Humane Studies Review
Spring 1997 Volume 11 Number 1

In this issue:

The Origins of the Austrian School of Economics

Recent Publications by IHS Friends and Alumni

? Copyright 1997, by the Institute for Humane Studies
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THE ORIGINS OF THE AUSTRIAN SCHOOL OF ECONOMICS

John Moser

John Moser received his Ph.D. in history from the University of Illinois at Urbana-Champaign in 1995. He is author of the upcoming book, *Twisting the Lion's Tail: Anglophobia in the United States, 1921-1948* (Macmillan Press). John is currently a Program Officer at the Institute for Humane Studies.
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.......INTRODUCTION.......

The early development of the Austrian school of economics, and the intellectual battle waged between it and the German historical school are episodes in the history of thought which have been largely overlooked. In the field of economic theory there has been a revival of interest in the Austrian school, sparked by its two most important adherents of the late twentieth century, Ludwig von Mises and Nobel laureate Friedrich von Hayek. Yet in the realm of intellectual history the Austrian school has remained a footnote at best. This is especially surprising given that the cultural and intellectual history of Vienna in the late nineteenth and early twentieth centuries has been such a fertile subject of study. Nevertheless, even a work of such quality as Carl Schorske's *Fin-de-Siecle Vienna* contains not a single mention of the Austrian school or of any of its founding members. This essay will discuss the early years of this very important school of economic thought, and will attempt to place it in the context of late nineteenth-century Austria.

Before concerning ourselves with the actual contributions of the founders of the Austrian school, we ought first briefly look at the movement's prehistory. The subjective theory of value, one of the Austrian school's main pillars, actually goes back to the medieval Scholastic philosophers. These thinkers asserted that to possess value an object must be both useful and scarce.1 Especially significant among the scholastics was the so-called Salamanca school of 16th century Spain, a group of men whom economist Murray Rothbard referred to as "proto- Austrians."2 At the time the dominant theory of value was that of the just price, a variant of the cost-of-production theory which has manifested itself in many forms throughout the centuries, most recently and persistently in Marx's labor theory. In response to this Luis Saravia de la Calle wrote in 1544 that

"Those who measure the just price by the labour, costs, and risk incurred by the person who deals in the merchandise or produces it, or by the cost of transport or the expense of traveling...or by what he has to pay the factors for their industry, risk, and labour, are greatly in error.... For the just price arises from the abundance or scarcity of goods, merchants, and money...and not from costs, labour, and risk.... Why should a bale of linen brought overland from Brittany at great expense be worth more than one which is transported cheaply by sea?... Why should a book written out by hand be worth more than one which is printed, when the latter is better though it costs less to produce?... The just price is found not by counting the cost but by the common estimation."3

The Salamanca school, however, rarely followed this idea through systematically, and, as F.A. Hayek has written, "never to the point of realizing that what was relevant was not merely man's relation to a particular thing or a class of things but the position of the thing in the whole...scheme by which men decide how to allocate the resources at their disposal among their different endeavors."4

It has been common for historians of economic thought to link all "free-market" theories together in a common chain, and to give undue weight to the ideas of the Scottish Enlightenment and especially to Adam Smith. However, these thinkers had little influence on the Austrians, who drew largely on French subjectivist economists such as E.B. de Condillac, Louis Say, Auguste Walras, and Jules Dupuit. The classical school of political economy pioneered by Adam Smith and David Ricardo, meanwhile remained wedded to an "objective" theory of value; as late as 1848 John Stuart Mill in his *Principles of Political Economy* not only reiterated the classical argument but calmly asserted, "Happily, there is nothing in the laws of value which remains for the present or any future writer to clear up; the theory of the subject is complete."5 Adam Smith, long held up as the paragon of free-market capitalism, was severely criticized by Murray Rothbard, who claimed that "his devotion to laissez-faire was dubious at best," and that his economic theory was "retrograde and disastrous."6

.......THE FOUNDERS OF THE AUSTRIAN SCHOOL.......

The major precursors of Austrian economics, therefore, came not from the classical school but rather from the so-called Lausanne school in France, and its principal theorist, Leon Walras (1834-1910). Walras, who was in turn influenced by the Englishman W. Stanley Jevons (1835-82), presented economics as "the calculus of pleasure and pain of the rational individual." Using the theories of the scholastics and the French physiocrats as their base, Jevons and Walras expanded on the subjective theory of value, and along with Carl Menger, the founder of the Austrian school, launched what some have called a "neoclassical revolution" in economics.7

Carl Menger (1840-1921) was born in Austrian Poland, the son of a lawyer. He studied law at the universities of Vienna and Prague and received his doctorate at the University of Cracow in 1867. Afterward, Menger obtained a position in the press section of the prime minister's office. It was there, in Vienna during the heyday of Austrian liberalism, that Menger became interested in price theory.8 In 1871 he completed his *Grundsaetze der Volkswirtschaftelehre*, the work which established him as a significant economic theorist.

Like the works of Walras and Jevons, Menger began his *Grundsaetze* with an acceptance of the subjective theory of value. However, he made several significant deviations from their work. The first, and perhaps most important, was a fundamental rejection of the use of mathematical methods. While Walras dealt primarily with quantities, expressed in terms of mathematical formulae, Menger insisted that the function of economics was not to investigate specific quantities of economic phenomena, but rather their essences, such as the concepts of value, rents, profit, division of labor, et cetera.9

Another point which Menger stressed was the importance of uncertainty in making economic decisions. Whereas classical and neoclassical economists alike had typically assumed that *homo oeconomicus* was fully informed about all the data necessary for making rational decisions, Menger asserted that such perfect knowledge never exists, and that therefore all economic activity implies risk. As a result, he saw the main role of entrepreneurs as being the collection and evaluation of information: "The quantities of consumption goods at human disposal are limited only by human knowledge of the causal connections between things, and by the extent of human control over these things."10

Menger saw the roots of uncertainty in the time-consuming nature of economic processes. Assuming that all production takes time, producers have no way of knowing for certain that the market conditions prevailing when the production begins will continue to exist when the final product is ready for delivery. The result is that the price of the finished product bears no resemblance to the costs of production, since the two represent market conditions at very different points in time.11

As a result of the *Grundsaetze* Menger received the chair of economic theory at the University of Vienna in 1873, at the then unheard-of age of thirty-three. In addition, he was employed as a tutor to Crown Prince Rudolf in 1875. In this capacity he accompanied Rudolf on his extensive travels through Germany, France, and the British Isles. He is also thought to have assisted the crown prince in the composition of a pamphlet, published anonymously in 1878, which was highly critical of the higher Austrian aristocracy. A minor scandal erupted when in 1906, seventeen years after Rudolf's tragic suicide, his authorship of the pamphlet was discovered.12

Menger was named to the *Hofrat* and was appointed to the Austrian *Herrenhaus* in 1900.13 By this time, however, he had become intensely pessimistic about the future of Europe (largely the result of the *Methodenstreit*, detailed below), so much so that in 1903 he gave up teaching altogether. Menger was repulsed by the ideas coming out of the universities of Germany, and predicted even before 1880 that eventually "the policies as conducted by the European powers will lead to a horrible war that will end with gruesome revolutions, with the extinction of European culture and the destruction of prosperity of all nations."14

Though Menger retired from public life at an early age, his writings were to inspire several generations of economic thinkers, many of whom would carry the Austrian school of economics into the post-World War I era. While these later economists lie beyond the scope of this study, we shall now examine the contributions of Menger's two most immediate successors, Eugen von Boehm-Bawerk and Friedrich Wieser.

Eugen von Boehm-Bawerk (1851-1914) read Menger's *Grundsaetze* as a student, and though he never studied under Menger, he quickly became an adherent of his theories. After completing his studies, Boehm-Bawerk entered the Austrian Ministry of Finance, and then in 1880 became a *Privatdozent* in Political Economy at the University of Vienna. In 1881 he joined the faculty at the University of Innsbruck, and it was there that he completed his chief work, the two-volume *Kapital und Kapitalzins*, which brought him an international reputation.15 In this work Boehm-Bawerk built upon the time-preference ideas of Carl Menger, insisting that there is always a difference in value between present goods and future goods of equal quality, quantity, and form. Furthermore, the value of future goods diminishes as the length of time necessary for their completion increases.

Boehm-Bawerk cited three reasons for this difference in value. First of all, in a growing economy, the supply of goods will always be larger in the future than it is in the present. Secondly, people have a tendency to underestimate their future needs due to carelessness and shortsightedness. Finally entrepreneurs would rather initiate production with goods presently available, instead of waiting for future goods and delaying production.16

However, Boehm-Bawerk is remembered less for his contributions to economic theory than he is for his political career. In 1889 he was called to Vienna by the Finance Ministry to draft a proposal for direct tax reform. The Austrian system at the time taxed production heavily, especially during wartime, providing massive disincentives to investment. Boehm-Bawerk's proposal called for a modern income tax, which was soon approved and met with a great deal of success in the next few years.17

As a result of this experience Boehm-Bawerk was named Finance Minister three times in the years after 1895. He held office for only a short time on the first two occasions, but on the third time, in 1900, he maintained the position for nearly five years. As Finance Minister he fought continuously for strict maintenance of the legally fixed gold standard and a balanced budget.18 In 1902 he eliminated the sugar subsidy, which had been a feature of the Austrian economy for nearly two centuries. He finally resigned in 1904, when the increased fiscal demands of the army threatened to unbalance the budget.19 Evaluations of his performance as Finance Minister remain mixed, however. Economic historian Alexander Gerschenkron criticized his "penny pinching, 'not-one-heller- more-policies'," and lays much of the blame for Austria's economic backwardness on Boehm-Bawerk's unwillingness to spend heavily on public works projects.20 Joseph Schumpeter, on the other hand, praised the minister's efforts toward "the financial stability of the country."21 In any case, his popularity upon leaving office cannot be denied. The Austrian state credit had so much improved under Boehm-Bawerk that he had been able to carry out a reconversion of the public debt. On his retirement the government offered him the high-paying post of Governor of the *Bodenkreditanstalt*, but he turned it down to devote the rest of his life to academia.22

The third of the trio of the Austrian school's founders is Friedrich Wieser (1851-1926). Born in Vienna, the son of an important official in the War Ministry, Wieser studied jurisprudence at the University of Vienna. Like Boehm-Bawerk, he had a keen interest in economics, but he was dissatisfied with the discipline, dominated as it was at the time by the German historical school (see below). Also like Boehm-Bawerk, he was converted to Menger's theories by the latter's *Grundsaetze der Volkswirtschaftslehre* in the early 1870s. In 1884 Wieser became a professor at the University of Prague, where he was appointed to the chair of political economy in 1889. Upon Menger's retirement in 1903 Wieser was offered the chair of political economy at the University of Vienna, and he held this post until 1922.23

It is in Wieser's principal work, *Wesen und Hauptgesetz des Wirtschaftlichen Wertes*, that we find his most significant contributions to economic theory. It was Wieser who coined the term "marginal utility" (*Grenznutzen*), a phrase which has now come to be associated with all subjectivist theories of value since those of Jevons, Walras, and Menger. Wieser interpreted costs in terms of sacrificed utility (or "opportunity costs," as they have since come to be known)--means which would otherwise be employed elsewhere.24

Wieser also developed the notion of the paramount importance of accurate calculation to economic efficiency. Prices to him represented, above all, information about market conditions, and are thus necessary for any sort of economic activity. A socialist economy, therefore, would require a price system in order to operate. This theme would be further developed by Ludwig von Mises, who demonstrated the impossibility of economic calculation under socialism.25

Finally, Wieser stressed the importance of the entrepreneur to economic change. More concerned with processes than actual outcomes, he saw change as being brought about by "the heroic intervention of individual men who appear as leaders toward new economic shores." This idea of leadership was later taken up by Joseph Schumpeter in his treatment of economic innovation.26

The precise value of Wieser's contributions has been a subject of debate for subsequent economists of the Austrian school. Indeed, Ludwig von Mises claimed that he was "more harmful than useful," and that he "never really understood the gist of the idea of Subjectivism in the Austrian School of Thought."27 It may be that Mises' criticism was motivated by ideology, for of the early Austrians Wieser was the only one to reject economic and political liberalism. In his last work, *Das Gesetz der Macht*, for example, he wrote that "freedom has to be superseded by a system of order."28 More recently, however, there has been a revival of interest in Wieser among some younger economists of the Austrian school, who praise him for establishing "a bridge to many of the concerns of contemporary Austrian economics."29

.......THE *METHODENSTREIT*.......

The Austrian school of economics, of course, attracted its share of critics, most of whom came from Germany. The study of economics in the Second Reich was dominated by the so-called German historical school, which argued that economic theories could only be derived from experience, that is, from the study of history. They largely accepted the conclusions of the British classical economists, but they asserted that a study of German history would produce very different results. In short, they rejected the idea that economic theorems could be held as universally valid.30

The German historical school effectively controlled academia in Germany, mainly through the efforts of Friedrich Althoff, the Prussian minister of education in charge of university affairs from 1882 to 1907. Since Prussia had by that time become the intellectual center for Germany, and the education ministry largely dictated the curricula of Prussian universities, Althoff was able to exercise almost absolute power over German scholarship. Althoff, however, was no social scientist--when it came to subjects such as sociology, history, and economics, he relied entirely on the advice of his friend Gustav von Schmoller, at the time the leading intellectual champion of German historicism.31 As a result, as Ludwig von Mises claims,

"[E]conomics in the second German Reich, as represented by the Government-appointed university professors, degenerated into an unsystematic, poorly assorted collection of various scraps of knowledge borrowed from history, geography, technology, jurisprudence, and party politics, larded with depreciatory remarks about the errors in the abstractions' of the Classical school. Most of the professors more or less eagerly made propaganda in their writings and in their courses for the policies of the Imperial Government...."32

Given German historicism's distrust of theory, at least of theory not derived from historical experience, it was inevitable that there would be a clash between it and Menger's ideas, which were based on theories of human action which purported to be universally valid. The first salvo was fired by Schmoller himself, when he wrote an unfavorable and condescending review of Menger's *Grundsaetze der Volkawirtschaftslehre*. Menger replied in a brochure provocatively titled "Die Irrthuemer des Historismus in der Deutschen Nationaloekonomie" ("The Errors of Historicism in the German Political Economy"), which was published in 1884. A dispute thus began which would last for decades and would eventually include some of the most famous names of turn-of- the-century economic thought--Lujo Brentano and Werner Sombart on the German side, and Boehm-Bawerk, Wieser, and Ludwig von Mises on the Austrian.33

Interestingly enough, it was only as a result of the *Methodenstreit* that the term "Austrian school of economics" came into existence. In 1883, in a characteristically unfavorable review of Menger's second book, *Untersuchungen usher die Methode der Sozialwissenschaften und der Politischen Oekonomie Insbesondere*, Schmoller used the term as an epithet against Menger and his followers. The reference was certainly not lost on those in the field--the word "Austrian" used in connection with a style of thought carried strong connotations of backwardness, and conjured up images of the Counter- Reformation and of the Age of Metternich.34 In so doing Schmoller hoped to set off his own mode of thought in stark relief, making the struggle one of enlightened Hegelian Germany versus the quaint, old-fashioned Habsburg Monarchy.35 Nevertheless the name stuck, though in the post-1945 era few would claim that Germany has a monopoly on "enlightened" thought.

The *Methodenstreit* had serious ramifications both for academia and for politics. Intellectually, it was a question of whether there could be a science, apart from history, which could explain the dynamics of human action. Politically, meanwhile, it represented a conflict between economic liberalism and the authoritarian welfare state of Bismarckian Germany. When one considers that economic laws such as those offered by Austrian political economy provided devastating critiques of government intervention in the economy, it is easy to deduce how a school of thought that rejects the validity of economic laws could be put to use for political ends. This is exactly what happened in Germany, as the academic community became "the intellectual bodyguard of the House of Hohenzollern," writing extravagant justifications for labor legislation, progressive taxation, social security, protective tariffs, and the formation of industrial cartels.36

.......CONCLUDING REMARKS ABOUT THE AUSTRIAN SCHOOL.......

What was "Austrian" about the Austrian school? It did in certain ways reflect the character of turn-of-the-century Austria. Whereas in Germany the influence of Hegel led academics to try to "overcome" the ideas of Western Europe, Austrian scholars used these ideas as a basis for their own theories--thus it was an age of Franz Brentano's neo- Aristotelian philosophy, of Bolzano's epistemology, of Mach's empiricism, Husserl's phenomenology, and Freud's psychoanalysis.

Two other uniquely Austrian traits also deserve mention. First of all, the first generation of the Austrian school contained a spirit of compromise between pure laissez-faire and the traditional Austrian ideals of order and bureaucracy. Though Menger and Boehm-Bawerk were both political and economic liberals they did not espouse the radical laissez-faire principles of their intellectual descendants such as Mises and Rothbard. Menger, for example, rejected the blending of his subjectivist theories with Manchester liberalism, and Boehm- Bawerk feared that unbridled free competition would lead to "anarchism in production and consumption."37 Certainly both believed in a strong and stable social order based ultimately on the authority of the State.

A second aspect is the strongly psychological nature of the Austrian school. No other economic school of thought has placed such a premium on the effects of psychology--as far as it determines an individual's perceptions of means and ends--on the economy as a whole. There is no doubt some connection between this tendency and a general interest in psychology in late nineteenth century Vienna, as seen in the works of Arthur Schnitzler, Franz Grillparzer, and of course those of Sigmund Freud and Alfred Adler.

In conclusion it is worthwhile to say something of the relation between Austrian economics and another significant economic theory of the nineteenth century, Marxism. Though many Marxist authors have attempted to portray the Austrian school as a bourgeois reaction to Marx, such an interpretation is untenable: Menger wrote his *Grundsaetze* at almost the same time as Marx was completing *Das Kapital*. The Austrian economists were, however, the first to clash directly with Marxism, since both dealt with such subjects as money, capital, business cycles, and economic processes. Boehm-Bawerk wrote extensive critiques of Marx in the 1880s and 1890s, and several prominent Marxists--including Rudolf Hilferding--attended his seminar in 1905-06. In contrast, the classical economists had shown little interest in such topics, and many of them did not even gain familiarity with Marx's ideas until well into the twentieth century.38

Clearly, the early history of the Austrian school of economics deserves to be examined more closely, especially in light of the tremendous impact that Austrian ideas had in the free- market revivals of the 1980s in Britain and the U.S. Most of what has been written on the subject to date has been by economists, not historians, as they have come to realize the enormous contributions which Menger, Boehm-Bawerk, and Wieser have made to the discipline. However, they are not only of interest to economists--their work deserves to be studied in the context of turn-of-the-century Europe alongside other great minds of that era.

_____________________

1. F.A. Hayek, "Economic Thought VI: The Austrian School," in David L. Sills (ed.), *International Encyclopedia of the Social Sciences* (New York: Macmillan and Free Press, 1968), p.458.

2. Murray N. Rothbard, "Adam Smith Reconsidered," *Austrian Economics Newsletter* 9 (Autumn 1987), p.5.

3. Murray N. Rothbard, "New Light on the Prehistory of the Austrian School," in Edwin G. Dolan (ed.), *The Foundations of Modern Austrian Economics* (Kansas City: Sheed and Ward, 1976), p.55.

4. Hayek, "Economic Thought," p.458.

5. Ibid., p.459.

6. Rothbard, "Adam Smith Reconsidered," p.7.

7. Erich Streissler, "The Intellectual and Political Impact of the Austrian School of Economics," *History of European Ideas* 9 (1988), p.192.

8. F.A. Hayek, "Carl Menger," in Sills (ed.), *International Encyclopedia of the Social Sciences*, p.124.

9. Emil Kauder, "Intellectual and Political Roots of the Older Austrian School," *Zeitschrift fuer Nationaloekonomie* 17 (1957), p.413.

10. Streissler, "Intellectual and Political Impact," p.194.

11. Ibid.

12. Hayek, "Carl Menger," p.125.

13. Streissler, "Intellectual and Political Impact," p.198.

14. Ludwig von Mises, *Notes and Recollections* (S. Holland, IL: Libertarian Press, 1978), pp.34-5.

15. Friedrich Wieser, "Boehm-Bawerk," in R.H. Inglis Palgrave (ed.), *Dictionary of Political Economy* (London: Macmillan, 1894), p.825.

16. Emil Kauder, "Boehm-Bawerk," in Sills (ed.), *International Encyclopedia of the Social Sciences*, p.122.

17. Wieser, "Boehm-Bawerk," p.825.

18. Ludwig von Mises, *The Historical Setting of the Austrian School of Economics* (New Rochelle, NY: Arlington House, 1969), p.18.

19. Kauder, "Boehm-Bawerk," p.119.

20. Alexander Gerschenkron, *An Economic Spurt that Failed*: *Four Lectures in Austrian History* (Princeton: Princeton University Press, 1977), pp.127-8.

21. Joseph Schumpeter, "Eugen von Boehm-Bawerk," *Neue Oesterreichische Biographie* (Vienna, 1925), p.79.

22. Wieser, "Boehm-Bawerk," p.825.

23. Oscar Morgenstern, "Friedrich von Wieser, 1851-1926," *American Economic Review* 17 (1927), p.669.

24. Hayek, "Economic Thought," p.460.

25. Streissler, "Intellectual and Political Impact," p.195.

26. Ibid.

27. Mises, *Notes and Recollections*, pp.35-6.

28. Kauder, "Intellectual and Political Roots," p.421.

29. Robert B. Ekelund, Jr., and Mark Thornton, "Wieser and the Austrian Connection to Social Economics," *Forum for Social Economics* 16 (Spring 1987), p. 2.

30. Mises, *Historical Setting*, p.23.

31. Ibid., pp.26-7.

32. Ibid., pp.23-4.

33. Hayek, "Carl Menger," p.125.

34. Mises, *Historical Setting*, p.30.

35. Barry Smith, "Austrian Economics from Menger to Hayek," in Wolfgang Grassl and Barry Smith (eds.), *Austrian Economics: Historical and Philosophical Background* (New York: New York University Press, 1986), p.vii.

36. Mises, *Historical Setting*, p.30.

37. Kauder, "Intellectual and Political Roots," p.421.

38. Streissler, "Intellectual and Political Impact," pp.195-6.

John Moser, Ph.D.
Institute for Humane Studies
[email protected]

If you'd like to learn more about Austrian economics, a good place to start is Professor Peter J. Boettke's home page:

http://www.econ.nyu.edu/user/boettke/mises.htm

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