A Great Revolution in Economics –Vienna 1871 and after Austrian economic thought: its evolution and its contribution to consumer behavior Lazaros Th. Houmanidis Auke R. Leen A great REVOLUTION In economics —VIENNA 1871 and after AUSTRIAN ECONOMIC THOUGHT: ITS EVOLUTION AND ITS CONTRIBUTION TO CONSUMER BEHAVIOR Lazaros Th. Houmanidis Auke R. Leen The letter type on the cover is of Arnold Böcklin (Basel 1827-1901 Fiesole). It is a typical example of the Art Nouveau (Jugendstil) style—the fashionable style of art in Vienna at the end of the 19th century (the time older Austrianism came in full swing). In a sense, Böcklin’s work represents the essence of Austrianism: “Never was he interested in the accidental; he wanted the everlasting”. Cereales Foundation, publisher Wageningen University P.O. Box 357, 6700 AJ Wageningen, The Netherlands E [email protected] Printed by Grafisch Service Centrum Van Gils B.V. Cover design by Hans Weggen (Art Director Cereales) © 2001 Lazaros Th. Houmanidis and Auke R. Leen ISBN 90-805724-3-8 In the memory of our beloved colleague JACOB JAN KRABBE PREFACE A Great Revolution in Economics—Vienna 1871 and after is about the revolution in economic thought that started in Vienna in the last quarter of the nineteenth century. After a time of trying to save the objective value theory the time was there for a new awakening of economic thought. In Vienna, for the first time by the 1871 publication of Menger’s Grundsätze, value become subjective, and the market a process with a sovereign consumer. This book is about this awakening that proved to be more than a plaisanterie viennoise. The book is the result of the collaboration of professor emeritus Lazaros Houmanidis of Greece and Auke Leen of the Netherlands. During his life long academic career Houmanidis has written numerous articles and books, mainly in Greek, about the Austrian School of Economics. These include The Subjective Theory of Value, from the Physiocrates until today (1954) and, more recently, History of Economic Theories (1999). Leen has written a book The Consumer in Austrian Economics and the Austrian Perspective on Consumer Policy (1999) and several articles and articles in books about the role of the consumer in modern Austrian economics. The first part, written by Houmanidis, mainly describes the older Austrian School of economics whose ideas were developed largely in Austria during the 1870s and 1880s. Similar views had been developed earlier, however, and other economists were also accepting a subjective theory of value at the same time. The main emphasis was on subjective marginal utility—not objective, physical realities. Houmanidis stresses the great importance of the Austrian school to the science of economics. Part one emphasizes both the subjective and the theoretical feature of the Austrian school. Both features are also extensively discussed from a non-Austrian, especially neo-institutionalist perspective too. Houmanidis concludes that Austrian and Institutional economics when combined can offer the expected solution to the crisis in economic theory from a humanistic point of view. In the second part of the book, Leen mainly describes the modern Austrian School of economics. He describes modern Austrian economics as an extension of Menger’s older static subjectivism: the market is first and foremost a process. In other words, subjective value is merely an implication of vi Preface the subjective appreciation of the economic process. Leen emphasizes the two essential features of this process: ignorance and entrepreneurial alertness. Ignorance is the foundation of the systematic quality of market processes and alertness drives the Mengerian market process. After an extensive overview of the method of Austrian economics, Leen then goes on to stress the role of the consumer in the market. He applies the modern Austrian vision on the market to the calculative and entrepreneurial role of the consumer. Consumers shape the pattern of resource use and the assignment of resource rewards according to their preferences. The role of the consumer, however, has been largely ignored in modern Austrian economics, as a result of the debate on rational economic calculation under central planning during the period between the wars. Though the debate in and of itself brought to the fore the idea of the market as a competitive-entrepreneurial process of discovery, the emphasis on the producer pushed the role of the consumer to the side in modern Austrian economics. Hoping for a logical and just critique of our efforts on the subject of older and modern Austrians economics, we offer our research to the reader who can help us to judge our work better. ACKNOWLEDGMENTS We are deeply grateful to J.A. Bijkerk, Annelies Coppelmans, Karen van der Heide, Karla ter Horst-van Domburg, Gerry van Nieuwenhoven, P. Odunga, Juanita Rothman, C. Tjovas, Dineke Wemmenhove, and Margeret van Wissen for transforming our work into a finished typescript. The making of the manuscript into a ready-for-publication form owes everything to their professionalism and care. CONTENTS PART I AUSTRIAN ECONOMIC THOUGHT: ITS EVOLUTION 1 THE MAIN PROBLEM 15 1.1 The significance of value: Wicksell versus Cassel 15 1.1.2 Two basic and controversial elements in the determination of value 18 1.1.3 The theory of marginal utility and its precursors 20 1. 2 The paradox of value in Smith’s thought 23 1. 2.1 The differentiation of some classicists from the objective value theory 26 1. 3 Naturalism and voluntarism 30 2 THE OLDER AUSTRIAN SCHOOL ON VALUE AND DISTRIBUTION 35 2.1 Subjectivism and marginal utility 37 2.1.1 Some other precursors of marginal utility 39 2.1.2 A Prelude 40 2.1.3 The debate of methods and the new horizons in economics 41 2.2 Carl von Menger 43 2.2.1 Some complementary remarks on Menger’s theories 50 2.3 Eugen von Böhm-Bawerk 54 2.3.1 Böhm-Bawerk’s theories on distribution 56 2.3.2 Complementary remarks 57 2.4 Friedrich von Wieser 58 2.4.1 Complementary ideas and aspects on Wieser’s theories 62 2.4.2 Concluding remarks 64 x Contents 3 THE NEO AUSTRIANS 73 3.1 The new horizons in the evolution of marginalism 73 3.1.1 Economic calculation and the role of time 75 3.1.2 Human action under the exploration of Neo Austrians 77 3.2 Complementaries and final remarks 79 3.2.1 Some doctrinaire discussions 87 3.2.2 Can the Austrian School be combined with the Institutional School? 96 PART II AUSTRIAN ECONOMIC THOUGHT: ITS CONTRIBUTION TO CONSUMER BEHAVIOR 4 THE DEMISE OF THE CONSUMER: THE SOCIALIST CALCULATION DEBATE 101 4.1 How the consumer became lost 101 4.2 The consumer: somewhere along the way of the market process 104 5 PRAXEOLOGY 108 5.1 The method of Austrian economics 108 5.1.1 The older roots of praxeology 108 5.1.2 The modern Austrian roots of praxeology 109 5.2 The different parts of praxeology 112 5.3 Concepts and laws of human action 114 5.3.1 Praxeological concepts of action 114 5.3.1.1 Valuation 115 5.3.1.2 The marginal unit 115 5.3.3 Indifference curves 116 5.3.3.1 Indifference and preference 117 5.3.3.2 Indifference and exchange 118 5.4 Praxeological laws 121 5.4.1 The law of decreasing returns 122 5.4.1.1 What the neoclassicals say 123 Contents xi 5.4.1.2 What the Austrians say 124 5.5 Praxeology versus the natural sciences 126 5.6 Praxeology versus quantitative economics 129 5.6.1 Mathematical economics 129 5.6.2 Econometrics 132 6 THE MARKET PROCESS 135 6.1 Equilibrium states versus disequilibrium processes 135 6.1.1 Negative and positive externalities 139 6.2 What drives the market process? 141 6.2.1 Menger’s goods characteristics 142 6.2.2 Böhm-Bawerk’s goods characteristics 144 6.2.2.1 Ryle on knowing how and knowing that 145 6.2.3 The entrepreneurial consumer 148 6.3 What constitutes the market process? 151 6.3.1 Short cuts in equilibrium: the first and second generation 151 6.3.2 Short cuts in equilibrium: the third generation 153 6.3.3 Short cuts in disequilibrium: Schönfeld-Illy 155 6.3.3.1 Schönfeld-Illy: a modern-Austrian forerunner 155 6.3.3.2 Schönfeld-Illy’s three principles 158 6.3.3.3 Böhm-Bawerk versus Schönfeld-Illy on total value 160 6.3.4 The discovering consumer 162 6.4 What characterizes the market process? 164 6.4.1 Competition among consumers: the why not 164 6.4.2 Competition among producers and consumers 167 6.4.3 The competing consumer 172 7 SUMMARY AND CONCLUSIONS OF PART II 174 Bibliography 179 Part 1 Austrian Economic Thought: its evolution “And marginal utility is subjectively estimated; it corresponds to a subjective maximization of the total utility” —Perroux 1 THE MAIN PROBLEM 1.1 The significance of value: Wicksell versus Cassel he most important phenomenon and the cornerstone of economics is the phenomenon of value. Lewis Haney rightly writes, “Value being the heart of economics, the economist’s philosophy is bound to shape his value theory” ([1949], 1951, p. 16). Unfortunately, the theory of value presents great difficulties as it is connected with two conflicting views: the objective and the subjective one. Concerning the endeavor for the best approach, William Smart argues: "Yet the history of economic science is strewn with the wrecks of value” (1966, p. 1). Gustav Cassel ([1918], 1927) from his point of view observed that price is important for economics, since it determines the phenomenon of goods and services.