Some 13 years ago (in the May 1996 , which celebrated the first 50 years of public service splendidly contributed by the Foundation for Economic Education), I dwelt on the pivotal role played by FEE in upholding the flag of Austrian economics. I dwelt especially on the role it played (most importantly by providing Mises with a congenial “base”) in nurturing the Austrian economics tradition during decades in which the professional reputation of the school was at its very lowest. That paper focused, in part, on the contribution of the Foundation to the subsequent revival of Austrian economics in this country. The present note complements that earlier piece by focusing on the altogether dramatic character of the long-run impact of this magnum opus of Mises, a work that anchored everything which Mises was to write under FEE auspices, and to which the Austrian economics revival is, unquestionably, to be attributed.

The Intellectual Drama of Human Action

The term “drama” may seem out of place in regard to a serious tome on the foundations of a serious discipline. But Human Action is no ordinary work. It is a work which, at the time, was seen as written in starkly uncompromising fashion, articulating a particular worldview and a particular understanding of economics–at a time when that worldview and that understanding were thought to have been decisively nudged off the professional stage. The book came to be summarily dismissed, and subsequently ignored, as the last gasp of a dying intellectual tradition. But this judgment was grievously mistaken.

Human Action was not a work merely presenting, once again, the ideas of an earlier tradition. The book in fact represented, we must point out, a dramatic revision, a dramatic deepening of the insights of the Austrian school. Precisely when the Austrian economics tradition was widely seen as virtually dead, as material only for treatises on the history of economic thought–precisely at that time that very tradition brilliantly produced a sparkling, fresh, fundamentally new interpretation of its central tenets. Six decades later we can see how Mises’s revision and reinerpretation inspired a revival of serious academic and scholarly interest in Austrian economics. Seen from this perspective, the 1949 publication of Human Action must surely be recognized as a dramatic episode in the history of economics.

The Decline of Austrian Economics, 1932–1945

At the outset of the 1930s the Austrian school of economics was recognized on the continent, in the United Kingdom, and in the United States as an important component of contemporary academic economics. For young scholars from America visiting the European academies at that time, an invitation to present their work at a seminar at the University of Vienna was a highly valued professional achievement. In Britain, Lionel Robbins, the most prominent economist at the University of London, published his 1932 classic, An Essay on the Nature and Significance of Economic Science, replete with insights and citations the author had culled from the Austrian literature and from his visits to Vienna. In that same year Robbins invited the brilliant young Friedrich Hayek (a close associate and protégé of Mises) to join the London faculty in a prestigious professorship. And Hayek’s appearance on the British academic scene had an almost dramatic impact on British economics discussion, especially in regard to capital and monetary theory.

Yet just a few short years later, it seemed, this success had evaporated. The advance of economic theory in the ’30s (advances related in particular to the work of Piero Sraffa and John Maynard Keynes, to theories of imperfect and monopolistic competition, to the theories of socialist economics, and to sophisticated advances in mathematical economics) seemed to have left the Austrians far behind. They were seen to have been defeated by Keynes (in regard to macroeconomic issues), by Frank Knight (in regard to capital theory), and by Oskar Lange and by Abba Lerner (on the possibility of efficient socialist economic planning), and to have failed to keep pace with the exciting developments in welfare theory, econometrics, and mathematical economics. The physical dispersal of the circle of Vienna economists who had attended Mises’s famed privatseminar as a result of the political turmoil of the times certainly contributed to the impression that the Vienna tradition was no longer a live component of modern economic thought. (Mises himself had left Vienna for Geneva in 1934.) Although Mises published Nationalökonomie in Geneva in 1940 and Hayek published The Pure Theory of Capital in 1941, the economics profession paid virtually no attention to these works. By the end of World War II, with Mises a refugee in New York and without a regular academic position, the outlook for the future of the Menger-Böhm-Bawerk tradition seemed bleak indeed.

Moreover, it can be argued, certain aspects of the developments in mainstream economic theory during the ’30s–despite their overall thrust away from the path of Austrian theory–may well have seemed to erode the case for a distinctive Austrian presence. In its early years the Austrian school had gained its distinctiveness from its pioneering challenge to the dominance of the German Historical School. But by the 1930s, that war (on behalf of the legitimacy of abstract economic theory) had been decisively won; all the major schools of European economic thought were on the side of the Austrians in regard to the role of pure theory. And in 1932 Mises himself had written to the effect that all “modern” schools of economic thought subscribe to the same set of economic principles, albeit in different languages and with different modes of exposition. Mises himself, it seems clear, had (in 1932) not recognized the gulf that (as would later become amply clear!) separated the dominant Anglo-American mainstream from the economics that Mises himself identified with the Austrian tradition. So a number of Mises’s disciples (including, perhaps, Fritz Machlup, Gottfried Haberler, and Paul Rosenstein-Rodan) might be excused for thinking that what was important to the Austrian tradition was by now (the ’30s) well-accepted in mainstream economics. There was no intellectual profit, such Austrians came to believe, to be gained by insisting on the distinctiveness of the Austrian label.

The Socialist Calculation Debate and the Mises-Hayek Revolution

Yet if the immediate post-World War II scene appeared so wholly inhospitable to a distinctive Austrian economics, both Mises and Hayek were in fact working, independently but along parallel paths, toward a revolutionary reinterpretation of their intellectual heritage. (This note is, of course, focusing on Mises’s classic work of 1949. But it would be a serious mistake to fail to note that the “drama” we have seen in the appearance of Mises’s book had its parallel in the appearance of Hayek’s 1948-49 volume of essays, Individualism and Economic Order. I have elsewhere discussed the complementarity between those two contributions in “Ludwig von Mises and Friedrich von Hayek: The Modern Extension of Austrian Subjectivism,” republished as chapter 7 in my The Meaning of Market Process: Essays in the Development of Modern Austrian Economics.)

The “socialist economic calculation debate” that raged in the prewar decade had, it seems reasonable to believe, induced the revolutionary revisions in their understanding of markets. The uncritical acceptance by the economics profession of the Lange-Lerner thesis–that socialists can plan efficiently by modeling their plan after general equilibrium conditions (postulated by mainstream theorists as governing competitive market systems)–taught Mises and Hayek that their own understanding of how markets work differed fundamentally from that of their neoclassical colleagues. Mises, in particular, now realized that mainstream neoclassical theorists do not subscribe to the same understanding of the economic principles governing markets to which Austrian economists (or, at any rate, he) subscribe. Mises wrote Human Action to articulate with utmost conviction his refusal to accept that mainstream neoclassical interpretation of how markets work. Human Action was a defiant declaration of theoretic independence–a declaration spelling out explicitly what had hitherto (at least in Mises’s view) been implicit in earlier neoclassical (and particularly in Austrian) market theory. (See Frank M. Machovec’s Perfect Competition and the Transformation of Economics.)

This explicit articulation constituted a dramatic, revolutionary deepening and extension of existing Austrian theory. That it came to inspire the late-twentieth-century revival of Austrian economics, although ignored and overlooked when it was first published, is in large part what made the publication of Human Action an episode of intellectual drama.

Market Process Versus Market Equilibrium

What the socialist economic-calculation debate taught Mises, I believe, is that it is necessary, in order to promote economic understanding of what the market system achieves, to replace expository emphasis on attainable market equilibrium patterns with an emphasis on the character of the processes of equilibration. (For an exhaustive exploration tending to support this assertion, see Don Lavoie’s Rivalry and Central Planning:The Socialist Calculation.)

This latter emphasis reveals the essentially entrepreneurial character of the market process and underscores the role of dynamic competition (as against the state of so-called “perfect competition”) in this entrepreneurial process. (In Hayek’s work a parallel shift of emphasis was being articulated: namely, a replacement of a world of imagined perfect mutual knowledge by a world in which the market “learning” process tends continually to expand the scope of mutual knowledge–subject, of course, to the continual disruptions generated by exogenous changes in demand patterns, resource availabilities, and so on.) The writers who believed that central planners could emulate market efficiency had overlooked, in Mises’s view, the subtle processes of entrepreneurial discovery, through which alone one could postulate any systematic tendencies toward market equilibrium.

By focusing on the entrepreneurial process at work in markets unhampered by governmental obstacles to competitive entry, Mises offered much more than a reinterpretation of traditional price theory. His insights offered a brilliant new understanding of the meaning of market competition and thus also a revolutionary perspective on the theory of monopoly. Mises’s understanding of the market process implied not only the rejection of mainstream orthodoxy in the theory of socialism, but also far-reaching implications for the theory of antitrust policy and, more generally, for the theory of government regulatory policy.

For many years this new emphasis in Misesian-Austrian economics was completely ignored. In the immediate post-World War II decade the focus of professional attention was not on the precise formulation of the foundations of microeconomics, but on the extent to which microeconomics must, in the real world, be superseded, as a practical matter, by Keynesian macroeconomic considerations. Moreover, the increasing sophistication of mathematical economics, and its applications in the elaboration of the ambitious Walrasian general-equilibrium theoretic enterprise, combined to make Mises’s ideas seem old-fashioned, elementary, and even primitive. As is now well-known, these were decades (stretching from after the 1921 publication of Knight’s Risk, Uncertainty and Profit until William Baumol’s pioneering work almost half a century later in the resurrection of the entrepreneurial role) in which mainstream economic theory almost completely lost sight of the entrepreneur.

The Drama of the Austrian Revival

But Mises’s great work was not destined to be buried forever under this deafening silence. By the 1960s and ’70s younger students and scholars were beginning to discover Mises’s work and to recognize the sparkling freshness of his ideas. The economics profession–or at least some of its more daring and independent-minded graduate students–was at the same time beginning to take note of and to acknowledge the stultifying irrelevance of much of what was being taught in mainstream graduate departments. The downfall of Keynesian economics during the latter decades of the century focused renewed attention on the foundation of microeconomics. In Human Action more and more young scholars rediscovered ideas that enabled them to make sense of the complex world that economic science is supposed to help us understand. The downfall of the Soviet Union focused attention on the profound truths about socialism to be extracted from the Misesian foundations. That downfall taught many that the mainstream of the profession, which had for decades defended the possibility of socialist economic efficiency and had contemptuously dismissed those who had challenged that possibility, was simply and ingloriously wrong.

The modest revival of interest in the Austrian economics tradition over the past four decades has highlighted, in my opinion, the drama inherent in the first appearance of Human Action. This work was the courageous manifesto of a scholar of incorruptible integrity who, close to the seventh decade of his life, contributed a brilliantly fresh articulation of economics truths. That this work was ignored for decades and only subsequently won recognition (albeit modest) adds to the intellectual drama of this episode in the twentieth-century development of economic thought. Speculation concerning the future influence that may yet be exerted by this towering work only enhances the excitement sparked by this drama.

In the first article of this trilogy we explored some of the ambiguities and difficulties that surround the very idea of “economic advice” based on economic science. In the second article we set forth some of the basic foundations of economic science (with special reference to what the science can teach us about what we called the “benign” character of the spontaneous market process). We are now ready to draw together the various strands of our discussions and to set forth the scientific legitimacy of economic advice based on an accurate understanding of the nature and significance of the free-market process.

As was developed in the preceding article, economic science has explicated the nature of the forces that govern the market process. What we saw was that the market process is made up of powerful tendencies set into motion by “erroneous” market decisions. Such “erroneous” (that is, uncoordinated) market decisions are responsible for “imbalances,” in which over-optimistic expectations are frustrated and disappointed, while overpessimistic expectations are translated into overlooked opportunities for mutually beneficial exchanges. The market process consists partly of forces that tend to modify over-optimism, replacing erroneously hopeful decisions by more realistic market bids and offers (and more realistic production plans); and it consists, in addition, of “entrepreneurial” tendencies toward the discovery of hitherto overlooked opportunities. At any given time these coordinative tendencies are operating to eliminate the earlier errors—at the same time as “exogenous” changes in consumer preferences, resource availabilities, and technological possibilities are altering the very framework against which “error” is to be defined.

To the extent that production decisions are geared, not to the satisfaction of current consumer needs, but to the satisfaction of future needs, our above capsule description of the market process must be deepened. We must recognize that a production decision may be “over-optimistic” not only in overestimating the urgency of consumer demand for today’s fresh milk, but also in overestimating the future demand for a particular style of automobile. Such a production decision may be “over-pessimistic” not only in failing to realize that today’s market will express an unsatisfied demand for cheese products (which might have been even more profitable than the production of fresh milk), but also in failing to realize that (perhaps as a result of advances in medical research), in five years’ time the demand for fresh fish (and thus the profitability of now producing fishing trawlers) may increase substantially.

To recognize all this does not require us to change our basic understanding of the nature of the forces that make up the market process. It merely requires us to recognize that these forces operate along channels that permit us to apply our elementary understanding of the “law” of supply and demand to levels of intertemporal complexity not noticed previously. Ultimately, however, the intertemporal coordinating forces unleashed by the “law” of supply and demand operate in ways fundamentally similar to the operation of this “law” in the simplest of markets. Market decisions are continually modified to take more realistic account of future possibilities; entrepreneurs are continually alert to the possibilities of discovering hitherto unnoticed gainful opportunities (whether these opportunities are short-run or long-run in their nature).

Is the Market Process Really Benign?

Our discussion in the preceding section (and in parts of the preceding article) may suggest that each step of the market process is, at least in its tendency, socially beneficial. After all, this process tends to correct the erroneous expectations that individuals may have. It tends to discourage individuals whose over-optimism might otherwise inspire them to undertake projects doomed to failure. And it tends to inspire individuals to discover hitherto overlooked ways in which they can be useful to each other. To the extent that we would hope that such opportunities would be discovered, the market process, it would seem, is “benign” in its tendency. But what about the possibility that the successful achievement of mutually beneficial exchange between parties A and B is seen by party C as an undesirable development? (Economists term such situations “externalities.”) We may consider several different scenarios.

a) Suppose, as a result of newly discovered trade possibilities between A and B, C (who had previously enjoyed B’s spending as a customer in his store) now finds his income reduced. Of course he is dismayed by the newly discovered mutually gainful exchange opportunity between A and B. (C would be similarly dismayed if, as one who used to buy from A at a low price, he now finds himself forced to match the higher price that B is now paying A in their newly discovered mutually gainful exchange.) While C certainly feels himself to have been “hurt” by the discovery, does this compromise our earlier judgment that the latter discovery is socially beneficial? The basis for our earlier judgment was the implicit assumption that the trade between A and B benefits them both (which is certainly the case) without affecting anyone else negatively (which is not the case in our present scenario).

Without entering into any deep philosophical issues revolving around comparisons between the “harm” suffered by C and the gains enjoyed by A and B, let us carefully notice that C has not really been harmed at all. What has happened is merely that C, who had enjoyed income received by selling to B as a result of B’s earlier ignorance, is now no longer able to do so. (Or, in our alternative case, C, who had enjoyed being able to buy cheaply from A, as a result of A’s earlier ignorance, is now no longer able to do so.) C has not been harmed in the sense of having lost any of his physical assets. Nor, as we shall see, has he been harmed in the sense of having lost some of the established true value of his assets; his “harm” consists strictly in his having now to live with a more realistic assessment (by himself and others) of what his physical assets are worth, and have really been worth, to others. Up until now he has, as is presently apparent, been extracting an unrealistically and unjustifiedly higher value from others, in exchange for what was really a lower-value asset.

But what if the exchange between A and B does indeed physically harm C; suppose that what A sells to B is his service as a musician and that this music played by A is so loud and so repulsive to C that the latter feels as if physically assailed. Let us consider this as scenario b).¹

b) A sells live music to B; C’s life is totally disrupted by what he considers atrocious noise. Surely we cannot describe the discovery by A and B of this opportunity for mutually gainful exchange as constituting an unambiguously socially benign development. Surely the gain to A and to B has to be offset, at least in part, by the harm caused to C. Let us distinguish two cases: (i) one in which the law recognizes C’s right not to be disturbed by other people’s music and (ii) one in which the law does not restrain individuals from disturbing others with their noise. In case (i), C’s right not to be disturbed will certainly have to be taken into account by A and B. They will, if they wish to trade with each other, have to pay C to persuade him to permit them to do so. If C accepts such a payment, we would have a three-way trading arrangement in which everyone (at least in his own estimation) has been made better off. B gets to hear music at a total cost that he apparently believes to be worthwhile; A plays his music for a net price (after paying C) that he finds worth his while; C, while he must now sacrifice his peace and quiet (to which he is legally entitled), finds that the payment he receives from A and/or B is more than sufficient to make it worthwhile to do so. Everyone (to whom the trade between A and B is of relevant interest) has gained from trade.

In case (ii), in which the law does not recognize any right not to be disturbed by the noise of next-door music-lovers, C’s pain will be legitimately ignored by A and B (unless of course they choose to act altruistically to consider C’s suffering). But C has a way of making sure that his pain is taken into account by A and by B; he can offer them money to sign a contract undertaking not to play music during agreed-on periods. If they accept his money, C will consider himself to have gained (since he has purchased peace and quiet, to which he had not previously been legally entitled). If they do not agree to such a contract, C will indeed suffer from the music; but it is the legal system that is the source of this pain. The market process merely translates the legally recognized rights of A and B into corresponding realities. In both case (i) and case (ii) the market process benignly tends to reveal all relevant opportunities for mutually beneficial gain—within the given framework of legally recognized (and enforced) individual rights. We may approve or disapprove the morality of the legal system of rights, but given that system, whatever it may be, the market process benignly tends to inspire mutual discovery; it tends to bring about coordination among the decisions of all those who are considered relevant by society’s adopted system of law.

Has Economics Proven the Market Process to Be Morally Good?

We have seen that elementary economic reasoning shows that the market process tends to promote the discovery of hitherto overlooked possibilities for mutually beneficial exchanges. We have therefore described the process as “benign” in its tendency. Does this mean that the market process is morally “good”? Have we shown that, since the market process is economically good, we have scientifically demonstrated that public policies which promote the market process are morally good policies, while those which hinder the process are morally bad? Have we used science-based “is” statements to generate morally compelling “ought” statements? Careful examination of our reasoning will show that we have not demonstrated any necessary moral goodness in the market process—but that we have nonetheless succeeded in securing a valid basis for economic policy, properly understood.

What we have called the “benign” results that tend to flow from the spontaneous market process are benign in a very special, limited, sense. It seems a pity that Jones, who prefers a (which he does not have) to b (which he does), is somehow (let us say as a result of unnecessary ignorance—unnecessary in the sense that it could be eliminated with virtually zero cost) held back from trading with Smith, who prefers b (which he does not have) to a (which he does). A market process that tends to reveal to both Jones and Smith a way in which they can mutually benefit each other (without harming anyone else) seems to be an obviously “socially” beneficial process. But the beneficial character of this process is strictly relative to Jones’s and Smith’s given preferences. If these preferences are, in a moral sense, praiseworthy, the process that promotes their fulfillment can be seen as morally praiseworthy too. But suppose that the a which Jones prefers is a cholesterol-laden dessert that is likely to trigger a heart attack; suppose further that the b which Smith prefers is a hectic ride on a wildly unsafe motorcycle on a busy highway. Surely many observers would think the world a morally better place without the implied exchange. But—and this is the important point—the economist who applauds the market process is doing so not as a moralist; he is doing so strictly within the “instrumentalist” framework of his profession. He is pointing out that, from a purely economic point of view (that is, in terms of given preferences and given resources), free exchange is “beneficial” in its tendency, for all relevant parties.2

An educational psychologist who has been consulted on the best color that might be chosen for the walls of a classroom may recommend a bright color that will stimulate alertness and learning. But before pronouncing this color to be morally superior to other possible classroom-wall colors, we would want to be sure that the classroom is to be used for morally good teaching purposes. If the classroom is to be the arena in which students are indoctrinated into hateful ideologies, we would probably consider a color which slows down the learning process to be morally superior to the alertness-inducing color. “Goodness” is strictly relative to the professional focus of the expert. For the educational psychologist this focus is the promotion of alertness to new information—regardless of the moral status of that information. For the economist the professional focus is the fulfillment of mutually beneficial opportunities for exchange, based on given preferences and resources—regardless of the moral status of those preferences.

But if this is properly understood, it does not appear to be wrong to label a coordinative economic policy to be “good economic policy,” since it does promote mutual discovery among the Smiths and the Joneses. The economist who argues that one economic policy is economically better than another policy is doing so strictly within his professional framework.

What We Have Not Claimed

There are other claims that are not implied by our claim on behalf of the economic goodness of the market process. To show this does not, however, call for philosophical or moral insight; it simply requires rigorous economic reasoning.

For example, take the idea that free markets maximize national wealth. Now the great economists who were the founding fathers of the discipline—the “classical economists”—did indeed define their science as the “science of wealth.” It is well known that the (short) title of Adam Smith’s classic work is The Wealth of Nations. As we noted in the first article, Smith, followed by the other classical economists, took it for granted that the objective of good economic policy is to increase national wealth. Yet the very meaning of the term “aggregate national wealth” (especially if confined as it was in classical economics to material wealth) begins to crumble away, as a scientifically useful term, as soon as it is subjected to analysis.

Two bushels of wheat may certainly appear as more wealth than one bushel. But are they also more wealth than, say, a package of one bushel of wheat and one sack of potatoes? And even when we consider only wheat, are we sure that two bushels owned by a single wealthy person constitutes more wealth than one bushel that has been somehow distributed among several desperately poor large families? Simply drawing attention to the valuation problems of adding up apples and oranges, or to the complications introduced by the insights of subjectivist (and especially, Austrian) economics, explains why economists at the end of the nineteenth century sought to replace the criterion of aggregate national wealth by less-physical concepts. One such concept, which came to be associated particularly with the work of British economist A. C. Pigou, was that of the aggregate national “economic welfare.” What good economic policy seeks to maximize, according to this approach, is the aggregate economic well-being of the members of society.

But the idea of treating individual economic welfare as something that might in principle be added together with someone else’s individual economic welfare is one which could hardly be sustained. In particular Austrian economics, which had pioneered the subjectivist understanding of consumer utility, could never accept any such aggregate notion. Moreover, attempts to replace direct notions of aggregate welfare by less-direct formulations (that is, those implied in the notions of aggregate efficiency in the allocation by society of its economic resources) are easily seen to be doomed to failure.

Thus, it turns out, economic policy advice cannot meaningfully claim to be based on the idea that a particular policy should be described as economically “good” because it tends to promote aggregate wealth, or aggregate economic welfare, or a more efficient allocation of a society’s economic resources.³ We seem to be forced back to the more modest (but yet enormously important!) claims examined earlier—that certain economic policies may be shown to promote mutual discovery by potential market participants (and may therefore be considered to be “economically good” policies). Sometimes, as we have indicated, this is expressed by pointing out that such policies promote “coordination” among the decisions made in a society. They tend to alert relevant market participants about the possibilities available to them, tending thus to ensure that potentially beneficial opportunities for innovative production, and mutually gainful exchange, do not go unnoticed and unexploited. Implicit in the work of Ludwig von Mises, however, are insights into several additional criteria for judging economic policies to be good or bad.

Ludwig von Mises and the Goodness (or Badness) of Economic Policies

Mises never did fully explain the basis on which he felt able to pronounce an economic policy to be good or bad. He never (as far as I am aware) explicitly discussed the “coordination” criterion for good economic policy to which we have repeatedly referred. But there are grounds for believing our position in this article to be consistent with Mises’s philosophical and economic perspectives. In his explicit discussions Mises seems to have grounded his judgments (on the goodness or badness of economic policies) on one or more of three separate foundations:

Self-Frustrating Economic Policies: A policy that can be shown by economic science to bring about results that are emphatically not desired by the policymakers themselves is bad policy. A classic Misesian example of this was the policy of urban residential rent control. Whatever the merits might be of the results hoped for from a policy of rent control, it must be pronounced a bad policy. Economic analysis shows that it tends to generate housing shortages—which were not (one hopes!) the objective of the legislators.

Unsustainable Policies: A policy that can be shown to be inherently impossible to be successfully carried out is an obviously flawed policy. For Mises a policy of monetary inflation (to fuel a boom in the initiation of long-term capital-using ventures) is a bad policy because economics shows how extremely unlikely it is that any such sustainable boom will result. Such a boom can be sustained only through long-run consumer sacrifices, which the consumers are not in fact prepared to make. Such policies amount to attempts to run simultaneously in two opposite directions. Economics can show that a particular policy cannot expect to be successfully completed. Such a policy may be described as bad policy.

Violations of Consumer Sovereignty: Mises (like most economists) apparently supposed that most people believe it to be a “good thing” for members of society to fulfill their preferences. He therefore shared the conviction of most economists that a policy which structures a society’s allocation of resources in patterns clearly at odds with the dynamics of consumer preferences is an economically “bad” policy. A policy that creates a pattern of excise taxes tending to nudge consumer purchases away from goods and services the consumers prefer, toward goods and services legislators believe to be “better” for consumers—is a policy that Mises believed to be “bad,” because it violates consumer sovereignty.⁴

Science and Passion

We noted in the first article in this series that writers have been puzzled by the passion with which Mises denounced what he believed to be bad economic policies. Fritz Machlup, an eminent economist and devoted student of Mises, was one of these writers. Mises’s passion seems, at first glance, difficult to reconcile with his own insistence on the absolute necessity for scientific wertfreiheit—detached objectivity—in social science. When Mises denounced socialism as a disastrous economic system—one that tends to impoverish society, to bring misery on its members, and to threaten the very survival of Western civilization—he waxed passionate. He was firmly convinced that economic science shows all this to be true. (In particular he was convinced that economics demonstrates how the most benevolent of would-be national planners would not be able to plan [that is, to coordinate individual activities] at all! Thus a policy of socialism—that is, a system in which an integrated, single, national plan is sought to replace the “anarchy” of innumerable individual plans in a free-market society—is one that is simply impossible to carry out [just as would be a policy aiming to run in two opposite directions at the same time].)

But by now it should be clear that there is no inconsistency in Mises’s positions. Because Mises believed—on objective, scientific grounds—that socialism is a sure recipe for misery and worse, he believed it to be his moral duty to communicate his belief to society with whatever passion might be able to command attention and inspire political relief. Machlup may have seen this as a violation of wertfreiheit. Mises would have vehemently disagreed. His passion was—like the passion of someone earnestly preaching the health dangers of tobacco smoking—based on cold, objective science.

As we saw in the first article, the eminent economist George Stigler believed that any “preaching” by any economist for any particular economic policy is, on grounds of consumer sovereignty, out of order. Stigler believed that the public already knows full well what the likely results of any economic policy are likely to be. If the economist is preaching against a policy voluntarily adopted by the public through its political channels, he is simply attempting to promote what he believes to be better for society over what society believes to be better.

But economic science surely has, again and again, revealed how particular policies result in outcomes not foreseen by policymakers, or by those who elected or appointed them. Economics shows how imperfect knowledge may be responsible for enormously valuable (and completely overlooked) opportunities remaining unexploited. It is no violation of consumer sovereignty to demonstrate where such ignorance has been (or is likely to be) responsible for disastrous results. In fact, to demonstrate this is to promote consumer sovereignty. As long as the philosophical and moral detachment of economic science is well understood, this science can be used, in a wertfrei manner, to inform the public of what it does not yet know. Where the results of such ignorance are likely to be serious, the economist (in his capacity now of a citizen fully alive to society’s suffering) may consider it his moral obligation to bring the results of his objective scientific researches to the attention of the public. Such moral obligation may indeed be expressed with Misesian white-hot passion—but this is, in principle, in no way inconsistent with the cold objectivity with which those researches were conducted.

1. This scenario has been extensively explored in a literature pioneered by Nobel laureate Ronald H. Coase; see his celebrated paper, “The Problem of Social Cost,” Journal of Law and Economics, Vol. III (October 1960).
2. For the classic statement of these insights, see Lionel C. Robbins, An Essay on the Nature and Significance of Economic Science, 2d edition (London: Macmillan, 1935), especially Ch. VI.
3. See further my paper, “Welfare Economics: A Modern Austrian Perspective,” published as chapter 11 in Israel M. Kirzner, The Meaning of Market Process, Essays in the Development of Modern Austrian Economics (London: Routledge, 1992).
4. For a pioneering discussion of coordination, as introduced into normative economics by eminent Austrian economist Friedrich A. Hayek, see Gerald P. O’Driscoll, Economics as a Coordination Problem, The Contributions of Friedrich A. Hayek. See also my “Coordination as a Criterion for Economic ‘Goodness,’” published as chapter 7 in Israel M. Kirzner, The Driving Force of the Market, Essays in Austrian EconomicsLondon: Routledge, 2000). See also Israel M. Kirzner, Ludwig von Mises: The Man and His Economics (Wilmington, Del.: ISI Books, 2001), pp. 163–71London: Routledge, 2000). See also Israel M. Kirzner, (Wilmington, Del.: ISI Books, 2001), pp. 163–71

How can positive science (consisting entirely of “is” statements) be translated into “ought” statements within the framework of economic understanding? In the first part of this series we drew attention to some of the paradoxes surrounding economic advice. In particular we drew puzzled attention to the passionate advocacy by Ludwig von Mises of free-market arrangements—the same Ludwig von Mises who insisted on an attitude of purest, disinterested wertfreiheit (“value-freedom”) on the part of all social scientists. In the present article, as a step toward clarifying these paradoxes and puzzles, we discuss the nature of the strictly positive central propositions of economics. We shall find that a careful appreciation for the manner in which economic science accounts for the existence of chains of economic cause and effect can help us see how knowledge of these chains can sustain very definite ways of providing advice and guidance to economic policymakers. Statements describing chains of cause and effect are “is” statements. But, as we shall see, these statements can, in a carefully defined sense, generate the “ought” statements of which economic advice consists.

Cause and Effect in Economic Affairs

Economic science was established as a branch of knowledge in the eighteenth century, when the classical economists recognized that there exist systematic chains of cause and effect in economic phenomena (just as they exist in regard to physical phenomena). Although subsequent progress in economic theorizing radically altered the way in which economics understands economic cause and effect, it was the classical economists who, by establishing the idea of systematic chains of cause and effect, established the scientific discipline of economics.

The very perception of a scientific discipline of economics (or “political economy,” as it was called by the classical economists of the late eighteenth and early nineteenth centuries) carries revolutionary implications for public policy. As Mises emphasized again and again, the discovery of regularities in economic phenomena means that statesmen concerned with public policy can no longer treat the economy as putty that they are free to mold into whatever shape they believe best for society. Every political act, every legislative constraint over economic activity, and every public subsidy must now be recognized as entailing specific consequences. Before instituting any tariff, before granting any right of monopoly, before printing any money, before imposing any kind of price control, those responsible for state policy must ask themselves whether they have fully taken into account all the consequences that are likely to follow from these actions. There are, the classical economists had shown, “laws” of economics that must be respected and taken into account if economic disaster is to be avoided.

But how can such “laws” possibly exist? Surely an intuitive impossibility blocks any conceivable “laws” from existing. It is one thing to observe and understand regularities and causal or functional relationships in physical phenomena. But to expect such regularities and relationships in economic phenomena (which represent the outcome of the independently made decisions and actions of millions of freely choosing individual agents) seems to be glaringly counterintuitive. There seems to be no way of ensuring that freely choosing agents “obey” the regularities that a science might declare to be determinative.

This intuitive difficulty is the fundamental reason why both economic theorists and philosophers have, during the past two centuries, puzzled and argued over the very possibility of an economic science, and over its epistemological character. The present series of papers (and this one in particular) are informed by the insights and philosophical framework identified with the Austrian School of Economics, and especially with the thought of its leading twentieth-century representatives, Mises and F. A. Hayek.

In this framework the focus of attention is on the purposefulness of human beings, and on the way in which the expectations and knowledge of these human beings are systematically modified by economic experience. Changing economic experience alters the terms on which individual agents in fact find themselves able to choose; that experience also teaches agents where they had over-optimistically or over-pessimistically misjudged the terms on which others were prepared to trade with them; that experience also alerts individual agents to opportunities for the future that had hitherto not existed or that have until now not been noticed. Economic theory is able, in this analytical framework, to provide understanding of how exogenous changes in resource availabilities, technical knowledge, and consumer preferences may systematically change market phenomena, and thus determine the course of production and the patterns of resource allocation. To illustrate this approach to economic reasoning, let us take perhaps the most basic of the “regularities” in the market economy, the “law” of supply and demand.

The “Law” of Supply and Demand

This basic understanding of the behavior of market prices identifies the nature and the direction of the forces operating in the market for each product and for each resource. This understanding sees the market for any given item, be it a product for human consumption (such as milk or the services of an opera singer), or a resource (such as farmland for growing crops or the services of an engineering instructor for the training of engineers), as being continually modified by market experience in systematic fashion. At any given time “too much” or “too little” of the given item may be offered for sale (or sought to be bought). (“Too much” being offered for sale means that, at current prices, more of an item is being offered for sale than is being bought. “Too little” being offered for sale means that, at current prices, more of the item is being sought to be bought than sellers wish to sell.) The “law” of supply and demand focuses attention on the existence of spontaneous market forces tending to “correct” these imbalances.

Where “too much” has been offered for sale, falling prices (for the relevant item) tend to encourage some (“marginal”) sellers to cut back on its production and to encourage potential buyers to seek additional quantities for purchase. Where “too little” has been offered for sale, rising prices for the relevant item tend to encourage potential sellers to increase production (and thus the quantities they will offer for sale) and to discourage some (“marginal”) buyers from continuing to buy. Were this process of adjustment in a given market to be permitted to continue indefinitely (that is, were the costs and techniques of production for the relevant item, on the one hand, and the preferences of the consumers, on the other, to remain indefinitely unchanged while market adjustments continued), the market for that item might be imagined to attain “equilibrium.” Market equilibrium corresponds to the imaginary state of affairs in which neither “too much” nor “too little” of an item is being offered for sale. In such an imagined state of equilibrium there would be no scope for market forces to be set into motion. Prices and quantities offered for sale and sought to be bought are, in such an imagined state of equilibrium, such that no tendencies are set in motion for any of them to change.

Contrary to what many students of economics have been taught to believe, the “law” of supply and demand does not (when it is properly understood) declare that each market is at or near equilibrium at each moment. Nor does it declare (the less-objectionable form of the above) that markets tend rapidly to achieve equilibrium. Rather the “law” declares that, to the extent that a market, at any given moment, is not at equilibrium, this will itself set into motion forces predominantly pushing the market in the direction of equilibrium.

However, it should be understood and emphasized, the continual changes in the relevant exogenous variables (for example, the costs of production, the availability of resources, and the patterns of consumer preferences) will almost inevitably ensure that the equilibrium position for a market at any given moment is different from what that position was at any earlier moment. So the market forces unleashed by the disequilibrium conditions at one moment will almost certainly not ensure the attainment of equilibrium at any subsequent moment.

Nonetheless, it is reasonable to point out, the more gross imbalances present in the market at any given moment will, according to the “law” of supply and demand, tend to be corrected. An “oversupply” places pressure on prices to fall, discouraging marginal sellers from some production and encouraging additional purchases, and thus tending to eliminate the imbalance. A “shortage” operates in the reverse, but equally benign, direction. Let us examine why the elimination of these “imbalances” can legitimately be described as “benign.” In the final article of this series, this will help us to understand the sense in which economic theory can, in scientifically objective fashion, promote sound economic-policy advice.

Market Imbalance—Why Is It Regrettable?

Let us consider the case of “overproduction” in a particular market (a market seen as isolated and insulated from other markets). Due to miscalculation or other error, the decisions of producers in this market have overestimated the eagerness of buyers to buy. The amounts offered for sale, and the prices expected and asked by potential sellers, are not matched by the decisions of potential buyers (and thus by the prices at which potential buyers expect to be able to buy, and at which they are willing to buy). This imbalance corresponds to decisions that have turned out to have been disappointing, and to decisions that turn out to have been regrettable. Some potential sellers (who might otherwise have offered to sell for lower prices, but who mistakenly held out for higher prices) are disappointed in that their plans to sell at higher prices cannot be successfully carried out. Those sellers may also regret their refusal to offer to sell at lower prices, or they may regret their decisions to produce in the first place. The failure of the decisions of some of the potential sellers to dovetail with corresponding decisions of potential buyers reveals the “error” of all of those decisions and is the source of both disappointment and regret.

A different, more accurate pattern of decisions, by both potential buyers and potential sellers, might have permitted them to achieve more successful fulfillment of plans than has in fact occurred. When a pair of market participants might have engaged in voluntary exchange to mutual advantage (for example, at a lower price), their failure to have done so (due to “error”) seems, at least at first glance, to have been unambiguously unfortunate—for everybody. Nobody, it seems at first glance, has gained anything by the fact that potential steps to mutual advantage were not taken.

So, if we are correct in this judgment, the market process, which according to our “law” of supply and demand initiates continual market tendencies toward the correction of such imbalances, would appear to be benign. It tends to discover and to correct “erroneous” market decisions—that is, decisions which operate to frustrate the exploitation of potentially mutually gainful exchanges.

Although we have been careful to express this approving judgment (for the outcome of the “law” of supply and demand) strictly in tentative terms, we shall find that it in fact holds more robustly than we have suggested. As we shall see in the final article of this series, it tends to hold even when we drop the special assumptions made in this section. There is a definite sense in which the “positive” theory of supply and demand leads ineluctably to an understanding of its socially benign character (that is, of its “normative” implications). We have in fact glimpsed here the basis for scientifically based economic advice. But the present article has not yet completed its exposition of the “positive” operation of the “law” of supply and demand. Before proceeding further we must explore more carefully exactly how this “law” achieves its magic—its tendency to correct market imbalance. We shall find that the “normative” discussion of this section can help us understand the “positive” operation of the competitive market process.

How the Market Works*

As we have seen, market imbalance reflects and expresses decisions that have been made in error. Market participants have been disappointingly left with unsold goods. Had they known this previously, they might have produced fewer units of these goods; they might even have gone into entirely different lines of production; or they might have been happy to have sold for lower prices (the only reason for their having failed to do so being their erroneous conviction that they could obtain higher prices).

Notice that this understanding of market imbalance refers, in effect, to two distinct kinds of error. One kind of error made by participants in the market we have considered is that mutually gainful exchange opportunities have simply not been taken advantage of. (Thus when market prices have been “too high,” generating offers to sell that have been rejected, this is likely to mean that mutually gainful sales could, in principle, have occurred at lower prices.) A second kind of error has meant that some market participants have been led to believe (quite erroneously) that (nonexistent) opportunities for mutually gainful exchange really did exist. The first of these two kinds of error is thus to fail to recognize existing opportunities. The second kind of error is to “see” opportunities which in fact do not exist. One might describe the first kind of error as one of undue pessimism (failure to see opportunities really staring one in the face); the second kind of error might be described as one of undue and unjustified over-optimism. This insight can help us understand the process of market adjustment, the operation of the “law” of supply and demand.

Let us consider the errors of over-optimism. Whenever such an error occurs, it is discovered (and thus presumably corrected) almost inevitably. One’s market experience reveals where one has been over-optimistic; the opportunities that one had over-optimistically expected to encounter simply do not happen. Such chastening experience tends, almost inevitably, to rein in over-optimistic market anticipations. Such experience “teaches” where and how more realistic expectations are in order. Where over-optimistic would-be sellers had, for example, refused to sell for lower prices (confidently, but erroneously, expecting to sell at higher prices), their disappointing experience in the market tends to teach them to lower their asking prices.

But the other kind of error (that expressing undue pessimism) does not seem capable of “automatic” correction in any similar way. An opportunity (for mutually beneficial exchange) that was not seen today by the relevant parties (and therefore not taken advantage of) may not be seen tomorrow either (even if it still exists tomorrow). Let us take an example. If different prices for “the same” item have been prevailing in different parts of “the same” market, this is a scenario in which potentially mutually advantageous trading opportunities have existed, but have been missed. After all, in any market in which buyers have been buying at higher prices while some sellers have been selling at lower prices, we have a situation where these buyers and these sellers could obviously have benefited by trading with each other at some price lower than those higher prices at which the buyers have been buying, but higher than those lower prices at which the sellers have been selling. Clearly these market participants were simply unaware of what was going on elsewhere in this same market. But there seems no obvious manner in which such unawareness might be spontaneously replaced by superior market information. There seems no obvious way through which the market might tend to replace widely divergent market prices with less divergent prices.

It is here that the spontaneous market process depends on entrepreneurial alertness for one of the most fundamental (and widely recognized) tendencies in free, competitive markets: that prices for the same item do move toward a single price throughout the market.

Entrepreneurial Alertness

One of the less obvious, but nonetheless most powerful elements acting in markets is entrepreneurial alertness—the propensity of human beings to notice that which it is in their interest to notice. Sooner or later buyers paying unnecessarily high prices do tend to discover where they can obtain comparable goods at significantly lower prices. Sellers selling for unnecessarily low prices do tend to discover where they can find buyers willing to pay higher prices. Moreover, sooner or later entrepreneurs will discover that they can grasp pure profit simply by buying at the lower prices and selling at the higher prices. We do feel convinced that widely diverging prices in the same market for a given product or resource will give way in this fashion to competitive forces tending to push these diverging prices toward each other. Errors of undue pessimism do tend to be corrected in this way—as a result of entrepreneurial alertness.

So the “law” of supply and demand explains chains of economic causation along each of two distinct dimensions. First, as we have seen earlier, it operates toward the correction of market imbalances for given items. Second, it operates to correct such imbalances at the same time as it corrects the phenomenon of divergent prices for each such item. The forces of supply and demand operate to correct “wrong” decisions that are unduly optimistic, at the same time as it operates to correct “wrong” decisions that are over-pessimistic.

The Broad Scope of Our Analysis

Our discussion thus far has been extremely simple both in its assumptions and its substance. We have talked of the market for a “given item” while assuming this market to be isolated and insulated from all other markets. When one broadens one’s analytical perspective to include the markets for innumerable products and resources that may be bought and sold, and to include not only simple buying and selling decisions but also decisions on what to produce and how to produce, it might appear that we are now in a world of mind-boggling complexity, for which our simple analysis has little relevance. But this is not the case. The insights of the previous sections do have immediate relevance even for the most complicated of interlocking markets.

Consider, for example, a market in which a particular item C is produced by combining input A with input B, in accordance with some production recipe. Imagine that such production is highly profitable. The combined costs of inputs A and B are, at a given level of output, significantly lower than the revenue obtainable from selling C in the consumer-goods market. This scenario may seem fairly complicated (in comparison with the scenarios discussed earlier). But we should notice that this scenario is one in which buyers are paying higher prices than necessary, and sellers are selling at lower prices than necessary—exactly as in the single-item market discussed in the preceding section. Thus those selling A and B at prices summing to less than the price being paid for C could, in principle, have produced C and sold it for the higher price (since only A and B are needed to produce C). The profitability of this line of production results from a (disguised) divergence of prices “for the same item” in the same market (that is, it results from the circumstances that everything needed to produce C can be bought for less than the market price for C). Thus this profitability can be expected (unless we postulate monopolistic control of access to resources A and B) to tend to attract competitive entrepreneurial attention. This will tend to eliminate the profitability of this line of production (by pushing the price of C and the sum of the prices of A and B closer together).

Although this is not the place to do so, similar analysis can demonstrate the broad relevance of our earlier discussion of the “law” of supply and demand to key aspects, at the very least, of complex market scenarios.

Cause and Effect in Economic Affairs

Our discussion has illustrated the way in which simple economic theory accounts for the existence of definite and systematic chains of cause and effect in economic affairs. There do exist definite ways in which economic decisions made in any one period tend to take systematic account of the other decisions being made in the same markets. In this way decisions do mold each other in systematic fashion. And we have seen how the manner in which such “molding” tends to occur appears, at least at first glance, to deserve being called “benign.” This simple analysis will help us understand, in principle, how economic theory can lead toward making judgments on the “goodness” of specific policy initiatives through an understanding of the likely consequences of such initiatives.

We are now ready to tackle, in the final article in this series, the question posed at the beginning of the first article: Can positive economic understanding be translated into scientifically objective and valid economic advice?

*Much of the material in this article, and especially the material in this section, is covered in greater detail in my monograph How Markets Work: Disequilibrium, Entrepreneurship and Discovery (London:  Institute of Economic Affairs, 1997).

As is the case with virtually all branches of human knowledge, economic knowledge and understanding are valued not only (or even primarily) for their own sake, but for their usefulness in practical terms. The enormous sums expended each year on economic research and economic education certainly would not be forthcoming if it were not expected that such research and education could help promote wise policies leading to prosperity and economic well-being.

Indeed, there can be no doubt that those advocating free-market policies (in The Freeman or elsewhere) do so firmly convinced that such advocacy grows naturally out of economic understanding. I certainly share this conviction. Yet the path leading from valid economic understanding to sound economic policy advice is not straightforward. To proceed from an “is” statement to an “ought” statement is, in all contexts, fraught notoriously with philosophical hazards. In the context of economics these dangers are compounded further by the subtleties that complicate the sources of economic understanding itself.

Our attempt to clarify the basis in economic science for valid and useful economic advice will proceed as follows. In the present article we elaborate on the apparent paradox involved in offering “scientific” advice (that is, advice supported or even entailed by science) in the economic arena. In the second article we shall examine the philosophical foundations of economic science itself (with a special interest in its potential in regard to economic policymaking). In the concluding article we will try to draw together our various insights and to formulate our conclusions in regard to the scientific validity of economic advice.

The “Science” and the “Art” of Political Economy: A Nineteenth-Century Dilemma

The founding fathers of economics, including, most prominently, Adam Smith, generally saw their discipline as constituting what came to be called an “art”—that is, a body of advice on how to achieve a well-defined objective—the enhancement of national wealth. Although the title of Adam Smith’s classic was An Inquiry into the Nature and Causes of the Wealth of Nations (suggesting it to be a disinterested scientific inquiry, concerned neither to promote increased national wealth nor to prevent it), Smith himself has usually been seen to have conceived his subject as an art (setting forth ways to increase national wealth).¹ But thoughtful economists of that period had serious misgivings about such an approach.

Some of the classical economists following Smith indeed wrestled with the relation between a science of political economy and an art of political economy. One such economist was Richard Whately, who was not only an economist of note but also an Anglican archbishop. He felt the need to defend himself in regard to his interest in the science of wealth (an interest his critics apparently thought of as unbecoming a clergyman). Whately pointed out (in a 1831 lecture at Oxford) that the conclusions of political economy can be deployed in policies designed to reduce wealth (if wealth be seen as morally suspect)—just as they can be used to formulate policies for increasing wealth!

At one stage in his academic career Nassau Senior, one of the most prominent early nineteenth-century political economists, flatly denied the very possibility of such an art.² Although Senior later retreated from this categorical position, he was never completely reconciled to the idea of political economy as an art. In his 1860 presidential address to The Section of Economic Science and Statistics (of the British Association), almost a quarter century after his denial of the possibility of an art of political economy, Senior insisted that the political economist is concerned only with the production or distribution of wealth—regardless of whether “wealth be a good or an evil.” He clearly believed that, qua economist, the economist has no business offering advice. “Whenever he gives a precept, whenever he advises his reader to do anything, or to abstain from doing anything, he wanders from science into art. . . .”³

As the nineteenth century wore on, Senior’s qualms came to be ignored. Particularly on the Continent, economists paid scant heed to Senior’s admonitions. The German Historical School (which dominated continental economics during the closing decades of the century) made no attempt whatever to separate their substantive economics from advocacy on behalf of specific social programs. For them it was precisely this advocacy that gave economics its importance as a branch of knowledge. Joseph Schumpeter cited the testimony of a student in a class taught by a prominent leader of the School, to the effect that the mood in the classroom resembled that of an election rally.

It was the great sociologist Max Weber who recognized the danger to the reputation of economics as an objective science that was posed by such a politicized attitude. He maintained that the scientific character of any social science requires that it be meticulously impartial as between different judgments of value. This ran counter to the dominant perspective in German economics. At a meeting of German-language social scientists held in 1907, Weber’s position was the subject of bitter disagreement. Weber insisted that scientists who disagree sharply on moral priorities should, despite this, be able, at least in principle, to agree on the positive propositions of their discipline. We shall return very soon to comment further on this Weberian doctrine of wertfreiheit (freedom from value judgments).⁴

The Twentieth Century: The Economics of Welfare

By the end of the nineteenth century, mainstream economic theorists no longer saw their discipline as concerned with material wealth. Instead they focused on the subjective sense of well-being that human beings hope to derive from their wealth and from their economic activities. This led them (particularly in England) to see economics as primarily concerned with “welfare.” Very soon they were speaking of the “economics of welfare” (the new title of A.C. Pigou’s 1920 book, itself the second edition of a 1912 book titled Wealth and Welfare). To think of economics as the science able to promote economic welfare seemed an innocuous small step. Thus for much of the first half of the twentieth century it was taken almost for granted that the economist is the expert who formulates policies to be implemented in order to promote aggregate economic welfare. It seemed to be obvious that economists had the professional duty of advocating policies they believed would, scientifically, enhance social well-being. And even economists squeamish about the philosophical coherency of any notion of aggregate well-being were able to devise more carefully formulated versions of welfare economics by reference to “Pareto optimality” or similar sophisticated constructions.

It was during this period that economists began to find ample employment opportunities in government. As the tide of public opinion turned (during the second quarter of the century) decisively in favor of massive government intervention in the market economy, economists increasingly saw their discipline as capable of generating very definite policies for enlightened governments to follow. Economists were placing their science (particularly the branch that made up “welfare economics”) at the service of political parties. Inevitably this tended to raise those same gnawing questions concerning the objectivity and impartiality of that science which had so troubled Max Weber. More and more, it seemed, any political program, any proposal for economic legislation, could find economists prepared to present a “scientific” case in its support.

Mises and Wertfreiheit

Ludwig von Mises, the towering Austrian School economist of the twentieth century, was an ardent champion of Weber’s wertfreiheit principle for all social sciences, and particularly for economics.⁵ He believed that the objectivity of the science requires nothing less than its complete detachment from the personal preferences and value judgments of its practitioners. Implicit in Weber’s wertfreiheit principle is the conviction that it is, at least in principle, possible for the economist to pursue his science in detachment from his own personal judgments of value. In fact, however, some twentieth-century philosophers have challenged (and do still challenge) this, maintaining that it is an illusion to believe that one can suppress one’s value judgments while engaging in one’s science. Inevitably, they argue, one’s science reflects one’s moral presuppositions. Mises may have agreed that to maintain such detachment may be difficult—but he would have emphatically rejected claims that it is impossible. It is the scientist’s obligation to the reputation and integrity of his science, Mises would have insisted, that he insulate his scientific work from any hint of “contamination” arising from personal predilections. The medical researcher exploring the links between cigarette smoking and cancer must pursue his laboratory testing and his statistical analysis without that research being affected in any way by his own preference for smoking or his own fears concerning the disease. So too must the economist’s analysis of markets, of regulation, and their consequences be utterly independent of his own moral opinions concerning liberty, the inequality of incomes, or whatever.

Mises’s position offers a fascinating illustration of the ambiguities and complexities involved in the wertfreiheit principle. Gunnar Myrdal was a prominent twentieth-century Swedish social scientist. (His positions on economic policy were so utterly at odds with those of Mises, that when, in 1974, Myrdal and F. A. Hayek were joint recipients of the Nobel Prize in economics, it was widely understood that these choices represented a kind of ideological balancing act, with Hayek’s approving views on free markets being counterbalanced by Myrdal’s advocacy of comprehensive government control of the economy.) In 1930 Myrdal published a German-language book that examined the history of economics and concluded that most of the leading economists during that history had injected political presuppositions and ideals into what they presented as scientific investigations. This book was translated into English in 1955. Fritz Machlup (himself an eminent Austrian-trained twentieth-century economist who had been a pupil of Ludwig von Mises and who treated Mises at a personal level with exemplary loyalty) wrote a review of this published translation. Machlup drew attention to Myrdal’s declaration that (unlike the other schools of economic thought) the Austrian School of economics was not guilty of injecting political ideals into their scientific work. Machlup found this approving judgment surprising. “How did the anti-interventionist writings of the Austrian von Mises escape Myrdal’s attention?” he asked. Apparently Machlup was not able to reconcile Mises’s stated insistence on wertfreiheit and detachment from ideological pre-commitments with Mises’s eloquent writings in favor of laissez faire and the free-market economy.

In fact a reader of Mises’s work cannot fail to sense a paradox surrounding the passion with which Mises wrote his economics. By the time we reach the third part of this series, we shall hopefully have resolved this paradox. Here we shall merely identify it and relate it to the broader challenge of extracting useful advice from wertfrei economic science.

Ludwig von Mises and the Importance of Economics

Mises was, as we have seen, convinced that economics must be pursued dispassionately—as a wertfrei discipline—but he wrote with white-hot passion about the dangers that face mankind should it ignore the truths which academic science reveals. He concluded his magnum opus, Human Action, with the following searing sentences: “The body of economic knowledge is an essential element in the structure of human civilization; it is the foundation upon which modern industrialism and all the moral, intellectual and therapeutic achievements of the last centuries have been built. It rests with men whether they will make proper use of the rich treasure with which this knowledge provides them or whether they will leave it unused. But if they fail to take the best advantage of it and disregard its teachings and warnings, they will not annul economics; they will stamp out society and the human race.”⁶

It is this passionate conviction on the utter importance of the teachings of economic science that accounts for the attention which Mises paid to the philosophical status of those teachings. Mises believed that the enemies of the free society can maintain their advocacy of central planning and massive government intervention in (or replacement of) the market economy only by ignoring or denigrating economic science. He saw all the attempts to question the validity of the foundational propositions of economics as driven by the ulterior motive of discrediting laissez-faire economic policy. Because Mises believed that only laissez-faire policies can sustain modern civilization, he felt driven to clarify and defend the philosophical foundations of what he called “modern economics.” (For Mises, modern economics was the body of economic teachings rooted in the classical economics of Adam Smith and his followers, as refined and reformulated by the so-called neoclassical economists, including especially the founder of the Austrian School, Carl Menger and his followers, among whom was Mises’s own teacher, the eminent Eugen von Böhm-Bawerk).

Mises’s clarifications of the foundations of neoclassical economic theory included, in particular, his defense of economics from the Marxist charge that conventional economists are merely the lackeys of Wall Street, advocating free markets only in order to serve their capitalist paymasters. Mises saw clearly that, unless economists purged their science of any taint of personal bias (that is, as expressing personal judgments of value), their teachings would be vulnerable to such dismissal. Precisely because he saw free markets as the essential prerequisite for civilized, prosperous society, and because he believed that disinterested economic analysis definitively supported this view, Mises was terrified by the possibility that economic science was to be dismissed as nothing but capitalist propaganda. Fritz Machlup saw Mises’s advocacy of laissez faire (his “anti-interventionist” writings) as an example of precisely that departure from impartiality in the pursuit of economic science, for which Myrdal had indicted so many economists (but for which had declared the Austrian School, in general, as having been not guilty). We shall return, in the third essay in this mini-series, to examine the validity of Machlup’s charge.

Most economists of the postwar period did not pay much attention to these concerns. It is true that Milton Friedman, one of the leading scholars of the eminent Chicago School, advocated (in an influential 1953 essay) what he called “positive economics” (in which economic propositions could be established that might command the assent of scholars regardless of their personal predilections). But this came to be viewed primarily as an exercise in methodology, presenting the case for treating economics as a strictly empirical (as opposed to a logical) discipline (rather than as a case for wertfreiheit).

From time to time more serious attention was devoted to the wertfreiheit issue. Thus a leading historian of thought, Terence W. Hutchison (who was, as it happens, a scholar in the methodology of economics who had bitterly criticized Mises’s own methodological writings), wrote a book on the subject. But few other economists gave much thought to the dangers to their impartiality (or to their perceived impartiality) that may lurk in their policy pronouncements. And some economists otherwise deeply influenced by the Austrian School, and Mises in particular, expressed strong reservations against the wertfreiheit doctrine. Thus Murray Rothbard, a leading disciple of Mises, argued for the explicit articulation of the ethical principles on the part of the economic scientist offering policy advice.

Recently a noted exponent of free-market economic policymaking, Daniel B. Klein, called on economists to deploy their science to modify the political-economic choices of the public.⁷ Klein contended that economists who themselves value the free society have a moral obligation to help mold public opinion toward an appreciation for liberty. Economists are in a unique position to do this because they enjoy a respected professional reputation. Instead of spending their time talking to each other in the language of abstract mathematical models, economists ought to be engaging in “public discourse,” talking to Everyman about issues of practical public policy. Klein surveys a swath of literature in which economists, both advanced scholars and frustrated graduate students, bemoan the irrelevance of the academic work being done by the economics profession. He finds the profession locked into a mindset in which it is in the rational professional interest of the individual economist to avoid addressing Everyman on realistic issues, focusing instead on the abstract models upon which professional repute and rewards (perversely) depend. In urging the economist to tell Everyman what is good for him, Klein is clearly urging the economist to see his professional responsibility as extending beyond the strictly positive. The economist must not only—or even primarily—concern himself with the understanding and prediction of chains of economic cause and effect; he must also deploy that understanding to advise (and even to exhort) the man in the street as to what are his best (and worst!) courses of action.

Castigated Economists

In urging the economist to tell the public what economic science sees as good for them, Klein was explicitly rebelling against the position taken by George J. Stigler, the Nobel-laureate Chicago School economist. In 1982 Stigler published a book in which he castigated economists (from Adam Smith to Stigler’s own time) for doing precisely what Klein wished them to do (that is, to tell the public what is good for them). Stigler strongly protested against economists being “preachers” (treating the public as mistaken, perverse children whose behavior can be improved if they are properly instructed through appropriate moral suasion).

For Stigler the economist should refrain from “preaching” not because of any concerns that such preaching violates their scientific objectivity and moral neutrality. Rather Stigler denounced such preaching because to preach economic policy is to believe—quite mistakenly, in Stigler’s opinion—that the economist knows what is economically good for the public better than the public itself knows. Stigler carries the assumption of perfect knowledge (which has notoriously characterized many of the models constructed by economic theorists in order to account for real-world facts) to a consistent, but extreme, degree. He assumes, in effect, that all that economics might be able to teach is already known to the public and to its political agents. The economist may think the outcome to be expected from a given policy to be undesirable, but if the public adopts that policy this proves that the public in fact desires that very outcome. The economist who denounces that policy as “wrong” is simply revealing that he has a set of objectives different from those that are in fact being pursued by the public.

Certainly the history of economics reveals little unanimity among economists concerning the possibility and the usefulness of the wertfreiheit principle. The prestige associated with the teachings of economic science, and the importance that educated public opinion attaches to them, have waxed and waned during that history. The views of economists themselves as to whether or not they have an obligation to enlighten the public on economic policy have varied widely. It is against this rather confusing background that we shall try to clarify the legitimacy of (“scientific”) advice to the public by economists.

From “Is” to “Ought”

In the second of this series we shall review the foundations of the strictly positive lessons taught by economic science. That is, we shall briefly set forth the nature of the economic reasoning that establishes the existence of chains of cause and effect in the economic sphere. In this regard we shall follow the Austrian tradition in economic reasoning, particularly as developed in the relevant writings of the twentieth-century leaders of that tradition, Mises and F. A. Hayek. What will emerge from this examination is insight into the powerful market tendency to systematically translate consumers’ rankings of needs, and physical resource constraints, into corresponding patterns of resource allocation. This systematic translation, we shall see, follows from the purposefulness of human action, the entrepreneurial propensity of human beings to discover what is of interest to them, and from the information-communicating capabilities of the market price system. This will lead us directly to the third and final part of this series.

In that third article we shall examine what implications this Austrian perspective holds for the possibility of offering impartial advice on public-policy issues, such that the advice does not reflect any personal or ideological preferences of the economist offering it. Only if this possibility exists can the doctrine of wertfreiheit be upheld consistently by the policy adviser; only if this possibility exists can the objectivity and impartiality of the advising economists be preserved; only if this possibility exists can we hope to uphold the scientific repute of economics. Our conclusions in regard to these questions will enable us to clarify some of the paradoxes we have encountered in the present article. They will provide us, in particular, with an understanding of how the teachings of free-market economists need not compromise their objectivity and impartiality, and may, nonetheless, be presented with passionate conviction and dedicated advocacy.

Notes

1. See for example J.N. Keynes, The Scope and Method of Political Economy (1st ed., 1891) 4th ed. (London, 1930), p. 39n.
2. On this see Marian Bowley, Nassau Senior and Classical Economics (London: George Allen and Unwin, 1937), p. 54.
3. See the text of this presidential address in R.L. Smyth, ed., Essays in Economic Method (London: Duckworth, 1962), p. 21.
4. For a more detailed discussion of the wertfreiheit principle, see Israel M. Kirzner, “Value Freedom,” in Peter J. Boettke, ed., The Elgar Companion to Austrian Economics (Aldershot: Edward Elgar, 1994), pp. 313–19.
5. See Ludwig von Mises, Human Action, 3d ed. (Chicago: Contemporary Books, 1966), pp. 881–85.
6. Ibid., p. 885.
7. Daniel B. Klein, A Plea to Economists Who Favour Liberty: Assist the Everyman (London: Institute of Economic Affairs, 2001).

First paradox: FEE’s style is one of modesty, humility, tolerance, a steadfast refusal to browbeat those who do not agree with us. Now at least superficially, this attitude of tolerance and modesty appears to be inconsistent with what the late Ben Rogge used to call “FEE’s predictability.”

Quite frankly, I know of no other organization on our general side of the street whose position on any given issue is as predictable as FEE’s. No ifs, ands, or buts. No equivocation. Just right down the line, ramrod straight, for a society based on the principle of anything that’s peaceful.¹

All of us know how Leonard Read used to detest anything that resembled a “leak.” Well now, surely this inability to compromise, this apparently intransigent attitude would seem difficult to reconcile with the characteristic courtesy, tolerance, and genuine humility of FEE’s style. This is my first apparent paradox.

Let me turn to a second apparent paradox. FEE expresses, by its very being, a passionate belief in the sanctity of individual freedom, in the dignity and profound moral worth of a free society. Well, this profound belief surely seems difficult to reconcile with FEE’s refusal to evangelize for what it believes in so passionately. If freedom is so sacred, then how can we sit back and refuse to sell it? That is my second paradox.

The resolution of these apparent paradoxes, I suggest, brings us close to the very core of FEE’s mission and its identity. I believe the key to all this can be provided by what I shall call the open-endedness of knowledge. Knowledge is open-ended in the sense that no matter how much we know, this is as nothing compared with what we know that we do not know. We all remember Sir Isaac Newton’s remark about playing with pebbles of knowledge on the beach while the great ocean of scientific knowledge remains out there untouched before us—a magnificent and lofty thought.

Surely, one critically important premise of FEE’s philosophy is this very lively awareness of the limits of our knowledge. So, knowledge is open-ended in the sense of always being seen as incomplete. It is always only a fragment of that which is available to be known.

There is a second idea included as an integral part in this notion of the open-endedness of knowledge. Knowledge is open-ended also in the sense that no matter where the limits and boundaries of one’s present knowledge may lie, free human beings possess an innate propensity to transcend spontaneously those barriers, those limits, to continually escape those limits, through discovery of new horizons of knowledge the very existence of which was hitherto unsuspected. Life consists, in this sense, of a never-ending series of spontaneous leaps of discovery. The life of freedom is thus a continual expression of the dynamics of continual discovery. The free life, a life for which the open-endedness of knowledge is a central ideal, is one in which the sense of potential—unending potential, unending discovery—is at the heart of one’s being. Open-endedness in this sense is the very opposite of the state of stagnancy.

I would like to illustrate and explore the significance of this open-endedness of knowledge for each of three separate facets of FEE’s philosophy and approach. First, the basic understanding of economic relationships. After all, FEE is a foundation for “economic education.” Second, the deep commitment mentioned earlier to the dignity and fertility of individual freedom. (The “fertility of freedom” is a phrase coined by the late Fritz Machlup; it expresses a profoundly important idea.) As to FEE’s ideal of a free and peaceful society—what role does the open-endedness of knowledge play in that ideal? Third, what role does the open-endedness of knowledge play in FEE’s soft-spoken, non-aggressive style of communicating its message and its philosophy to the world?

Open-Endedness of Knowledge and Economic Understanding

Let us consider the first of these three facets of FEE’s work—the open-endedness of knowledge as a source of economic understanding. Here I may be excused for referring to the essential differences that separate Austrian economics, the economics that we’ve learned from Mises and Hayek, from the standard mainstream view. To the standard mainstream view in economics, since about 1930, the view of the world has been one in which the future is essentially known, in which the participants in markets are in effect completely informed about the relevant decisions made throughout the market by fellow participants. This is a world of equilibrium, a world in balance, a world in which quantitative economic predictions are entirely feasible. Austrian economics has a quite different view of the world, and a quite different view of the way in which economic relations can be grasped. I quote from Ludwig von Mises:

The fundamental deficiency implied in every quantitative approach to economic problems consists in the neglect of the fact that there are no constant relations between what are called economic dimensions. There is neither constancy nor continuity in the valuations and in the formation of exchange ratios between various commodities. Every new datum brings about a reshuffling of the whole price system, the whole price structure. Understanding, by trying to grasp what is going on in the minds of the men concerned, can approach the problem of forecasting future conditions. We may call its method unsatisfactory and the positivists may arrogantly scorn it. But such arbitrary judgments must not and cannot obscure the fact that understanding is the only appropriate method of dealing with the uncertainty of future conditions.²

It was Mises’ disciple, Friedrich Hayek, who fully explained the importance for economic understanding of recognizing the limitations of knowledge. It was as a result of his attempt to explicate the Mises-Hayek side of the celebrated socialist economic-calculation debate that Hayek first articulated the significance for market competition of dispersed information. Hayek taught us that the crucial element in market competition is the circumstance that knowledge is never concentrated in a single mind—always dispersed. We never know everything. None of us. No single mind can possibly know everything. No single mind can possibly grasp the entire economic problem that tends to be solved through spontaneous market processes. In more recent work, Hayek has emphasized the character of market competition as, in his terminology, a discovery procedure—and I quote:

Competition is . . . first and foremost a discovery procedure. No theory can do justice to it which starts from the assumption that the facts to be discovered are already known. There is no predetermined range of known or “given” facts, which will ever all be taken into account. . . . The real issue is how we can best assist the optimum utilization of the knowledge, skills and opportunities to acquire knowledge, that are dispersed among hundreds of thousands of people, but given to nobody in their entirety. Competition must be seen as a process in which people acquire and communicate knowledge; to treat it as if all this knowledge were available to any one person at the outset is to make nonsense of it.³

Hayek’s broader philosophy has proceeded from these fundamental insights to appreciate their even more far-reaching implications. And Hayek in fact says that “Civilization rests on the fact that we all benefit from knowledge which we do not possess.”⁴

So far it might seem that these Austrian insights rest fundamentally on the awareness of human ignorance, on the limitations of human knowledge, but in fact they rest also on that second element in the open-endedness of knowledge that I have referred to. These insights rest, that is, also upon an appreciation for the propensity within human action to discover what was hitherto unknown—what I like to call the entrepreneurial propensity in human action. It is this propensity that is responsible for entrepreneurial alertness for pure profit opportunities, for entrepreneurial discovery, for bursting asunder the limits of existing knowledge. It is upon this alertness that we rely for the manner in which the market continually propels prices and decisions in the direction of greater mutual coordination. It is entrepreneurial alertness to existing errors that leads to their discovery and their eventual tendency to be corrected.

Commitment to Freedom

Let me turn to the second of the three applications of the open-endedness of knowledge: the importance of the open-endedness of knowledge for our commitment to the dignity of freedom and its fertility in a free society. Here a great deal depends, I would suggest, on our instinctive recoil from the arrogance of benevolent dictatorship. Let me quote Leonard Read here:

There are numerous virtues and vices that account for the rise and fall of societies. Near the top of the list are the two opposites, humility and pride. . . . Pride sprouts and grows from ignorance and self-blindness. Those with a haughty spirit foolishly believe they know the most, whereas they know the least. While they don’t know how to make a pencil, or why grass is green, or who we are, they “know” how to run our lives. In their blind pride, the least taste of political power drives them to become power addicts. Until such persons seek help there is little we can do to curb their addiction. What we can and must do is to develop in ourselves the strength of character to resist the temptations of power.⁵

I would suggest that our disgust for the arrogance of dictators is only part of the story. Surely, our commitment to a free society rests also on our appreciation for the immensely valuable spontaneous discoveries that the human spirit can generate when left free. It is our admiration for individual creativity that is responsible for our reverence for the free society. So here we have both of those elements in the open-endedness of knowledge—undergirding our regard for freedom in a free society: (1) our recoil, our disgust for the arrogance of those who believe they know how to run other people’s lives, and (2) our awareness, our appreciation for the propensity in human beings to continually expand what they know, what they can create.

FEE’s Style

Let me turn to the third aspect of FEE’s work and illustrate the significance of the open-endedness of knowledge for FEE’s unique style and approach in communicating its message to the world. Here I think two points of contact ought to be noticed between the open-endedness of knowledge and FEE’s characteristic style. We recall that this style involves first of all an innate courtesy, modesty, and tolerance. (No name-calling, Leonard Read taught us, no arrogance!) Second, the FEE “style” reflects a confidence, a faith, if you like, that those who can benefit from our message will find us almost of their own accord. They will discover us. Certainly this confidence is a remarkable feature of FEE’s style.

I have one final quote from Ben Rogge, taken from a high school commencement address. He was talking to these youngsters about what they might expect of college. Ben said: “Hopefully, you will . . . come to know how little you know, in fact how little is known about man and his world by even the most knowledgeable around you. This is to say that you may come to carry with you through life a deep sense of wonder and of awe, not of what you do understand, but of the deep and mysterious processes which neither you nor anyone else fully understands.”⁶

Open-endedness of knowledge is the root of FEE’s modest, tolerant style. But then we said there was another aspect to that style—the confidence, the faith, that those who can benefit from our teachings, from what we have to offer will find us out, will seek us out. Listen to Leonard Read:

Forget the “selling freedom” notion! Right method calls for concentration on the improvement of the most approachable person on earth—one’s self. This is practical because accomplishment is possible. This tactic disposes of the numbers problem, the impossible—selling the masses. Do not seek followers! . . .What seek ye then? The achievement of understanding and clarity of explanation . . . so that those who wish to learn may come upon enlightenment. If you are successful, those with inquiring minds will find you out.⁷

Here, surely, we have Leonard Read thinking of the spontaneous discovery potential that will bring our audience to our doors. If we hold up the standard, if we show them what a free society means, they will find us out.

Let us return to the two apparent paradoxes that I mentioned earlier. I believe that it should be easy to see that these paradoxes dissolve immediately just as soon as we recall the significance of this open-endedness of knowledge. We asked how a passionate commitment to freedom could be reconciled with an attitude that refuses to go out and sell the freedom principles to others. We asked how FEE’s refusal to compromise, refusal to recognize exceptions could be reconciled with its attitudes of modesty and tolerance. But these questions are easily answered.

A passionate love of freedom as well as FEE’s modest style and courtesy both grow out of our awareness of our own fallibility and of the arrogance of those who presume to know enough to control others. We know how little we know!

If we appear uncompromising, this is because we are absolutely sure of this one thing that we know with certainty; that is, that human knowledge is open-ended and inescapably limited.

Concerning this item of knowledge, we cultivate no false modesty. We know for sure how little we know. And we know for sure how this open-endedness of human knowledge is responsible for the spontaneously coordinated operation of free markets. And we know for sure how this vitiates so much fashionable economics.

We have begun to understand the open-endedness of human knowledge—including the potential for spontaneous discovery that rests in the human breast. This understanding nourishes our conviction that what we need to do is to deepen our own understanding of the nature of a free society with full confidence that others will seek us out. We do not need to sell. We do not need to attack, to indulge in name-calling.

The Formula for FEE’s Future

In a word, FEE’s unique style, its unique and quietly passionate commitment to a free society, its commitment to the basic principles of sound economic understanding—all of these fit cohesively into a single integrated whole. This I submit is an important element in FEE’s formula. I believe that a renewed self-appreciation for these basic principles can continue to provide stimulation and motivation for FEE’s activities for many years to come.

I believe that by mobilizing the dedicated and informed enthusiasm of those many thousands of persons connected with FEE, we can proceed to translate these abstractions—and they are abstractions—into the day-to-day activities of FEE.

Let us never lose our courtesy and our tolerance. Let us never forget our distaste for the arrogance which lies at the root of all threats to a free society. Let us never lose our confidence in the intellectual alertness of a free citizenry. Let us persevere in our search for understanding in our economic studies.

We need never fear new ideas. We need never be unsure concerning new proposals, provided we appraise each one of them against our own standards and our own criteria involving leak-proof economic understanding, unified with unfailing courtesy to others in the way in which we reveal our own passionate love of freedom. Let the open-endedness of human knowledge be our inspiration and our guide as we navigate our way through a future of limitless possibilities for free human beings.

Notes

1. Benjamin Rogge, “The Power of Tomorrow: Whither FEE?” mimeographed version of talk given to FEE Fall meeting, November 18, 1979, p. 4.
2. Ludwig von Mises, Human Action (New Haven: Yale University Press, 1949), p. 118.
3. F. A. Hayek, Law, Legislation and Liberty, Vol. 3: The Political Order of A Free People (Chicago: University of Chicago Press, 1979), p. 68.
4. F. A. Hayek, Law, Legislation and Liberty, Vol. 1: Rules and Order (Chicago: University of Chicago Press, 1973), p. 15.
5. Leonard E. Read, Liberty: Legacy of Truth (Irvington-on-Hudson: Foundation for Economic Education, 1978), p. 15.
6. Benjamin Rogge, Can Capitalism Survive? (Indianapolis: Liberty Press, 1979), p. 280.
7. Leonard E. Read, Liberty: Legacy of Truth, op. cit. p. 62.

Given the age of the lecturer, these lectures are noteworthy indeed. This reviewer does not in any way quarrel with Baumol’s observations. And he is fully appreciative of the stroke of editorial genius that inspired the editors to undertake the publication of these lectures and to contribute valuable introductory and concluding essays to the volume. At the same time, he must record certain reservations.

There can be no question that these lectures contain a wealth of information and reflect an extraordinary familiarity with an enormous literature. The lectures must have been fascinating for the LSE students who heard them. After all, Robbins was one of the most famous British intellectuals and public figures of his time. This writer had the privilege of meeting Lord Robbins on one occasion and can attest to the kindness, open-mindedness, and generosity of spirit he displayed. The lectures in this volume reflect the sparkling humor and the “virtues of civilized behavior and scholarship” with which they were delivered.

Yet as a contribution to the history of economic thought, this volume is something of a disappointment in two respects.

First, despite the title of the volume, the lectures were never intended to constitute a treatise or textbook on the history of economic thought. The treatment of the many economists and other thinkers (starting with Plato and concluding well into the twentieth century) is often superficial and incomplete. Many of the expositions that Robbins provides of the ideas of the great economists seem far too sketchy to have been intelligible to his listeners (unless they had independently studied those writers). The lectures, despite some references to later writers, do not cover twentieth-century economics beyond the work of Alfred Marshall, Irving Fisher, and their generation. Except for a few lectures, they concentrate on specific economists or doctrines, with little attempt to trace broad developments in economic thinking or the growth and decline of major schools of thought.
These negative observations do not, of course, represent criticisms of the lectures themselves, which, as mentioned, never set out to offer an oral treatise on the history of economic thought. But they do represent a certain disappointment regarding the expectations generated by the book’s title.

The second sense in which the volume comes as something of a disappointment has to do with a question of substantive doctrinal import that is likely to be of interest to readers of Ideas on Liberty. I am referring to the pivotal role Robbins played in the twentieth-century history of Austrian economics. Almost a half-century before the delivery of these lectures, Robbins was one of the most influential British economists of his time. Much of his influence was exercised in a manner of great significance for the development of the Austrian tradition, under the spell of which Robbins seems, at least at that time, to have fallen. It was Robbins who invited Hayek to London for his famous 1931 series of lectures (and had him appointed soon afterwards to his professorship); it was Robbins who inspired the publication during the early ’30s of English-language versions of two important books by Ludwig von Mises, his 1912 work on monetary theory and his devastating 1922 critique of socialist planning. And it was Robbins who published his own extremely important 1932 The Nature and Significance of Economic Science, replete with Austrian insights and citations from Austrian writers. In other words, the Robbins of the early ’30s was a British follower of the Austrian tradition who introduced it into the mainstream of economic thought of his time. Alas, one searches in vain, in these lectures, for any trace of that Lionel Robbins.

To describe this as a disappointment is not entirely accurate. It is well known that Robbins distanced himself from the Mises-Hayek position decades ago—partly under the influence of Keynesian economics, partly as a result of other influences. Yet, as one opens these pages, one might have perhaps expected, in Robbins’s treatment of the Austrian School, that he might reveal some flicker of that excitement with which he had absorbed the ideas he learned in Vienna a half-century earlier. This reviewer could hardly detect any such flicker of excitement. It is true that Robbins refers with obvious respect to Ludwig von Mises, but he is careful and quick to note that “Mises is a very controversial figure in regard, let us say, to his views on methodology and in regard to his views on the possibility of calculation in a pure collectivist state”—thus indicating that he, Robbins, no longer stood for the Austrian positions on these very two subjects that he had staunchly defended during the ’30s.

Despite Robbins’s own abandonment of the central ideas that suffused his work in the early ’30s, the intellectual historian of the Austrian tradition must nonetheless record the timeless significance of that work for the subsequent development of that tradition. The slow but powerful influence that Mises and Hayek came to exercise on late twentieth-century Austrian economics, and the current significant revival of the Austrian tradition, could not have happened the way it did without Robbins’s contributions. In celebrating the brilliance of these lectures, therefore—and in spite of the volume’s disappointments—we pay homage, as well, to an open-minded thinker who, as a young man, possessed the intellectual acumen that enabled him to introduce the Austrian tradition onto the world stage of economics.

Upon re-reading Professor Ahiakpor’s comment, especially his quotations from Stigler and other mainstream writers who emphasize the unrealistic nature of the assumptions of the perfectly competitive model, and particularly its assumption of perfect knowledge, I believe that I can put my finger on the source of Professor Ahiakpor’s misunderstandings. In fact, I will use several passages from Stigler’s textbook on price theory (not the source of Professor Ahiakpor’s Stigler quote) to attempt to clarify matters.

As a prelude to his discussion of how demand and supply determine price, Stigler carefully articulates the conditions (especially that of perfect knowledge) needed for perfect competition.^[2] He then proceeds to address possible misgivings concerning these conditions. “If the reader bristles at the acceptance of assumptions such as perfect knowledge . . . he is both wrong and right. He is wrong in denying the helpfulness of the use of pure, clean concepts in theoretical analysis: they confer clarity and efficiency on the analysis, without depriving the analysis of empirical relevance. He is right if he believes these extreme assumptions are not necessary to the existence of competition . . . .” (Italics in original.)

Clearly, Stigler’s position can be stated in three points: (a) the real world is not perfectly competitive; it is not characterized by perfect knowledge; however, (b) the economist is best able to explain price determination in the real world by referring to a “pure and clean” analytical model of supply and demand under conditions of perfect competition; and (c) this pure and clean model is then useful in understanding the real world because the degree of competition and of perfection of knowledge in the real world is sufficiently close (to the pure and clean concepts of the analytical model) as to render that analytical model a useful basis for understanding price determination in the real world.^[3] Ahiakpor has focused exclusively, it seems, on points (a) and (c), and somehow concluded that mainstream explanations for price determination do not depend analytically on perfect-knowledge assumptions. But surely this conclusion is quite mistaken; point (b) cannot be denied.

For mainstream economics (and particularly for Stigler) the applicability of the pure and clean analytical model of supply and demand to the real world of imperfect knowledge is based entirely on the belief (hope?) that the degree of such imperfection in knowledge is not serious enough to compromise the applicability of the pure model. But the analytical basis for such application remains the pure and clean model itself. Any explanation of real world price determination rests, in mainstream economics, on the validity of the explanation for price determination offered by the pure and clean model of supply and demand, under conditions of perfect knowledge. The Austrian critique points out the internal, analytical inadequacy of that pure and clean model (quite apart from the unrealism of its assumptions).^[4] As Hayek and the modern Austrians point out, the true explanation for the emergence of the market price refers strictly to those very imperfections of knowledge that mainstream economists find it necessary to downplay.

The Model’s Uses

I would like to make a concluding observation. The asperity of Professor Ahiakpor’s comment suggests that he has read my pieces as expressing complete dismissal of mainstream economics and as doing so with complete hostility toward it. This is by no means the case. Speaking strictly for myself (rather than on behalf of Austrian economists), I can say that there certainly are important uses for the mainstream perfect knowledge model. For many rough and ready purposes of applied economics, it is this model that is the most useful practical tool. I have often stated that if students had to be exposed to only one lecture in economics, I would hope that that lecture would be the mainstream supply-and-demand lecture. But, I must insist, such usefulness, as a matter of pure science, is severely limited. For adequate understanding of how markets work it is necessary to go beyond the perfect competition/perfect knowledge analysis, and to explore the processes that flow from imperfect knowledge and from the entrepreneurial decisions set in motion by such imperfection of knowledge. The truth is that recognition of this scientific insight turns out to be of utmost importance for developing enlightened public policy. For as Austrian economists know, it is in and through these processes that free markets make their contribution to human well-being.

Notes

1. I list here three examples, at different levels of sophistication: George J. Stigler, The Theory of Price, 3rd ed. (New York: Macmillan, 1966), pp. 87-89 (leading into his discussion of price determination through demand and supply); J. M. Henderson and R. E. Quandt, Microeconomic Theory: A Mathematical Approach (New York: McGraw-Hill, 1958), chapter 4 (and especially p. 86, leading into the discussion of market equilibrium in terms of supply and demand analysis); and D. Salvatori, Microeconomics (New York: HarperCollins, 1991), p. 26.
2. Stigler (p. 87) treats perfect competition as equivalent to the state in which each market participant faces infinitely elastic supply or demand curves—the state which corresponds to the price-taking assumption to which Professor Ahiakpor refers.
3. Many mainstream economists would follow Milton Friedman in arguing that the absence of realism in the assumptions of the perfectly competitive model is almost irrelevant to the usefulness of the model in predicting real world outcomes. For Friedman’s well-known position on this see his Essays in Positive Economics (Chica go: University of Chicago Press, 1953), pp. 14f.
4. It was Hayek who, in his brilliant 1946 critique of the perfectly competitive model, identified its central flaw as an explanation for price determination. The model cannot explain how price comes to be that which the model predicts. The model can only, given its assumptions, postulate that that is the price. The model assumes the result the emergence of which we are seeking to explain. See F.A. Hayek, Individualism and Economic Order (London: Routledge and Kegan Paul, 1949), pp. 93f.

In preceding articles we outlined the way in which Austrian economists understand the entrepreneurial competitive market process that is responsible for the law of supply and demand. In the present article we pursue this understanding further, to permit us to see why government interventions in spontaneous market processes tend to frustrate and obstruct the coordinative tendencies that the market process generates. The most extreme sense in which such obstruction may occur is in the pure socialist economy (in which all productive activities are governed wholly by a central planning authority). Here the obstruction is total; market tendencies toward spontaneous coordination are completely paralyzed. But less extreme (less “total”) forms of government intervention, particularly so-called “mixed” systems, incorporating significant central regulation of market activity, will be seen to suffer from the same kind of difficulty—the frustration of market tendencies toward spontaneous coordination.

Mises on Socialism

It was in 1920 that renowned Austrian economist Ludwig von Mises enunciated his thesis that centralized socialist planning was, in a definite sense, simply impossible. What he meant by this provocative assertion has often been misinterpreted. Mises did not claim that a socialist system cannot exist; nor did he predict unequivocally that such a system cannot survive for many years. What Mises meant was that, with the best will in the world, with the most dedicated and incorruptible central planners in the world, it is simply impossible to plan centrally for an entire economy. The decisions made by the central authorities in an economy without a market for productive resources cannot possibly take into account all the alternatives that would, in principle, need to be taken into account in order for decisions to be able to be described as socially efficient. Without a market for productive resources (and thus without market prices reflecting the urgency with which consumers in other industries are demanding the services of these resources), central planners have no way of ensuring that resources flow to satisfy the more urgent, rather than the less urgent, demands among consumer preferences.

In a market economy the price of a resource expresses the priority with which consumers wish entrepreneurs to direct that resource for the satisfaction of their preferences; a high resource price means that entrepreneurs, somewhere, are aware of a productive employment for this resource that consumers value highly. For an entrepreneur to allocate this resource to any particular industry, he must, in the market competition for the resource, outbid other entrepreneurs; that is, he must be convinced that he has identified a use for it which consumers value more highly than consumers value alternative uses for that resource. Without themselves necessarily being aware of the nature and value of these alternative uses, the entrepreneurs are led, yes, as if by an invisible hand, to allocate resources in a way that takes account, in effect, of these alternative uses.

But for the central planners, operating as they must without market prices for resources (since there can, by definition, be no resource markets in the socialist economy), a decision made as to whether to allocate steel to the construction of a bridge or to the construction of an apartment building cannot be made on the basis of any measures of alternate urgencies of need; there simply are no such measures. The central authorities may decide to build the bridge, but their decision is not “rational” (in the sense of expressing a rational selection among alternatives). Central planning, in the ordinary sense of the term “to plan” (which expresses the idea of taking into account the need to balance conflicting objectives), is, as Mises showed, impossible.

The Myth of So-Called “Nonmarket” Prices

In the interwar debate that ensued as a result of Mises’s provocative assertion, one attempted socialist response stood out among the others. This was the suggestion, offered separately in the 1930s by two competent socialist economists, Oskar Lange and Abba R. Lerner, that socialist planning might be possible, provided decisions, to be made by socialist employees, could be guided by nonmarket “prices” for resources—that is, by prices promulgated by a central authority, without any resource market, but as based on regular reports to the authority of shortages or surpluses of each particular resource during the preceding production period. Space limitations do not permit us here to spell out the details of this suggestion. As we shall see, its central, damning weakness is the notion that resource “prices” can be promulgated without the spontaneous interplay of the bids and offers of profit-hungry competing entrepreneurs.

Remarkably, but in a sense disastrously, mainstream economics for some four decades ignored this weakness and pronounced the Lange-Lerner suggestion a valid and definitive solution to the problem identified by Mises. Only during the past two decades have economists finally conceded the power of Mises’s argument. In an outstanding 1985 revisionist work devoted to the socialist economic calculation debate—a work rooted in the Austrian understanding of the market process—Donald Lavoie effectively dissected the fallacies that underlay the mainstream illusion that Lange and Lerner had solved the Misesian dilemma.* The source of the illusion is the mainstream preoccupation with states of equilibrium, to the exclusion of any appreciation for the way in which the dynamically competitive ventures initiated by profit-seek-ing entrepreneurs are responsible for the calculative usefulness of real-world market prices. To imagine that a central planning bureaucracy might generate numbers in a manner that might remotely resemble the way in which prices are generated in the course of market competition is fundamentally to misunderstand the way markets work.

To put this in somewhat different terms: the mainstream’s willingness to accept the Lange-Lerner notion of nonmarket “prices” parallels precisely that mainstream’s enunciation of the “law of supply and demand” in strictly equilibrium, nonentrepreneurial terms. Mises’s (and also F. A. Hayek’s) refusal to acknowledge meaningfulness in such nonmarket “prices” parallels precisely the Austrian insistence on understanding the law of supply and demand as the manifestation of an entrepreneurial process.

*Donald Lavoie, Rivalry and Central Planning: The Socialist Calculation Debate Reconsidered (New York: Cambridge University Press, 1985).

The Economics of Government Intervention

Our articulation of the Austrian version of the law of supply and demand, and our corresponding understanding of the Austrian refusal to accept the Lange-Lerner solution (in terms of centrally promulgated nonmarket prices) to the socialist economic calculation problem first identified by Mises permits us to push the logic a little further. It seems reasonable to interpret Mises’s well-known general rejection of government intervention (not only for the socialist model, but more particularly for the “mixed” economy) as a consistent application of his insights into the impossibility of rational central planning in a socialist economy. Each and every act of government regulation constitutes, no matter what noble intentions for social betterment such regulation may reflect, an act of interference with the spontaneous market process generated by entrepreneurial competition.

No one claims that the results of this spontaneous market process are, at any given moment, those that would express perfect social efficiency as seen from a vantage point of imagined omniscience. What Austrians claim for the spontaneous market process is that it is the only procedure available to less-than-omniscient humans to move systematically in the direction of social efficiency, properly defined and understood. For government regulators to believe themselves able systematically and deliberately to improve on the results of the free-market competitive process is not only arrogantly to assume themselves able to approximate the omniscience needed to do so; it is also to fail to realize how their activities are inevitably destined to distort and/or paralyze that market process through which society grapples creatively and constructively with its lack of omniscience. It was Ludwig von Mises who, in his critique of the possibility of socialist planning, drew indirect attention to the central planner’s crippling lack of the knowledge necessary to plan centrally. It was Mises’s subtle understanding of the dynamics of the competitive market process that made him, more than all other twentieth-century economists, the complete skeptic regarding the social usefulness of government intervention in otherwise market economies.

We commenced this four-part series with an Austrian critique of the textbook version of the law of supply and demand. Consideration of the Austrian understanding of that law in terms of a competitive-entrepreneurial process of mutual discovery and coordination led us to a thoroughly negative perspective concerning well- meaning attempts to “maintain competition” through so-called antitrust policies. We have now concluded with brief attention to the manner in which the Austrian view leads, not only to a critique of the pure socialist economy, but also toward the critique of interventionism in all its forms.

The systematic character of the market process derives, in the Austrian view, from the interplay of the actions of entrepreneurial human beings. Entrepreneurs act imaginatively and creatively, seeking to identify and to grasp market profit opportunities (generated by earlier entrepreneurial limitations of vision). As a result of the interplay of such entrepreneurial acts of vision, product prices and quantities of product offered for sale tend to be nudged systematically in the direction of the market-clearing price/quantity configuration.

In the present article we draw attention to the essentially competitive character of this entrepreneurial process and draw out some critical implications for any assessment of governmental antitrust policies. We must begin by pointing out certain crucial ambiguities that have long plagued economists’ use of the adjective “competitive.” The problem was identified over half a century ago by F. A. Hayek; despite the valiant efforts of Hayek and others, the problem continues to confuse both economists and the public.

The Meaning of Competition

For the mainstream of economic theory the notion of competition has come to be associated with the absence of market power (to effect change in price or product quality). A competitive market is one in which no firm possesses market power. There is a certain reasonableness to this use of the term. Competition is seen as the antithesis of monopoly. Monopoly is identified with possession of the power to name one’s price without having to worry whether this will encourage one’s potential customers to seek more favorable terms elsewhere.

Competition is therefore reasonably understood to mean the situation in markets where such monopoly power is absent. “Perfect” competition therefore came to mean the situation in markets where each and every participant lacks any power whatever directly to influence product price or product quality. The conditions needed to define such a perfect situation are, as we would expect, completely unrealistic, including (as we saw in the first in this series of articles) universal perfect information concerning all current market events and potential events. But this is not necessarily a damning weakness; the notion of the state of perfect competition is, after all, seen in mainstream economics not as a description of reality, but as a model able to serve (a) as a theoretical framework helpful for understanding real-world markets, and (b) as a yardstick of perfection against which to assess the seriousness with which real-world situations (of less-than-“perfect” competition) fall short, in terms of the resulting pattern of resource allocation, as compared with the perfectly competitive efficiency ideal. It is this model of perfect competition which is, in mainstream economics, seen as the heart of the law of supply and demand, and which has, in the history of modern antitrust policy, driven governmental efforts to “maintain competition”—that is, to secure a structure of industry reasonably close to the perfectly competitive ideal.

For Austrians, however, the term competition has a completely different meaning, both for understanding how markets work and for formulating public policy in regard to the structure of industry. Austrians find the mainstream meaning of “competition” not only unhelpful, but in fact grossly misleading in terms of economic understanding. For Austrians it is clear that to seek to emulate an “ideal” state in which no single entrepreneur can have impact on market price or output quality is in effect to seek to paralyze the competitive market process.

Following a long tradition in economics going back at least to Adam Smith, Austrians define a competitive market not as a situation where no participant or potential participant has the power to make any difference, but as a market where no potential participant faces nonmarket obstacles to entry. (The adjective “nonmarket” refers, primarily, to government obstacles to entry; it is used to differentiate such obstacles from, for example, high production costs that might discourage entry. These latter do not constitute noncompetitive elements in a market; to be able to enter means to be able to enter a market if one judges such entry to be economically promising-it does not mean to be able to enter without having to bear the relevant costs of production.) That is, a situation is competitive if no incumbent participant possesses privileges that protect him against the possible entry of new competitors.

The achievements that free markets are able to attain depend, in the Austrian view, on freedom of entry, that is, on the absence of privilege. It is because the law of supply and demand (as understood by Austrians) depends crucially on freedom of entry that this meaning of the term “competition” is so important. As we shall see, it is because of this importance that so much twentieth-century antitrust policy can be seen as positively harmful, as seriously obstructing the competitive-entrepreneurial market process.

Semantics and Substance

Certainly the dispute concerning the meaning of “competition” is a semantic one. But, together with, and underlying, the semantic squabble (which, admittedly, should not overly concern us as economists; after all, new terms can be coined that are not subject to misunderstanding), there is a profound substantive disagreement concerning the way in which markets work. The mainstream notion of competition sees it as a state of affairs: the notion of competition has nothing to do with the process through which the market achieves its results. For Austrians, on the other hand, it is the market process that is important. And that market process cannot be imagined at all without necessarily departing from that state of complete powerlessness which mainstream economics sees as perfectly competitive. For Austrians the adjective “competitive” captures the essential feature of the market process.

In other words, entrepreneurial actions that are, in the Austrian sense of the term,^* seen as essentially and emphatically competitive, as critical steps in the market process, are, in the mainstream view, seen as anticompetitive, as monopolistic, as aberrations to be eliminated for the sake of the efficient-market ideal. As a result of this confusion of thought in twentieth-century economics, governments ostensibly intent on maintaining the competitiveness of markets have been seen as having the obligation to outlaw and zealously stamp out the very actions through which ordinary competitive strategies are effected. A brief glance at typical tools in the antitrust kit can help illustrate this Austrian critique.

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* This is also the sense universally adopted by business people, and the sense once universally followed by economists as well.

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Some Tools of Antitrust

Obstructing mergers. Antitrust policy has traditionally frowned upon (and often prohibited) mergers between hitherto competing firms. The rationale is, given the mainstream perspective, obvious and plausible. Replacing two competing firms by one larger firm cannot but constitute a reduction in the degree of market competition (in the mainstream definition of the term). Two less powerful firms have been replaced by one more powerful firm.

But the Austrian view must be that such a merger, provided the potential entry of others has not been and is not being artificially blocked, is itself an entrepreneurial act, a competitive act; the blockage obstructs the way in which market competition is able to discover the best size of firms and thus the lowest cost at which production can be maintained. (Even if a single firm supplies an entire industry, the industry is still competitive, in Austrian terminology, so long as the firm is kept on its toes by the potential threat of new entrants into this industry, as well as by the threat and/or reality of competition from industries producing substitute commodities.)

Outlawing price collusion. A group of powerful firms may collude to keep prices high; their motives may be to cartelize the industry, to eliminate interfirm competition and thus to force the consumer to pay more. For this reason antitrust policy has of course been directed toward preventing such price collusion. But the Austrian perspective sees matters quite differently. Even where the motive is indeed to paralyze interfirm competition, such collusion is itself a competitive step—since, in the absence of artificial blockage against entry, such collusion can be taken only in the face of the threat of competition from new entrants (who may in fact be able to profit by offering to sell at lower prices). No one knows when a price is “too high”; only the competitive process of entry (or of the threat of potential entry) can reveal the lowest level of price that can be sustained. So long as entry is open, the colluding firms may, in seeking to maintain their higher prices, be unwittingly attracting new entrants to reveal the truth that lower prices are sustainable. Or they may, if no such new entry occurs, be demonstrating that the cost structure indeed dictates these higher prices, as being the lowest ones sustainable in a competitive world.

Preventing predatory price-cutting. What seems, from the mainstream perspective, a clear strategy of eliminating competition occurs where a large firm temporarily keeps prices very low, thus forcing smaller competing firms out of the industry, and is then able to raise prices drastically with impunity. Careful theoretical and historical analysis has cast serious doubt on even the possibility that such a strategy could be successful and on the validity of the classic claims that such strategies were indeed employed around the turn of the century in U.S. industry. But the Austrian objection to government attempts to limit so-called predatory price cuts does not rest on this analysis. Rather the Austrian objection is that, so long as entry is not artificially blocked, even where “monopoly” positions have indeed been acquired through “predatory” price-cutting, these positions have been acquired as part of the competitive process, and can only be maintained in the teeth of new potential competition.

No one can know when a price cut that eliminates a competitor is intended to establish a “monopoly”; more to the point, even an attempt to establish a “monopoly,” taken in the face of freedom of entry, is itself a competitive step. No one denies that economic muscle may be used to confront consumers with higher prices. But if competition can indeed conceivably serve the consumers better, then these higher prices are themselves the way—the competitive way—through which it becomes profitable for new entrants to discover how better to serve consumers.

Inexorable Market Competition

Our desperately brief glance at antitrust attitudes should perhaps suffice to confirm our central Austrian thesis: What is needed to stimulate that all-powerful entrepreneurial-competitive process upon which the free market depends is nothing more than freedom of entry to anyone with an idea of how to profit by serving consumers more faithfully than they are being currently served. It is important to remember that no claim is made that freedom of entry entails that competitors refrain from attempts to monopolize markets. They may attempt to do so; and certainly their efforts may possibly place the consumer in a worse position (than he might be under a system reflecting perfect knowledge). The Austrian claim is that since no such perfect knowledge can exist, we must rely on the competitive-entrepreneurial process to reveal how the consumer may be better served. To obstruct this process in the name of competition (!) is to undermine the only way through which the tendency toward social efficiency is possible. By obstructing or preventing entrepreneurial steps taken that do not fit the “perfectly competitive” model of universal utter powerlessness—even if such obstruction or prevention stems from the best of intentions on behalf of consumers—government is necessarily tending, to a greater or lesser extent, to paralyze what is truly the competitive process.

Final Part

Last month we promised to explain how Austrian economics presents its understanding of the law of supply and demand by invoking the entrepreneurial character of dynamically competitive markets. The key element in this Austrian understanding is the appreciation that individual buying and selling decisions are examples of what Ludwig von Mises called human action. For Mises, each human being is, in a very important sense, an entrepreneur. (See Ludwig von Mises, Human Action, 3rd edition, 1966, p. 252.) And it is the entrepreneurial element in those decisions that is responsible, in the Austrian view, for that crucially important tendency toward market-clearing that (for Austrians as well as for non-Austrians) constitutes the heart of the law of supply and demand.

The Meaning of Human Action

The Misesian notion of human action is significantly richer than the mainstream-economics notion of the economizing decision. An economizing decision is seen as the selection of the most desirable option out of an array of given alternatives with a given ranking of what is more desirable and less desirable. Since both the alternatives available and the ranking are already identified prior to the act of decision, such decision-making consists essentially of the solution to a mathematical maximization exercise; the outcome is predetermined: it is implicit in the given context within which the decision is to be made.

For Misesian human action, on the other hand, the action is, most importantly, seen as including the determination of both what the available alternatives are and what ranking of relative desirability is to be adopted. Determining these elements inevitably exposes the agent to the uncertainties of an open-ended future (in a sense absent in the context of the standard “economizing decision”): action is the present choice between future alternatives that must, in the face of the foggy uncertainty of the future, now be identified in the very act of choice. It is this aspect of human action that renders it, for Mises, essentially entrepreneurial. Mathematical expertise in solving maximization problems is of very limited help in choosing among courses of action when the very alternatives must be “created,” as it were, by the agent’s entrepreneurial imagination and creativity, by his daring and boldness.

The Entrepreneurial Role

For Austrian economics the entrepreneurial role is, despite—or more accurately, precisely because of—its analytical “fuzziness,” responsible for the systematic character of market processes (“fuzzy” since no economist can “model” the creative imagination of the entrepreneur acting under open-ended uncertainty). Going beyond the context of the entrepreneurial elements in each individual human action, Austrian economics focuses on the role of the businessman-entrepreneur in the dynamic market process. The successful businessman-entrepreneur “sees” what other market participants have not yet seen; the entrepreneur sees opportunities to buy at one price and to sell at a higher price. To see such opportunities will typically call for (a) superior imagination and vision (since the perceived opportunity to sell at the higher price is likely to exist only in the future) and (b) creativity (since such a profit opportunity is likely to take the form of selling what one buys in an innovatively different form, and/or different place, than was relevant at the time of purchase).

It is because Mises saw each human being as, to some extent, an entrepreneur that he understood the powerful tendencies that exist in free markets for profit opportunities to be sensed and exploited (and thus eliminated) by profit-oriented entrepreneurial market participants. In a dynamically changing world, new profit opportunities are continually emerging, and their emergence continually generates the incentives toward their discovery and exploitation. It is this ceaseless re-creation and discovery of entrepreneurial opportunities that make up the market process we observe in the world around us.

The Law of Supply and Demand Reconsidered

For Austrians, the law of supply and demand is simply an insight into one particular (but central) element in this more comprehensive, dynamic, entrepreneur-driven market process. For any particular commodity, the market forces acting on the prices at which it will be bought and sold (and thus the market forces acting on the decisions made to produce and to buy it) tend to identify and exploit the opportunities (structured by the technology and the economics of its production on the one hand, and by the urgency with which potential consumers wish to consume it, on the other hand) and thus to ensure that the quantities which are simultaneously worthwhile for producers to produce and for consumers to buy will in fact tend to be produced, offered for sale, and purchased.

If, for example, current production of this commodity is “too low,” this means that opportunities exist for additional units to be produced at an outlay below the highest price potential consumers would be prepared to pay; it is “worthwhile” to produce these additional units. Entrepreneurial producers will tend to discover and act on such opportunities. If, on the other hand, current production is “too high,” this means that the production outlay for at least some units exceeds the highest price potential consumers are prepared to pay for them; these units were produced as a result of entrepreneurial error. Entrepreneurial producers will tend to discover these (marginal) losses and cut back on production.

The entrepreneurial forces acting on the market for any one commodity are thus continually pushing that market toward the market-clearing point—that is, to where (a) the quantity produced is such that (only) all units “worth producing” are indeed produced, and (b) the market price for this commodity is just high enough to make it, as a practical matter, worthwhile for producers to produce this quantity, and is just low enough to make it worthwhile for consumers to buy it.

Clearly, these forces would, were all other dynamic changes in market conditions to be suspended, tend to achieve exactly those outcomes identified, in more conventional mainstream formulations of the law of supply and demand, by the intersection of the supply curve and the demand curve. It is for this reason that we have described Austrian economics as basically in agreement with mainstream economics in its emphasis on the centrality of the law of supply and demand. It is worthwhile, however, briefly to ponder the sense in which the Austrian version of the “law” avoids reliance on any presumption of universal perfect market knowledge (a presumption that, as seen in the preceding article, pervades much standard economics).

The Role of Ignorance and Learning in the Entrepreneurial Market Process

As Austrian economist F. A. Hayek emphasized, the market process we have been describing in entrepreneurial terms can also usefully be understood in terms of learning. The process through which the market tends to generate the “right” quantity of a commodity, and the “right” price for it, can be seen as a series of steps during which market participants gradually tend to discover the gaps or errors in the information on which they had previously been basing their erroneous production and/or buying decisions. Buyers who had overestimated the willingness of producers to produce and sell the commodity had been “incorrectly” refusing to offer higher prices (that they would indeed have been prepared to pay); those who had underestimated that willingness were “incorrectly” offering higher prices than were in fact needed to inspire sellers to produce. Sellers who had overestimated the willingness of buyers to buy were “incorrectly” asking higher prices (and were producing more units of the commodity than it was “really worthwhile” to produce), and so on. The market process is one in which, driven by the entrepreneurial sense for grasping at pure profit opportunities (and for avoiding entrepreneurial losses), market participants, learning more accurate assessments of the attitudes of other market participants, tend toward the market-clearing price-quantity combination.

Two concluding observations are in place at this point. First, we should emphasize, once again, that this “law” is simply an element in the more general dynamic, entrepreneurial market process that is continually at work not only (as in the narrowly defined law of supply and demand) within a particular industry, but also between industries. It is this that renders understanding of the law so important for the broader and deeper understanding of the role of free markets generally in achieving socially effective economic outcomes.

Second, we should emphasize the extent to which the law of supply and demand is being continually buffeted and interrupted—and continually re-asserted and recreated—in the real world of dynamic change. (The circum stance that these dynamic changes typically take the form of forces acting on a particular commodity market from other commodity markets reinforces the observation made in the preceding paragraph.)

Next month we will again explore the dynamic entrepreneurial free-market process with particular concern for the nature of and role for competition in this process, and for the implications in regard to antitrust policy.

Part III