EconoMonitor

The Austrian and Chicago Schools

This is from History of Economic Thought: A Critical Perspective, by E.K. Hunt, a long out of print textbook I had when I was an undergraduate at CSU Chico. It explains how the “Austrian and Chicago schools reduce all human behavior to rational maximizing exchanges and hence are able to prove that in every respect, economic and non-economic, a free market, capitalist system is the best of all possible worlds,” and gives some of the critical reactions to that point of view:

The Austrian and Chicago Schools

The school of neoclassical economists that advocates extreme laissez-faire Capitalism represents the contemporary counterparts of Senior and Bastiat. In a sense this group really represents two separate but similar schools – the Austrian School and the Chicago School. The Austrian School traces its lineage directly back to Carl Menger (Chapter Eleven), Menger’s extreme methodological individualism is the basis of the social philosophy of the Austrian School.

While Menger’s first generation of disciples included both social reformers and conservatives, the ultraconservative nature of the Austrian School is more properly thought of as the product of two of Menger’s second-generation disciples, Ludwig von Mises and Friedrich A. Hayek. Both von Mises and Hayek taught at various times at the University of Chicago. Together with Frank H. Knight, who taught for many years at the University of Chicago, they were the most important influences in the formation of the Chicago School. For the past generation, Milton Friedman has been the most influential member of the Chicago School. In 1976, Friedman was awarded the Nobel Prize in economics.

The problem with classifying the Austrian and Chicago schools together is that although they both emphasize the universal beneficence of exchange, extreme individualism, and a doctrinaire advocacy of laissez-faire, they have methodological differences. The Austrians generally advocate a rationalist approach to economic theory, while Milton Friedman and his followers generally advocate an empiricist approach. Although it is currently very common in the academic economics profession to hear all extremely individualistic advocates of laissez-faire referred to as the “Chicago School,” it is probably more accurate to say that the more conservative wing of contemporary neoclassicism is about evenly divided between those who on methodological grounds follow the Austrian School and those who follow Friedman’s Chicago School. We do not believe these methodological differences to be terribly significant,17 so we shall consider these contemporary advocates of extreme laissez-faire together.

One of the most frequent claims of these schools, which is nearly identical to that made by Senior and Bastiat, is that their theory is pure, value-free science that contains no normative judgments at all. Friedman, for example, argues “that, in principle, there are no value judgments in economics.”18 Similarly, Richard McKenzie and Gordon Tullock have written: “The approach of the economist is amoral. Economics is not concerned with what should be, … but rather with understanding why people behave the way they do. “19 They maintain that their “analysis is devoid (as much as possible) of our own personal values.”20 In a widely used textbook written from the Austrian and Chicago perspective, Armen Alchian and William Allen have stated: “Economic theory is ‘positive’ or ‘non-normative.’ “21

Not only is the theory of these schools purported to be pure value-free science, it is claimed that only their theory merits the name economics and that their theory is equally valid for all people, in all social systems, in all times. In their introductory chapter, for example, McKenzie and Tullock proclaim: “In fact, it is the thought process or the mental skill developed below [in their book] that defines an economist.”22 The modesty of the devotees of these schools is matched only by the purported scope of their theory. Their theory “is a valid core of economic theory applicable to all economic systems and countries.”23

Before the reader becomes overawed by the claim of the Austrian and Chicago schools as constituting the only value-free economic theory that explains all behavior, in all societies, in all places, and in all times, we suggest a careful consideration of the following statement by Joan Robinson (who made many original theoretical contributions to neoclassical theory – admittedly of the liberal variety – in the 1930s, before she abandoned neoclassicism):

There has been a good deal of confused controversy about the question of ‘value judgments’ in the social sciences. Every human being has ideological, moral and political views. To pretend to have none and to be purely objective must necessarily be either self-deception or a device to deceive others. A candid writer will make his preconceptions clear and allow the reader to discount them if he does not accept them. This concerns the professional honour of the scientist. 24

A reading of the literature of the Austrian and Chicago schools shows their analyses to be about as value free as the writings of Senior, Bastiat, and Menger (who also made that claim). In fact, it shows that the values that have always been at the base of the most extremely conservative, utilitarian, laissez-faire tradition clearly form the foundations for these schools. The writings of these schools could be quite accurately characterized as the ideology of Bastiat stated in terms of the maximizing marginal calculus.

The Austrian and Chicago schools are generally not particularly bothered by the four major areas (listed above) in which liberal neoclassicists believe that the competitive laissez-faire theory is not a good representation of reality, and so, unlike the liberal school, they see very few reasons to extend the proper scope of government activity beyond the protection of the existing system of market power (that is, the protection of private property and the enforcement of contracts). They generally reduce, as we shall see, all human behavior to acts of exchange. Marx said of Bastiat and the other precursors of these schools, when one looks only at exchange, one is struck with the illusion that capitalism is a veritable Eden of the rights of man – freedom, equality, property, and Bentham (see the quotation by Marx in Chapter Nine). The four liberal neoclassicist objections to extreme laissez-faire are summarily disposed of by the Austrian and Chicago schools.

First, they maintain their faith in Say’s Law of the automaticity of the market. They simply assert that what instability has been observed in capitalism is wholly the fault of too much government. Thus, Friedman writes: “The fact is that the Great Depression, like most other periods of severe unemployment, was produced by government mismanagement rather than by any inherent instability of the private economy.”25

Second, they simply deny that the gigantic corporations generally have any significant or meaningful monopoly power. Again, Friedman writes: “The most important fact about enterprise monopoly is its relative unimportance from the point of view of the economy as a whole.”26 The small and insignificant amount of monopoly power that does exist is almost never due to the actions of capitalists. Any attempts on the part of private capitalists to secure monopoly power, Friedman assures the reader, “are generally unstable and of brief duration unless they can call government to their assistance.”27 Once again, government, not the capitalist, is the culprit (although the evil is small and insignificant): “Probably the most important source of monopoly power has been government assistance.”28

Third, the only “legitimate” socially consumed good that these schools generally feel the government should provide is defense. “I cannot get the amount of national defense I want and you, a different amount.”29 In this particular case, the government can provide us with defense, but in nearly all other cases “government intervention limits the area of individual freedom”30 and is therefore undesirable.

Fourth, we have already discussed these schools’ reaction to externalities (see Chapter Fifteen). Their answer is to create property rights to pollute and then to establish a market for the free buying and selling of these rights. We saw that this recommendation is based on these schools’ individualistic belief that externalities are simply metaphysically given. Once one recognizes that individuals can, in fact, create externalities at will (because, in reality, we do live in a social world, not millions of individual worlds), then one sees that the recommendation of these schools would guarantee us that the free market would become an “invisible foot” that would automatically maximize human misery (see Chapter Fifteen).

So the Austrian and Chicago schools dismiss all of the liberal neoclassical economists’ concerns and then advocate extreme laissez-faire. In Capitalism and Freedom, for example, Milton Friedman advocates the elimination of (1) taxes on corporations, (2) the graduated income tax, (3) free public education, (4) social security. (5) government regulations of the purity of food and drugs, (6) the licensing and qualifying of doctors and dentists, (7) the post office monopoly, (8) government relief from natural disasters, (9) minimum wage laws, (I0) ceilings on interest rates charged by usurious lenders, (11) laws prohibiting heroin sales, and nearly every other form of government intervention that goes beyond the enforcement of property rights and contract laws and the provision of national defense. Such are the conclusions of the value-free science of the intellectual descendants of Bastiat. The invisible hand, they believe, will do very nearly everything rationally and efficiently while preserving a maximum of freedom.

If, when reading Veblen’s critique of John Bates Clark, the reader thought that Veblen’s mocking example (in which “a gang of Aleutian Islanders slushing about in the wrack and surf with rakes and magical incantations” could be understood as harmonious neoclassical maximizers) was a little extreme, then one should read Alchian and Allen, or anyone of the writers of the Austrian or Chicago schools who piously announce the universality of their value-free science.

Their science applies everywhere because it applies nowhere. Most theorizing by these schools is purely tautological. The argument goes like this:

1. All human behavior involves choice.

2. In any choice situation, whichever alternative is chosen involves gains and costs (whether explicit costs or implicit “opportunity” costs).

3. Therefore, all human behavior involves exchange, since it involves acquiring gains in exchange for costs.

4. All human beings choose rationally; that is, they exchange in such a manner as to maximize the excess of the utility of the gain over the disutility of the cost (or the utility forgone in the opportunity cost).

5. Therefore, all choices are rational and represent the best possible alternatives among those available in the exchange process (the utilitarian neoclassicists have always avoided facing the issue of how capitalist society gives some individuals so many alternatives and others so few) .

6. Since all choices, or exchanges (they amount to the same thing), are rational and maximize each chooser’s or exchanger’s utility, then total utility is always maximized .

7. Therefore, free exchange in a capitalist society harmonizes all interests, maximizes utility, results in rational prices, results in efficient resource allocation, and, in general, automatically creates the best of all possible worlds.

8. Furthermore, since all human activity is in reality exchange, each and every aspect of a capitalist society is rational and blissful.

…Austrian and Chicago schools reduce all human behavior to rational maximizing exchanges and hence are able to prove that in every respect, economic and non-economic, a free market, capitalist system is the best of all possible worlds. … Smith and Ricardo, in the grandeur of their general vision of capitalist society, saw the economy, as we have seen, from both a utility (or exchange) perspective and a labor (or production) perspective. Neoclassical economics represents the final, ultimate extension of the utility perspective. In the development of this perspective, we have seen throughout this book an intellectual degeneration from Ricardo onward. Only eclectics such as Mill, Keynes, and Samuelson could escape the force of this degeneration, because they had enough common sense to combine more realistic perspectives with their utility perspective. The degeneration is now complete. The banalities of McKenzie and Tullock can be said to be the ultimate triumph – and the inevitable result – of the development of pure, logically consistent, individualistic utilitarianism. …


Originally published at Economist’s View and reproduced here with the author’s permission.

7 Responses to “The Austrian and Chicago Schools”

DINESH DESAIJanuary 5th, 2009 at 12:32 am

RATIONALITY IS A TRICKY CONCEPT. WHAT IS RATIONAL TO ONE MAY SEEM IRRATIONAL TO OTHERS. RATIONALITY IS NOT INDEPENDENT OF THE ECONOMIC ENVIORNMENT. A FARMER WHO USES A PLOW AND A PAIR OF BULLOCKS TO TILL LAND IN THE 21ST CENTURY MAY SEEM IRRATIONAL. BUT, HIS RATIONALITY IS DEFINED IN THE CONTEXT OF HIS KNOWLEDGE BASE AND AVAILABILITY FACTOR.

illiterateJanuary 5th, 2009 at 1:21 am

keynes is wrong. government spending is ok only if manages to increase productivity. keynes solution is like socialism : likely nobody starves but everybody overall is worse off. it is terrible what governments are doing now, simply because they dont know what else since experience is missing.

ram chandarJanuary 5th, 2009 at 1:33 am

interesting. the austrians have been living in their make believe world as many academics do. it seems they want the world to be their way and thus are creating a pseudoscience to fit their fantasy. the rationality argument makes a presumption that human population is homogenous. some humans are more greedy than others and will make “RATIONAL” choices which emphasize short term gains over long term gains and thus make “IRRATIONAL” choices just like a gambler does. others are altruistic and will in fact make “IRRATIONAL” choices of giving up implicit “opportunity” costs to other people. even if we deceive ourselves into believing that humans are homogenous and their usual “RATIONAL” choice is driven by greed i.e. tendency to immediate gratification than deferment of desires to sometime in future, the so called “RATIONAL” is not really rational since it is indeed a subjective fear of the future.

ram chandarJanuary 5th, 2009 at 1:37 am

i guess we are all illiterates in a way but lets not talk about central planning here. socialism is central planning. lets rather talk about collectivism vs individualism. humans are social animals and not designed to live in light houses (although some of us do but its the bell curve dear). so if we are social animals then collectivism triumphs individualism. however total collectivism may not be the answer but the bias has to be in favor of collectivism if the dispute arises between the two.

IainJanuary 5th, 2009 at 1:38 pm

I’m pretty sure ‘the austrians’ argue the exact same point about rationality as you ram. As Ludwig Von Mises put it in Human Action (http://mises.org/humanaction/chap1sec4.asp)”When applied to the ultimate ends of action, the terms rational and irrational are inappropriate and meaningless. The ultimate end of action is always the satisfaction of some desires of the acting man.”I.e. people make choices to satisfy there own desires not to maximise some global, er, thing that applies to everyone.”No man is qualified to declare what would make another man happier or less discontented”I think that’s the key point right there…”Their science applies everywhere because it applies nowhere” sounds like gobbledygook to me.

BuckeyeJanuary 9th, 2009 at 8:35 am

Austrians have been right about predicting all the recessions. Roubini was one of the few mainstream economists to see this recession coming but if you look at all the Austrian economists they have predicted this coming for years. Government always for political reasons tries to interfere when corrections come and in the end always makes them worse or just creates bubbles that lead to depressions. Freedom and true capitalism work as long as we keep the meddling government and central banks with their own selfish motives out of the way of the free markets.

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