Freeman

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Vienna and Chicago: A Tale of Two Schools

It's a Shame the Schools See One Another's Philosophies as Competitive Rather Than Complementary

FEBRUARY 01, 1998 by MARK SKOUSEN

“Austrian economics has been important to the development of modern economics, but its role in current practice is much diminished.” —Sherwin Rosen, University of Chicago[1]

Since its inception, the Foundation for Economic Education has been associated with two free-market schools, the Austrian school of Ludwig von Mises and, to a lesser extent, the Chicago school of Milton Friedman. Mises, after leaving Vienna for New York City, was closely involved with Leonard Read, FEE’s founder. He spoke frequently at FEE’s headquarters in Irvington-on-Hudson, and wrote regularly for The Freeman.

Read also developed a relationship with Friedman, who along with University of Chicago colleague George Stigler, wrote one of FEE’s earliest publications. “Roofs or Ceilings?,” published in September 1946, contended that postwar rent controls were counterproductive and should be removed. The FEE pamphlet was highly controversial at the time and was attacked on both sides of the political spectrum. Ayn Rand labeled the pamphlet “collectivist propaganda” and “the most pernicious thing ever issued by an avowedly conservative organization” because the economists favored lifting rent controls on practical, humanitarian grounds, not in defense of “the inalienable right of landlords and property owners.”[2]

In a highly negative review in the American Economic Review, Robert Bangs assailed Friedman and Stigler, declaring, “Removal of rent controls now would not solve the housing problem, but it could easily contribute to a worsening inequality.”[3]

Both the Austrian and Chicago schools of free-market economics were decidedly unpopular at the beginning of the postwar period, but now, a generation later, their views are represented in almost all textbooks and economics departments.

Why Has the Chicago School Gained So Much Influence?

The Chicago school, led by Milton Friedman, has especially gained recognition among professional economists. Followers of the Chicago school have won a dozen Nobel Prizes in economics since the award’s inception in 1969.

Why has the Chicago school been more successful than the Austrian school? Both favor private enterprise, low taxes, minimal government, free markets, and sound money. Although differing on methodology and occasionally on policy (e.g., the Austrians support either free banking or a gold standard while the Chicago monetarists advocate a controlled fiat money policy), they have more in common than not. Both Mises and Friedman were founding members of the Mont Pelerin Society. It is too bad that the Misesians and the Friedmanites usually see one another’s philosophies as competitive rather than complementary.

The Advantages of Empirical Work

Historically, Friedman and his followers have taken a different road from the Austrians. They stress quantitative empirical work to test their theories. They also published more of their findings in the professional journals and with well-known university presses. They see themselves as inside the profession. The results were so remarkable that they gradually caught the attention of the rest of the discipline. Take, for example, Milton Friedman’s (coauthored with Anna J. Schwartz) monumental Monetary History of the United States, 1867-1960, a study sponsored by the National Bureau of Economic Research and published by Princeton University Press in 1963. With meticulous research, he demonstrated how the Federal Reserve allowed the money supply to contract by a third during 1929-33. His statistical work gave powerful credence to the idea that it was government, not free-enterprise capitalism, that caused the Great Depression. Friedman’s quantitative study did more to restore faith in free enterprise than a thousand sermons on the virtues of economic liberty. His applied approach was far more effective in destroying the basic tenets of Keynesianism than philosophical tomes. For these contributions to economics, Friedman was awarded the Nobel Prize in 1976.

Friedman’s empirical application of his free-market views has had a wide influence on think tanks and practical politics. The Chilean economic miracle (controlling inflation, cutting taxes, privatizing Social Security) is largely a result of the policy recommendations of the Chicago Boys, economists who studied under Friedman. The Cato Institute’s (and other free-market think tanks) focus on case studies is an outgrowth of Friedman’s research methods.

The Austrians Take Another Path

The Austrians, on the other hand, do not believe theory can be derived or tested empirically. Mises’s method, praxeology, deduced economic principles logically from the axiom that human beings act—that is, attempt to improve their circumstances. Austrian economists prefer to state their theories verbally rather than mathematically. (Mises declined to use even graphs on methodological grounds.) Hayek, despite differences over method with Mises, warned that economics should not mimic physics. He designed a graphic presentation of the Austrian theory of the business cycle, but offered no statistical evidence. Henry Hazlitt dissected Keynes’s General Theory with deft and substantive arguments, but without quantitative analysis, his Failure of the “New Economics” (D. Van Nostrand, 1959) fell on deaf ears. Israel Kirzner established an Austrian center at New York University, but has limited his analysis to high theory. Murray Rothbard used historical data to illustrate the Austrian theory of the business cycle as applied to America’s Great Depression (D. Van Nostrand, 1963). But the skepticism about mathematics, econometrics, and regression analysis harmed the standing of the Austrian school in the eyes of other economists.

The Next Half Century Belongs to . . .

As we enter a new millennium, where do we go from here? Management guru Peter Drucker has correctly predicted that the “next economics” must emphasize “microeconomics” and in particular productivity and capital formation. “Capital is the future,” he declares.[4] In my judgment, the Austrian school is ideally suited to play this role. With its concentration on entrepreneurship, capital theory, and subjectivism—the foundations of microeconomics—Austrian economics has a bright future and may even eclipse the Chicago school, especially if the Chicago school (as embodied in the New Classical and Rational Expectations theories) focuses too heavily on tedious mathematical modeling.

Recently Austrian economists have engaged in applied science and case studies, applying their theories to organizational behavior, marketing, finance, trade, and government policies. Granted, statistical analysis has its limitations, as Hayek pointed out in his Nobel-Prize lecture, “The Pretence of Knowledge,” but that does not validate the radical subjectivist view (of Lachmann and others) that nothing is verifiable.

Examples of Applied Economics by Austrians

Recent examples of quantitative and case studies by economists sympathetic to Austrian economics include the privatization efforts by Madsen Pirie and Eamonn Butler of the Adam Smith Institute, the currency reform measures of economist Steve Hanke, and the empirical work of historian Robert Higgs and economists Richard K. Vedder and Lowell Gallaway.[5] George Selgin and Lawrence White have done extensive historical work on free banking, both in the United States and foreign countries.[6]

I applaud the recent breakthrough empirical work, Economic Freedom of the World, 1975-1995 (Cato Institute, 1996), by James D. Gwartney, Robert A. Lawson, and Walter E. Block. The authors, representing both major schools of free-market economics, have demonstrated statistically and graphically a strong correlation between economic freedom and the rate of economic growth. Milton Friedman, in the introduction, echoes Mises when he states, “It did not require the construction of an index of economic freedom for it to be widely believed that there is a close relation between economic freedom and the level and rate of economic growth.” But Friedman, ever the consummate quantitative economist, contends that a picture is worth a thousand words. “No qualitative verbal description can match the power of that graph,” he concludes.[7]

As more and more graduate students with an Austrian bent acquire skills in econometrics, I expect to see advances in applied Austrian business cycle theory. Charles Wainhouse’s doctoral dissertation at NYU was the first to test the Austrian business-cycle theory using time series, and others are following in his footsteps.[8]

If Austrians devote most of their energy debating abstractions, I’m afraid they will remain an obscure school preaching only to the choir. As University of Georgia professor Peter G. Klein states, “If Austrians focus on metaeconomics, and try to force mainstreamers to rethink abstract issues of epistemology, we’ll go nowhere.”[9]


Notes

  1. Sherwin Rosen, “Austrian and Neoclassical Economics: Any Gains From Trade?,” Journal of Economic Perspectives (Fall, 1997), p. 139. See also Leland Yeager’s perceptive response, “Austrian Economics, Neoclassicism, and the Market Test,” pp. 153–165.
  2. Letters of Ayn Rand, edited by Michael S. Berliner (Dutton, 1995), p. 326. In these revealing letters, Rand offered to serve as “unofficial editor” for Read’s publications, but she was turned down. (p. 335).
  3. Robert Bangs, review of “Roofs or Ceilings?,” American Economic Review, June, 1947, pp. 482-3.
  4. Peter Drucker, Toward the Next Economics and Other Essays (Harper & Row, 1981), p. 10.
  5. Robert Higgs, “Wartime Prosperity? A Reassessment of the U.S. Economy in the 1940s,” The Journal of Economic History (March 1992), pp. 41–60; Richard K. Vedder and Lowell Gallaway, Out of Work (Holmes & Meier, 1993). Also see their article, “The Great Depression of 1946,” Review of Austrian Economics 5:2 (1991), pp. 3–31.
  6. See, for example, Lawrence H. White, Free Banking in Britain (Cambridge University Press, 1984); George A. Selgin, The Theory of Free Banking (Rowman & Littlefield, 1988) and Selgin, Banking Deregulation and Monetary Order (Routledge, 1996).
  7. Milton Friedman, “Foreword,” Economic Freedom of the World, 1975–1995, by James D. Gwartney, Robert A. Lawson, and Walter E. Block (Cato Institute, 1996), pp. vii–viii.
  8. Charles E. Wainhouse, Hayek’s Theory of the Trade Cycle: The Evidence from the Time Series, Ph.D. dissertation, New York University, 1984. See also William A. Butos, “The Recession and Austrian Business Cycle Theory: An Empirical Perspective,” Critical Review 7:2–3 (1993), pp. 277–306, and Mark Skousen, The Structure of Production (New York University Press, 1990).
  9. Interview in Austrian Economics Newsletter (Mises Institute, Winter, 1995), p. 7.

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February 1998

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