The Austrian Keys

By Leo Dunbar, Age Monthly Review, Melbourne 1985.

The economic affairs of many countries and the dismal science itself are in a very sorry state. Shortsighted protectionist policies in Western countries aided by ideologically crazed dictators at home have destroyed the economies of the Third World resulting in famine and civil war. The collectivist utopia has yet to emerge from the ruin of human rights in the Marxist states. The Keynesian revolution has delivered the twin spectres of inflation and unemployment. People search for solutions where they want to find them instead of looking where they are, like drunks hunting for their keys under the street-light, not in the lane where they fell to ground.

We rightly suspect simple solutions for complex problems but many of our economic and related social ills do indeed have a single basic cause, manifest in a thousand guises ranging from the Egg Marketing Boards to the Australian wage fixing Commission and the tariffs which raise the price of our clothing and shoes by half.   The root of economic evil is the disruption of open markets by constraints on trade, state-protected monopolies, cartels, and counter-productive regulations and charges. The keys which ‘fell in the lane’ are the ideas of the Austrian school of liberal economists, founded by Carl Menger (1840-1921), Friedrich von Wieser (1851-1926) and Eugen von Bohm-Bawerk (1851-1914). Other major figures are Ludwig von Mises (1880-1973), Friedrich A. Hayek (the 1974 Nobel Laureate), Ludwig Lachmann, Israel Kirzner and Murray Rothbard.

Their ideas support the policies of open markets and free trade, now labelled ‘economic rationality’ or ‘dryness’ and in the current political climate this may be their main interest.   But their impact ranges far beyond economic policy to embrace all aspects of methodology in the human sciences.   The Austrians addressed the dilemma of human knowledge and action under conditions of uncertainty, long before the official collapse of positivism precipitated the modern crisis of confidence in science and reason. Their framework for analysis of human action has turned up in the work of later theorists including Max Weber, Talcott Parsons and Karl Popper, without recognition of Menger’s prior achievement.

The ideas of the Austrian school challenge the interventionist role of the state whether by socialist central planning or by Keynesian fine-tuning. They challenge the dominant paradigms in mainstream   economics,   both   the equilibrium   analysis   of neoclassical micro-economics and the numerology of neo-Keynesian macro-modeling. A revival of Austrian modes of thought would precipitate a major paradigm shift in theory and in economic policy as well. So far this danger has been avoided by the simple expedient of ignoring them.   Particularly amusing examples of this intellectual astigmatism are afforded by Talcott Parsons and his younger   colleague Thomas R. Merton. Parsons established himself as the leading American social theorist of his generation with a gigantic tome called The Structure of Social Action (1937). This drew from the works of Durkehim, Pareto, Marshall and Weber to re-invent the Austrian wheel of methodological individualism, articulated by Menger more than half a century earlier. Parsons read German and studied in Germany so he could not use the usual Anglo-Saxon excuse that Menger’s works were not accessible to him. Merton specialised in the history of ideas and especially in simultaneous or parallel discoveries but he missed this one, in his own field. Some popular writers on economics such as Lester Thurow (Dangerous Currents), John K. Galbraith   and the late Joan Robinson apparently   have no knowledge or understanding of the Austrians.

Marxists and other supporters of pervasive state intervention such as Galbraith have done well to ignore the work of Menger, Mises and Hayek because they refuted the intellectual core of Marxism, leaving an empty ideological husk.   Marxist principles cannot survive the confrontation with historical evidence and Austrian analysis.

The decline of the Austrians

Four reasons account for the eclipse of the Austrian tradition. First, economics fell under the spell of mathematical analysis. Second, the subjectivism and methodological individualism of the school were misrepresented as ontological individualism, as a claim that only atomistic individuals existed, independent of social contexts and historical influences. Third, the Austrians taught that the undesirable conseqences of most forms of state intervention in markets far outweigh the intended effects and this put them at odds with all progressive social movements up to the present time. It has also enabled opponents to falsely depict market liberalism as a form of   conservativism. Fourth, after 1914 the school did not exist in any formal sense because Menger, Weiser and Bohm Bawerk had no instinct for academic empire building.

Philip Mirowski, writing in ‘Physics and the marginalist revolution’ Cambridge Journal of Economics (1984) described how Jevons, Walras, Edgeworth and Pareto placed mathematics at the heart of the new economics and systematically lifted themes and concepts from Newtonian mechanics.

‘The hard core of neoclassical economic theory is the adoption of mid-nineteenth century physics as a rigid paradigm, a hard core it has preserved and nourished throughout the twentieth century’.

This hard core produced a linkage of neoclassical economics with mathematical formalism; consequently much work in econometrics and model building has little practical application and belongs to pure mathematics.   This line of thought assumes perfect competition, complete knowledge and unfailing rationality. The Austrians harboured none of these assumptions but the Newtonian hard core made their work appear primitive and unscientific in comparison with the mathematical formalism in the mainstream of the subject.

Menger participated with Walras and Jevons in the marginalist revolution but his methodological interests ran deeper. He rejected   the Newtonian paradigm because he believed   that sociology and economics could not use the methods of the natural sciences. In his search for a true science of economics he wrestled with Kant’s problem of the demarcation of science and his polemic against the crude empiricism of the historical school led him to Hume’s problem of induction. His obsession with these problems (which are still unresolved) limited his output and in the last three decades of his life he wrote virtually nothing.

One of the most distinctive features of the Austrians is their subjectivism, especially the subjective theory of value   which distinguished Carl Menger from Walras and Jevons. His Grundsatz der Volkswirtschaftslehre (Foundations of Economics, 1871) placed the individual at the centre of the social scene; not the hedonistic social atom of classical theory, rather the individual with all his or her diverse wishes, wants, sentiments and attachments.   This takes account of   historical and social factors, and also of the knowledge and values internalised by individuals.   Knowledge is always imperfect and so a systematic study of human affairs must take account of the unexpected and unintended outcomes of actions and plans. The flux of events dictates that a realistic analysis must address the dynamic aspects of social and economic processes.   Ludwig von Mises   wrote in Notes and Reflections

“What distinguishes the Austrian School and will lend it immortal fame is precisely the fact that it created a theory of economic action and not of economic equilibrium or   non-action. The Austrian School endeavours to explain prices that are really paid in the market, and not just prices that would be paid under certain, never   realizable   conditions.   It   rejects   the mathematical method, not because of ignorance of mathematics or aversion to mathematical exactness, but because it does not emphasise a detailed description of a state of hypothetical static equilibrium’.”

Myths and markets

Austrian studies of real markets and the effects of technological innovation refute many myths. One of these is the view that capitalism is a system which generates misery and injustice, a notion which persists either as an article of religious faith or as an assumption picked up from some authority such as Bertrand Russell and never re-examined.

‘The industrial revolution caused unspeakable misery both in England and America. I do not think that any student of economic history can doubt that the average happiness in England in the early nineteenth century was lower than it had been a hundred years earlier; and this was due almost entirely to scientific technique’ (Bertrand Russell in   The Impact of Science on Society).

The best evidence against this picture is in the voluminous files collated for the Royal Commissions and Committees of Inquiry conducted from the eighteenth century into the 1850s. The workers did not live in pastoral bliss before the industrial revolution; instead they eked out miserable and precarious existences from one famine or plague to the next. The revolution improved their wages, their health and their life expectancy. Those who suffered the lowest wages and the cruelest working conditions   were those least affected by the new modes of production, especially domestic servants and farm labourers. Much of this evidence is summarised in Capitalism and the Historians edited by Hayek, especially in Hutt’s paper on the Factory System. To balance Charles Dickens’ bleak picture of factory work consider the situation of Charlotte Bronte, constrained by her social status form ‘menial work’ in the mills, forced to the servitude of governess duty, frantic with discontent at her lot, and craving for the shorter hours and better pay of the “repressed and exploited” millhands. Actually the Dickens view does not do justice to the reality.

Mises and Hayek demolished the idea that central planning for the whole economy would be more efficient than the ‘anarchy’ of the open marketplace. The major methodological problem of socialism or a central command economy is the calculation of all the inputs and outputs required in each and every sector of the economy and every single production unit. Mises and Hayek concluded that this problem is insoluble, so there is no way that such a system could function.   This argument is entirely technical (value free) and does not depend on objections to the regimentation that would be required in such a system.   It is widely believed that the calculation problem has either been solved (in principle) or may be solved with aid of modern computers but this ignores the real-world fact that both the Soviet Union and China are moving away from their attempts at central ‘command’ planning to allow more free play for market forces.   The Austrians are not Utopians and they never claimed that the real world contains perfect competition or perfectly efficient resource-allocation; the command economy is criticised not merely for being less efficient (as it clearly is when steps are taken in that direction), but for being impossible in principle.

Austrian analysis in Australia

An ‘Austrian’ in Australia demonstrates the strength of the Austrian analysis of our economic predicament. In The Destruction and Creation of Jobs (Australian Institute for Public Policy, 1985)   Wolfgang Kasper explored the destructive effect   on employment of the “stop-go” policymaking which has prevailed in Australia, whereby successive governments deliver various brands of snake oil to the creaking wheels of industry.   The selection of policy instruments has been too narrow and concentrated in the area of macro-manipulation, whether of the Keynesian ‘print more money’ kind or the monetarist ‘print less money’ variety.   This echoes the comment by Brittan (Encounter, April ’85) that both Keynes and the monetarists tried to get around the real problem which is malfunction of the labour market due to state-protected monopolies and other rigidities in the centralised wage-fixing system.

The ‘Austrian’ prescription for economic recovery has three major parts;   first, open markets without import restrictions or constraints on entry to local markets; second, a variant on the open market theme,   namely de-regulation of the rigid and centralised wage-fixing system; third, reduced public sector spending and privatisation. These strategies are linked because the problems they address are interlocked; Kasper shows how trade barriers in the form of tariffs and quotas generate leverage for organised labour to form monopolies in the labour market which in turn creates problems for job creation and increased efficiency.   Unfortunately for the Labor ‘dries’ the labour monopolies are apparently untouchable (by Labor). Equally unfortunately for the Liberal dries the tariffs and quotas are sacrosanct for the ‘wets’, the ‘pragmatists’ and their backers in heavily protected industries, especially textiles, clothing and footwear.

  1. Free trade in goods

The case for free trade requires a grasp on the principle of opportunity costs, a concept developed by Menger’s pupil von Weisser. This can be explained by a homely example. Some people will deliberate for weeks over the purchase of an item such as a lawn mower, poring over Choice, visiting discount houses and garage sales to obtain the best value in town. They may save $20 or $25 but the time might have been used to write an immortal sonnet or an article for the Age Monthly Review. In this instance, the opportunity to earn undying fame or hundreds of dollars was foregone in order to buy a slightly cheaper lawnmower; a large but invisible opportunity cost was incurred in saving a visible $25.   This principle can be applied to the tariff barriers against free trade.   The decline of an industry and the loss of jobs is clearly visible as a “social cost” or at least as a social problem for the workers and their families. Hence the appeal of protection from foreign competition which has been the basis of opposition to free trade for centuries.   But protection has a cost due to the lost opportunity   to generate employment and outputs in some more productive enterprise. For example we pay to protect jobs in BHP in three ways: First our steel is more expensive than it should be, adding to the cost of almost everything we buy from cars to tins of cat food. Second, we pay by the diversion of investment towards BHP and away from unprotected   firms which would create more jobs and more wealth. Third, the protected market for steel encourages unions in the metal trades to make extravagant wage claims because the industry can automatically pass on the wage costs in the form of higher prices. This contributes to inflation as do the wage flow-ons in other industries (courtesy of the Arbitration Commission).

The main feature to emerge from this analysis is that protection works against the creation of productive jobs in the medium to long term even if it saves some jobs in the immediate present. In addition it puts up the price of goods which of course impacts heavily on the poor, especially when the items affected are essentials such as clothing and shoes. Tariffs and other forms of interference in free markets have immense welfare implications (by raising prices) and the welfare lobby should take up cudgels in defence of Senator Button against the rag trade which is crying out about job losses if their protective tariffs are phased out. When the function of open markets in keeping prices down is better understood there will be fewer attempts to control prices by expensive and useless embryonic forms of the police state such as Price Justification Tribunals.

Free trade provides an unexpected and important spin-off that demands special notice in this International Year of Peace. Mises studied the restraints on trade imposed by Nazi Germany and he emphasised the importance of free trade as an instrument to promote peace and goodwill between countries. Collapsed economies breed social upheaval and the rise of dictators, who unite   and control   their country by fabricating or creating external threats.   The world is certainly not short of   collapsed economies, mostly due to the ‘beggar my neighbour’ policies of protection that most Western countries pursued after World War II.   An obvious example is the agricultural policies of the EEC and the US which have destroyed the world markets for many farm products and so beggared much of the Third World, not to mention Australian sugar farmers. Seen from this perspective the fund-raising efforts of Bob Geldorf and his helpers miss the point of the problem; they are a ‘band-aid’ effort in the worst sense of the term. Efforts should be redirected to bring pressure to bear upon the signatories of the General Agreement on Tariffs and Trade (GATT) to open up the markets of the world to free trade. Critics of this argument might point to the colonial wars over trade but these were fought to keep other trading countries out or to impose trade upon unwilling partners (as in the Chinese opium wars). These wars were fought for protection, not for free trade so they indicate the danger of the protectionist mentality.

Part of the socialist mythology is the idea that   unrestrained competition leads to monopolies and to exploitation. This ignores the fact that virtually all monopolies that exist at present are either state-owned (Australia Post, the railways) or protected by state regulations and controls (BHP and large sections of manufacturing). The entrepreneurial element is rarely absent from human behaviour and it is interesting to note the forms that this takes in protected industries. Management looks for ways to increase protection or state assistance (instead of production) and employees seek ways to avoid productive work or to create substitutes for it. Similar strategies are employed by workers in that most protected of all industries, the public service, where the entrepreneurial function at upper levels is largely devoted to empire building. Socialist rhetoric in favour of state intervention and control of the economy has been so successful that conservatives have taken up the cause. This highlights one of the features which socialists and conservatives share, namely the belief that any problem demands immediate state interference to   put things in order. Compare tariff protection   and censorship.

  1. The labour market

The mania for central control is epitomised by the centralised wage fixing system. This has come under fire from economic rationalists but critics are still a very small minority. The existing system is widely regarded as a triumph of reformism and a dyke holding back the mutual rancour of capital and labour such that an ‘unholy free for all’ will erupt if the system is relaxed. Against this view, the mischievous effects of the conciliation and arbitration system in slowing down economic growth and generating unemployment are documented by Paddy Mcguinness in The Case Against the Arbitration Commission (Centre for Independent Studies, 1984) and in Wages Wasteland, edited by Hyde and Nurick, (Hale and Ironmonger, 1985).

The Labor Party and the unions castigate John Howard and the de-regulators for lack of a wages policy, insisting that de-regulation will result in higher wages, forced by the threat of industrial mayhem in the absence of central control. This expectation is based on past experience when strikes succeeded because protected industries could capitulate to wage demands and simply put up their prices under threat of strikes or disruption by ‘go slows’ and ‘work to rules’ campaigns. The result is our current slide towards banana monarchy status. But things work differently in open markets because strikes will simply put the firm out of business and throw workers on the dole. The open market turns out to be a device to eliminate industrial conflict, just provided that the rank and file of union members are allowed a secret ballot on strike decisions. After all, they and not the union leaders are the ones who will lose their jobs if they put the company out of business.

De-regulators are likely to run foul of people who believe in ‘wage   justice’ which usually means payment regardless of productivity. The kind of wage justice which we really need means rewards for effort and skill to individual workers or work teams. This may be difficult to organise for some kinds of work but the principle is sound. It could produce large differences in pay among people ostensibly doing the same work but this will be partly a matter of choice (some people will choose to work less or less effectively) and everyone will benefit provided that increased productivity flows on in lower prices. Again the benefits depend on open markets because if competition is lacking then prices can be inflated and the industry can cream off super-profits.

  1. Reduced public expenditure and privatisation

The third   strand of economic rationality is reduced public spending which will be fairly painless as the other policies take effect, though people with vested interests in the status quo will generate a storm of protest. Significant job creation will reduce a major part of the welfare bill.   The elimination of tariffs and other types of interference in markets will dispense with armies of   clerks who tend the   luxurious jungle of regulations.   Privatisation will be on the agenda and here the major need is to dispel the threats put about by entrenched interests who play on the widespread ignorance of the positive function of markets. “Selling the family silver” is one of the derogatory images used to discredit privatisation. Even people such   as Katherine West have castigated the Liberals   for frightening the voters with abstract and jargonistic words such as privatisation and de-regulation. She of all people, as an academic commentator free of the daily grind of Party affairs and Parliamentary duties, is in a position to explain the benefits of the policies that we need for economic recovery so they will cease to be electoral liabilities.

Privatisation is more aptly called ‘participation’ and it is a radical revival of the socialist notion of public ownership of the means of production, instead of ownership by small groups of robber barons.   Socialists want the state to take over the means of production and these are to be held in trust for the   public but this has turned out to be a failure. The obvious alternative is to cut out the middleman (the state) and let everyone have a personal interest in the currently state-owned enterprises (plus wider ownership of shares in private enterprise). Samuel Brittan and   others have advocated   the allocation of   shares   in nationalised industries to everyone, on a pro rata basis and many other techniques can be used to give workers a genuine stake in their enterprise and its efficiency.   Privatisation and participation are ideas with a great future because among the failures of the Thatcher era many aspects of privatisation have emerged as clear winners on many criteria including efficiency and effectiveness, worker morale, innovation and flexibility in responding to the needs of clients.

Four sets of problem people

The ideas of market liberalism are not yet widely understood because four groups of people confuse the issues. These are the ‘do nothing free marketeers’, the conservatives, the ‘dries’ in the Labor Party and the socialist intellectuals. Malcom Fraser and Joh Bjelke Petersen are examples of ‘do nothings’ who mouth the slogans of free enterprise but in fact do not open up markets or dismantle controls and regulations.   The conservatives do not even pretend to support free markets though they claim to oppose socialism, often while they support de facto socialist policies (i.e. the old rural socialists of the Country Party). The Labor dries share many aims of their Liberal counterparts but they are obliged to be especially severe on the ‘New Right’ to deflect criticism from the Left of their own party. And the intellectuals of the Left are so blinkered by their ideological assumptions that they have not started to grasp what Hayek and the market liberals are talking about.

The linkage of market liberalism with ‘Conservativism’ and ‘The Right’ is almost universally assumed and this has provided tremendous leverage for the Left in their polemics against economic rationality. For this reason Hayek raised many eyebrows with his insistence that he is not a conservative at all. His postscript to The Constitution of Liberty titled ‘Why I am not a conservative’ suggested that we should break out of the one-dimensional mode of thought which places the Left, Centre, and Right in a line with the socialist radicals at one end, the conservatives at the other and   classical (non- socialist) liberals in the middle. It is more appropriate to arrange the three groups in a triangle,   each pulling in a different direction. But the conservatives do not really pull at all, they simply slow down the rate of change. They follow social trends without having any positive programme of their own and the trends in recent decades has been towards socialism and interventionism. So the conservatives have become a major impediment to the kind of changes that liberals wish to pursue   to protect civil liberties and to promote economic rationality for the good of all, especially   the poor and the unemployed.   The welfare benefits of dryness have not yet been properly explained.   Dryness promotes welfare by creating jobs and lowering prices. Clearly the best form of welfare is   gainful employment and   price reductions provide relief for people on low and fixed incomes who suffer most severely from the inflationary spiral.

Most of the policies that are sketched above address economic issues but of course poverty and unemployment are not just economic problems.   They are massive human problems and they outcrop in the form of violence, crime, vandalism, suicide, rape and drug addiction. Of course multiple causes are at work but the economic component is especially significant for its effect on youth unemployment. What price social cohesion for the future with almost a quarter of young people denied a stake in society? It is not just the statistics that count; it is the psychic scars of assaults and burglaries, the restricted lifestyles forced on people terrified of public transport at night,   the hopes and dreams of parents snuffed out when the victim of a drug overdose is identified on the mortuary slab.   The ideas of the Austrians need to be revived in the interest of the truth, also for the benefit of the poor in this country and the suffering millions in the Third World.

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8 Responses to The Austrian Keys

  1. It’s unfortunate that so little has changed in the 33 years since this article was published.

  2. Alberto Sampaio says:

    Thank you for sharing. Excellent article. The true is there, but social justice continues to be the mermaid’s song to keep the dreams (nightmare for all) of socialisms (of a greater or lesser degree)

  3. Rod Thomas says:

    The claim that JK Galbraith had no knowledge or understanding of the Austrians is not wholly true. He thought that Hayek had ‘one of the finest and most untouched of late-eighteenth-century minds’ (JK Galbraith, A view from the stands. Hamish Hamilton 1987 p.404).

  4. It’s just too bad that Keynes, and hence, Galbraith, was inspired by Malthus, a discredited early-eighteenth-century mind.

  5. Rod Thomas says:

    As was Charles Darwin, and hence, Karl Popper.
    But I wonder who told the best jokes.

  6. Rafe says:

    Galbraith was a captivating dinner companion as Peter Boettke recorded having dined with him in old age, that was despite fundamental disagreements on economics.
    As for jokes, Galbraith told a story of growing up on a Canadian farm where he was dating a young lady and they happened to witness the congress of a bull and cow. Galbraith opined that he would like to be doing that and the young lady replied ‘Well its your cow!”.

  7. Rod Thomas says:

    Yes, Galbraith recounts that story in his nostalgic book about the Scottish Canadians from whom he was descended. The Austrians also had a wit: Joseph Schumpeter. Richard Swedberg’s study of his life and work includes a list of about 100 of his sometimes witty aphorisms. But that list does not include one that Galbraith heard first-hand from Schumpeter when they were colleagues at Harvard University: ‘one servant is worth a thousand gadgets’.

    We need more humour in the world. Will we ever see their like again?

  8. Rod Thomas says:

    Yes, Galbraith recounts that story in his nostalgic book about the Scottish Canadians from whom he was descended. The Austrians also had a wit: Joseph Schumpeter. Richard Swedberg’s study of his life and work includes a list of about 100 of his sometimes witty aphorisms. But that list does not include one that Galbraith heard first-hand from Schumpeter when they were colleagues at Harvard University: ‘one servant is worth a thousand gadgets’.

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