Ideas have consequences. This is especially true in the world of economics, where good ideas can pull nations out of poverty and lead to prosperity—and where a single bad idea can wind up being a calamity for millions.
In the mid-nineteenth century, Karl Marx was an unemployed writer scribbling in the British Museum while his family starved. Several decades later his ideas on economics—which added a toxic mix of materialism, atheism, and class warfare to the classical school’s labor theory of value (the value of a product is determined by the labor that goes into it)—had come to dominate much of the world, embraced by tyrants in the Soviet Union, China, Cuba, and many other countries. Marxism led to tyrannical regimes that claimed more than one hundred million lives through political persecution, famine, warfare, purges, and much more.
How different things would have been in China and Russia had the revolutionaries adopted the concepts of free markets and liberty. These ideas guided the Founding Fathers in the United States toward the end of the eighteenth century, and produced the freest, strongest, and most prosperous nation in history. More recently, in 1948, Germany’s economics minister, Ludwig Erhard, responded to economic distress by adopting free markets and sound money, bringing to the underclass a realistic hope of prosperity. The experiment succeeded. He could have chosen the same path as East Germany, which struggled.
John Maynard Keynes captured the extraordinary influence of economic ideas when he commented:
The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas.
Keynes’s own career is a testament to this idea: no twentieth-century economist had as great an influence on the course of government economic policy as he did. And Keynes was quite right about the power of wrong ideas. Adding to the tragedy of Marxism is the fact that while Marx was conjuring up his faulty ideas, the Western world, which had seen warfare as far back as anyone could remember, was in the midst of a century of peace thanks to the premises of classical liberalism—simple economic ideas like the gold standard, free markets, and liberty.
By the 1970s, Keynes’s own ideas had produced a seemingly intractable economic dilemma. The United States and the rest of the developed world were wracked by inflation and economic stagnation. In late 1974, accepting the Nobel Prize in Economics, F. A. Hayek surveyed this scene and concluded that economists deserved blame: “We have indeed at the moment little cause for pride: as a profession we have made a mess of things.” Hayek noted that the ruinous inflation of the 1970s had been “brought about by policies which the majority of economists recommended and even urged governments to pursue.”
The Austrian School was not part of the economics establishment that urged such misguided policies. It is important to understand the contributions of the many thinkers—including Hayek—who have developed the substantial teaching of the Austrian School over more than a century.
The Austrian School’s influence is quite small in the American academy. Thus it may surprise the reader to discover that the Austrians’ essential ideas form the foundation of modern mainstream economics.
Ludwig von Mises, who is credited with bringing the Austrian School to the United States during World War II, made this point when describing the spread of Austrian thinking in the early twentieth century:
The number of foreign economists who applied themselves to the continuation of the work inaugurated by the “Austrians” was steadily increasing. At the beginning it sometimes happened that the endeavors of these British, American, and other non-Austrian economists met with opposition in their own countries and they were ironically called “Austrians” by their critics. But after some years all the essential ideas of the Austrian school were by and large accepted as an integral part of economic theory. [By the 1920s], one no longer distinguished between an Austrian school and other economics. The appellation “Austrian” school became the name given to an important chapter of the history of economic thought; it was no longer the name of a specific set with doctrines different from those held by other economists.
But there are exceptions. The most important distinguishing characteristic of Austrian economics is its emphasis on the individual acting person. Whereas the other schools think in terms of aggregates, Austrians observe individuals participating in the marketplace, what Mises calls “methodological individualism.”
Additionally, unlike the other schools, Austrians rarely speak of capital or labor as homogeneous units. It follows that Austrians don’t see mathematics as essential to economic thought; at best, math is a visual or conceptual aid. One will not see many equations or graphs in an Austrian treatise. Even Lord Keynes, often considered the nemesis of the Austrian School, now and then spoke harshly of math: “Too large a proportion of the recent ‘mathematical’ economics are mere concoctions, as imprecise as the initial assumptions they rest on, which allow the author to lose sight of the complexities and interdependencies of the real world into maze of pretentious and unhelpful symbols.”
Still, many departments of economics that describe themselves as Keynesian insist on the substantial use of mathematics. Obviously, they have not read their master, or don’t take him seriously! For instance, the following formula is commonly used in macroeconomics classes at both the graduate and undergraduate levels: Y [GNP or output] = I [investment] + C [consumption] + G [government spending] + (X – M) [exports minus imports]. This equation assumes that all forms of investment or consumption or government are the same. To the Austrians, such a formula is woefully inadequate and misleading. In real life, each unit of investment is usually different: some are more productive than others; some are long-term, some short-term; each one has a different profitability. We are all taught in elementary algebra that you can’t add apples and oranges.
In the tradition of Aristotle and Thomas Aquinas, Austrians see economics as a practical science that deals with human nature and human choices. They believe that certain, very general laws of human action can be discerned by observation and deduction. The laws they deduce apply to human choice and nature in the face of scarcity.
The Austrians are also fascinated with the division of labor as it has developed over time. They see the economy developing spontaneously and give great credit to entrepreneurs as the spark plugs of economic progress. Because of this observation, most Austrians are skeptical of government intervention. They tend to favor free markets and have been quite critical of socialism and planned economies. Since the Austrians hold that value begins with the individual acting person, the school comes into conflict with any objective theory of value such as those proposed by either the classical school or Marxism. There is a long history of intellectual debate between Marxists and Austrians, culminating in the predictions of Mises and Hayek that a socialist economic order was impossible and would collapse.
This passage is excerpted from Harry Veryser’s new book, It Didn’t Have to be this Way, published by ISI Books.