The Foundations of Modern Austrian Economics
By Edwin G. Dolan
In June 1974 the Institute for Humane Studies sponsored the first of a series of conferences on Austrian economics. This conference was held at Royalton College in South Royalton, Vermont, and attracted some fifty participants from all regions of the United States and three continents abroad. The conferees came to hear Israel M. Kirzner, Ludwig M. Lachmann, and Murray N. Rothbard survey the fundamentals of modern Austrian economics and thereby challenge the Keynesian-neoclassical orthodoxy, which has dominated economic science since World War II.Each lecturer addressed himself to two general questions: What is the distinctive Austrian contribution to economic theory? And what are the important problems and new directions for Austrian economics today? By answering these questions, the papers collected in this volume become more than just a set of conference proceedings—they take on the character of a manifesto and provisional textbook as well…. [From the Preface by Edwin G. Dolan]
First Pub. Date
Kansas City: Sheed and Ward, Inc.
Collected essays, various authors. 1976 conference proceedings. Includes essays by Gerald P. O'Driscoll, Israel M. Kirzner, Murray N. Rothbard, Ludwig M. Lachmann, and more.
The text of this edition is copyright ©1976, The Institute for Humane Studies.
One of the areas in which disagreement among Austrian economists may seem to be nonexistent is that of methodology. Yet I shall attempt to point out that even with respect to method there are differences of opinion among individual thinkers. Some light may be cast on these differences by drawing attention to two distinct strands of thought that run through the writings of Austrian economists on the question of method. By separating these strands and then focusing on each in turn, we may discover and define different perspectives on economic method and perhaps more clearly understand how these different perspectives grow out of the unique view of method shared by all Austrian economists.
The general outline of the Austrian position on methodology is well known. Austrian economists are subjectivists; they emphasize the purposefulness of human action; they are unhappy with constructions that emphasize equilibrium to the exclusion of market processes; they are deeply suspicious of attempts to apply measurement procedures to economics; they are skeptical of empirical “proofs” of economic theorems and consequently have serious reservations about the validity and importance of a good deal of the empirical work being carried on in the economics profession today. These are the general features of the position that we know very well; yet within this general view we can distinguish two independent strands of argument. It is upon this debate that I should like to focus my attention in this paper.
It will be helpful to cite two statements—by prominent Austrian economists—about what economics as a discipline is supposed to achieve. The first is by Friedrich A. Hayek, and the other is by Ludwig M. Lachmann. Hayek in his
Counter-revolution of Science contended that the function of social science, and by implication economics, is to explain how conscious, purposeful human action can generate unintended consequences through social interaction.
*39 The emphasis here is on the unintended consequences of individual human decisions. To explain phenomena that are not the unintended consequences of human decision making is outside the scope of the social sciences in general and economics in particular. Hayek’s position was cited by Alexander Gerschenkron in his contribution to the Akerman
Festschrift, and I think Gerschenkron was perceptive in focusing on exactly what is, in Hayek’s view, the fundamental task of economic explanation.
Let us contrast the Hayek view with one expressed by Lachmann. Lachmann’s position on the purpose of economic explanations is dealt with at length in his contribution to the Hayek
Festschrift, Roads to Freedom.*41 Here, however, I shall quote from a more recent statement of his position that appeared in his review of John R. Hicks’s
Capital and Time:
Economics has two tasks. The first is to make the world around us intelligible in terms of human action and the pursuit of plans. The second is to trace the unintended consequences of such action. Ricardian economics emphasized the second task, the “subjective revolution” of the 1870s stressed the urgency of the first, and the Austrian school has always cherished this tradition.
Thus, we have here two tasks for economics. Besides the task that Hayek emphasized—the tracing out of the unintended consequences of action—we have the requirement that it make the world around us intelligible in terms of human action.
It is worth reminding ourselves that the two tasks Lachmann identified are to be found in Carl Menger’s writings. In the third
part of his 1884 book on methodology Menger pointed out that actions do have unintended consequences, and he made it very clear, as Hayek had done, that economics is the science that is able to explain how these unintended consequences emerge in the market place.
*43 But Menger was also aware of the other task Lachmann emphasized. In a letter Menger wrote Léon Walras, cited by T. W. Hutchison in several of his writings,
*44 Menger insisted that the economist is not merely after the relationships between quantities, but the
essence of economic phenomena: “the essence of value, the essence of land rent, the essence of entrepreneurs’ profits, the essence of the division of labor.”
*45 This view is what Kauder meant when he described Menger as holding that economics deals with social essences,
*46 and what Hutchison called “methodological essentialism.”
I have asserted that two distinct strands of thought may be identified in the writings of Austrian economists with regard to the meaning and purpose of economic explanation. I would now like to distinguish two distinct insights about the economic world that receive varying emphasis and are not often adequately differentiated. First, there is the insight that
human action is purposeful, and, second, there is the insight that
there is an indeterminacy and unpredictability inherent in human preferences, human expectations, and human knowledge. Now these two insights are really quite distinct, because one does not encompass the other in any logical or epistemological sense. That human action is purposeful is an insight by itself, and that human knowledge and expectations are largely unpredictable is another. Nor is the truth of these two propositions equally obvious. The purposefulness of human action is something we arrive at by introspection. In this sense it is “obviously” true. On the other hand, the insight that men’s preferences are inherently unpredictable—that we cannot discover consistent patterns in what men prefer and that we cannot postulate that there are consistent patterns in
what men know and expect to happen—cannot be arrived at by introspection. The truth claimed for this last insight depends on our observations of our fellow men; that we do as a matter of fact find them to be unpredictable in their actions and expectations about future states of the world.
To me, the different emphasis Austrian economists attach to these basic insights is largely responsible for their different attitudes regarding the purpose of economic explanation. The recognition of purposefulness is, of course, fundamental to our definition of economics as the logic of choice. We are able to use our logic to simulate the actions of other human beings only because we share the logic that other men’s purposes lead them to harness in their own interests. The recognition of purposefulness is essential to our positive conception of economics as the logic of choice and to our enterprise of studying the consequences of purposeful action. But if we consider those aspects of the Austrian approach that are used, not to derive economic laws, but to criticize other areas of contemporary economic thought, then the second of these basic tenets comes into prominence. Our dissatisfaction with empirical work and our suspicion of measurement rest on the conviction that empirical observations of past human choices will not yield any regularities or any consistent pattern that may be safely extrapolated beyond the existing data at hand to yield scientific theorems of universal applicability.
Let us try to understand the role these basic tenets of Austrian economics play in the Lachmann-Hayek discussions concerning what economic explanation is all about. In 1938 T. W. Hutchison published
The Significance and Basic Postulates of Economic Theory.*48 The book received a blistering Austrian-like critique from the pen of Frank H. Knight, who was on most other issues, such as capital theory, not in sympathy with the Austrian school. In that article Knight conveyed some brilliant insights about the
relationship of economics to the study of human action. Knight noted that “the whole subject of conduct—interests and motivation—constitutes a different realm of reality from the external world.” In addition to the external world, with which the natural sciences are conversant, there is a different realm of reality, a realm no less real than the external world, but nevertheless different from it. This other realm is that of human conduct, which Knight identified as interests, motivation, and purpose.
The first fact to be recorded is that this realm of reality exists or “is there.” This fact cannot be proved or argued or “tested.” If anyone denies that men have interests or that “we” have a considerable amount of valid knowledge about them, economics and all its works will simply be to such a person what the world of color is to the blind man. But there would still be one difference: a man who is physically, ocularly blind may still be rated of normal intelligence and in his right mind.
Here, surely, we have the first of the basic tenets of Austrian theory, that there is a realm of reality constituted of human motives, interests, and purposes, and that, although purposes cannot be seen or touched, they are nonetheless “there.”
When Lachmann called upon economists to make the world intelligible in terms of human decisions and purposes, I take it that he was telling us the following:
It is the task of science to describe and explain reality. If reality consists of more than the external world, then a science that is confined to the facts of the external world is simply incomplete. It does not account for everything that is there. The Austrian approach insists that there is something besides the facts of the external world and the relationships that may be postulated between these bare facts. What is that something else? It is the realm of reality that Knight pointed to, the realm of purposes. And even if one were able to explain the facts of the external world in terms of similar facts, without regard to the human purposes underlying these facts, one would not have explained everything there is to be explained, not have set forth everything there is to set forth. One would have failed to make the world intelligible in terms of human action, that is, in terms of human purposes. Thus, even if the second Austrian tenet (that there are
no constants in human behavior) were false, even if one were able to postulate consistent chains of cause and effect that depend only on externally observable phenomena, still one has failed to fulfill one’s scientific obligation. There is a realm of reality called purposes. It is there, and if we fail to point it out, then we fail in the task of making the world intelligible in terms of human action.
Let us consider a simple example. Suppose a man from Mars is doing research for his doctorate and, after focusing his telescope on a particular location on Earth, discovers a certain regularity. Through his telescope he observes a set of boxes lined up in a row. He further discovers that a smaller box moves past these boxes every day at 7:30 A.M., comes to a stop at one of the boxes, and then, after a short stay, moves on. Moreover the investigator discovers something else; out of one of these boxes a body emerges every morning, and when the moving box makes its daily stop, the body is swallowed up by the moving box. Discovering this regularity, the researcher postulates a definite law, the law of moving boxes and bodies. As he goes on with the research, however, he discovers that sometimes the box moves away before the body has entered it, leaving the body behind altogether; while sometimes the body moves at an unusually rapid speed, arriving at the daily moving-box stop just in time to be swallowed up before the box moves on. Now this Martian researcher may be able to predict just when the person is going to miss the box and when he is going to catch it. He may even be able to explain the movements of the body and the box entirely without reference to the fact that someone is trying to catch the bus because he wants to get to work on time. But if he does so, he has not told us everything there is to be learned about this situation. A theory of moving bodies and boxes that does not draw attention to the dimension of purpose gives a truncated picture of the real world.
This is what economics, in the Austrian view, is all about. Economics has to make the world intelligible in terms of human motives. It is more than simply moving boxes or changing economic quantities. This is the task to which Lachmann drew
our attention when he insisted that we must make the world intelligible in terms of human purpose.
A memorable passage in Hayek’s
Counter-revolution is the one in which he explained that objects useful to human beings are simply not objective facts.
In fact most of the objects of social or human action are not “objective facts” in the special narrow sense in which this term is used by the [natural] Sciences…they cannot be defined in physical terms…. Take the concept of a “tool” or “instrument,” or of any particular tool such as a hammer or a barometer. It is easily seen that these concepts cannot be interpreted to refer to “objective facts,” i.e. to things irrespective of what people think about them.
Pursuing this point Hayek asserted (in a footnote reference to the work of Ludwig von Mises) that every important advance in economic theory in the preceding century had been a result of the consistent application of subjectivism.
*51 Lachmann’s advice to economists paralleled Hayek’s. According to Hayek, when we deal with artifacts—with tools and instruments or other products of human beings—we have not exhausted the description of what it is that we are describing if we stubbornly confine ourselves to their physical entities. We have not described a hammer until we have drawn attention to its purpose. Lachmann, similarly, instructed us that when we deal with broader questions, with institutions and regularities in economic affairs, we have not completed our task if we have not called attention to the purposes and motives and interests that underlie these phenomena. A hammer is more than a handle with a metal head; so is a price more than a number, milk consumption more than a number of gallons, and its relationship to price more than a simple functional relationship. A whole world of interests and motives is “there,” is real, and it is surely our responsibility as scientists to make it clear.
Critics of Austrian methodology often argue that since praxeology deals with unobservables, it is inherently incapable of telling us anything scientific about observables. The latest (and perhaps the clearest and most sympathetic) statement of
this argument was by James Buchanan, in his contribution to the Hayek
Festschrift,*52 when he drew attention to the distinction between (1) the logic of choice (what he called the abstract science of economic behavior) and (2) the predictive science of human behavior. Buchanan argued that if we treat economics as the logic of choice, it cannot in principle lead to refutable hypotheses because no particular preference ordering has been specified, and to that extent it cannot tell us anything about the real world.
In answer to Buchanan, our discussion indicates that the truth is the other way around. We are not only able to say something about the real world; we are also able to say a great deal about a large and important area of human experience about which other disciplines are necessarily silent—the realm of purpose. This needs to be stated and restated, emphasized and reemphasized, again and again! The real world is more than the external world; the real world includes a whole range of matters beyond the scope of the measuring instruments of the econometrician. Economic science must be able to encompass this realm.
It is helpful in pursuing this strand of thought in Austrian methodology to constrast the Austrian use of purpose with the rationality hypothesis often employed by economists. For many non-Austrian economists this hypothesis is invoked with apologies and is considered something of a necessary evil. It is used to get theoretical results and is justified on the grounds that these results seem to fit the facts of the outside world although the hypothesis is philosophically suspect. Thus we find Gary Becker eager to demonstrate how certain fundamental theorems of economics do not require the rationality hypothesis—that rather embarrassing piece of excess baggage.
*53 For Austrian economists, on the other hand, the notion of purposefulness is not merely a useful tool to obtain results but an essential element of economic reality that cannot be omitted. Making reference to human plans and motivations is an essential part of the economist’s scientific task.
Let us turn to the second basic tenet of Austrian methodology, the proposition that there is an inherent unpredictability and indeterminacy with regard to human preferences, expectations, and knowledge. I have already pointed out that this proposition does not have the same introspectively obvious ring of truth that the idea of human purposefulness does. Are we really so certain that human wants and human preference-orderings and the manner in which they undergo modification are inherently unpredictable? In fact, I wish to suggest that asserting this creates something of a dilemma for the Austrian economist.
There is a passage in an essay by Hayek that deals with this very question. In that essay Hayek discussed the concept of equilibrium and raised the problem of whether or not there is a tendency toward equilibrium in the economic world. Hayek remarked:
It is clear that, if we want to make the assertion that, under certain conditions, people will approach that state, we must explain by what process they will acquire the necessary knowledge. Of course, any assumption about the actual acquisition of knowledge in the course of this process will also be of a hypothetical character. But this does not mean that all such assumptions are equally justified. We have to deal here with assumptions about causation, so that what we assume must not only be regarded as possible…but must also be regarded as likely to be true; and it must be possible, at least in principle, to demonstrate that it is true in particular cases. The significant point here is that it is these apparently subsidiary hypotheses or assumptions that people do learn from experience, and about how they acquire knowledge, which constitute the empirical content of our propositions about what happens in the real world.
Hayek, then, asserted that when postulating a tendency toward equilibrium, we do have to resort to a particular empirical proposition. Moreover, the empirical proposition in question would seem to contradict the other idea that there are an inherent unpredictability and an indeterminacy about human preferences and human knowledge. If we are to be able to say anything
about the process of equilibration, especially if we are to say something about the course by which human decisions lead to unintended consequences, we shall have to rely upon the particular empirical proposition that men learn from market experience in a systematic manner. This is inconsistent with the second tenet underlying Austrian economics that there is an inherent indeterminacy in the way by which human knowledge changes.
Hayek’s argument is straightforward. In disequilibrium man’s knowledge is imperfect, some people are making mistakes; equilibrium is the situation in which nobody is making mistakes. A movement from disequilibrium to equilibrium must therefore be one in which men gradually learn to avoid mistakes, so that their actions become more and more coordinated. Where do we derive our confidence that this type of learning in fact takes place? Hayek stated very clearly that this is an empirical hypothesis. If we reject this hypothesis, then we reject the basis for viewing the market process as an equilibrating mechanism—that is, reject the claim that economics can tell us anything definite about the unintended market consequences of human actions. We may still be able to make the world intelligible—that is, we may explain that what happens happens because human beings pursue their purposes. We can assert that their interacting decisions generate certain changes in knowledge, but we shall no longer be able to say in which particular directions knowledge changes, and we can no longer postulate a determinate process toward equilibrium. We shall, to put the matter succinctly, not be able to go beyond the first Lachmann task in order to pursue the program advanced by Hayek. If, however, we confine ourselves to the enormously important task of making the world intelligible in terms of human purposes, we need not accept Hayek’s empirical proposition about the coordination of plans and the progressive elimination of mistakes. But if we are to explain the unintended consequences of human action, that is, if we are to assert that there is a tendency for entrepreneurial profits to be eliminated, or for prices to move in one direction rather than another, we must be able to say something
about the manner in which human knowledge and human expectations undergo modification. If one accepts this particular empirical hypothesis, one has surely weakened, perhaps irreparably, the second basic tenet underlying Austrian methodology.
We have identified two requirements of economic explanations that Austrian economists consider important. We have also identified two basic tenets that seem fundamental to Austrian methodology. It turns out, however, that while one of these basic tenets, that of human purposefulness, is sufficient to sustain one of these two requirements (that of making the world intelligible in terms of human action), the second, which asserts the unpredictability of human knowledge, is inconsistent with the requirement that economic explanations trace the unintended consequences of human action. It seems therefore that the future progress of the Austrian school in applying its basic methodological tenets requires some decision about the extent to which the second tenet about the inconstancy of human purposes and knowledge can be upheld as a general proposition.
The Counter-revolution of Science: Studies on the Abuse of Reason (Glencoe, Ill.: Free Press, 1955), p. 39.
Money, Growth, and Methodology, ed. Hugo Hegeland (Lund: C. W. K. Gleerup, 1961), p. 180.
Roads to Freedom: Essays in Honour of Friedrich A. von Hayek, ed. Erich Streissler et al. (London: Routledge & Kegan Paul, 1969), pp. 93-104.
South African Journal of Economics 41 (September 1973): 204.
Problems of Economics and Sociology, trans. Francis J. Nock, ed. L. Schneider (Urbana: University of Illinois, 1963). The title of the 1884 German edition of the work is
Untersuchungen über die Methode der Socialwissenschaften und der Politischen Oekonomieinsbesondere, and it is therefore sometimes referred to as
Investigations into Method, which more correctly indicates the character of its contents.
A Review of Economic Doctrines, 1870-1929 (Oxford: Clarendon Press, 1954), p. 148; idem, “Some Themes from
Investigations into Method,” in
Carl Menger and the Austrian School of Economics, ed. J. R. Hicks and Wilhelm Weber (Oxford: Clarendon Press, 1974), p. 17 n.
Journal of Political Economy 43(April 1935): 187-207; also see Léon Walras,
Correspondence of Léon Walras and Related Papers, ed. W. Jaffe, 2 vols. (Amsterdam: North-Holland Publishing Co., 1965), 2:3.
A History of Marginal Utility Theory (Princeton: Princeton University Press, 1965), p. 97.
The Poverty of Historicism (New York: Harper & Row, 1961), pp. 28-38.
The Significance and Basic Postulates of Economic Theory (London: Macmillan & Co., 1938).
On the History and Method of Economics, ed. Frank H. Knight (Chicago: University of Chicago Press, 1956), p. 160.
The Counter-revolution, pp. 26-27.
Roads to Freedom: Essays in Honour of Friedrich A. von Hayek, ed. Erich Streissler et al. (London: Routledge & Kegan Paul, 1969), pp. 47-65; see also James M. Buchanan,
Cost and Choice (Chicago: Markham Publishing Co., 1970).
Journal of Political Economy 70(February 1962): 1-13.
Individualism and Economic Order (London: Routledge & Kegan Paul, 1952), p. 46.
Part 2, Essay 3, New Light on the Prehistory of the Austrian School