What is Austrian economics?

The origin of Austrian Economics dates back to 1871 through Carl Menger’s Principles of Economics. Since its first appearance the Austrian School of Economics fell out of popularity for much of the 20th century. Over the last 50 years however there has been a great resurgences in the laissez-faire ideas espoused by the Austrian School, through notable Austrian Frederich Hayek’s Nobel Prize and the followers of iconic Austrian economists Ludwig von Mises and Murray Rothbard. Furthermore during the Republican 2012 presidential candidate bid, popular candidate Ron Paul consistently professed his support for Austrian Economics, again bringing it to the forefront of attention. So what is Austrian economics? Despite its increasing prominence, the answer to this question is seldom answered by the average economics student. In this article I will attempt to explain the basis of rationale Austrians use to study the economy and understand markets.

There are three main cornerstones upon which Austrian Economics is built upon, the first of which is methodological individualism. Austrian economists would argue that the economics is the study of individuals, as they are the only unit who actually act. Although this is not exclusive to Austrian economics, the difference to mainstream economics is that it does not stress the maximising behaviour of individuals. The idea behind this is that it is impossible for individuals to assert that they are maximising gains or minimising costs. So instead, Austrian economics analyse the process upon which individuals receive information and subsequently form expectations upon the ideal solution. Furthermore, Austrians refrain from mathematical use in capturing what will take place in the economy as it fails to capture the complex social behaviour of humans.

The second main pillar of Austrian economics is methodological subjectivism. This tenet asserts that actions of individuals are based on a scale only understood by the individual. Austrians thus view that economic value of a good is different for each individual, and thus there is no one efficient action for all individuals within the economy.

Finally Austrian economics are concerned with the process of decisions rather than the end state. While mainstream economics often focuses upon the end results of individuals’ actions, Austrians however argue that the outcome of the execution of each individual’s decision is unpredictable. For this reason Austrians believe there is no end state but rather individuals continually act in a way appropriate to continual information.

These three tenets form a very different viewpoint of economics than that which is usually taught in textbooks. To the Austrian economist all costs and benefits are subjective and unmeasurable so only individuals can decide whether decisions are efficient or inefficient. Through this Austrians challenge general equilibrium analysis that supply equals demand. The assumption this model makes is that individuals know that prices are tending towards the equilibrium price. But this raises the question as to why a market isn’t already operating at the equilibrium price if it is known. Thus, Mises’ argues that although prices are indeed being moved by some ‘invisible hand’ to a final price, this final price is also consistently changing simply by the varying and dynamic nature of human behaviour. Mises asserts that equilibrium can only occur in a fictional world where the same market transactions are repeated again and again allowing no room for entrepreneurial functions.

Another important implication of Austrian economics is the idea of economic efficiency. For an Austrian economist, efficiency is defined as the fulfilment of purposes most important to the individuals rather than the ones which are less so. Through this, the commonly known Austrian concept of opportunity cost arises. Opportunity cost is the value attributable to the next best alternative foregone when performing an action. Austrians measured the relative importance of individual’s purposes through considering their opportunity cost.

The Austrian philosophy also leads to many implications about public policy. One of the core beliefs of Austrian economists is the destructive nature of central planning. Both Mises and Hayek argue that in a centrally planned economy that the information used by the planners is miniscule in comparison with the total information available in the economy. For this reason much of the available information is never acted upon and thus inefficient decisions are made. In the free market however, with private ownership of production each individual can act upon his or her own information and as such generate appropriate market prices for resources. In this instance the market price now summarises the knowledge of every actor within the market. With public policy however, there are instances of information asymmetry where the central planner is unable to detect buyer and seller price signals and by enacting central resource allocation this will further distort prices signals.

The Austrian school of economics is indeed one of my favourite schools of economic thought. Its analysis of the economy is much broader than the one presented in this article, from its views on the business cycle to the emergence of mal-investment. Its focus upon individuals truly differentiates itself from mainstream economics and perhaps its focus on processes and not exact mathematical outcomes is the answer to the call for pluralism.


Further reading

[1] Ludwig von Mises Institute (June 2011), “What is Austrian Economics”, http://mises.org/etexts/austrian.asp

[2] Walker, D (2012), “Austrian Economics”, http://www.econlib.org/library/Enc1/AustrianEconomics.html

[3] Horwitz, S (2010), “What Austrian Economics is?”, http://www.coordinationproblem.org/2010/11/what-austrian-economics-is-and-what-austrian-economics-is-not.html