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The Economics of Liberty

Mises Daily: Friday, April 19, 2013 by

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[This is pat 2 of 2 of an article originally published in the April 2013 edition of Future of Freedom.]

Classical Liberalism and the Austrian School by Ralph Raico (Auburn, Ala.: Ludwig von Mises Institute, 2012); 347 pages.

The passionate interest in economics among libertarians is not immediately understood by all students of liberty. Even those generally in favor of economic freedom for ethical reasons may wonder why so many libertarians adhere specifically to the Austrian school. Complicating the matter even further, libertarianism is a political philosophy—and liberalism a political orientation—that concerns ethical principles of what the government ought and ought not to do. Economics, in stark contrast, is often described as a science, and in particular a value-free science, that can teach us a lot about the material world of scarcity, but does not in itself tell us what the state ought to do. So why are so many libertarians not just free-marketers, but also inclined toward the most a priori of economic schools—that of the Austrians? Ralph Raico makes sense of it all in Classical Liberalism and the Austrian School.

Austrian economics and individual liberty

I wish that I had read Ralph Raico when I first became a libertarian, for his explanation of liberalism’s relationship to Austrian economics is the best that I know of, bringing great clarity to the question. He sums up the distinctive elements perfectly: “According to [Ludwig von Mises], economics teaches the means necessary for the promotion of the values most people endorse. Those means comprise, basically, the maintenance of the free market, private property economy. Thus the economist qua economist passes no value judgments, including political value judgments. He only proposes hypothetical imperatives: if you wish to achieve A, then do B.”

As an example we might consider the minimum wage. Economics informs us that raising the minimum wage will, other things being equal, increase unemployment by pricing low-skilled workers out of the labor market. This is a scientific insight. The libertarian is against minimum-wage laws primarily because they are a violation of the rights of both employer and employee to freely make an agreeable deal. But to reinforce this point, the libertarian, steeped in economics, can explain that the results likely to be produced by the minimum wage are not what most people want. Economics is value-free in that it doesn’t tell us whether we should want to increase unemployment, only that raising the minimum wage will tend toward that consequence. But since most decent people do not want to increase unemployment, the science of economics is nicely complementary to the libertarian ethical principle.

Because economics reinforces the case for liberty, “there is a sense in which economic theory per se, any analytical approach to economic questions, can be said to favor the market economy…. But Austrian economics has been so often and so closely tied to liberalism that it is plausible to seek the connection also in its distinctive economic theories.”

Liberalism is concerned with ethical individualism. Methodological individualism—the analytical reduction of all human activity down to the individual actors—is central to Austrian economics and has been from the start. Carl Menger, founder of the Austrian School, explained a nation’s economy in terms of “the results of all the innumerable individual economic efforts in the nation…. Whoever wants to understand theoretically the phenomena of ‘national economy’ [must] attempt to go back to their true elements, to the singular economies in the nation.” (Emphasis in original.)

Liberalism is concerned with ethical individualism

Also quite conducive to liberal individualism is the Austrian emphasis on subjectivism—the principle that persons make economic choices that are based on their subjective preferences. Classical liberals, Raico writes, “focused on the individual human being per se … as the fountainhead of creative response to an ever-changing world.” Economic schools of thought more in line with central planning, such as mainstream macroeconomics, tend to assume “that various global magnitudes act upon one another,” an assumption that liberals as well as Austrians would question. Moreover, “Individuality bears an intimate, perhaps even logical connection, to diversity, and Austrianism, in contrast to neoclassical economics, likewise accentuates the role of diversity in economic life.”

Austrians tend toward many general themes in liberalism, such as “the recognition of the self-regulating capacity of civil society”—or what Austrians call spontaneous-order theory. Yet unique and much more specific Austrian insights go even further in undermining the case for government intervention. They include the impossibility of states’ engaging in economic calculation without prices as “the fatal flaw of central planning”; the Austrian theory of the business cycle, which demonstrates the inability of central banks to manipulate market interest rates without distorting the economy and thereby causing booms and busts; “the analysis of the market as a process”—an approach that stifles socialist pretensions; and Mises’s explanation of why government interventionism is unstable, since one intervention leads to another and society eventually descends toward totalitarianism. Most important in Raico’s assessment is the approach of Austrian economics toward the free market not simply as “producing the greatest possible amount of material goods,” as it is seen by neoclassical defenders of the market, but rather as, in Menger’s words, “a pattern of economic governance exercised by consumer preferences.

Moreover, the Austrian School itself emerged in an ideological context. Many of the first Austrians in the late 19th century were intimately involved in debates with the Marxists on key questions of economic theory, particularly the theory of value. The Austrians played a major role in the marginal revolution, overthrowing centuries of understanding economic exchange value (price) in terms of labor. The labor theory of value was generally taken for granted by Adam Smith and the classical school of economics. The Austrians, however, believed that economic value, including exchange value, originated in the subjective valuation of individual economic actors who—and this is most important—value units of goods on the margin; that is, that they assess the next unit of a commodity in relation to the next-most-valued thing they would forgo to obtain it.

This revolution in value theory finally answered mysteries that had nagged economists for many years, such as the diamond/water paradox. Why is a diamond worth so much more than a cup of water in most circumstances, but not if you are dying of thirst in the desert? Why would an additional cup of water be worth less once you’ve had one cup? Marxism’s whole conception of exploitation was wrapped up in basing the objective value of a commodity on the labor it “contains.” Because Marxism was one of the economic schools most conducive to the creation of a totalitarian state and so was at war with the Austrians over basic theory of value, Austrian economics was distinguished early on as the camp of individual liberty.

Yet the historical context of the Austrian School’s emergence might explain why not all early Austrians embraced liberalism consistently. Raico explains that “the underlying tradition in Austria was one of state paternalism, to the point where even the expression of the concept of a spontaneous economic order had been actively suppressed.” Such considerations among others meant that early luminaries of the school, such as Friedrich von Wieser and Eugen von Böhm-Bawerk, did not always adhere to classical-liberal ideas.

Two 20th-century Austrian economists, for their part, were far more distinct in their classical liberalism and have become universally recognized as significant figures in the birth of modern libertarianism: Ludwig von Mises and F.A. Hayek. Beginning with them, “the links between liberalism and the Austrian School become intense and pervasive.” Mises was decisively a liberal, having “highlighted the possibilities of meeting the needs of the deserving poor through private charity and assailed Bismarckian schemes of social insurance.”

Hayek, on the other hand, at times took positions that few libertarians today would endorse. Seeing the state as “a service agency,” he believed that (in his words) “there is little reason why the government should not … play some role, or even take the initiative, in such areas as social insurance and education, and temporarily subsidize certain experimental developments.” Yet it would be an understatement to say that Hayek was a brilliant thinker and economist whose many insights have helped develop libertarian theory.

Illiberal economists and scholars

That the economic divide is as prevalent as any divide between modern and classical liberals should be obvious. It is important to ask, therefore, about the major economic influences on modern liberalism and their relationship to original liberalism. We focus on John Maynard Keynes, whose brand of economic theory is the most dominant strain of economics in the modern world, enjoying a virtual monopoly on the economic thinking of modern liberalism.

Raico asks whether Keynes was a liberal. Since modern liberals claim the legacy of classical liberalism, this is a most important question indeed. Raico writes, “It is now common practice to rank John Maynard Keynes as one of modern history’s outstanding liberals, the most recent ‘great’ in the tradition of John Locke, Adam Smith, and Thomas Jefferson…. If he is different from the ‘classical’ liberals in a few obvious and important ways, it was simply because he tried to update the essential liberal idea to suit the economic conditions of a new age.”

In fairness, Keynes did embrace values “such as tolerance and rationality” and “always called himself a liberal…. But none of this carries great weight when it comes to classifying Keynes’s political thought.”

The general idea espoused by those who call Keynes a great liberal is that his “turn to neo-mercantilism was necessitated by his discovery of fundamental flaws in classical economics,” especially in light of Britain’s unemployment problems of the 1920s and the Great Depression. According to Raico, however, those crises “were themselves produced by misguided government policies.”

There are other problems with inducting Keynes into the Liberal Hall of Fame: “Liberalism is characterized by its insistence on rules, in political as in economic life.” The rule of law and laissez faire are conspicuous examples. But “it is no exaggeration to say that [Keynes] was constitutionally averse to rules, or ‘dogmas,’ as he often called them.”

Moreover, “authentic liberalism has traditionally harbored a deep distrust for agents of the state,” whereas Keynes’s “airy reliance on economic experts whose sage advice would be put into effect by self-denying politicians flies in the face of this wholly warranted suspicion and all of the historical and theoretical evidence supporting it.” Keynes went so far as to believe that the state should “even decide the optimal level of population” and, at times, that the state should be active in eugenics-based social engineering. He also spoke highly of the Soviet system and, in the preface to the German edition of his General Theory, remarked that the Nazi “totalitarian state” was more compatible with his economic prescriptions, owing to “the theory of output as a whole” than were “the Anglo-Saxon countries.”

Yet many if not most intellectuals remain devoted followers of Keynes—which raises a question: why do intellectuals oppose economic liberty? “The continued flourishing of [anti-market] intellectuals remains an enduring puzzle and problem for classical liberals,” Raico writes. His treatment of that question wonderfully explores the relevance of intellectuals and their ideas in shaping society and the role of historical myth in perpetuating statist thought.

Raico sees the problem as multidisciplinary: “In literature, economics, philosophy, sociology, and other subjects, the student is continually subjected to data and interpretations that converge on a single point: the viciousness of private enterprise and the virtuousness of state intervention and state-supported labor unionism.”

For Hayek the problem is principally one of poor understanding: “Hayek’s view of the intellectuals,” Raico writes, “is flatteringly benign: their ideas are determined by and large by ‘honest convictions and good intentions.’” Raico is unconvinced by Hayek’s attempt to explain this poor understanding. As one example, Hayek “appears to be saying that because the natural sciences have made great advances and because innumerable particular engineering projects have succeeded, it is quite understandable that many intellectuals should conclude that ‘the direction of all forms of human activity according to a single coherent plan’ will be similarly successful.” But Raico challenges the entire premise, pointing out that “the advances of the natural sciences were not brought about in accordance with any overall central plan; rather, they were the product of many separate decentralized but coordinated researchers.”

Raico finds more value in Mises’s explanation: “Often Mises emphasizes invidious personal motivation—resentment and bitter envy—as the source of this attitude.” He is even more moved by Mises’s other insight—that “the contempt of money-making [is] deeply ingrained in western culture,” leading to “hostility towards capitalists, trade, and speculation.”

Revitalizing a grand tradition

Raico is a great historian but also a player in the history of libertarian ideas. At one time or another, he was associated with the three men regarded by many as the 20th century’s greatest Austrians and libertarian scholars: Mises, Hayek, and Murray Rothbard.

To the extent our tradition of liberalism has faded, Raico serves as an eloquent bearer of bad news. In an essay on Eugen Richter, he gives his eulogy for German liberalism. In America the decline of liberalism has in large part been due to militarism, which Raico addresses in his discussion of Arthur Ekirch’s book The Civilian and the Military.

If liberalism has failed to challenge the modern state, perhaps part of the reason is that it has not been radical enough. Reviewing Mises’s great work Liberalism, Raico takes issue with his mentor’s failure to be more hard-line in opposing colonialism and imperialism. If ever there was a great mind to whom every libertarian owes an intellectual debt, it is certainly Mises. Yet even he went astray at times. Raico finds the problem in Mises’s antiseptic conception of the state. For him, the state is simply “the apparatus of compulsion and coercion.” He contemptuously rejects Nietzsche’s dictum that “the state is the coldest of all cold monsters.”

Yet being radical is not enough. We must understand our role in the history of ideas, including what came before us!