Austria misunderstands Hayek

A very recent speech on Austrian economics by Ewald Nowotny, Governor of the Austrian central bank, piqued my curiosity (see speech here and extra slides here). I ended up very disappointed.

Nowotny’s speech is actually very interesting from a historical perspective. He goes over the structure of the 19^th century Austro-Hungarian Empire, its limited liberalism, over-regulation, rigid societal structure, economic interventionism and limited entrepreneurial and commercial development, and describes how this influenced the individualistic state of mind of early economists of the early Austrian school, such as Carl Menger, Eugene Bohm-Bawerk and Friedrich Wieser. They introduced such critical concepts as the law of diminishing marginal utility (which entered the mainstream economic framework following the so-called ‘marginal revolution’ of Menger, Jevons and Walras), methodological individualism, and the fact that all economic activity involves uncertainty and time.

The disintegration of the empire following WW1, the hyperinflation experience, the rise of socialism and later the Great Depression reinforced this individualistic, anti-state intervention trend and led to the dynamic capital, entrepreneurial, business cycle, market structure, knowledge and law theories (all very laissez-faire) of Ludwig von Mises, Joseph Schumpeter and Friedrich Hayek. Nowotny very usefully summed up the historical events using the two following timelines:

But that’s about it. The rest of the speech is desperately anti-Austrian school, and completely misrepresents the views of some of its most famous proponents.

According to Nowotny:

contrary to more recent definitions that would define freedom as the free availability of opportunities, the definition of the Austrian school of economics always remained a negative one that exclusively defined freedom as the absence of constraints. This should become decisive for the spin that later Austrian economists took toward analytical nihilism.

While there are many definitions of ‘freedom’ within the Austrian school, not all scholars agreed with what Nowotny characterises as “the absence of constraints”. Even Murray Rothbard and his brand of anarcho-capitalism involves some constraints (via the market process or natural law). On the contrary, Hayek was very clear in The Constitution of Liberty that freedom was defined within a given general ruleset, under the framework of the rule of law. Whether analytical nihilism applies to Austrian scholars is also debatable (and it is unclear what he meant by that). The fact that they mostly rejected mathematics as an analytical tool to represent the economy does not imply that their reasoning was non-analytical (on the contrary) or that they also rejected maths as an analytical tool for economic calculation at the micro (company) level.

Nor did the statements that Hayek “completed [the Austrian school] transformation toward the libertarian fringe in which it is situated today” and that he “developed the economic concept of knowledge that already had been present in Menger’s thought into a full-blown attack against any public interventions” true. In reality, Hayek has often been slightly milder in his attacks against the state than Mises. It is clear from books such as The Road to Serfdom or The Constitution of Liberty that he considered the state as having a role in society, as long as it obeyed the rule of law and operated on the same conditions as private enterprises (although he later admitted – in a later preface to The Road to Serfdom – that he had put too much faith in the ability of government to perform a number of tasks). Some even called Hayek a “moderate social democrat” (a more than excessive statement in my view).

Equally, Hayek didn’t seem to be a great fan of free, or laissez-faire, banking either as George Selgin just pointed out (see also White’s great article Why Didn’t Hayek Favor Laissez Faire in Banking)*. The Austrian business cycle theory did not, as Nowotny asserts,

in his hands turned into a theory that regarded credit creation by public authorities as the main source of economic fluctuations. Completely ignoring that problems of this kind might also arise in the private sector, Hayek thus fervently argued for an absolute minimum state.

This was rather Mises’ view. In Monetary Theory and the Trade Cycle, Hayek seemed to believe that private commercial banks could naturally overexpand, without a central currency issuer (i.e. central bank) injecting extra cash into the economy.

Were Austrian scholars guilty of ‘therapeutic nihilism’? While they indeed declared that government treatments would in the end make things worse, they argued for the implementation of free market measures to render the economy healthier and more stable in the long run.

But the real nature of Nowotny’s ideology, which (mis)guides his destruction of Austrian scholars, remains in the single following statement:

As early as in 1930 Hayek’s prime policy recommendation to fight the crisis – published in his book “Prices and Production” – was to refrain from any interventions and wait for markets to stabilise themselves. This was a recommendation whose devastating effect only becomes clear when it is contrasted with the beneficial effects of the successful New Deal in the USA that did exactly the opposite.

Is it necessary to emphasise that the myth of the beneficial effects of the New Deal during the 1930s has been debunked by many economists over the past decades, both mainstream and unorthodox? For one thing, the New Deal surely lengthened the Great Depression in the US (see a summarised version of the arguments against the New Deal by Steve Horwitz here).

While I am not an expert on post-WW2 Austria and its economic performance, I still find it slightly ironic that Governor Nowotny, despite its obvious Keynesian tendencies, argued that ‘hard currency’ policies were in large part the reason underlying the economic revival of his country. This seems to me to be the sort of policy advocated by…Hayek or Mises, but not by Keynes.

After finishing reading the speech, it becomes clear that Nowotny has likely never read the authors he criticises. One cannot seriously declare that “uncertainty was handled by stabilizing expectations through corporatist institutions and by a generous social state” and that “knowledge dispersion was promoted by centralized collective bargaining institutions” after reading Austrian authors. This is a complete misunderstanding of Hayek’s depiction of a spontaneous order that relies on the knowledge of the “particular circumstances of time and place”. And indeed, the literature to which Governor Nowotny refers does not include any book or article from any of the authors mentioned above…

We would really have enjoyed a deep discussion of the Austrian conception of time and dynamic analyses (which Nowotny mentions) and their impact on the capital structure and the conduct of monetary policy. Instead, we end up with a traditional static equilibrium Keynesian misunderstanding of Austrian theories. Austria has sadly lost its Austrian tradition.

*Although I have to admit that Hayek’s position isn’t very clear. He seems to take a Bagehotian position: he didn’t like the way the banking system had evolved, hence he recommended (mistakenly or not ) against ending central banking

PS: See this great blog post from David Glasner on Israel Kizner, and his Austrian approach to entrepreneurship. A stark contrast with Nowotny’s speech.

PS2: I’m back from short holidays, so will blog more frequently from now on.