[An updated version of this article can be found at Austrian School of Economics in the 2nd edition.]
The Austrian school of economics dates from the 1871 publication of Carl Menger's Principles of Economics (Grundsätze der Volkswirtschaftslehre). Two of Menger's students, Eugen von Böhm-Bawerk and Freidrich von Wieser, carried his work forward and made considerable contributions of their own. Especially notable is Böhm-Bawerk's analysis of capital and interest. In the 1920s, 1930s, and 1940s, Ludwig von Mises and Friedrich A. Hayek continued the Austrian tradition with their works on the business cycle and on the impossibility of economic calculation under socialism.
Austrian analysis fell out of favor with the economics profession during the fifties and sixties, but the awarding of the Nobel Prize in economics to Hayek in 1974, coupled with the spread of Mises's ideas by his students and followers, led to a revival of the Austrian school.
The major cornerstones of Austrian economics are methodological individualism, methodological subjectivism, and an emphasis on processes rather than on end states.
Since the Austrian economist holds all costs and benefits to be subjective and, therefore, not measurable, only the individual can decide what actions are efficient or inefficient. Often the individual may decide, after the fact, that a decision was not efficient. In the actual process of acting to achieve an end, an individual will discover what works best. And even then, what worked best this time may not work best next time. But a person cannot know this without the process of acting.
The notion of an equilibrium state is sometimes seen as the epitome of economic efficiency: supply would equal demand, and therefore, no surplus or shortage of goods would exist. This assumes, however, that market participants know where the equilibrium price is and that moving toward it will not change it. But if the price is already known, why isn't the market already in equilibrium? Furthermore, the movement to equilibrium is a process of learning and of changing expectations, which will change the equilibrium itself. To the Austrian economist efficiency is defined within the process of acting, not as a given or known end state of affairs. Efficiency means the fulfillment of the purposes deemed most important to an individual, rather than the fulfillment of less important purposes. The Austrian economist never speaks of efficiency outside of the individual.
So what do Austrian economists do? They try to understand the process by which knowledge is generated, spread, and used within the economy. They focus on the institutions that emerge because people lack perfect knowledge and try to cope with this uncertainty. Money is just one example of such institutions.
A medium of exchange, or money, spontaneously emerges because individuals engaging in trade want to decrease the uncertainty that they will be able to obtain goods that they themselves are not producing. When a commodity is generally accepted in all exchanges, people can specialize (in producing corn, for example) and can be certain that they will be able to exchange the corn for the medium of exchange. They can then use the medium to obtain other goods that they want. The existence of money enhances the benefits of specialization and division of labor. Austrian economists explain how and why money and other institutions emerge; they do not take them as given, as do many neoclassical economists.
The basic question for the Austrian economist is, Which institutions enable individuals to reach their own goals, and which do not? Therefore, their policy recommendations run to changes in the institutional framework within which a society operates. Two key public policy issues that provide good illustrations of Austrian analysis are antitrust and central planning.
Although the theory of competition and economic calculation are good examples of Austrian economic analysis, there are many others. The Austrian theory of the business cycle and of the inflationary process that takes place because of credit expansion through monetary policy, and the Austrian explanation of the emergence of money in a modern economy are also important contributions to economic analysis. Today, Austrian economists are also working in the areas of environmental economics, labor economics, and legal analysis. Many of the traditionally Austrian theories, and even methods, are being accepted into mainstream economic analysis.
This is especially true of the Austrian view of central economic planning. The Austrian analysis of central planning, although never stated explicitly as such, is found in the writing of many mainstream economists. Robert Heilbroner, for example, who himself advocated socialist policies in the past, attributes the collapse of the Soviet economy to a knowledge problem. He states:
Planning thus requires that the immense map of desired national output be carved up into millions of individual pieces, like a jigsaw puzzle—the pieces produced by hundreds of thousands of enterprises, and the whole thing finally reassembled in such a way as to fit. That would be an extraordinarily difficult task even if the map of desired output were unchanged from year to year, but, of course, it is not....
And Charles L. Schultze, formerly President Jimmy Carter's chief economic adviser, writes: "The first problem for the government in carrying out an industrial policy is that we actually know precious little about identifying, before the fact, a 'winning' industrial structure."
Deborah L. Walker teaches economics at Metropolitan State College of Denver and was previously an economics professor at Loyola University in New Orleans.
Dolan, Edwin G., ed. The Foundations of Modern Austrian Economics. 1976.
Hayek, Friedrich A. Collectivist Economic Planning. 1975.
Hayek, Friedrich A. Individualism and Economic Order. 1948.
Kirzner, Israel M. Competition and Entrepreneurship. 1973.
Menger, Carl. Principles of Economics. 1871. Reprint. 1981.
Mises, Ludwig von. Human Action: A Treatise on Economics. 1949.
Spadaro, Louis M., ed. New Directions in Austrian Economics. 1978.