Austrian School of Economics (late 19th century – present time) • Another heterodox current in the 20th century economics • Founder – Carl Menger (1840-1921) – Contributed also to the Marginalist revolution of the 1870s • Other important members: Ludwig von Mises (1881-1973) Friedrich August von Hayek (1889-1992) Austrian School of Economics • Austrian School (AS) shares the origins with neo- classical economics, but is very different in terms of subjects analyzed and methods used. • AS not interested in mathematical economics or perfect competition analysis of markets • AS interested rather in broader questions of the long run changes in economic systems, choosing the right economic system (socialism vs. capitalism) etc. • Made significant contribution to the so-called debate on economic systems (late 19th century – 1940s) Austrian School - assumptions • rejects mathematical approach to economics • focuses on the study of economic processes rather than economic events • examines disequilibria rather than equilibria • rejects econometrics and other empirical methods • assumes that some important economic truths are self-evident in human minds (e.g. that people are rational) and that you can logically deduce from them all other important economic laws or regularities Austrian School • AS is disregarded by mainstream economics as unscientific... Why? • Because it rejects mathematics and econometrics • But it is quite well established in modern economics… Why? • Possibly, because (as some suggest) it is financed by the big business... Why? • AS supports strongly free-market economy and laissez-faire policies. Debate on economic systems (on rationality and efficiency of socialism vs. capitalism) • Austrian contribution to the debate • Three stages: 1) late 19th century – AS criticized Marx’s labour theory of value 2) just after 1917 – AS argued that socialism is not compatible with individual liberty 3) 1920s-1940s – called socialist calculation debate • von Mises and von Hayek took part in stage of the debate from the AS side. Socialist calculation debate: 1920s-1940s • In 1920 L. von Mises argued that rational allocation of resources in socialism is not possible. Why? • No method of calculating relative costs of the means of production in socialism. • Because, without private property there is no market for capital, and various capital goods are not priced properly. • Therefore, rational economic calculation is not possible and the system is economically irrational. Socialist calculation debate • Socialists’ answer to von Mises was given by Oskar Lange (1904-1965) in two papers from 1936-37. • Lange’s model: – 1. there are markets for consumers’ goods and allocation of labour – 2. there is social ownership of capital, but a central planner provides strict guidelines for production to enterprises. Socialist calculation debate: Lange contra Mises • In Lange’s model, central planner informs managers that they must obey the rules: 1. p = MC 2. set output at which AC are at minimum. • This would imitate capitalism and socialism can be saved – it is as efficient as capitalism. • But how to calculate MC and AC in socialism? Socialist calculation debate: Lange contra Mises • So, how to calculate MC and AC in socialism? • Lange’s answer – use ‘trial and error’ method: – Set the initial price at random level and observe the volume of inventories (IN). – If IN are increasing – lower the price – If IN are decreasing – increase the price • In the end you will converge to the equilibrium price • Those production guidelines assure that productive efficiency is the same as in capitalism, even without private property. Socialist calculation debate: Lange contra Mises • In fact, Lange argued for something stronger • Socialism even outperforms (is superior to) capitalism, because three evils of capitalism can be removed from socialism: – imperfect competition and monopolies – business cycles – very unequal distribution of incomes Socialist calculation debate: Hayek contra Lange • von Hayek tried to answer Lange in a series of papers from 1940s • The most imoprtant of Hayek’s arguments: – Lange’s model is preoccupied with equilibrium, but possesses no ability to discuss the necessary adaptations to changing conditions in real life. – Competition in free market economies is an information processing mechanism – Competition allows consumers to reveal their preferences and producers to discover efficient production technologies Socialist calculation debate: Hayek contra Lange • Competition allows consumers to reveal their preferences and producers to discover efficient production technologies • Also, it allows to introduce new products (technological progress) • Free competition makes use of (local) knowledge of the particular circumstances of time and place (e.g. Unexploited opportunities for profit, unused machines, reliability of trading partners etc.) Socialist calculation debate: Hayek contra Lange • Such knowledge (particular circumstances of time and place) is local, dispersed and often tacit. • It can not be aggregated into statistical knowledge (which by its nature has to abstract from such localities) • In particular, such knowledge can not be collected by the socialist central planner • Therefore, capitalism is more efficient than socialism, because it utilizes a greater amount of knowledge of economic agents. The debate on socialism vs. capitalism after Hayek • Hayek’s arguments not accepted in mainstream economics – partly because they were not stated in a formal model. • Since 1940s to late 1970s mainstream economics rejected Austrian critique of socialism, and accepted the view that socialism is as efficient as capitalism. (Lange won the debate) • Since late 1970s the attitude of mainstream toward socialism began to change (as problems in socialist economies were more and more evident). • In 1980s and 1990s, mainstream economics formulated its own arguments against socialism. Economics of information (since 1970s on) against socialism • Socialism faces enormous incentive problems. • Managers, directors, planners and other decision- makers in socialism do not have enough economic incentive to follow rules aimed at operating plants, firms (and the whole economies) in an efficient manner. • They will rather pursue their own interests – exploit the system to gain private profits. • And there are no effective mechanisms that would force them to behave in a socially efficient way..