Economics for Real People An Introduction to the Austrian School 2nd Edition Economics for Real People An Introduction to the Austrian School 2nd Edition Gene Callahan Copyright 2002, 2004 by Gene Callahan All rights reserved. Written permission must be secured from the publisher to use or reproduce any part of this book, except for brief quotations in critical reviews or articles. Published by the Ludwig von Mises Institute, 518 West Magnolia Avenue, Auburn, Alabama 36832-4528. ISBN: 0-945466-41-2 ACKNOWLEDGMENTS Dedicated to Professor Israel Kirzner, on the occasion of his retirement from economics. My deepest gratitude to my wife, Elen, for her support and forbearance during the many hours it took to complete this book. Special thanks to Lew Rockwell, president of the Ludwig von Mises Institute, for conceiving of this project, and having enough faith in me to put it in my hands. Thanks to Jonathan Erickson of Dr. Dobb’s Journal for per- mission to use my Dr. Dobb’s online op-eds, “Just What Is Superior Technology?” as the basis for Chapter 16, and “Those Damned Bugs!” as the basis for part of Chapter 14. Thanks to Michael Novak of the American Enterprise Insti- tute for permission to use his phrase, “social justice, rightly understood,” as the title for Part 4 of the book. Thanks to Professor Mario Rizzo for kindly inviting me to attend the NYU Colloquium on Market Institutions and Eco- nomic Processes. Thanks to Robert Murphy of Hillsdale College for his fre- quent collaboration, including on two parts of this book, and for many fruitful discussions. Thanks to the many commentators on the book (and sections of it as they appeared in article form), whose efforts improved this book tremendously and drove me to greater precision and clarity of expression. These include Walter Block (Loyola 5 6 ECONOMICS FOR REAL PEOPLE University), Peter Boettke (George Mason University), Sam Bostaph (University of Dallas), Colin Colenso (Shanghai, China), Harry David (New Haven, Conn.), Brian Doherty (Reason), Richard Ebeling (Hillsdale College), Roger Garrison (Auburn University), Jeffrey Herbener (Grove City College), Sanford Ikeda (SUNY Purchase), Stephan Kinsella (Houston, Texas), Peter Lewin (University of Texas at Dallas), Stan Liebowitz (University of Texas at Dallas), Jeanne Locklair (Laboratory Institute of Merchandising), Marcel Popescu (Romania), Joseph Salerno (Pace University), Jeff Scott (Wells Fargo), Glen Tenney (Great Basin College), Jeff Tucker (Mises Institute), Christopher Westley (Jacksonville State University), Rich Wilcke (University of Louisville), Marco de Wit (Univer- sity of Turku), James Yohe (University of West Florida), Sean Callahan (my brother), and my parents, Eugene and Patricia Callahan. Any errors that remain are, of course, entirely mine. Thanks to Pete Kavall, for teaching me what science is, and to Chogyam Trungpu and Tarthang Tulku, for continuing inspiration. CONTENTS The harm done . was that they removed economics from reality. The task of economics, as many [successors] of the classical economists practiced it, was to deal not with events as they really happened, but only with forces that contributed in some not clearly defined manner to the emergence of what really happened. Economics did not actually aim at explaining the formation of market prices, but at the description of something that together with other factors played a certain, not clearly described role in this process. Virtually it did not deal with real living beings, but with a phantom, “economic man,” a creature essentially dif- ferent from real man. —Ludwig von Mises The Ultimate Foundation of Economic Science Introduction Stayin’ Alive . 11 PART I: THE SCIENCE OF HUMAN ACTION CHAPTER 1 What’s Going On? On the nature of economics . 17 CHAPTER 2 Alone Again, Unnaturally On the economic circumstances of the isolated individual . 33 7 8 ECONOMICS FOR REAL PEOPLE CHAPTER 3 As Time Goes By On the factor of time in human action . 47 PART II: THE MARKET PROCESS CHAPTER 4 Let’s Stay Together On direct exchange and the social order . 59 CHAPTER 5 Money Changes Everything On indirect exchange and economic calculation . 81 CHAPTER 6 A Place Where Nothing Ever Happens On the employment of imaginary constructs in economics . 95 CHAPTER 7 Butcher, Baker, Candlestick Maker On economic roles and the theory of distribution . 101 CHAPTER 8 Make a New Plan, Stan On the place of capital in the economy . 121 CHAPTER 9 What Goes Up, Must Come Down On the effect of fluctuations in the money supply . 137 CONTENTS 9 PART III: INTERFERENCE WITH THE MARKET CHAPTER 10 A World Become One On the difficulties of the socialist commonwealth . 157 CHAPTER 11 The Third Way On government interference in the market process . 177 CHAPTER 12 Fiddling with Prices While the Market Burns On price floors and price ceilings and other interferences with market prices . 189 CHAPTER 13 Times Are Hard On the causes of the business cycle . 209 CHAPTER 14 Unsafe at Any Speed On improving the market through regulation . 237 CHAPTER 15 One Man Gathers What Another Man Spills On externalities, positive and negative . 249 CHAPTER 16 Stuck on You On the theory of path dependence . 259 CHAPTER 17 See the Pyramids Along the Nile On government efforts to promote industry . 271 10 ECONOMICS FOR REAL PEOPLE PART IV: SOCIAL JUSTICE, RIGHTLY UNDERSTOOD CHAPTER 18 Where Do We Go from Here? On the political economy of the Austrian School . 291 APPENDICES APPENDIX A A Brief History of the Austrian School . 307 APPENDIX B Praxeological Economics and Mathematical Economics . 321 Bibliography . 329 References . 335 Index . 343 About the Author . 352 INTRODUCTION Stayin’ Alive WHY READ THIS BOOK? ERHAPS, AT SOME point, you have heard about the Aus- trian School of economics and are curious as to what it is. Or you may be discouraged by the economics Pyou have encountered in textbooks and newspapers, and are searching for a more realistic view of economic life. The dom- inant school of economics, often referred to as the Neoclassi- cal School, seems to describe people behaving in ways that are hard to relate to the human activity we see around us every day. The textbook humans seem robotic, rigidly obey- ing a set of equations that “maximizes their utility” based on a set of parameters. The equations themselves are said to “cause” supply and demand to meet at an equilibrium price— one that sets the quantity demanded equal to the quantity supplied. What place do humans have in such a system of equations? It seems difficult to relate those mathematical con- structs to the world in which we live. How is the idea of man as a utility equation solver relevant to an Islamic revolution, to Mother Teresa, to Jimi Hendrix, or to your own decision to take a vacation that you “really can’t afford,” but really need? 11 12 ECONOMICS FOR REAL PEOPLE Yet, you feel that economics ought to be relevant to real life. Doesn’t it deal with jobs, money, taxes, prices, and indus- try: stuff of everyday existence? Why should the subject seem so obscure? The Austrian School of economics is an alternative to the mainstream approach. It places economics on a sound, human basis. It avoids the traps that plague most of modern econom- ics: the assumption of selfishness as the basic human motiva- tion, a narrow definition of rational behavior, and the overuse of unrealistic models. This book is an attempt to introduce you to the main ideas of the school. The Austrian School is so-named because most of its early members hailed from—you’ve probably guessed by now— Austria. The Nazi occupation of that country, however, scat- tered the practitioners. Today we can find prominent Austrian School economists all over the world. I will use “Austrian economist” to mean a member of the Austrian School, whether or not the person in question ever lived in Austria. My focus will not be on the history of the school, although I have included an appendix with a brief overview of that his- tory. Nor is my goal to convince professional economists of other schools to “convert.” It is instead intended to be the proverbial “guide for the intelligent layman.” While I have always tried to be precise, I have tried to avoid entering into the fine details of esoteric debates from the economics pro- fession, which would only create a schizophrenic book. Because of the nature of this book, it cannot explore Aus- trian economics in the same depth as do systematic treatises such as Murray Rothbard’s Man, Economy, and State or Lud- wig von Mises’s Human Action. If this book succeeds in inter- esting you in this subject, it will have done its job; I urge you to then pick up one of these masterworks on the topic. (There is also a bibliography at the end of the book recommending further reading.) INTRODUCTION 13 But there are advantages to the approach taken by this book. First of all, Rothbard’s and Mises’s tomes are huge: you don’t really want to be hauling a book like that to the beach, now, do you? Second, most people are not attempting to become professional economists. You probably have a very limited amount of time and effort you are willing to put into the subject, at least until you sense of how it might benefit you to know more. Last, neither of those great works has anything about the hit TV show Survivor 1 in it, nor does either of them so much as mention the actress Helena Bonham-Carter. I guar- antee that this book will be free of both of those flaws. Speaking of Survivor (see, you didn’t even have to wait long before I took care of the first problem!), I’m going to ask you to imagine a slightly different conclusion to the series.