich Hayek (Nobel Prize 1974), Ludwig von Mises, Carl Menger, Murray N. Rothbard, Eugen von Böhm- Bawerk, Israel Kirzner
  • 4. Austrian school vs. neoclassical school (1/3) Points of comparison Austrian paradigm Neoclassical paradigm Concept of economics (essential A theory of human A theory of decision: maximization principle): action, understood as a dynamic subject to restrictions (narrow process (praxeology). concept of „rationality”). Methodological outlook: Subjectivism. Stereotype of methodological individualism (objectivist). Protagonist of social processes: Creative entrepreneur. Homo economicus. Concept of information: Knowledge and information are Complete, objective, and constant subjective and dispersed, and they information on ends and change constantly. A radical means is assumed. Practical distinction is drawn between (entrepreneurial) knowledge is not scientific (objective) and practical distinguished from scientific knowledge (subjective). knowledge. Reference point: General process which tends Model of equilibrium (general or toward coordination. No partial). Separation between micro distinction between micro and and macroeconomics. macroeconomics: each problem is studied in relation to others.
  • 5. Austrian school vs. neoclassical school (2/3) Points of comparison Austrian paradigm Neoclassical paradigm Concept of „competition”: Process of entrepreneurial rivalry. State or model of „perfect competition.” Concept of cost: Subjective (depends on Objective and constant (such that a entrepreneurial alertness and the third party can know and measure resulting discovery of new, it). alternative ends). Formalism: Verbal (abstract and formal) logic Mathematical formalism (symbolic which introduces subjective time language typical of the analysis of and human creativity. atemporal and constant phenomena). Relationship with the empirical Aprioristic-deductive reasoning: Empirical confirmation of world: Radical separation and hypotheses (at least rhetorically). simultaneous coordination between theory (science) and history (art). History cannot confirm theories.
  • 6. Austrian school vs. neoclassical school (3/3) Points of comparison Austrian paradigm Neoclassical paradigm Possibilities of specific Impossible, since future events Prediction is an objective which is prediction: depend on entrepreneurial deliberately pursued. knowledge which has not yet been created. Only qualitative, theoretical pattern predictions about the discoordinating consequences of interventionism are possible. Person responsible for making The entrepreneur. The economic analyst (social predictions: engineer).
  • 7. Thoughts and quotations (1/2) 1. Man does not so much allocate given means to given ends, as constantly seek new ends and means, while learning from the past and using his imagination to discover and create the future (via action). Thus, for Austrians, economics forms part of a much broader and more general science, a general theory of human action (and not of human decision or choice). = PRAXEOLOGY 2. For Austrians, cost is the subjective value the actor attaches to those ends he gives up when he decides to pursue a certain course of action. = NO OBJECTIVE COSTS 3. Hayek uses the term „scientism” to refer to the unjustified application of the methodology of the natural sciences to the field of the social sciences. = NO MATHEMATICAL FORMALISM 4. It is obvious that our concept of entrepreneurship is of an essentially humanistic nature, a concept which makes economics, as it is understood and advanced by members of the Austrian school, the quintessential humanistic science. = HUMANISTIC STNDPOINT
  • 8. Thoughts and quotations (2/2) 5. Those who gauge the just price of an article by the labor, costs, and risks borne by the person who deals in or produces the merchandise are seriously mistaken; for the just price springs from the abundance or lack of goods, merchants, and money, and not from costs, labor, and risks = BROAD BASE OF FACTORS INFLUENCING PRICE GENERATION 6. The equilibrium price depends on so many specific circumstances that only God can know it. = AWARENESS OF LIMITATIONS 7. All unjustified intervention in the market constitutes a violation of natural law. = LIBERTARIANISM 8. The dynamic process of entrepreneurial coordination would eventually lead toward a state of equilibrium, though this state can never be reached in real life. = DYNAMISM 9. It is never feasible for the blind to lead the sighted. = CRITIQUE OF GOVERNMENT INTERVENTION
  • 9. The Austrian school nowadays Myths regarding the Austrian school or the points of critique raised by neoclassicals: 1. The two approaches (the Austrian and the neoclassical) are not mutually exclusive, but complementary 2. Austrians should not criticize neoclassicals for employing simplified assumptions which make reality easier to understand 3. Austrians fail to formalize their theoretical proposals 4. Austrians produce very few empirical studies 5. Austrians jettison economic forecasting 6. Austrians lack empirical criteria by which to validate their theories 7. Austrians are dogmatic
  • 10. Conclusions Major „sins” of neoclassical economists that „feed” Austrian economists: 1. Neoclassicals focus exclusively on equilibrium states via a maximizing model which presupposes that the information is „given” 2. Neoclassicals often arbitrarily select variables and parameters for both the target function and the restrictions, and in doing so, they tend to include the most obvious aspects and overlook others which, though of vital importance, are more difficult to handle empirically (moral values, habits and traditions, institutions etc.) 3. Neoclassicals concentrate on equilibrium models which treat true cause-effect relationships with mathematical formalism and thus blur them 4. Neoclassicals raise mere interpretations of historical reality to the level of theoretical conclusions, interpretations which may be significant in certain specific situations, but which cannot be considered theoretically valid on a universal scale, since they reflect only knowledge which is historically contingent 5. The insufficient attention to the role played in the market by subjective information, knowledge, and learning processes