The Austrian school offers a unique perspective on human action, the role of the entrepreneur, the market, capital, and the importance of individual freedom. Austrian economics is one of the most distinguished and intellectually rigorous schools of economic thought. It has a long history, even with ideas dating back to at least the 16th century and the 17th century, experiencing an impressive renaissance. The Austrian school, in the true sense of the word, originated in the late 19th century and got its name from the fact that the founding fathers of the school—Carl Menger, Eugen von Böhm-Bawerk, Ludwig von Mises, and Friedrich von Hayek—all came from the Austrian Empire.
One of the outstanding characteristics of the Austrian school of Economics is the importance that theory accords to capital and entrepreneurship. The emphasis on these factors also distinguishes the economics of the Austrian school most clearly from what is usually taught at universities today as “economics.” Especially in the discipline called “macroeconomics,” the textbooks draw the picture of an economy that gets by without capital and entrepreneurs. It’s a bit like trying to explain the function of an automobile, but ignoring the role of engine and driver. Even in the theory of growth, entrepreneurship is absent and the role of capital is mystified as something that expands and shrinks without structure automatically according to the amount of net investment, which, in turn, is modeled as a function dependent on national income.
Another main difference between Austrian Economics and the so-called mainstream is that the explanatory model of the Austrian school starts with the individual. It is not statistically-constructed aggregates (such as the volume of savings and investment, for example) that are the causal forces, but the individual economic actor. This so-called “methodological individualism” states that social phenomena must be explained in terms of the actions and decisions of individuals and not in abstract collective categories such as “society” or “state.” In other words, the Austrian school emphasizes that the individual—as a human being with all his or her unique preferences, constraints, and information—drives economic activity.
For the followers of the Austrian school, economic analysis is based on the assumption that people act purposefully. This approach is known as praxeology, the study of human action. Praxeology assumes that people are decision-makers, not passive objects or automatons that merely react to stimuli. Human action is goal-oriented and the actor chooses those means that seem the best to him to achieve this aim. Choice of goal and means is the core of every human action, not stimulus and response, as behaviorism claims.
The Austrian school emphasizes that valuation is subjective and personal. Individuals make their decisions based on personal preferences, needs, and circumstances. Since every person has different preferences, goals, and desires, he or she attaches different values to the goods and the range of possible actions. It is precisely from this circumstance that the act of economic exchange arises. In the exchange of goods and services, “unequal” values are exchanged, but the motive of exchange is the difference in valuation. In an economic exchange, one gives up the good that one values less to get the good to which one values more. Exchange is voluntary human action, as each participant in a voluntary exchange wins.
The Austrian school shares the marginal utility principle with neoclassical economics. According to this, the subjective value the individual attaches to a good or service decreases when more of this good is immediately available. The law of diminishing marginal utility states that additional (marginal) satisfaction a person gains from consuming each additional unit of a good or service decreases as more units of this good or service within a definite time frame are used for consumption. Marginal utility refers to the additional benefit a consumer receives from consuming another unit of a good or service. In other words, the principle of diminishing marginal utility states that—all other things being equal—the additional satisfaction of each unit obtained from consumption decreases as the amount consumed increases.
Individuals choose different resources (means) to fulfill their desires or goals (purposes). Resources can be material (such as money, land, or tools) or intangible (such as knowledge, time, or work). In decision-making, the marginal utility must be balanced with the marginal costs of an action. These costs exist as opportunity costs and exist in the value of the next best alternative, which must be sacrificed if a decision is made for a particular action. From this consideration derives the principle that every chosen action implies costs.
Action is oriented toward the future and, therefore, subject to uncertainty. Human action takes place in a world of uncertainty and contingency. Individuals act based on expectations, not certainties, which is why planning and decision-making are inherently dynamic. Error is an inseparable component of human action. The market itself is a constant process of correction and thus stands in contrast to the state, in which the immutable status (i.e., the state’s unchanging position from the Latin “status”) is already inherent in the etymology of the concept.
Since human actions unfold over time, it is subject to the principle of time preference, according to which individuals prefer the enjoyment of goods the closer their consumption is to the present. The interplay of current and future preferences influences decisions about investment and savings. Time preference is also the basis for explaining the interest rate and thus is fundamental for exchanges through time and economic development.
According to the Austrian school of Economics, business cycles are caused by distortions in the capital structure, which, in turn, result from excessive artificial credit expansion by central banks. When monetary authorities lower interest rates below the natural rate (the rate according to the prevailing time preference), they produce a boom in credit-financed investments. However, these investments are misguided because the artificially-low interest rates signal false information about savers’ true preferences. As a result, companies invest in projects that are not economically sustainable, leading to a correction or collapse once the central bank raises interest rates or credit expansion slows. The Austrian theory thus underlines the importance of sound money and the dangers of state intervention in the economy.
The Austrian school also possesses a unique perspective on the theory of capital. The approach emphasizes the time-structure of production, according to which the completion of products must be seen as a multi-stage process in which different types of capital goods (tools, machines, infrastructure, etc.) are combined over time to finally form a consumer good. Capital is not an isolated homogeneous factor but exists in the form of various production goods that come into play at different stages of production.
In the view of the Austrian school, entrepreneurs play a central role in the capitalist economic system by recognizing profit opportunities, anticipating changes in the market, identifying unmet needs, and directing resources toward producing those goods and services that satisfy those needs. Entrepreneurship is based on uncertainty about the future. The specific entrepreneurial profit comes about through the successful management of uncertainty. Entrepreneurs must base their decisions on imperfect knowledge. In this perspective, entrepreneurial competition works as a discovery process. Markets, therefore, are not only essential for the efficient allocation of the present factors of production, but even more so are a procedure to find out about preferences and the best ways for their satisfaction.
The market itself is to be understood as a spontaneous order, as a system in which order arises naturally from the actions of individuals, without the need for central planning or direction. In markets, individuals who pursue their interests inadvertently create an efficient allocation of resources. Prices serve as signals that help individuals to coordinate their actions in a decentralized manner. This concept is decisive for the criticism of central planning. The economists of the Austrian school argue that central planners cannot have all the real-time, often qualitative, and subjective knowledge required for an efficient distribution of resources in an economy. One needs market prices that are determined by supply and demand on the market, and are the result of the spontaneous actions of individuals. One cannot maintain a complex economy by command and obedience. By focusing on human action, Austrian economics concludes that central economic planning must necessarily fail. Since planners lack the necessary information in the form of market prices, they cannot rationally allocate capital even if they have the best intentions. The complex web of economic relations can only be maintained by market processes driven by the voluntary actions of individuals.
From the point of view of the Austrian school, institutions such as markets, property rights, legal systems, and money arise organically from the actions and interactions of individuals and are not the product of state design. These systems evolve by trial and error, through which norms and conventions emerge naturally. For example, the development of property rights is seen as a spontaneous process that helps individuals resolve conflicts over scarce resources without the need for a central authority. This understanding of order in society stands in direct contrast to the top-down view of state intervention, which is central to many other schools of economic thought. While acknowledging the need for some basic legal frameworks, Austrian economists argue that additional kinds of state intervention distort the natural order and regularly lead to unintended negative consequences.
Unfortunately, the valuable insights of the Austrian school remain closed to most people because they are contrary to the political interests of power. Many disasters could have been avoided in the past if more people had stood up to the falsehoods incessantly proclaimed by state-believing politicians and their entourage. It is not different in our time.
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