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The Odyssey of Sound Economics

Mises Daily: Tuesday, October 23, 2012 by


Imagine a world in which the works and ideas of Ludwig von Mises had been neglected and ultimately forgotten. The socialist-calculation argument, the Austrian theory of the business cycle, praxeology: each nothing more than a footnote in the history of economic thought.

Imagine a world in which the only Austrian economists were a handful of diffuse and eclectic thinkers puttering around harmlessly and fruitlessly in academia.

Imagine how bleak and hopeless the future would look in such a world in which there was no radical, hardcore approach to liberty, underpinned by systematic, sound economic theory, available to the public: only the waffling of woolly moderates and the tentative propositions of positivist and eclectic economists.

That is what the world would be like today if not for the Ludwig von Mises Institute. In two groundbreaking academic articles, Joseph T. Salerno masterfully and convincingly tells the story of how LvMI rescued sound economics after a century of vicissitudes and near-death experiences for the Austrian School.[1] This essay aims to condense that story for the lay person.

Truth can be a fragile thing: a flickering flame that can be easily extinguished if not tended to sedulously. This is particularly the case for sound economics.

But even a partial truth, if it sets the intellectual world ablaze, can do a tremendous amount of good. Such was the case of the Classical School of economics, which, in spite of its grave flaws, helped to engender the age of liberalism and the Industrial Revolution.

A more complete truth was discovered in the "Marginalist Revolution" of economics in the 1870s. In this revolution, the objective theories of value of the Classical School were supplanted by subjective theories. Value was no longer attributed to whole classes of goods, nor was it considered a quality imparted to a good by the costs or labor expended in producing it. Value, according to what Ludwig von Mises called "modern economics," was a personal and subjective evaluation of a unit of the good in question.

The new, subjectivist economics had the potential to revolutionize society, as Classical economics did before it, especially as it was formulated by Carl Menger, the founder of the Austrian School, and one of the originators of subjective marginalist theory. As Israel Kirzner wrote,

For Menger, incomes in a capitalist system express the relative urgency of the consumer needs that those income earners can satisfy. The theory of income distribution becomes for Menger simply an extension of the theory of value. In capitalism, the importance of particular consumer needs is transmitted through the structure of production. As this ripple proceeds, both the prices of higher order goods and the incomes of the various producers are determined. [Menger's] scientific results contained … ideological dynamite. They suggested the view of the market economy to which its defenders could triumphantly appeal.[2]

The economic theory of the new Austrian School was importantly different from that of the Classical School, and not just in its value theory. The Classical theory of the economy, especially as formulated by David Ricardo, was profoundly unrealistic. Ricardo introduced many arbitrary assumptions from which he deduced his conclusions. He assumed conditions that are nowhere to be found in the actual market phenomena he attempted to describe, and that did little to nothing to elucidate those phenomena.

Menger, however, in order to explain the formation of real prices as they actually are seen in the market, was careful to introduce into his theory conditions that are actually found in the reality he was trying to explain. Menger's theory, unlike Ricardo's, was realistic.

However, Menger was not the only figure in the Marginalist Revolution. Two other economists independently formulated marginal theories of value in the same time period. One was the Englishman William Stanley Jevons, and the other the Frenchman Léon Walras.

Unfortunately Walras did not undertake a realist approach like Menger's. His system was perhaps even more unrealistic than Ricardo's. Walras based his theory on the notion of "general equilibrium," an imaginary world of endlessly repetitive economic activity in which there is no variation, and therefore no uncertainty. This concept, known as the evenly rotating economy to modern Austrians, is an important construct to contrast with reality, especially so as to help the mind conceptually distinguish between profit and interest: two phenomena that are very much present, but intermingled, in the real world.

But Walras did not use it this way. Instead, he analyzed various hypothetical states of general equilibrium. However internally consistent these analyses may have been, they did not shed any light on the operations of real-world markets. Mises referred to this kind of analysis as a scientifically vain sort of play. Walras also explored a hypothetical process by which a market in disequilibrium might "grope" its way toward equilibrium. But the assumptions made in formulating this process were also completely unrealistic, and thereby completely useless.

While Walras's theory was like Ricardo's in its unrealism, it was actually worse than Ricardo's in an important way. While Ricardo abjured reality to some extent, at least he embraced the notion of cause and effect. Walras abjured both realism and cause and effect. In Walrasian general equilibrium, prices mutually determined one another. There was no direction in which causation flowed.

Menger on the other hand sought out causal laws with which to explain the price phenomena of the real world. Menger's emphasis on causal laws also contrasted with the approach of the historicism that was prevalent in German-language scholarship at the time, which denied the existence of any economic laws, causal or otherwise.

It is because of this dual emphasis on causal laws and realism that Salerno calls the Mengerian tradition "causal-realist." As causal-realist economics is the only kind of economics that is both true and useful, it may also be simply called "sound economics."

This rift at the outset of the Marginalist Revolution between Mengerian causal realism and Walrasian "acausal anti-realism" was to prove momentous. The Walrasian strain would ultimately become a major part of "mainstream economics" in the 20th century, and would even come to infect the Austrian School itself.

Menger had two chief protégés: Eugen von Böhm-Bawerk and the latter's brother-in-law Friedrich von Wieser. Böhm-Bawerk extended and elaborated Menger's value theory and causal-realist price theory. Wieser on the other hand adopted the former, but largely ignored the latter, instead formulating his own form of general-equilibrium theory.

Menger and Böhm-Bawerk helped to inspire an Anglo-American causal-realist tradition, led by John Bates Clark, Philip Wicksteed, Frank Fetter, and Herbert Davenport.

Ludwig von Mises studied under Böhm-Bawerk, and was greatly influenced by Menger, saying that Menger's Principles of Economics "made an economist" out of him. Mises adopted and extended the causal-realist approach, using it to make huge strides in the theories of money, the business cycle, economic calculation, and much more.

Another Austrian, Joseph Schumpeter, was chiefly influenced by his teacher Wieser and by reading the works of Walras. He too adopted a Walrasian general-equilibrium approach to price theory.

In the decade leading up to World War I, Schumpeter was far more influential than Mises, partly because Mises had not yet woven all of his advances together into a systematic treatise. So Schumpeter was free to, as Salerno states, "recast the price-theoretic core of Austrian economics along the lines of (verbal) Walrasian general-equilibrium analysis."

Due to this, the fourth generation of the Austrian School, including F.A. Hayek, under the prevailing influence of the writings of Wieser and Schumpeter, was captivated by the Walrasian approach. Hayek, in his early works, "viewed general-equilibrium theory as the core of economic theory."[3] However, Hayek was also influenced by Mises to a significant degree (especially in his early "macroeconomics") and made enormous contributions to causal-realist production and business-cycle theory.

Hayek carried the "Walrasian contagion" with him to the London School of Economics (LSE), and there introduced it to the English-speaking world. As Salerno writes, "It was under Hayek's influence that economists at LSE, especially John Hicks, began to introduce Walrasian general-equilibrium theory … to Anglo-American economists."[4] Hayek and Hicks swayed Lionel Robbins, the head of LSE, away from Mengerian causal-realism and toward Walrasian general-equilibrium theory. This had the effect of moving LSE itself in that same direction.

The Hayek-Hicks reconstruction of general-equilibrium theory combined with the partial-equilibrium approach of Alfred Marshall to take over Anglo-American microeconomics, almost completely supplanting the causal-realist tradition of Wicksteed, Fetter, Clark, and Davenport. So complete was the conquest that George Stigler, in 1946, would sniff at Böhm-Bawerk for having spurned mutual determination and for clinging stubbornly to "the older concept of cause and effect."[5]

The causal-realist tradition dwindled in influence throughout the interwar period. Then, virtually on the eve of the Second World War, Mises saved it from oblivion when he finally published his systematic treatise, the German-language Nationalökonomie. In this book, Mises reformulated and refined the advances of his predecessors, connecting those advances with his own trailblazing theories into an integrated whole. The book was the scientific apogee of causal-realist economics.

But there was no audience for such a work in a German-speaking world already overrun by the Nazis, and the book fell dead from the presses. Soon after, the Nazi advance drove Mises from Europe, and he had to find refuge in America.

But Mises was faithful to his motto as always: tu ne cede malis, "yield not to ills."[6] He was determined to set the world right, and he believed the only way to do so was through sound economics. And so, nine years later he wrote his systematic treatise again, this time in English, titling it Human Action.

Yet even in America the audience for such a book was limited, so widely had anti-liberal, and anti-causal-realist doctrines spread. Human Action did inspire some followers who adopted Mises's approach, notably Henry Hazlitt and Hans Sennholz. But the book was unable to, by itself, reestablish a causal-realist school in America.

This was chiefly for two reasons. One reason was a lack of dedicated institutional support. The institutions that supported Mises were interested in marshalling arguments for economic liberty, but were not specifically dedicated to Mises's scientific project.

Secondly, while in Human Action Mises elaborated on his own extensive original contributions and refinements, he assumed the reader was already familiar with other core aspects of sound economics. But this was an assumption that could not be made given the parlous state of economics in the English-speaking world. There was a need to bridge the gaps in Mises's magisterial system.

That need was filled by Murray N. Rothbard, a genius who throughout the 1950s was able to do for Misesian economics what Euclid did for geometry: fill in the lacunae of the system and make explicit the step-by-step deductions by which the theoretical edifice was built. The result was Man, Economy, and State, published in 1962.

Man, Economy, and State made sound economics so clear to apprehend that it was a career-defining influence for a number of isolated scholars. By 1974, there were enough Rothbardians for an Austrian-economics conference, funded by the Institute for Humane Studies, to be organized in the small Vermont village of South Royalton.

The conference itself is often billed as the event that inaugurated the modern Austrian-economics movement in America. But really it was simply the first physical congregation of a movement that had been growing since the publication of Rothbard's treatise. Young Rothbardians made up the majority of the participants at South Royalton. Had it not been for that book, there would not have been enough Austrians to even merit a conference.

Moreover, South Royalton was at best a mixed blessing, as it led to history repeating itself. Once again, a school of economic thought was bifurcated between two strands. In the Marginalist Revolution, the split was between Menger and Walras. In the second generation of the Austrian School, it was between Böhm-Bawerk and Wieser. In the third generation, it was between Mises and Schumpeter.

A major divide within the reborn Austrian School in America was between Rothbard and Ludwig Lachmann, a South African scholar who was lifted to prominence by South Royalton. Lachmann had made some significant contributions to Misesian economics. But, after being suddenly converted to the nihilist methodology of George Shackle, he began to develop a very anti-Misesian view of the market economy.

For example, Mises had made the realistic claim that acting man is capable of grappling with uncertainty concerning the valuations of his fellow man using the human faculty of understanding. Thanks to this, historical and anticipated prices were apt tools for meaningful economic calculation.

Lachmann, on the other hand, made the unrealistic assumption that acting man was beset with such "radical uncertainty" that anticipated prices were meaningless with regard to the rational allocation of resources. This view was non-causal-realist in its use of unrealistic assumptions, as well as in its quasi-historicist denial of causal laws providing rational order in the market. Unfortunately, in spite of Rothbard's efforts, a number of young Austrians followed Lachmann into the nihilist wilds.

Sound economics suffered a tremendous blow when, as Salerno tells it,

the new major funding source for I.H.S. and the Cato Institute, a newly-established libertarian "think tank," made a momentous decision in the late 1970s to deliberately downplay the role of Ludwig von Mises in Austrian economics because his radical intransigence in economic method, theory, and policy risked alienating moderate, neoclassical "free-market" economists, graduate students, and economic policymakers who the new financial-institutional axis was eager to draw into its ambit.

As time went on, Mises's name was mentioned less and less at conferences and symposia sponsored by these financially allied institutions and soon became almost anathema. As Mises was being phased out, there emerged an increasing emphasis on the contributions of Friedrich Hayek, who had won the Nobel Prize in 1974.[7]

Affairs worsened in 1980 when

a lavishly financed Ph.D. program in anti-Misesian, pro-Lachmannian "Market Process" economics was instituted at George Mason University in northern Virginia.[8]

This program would later be led by Don Lavoie, a Lachmannian who inculcated in several of his students a methodological eclecticism that they champion to this day.

In the following year, Rothbard was forced out of the Cato Institute, which he had cofounded, his shares in the organization being confiscated. Rothbard had hoped Cato would be a vehicle for promoting Misesian economics. Yet, even before his ouster, the organization had already started drifting toward neoclassical economics, and especially toward the Chicago School. Now, causal-realist economics was as isolated as ever, having lost almost all of its institutional support. Sound economics was once again on the verge of being lost to the world.

But as they say, it is always darkest before the dawn. And in the very next year, Lew Rockwell, on a shoestring budget, founded the Ludwig von Mises Institute for Austrian Economics (LvMI's official name). What is more, he did so in the face of furious opposition from the same billionaires who had chosen to downplay Mises, financed the diffuse GMU program, and forced Rothbard out of Cato.

Sound economics finally had an institutional home. Through LvMI's journals, always edited by hardcore Misesians, starting with Rothbard, causal-realist economics has been developed for 30 years. Through LvMI's conferences, always directed by hardcore Misesians, starting with Rothbard, causal-realist economics has been disseminated for 30 years.

LvMI has provided a venue for scholars who had independently discovered Austrian economics to come together. One of those scholars is now our academic vice president, Joseph T. Salerno. LvMI has also been an engine for the production of new Austrian scholars. One of those LvMI graduates is now our executive director, Peter G. Klein.

Under the stewardship of these two champions of causal-realist economics and of Mr. Rockwell, and with your financial support, we can rest assured that the flame of sound economics — after being buffeted by fate for over a century, time and again at the point of being extinguished, only to be saved at the last moment by an isolated genius — will be tended to safely and sedulously for many years to come.

What is more, truth, if made accessible, can spread like a prairie fire. Ron Paul has inspired thousands with his message of liberty. These thousands are a huge potential seedbed for future growth in the causal-realist Austrian School. (For all we know, among their ranks may even be another genius on the level of Mises or Rothbard.) And we can reach these potential Austrians now more easily than ever through Mises.org.

Mises.org can also be an enormously powerful tool for the Austrian School scholars and educators that LvMI has nurtured to reach the general public, so as to effect an ideological revolution. That mission is what makes sound economics so important in the first place, for as Mises wrote,

The flowering of human society depends on two factors: the intellectual power of outstanding men to conceive sound social and economic theories, and the ability of these or other men to make these ideologies palatable to the majority.[9]

This is why Mises called sound economics "the pith of civilization."[10] For the sake of our beleaguered civilization, support the preservation, development, and dissemination of sound economics. Please give today.


[1] "The Place of Mises's Human Action in the Development of Modern Economic Thought" (1999) and "The Rebirth of Austrian Economics — In Light of Austrian Economics" (2002).

[2] Transcribed from the audiobook Early Austrian Economics by Israel Kirzner.

[3] Salerno (1999)

[4] Ibid.

[5] Quoted in Murray N. Rothbard, Man, Economy, and State, chapter 5.

[6] Mises's entire motto was Tu ne cede malis sed contra audentior ito, a Latin line from Virgil's Aeneid, which, according to H.R. Fairclough's translation of the epic poem, means, "Yield not to ills, but go forth all the bolder to face them."

[7] Salerno (2002)

[8] Ibid.

[9] Ludwig von Mises, Human Action, chapter 37, emphasis added.

[10] Mises, Human Action, chapter 38.