Reading What Austrian Economics IS and What Austrian Economics Is NOT (Steven Horwitz) Transcipt

I'm Steve Horwitz, Charles A. Dana Professor of St. Lawrence University in Canton, New York.

What I'd like to talk about today is what Austrian Economics is and what Austrian economics is not. We actually start with what Austrian economics is not. For many people, Austrian economics is often defined as free market economics or defined in terms of part of the classical liberal tradition, and it certainly is. But I think it's important to distinguish the analytical propositions of Austrian economics. That is, how Austrian economics describes the world from the policy conclusions that we often associate with it. So in that sense, what Austrian economics is not is it's not free market economics. Rather, it's a set of claims about how markets work, about how economies work, and about how the social world works. It's a framework for economic analysis and not a set of policy conclusions.

So for example, one of the things that Austrians claim is that only individuals choose. When we talk about things such as Walmart lowering prices or we say the government raised taxes, in a way we're speaking metaphorically. We're not talking the government as a whole does an act, Walmart as a whole does an act. When we say those things, what's really happening is that individuals within the organization we call Walmart or the organization we call government are making choices, and those choices are reflected in the way in which Walmart, again, lowers prices or the government raises taxes.

Another claim that Austrians make in the economic world is about understanding the role of exchange and the way in which institutions and rules condition those exchanges. What I mean by that is the following. The most fundamental fact about market economies is that people engage in exchange to improve their well-being. I trade with you, you trade with me. When we trade, what we say in economics is that that trade is ex ante - that is, before the fact - mutually beneficial. We trade because we think we'll both be better off. That's the fundamental fact of economics. But what Austrians point out is that not just about our markets about exchange, but what matters for how well those exchanges go that is how effective those exchanges are in improving people's well-being. Are the institutions in the rules within which people operate? So in economies, for example, that protect private property will see better results from exchange than economies that don't protect private property.

Another claim that Austrians make about the way the world works is that cost and utility are subjective. What Austrian economists mean by that is that only the chooser can know for sure how valuable a good is or what the cost of their actions are. All economists, of course, talk about the idea of opportunity cost. When we choose one thing, the cost of that choice is the next best thing we gave up. But what Austrians emphasize is that opportunity cost is both subjective and expected. What Austrians mean by that is that only you can know what you imagined you would have gotten out of the choice you didn't make. So if I choose to eat at one restaurant rather than another, the cost of choosing the one restaurant is what I thought I would have gotten out of going to the other. I never know for sure. Cost is actually never experienced precisely because we give it up.

Austrians also argue that prices are knowledge surrogates and that the price system as a whole economizes on the amount of knowledge and information that people need in order to make choices. What Austrians are saying with this claim is that when we think about how market systems operate, ideally what we want to happen, for example, when a particular good gets more scarce is we want people to use less of it. Friedrich Hayek's famous example about a tin shortage is the one that is frequently invoked. If for some reason the supply of a natural resource shrinks, we want people to use less of it because the good is more scarce. But how do we tell people? How do we inform people that this good is now in short supply? What Hayek and other Austrian economists have argued is this is exactly what the price system does. The people who actually are at the forefront and know what happened to this resource begin to economize on their use of it, they will demand more for it if someone wants to buy it from them. As that price starts to go up, buyers realize that that resource is more expensive. The things that they're making out of that resource, they now realize will be more valuable. They start looking to get a higher price for it and so on.

Eventually, this rising price ripples all the way through the economy. And people at the other end of it - consumers are going to the store and are buying a product that they don't even know is made out of this particular material - face higher prices. They're now led to make different choices. Faced with that higher price, they will substitute away from the good that's using this more scarce resource into something else. What's great about this is that no one needs to know. Or at least most people don't need to know exactly why this resource became scarce or even that it became scarce. All we need to see is the rising price. What the rising price does is provide us with incentives wrapped in knowledge. That is, the rising price tells us that this good is more scarce and provides an incentive to economize on it, because now it's more expensive.

What Austrians argue is that this is one of the most important features of the price system - the way in which prices economize on knowledge and serve as knowledge surrogates to inform us about the changes in real resources, about change in the people's preference, about change in people's knowledge.

As important as the role of the price system is in providing knowledge to people, that's only going to work Austrian's claim in a regime where private property is significantly protected. In order for prices to be meaningful conveyors of knowledge in the way that Austrians claim, they have to result from real exchanges made by real people. And the only way people can engage in exchange is if they can own private property and can exchange it with others. So the ability to own private property and to exchange private property in the market place is key to generating prices that are informative in the way that Austrians talk about.

This is particularly true with the prices of inputs, of capital goods - what others are calling the means of production. For a century or more, socialists have claimed that private property in the means of production is exactly the problem with capitalism. And that what socialism would do by making those means of production commonly known was to end the exploitation and alienation that capitalism creates.

What Austrians have argued though as, again, analytical proposition is that without private property and the means of production, without private property and capital, there's no way to get prices of those goods. And if there's no way to get prices of those goods, there's no way to know how scarce they are, there's no way for producers to know whether they're producing efficiently or not. So if we care about having an economy that produces wealth for the most people possible, we need to also care about the fact that the means of production are privately owned. For Austrians, that's not an ideological position. That's an analytical claim about the way in which economies work.

Lastly, Austrians argue that markets, and in fact many social institutions more generally, are what we call spontaneous orders. That is, markets are the product of human action but not human design. Nobody invented the market. Nobody can actually control markets. Markets are evolutionary processes that emerge from the choices of individuals over time.

So once we understand that markets are spontaneous orders, the idea that somehow we can regulate or direct or control them or, again, almost many other social institutions as well, becomes what Hayek called a fatal conceit. That is a false belief in the power of our ability to create and design social institutions. And when we think about Austrian economics at the largest scale possible, it's an understanding that markets are self-organizing adaptive systems and not something that human beings invented and can construct and reconstruct as we wish.

Why then are so many Austrians in favor of free markets if Austrian economics, in and of itself, is a series of claims about how markets and how economies operate? I think the answer to that question is something like the following. If it's true what the Austrians say about how markets operate, and if it's true, for example, that we need private property and capital goods to be able to allocate those goods efficiently, then if one wants to live in a prosperous, peaceful world where people cooperate with each other, where the least well-off among us do as well as possible, then one would want to adopt those free market institutions as a way to get to those results.

So Austrian economics is a framework for understanding how markets work. The kinds of classical liberal and free market policy conclusions one might draw from Austrian economics require other arguments or other assumptions or other ethical beliefs to get to those conclusions. But Austrian economics is not free market economics. Austrian economics is a series of claims about how markets work, about how economic systems work.