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 19th 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:

Austrian econ timeline

Austrian econ timeline 2

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.


5 responses to “Austria misunderstands Hayek”

  1. viennacapitalist says :

    I have studied at the University of Vienna and most econ profs I have met don’t know anything about the Austrians and freely admited that, the same goes for Mr. Nowotny
    Austria’s post WWII success was due to people like Reinhard Kamitz, finance minister without being membe of any party, an ordoliberal and hard money advocate (he also held the same post as Nowotny). Also keep in mind that Austria benefitted from an inflow of Sudentendeutsche, i.e. Germans that had to flee from Eastern Europe (Czech, Poland a.s.o.) who on average were very well educated and due to a lack of contacts were forced to start businesses. Many a familly owned business was founded by them…

  2. Amit Jairath says :

    Being from Austria I can tell you that schools and universities here are ignorant of the Fact of how Austrian Economics works. This is mainly due to the syllabus prefix given by the government, which is very much focused on quasi socialism, where the state provides for most of your basic in needs (at least in theory) and less regulation is more or less a wet dream. The only time we saw Austrian economics in action within Austria was during the great depression in Wörgl, municipality which was the poorest at the time and collapsed financially. The mayor and the people started to print their own paper money backed by stamps that summed up the output of products and services you created. Within a year Wörgl rose to being Austrias most wealthy municipality, with no more need for the Austrian Schilling printed by the Central Bank. What happened next? Of course the control freaks and power hungry beauraucrats and politicians stepped in and vetoed against the independency of Wörgl. The central bank had put in a lawsuit against Wörgl and they were soon ordered to follow the law, which was always a control mechanism for the system runners. Wörgl soon fell into debts again, as it’s municipality bank was installed linked to the central bank.

    The nation can be proud of having had an example like Wörgl, as much as it’s people can be pittied that Wörgl model never took over the country.

  3. mckinneyrd says :

    I think it’s a sign of the growing importance of Austrian theory that mainstream economists feel compelled to respond. But they are so lazy, or dishonest, that they can’t be bothered with actually learning it.

    Most criticisms of Austrian econ that I have read have done nothing but advertise the critic’s ignorance. I was just re-reading the Hayek/Knight debate about capital. It’s astounding how obtuse Knight was.

  4. Troy Lynch says :

    Well said, viennacapitalist and Amit Jairath. It seems that, as you have noted, it is the same every where – most mainstream academic economists no nothing or very erroneous things about the Austrian School of economics. If one wishes to do graduate studies at the LSE or elsewhere (in the US or Europe), one must imbibe the same tired advanced microeconomics, macroeconomics and econometrics, which tend to miss the important actions of individuals and entrepreneurs. I did my PhD on Austrian capital and interest theory here in Australia; mainstream economists can tend to view Austrian economics and the history of economic thought as anachronistic and feel that (mainstream) economics has arrived. I teach a course in Classical economics by Steven Kates at RMIT University in Melbourne, Australia (probably the only one in the country). In his text, Free-Market Economics (ISBN: 9781782547969) he bases his theories on Mill, but he is still able to avoid all of the obfuscation of geometry and mathematics and teach (Classical) economics as a social science – a science nonetheless.

    This guy, Nowotny, knows how to trot out the correct phrases that give the impression he understands what is going on, but he passed over individualism, subjectivism and marginal theory in a couple of sentences, and went on to affirm what appears to be the saving graces of institutionalism and Keynesianism. It is reasonably logical: if that is all one ever learns, it is impossible to think outside of those parameters.

    Julien, I like you measured analysis. Nowotny castigates Hayek as touting extreme views, when in fact Mises really understood the implications of individualism and the importance of capital investment and economic progress, while Hayek was, as you note, ambivalent on a number of things. I just simply point out to my students, that if they can read only one text on economics, read Human Action!


  5. Julien Noizet says :

    Thank you all for your interesting comments!

    Troy, yes, Human Action should be one of the first books econ students should read (they should be exposed to all sorts of econ schools and not just orthodox stuff).
    Apart from that, I think that Mises was also ambivalent on a couple of things, in particular on the full/fractional/free banking debate.

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