2. The essential diferences between the Austrian and Neoclassical schools

Perhaps one of the main features which is lacking in the study programs of the schools of economics is that, to date, they have not given a complete integrated view of the essential elements of the modern Austrian paradigm vis-à-vis the mainstream neoclassical approach. In Chart No. 1, I have tried to fill this gap in a way that is complete but, at the same time, clear and concise, so that it is possible to understand at a glance the different opposing points between the two approaches, which I then discuss briefly.

(POINTS OF COMPARISON)
AUSTRIAN PARADIGM / NEOCLASSICAL PARADIGM


1. Concept of the economic point of view (essential principle):
Theory of human action understood as a dynamic process (praxeology) / Theory of decision: rational and based on constraint maximization

2. Methodological starting point:
Subjectivism / Stereotype of methodological individualism (objectivist).

3. Protagonist of the social processes:
Creative entrepreneur / Homo oeconomicus.

4. Possibility that the actors err a priori and nature of entrepreneurial profit:
Pure or sheer entrepreneurial error and ex post regret exist. Pure entrepreneurial profits arise from alertness / There are no regrettable errors because all past decisions are explicable in terms of cost-benefit analysis. Profits are considered the payment for the services of a factor of production.

5. Nature of information:
Knowledge and information are subjective, disperse and change constantly (entrepreneurial creativity). Radical distinction between scientific knowledge (objective) and practical knowledge (subjective) / Complete, objective and constant information on ends and means is assumed. There is no distinction between practical (entrepreneurial) knowledge and scientific knowledge.

6. Reference point:
General process with a coordinating tendency. There is no distinction between micro and macro: all economic problems are studied in relation to each other / Model of equilibrium (general or partial). Separation between microeconomics and macroeconomics.

7. Concept of “competition”:
Process of entrepreneurial rivalry / Situation or model of “perfect competition”.

8. Concept of cost:
Subjective (depends on the alertness of the entrepreneur for the discovery of new alternative ends) / Objective and constant (it may be known by a third party and measured).

9. Formalism:
Verbal logic (abstract and formal) which allows the integration of subjective time and human creativity / Mathematical formalism (symbolic language typical of the analysis of constant atemporal phenomena).

10. Relation with the empirical world:
Aprioristic-deductive reasoning. Radical separation and, at the same time, coordination between theory (science) and history (art). History cannot prove theories / Empirical falsation of hypotheses (at least rhetorically).

11. Possibilities of specific prediction:
Impossible, since what happens depends on future entrepreneurial knowledge which has not yet been created. Only qualitative and theoretical “pattern predictions” on the discoordinating consequences of interventionism may be made / Prediction is a deliberately sought objective.

12. Who is responsible for the prediction:
The entrepreneur / The economic analyst (social engineer).

13. Present situation of the paradigm:
Notable re-emergence over the last 20 years (especially after the crisis of Keynesianism and the fall of real socialism) / Situation of accelerated crisis and change.

14. Amount of “human capital” invested:
Minoritary, but growing. / Majority, although it shows signs of dispersal and division.

15. Type of “human capital” invested: Multidisciplinary theorists and philosophers. Radical libertarians / Specialists in economic intervention (piecemeal social engineering). Very variable degree of commitment to freedom.

16. Most recent contributions:

Critical analysis of institutional coercion (socialism and interventionism) / Public Choice theory


. Theory of free banking and economic cycles / Economic analysis of the family

. Evolutionary theory of institutions (juridical, moral) / Economic analysis of Law

. Theory of entrepreneurship / New classical macroeconomics

. Critical analysis of “Social Justice” / Economics of “information”

17. Relative position of different authors:

ROTHBARD, MISES, HAYEK, KIRZNER COASE / DEMSETZ ,BLAUG SAMUELSON,BUCHANAN ,STIGLITZFRIEDMAN,BECKER

 

 

Theory of action (Austrians) versus theory of decision (neoclassicals)

For the Austrian theorists, economic science is conceived as a theory of action, rather than a theory of decision and this is one of the features that most clearly distinguishes them from their neoclassical colleagues. In fact, the concept of human action covers the concept of individual decision and much more. In the first place, for the Austrians, the relevant concept of action includes not only the hypothetical process of decision in an environment of “given” knowledge of the ends and means but, above all, and this is the most important point, “the very perception of the ends-means framework within which allocation and economizing is to take place”.(2) Moreover, the most important factor for the Austrians is not that a decision is taken, but that it is taken in the form of a human action in the process of which (that may or may not be culminated) there is a series of interactions and processes of coordination the study of which constitutes, for the Austrians, precisely the research subject of economic science. Therefore, for the Austrians, economics, far from being a theory on choice or decision, is a theory on the processes of social interaction, which may be coordinated to a greater or lesser extent depending on the alertness shown by the different actors involved in each entrepreneurial action.(3)

Consequently, the Austrians are especially critical with the narrow conception of economics that originates from Robbins and his well-known definition of it as a science which studies the utilization of scarce resources which may be put to alternative uses in order to satisfy human needs.(4) Robbins’ conception implies given knowledge on ends and means and, therefore, the economic problem is reduced to a mere technical problem of allocation, maximization or optimization, subject to known constraints. In other words, the conception of economics in Robbins corresponds to the core of the neoclassical paradigm and is completely foreign to the methodology of the Austrian School as it is understood today. In fact, the Robbinsian man is an automaton or caricature of the human being, who merely reacts passively to events. As opposed to Robbins’ conception, the position of Mises, Kirzner and the rest of the Austrians should be highlighted. They consider that what man really does, rather than allocating given means to given ends, is to constantly seek new ends and means, learning from the past and using his imagination to discover and create (by action) the future. Therefore, for the Austrians, economics is subsumed under or integrated into a much more general and broad science, a general theory of human action (not of human decision). According to Hayek, if, for this general science of human action “a name is needed, the term praxeological sciences now clearly defined and extensively used by Ludwig von Mises would appear to be most appropriate” (5).

Subjectivism (Austrians) versus objectivism (neoclassicals)

A second aspect which is of capital importance for the Austrians is subjectivism.(6) For the Austrians, the subjectivist conception consists of the attempt to build economic science on the basis of the real human being of flesh and blood, considered as the creative and leading actor in all social processes. This is why, for Mises, “economics is not about things, tangible material objects. It is about men, their meanings and actions. Goods, commodities and wealth and all other elements of conduct are not elements of nature; they are elements of human meaning and conduct. He who wants to deal with them must not look at the external world. He must search for them in the meaning of acting men”.(7) Therefore, for the Austrians, and to a great extent unlike the neoclassicals, the constraints in economics are not imposed by objective phenomena or material factors of the external world (for example, the oil reserves), but by human entrepreneurial subjective knowledge (the discovery, for example, of a carburettor that doubles the efficiency of the internal combustion engine has the same economic effect as the duplication of all the physical oil reserves).

Entrepreneur (Austrians) versus homo oeconomicus (neoclassicals)

Entrepreneurship is the force which plays the leading role in Austrian economic theory while, on the contrary, it is conspicuous by its absence in neoclassical economic science. In fact, entrepreneurship is a typical phenomenon of the real world, which is always in disequilibrium and cannot play any part in the models of equilibrium that absorb the attention of the neoclassical authors. Furthermore, the neoclassicals consider entrepreneurship as simply one more production factor which may be allocated in accordance with its expected costs and benefits, without realizing that, when analyzing the entrepreneur in this way, he makes an insoluble logical contradiction: to demand entrepreneurial resources in accordance with their expected benefits and costs implies the belief that some information is available today (the probable value of the future costs and benefits) before it has been created by entrepreneurship itself. In other words, the main function of the entrepreneur consists of creating and discovering new information that did not previously exist and cannot be known, meaning that it is humanly impossible to make any neoclassical prior decision on allocation on the basis of expected costs and benefits.

In addition, today there is unanimity among all Austrian economists in classifying the belief that entrepreneurial profit arises from the simple assumption of risks as a fallacy. Risk, to the contrary, merely gives rise to another cost of the production process, which has nothing to do with pure entrepreneurial profit.(8)

Entrepreneurial error (Austrian) versus ex post rationalization of all past decisions (neoclassical)

The very different role played by the concept of error in the Austrian and Neoclassical Schools is not usually appreciated. For the Austrians, it is possible to commit sheer entrepreneurial errors(9) whenever an opportunity for gain remains undiscovered by the entrepreneurs in the market. It is precisely the existence of this type of error that give rise to pure entrepreneurial profit. On the contrary, for the neoclassicals, there are never pure entrepreneurial errors which may subsequently be regretted (regrettable errors). This is due to the fact that the neoclassicals rationalize all decisions taken in the past in terms of a supposed cost-benefit analysis made within the framework of a constrained maximization. Therefore, pure entrepreneurial profits have no reason to exist in the neoclassical world and, when they are mentioned, are considered merely as payment of the services of a production factor or as income arising from the assumption of a risk.

Subjective information (Austrians) versus objective information (neoclassicals)

Entrepreneurs are constantly generating new information, which is essentially subjective, practical, disperse and difficult to articulate.(10) Therefore, the subjective perception of information is an essential element in Austrian methodology that is absent in neoclassical economics, since the latter always tends to handle information objectively. In fact, most economists do not realize that, when Austrians and neoclassicals use the term information, they are referring to radically different things. In effect, for the neoclassicals, information, like commodities, is something that is objective and is bought and sold in the market as a result of a maximising decision. This “information”, which may be stored on different supports, is not in any way information in the subjective sense of the Austrians: relevant practical knowledge that is created, interpreted, known and used by the actor in the context of a specific action. This is why the Austrians criticize Stiglitz and other neoclassical theorists of information for not having been able to integrate their information theory with entrepreneurship, which is always its source protagonist, as the Austrians have done. Furthermore, for the Austrians, Stiglitz does not fully understand that information is always subjective and that the markets they call “imperfect”, rather than generating “inefficiencies” (in the neoclassical sense) give rise to the formation of potential opportunities of entrepreneurial gain, which tend to be discovered and made use of by the entrepreneurs in the coordination process that they are continually stimulating in the market.(11)

Entrepreneurial coordination (Austrian) versus general and/or partial equilibrium (neoclassical)

The models of equilibrium of the neoclassical economists usually ignore the coordinating force that entrepreneurship has for the Austrians. In fact, this force not only creates and transmits information but, more importantly, also drives the coordination between the unadjusted behaviours of agents in society. Effectively, all social discoordination materializes in an opportunity for gain which remains latent until it is discovered by the entrepreneurs. Once the entrepreneur realizes that the profit opportunity exists and acts to take advantage of it, it disappears and there is a spontaneous process of coordination, which explains the trend towards equilibrium that exists in any market economy. Moreover, the coordinating nature of entrepreneurship is the only factor which makes it possible for economic theory to exist as a science, understood as a theoretical corpus of laws of coordination which explain the social processes.(12) This approach explains why the Austrian economists are interested in studying the dynamic concept of competition (understood as a process of rivalry), while the neoclassical economists concentrate exclusively on the models of equilibrium which are typical of the comparative statics (“perfect” competition, monopoly, “imperfect” or monopolistic competition).(13) For Mises, as we see in the quotation at the beginning of this paper, there is no sense in the construction of economic science based on the model of equilibrium, in which it is assumed that all the relevant information for drawing the corresponding functions of supply and demand is considered “given”. The basic economic problem for the Austrians is quite different: to study the dynamic process of social coordination in which the different individuals are continually generating new information (which is never “given”) when they seek the ends and means that they consider relevant in the context of each action in which they are involved. thus establishing, without realizing it, a spontaneous process of coordination. For the Austrians, therefore, the basic economic problem is not technical or technological, as it is usually conceived by the theorists of the neoclassical paradigm when they assume that the ends and means are “given” and pose the economic problem as if it were a mere technical problem of maximization. In other words, for the Austrians, the basic economic problem does not consist of the maximization of a known target function subject to constraints that are also known. It is, on the contrary, strictly economic: it emerges when there are many ends and means competing among themselves, when knowledge of them is neither given nor constant, but is dispersed over the minds of innumerable human beings who are continually creating and generating it ex novo and, therefore, all the possible alternatives which exist, all those which will be created in the future, and the relative intensity with which each of them will be pursued cannot even be known.(14)

Moreover, it is necessary to realize that even what appear to be merely maximizing or optimizing human actions always have an entrepreneurial component, since the actor involved in them must have realized previously that this course of action, which is so automatic, mechanical and reactive, is the most advisable in the specific circumstances in which he has found himself. In other words, the neoclassical approach is merely a specific case, of relatively minor importance, which is included and subsumed under the Austrian conception, which is much more general, richer and more explicative of the real world.

Furthermore, for the Austrians, there is no sense in separating microeconomics and macroeconomics into two watertight compartments as the neoclassical economists do. On the contrary, economic problems should be studied together on an inter-related basis, without distinguishing between their micro and macro components. The radical separation between the “micro” and “macro” aspects of economic science is one of the most characteristic insufficiencies of modern introductory manuals and textbooks on political economy. Instead of providing a unified treatment of economic problems, as Mises and the Austrian economists try to do, they always present economic science as divided into two different disciplines (“microeconomics” and “macroeconomics”) with no connection between them and which, therefore, can be studied separately. As Mises rightly says, this separation originates from the use of concepts which, like the general price level, ignore the application of the subjective and marginalist theory of value to money and continue anchored in the pre-scientific stage of economics, when it was still attempted to make analyses in terms of global classes or aggregates of goods, rather than in terms of incremental or marginal units of them. This explains the fact that, to date, a whole “discipline” based on the study of the mechanical relationships which supposedly exist between macroeconomic aggregates has been developed, the connection of which with individual human action is difficult, if not impossible, to understand.(15)

In any case, the neoclassical economists have converted the model of equilibrium into the focal point of their research. In this model, they assume that all information is “given” (either in certain or probabilistic terms) and that the different variables are perfectly adjusted. From the Austrian point of view, the main disadvantage of this methodology is that, as it assumes that all the variables and parameters are perfectly adjusted, it is easy to draw erroneous conclusions on the cause and effect relationships between different economic concepts and phenomena. Thus, the equilibrium would act as a sort of veil that would prevent the theorist from discovering the true direction that exists in the cause and effect relationships of economic laws. For the neoclassical economists, rather than laws of tendency that go in a single direction, what exists is a mutual (circular) determination between the different phenomena, the initial origin of which (human action) remains concealed or is considered of no interest.(16)

Subjective costs (Austrians) versus objective costs (neoclassicals)

Another essential element of Austrian methodology is its purely subjective conception of costs. Many authors believe that it would not be very difficult to incorporate it into the mainstream neoclassical paradigm. However, the neoclassicals only include the subjective nature of costs rhetorically and, in the final analysis, although they mention the importance of the concept of cost of opportunity, they always incorporate it into their models in an objectivized form. However, for the Austrians, cost is the subjective value that the actor places on the ends which he renounces when he decides to undertake and follow a certain course of action. In other words, there are no objective costs. Costs must, rather, be discovered through the entrepreneurial alertness of each actor. In fact, many possible alternatives may go unnoticed but, once they are discovered, they radically change the subjective perception of costs on the part of the entrepreneur. Objective costs which tend towards determining the value of the ends do not, therefore, exist. The real situation is the exact opposite: costs are assumed as subjective values (and, therefore, are determined) depending on the subjective value of the ends really sought (consumer goods) by the actor. Therefore, for the Austrian economists, it is the final prices of consumer goods, as the materialization of subjective valuations in the market, that determine the costs which the actor is willing to incur in order to produce them and not, as the neoclassical economists so often imply, the opposite.

Verbal formalism (Austrians) versus mathematical formalism (neoclassicals)

Another aspect of interest is the different position of the two Schools regarding the utilization of mathematical formalism in economic analysis. From the origins of the Austrian School, its founder, Carl Menger, took care to point out that the advantage of verbal language is that it can express the essences (das Wesen) of economic phenomena, something that mathematical language cannot do. In fact, in a letter he wrote to Walras in 1884, Menger wondered: “How can we attain to a knowledge of this essence, for example, the essence of value, the essence of land rent, the essence of entrepreneurs’ profits, the division of labour, bimetalism, etc., by mathematical methods?”(17) Mathematical formalism is especially adequate for expressing the states of equilibrium that the neoclassical economists study, but it does not allow the inclusion of the subjective reality of time, and much less the entrepreneurial creativity, which are essential features of the analytical reasoning of the Austrians. Perhaps Hans Mayer summed up the insufficiencies of mathematical formalism in economics better than anyone when he said that: “In essence there is an immanent, more or less disguised, fiction at the heart of mathematical equilibrium theories: that is, they bind together in simultaneous equations, non-simultaneous magnitudes operative in genetic-causal sequence as if these existed together at the same time. A state of affairs is synchronized in the “static” approach, whereas in reality we are dealing with a process. But one simply cannot consider a generative process ‘statically’ as a state of rest, without eliminating precisely that which makes it what it is”.(18) This means that, for the Austrians, many of the theories and conclusions of the neoclassical analysis of consumption and production do not make sense. This is true, for example, of what is called the “law of equality of weighted (by prices) marginal utilities”, the theoretical foundations of which are very doubtful. In fact, this law assumes that the actor is capable of simultaneously valuing the utility of all the goods at his disposal, ignoring the fact that any action is sequential and creative and that goods are not valued at the same time, making their supposed marginal utility equal, but rather one after another, in the context of different stages and actions for each of which it is not only that the corresponding marginal utilities may be different, but that it is not even comparable.(19) In short, for the Austrians, the use of mathematics in economics is defective because they synchronically bind together magnitudes which are heterogeneous from the points of view of time and entrepreneurial creativity. For the same reason, for the Austrian economists, neither do the axiomatic criteria of rationality often used by the neoclassical economists make sense. In effect, if an actor prefers A to B and B to C, it is perfectly possible that he prefers C to A, which does not make him “irrational” or inconsistent if he has simply changed his mind (even if this only lasts the hundredth part of a second that posing this problem lasts in his own reasoning).(20) For the Austrians, the neoclassical criteria of “rationality” tend to confuse the concepts of constancy and consistency.

Relation with the empirical world: the different meaning of “prediction”

Lastly, the different relationship with the empirical world and the differences regarding the possibilities of prediction place the paradigm of the Austrian School in radical opposition to that of the neoclassicals. Effectively, the fact that the “observing” scientist cannot obtain the practical information which is being constantly created and discovered in a decentralized way by the “observed” actors-entrepreneurs explains the theoretical impossibility of any type of empirical verification in economics. In fact, the Austrians consider that the same reasons that determine the theoretical impossibility of socialism explain that both empiricism and the cost-benefit analysis or utilitarianism in its strictest interpretation are not viable in our science. It is irrelevant whether it is a scientist or a governor who vainly tries to obtain the practical information that is relevant to each case in order to verify theories or endow his commands with a coordinating nature. If this were possible, it would be viable to use this information either to coordinate society through coercive commands (socialism and interventionism) or to empirically verify economic theories. However, for the same reasons, first, in view of the immense volume of information in question; second, due to the nature of the relevant information (disseminated, subjective and tacit); third, because of the dynamic nature of the entrepreneurial process (information which has not yet been generated by the entrepreneurs in their process of constant innovating creation cannot be transmitted); and fourth, due to the effect of coercion and of scientific “observation” itself (which distorts, corrupts, impedes or simply makes the entrepreneurial creation of information impossible), both the socialist ideal and the positivist or strictly utilitarian ideal are impossible from the point of view of Austrian economic theory.

These same arguments are also applicable in order to justify the Austrians’ belief that it is theoretically impossible to make specific predictions (i.e., referring to determined coordenates of time and place with a quantitative empirical content) in economics. What will happen tomorrow can never be scientifically known today, as it largely depends on knowledge and information which have not yet been entrepreneurially generated and which, therefore, cannot yet be known. In economics, therefore, only general “trend predictions” can be made (what Hayek calls pattern predictions). These are of an essentially theoretical nature and relative, at most, to the forecast of the disorders and effects of social discoordination produced by institutional coercion (socialism and interventionism) on the market.

Moreover, we must remember that objective facts which may be directly observed in the external world do not exist, due to the circumstance that, according to the Austrian subjectivist conception, economic research “facts” are simply ideas that others have on what they pursue and do. They may never be observed directly, but only interpreted in historical terms. In order to interpret the social situation which constitutes history, a prior theory is necessary and, moreover, a non-scientific judgement of relevance (verstehen or understanding) is required. This is not objective but may vary from one historian to another, converting his discipline (history) into a true art.

Finally, the Austrians consider that empirical phenomena are constantly variable, so that there are no parameters or constants in social events and everything is a “variable”. This makes the traditional objective of econometrics difficult, if not impossible, together with any of the versions of the positivist methodological program (from the most ingenuous verificationism to the most sophisticated Popperian falsationism). As opposed to the positivist ideal of the neoclassicals, the Austrian economists aim to construct their discipline through apriorism and deduction. The question is, in brief, to prepare an entire logical-deductive arsenal (21)on the basis of self-evident knowledge (axioms such as the subjective concept of human action itself, with its essential elements) which arise by introspection in the personal experience of the scientist or is considered evident because nobody can argue the axioms without contradicting himself. (22) This theoretical arsenal is, according to the Austrians, indispensable for an adequate interpretation of the apparently unrelated mass of complex historical phenomena which constitute the social world and for drawing up a history towards the past or to predict events towards the future (which is the typical mission of the entrepreneur) with a minimum degree of consistency, guarantees and chances of success. It is now possible to understand the great importance that the Austrians in general place on history as a discipline and on their attempt to differentiate it from economic theory while relating it appropriately thereto.(23)

Hayek calls the undue application of the method appropriate for natural sciences to the social science field scientism. Thus, in the natural world, there are constants and functional relations that allow the application of mathematical language and the performance of quantitative experiments in a laboratory. However, for the Austrians, in economics, unlike the world of physics and the natural sciences, functional relations (and, therefore, functions of supply, demand, costs or of any other type) do not exist. Let us remember that, mathematically, according to set theory, a function is merely a one-to-one (bijective) correspondence between the elements of two sets which are called the “initial set” and the “final set”. Given the innate creative capacity of the human being, who is continuously generating and discovering new information in each specific circumstance in which he acts in respect of the ends he aims to pursue and the means to attain them he considers to be within his reach, it is evident that there is none of the three elements necessary for a functional relationship to exist: a) the elements of the initial set are not given or constant; b) the elements which constitute the final set are not given or constant; and c) and this is the most important point, neither are the correspondences between the elements of the two groups given, but rather vary continually as a result of the action and creative capacity of the human being. Thus, in our science, according to the Austrians, the use of functions requires a presupposition of constancy be introduced into the information, radically eliminating the protagonist of the whole social process: the human being endowed with an innate creative entrepreneurial capacity. The great merit of the Austrians consist of having shown that it is perfectly possible to create the whole corpus of economic theory logically,(24) without any need to use functions or to establish assumptions of constancy which are contrary to the creative nature of the human being, who is the sole true protagonist of all the social processes studied by economic science.

Even the most well-known neoclassical economists have had to recognize that there are important economic laws that cannot be empirically verified (such as the theory of evolution and natural selection).(25) The Austrians have placed special emphasis on the insufficiency of empirical studies to drive the development of economic theory. Effectively, at most, empirical studies may provide some information on certain aspects of the results of the social processes which occur in reality. They do not, however, provide information on the formal structure of said processes, the knowledge of which constitutes precisely the research subject of economic theory. In other words, statistics and empirical studies cannot provide any theoretical knowledge (the error of the historicists of the 19th century German school consisted precisely of this and is, to a great extent, repeated today by the Neoclassical School economists). Furthermore, as Hayek rightly said in his speech on receiving the Nobel Prize, aggregates which can be measured in statistical terms often lack theoretical sense and, vice versa, many concepts with great theoretical significance cannot be measured or treated empirically.(26)

In short, the main criticisms that the Austrian economists make of the neoclassicals are the following: in the first place, they concentrate exclusively on states of equilibrium through a maximizing model which assumes that the agents have full information on the target functions and their constraints; second, the often random choice of variables and parameters for both the target function and constraints, tending to include the most obvious ones and forget others which, although they are of great importance, are more difficult to handle empirically (moral values, customs, etc.); third, they concentrate on models of equilibrium that they treat with the formalism of mathematics and which hide the real cause and effect relationships; fourth, they raise to the level of theoretical conclusions what are merely interpretations of the historical situation and, although they may be relevant in some cases, cannot be considered to have universal theoretical validity, as they only involve historically contingent knowledge. The above considerations do not mean that all the conclusions of the neoclassical analysis are erroneous. On the contrary, a great many of them are probably appropriate and valid. The only matter to which the Austrians wish to draw attention is that there is no guarantee of the validity of the conclusions reached by the neoclassical economists and those which are valid may perfectly well be drawn from the dynamic analysis that the Austrians advocate. This analysis has, in addition, the advantage that it allows erroneous theories (which are also very numerous) to be isolated, as it shows up the defects and errors that are currently concealed by the empirical method based on the model of equilibrium developed by the neoclassical economists.

 
Jesús Huerta de Soto
Professor of Political Economy
King Juan Carlos University of Madrid, Spain

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2. Israel M. Kirzner, Competition and Entrepreneurship, Chicago University Press, Chicago 1973, p. 33.

3. Israel M. Kirzner, The Meaning of Market Process: Essays in the Development of Modern Austrian Economics, Routledge, London 1991, pp. 201-208.

4. Lionel Robbins, An Essay on the Nature and Significance of Economic Science, Macmillan, London 1932 and 1972.

5. F.A. Hayek, The Counter-Revolution of Science: Studies in the Abuse of Reason, Free Press of Glencoe, Illinois 1952, p. 209.

6. The Austrian subjectivist concept allows economics to be generalized into a science that deals with all human actions and has full objective validity, which is paradoxical only in appearance.

7. Ludwig von Mises, Human Action: A Treatise on Economics, 4th revised edition, The Foundation for Economic Education, New York 1996, p. 92.

8. Ludwig von Mises, Human Action, op. cit., pp. 809-811.

9. Israel M. Kirzner, “A Tale of Two Worlds”, Advances in Austrian Economics, Jay Press, Greenwich, Connecticut 1994, Vol. I, pp. 223-226.

10. See Jesús Huerta de Soto, “The Economic Analysis of Socialism”, Chap. 14 of New Perspectives on Austrian Economics, Gerrit Meijer (ed.), Routledge, London and New York 1995.

11. Regarding the Austrian criticism of Grossman-Stiglitz’s theory of information, see Esteban Thomsen, Prices and Knowledge: A Market Process Perspective, Routledge, London 1992; and also Israel M. Kirzner, “Entrepreneurial Discovery and the Competitive Market Process”, The Journal of Economic Literature, March 1997, volume XXXV, no. 1, pp. 60-85.

12. Rothbard and Kirzner have criticized the extreme subjectivist position held by some theorists who, like Lachmann and Shackle, believe that there is no coordinating tendency in the market. This error originates from ignorance of the coordinating force of all entrepreneurial human action. See Murray N. Rothbard, “The Present State of Austrian Economics”, in Journal des Économistes et des Études Humaines, Vol. 6, No. 1, March 1995, especially pp. 56-59; and Israel M. Kirzner, “The Subjectivism of Austrian Economics”, Chap. 1 of New Perspectives on Austrian Economics, op. cit., pp. 11-22.

13. My Austrian School colleagues usually refer to the fact that entrepreneurial processes tend to lead the system towards equilibrium, although they acknowledge that this is never reached. I prefer to talk about a different model, which I have described as the “social big bang”, that allows unlimited growth of knowledge and civilization in a way that is as adjusted and harmonious (i.e. coordinated) as is humanly possible in each historical situation. This is the case because the entrepreneurial process of social coordination never ceases or becomes exhausted. In other words, the entrepreneurial act consists basically of creating and transmitting new information that will inevitably modify the general perception of goals and means of all the actors involved in society. This in turn leads to the unlimited appearance of new disorders which imply new opportunities of entrepreneurial gain that tend to be discovered and coordinated by the entrepreneurs. This repeats itself successively, in a never-ending dynamic process that constantly makes civilization advance (model of the coordinated “social big bang”). See Jesús Huerta de Soto, Socialismo, cálculo económico y función empresarial, Unión Editorial, Madrid 1992, pp. 78-79.

14. A.M. Endres even refers to the “Mengerian principle of non-maximization”. See his article “Menger, Wieser, Böhm-Bawerk and the Analysis of Economic Behaviour”, History of Political Economy, Vol. 23, No. 2, Summer 1991, pp. 275-295, especially footnote 5 on p. 281.

15. “Modern economics does not ask what ‘iron’ or ‘bread’ is worth, but what a definite piece of iron or bread is worth to an acting individual at a definite date and a definite place. It cannot help proceeding in the same way with regard to money. The equation of exchange is incompatible with the fundamental principles of economic thought. It is a relapse to the thinking of ages in which people failed to comprehend praxeological phenomena because they were committed to holistic notions. It is sterile, as were the speculations of earlier ages concerning the value of ‘iron’ and ‘bread’ in general”. Ludwig von Mises, Human Action, op. cit., p. 400.

16. Mises calls equilibrium an “evenly rotating economy” and considers it an imaginary construction with a strictly instrumental value for improving the analytical comprehension of only two problems in our science: the emergence of entrepreneurial profits in a dynamic environment and the relationship that exists between the price of consumer goods and services and the price of the production factors necessary to produce them. In this specific aspect, I would go even further than Mises himself, as I believe that it is perfectly possible to explain the emergence of entrepreneurial profits and the trend toward fixing the prices of the production factors in accordance with the discounted value of their marginal productivity, without any reference to models of equilibrium (either general or partial), but merely to the dynamic process which tends towards what Mises calls a “final state of rest” (which is never reached). See Ludwig von Mises, Human Action, op. cit., p. 248.

17. L. Walras, Correspondence of Léon Walras and Related Papers, W. Jaffé (ed.), North Holland, Amsterdam, Vol. II, 1965, p. 3.

18. Hans Mayer, “The Cognitive Value of Functional Theories of Price: Critical and Positive Investigations concerning the Price Problem”, Chap. XVI of Classics in Austrian Economics: A Sampling in the History of a Tradition, Israel M. Kirzner (ed.), William Pickering, London 1994, Vol. II, p. 92.

19. Hans Mayer tells us that when “all wants differing in kind or quality are not reciprocally present to one another, then the postulate of the law of equal marginal utility becomes impossible in the real world of the psyche”. And he very descriptively adds, commenting on the theoretical absurdity of the forced synchronization of utility estimations, that “It is as if one were to express the experience of aesthetic value of hearing a melody -an experience determined by successive experiences of individual notes- in terms of the aesthetic value of the simultaneous harmonization of all notes of making up the melody”. Hans Mayer, “The Cognitive Value of Functional Theories of Price”, op. cit., pp. 81 and 83. Very similar critical analyses may be made with regard to the indifference-preference curves and the income effect-substitution effect. See, in this respect, Pascal Salin, “The Myth of the Income Effect”, The Review of Austrian Economics, Vol. IX, No. 1, 1996, pp. 95-106.

20. Ludwig von Mises, Human Action, op. cit., pp. 102-104. And, likewise, Murray N. Rothbard, “Toward a Reconstruction of Utility and Welfare Economics”, in Austrian Economics, Stephen Littlechild (ed.), Edward Elgar, Aldershot, England 1990, Vol. III, p. 228 onwards. On the use of mathematics in economics, see, in addition, our comments on pp. 24-25.

21. Thus, an outstanding example is the demonstration of the Law of Diminishing Returns which Mises sets out in exclusively logical terms (point 2 of Chapter VII of Human Action). This logical demonstration is based on the fact that, in sensu contrario, if the mentioned law were not true in the world of human action, the production factor considered as fixed would have an unlimited production capacity and, therefore, would be a free good. Karl Menger, the son of the great Austrian economist, has tried, in our opinion fruitlessly, to refute Mises’ theorem on the strictly praxeological nature of the Law of Diminishing Returns. See Karl Menger, “Remarks on the law of Diminishing Returns. A Study in Meta-Economics”, Chapter 23 of Selected Papers in Logic and Foundations, Didactics, Economics, D. Reidel Publishing Co., Dordrecht, Holland, 1979, pp. 279-302.

22. The former is the position upheld by Rothbard and the latter by Mises. See the summary of the Austrian methodological position by Hans-Hermann Hoppe in his Economic Essence and the Austrian Method, The Ludwig von Mises Institute, Auburn University, Auburn 1995, as well the most recent and clarifying article of Barry Smith “In Defense of Extreme (Fallibilistic) Apriorism”, The Journal of Libertarian Studies, vol. 12, No 1, Spring 1996, pp. 179-192.

23. A favourable and dispassionate explanation of the methodological paradigm of the Austrians may be found in Bruce Caldwell, Beyond Positivism: Economic Methodology in the Twentieth Century, Routledge, 2nd edition, London 1994, pp. 117-138. On the relationship between theory and history, the most important work is Ludwig von Mises, Theory and History, Yale University Press, Yale 1957, together with Hayek’s classic work The Counter-Revolution of Science, Liberty Press, Indianapolis 1979.

24. It would be preferable to say “praxeological”. According to Mises, logic may be distinguished from praxeology because the former is constant and atemporal and the latter includes time and creativity. Ludwig von Mises, Human Action, op. cit., pp. 99-100.

25. See Sherwin Rosen, “Austrian and Neoclassical Economics: Any Gains from Trade?”, The Journal of Economic Perspectives, volume II, no. 4, Fall 1997, pp. 139-152.

26. F.A. Hayek, “The Pretence of Knowledge”, The American Economic Review, December 1989, pp. 3-7.