Economics: the Austrian School and Keynes

Austrian School of Economics

Carl Menger (1840-1921) addressed the diamond-water paradox that had been puzzling classical economists: the fact that humanity finds diamonds more valuable than water although water is far more important. Like Schopenhauer, Menger concluded that people followed impulses more than reason. Menger focused on the uncertainties in human behavior. He asserted that complete knowledge of what is going to happen economically does not exist and that decisions based on expectations of what will happen involve risk. Producers take a risk because they cannot predict with certainty that what they receive in sales will be greater than their production costs. As obvious as this is to people today, it was not the economic model that was standard before Menger. With Menger began what became known as the Austrian School of Economics. It was for entrepreneurs, believed Menger, to collect and evaluate information as best they could and to take calculated risks – a view that more than a century later would appear as common sense.

A fellow Austrian, Eugen von Böhm-Bawerk (1851-1914), read Carl Menger's "Principles of Economics," became an adherent of his theories and wrote criticisms of Marx's economics, describing capitalists as helping rather than exploiting their employees. Böhm-Bawerk taught courses at the University of Vienna, and among his students were those who would become well-known as associates of the Austrian School of Economics: Joseph Schumpeter, Ludwig von Mises and Henryk Grossman.

Schumpeter taught at Harvard beginning in 1932 and was most influential. He described capitalism as destroying itself by its successes rather than its failures as Marx had described. Schumpeter claimed that socialistic creations would create the destruction, hampering the beneficence of the individualist entrepreneur hero. Among his students was Alan Greenspan, chairman of the US Board of Governors of the Federal Reserve, 1987-2006, who shared with Ayn Rand a belief in the individualist enterpreneur hero.

Ludwig von Mises and Friedrich von Hayek also left Europe, running from Hitler, von Mises to New York, Hayek to London. They believed that a few bureaucrats – no matter how bright – trying to constrict economic development into a plan of their making were not superior to a society-wide freedom to innovate and allocate resources, with consumers free to spend their money as they pleased.

Hayek was responding to European fascism and the Soviet Union. He claimed that government guided by majority opinion made sense only if that opinion was independent of government. Hayek believed it best to leave a free play of ideas among the masses in economic matters. People following their own innovations and doing what they see as in their interest is better, he proposed, than a few bureaucrats trying to constrict economic development into a plan of their making – no matter how bright the planners. Hayek won the Nobel Memorial Prize in Economic Sciences in 1974.